K-Swiss Slowed In Footwear Race After Giant Feud By SHELLY GARCIA Senior Reporter A long-running feud between the world’s biggest athletic footwear maker and the country’s largest athletic footwear retailer left K-Swiss Inc. wide open to score big over the past year and a half. But in the end tiny K-Swiss was out of its league. After picking up big increases in sales and earnings in 2003, Westlake Village-based K-Swiss said it expects to report lower earnings per share in the coming quarter than it did a year ago, and the company said it would not meet previously anticipated projections for revenues and earnings for the full year. K-Swiss has still got game the company expects full year revenues in the range of $460 million to $480 million and earnings somewhere between $1.40 and $1.50 per diluted share. At the low end of the estimate, that would amount to a 7 percent rise in revenues and a 6 percent increase in earnings per share over the 2003 period. But those estimates are down from initial projections of $490 million to $510 million in revenues for the year and earnings of $1.50 to $1.65 per share. Worse yet, K-Swiss said its second quarter earnings would fall sharply on a year-over-year basis and its revenues would be flat versus the second quarter of 2003. The news sent Wall Street calling foul; analysts in turn downgraded their estimates and the share price for K-Swiss plummeted 20 percent after the late April announcement. On Thursday, May 20 shares in K-Swiss closed at XX, down XX from $24.53 a share on the day before the announcement. “We expect K-Swiss results to be hurt by Foot Locker over the next couple of quarters,” wrote Margaret Mager, an analyst with Goldman Sachs, “however we think the business will stabilize by 4Q as K-Swiss begins to anniversary the Foot Locker reductions.” (Goldman Sachs maintains an investment banking relationship with K-Swiss.) The major reason for the decline is an anticipated falloff in business with Foot Locker Inc., a national chain with more than 2,000 store outlets that had been increasing its business with K-Swiss consistently since late in 2002. Retail dispute That’s when Foot Locker and its biggest supplier, Nike, squared off over the athletic shoe manufacturer’s policy of requiring stores to accept less popular styles in return for access to its biggest sellers. To cope with the less desirable inventory, Foot Locker offered customers so-called BOGO promotions, buy one pair at full price and get one at half price, a marketing tool Nike viewed as cheapening a brand it spends in excess of $1 billion annually to build. Nike canceled a portion of its shipments to Foot Locker and Foot Locker cut an even larger portion of its orders to Nike, giving a host of other manufacturers the chance to vie for an estimated $250 million to $500 million in orders that would otherwise have gone to Nike. “This opened up a world of opportunity for other brands to get shelf space in Foot Locker stores,” said John Shanley, managing director of Wells Fargo Securities LLC. K-Swiss, along with other niche manufacturers like Puma and majors like Reebok and Adidas all saw increased orders from Foot Locker, but for a small company like K-Swiss the effect was even more dramatic. By the first quarter of last year, Foot Locker had grown to represent about 30 percent of total sales at K-Swiss, and the company’s performance rocketed upward. For its full 2003 year ended Dec. 31, K-Swiss reported net income soared nearly 75 percent to $50.1 million and revenues rose nearly 50 percent to $429 million. As business boomed, so too did K-Swiss shares, nearly doubling through 2003 to a high of $48.84 before a two-for-one stock split late in the year. Then the proverbial other shoe dropped. As the dispute ran on, Nike had reallocated a significant portion of its inventory to Footstar Inc., which operated 429 Footaction and 88 Just For Feet stores, but early in March, the financially troubled company announced it would close about 165 of those stores, sending Nike back out onto the court for additional sales outlets. Nike and Foot Locker patched it up. “Now you have the opposite working against them,” said Mitch Kummetz, senior research analyst with D.A. Davidson of K-Swiss’s current predicament. “You’ve got Nike doing more business with Foot Locker and Foot Locker is allocating more dollars toward Nike and that’s going to come from somewhere else.” Slow in growth K-Swiss’s just released first quarter results showed no ill effects of the renewed relationship between Foot Locker and Nike. The company reported net earnings rose 59.5 percent to $21.8 million for the period ended March 31 and revenues increased 31 percent to $152 million. But in the company-issued guidance for the second quarter, K-Swiss said it expected sales in the neighborhood of $111 million to $117 million and earnings per diluted share in the range of $0.28 to $0.33 cents. For the comparable quarter of 2003, the company earned $0.67 on sales of $111.8 million. “Foot Locker’s decision to cut back on their futures has slowed our rate of backlog growth, and we have adjusted our guidance to reflect that,” Steven Nichols, K-Swiss president and CEO said in a conference call to analysts late last month. Last year at this time, Foot Locker accounted for a 28 percent backlog in orders at K-Swiss, but going forward, the company said it was looking at a 35 percent decline in its future orders, largely due to Foot Locker. “Cutting back on Reebok is relatively insignificant,” said Shanley, “They’re over $2 billion in revenues. Cutting back on K-Swiss, which is a $400 million company, it’s more than a hiccup. It can give you a dose of cardiac arrest.” Analysts were mixed in their response, with some, like Shanley and Mager, regarding the situation as temporary. At the least, they said, K-Swiss’s orders with Foot Locker have ranged from a high of 35 percent of the company’s sales to a low of 13 percent, which would indicate that the falloff in business with Foot Locker is not likely to erode much further. But others reasoned that K-Swiss may not have lost as much Foot Locker business as it had if its line had broader strength than The Classic, a white-on-white shoe that has long represented the bulk of K-Swiss’s sales. With a shift in fashion to more colorful athletic shoes, coupled with Nike’s return to Foot Locker, analysts like Kummetz lowered the stock’s rating from “buy” to “neutral.” “I’m a little worried about the back half of the year,” Kummetz said.
