K-Swiss: When Customers Go Belly-up

By Bob Fredeen (TMF Bobdog)
January 12, 2000

For the past year, K-Swiss (Nasdaq: KSWS) has been one of the strongest athletic shoe stocks. In May 1999, the share price hit its all time high of $59 13/16 (split adjusted) as the investing world realized that K-Swiss was one of the hottest shoe brands out there.

K-Swiss shoes were among the top-sellers of 1999, even in the last two months of the year, when the company had 2 models in the top 10 according to SportsTrend Info.'s point of sale (POS) survey. But in the last couple of months the market has been avoiding the stock like the plague, and today the bottom fell out as shares fell more than 20%.

The question: Is the 20% drop the share price suffered today a response to some obscure, Wise rule that we don't know about, and wouldn't want to know about if they were willing to tell us? Or, is there an actual problem?

First, let's look at the announcement K-Swiss made today. The company announced it expects EPS for the fourth quarter ended December 31 to be between $0.40 and $0.50, compared to analysts' expectations of $0.55. Sales should be between $49 and $50 million. These numbers compare to an EPS of $0.32 on sales of $40 million in Q4 of 1998. The lower earnings were due to "unexpected order cancellations" due to financial troubles at some of the company's major accounts. The company also announced that worldwide futures orders for delivery between January and June 2000 were $106 million, down 24% from $140 million a year earlier. First quarter futures were down 26% and second quarter orders were down 22%. Domestic orders fell 27%.

Finally, in an attempt to mollify the market, the company announced it spent $6 million purchasing 360,000 shares of common stock in the fourth quarter. The market was unimpressed, and the stock plunged.

Obviously, that was quite a load of bad news. While the news about last quarter was bad, the other items are much more serious. First, the traditional measure of a footwear company, futures orders, looked bad. Basically, this figure measures commitments from retailers to buy shoes in the future, thus the name. It shows the confidence retailers have in the company's products, and it shows retailers' opinions on what consumers want. It also shows how strong the company is in the industry. If you're selling a hot shoe, everybody wants it now and they'll order it from you, or even pay you up front.

Apparently, K-Swiss, with all of its recent success, is not getting orders for this year. Which leads to the second piece of bad news: There is some weakness in the company's retail customers. According to analysts quoted by Bloomberg, K-Swiss's largest clients last year were Venator's Footlocker and Champ's chains, Foot Action, and Just for Feet. Venator managed to avoid bankruptcy last year by selling a host of assets. Just for Feet filed for bankruptcy in November 1999. Another client that likely reduced earnings in Q4 is JC Penney, which has decided to sell fewer athletic shoes at its stores. K-Swiss also faces the fallout from bad inventory decisions at Just For Feet and other retailers, leaving too many shoes in the retail channel and too little money available for new purchases.

All these problems have already hammered the company on its balance sheet. Accounts receivable was at $34 million at the end of Q3 while inventory levels were at $40 million. That's before the canceled orders in Q4, so you can bet inventories are still rising. Accounts payable was below $5 million in Q3. This clearly demonstrates where K-Swiss stands in the industry -- it has to give its customers lots of credit, it must maintain inventory to fill current orders, and it can't get much credit from its suppliers.

Is there a problem? Yep. It's hard to turn in triple-digit growth rates when your customers are going out of business. It's even harder when your former customers are holding fire-sales for the inventory they have in their possession. Regardless of how many good things are going on with K-Swiss, it is suffering from some serious problems "downstream." I suppose this is an object lesson in watching a company's customers, not just the company itself.

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