Skechers USA: Corporate Governance Issue

| About: Skechers USA (SKX)
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Skechers USA Inc. (NYSE:SKX) enthusiasts just heard appalling news: the shoes don't work and you have to exercise instead. It's probably no consolation that the Shape-Up maker had expressed a lot of hope in recent years about its finances, too.

The ads were certainly inspiring. Kim Kardashian breathily dumped her personal trainer for her hot pink Shape-Ups in a Superbowl commercial last year. Brooke Burke said the newest way to burn calories is to tie your laces. The chiropractor Dr. Steven Gautreau cited an "independent" clinical study about the shoes' fitness benefits without also mentioning his marriage to a Skechers marketing executive; the company had paid him to conduct his research. After the Federal Trade Commission alleged that such practices are deceptive, the regulator said Wednesday that Skechers agreed to a $40 million settlement and customer refunds.

Skechers' CFO David Weinberg vigorously denied the charges in a statement Wednesday. He said his team could have prevailed in vindicating the claims in court, but could not ignore the "exorbitant cost and endless distraction of several years spent defending multiple lawsuits in multiple courts across the country."

Fair enough. But this isn't the only example of arguably optimistic statements made by the company. As the shoes grew in popularity, Skechers said its supplies in the year ended Dec. 31, 2010 were going to be worth $398.6 million once it sold them. Then the fickle masses began to lose interest and became more price conscious. In the year ended Dec. 31, 2011, Skechers' inventory sank to $226.4 million - more in line with its value in earlier years.

Management's optimism has manifested itself in other areas as well. Customers owed $182.7 million in 2011 that Skechers hadn't actually received yet but expected to collect within a year, or about 11% of the company's sales at the time. The proportion of Skechers' as yet uncollected revenues to its actual sales has risen each quarter since September 2010 and is above the industry median.

The company also has more costs these days that it doesn't expect to include in its earnings until later. Its prepaid expenses have risen steadily for years and amounted to $88 million at year end 2011, compared to only $14 million in 2007.

We give the company an F on its corporate governance, owing to factors such as the Greenberg family's ability to control the result of director elections and nearly all matters subject to shareholder vote.

In part due to such factors, Skechers' financial statements reflect an AGR of 40 as of March, indicating higher accounting and governance risk than 60% of comparable companies. The score has dropped significantly since December 2010, when it was an unusually conservative 95.

A Skechers' representative did not respond to a request for an interview within press time.

To be fair, Skechers' CEO Robert Greenberg and his team have been trying to right the ship. He said on April 25 that sales during January, February and March were in line with the company's expectations given changes in retail trends. Noting efforts such as a continued focus on reducing Skechers' operating expenses and significantly lower inventory, he said he expects the company will return to profitability later this year. It lost $3.7 million in the first quarter compared to $11.8 million earned in the comparable period of 2011.

Skechers has underperformed the benchmark index S&P SmallCap 600 since 2009 by a little more than 3%. Investors were pleasantly surprised after the news, and the stock jumped 13.7% to $16.96 per share on April 26. It has continued rising since to $17.85 per share intraday on Thursday.

Hopefully this optimism will be more than adrenalin.

  • Region: North America
  • Industry: Footwear
  • Sector: Cyclical Consumer Goods / Services
  • Market Cap: $ 903.4mm (Small Cap)
  • ESG Rating: F
  • AGR: Average (40)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I work full-time for GMI as a corporate governance expert.