Globe’s Results for the Year; Good, but What’s Going on in North America?

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I’m kind of late writing about this, but Quiksilver inconveniently filed for bankruptcy right before I went on vacation and I was focused there. The headline is that Globe improved its performance. However, there isn’t much to analyze. Basically they tell us, “We did good and think we can do better.”

Hope so. Anyway, here’s a brief presentation and discussion of the numbers. Just to remind you, Globe is Australian and all the numbers are in Australian dollars.

Revenue rose 32.7% from $104 to $138 million for the years ended June 30 2014 and 2015. Revenue from all their brands rose. Globe was up 24% and Dwindle 34%. 4Front was up 36%. That’s their licensing and distribution business for Australia and New Zealand. The brands they manage are Stussy, Obey, Vision Streetwear, and Komono. Hardcore, “…the largest distributor of leading brand skateboard products, both owned and third party international brands, in Australia and New Zealand,” rose 39%. Its brands include Girl, Lakai, Thrasher, Chocolate, Flip and others you would recognize.

Finally FXD, which sells “carefully designed and styled work wear,” was up more than 100%. This brand, I recall, is pretty new and I imagine that growth is from a small base.

How did they accomplish this growth? “Past diversification strategies and brand investments driving growth.” Well, that certainly explains it. You can see why this might be a short article.

Revenue in the Australasia segment rose 32.6% from $37.7 to $50 million. Sales in Australia rose 30.5% from $34.9 to $45.5 million. Clearly, most of the segment’s growth was in Australia, which represented 91% of segment revenue.

All the divisions reported growth in the segment. “Improvement in performance [was] due to strategic diversification of brands, categories and new distribution channels.” Moan. Come on guys. Give me something at least a little specific to work with here so I can explain your good results to people.

North American revenue was up 26.3% from $39.2 to $49.5 million, with U.S. revenues up 16.4% from $20.8 to $24.2 million. Hmmm. Wait a minute. Those segment numbers are from note three, paragraph b of their filed report. But the slides they provided as part of their presentation says North American net sales grew by 14% as does the discussion of the results in the financial filing. I don’t know- 26.3% seems better than 14%.

Somebody at Globe help me out. Is the 14% constant currency maybe? Or have I lost the ability to read or work my calculator? Anyway, I’m giving you the numbers as reported in that footnote. The increases I calculated from the financial report is the same for the other two segments as what’s reported in the presentation, so I’m thoroughly confused.

European revenues rose 41.5% from $26.6 to $37.6 million.

The Australasia segment EBITDA rose from $3.34 to $5.65 million. The North American loss worsened from $1.03 to $1.67 million. Losses aren’t supposed to rise when revenues goes up 26.3%. Or even 14%. Wonder what’s going on there. Europe’s EBITDA was up from $3.60 to $6.97 million. That’s quite an increase.

Let’s move a little further down the income statement. Globe’s income statement doesn’t show a gross profit line. But in a note they do show something called “Cost of sales.” I’m going to use that (perhaps not correctly) as what we’d call cost of goods sold to calculate a gross margin. When I do that, I get 46.1% in 2015 compared to 46.4% in 2014.

Net income in 2014 was a loss of $12.3 million. In 2015, Globe reported a profit of $3.72 million. There are a couple of items you need to be aware of in evaluating these comparative results.

Last year, there was a $17.1 million charge for impairment of assets. In 2015, there was no such charge. Due, I think, at least partly to that charge there was tax benefit in 2014 of $3.3 million where 2015 shows a tax expense of 1.7 million. That’s a $5 million difference.

If we look at the pretax numbers and take out the impairment charge, you’ll see that Globe would have earned $1.45 million last year compared to $5.42 this year on a pretax basis.

The balance sheet is pretty solid with no borrowings or long term debt. Equity grew consistent with the net income. The current ratio is solid.

As I’ve already complained, we’re not getting a lot of specifics. Basically, after some tough years, Globe is running its business better. As they put it, “This revenue and profitability improvement was a consequence of the recent investments and diversification into new markets and brands and as such, growth came from multiple brands, product categories and geographic regions.”

As usual, I’m pretty sure there was no magic bullet. Just hard work, some difficult lessons, and management discipline. North America still seems to have some issues with the loss increasing even with a solid sales increase.

Quiksilver’s 10Q; Not Really a Surprise

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In the aftermath of Quik’s bankruptcy filing, the 10Q feels like an afterthought. Still, it’s worth a brief review. There was no conference call. Hell, what’s left to say?

In the quarter ended July 31, revenues fell 11.1% to $336 million from $378 million in the same quarter last year. Gross margin didn’t do much of anything, rising from 47.9% to 48%. Below are the comparative sales and gross profit for both quarters.

Quik 7-31 10q 9-15 #1Revenues as reported for the Americas, EMEA and APAC were down, respectively, 15.3%, 8.7% and 4.1%. Talking about revenues, Quik tells us, “Year-over-year net revenue and gross margin comparisons continuing to be unfavorable due primarily to the impact of currency exchange rates and licensing. We also expect our net revenues and margins to be unfavorably impacted by late deliveries in the short term and an evolving distribution channel strategy, particularly in North America.”

I don’t know what they mean by the “evolving distribution channel strategy.” I hope they mean they are pulling back from some questionable channels.

By channel, wholesale revenue fell 15% from $233 to $198 million. Retail was down 9% from $123 to $112 million. E-commerce rose from $20 to $21 million, or by 5%. Licensing revenue was $5 million, compared to $2 million in last year’s quarter.

They note that the drop in wholesale revenue includes $21 million “…from licensed product categories.” Instead of getting that $21 million, they received $5 million in revenue, but of course they received it without any cost or effort. Ignoring for a moment the impact on the brands of where and how that product was sold, it seems like a pretty good deal if for no other reason than the positive impact on cash flow.

By brand, Quiksilver was down 6% from $141 to $132 million, Roxy by 18% from $118 to $97 million, and DC by 11% from $108 to $96 million.

We’ve got a 19.2% reduction in SG&A expense from $205 to $166 million. These numbers include asset impairment charges of $17.4 million in this year’s quarter compared to only $180,000 in last years. $16 million represented “…the write-down of the carrying value of the Quiksilver trademark…”

“The decrease in Americas segment SG&A was primarily due to reductions in employee compensation, advertising, and bad debt expenses. The decrease in EMEA and APAC segment SG&A was almost entirely due to changes in foreign currency exchange rates.” Remember that a stronger dollar makes things cheaper when translated into US dollars.

When we’ve got a goodwill impairment charge of $80 million, down from $178 million in last year’s quarter. We’ve got an operating loss that’s fallen from $203 to $102 million, but you can see that’s pretty much just the result of the impairment charge being $100 million lower. Interest expense at $18 million is a big lower than the $18.7 million in last year’s quarter and foreign currency produced a gain of $4.7 million compared to a loss of $2.3 million last year.

So the net loss fell from $223 to $125 million. Depending how you think about the goodwill impairment charge, you might conclude that this year’s quarter was pretty much the same as last year’s.

The key thing to note on the balance sheet is that the long term debt has been classified as a current liability due to the bankruptcy filing. That interesting, because obviously the September 9 bankruptcy filing occurred after the July 31 date of the financial statements. Quik says the reclassification is what’s required by generally accepted accounting principles. They also tell us, “As of July 31, 2015, the estimated fair value of the Company’s borrowings under lines of credit and long-term debt was $583 million, compared to a carrying value of $822 million.”

At the end of the day, the balance sheet as presented isn’t of much interest right now, as all the unsecured creditors have made a contribution to Quik’s equity by virtue of the filing. That is, they can’t get paid unless the court approves payment or until a plan is confirmed. Some will get more, some less and a lot nothing.

That’s pretty much the end of the shortest analysis of a Quik filing I’ve ever done. My two major concerns as we watch the current restructuring process move forward continue to be 1) where will the sales growth come from and 2) is existing, long term management the right ones to pull this off.

Quiksilver’s Bankruptcy Filing: And the Beat Goes On

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As pretty much everybody knows, Quiksilver filed for Chapter 11 Bankruptcy on September 9th. This is another step in a long process that’s been going on for years now and that we’ve followed together on these pages and in other places.

This will not be an explanation of bankruptcy or a discussion of why companies get into trouble. I’ve written those articles years ago (not specific to Quiksilver) and have posted them at the bottom of my home page under Classic Market Watch Columns. I sent that same link and information out last week. That’s probably the first time most of you have seen the bottom of my home page. Hell, I haven’t seen it in a while.

Before we get into some of the specifics of the filing and the plan, let’s briefly talk about what I think matters most.

In every report from Quiksilver I’ve analyzed in recent years, I’ve asked, “Where’s the sales growth going to come from?” No amount of bankruptcy filing, restructuring, store closings, downsizing and rejection of contracts resolves that issue.

That doesn’t make the filing unimportant. As I wrote before the filing, some form of restructuring had to happen because the existing balance sheet and implied cash flow did not support continued operations. As a result of the filing, and assuming the plan is approved, debt and interest expense will decline and so will other expenses. For example, Quiksilver reported it had north of 700 stores at April 30. Lease contracts for unprofitable stores will be rejected in bankruptcy and the store count will decline. That will reduce expenses further.

But it will also reduce sales once the liquidation of excess inventory that results from the closings is done. I’m fine with that. The Quiksilver, Roxy and DC brands could all stand to be a little less broadly distributed from a brand building point of view. As you know, however, I believe there’s a potential conflict between building brands with hard to differentiate products and being a public company.

My point is that none of this restructuring stuff matters unless consumers want to buy products with the Quiksilver, Roxy and DC names on them. The good news in that regard is that consumers typically don’t notice a bankruptcy filing. With that in the back of our minds, let’s look at what’s happened.

Who Filed for Bankruptcy?

While it’s easy to say, “Quiksilver filed for bankruptcy,” that’s not an description adequate for our discussion. Quik’s U.S. operations filed. Here’s a list of the legal entities included in the filing.

Quik bk filing 1 9-15

 

 

 

 

 

 

 

 

 

And here’s Quik’s complete organizational structure from one of the filing documents. I know the picture is too small to really read, but I just wanted you to have a sense of the scope of the legal entities composing what we think of as Quiksilver. The shaded boxes are the ones filing for bankruptcy, and correspond to the list above. The legend at the bottom right of the chart refers to the shaded boxes as “Non-Debtor.” I think that’s a mistake.

quik bk filing 2 9-15

Now, why do you care?

A “Prepackaged” Filing and the Role of Secured Creditors

Without getting into too much detail (like I’m going to be able to avoid that), you are probably aware that Quik has various pieces of long term debt. Around one-third of it is secured. That is, if Quik doesn’t perform under the terms of the deal under which they borrowed the money, the secured debtholders can seize the collateral securing the loans. Collateral can include various classes of assets including inventory, receivables, cash, trademarks, buildings, etc. It just depends what’s in the agreement.

That doesn’t change in bankruptcy. The secure creditors still have the right to the assets if Quik doesn’t perform under the loan agreement. But if the secured creditors take their collateral, Quik ends up selling its assets for the benefit of its creditors, the company goes away, and the secured creditors get less than if they can somehow restructure the debt and keep Quik operating. Or at least so they’ve apparently calculated. Knowing what I know about what happens to asset values in liquidation scenarios, I suspect they are right.

So a secured creditor has some leverage, and you can’t do a chapter 11 bankruptcy, prepackaged or otherwise, without their cooperation. Quik has played “Let’s Make a Deal” with that creditor in advance, and the plan is effectively part of the filing.

The press release tells us the filing “…is supported by 73% of the Company’s senior most class of debt…” It further tells us that “…holders of the Company’s Eurobonds sufficient to waive any technical default arising from the filing have agreed to allow the Company to reorganize its U.S. operations in Chapter 11.”

The rights and remedies of the secured creditors are no doubt carefully spelled out in documents, and you may all feel free to go find and read those documents to your heart’s content, because I’m not going to. My hope is that whichever, if any, secured creditors may not have agreed to this deal don’t have the ability to slow it down. The whole purpose of a prepackaged deal is to get the company in and out of bankruptcy quickly.

Here’s a list of the three biggest chunk of Quik’s debt included in the filing. The first one is the notes denominated in Euros.

Quik bk filing 3 9-15

You’ll note the $279 million in secured notes in the middle. You may also notice that none of this is due to be repaid farther away than 2020, and the first notes (the ones denominated in Euros) are due in 2017.

Who’s Getting Treated How and Just What’s the Deal?

 The thirty largest unsecured creditors are listed in the original filing. The biggest by far is US Bank as trustee for $225 million of unsecured notes. That’s the third item on the chart above. The next largest is, I think, a supplier and it’s for $7.3 million. Most of the rest are for merchandise, but there is a couple for “real estate” that I take to be store leases. Don’t know for sure. There are a few individuals for severance. As you are aware, Quik already stop paying under its severance agreements (35 people I think), but most of those amounts aren’t big enough to make the top 30. The smallest amount on this list is $931,000.

Unsecured creditors don’t typically do well in a chapter 11 filing, but in this case it sounds like some will do better than others. What I’ve typically seen is that they have to be dealt as a single class and treated equally. They can’t be paid until the case is settled, though they can continue to sell to the filing company (in this case Quik) if they want to.

Quik, however, has petitioned the court to pay some or all of what they owe to “critical suppliers.” The court has approved those payments up to some specific limits. That makes some sense to me because they need these suppliers to get product. If these suppliers start messing with production or the supply chain, Quik could be in a world of hurt quickly. Okay, they already are, but even more hurt.

I wonder- if I were one of those critical suppliers, I’d be thrilled to get paid but I’m not clear how excited I’d be to continue to give Quik terms on new products. Those must be interesting discussions.

It would be great if some lawyer reading this would explain what I don’t understand. I know bankruptcy judges have a lot of discretion (they should), but I’m surprised you can treat some unsecured creditors differently from others.

The rest of the unsecured creditors are not going to do quite so well as the critical suppliers. They would “…receive cash in an amount equal to its pro rata share of the Unsecured Creditor Recovery.” The total of that Unsecured Creditor Recovery is $7.5 million. We haven’t yet seen the schedule that shows us all the unsecured creditors, but I’m thinking this will mean pennies on the dollar.

Then there are the holders of the common stock. There’s a 60 page list of those people. Interestingly, there seem to be an awful lot of people who own one share. Last time I saw, Quik stock was trading between $0.08 and $0.10 a share. As currently structured, those shareholders are going to end up holding common stock that’s worth exactly and specifically zero. Just to be clear, here’s how Quik put it in an SEC filing. “All of the Company’s existing equity securities, including its shares of common stock and warrants, will be cancelled and extinguished, without holders receiving any distribution.”

Like the people with severance agreements, some store landlords can expect their leases to be rejected in bankruptcy. Quik will close the stores where they choose to do that, though they would have the option of renegotiating the leases with the landlord to get more favorable terms.

So far, there are 27 stores to be closed and, in fact, that process started before the filing when Quik made a deal with a liquidator to sell the inventory and fixtures in those stores. The process is to be completed by the end of December.

Quik has also opened some “pop up” locations to dispose of obsolete or distressed inventory. I don’t quite know if that refers only to the inventory from the stores being closed or not.

Product from all three brands is involved in the store closing and liquidation. This can’t be good for the brand’s market perception.

The happiest people in this deal have to be the ones who hold the Euro notes. Basically, if they keep quiet and don’t cause trouble, the non-debtor foreign subsidiaries will continue to pay principal and interest as it comes due during bankruptcy, and the claims of the Euro holders will be unchanged when Quik exits bankruptcy. And if they want, they can get 25% of their notes paid down if they agree to extend the maturity by three years. Quik would like those notes not to have to be paid in 2017.

The other two sets of notes, totaling about $500 million, will go away. That will result in a big improvement in the balance sheet and reduction in interest expense. However, the 2018 notes can be converted into common stock. The 2020 notes will be in the unsecured creditor pile and get not much as I described above. Boy, are they screwed.

Oaktree Capital, as you know, will provide part of the “debtor in possession” (DIP) financing. Some lenders like to do DIP financing because it has a priority in bankruptcy over just about everything. As I recall, it’s senior to all claims except taxing authorities and the professionals (lawyers, accountants, etc.) who work on the case. Oaktree will provide $115 million in DIP financing. Bank of America will provide another $60 million, essentially continuing their asset based lending facility through the bankruptcy process.

By definition, asset based lending facilities are secured. But you don’t see it in the debt list above because it’s short term borrowing. There was $33 million outstanding under that line at April 30. I’m guessing that maybe there was $60 million outstanding at the time of the filing.

When they exit bankruptcy, Bank of America will replace its existing ABL line with a new $75 million line. As a secured creditor, it appears they will more or less come out of this whole. Asset based lenders usually do.

“Upon consummation of the Proposed Restructuring, the new Company will be funded by two separate rights offerings of up to $122.5 million and €50.0 million, respectively. Both rights offerings will be backstopped by the Plan Sponsor [Oaktree]. It’s the owners of the $279 million of notes due in 2018 and of the Euro notes that will have the chance to participate in these offerings. And if they don’t participate, Oaktree will take the whole amount. That’s what’s meant by “backstop.”

This will apparently involve some combination of new debt and common stock at a discount price. We don’t’ yet know what the new price will be. The proceeds from those two offerings will be used to repay Oaktree it’s DIP financing (yes, they may end up partly repaying themselves), paying the unsecured creditors, buying back the 25% of the holders of the Euro debt from those who want to extent their notes for three years, and for “general corporate purposes.”

What Does This All Mean?

As I started off telling you, no amount of restructuring addresses in any way the attractiveness, or lack of attractiveness, of Quiksilver’s brands in the market. But, hopefully, it gives them another chance to focus on that.

That was the whole idea when they got out from under the Rossignol debacle and brought in financing from Rhone, but here we are with a bankruptcy filing. In the words of Quik CEO Pierre Agnes in the press release, “Our fresh capital structure, with a very low level of debt for our industry, will enable us to invest in and reinvigorate our brands and products. We are confident we will emerge a stronger business, better positioned to grow and prosper into the future.”

This restructuring does a lot more for the balance sheet than the prior one. But I bet if I went back and looked at the press release for that deal, I’d find similar words.

The next thing I’m focused on is the roll of Oaktree. As you know, they are a major investor in Billabong, and now in Quiksilver. All over the summary plan document is the recurring phrase, “…which shall be in form and substance acceptable to Oaktree.” How is this going to work exactly? How much control will Oaktree exert? Their representatives resigned from the Billabong board right before the filing, but I’d be pretty surprised if somewhere, somehow, Oaktree people hadn’t thought about some kind of coordinated strategy or consolidation or sharing of functions or something. I doubt the legal and ownership structure would permit that right now, but everybody wants to be the next VF.

Quiksilver stock, as you probably know, has been delisted from the New York Stock Exchange. As of September 10th, it was traded on the over the counter market under the symbol ZQKSQ. Large chunks of stock are going to be owned by Oaktree and others. Someday, it’s possible they may want that stock to go up in value so they can sell it and make money.

I’m guessing that if things go well for Quik, we’ll see a secondary offering a year or three down the road so that the current shareholders can have some liquidity for their holdings. But we don’t have to worry about that right now.

Meanwhile, somebody sent me a copy of a letter than Quiksilver President Greg Healy sent out to dealers more or less when the filing occurred. I’m not going to reproduce the whole letter, but I want to quote one sentence.

“The challenges we face today stem from poor decisions made by previous management, which saddled the Company with a burdensome debt load.”

I’m kind of wondering what they mean by “previous management.” Not Andy Mooney. The debt was there before anybody at Quik had ever heard his name. It’s true that Andy didn’t understand the market, but he was also responsible for initiating a bunch of operational changes that should have been implemented, in some cases, years sooner.

This statement really bothers me, because it suggests not being completely in touch with reality. There is nothing worse in a turnaround. And the longer a turnaround lasts, the more the pressure builds and the harder it gets to be in touch with reality. Andy Mooney may have been the wrong outsider, but my experience is that an outsider is a good idea. I am wondering just how much leverage Oaktree will exercise in this area. Remember, they brought Neil Fiske into Billabong.

I’m going to urge you all again to go to the bottom of my home page under Classic Market Watch Columns, and read the one about why companies get in trouble.

The next court hearing is scheduled for October 6th. I’ll watch for new documents and try to keep you up to date. In the meantime, keep in mind that this necessary step doesn’t solve all Quiksilver’s problems- it just gives them another chance to address them.

Article on Quiksilver Bankruptcy Filing

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A reader forwarded this article, published in Australia, to me.  I thought it had some good information.  I’m particularly intrigued by the short discussion about how Quiksilver and Billabong will or will not be combined or work together.  Here’s the link.

The Quiksilver Conundrum; There Has to be a Deal

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I’ve resisted writing this, but with the recent article in Bloomberg highlighted by Boardistan and Shop-Eat-Surf reporting, also based on a Bloomberg, that Quik had hired a restructuring firm, I guess there’s no reason not to.

What I want to do is take you through Quik’s circumstances and choices based on their most recent balance sheet dated April 30, 2015 We’ll seeing another one shortly, but I doubt that’s going to change my analysis. I also want to consider with you what a “restructuring” might mean and how it impacts the industry.

Quik’s most recent balance sheet states there are 174,642,124 shares of common stock issues and outstanding. That’s not a fully diluted number, but let’s work with it. As I write this (September 4) Quik’s stock is trading at $0.46 a share. Multiplying that price by the number of shares outstanding gives us a market capitalization of $80.3 million.

Now let’s suppose that all the shareholders of Quik’s common stock- every last one of them- offered to give me their shares for free. And let’s further assume that somehow when I got all those shares for free I wouldn’t have to pay income tax on $80.3 million in income.

How would I respond to the offer? Very, very carefully. If I accepted, I would become the owner of all of Quik’s assets- and its liabilities.

The liabilities total $1.153 billion, and I can guarantee that they are mostly very, very real. The largest is $785 million of long term debt. Total assets of $1.139 billion are less than liabilities. Hence the negative equity on the balance sheet.

In any kind of restructuring, we’d have to take a hard look at those asset values. Okay, I believe the $48 million in cash on the balance sheet is probably worth $48 million no matter what. I’m not so sure what the fixed assets of $190 million, the intangibles of $138 million and the goodwill of $80 million would be worth.

There’s also inventory of $291 million and receivables of $252 million. In any sort of a messy restructuring, would those be worth 100 cents on the dollar? My experience is that they would not, but it depends on just how things come down.

So were I to accept the offer, I’d own a company that wasn’t making any money and, realistically speaking, had assets that were significantly less than its liabilities. Sounds like a bad deal.

That’s why I am not expecting, and have not been expecting, any kind of offer to buy the equity. You’d just have a new shareholder with the same problem the current shareholders have.

Unless you think that the three brands- Quiksilver, Roxy and DC- have value well in excess of what they are carried for on the balance sheet.

Whoops- as I sit here writing this Shop-Eat-Surf has just published a story that says, “Quiksilver cuts jobs, stops severance payments.” To me, that’s further indication of their cash flow issues (not new) but also may have to do with ongoing negotiations.

Anyway where was I? Oh yeah- the value of the three brands. What I’ve said in the past is that all three brands have value, but that it would be easier to recognize that value as a private company. I’m pretty confident there’s no reasonable valuation that generates a sales price of a brand that solves Quik’s balance sheet problem. The sale price goes to pay down debt and leaves the company proportionally with the same problem on a smaller scale.

There are buyers for all three brands, but probably not at a price that does Quik any good. I’d love to be wrong and think we’ll find out if I am pretty soon.

You can see what’s going on. Quik has continuing and worsening cash flow issues. It’s in a lousy negotiating position. What I assume are ongoing negotiations and analysis is dealing with exactly the valuation assets I’ve raised for both the balance sheet accounts and the brands under different scenarios.

My best guess is that there’s no reasonable valuation a buyer will accept that can work without a restructuring of the debt, through whatever vehicle and in whatever form that might take. Quik management and the restructuring firm will be negotiating not just with potential buyers but with the secured creditors to try and put such a deal together.

As an industry, we have to be concerned about what happens to Quik’s three brands. We’d like them to end up where they could be nurtured a little to recognize their value, rather than blown up in distribution. It’s already been disconcerting for me to walk into Fred Meyers and see Quik and DC kids’ stuff on the racks and discounted in the Sunday newspaper ads.

I’ve highlighted for some time now what I see as a conflict between building a brand and being a public company. The way you rebuild brands in our current environment- like Billabong and Skullcandy are trying to do as public companies- is to pull back on distribution to better position the brand and improve margin while reducing expenses. But this requires some patience and I don’t think it lends itself to valuations that solve Quik’s problem.

Quik’s last financial statement reporting was in early June, so we should be seeing the next one any time. There’s going to be some kind of deal, and I don’t see how it can avoid involving some restructuring of debt. Let’s hope that whatever form it takes, the brands are still positioned to be supportive of the industry.

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

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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.

Deckers June 30 Quarter and Some Perspective on Sanuk

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It wasn’t a great quarter for Deckers, the owner of UGG and Teva as well as Sanuk, though let me start out by reminding you that seasonality means this is always Deckers’ worst quarter.

Sales rose 1.1% from $211.5 to $213.8 million. The gross profit margin fell slightly from 41% to 40.5%. SG&A expenses rose steeply from $37.3 to $47.3 million. The operating loss jumped 26% from $50.5 to $63.7 million.

The net loss also rose from $37.1 to $47.3 million, or by 27.5%. It’s less than the operating loss due to tax benefits of $13.7 million in last year’s quarter and $17.4 million in this year’s.

Sanuk, we find further on, had wholesale revenues for the quarter of $28.5 million, down 11.6% from $32.3 million in last year’s quarter. Operating income on that wholesale business fell 22.6% from $6.9 to $5.3 million.

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SPY’s June 30 Quarter; Kind of More of the Same

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As usual, I’ll start off my discussion of SPY by saying how much I like the brand and how I think they’ve done most of the right things in terms of operations and brand positioning. But then I move on to the financials (the June 30 quarter in this case) and bemoan, as I have before, how they are smaller in revenues than they need to be to get traction in the highly competitive sunglass market and support spending at the level required.

I don’t really even care about the $21.5 million payable to stockholders on the balance sheet. True, there’s some interest expense, but that’s been reduced since the debt holder reduced the interest rate last year. The only thing that debt does is prevent the company from being sold, which I think would have happened without that debt sitting there.

Revenues fell 0.75% to $8.12 million compared to $8.18 million in last year’s quarter. U.S. and Canadian revenues fell 1.64% from $7.03 to $6.91 million. In the rest of the world, they rose 4.67% from $1.16 to $1.21 million. They don’t discuss the impact of currencies, but I’d tend to look at that increase as being pretty good given the strength of the U.S. dollar. Here’s how they describe the sales decline.

“The period over period decrease in sales is principally attributable to lower sales of our prescription frames and goggle product lines which each decreased by $0.2 million, or 21.5% and 37.4% respectively… The decrease was partially offset by an increase in sales of our sunglasses, which increased by $0.2 million or 2.5%. Sales also included approximately $1.2 million and $0.3million of sales during the three months ended June 30, 2015 and June 30, 2014, respectively, which were considered to be closeouts.”

First, with just a little mental math you can see that the prescription frame business must be pretty small if a decline of $200,000 means that revenues fell by 21.5%. You can make the same argument for the 37.4% decline in goggles, though I’d be a bit more cautious given the seasonality of that business. Here’s the percentage of sales by product line from the 10Q.

SPY 6-30 10q 8-15

 

 

 

 

 

What’s of more concern to me is the $1.2 million in closeout business compared to $0.3 million in last year’s quarter. I’ve previously commented that SPY seemed to be getting inventory issues under control, but now I’m not so sure. The June 30 balance sheet shows a 21.2% increase in inventory from $6.56 to $7.95 million.

The gross margin took a big hit falling from 55.5% to 49.5%. Here’s what they say about the decline.

“Gross profit as a percentage of net sales was 49.5% for the three months ended June 30, 2015, compared to 55.5% for the three months ended June 30, 2014. The decrease in our gross profit as a percent of net sales during the three months ended June 30, 2015 compared to the same period in 2014 was primarily due to: (i) higher sales of closeout products at reduced price levels and (ii) lower sales of higher margin prescription frames.”

That seems to confirm inventory is an issue.

They continue to reduce operating expenses, which fell from $4.4 to $4.1 million. Interestingly, they have given early notice that they are terminating the lease on their headquarters and, in December of this year, expect to move to a new facility. Rent will rise from around $29,000 a month to $48,000.

The fall in the gross margin meant that operating income went from a positive $101,000 to a loss of $42,000. Interest expense was down from $751,000 to $491,000 for the reason I mentioned above. There was still a net loss, but it was down from $742,000 to $516,000. That’s less than the decline in interest expense.

On the balance sheet, equity is negative at $17.7 million. Practically speaking, however, you can consider the notes due to shareholder as equity. The current ratio declined a bit from 1.49 to 1.27. Current assets were up around $1 million, but the current liabilities rose more on the back of an increase in the line of credit.

That’s kind of it. If I could dig into one thing, it would the rise in inventory and the closeouts. I’d like to know it doesn’t indicate an issue with product acceptance in the market.

The Beat Goes On- Skullcandy’s Results for the June 30 Quarter

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Since right after he joined the company, Skull CEO Hoby Darling has been pushing the same five pillar strategic plan as the company works through its issues and out of turnaround mode. I’ve reviewed those five pillars every quarter since he presented them, and I think I’m done.  You can go read one of my earlier articles or the conference call transcript if you need your memory refreshed.

Those five pillars are hardly unique to Skull- some of them are things that need to be done well by any company. But what I like is that they aren’t “things you have to do in a turnaround.” They are five targets, or areas of focus, that provided when he presented them, and continue to provide, a focus and consensus about how Skullcandy expects to succeed.

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VF’s June 30 Quarter: Damn This Strong Dollar!

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VF reported a 4.62% revenue increase in the quarter that ended June 30 compared to the same quarter last year (prior calendar period- PCP). The increase was from $2.402 to $2.514 billion. As usual, we’ll focus on the Outdoor & Action Sports (OAS) segment, as that’s where most of the action seems to be.

Below is the chart from the 10Q that lays out the revenues and operating profits of each of VF’s segments for the quarter and the half year.

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