Heelys' Wheels Are Falling Off

Heelys (Nasdaq: HLYS  ) just did a revised-expectations face-plant.

The roller-shoe specialist actually just completed a very good quarter -- earnings zoomed ahead to $0.45 per diluted share, from $0.17 a year earlier, and sales kept pace, too, by growing 140% to $74.3 million. But nothing good happens when you're rolling along and the bearings seize up. That's what happened then the Street got news of an anticipated second-half slowdown. The stock dropped more than 40% this morning. The fad is apparently over.

As you probably know, the company makes sneakers with removable wheels -- shoes that can double as roller skates. You stop by leaning your foot back. These were very popular about a year ago, but I haven't seen many kids at all using them lately. It probably hasn't helped that many stores and schools have banned kids from wearing Heelys on their premises.

Company guidance confirms my personal observations. For the third quarter, management now expects sales of $55 million to $58 million and diluted earnings per share in a range from $0.28 to $0.30. The consensus estimate had been for $68 million in sales and per-share earnings of $0.38. The company also lowered its expectations for the full year, with net sales and net income growth now projected to be 10% to 15% in 2007. Given a higher share count, earnings-per-share growth should come in lower than the above growth. Retailers have an overstock of the company's products, too, so look for margins to contract as well.

This company clearly needs to expand its product line. The latest figures aren't available, but as of March 31, 98% of its sales was from the core roller-shoe product. Now that the fad seems to have diminished, the company has no other products -- to speak of -- that it can sell. The situation reminds me of Coleco, when it produced the Cabbage Patch collection. The success of that one product wasn't enough, and when the fad diminished, it filed for bankruptcy protection.

As a standalone company, Heelys, too, may continue to struggle with a reliance on a product that's a passing fad. The Cabbage Patch line was later manufactured by Hasbro (NYSE: HAS  ) and Mattel (NYSE: MAT  ) , where it became just one part of some broad product offerings. Similarly for Heelys, salvation may have to come in the form of a sale to a bigger footwear company, such as Nike (NYSE: NKE  ) . Investors need to hope that if that happens, it happens quickly, before the company crashes completely.

Related Foolishness:

Hasbro is aMotley Fool Stock Advisor selection. See what other stocks make up Tom and David Gardner's list of recommendations with a free, 30-day trial.

Mattel is a former Inside Value pick.

Fool contributor Larry Rothman is happy to receive feedback, and he promises to read it when he's not being wrestled by his three children. He doesn't have any positions in the companies mentioned.


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