The Quiksilver Bankruptcy: Where Should We Be Focused?

As we go through the process of watching Quiksilver try to resurrect itself what issues should have our attention? Certainly not the endless pages of bankruptcy court filings. Not even I’m reading all of those. The process will grind through to its conclusion. The secured creditors will come out more or less intact, the common stockholders and unsecured creditors, not so much. As I read the deal right now, the common shareholders will get the big goose egg and most of the unsecured creditors 2.7% of whatever they were owed.

Those chips will fall where they may. In the meantime, there are four things we might care about as an industry. Or at least there are four things I think we might care about. Here’s the short list. You’ll see that they are not unrelated.

1. Quik’s balance sheet
2. Brand value and position
3. The management team
4. Any possible combination with Billabong.

Let’s take a brief look at each.

The Balance Sheet

It’s common knowledge that the level of Quiksilver’s debt is one of the things that led to the bankruptcy filing. Their last published 10Q (for the quarter ended July 31) showed long term debt of around $800 million. Interest expense during that quarter was $18 million. Multiply that by four and it’s around $72 million a year; simply unmanageable given their revenue.

Comparable debt when they exit bankruptcy, as the plan is currently structured, will be $318 million, or 60%, lower. In projections filed with the court, Quik projects interest expense in 2016 at $27.5 million, which is way better than $72 million. If you accept their assumptions, the projected balance sheet seems reasonable and manageable.

The projections Quik has provided the court are for the years ending October 31, 2016-18. For the first year, they are projecting revenue of $1.247 billion, ending receivables of $224 million and ending inventory of $292 million. The last full annual report we have was for the year ended October 31, 2014. For that year, Quik reported revenue of $1.57 billion. Year end receivables were $320 million and inventory $278 million. We don’t have a full year number for the year ended October 31, 2015. Revenue for the nine months ended July 31, 2015 were $1.01 billion down from $1.17 billion from the same period the prior year.

Okay, I’m just sort of thinking out loud here. I’d like to see a further decline in inventory given the decline in sales, but they are going through a chapter 11 proceeding and there’s going to be some further store closing and rationalization of the business so I can see why it wouldn’t happen the first year.  I also notice they are planning for little to no inventory increase in the next two years as sales grow to $1.297 and $1.391 billion respectively. That’s a good thing.

So the balance sheet seems reasonable, which is as much as I can ever say about any projection.

Brand Value and Position

 Not to overstate the obvious but if the brands can’t keep/recapture/build some credibility with the target customers, nothing else matters and a bankruptcy filing and the associated restructuring will just buy some more time for Quiksilver before it finds itself in trouble again.

In that regard, I am actually encouraged by the revenue decline Quik is projecting for its first year.  Let’s look at a couple of comments Quik makes in discussing its projections.

“Global wholesale revenues in 2016 are projected to decline compared to the prior year, primarily impacted by decreased volume, particularly in North America, and will partially be offset by increased selling prices. Growth is projected to be 7% in both 2017 and 2018 and will be largely driven by sales volume and increased revenues from ex-licensed categories. “Global retail sales in 2016 are projected to decline compared to the prior year due to the impact of store closures, a majority of which will occur in the U.S. New store openings and store growth, focusing on Boardriders and shop-in shop retail concepts, will drive sales growth in through 2018.”

Then, talking about the Americas (United States, Canada, Mexico, Brazil) they say:

“Sales in 2016 are largely impacted by a decline in North American orders as the Company exits certain distribution channels. Going forward, sales growth is projected to be driven by increased revenues from sales of previously licensed product categories and growth in Mexico and Brazil, with modest growth in North American orders.”

The part where they talk about exiting some distribution in North America and increasing selling prices gives me a warm, fuzzy feeling. Regular readers know I think being cautious with distribution is critical to brand building and getting good margins when, as in the case for most brands in this industry, your product isn’t fundamentally different from the competition’s.

And if that helps you raise your prices, as Quik seems to allude to, that means you can improve your bottom line even if you don’t grow your revenues and you can also reduce the working capital invested in the business.

On the other hand, I don’t much like the part where they talk about revenue from the previously licensed products being one of the drivers of global growth in 2017 and 2018. As I read that, instead of royalty income, they will have top line revenue. Nothing wrong with that (and I like that they are pulling back from the licensing program) but it’s kind of robbing Peter to pay Paul.

Quiksilver has damaged its brands’ positioning and credibility as a result of some of the distributions decisions it has made in recent years. It sounds like they are going to reverse some of those. Good. I hope it’s not too little too late.

The Management Team

Remember how Billabong bemoaned how hard it was to keep good management as they went through their restructuring travails? Quiksilver, I imagine, has the same problem. Billabong resolved the issue not just by completing their financial restructuring but by bringing in a new CEO who has made big changes in both the organization and the management team.

Quiksilver tried that with Andy Mooney and it didn’t work out. I know all the reasons people say Andy was the wrong person and I agree with some of them. I also know he started taking some required actions that should have been started way before he got there but weren’t. He also didn’t have the advantage of coming in as the financial restructuring was completed.

I wrote at the time with some sympathy about how founders and long established CEOs often had a hard time making difficult decisions a business required because of momentum and their long standing relationships with the people and organization. Maybe having to file a chapter 11 wipes out any hesitancy about making fundamental changes (not just tough decisions- plenty of those have been made at Quiksilver) in the business focus and direction. I hope so. At the very least, potential new senior hires will have to note (fairly in my opinion) that existing leadership bears some responsibility for Quiksilver’s current circumstances.

Combination with Billabong

 With Oaktree Capital Management involved on both sides, one can’t help but wonder if a merger between Billabong and Quiksilver is a possibility. Though we know the subject has come up, we’re still left wondering. As you may recall, the Oaktree representatives on the Billabong Board resigned right before the Quiksilver filing, and Oaktree’s involvement, was announced to avoid an obvious conflict of interest.

I don’t have enough information to even form an opinion as to whether or not a merger would be a good idea. Both Billabong and Quiksilver management kind of have their hands full right now, so I’m pretty confident it’s not imminent.

The reason some might like the merger idea is because it would imitate the highly successful VF actions sports coalition that includes Vans, The North Face, Timberland, Reef and other brands. Except it doesn’t really. Quiksilver and Billabong are direct competitors. The VF brands mostly don’t compete with each other. I expect that Billabong, as I’ve written, has already benefited from Quiksilver’s problems. If I were Billabong, I’d keep my powder dry and see how Quik manages its brand positioning issues. I might even be cheering for Quiksilver to succeed, because I as Billabong might not want well known surf and skate brands thrashing around in the market.

So you (and I) are saved from reading too much small print on legal documents. You can assume that the balance sheet is adequate and that a merger between Quiksilver and Billabong is not imminent (please no announcement to the contrary the day after I publish this). The overriding issue is the direction the management team takes the brands. At the end of the day, that’s what will matter.