The footwear industry is brutally competitive, and it looks like K-Swiss (Nasdaq:KSWS) is well on its way to being one of those cautionary tales. Although K-Swiss technically broke a five year streak of year-on-year revenue declines, free cash flow has declined six years running and the company's ongoing survival is no sure thing. While a hit product could turn things around relatively quickly, K-Swiss is starting to look like a longer and longer shot with each quarter.
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A Fairly Lousy Fourth Quarter
Although K-Swiss did report 18% revenue growth for the fourth quarter (against expectations of a 3% drop), that surprising jump in sales did the company little good. Domestic sales rose more than 10% and international sales jumped almost 24%, but profitability was a major issue.
Gross margin fell about seven points from last year and missed the relatively few estimates out there by a wide margin. Management held the line on SG&A expenses and adjusted operating loss was basically in line with the year-ago level. (For related reading, see Understanding The Income Statement.)
Futures Looking Grim
To beat by so much on the top line and still miss by so much on the bottom line is bad enough. Worse still were the company's futures sales. Futures orders were down 21%, with domestic orders down 52%. That's a pretty crushing outlook, and not surprisingly management revised guidance for 2012 sales below prior analyst expectations.
Just to offer a frame of reference, Nike's (NYSE:NKE) future sales through April 2012 reported back in December were up 13%.
A Downward Spiral
The dynamics of the retail trade make the K-Swiss situation even worse. When Kohl's (NYSE:KSS), Foot Locker (NYSE:FL) and other retailers find that they can't move product, not only do they order less, they also give less shelf space to that company in the future. Less shelf space means less opportunity to move product and it quickly becomes a self-perpetuating downward cycle.
Retailers sometimes can afford to be patient or generous. After all, giving too much space to Nike, Adidas and ASICS means giving too much power to those companies and too much control over margins. So while Skechers (NYSE:SKX) has had its difficulties lately, the sales trends of recent years has been quite a bit different than for K-Swiss and Skechers may still get some benefit of the doubt.
For K-Swiss, though, the clock is ticking. Although the company's sales base has fallen to a point where a hit product (like a refreshed Classic lineup) could make a major difference, stocking K-Swiss product is no longer a must for footwear retailers.
Like many footwear companies, K-Swiss gets a lot of its product from China, Thailand, and Vietnam. As has been reported fairly widely in recent years, wage inflation is pushing up COGS from these countries and applying more pressure to margins. While Nike and Adidas can offset this with price hikes, the weakness in K-Swiss's market position suggests less pricing power. (For related reading, see Analyzing Operating Margins.)
The Bottom Line
It wasn't too long ago that footwear retailers Foot Locker and Finish Line (Nasdaq:FINL) were in terrible shape and plenty of writers were consigning them to the boneyard. Even more recently, footwear retailer and wholesaler Brown Shoe (NYSE:BWS) was in pretty rough shape as well.
Unfortunately, these are not especially relevant stories for K-Swiss investors because of the differences in running a retail business versus a manufacturing business. To whatever extent Brown Shoe's experience is relevant, their turnaround in their proprietary footwear business has been a byproduct of having a wide range of styles and brands to leverage, as well as competing more effectively up-market. With K-Swiss, that means going head-to-head with Nike or Adidas's Reebok brand, and that hardly seems like a winning formula.
Days inventory outstanding is close to half a year now and the pace of negative free cash flow just isn't sustainable for much longer. If K-Swiss can somehow turn it around, the rewards to shareholders would be considerable. Unfortunately, there's nothing in recent financial reports to suggest that results have bottomed, let alone are on the way back.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.
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