MARKET WATCH: Additional Analysis of Quiksilver’s Q4 Results

Jeff Harbaugh

• December 19 2008
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• 3 comments

Quik didn’t include a complete balance sheet with the press release, so I was inclined to wait for the 10Q to be filed before commenting. But what the hell- I’m snowed in up here for the second straight day with more forecasted for the weekend. Biggest storm and coldest weather since 1990 in the Seattle area. The good news is that the resorts are opening today, finally. The poor retailers! They may literally lose half or more of the remaining shopping days until Christmas.

The word from the conference call can be divided conceptually into two messages. Part One: “Hurray! Our brands are solid, we no longer have to spend management time and money on Rossignol, and our banks, with Rossignol gone, are working with us to restructure our short term debt.” Part Two: “Oh shit, this is the worst economy we’ve ever seen [they’ve got lots of company in that] and we’re not finished with the issue of managing our balance sheet and restructuring even with increased cooperation from our banks.”
Those are not actually quotes. I paraphrased a little.

For the three months ended Oct. 31, sales increased 3.3% to $606.9 million. Gross profit was up just 1.1% to $291.9 million. As a percentage, it fell 1% to 48.1%. As they described it in the conference call, pricing pressures overcame any product cost reductions.

Operating income fell from $71.9 million to a loss of $5.2 million. Partly, that’s because selling and general and administrative expenses rose about $15 million to $231.2 million. But more important are two non cash charges. One is a goodwill impairment of $55.4 million related to Australia. The second is a $10 million charge for retail store impairments. We learned on the call that they are planning to close 25 stores (nine in 2009) and this charge relates to those closures. We also heard that they had opened 66 new retail shops since the 4th quarter of 2007.

SIDEBAR

Let’s talk for a minute about noncash charges using this $10 million retail store impairment item as an example. Quik opened some stores. They spent a bunch of money on fixtures and improvements to the retail space to get ready to open. They paid, let’s say, $12 million for whatever this stuff was. That cash went out the door.

But because these fixtures and other stuff last a while, they don’t charge the $12 million to their income statement as an expense. They put it on their balance sheet as an asset and write it off over some period of years. Different kinds of assets get written off over different periods of years. Every quarter, you see a charge for these and similar assets under “depreciation and amortization expense.” Those are noncash expenses.

But now they close some stores, or know they are going to close them. Ever try and sell used fixtures?

You’re lucky to get one tenth of the purchase price. That $12 million cost has been depreciated to $10 million, but Quik’s clever accounting people know it’s not going to worth anywhere near that. Accounting rules require them to reduce its value on their balance sheet to whatever they think it’s worth. That reduction in asset value, even though it doesn’t require them to pay any cash, gets charged to expense in the period in which they write down the assets.

Let’s say they write those assets down to zero. Then, if some day they sell them for, say, $500,000 that amount becomes income and they get cash for them.

END of SIDEBAR

After taxes and some other expenses like foreign currency and interest, Quik reported a loss from continuing operations (that is, ignoring Rossignol) of $13.8 million. In the same quarter the previous year, they had a profit from continuing operations of $43.9 million.

Next comes the discontinued operations line. They had income of $12.9 from discontinued operations. In the same quarter last year, it was a loss of $154.9 million.

Now, how could they possibly make $12.9 on discontinued operations this quarter? Go read the sidebar if you haven’t already. This is no different from those fixtures written off in the example and then sold for $500,000.

The bottom line is that they lost $1 million in this quarter compared to a loss of $110 million in the quarter last year.

So their net income improved, though it’s still a small loss. Their operating income plummeted, and would have fallen 16.2% even without the big noncash charges.

For the year, they reported a loss of $226.3 million compared to a loss of $121.1 million the previous year on sales of $2.26 billion. Income from operations fell from $202.8 to $138.9 million. Their gross margin rose from 48.1% to 49.5% compared to the previous year.

Quiksilver is better off in many ways with Rossignol done and gone and not all of those are represented by a line item on the financial statement. They’ve been unlucky in that they made an acquisition that didn’t work out just as the worst recession any of us has ever had to manage through hit. The financial hangover from Rossignol won’t go away overnight and the recession is going to continue for a while. But at least now the uncertainty is gone they can just focus on building and managing brands.

Jeff Harbaugh is a consultant for the action sports industry and works with companies to identify and focus on critical business issues and opportunities fundamental to the bottom line. For more information, visit www.jeffharbaugh.com.