Volcom, Inc. Q3 2008 Earnings Call Transcript

Nov.28.08 | About: Volcom, Inc. (VLCM)

Volcom, Inc. (NASDAQ:VLCM)

Q3 2008 Earnings Call Transcript

October 30, 2008, 4:30 pm ET

Executives

Hoby Darling – VP of Strategic Development and General Counsel

Richard Woolcott – Chairman and CEO

Doug Collier – CFO and Secretary

Jason Steris – President and COO

Analysts

Jeff Van Sinderen [ph]

Mitch Kummetz [ph]

Krishnan [ph]

Eric Tracy [ph]

Shawn Martin [ph]

Jeff Mintz [ph]

Operator

Good afternoon. My name is Tim and I will be your conference operator today. At this time, I would like to welcome everyone to the Volcom’s 2008 third quarter conference call. (Operator instructions) Thank you, Mr. Darling, you may begin your conference.

Hoby Darling

Thanks Tim. Good afternoon everyone and thank you for joining us today to discuss Volcom's 2008 third quarter financial results. Joining me on the call today are Richard Woolcott, Volcom's Chairman and Chief Executive Officer; Jason Steris, Volcom's President and Chief Operating Officer; and Doug Collier, Volcom's Chief Financial Officer.

First, some quick housekeeping items before we begin. If you would like to be added to Volcom's e-mail distribution list to receive company information or if you'd like to change your contact information, please contact Evan Pondel at Pondel Wilkenson at 310-279-5973. Also we would like to mention that we have done something different this quarter trying to help those following the company to more easily capture and record our financial results. We’re including in the tables our press release, our third calendar financial results by segment. You can access the full release with this additional information from our website at volcom.com or SEC’s Edgar website at sec.gov. Doug will also review these numbers in the comments on the financial results.

In addition, be advised that this conference call is being broadcast live on the internet at volcom.com as well as earnings.com. A playback will be available from both sides for one year.

Please note that all information discussed on today's call is covered under the Safe Harbor provisions of the Litigation Reform Act. The company's discussion today will include forward-looking information reflecting management’s current forecast of certain aspects of the company's future. Particular statements about the future regarding our guidance, outlook for future business margins, financial performance, customer demand, growth and profitability all constitute forward-looking statements.

These forward looking statements are all based on management's current expectations, but they involve a number of risks and uncertainties. Actual results could differ materially from those stated or implied by these forward-looking statements due to risks and uncertainties associated with the company’s business. Certain risk factors associated with Volcom’s business are set forth in its Form 10-K and subsequently filed quarterly reports on Form 10-Q. The company disclaims any intent or obligation to update these forward-looking statements except as required by law. All forward-looking statements from today's call are qualified in their entirety by the foregoing cautionary statements. With that said, it's my pleasure to turn the call over to Richard Woolcott. Richard.

Richard Woolcott

Thank you Hoby, and good afternoon everyone. We are now well into the second half of the year and despite the deepening macroeconomic pressures on the retail environment the Volcom brand continues to build on its strength globally while laying the groundwork for future opportunities.

There is no question that the current environment poses its set of challenges for our company but we are confident in our ability to weather this storm and manage our businesses with the same discipline, commitment, and focus that has been critical to our success. As evidenced by the strength of our Q3 financial results, our balance sheet, and the overall power of the Volcom and Electric brands our management team is well prepared to guide the company through this period of economic uncertainty.

For Volcom to continue to succeed we believe it is important for us to focus on the fundamentals of our business. Our priorities are to maintain brand and product strength, work with our retailers, manage our growth initiatives, keep costs under control, and emerge a stronger company once the economy changes for the better.

On today’s call, I would like to discuss each of these priorities and how they are factored into our business. As we have said before the Volcom brand has a certain magic that resonates deeply with our customers. This band strength is derived from our quality products, our athlete programs, and worldwide marketing initiatives. In fact in a recent research report entitled Taking Stock With Teens, Volcom was named King [ph] of action sports after ranking number one in the board sports category for the second consecutive survey.

Given the current retail environment, it is important that we continue to deliver the best products possible. This has been a major initiative at the company and I believe our efforts are paying off. For spring 2009, our areas of focus have included denim and board shorts and so far we’re very pleased with the feedback from our retail buyers across the nation. Overall, the line as been well received and we believe both the upcoming summer and fall collections are just as good or even better than spring.

Our team riders and events also play an integral role in the company’s momentum and we’re focused on making sure that we maximize all of our current marketing initiatives. When I look back over the last couple of months and for the rest of the year, I feel very good about what we are doing and believe our efforts are right on target.

I would like to now highlight now some of our recent happenings. We just released a 22 minute movie entitled All The Days Roll Into One that has begun airing on Fuel TV. This piece features our highly talented skate team as they charge hard in a daily skate attack on New York City. We have also recently signed snowboard superstar and Volcom street rider, Gigi Ruff, to our outerwear team along with Olympic hopeful (inaudible). Both of these riders are major players in the world of snowboarding and are now riding custom made team only [ph] Volcom snowboards along with wearing our outer wear.

And in surfing news, Bruce Irons has won his first major WCT event in August at the Rip Curl Search Pro in Bali. This is a huge win for Bruce and gives him even more confidence as he turns his attention to the upcoming Hawaiian winter season. I would also like to point out that we just finished our second annual Volcom Rock tour with headlining band Motorhead in September, successfully completed our Wild in the Parks skate tour with the championships in Arizona just a few weeks ago and we hosted the West Coast (inaudible) Finals this past weekend here at Volcom headquarters in Costa Mesa, California.

These are just a few of the marketing initiatives that helped keep the brand front and center with our core customers. Our marketing teams are charging full speed ahead and I’m confident that our efforts will keep us vibrant during these tough times.

I would now like to take a moment to discuss how we are working with our retailers given the current environment. For the past several months, we have been regularly meeting with our key accounts to better understand exactly what they are experiencing in these volatile times. The overall read out there is that business is tough and retailers are doing their best to adjust to the slowdown. Some of the changes we’re seeing include retailers ordering more conservatively, asking for extended terms and looking for more in season discounts. We’ve also noticed that some retailers are adjusting their holiday buys in order to minimize inventory risk.

To address these changing dynamics it is important that we help our retailers achieve superior presentation of our product. Our rep teams have been constantly on the road making sure that our Volcom sections in the stores have the freshest product as well as the most effective displays and assortments.

On a recent road trip visiting accounts, I was very impressed with Volcom’s in-store presentation and especially excited to see how well our outerwear looked on the floor. Overall, I believe we are strongly represented at retail and I’m confident that we’re ready for the upcoming holiday season.

To accommodate for the current conditions, we are somewhat moderating our growth initiatives. On the retail side, this means taking a more conservative approach when opening company owned Volcom branded retail stores. By the end of this year, we expect to have a total of 13 company owned Volcom stores up and running with 10 stores in the U.S., 2 in Europe, and 1 in Japan. This is in addition to the two LS&S stores we have in Southern California. I would also like to note that the Volcom Waikiki Bruce Iron signature store is now open and it looks great.

Our plan moving forward is to primarily focus on managing our current store base but we will continue to evaluate additional locations when they come available. Certainly with the acquisitions we have made this year, our focus in the near term is to continue to integrate these into the fabric of Volcom before we take on any new opportunities.

I would now like to talk a little bit about Electric. We continue to believe strongly in the brand’s potential, its products and internal team. So far the integration is going well and both companies are in constant communication strategizing for the future. Electric is similar to Volcom from a board perspective and the acquisition allows us to broaden our reach into different markets including Motorcross and NASCAR.

Sunglass manufacturers are not immune to the economic woes and Electric is no exception. But Electric is one of the strongest and sunglass and goggle brands in the market and their product is on point with what consumers are looking for.

Recent product launches include the Hoodlum Sunglass model in July, the Hoy Sunglass model in August, and in September the company introduced its Fiend sunglass model. Electric also has a small, but growing soft goods and accessories business, we have been working on with them to strengthen operations and broaden the scope of this segment.

The Electric Spring ’09 line, which reflects our initial collaboration is a well rounded collection and is on track to start shipping December 01, 2008, for the holiday season. Now we have also successfully transitioned all inventory, and are now shipping Electric products from our new warehouse in Irvine, California.

Okay, now let us turn our attention to Europe. The economic environment here is beginning to mirror the conditions we’re seeing in the U.S. Territories such as France and the United Kingdom are being hit the hardest but we’re finding some bright spots, especially Germany and Austria, which continued to perform well. Another positive note is that the back-to-school period was a generally good. The weather has also turned cold and wet in Europe, so denim, fleece, and jackets have generally been selling well. We still have a lot of opportunity throughout the region and we will continue to focus on the positive areas until the economy turns for the better and we can broaden our growth efforts.

I would also like to point out that we are now planning to sell direct in the UK effective January 1, 2009. The decision comes after a decade of working in this territory and it simply makes sense given the opportunity there. The new program will include an office in England staffed with a country manager, customer service, a rep force, and a marketing manager. All orders will be shipped from our distribution center in France directly to our retailers in the UK. We’re very excited about this new opportunity and can’t wait until we’re 100% up and running. Furthermore, we recently opened a Volcom branded store in London and the reaction from the local community has been very encouraging.

Now looking at Asia, we announced the acquisition of our Japanese distributor during the third quarter. The acquisition is moving along according to plan and we expect to take control of the operation effective November 1, 2008. Japan continues to be a strong market for Volcom and the region is an important part of our international growth strategy. With growing interest in you board sports throughout Asia we believe the acquisition will help us fine tune our product offering, establish more competitive pricing, as well as seamlessly integrate with our global sales, purchasing, and marketing strategies.

So, as you can see there is a lot going on at the company and we’re making good progress with many of our long-term growth initiatives. However, the most important focus right now is that we stay healthy and successfully ride out this economic storm, while keeping our costs and inventory levels under control. With regard to controlling costs, we are reviewing all aspects of the business in order to find cost savings without affecting the momentum of the brand. We’re also evaluating our margin and looking for ways to improve our sourcing while operating more efficiently throughout the product lifecycle.

And perhaps the most important characteristic of our business is our solid cash position. As of September 30, 2008, we had approximately $73 million in cash and no significant debt. We believe this puts is an excellent financial position during this period of economic uncertainty. Of course our cash position is not the only attribute at Volcom that is going to help us get through these times. The environment requires we leverage our strengths, while we have leveraged our strengths that have made Volcom one of the strongest brands in action sports. Simply put, we need to continue to do what we’re good at running the business with discipline, commitment, and focus.

Several weeks ago, Volcom was named one of Forbes magazine’s 200 best small companies. This recognition is the direct result of the strength of the brand and our internal team. And while I think about the environment and the long-term potential of Volcom, I’m very thankful for the position that we’re in. Not only -- we not only have the resources to weather the current environment but we also have the ability to become a more dominant player when conditions turn around. The bottom line is that this is a great time of opportunity for our company and we intend to maximize the brand strength and momentum in the years ahead.

As always I would like to thank the entire Volcom family, our athletes, retailers and shareholders for their continued support and commitment. And with that I would like to turn the call over to our CFO, Doug Collier, to review our financial results for the third quarter. Doug.

Doug Collier

Thank you and good afternoon. As Richard noted the Volcom brand is among the strongest in our industry and continues to perform well at retail. However, as we all know the current retail environment is extremely difficult. Even in this difficult environment our results for the third quarter on a consolidated basis exceeded our revenue and earnings guidance.

As we look forward, we realize that we are not immune to the deteriorating economic conditions in the U.S. and abroad. We are fully aware of the adverse business conditions and accordingly we are adjusting our expectations for the fourth quarter. But we have never seen times like this in our 17-year history. We believe we have the resources to face this challenge. Our balance sheet is solid with a strong cast position and no significant debt. Also despite the current economic downturn the Volcom and Electric brands continue to perform well in the marketplace.

Now let us look at some of the numbers for Q3. For the third quarter ended September 30, 2008, total consolidated revenue increased 22.7% to $111.7 million compared with $91 million in the third quarter of 2007.

Let me break down our Q3 revenue by each of our three business segments; The U.S., Europe and Electric. First, let’s look at the U.S. segment. This segment includes revenue from the U.S., Canada, Japan, and most other international territories outside Europe, as well as our domestic Volcom branded and LS&S retail stores.

Total revenues for our U.S. segment including loyalties for the third quarter increased 11.6% to $72.8 million compared with $65.2 million in Q3 of 2007. This was approximately $2.8 million above the high-end of our guidance and primarily reflected better than expected demand from Volcom retailers.

The breakdown of the U.S. product revenue in Q3 by category is as follows. Our men’s product revenue increased 10% to $30.2 million for Q3 compared with $27.4 million in the third quarter of 2007. Our girl’s product revenue increased 25% to $20 million versus $16 million in the third quarter of 2007. The increase in girl’s revenue was anticipated and was primarily related to strong business with PacSun. Outside of PacSun, our girl’s business decreased 4% compared to Q3 of last year.

Boy’s revenue, which includes our kid’s line for boy’s aged 4 to 7 decreased 3% to $5 million compared with $5.1 million in Q3 of 2007. This decrease in boy’s revenue was due primarily to the timing of shipments within quarters. Year-to-date boy’s has increased 17% compared to last year.

Snow revenue grew 12% to $15.9 million compared with $14.3 million last year. We’re excited to see solid growth in this core category as our snow products continue to be well received in the market place.

Revenue from our Creedler footwear line decreased 68% to 316,000 versus $1 million in the 2007 third quarter. This decrease is attributable primarily to our transition away from the closed-toe slip-on category.

Revenue from our girl’s swim line decreased 53% for the quarter to 71,000 versus 150,000 last year. This decrease is due primarily to the timing of shipments between quarters. For the first nine months of 2008 girl’s swim has increased 97% to 5.3 million compared to 2.6 million for the same period last year.

International product revenue, which is reported as part of our U.S. segment and consists primarily of sales in Canada and Japan and does not include licensing revenue, decreased 8% to $14.5 million or 20% of our U.S. segment product revenue for the quarter compared with $15.9 million or 24% for the comparable period in 2007. This decrease was primarily due to price reductions implemented this year in Canada to better align our prices with those of our competitors. For Q3 of 2008 unit sales in Canada increased 8% compared to Q3 of last year.

Looking at our revenue by distribution channel, revenue from our five largest accounts increased 46% to $30.8 million in the 2008 third quarter, representing 43% of U.S. segment product sales. Revenue from PacSun, our largest customer, increased 83% to $18.8 million for the quarter or 26% of U.S. segment product revenue, compared with $10.3 million or 16% of our U.S. segment product revenue for the comparable period in 2007.

Our business with PacSun in the third quarter was ahead of plan by about $2 million and reflected strong sales for both our men’s and girl’s products. Excluding PacSun, revenue from our next four largest accounts increased 11% for the quarter and has increased 10% year-to-date. In Q3, revenue from accounts outside our five largest accounts, which represented 57% of U.S. segment product revenue for the quarter, decreased 5% to $41.4 million. This group includes independent core stores, which are particularly exposed to the challenging retail environment. Year-to-date revenue from this group has increased 30%.

Now let’s look at revenue from the Europe segment. As a reminder, Volcom Europe began full operation in the third quarter of 2007. So this is the first quarter when year-over-year comparisons are meaningful.

Revenue from Europe increased 20% to $31 million for the third quarter of 2008 compared with $25.8 million in the comparable period last year. On a constant dollar basis revenue increased 6%. In the most recent quarter revenue was below our guidance by about $1 million. This shortfall was primarily due to cancelled orders.

In Q3, revenue by category in Europe is as follows; men’s increase 14% to $16 million compared to $14 million in Q3 of 2007. Girl’s increased 26% to $6.5 million compared with $5.2 million last year. Snow increased 13% to $7 million compared with $6.2 million in Q3 of ‘07. The balance of the Europe segment product revenue was primarily made up of Boy’s, Creedlers, and Girl’s swim which were approximately 914,000; 121,000; and 39,000 respectively.

Finally, revenue from our third business segment Electric was $7.9 million for the quarter.

Turning to our gross margin, on a consolidated basis Q3 gross profit, as a percentage of total revenue was 49.4% compared with 50.4% in the same period in 2007. In our U.S. segment, Q3 gross margin on product decreased 180 basis points to 45.8%, compared to 47.6% in Q3 of 2007. The decrease primarily reflects the continued soft retail environment resulting in additional discounts during the quarter.

In our Europe segment gross margin was 55.3% versus 56.4% last year. The decrease was primarily due to increased inventory liquidation during the quarter.

Gross margin in the Electric segment was 56.3%. Electric gross margin in the third quarter was slightly lower than the previous two quarters primarily due to goggle shipments, which has a slightly lower gross margin than sunglasses and some additional inventory liquidation during the quarter.

Selling, general, and administrative expenses on a consolidated basis were $30.3 million in the third quarter of 2008 versus $22.8 million for the same period of 2007. As a percentage of sales consolidated SG&A expenses were approximately 27.1% of total revenue for the third quarter of 2008 compared with 25.1% for the same period in 2007.

For the U.S. segment, SG&A expenses in the third quarter increased 9.9% to $19.6 million, compared with $17.8 million in Q3 of 2007. For the Europe segment, SG&A expenses in Q3 increased 33% to $6.7 million compared with $5.1 million in Q3 of last year. On a constant dollar basis, SG&A increased 17%. This increase reflects additional personnel and infrastructure required to develop this territory.

In our Electric segment, SG&A in Q3 was approximately $4 million, which includes non-cash acquisition related amortization of approximately $500,000. Consolidated operating income for the third quarter increase 8.2% to $24.9 million, compared with $23 million for the same period in 2007. Consolidated operating margin was 22.3% for the third quarter compared with 25.3% in the third quarter of 2007. For the U.S. segment operating income in the third quarter was $14.1 million compared with $13.5 million for the same period last year.

Operating margin for the U.S. segment was 19.3% for the quarter compared to 20.7% in the third quarter of ‘07. The drop in US segment operating margin in Q3 was primarily due the previously mentioned decrease in gross margin for the quarter.

In the Europe segment, operating income for the most recent quarter increased 9.7% to $10.4 million compared with $9.5 million for the same period in 2007. Operating margin for the Europe segment was 33.7% for the quarter compared with 36.8% in the comparable period in 2007. This decrease in operating margin is primarily due to the increase in SG&A discussed previously.

In the Electric segment, operating income in the third quarter was $384,000 again this includes non-cash acquisition related amortization of approximately $500,000. On a consolidated basis the company recorded a provision for income taxes for the third quarter of this year using a 35.5% effective annual tax rate.

Consolidated net income for the third quarter of 2008 was $16.3 million or $0.67 per diluted share compared with net income of $14.5 million or $0.59 per diluted share in the third quarter of 2007.

I would like to take a minute and discuss the strength of Volcom’s balance sheet. At September 30th 2008, the company had approximately $73 million in cash. This balance is net of approximately $29 million paid earlier this year for the acquisitions of Electric and LS&S. Please note as presented on the consolidated statement of cash flows the company generated $13.8 million in cash from continuing operations for the first nine months of 2008. Also the company had no significant debt and had stockholders equity of approximately $203 million at the end of the quarter.

Consolidated accounts receivable increased $13.7 million or 20% to $81.3 million at the end of the quarter compared with $67.6 million at September 30th 2007. Of this increase $7.2 million was incremental related to Electric. The consolidated receivable balance at September 30th 2008 represents days sales outstanding of 84 days compared to 93 days at the end of Q3 last year.

Consolidated inventory totaled $25.8 million at September 30th compared with $16.7 million a year before. The inventory at the end of Q3 includes $5.8 million of incremental inventory related to Electric, $1.1 million of incremental inventory related to our retail stores and $770, 000 of incremental inventory in Europe. Excluding the incremental inventory from our newer businesses, inventory increased 11%. For our US segment inventory turns calculates to 8.6 times per year or once every 42 days well above industry averages. Please note that the eyewear industry requires available to sell inventory as a significant part of revenue is generated through replenishment business.

Also eyewear styles can be marketed for an extended time period in some cases for as long as a few years. Thus, the risk of obsolete inventory is much less for eyewear than apparel.

Further it should be noted that the build in inventory in our retail stores is related to the number of Volcom and LS&S owned and operated stores that were open for business. At September 30, 2007, we had 5 such stores, while we had 11 stores at the end of Q3 this year.

On a consolidated basis, the inventory turn rate calculates to 7.6 times per year or once every 48 days, again, this is well above industry averages.

I will now turn to our financial guidance for the fourth quarter and full year of 2008. Forecasting revenue in this economic climate is understandably difficult. While the Volcom brand continues to perform well at retail many of our accounts are anxious about the upcoming holiday selling season. Because global retail conditions have continued to deteriorate especially in the last few weeks some retailers have delayed or reduced some orders.

While we understand the situation is not a reflection on our brand, our products, or our company we have had to temper our revenue forecast for the remainder of the year. We have adopted a much more conservative stance on our revenue expectations. Further, we believe that the general caution from retailers given the overall soft retail environment will continue to put pressure on our gross margins.

With the current business climate in mind, consolidated 2008 fourth quarter revenue is expected to be between approximately $69 and $71 million or approximately flat to an increase of 3%. This includes anticipated revenue of approximately $53 to $55 million from the U.S. segment, approximately $11 million from our Europe segment and approximately $5 million from Electric. Generally consistent with our previous expectations for 2008 in Q4 we project revenue from PacSun to be down approximately 35% compared with Q4 of 2007, which was approximately $14.4 million. For the year we expect revenue from PacSun to be up approximately 5% from last year.

EPS for the fourth quarter of 2008 is anticipated to be between approximately $0.17 to $0.19. For the full-year of 2008 projected consolidated revenue is now expected to be between $333 million and $335 million, down from our prior guidance of between $344 million and $347 million. Please note that $3.3 million of the revenue guidance decrease was related directly to changes in projected FX rates. Broken down by business segment, $1.7 million is related to Europe, $1.1 million to Canada, which is reported in our US segment and $500,000 is related to Electric.

2008 projected revenue includes approximately $235 million to $237 million in the U.S, approximately $73 million in Europe and approximately $25 million from Electric. EPS for the year is expected to be between $1.42 to $1.44 versus our previous guidance of $1.50 to $1.53.

We expect that Q4 and full year 2008 tax rate to be approximately 35.5%. Fully diluted shares outstanding for the fourth quarter and full year of 2008 are expected to be approximately 24.4 million. Beyond this year, our visibility into 2009 is limited at this point. Because of the volatile global economic climate, many of our retailers have changed their buying patterns and are becoming more conservative with their prebook orders. Due to lack of visibility, we’re not currently in a position to provide formal guidance for next year. We will have a much better read on next year when the holiday shopping season is completed and we gather additional booking information. We will update everyone on our 2009 expectations during our next conference call in February.

In putting forth this outlook, we want to remind everyone of the complexity of accurately accessing future earnings and revenue growth, given the challenging economic environment, the difficulty in predicating sales of our products by our key retailers including PacSun, change in fashion trends and consumer’s preferences, and sourcing cost.

The current economic climate will create a difficult short-term business environment. However our company with its old wide band strength of Volcom and electric, enviable cash position and dedicated team of employees, athletes, sales reps, and distributors around the globe is positioned to steer through this downturn and emerge from it with a distinct competitive advantage.

With that we will open the call for questions.

Question-and-Answer Session

Operator

And your first question comes from Jeff Van Sinderen [ph].

Jeff Van Sinderen

Good afternoon. I guess my first question is in terms of the outlook, how are you planning to manage inventory for end of season shipment now that retailers are buying more at once and delaying some orders, canceling some orders and then how do you avoid the pitfalls of having some access product or having too much excess product end up in the off-price channel?

Jason Steris

Hi, Jeff, this is Jason here. I think that is a great question. Definitely right now for us inventory is one of our number one focuses as we transition to Q4 and especially as we look into the first half of, specifically Q1 as we are preparing for spring. I can tell you know, as we’re in this environment right now we’re seeing some cancellations from some of our retailers and we’re working this closely as we can with them to accommodate their needs and get their inventories in line and there is the short term -- there’ll be some excess inventories liquidated in this quarter. But as we move forward we’re looking really closely at our buying procedures and the amount of products that we’re actually bringing in and working much closer with the retailer, and I think what we’re seeing from the retailer standpoint now is that -- they’re placing softer prebooks looking into future orders based on this environment now and it is really a fine line of where -- how much inventory you place versus the prebook and we are not putting ourselves in a position where we’re going to have a lot of excess inventory for that and stuff that we have talked about in the past is we do have a lot of carryover programs, stuff that will move forward, stuff that will be in spring and will move into summer, stuff that has got a longer shelf life and those are the styles that we will really focus on right now if you’re going to put some excess inventory and in some of the shorter lead time styles such as T-shirts and things like that. So, overall as a company we are tightening up our inventories and are really focused on it.

Jeff Van Sinderen

So, looking forward to spring you should really have less probably falling into the off-price channel?

Jason Steris

Yes, I mean we’re not quite there yet but with our inventory management right now that is our goal all the time is to try and limit that amount of product that is in that outlet.

Jeff Van Sinderen

Okay, good. And then maybe you can talk about any trends you are seeing at Laguna Surf & Sport and maybe how that is influencing elements of your wholesale business planning?

Jason Steris

Yes absolutely, that has been a great acquisition for us. Nothing on a grand scale, but just in terms of information and expertise that we have gained bringing Eric John, the founder of Laguna Surf & Sport onto our team. It has been a big help to our overall retail program. He’s helping us out with our branded store strategy and then specifically the stores themselves looking in terms of our footprint in there and in our displays and just maximizing our real estate in there and our sell through has been, have a little more power around that really helped us out and being in our backyard it is important to the brand and in terms of working really close their buying teams they have got three key buyers within that organization that are working closely with our teams, seasonally looking at, hey, what is working for you guys, here’s what is happening in the market and really gaining the information that can come right back to our product teams to help us maximize our strengths out there. So overall there is three key points to that acquisition that has been exiting for us.

Jeff Van Sinderen

Good, and then one more and I will let somebody else jump in. Can you talk a little more about how you’re thinking about your strategy to expand in Europe and how that can play out and also I guess, what sort of hurdles who are encountering there in terms of opening more doors or expanding into different channels like the department store or sporting goods stores.

Richard Woolcott

Sure, hi Jeff. This is Richard here. I will jump in and then discuss a little bit about Europe. I mean, first of all what we’re seeing there is the environment over there is really beginning to mirror what is happening in the U.S. and obviously you know, when you have issues in the U.S. they become more of a -- they have more of a global impact these days. And so first of all our team is working through that particularly in some of the territories that are hit a little bit hard and we have got some strong points, strong areas over there such as Germany and Austria, Norway and Switzerland and then some areas that are struggling a little bit more such as the Italy and Spain and in France. But first of all first we’re looking at our existing retailers seeing what we can do there to work through some of the issues with them particularly going into Q4 and then in terms of moving forward, we definitely see that there is opportunity not only in our existing distribution but also with some of the -- there are some new retailers that we’re looking at right now reviewing that we could potentially could open in the future and we’re working with each one of our distributors individually to see what opportunities are in their territories. I think the best news for us is Volcom is still a relatively small brand -- smaller brand over there with lot of opportunity moving forward not only in our existing footprint but with our increased distribution. But we haven’t really jumped into that. What we’re trying to do is just work through the environment right now and particularly into Q4, making sure that we have got a strategy in place to be able to weather the environment that we’re starting to see over there and a lot of it is going to mirror what happens here in the US. I think if we can get some stability here in the U.S. and hopefully in the next three to four months I think that’ll play in our favor over in Europe. So, while we got kind of got our short term plan and then also we’re strategizing for next year and beyond.

Jeff Van Sinderen

Okay, well it sounds like you guys are focusing on the right things and good luck and thanks a lot.

Richard Woolcott

Thanks Jeff.

Jason Steris

Thank you.

Operator

And your next question comes from Mitch Kummetz [ph].

Mitch Kummetz

Hi, thanks. And thanks for all the detail in the call. The first question is just a follow on Jeff’s question there on Europe, Doug I think you mentioned that you are going direct in the UK starting January. Could you just provide a little bit more color on that? I mean -- was that just a distribution agreement that lapsed and so you are taking it over. Did you buy it in and how big of a market is that in terms of your overall European business and what would you expect to capture in terms of incremental revenue and profit by being direct versus selling to your distributor there?

Richard Woolcott

Hi Mitch this is Richard. I think I will jump in a little bit and if Jason are Doug wants to jump in too here, but yes, I think in the UK we’ve had -- we had a relationship distributor relationship there for a number of years and as we took over the territory now with our own company. The UK was one area that we felt that was really important for the brand moving forward and I do think that there is opportunity there from a sales perspective and I also think there is opportunity there from a branding perspective particularly with the skate scene. Now there is a great music scene there too. And just from kind of an influential leadership type of perspective and what they’re doing is we’re investing in -- I said that in my script are we’re going to be putting in an office where we have a country manager or a manager overseeing the territory. We will have a group of sales reps, our marketing team there and also in the infrastructure of customer service. And with that we really do think that they we can increase our footprint in the UK and I -- you know so far particularly just with the store that we put in over there we have had a lot of -- we had a great reception from the local community in the skate scene and some of the core Volcom fans over there in the UK. So, you know overall we’re excited about it. We’re still in the stages of putting that team together and we will be taking over those sales beginning in the first of the year and on the next call we will be able to give you a clear picture on exactly what the strategic kind of outlay will be. But we’re right in the process of just putting kind of the program together right now.

Mitch Kummetz

Okay, could you at least give us a sense as to how big a part of that --that of your overall European business that UK currently represents?

Doug Collier

Yes, Hi Mitch this is Doug. I think when we look at the UK and what a key market that is, right now it is probably not a big a part as we like it to be. I mean they’ve done a real good job developing the brand and developing that core base. But we think as we get over there and take charge of that territory we can actually have it become a bigger percentage of that revenue. So that is part of the strategy as well as obviously the margin enhancement as we go forward owning that distributorship.

Mitch Kummetz

Okay, and then a second question on Europe. You know with what has happened in terms of currency of late with the Euro down I think $1.30 now, how do you look at your European business in terms of you know, that impact of currency on your revenue translation and the potential impacts on profitability. I mean I know you don’t want to provide ’09 guidance but you know, how big of a drag does that become on your European business as you go forward at these current rates?

Doug Collier

Yes, hi Mitch. Doug here. You know it doesn’t really affect the business there that much. I mean they’re buying in U.S. dollars. That is obviously a factor. But most of this is just translation that we just bring across from Europe and to see their currency drop about 20% since July the last time we talked, it is an impact especially on Q4 you know when we looked at our revenue from Europe in Q4. So, you know then going forward and trying to estimate where that is going to be. That is another one of the sort of the places where we lack visibility in 2009.

Mitch Kummetz

Okay, and then one last question. I’m just trying to get a better handle on your margins of your core US business. I think given what your guidance is now for Q4 it looks like probably your operating margin on the U.S. business comes in sort of mid teens level which is down from a, let us say low 20s, couple of years ago. When you look at that deterioration and I think it is mostly gross margin, how do you think about that? Is it mostly just a function of the environment that we have been in for the last year or so or is it also partially a function of changes in mix in product and distribution and then opening up your own stores and you know, how much of that -- when you look at that deterioration you feel this is sort of a sustainable level that we’re at now or do you think that there is an opportunity to recapture that once we see the environment get better. Just want to get your thoughts on your outlook for margins and kind of how you think about that on a go forward basis?

Jason Steris

Hi, Mitch this is Jason here.

Mitch Kummetz

Hi Jason.

Jason Steris

Yes, I will point out the two factors we are seeing currently right now affecting it would be the environment in terms of just the discounts and the markdowns we’re saying currently and then the other side would be some of the margin pressure we’re feeling from some of our larger accounts or some of our newer distribution and just you know, as we have become a bigger partner for them discount becomes a -- or margin pressure becomes a factor. So really those two and I think the first one of the discounts in the markdown being a key factor of that environment right now is that we do see that as we come out and get into a stronger environment in the future that that can be one area that can be -- that may go away for us and for us right now internally we’re really focused on our margin and in terms of working on 2009 products and you know and trying to improve our, you know, whether it is our sourcing or efficiencies or more dropped [ph] shipments. We have a slew of initiatives right now that we’re focused on. So when this environment does clear up hopefully that is one area that can you know, bounce back and then but in the short-term it is really for us to just maintaining those margins right now and you know, I think maintaining would be more realistic in this current environment that we are in right now, but definitely a major focus for us.

Mitch Kummetz

All right. That is helpful. That is all I had. Thanks, good luck.

Doug Collier

Thanks, Mitch.

Richard Woolcott

Thanks.

Operator

And your next question comes from Jim Duffy [ph].

Krishnan

Hi this is actually Krishnan [ph] calling in. Had a question on the changes in the buying patterns. Wondering if you could provide a little bit of perspective on the promotional environment out there for some of your competitors and what you guys are seeing when you go in to have conversations with some of your customers.

Richard Woolcott

Hi, who is it?

Doug Collier

It is Krishnan.

Richard Woolcott

I am sorry, Krishnan. This is Richard. Yes, I will start and then maybe Jason will jump in here too.

Krishnan

Thanks.

Richard Woolcott

I think the first -- the first thing that we have seen is which is unique. Normally we have not seen this in the past is and particularly how it is affecting Q4 is that we’ve -- when you go out you do your initial prebooks, you collect all your orders and that is really your visibility as you are going into that next season and what we have seen happen over the last from probably in September and then particularly what happened at the beginning of October when we had the basic meltdown here in the U.S. the retailers got really nervous and they came back and they came back to us said, hey guys we need to readjust these buys, and looking at holidays going, is there anyway we can shave some stuff off. We’re worried about our inventory levels and we definitely need to take a more conservative stance. So that was really the first part in terms of what we’re seeing with our retailers was okay, we have got to go in and adjust. We have to adjust the initial holiday buy in some instances. And we have also had them ask us well hey, can I move some orders or shift some orders around maybe can I take it a month later or would you guys, could you ship it to me closer to holiday and so on and so forth. So that this kind of what we’re seeing in Q4. What we’re also seeing is given the retail climate right now is we’re taking a much more conservative approach on our reorder business or our additional in season business. Meaning that normally we would assume that there would be follow up business particularly as we got close to holiday, but now I think with the caution out there within inventory and with kind of the mood out there with the consumer we are not assuming there is a going to be a lot of reorder business. So, we are taking that into consideration and those two are really the factors that have affected Q4. Something that we think could happen in the future that I think retailers are going to be planning their inventories closer to end season, closer to a particular holidays, or kind of high traffic times. So, we are assuming that those patterns could change and the buying habits can change even moving forward. So, I think a lot of it is going to be dictated by this environment and we’re just going to attack it as it comes and be proactive with it.

Krishnan

Can I just ask a follow up there on sort of the downstream side of things. Have you been able to push back on your suppliers and trim some of the orders that you may have already placed.

Jason Steris

Hi, Krishnan. This is Jason here.

Krishnan

Hi Jason.

Jason Steris

You know we have definitely been working closely with our suppliers through this quarter on inventory planning and costs and everything across the board. Those are few areas where we were able to maneuver through few inventories and then lot of that stuff just planned out so early in advance that it is hard to get out of that thing. So a little bit but I think for the most part it is kind of your question on (inaudible) the minute you know we got a sense of things were getting worse we really went back to our vendors to look to them for help whether it is margin or inventory control. So, a little bit of that for sure.

Richard Woolcott

Hi, Krishnan. I would like to point out that with the environment we have been preparing ourselves for this over the course of this year anticipating the slowdown and being strategic in our thinking and in our steps and so when we came upon this next wave of the downturn and particularly as we are going into Q4 we have been very as Jason has said earlier on the call we have been watching the inventories very closely and trying to manage exactly what we believe the retailers’ expectations and needs will be and planning that accordingly with what we have got on hand now and as Jason has said too as what we are -- as we are planning to move forward. So we’re very entrenched in the situation right now. We feel like they’re got our arms around the environment and planning accordingly and we’re ready just to manage the business through this crisis. But overall on the other side of that I feel -- I feel very confident in where the brand is at as we move forward in terms of the brands’ strength, in terms of how it is performing at retail, and you know the potential of the company when this situation turns around. So, we’re kind of in a two step process, weather the short term and really take advantage of the long-term. So, overall feel good even though it is challenging. I feel like our team is on their game.

Krishnan

All right. Thank you very much. It is very helpful.

Richard Woolcott

Thanks Krishnan.

Jason Steris

Thanks Krishnan.

Operator

And your next question is from Eric Tracy [ph].

Eric Tracy

Hi, good afternoon guys. And thank you very much for all the detail.

Richard Woolcott

Hi Eric.

Eric Tracy

Maybe first Richard, I understand that always the number one priority is not to dilute the brands but is there sort of any opportunity to maybe open some additional incremental doors to sort of offset the weakness in the existing channels of distribution. How do you think about say about opening whether it is a bigger box like Dick’s or just some other specialty stores. Could you provide some detail on that?

Richard Woolcott

Well, I think Eric right now in the environment that we’re in, our priority at this point, I mean we don’t have much time left for Q4 in terms of I think we’ve got what 60 days left till the end of the year. So our number one priority is to work with our existing retail group and to get through -- at least get through this holiday season and then kind of reassess and see how the environment has played out, because a lot has to do with number one, we have got the election coming up, we’ve got holiday that we still go to work through and then we also have to get some type of stability within this environment. I think once all of that happens, I think then we’re going to have a much -- much more visibility and a clear picture to be able to strategize as we move into ‘09 and beyond. And in terms of distribution, I do think that there is some areas but I don’t think we’re ready yet to be aggressive in any manner. I think there can be little pockets where there is some accounts you can open and maybe get some additional revenue but I think right now it is really stick by our existing retail group and to dive in and to work to the best of our ability with them and get through this tough time. Because I do think when times turn and they get better what we do now is going to be important to the relationship as we move forward. So, it is really focusing on the business at hand and making sure that all of ducks are in the row at this point in time and eventually there is opportunity and I think there is a global opportunity, there is opportunity with Electric. You know we’re just bringing on Japan. So from a global perspective it is there. It is just we’ve got to ride through this economic pressure. It is not just on the U.S. it is a global pressure and our goal is to stay healthy, is to say strong and to protect the brand as we move through this and to protect those relationships with our core existing retailers.

Eric Tracy

Thanks.

Richard Woolcott

That is kind of the initial plan and eventually we will get -- we will look to move forward and research additional distribution but right now we’ve got our hands full and I think we’ve got to stick by our retailers.

Eric Tracy

Okay, fair enough. And then maybe just following up on some of the previous discussion around the gross margin, is there any thought and you mentioned it is kind of slowing the retail store growth but any possibility to maybe control that sort of distribution and open outlet stores so that you are not having to clear products through some of these off-price channel sort of putting the balance sheet to work and opening some of the outlet stores.

Richard Woolcott

Yes, Eric I mean, yes, we’re looking those things. We actually do have a licensed outlet store program. You know, we don’t own those stores but someone exclusively opens those stores for us and those give us a little bit better gross margin than if just going the traditional off-price. So that is something we’ve already been working on.

Eric Tracy

Okay and then maybe just lastly on the UK, any material CapEx or infrastructure builds around that?

Doug Collier

Not a lot of CapEx on that. I mean we’re going to have some SG&A over there but there is definitely opportunity since we will be capturing the vertical margin there, or an increase through the distributor. So -- and not a real big operation over there. It is something that really it is more of an opportunity and something that we see as potentially a big market in Europe for us that is not there right now. So, it is more of a future opportunity.

Eric Tracy

Okay, and then just I guess my last, on with that in mind and you gave got there was $73 in cash not really rolling out or major infrastructure builds, is it just in this environment we want dry powder. Any other thoughts be it acquisitions or other uses of cash to kind of enhance shareholder value.

Richard Woolcott

Yes, that is our number one priority is how can we enhance shareholder value and I think right now as rough as things are out there we feel very fortunate to be one of the few companies that we have a lot of cash and if things are -- in some ways this tough environment might work to our favor when it is all over. Because there are a lot of other companies, maybe even some of the smaller ones, they are going to have a tough time producing product and any of those problems that go around cash flow or anything like that. That is not something that we have deal with. We are in real strong position there and we feel fortunate for that. So it’s a good place to be in right now.

Eric Tracy

Absolutely. Okay thanks guys and best of luck.

Richard Woolcott

And right thanks Eric.

Jason Steris

Thank you Eric.

Operator

And your next question is from Shawn Martin [ph].

Shawn Martin

Hi guys. How are you?

Richard Woolcott

Hi Shawn.

Shawn Martin

Question for you, you talked a lot about the gross margin line and I just wanted to dig in a little bit into the SG&A portion, is there -- can you quantify or at least talk about what are the areas of opportunity that maybe fixed versus variable within that bucket and what are the steps that you are looking at to potentially control some of the growth in that particular line item?

Doug Collier

Yes, in the -- Shawn this is Doug. Yes, looking at the SG&A that is something that we have been focused on for a while now. You know there are some things that are fixed and not a lot of that in our business. I mean we have got our rent and you know, some depreciations and things like that that are going to be fixed and there are a lot of variable costs or things that we are going to want to keep intact, things around improving our products, our branding efforts. Those are the things that we think that we need to look at right now as far as cutting. And there are some areas you know, where we can tighten the belt a little bit and we have already done that this year. And you know looking out into next year I think in all of our companies that is something we’re going to have to continue to do but fortunately we are not in a position where you know we are absolutely forced to do things that we don’t want to do that or going to maybe have an adverse effects on the products or the brand at this point.

Shawn Martin

Okay, and then in terms of the sourcing you were talking about with some of your vendors not pushing products back necessarily but have you seen any change with -- we hear these articles and see these articles about factories closing down and potentially deals not getting done because labor costs are much higher and input costs are higher. Have you noticed anything starting to abate on that particular front just with the demand slowing?

Jason Steris

Hi, Shawn this is Jason. That is great question. Definitely seeing as China went through a boom over the last five years of manufacturing a lot of new factories popped up over that time and it is definitely pulling back. We have seen you know a lot of the smaller guys go away but you know for us right now we’re working with a good sized group of established and existing vendors that have proven to deliver quality product on time for us. Our teams are over there on a regular basis. Our compliance team is working closely with them in all levels of compliance and -- so for us we’re definitely secured with our existing teams and we haven’t see anything on our front door but it is definitely seen you know a lot of these factories go away which you know, for us is just has anything been a little bit more favorable of just having you know, our guys come back a little bit less competition out there for them and just better efficiencies with our existing guys and definitely always watching and it is an evolving area in the company and we have got a close eye on it.

Shawn Martin

And then in terms of just regionally across the U.S. have you noticed any differences in sales patterns that have changed, clearly most people understand that the environment has changed dramatically over the past 5 to 6 weeks, but just kind of normalizing through the third quarter where there any changes in the pattern of sales that you were seeing just regionally across the United States.

Richard Woolcott

Yes, absolutely. What we’re seeing -- we’re seeing a little bit tougher business right now in California and Florida. We’re seeing -- one thing we’re seeing across the board we’re seeing strength in more of the coastal accounts and some of the inland accounts being a little bit tougher with little bit of colder weather on the east coast, northeast and kind of that Central East area we have seen being a little bit of a stronger pocket compared to the West Coast. Pretty good businesses in the Rockies, but I think California and Florida will be kind of the some of the tougher markets right now, but that the one trend we are seeing coast to coast would be that the coastal accounts versus the inland accounts are doing much better and probably a bit better than the mall stores as well.

Shawn Martin

Okay and then final question you did have I know you quantified this before but is there any way to quantify the gross margin impact due to some of the off-price selling of the inventory, just clearing some of that product out. Can you quantify the gross margin impact on that?

Richard Woolcott

While some of the clearance inventory -- the sales we make at the clearance outlets, the gross margin is not real good on that and all of that is worked into our Q4 guidance.

Shawn Martin

Okay. That is fair. Thanks a lot for your time guys. I appreciate it.

Richard Woolcott

All right. Thanks Shawn.

Doug Collier

Thanks Shawn.

Shawn Martin

Take care.

Operator

(Operator instructions) The next question is from Jeff Mintz [ph].

Jeff Mintz

Can you talk just a little bit about what happened to tax on this quarter. It looks like you said that there was kind of a $2 million ahead of plan and it looks like next quarter it is coming back down you know, what was their ordering pattern and kind of what is going on there.

Jason Steris

Hi, Jeff this is Jason here.

Jeff Mintz

Hi Jason.

Jason Steris

Not a huge change in the overall guidance for the year on PacSun. We did see a timing of some orders falling into Q3 but overall if you look at the whole year we’re up a little bit -- little bit extra a couple of extra orders on the men’s side, but for the most part not a huge change there in terms of the annual guidance.

Jeff Mintz

Okay, but I mean it looks like they’re taking orders a little earlier and it sounds like a lot of other people are delaying orders. Is that something in your relationship with them or is that kind of how they’re running their business now.

Jason Steris

You know I think it is a little bit more of just you know the products available for them to get the product out there on the floor, you know, it made sense at the time depending on the category we had a transition of T-shirts going into V-necks and there just availability on some products that there were open to taking. So, it wasn’t a huge -- a huge change overall like I said but just kind of a function of hey, there is available product here and the timing of it and the teams are ready to take them.

Jeff Mintz

Okay, great. Thanks. And then on your own retail stores, can you just talk a little bit about what you’re seeing in terms of traffic patterns there and I know you don’t give comps but just kind of a sense of how much the overall consumer slowdown is hitting your own retail stores.

Richard Woolcott

Yes, Hi Jeff. This is Richard here. It is -- that is an interesting barometer for us and it is one thing that we look at that we can get direct information that will give us a read of what is happening out there with the consumer. You know, we did see a specific trend before that one -- that first week in October. We’re trending one -- in one direction and that that first week in October really put it then I think in that kind of consumer movement out there. I mean it basically froze the country and so we noticed that and we have no noticed things pick up again from that time frame and we’re really and typically in kind of this holding pattern before holidays. So I think the next weeks things will just be constant and then what we are hoping to see is the closer we get to Thanksgiving and that Thanksgiving weekend we start to see the holiday sales. But it is great -- our retail stores are a great read for us not only for sales but for what products are moving and it is the temperature read. And you know, the sales -- the sales in the store performance is within line with what we have been planning internally and we are constantly updating in terms of how the environment is doing but I will tell you we really saw in that first week of October the consumer market out there really took a hit and I think it is starting to recover but we’ve got to get more stability and more confidence back in the marketplace and I think once the consumer gets that level of confidence and I think the retailer gets that level of confidence, I think we’re going to -- we will be into a new environment but at least we will be in a stable environment. But that is kind of the overall read right now.

Jason Steris

Hi Jeff. This is Jason here. Just to kind of go back on that PacSun question, one thing I left out, you know, we had talked about on the last call was our juniors business picked up a lot in the back half and you know we had sort of a soft first half. There was some excitement with the buying team and everybody to get that initial force set out there sooner than later. So we did see definitely a little bit of acceleration on the growth side as well just getting that juniors business back up to speed. So, just want to point that out.

Jeff Mintz

Okay, great. That is helpful and then finally and Jason it might be too early but do you have any kind of early reads on snow sell-through or is it just a little bit too early to start getting those.

Jason Steris

You know it is a little bit early but there are pockets of excitement happening. I talked to our sales manager this morning about it and you know, he has getting a few calls from some of the online guys that we work with -- some of the you know, the Northwest accounts. There is some activity there that we heard. There has been some snow in Colorado. Little pockets of excitement nothing to really get into right now but there is definitely some sell-through happening In different parts of the nation and then also some of the colder weather happening over in Europe is encouraging. So, I think it is just heating up right now. All the products out there look really good on the floor. All the companies are out with their floor set. So, you know the presentations there and it seems like there is some early excitement happening and I feel good about what we have out there in terms of our floor set right now. It looks really good out there.

Richard Woolcott

Then we have -- I think we have got our first real cold front coming through in the next couple of days on the West Coast here. So, that is good timing beginning of November and there is a couple of mountains that have opened in Colorado or some little resort. So, at least we are seeing some activity from the weather side of things and if that continues that is just good momentum as we go into the main part of that outerwear season. So, so far so good. We will see how these storms start lining up. I think the first one is tomorrow or the next day. So that is good news.

Jeff Mintz

All right Bob. Thanks a lot and good luck to you.

Richard Woolcott

Thank you.

Jason Steris

Thank you.

Operator

That concludes the Q&A segment. I would now like to turn the car back over to Richard Woolcott.

Richard Woolcott

All right. While I just want to say thank you for every one who have been on the call and for all the support and we look forward to talking with you again on the next call. So thanks again and have a great day.

Operator

This concludes today’s conference call. You may know disconnect.

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