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Quiksilver Inc. (NYSE:ZQK)

F3Q09 Earnings Call

September 3, 2009; 4:30 pm ET

Executives

Bob McKnight - Chairman, President & Chief Executive Officer

Joe Scirocco - Chief Financial Officer

Steve Tully - President

Bruce Thomas - Vice President of Investor Relations

Analysts

Sean Naughton - Piper Jaffray

Mitch Kummetz - Robert Baird

Anna Andreeva - JP Morgan

Jeff Van Sinderen - B. Riley

Grant Jordan - Wells Fargo

Carla Casella - JP Morgan

David Glick- Buckingham Research Group

Operator

Good afternoon ladies and gentlemen, thank you for standing by. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. (Operator Instructions)

I’d now like to introduce Bruce Thomas, Quiksilver’s Vice President of Investor Relations, who will chair this afternoon’s call.

Bruce Thomas

Thanks operator. Good afternoon everyone and welcome to the Quiksilver third quarter fiscal 2009 earnings conference call. Our speakers today are Bob McKnight, our Chairman and President and Chief Executive Officer; and Joe Scirocco, our Chief Financial Officer.

Before we begin I would like to briefly review the company’s Safe Harbor language. Throughout our call today items maybe 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 these 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.

All forward-looking statements made on this call speak only as of today’s date and the company undertakes no duty to update any forward-looking statements. In addition, this presentation may contain references to non-GAAP financial information. A reconciliation of non-GAAP financial information to the most directly comparable GAAP financial information is included in our press release, which can be found in electronic form on our website at www.quiksilverinc.com.

With that out of the way, I’d like to turn the call over to Bob McKnight.

Bob McKnight

Thanks Bruce. Good afternoon everyone and thanks for joining us on our third quarter conference call. The fiscal third quarter was a very important period for our company as we delivered on the financial expectations we set a quarter ago and secured our global refinancing plan. Our new term loan and Americas asset-based line of credit were funded in late July, eliminating any near term liquidity issues.

In early August we announced that we had entered into an agreement with our European banking partners on a new committed four year facility designed to consolidate our European debt obligations, including previously uncommitted lines of credit. We expect to close this transaction in September. With these things accomplished, we now have returned our full focus to streamlining the business and developing our brands Quiksilver, Roxy and DC.

Let’s now turn to the high level financial highlights from the third quarter. Consolidated net revenues declined 11% to $501 million, but declined only 5% in constant foreign currency. Consolidated gross profit declined by 370 basis points to 46.7% of sales, while expenses during the quarter decreased by $28 million compared to the same quarter a year ago.

This excludes an $8 million restructuring charge that Joe will discuss a bit later. Excluding this charge our continuing operations generated operating profit of roughly $31 million on a pro forma basis. As a result, our income from continue operations, excluding the charge and offsetting tax adjustment was $4 million or $0.03 per share compared to income of $33 million or $0.25 per share in the third quarter of 2008.

Even though our third quarter performance was inline with expectations, the overall environment remains very challenging. The young men’s business is meeting retailers reduced expectations and our business in that segment appears to be stabilizing. However there is a clear trend towards price pointed fast fashion and the juniors market is affected to a greater degree than other segments, apposing a particular challenge to our Roxy business.

Footwear sales, which until recently were trending better than apparel, have softened and obviously every retailer is attempting to buy very conservatively. As a result of these market dynamics we have reduced our revenue expectations for Q4. Also impacting our earnings will be a higher interest associated with our new financing and an unusual tax provision that Joe will discuss in a moment. Including its effects, we now expect to generate a loss per share in the mid single digit range in the fourth quarter.

Let me take a moment to comment on some of the things we’re doing within our brands to combat the difficult market conditions. Performances in our Quiksilver young men’s business have been more consistent than our Roxy juniors business and we have great sell-throughs in some of the new technical performance products, such as our Diamond Dobby Board Shorts and CoolMax Denim.

Diamond Dobby is a high performance material that is virtually weightless, rash proof, and dries twice as fast as a typical board short. It’s extremely comfortable to wear and the most technically innovative board short we have ever produced. Threadline is a core of skate collection anchored by our CoolMax signature denim line that stretches, breathes, and it whips away moisture, unlike any other denim fabric.

Our focus within Quiksilver is on refining our product segmentation and looking for better ways to leverage our global design and product development capabilities. For example, our snow offerings are now developed as a global range based in Europe and similarly, we’re developing a core surf range in Australia and a core skate range in the U.S., from which each region will draw.

To better adapt to anticipated trends in the juniors world, we have made changes on the product development side of Roxy. The Roxy Girl is still the same confident, high spirited, fun loving girl that the business was founded on, but there’s a segment that is now older, which has different tastes and preferences. We’ve seen that firsthand with the successful launch of the Quiksilver women’s line, which has been widely embraced globally by specialty retailers and performed very well.

We’re taking some of the things we’ve learned on the women’s side and applying them to Roxy to broaden the Roxy appeal to include a slightly older customer. We moved our entire juniors design group back into the leadership of Summer Rapp, who has recently been responsible for the Quiksilver women’s line.

We’re dramatically reducing the number of SKUs and focusing the line around key fashion items. We’re also broadening the target age to include a slightly older customer. While our Roxy Girl will always have sand in her pockets, we’re making more of a connection through art, music and fashion.

We’re also segmenting the product into key classifications and strategically managing distribution. These changes will be evident in spring/summer 2010 and we’re very excited about our collaboration with electronics giant JBL that currently features Roxy styled stereo headphones and will soon announce a fantastic new collaboration with a renowned fashion designer, which whom we’ve developed a limited signature collection with Roxy.

In addition to product improvements, we’ve implemented plan to improve profitability by $40 million to $60 million to various cost reduction and gross margin initiative. Thus far these initiatives have focused on the Quiksilver Roxy businesses primarily in the Americans region.

We have deferred any such action in the DC business, while we consider the potential sales of DC as part of our review of strategic alternatives, but as soon as our new financing was in place and the potential for DC sale was taken off the table, we immediately expanded to scope of our restructuring effort to include DC.

Make no mistake DC is a great brand for the bright future and tremendous growth potential, particularly in the European, Latin America and Asia Pacific markets. However, we took immediate action that would enable us to manage the business more respectively by leveraging our global infrastructure and adopting product development and delivery to local demand to each of our markets. This will provide the opportunity for some streamlining and other things, which is appropriate in light of recent market condition.

Inspired by our companywide cost reduction efforts, we are also taking a more measured and creative approach to marketing and advertising. Let me give you just a few examples. First, our creative team recently introduced a new viral video featuring our skate athletes, including Quiksilver team rider Tony Hawk.

In this virtual video, the skateboarders leap out of the tiny video window on the computer screen and shred the surrounding webpage, demonstrating their skateboard tricks to unsuspecting viewers. At last count, this virtual video commercial had been viewed hundreds of thousands of times, clearly reaching a large number of potential customers within our target demographic.

In addition, Tony Hawk continues to push boundaries and open the online door to our key audience, combined with its 1.5 million followers on Twitter and over 45,000 MySpace friends, Tony is a true ambassador for the brand and inspires us to latch onto this new wave of online marketing. In another very creative marketing campaign, Quiksilver partnered with a local skate shop to open up a pop up shop and skate ramp in the Nolita neighborhood of Manhattan last week.

This eight day retail installation made use of an otherwise vacant retail space to which we quickly added a skate ramp and sold exclusive, limited edition skate goods, t-shirts and Quiksilver signature denim. Between the prime location and the curiosity factor, traffic was strong, and we have clearly reached many kids and young adults who wouldn’t normally have been exposed to our skate program in such a memorable way. These new fans identify with a big company acting small in their community.

On the tradeshow side, we’ve come up with some really creative ways to participate in the major events without incurring the high costs of building a big booth and transporting it around the country. Beginning with Surf Expo in mid August, we created a mobile tradeshow by combining the Quiksilver Roxy buses with pop up tents. We simply parked the buses on the floor of the tradeshow and surrounded them with canopies and all the rest of the goodies, giving us plenty of space to show our product and meet with customers.

This strategy enables us to participate in these shows at a 75% cost savings. Traffic in our pop up booth was strong in Florida, and the feedback on the spring 2010 collections was very positive. We’re looking forward to being back at ASR in San Diego next week. I mentioned Tony Hawk’s exposure a moment ago, and I’d like to wrap up with a few remarks about Kelly Slater, the ultimate ambassador to the board sport lifestyle and whose exposure in the surf industry is legendary.

We were thrilled last quarter to report that Kelly resigned with Quiksilver, and we are very excited about some great projects that we are working with him on. Kelly continues to work towards broadening the exposure of surfing through project such as his upcoming 3-D IMAX movie that will hit screens all over the world in February.

Also his company is working on wave pool technology, and he’s got some great ideas that we’ll work on together to enhance the marketability of surfing and bring surfing competitions to a broader audience in new and innovative ways. Kelly is surfing’s main attraction, and he will play an important role in our marketing direction and in certain product development initiatives in the years ahead.

With that, I’d like to turn the call over to Joe Scirocco for additional details on the quarter and our outlook for Q4.

Joe Scirocco

Thanks Bob and good afternoon everybody. I’ll be addressing our continuing operations, which are results without Rossignol, which was sold during the first quarter of the year. As reported consolidated net revenues declined to $501 million in the third quarter from $565 million the third quarter last year; in constant currency, consolidated net revenues declined 5%. Note that we translated the euro at $1.56 last year versus $1.39 this year, and the Australian dollar at $0.95 last year versus $0.79 this year.

Revenues in the Americas were down 6% compared to last year with contraction in both the wholesale and retail distribution. We closed a net of eight stores since at end of the third quarter of 2008. We also saw a mix shift towards off price product when compared with the same quarter a year ago.

European revenues in constant currency were down 8%. We opened a net of seven new shops and concessions in the third quarter and a total of 32 net new shops and concessions over the last year. Our European region continues to be our highest performing business despite the economic backdrop, as it delivered 13% operating profit in the quarter.

Revenues in our Asia/Pacific region were up 12% in constant currency, which for us is the Australian dollar. While our underlying performance in the region is pretty consistent with that of last year, the 12% growth is largely due to the effect of the yen on the regional consolidation of our Japanese business. This quarter the yen improved 34% against the Australian dollar compared to the prior year.

Our consolidated gross margin decreased by 370 basis points to 46.7% for the quarter. This decline was primarily driven by pricing pressure in the Americas region, although each of our regions experienced some degree of gross margin compression, even after taking into account reduced cost of goods through our sourcing initiatives. This reflects the prevailing market conditions and we continue to prioritize inventory reduction and cash generation even at the expense of gross margin.

Third quarter pro forma SG&A expenses decreased 12% to $204 million from $232 million a year ago. This excludes pre-tax severance and facility related restructuring charges of approximately $8 million. As a percentage of sales third quarter pro forma SG&A declined by 50 basis points to 40.6% of sales down from 41.1% in the same quarter a year ago.

Pro forma operating income excluding the pre-tax restructuring charge was $30.8 million in the third quarter down from $52.7 million in the same quarter a year ago, primarily as a result of lower margins in each of our regional businesses and expense deleveraging. Interest expense was $15.3 million in the quarter up from $11.8 million a year ago. This reflects the reallocation of Rossignol’s debt and interest to Quiksilver’s accounts, last year they were classified in discontinued operations.

During the quarter we also recognized as a special item a $7 million tax credit related to the finalization of certain tax deductions more favorably than we originally anticipated. After interest and after applying our tax provision our pro forma consolidated income from continuing operations for the third quarter, excluding restructuring charge and the offsetting tax adjustment was $3.7 million or $0.03 per share compared to income of $33.1 million or $0.25 per share in the same quarter a year ago.

This result was essentially inline with our expectations. I’d now like to turn your attention to the balance sheet for a few moments. Accounts receivable at $424 million are 14% lower than for the same period last year and down 9% in constant currency. On an overall basis, DSOs decreased by two days to 71 days this year compared to 73 days in the third quarter a year ago.

Inventory at quarter end was $334 million down 7% as we reported and down 1% in constant currency compared to the same period last year. We have made adjustments to our buys and are taking aggressive action to liquidate excess inventory in order to bring supply and demand into balance as efficiently as the environment permits. In a transaction that we first described to you in June, our private equity partner, Rhone, funded the $150 million senior secured term loan at the end of July.

This transaction granted to Rhone 25.6 million warrants that would equate to just less than 20% of Quiksilver’s existing outstanding shares if exchanged. These warrants are valued at $23.6 million based on the share price as of July 31, which as well below the $68 million value we originally estimated in early June. This new warrant value will be amortized as part of interest expense.

So, whereas we previously estimated our annual interest expense for 2010 to be $110 million, we now believe that interest expense beginning in 2010 will be closer to $100 million annually. Approximately $30 million of this is expected to be non-cash in nature. Now let’s turn our attention to the outlook for Q4. Based on current trends, we are modeling revenues down in the mid teens on a percentage basis for Q4, driven by an expected decrease in the Americas region.

This is partially attributed to a difficult comparison versus last year when the American region grew by 10%. We expect the price discounting will drive further gross margin contraction of approximately 150 basis points compared to last year. We continue to cut costs therefore SG&A is expected to be lower than it was last year, excluding any further restructuring charges.

However, we expect it to be nearly 400 basis points higher as a percentage of sales due to the lower revenue expectations and a slight shift in mix to our own retail stores. We have two items below the operating line that are expected to turn positive operating results into a loss in Q4. First, interest expense is expected to be around $21 million, reflecting higher rates applicable to the new term loans and ABL financing.

Second, our tax provision is expected to be approximately $11 million in Q4. This reflects taxes provided on expected foreign income without the benefit for any losses generated by the U.S. operation, which includes corporate overhead and bond interest. Given these assumptions, we expect to generate a loss per share in the mid single digit range in the fourth quarter. Again, please note that this outlook does not include any special charges.

With that, I’ll turn the call back over to Bob for closing remarks.

Bob McKnight

To summarize, as you have heard, we made great progress this quarter on the financing front and have essentially rebuilt the capital structure of the company. With the proper funding now in hand, we are evaluating every aspect of our business to streamline operations, improve productivity, and increase profitability.

We know we still have a lot of work ahead of us, we also know we have three of the best, most authentic brands in the action sports sector, and this sector continues to gain share around the world. So while Quiksilver has always been the leader in the action sports space, our newly refinanced capital structure provides us with an opportunity to improve the profitability of the business and drive shareholder value.

Operator that concludes our prepared comments, we’re now ready for the question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Sean Naughton - Piper Jaffray.

Sean Naughton - Piper Jaffray

In terms on the domestic front, your distribution is obviously relatively broad based. Have there been any differences that you have seen in the sell-throughs in different parts of the channel? So for example, the department store versus sporting goods? Or the independent channel in your own retail stores?

Steve Tully

I think to answer your question is just most challenging area in terms of retail performance has been in the mall based retailers. I think that’s where it’s been most difficult, in the department stores and those national chain that are based in the malls. I think we’ve had a little more success at the independent retailers around the country.

Sean Naughton - Piper Jaffray

Then following up on that, for your own retail stores, can you remind us where you are on the outlook for store openings and store closures as well as anything on the comps domestically versus your international comps?

Joe Scirocco

So in terms of store closures and we had previously said that we were looking at somewhere in the range of 25 stores. We believe that during the current fiscal year, we should have closed somewhere in the order of eight or nine, and I think we maybe nearly done with that at this point.

Going forward we continue to look at the profitability of our retail business, which is profitable around the world, but currently not so in the U.S. That’s obviously the result of comps, which have been significantly worse in the U.S. than they have been abroad. Our European business by contrast in the past quarter was comping down in sort of a high single digit range, which was offset by new store opening.

So whereas, we’re growing the retail platform in other parts of the world, in the U.S. we’re focused on rightsizing that. We have a number of stores that we continue to monitor and we’d look to take out those stores with negative cash flow if we are not able to foresee improvement and profitability as we finalize next year’s plan.

Sean Naughton - Piper Jaffray

Then lastly on the inventory, it looks like it’s down about 7% and you’re looking for sales down about mid teens obviously for the October quarter. Are there any specific pockets that you’re a little concerned about and then also lastly, what is your primary method of liquidation right now?

Joe Scirocco

We’re down about 1%, I guess in constant currency. Given our business volumes being down 5% in constant currency, we’d like to be a little lighter on inventory. I don’t think there are any overwhelming issues. There are pockets around the globe. The Japanese business has been suffering since probably January, February timeframe with a pretty abrupt decline in their business expectations and so as we adjust inventories there we have a little bit further to go.

Bob mentioned the recent trends in footwear, which have cause us to probably put more in the off price market than we have in the past, but we’re using our normal channels of liquidation for these goods. So they would typically go in the U.S. through TJ Maxx or Ross Stores or something like that.

Overseas, we have greater limitations because of restrictions on sale periods and a limited market for goods in the off price market and so what we would typically do there is utilize our own outlets and liquidation is a slower process, but our inventories are in some respects more easy to manage overseas, because our sale periods tend to precede the time at which we buy goods. So we think we’re in pretty good shape, we’d like to be a little leaner.

Operator

Your next question comes from Mitch Kummetz - Robert Baird.

Mitch Kummetz - Robert Baird

I’ve got a few questions. Let me start just where you left off, Joe on the shoe business and the softness there. If you talk a little bit more about that, is it a price point thing? Is it a lack of a trend or a lack of newness? Is it more U.S. than outside the U.S.? Could you just maybe elaborate a little bit on what’s been happening there?

Joe Scirocco

I mean, I’m probably not the best person to speak to product trends, but the indications that we’ve seen have really been that there’s been more of a shift towards canvas vulcanized shoes as compared to the touch sole leather uppers that the core skate brands have traditionally been dealing with.

So I think that’s one sort of general trend. I think that the major customers in the larger stores, the majors in footwear here in the U.S., are indicating that they’re wanting to balance their inventories a little better, and so there’s some shipping delay of product shipments that would normally go in Q4. So that’s driving it as well.

Outside the U.S. it’s very interesting that even in this dramatic downturn that the European economies are seeing, our DC business will still grow low double digits in fiscal 2009. So outside the U.S. it’s holding up very well and notwithstanding the prognosis for the broader economies, I think that our business has a lot of opportunity for growth there.

Mitch Kummetz - Robert Baird

Then secondly, Bob you made the comment coming out of Surf Expo that your spring lines were well received. Maybe you or Steve Tully could provide a little bit more color on that. I mean is there anything by category that really stood out or by gender and then maybe talk a little bit about also at Surf Expo, but what retailers were saying about current business and what appetite they might be having right now for writing actual orders on that spring product?

Bob McKnight

I mean, we’re pleased to get a good reaction from both our Quiksilver and Roxy lines from our spring ‘10 offering. The Quiksilver side, again it’s performance boardshorts, we’ve had really great success with our Diamond Dobby collection, we are expanding that going forward.

In many parts of the line we’re kind of leaning on the Quiksilver brand, the logo product has been very well received and continues to be very well received in the t-shirt area, lightweight fleece and so forth and our line is pretty broad based we are having a great sandal year this year and prospects for the sandal business going forward are pretty good as well and in the key categories, t-shirts, walkshorts, we’ve got a great offering and the line was received very well there.

We’re selling things like Lycra that a bit surprising there, but it seems that there is a trend for sun protection and we had a good year this year with Lycra and that continues to look good for next year and we’re looking at of course near the trend that’s going on now is the flannel plaid woven that looks like it’s going to continue in the spring, it’s doing very well right now.

We have a Lifeguard Hat that’s kind of run away for us back to that sun protection thing. On the Roxy side, dresses remain good the trend that’s emerging is this rompers trend in skirts and fashion sandals are good. We’ve got some great vulcanite slip-ons that are doing very well in the Roxy area.

Accessory business is actually pretty decent as well, and it looks like in the swimwear that this neon and animal trend will continue to emerge. So, to your question about how retailers are feeling, was it about spring or about back-to-school?

Mitch Kummetz – Robert Baird

Back-to-school

Steve Tully

One other comment on Roxy too is that we have launched a Roxy athletics offering and so we’re in our second season now, and although it’s small it’s retailing very well and we got a great reaction to the next line when we were down at Surf Expo.

In terms of back-to-school, I think it’s, generally the comments were it’s got a little bit of a late start and when we were at Surf Expo, it was a couple of weeks ago, so some people down 10% to 15%. I think the best-case scenario we talked were people who were flat trying to deal with the later shift in the Labor Day.

So, I think people remain conservative in their outlook. Many of them have already taken all the reductions in terms of expenses and so on in their store, so they’re living with business the way that it is now, but I think they continue to look forward towards spring with a conservative outlook.

Mitch Kummetz - Robert Baird

Joe, help me out on the SG&A in the quarter. What was it, axing out the restructuring, because it wasn’t the 2011/7 right?

Joe Scirocco

That’s correct. If we do this in constant currency, which I think is probably one way to look at it, we were sort of flattish in Europe and Asia/Pacific, maybe a bit lower than last year. In the Americas region, excluding the restructuring I think we are net of about $5 million below last year. So, functionally we’re at a pretty significant run rate in terms of expense levels versus last year. Again, our primary focus here has been in the Americas region and we continue with that process.

Operator

Your next question comes from Anna Andreeva - JP Morgan.

Anna Andreeva - JP Morgan

Bob, I was wondering if you could give us a sense what kind of revenue decline in the Americas regions you guys are embedding in your guidance for the fourth quarter.

Joe Scirocco

Andreeva maybe I can take that one for Bob. So, we commented on the call that we expect the Americas region in Q4 to be down somewhere in the range of like 20%, but we have to qualify that, because that comes on the back of a comparison to last year in which we were actually up 10%. So, we have some timing issues last year that inflated the fourth quarter somewhat.

I think if you look at the third and fourth quarter together for the Americas, in both the third quarter and the fourth quarter you’re looking at about a minus 10% decline. So if you take a two year trend, I think you’ll see that it’s a pretty consistent, and as Bob said, we think that business has more or less stabilized.

Anna Andreeva - JP Morgan

Just looking at your European business, ex-currency, improved during the third quarter. Could you maybe talk about that are you seeing any bottoming in Europe and any color by market. You guys have significant exposure to those straggly markets in Spain, Italy and France, what are you seeing there?

Joe Scirocco

We see some stabilization. I think the markets of Spain and the U.K., as you correctly point out, are particularly difficult. Bob.

Bob McKnight

I was going to say that, we’ve heard that they’re stabilize and actually getting a little bit better from where they were a quarter or two ago in Spain and the U.K. Still very difficult, though, but we see our business more or less stabilizing across the European region.

Joe Scirocco

What’s interesting there is that, most of the business in Europe is done on a pre-book basis, and so as the retailers are being very cautious, our pre-books really dictate the quarters and so our business volume can be off a bit. Importantly though, goods are really selling through very well.

There’s a limited amount of reorder business in Europe, but we saw an interesting pickup in certain countries in June and July. That gave us some confidence. We sell a pretty substantial portion of the season at full price before we go on sale. As I said, our own retail comps in Europe are sort of in the high single digit negative, which is quite a bit better than here in the U.S.

Anna Andreeva - JP Morgan

So sequentially, could we see continued improvement in the fourth quarter, especially you’ll be lapping a significantly easier comparison in that region? I mean just for Europe overall.

Joe Scirocco

Yes, I mean, I would expect that we’ll be positive in terms of revenue growth in Europe in Q4.

Anna Andreeva - JP Morgan

You mentioned your comps here in the U.S., I wasn’t sure if I missed that. What were comps in the U.S.? Previously you guys talked about the Hawaii, California, Arizona, Nevada, Florida markets being pretty challenging. Are you seeing any bottoming there?

Steve Tully

In terms of those market places, they are still very challenging for us. Not sure about the bottom, but as I look at our back-to-school selling and look at the most challenging areas, they’re those that you mentioned.

Joe Scirocco

So comps in the U.S. are on the order of 20% down for the quarter. We see better results in the off-price stores, which is no surprise, the customers shopping price point at this point.

Operator

Your next question comes from Jeff Van Sinderen - B. Riley.

Jeff Van Sinderen - B. Riley

Can you guys talk a little bit more about how you’re approaching expense cuts, what you’re targeting, what you think is feasible in terms of dollar reductions for next year?

Joe Scirocco

We can, sure. Much of it is connected to the restructuring efforts. In Bob’s prepared comments, he made a number of references to changes in product engineering, product development. Our principal objective in achieving this $40 million to $60 million profitability improvement is related to margin initiatives. We think that will give us about 50% of the total. SG&A will follow and a lot of the SG&A reduction will be driven actually by some of the margin initiatives.

So just as some examples, Bob mentioned tighter SKU management and the development of global ranges and as we go in that direction with for example skate being developed here in the U.S. as a global range, surf in Australia, just as examples, we expect that we can have a significant amount of streamlining in terms of the overhead structure associated with three regions that are currently doing that business now.

So there are other initiatives that have to do with fabric and vendor aggregation, and in addressing those points as well we believe, we will concentrate our sourcing much more through our own in-house agency, which is Quiksilver Asia Sourcing and so in doing so, we can eliminate some of the regional sourcing that we currently have in our business.

In addition to that, we’re doing a number of things to limit margin leakage, and that includes enhanced demand planning and putting a number of metrics and disciplines around all aspects of the supply chain. So as we do that, SG&A should be streamlined. Just as an example, when compared to the beginning of let’s say January of 2009.

I think we’ve probably reduced overall payrolls by somewhere in the range of $12 million and apart from just infrastructure streamlining, we’ve also taken a knife to expenses in a pretty big way. So out-of-pocket expenses as Bob mentioned, some efficiencies in the marketing tradeshows, facilities, and travel and all the usual suspects are on the table for reduction here.

Jeff Van Sinderen - B. Riley

Can you remind us, how many U.S. company-owned stores you guys have now and then how many leases you have coming up over the next year for renewal?

Bob McKnight

We’ve got about 125 stores in the U.S., and I can’t tell you the renewal status at this point. In terms of the latter, we can get that for you, but probably just give us a call back afterwards.

Jeff Van Sinderen - B. Riley

So, but the idea is that you’re going to address the ones that are underperforming or renegotiate and I take it you’re in the process on some of those that are coming up?

Joe Scirocco

We’re very much in process, yes. For those that are coming up soon, that’s easy. We’ve also looked at kick out clauses that we have, when we take that into account, as well as our ability to renegotiate. In a couple of cases there are stores in which other tenants happen to have a unique interest, and so where possible we look to strike those deals as well. This is a daily effort.

Operator

Your next question comes from Grant Jordan - Wells Fargo.

Grant Jordan - Wells Fargo

In terms of just your balance sheet, obviously you’ve got a lot of moving parts and some refinancings are expected to close post the end of Q3. Could you just walk us through kind of the pro forma pieces of the debt and how those stand in terms of maturities?

Joe Scirocco

Essentially, the European credit facility, the club deal that we talked about is committed. So it’s just a question of documentation and that type of thing that will bring it to closure in the month of September. So essentially, our debt structure is in place. We closed the quarter with $1.37 billion or so in debt and then in terms of the ladder, we’ve really relieved a lot of pressure in the near term.

From memory, we will have about EUR28 million or so worth of maturities that come through in the next fiscal year and that will be in Europe. Apart from that, we have scheduled maturities on the European ladder, but it basically starts at like EUR28 million and ratchets up from there a little bit each year.

The ABL that was recently concluded in the U.S. has a three year maturity. The French club deal will be amortizing, having a four-year maturity. So we really bought ourselves quite a bit of time and breathing room here. In addition, I would just point out that under the existing facilities, as we close the quarter we have about $145 million or so of availability as well as net cash on the balance sheet of $117 million that’s unrestricted. So we’ve really relieved the pressure in the past quarter.

Grant Jordan - Wells Fargo

I believe that some of the covenants of the European facility require that cash to stay there to service the European debt. If you could just give us a rough estimate on say an LTM EBITDA number, what’s the breakout between Europe and the U.S.?

Joe Scirocco

There’s a bit of ring fencing in each of the businesses. I don’t know that we’ve broken EBITDA out on a regional basis. What I would say is that, we’re carrying probably $15 million to $20 million of D&A here in the U.S. Our European D&A is probably on the same order. So you can work with our regional forecasts and history in which we disclose operating income and just add back you D&A, you’ll be have a good idea of where we stand.

Grant Jordan - Wells Fargo

Then my last question, in the quarter you obviously brought inventories down, but payables came down a pretty good. I mean, payables went up a pretty good amount as well. Is that a trend that we should expect to see continue, or was there any specific thing driving that?

Joe Scirocco

I think like everybody else, we try to manage cash flows as well as we possibly can. We did a pretty good job of it this year, at least until the financing was completed at the end of July. Since that time, we’ve obviously used that cash to go back to vendors and take care of them as and when we could and so that payables number will comedown in Q4, but like everybody else, we’re trying to collect faster and conserve cash as much as possible.

Operator

(Operator Instructions).Your next question comes from Carla Casella - JP Morgan.

Carla Casella - JP Morgan

On the inventory front, you mentioned you’re working on getting inventory inline with sales. Do you have a sense for how long that may take? When do you expect to have it in targeted levels?

Joe Scirocco

I’d like to say by year end, but as a practical matter, at year end our current forecast show us with about five to seven days more inventory on hand than we had a year ago. So if the end of 2008 was a normalized level, and I’m not sure that it was. That would imply we have about five to seven more days to go, which translates to about $15 million. Hopefully, we get that done in Q4, and if not, soon thereafter.

Carla Casella - JP Morgan

Can you just give us a sense for as we go into the next few months, in a normal season, how much of your ship-in to the customers would be the initial ship-in versus replenishment? Are you changing your targets or outlook for that for this year? I guess I’m thinking for back-to-school or for holiday merchandise?

Joe Scirocco

It varies a bit. In Europe, reorders tend to be less than 10% of the season. In the U.S., Steve correct me, I want to say 15% of in normalized environment. So retailers are buying tighter and hoping to chase goods rather than chase sales.

Of course, we are trying to do the same thing. One of the initiatives that we have underway with our gross margin initiative is to create an alternative supply chain for faster term product, to be able to get back into supply and to meet that demand, but just from a pre-booking standpoint, people are being pretty conservative.

Carla Casella - JP Morgan

So then sitting in September now, would you already have a good sense I’m assuming for then, for the holiday, the initial orders. It’s just the replenishment that is still up to question?

Steve Tully

Yes. That’s correct.

Operator

Your last question comes from David Glick- Buckingham Research Group.

David Glick- Buckingham Research Group

Most of my questions have been answered, Joe. I just wanted to confirm what you said, make sure I understood the tax projection for Q4. Was that an $11 million net tax expense, or was that just the foreign portion? Because when we’re flow through your assumptions using an $11 million tax expense, we’re having a little trouble getting to the negative mid single digit loss.

Joe Scirocco

It’s a very strange thing the tax expense of $11 million is projected to exceed the pretax. It’s kind of a weird thing, but in the current accounting rules, we’re not allowed to take credit for taxable losses in the U.S., and it’s not that our operations in the U.S. are unprofitable, but it’s the fact that the Americas region on a tax return is combined corporate group, which includes $40 million of bond interest and the corporate overhead of the organization. So we’re not allowed to take credit for that provision, and the $11 million could well exceed the pretax line.

David Glick- Buckingham Research Group

That is the number that you’re projecting on the tax line on the income statement is $11 million.

Joe Scirocco

Yes. We give it to you as a number rather than a rate just because the rate wouldn’t (multiple speakers)

David Glick- Buckingham Research Group

Rate makes no sense.

Joe Scirocco

Right.

Bob McKnight

Okay, operator that concludes today’s call. On behalf of everyone here at Quiksilver, thank you for participating. We look forward to providing our fourth quarter and fiscal 2009 full year results in December.

Operator

Thank you. Ladies and gentlemen, the replay for this call will be available from 6.30 pm today until midnight on September 10. This does conclude today’s conference. We appreciate your participation. You may disconnect at this time.

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