Billabong’s Half Yearly Report: Starting Over

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Billabong reported their financial results for the six months ended December 31, 2013 last Thursday. I’ve been diving into a hoard of details they posted. After all of that, I think I’m going to end up spending a lot less time than usual on some of those details. 

That’s because I largely agree with a couple of comments from Billabong management in their conference call. I’d like to start by sharing those with you. 
 
Early in his comments, CEO Neil Fiske said, “…18 months of leadership distraction and organizational turmoil, which impacted all our brands. It is important to recognize that the company’s protracted transactions process hit the Americas region particularly hard. First, by creating a long gap in leadership and subsequently, a significant loss of talent.” 
 
He goes on to describe the people they have hired, are hiring and have still to hire. Later on he notes, “During the next six months we expect to complete our portfolio review, looking at each brand’s growth plan and fit with our longer term strategy. We will also initiate work on the brand books as guiding documents that are the cornerstone of a new brand management system.” 
 
Then CFO Pete Meyers, talking about the six months results, says, “Overall a mixed result as Neil has outlined, but somewhat ancient history in the context of the opportunity to reform this business in the years ahead. By the way, you’ll notice that my slides are in the old format and that’s symbolic as they deal almost exclusively with the old Billabong and that the results today predate any impact of the turnaround plans that we’ve shared with you and next time they’ll be in the same style as Neil’s.”
 
Meanwhile, there will be a major (that is not a strong enough word) and really intriguing reorganization of the company. The Billabong, Element and RVCA brands will each get a global head responsible for global merchandising and marketing. They will each report to the CEO and be responsible for the brand’s income statement. 
 
However, says CEO Fiske, “…we are not centralizing design or merchandising into any one region. Rather, we are leaving design, merchandise and marketing teams in each region to be close to the market, fast and highly responsive to local customer needs.” 
 
There will also be regional presidents for each of the Americas, Asia Pacific, and Europe to“…drive sales distribution and channel development in their respective geographies, while providing critical input on customer needs back to the brand teams. They will drive the go to market model for each country based on a newly defined tiering system. Regional leaders will also take responsibility for growing the smaller emerging brands, for example Tigerlily in Asia Pacific or VonZipper in the Americas.”
 
The third piece of the organization contains the global functions. These will include the CFO, a chief operating office, somebody in charge of human resources and, most interestingly to me, “…a turnaround office leader focused on cost takeout and accelerating the impact of key initiatives.” 
 
The gentleman they’ve hired in that role (Bennett Nussbaum) has an impressive background in turnaround management and clearly doesn’t need a job. It will be interesting to see how he interfaces with the organization to keep it turnaround focused and how long this job lasts. I’d be curious to know if he reports to Neil Fiske or directly to the Board of Directors. I can imagine him ranging all over the company with quite a degree of discretion. I don’t recall ever hearing about a company hiring a turnaround manager who wasn’t the person in charge, but I think it’s a great idea in these circumstances. 
 
“The objective of the global support functions is to build global scale capability and efficiency, driving our cost down so we can reinvest in the brands. We can no longer afford to have three regional supply chains, three regional IT structures with different systems, five different direct consumer technology platforms, high cost logistics in fulfilment and underdeveloped human resource management.”
  
They are going to rely on these cost reductions to fund expanded brand marketing. Finding those cost reductions is part of the responsibility of the Turnaround Office. Their balance sheet doesn’t really give them another choice.
 
When I was in business school (which is beginning to feel like it was shortly after the second Crusade), they described this kind of organization as a matrix. Which I think is a great way to describe it, because there are definitely going to be some people who wake up and find out they’ve been living in a dream world. 
 
The positive thing about a matrix organization is that it can facilitate good communications and group the right people to work on an issue. The potential problem is that roles and relationship are sometimes not completely clear. What happens when what the head of the brand wants to do conflicts with the ideas of the regional president? Every organizational structure has its strengths and weaknesses. A matrix structure can be less efficient at decision making. You manage that through constant communication and developing mutual respect and trust. As was noted somewhere in the conference call, I’d love to have the frequent flyer miles these people are going to rack up. 
 
There are additional changes and reevaluations going on across the company at various levels. You can see why I’m not as focused on the historical financial statements as I might usually be. The company that is going to emerge over the next year or three isn’t going to look like the one that produced these six months results. Lots of different people. A new organization and reporting relationships. A focus on “…fewer, bigger, better stories that cut through the clutter and better align to our key merchandising programs.” Probably fewer brands in total. A reorganization of the marketing function. Fewer SKUs, fewer factories. There’s a lot more. With every month that passes, it’s going to resemble less and less the company who’s financials I’m discussing here. 
 
But it’s not in my nature to ignore those results, so let’s move on to them now. Remember the numbers are in Australian dollars. 
 
First, let’s look at the numbers as reported on the financial statements. These include brands that were sold during the year (Nixon, Dakine) as well as a bunch of expenses Billabong characterizes as “significant,” meaning they had to do with the refinancing and restructuring and the big general mess they had to manage. As I’ve said before, I don’t believe that just because you screw up you get to exclude certain expenses from your operating results on, I guess, the promise that you’ll never screw up again. 
 
Sales from continuing operations rose 3.2% from $563 million in the prior calendar period (pcp) to $580 million. Gross profit margin fell from 54.9% to 53.6%. The pretax loss from continuing operations was $40 million compared to $439 million in the pcp. Operating expenses were up a bit, but what stands out is that last year’s income statement had Other Expenses of $513 million largely from the write down of the brands and goodwill. The number this year was $61 million in charges. Last year’s finance costs, however, were just $10.3 million compared to $57.3 million in the current period. After discontinued operations, we have a bottom line, after tax loss of $126 million compared to a loss of $537 million in the pcp.
 
Here’s how that breaks down by region as reported, including discontinued operations and significant items. 
 
 
 
Let me point out that the segment EBTDAIs excludes the impairment charges. That’s the “I” on the end. The reason I’m telling you that is because the numbers from the presentation that came with the conference call, which I refer to below, talk about EBITDA. There ain’t no “I” on the end. I’m going to assume that’s a typo, because the segment numbers are the same in both places. 
 
The big problem, you can see, was in the Americas. “The result,” they tell us, “…reflects weakness in the Canadian market, smaller brands & South America.” We’re specifically told that Sector 9’s revenues were down 20% in the Americas. They also point to what they call “operational instability” in the region due to personnel changes and general uncertainty. “…we believe,” says CEO Fiske, “the decline in the Americas result has much more to do with the organizational turmoil and loss of talent associated with the 18 months of protracted deal related distraction than any underlying issues with the strengths of the brand.” 
 
There was an as reported EBITDAI margin of negative 5.7% compared to a positive 4.2% in the pcp. For their continuing business, EBITDAI margin fell from a positive 8.7% to 4.7%. 
 
Things look better in the Australasia region, where the reported EBITDAI margin rose from 5.3% to 6%. For the continuing businesses it was up from 11.8% to 12.6%. They closed some stores, but took out some costs to get the improvement. Comparable store sales were up 3.2% including online sales. 
 
In Europe, the reported EBITDAI margin deteriorated from (0.5%) to (8%). For the continuing business, it fell from (2.5%) to (3.5%). They point, like everybody else, to the lousy macro-economic situation in Europe and the expected startup losses of Surfstitch. Brick and mortar comps in Europe were up over 5%.  They still see some softness in the Billabong brand. 
 
At December 31, excluding the West 49 stores, Billabong had a North American store count of 66. There were 112 in Europe and 252 in Australia.
  
Next, from their presentation, is the chart that includes the “as reported” results and then removes significant items and discontinued businesses and gets us to the continuing businesses results they’d like us to focus on. 
 
 
 
As long time readers know, I tend to prefer the as reported numbers (statutory results as they call them in Australia) because they don’t allow for finagling. In this case, because the refinancing has gone on so long, cost so damn much, and had such a destructive impact, I think maybe looking at the continuing business is the right thing to do. 
 
Except for some of the significant items where it looks to me like finagling happened. Here’s the list of significant items. 
 
 
 
You can look at the list and decide for yourself which it is or is not okay to exclude. My point of view is that things like “inventory clearance below cost,” “redundancy costs,” maybe part of the financing costs and perhaps part of others are hard to justify excluding. You’ll note that by excluding them they managed to show a small profit from continuing businesses of $3.9 million. If I were a suspicious person, I could conceivably think they figured they might as well exclude stuff until a profit appeared. And honestly, I might have done the same thing. 
 
Over on the balance sheet, equity has fallen to $194 million from $618 million a year ago. Cash is up, and inventory and receivables are both down. How much of the declines are the result of the sale of brands and how much from better management is hard to tell. The current ratio has improved, but that’s because the refinancing transferred current liabilities for borrowings to non-current liabilities. Current borrowings were at $9.5 million, down from $280 million at the end of the prior calendar period. Total liabilities, however, rose from $674 million to $765 million. 
 
Cash generated from operating activities went from a positive $29 million in the pcp to a negative $27 million in the six months ended December 31, 2013. That’s almost completely due to the costs of the refinancing they tell us.
 
As you are probably aware, Billabong is in the middle of a rights offering which, if successful, will improve their balance sheet. 
 
So much for not spending too much time on the financials. Let’s start to wrap up with a comment by CEO Neil Fiske in response to an analyst’s question. 
 
“So what is important, I think, to all of our brands is that they have authenticity with the core of the market. It is a little bit of a paradox in the sense that when we focus on the core of the market and we grow relevance, share and aspiration with that core the brands become more widely appealing. So really our strategy is to focus narrowly, but create brand positions that are so well-defined and aspirational that inherently they have broad appeal.” 
 
A week or ten days ago, I wrote about some similarities between Billabong and Quiksilver. I suggested that what we had to watch for were clues to what products they were going to sell to which customers. Neil’s put it more eloquently than I did. And he’s focused exactly on the correct and most difficult management task. 
 
Long time readers will know I’ve asked the question, “Can you stay credible as you broaden your distribution?” I’ve suggested that the further away you get from the core, the harder it is to stay credible and compete because the more likely it is that the customer may know your brand, but not your story. And the story is the brand’s single most important point of differentiation. 
 
Goldman Sachs analyst Phillip Kimber asked a related question I really liked. 
 
“One of the key things in managing a brand is being very tight on the distribution in which it’s released to. I’m just wondering if that’s an issue that will be part of this turnaround –i.e. you may have to drop sales materially because you choose not to service them because you’re looking to strengthen the brand as a result. Is that part of this turnaround? 
 
Here’s Neil’s answer: 
 
“One of the things I think that we do have in our positive column is that we’ve really focused on quality of distribution, over the last couple of years in particular. As you recall we got a little sideways a couple of years ago in the US in particular with sales to the Closeout Channel. We’ve cleaned up a lot of that distribution and we are really focused on quality distribution channels. I think within the trade we are seen as having not over extended the brand and have kept our distribution quite clean and brand appropriate.”
  
He didn’t exactly answer the question, except to say he thinks they’ve done a good job with distribution recently. But it’s a big part of the what do you sell to which customer question. Right now, in the middle of a turnaround where cash flow and brand building are probably more important than sales growth, and where public market expectations may be lower, is a great time to be cautious in distribution and build the brands for the future.

 

 

Billabong and Quiksilver; Two Peas in a Pod

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Billabong’s announcement last week that it was, among other things, conducting a strategic review of SurfStitch and Swell caused me to focus on the similarities of its situation to Quiksilver’s. It also made me realize that most of what has been discussed publically by both companies is what I’ll call mechanical issues. I want to remind you what those are and then move on to the way more important and difficult to manage strategic issue they both face but, understandably, don’t spend a lot of time talking about in public. 

We all know that both Billabong and Quiksilver got into trouble due to some acquisitions they paid too much for, their aggressive forays into retail and their tendency to allow units to operate independently, resulting in an unsustainable cost structure.
 
I think those things would have come back and bit them in the butt even if the economy hadn’t cratered, but the teeth marks wouldn’t have required as many stitches. With their balance sheets out of whack, both had to sell assets, raise expensive capital, change management, cut costs, push for revenue in ways they would (I hope) have preferred not to, rationalize their sourcing and reduce SKUs, consolidate and coordinate design and marketing, and revise and upgrade their information systems.
 
Now, I call those things mechanical. That’s not to suggest they were easy to do, or that exactly what to do was always obvious. But nobody doubted they had to happen (and outside stakeholders didn’t give them a choice anyway). That gives you the refreshing liberty to say, “Let’s get at it!” and start without too much analysis. There was, to use one of my favorite phrases, some low hanging fruit.
 
The process isn’t complete (it’s never really complete- it’s a long term way of thinking), but it’s well underway. Both companies will see significant improvement in their bottom lines as a result.
 
So let’s move on to the hard part. What brands should sell what product to which consumer? I’m sure I could figure out a more erudite way to say that, but why bother. They had to start to address the mechanical stuff before they could really focus on market segmentation (there- that’s a more erudite term) because some of it represented survival issues. It’s hard to care which way you’re rowing when there’s a big hole in the bottom of the boat.
 
Part of the process of keeping the boat floating through the restructuring was to press for sales in places and in ways they didn’t want to do. I assume it helped in the short run- perhaps not so much in the long run. Both companies have some recovering to do from distribution decisions they made while managing those short term survival issues.
 
In the long term, the ONLY THING THAT MATTERS competitively is their ability to figure out the market segmentation thing. The mechanical stuff is necessary but not sufficient. The what product to sell to which customer issue is existential. If they don’t do that well, they’ve got no business or at best a dramatically different business. “Dramatically different” is code for a brand that doesn’t do this well and finds itself milking its market credibility with cheaper product in broader distribution until there’s nothing left.
 
Both companies want to grow the top as well as the bottom line. (What?! Public companies focused on top line growth?!  Shocked! I’m shocked!) If they could, at least for a while, just worry about improving the bottom line (and the balance sheet) their jobs would be a whole lot easier. The mechanical issues, as I so blithely call them, are simpler to manage. And as I’ve written, market segmentation takes care of itself initially though distribution management which builds brand strength for future growth.
 
But you can’t do that for too long. You risk finding yourself stuck in a niche you can’t get out of. For some brands, that wouldn’t necessarily be a bad result. It’s difficult for Quik and Billabong because that market niche might tend to be a predominantly older customer group that has been loyal to the brand for a long time but will inevitably buy less.
 
Their challenge over the longer term is to continue to appeal to their traditional customer groups (if only for the cash flow) while also reaching the younger demographic they have to evolve towards. Not easy.
 
So that’s why I perked right up way back when Launa Inman became Billabong’s CEO and, in her initial presentation of her strategy, talked about the need to figure out what the brands stood for and how the customers and potential customers perceived them. Billabong proceeded to spend a lot of money on that issue. We never heard the results, but why would we? You can tell all your competitors that you’re cutting costs, improving systems, reducing SKUs and consolidating certain function. They’re doing it themselves and are probably wondering why you didn’t get on with it sooner. But I can’t think of any good reason (outside of a brain tumor or psychotic episode) why’d you’d share findings about what customers think of your brands, why they buy them, and how you’re planning to position those brands.
 
Part of that evaluation will determine product direction. It’s fair to say that when you’re trying to keep a company alive, you aren’t likely to take a lot of product risk if only because you can’t afford things that don’t work. But armed with their evaluations of who’s buying what product and why, I would expect to see both companies be more aggressive with product development and introductions. The consolidation of those functions from regional to worldwide should make that easier by making it more cost effective. It’s time to take some risks.         
 
Most of us think it’s important that Billabong and Quik do well because they are positioned to represent the surf industry in the broader market. It seems to be an industry article of faith, practically a mantra, but it has the ring of truth to it.
 
I’m not sure any more what “the surf industry” means. Don’t feel bad surf people. I feel the same way about other segments of action sports and, by the way, am not quite sure what exactly the action sports market is either.
 
But recognize that neither Billabong nor Quik is a pure surf company in the way they were years ago.   The “core” surf market is way too small to support much growth for either company. Anyway, that seahorse left the barn years ago when they both acquired non surf brands that represent significant percentages of total revenue.
 
I will always look at the numbers (I can’t help myself). But the numbers, by the time we see them, only tell you what has already happened. As I try and figure out how Quik and Billabong are going to do, I’ll be looking for clues to their product and market segmentations decisions, because at the end of the day, that’s mostly what’s going to matter. And not, you might consider, just for Quiksilver and Billabong.

 

 

Thoughts from the SIA Show

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So I confess. I’m from Seattle and there was no way in hell I was going to be on a plane Sunday while the Super Bowl was on. I left Saturday. But in my two days wandering the show, I had some thoughts I wanted to share with you. 

There was a bit more of a somber attitude at the show then I’ve ever noticed. Everybody I talked to seemed to feel the same way. I particularly noted that the noise/crowd/enthusiasm difference between snowboarding and the rest of the show wasn’t as I was used to. That doesn’t mean there wasn’t a lot of business being done- my sense is that there was. I’d also note that the “core” (still hate that term) snowboard hard goods brands were interspersed with some large booth from brands I’d label as tangential to snowboarding and the snowboard ghetto, as we’ve come to call it, was more spread out. Perhaps that accounted for it. That’s probably a good thing. It recognizes market realities.
 
There were also business reasons why the mood was different. The apparent ongoing decline in snowboarding, a recovering, but still weak economy,  lack of California and Northwest snow, some negative publicity for snowboarding (deserved or not?) and issues of inventory may have had something to do with it.
 
Which brings me to distribution. Everything always seems to bring me to distribution in this industry. At the risk of oversimplifying (I get to do that because I don’t have to actually run a winter business any more), to make money in winter sports, you have to plan for what you think is an average winter in your market and produce/buy 10% (or 15% or 20%?) less than that. You make/buy only what you think you can sell at full margin during the season.
 
You do not wail and gnash your teeth when you run out of inventory and can’t fill reorders when it dumps late in the season. You just calmly remind the buyer to order more in preseason next year (or tell the customer to come in sooner if you’re a retailer) and thank your lucky starts that your inventory is clean.
 
Because the absolute best way to guarantee you don’t make money in winter sports is to have a bunch of left over inventory you have to close out. Not only do you make little to no money on that inventory, but it might have cost you a full margin sale at some point in the future.
 
That’s a particularly important point when all product is good and there’s no reason to replace it very often (On the plus side that reduces the cost to participate). There are fewer chances to make a sale than there used to be. I talked to a couple of industry types who had been offered free boards by brands and actually turned them down. They just didn’t need them and didn’t want to break in a new setup. Getting a new board for free was too much trouble, which sounds strange when I say it.
 
 My point of view on distribution and making money in this business seemed to be validated when I talked to three established snowboard brands who manage their production and distribution carefully. They’d all had issues with west coast retailers who couldn’t move product because of lack of snow. But the brand’s inventory was clean. So clean that they had trouble filling reorders from places with snow. Their solution, which worked because their inventory was clean, was to take the product from the first retailer and move it to the second.
 
Maybe the no snow retailer didn’t really want to give up the inventory even though they couldn’t pay. They just asked for big discounts to keep it. And maybe the product coming back doesn’t exactly match what the retailer with snow wants. Maybe the opportunity happens too late in the season to pull it off. Maybe some other stuff too. There is definitely friction in the process and some cost.
 
But at least these brands had the potential opportunity to take back some inventory and place it with somebody who could move it at full margin. They weren’t in a fight to be paid with a customer they wanted to keep for next season, and they’d made another customer very happy. Maybe there was some margin given up, but it was a lot less than if you had to close the stuff out.
 
This opportunity only existed because the brand was deliberate and cautious with inventory in the first place.
 
I also had occasion to talk with Jono Zacharias who, last time I updated my Outlook, was SVP for Global Sales at Westlife Distribution (686). He told me, speaking of distribution, something interesting. Apparently their best-selling pieces were the same in Europe, Canada and the U.S. this year. And their dogs- uh, I mean styles that didn’t sell quite so well- were the same in all three geographies.
 
I’m hypothesizing that says something about the internet and social networking. My sense is that wouldn’t have been the case a few years ago. Maybe it’s just a coincidence (it wasn’t true with Japan). If I were Jono, or a sales manager for another brand, I might go back a few years and check that out.
 
First, of course, you have to have the systems to do that. I’ve noted in my various articles all the companies spending money on systems to accumulate, integrate and analyze sales and inventory data. If there is some growing cohesiveness among styles and trends across geographies, then the implications for production, distribution and the numbers of SKUs you need could be significant. Just something to think about.
 
You know what? In spite of our industry’s macro problems, snow sliding is still FUN and SIA’s show does a great job reminding us of that. We’ve got something good to sell. The pace of change is disconcerting, but that usually means opportunity. Let me know if there’s a geographic convergence among your successful products. What can you do with that to run your business just a bit better?   
 
          

 

 

Intrawest Officially Trading as a Public Company. What’s the Impact?

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As many of you know, Intrawest, the owner of Steamboat, Winter Park, Tremblant, Stratton, Snowshoe, Mammoth, and half of Blue Mountain, started trading as a public company on January 31. The initial offering price for the stock was supposed to be $15 to $17, but it ended up going public at $12 in a soft stock market where fear of the Fed tapering and its impact on certain developing countries is taking its toll. As I write this Monday morning, the stock is at $11.78 at 9:40 AM Pacific time with the whole market taking another drubbing. The trading symbol is SNOW, which kind of makes sense.

I explained the rationale for the public offering a couple of weeks ago in this article. To summarize, they are great at running resorts, but the real estate crunch did them in. It left them with an untenable debt burden and they are resolving the problem by having most of the creditors agree to convert their debt to common stock. I guess I think they would have preferred another solution, but didn’t have one.
 
When I wrote my initial article, I did it based on an SEC filed S1 which didn’t have all the numbers filled in. That’s standard procedure. Now, with the company actually public, there’s a final prospectus with all those numbers, and I thought I’d point out a few things. You can see that document here.
 
The selling price is $12.00 a share, but the underwriting discount is $0.78 a share, so the selling shareholders get $11.22 a share before the costs of doing the deal.
 
With the deal done, the “initial shareholders” control 65.3% of the common stock. Those shareholders are all controlled by the Fortress Investment Group. For this discussion, you can pretty much think of Fortress as the seller of most of the shares.
 
As part of the deal, Fortress converted about $1.4 billion in debt to equity. Intrawest itself sold 3.125 million shares and will receive about $32 million. The initial shareholders sold 12.5 million shares and are receiving (probably on February 5th) about $140 million. To be clear, that $140 million is not available to Intrawest for operations. It goes to the entities who converted their debt to equity.
 
Let’s see what Intrawest has accomplished financially by doing this deal, starting with the income statement.
 
For the years ended June 30, 2011, 2012 and 2013, Intrawest reported net losses of $499 million, $336 million, and $296 million respectively. Yet in those same years, they had positive cash flow from operations of $21 million, $43 million and $42 million respectively.
 
If you look at the expenses for those years, you’ll see all kinds of noncash expenses for losses on sale of assets and impairments of goodwill, real estate, and long-lived assets. They are particularly big in 2011, and decline thereafter. The loss from operations is $197 million in 2011. It falls to $19 million in 2012 and is a positive $3.5 million in 2013.
 
But below the operating line is interest expense. Here’s the numbers for the three years in millions of dollars.
 
Interest expense on third party debt                     (143,463)             (135,929)             (98,437)
Interest expense on notes payable to affiliates    (160,943)              (195,842)             (236,598)
Total Interest                                                      (304,406)             (331,771)             (335,035)
 
That, I think, can be characterized as a lot of interest and the bottom line, as indicated above, reflected it. What’s the impact of getting rid of it which, after all, is the purpose of Intrawest going public?
 
In a pro forma income statement they provided, which assumes the deal is done (it is done now), interest expense in the year ended June 30, 2013 falls from the $335 million shown above to $48 million. Net income goes from a loss of $296 million to a profit of $5.4 million. Quite a difference.
 
With the assets all written down to a reasonable value and interest expense reduced dramatically, Intrawest can now go about making money running resorts. That’s not a slam dunk, but it’s lower risk than mountain real estate right now. And who knows, maybe there will be a time in the future when those now low valued assets will be worth a bunch again.