Archive for month: September, 2012

I refer to this as the “big bath” approach. That is, if things look bad and your audience is going to hate what you tell them anyway, might as well get all the bad news you can identify behind you. This is good because not only does it mean fewer negative influences going forward (both financially and in terms of management focus) but there’s a reasonable chance that some of these assets you’ve written down will turn out to have some value that will go right to the bottom line in future periods.

 

A really good time to do this is when you have a new Managing Director and CEO coming in and, as you’re aware, Launa Inman joined Billabong on May 9th, coming from Target Australia (no relationship t Target in the U.S. except that they license the name.

 

CEO Inman presented her strategic plan for the company, and I’ll get into the details below. Much of her approach is what I’d call blocking and tackling. That, by the way, is a very, very good thing. It’s fundamental, but it’s critical. Those of you who have followed my suggestions for how companies should be approaching a lower growth, consumer centric environment won’t be surprised that I like what she proposes for Billabong.

 

 

Here are a few things to keep in mind as we go through this. First, all the numbers are in Australian Dollars unless I say otherwise. Second, “pcp” means prior calendar period.   Third, The Australian Dollar is worth US$ 1.03 today (August 31). On June 30, it was worth US$ 1.016. Fourth, if you want to review the financial report, conference call transcript, or the slides for the fiscal year review or new strategic plan, you can find them here.

 

 

I imagine most of you were hoping to find out what’s going on with the July 23^rd offer from TPG International to buy Billabong for $1.45 a share. Me too. But all we found out on the conference call was that the confidentiality agreement had been signed and the due diligence commenced. However, in footnote 41 on page 123 of the financial report, I did find the following:

 

“There is no guarantee that, following the due diligence process, a transaction will be agreed or that the Board will recommend an offer at the current proposed offer price. In fact, the Board does not believe that the proposal reflects the fundamental value of the Group in the context of a change of control transaction.”

 

Billabong’s board of directors doesn’t think $1.45 is enough. As you’ve probably noticed, there’s some speculation that other buyers might be out there lurking in the lichens. This will be interesting to watch.

 

 

Here’s the broad brush. Billabong lost $276 million on revenue of $1.44 billion. Last year, they earned $119 million on revenue of $1.56 billion. Cost of goods sold rose from $728 million to $765 million. Gross margin fell from 53.3% to 47%.

 

I’m going to go ahead and present some of the other income statement numbers, but starting with sales, I’m going to go back to clarify and explain a bit.

Selling, general and administrative expenses (SG&A) rose 14.2% from $564.7 million to $645 million. Other expenses rose 275% from $144.8 million to $544 million. Last year’s pretax profit was $88.7 million. This year’s pretax loss was $522 million. There was an income tax benefit of $40 million this year and you have to then add in the $206 million gain on the sale of 48% of Nixon to get to the net income number.

 

Billabong operates in three segments. Australasia includes Australia, New Zealand, Japan, South Africa, Singapore, Malaysia, Indonesia, Thailand, South Korea and Hong Kong. The Americas is the U.S., Canada, Brazil, Peru and Chile. Europe is Austria, Belgium, the Czech Republic, England, France, Germany, Italy, Luxembourg, the Netherlands and Spain.

 

The Rest of the World “…relates to royalty receipts from third party operations.” I conclude that the countries listed in the three segments are where Billabong has its own operations. The royalties were $2.6 million during the year.

 

Here’s the revenues and EBITDAI for the three segments for the last two years. 

 

 

I know most of you know this, but EBITDAI is earnings before interest, taxes, depreciation, amortization and impairment charges. Call it the operating result. The impairment charges total $343 million. We’ll discuss them below.

 

Now, the plot thickens. Billabong adjusts the numbers above to “…exclude significant and exceptional items…” These are “…items associated with the strategic capital structure review…” 

 

“Significant income and cost items associated with the strategic capital structure review includes

but is not limited to, doubtful debts, inventory write downs and redundancies partially offset by the gain on sale of 51.5% of the Nixon business (significant items). Exceptional items include other costs and charges associated with certain initiatives outside the ordinary course of operations (exceptional items) (collectively significant and exceptional items).”

 

Here’s the numbers for the recent year with those items removed. 

 

 

It’s a miracle. Instead of an EBITDAI loss in its three main segments of $74 million, Billabong shows an EBITDAI profit of $118 million and a net income of $33.5 million instead of a loss of $275 million.

 

There is justification for making some of these adjustments, and I’m not against trying to show a true picture of operating results. But I’m not quite certain how bad debts and inventory can be removed from operating results. I mean, if some of the inventory ain’t worth much, and you can’t collect the receivables, that’s pretty much about how you operated I think. 

 

I guess the argument is that they identified and took these write downs because of their strategic review, and are starting fresh, have a new CEO, and just want to clear the decks (see “the Big Bath” discussion at the start of the article).

 

In the Australasia segment, they note that “Sales…increased over the pcp principally as a result of the inclusion of a full year of trading for the prior year acquisitions of SDS/Jetty Surf and Rush Surf in Australia.” I conclude revenues would have been at best even without that acquisition related revenue. They mention as factors reduced June shipments and a highly promotional environment. Australia represented 65% of the total segment revenues.   

 

In the Americas, they point to wholesale and retail performance in Canada as a major reason for the reduction in EBITDAI margins. They note issues with West 49 on a couple of occasions. The U. S. was 59% of this segment’s total revenue.    

 

They talk about the impact of sovereign debt issues in Europe having “… a significant adverse impact on consumer confidence and demand, especially in southern European territories…” The result was delays in shipments, weak in-season repeat business, and soft trading conditions in their owned retail. CEO Inman noted that Billabong has historically been very strong in Southern Europe. Unless you live under a rock somewhere, you know that things are pretty bad there. The comment in the conference call  that about 25% of their accounts in Europe having closed was indicative of the situation. France, interestingly, is 83% of the European segment’s total revenue for the year ended June 30, 2012 which further illustrates how bad Southern Europe must be if it can have the impact.

 

Wholesale revenues were $1.07 billion. However, that includes sales to owned retail. If you eliminate sales to owned retail, you get down to wholesale revenue for the year of $831 million. Retail revenues were $719.6 million. Billabong had 634 company owned stores at year end. Same store sales grew 1.4% in the U.S., but fell 10.4% in Canada, 1.9% in Europe, and 3.7% in Australia.  

 

Let’s move on now and look at expenses.

 

The cost of goods sold amount includes $73.5 million of the “significant” items. This includes both a loss on inventory already sold as well as an allowance for writing down inventory that is “realizable below cost.” Total June 30 inventory was $293 million, so that’s a pretty big number. It also goes a long way towards explaining the decline in the gross margin.

 

There’s a pretty long list of “significant” items included in the general and administrative expenses. I thought the best thing to do was just pull the list from the financial report.

 

 

There was another $6.5 million as well, bringing the total to $117 million.

 

As noted above, SG&A totaled $645 million for the year including this $117 million. The $33 million doubtful account expense is a result of their decision to stop working with certain wholesale accounts. That decision, Billabong believes, means the receivables are less likely to be collected and so they’ve taken a provision for them.

 

Billabong closed 58 stores during the year ended June 30, and expects to close an additional 82 during this year. That explains the early termination expense of $58 million.

 

Just to remind everybody, most of these large expenses (and the inventory charges) ultimately free up working capital and reduces annual expenses. So while it hurts in the period you take these charges, it’s a continuing benefit in future periods.

 

Down in other expenses there’s a $343 million charge mostly for impairment of goodwill, brands and intangibles. This is a noncash charge, but it is a real indication of declining expected cash flow and value of the assets.   Along these, lines we see in other income a credit of $22 million for a reduction in already booked earn outs for acquisitions.

 

Equity on the balance sheet fell as a result of the loss from $1.196 billion to $1.027 billion in spite of the gain on the sale of Nixon and the equity raised. But total liabilities fell by 47% from $834 million to $441 million. The total liabilities to equity ratio stayed constant at 1.02 times.

 

Cash rose from $145 million to $317 million but the current ratio deteriorated, going from 2.34 times to 1.47 times. However, that’s mostly because current borrowings rose from $15 million to $229 million, while longer term borrowings fell from $597 million to $249 billion.

 

Receivables fell by 34.5% reflecting in part the elimination of Nixon receivables as well the write down of $33 million for doubtful accounts. Impaired receivables rose from $21 million to $52 million over the year. Just because it is classified as impaired doesn’t mean all or part of a receivable won’t be collected. Billabong increased the provision for its impaired receivables from $20 to $40 million.

 

I guess the way to look at the financials- and especially all the write downs and impairment charges- is to say that they represent an acknowledgement of some mistakes made and opportunities to do some things better.  The question then becomes if they have identified the mistakes and what are they going to do differently. That takes us to CEO Launa Inman’s strategic presentation.

 

I thought the meat of the presentation started when she looked at Billabong’s challenges. Externally, these were the “unprecedented macroeconomic environment,” the impact on the Billabong brand of the shrinking account base, and the strength of the Australian dollar.

 

Internally, the challenges she focused on included the organization’s inability to keep pace with its global expansion, the poor performance of the Billabong brand, problems in implementing the retail strategy, and issues with the supply chain costs and responsiveness. That last one includes not just where you have stuff made, but how you move it and how you manage your inventory. It has a lot to do with information systems, or the lack of them. 

 

I want to make two points here. The first is that the internal challenges would have been, and were, challenges even if the external ones hadn’t been as severe. Cash flow and fast growth, I’ve said a time or two, covers up a lot of problems. When the good times ended, the problems became harder to ignore and got meaningful quickly.

 

Second, Billabong had tended (before West 49) to acquire strong brands with solid management and, I’m told, let them run pretty independently. I liked that approach, but you can see how it could create some inefficiencies a company can’t afford when times aren’t quite so good even if the management teams at each company ran their brands well. CEO Inman noted, “One of the things we as an organization have is great entrepreneurs who really understand the customer in many ways but yet at the same time we’ve never really analyzed the data to ensure that everything we do going forward has facts and is fact based so that we can make clear and concise decisions. “      

 

They started to address their challenges by collecting some information. They spent $20 million on consultants doing it. I like the sound of that.   They measured the size of their markets. They did extensive customer research in the U.S., Australia, and France. They did it for all their brands and for snow, skate, and surf. Who are our customers, how do they perceive us, and why do they buy from us Billabong wanted to know. CEO Inman noted, “This was in fact the first time that this research has ever been actually done.”

 

Part of their work with consultants was “… to have a real deep dive into the profitability of the brands, of the actual retail outlets, the supply chain and also even look at the opportunities of e-commerce.”

 

How you can run a business without that information (as best you can get it) is beyond me, and I think it’s great they started with this research even at a time when money was tight. You can’t fix it if you don’t know what’s broken, and an objective, outside, opinion not based on anecdotal evidence is a good place to start.

 

Billabong, as part of its research, benchmarked itself against leading brands (not just in action sports) to see where it stood. Among the things they found out was that “…We had the highest awareness within the board sport market but yet for all that we weren’t really differentiated.”

 

So what are they going to do? They’ve got short, medium and long term plans and you really ought to review the presentation yourself at the Billabong web site. This damned article is already 2,500 words and I’m not done yet. I hope somebody actually reads this far.