More than $590 million in write-downs, an almost $175 million loss for FY20, legal action, investigations by the regulator and talk of divesting business units are just some of the revelations and issues faced by Freedom Foods Group. The full scale of its woes was revealed in its FY20 financial results released on 30 November.
Snapshot
- total revenue $580.2m, up 26% on FY19 (restated)
- adjusted EBITDA loss of $86.5m, compared to a loss of $88m in FY19 (restated);
- statutory net loss after tax of $174.5m, compared to a loss of $145.8m in FY19 (restated);
- net asset reduced to $61m after write-downs and restatements of approximately $590m for FY20 and prior years;
- net debt pre-AASB16 lease liabilities is $275m at 30 June 2020, it is expected to increase to around $335m by recapitalisation;
- Dairy and Nutritionals revenue up 37% to $362.9m;
- Plant-based Beverages revenue up 30% to $132.3m; and
- offshore revenue up 29% to $109.8m, now 19% of overall revenue.
Non-executive chair Perry Gunner, who had the unenviable task of telling shareholders in June inventory write-downs would be closer to $60 million than the $21 million revealed in May, said FFG shareholders and employees had the right to feel angry and frustrated. Rebuilding the company would not be a quick or easy process.
The company revealed that its $11.3 million profit for FY19 was now a $145.8 million loss. Its statutory net loss after tax for FY20 was $174.5 million.
Its external auditor Deloitte said in its report (in FFG's annual report) that the findings of its investigations “identified significant control deficiencies and there was an increased risk of management override of controls and therefore was a key audit matter... and that a substantive approach was appropriate”.
Gunner also used the opportunity to announce his retirement, as did non-executive director Trevor Allen.
FFG started to unravel when the board became aware of internal abuse of its equity incentive plan, with some staff being granted share options and/or extension of the share option expiry date by management over a five-year period, from September 2014 to September 2019. This cost shareholders around $5.5 million.
Once this was discovered, the board started asking questions, with two new board members – Genevieve Gregor, chair of the board's risk and compliance committee and Jane McKellar, chair of the people and culture committee – driving investigations.
A raft of external advisors was called in – PwC, Ashurst, Arnold Block Leibler and Moelis Australia – as the scale of the disaster was revealed, all of which identified “a significant number” of accounting issues.
In November, The Australian Financial Review said a whistle blower had contacted ASIC over FFG accounting practices as far back as 2019.
FFG is now assisting the Australian Securities and Investments Commission with its investigations.
The company is now in a position where significant recapitalisation is needed, and it said it will remain in a trading halt until that is announced. Interim CEO Michael Perich said it needed to raise up to $280 million and is intended to be raised via an ASX-listed secured convertible note, underwritten by a new investor.
“The plan is to refinance existing senior debt facilities to rest the company's balance sheet and provide a more flexible funding structure (covenant lite, increased tenor) to provide runway for the turnaround and future growth.
“Recent unprofitability and material uncertainty on the outcome of Blue Diamond litigation means it is prudent to raise capital in secured debt form that provides equity linked to operationality and flexibility. Saying traditional forms of raising capital like equity raising have been considered but are likely to be dilutive,” Perich said.
The company was in “exclusive, advanced discussions” with a new investor to support both the capital and operational turnaround of the business, he said.
FFG expects to announce recapitalisation details before the end of CY20. Its net debt increased by $87 million to $275 million on 30 June, and it expects debt at the time of recapitalisation to be approximately $335 million.
In its report, the board expressed its concerns that there is a risk the proposed fund raising being completed will not complete, with the main risks including the satisfactory completion of the counterparty’s due dilligence, regulatory approvals and other conditions precedent typical for a transaction of this nature.
“The ongoing support of the group’s major shareholders and lenders both in the period prior to and subsequent to the proposed fund raising is critical to the ability to continue as a going concern,” it said.
The fund raising will allow FFG to reduce existing senior finance facilities and provide additional working capital. “It needs to refinance existing debt with more flexible capital that provides the company with the necessary runway to turn the business around,” the board said in the annual report.
"Focus on core brands and on core products within those brands"
Perich said FFG had gone through considerable growth over the last few years but its systems and processes had not moved at a similar rate.
“Systems, processes and culture held its employees back... New leadership group, new board members – embarking on a program to restructure the group and ensure silos cannot stifle collaboration and innovation – to ensure policies and procedures are applied uniformly across the business,” he said.
In the three years to 2019, FFG invested $430 million in capital expenditure. It built new nutritional capabilities (including lactoferrin production) and a doubling of its milk capacity (from 250 to 500 million litres) at its Shepparton plant.
But as Perich said: “Freedom Foods' aggressive growth campaign was not profitable growth.”
Of its staggering $590 million in write-downs and restatements, $372 million was for capital expenses that it did not record as a capital expense. The company revealed that most of the costs capitalised during the commissioning phase of the capital investment program had not been treated as an expense.
“These accounting treatments contributed to decisions on new products and expansions that were based on unrealistic assessments of market opportunities and margin assumptions that were not realised.
“As a result, too many group products were sold at prices that did not fully recover their costs,” FFG said.
Its FY20 financial report said in Dairy and Nutritionals at its Shepparton plant, FFG produced just over 13 tonnes of lactoferrin when its total capacity is 33 tonnes. Total UHT processing capacity is 500 million litres but in FY20 it only processed 304 million litres of UHT.
The company wrestled with operational issues which led to higher wastage, lower lactoferrin yields and surplus milk being traded at a loss.
If there was any good news for the company, it was in plant-based beverages and its export markets. MILKLAB sales grew 73 per cent, with new distribution channels including McCafé for MILKLAB almond. It processed 76.8 million litres of plant-based UHT milk with the capacity to scale up to 120 million litres.
Overall export sales to Southeast Asian markets rose 261 per cent to $34 million, showing an increased market acceptance of Australia’s Own and MILKLAB dairy brands.
Export of UHT milk to China rose by 7.7 per cent to $60 million, led by increased sales to contract partners.
But its Cereal and Snacks business performance was disappointing. Unrealistic operational costing budgets led to sales prices being too low on some products and ineffective trade spending in the retail channel. Its NPD did not fare well either, failing to achieve anticipated returns. Revenue in Cereals and Snacks fell 14 per cent to $70 million with the adjusted EBITDA pre-AASB16 loss rising slightly to $32.1 million.
The solid performance by plant-based and nutritionals was outweighed by under-performance of cereals and its speciality seafood business.
A company-wide review of “every line, every site, every sales channel and every market segment” is underway, with Perich saying products not delivering value will be removed. The divestment of Cereals and Snacks and its Speciality Seafood business units is on the cards.
Perich said: “It needs to become a simpler business, and we are identifying and removing unnecessary layers of complexity in manufacturing, marketing and the product suite which adds costs, waste and risks to the business – this review process may result in the divestment or closure of non-core assets and/or businesses.”
Meanwhile, legal action by Blue Diamond is ongoing, with the US company seeking: compensatory and general damages for breach of the licence agreement, which it says to be at least US$16 million; compensatory and general damages for breach of an alleged oral agreement; and specific performance of the licence agreement. FFG disputes its claims and is defending its position, it said.
Timeline
- CFO leaves and CEO on leave;
- chair Perry Gunner reveals writedowns will be greater than expected;
- CEO leaves;
- trading halt extended;
- Michael Perich appointed interim CEO;
- standstill agreement reached;
- Blue Diamond launches legal action;
- trading halt extended; and
- Food & Drink Business profile of Freedom Foods Group in October 2019.
