K-Swiss management feels they are heading into one of their cyclical business troughs, a situation the company feels they can handle as they have before. This time it looks as though the pullback at Foot Locker is having a profound impact on both sales and futures backlog even as the International business starts to play a much larger role in the companys future growth.
Some market-watchers didnt quite know what to think about comments made by K-Swiss chairman and CEO Steven Nichols on Wednesday when he basically told the market that business was heading south and he doesnt see a turnaround coming in the next year or so.
“It is clear that the strong momentum of the domestic K-Swiss brand we experienced all through 2003 and into 2004 first quarter has ended,” said Mr. Nichols in a conference call with analysts.
The source of the domestic decline is clearly based on the moves made by Foot Locker earlier this year when they made a much talked about effort to cut back on K-Swiss even as the brand appeared to be soaring at retail elsewhere.
Sales to Foot Locker were 16% of Q2 sales versus 27% in the year-ago period, which would appear to indicate a 43% decrease in sales to the retailer in the quarter.
Excluding the effect of Foot Locker, sales were up 13% with the balance of the retail customer base.
Regarding the backlog picture, KSWS said that Foot Locker futures were down more than a third to 20% of the total at the end of the quarter versus 32% of open backlog at the end of Q2 2003.
Foot Locker Q4 futures were down more than 40% against a total KSWS backlog decline of just 1% for the period. FL third quarter backlog was down “somewhat less” than 40% for Q3 against a total backlog gain of 7% for the quarter. Total domestic futures backlog was said to be flat for Q3 and down 10% for Q4.
Regarding the Footaction business, KSWS said they had not yet seen any orders for the stores acquired by Foot Locker and that the business would be at-once business until futures orders are placed. KSWS said that FL asked them to reserve Classic inventory for the stores.
Excluding Foot Locker, backlog at quarter-end was up 23% with the balance of the domestic market.
Nichols said they expect two or three more quarters of declining sales to Foot Locker, but to a lesser extent than the Q2 decline.
One of the other issues for the Q2 domestic K-Swiss brand business involved a new direct-to-customer shipping program that bypasses the companys DC. The company said about $9.5 million of container orders scheduled for delivery in June were in transit, but were required to reach the customers DC for revenue recognition.
Total company sales would have been up 5.2% for the quarter if they had been posted in the historical manner. Domestic sales would have been flat for Q2.
The orders were in limbo until the customer received them and were not part of the Q3 backlog figures either since KSWS does not recognize for backlog purposes any orders originally scheduled for delivery prior to the end of the quarter. The goods were delivered in July and will show up as sales for the third quarter.
While the domestic business is hurting, the International side continues to chug along in both sales and backlog.
Sales in Europe, a region that is track to be profitable for the first time, were up 41% for the second quarter and backlog in the region increased 75%. Nichols said that he could see its business double in the next 18 months. He said that business in the U.K. was “spectacular, literally off the charts” and Benelux was “very, very good”. He did say the German economy was suffering a bit, but business there was still good. They now plan to go aggressively after Spain and France.
In Asia, sales were up 59% for the second quarter, driven by a 114% increase in sales in Japan, and backlog was up 52% at the end of the period. Nichols said they were very successful in Hong Kong and Korea already, but hinted that doubling or tripling the business elsewhere in the region was not out of the question since market share for the brand there was “just slightly above zero.”
International futures were up 45% for the third quarter and jumped 144% for the fourth quarter deliveries.
Total worldwide K-Swiss brand revenues decreased 3.9% to $106.0 million for Q2 from $110.3 million for the year-ago quarter. The balance is Royal Elastics.
The K-Swiss brand decrease for Q2 was the result of a decrease in the volume of footwear sold partially offset by higher average wholesale prices per pair.
The volume of footwear sold decreased 6.5% to 4.1 million pair in Q2, primarily the result of decreased sales of the Classic (-5.7%), Training (-18.9%), and Childrens shoes (8.9%), offset by an 18.7% increase in unit sales of Tennis shoes. This pairage decline was offset by an increase in the ASP to $25.55 from $24.93 for the year-ago quarter, an increase of 2.5%.
Classics revenues were down 2%, with Original Classics down 12% from the prior year quarter and LE Classics and others up 14% for the period to 30% of revenues. Sales of the Classic shoe were up 4% for the period and the Black Classic was up 32% versus LY.
Revenue in the Tennis category was up 16% for the period, with Traditional Tennis up 22%. The Training category was down 20% and Childrens was down 9% for the quarter.
K-Swiss plans to add Basketball in Q3, with a broader launch in the fourth quarter. The category will be called Roundball and will be positioned as a lifestyle look rather than a performance product. Nichols said they saw opportunity in offering a category where there is a different buyer and open-to-buy and basketball made sense since it is driven by the same demographic that has driven the K-Swiss brand.
Full year earnings are now seen in the $1.39 to $1.47 per diluted share range on sales between $450 million and $460 million. That stacks up against prior guidance of EPS in the range of $1.40 to $1.50 per diluted share on sales of approximately $460 million to $480 million.
Gross margins are seen between 44% and 45% for the year and SG&A is not expected to rise above $117 million for 2004. Royal Elastics is not expected to exceed a net loss of 15 cents per share for the year.
OTHER KEY METRICS:
- Sold 805,000 pair of the Classic in Q2
- SG&A at 26.2% of sales, up 50 bps from Q2 LY
- Q3 EPS forecast at 33¢ to 37¢ per diluted share
>>> Not sure which is more surprising here — the candor of Mr. Nichols or the fact the market didnt whack the stock harder for the week
>>> The negative view doesnt appear to make sense as the SportScanINFO numbers continue to reflect strong sales growth at retail…