Black Diamond Inc. (Nasdaq:BDE) said that despite strong demand for its core climbing and mountain gear in North America, its losses grew in the first quarter due to Europe’s “practically non-existent winter” and weak currency.

The company also incurred quality-control problems while ramping up U.S. manufacturing of carabiners and other products formerly made in China, which resulted in higher than expected expenses, including product recalls and extensive reinspections, and squeezed margins.

Total sales on continuing operations, excluding results from the Swedish action sports brand POC that BDE sold last October, fell 9 percent to $38.2 million in the first quarter ended March 31. Excluding currency impacts, total sales declined 4 percent.

The weakening of the euro and other foreign currencies, which comprise 40 percent of the company’s revenue during the quarter, shaved revenue by $2.1 million, or 510 basis points compared with the year ago quarter, officials said. A decline in ski sales in Europe, which suffered an unusually dry winter, also contributed to lower sales.

North American sales grew in the 4-6 percent range, driven in part by stronger-than-expected demand for new products. Solution, Momentum, Primrose and Couloir harnesses, the Half Dome helmet, climbing accessories and especially the Mojo chalk bags, creek climbing packs, and rock climbing sportswear like the Credo and Notion Pants all sold well. Apparel sales exceeded expectations, due in part to strong sales of discontinued merchandise in Europe and strong e-commerce sales of both discontinued and in-line product.

“REI, Backcountry.com, and Amazon continued to drive strong sell through of our product,” said Black Diamond Equipment Brand President Mark Ritchie.

Sales to international distributors declined due to the strong dollar and other factors, but Ritchie said those supplying the important Japanese and South Korean markets appear ready to replenish inventory.

Recalls hurt gross margin
Gross margin tumbled 670 basis points (290 basis points currency neutral) to 28.7 percent due primarily to currency headwinds (380 basis points); but also because of quality-control problems encountered repatriating manufacturing activities from Asia to the United States (270 basis points).

“Things have not gone totally smoothly,” Ritchie told investors during the company’s May 2 conference call. “We had delays in getting equipment over here from China. We had an anodization supply chain that had agreed to work with us, that we had worked with for many years in the past, that reneged after we started the project and got it going. We had some delays in getting other various material supply chains up and going.”

A fall in the unemployment rate from 6 to 3 percent since the inception of the project also made it “very challenging” to fill some manufacturing positions. That was compounded by larger-than-expected demand for some product during the quarter, and ultimately, the recall of 1.16 million carabiners and 208,600 nylon runners during the quarter.

“So we pushed really hard on a lot of this stuff,” Ritchie said. “In fact, it’s arguable that we pushed a bit too hard and we ended up with some quality problems as its been noted with a couple of recalls that we had to endure.”

The good news, he added, is that the vast majority of recalled units that have been inspected meet spec and don’t need to be replaced, which means that most of the costs associated with them have already been incurred.

Vestis debt write-offs limited to first quarter shipments
Write-offs of inventory shipped during the quarter to retailers that filed for bankruptcy in April trimmed gross margin by another 90 basis points. Ritchie noted that the company had been paid for all merchandise shipped to those retailers through the end of 2015.

Court records shows BDE was owed $396,902 by Vestis Retail Group LLC when it filed bankruptcy last month. Most of that debt is believed to be owed by Eastern Mountain Sports, which Vestis plans to continue operating after exiting bankruptcy this summer.

“The receivable status for these clients in no way led us to believe reorganization was eminent,” noted Black Diamond CFO Aaron Kuehne, who added that the bankruptcies and related store closings have not had a significant impact on the company’s full-year guidance.

Selling, general and administrative expenses decreased 6 percent but still climbed to 37.2 percent of sales, up from 36 percent during the quarter a year earlier.

Net loss from continuing operations was $4 million, or -13 cents per diluted share, compared to a loss of $1.7 million, or -5 cents in the year ago quarter. The result included $462,000 related to severance and other restructuring charges, including costs incurring relocating Black Diamond Europe from Basel, Switzerland to the more affordable Euro-based economy of Innsbruck, Austria.

Adjusted EBITDA was -$2.4 million compared to $1.2 million in the first quarter of 2015, primarily driven by lower sales and gross margin.

Black Diamond Inc. ended the quarter with cash and marketable securities of $96.2 million and total debt of $20.6 million, or roughly flat with December 31, 2015 levels after repurchasing 360,221 shares of its common stock for a total cost of approximately $1.5 million, or $4.21 per share. Inventory was $46.2 million, down 10 percent compared with the end of 2015.

2016 guidance affirmed 
Despite the unanticipated recall costs, Black Diamond reaffirmed its fiscal year 2016 sales guidance, which calls for sales to be flat or grow up to 3 percent in currency-neutral terms to $155 million to $160 million compared to 2015. Gross margins are forecast to be 32.5-33.5 percent, compared to 34.9 percent in 2015. That equates to gross margin of 35.8-36.8 percent in currency-neutral terms, which would be an increase of 90-190 basis points compared to 2015.  The guidance assumes the euro will continue to trade for about $1.08.

The company shipped new in-store displays and fixtures to 27 key retailers and began rolling out its Gym-to-Crag marketing platform, which represents a pivot toward thriving climbing gyms. In spring 2017, Black Diamond will introduce a passive belay device for single pitch indoor and outdoor climbing and a kid’s full-body harnesses to address the growing market of families now participating in indoor climbing.

All hands on deck at manufacturing operation
Senior management’s top priority in the current quarter is increasing manufacturing output of its carabiners, cams and other anodized gear to meet demand and prevent competitors from taking market share.

“Not just manufacturing, but category directors, design, development, quality assurance, and supply chain management [are] working with the manufacturing team to redeploy a lot of our engineering group to assist in ramping up the manufacturing activity,” Ritchie said.

Black Diamond expects to reduce its apparel line to around 200 styles and approximately 2,400 SKU’s from around 300 styles and approximately 3,900 SKU’s from a year ago.

“We are reducing our apparel business in order to speak directly to our core consumer while also achieving industry appropriate margins,” Ritchie said. “To be clear however, we remain absolutely committed to our apparel business as we recalibrate the line and the resources towards more humble objectives.”

Parent company Black Diamond Inc. also continues to work with Rothschilds Inc. to vet investment opportunities, including those outside the outdoor industry, that will enable it to take advantage of tax benefits that will allow it to shield $166 million in future income from federal income taxes.  The company’s criteria include cash flow positive assets, preferably in the United States, with enterprise values of $250 million to $500 million.

–Charlie Lunan