MARKET WATCH: Quik’s Annual and Quarterly Report

Jeff Harbaugh

• January 05 2009
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• 8 comments

Rossignol Gone, Leverage Issue Being Managed

They filed this thing on December 30th. I, having no life, read all 89 pages New Year’s morning. I strongly recommend Proseco (Italian sparkling wine) over champagne. It seems to do fewer bad things to you.

The Quarter

The best numbers from the quarter are from the December 18th press release. Here’s the link. Revenue for the quarter ended October 31 fell 22.1% compared to the same quarter last year to $606.9 million. The gross profit percentage grew from 46% to 48.1% even though total gross profit fell 18.6% to $291.9 million with the drop in net revenues.

Net income for the quarter was a loss of $1.0 million compared to a loss of $111 million in the same quarter in 2007. Last year Quik reported a profit from continuing operations of $43.9 million, compared to a loss of $13.8 million for this year’s October 31 quarter. That’s a change of $57.5 million and includes, as I pointed out when I wrote about the press release, non cash charges of $65 million. $10 million was for retail stores that aren’t working out. $55 million was for some Australian assets. Let’s go footnote diving and see if we can get some clarity on the $55 million.

Statement of Financial Accountant Standards 142 requires you value your intangible assets at least annually. When Quik carried out this procedure, they decided, using a combination of discounted cash flow and market valuation methods, that these assets were overvalued by $55 million, so they wrote them down by that amount.

“The value implied by the test was affected by (1) reduced future cash flows expected for the Asia/Pacific segment, (2) the discount rates which were applied to future cash flows, and (3) current market estimates of value. The discount rates applied and current estimates of market values have been affected by the recent macro-economic conditions, contributing to the estimated decline in value.”

The goodwill they wrote down came from the acquisition “…of the Australian and Japanese distributors in fiscal 2003, including subsequent earn out payments to the former owners of these businesses, and the acquisition of certain Australian retail store locations in fiscal 2005.”

Basically, if they’d known what they know now, they wouldn’t have paid as much for them as they paid when they bought them.

The Year

Revenue for the full year grew 10.6% to $2.26 billion. The link to the 10K is here.

The effect of foreign currency exchange rates generated $105.7 million, or about 50%, of the total $217 million revenue increase. The rest was from higher unit sales. Apparel was 65% of sales, down from 66% the previous year. Footwear represents 20% up from 18% before and 16% the year before that. Accessories make up the remaining 15%. They note separately that DC represents 21% of sales from continuing operations.

The Quiksilver brand is 39% of revenues and Roxy 34%. In the Americas, the revenue increase of 7% came mostly from DC. Quiksilver and Roxy were both down slightly.

The breakdown of revenues by distribution channel is interesting. In total, 40% are to what Quik calls core market shops. 36% are specialty stores and 12% department stores. The remainder is U.S. exports and distributors.

In the Americas, 30% are to core market shops, and 34% and 21% to specialty and department stores respectively. In Europe those numbers are 41%, 42%, and 6% respectively. For Asia/Pacific, they are 79%, 20% and 1%. I’d love to have a conversation with somebody at Quik about those differences.
The gross profit margin rose from 48.1% to 49.5%. It was constant at 42% in the Americas, increased from 55.1% to 57% in Europe and from 49.5% to 52.9& in Asia/Pacific.

“The Americas gross profit margin would have increased due to higher percentages of sales through company-owned retail stores, where we earn both wholesale and retail margins, and improved sourcing costs, but such improvements were wholly offset by market related price compression. Our European gross profit margin increases were primarily due to a higher percentage of our sales through company-owned stores and improved sourcing costs. In Asia/Pacific, the gross profit margin increase compared to the prior year was primarily as a result of the change in mix to higher retail sales compared to the prior year.”
I think “market related price compression” is code for tough economic conditions.

Selling, general and administrative expenses were up 17% to $782 million, largely because of the cost of opening and operating new stores. At the end of the year, Quik had 472 company owned and 219 licensed stores worldwide. 145 were in the Americas, 414 in Europe and 132 in Asia/Pacific.

The asset impairment charges of $65 million that we discussed as part of the quarterly results totaled 2.9% of total revenues, and represented most of the reason why operating income fell from 9.9 to 6.2% of revenue, or $138.9 million.

Income tax expense fell only slightly from $34.5 to $33 million and the effective tax rate jumped from 22.8% to 33.5% “…due to the non-deductibility of the goodwill asset impairment recorded in fiscal 2008.”

Quik earned $65.5 million from continuing operations compared $116.7 million the prior year. There was a loss from discontinued operations of $291.8 million for the year compared to a loss of $237.8 million from discontinued operations the prior year. The net loss was $226 million compared to $121 million last year. There will be non cash lose, net of a tax benefit, of $59 million recorded in the first quarter for the sale of Rossignol.

The thing everybody has been focusing on when we look at Quik’s balance sheet is the issue of leverage and cash flow adequacy. At October 31st, Quik had a bunch of short term debt that banks were reluctant to extend lacking the completion of the Rossignol sale. Quik calls itself “highly leveraged,” but says they think their cash flow and existing credit facilities will be adequate for the next 12 months. They “plan to seek additional financing which includes extending the maturity of our short-term uncommitted lines of credit in Europe and Asia/Pacific. Potential sources of alternative financing include our existing lenders (for longer term financing), sales of assets and the broader capital markets.”

They recognize that “The availability and cost of new financing or asset sales are subject to certain risks and could be adversely affected by current credit and capital market conditions. “

The balance shows the decline in equity you would expect given the loss for the year- from $886 to $600 million. The current ratio at October 31 actually improved from 1.7 to 1.9. Total lines of credit and long term debt are up from $857 million to $1.06 billion.

What you have to do to understand the leverage/liquidity issues is to look at the details of Quik’s debt structure. In the Americas, the company has an asset based line of credit for $300 million that expires in April, 2110. Borrowing is limited to certain percentages of eligible receivables and inventory, and has a bunch of restrictions on what Quik can do. That would be paragraph 2 on page 27 if you want more details.
In Europe, Quik has arrangements with several banks for lines of $226 million that are “generally payable on 60 days notice.” They had about $144 in advances and letters of credit outstanding at October 31.
In Asia/Pacific they have lines of $81 million with about $60 million outstanding at October 31 that are payable on demand.

There are other borrowings as well with relatively short term maturities. Here sits Quik with loses over the last two years, Rossignol (at October 31) not yet sold, the global credit crisis making all bankers nervous as hell, and a shitty economy. Even though nobody, including me, expects it, what happens if, for example, the Asia/Pacific lenders call up Quik tomorrow and say, “Hey, please sends us our $60 million. This afternoon would be good.”

Would the demand for payment, or the actual payment, put Quik in default on any of its other facilities?

Could it cause other bankers to call their loans? This is the concern that Quik has addressed by closing the Rossignol sale and will improve further by restructuring some of its short term credit facilities and raising some additional cash.

After next quarter, we should start to see financial reports from Quik that just show them managing their brands and working to grow their business. I look forward to those results.

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.