Miss the SEC Format

Billabong released its annual financial report for the year ended June 30, 2008 in late September.  As it?s 116 pages long, you?ll just have to forgive me for not having it read and written about the next day.  If you want to read all 116 pages yourself, you can do it HERE.

Have a wonderful time.

This is not like the report that U.S. companies have to file with the SEC.  Well, it is in the sense that it?s long, and complex in parts and kind of boring.  But it?s different in the sense that it spends a whole lot less time discussing the market, the performance of brands and segments and all the stuff that we typically see in SEC filings under the ?Management Discussion? heading.  Still there are some numbers in there that are worth discussing, and that?s why I?m here.

They also released the 32 page shareholder review.  It duplicates a lot of the financial information in the financial report, but has a lot more pretty pictures.  So if you want to read that instead, here?s the link.  http://www.billabongbiz.com/documents/_20080926_Shareholder_Review_08_FINAL.pdf.

I should start by saying that these numbers are in Australian Dollars.  As I write this on October 17th, there are 1.438 U. S. dollars to the Australian dollar.  At the July 1, 2007 start of Billabong?s fiscal year, the number was 1.178.  At the June 30, 2008 end it was 1.04.  So during the fiscal year, the Australian dollar strengthened by about 11.7% against the U.S. dollar.  Since then, it has fallen by 38.3%.

I mention this because as you consider the results of companies (even U.S. companies that do a bunch of business in foreign currencies) you need to recognize the impact.  Billabong, for example, reports that after tax profit for the fiscal year was $176.4 million.  As they point out, that?s an increase of 12.6% in constant currency terms, but only 5.5% in reported terms.  Which is correct?  Neither?  Both?  Maybe.  It depends.   If you?re a U.S. investor in Billabong, you probably care how many U.S. dollars your shares are worth.  If you are trying to figure out if the stock is a good buy, maybe you need to ignore the impact of currency changes in trying to evaluate their operational efficiency.  Except of course changes in currencies impact the cost of goods and service.  And a company?s ability to compete in a given national market is impacted by exchange rates as well.  There?s no easy answer.  You can go to page three of Billabong?s financial report to read more about how changes in currencies impacted their results.

To put the exchange rate issue in perspective, Billabong?s sales in the Americas segment grew 16.1% In U.S. dollars.  In Australian dollars, the increase was only 2.6%.

Before I start, here?s a graph of Billabong?s stock price over the last year taken from a link on their web site.  It?s down, but so are most other companies.  Billabong, you should also note, has grown its net profit after taxes and raised its dividend each of its last five fiscal years.

Revenue in the year ended June 30 grew 10.1% to $1.354 billion (remember those are Australian dollars).  Cost of goods sold, of course, was also up with revenue but gross margin grew from 53.3% to 54.9%.  Selling, general and administrative expenses grew 12.3% to $399.4 million.  There?s no breakout that allows us to identify just marketing expense.  Net income after tax was $176.4 million, up 5.2%.

I have no idea how much of the company?s growth is acquisition generated.  I?d also love to know how much growth the Billabong brand itself has experienced, but the report doesn?t say.  The Dakine and Sector 9 deals closed after the fiscal year ended.  Billabong bought Xcel, Tigerlilly and Quiet Flight during the fiscal year (and ended the year with 242 retail stores).  Nixon and Element were earlier acquisitions.

According to the shareholder report, ?The acquisitions are part of a longer term strategy to build a portfolio of some of the strongest brands in the industry ? brands that not only lead their category in their home market, but also offer international growth appeal. The building of this brand portfolio is now largely complete.?  Doesn?t sound like they will be making any more major purchases.

I like Billabong?s acquisition strategy a lot.  They didn?t buy distressed brands they had to clean up and build.  They bought the best brands they could find in the markets they wanted to be in and they knew exactly what that market was.  They bought, as far as I know, brands with management in place and growth potential.  Because they had defined the kinds of brands they wanted and the markets they wanted to be part of they were efficient because they knew who they didn?t want to buy (I haven?t talked to them- I can just see it in who they bought and how).  Yeah, they paid top dollar (my opinion) but it?s very easy to buy a company and not so easy to integrate it into your operations and have it running on all cylinders right away unless it?s a great business to start.  Not that there won?t be integration issues- there are always issues- but I would expect them to be manageable.

The breakdown of the income statement by geographic segments is interesting.  The Australasia segment generated revenue of $415.7 million (30.7% of the total) and profit before tax of $227.3 million (92.6% of the total)  Sales in the Americas were $622.1 million but generated only $9.07 million of pretax profit (3.7% of the total).  In Europe, revenues were $314.4 billion and pretax profit $7.3 million, or 3% of the total.  The remaining $1.85 million in revenue generated the same amount in pretax income- looks like it?s mostly interest income.  The total revenue from the three geographic areas includes revenue from other than sales of product (mostly interest income I think) of, respectively, $2.96, $1.65, and $0.33 million.

In the Americas then, on its sales of product, excluding the interest and other income, Billabong earned $7.42 million pretax on sales of $620.5 million, or 1.2% before taxes.  In Australasia, on the other hand, their pretax income as a percentage of sales in that segment was 54.4%.  Wait a minute- that?s as unlikely as 1.2%.
The number for Europe is 2.2%.  What the hell is going on?  I can think of three issues that contribute to explaining this discrepancy.  First, there are some exchange rate issues here.  Second, I?m guessing that a lot of marketing expenses are incurred and booked in the U.S.  Finally, there may be tax reasons to show income in one country instead of another.  The report doesn?t say.

Welcome to the day after this article was first posted.  Somebody who spends a lot of time following Billabong was kind enough to send me an explanation for the segment results.  They told me that Billabong?s corporate structure has the brand trademarks residing in an Australian entity.  Royalties are paid by the offshore legal entities back to the Australian company that owns the trademarks.  They also run a central sourcing operation that this person thinks is within the Australasian division.  So the offshore regions pay sourcing fees to the Australasian business for the work it does on their behalf.  Both these activities result in more profit for the Australasian region and less for the others- hence the low return sales in Europe and the Americas.

The table on page 56 actually has a line for ?inter-company royalties and sourcing fees.?  The person who pointed this out was kind enough not to ask how the hell I had missed it.  They suggest focusing on the segment result just above that line.  If you do that, you find that the EBITDA (earnings before interest, taxes, depreciation and amortization) as a percentage of revenue for the Australasian, Americas, and Europe regions were, respectively, 26.5%, 18.0%, and 19.9%.  That makes a lot more sense.

Billabong?s balance sheet remains very strong, if not quite as strong as at the end of their last fiscal year.  Their current ratio is down from 3.3 to ?only? 3.07.  No short term liquidity issues here.  I guess they don?t have a banking subsidiary.

The debt equity ratio rose from 0.83 to 1.04.  They had capital expenditures of $146.9 million for the companies they bought and for ?general investment in owned retail globally.?  Their long term borrowings rose from $361 to $471 million.  I expect much of that went to pay for acquisitions.  It will be interesting to see how they financed the Dakine and Sector 9 purchases and the impact it has on their balance sheet.

A cash flow, I?ve said a few times, is a living breathing thing.  As I watch Billabong?s financial statements ?breath? with both internal growth and acquisitions I can see that somebody has a good handle on their financial management.