SPY’s Sales Up, Loss Reduced; But There’s Still That Pesky Balance Sheet

It’s been years since we’ve had an annual or quarterly report from SPY so focused on growing the brand and with so little mention of managing past problems. Remember, though, that all I know and write about is what I hear in the conference call or read in the public documents. Speaking of which, here’s the link to the 10K. 

Strategy and Market Positioning
SPY’s presentation is about new, innovative product, expense management and reduction, their “specialized athlete consultants,” (which I guess some people might call team riders), the brand’s irreverent attitude as a positioning statement, a stabilized and focused organization, a rationalized structure in Europe (going direct never made sense with just $6 million in revenue there), and the focus on and growth of the SPY brand.
SPY characterizes itself as a “…creative, performance-driven brand,” and divides its eyewear products into three groups:
“(i) sunglasses, which includes fashion, Happy Lens™, performance sport and women specific sunglasses; (ii) goggles, which includes snow sport and motocross goggles created for our core demographics, and a new goggle line extension for the SPY ® brand that targets new distribution opportunities and customers; and (iii) optical, which includes optical-quality frames and sunglasses for persons in a slightly older, but still youthful, demographic.”
“We design, market and distribute premium products for people who are happy to be outside, especially youthful people who love action sports, motorsports, snow sports, cycling and multi-sports markets. Our products embrace their attendant lifestyle subcultures, crossing over into more mainstream fashion, music and entertainment markets. We believe a primary strength is our ability to create distinctive products for young minded, active people with a very different and irreverent point of view.”
They talk a lot more about their business strategy and products in the first couple of pages of the 10K and it’s worth a quick read. Here are their product categories and retail price ranges for each.
Fashion Sunglasses                                                         $75 to $180
Happy Lens Sunglasses                                                 $140 to $200
Women-Specific Sunglasses                                       $$85 to $135
Performance Sport Sunglasses                                  $85 to $160
Prescription Frames                                                       $180 to $210
Snow Sport Goggles                                                       $40 to $160
Motocross Goggles                                                         $30 to $75
The management challenge is pretty clear. SPY’s a smaller company whose product categories range from core to broad fashion. Its description of its market and customers would seem to position it as a niche brand but, as noted above, it crosses over into much larger markets with much bigger competitors. It would be a really interesting exercise (I’m sure SPY’s team has done it) to look at competitor price points for each of SPY’s categories and see who they define as competitors. SPY looks like it’s created some innovative products to differentiate itself, but many to most of its competitors have a lot more money to throw at product development (SPY spend $600,000 in 2012). How do you succeed as a small company in both the core and larger fashion market?
Hardly a new question, is it? I’ve recently noted that Skullcandy has some of the same issues, and wondered how Quiksilver can be focused on performance products but sell them in very broad distribution (JC Penney for example) to people who may not really understand or care so much about performance. Bluntly, I think every action sports/youth culture brand has to address the issue. How?
You do it by building a solid brand identity with patience over a period of time that I think is measured in years. You develop a consumer base that identifies with your brand and supports it. You watch your distribution. You don’t push into the broader market; you wait until you are pulled into it. 
SPY, in spite of all its past issues, has done that if only by virtue of the brand having survived this long. The brand has some strength in spite of those past issues. But the balance sheet limits options, as we’ll discuss after reviewing the numbers. 
The Results
Starting with the GAP numbers, sales for the year ending December 31, 2012 grew 6.8% to $35.6 million from $33.4 million the previous year. Sunglasses represented 77% of sales. Goggles were 22%. The gross profit margin rose from 43% to 46.1%. This was due to sourcing more product from China (the impact of the Italian factory is declining), and selling less closeout product of both the SPY and the licensed brands (discussed below).   
Operating expenses fell 9.8% from $23.8 to $21.5 million. Most of that decline was in general and administrative expenses. The sales and marketing spend rose, which you’d expect given their strategy. Advertising rose from $721,000 to $819,000.
The loss from operations fell for the year from $9.4 million to $5 million. Total other expense (mostly interest) rose from $1.5 to $2.2 million. The net loss was $7.2 million compared to a loss of $10.9 million the previous year.
Now for some important clarifications. Remembered all those licensed brands they tried to market and gave up on? They sold $2.2 million of that during 2011 but only $500,000 of it during 2012. Further good news is that they expect to sell $50,000 of that stuff during the current quarter, but then they will be done. It’s all gone!
Anyway, their sales were up 6.8% in 2012 even though they sold $1.7 million less of those licensed brands. Sale of the SPY brand product actually increased in 2012 by 13% to $35.1 million from $31.1 million the prior year. Sales of SPY brand closeout product fell to $2.6 million from $3 million in the prior year.
Past reports from SPY have spent way too much time describing money they had to spend for one thing or another that hadn’t worked out. If we aren’t completely over those, we’re certainly getting damned close. Not only don’t they have to spend money on those various inconveniences anymore, but they don’t have to waste time on them when it could be better spent building the SPY brand.
Sales during the last quarter of the year fell by 4.3% from $8.5 to $8.1 million. But the gross profit margin rose from 33.1% to 44%. The net loss in the quarter dropped from $3.4 million to $1.2 million.
SPY expects one-third of its 2013 sales to come from its new products. They are targeting operating expenses of under $18 million and believe if they could get revenues to the $37 to $38 million level, they can break even at the operating profit level. To put things in perspective, an increase to $37 million would be a 3.9% revenue increase over 2012.
Be aware, however, that their definition of operating profit excludes the noncash interest that is being added to the principal of their debt rather than paid in cash. It was $700,000 in 2012 and I expect it to be higher in 2013. And that brings us back to-
The Balance Sheet and Strategy
As you recall, SPY’s major shareholder has put a whole bunch of money into the company. If he hadn’t, the company would have gone belly up or been sold for not much. As of the end of 2012, notes payable to stockholder on the balance sheet was $19 million. Total indebtedness, including those notes, lines of credit and capital leases was $23.9 million.
Where the balance sheet and strategy come together (or maybe where they conflict, actually) is in creating a company and brand with a value that would permit the shareholder to get his $19 million back as well as pay off the other debt. That requires not only that the company make money at an income before interest line, but that it demonstrate some solid growth potential.
When you look at their product categories (above) you see they are placing bets in quite a number of markets (though there’s some obvious overlap among them). I hope SPY, as a $36 million dollar company, has the resources to pursue them all. In a perfect world, you’d sell the company to a larger player with the resources to insure they could, but the circumstances of the balance sheet make that difficult.       
I like the operating and marketing actions SPY is taking. I just hope there isn’t urgency around growth that leads to them trying to push the brand too fast in too many categories.