Billabong revealed its sobering annual results last week amid a backdrop of tough retail conditions in the Australia market. It posted a net profit of $146 million, down 4.5 per cent and took into account $2.7 million in one-off costs from acquisitions earlier this year. Its combined group sales were $1.48 billion, down 11.2 per cent compared with 2009. Its forecast is conservative, with the company predicting a 2 to 8 per cent growth over the next financial year. Australasia, it says, is its worst performing sector, down 4.2 per cent to $425.7 million, compared with last year's $444.3 million, as consumer spending remains tight. Its wholesale orders have suffered as smaller retail stores continue to feel the affect of the global financial crisis, spiralling business confidence levels and a general tightening of discretionary spending. In Australia alone, its wholesale orders for summer and hi-summer are down 20 per cent and the company is bracing itself for a softer winter order book. Additionally, across this region Japan, South Africa and the New Zealand markets remain slow. But is good news. It purchased the 36-store chain, Rush, and believes its foray into online stores will help see its modest growth. The company also predicts the local market will benefit from the distribution of licensed footwear brands DVS and Lakai, the synergies between the new retail additions and the purchase of California's youth brand RVCA.

Billabong chief executive Derek O'Neill answered analyst’s questions following the announcement and then talked exclusively to ASB.

WHAT IS IT THAT'S GOING TO HAPPEN IN FY11 THAT'S GOING TO CONSTRAIN EARNINGS IN PARTICULAR AS PART OF THE TRANSITION?

Australia has these very high GP margins and when you lose some sales, effectively you have to sell a lot more in the US or Europe just to effectively catches up. So when you look at Australasia, Asia's always been a dilution to the overall Australasian business but Australia operates on very high margins. So effectively by assuming that based on the indents that we have that - and again, I'd like to think at some point the small retail environment's going to pick up but assuming that the indent deductions or reductions that we have is going to be pretty consistent through the year, then it takes a significant amount off the bottom line. If you look at the initiatives, what happens is that the initiatives, in terms of - I'll probably put West 49 on this and, frankly, Rush is a little bit the same. Until we can begin to fill the pipeline with products to give us a better wholesale margin opportunity then, frankly, they don't really deliver anything and in fact probably in the short-term they are slightly dilutive to the overall margin for the Group. But what happens is that you have to look at - firstly, if you look at Rush for example, it won't close until probably some time mid-October. Leases have to be transitioned and moved across. Then the buying is already done at that point for winter Australia. So our first real opportunity to influence the product pipeline effectively is probably from about May next year. We're not operating that business yet and therefore we're not influencing the buy at all and therefore we won't get to influence that buy until probably first summer 2011. So it really doesn't add a lot in the first six to nine months.

SHOULD WE EXPECT MORE RETAIL ACQUISITIONS, WHAT REGIONS ARE YOU UNDER PENETRATED IN FROM A RETAIL PERSPECTIVE?

I'll just say that obviously we've been a little more active in retail than probably what most people would expect. I think that we've been watching the last sort of five or six years with interest, in a sense, that we've learned a few lessons in regards to what happens in the market. I can probably bring up a couple of examples without being too specific. But over the last five or six years, we've seen in certain markets an increase in vertical product, house brand product in larger retailers in our sector which just frankly end up eroding the amount of space that's available for premium brands and I think it would be fair to say that there hasn't been too many examples of where that has been a resounding success to the retailer. And ultimately it ends up being deterioration in performance by that retailer, which just ends up actually doubling the problem for us. So we're looking at that in a sense that, can we always just sit back and just let that happen and watch that space that we've helped build, kind of get eroded back by retailers becoming brands? I think that we're changing our view on that point in a term of being a little more pro-active against that curve because, in particular in Australia right now, we're seeing - I've highlighted before that with the low $0.90 dollar, what was vertical going to do in the Australian market what a house brand product is going to do in the Australian market. I think it would be a fair assumption to say that right now in summer, there's more vertical product on the market than there has been for quite a while. I don't assume for a moment that that's going to be reducing in a hurry. Apart from that, we also looked at - over the last two to three years retailers increasingly are not buying products or brand space on what can turn in their store and what can sell in their store. Basically more and more are buying product on what is the deal. I would say that we are looking at parts of the market and thinking, well moving forward, we're going to counteract some of that. So I can't rule out potentially more retail opportunities for us. I can't eliminate it. I think we've got plenty going on right now and it's not really our current focus but I can't eliminate it. I will say though that in the US and in Australia, it's not so much in Europe like that, but US and in Australia, retailers that know that we have been a little bit active, quite a lot of them get on the phone. We call it somewhat the - some of the first generation of retailers in our sector are sort of wanting to move through. We acquired Becker in southern California, the Bay Action chain in Byron Bay. Some guys just want to take that risk factor off the table in particular when the markets are a little bit down, so it's amazing sometimes what phone rings.

HAVE YOU ORDERED MUCH FOR IN SEASON, BECAUSE HISTORICALLY IT WAS SORT OF 80-20 SORT OF ON THE INDENT AND THEN 20% IN SEASON? ARE YOU MANAGING INVENTORY QUITE CONSERVATIVELY THROUGH THE SEASON?

We've gone into the high summer period really cautious. I mean, we've - coming out of sort of that cycle in the US we're setting up our supply chain to try to make sure we could maintain a lot of fabric. We've got some styles that we can basically go in and cut and have very fast turnover. [Product] we can turn around very fast. The reality is that no, we feel pretty comfortable with our inventory levels. I think that even if spending did pick up for a month or two, frankly it would take a while to convince those small business retailers that things are kind of looking a little better. I think the forward order - we're just about to go out with winter and if you look at the winter gone, I know it's very cold the last few weeks but February through to end of May was very, very mild. Everyone was on sale very, very early. I think that for most clothing retailers and it's backed up by Bureau of Statistics numbers, clothing was a bit of a disaster in the winter period I think so expectations are is that retailers are going to be very soft on forward orders for that period as well. We'll just have to work as hard as we can to make sure we can supply what the market needs rather than what we want it to have. The other side as well is that obviously as we did in the US through that period, the benefit of having some of your own retail - and we can put some of those styles if we have some styles in excess. We don't have to land them in Australia. We could take them anywhere else in the world. We can move the product through. We don't think we have an inventory issue.

IN TERMS OF THE ONLINE BUSINESSES, CAN YOU GIVE US AN INDICATION OF HOW THEY TRACKED RELATIVE TO THEIR LOCAL MARKETS? ALSO IN TERMS OF SURFSTITCH, THEY'RE SELLING QUITE A BIG RANGE OF NON- SURF PRODUCTS NOW. ARE THERE ASPIRATIONS TO MAKE THAT INTO A BROADER USER BASED RETAILER RATHER THAN SURF SPECIFIC?

The whole lifestyle thing in certain contemporary youth fashion is pretty interesting to us. You look around the world and there's various retail concepts that sort of deal with that side and then there's pure surf. At various times we've also differentiated within the brands. I think we see Billabong as pure surf. We're not trying to turn Billabong into Diesel for example. But when we look inside our retail we're selling lifestyle. Frankly, Surfstitch is not just there to sell our group of brands. We saw Surfstitch as a terrific online partner and they really know what they're doing, those guys and they're integrating real knowledge right across our business worldwide. We are direct online for Nixon, Sector 9 and VonZipper in the USA for example and with Swell - we're also active in sort of the surf area. But Surfstitch, it's new for Australia. They're very successful at it and they've convinced us that there's opportunity in a number of different areas and, as I said, that kind of lifestyle, contemporary -- I'm reluctant to call it fashion but, you know, it is fashion - areas is pretty interesting for us.

DO YOU HAVE A SENSE OF HOW MANY WHOLESALE DOORS OR ACCOUNTS YOU CURRENTLY HAVE GLOBALLY? IS THAT FALLING? IS THAT ONE OF THE REASONS WHY YOU'RE OPENING YOUR OWN RETAIL?

In terms of the regions, our account base in Australia, we think, is probably reduced by about 5 per cent in the last say the last 15 months, 12 to 15 months, and the reasons for that are some of them just effectively closing, or selling and not continuing with board sports. The other one is that we have quite a few on sort of credit hold that, frankly, we probably won't - we may not continue with. So that is the first time we've seen that, the Australian account base has been very static for quite awhile. You know with some of the acquisitions, like sometimes we'll sell wax from the Palmer's brand into a milk bar or something, so it's a bit of a difficult accurate calculation. But there are probably about somewhere fewer than 1000 accounts in Australia and, ultimately, you know I'd say, out of the ones we sort of do regular business with; it's probably been about a 5 per cent reduction. In Europe, the addition of DaKine has probably added around 600 or 700 accounts because DaKine also works in bike shops and some other areas that are - you know accessory stores that we wouldn't have worked with in the past, so it's not an accurate one. But we think that in Europe there has been an overall decrease in accounts of around 2 per cent to 3 per cent. But we know that in Spain, for example, in the last 12 months we've removed another 14 per cent of accounts from our account base and we took about 10 per cent out a year earlier, so you know that also hasn't helped the overall numbers. In the USA, we've had about 1400 accounts a couple of years ago. We've seen some sort of steady declines down to sort of you know that 1200 type area over the last two to three years. We think that it's probably reasonably stable right now, but you know that just sort of remains to be seen. While there is a bit of a recovery going on, it's not like you know everybody is out of the woods or it's consistent across the country. What is clear is that, in real terms, there are not a lot of people opening new board sports space. So it's not like currently there is any real new business coming online into the industry.

DID YOU SEE THE RESULTS, PARTICULARLY FROM THE AUSTRALASIA, CHANGED THE OVERALL TONE OF THE ANNOUNCEMENT AND IS THE COMPANY WELL POSITIONED FOR THE FUTURE?

Australia as a whole has been weaker in the three months. Japan has been a challenge and South Africa was very tough. NZ, while it doesn’t have a major impact, has pulled the result down as well. Can you single out Australia a bit more… how has Australia performed? The last three to four months in Australia has been tough. Most companies didn’t understand the how much the stimulus helped, but February through to July had been slow. This combined with the late start of winter and the fact that most of the major department stores are continuously on sale also impacted the region.

CAN YOU EXPAND ON HOW AND WHEN BILLABONG HOPE TO INFLUENCE THE PRODUCT PIPELINE INTO COMPANY OWNED OR JV OWNED STORES, LIKE SURFECTION AND RUSH?

For both of these, we have to deal with is the product in stores now and the product order in the pipeline as well. For Surfection it will be from Christmas onward and rush, assuming the deals close, which wont be to the end of October, we wont have an opportunity until late May or June.

AMAZON IS REPORTED TO BE 70 PER CENT GSM PRODUCT SKEW. DO THEY SEE ALL COMPANY OWNED OR JV STORES ‘CAPPED’ AT 70 PER CENT GSM? IF NOT WHAT THE TARGET OR SATURATION POINT?

We want to have compelling retail that’s first and foremost. There is no fixed amount. It is our full intention to keep the stores multi-branded.

WHO ARE THE LARGER WHOLESALE AND RETAIL BUSINESS OPERATING OUTSIDE OF THE ACTION SPORTS MARKET THAT BILLABONG MOST IDENTIFIES WITH?

Urban Outfitters, in the US provide a store experience and do a good job at their merchandising. Fred Segal is also interesting as is Nike Town, which has really interesting product. There are a lot of different stores in Europe that are inspirational, like in places like Cologne in Germany. Brazil and Japan also have interesting and inspirational stores. Do you see the 20 per cent reduction on forward orders relating to Australasian market or reaction to Billabong owned brands by other market forces? Retailers are just nervous about moving forward and they don't want to commit too heavily. They would rather reduce the amount of product from the big brands rather than on all 22 wholesale orders.

YOU HAVE ALSO MENTIONED PREVIOUSLY YOU WEREN'T PREPARED TO CUT THOSE DEALS THAT SOME OF THE OTHER BRANDS ARE MAKING … THE DISCOUNTS?

We have been working with them a long time but it has never really been practice that we just give the product away. A short-term decision can lead to a long-term expectation and we have a responsibility to the industry. We have a responsibility to the industry to continue to heavily market the brands. And to do that we need brand commitment.

DO YOU SEE THE 5 PER CENT CONTRACTION IN YOUR ACCOUNT BASE FROM STORE CLOSURES CONTINUING?

There have been store closures and stores that someone else has closed down. It is never an easy situation. We think we are somewhere near a bit of a bottom on that side. Everyone that is currently doing business needs a break. Eventually people will start spending. We are going to go through a period where it's going to be a grind.

ARE THERE ANY POSITIVES IN THE AUSTRALASIAN MARKET?

It is hard to predict (when) but eventually it is going to get exciting again. I went to the ASR show in America recently and it was a change from 18 months ago when everyone was suffering a minor case of depression.

DO YOU THINK AUSTRALIA IS 18 MONTHS BEHIND AMERICA?

The stimulus did a good job at the time. America had really fearful conditions and a depressed economy. We have got a bit of drying up on spending but frankly we don't have the conditions. People just don't feel confident.

SO YOU'RE SAYING ITS MORE A CONFIDENCE THING AS OPPOSED TO PEOPLE TURNING AWAY FROM THE SURF INDUSTRY?

People need clothing. This is not isolated. You talk to any business or restaurant. The Government talks so much about debt compared with three years ago and people are now more afraid to spend.

WOULD YOU SAY THE AUSTRALASIAN MARKET IS THE TOUGHEST FOR YOU AT THE MOMENT? ARE AUSTRALIAN RETAILERS MORE SAVVY OR A MORE SOPHISTICATED MARKET IN TERMS OF TRENDING REPORTS ETC?

Australia is the toughest. But find anyone who has gone through this before and they will say they are well positioned to come out of it when consumers are ready to go. We are trying to help them through when we can and are prepared through the supply chain.

TELL US ABOUT THE RUSH ACQUISITION?

We have been doing a lot of business with Rush. They have been moving in areas that are away from other retailers. Wade is only in his early 40s and he has been in the surf shop since his early teens. That's 28 years. We are going to get a lot of insight from him. The shops operated in regional areas that aren't traditional surf shop areas, like Bondi or Torquay. We see it as an opportunity to add to the business. Wade himself is a great addition we can learn a lot from him. He was able to give a pretty unique perspective.

WILL YOU KEEP ALL THE STORES OPEN AND WILL IT STAY BRANDED AS RUSH?

It is our intention to keep the brand and keep them all open.

Words: Shannon Willoughby