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Quiksilver (NYSE:ZQK)

Q2 2013 Earnings Call

June 06, 2013 4:30 pm ET

Executives

Robert Jaffe

Andrew P. Mooney - Chief Executive Officer, President and Director

Richard J. Shields - Chief Financial Officer and Principal Accounting Officer

Analysts

Taposh Bari - Goldman Sachs Group Inc., Research Division

David M. King - Roth Capital Partners, LLC, Research Division

Mitchel J. Kummetz - Robert W. Baird & Co. Incorporated, Research Division

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Jennifer Black

Eric B. Tracy - Janney Montgomery Scott LLC, Research Division

Operator

Good afternoon, ladies and gentlemen, thank you for standing by. Welcome to the Quiksilver, Inc. Second Quarter Fiscal, 2013 Results Conference Call. [Operator Instructions] I would like to remind everyone that this conference is being recorded. I'd now like to introduce Robert Jaffe, Investor Relations for Quiksilver, who will host this afternoon's call. Mr. Jaffe, please go ahead, sir.

Robert Jaffe

Thank you, operator. Good afternoon, everyone, and welcome to Quiksilver Fiscal 2013 Second Quarter Earnings Conference Call. On the call today are Andy Mooney, President and Chief Executive Officer; Bob McKnight, Executive Chairman; and Richard Shields, our Chief Financial Officer. Rich is joining us from our offices in Europe.

Before we begin, I'd like to briefly review the company's Safe Harbor statement. Throughout our call today, items may be discussed that are not based on historical facts and are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In particular, statements regarding Quiksilver's business outlook and future performance constitute forward-looking statements, and results could differ materially from those stated or implied by those forward-looking statements as a result of risks, uncertainties and other factors, including those identified in our filings with the Securities and Exchange Commission, specifically under the section titled Risk Factors in our most recent annual report on Form 10-K and in our quarterly reports on Form 10-Q. All forward-looking statements made on this call speak only as of today's date, June 6, 2013, and the company undertakes no duty to update any forward-looking statement.

In addition, this presentation may contain references to non-GAAP financial information. A reconciliation of non-GAAP financial information. A reconciliation to the most directly comparable GAAP financial information is included in our press release, which can be found in an electronic form on our website at www.quiksilverinc.com.

In addition to our financial results, management will be providing comments on the company's multi-year profit improvement plan which we announced on May 16, 2013. Elements of the plan are discussed in the May 16 news release, as well as in a PowerPoint slide presentation, both of which can be found in the Investor Relations section of the company's website.

With that, I'd like to now turn the call over to Andy Mooney.

Andrew P. Mooney

Thank you, Robert. Good afternoon, everyone, and thank you for joining our call today. I'll begin with a summary of our profit improvement plan and then discuss our second quarter results. Rich will go into the financial details, followed by an outlook for the balance of the current fiscal year. We'll then open the call to questions.

Shortly after joining the company, I convened a multi-day meeting with the senior management team. The purpose of the meeting was to discuss organizational strengths and weaknesses, and to begin building a plan designed to enhance the strength and address areas for improvement. With the aid of outside specialist, the management team developed a profit improvement plan, which was then presented to our Board of Directors in late April. The board, after much discussion and input, unanimously approved that plan.

I think it's important to share 2 overarching aspects of the plan. First, the 3 core strategies we've consistently communicated, that of strengthening our brands, expanding sales and driving operational efficiencies will continue to guide our efforts. The plan, however, is designed to accelerate progress against these 3 key strategies. And second, the plan is quite detailed with tactics and areas of responsibility clearly defined. It includes 71 specific initiatives. These initiatives are being tracked and monitored by our project management team, which has been implemented and is being led by one of our senior staff that has accepted this position full-time.

To summarize, the plan calls for an increased focus on our 3 flagship brands of Quiksilver, Roxy and DC, each with a clear plan and a clarified brand positioning. Modest sales growth, improved cost structure and increased investment and demand creation. We believe the plan, when fully implemented in 2016, will improve EBITDA by approximately $150 million compared to fiscal 2012 results.

Approximately 1/2 of the improvement will come from supply chain optimization and the other half primarily from corporate overhead reductions, licensing opportunities, net revenue growth and improved pricing management. More specifically, the plan calls for improvement over the same period in the following areas: net revenues to increase at a Compound Annual Growth Rate of approximately 2.5%; and pro forma adjusted EBITDA to increase to at least 13% of net revenues. We do not, however, expect the improvement to be linear.

So where exactly are we in the process? We've completed the reorganization of the company from a regional structure to a global organization, with strong functional expertise in the key leadership roles. We have a essentially completed recruiting a new leadership team, having named Pierre Agnes, Global Head of Apparel; Tom Hartge, Global Head of Footwear; Kasey Mazzone Global Head of Supply Chain; Nicholas Drake, our newly appointed Chief Marketing Officer; Pam Leford [ph], Global Head of Licensing; Steve Finney, Head of Retail and E-com for North America; John Graham, SVP of wholesale sales for North America. The only open senior position is the Global Head of Retail Sales at the moment and we have retained a recruiting firm to help with the search.

We have exited several peripheral brands including the VSTR and Summer Teeth brands, and are considering the divestiture of other non-core brands. We've clarified our brand positioning by exiting overlapping product categories, including Quiksilver Women's, DC Surf and Quiksilver Skate.

In the area of marketing, we have exited or canceled most event sponsorships and released a significant number of sponsored athletes who we were not able to activate. Over time, we expect to further reduce both the number of sponsored athletes under contract and the events we sponsor. Importantly, we will redeploy the marketing savings to focus on permanent and seasonal in-store display, print advertising and social media.

A major element of our plan involves optimizing our global supply chain. This effort involves product line rationalization, demand aggregation, vendor consolidation, and refocused strategic sourcing processes through the selection of highest value product regions, as well as improved vendor negotiation planning. Our SAP system provides the foundation to allow all of this to happen. Thus far, SAP has been fully implemented in new North America and Europe.

We are transitioning to a global product design structure and now consolidated our product design and development to 2 global centers of excellence, one in Biarritz, France, and the other at our headquarters in Huntington Beach. As a point of reference, we've previously design products regionally at 21 separate design offices around the world. Each of our current design centers will be responsible for the global product line for specific product categories.

Moving forward, we will significantly reduce and rationalize the number of products we offer, including a style count reduction of 30% or more. And finally, we've identified a number of product categories for potential licensing opportunities and are in the early stages of negotiations.

With that overview of our profit improvement plan, I'll know briefly turn to the second quarter financial results.

Our Q2 performance reflects net revenue declined primarily within our Europe wholesale channel, as well as lower gross margins across all 3 flagship brands, but primarily within our DC brand. The revenue margin declines were partially offset by reductions in SG&A. Our wholesale channel in Europe was impacted by several factors this quarter, with the most significant being SAP implementation. And Rich will go into details on that in his remarks.

Our e-comm and emerging market revenues continued to grow, and continued to represent significant opportunities while also continued to be an area of investment for our company. Gross margins were impacted by increased discounting in DC products in the Americas and in all 3 brands in Europe as we continued to reduce prior season's inventory. And on the SG&A front, we reduced operating expenses by $6 million versus the same quarter of the prior year.

During the quarter, we continued to reduce staffing and closed underperforming retail stores. To date, we dealt a detailed profit improvement plan to improve the company's future performance. We implemented the appropriate global management structure and recruited world-class executives to lead the core functions. I am, of course, disappointed with the Q2 financial results, but confident on the actions we have and will continue to take lead overtime to a leaner, more efficient and more profitable company.

And with that, I'll now turn the call over to Rich to discuss our financial performance in Q2 in more detail.

Richard J. Shields

Thanks, Andy, and thanks, everyone for taking the time to join us this afternoon.

Second quarter net revenues were $459 million, down 5% or $25 million on a constant-currency basis. The revenue decline was focused in the Europe region where revenues decreased to $27 million or 14%. Asia-Pacific revenues decreased by $6 million, and Americas revenues increased $9 million all on constant currency.

In Europe, the $27 million revenue shortfall was driven by a wholesale channel issue. Wholesale revenues decreased by $30 million or 20%, and decreased for all 3 of our core brands. 3 important factors contributed to this decrease: core weather, economic conditions, which continue to pressure independent wholesale accounts as well as consumers, and most significantly, our conversion onto SAP caused substantial shipment delays which cost approximately $16 million in canceled orders from wholesale accounts.

Major system conversions involved scheduled system downtime when companies plan not to ship product. We had planned on being down for 1 week, similar to our experience when we converted on to SAP in North America. Unfortunately, it took 2 weeks to complete the conversion.

In addition, host conversion, there were issues with EDI transactions and with cross-doc transactions, both of which impacted our ability to ship an invoice our larger European wholesale customers during April. Consequently, we were late in being able to deliver against firm orders from wholesale customers and approximately $16 million in orders were canceled.

When we started shipping and began contacting customers to schedule product deliveries, we frequently had to provide a discount to prevent additional order cancellations, so we saw both the revenue impact from lost sales and a gross margin impact on sales not canceled.

We are now shipping and invoicing all European customers, and had some limited success in recapturing some of this lost revenue in the third quarter. Importantly, we believe this issue was behind us and that our relationships with our key customers remain strong.

While wholesale revenue in Europe declined 20%, revenue in our European retail stores was down only 2%, and our European e-commerce revenues increased by more than 40%, again, highlighting the impact of the SAP issue on our wholesale business, although the SAP cross-dock issues also impacted, to a smaller extent, our retail and our e-comm channels.

In the Americas region, revenues increased 4%, with most of that growth coming from Roxy in the wholesale channel. DC Footwear continued to have slow sell-through and we continued to use markdowns, discounts and clearance channel sales to drive some slow-moving styles in that brand.

We saw a continued growth in the Americas e-commerce channel in Q2. And Americas retail revenues were down due to having 12 fewer stores as we continued to close underperforming retail locations in that region. As a result, the 4 wall profitability of our Americas retail stores increased by over 250 basis points in Q2 versus last year.

Asia-Pacific revenues fell 9%, with the shortfall driven by headwinds in the Australia wholesale market. We are seeing slow turnover in our Australian wholesale accounts, but we were pleased to see solid positive comp store sales growth in our full price retail stores in that market.

Moving to gross margin, which declined by 320 basis points year-over-year. DC gross margins continued to face difficulties. Higher clearance channel sales, as well as discounts and markdowns on DC footwear, contributed half of the decrease in gross margin. Discounts provided in Europe to prevent additional order cancellations contributed another quarter of the decline, with the final quarter of the gross margin decrease coming from inventory reserves recorded on the VSTR, Summer Teeth and Quiksilver women's line which we discontinued in Q2. The European discounting due to system conversion and inventory write-down on the discontinued brands are expected to be isolated to Q2. However, the DC discounting is expected to continue into the second half of our fiscal year.

SG&A decreased by $6 million or 3% in Q2. The impact of our cost reduction initiatives drove expense savings of over $9 million in the second quarter as we reduced SG&A in each region. These expense reductions included reductions in employee costs, professional fees, athlete sponsorships and events, travel and entertainment, as well as other categories. These expense reductions were partially offset by increased costs in our e-comm business, which generated 31% revenue growth in constant currency. We acted on our profit improvement plan in Q2, and continue the process of rightsizing staff and improving our retail store portfolio.

Included in SG&A is $4.4 million of restructuring and special charges related to the closure of underperforming retail stores and to rightsizing our staff levels. During the quarter, staff reductions generated severance costs of $3.7 million and severance was recorded in all 3 regions.

Second quarter pro forma adjusted EBITDA of $19 million decreased by $22 million compared to last year, driven primarily by the impact of lower revenues and gross margins in the Europe wholesale channel, as well as the gross margin decline in the DC brand.

Moving to the balance sheet. The quality of our inventory improved as we have 25% less than prior season's inventory than a year earlier. Prior season's inventories represented 10% of total inventory at the end of Q2, which compares to 14% at the end of Q1 this year, and likewise, 14% at the end of Q2 last year.

Regarding liquidity. At the end of Q2, Quiksilver had $67 million available under our various credit facilities and within compliance with all applicable covenants on our debt and credit agreements. On May 24, we executed an expanded -- and extended 5-year credit facility, covering our U.S., Canada, Japan and Australia operations.

Lastly, based upon our recently announced profit improvement plan, we'd like to provide an update on our outlook for the current fiscal year.

We last provided guidance on December 13, and this guidance updates and supersedes those comments. We expect that our pro forma adjusted EBITDA in the second half of fiscal 2013 will exceed the $91 million generated in the second half of fiscal 2012 assuming currency rates remain stable. Consistent with our prior guidance, we expect capital expenditures to decrease by at least 10% from the $66 million recorded in fiscal 2012.

With that, I'll turn the call back to Andy.

Andrew P. Mooney

Thank you, Rich. As each week goes by, I'm increasingly confident that the profit improvement plan developed by the management team is achievable. That confidence has been bolstered due to the caliber of executive talent now in place to execute the plan. The management team is currently laser-focused on delivering the cost improvements outlined in our plan, in addition to making meaningful improvements in the quality of our product offering from fall '14 onwards. We've made substantial progress in system implementation, with SAP up and running in the 2 largest regions, knowing that in the short-term there would be bumps in the road as we implement.

In summary, we remain focused in every way, focused on our 3 flagship brands, focused on delivering on the cost agreements outlined in the plan, focused on improving our product offerings in must-win product categories and focused on the reallocation of marketing dollars to drive demand.

Robert Jaffe

Operator, that concludes our prepared comments. We're now ready for the Q&A session to start.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go right to our first question from Taposh Bari with Goldman Sachs.

Taposh Bari - Goldman Sachs Group Inc., Research Division

Andy, as you think about the strategic plan and what's happened over the last couple of quarters, can you help us appreciate, I guess, first, the metrics that you're most focused on here over the next couple of quarters? You're reducing SG&A nicely but sales and gross margins have fallen short the last 2 quarters. So looking out, you've completed your reorg, you have most of your leadership team in place, you have the strategic plan in place, I guess the question is, when do you expect to see some traction along that plan?

Andrew P. Mooney

Well, we are already gaining traction on the cost improvement aspect of the plan. And to directly answer your question on the metrics, really, the 2 key drivers for our rightsizing our organization to a level that we outlined on the plan and SKU rationalization, both of which, we have very firm targets for over the balance of this fiscal and calendar year. At this point, the management team is really focused on near-term, controlling the controllables, which is on the cost side of the equation. Midterm, we're also equally focused on improving the quality of our product offering and driving that with the reallocated marketing mix. But the impacts of that will not be seen until fall '14 and beyond.

Taposh Bari - Goldman Sachs Group Inc., Research Division

Okay. So I guess that's a good segue to my second question, maybe for Rich. The guidance you provided, EBITDA, adjusted EBITDA growth in the back half of the year, does that relate to 3Q and 4Q or only for the second half in total? And I guess, just a follow-up to that. It's been 10 quarters in a row now where your adjusted EBITDA has been down, just trying to get some more clarity behind your level of confidence in that guidance.

Richard J. Shields

Well, we are confident in the guidance for the second half, and the guidance we provided was for the second half of 2013 relative to the second half of 2012. We have had decreasing 12-month trailing EBITDA, and we want to make sure that the investor community understood that as we look at the second half of this year that we'll be turning the corner.

Taposh Bari - Goldman Sachs Group Inc., Research Division

Okay. Last one for you, for Andy. As we think about this longer-term plan, 13%-plus adjusted EBITDA, it comes out to roughly 9%, 10% EBIT margins. So as you think about the 3 geographies, help us understand how the structural profitability of those looks down the road versus where they have historically? I mean I'm trying to understand if you're implying or expecting some kind of European recovery or just how those -- how the margins of most or those geographies need to look, if you can help us there?

Andrew P. Mooney

There is really not -- and Rich, perhaps you can help me on this one just to verify the accuracy of my statements. There's really not a substantial difference in the relative margins between the geographies. We can really focus on the reduction of SG&A in every region by moving from basically 3 regional organizations that repeat the same work 3x to 1 global organization that does work once and does it well. The model, I think, as we kind of communicated here and is available in detail on the website, is a model that has a very conservative top line growth scenario. So there's always some potential upside on the top line, but not really from about -- until about fall '14 onwards until the impact of the management team is in place. But it's driven almost solely by SG&A reductions, cost improvements, which we believe are imminently achievable.

Operator

And our next question comes from Dave King with Roth Capital.

David M. King - Roth Capital Partners, LLC, Research Division

I guess first off, kind of following up on Taposh's question there. In terms of the EBITDA improvement in the back half, maybe you could provide just some further context in terms of where you think that's going to be coming from, whether it's some -- the decline's kind of abating on the gross margin front or whether or not it's going to be mostly coming out of SG&A side? And then whether or not you would think that improvement will start to kick in, in the third quarter versus the fourth quarter. Any color there would be helpful.

Andrew P. Mooney

Well, on the SG&A side, I think as was evidenced in the Q2 numbers, we are starting to see the results of the work that's being done on that side even before I joined the company starting to kick in. So we would expect to see ongoing and possibly even accelerated SG&A improvements in both Q3 and Q4. On the margin side, the comps get easier in Q4 of last year because we, in that quarter, really attempted to rightsize our inventory of past seasons inventory and that had an impact on our margins in Q4, so the comps are significantly easier there. But I think the short answer to your question is it's largely going to be driven on the SG&A side.

David M. King - Roth Capital Partners, LLC, Research Division

Okay, that helps, thank you. And then to what extent -- looking at the top line, to what extent did some of your clothes brands businesses, et cetera, and then what have you already done in terms of SKU rationalization, did that weigh on revenue trends at all this quarter? And then more importantly, how should we think about that as we move forward, both this year and then further out?

Andrew P. Mooney

Well, on the revenue side, VSTR and Summer Teeth were fairly immaterial on the revenue side. Quiksilver Women's slightly more material, but the real impact was more the write-down of the inventories that we had. We just wanted to move that inventory out the system and basically had to accept significant markdowns to kind of get it out of the system. And going forward, we don't see any material impact on overall -- there would only be material impact on the top line as a result of divestitures, and of course, divestitures would come with some form of monetization, of which would help our overall cash position and also help our interest position.

David M. King - Roth Capital Partners, LLC, Research Division

Right. And then on the SKU rationalization side, nothing?

Andrew P. Mooney

Yes. There is benefit there, of course. And most of all, really, the refocusing of the management team on our 3 most significant brands, which is where we see the real opportunity residing.

Operator

And our next question comes from Mitch Kummetz with Robert Baird.

Mitchel J. Kummetz - Robert W. Baird & Co. Incorporated, Research Division

I don't want to beat this guidance to death, but I just want to get a better sense. You talked about accelerating SG&A opportunity over the balance of the year and you talked about gross margin, the comps get easier there. But maybe you could just say, I mean, for the back half, do you expect sales to be up or down? Do you expect gross margin to be up or down? It will be helpful if you could just directionally give us the answer to those questions.

Andrew P. Mooney

I don't think we're going to get into that level of detail within the guidance. I think the guidance is what pretty much as we've communicated in the release.

Mitchel J. Kummetz - Robert W. Baird & Co. Incorporated, Research Division

Okay. Let me ask you about the long-term plan then. I know you're calling for a rather modest sales growth. I think you're saying 2.5% per annum. But at the same time, you've eliminated some peripheral brands, you've closed some stores, you're going to rationalize SKUs. Is there any way to kind of contextualize that 2.5% growth on kind of an adjusted base? I mean, I assume that's coming off of what you guys reported last year, but is there anyway to think about last year's number if you eliminate some of those businesses as to what that growth rate is on an apples-to-apples basis? Does it end up becoming sort of mid-single digit apples-to-apples or even something a little stronger than that? Do you understand what I'm asking?

Andrew P. Mooney

Yes, I do understand what you're asking, and perhaps Rich and I can answer the question between us. From my perspective, the 2.5% revenue growth is conservative. This is very much a product-led business. And my most recent micro example of that is when you have a particularly successful product launch as we did with the Diane von Furstenberg line with Roxy, you will see retail sales growing by 1,000% and during the period that, that occurs. We felt it was prudent to be conservative in the revenue modeling to really keep the management team focused on what is the most important task, which is the SG&A reductions, and really working on the infrastructure realignment and getting a business to the point where if we -- if there's any upside in a 50% margin business, you have a very good scenario. But we wanted to absolutely be able to bank on $150 million in EBITDA improvements by keeping focused on the SG&A and the cost improvement items.

Mitchel J. Kummetz - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then maybe last question. Just in terms of the SG&A, you've seen nice year-over-year improvement there just from a dollar standpoint. To achieve this $150 million of adjusted EBITDA improvement in the plan, where does that number have to go from a dollar standpoint? And can you maybe just sort of elaborate on some of the key buckets that will allow you to get to a lower dollar level in SG&A?

Andrew P. Mooney

Yes. I think as was communicated in the plan, about half of the cost improvements will come from supply chain optimizations. That's a combination of a number of things. But the key items would be a rationalization of the SKUs and the other 30%-plus rationalization of the vendor base from the current levels of around 630 to slightly over 200. We -- it's an extraordinary statistic, but we purchased 100 million units of products annually, but our average order placed at the factory level is only 1,400. So we paid significant premiums for small order quantities when we don't really need to. So the the combination of SKU rationalization is that vendor consolidation is simply placing larger quantities of orders with the vendors we have with what gave us gross margin opportunities, as well as significant SG&A reductions.

Richard J. Shields

And Andy, this is Rich, let me weigh in on that one also. Mitch, when we think SG&A, we're benchmarking that back against the fiscal 2012 SG&A,, which was 44.9%. And we've shared that you'll see a net benefit of at least 300 basis points. And when I say net benefit, that's because we've also communicated,

we'll be increasing marketing as a percent of sales by 250 bps. So what that means is that you'd be taking SG&A down into the high 30s, high 30% as a percent of sale, and then reinvesting some of that savings back into demand generation to drive some more top line growth. And I think that we agree with you that we've intentionally been conservative on the sales growth number at 2.5%. And likewise, that's also a net number, meaning that it does incorporate some loss of revenue, but not a significant amount of revenue from the discontinued brands. And we have looked at some product categories that were certain that the right answer would be to license those. So we've assume that some of that revenue goes away, and so the gross number of sales growth is obviously higher than the 2.5% that we're including as a net number. And indeed, we do feel optimistic about our continuing opportunities to invest in e-comm. We're excited about China. We continue to be excited about emerging markets, and then all the brands have got growth opportunities, but I think that we're even more optimistic than we have in the -- than in the past about the Roxy brand.

Operator

And we'll go next to Jeff Van Sinderen with B. Riley.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Maybe if we can just touch on inventory for a minute. Sounds like you've improved inventory aging. Maybe you can talk a little more about the level and quality of inventory you have now and where you think -- I guess, do you think that there is an inventory overhang still in the channel either here in the U.S. or overseas? Just trying to get a sense of where you think we are in the process of getting inventory properly aligned.

Andrew P. Mooney

Rich, would you like to kick that one off?

Richard J. Shields

Sure. Jeff, nice to hear your voice. Yes, so we ended with 135 days of inventory on hand that relates back to last year Q2 at 129. So we're up -- we're plus 6 days on inventory. Importantly, the quality of our inventory, quality meaning, the percent of our inventory that represents prior season's good, has come down. So we're down to 10% globally, and that compares against 14% sequentially off Q1 and also 14% year-over-year off Q2 2012. We mentioned in the call at the end of Q1 that we had postponed some Roxy clearance from Q1 into Q2, and we saw Roxy clearance just up modestly, but -- and we really had a strong focus on clearing DC. So if I look at the Americas, for instance, DC clearance was up 48% to $3.4 million. So we really had a strong focus on clearing DCs, primarily in the U.S. So I think that we feel better about the quality of inventory at 135 days. I think that we still got lots of opportunity to improve the working capital that's deployed in the business by bringing inventories down. I think importantly, if I look at the end of Q2, our European inventory, even though we did have some order cancellations, our European inventory is actually down $3 million from last year in prior season. So I think we've made some progress on bringing the quality of our inventory up, but we still got both short-term and long-term opportunities to bringing the aggregate amount of inventory that we have invested in the business down and free up that cash.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Okay. Good. And then maybe if we can shift over to DC for a minute. Your gross margin there obviously was pretty soft. Can you talk more about what you're experiencing with the DC business, how that's been trending lately, if there's any sign of stabilization? And then I guess, what actions are you taking to repair the business in terms of -- from a product standpoint?

Andrew P. Mooney

Yes, so the -- there's a number of things that contributed to the current softness on the revenue side of DC. One is that, 12 months ago, really we were capitalizing on a trend in the women's side of the business and to the men's and a lesser degree on high top silhouettes. The channels -- we both loaded the channels pretty heavily, and the channels could have inflicted some pain on themselves pretty heavily by buying aggressively into the fashion trend. That fashion trend has gone in a completely different direction. So a lot of the softness we're getting is kind of directly contributable to that. And essentially, that needs to kind of walk its way out of the system, and that's why we focused on a lot of the clearance elements. The other growth that was generated 12 months ago was really driven by moving fairly aggressively into the mid-tier channel. With hindsight, that could have been done a little bit more thoughtfully in terms of segmentation strategy. So we're committed to having a multichannel strategy. But going forward, we definitely need to be more considerate in the segmentation of the product line so that each of the channels can meaningfully coexist and continue to have good sell-throughs. In the short run, we're getting very strong success in our core channels. And in fact, as recently as this week, we released the Nyjah Houston signature model, and I think probably for the first time in DC's history, we had lines outside the stores that were carrying that model to anticipate delivery. So we remain very strong in the core. We have work to do in mid-tier, and we're doing some cleanup in the women's and men's fashion side of the business.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Okay. Good. And then as far as the EU business overall, are there any signs of stabilization that you're seeing there either in terms of booking trends or sell-throughs? Anything anecdotal to report on?

Andrew P. Mooney

Yes, our European business throughout the recession has actually held up remarkably well, with the exception of this quarter. And I think as we alluded to in the call, this quarter was somewhat of an aberrational scenario because of SAP implementation. And we're seeing -- again, as was alluded to in the call, we're seeing some very positive signs that we'll be able to recoup some of that business very quickly in Q3. So the brand is in great shape in Europe. The industry seems to be stable, although I would say that there's still some transitioning of business from small independent surf and skate operators into both big-box where we're well positioned in Europe, but also into e-comm where we're also well conditioned, both our own and other retailers. So the channel is going through somewhat of a metamorphosis, but we believe we're in particularly good shape in Europe from a brand share and a brand equity position. And if there's any sign of economic growth recovery to occur, we think we'll be well positioned to take advantage of that.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Okay. And then...

Richard J. Shields

Andy, this is Rich. Let me add 2 points there. First is that when we look at our preliminary May results, the European business is up year-over-year. That's 1 month. It can change a little bit during the entire quarter, but it's certainly a good sign in that the -- indication that the European business is moving beyond the SAP issue. And then lastly, on the SAP issue, maybe a little bit more color on a couple of items there. I mentioned in my comments that we had $16 million in the wholesale channel that were canceled orders. In addition, I mentioned that we had to give some discounts to customers that stood by their order book, and that was about $3 million. And then lastly, I also mentioned that in the retail and e-comm business, those were more modestly impacted by the cross-dock issues of about $2 million. So when I think about the total impact on SAP in the second quarter, you've got $21 million. So -- and as I mentioned, I think that we are now invoicing and shipping all customers in Europe. So a tough quarter in terms of SAP implementation, but happy to have that behind us and up and running fully on SAP now.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Good to hear. One last question. Just curious on your own retail stores, if there's any color you can share on differences in weather, warmer markets, colder markets, if the progression -- monthly progression has recently improved with weather breaking. And then also, any sort of promotional cadence color you can give there?

Andrew P. Mooney

Well, the business within our brick-and-mortar retail stores is generally, again, holding up pretty well. We've gone through an extended run here of modest increases, modest decreases on a kind of region-by-region, quarter-by-quarter basis alongside that. We've seen consistent continued robust growth in our e-comm business. Increasingly, we're working on having a much more integrated multichannel approach. And we believe that we'll be able to make significant improvements on that, a, with bringing on board a world class global head of retail, but also being able to kind of draw on Nicholas Drake's experience in terms of demand creation in the e-comm space, the digital space. So again, we're pretty optimistic about the future. But in the medium term, the business is kind of holding steady as -- holding steady in brick-and-mortar and growing nicely on the e-comm side.

Operator

And next, we have a question from Jim Duffy with Stifel, Nicolaus.

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Andy, so following the end of some of the noncore brands, do you still have any quality of revenue issues to call out? Is there any channels or categories to call out where you could be walking away from business that could impede the top line near term, or do you feel most of that's behind you?

Andrew P. Mooney

Well, in terms of any of the -- any elements of our core brands, we -- all of that is behind us and in fact, it's more likely that we'll be channel expanding. Roxy, for example, is a very healthy brand at the moment and experiencing some early success in the launch of its outdoor fitness line, which is really a move into the sporting goods channel. We were all at our sales meeting in France -- European sales meeting in France last week, our North America was happening here. That line has yet to even be introduced into the international markets, and it was very well received by the sales force and the retailers who have seen early pre-lines of it. So I think from here, on our flagship brands, if anything, we'll be looking to find intelligent ways to expand the channels rather than contract.

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Good to hear. And then any update on your investigation into licensing opportunities to speak to?

Andrew P. Mooney

Yes, we have had nothing to report. We've had -- I mean, first of all, we have a world-class executive to actually lead the process, and Pam Leford [ph] who -- she and I worked together at Disney. She led Disney's global textile and home effort, so a very substantial business. We've had multiple presentations from various significant licensing partners who are interested on any number of subsets of our business. Nothing to report at this point. We do have to bear in mind that, or just to emphasize, that when we move to a licensing model, we'll be trading our wholesale revenues for licensing revenues. So there will be a net decrease in the top line. But we would only, of course, do this if we envision a significant net increase at the EBITDA line, which is what -- how we modeled the transition from licensing. Some licensing categories will be almost entirely incremental and then others will be trading our existing wholesale revenue for licensing revenues and improved EBITDA.

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Understood. And then coming off of those sales meetings in the U.S. and Europe, can you speak about your order book looking into fall and holiday? What are some of the stronger areas in the portfolio? What are some of the areas where the orders are maybe a little bit more disappointing?

Andrew P. Mooney

Well, the sales meeting that I'm referencing is actually for spring '14. So the order book is booked, and I guess our viewpoint on the revenue impact is reflected in the guidance that we gave earlier on the call. But we're feeling bullish about spring even though the management team is not really able to get their hands fully on the steering wheel for fall of '14. At least if you gauge the sales force appreciation of the product presentations you've seen over the last couple of weeks, we're feeling mildly bullish, let's say, even in spring.

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then has the European order book seen any pressure from the missteps in 2Q related to the SAP deployment? Or are retailers ready to forgive you for that and move beyond and continue to build the business?

Andrew P. Mooney

They're definitely fully committed to us. We're such a significant player in action sports in Europe that they really need us as a partner and want us as a partner. They, of course, made us pay for the hiccup. So everything is in negotiation, so we had to give up a few margin points to have them take product outside the window. But we don't -- we're not concerned in the least that those customers are going to walk away from us as a result of this.

Operator

Next, we have a question from Jennifer Black with Jennifer Black & Associates.

Jennifer Black

Most of my questions have been answered. I wanted to know, the DVF collection was really awesome, as you mentioned, and I was curious to know if you're working on multiple collaborations and will you do that with all 3 brands?

Andrew P. Mooney

The answer is yes and yes. I think increasingly for aspirational brands, collaborations done the right way are fundamentally good for the brands. So we have one collaboration already secured on the Quiksilver side that we'll be rolling out for fall of next year. We've had a lot of interest, as you might expect, based on the success of the DVF collection on the Roxy side. So we're actually lucky to be looking at various options there. DC, we don't have -- we are looking, but we don't have anything lined up at this point. But very much, I think it needs to be something that we need to be doing going forward.

Operator

[Operator Instructions] We'll go next to Eric Tracy with Janney Capital Markets.

Eric B. Tracy - Janney Montgomery Scott LLC, Research Division

I guess directed for you, Andy, really want to focus on the top line, and I know you all feel really confident about the 2.5% as being conservative. But maybe just stepping back and thinking about the areas of opportunities for growth and accelerating growth. You mentioned channel expansion and doing it thoughtfully, Roxy as an example. But perhaps if you could provide a little bit more color just exactly what the strategy is. You also mentioned improving just the actual quality of the product, but I'm trying to assess where the pockets of growth reacceleration, be it in the U.S., in Europe. Is it primarily channel expansion? And if so, how do you reconcile that to sort of maintaining the brand equity, which is clearly the foundation is in the core?

Andrew P. Mooney

Yes, so let's take Roxy and Quik and the core business right now. The core continues to be -- the core channel continues to be a highly fragmented channel. So even if the core channel remains flat in terms of its total scale globally, which we don't believe will be the case because we believe that there will be growth in that segment in emerging markets, BRIC particularly, for example, but if we, for the sake of an academic exercise, we say the core is going to remain flat, our view is that consolidation within the core from a brand perspective is inevitable. And that the players who will succeed will be those ones that are well managed and well capitalized and we certainly intent to be one of those players. And so we're focused on core growth for Quik and Roxy within the channel. For Roxy, the significant channel expansion opportunity into sporting goods, with fitness, potentially running, potentially volleyball, any number of activities that are relevant to young women. We're not talking here about going into the mid-tier or necessarily nothing that in any way would be potentially damaging to the brand. If anything, it would, going into the sporting goods channel, would be kind of sympathical to exactly what we're doing in the core surf and snowboard channel. And then for DC, it's not really a channel issue. Even though we're a very significant brand within action sports, there's room for DC to grow in the mid-tier and beyond. We're almost nonexistent in specialty athletic channels worldwide right now. So again, I think by thoughtful line development and segmentation, we think -- we don't have really any channel limitations for DC, and we don't feel that we need to go anywhere that will be potentially damaging to the brand. And again, for DC, athletic footwear generally continues to be a lot of opportunities for athletic footwear brands, particularly in the BRIC markets.

Eric B. Tracy - Janney Montgomery Scott LLC, Research Division

Okay. So just to kind of recap. So DC, obviously growth in the core globally and a little bit of channel expansion; Roxy, channel expansion sort of thoughtfully in sporting goods. And then Quik is more of a consolidation play within the core, or is there any channel expansion sort of expected there?

Andrew P. Mooney

Yes, we have not modeled channel expansion for Quiksilver. We don't feel it's necessary. We feel that the existing channel is substantial enough. I would say it's not growing in the developed markets, but it continues to grow in the BRIC markets. That between BRIC growth and share growth within the developed markets, the 2.5% growth for Quik is readily attainable.

Eric B. Tracy - Janney Montgomery Scott LLC, Research Division

And I guess just to follow on that into the consolidation in the core space, I mean, historically, we've seen that the consumer and the retailers that sell these are constantly in search of the next sort of emerging brand. Are you seeing a sort of inflection in that, a shift that's suggestive of a willingness to sort of come back and be it -- I'm trying to reconcile what the consumer sort of wants in the core relative to maybe the retailers saying, "Hey, we want to work with stable brands with decent capital?"

Andrew P. Mooney

Retailers are business men. They're going to give -- they're open to buy to the people with a lower consistent return. The established brands, brands like ourselves, the Nikes, the VFs, potentially the PPRs of the world, they're going to invest in that channel. They're going to drive demand through that channel. They are the brands that are going to be securing the athlete endorsements. They're basically -- they're the brand that's going to be putting all of their money behind it. So there's always room for fresh brands to come into the space, but my belief is and this is -- it's not like this is a new thought or it hasn't happened in other industries it's the notion that there will be a whole host of new brands come into and grow significantly in this segment I think is how it used to be. It's not how it will be in the future.

Eric B. Tracy - Janney Montgomery Scott LLC, Research Division

Okay. Appreciate that. And then -- and I guess a follow-on to that just in terms of the demand creation, and it sounds like a pretty significant sort of shift in allocation of dollars away from typical athlete sponsorship to more traditional stand-in store and social media, how do we think about that too in terms of, again, historic versus on a go-forward basis? Historically, the young kid surfer sees an athlete or at least was perceived to, that was a driving sort of force behind. Are we saying that, that is -- the dollars, the return just was not there? And then how do we think about the traditional spend in some of these core channels? Is it fixturing? Is it -- are we still doing event-type sponsorship? Just give a little bit more color on the demand creation side would be helpful.

Andrew P. Mooney

Sure. So let's begin with athletes. Athletes are going to continue to be vitally important to building our brands. But even after the first round of pruning that we did, we still have 500 left. One might argue legitimately that we still have way too many. And so we're going to continue to kind of focus down on the number of athletes that we have because there's no question that kids are moved by athlete endorsement, but they're probably moved by about 10 athletes in the world, not by 500. In terms of events, the importance of events, in my view from the 20 years I spent in Nike, is a function of reach and frequency. If you can only get 2,000 kids on the beach to see the event, that's how many consumers you impact. Surf is a particularly difficult event to televise, so it's not like the 20 million surfers who are around the world will actually be watching any of these events in any large numbers. So we will still -- we will be very judicious about our event involvement. We're not giving up on it completely. But again, way less events than we have right now. And again, I think if you look to what's happening in the industry right now is that the big players, which again is maybe another way of answering your last question, that the big players are blocking out the real estate and the store. And the big players increasingly are bringing freshness on the product front to satisfy that consumer need, that they no longer have to look to the smaller brands and the smaller brands are finding it tougher to cross the threshold of those stores to even get their foot in the door. So permanent and seasonal point of sale display is an ongoing trend in the industry that we want to be part of. Social media, increasingly, is the way that kids both talk to each other about brands and are talked to back. A dialogue goes on between the brands. We want to invest very much in social media, very much in point-of-sale presentation. And we're going to be increasing our investment in print. There I'd say it would be primarily on the Roxy side because we believe, for young women in particular, print magazines, out-of-home, to a lesser degree is still a really meaningful investment, less so for young men, but certainly for young women it's a viable investment, and we have not been doing enough of it. And we believe if we do more, we'll see even stronger growth in Roxy than we've seen to date.

Eric B. Tracy - Janney Montgomery Scott LLC, Research Division

Okay. That's really helpful. And then I guess if I could just last, Rich, for you, in terms of the cadence of -- or Andy as well, just the cost cuts and how we should be thinking about the SG&A story playing out? If there's any way to give some color, too. Is it -- we're obviously seeing already come through. Is it relatively consistent over the course of 3 years or more front-end loaded, more back-end loaded? So I guess SG&A first and then supply chain optimization, I would assume that's going to take a little bit more time, so gross margin benefits a little bit longer out. But any sort of color in the cadence of the plan would be helpful.

Richard J. Shields

Well, yes, sure, thanks. I think that the different initiatives that we've laid out, we're at a different place in implementing those and they have a different timing in terms of their success and how they'll play into the P&L. The supply chain optimization clearly has the largest opportunity for us, and we look at that opportunity at being about half of the $150 million that we've outlined in total EBITDA opportunity. And that would basically improve our cost structure and allow us to return our gross margins back to the 52.5% that we were at in 2010 and 2011. We've obviously taken significant steps in that direction. The first significant step was bringing in Kasey Mazzone, who run the supply chain at Gap and Levi's. We brought in a world-class executive to run that. And then going through the SKU rationalization, vendor consolidation, demand aggregation, putting more thorough systems and processes in place around our supply chain are going to be important. If we move to the SG&A side, you've seen us consistently report severance and $3.7 million of severance in the quarter that we just closed, and that's clearly indicative of our desire and our willingness to execute against the staff rightsizing that we've outlined as important. I think you've also -- you also heard Andy mentioned some of the team that we brought in, in both the U.S. retail organization and some people that we brought in, in the wholesale organization, and then we're still looking for someone to run global retail. But in that process, we believe that there's opportunities for us to look at a more intelligent configuration of some of the SG&A expenses that we've got in those areas. So you'll see us continue to reduce athlete and events. You'll see us continue to book severance to rightsize staff to take out some of the nonproductive retail stores. We're working on the supply chain, and those are going to provide a real opportunity downstream. Obviously, the headcount cuts that we're doing today play out both in the back half of this year and then annualize into next year.

Operator

And this concludes our question-and-answer session today. I'd now like to turn the conference over to Mr. Jaffe for any further or closing remarks.

Robert Jaffe

That concludes our call today. On behalf of everyone at Quiksilver, thank you for participating, and we look forward to providing our fiscal 2013 third quarter results in September. Thanks, everybody.

Operator

This does conclude our conference for today. We thank you, again, for your participation.

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