Heelys’ Loss Widens in the Fourth Quarter

International sales decreased 43.5% to $3.5 million from $6.2 million a year ago. The decrease was the result of excess retail inventory in the European market and a sales order (approximate value $1.2 million) from Privee AG, the company's former Japanese distributor, that did not ship as a result of the termination by the company of its distributor agreement with Privee.    

Consolidated gross profit margin decreased to 36.8% for the latest three months from 39.8% a year ago. The decrease in gross profit margin is due to the impact of a $352,000 inventory impairment charge that was taken during the fourth quarter of 2010, offset by a decrease in inventory sourcing costs. All of the inventory related to the impairment charge was sold during the fourth quarter of 2010.

Selling, general and administrative expenses, excluding litigation settlements and related costs, were $5.9 million for the latest quarter compared to $5.1 million a year ago. This increase was primarily the result of an increase in production and consumer advertising costs to support marketing campaigns in the U.S. and Europe ($2.4 million for the three months ended December 31, 2010, compared to $925,000 for the three months ended December 31, 2009).

Loss from operations, excluding the impact of litigation settlements and related costs, increased from a loss of $547,000 in the latest quarter from a loss of $3.5 million a year ago.

The company reported a net loss of $3.2 million, or 12 cents per fully diluted share, for the latest quarter versus a net loss of $1.1 million, or 4 cents a share, a year ago.

Year-over-Year Comparisons

On a consolidated basis, net sales decreased $13.3 million to $30.4 million for the latest quarter, from $43.7 million a year ago.  Domestic and international net sales decreased $6.5 million and $6.8 million to $8.6 million and $21.8 million for the latest quarter, from $15.1 million and $28.6 million a year ago, respectively.  The decrease in domestic net sales is primarily the result of reduced sales to discount retailers combined with the loss of placement in several retail stores.  The decrease in international sales is primarily the result of a drop in sales to our Japanese distributor and lower than expected sales in the European markets where the company sells directly to retailers.

The company and Privee entered into an agreement pursuant to which the company and Privee agreed to mutually terminate the distributor agreement between the two parties effective as of February 28, 2011, which was the expiration date of the distributor agreement.  Privee accounted for 17.7% of the company's consolidated net sales for the latest year.  Sales to Privee decreased $2.2 million, or 29.4%, to $5.4 million for the year ended December 31, 2010, from $7.6 million for the year ended December 31, 2009. The company has determined that, after the termination date, it will have the company's newly formed Japanese subsidiary distribute company products in Japan.

On a consolidated basis, gross profit margin improved from 35.8% for the year ended December 31, 2009, to 41.6% for the year ended December 31, 2010.  The improvement in gross profit margin is primarily the result of a higher price per pair sold domestically resulting from the decrease in sales to discount retailers, a greater portion of higher margin sales in the Italian market and a decrease in material costs.

Selling, general and administrative expenses, excluding litigation settlements and related costs, were $17.4 million for the latest year, compared to $18.7 million a year ago. Litigation settlements and related costs incurred during 2009 were related to the class action lawsuit (filed in August 2007), the shareholders' derivative lawsuit (filed in October 2007) and the individual lawsuit (filed in May 2008). These lawsuits were settled during the third and fourth quarters of 2009.

Loss from operations, excluding litigation settlements and related costs, increased from a loss $3.1 million for the latest year from a loss of $4.7 million a year ago.

The company reported a net loss of $4.0 million, or ($0.14) per fully diluted share, for the latest year, versus a net loss of $5.1 million, or ($0.19) per fully diluted share a year ago.

Balance Sheet

As of December 31, 2010, the company had combined cash and investments totaling $67.6 million, compared with cash and investments of $66.5 million as of December 31, 2009. The change in the company's cash position was primarily the result of cash used to support operations of $3.3 million, including $1.2 million in payments to settle outstanding state tax liabilities, offset by federal income tax refunds received of $2.9 million and $3.1 million resulting from the carry back of 2008 and 2009 net operating losses to 2006 and 2007.

The company had inventory of $6.8 million in the latest quarter, compared with inventory of $6.0 million a year ago. The increase in inventory was largely the result of inventory held from the sales order to Privee that the company did not ship as a result of the termination of the company's distributor agreement with Privee.

Management Comments

Tom Hansen, chief executive officer of the company, commented, “Despite slow sales leading into holiday, we upped our advertising and marketing spend, primarily in our domestic markets, in Q4 for three reasons. First, to regain visibility with consumers and retailers. Second, to demonstrate to retailers our re-energized commitment to marketing the brand. And finally, to pull excess inventory through the system. Retailers have repeatedly mentioned the impact of the advertising on sell through at holiday, which was excellent. Visibility was high, and now, there is very little inventory in the domestic market that isn't fresh.”

Hansen went on to say, “We believe our biggest issue going forward is optimizing distribution. Domestically, we're at about 25% of our previous peak, or about 50% of the ideal number of retail stores. Internationally, we believe we have tremendous opportunities in Asia as well as Europe where many of our distributors have finally worked through old inventory issues and are ready to re-engage with the brand.”