Billabong’s Annual Results: Progress on a Long Road

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As I recall, the report I wrote on Billabong last year broke the 4,000 word barrier. I’m probably the only person who read the whole thing. But there was chaos and uncertainty last year and it seemed necessary to explain everything that was going on. 

As of this year’s end at June 30, there’s still chaos and uncertainty, but the chaos is more positive in the sense that it’s self-generated as Billabong’s new management team restructures pretty much every function and activity in the company in pursuit of a more efficient and competitive organization. The uncertainty is around how quickly they can get it done and just what the impact will be.
 
Before we get started, here’s the link to Billabong’s investor relations page.   Under “Featured Report” you can view, from top to bottom, the financial report, the presentation CEO Neil Fiske used to explain the results, and the press release. I’d suggest ignoring the press release. A little further down under “Upcoming Events” is the link for the August 28 earnings presentation, where you can listen to CEO Fiske discuss the results.
 
My suggestion is that you go review Neil Fiske’s presentation. It’s the best summary of what’s going on.
 
Normally, this is where I’d leap into the income statement results. We’ll get to that. But because so much is going on, and so much change is happening I am, bluntly, less concerned about the income statement than I’d normally be. I’ll start by highlighting some things Billabong has to do well if the turnaround is going to work. All numbers are in Australian dollars.
 
Success Factors
 
Let’s head directly to the balance sheet. Last year at June 30, with issues of unhappy lenders and liquidity problems highlighted by a “Wow, am I glad I wasn’t the CFO” current ratio of 1.02, Billabong wasn’t likely to be a going concern without a restructuring. As we know, they got the restructuring done. At June 30, 2014, there’s an imminently manageable current ratio of 2.2. Receivables and inventories are down significantly (due to the sale of West49 and Dakine, closing of 41 stores, and writing down and liquidating some inventory) with total current assets reduced by 20.4% to $496 million. Cash is $145 million compared to $114 million a year ago.
 
Current liabilities are down 63% from $612 to $225 million. Non-current borrowings, however, are up from $6 to $212 million as a result of the restructuring. Overall, total liabilities are down 30%. Total liabilities to equity has improved from 2.27 to 1.90 times.
 
Even with the improvement in the balance sheet, CEO Fiske tell us that market and branding programs, as well as the new management team, will be funded from efficiencies and expense reductions in other areas. They don’t really have a choice. Billabong is financially out of the hospital, but not yet ready to run a balance sheet fueled triathlon.
 
Cash generated by operating activities was a negative $77 million compared to a positive $12 million in the previous year. Most of this, we’re told, was due to refinancing and restructuring costs.
 
Second, and maybe it should be first, let’s talk about the quality and potential of brands. Billabong is placing its bets on the Billabong, RVCA, and Element brands. Of the Billabong stable of brands, these are clearly the three that offer the volume and/or growth potential the company needs. That they’d focus on them is unsurprising (Billabong’s other brands are Kustom, Palmers, Honolua, Ecel, Tigerlily, Sector 9 and Von Zipper).
 
Neil Fiske’s predecessor, Launa Inman, spent something like $1 million on consulting to find out what the brands stood for and where to position them. We never heard much about the results of that work. Let’s hope it’s given CEO Fiske some useful information.
 
These three brands already have a market position and stand for something with their existing customers. The challenge for older, established brands in our industry is to keep their existing customers as they age while also appealing to new ones. This is the time, when the public markets will be a bit patient if only because they recognize they have no choice, when Billabong can clean up its inventory and distribution even at the short term cost of some sales, and they are doing that. At the highest strategic level, every step the company is taking is about solidifying and building these brands.
 
Management is a big issue, and it sounds like there’s progress there. There’s a new executive leadership team in place, and below that level we’re told there have been 63 key hires or internal promotions. Some of the senior team has come on board within the last 100 days.
 
It speaks well of Neil Fiske and the company’s prospects that he’s been able to get so many apparently highly qualified executives on board so quickly. There are global heads in place for each of Billabong, RVCA, and Element.
 
You know that Surf Stitch and Swell were sold after June 30, with the deal to close shortly. Other owned brands are being evaluated for their potential. He didn’t quite come right out and say it, but it was pretty clear that brands not pulling their weight will be sold.
 
My guess is we’ll see some additional brands sold. It would be consistent with the “bigger, better, fewer” approach to its business Billabong has enunciated as well as its continuing, if lessened, financial constraints.
 
Next, they’ve got to fix North America. CEO Fiske was direct in describing the problems in North America. He noted that the corporate and leadership turnover hit the region hard and that the impact would be with the company a while longer. He further stated that it has suffered from a lack of good inventory management, poor buying decisions, and a historic tendency to overbuy inventory.
 
When we review the numbers, you’ll see the impact clearly.
 
Let’s not forget all the critical operational stuff that has the potential to generate many millions of dollars in incremental cash flow. SKUs are already down 20% with, I suspect, further reductions to come. They are rationalizing their supply chain and expect over some years to capture $20 to $30 million in incremental profit. Like most companies, they are working to get the right product to the right markets faster and are coordinating that effort with their marketing and merchandising.
 
What I just blithely said in two sentences is a monster project that touches every part of the company. It will be- it already is- messy, complex, and full of surprises. If it wasn’t I’d be worried they weren’t doing enough of the right things fast enough. Not to overdramatize, but Billabong is basically rebuilding itself for the modern world. It will take a while, and will really never be completely done because the market will keep changing.   But it has to happen.
 
Yeah, maybe I did overdramatize.
 
By the Numbers
 
This is complicated. That’s because there’s been a lot going on over the last year. The on again, off again, finally closed deal costs, the restructuring costs, and the write downs made financial comparisons a bit difficult. Billabong has tried to help by providing a breakdown of all these costs and financial statements with them excluded.
 
I hate the way companies exclude so called extraordinary or nonrecurring items, because there seem to be some new ones every year. But in this case, the numbers are so big I mostly think it’s a good thing to do. I’m going to work almost exclusively from the statutory report.   We’ll start with the numbers required to be reported, and then break out all the hopefully one-time items that Billabong calls “significant costs.”
 
As reported, revenue from continuing operations rose 1.6% from $1.107 to $1.125 billion. The gross profit margin slipped a bit from 51.1% to 50.6%, but that’s not surprising given the cleaning up going on. I’m glad it wasn’t more.
 
The loss before taxes and discontinued operations fell from $654 million to $167 million. But almost all that improvement was in the Other Expense category, which fell from $748 million to $167 million. Last year, remember, was the year of the huge noncash write downs for goodwill and brand value.
 
Interest expense, to nobody’s surprise, rose from $12.4 to $34.2 million “…driven primarily by the new financing arrangements…”
 
Believe it or not, income tax expense was $75 million, up from $30 million last year. Yes, I know- losing money but paying taxes seems odd. But lots of deals and lots of restructuring can make it happen. Feel free to read all the fine print about it you’d like.
 
After tax loss from discontinued operations was down to $30 million from $179 million last year. The discontinued operations include Dakine and West 49 which were sold during the year, and the interest in Nixon which was restructured.   That leaves a bottom line loss of $240 million compared to $863 million in the prior year.
 
Okay, let the fun begin. Below are the segment revenues and EBITDAIs for both years as reported. These numbers include discontinued operations and the significant items.
 
 
Europe isn’t exactly a thing of beauty, but at least the loss declined some even as revenues fell. You can see the biggest problem by far is in the Americas. If you’re interested, revenue from discontinued operations was $238 million last year and $98 million in fiscal 2014. In his discussions of the Americas, CEO Fiske refers to Billabong’s forward orders growing and RVCA “reaccelerating.” About Element he says “…rebuilding underway.”
 
Now, here’s EBITDAIs by segment excluding first the significant items and then those items and discontinued operations.
 
 
You can see that the EBITDAI goes from a loss of $52.3 million as reported to a gain of $52.5 million. Take a moment to compare the third column in the first chart with the second column in the second chart.
 
They also provide the chart above in constant currency. But the results aren’t different enough for me to feel like I need to inflict it on you.
 
2014’s reported loss of $240 million becomes a net loss of only $14.4 million with all that stuff excluded. The 2013 loss of $863 million becomes a gain of $7.7 million. Those are pretty significant differences.
 
I want to say just a few words about what’s in those significant items. For those of you who really want the details, it’s all laid out starting on page 98 of the statutory financial report. I don’t think Billabong has to worry about its servers crashing as people flock to check it out.
 
Significant items from continuing operations totaled $116 million in 2014 compared to $669 million last year. The decline is mostly the result of the write off of goodwill, brands, and other intangibles falling from $440 million last year to $29 million this year.
 
You may remember my ranting from last year as I looked at these items. Some of them I can understand excluding, but in other cases the argument seems weak.
 
The poster child for ones I don’t think they should do this with is “Net realizable value shortfall expense on inventory realized.” They wrote off some bad inventory. It was “only”$14 million this year compared to $23 million last year.   I know it was a different management team, and you really, really promise not to do it again, but I guarantee you will have some inventory write downs this year.
 
What bothers me is not that they do this- I think it can have value in representing the company- but the apparent discretion management has to decide how much of it they do.   This is why I strive to pay the most attention to as reported numbers.
 
There are three things you should focus on as you evaluate Billabong going forward; the balance sheet, brand strength, and gross margin. The balance sheet will help you figure out if the company will have the financial strength to do what it needs to do.  Brand strength is, at the end of the day, the one thing they can’t get along without. Improving gross margin will tell us that the operational changes they are making are having an impact.
 
I like the plan. Now all they have to do is do it.

 

 

Thoughts on the Omnichannel; Decker’s June 30 Results and Sanuk’s Impact

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Deckers is mostly of interest to us because of their ownership of Sanuk. We’ll talk about how Sanuk is doing. But Deckers management say some interesting, perhaps even insightful, things about online business and the omnichannel and I want to focus on those as well. Let’s start by getting some of the numbers out of the way. 

In a quarter that Deckers management describes as being historically their weakest, the company had a sales gain of 24.1%, with sales rising to $211 million from $170 million in the same quarter last year. “The increase in overall net sales was primarily due to an increase in our UGG brand sales through our wholesale channel and retail stores as well as an increase in our Teva brand wholesale sales,” says the 10Q.
 
But Tom George, the CFO, tells us in the conference call, that “Nearly half the upside revenue was attributed to the timing of wholesale and distributor sales and the other half with some higher than expected sales. The higher than expected sales contributed approximately $0.05 to the EPS while the other $0.21 was due to the timing of sales and operating expenses.”
 
So half of the revenue increase was just timing differences that don’t change their estimate of total revenue for the year. That is, the revenue was booked in the June 30 quarter instead of the September 30 quarter. But the other half of the revenue increase is from higher than expected sales.
 
In spite of that sales gain, the net loss rose from $29.3 to $37 million. How’d that happen?
 
There was a very minor decline in the gross margin from 41.1% to 41.0%. Gross profit basically rose with sales from $69.8 to $86.8 million. I guess that’s not it.
 
Ah, here we go. Selling, general and administrative expenses were up 21.9% from $112.6 to $137.3 million. That increase included $11 million for opening 37 new stores (they’ve got 126 stores worldwide), $4 million for marketing and promotions related to the UGG and Hoka brands, $3 million for “information technology costs,” and $3 million for ecommerce. As a percentage of sales, it fell from 66.2% to 64.9%.
 
Sanuk’s wholesale revenues were $32.3 million, up 16.4% from $27.8 million in last year’s quarter. That represented 21% of Decker’s total whole sale business of $154 million in the quarter. UGG was $74 million and Teva, $35.6 million at wholesale. Deckers tells us that “Wholesale net sales of our Sanuk brand increased primarily due to an increase in the volume of pairs sold, partially offset by a decrease in the weighted-average wholesale selling price per pair. The decrease in average selling price was primarily due to a shift in product mix.” They gained $7 million in revenue in higher volume but lost $2 million due to lower selling prices.
 
Sanuk’s total sales for the quarter were $36 million, up 19.6% from $30.1 million a year ago. That includes ecommerce sales of $2.71 million up from $2.09 million in last year’s quarter and sales in Decker’s retail stores of $243,000, up from $22,000.  We’re told in the conference call by President and CEO Angel Martinez that, “Sanuk had a strong quarter due in large part to the continued success of women’s sandals, most notably the Yoga Sling Series.” The brand is also being expanded into “…the broader selection of casual shoes and boots that can be comfortably worn during colder weather.”
 
He talks further about this in response to an analyst’s question. “…when we acquired that brand, the brand really was 70% men’s, 30% women’s. It was primarily distributed in surf shops and actions sports distribution. And we knew that the gender profile of the brand would need to alter significantly, if we would to have any hope of selling product in department stores for examples. So one of the things we are seeing with Sanuk is a major transition to a much more compelling women’s product offering.”
 
Even though its revenues are the smallest of Decker’s three biggest brands, Sanuk’s operating income, at $6.9 million, was larger than that of either UGG or Teva which, respectively, had operating income of $2.7 million and $4.8 million. That’s an operating profit margin of 21.4% for Sanuk compared to 13.4% for Teva and 3.6% for UGG.
 
In what can only be acknowledged to be a blinding glimpse of the obvious, I’d say Deckers needs to get that operating margin for UGG up. I suppose they are as the UGG brand had an operating loss of $510,000 in last year’s quarter. Decker’s marketing spend has increased from 5% to 6% of sales, with the majority “…being directed towards the UGG brand with the incremental dollars going towards the combination of digital programs and tactics aimed at broadening brand awareness and driving traffic to our direct-to-consumer channel.”
 
We’re also told that, “The increase in income from operations of Sanuk brand wholesale was primarily the result of the increase in net sales offset by a 5.1 percentage point decrease in gross margin as well as increased operating expenses of approximately $500. The decrease in gross margin was primarily due to a shift in sales mix as well as an increased impact from closeout sales.”
 
As you recall, when Deckers acquired Sanuk In July of 2011, there were some big contingent payments required. The last year of the earn out is calendar year 2015 and that earn out will be 40% of Sanuk’s gross profit. Deckers has a long term contingent liability of $28 million booked for that. There was an earn out due and paid in 2013 (I think it was less than 40%- maybe 35%), but there is none due in 2013. 
 
Meanwhile, Deckers ecommerce revenue rose from $10.7 million to $15.4 million. But operating income for that segment fell from $1.7 million to $809,000. Retail store revenues rose 29.4% from $32.5 to $42.0 million but the operating loss on those retail operations climbed from $9.8 million in last year’s quarter to $15.9 million.
 
The balance sheet remains in pretty good shape, though current ratio has declined just slightly and total liabilities to equity is up a bit compared to year ago. I’d note that they managed to reduce their inventory very slightly even as sales rose even while bringing some $17 million in product in early due to concern about a West Coast port strike.   Cash is up a bunch from $49.1 to $158 million.
 
Given the increase in cash, I find it interesting that after the June 30 balance sheet date, they took a mortgage on their corporate headquarters for $33.9 million. They expect to use those proceeds “…for working capital and other general corporate purposes.” I’m not clear why they did that.
 
Okay, on to interesting omnichannel stuff. 
 
Dave Powers, Decker’s President, Omni-Channel, tells us that total direct to consumer (DTC) was up 33% in the quarter compared to the same quarter last year.   But that includes 37 new retail stores and, as we’ve already noted, the loss from their retail stores was larger than in last year’s quarter.
 
Comparable DTC sales were up 10%, but that included a 39% increase in e-commerce sales and a “…low single-digit comparable store sales decline.”
 
As I’ve discussed a few times before, the holy grail of e-commerce is when the brick and mortar and online activities support each other. The sum has to be bigger than the parts or the rather significant investment in omnichannel activities just doesn’t make sense. Right now, we see Decker’s brick and mortar comparable store sales down, while e-commerce is up. How do you know when your e-commerce isn’t cannibalizing your brick and mortar?
 
Deckers knows this is important. Dave Powers says, “We now know that brick-and-mortar locations fuel e-ecommerce and vice versa. And we believe that a portion of our e-commerce growth is fueled by our increasing store base. We see the internet UGG program and similar omni-channel initiatives providing increased contribution to overall DTC comps going forward as we further tie our stores and website.”
 
He goes on, “The key next step of our omni-channel evolution will be the opening of a smaller concept omni-channel store in Tysons Galleria this fall. That will feature new in-store web technology such as interactive displays and the ability to reserve online and pickup in-store.”
President and CEO Angel Martinez notes that their average cost to build out stores is down 30%. He doesn’t attribute that all to smaller stores and omni-channel related stuff, but I imagine it’s had some impact. In another comment, he notes that stores may no longer need the back room. Obviously, that’s omnichannel related and has implications for further reducing real estate costs.
 
The devil, as always, is in the details, and here are a few of those. They are rolling out something they call Infinite UGG which “…gives us the ability to offer our retail customers every skew available from the UGG brand to our in-store POS system…Our UGG by You customization program will include additional files and design details for the consumers to choose from such as the popular daily bow and daily button…we’re also extending retail inventory online or RIO, a new tool launched this past spring in select stores in North America and EMEA advance of the fall and holiday selling season. RIO provides customers with visibility into store inventory, helping them to efficiently locate the product they want prior to visiting the store.”
From what I know, this isn’t unique to Deckers, but it certainly feels to me that they are doing the right things. CEO Martinez talks about this from a more strategic perspective.
 
“…just a few short years ago we were a wholesale vendor that delivered product twice a year and our success was largely driven by how well buyers, wholesale buyers responded to our collections at industry tradeshows. The consumer had very little influence in shaping our future direction. This dynamic has been turned completely upside down. The consumer is now the gatekeeper and we’ve transformed our business model to not only adapt to the new retail paradigm but also to thrive and to grow.”
 
“We now drop product more than 10 times a year and communicate with consumers on a much more frequent and personal basis. This constant flow of information is reshaping our growth strategies including our product development and store expansion plans, as we now have much better insight into pinpointing demand and directing capital towards what we believe will be high return, high productivity locations.”
 
Dave Powers adds to this when responding to an analyst’s question:
 
“So we’re starting to think about the stores as not just the store in a four-wall P&L but a store that impacts the overall macro environment of our brand in that metro area. The inverse of that is that we have the ability now through analytics and increasingly CRM and loyalty programs through e-commerce to better target customers in those metro areas we know where they are. And we can send them through merchandising and marketing initiatives digitally back to the store.”
Sorry for the long quotes, but I couldn’t say this important thing any better.   And I could go on with more quotes, but I think you get the picture. Deckers is making a big bet on the omnichannel. Well, who isn’t? But their conception seems particularly well thought out.
 
When Deckers first bought Sanuk, I suggested that they didn’t quite know what they’d bought and what to do with it. Given the price they paid, I have to believe they are not completely happy with the results to date. To justify the purchase price, they have to be able to take it from a quirky surf, beach, action sport brand to one that will sell well in broader distribution. But of course they have to do that without losing the quirkiness. 
 
Quite a challenge and the 5% decline in Sanuk’s gross margin during the quarter gives me pause.   So here we are again. Can a brand owned by a public company grow fast enough to satisfy Wall Street without damaging the brand? I hope the crew at Sanuk is following what Skullcandy is trying to do.

 

 

The Great Deformation: The Corruption of Capitalism in America

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If you finish The Great Deformation: The Corruption of Capitalism in America, by David Stockman, you should get a t-shirt saying you made it through.  At 700 pages, it’s a journey.  It tells you things about what’s gone on since the Federal Reserve was created, and right through 2012, that you won’t find anywhere in the mainstream media.  You may love it, or it may make you furious, or both, but it will change your perspective.  You might want to take a look at Stockman’s web site and consider signing up for his emails.

Maybe a Public Company Can Actually Pull This Off! Skullcandy’s June 30 Quarter

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I’ve written probably way more times than you want to hear about how it’s been a good time to focus on brand building, distribution, and gross margin dollars rather than generating big sales increases that can only be realized in the short term with resulting long term damage to a business.   And I’ve sympathized with public companies who’d like to take this approach, but have a hard time doing it because of Wall Street growth expectations.

Well guess what? It looks like Skullcandy might just have a chance to do it. For the quarter, they reported a 6% sales increase to $53.9 million from $50.8 million in the same quarter last year. They had net income of $1.58 million compared to a loss of $689 thousand last year.
That’s nice, and it’s necessary. But from my point of view, what it does is buy Skull some time, and acquiescence from Wall Street, to continue doing what they’re doing.

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Losing a Big Customer Sucks: SPY’s Quarter

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Long time readers have been through the saga of Spy with me. But for the last couple of years, they’ve pretty much done things right. They’ve cleaned up inventory, managed expenses down, focused on a niche they can compete in, strengthened the management team, done some innovative product things, gotten out of products that weren’t working, and created and communicated a company vision consistent with their market position.

So then, in the quarter ended June 30 their largest retail sun glass customer stops carrying their brand. They also chose not to ship to their largest moto customer due to credit issues. I’m okay with that. I’ve always thought that only shipping to people who could pay you was a pretty good idea.

Quarterly sales declined 18.1% from $10 to $8.2 million, the first quarter over quarter decline in a while. The good news, they tell us in their conference call, is that the sales to the big retail sunglass customer were their lowest margin sales. We see that in their gross margin, which rose from 52.8% in last year’s quarter to 54.4%. But there’s a bit of lipstick on pig syndrome here, as total gross profit fell 13.9% from $5.28 to $4.54 million.

I also want you to see what they say about the sales decline in the 10Q, as it’s not as specific as the conference call in attributing most of the decline to the loss of one customer. “The decrease in sunglass sales during the three months ended June 30, 2014 is principally attributable to an overall decline in the consumer market coupled with several key retailers currently holding lower levels of inventory and fewer closeout sales of our sunglass products.” I am left wanting to know exactly how much in sales the one customer cost them.   I’m wondering why they didn’t mention it in this section of the 10-Q.  If most of the decline was from one customer, well, fortunes of war.  But if that customer doesn’t explain most of it, there’s a whole different problem.

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Vestis Retail Acquisition of Sport Chalet to Move Forward

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As you know, Vestis Retail Group has been in the process of doing a tender offer for the shares of Sport Chalet. We learn this morning that they’ve acquired enough shares for the deal to go forward. Here’s a link to a press release making the announcement.   And here’s a link to my original article explaining the deal. 

I’m glad this got done. Last week, it wasn’t quite clear that they would get the shares needed for the non-family shareholders to get the offered $1.20 a share. If enough shares hadn’t been tendered, the offer was going to drop to $1.04 per share.   Sports Chalet needed a deal and I think Vestis, with their other sporting good retail properties, can help Sports Chalet be successful.

 

 

All About Outdoor & Action Sports: VF’s Quarter

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That the outdoor and action sports segment (OAS) of VF’s business is critical to its overall success is pretty obvious from the numbers. Total company revenue for the quarter rose 8% from $2.22 to $2.4 billion. OAS revenue rose 16% from $1.1 to $1.28 billion. OAS generated more than 53% of the quarter’s total revenues. OAS revenue experienced “…double-digit percentage growth in every region and channel.”

But revenue from VF’s other segments- coalitions as they call them- grew by just one half of one percent from $1.116 to $1.123 billion. These other segments are jeanswear, imagewear, sportswear, contemporary brands, and other.
The same trend can be seen in VF’s operating profit. Total operating profit rose 6% from $269 to $285 million. OAS operating profit was up 16% from $100 to $131 million. Ignoring OAS, total operating profit for the other segments fell 8.4% from $168.6 top $154.5 million.

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Volcom’s New Positioning and Kering’s Half Year Results

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Back on July 9th, Volcom presented a new brand vision to a group of 100 retailers and media people. I wasn’t invited so all I know is what was reported in Transworld and a little that some people have told me.

Last week Kering, Volcom’s parent company, released its results for the 6 month ended June 30, 2014, so this seems like a good time to touch on both and the relationship between them.
Just to remind everybody, Kering’s 2013 revenue was 9.7 billion Euros. Its Luxury Division, which includes 13 brands, like Gucci, that I’d characterize as high end provided 67% of its revenue. Its Sport and Lifestyle Division (S&L) provided the rest of the revenue (3.25 billion Euros) and includes Puma, Volcom, and Electric. “The PUMA Group owns the brands PUMA, COBRA Golf, Tretorn, Dobotex and Brandon.”
Puma’s 2013 revenue was 2.002 billion Euros and its “recurring operating income” was 192 million Euros. Volcom and Electric together had revenue of 245 million Euros and generated “recurring operating income” of 9 million Euros. Puma, then, dominates the S&L division.

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