MARKET WATCH: Quik’s Quarterly Report and Conference Call

Jeff Harbaugh

• March 16 2009
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Quiksilver (along with the rest of us I guess) got caught in a series of economic and financial circumstances that it couldn’t have imagined. With that in mind, and before I get to day’s topic, I want to suggest that you all scurry to the library or the book store and get a copy of “The Black Swan- The Impact of the Highly Improbable.” It’s by Nassim Nicholas Taleb and is very relevant to the situation we find ourselves in.

Meanwhile, back at Quik’s quarterly report for the quarter ended January 31st, 2009, I’m going to jump right to footnote 13- Debt and Subsequent Events.

The Ongoing Liquidity Issue

As Quik acknowledged in the conference call, there is a lot of concern about the company’s balance sheet and liquidity.  This note tells us something about why.  It tells us that they have “…lines of credit and agreements that allow for total maximum cash borrowings and letters of credit of $588.8 million.”

Then it explains that “…total maximum borrowings and actual availability fluctuate depending on the extent of assets comprising the Company’s borrowing base under certain credit facilities.”  I haven’t read all the credit agreements, but that typically means they can borrow some percentage of receivables and inventory and maybe against some other assets as well.  There are certain restrictions on those percentages.  For example, they probably can’t borrow against receivables that are not current or against that three year old inventory of t-shirts in really ugly colors because the lender doesn’t think they are worth much.

They go on to tell us that they had total borrowings of $448 million at January 31 including $48.7 million of letters of credit.  Now, the difference between the $588.8 million allowed to be borrowed under the agreements and the amount actually borrowed at January 31 is $141 million.

But, they tell us, only $80.6 million was available to borrow at January 31 “…of which $40.7million was committed.”  Of that $40.7 million that’s committed, “the entire amount can also be used for letters of credit.”  They also say they have another $60.1 million “…in additional capacity for letters of credit in Europe and Asia/Pacific…”

So what the situation seems to be is that they had exactly $39.9 million available to borrow in cash if they needed it at January 31. That number changes literally every day as inventory comes and goes, is converted to receivables, and as money is collected.

To oversimplify a bit, the question everybody is asking is, “Is this enough?” I don’t know the answer to that.  Consider that $39.9 million in the context of a January 31 balance sheet with assets of $1.76 billion, total liabilities of $1.4 billion and current liabilities of $615 million.

Quik thinks it’s enough. They say in the 10Q they “…believe that our cash flows from operations, together with our existing credit facilities will be adequate to fund our capital requirements for at least the next twelve months.”

Nevertheless, their European bank group (see what I wrote last week about the 8K they filed HERE agreed to extend the credit line for three months at a higher interest rate rather than restructure it.  During those three months, Quik intends “…to conclude either a strategic or refinancing transaction within the period covered by this extension, in which case this credit facility would either be refinanced or repaid.”

Financial Statements

Sales for the quarter fell 10.7% to $443 million compared to the same quarter the previous year.  The decline was only 4% in constant currency.  Sales in the Americas were hardest hit, falling 13.4% to $203 million.  Europe was down 9.3% to $182 million.  Asia/Pacific fell 4.6% to k$58 million.

The gross margin changes tell more of the store.  In the Americas, it fell from 43.4% to 37.2%.  They explained in the conference call that they were, in the Americas, focusing on inventory reduction and cash generation over gross profit, and you can see that here. They also indicated it was the result of a high level of U.S. discounting.

The European gross margin actually grew from 54.8% to 55.5% and the Asia/Pacific one was up from 52.6% to 53.3%.  Operating income in the Americas fell from a positive $7.1 million to a loss of $16.3 million.  Europe’s was up slightly from $21.6 to $22 million, and Asia was nearly unchanged, falling from $3.82 to $3.79 million.

My concern here is that I think Europe may be about six months behind the U. S. in the economic cycle.   Their banking system is actually in worse shape than ours.  Hard to believe isn’t it?

Selling, general and administrative expenses were down 6.6%, but as a percent of sales rose from 44.6% to 46.7%. Changes in foreign currency exchange rates were responsible for $15.7 million of the decrease, which is interesting since the entire dollar decrease was only $14.6 million. I guess what we can conclude is that without the exchange rate impact, those expenses would have been up on a consolidated basis.

Quik reported a loss from continuing operations of $66 million, compared to a profit of $7.6 million in the same quarter the previous year.  However, that includes a write off of deferred tax revenues of $50.6 million and severance charges for the people laid off from Quik.  Without those two items, the loss would have been $9 million.

The $9 million loss is done on what companies call a “pro forma” basis. They exclude so-called onetime items with the goal of giving you a better perspective on how things are going for the operating business.  I understand the logic, but it seems that every year there are new things that are “one time” occurrences.  The severance expenses are real. The loss of the deferred tax revenue will impact net income in the future.  I think I’ll stick to the generally accepted accounting principles numbers.  Here endeth the philosophy of accounting discussion.

The net loss for the quarter was $194 million compared to a loss of $22 million last year. That includes a loss from discontinued operations (Rossignol) of $129 million this quarter compared to $30 million in the same quarter last year.

The most important balance sheet item is the liquidity issue I spent some time on at the start of this report. I did go and find the January 31, 2008 balance sheet. Comparing the two January 31 balance sheets, we see that the current ratio has declined slightly from 1.72 to 1.63. But the total liabilities to stockholders’ equity ratio has jumped from 1.82 to 3.81, indicative of the losses over the past year and the Rossignol associated costs.  Like the report says, they are highly leveraged.

Both the October 31 and January 31 2008 balance sheets include Rossignol, so we can’t really make valid comparisons of receivables and inventory based on those statements. Happily, the conference call shed a little light on those items.

Receivables, at $373 million, were 7% lower than last year. Though they don’t say it that has to exclude Rossignol because of the level of receivables on the January 31, 2008 balance sheet ($639 million).  Inventories are up 4% compared to January 31, 2008.  They blame that on some early receipt of product and weaker demand, and say they are responding by adjusting their buys (down I assume) and through aggressive action to liquidate inventory.

The impact of the recession on Quiksilver seems to be in line with the impact on other companies.  Unfortunately, it happened when they were weakened by Rossignol and all the associated problems. And now they have to address the blowback in what is simply the worst market to raise money or sell assets anybody has seen in decades. Should be an interesting three months. 

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.