Billabong’s Six Month Report: The More Things Change, the More They Stay the Same

Six months ago, reporting on Billabong’s results for the whole year, I said this was a challenging turnaround, Billabong was doing things right, they were starting to see results, but the market was tough, and implementing their plan was taking longer and costing more (perhaps because it’s taking longer) than they’d initially expected.

That’s all still true for the six months ended December 31, 2016.

I’ll start with the numbers as reported (numbers in Australian dollars).

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Billabong’s Annual Meeting: The Future’s Still Coming

Billabong held its annual meeting on November 22.  Back in August, I reported on Billabong’s results for the year ended June 30.  Here’s the link to that article.  The headline numbers then (all numbers in Australian dollars) were revenue from continuing operations of $1.10 billion and a net loss after tax of $23.7 million.  I started that article with these points which seem just as relevant now as they did then.

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The Future Isn’t Here Yet: Billabong’s Results for the Year

Billabong published its results for the year ended June 30th last week.  The headline numbers (all numbers in Australian dollars) are revenue from continuing operations of $1.10 billion and a net loss after tax of $23.7 million.  The numbers for last year (pcp- prior calendar period) were revenue of $1.06 billion and a profit of $4.15 million.  Pretax loss actually declined from $20.2 to $15.9 million.  Those are the numbers from the consolidated income statement.

However, those summary numbers are not the whole story.  There are the usual discussions to be had and adjustments to be made (or not) with regards to taxes, exchange rates, discontinued and sold operations and the inclusion or exclusion of the “significant” items.  Before we have fun with all that, how about we take a moment and look at Billabong’s overall situation?  It’s kind of like I’m doing my conclusion first, but I think having this stuff in mind will help you understand Billabong’s challenges and opportunities when we start to get down into some of the weeds.

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Billabong Sells Sector 9 and Lets Fly with a Press Release

Well, the press release was back on June 3rd.  And the sale of Sector 9 was, I guess, a week ago.  Happily, it’s not my job to be timely, but to give you things to think about with the goal of maybe helping you do better business.

So let’s think about Billabong.  Back when CEO Neil Fiske took over, there was a decision early on to focus on their big three brands- Billabong, Element and RVCA.  Good decision, I thought.  Most recently, they’ve sold Sector 9 for US $12 million.  As I’ve written previously, I expect the sale of additional brands.  Some of them may be small enough that a formal announcement of the sale won’t be required.  Maybe they are already gone.

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Good and Bad- Billabong’s Six Month Results

Billabong presented its results on February 26th, which is a day before I took off for a week in Scottsdale to golf and have a drink or two with old friends. As usual, a lot seems to have happened while I was gone, and I’m working to catch up.

I agree with Billabong CEO Neil Fiske who said, “There are important positives to report among a mixed overall result this half.”

Let’s right get to the numbers as reported and then as adjusted. In this discussion, I’ll rely mostly on the formal financial report with the audited financials. All the numbers are in Australian dollars.

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Billabong Holds Its Annual Meeting; Progress and Headwinds

At Billabong’s annual meeting a couple of days ago, CEO Neil Fiske and Global Billabong Brand Manager Shannan North made presentations describing the company’s progress and challenges since the results for the year ended June 30 were announced in July. Let’s see what they said.

It’s only been four months since the year’s results were presented so, as CEO Fiske put it in his opening remarks, “The themes of our presentation today are not new.”

He reemphasized that the turnaround, while taking hold, was a long term effort. “We said a couple years ago that this was a complex difficult turnaround. That it is going to take time to build the foundation necessary to sustain growth and margin expansion.” Below is the list of areas, taken directly from the presentation, where the turnaround continues to be focused.

  1. Brand
  2. Product
  3. Marketing
  4. Omni-Channel
  5. Supply Chain
  6. Organization
  7. Financial Discipline

If you’re looking for more detail on these, you can see Billabong’s earlier discussions in documents on their investor web site, and I’ve reviewed them in previous articles on my web site. I’m sure we agree that all seven are important. But in which areas can Billabong do something better than other industry companies? Where can it build a sustainable competitive advantage?

Overall, I believe that size is now an advantage in this industry, if only because of the investment in systems and in the omnichannel that’s required. Billabong, compared to most industry companies (depending on how we define the industry) has that going for it. I’ll also say I think Quiksilver’s problems have given Billabong an opportunity in some markets.

Starting from the bottom of the list, financial discipline gets easier as your balance sheet gets stronger. Billabong’s has certainly strengthened and I note that they are funding marketing programs through reduced expenses in other areas. Sounds like financial discipline to me.

I’ve no doubt there is money to be saved through revamping both the organization and the supply chain. But these are things other companies can and are doing as well. If you see these as a long term competitive advantage, it’s because you believe Billabong’s revamped management team can do it better than competitors.

Neil thinks that “over the next several years” they can get to the point where they are spending $30 million less annually on sourcing and logistics. He thinks they can cut their product lead times by 30%.

Making good product seems like the price of entry. Not something you can do better than others in the long run- you just have to do it to have the chance to compete. You can come up with some product innovations from time to time, but I doubt you can keep your competitors from doing the same.

Branding is a place where Billabong has an opportunity. This has a lot to do with their organizational changes. As Neil Fiske put it, “We are moving from a fragmented and regional business to a brand led, global company focused on building big powerful brands and maximizing their reach.”

The focus on what they decided are their three strongest brands with the greatest potential- Billabong, Element and RVCA- allows for certain efficiencies in all areas of the business. Remember, none of the seven strategies stand in isolation from each other.

Billabong is 52% of the company’s wholesale business, with each of Element and RVCA representing 16%. I suspect RVCA has the most growth potential. It’s not closely tied to a single activity like the Billabong and Element brands. In this regard, I thought Shannan North’s comment, talking about the Billabong brand, that “The brand’s turnaround is as much based on gross margin expansion as it is on revenue growth…” was interesting and appropriate.

For now, the Billabong brand (and I suspect Element as well) will be focused on its core (I still hate that term) market. At some point, with that further solidified, it will be interesting to see if they have the ability to break out of their core positioning without damaging that positioning. That’s pretty much the challenge for any brand in this industry as it grows, isn’t it?

Okay, omnichannel. Yes it’s important. As Neil puts it, “…probably the biggest game changer. Being able to connect all our channels – retail, wholesale, and ecommerce – to give the customer a seamless brand experience. Anytime, anywhere. Bricks and clicks. Content and Commerce. Social, mobile, local. Knowing our consumer like the back of our hand and being able to engage them on their terms, the way they want to interact. Omni is about unlocking the full value of the multi-channel shopper from one global unified platform.”

If Billabong was doing it badly, they need to do it well. Again, I’ll ask if that’s a source of competitive advantage or something you have to do well to compete.

2016, we learn, “…will be a year of heavy implementation on our big initiatives,” as CEO Fiske puts it. But, he points out, “…we have a set of external market challenges that must be met and overcome. Here’s what he says they are.

Billabong Holds Annual Meeting 11-15

 

 

 

 

 

 

 

He says, “Last year at this time, the Australian Dollar was 87 cents to the US dollar and the Euro was 1.25 to the US dollar. Today the Australian Dollar is closer to 71 cent and the Euro closer to 1.07 Euros.” The problem, he says, isn’t so much the level as it is adjusting to the new level when currency values change quickly. I agree.

“Our second challenge,” he continues, “is the sector weakness we are seeing in the last several months in North America. This includes the big action sports chains, department stores, teen retail, and tourist retail. Specialty retail, where we hold the number one position, is better but still relatively flat and cautious. The hardgoods market in skate has been particularly slow in the first few months of our fiscal year and this has hurt sales of both Sector 9 and Element skateboards.”

Finally, he notes that “…price discounting and promotion online and in the mall remain high and the consumer is waiting for deals. We don’t intend to enter the fray. We will stay focused on quality products, quality distribution, and price integrity… on strengthening our brands with the core consumer.”

I like that decision. If you’re focused on building big brands, how else can you approach it?

The overall financial result is that EBITDA for the first four month of this fiscal year is $2.5 million Australian dollars less than what it was last year.

Billabong is working to pull off a complex turnaround in market conditions that are not improving quickly if at all. Though their balance sheet is restructured, they are not without financial constraints on what they can do and how quickly. I like their plan and focus. Anybody who expected to see faster, stronger results in this economy was kidding themselves.

The thing I wish I understood better is where they are going to be able to consistently do better, not just as well, as their competition. I’m also wondering if Billabong and Element can find ways to eventually expand beyond their surf and skate franchises with the brand positioning they are working so hard to manage intact. If there is some constraint on revenues growth by these two brands (perhaps offset by improved margins and profitability even with lower revenue growth), maybe some of their other brands, in addition to RVCA, will step up and surprise us.

Light at the End of the Tunnel – But it’s Not a Short Tunnel; Billabong’s Annual Report

What we have here is progress, but still a long way to go. That’s how Billabong’s management characterizes their results, and I agree. I’ll take a look at the financials as reported and with the impact of divestures and certain “significant items” removed. Regular readers know I’m not quite comfortable with some of the stuff that Billabong management characterizes as “significant” and removes from their operating results. Happily, the number has declined dramatically for the June 30 fiscal year.

Next, I want to touch on exchange rates and how they affect the results. It’s way more complicated than is the Australian dollar “strong” or “weak,” though that’s often how the issue is characterized.

Finally, I want to talk about how extensive and complex Billabong’s makeover is. Basically, they are rebuilding the company while running it. It’s kind of like highway construction, where you have to keep the road open while you redo it. It adds cost and slows down the process, but you’ve got no choice.

I want to point you to Billabong’s investor web site, where you’ll find the documents I discuss. Under “Featured Report,” I particularly suggest you take a look at the full year report presentation which they refer to in the conference call. The transcript of the conference call is also there.

Financial Results

All the numbers are in Australian dollars unless I say otherwise. At June 30, it costs you about $0.75 US to buy one Australian dollar.

For the year ended June 30, 2015, what they call “Revenue from continuing operations” was reported on the official financial statement as $1.056 billion (US$792 million based on the June 30 exchange rate). That’s up 2.82% from the prior calendar period (pcp) result of $1.027 billion. That does not include $10.6 million of other income this year and $6.3 million of other income in the pcp. It does include the revenue from brands that were divested at some point during the two years.

Gross margin rose from 52.2% to 53.1%. Selling, general and administrative expenses rose 1.6% from $423 to $429.6 million. Other expenses fell 23.1% from $165.9 to $127.7 million. Finance costs declined from $82.2 to $34.3 million, or by 58.3%. As you’ll see, much of those two declines were the result of the restructuring and refinancing expenses in the pcp.

Below is the rest of the income statement. Seems easier to show you than to describe it. The first column is for the year ended June 30, 2015 and the second for the pcp.

Billabong 6-30-15 annual report 1

 

 

 

 

 

 

 

As you can see, as reported Billabong earned $4.15 million compared to a loss of $233.7 million in the prior calendar period. Mostly, the change from a big loss to a small profit is due to a reduction in all the costly tax, restructuring, and financial expenses they had last year.

Okay, now let’s take out the businesses they sold and their significant items. They do that for us in the presentation they used at the conference call. Page 22. Billabong sold it’s 51% stake in SurfStitch and it’s 100% ownership in Swell on September 5, 2014, which is in the most recently ended fiscal year.  West 49 was sold in February of 2014. Dakine was out the door in July of 2013. Discontinued operations generated $196 million of revenue in fiscal 2014, but only $15.4 million in fiscal 2015.

Billabong 6-30-15 annual report 2

 

 

 

 

 

 

 

 

The first thing I’ll point out before somebody points it out for me is that the Sales Revenue number of $1,063.7 million is not the same as in the numbers from the official financial statement I just quoted. I’m not saying it’s wrong. I just can’t figure out why it’s different.

Taking out those items leaves us with a slightly reduced net income (from $4.2 to $3.0 million) for the June 30, 2015 fiscal year. More importantly, comparing the last two columns in the chart, you see an increase in EBIT from $25.9 million in the pcp to $32.8 million for the June 30, 2015 year.

Okay, significant items. For you data geeks, go to the Billabong investor web site. Under “Featured Reports” click on “Full Year Reports to 30 June 2015.” Go to page 69. Look at note (dd) “Significant Items.” I won’t blame you if you don’t read every word, but you might just peruse the list and note the discretion management seems to have in terms of what is or is not classified as a significant item.

If you want to suffer even more, go to page 86 of the same document where Note 8 starts. It lists all the significant items for the recently ended fiscal year and the pcp. A more detailed description of just what those items are appears on the next two pages.

What!?! You didn’t hang on each word?! Yeah, me neither.

The good news is that the significant items from continuing operations totaled $24.7 million this year compared to $120 million in the pcp. After discontinued operations, the total fell from $146 to $11 million.

You can’t just ignore numbers of this size, and certainly some of these are one time numbers. But if I were an investor, or potential investor, in Billabong, I’d be digging into these to satisfy myself as to the improvement of the continuing business from last year to this year.

Now let’s move on to the results by segment. First, as reported.

Billabong 6-30-15 annual report 3

 

 

 

 

You can observe revenue drops for Asia Pacific, the Americas, and Europe of 10.8%, 15.3%, and 9.7% respectively. EBITDAI fell by 28.3% in Asia Pacific, but improved dramatically in the other two segments. The result is a $107 million turnaround is EBITDA as reported.

Taking out the discontinued operations and significant items gives a different segment and total EBITDAI result. The change in EBITDAI is not nearly as dramatic but, then again, it shows as positive in the pcp.

Billabong 6-30-15 annual report 4

 

 

 

 

 

 

The next chart in the report is EBITDAI in constant currency. I’m not even going to show you that and I guess this is a good place to explain why.

Foreign Exchange

In the first place, if you’re an Australian investor in Billabong, I expect you mostly care about results in Australian dollars. But perhaps more importantly, there is a complexity here that goes way beyond whether the Australian dollar is “strong” or “weak” against the US dollar.

Billabong management does a great job trying to highlight and explain this. They provide a chart on page 71 of the document I point you to above that shows their exposure in Australian dollars, US dollars, Euros, and “other” currencies. There are both assets and liabilities involved and, if most of the exposure is in the first three currencies the “other” is not insignificant. Billabong “…receives revenue in more than ten currencies…”

In the conference call CFO Peter Myers spends way more time on this issue than I would have expected. Just to give you a way to think about all the moving parts, here are a few things he says. This would be a place where you can skim a few paragraphs if you want to, but I think it’s important.

“As an Australian listed entity with US operations, it is logical for us to have a significant part of our debt denominated in US dollars to match our foreign currency assets with foreign currency debt. So whilst it is true that the Aussie dollar equivalent of our debt is higher, so is the Aussie dollar value of our businesses and our US dollar earnings…”

“…the Aussie dollar value of businesses that are predominantly US-based, like RVKA and BZ, and the value of our US dollar earnings from our more global businesses like Billabong are also growing in Australian dollar terms. We also have US dollar cash flows to match our US dollar interest obligations.”

“So before that allocation of central costs, the Australian dollar value of the earnings from the Americas was AUD42 million, or about $35 million. So you see we have the Americas give us US dollar EBITDA of $35 million to match our US dollar interest obligations of $25 million, but — and it’s a significant but — it does serve to reinforce how important it is to us that we build the earnings base in North America, as it’s obvious the FX changes do impact on all of our financial ratios, et cetera.”

“The other big impact of the currency is in our input prices, the product purchases. In APAC alone, and bear in mind there is a European effect here as well, we have cost of goods sold of over AUD150 million, the vast majority of which is bought in the US dollar-exposed market.”

Sorry to let Pete go on for quite so long there, but I thought it important you appreciate the complexity and all the moving parts. While currency movements in the recently ended year may have been more dramatic than usual, the issue isn’t going away. At the end of the day, however, it’s how many Australian dollars of net income Billabong generates that will be the barometer of the company’s success or failure.

Reducing Complexity

Billabong’s brands include Billabong, Element, RVCA, Kustom, Palmers, Honolua, Xcel, Tigerlily, Sector 9 and Von Zipper.

“The Group operates 404 retail stores as at 30 June 2015 in regions/countries around the world including but not limited to: North America (60 stores), Europe (102 stores), Australia (123 stores), New Zealand (30 stores), Japan (46 stores) and South Africa (27 stores). Stores trade under a variety of banners including but not limited to: Billabong, Element, Surf Dive ‘n’ Ski (SDS), Jetty Surf, Rush, Amazon, Honolua, Two Seasons and Quiet Flight. The Group also operates online retail ecommerce for each of its key brands.”

Some of those stores carry multiple brands. Others don’t. About 55% of revenues are from wholesale. No single customer is 10% or more of their revenues. They expect to close around 40 stores this year, but have a new store model they believe gives them the opportunity to open new ones, so the net number of stores may not change much.

That’s a lot of moving parts in a lot of countries for a company that did just over a billion dollars Australian during the recently ended year. You probably also recall that Billabong’s brands operated pretty independently for a long time. The company is moving to change that in the name of efficiency and brand building. To me, Billabong really couldn’t support the implicit inefficiencies in the structure it had with the revenues it’s generating.

Let’s see what they’re doing.

CEO Neil Fiske has a seven part strategy the company has been implementing since shortly after he came on board in September, 2013. From their filed report, here are the strategies and descriptions of what they involve.

Billabong 6-30-15 annual report 5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

I want to make a few general comments on this. First, you should note that pretty much no part of the business is untouched. Second, while this will ultimately save them a lot of money (they have for example cut the numbers of suppliers they work with by 50%) it’s going to cost a bunch of money to implement.

Third, there is a certain urgency to doing all this, and an imperative to interconnect these functions that wasn’t so important or at least so necessary 10 years ago. And I will point out that doing much of this doesn’t create a long term competitive advantage. It’s just what Billabong, as well as other larger companies in our space, have to do to have the chance to compete. Certainly when you looked at the chart above you noted that many of the actions they are taking seem obvious and necessary.

You may even have asked, “How the hell can they not have done this stuff before now!” I have no idea what went on inside Billabong, but trying being the CEO of a publicly traded corporation and explaining to your board of directors that you’re going to rip the place apart, it’s going to take a couple of years to reconfigure, it will cost a lot of money, it may not work out, and in the meantime, your earnings are going to suck. Good luck with that.

Typically, the pressure has to come from an outside change agent.

Neil also talks about their “…fewer, bigger, better…” approach. This means that they are focusing on their three big brands; Billabong, RVCA and Element. That was a financial imperative for a money losing company, and it’s certainly the place where they can see the most immediate return. Think of it in percentage terms. A 5% increase in Billabong branded sales is way more dollars than a 5% increase in Von Zipper, and larger brands will benefit more from the various restructurings going on.

The other brands aren’t insignificant, though we don’t know how much revenue they are doing. We are told the big three represent something like two-thirds of the wholesale business worldwide.

CEO Fiske tells us that “…Tigerlily has shown standout performance once again. Sales are up over 40% and comp store sales grew 7.8% for the year. Collectively, the rest of the emerging brand portfolio was down in sales and EBITDA. With the progress of the big three brands well underway, we can now focus on the strategy and the performance of the emerging brands.”

This is the first time they’ve said much about the other brands. I still won’t be surprised if more get sold, but it’s hopeful that they think they have the breathing room to give them some attention.

Here’s a series of comment Neil made about Europe. “Gross margins [He’s talking in constant currency] lifted 650 basis points for the year as we focused on quality revenue, quality accounts, quality distribution…Revenue for the year declined 1.7% as a result of our decision to narrow our account base, tighten trading terms and build margin… In retail, comp store sales for the region were up 2.9%. Store level profitability improved 160 basis points before the effect of provisions, driven by the improvement in retail gross margins. Total store count at year end was down from 111 to 102 as we rationalized our network of outlet stores from 24 to 17 and country presence from nine to five.”

 I added the emphasis. Note the focus on quality, simplification, margin, branding and efficiency over sales growth. Or rather, the confidence that those things will lead to sales growth. This is a theme not just for their European operations, but across the other segments and found in their strategy as well.

I haven’t focused as much on brand and segment specifics as in previous Billabong reports. I really don’t want us to get lost in the weeds right now.

I’m kind of going “Billabong blind” from shuffling through all these documents and trying to create a coherent whole, but I think it was CFO Myers who said, somewhere, that he was surprised to be calling such a small profit a turning point for the company.

I know what he means. Currency, significant items (I know, I just can’t leave that alone) and divestitures make it something of a challenge to compare results over years, but there is the sense that the elements of the strategic makeover are starting to have an impact. Maybe a better way to put it is that it really feels for the first time like rebuilding the road while they drive on it is something that has a reasonable chance of succeeding.

The balance sheet is at least stable. Operating results seem to be improving and even where they aren’t improving, there’s some sense of progress in doing the things that will improve them.

The problem is most definitely not solved. There are currency issues, work remains on their retail operations, the overall economic environment isn’t too great, and completion of the systems and structural transition will take a couple of years. But things are better than a year ago and the path seems a bit clearer.

Billabong Turns a Profit; But There’s More Work to Do

Wow, this is going to be way shorter than most of my previous Billabong articles. Where’s the drama, the kind of hard to get your head around accounting, the recapitalizations and explanations thereof, the endless list of “significant items” I always complain about?

Gone. Mostly. Well, not all the significant items. Billabong is implementing their plan and running their business. The watch word that ran through the conference call was “transparent” and the call and documents really were.

We’ll get to the numbers. First, I want to show you and discuss a few quotes from CEO Neil Fiske.

“I think we’re getting better at running our operations, sometimes at the expense of pumping up top line sales, but with better margins…We tried to maintain a full price brand building, equity building business, and not chase volume for the sake of volume, where we’d dilute our margins.”

Long time readers know I’ve been recommending a focus on operating profit over sales growth (not specifically for Billabong) since sometime in 2008 when the Great Recession hit. You certainly leave the financial documents and conference call with the sense that Billabong has the chance to grow sales, but I suspect as they get more of their systems/supplier/logistics/ changes done, we’ll see efficiency improvement that will also help their bottom line.

Speaking of that, here’s the link to the Billabong investor page. You can review all the documents from the half year report and see the conference call transcript and presentation. If you want to. If you don’t, at least open the transcript and start reading two thirds of the way down page five with the paragraph that starts “Ultimately.” Read about two pages from there and see what they are doing with their systems, suppliers, and logistics.

What they are doing is really hard, really disruptive, really complex, and really necessary. Good for them.

“For the first time, we will have one system capable of supporting all our channels in all our regions, including brick and mortar, retail, catalogue, digital commerce, wholesale accounts and licensed stores.”

The goal is deploy the new platform in 12 to 15 months. That’s just one of the systems they are working on. They are also in the process of “…reducing our global vendor list from over multiple hundreds of suppliers to a much smaller group of preferred vendors.”

This is not just about buying some computers and software. That’s the easiest, though not easy, part. It’s aligning the people and processes to get the most out of those systems that’s hardest.

Those processes include “…tighter integration between merchandising and sales and marketing in our go-to-market calendar…” Neil notes that they are “Going to market with a point of view about what’s important, what we stand for and what we want them [the retailers] to get behind.

All things being equal, I’d expect these changes to offer opportunities to both increase revenue and cut costs as they come on line.

The Numbers

Let’s start with the “as reported” numbers. All numbers are in Australian dollars. As we do that, keep in mind they sold West 49 in February 2014 and SurfStitch and Swell in September of the same year. We’ll look at the numbers without them in a bit.

Revenue from continuing operations for the six months ended December 31, 2014 fell just slightly from $527.2 to $525.8 million. Gross margin rose from 44.8% to 45.2%. SG & A expense was down 1.85% from $217.2 to $203.2 million. The result was an operating profit from continuing operations of $12.5 million, a big improvement from a loss of $34.9 million in the pcp.

Net profit was $25.7 million, up from a loss of $126.3 million in the pcp. $71.4 million of that improvement comes from a change in income tax expense and has nothing to do with how the business operated. Interest expense fell from $57.2 million to $16.2 million as a result of the restructuring. Discontinued operations contributed an after tax profit of $10.5 million compared to a loss of $23.1 million in the pcp.

If you add up the changes in income taxes, interest expense and discontinued operations you’ll find that the improvement in net income as reported was only about $6 million excluding those items. It’s not quite as simple as that, but you can see what I mean.

Obviously, there was a lot going on and Billabong has helped us to isolate that so we can see how the business is doing. You know what the discontinued operations represent. The “significant items” generated income of $13.5 million in the most recent period. They were an expense of $65.6 million in the pcp. They are restructuring costs, deal costs, inventory write downs, and a host of other stuff. See footnote 4 in the financial statements if you’re interested.

We could have a long conversation about which of these should be included or excluded. Every company seems to have some new significant items or extraordinary events or one time charges pretty much every year. They have an impact on the bottom line. Some, I’m okay with excluding for the operating analysis. Others, not so much. Anyway, let’s just acknowledge that there’s a certain amount of art in this and move on.

Below are the segment revenues and EDITDAs including the items and discontinued operations.

Billabond 12-31-14 results chart 1

 

 

 

 

 

Next, from the presentation during the call, here’s a breakdown of revenue and EBITDA by geographic segment that excluded the significant items and sold businesses.

Billabong 12-31-14 results chart 2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

You can see that revenues fell slightly as did EBITDA. The gross margin for the continuing business was 54.9%, down from 55.4% in the pcp.

In the Americas, Billabong and RVCA grew 9.5% and 5.7% respectively. There was weakness in the Canadian market and Element brand. There was $6.1 million less in wholesale business from West 49, who is now a wholesale customer. CEO Neil Fiske makes the interest comment that “…when we owned this business [West 49], we were pushing our family brands hard. Arguably with too much inventory and too little regard for the natural level of consumer demand.”

Comparative store sales were down 3.5% in the Americas, but only 0.4% in the U.S. The number of stores fell from 173 to 68 mostly due to the sale of West 49.

The good news in Europe is the strong performance of Element (we aren’t told exactly what that means) and the improvement in the gross margin from 49.4% to 55.9% after adjusting for the divestments. It was even a little better as reported. You can see the result above in the improved EBITDA. Neil says the improved margin was “…driven by better inventory control, improved merchant planning, margin management and a focus on higher quality distribution.” Comparative store sales were flat but store margins rose 1.7%. The number of stores, at 111, was down from 112 in the pcp.

Asia Pacific suffered from soft Australian retail sales.

It’s interesting that we still don’t hear much about their other brands. They do mention opening some Tiger Lily shops, but that’s it. I’d be curious to hear what’s going on with Sector 9 and Excel, among others. I still wouldn’t be surprised to see the sale of some other brands.

The balance sheet has strengthened enough as a result of the recapitalization that I’m going to pay them the compliment of not spending much time on it. Non-current liabilities have fallen from $512 million a year ago to $268 million at the end of December 2014. Equity has risen from $194 million to $311 million. If I wanted to pick around the edges a little, I might ask why receivables were actually up a bit given the decline in revenue. Maybe because of the growth of the wholesale business. Cash flow from operations was a positive $13.7 million for the six months compared to a negative $27.3 million in the pcp.

So “stabilizing,” the word Neil Fiske uses, is the right one to describe the continuing business. The profit turnaround is more about the taxes, interest and discontinued operations. However, a chunk of that represents benefits Billabong will continue to see- especially the interest expense reduction. The plan they are pursuing is the same one Neil announced when he took the CEO job, and it looks like they continue to move forward.

 

 

 

 

The Elements of a Turnaround; Billabong’s Shareholder Meeting

Billabong Chairman Ian Pollard and CEO Neil Fiske both spoke at the Billabong shareholder meeting on November 21. Billabong, like Skullcandy, is an acknowledged turnaround in process. Both are using the fact that the public markets designate them as such to approach their turnarounds in what I consider to be the right way.

I would particularly highlight three components of that approach. The first is that they have balance sheets which, if not as strong as they might like (who’s ever is?) are strong enough that they support the turnaround and are no longer an everyday distraction. If you don’t have that balance sheet strength, it’s the most important thing in the world. When you have it, you have the luxury of not having to worry about it all the time. I won’t say you take it for granted.

Second, they say they are brand focused in everything they do. Building “…strong global brands” is how CEO Fiske put it. Good, because at some level a differentiable brand is all you can hope to have.

Third, they both acknowledge that this is going to take some time and that they aren’t going to take short term actions that damage their long term plans. As Chairman Pollard put it, “…do not expect to see us radically change direction in the interests of short-term performance.”

Over a year ago, while Billabong was in the midst of trying to make a deal and get its financial structure in order, I saw RVCA product, on two occasions, in a place where you would not want to see it. It’s gone now, hasn’t been there in months and months, and I am sure I won’t see it again.   But had I been running Billabong at that time and needed the cash flow, I would have made the same decision. And that sort of closes the circle with component number one- the requirement of balance sheet strength that enables you to pursue your brand strategy- and lets us move on from there.

Why does this take so long? Consider how Neil describes the process.

“First we laid out our detailed strategy.”

“Then we re-aligned the organization to that strategy.”

“We then assessed our gaps in talent and capability and brought in new leadership and skill sets across the organization.”

First you have to decide what to do, then you organize to do it, then you find the right people to execute it. There is a certain logic to the approach.  I imagine it wasn’t quite as linear as it sounds, especially once step one was completed, but it’s not complete yet.

So, far, there have been 65 new appointments of senior executives- some internal, some not. Of the senior management team of 10 executive, only CFO Pete Myers was in his current job 15 months ago.

That’s a lot of change, and new executives don’t just spring on board fully functional- especially when the organization is being shifted or created around them. Indeed, it can be a bit hard to hire them until you know exactly what you are going to ask them to do and who you want them to manage.

Chairman Pollard said, “Those appointees cannot effect major change until they fully understand and evaluate what specific change is required and how to execute most effectively on that.”

“For example, in areas like IT or supply chain, we cannot just shake-up our disparate global systems and processes within a matter of months with all the disruption, cost, distraction and execution risk that brings. Our approach is and will continue to be to do things once and do them right, even if that takes longer.”

So patience is the reasonable and requested order of the day.

We find out a bit about how various brands are doing in each region. “The Americas remain our biggest challenge and opportunity,” CEO Fiske tells us. He thinks it will continue to be weak through the first half of 2015, with the second showing “…the potential for some recovery…”  It’s hard to know how to interpret that phrase.

Canada is down 17% this year to date “…on a like for like basis.” That means ignoring West 49. Brazil is off 25% and they are resizing and restructuring that business. “…Element U.S. will remain weak for some time as we are completing a major overhaul of the team there under our new global brand leadership model.”

“Europe has turned around, we expect that region to be profitable this year, and it is showing steady improvement. In the U.S., Billabong is growing again and RVCA is re-accelerating, with both brands showing strong forward orders for spring.”

As you know, Billabong owns seven brands in addition to Billabong, Element and RVCA. I find it interesting that the only one we hear about is Tigerlily, which we’re told has grown 20% annually in Australia over the last three years.   I speculated in an earlier article that I thought we might see some additional brand sales because of Billabong’s decision to focus on its big three and because they are committed to funding investments with “…cost reduction, productivity gains, and global scale.” I still think such a sale might happen because of that focus. And they could make good use of the cash.

Neil recaps Billabong’s seven pillar strategy, reminding us that they revolve around brand, product, marketing, omni-channel, supply-chain, organization and financial discipline. If you want to see what Neil says, download and read his speech here. It’s the first item under “Recent News.”

Much of what he discusses are the same things other companies have been paying more attention to since 2008 or so; ecommerce, inventory management, rationalizing sourcing and logistics, being cautious where you spend money, etc.   There’s nothing particularly unique about the steps Billabong is taking, but it’s very important stuff not just in controlling expenses, but in building brands.

I particularly noted the efforts Billabong is making in managing its infrastructure. Here’s the slide they showed.

Billabong annual meeting 11-14

 

 

 

 

 

 

 

 

 

 

 

 

Slide’s a little hard to read.  Sorry.  You should come away from it realizing three things. First, that it was a bit of a mess and there’s a lot of money to be saved (though first they will have to spend some to make it happen). Second, that it’s going to take time. And third, that it has to happen if they are going to grow “strong, global brands.”  Operating well was always part of brand building, but in the days of the internet the two are even more closely related.

Baring an unexpected announcement, we’ll next hear from Billabong when they report their half year results this summer. I will look forward to learning how the turnaround is progressing.

Billabong’s Annual Results: Progress on a Long Road

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.