Heelys’ Losses Widen in Q3

Domestic net sales increased $992,000, from $1.3 million in the quarter to $2.3 million for the three months ended September 30, 2011. The increase in domestic net sales is primarily the result of increased unit sales of its Heelys wheeled-footwear resulting from expanded placement from the same period last year in existing and new retail outlets.

International net sales decreased $2.6 million, to $4.3 million from $6.9 million a year earlier. This decrease in international net sales was primarily the result of reduced sales in the Japanese market resulting from the transition from sales to a third-party distributor to the establishment of our own sales office in that market and the impact of the March 2011 earthquake and related tsunami, nuclear and other disasters in the region, as well as continued decreases in sales in our French and German markets, offset by significantly higher sales in our Italian market and to our independent distributor in Russia.

Consolidated gross profit margin decreased to 36.8 percent for the three months ended September 30, 2011, from 39.7 percent for the three months ended September 30, 2010. The decrease in gross profit margin was primarily the result of discounted sales of footwear purchased from our former distributor in Japan and the cost to destroy damaged product in Europe that we deemed to be unsellable.

Selling and marketing expenses increased from $1.0 million for the three months ended September 30, 2010, to $1.8 million for the three months ended September 30, 2011. This increase was primarily due to marketing and advertising costs for development of new online advertising materials to support back-to-school efforts including games, banner ads and videos, as well as two new television commercials and in-store displays that are available to its distributors globally for this holiday season and beyond, and increased commissions on international sales attributable to an increase in sales in our Italian market.

General and administrative expenses increased $122,000, primarily due to increased shipping and handling costs resulting from increased sales in our Italian market and handling costs of our inventory in Japan and increased general and administrative costs directly attributable to opening and operating its office in Japan. These increases were offset by a decrease in legal and other fees related to our intellectual property and associated enforcement efforts, which are the result of differing enforcement actions during the periods and an overall cost containment effort by management.

Loss from operations increased from a loss of $185,000 for the three months ended September 30, 2010, to a loss of $1.9 million for the three months ended September 30, 2011.

Balance Sheet

As of September 30, 2011, the  company had combined cash and investments totaling $62.6 million, compared with cash and investments of $67.6 million as of December 31, 2010. The change in the  company's cash position was primarily the result of the loss from operations for the nine months ended September 30, 2011, inventory purchased from our former Japanese distributor, inventory purchased to support business operations and timing of the collection of trade receivables.

Management Comments

Tom Hansen, chief executive officer of the  company, commented, “Momentum remains strong in the U.S. where we continue to add new doors and sustain the sell through gains we made during Q2. We still expect our holiday door count to be up approximately 50 percent from last year and we're on track to continue our year-over-year sales growth in the U.S. through Q4. Difficult economic conditions and uncertainty continue to impact consumer spending throughout Europe though our sales remain strong in our newer markets such as Italy. Japan remains a difficult environment and a challenge. Decreases in consumer spending and aging inventory have had an impact on our business there. After meetings with Japanese toy and sporting good retail partners, our impression is that the impact of the earthquake and tsunami on the cultural environment there is beginning to ease. Reception of the first models from our new global design initiative has been positive and we expect that new product to hit the Japanese market mid-summer. We still see opportunities in Asia and we're accelerating our efforts to increase distribution and drive our business in the region.”