Quiksilver Nails Third Quarter Wave

By Richard McCaffery (TMF Gibson) (TMF Gibson)
September 9, 1999

Surf and snowboard clothing outfitter Quiksilver (NYSE: ZQK) announced that fiscal third quarter earnings increased 38% to $5.6 million, or $0.24 per diluted share, beating Zacks mean estimate of $0.23.

Net income growth actually outpaced sales, which jumped 34% to $105.2 million, up from fiscal Q3 sales of $78.3 million. Analysts expect fiscal 1999 earnings per share (EPS) of $1.11, up 35% from last year, as well as 25% EPS appreciation over the next five years. That kind of growth looks better than a big wave.

The Huntington Beach, Calif. company sells its line of Quiksilver T-shirts, surfer shorts, jackets, fleeces, and snowboarding equipment primarily to teenagers and the hip twenty-something crowd. The company peddles its wares from more than 11,700 specialty stores, surf shops, and department stores nationwide, and from 3,300 points of sale in Europe, including two Boardriders Clubs outlets that just opened in Paris.

At a forward P/E of 17, the company is trading at a multiple below its near-term projected growth rate. For a company that has a history of topping analyst estimates, meeting year-end EPS figures isn't a stretch. Virtually every analyst has a "buy" rating on the company.

In addition to sales and net income growth, inventories increased just 3.7% this quarter to $73.2 million from $70.5 million at the end of October, and receivables increased 20% to $94.5 million from $78.3 million. Both numbers are well below the company's growth rate.

So why have the company's shares fallen 37% since July to close yesterday at $18 7/8? Move to the Q2 cash flow statement for a closer look. While inventories and receivables are growing modestly relative to sales growth, the company's operating activities were cash flow negative to the tune of $7.7 million for the first six months of 1999. The biggest culprit? A $26.2 million charge for trade accounts receivable, an item that represents millions of dollars Quiksilver's customers owe the company.

At the end of the fiscal third quarter, the company had $97.9 million in total receivables, which represents about 83 days of receivables outstanding based on sales for the last four quarters. As a rule, under 90 days outstanding is considered manageable so investors shouldn't regard the number as way out of joint. It's also a decrease from 93 days of receivables outstanding at the end of last year. But it still bears watching, especially since the company discloses in its financials that some of its customers have in the past filed for bankruptcy.

Now, lots of companies have customers that go broke, but management mentions it specifically and as a result investors aren't out of line to expect a margin of safety. Investors should also keep an eye on the rise in receivables considered doubtful accounts since it's fair to assume a portion of Quiksilver's customers are marginal businesses.

Move to the cash flow statement from Quiksilver's annual report and you'll see it hasn't been cash flow positive since 1996, when operating activities generated $5.5 million. To offset these losses, the company has borrowed from its line of credit to generate working capital for growth. At the end of last quarter, interest expense had jumped 31% to $908,000 from $691,000 a year ago.

Quiksilver's debt isn't out of whack relative to shareholder's equity, with long-term debt representing 18.2% of equity. But the company has just $2.3 million in cash and equivalents and $77.7 million in current liabilities. That's pretty tight.

Like all fast-growing companies, Quiksilver must balance the need to grow quickly, foster brand awareness, and capture market share with financial reality. Management may be willing to sacrifice profitability for growth, and that's fine for a while. Eventually, however, the company has to start generating cash if it's going to reward shareholders. Careful investors may want to watch from the shore.

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