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ON THIN ICE

Performance Sports Group, parent company of hockey-gear maker Bauer, staged a bold expansion to capture a dominant share of the market.

But rapid growth has caught up with the once high-flying company, which is now struggling with financial woes, an SEC investigation, angry retail partners and allegations of artificially inflated sales. Christina Pellegrini and Janet McFarland report

Ron Rugal has sold gear to hockey players for more than three decades. In recent years, one equipment maker has been king: Bauer.

Last year, Mr. Rugal, owner of the Detroit-based B&R Sports chain, carried "pretty much everything" in Bauer's product catalogue – and not much else. At one point, Bauer accounted for as much as 90 per cent of the inventory in his 12 stores across Michigan and Illinois. Players would leave his shops outfitted from head to toe in the brand.

But during the past few years, Mr. Rugal has become disillusioned with the equipment maker, particularly after it said it would become his competitor by opening its own stores, not far from his shops in Detroit and Chicago, and in as many as eight other cities including Toronto and Montreal.

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"I feel like our marriage was good and all of a sudden, we're getting divorced," Mr. Rugal said in an interview. "I don't think they are being very honest."

Mr. Rugal felt it was time to diversify his business. Now, the share of Bauer gear in his stores has shrunk to about 40 per cent, with rival hockey equipment brand CCM, which is owned by Adidas AG, gobbling up the difference.

"We're selling a lot of CCM skates right now, for a couple of reasons," added Mr. Rugal. "They actually hit a home run. And I'm pissed off at Bauer."

The revolt by retailers like Mr. Rugal could not be coming at a worse time for Performance Sports Group (PSG) Ltd., the Exeter, N.H.-based company behind Bauer and also Easton baseball gear.

With a market cap of just $181-million (U.S.), the company is struggling under the weight of about $440-million in debt and watching its sales decline, as it copes with a string of bankruptcies of major U.S. sports retailers that carried its gear.

The news has gotten worse. PSG revealed in August it is under investigation by the U.S. Securities and Exchange Commission and in Canada, too, after being hit with a shareholder class-action lawsuit alleging it misled investors by not disclosing that its "record" sales were a result of a "fraudulent scheme" to inflate and manipulate its revenues.

The board has launched its own review of the company's accounting, delaying the release of its financials for its last fiscal year. It has an Oct. 28 deadline to file, or face defaulting under its loan covenants.

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Potential buyers are now circling the company, including investment giant Toronto-based Fairfax Financial Holdings Ltd., which often takes bets on distressed companies.

PSG declined requests to comment for this story.

PSG's reversal is stunning for a high-flying company whose Bauer brand holds a crushingly dominant 56-per-cent share of the hockey gear market, a proportion it boosted from 28 per cent in 2006 through a series of bold expansion moves.

Acquisition spree

1. Mission-Itech
Hockey equipment, 2008, $23.9-million (U.S.)

2. Jock Plus
Sports apparel, 2009, $3.4-million (U.S.)

3. Maverik
Lacrosse equipment, 2010, $13.6-million (U.S.)

4. Cascade
Lacrosse helmets, 2012, $64-million (U.S.)

5. Inaria
Soccer apparel, 2012, $7-million (Canadian)

6. Combat
Baseball bats, 2013, $3.37-million (Canadian)

7. Baseball and softball division of Easton-Bell Sports
2014, $330-million (U.S.)

8. Licence for patents and technology assets of Q30 Sports LLC
2015, $7-million (U.S.) plus future payments up to $18-million

9. Easton Hockey Holdings Inc.
Hockey equipment, 2016, $10.9-million (U.S.)

First modern skate

Founded in 1927, Bauer is woven into the fabric of Canada's rich hockey history – it made the first modern skate – but the brand hasn't been Canadian-owned for decades.

Lured by the surge of interest in in-line skates, sports giant Nike Inc. bought Bauer's parent company, Montreal-based Canstar Sports Inc., in 1995 for $395-million. When growth flagged, however, Nike sold what was then-called Bauer Performance Sports Ltd. in 2008 to U.S. private equity firm Kohlberg & Co. for $200-million.

As a private-equity investor, Kohlberg developed a new plan for Bauer: become more than just a hockey-equipment maker, grow its size through acquisitions, and then list Bauer on a stock exchange to provide a clean exit for the private owners.

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Bauer launched an ambitious expansion spree, buying eight sports equipment and apparel companies that allowed it to branch out from its hockey base into lacrosse, soccer and baseball. Its biggest deal was completed in April, 2014, when Bauer purchased the baseball and softball divisions of Easton-Bell Sports Inc. for $330-million (U.S.), financed with debt.

Kohlberg began its exit strategy in 2011, selling a portion of its stake when Bauer listed on the Toronto Stock Exchange. Then, in June, 2014, two months after the Easton deal was completed, the company changed its name to Performance Sports Group and announced a bigger stock offering, as well as a new listing on the New York Stock Exchange.

Kohlberg sold most of its remaining shares into the market between 2012 and 2014, but has kept a 5.3-per-cent stake.

Kevin Davis, former CEO of Performance Sports Group, is shown in 2011 as his company, then known as Bauer Performance Sports, went public in Toronto.

Kevin Davis, former CEO of Performance Sports Group, is shown in 2011 as his company, then known as Bauer Performance Sports, went public in Toronto.

Deborah Baic/The Globe and Mail

Bauer-branded stores

Continuing to increase revenue without relying as heavily on acquisitions required a new strategy. The company, led by chief executive officer Kevin Davis, chose one that would bypass the middleman.

On Jan. 8, 2015, the nearly-90-year-old manufacturer surprised the market with news it would open as many as 10 of its own Bauer-branded stores in key hockey cities across North America, arguing the move would benefit everyone by raising the profile of the brand and growing the sport.

But the decision sparked anger among a group of hockey retailers that Bauer had, up until that point, relied on exclusively to sell its goods. The Globe and Mail spoke to retailers across North America who expressed degrees of angst over the Bauer stores. (Several requested anonymity so they could speak candidly about a key vendor.)

"Did they screw over the family businesses in the area? They are. That's the bottom line," said one retailer in Boston. "You don't do that to people who have brand loyalty and supported your product."

Many retailers believe Bauer has now evolved into a major competitor that will target their customer base. The hockey market, they say, is relatively small, totalling $670-million (U.S.) in 2015, and sales of gear like skates and pads at a new Bauer store could easily eat into sales at another retailer.

"You're not creating new business," said Scott Neiles, chief executive officer of Winnipeg-based Home Run Sports, a sporting-goods chain with five stores in three provinces. "Anybody who starts up now is taking business, especially in a hockey market that's dwindling."

Also, some retailers feel like they've been played. Many stores were part of a virtual program that collects data about their total sales and shares them with PSG to help manage their inventory. Some retailers believe the company is using their internal data against them.

"I basically gave them my books and they took it and ran with it," said Mr. Rugal of B&R Sports. "I'm mad at myself for getting that close."

The opposition from retailers spurred PSG's former chairman, Graeme Roustan, to enter the fray. A Canadian businessman who has owned hockey arenas and their pro shops, Mr. Roustan had worked with Kohlberg to negotiate the Bauer acquisition in 2008 and was installed as the company's chairman. Although he left the board in 2012 to pursue a plan to try to bring a second NHL team to the Toronto area, he still followed PSG closely and held 1.4 per cent of its shares in 2015. (Mr. Roustan won't disclose his current ownership stake, if any.)

Retailers thought if anyone would be able to convince Bauer to abandon its plans to compete against them, it would be Mr. Roustan, who worried Bauer was alienating its key partners with its retail strategy.

"Taking that step is disruptive, if you ask the retailers, in a very terrible way," he said.

He, too, felt PSG was making a critical error, so he decided to try to return to the board, offering to re-join at the next annual meeting. The board, however, unanimously rejected multiple overtures he made in 2015.

His successor, Bernard McDonell, issued a critical statement about Mr. Roustan, saying he didn't have the experience or business acumen to be a director, especially since PSG was no longer just focused on hockey. He added Mr. Roustan has a "track record of disagreements and litigation with business partners."

But Mr. Roustan hasn't gone away, despite taking "a lot of heat" for his activism. He says he has continued his battle, becoming a constant voice of opposition and issuing press releases, because he feels a "fiduciary duty" to the Bauer brand.

"They throw you under the bus and say you're a lunatic, but if you believe in what you're doing and if you believe what you're hearing and you need to make a point about it, you have to be willing to take the heat," he said. "And I've taken a lot of heat."

Undeterred, PSG has forged ahead with its plans, opening a massive store in a Boston suburb and a larger location in the Minneapolis area. Both have an indoor ice rink, where customers can be fitted and try products before they buy them. A third store is slated to open in 2017 in the Toronto suburb of Vaughan. (While its board has approved a fourth location, the company said it would pause further expansion as it reviews its debt.)

By mid-March of 2016, CEO Kevin Davis said that the company's "seeing really fantastic results from the two stores" so far, adding, "If nothing else, it creates a tremendous amount of brand zealots for the Bauer brand."


Growth hard to sustain

Bauer, under Mr. Davis's leadership, had recorded nothing but rising annual revenues since its launch as a public company, and investors had become accustomed to rapid growth. Its revenues more than doubled from $257-million in 2010 to $655-million in 2015, while the company's share price more than tripled over four years to its peak in 2015.

But the growth was increasingly hard to sustain, especially in sectors as mature as hockey and baseball. Global registered participation in hockey grew by about 2 per cent per year in the decade up to 2014, while U.S. participation in baseball has been on a steady downward slide An overexpansion of sporting-goods stores and a steady rise in Internet shopping hit U.S. sports retailers hard. A spate of bankruptcies began in 2015, with the largest coming in March from U.S. giant Sports Authority.

For a while it looked like PSG could weather the storm, posting strong growth in baseball and softball revenues as recently as mid-January. It lowered its earnings guidance for the full year, but gave no hint of major problems. But two months later, on March 8, PSG shocked the market with news it was cutting its earnings forecast for the full year, ended May 31, by almost 80 per cent, and was seeing sales crater in the baseball division. Stunned investors pushed PSG's share price down 66 per cent that day to $3.90 (Canadian) on the TSX.

Weakness in the baseball division seemed to come out of left field. PSG revealed baseball and softball equipment sales had slumped sharply in late 2015, particularly pricey bats. PSG blamed the sales decline, in part, on bad weather in the United States and a flood of liquidated gear in the market.

The company also signalled it would report a large loss for the third quarter, ended Feb. 29, and in April revealed the loss would hit $188-million – compared with a loss of $12-million in the same quarter last year – driven by a $145-million (U.S.) writedown of the value of goodwill and intangibles in its baseball and softball unit. It was a revelation that Easton may not have been worth nearly the $330-million PSG paid for it just two years earlier.

"It's a confession," said Al Rosen, founder of Toronto-based forensic accounting firm Rosen & Associates Ltd.

Mr. Davis told investors on March 15 that PSG was facing a "perfect storm" of unrelated issues that emerged during the fiscal third quarter. "We were just unfortunate to have it exactly at the same time," he said.

On March 22, two weeks after stunning investors with bad news, Mr. Davis left the company. He was replaced in June by Harlan Kent, former CEO of Yankee Candle Inc.

Bauer merchandise on display at Mr. Rugal's store.

Bauer merchandise on display at Mr. Rugal’s store.

Natalie Shaver for The Globe and Mail

Orders delivered early

Before the market took a turn for the worse and PSG shook up its top brass, retailers say they saw Bauer employing more aggressive sales tactics in order to hit ambitious targets.

In 2014, for example, Mr. Rugal's orders from Bauer suddenly started being delivered before their scheduled shipment date. "Stuff I wanted in June, July and August was showing up in May without any warning," he said. When he raised concerns about how to pay so much earlier than expected, Mr. Rugal said he was told he could pay according to the original schedule, stretching out PSG's payables for months. It wasn't long before his bills started piling up.

"They wanted me to order more stuff, but I already had too much," Mr. Rugal added. "I was like, 'How can I order 20 per cent more when I have all this product?'"

Dave Beaton, store manager at retailer Just Hockey Source for Sports in Toronto, said Bauer is "a little more strong handed" in its dealings, but added other companies also push him to order more in exchange for bigger discounts.

Some retailers said they could not buy more Bauer gear, despite the threat of losing volume discounts, because it already made up such a large share of their stock. Steve Davies, owner of competing hockey-gear maker Winnwell Clean Hockey Inc., believes PSG's problem was that it was a public company under pressure to show increasing sales every quarter despite what he sees as declining growth in hockey participation and a weak hockey market in 2015 in particular.

"The distribution channel is constipated – there's nothing else you could put into it because it's not coming out the other end in sales at retail."

By late 2015, Bauer itself was growing concerned about retailers' unpaid bills. When Mark Vendetti replaced Amir Rosenthal as chief financial officer in late 2015, according to Mr. Rugal: "The new CFO came in and said, 'Hey, you've got to pay all your past due bills.'"

Mr. Neiles, who runs Home Run Sports, says over the past few months, PSG has refused to ship any Easton gear until retailers were up to date on their accounts. "That's an aggressive stance that nobody is taking" across the industry, he said.

In June, PSG said customer credit issues dampened results in its fourth quarter. It also said it didn't fulfill some orders because certain customers "were not settling their outstanding payments in line with our requirements."

Handout

'Manipulative sales tactics'

Investors questioned how so much bad news came to light so suddenly at the end of the third quarter and why some of PSG's customers were abruptly being cut off in the fourth quarter. Some critics offered a darker version of events than the one the company described.

A class-action lawsuit on behalf of shareholders filed this year in a New York court alleges PSG was suffering the fallout of a tactic known as "channel stuffing," whereby customers are induced to order more products than they really need so the vendor can record sales sooner and bolster their earnings.

The complaint quotes several anonymous retail sources describing high-pressure sales tactics, alleging PSG had inflated sales in 2014 and 2015 by forcing retailers to boost their orders or risk losing their discounts. The lawsuit said PSG did not tell investors it was "pulling orders forward" so that sales would occur earlier than they did in previous years. Stores were groaning with excess inventory and finally had to curtail further purchases, the lawsuit alleges, which it said led to a sharp drop in Bauer and Easton sales in late 2015 and early 2016.

"The defendants represented to the market that these 'record-setting' figures were the result of 'organic sales growth' and their ability to leverage the PSG platform to achieve cost efficiencies," the lawsuit said. "In reality, they were the result of manipulative sales tactics that the defendants knew were not sustainable."

The claims have not been proven and the case has not proceeded to a trial.

PSG has said little about the allegations. Lawyers for PSG, now president of brands Mr. Rosenthal and Mr. Davis have filed a joint motion seeking to have the case dismissed because there are no grounds to support the claims. Their application says there is nothing inherently improper in the sales techniques outlined in the complaint.

"Persuading customers to place large orders, book early, and accept delivery of merchandise ahead of schedule are hallmarks of a thriving enterprise and do not, standing alone, suggest that anything improper – much less fraudulent – is afoot."

However, Mr. Rosen, the accountant, reviewed PSG's financial statements and believes some accounting irregularities were "glaring" and "detectable" all along. "You have tons of inventory-on-hand compared to what you're selling, you've got tons of receivables, you've got this garbage with goodwill" for Easton, he said. "You've got three strikes. In baseball, you're out."

PSG revealed in August that its audit committee had initiated an internal investigation into its accounting practices.

Streetwise: Performance Sports in talks with Fairfax, Sagard Capital Fairfax recently acquired another struggling sports equipment company, buying Canada’s largest golf retailer, Golf Town.

Financial players circling

Surrounded by storm clouds, PSG is scrambling to cut costs to manage its $440-million debt.

In July, the company said it would consolidate the entire baseball and softball business at Easton's new facility in California, leaving it with no distributor in Canada. In early August, PSG said it had cut 15 per cent of its work force since the end of May, while many other employees have left since then.

The uncertainty about PSG's future also appears to be adding to the company's sales problems.

Mr. Davies, from rival equipment maker Winnwell, said his firm has seen sales climb at Bauer's expense because retailers don't want to rely too heavily on Bauer for 2017 merchandise orders in case its problems create delivery challenges.

"It causes people to be conservative and somewhat cautious," he said. Several hockey retailers who spoke to The Globe said they are shifting their stock away from Bauer gear toward other brands, although others said they've made no changes and like the 2017 product line.

"Knowing that their plan is to have a store next to ours, of course we don't want our customers to continue to want Bauer product," said an executive at another U.S. sporting-goods chain. "That's just going to give them another outlet to purchase the product." Mr. Rugal added he is carrying must-have Bauer products that customers want the most, but for goods that are not brand-sensitive, like neck guards or laces, "I don't have to buy from them. And I won't any more."

PSG said in August it retained U.S. investment bank Centerview Partners LLP to advise on negotiations with its lenders and explore its strategic alternatives.

Financial players are now circling, believing PSG is bargain-priced and can be rescued.

PSG's largest shareholder, Sagard Capital Partners LP, which owns 17 per cent of the stock, has teamed up with Canada's Fairfax Financial to pursue PSG together. Sagard is a U.S. private investment firm owned by Canada's wealthy Desmarais family. .

In September, Toronto-based Brookfield Asset Management Inc. also emerged as a player in the drama, disclosing that it had purchased a 13.2-per-cent stake and media reports say it is weighing a takeover bid of its own.

If a white knight doesn't emerge , PSG may find more value in selling its brands in pieces.

Dave King and Nicholas Meyers, research analysts at Roth Capital Partners LLC, peg the value of its brands at $1-billion, with the hockey business accounting for about $650-million. The company knows the lion's share of its worth is tied to the Bauer brand, with former CEO Mr. Davis telling investors in March: "If we take our top-selling ice-hockey skate and we put a Nike swoosh on it, we will sell 40 per cent less."

This resonates with deep-pocketed investors, who believe the Bauer and Easton brands are iconic and still command deep customer loyalty.

"If little Timmy and Johnny playing hockey want Bauer skates," said one of PSG's American institutional shareholders who asked to remain unnamed, "bad blood between retailers and a supplier isn't going to get in the way."

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