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.
What exactly is a Chapter 11 bankruptcy filing and how does the process work?
A Chapter 11 is a “reorganization” bankruptcy. That is, it is filed with the assumption that the filer will use the protection of the court to reorganize its finances so that it can continue as a going concern. That doesn’t always happen, but it’s the intention going in.
There are a number of schedules you have to file with the court when the bankruptcy occurs. These included assets and liabilities, income and costs, a schedule of existing contracts and some others. Typically, the owner of the business becomes the “debtor in possession” and is responsible for the continued management of the business and control of the associated assets. He is in a position of fiduciary responsibility with the same powers and obligations as if a Trustee had been appointed to manage the business. He’s required to file the monthly reports, can hire attorneys, accountants, appraisers or other professionals to help with the case, and file tax returns.
Note that a corporation has standing as a separate entity, so an owner’s personal assets are not at risk in a corporate filing, except to the extent of his equity in the business (or if he has given a personal guarantee, though that’s an issue outside of bankruptcy). A sole proprietor filling a chapter 11, on the other hand, will find his personal assets are part of the bankruptcy. Something to think about.
All You Need Is Cash- and a Bankruptcy Attorney
With the filing of the bankruptcy petition, all collection efforts by creditors are required to cease. In fact, the company is not permitted to pay any unsecured debts incurred prior to the date of the bankruptcy filing.
Actually, it’s worse than that. The debtor in possession has the right and maybe the obligation to recover certain payments or transfers of property made prior to the bankruptcy filing so they can be equally divided among creditors. You can understand how the bankruptcy judge and creditors might insist on that if the owner used corporate assets to buy a Caribbean island a week prior to the filing when he wasn’t paying his creditors. Giving stuff to relatives or other insiders in anticipation of the filing is also a no-no.
Generally, this does not apply to payments made in the ordinary course of doing business, so one thing you make sure you do is pay your employees everything you owe them up to the day of the filing. Remember you’re trying to restructure the business and it can be kind of hard if the employees have been stiffed right along with the other unsecured creditors.
You’re also going to need cash for a retainer for your friendly bankruptcy attorney, who knows he won’t get paid for 120 days or so after the filing and wants some money to bill against. The phone company and other utilities will probably want a deposit to continue providing service, and some of your suppliers you haven’t paid and now can’t pay by law may be reluctant to ship you more merchandise on credit (though their chances of getting paid on new shipments may actually have improved).
It takes some cash to file a successful chapter 11. Any company thinking about it should be hoarding some in advance.
Cash Collateral
If there’s a bank or other financing source involved, chances are they have security in the company’s assets. If you don’t pay them, they have the right to the inventory, receivables, trade name, furniture and fixtures, patents, copy machine, and your lunch in the office refrigerator. But of course, if they take all that and try to liquidate it to get themselves paid, there’s no business.
The debtor in possession can’t use that cash collateral, as it’s called, without permission of the secured creditor or authorization of the court. The court is required to make sure the collateral belonging to the secured party is adequately protected on a continuing basis. So typically there will be a cash collateral hearing where the secured creditors, the judge, and the debtor in possession, along with appropriate attorneys, will figure this all out.
The secured creditors’ interest is in ultimately collecting their money. They know things were going to hell before the filing. They also know that if they had to sell the debtor’s inventory and collect his receivables themselves, it might not go too well. So, if they believe they can continue to be adequately secured and that the debtor in possession has a fighting chance to turn the business around, they will often not oppose the debtor’s use of cash collateral. And even if they do the bankruptcy judge, who has quite a bit of discretion in the whole bankruptcy process, can require them to allow it as long as they have “adequate protection.”
The debtor needs use of the cash collateral to continue to operate the business, but there’s a chance he also needs some additional financing. There is a class of lender who provide “debtor in possession” financing. Remember that as a result of the filing, all the unsecured creditors have made an involuntary and hopefully temporary contribution to the debtor’s capital, immediately strengthening the balance sheet. A lender supplying debtor in possession financing often has priority over existing unsecured debt, so their risk is reduced.
I don’t know what the debtor in possession financing market is like right now given current economic conditions. It will be interesting to find out.
Now What?
Well, the immediate pressure is off the debtor in possession, and he can try and restructure his business. He’s no longer spending all his day shucking and jiving with creditors and figuring out how to make payroll. He has an exclusive period of 120 days in which to file a plan of reorganization. Nobody else can do it during that time. The 120 day can be extended, but not past 18 months. Knowing that somebody else (like the creditors’ committee) might be allowed to file one can motivate the debtor to get it done.
There’s probably been a creditors’ committee formed which typically consists of the 7 largest unsecured creditors. They can be more or less active, but typically consult with the debtor in possession on running the business and developing the plan. It can be useful to have the committee looking over the debtor’s shoulder.
There may be various legal proceedings going on where, for example, certain creditors try to get relief from the stay that keeps them from trying to collect their money.
The debtor has the right to reject contracts and leases he does not believe are in his interest. He’ll be busily using that leverage to restructure his business.
He’ll also be working to convince customers, suppliers (who have not been paid but can be paid for new work in bankruptcy), and employees that the business is viable and that they should continue to deal with him. What fun.
The Plan
At the core of the plan eventually filed with the courts is the issue of who gets paid how much. As the business and its assets are the source of that repayment, how the business is going to operate and how much cash it flows off are critical. It would be typical for the plan to classify those who are owed money as secured creditors, unsecured creditors, and equity security holders, though there can be others. The further down the list you are, the lower your priority. The tax authorities and the lawyers and other professionals who worked with the firm during the bankruptcy are at the top of the list.
Typically, there’s not going to be enough to give everybody 100 cents on the dollar, so there’s some negotiations involved in getting the plan approved. If I remember this right, a whole class of claims is said to accept the plan if the creditors in that class who do accept it represent at least two-thirds in amount and more than one half of the numbers of claims in the class. One of the things that’s sometimes done to simplify the approval process is to agree to pay all the smallest claims 100% of their claim when the plan is approved. That tends to get them on your side.
I’ve described in about 1,500 words a process and set of circumstances on which many books have been written. There can be a lot of permutations and combinations, but I hope this gives you the general picture. The process of getting a company through a bankruptcy is interesting and challenging – though not so much if you’re the debtor or a creditor.
Read more at http://business.transworld.net/features/market-watch-chapter-11-bankruptcy-what-does-that-mean-exactly/#0zv6LhGGjHbcbx60.99
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.
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.
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.
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.
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.
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.
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.
We’ve all heard the phrase, “Taking away the punch bowl.” As far as I know, it originated in the 1955 speech of Fed Chairman William McChesney Martin, which is presented below in its entirety. I suspect that most people, if they take the time to read it and have just a little knowledge of current Fed policy, will wish Mr. Martin had been Fed Chairman from maybe 1995 to 2014 instead of from 1951 to 1970. Bluntly, I suspect that if he had been Chairman in the current era, the bubbles that lead to the Great Recession would never have happened and zero interest rates, with all the misallocation of capital they cause, wouldn’t have been allowed to persist.
I suppose on the one hand this has nothing to do with the action sports or active outdoor market. On the other hand, it has everything to do with the difficult times we find ourselves trying to run businesses in.
ADDRESS OF WILLIAM MCCHESNEY MARTIN JR.
Chairman, Board of Governors of the Federal Reserve System
Waldorf Astoria Hotel New York City October 19, 1955
There’s an apocryphal story about a professor of economics that sums up in a way the theme of what I would like to talk about this evening. In final examinations the professor always posed the same questions. When he was asked how his students could possibly fail the test, he replied simply, “Well, it’s true that the questions don’t change, but the answers do.” Here the questions are in large measure hardy perennials: How do we attain and retain prosperity? How do we achieve normal healthy growth? How do we preserve the purchasing power of our money? The answers to these interrelated questions in the 1950’s far differ in important respects from those of earlier decades.
My purpose tonight is to explore with you some of the main currents and undercurrents of thought which have colored and shaped these differing answers.
It is, of course, unorthodox, if not downright poor form, to reach your conclusion in the course of your introductory remarks. But, as a matter of emphasis, I would like to state it now.
In the absence of war, or serious conflict among our people over political or social aims, the road to a substantially higher standard of living lies ahead of us as clear and as smooth as our modern turnpikes. We have passed through the turnstiles and are, in my judgment, out on the open road. This position has been achieved after a good many ups and downs false starts, adaptations to war and preparations for war, false turns, and poor directions. Furthermore, the machine we are driving is adequate and capable of traversing the grades, curves, crossroads, and danger points, provided only that the drivers observe the speed laws, are alert and responsible, and sufficiently trained and experienced in the art of driving to understand the nature of the principles of propulsion, and the goals of the journey they are making. Our ability to travel this road safely depends upon a community of drivers who understand and utilize the time-tested principles which are derived from our inheritance.
It seems rather striking that one of the ideas now firmly imbedded in our articles of material faith, the concept of governmental responsibility for moderating economic gyrations, is almost entirely a product of our own Twentieth Century.
This concept, which is steadily being brought into sharper focus, has evolved from general reaction to a succession of material crises heavy in human hardship. It grew from mass desperation and demand for protection from economic disasters beyond individual control.
The Federal Reserve System, which I have the honor to represent, was our earliest institutional response to such a demand. It emerged out of the urgent need to prevent recurrences of such disasters as the money panic of 1907, and out of the thought that the Government had a definite responsibility to prevent financial crises and should utilize all its powers to do so.
Accordingly, 42 years ago Congress entrusted to the Federal Reserve System responsibility for managing the money supply. This was an historic and revolutionary step. In framing the Federal Reserve Act, great care was taken to safeguard this money management from improper interference by either private or political interests. That is why we talk about the overriding importance of maintaining our independence. Hence we have our system of regional banks, headed up by a coordinating Board in Washington, intended to have only that degree of centralized authority required to discharge effectively a national policy. This constitutes, as those of you in this audience recognize, a blending of public interest and private enterprise uniquely American in character. Too few of us adequately recognize or adequately salute the genius of the framers of our central banking system in providing this organizational bulwark of private banking and business.
Since the Federal Reserve System came into being, the problems of inelasticity of currency and immobility of bank reserves—which so often showed up as shortages of currency or credit in times of critical need—have been eliminated, and money panics have largely disappeared. In this specialized respect there can be no doubt that the System has made notable progress, but in the more fundamental role of stabilizing the economy the record is not so clear. All of us in the System are bending our best efforts to capitalize on the experience of the past, and our current knowledge of money, so as to make as large a contribution as possible in this direction. But a note should be made here that, while money policy can do a great deal, it is by no means all powerful. In other words, we should not place too heavy a burden on monetary policy. It must be accompanied by appropriate fiscal and budgetary measures if we are to achieve our aim of stable progress. If we ask too much of monetary policy we will not only fail but we will also discredit this useful, and indeed indispensable, tool for shaping our economic development.
The answers we sought to the massive problems of the 1930’s increasingly emphasized an enlarging role for Government in our economic life. That role was greatly extended again in the 1940’s when the emergency of World War II led to direct controls over wages, prices, and the distribution of goods ranging from sugar to steel.
That experience led to growing concern over the effect of a straitjacket of controls on the economy’s productive capacity, and the price that would be exacted in terms of individual liberty if the harness of wartime economic controls were carried over into the post-war years.
Such a straitjacketing of the economy is wholly inconsistent with our political institutions and our private enterprise system. The history of despotic rule, of authoritarian rule, not merely in this century but throughout the ages, is acutely repugnant to us. It has taken a frightful toll in human misery and degradation.
The transformation of this country from a wilderness to a highly developed civilization demonstrates the results that can be obtained through a system which is directed toward releasing, not shackling, energies and abilities. The fruits of these energies and labors are shared in growing abundance, not by primitive barter, but by the processes of the market place.
The advantages of a system where supply capacities and demand wants and needs are matched in open markets cannot be measured in economic terms alone. In addition to the advantages of efficiency in the use of economic resources, there are vast gains in terms of personal liberty. Powers of decision are dispersed among the millions affected instead of being centralized in a few persons in authority.
The basic concept of the market system has remained with us since the founding of the nation. It has remained the cornerstone of our society to this day, although we have done some extensive remodeling of the structure as a whole from time to time.
We have in the past done some remodeling for the admirable purpose of correcting structural defects and distortions. Competitive, freely functioning markets are one thing, and rigged markets are another. Rules and regulations to prevent rigging are necessary and essential to a sound structure.
Other remodeling has come about because the American people have refused to accept economic goals as their sole objective. That was true in older generations, as well as our own. Our family inheritances have, I am glad to say, usually included the beliefs that man cannot live by bread alone, and that in a properly equipped home library the Bible should occupy a more important place than a manual of arms or a mail order catalogue. Let it be said, to our credit, that American economic action has often been determined by balancing material advance against other human objectives.
For these reasons, and perhaps others, our market system has been modified continuously throughout this country’s history. Ideas of market places functioning with no rules or regulations except the “law of the jungle” have, quite justly, gone the way of the great buffalo herds. When we speak today of “free markets” we of course mean markets that are only relatively free, as the freedom of speech we enjoy is itself only a relative freedom. The essential characteristics of free markets have nevertheless been retained.
It is true that in a great emergency we have been willing to make a departure from our market structure, but our mood has been that of the man who has to leave home for the confines of a bomb shelter. When a war comes on, we are willing to put up with all sorts of economic controls and dictation of even small details of our economic life. The dignity of the individual gets submerged in the necessity to win the war. The law of supply and demand is suspended temporarily, but it cannot be permanently repealed. It is always with us just as is the law of gravity.
When peace is restored we do not continue to ignore it. We cannot substitute the judgment of a few in authority for the free and independent judgments of the community as they are expressed in the market place. We cannot do so, that is, and retain our concept of freedom in a competitive, private enterprise economy.
I am not unaware that freedom entails certain hardships on the nervous constitution. It gives us opportunity to choose, but it also requires the making of choices. The pleasure of having a choice to make is counterbalanced by not only the necessity for making a choice, but also the responsibility for accepting the consequences of that choice, whether good or bad. Naturally we like the consequences only when our choice proves right. That’s one reason it is easier to make a mistake than to admit one.
It requires no strain on my imagination to suppose that there might be some, even in this audience, who occasionally feel a nostalgia for the pegged money market that came into existence during the war and continued until the Treasury-Federal Reserve accord of March 1951 turned us back in the direction of a freer market.
Free markets, like free economies, have a way of going down as well as up, and thus reminding us that our system is one of profit and loss, entailing penalties as well as rewards. During the last four and a half years the Federal Reserve has pursued a monetary policy characterized by flexibility, or prompt adaptation to the sharply changing needs of a dynamic economy. It has been necessary in this period to combat both the forces of inflation and of deflation.
There are some who contend that a little inflation—a creeping inflation—is necessary and desirable in promoting our goal of maximum employment. My able associate, Allan Sproul, President of the Federal Reserve Bank of New York, put his finger on the fallacy in this contention in testifying before a Congressional committee earlier this year when he said:
“Those who would seek to promote ‘full employment’ by creeping inflation, induced by credit policy, are trying to correct structural maladjustments, which are inevitable in a highly dynamic economy, by debasing the savings of the people. If their advocacy of this course is motivated by concern for ‘the little fellow’, they should explain to the holders of savings bonds, savings deposits, building and loan shares, life insurance policies and pension rights, just how and why a rise in prices of, say, 3 per cent a year is a small price to pay for achieving ‘full employment’. They should also explain to all of us—little, big, and just plain ordinary Americans—what becomes of our whole system of long term contracts, on which so much of our economic activity depends, if it is to be accepted in advance that repayment of long term debt will surely be in badly depreciated coin.”
If inflation would in fact make jobs, no reasonable man would be against it. But as I have frequently emphasized, inflation seems to be putting money into our pockets when in fact it is robbing the saver, the pensioner, the retired workman, the aged–those least able to defend themselves. And when the inevitable aftermath of deflation sets in, businessman, banker, worker, all suffer. That doesn’t mean jobs. It means just the opposite.
There have been some rather wide swings in attitudes toward monetary policy during recent years. In the depression, a great number came to the conclusion that monetary policy was ineffective as an instrument for promoting recovery from economic decline. Following World War II, some were troubled by the move from direct controls to restoration of the general control involved in monetary policy because they feared it could not restrain the inflation then prevalent—not, that is, without being so drastically exerted as to plunge us into a devastating depression.
Nowadays, there is perhaps a tendency to exaggerate the effectiveness of monetary policy in both directions. Recently, opinion has been voiced that the country’ s main danger comes from a roseate belief that monetary policy, backed by flexible tax and debt management policies and aided by a host of built-in stabilizers, has completely conquered the problem of major economic fluctuations and relegated them to ancient history. This, of course, is not so because we are dealing with human beings and human nature.
While the pendulum swings between too little or too much reliance upon credit and monetary policy, there is an emerging realization (more and more widely held and expressed by business, labor and farm organizations) that ruinous depressions are not inevitable, that something can be done about moderating excessive swings of the business cycle. The idea that the business cycle can be altogether abolished seems to me as fanciful as the notion that the law of supply and demand can be repealed. It is hardly necessary to go that far in order to approach the problems of healthy economic growth sensibly and constructively. Laissez faire concepts, the idea that deep depressions are divinely guided retribution for man’s economic follies, the idea that money should be the master instead of the servant, have been discarded because they are no longer valid, if they ever were.
Nor does the discarding of old ideas and the substitution of new ones mean that we are throwing basic laws or principles overboard. It is the return to first principles in many parts of the free world that is the most significant aspect of world-wide recovery and progress outside of the Iron Curtain. And that, in turn, vastly brightens the hope of lasting peace.
By first principles I mean time-tested basic concepts of the market place and the development of competitive private enterprise, with only that degree of Government interference or regulation necessary to prevent abuses and excesses. We see a return to these concepts here and abroad because other concepts have failed, and where there has not yet been a revival of these concepts economic troubles are acute.
As I suggested at the outset, the basic problems, the questions, remain pretty much the same always. The answers are different—and no one would be so rash as to say that we have ultimate solutions for all of our problems. We can say confidently, I think, that we have discarded some wrong answers—that we have returned to some of those fundamental principles under which our society, our institutions, have flourished with incomparable benefits, benefits not merely material.
There will always be some, of course, who think we must go through the wringer periodically to purge the economy. There will always be cynics and defeatists, no doubt, who say that because there have always been disastrous depressions and more disastrous wars, we must accept these visitations as inevitable. If there are enough hopeless Jeremiahs, enough defeatists and cynics, those calamities are indeed inevitable. If we do nothing about it, if we do nothing to prevent inflation and thus avoid the inevitable aftermath of deflation, then of course we are defeated. Today’s generations will accept no such fatalistic philosophy.
If we fail to apply the brakes sufficiently and in time, of course, we shall go over the cliff. If businessmen, bankers, your contemporaries in the business and financial world, stay on the sidelines, concerned only with making profits, letting the Government bear all of the responsibility and the burden of guidance of the economy, we shall surely fail. I am as weary as you are of pious platitudes and after dinner preachments about leadership and financial statesmanship. But the fact is that the Government isn’t something apart and remote from you. It is you—all of us. If those responsible for major decisions in business, finance, labor, agriculture, are irresponsible, Government can’t compel you, short of moving in the direction of dictatorship, to be reasonable, or moderate, or prudent. In the field of monetary and credit policy, precautionary action to prevent inflationary excesses is bound to have some onerous effects—if it did not it would be ineffective and futile. Those who have the task of making such policy don’t expect you to applaud. The Federal Reserve, as one writer put it, after the recent increase in the discount rate, is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.
But unless the business community, leaders in all walks, exhibit moderation, prudence, and understanding, then we will fail and deserve to fail, I cannot believe we will be so blind. I have a deep and abiding faith in that undefinable yet meaningful phrase we frequently use—“the American Way of Life.”
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.
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.
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.
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.
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.
Let’s review. Volcom and Electric are in Kering’s sport and lifestyle (S&L) division which includes PUMA. In 2014, Kering had consolidated revenue of 10.038 billion Euros. The S&L division’s revenue was 3.245 billion Euros. Of that, PUMA was 2.99 billion Euros and “other brands” in S&L had revenue of 255 million Euro and operating profit of 10 million Euro (see chart below).
Other brand revenue in the S&L division (which I think is Volcom and Electric) rose in the quarter ended June 30, 2015 to 64.8 million Euros from 53 million in the same quarter last year. That a gain of 22.3% as reported. For the six months ended June 3, revenue rose 15.3% from 112.6 to 129.8 million Euros. You can discern from those numbers that the second quarter was better than the first.
The chart below from Kering’s report shows the results for the first half of both years. You’ll note that there’s a small operating loss shown even with the revenue increase and a 5% reduction in headcount.
In the conference call, we’re told there was a “…muted first half…” for Volcom and Electric. Trends improved in the second quarter with revenue up 2.6% based on constant currency. Volcom’s second quarter growth was reported to be 6%, also using constant currency. If Volcom revenues were up 6% in the second quarter, but Volcom and Electric together were up 3%, then I have to conclude that Electric was down. That’s what the financial report says.
“After a major repositioning drive in the accessories market and a complete overhaul of its offeringaround new ranges of sunglasses, snow goggles and watches during the previous two years, Electric reported strong sales growth in 2014. However, as substantially all of the brand’s sales are now generated through the wholesale distribution channel, its revenue declined in the first half of 2015, weighed down by wholesalers’ wait-and-see attitude during the period as well as by a less favourable delivery schedule.”
Sunglasses are a tough business.
The financial report refers to “…ongoing tough market conditions for Surfwear and Action Sports.” Wholesale revenues rose 0.8% and store sales were up 6.6% and represented 15% of total sales. Those numbers are in constant currency. Volcom had 52 stores at the end of the quarter “…including nine in emerging markets.”
Talking just about Volcom, the report stated, “In North America – still the brand’s main market, representing 67.3% of revenue – sales rose 1.3% on a comparable basis. Revenue contracted in Western Europe and remained stable in Japan, although these effects were offset by extremely encouraging business development in emerging markets, particularly in the Asia-Pacific region.”
Well, that’s kind of it. As usual, there wasn’t a lot of information. Damn, it’s a tough market out there. I think Volcom can be more valuable to Kering than their revenues or results so far suggest because of who the customer is. I hope Kering understands that.
