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They say the market is forward-looking, but it’s been backward-looking with K-Swiss until (hopefully) now.  The shoemaker is in its third fashion slump since coming public in 1990.  Having emerged stronger twice before, a lot of folks have been slow to readjust their thinking in the face of a sharply-declining backlog of orders. 

But now I think the shares are just too cheap – which means of course there’s probably yet another leg down.  And I’ll further note that management has not been buying back shares – or at least they weren’t in the low-$20s, up through the last conference call.

So it is with great hubris that I suggest this is worth $18.10 of your hard earned cash, given all the above and the fact that EPS ex-interest are likely to be something like 55-cents next year.  But keep in mind the $8.50 in net cash (no debt) they’ll have at year end, and more importantly that this is a fashion cycle downturn, ’08 is probably the trough year, and this management team has a 17-year history of doing right by shareholders (such as themselves, with 20%+ of s/o).

Basically, I don’t see why they can’t get back to around $2.00 FCF/ share, putting this at about 5X FCF… in a few years, that is.  But given high quality management and a business that can do a nearly 100% ROIC at the peaks, that’s still pretty cheap.

A brief history:

CEO Steven Nicholas bought the company in an LBO back in 1986, after having spent 25 years in marketing at Stride-Rite.  It was a one-product company then, making only the “Classic” – the first tennis shoe with a leather upper.  Today the Classic is still 70% of sales, which sort of explains the volatility in earnings during fashion blips.  The rest comes from other tennis and training shoes.  

K-Swiss had a huge run from about $33M in ’87 to $150M in ’94.  Then tennis stopped being cool.  Rather than cut prices, management cut back on supply – a strategy they have always held, as it keeps the brand’s image intact such that they live to fight another day.  So today we see sharply dropping sales, yet gross margins north of 45% (huge for this industry).

The company hired new marketing people who then came on board and created a new line called “Limited Edition” – a huge hit that drove strong sales through 1999.  Eventually retailers over-ordered, and the resulting pullback coincided with a general contraction in athletic footwear in 2000 (think Just-for-Feet bankruptcy).

They pulled away from LE, re-emphasized the Classic, and tweaked the marketing image to be less-preppy and more “hip-hop.”  Sales soared to over $380M in 2005. 

But in 2006, K-Swiss lost its “cool” – the marketing was stale and the product line had

seen little innovation.  Classic was out, low-profile was in.  In women’s, a trend toward low-priced and casual footwear has been especially tough, and accounts for a lot fo the pain you see industry-wide (think FL, FINL)  Management made it clear that they were heading into a downturn, though it took Wall Street a while to really listen.  (They make everything pretty clear, by the way.  I really encourage you to read some conference call transcripts.  I doubt you’ll find a more candid team out there.)

Time for Act III:

There are no guarantees where consumer fashion is concerned, but the nice thing about this slump (versus the previous two) is that this time the company is sitting on a huge pile of cash.  Plus today it’s truly a global brand.

That cash means they need not cut corners on growth investments during tough times.  (You will notice that SG&A is not down despite sales trends, similar to previous slumps.)  They’ve hired a lot of new talent.  Nearly the entire top management team has experienced turnover in the past 18 months.  Previous to that there was just about no turnover for 10 years.  They’ve signed Anna Kournikova in a sponsorship deal (with more big-name athletes likely on the way).  Plus the product development spend is up, as is marketing to support expansion in Asia and a selective store building strategy in key markets (first U.S. store will open in LA in 2008). 

As for being global, the Europe business will do something like $130M this year, up from less than $18M in 2002.  The interesting thing is that this is coming almost entirely from the UK, Germany and Benelux.  They’ve just started to build their business in France, Italy and Spain, which together make up 50% of the European market.

ROW will be north of $60M, about $40M of which is Asia.  This is growing quickly, as you might imagine.  South Korea is actually their biggest market.  They’re making a big push in Japan and have a significant ops Taiwan and China as well.

Note that apparel is only 1-2% of sales currently.  Peers are anywhere from 10-50%.  A new head of apparel has been hired – previously with Puma, where he took that business to $600M.

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