Quiksilver Management Discusses Q1 2014 Results - Earnings Call Transcript

Mar. 6.14 | About: Quiksilver, Inc. (ZQK)

Quiksilver (NYSE:ZQK)

Q1 2014 Earnings Call

March 06, 2014 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

Erinn E. Murphy - Piper Jaffray Companies, Research Division

Karru Martinson - Deutsche Bank AG, Research Division

Kelly L. Halsor - BB&T Capital Markets, Research Division

Andrew Burns - D.A. Davidson & Co., Research Division

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

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

Jim Duffy - Stifel, Nicolaus & Company, Incorporated, Research Division

Christian Buss - Crédit Suisse AG, Research Division

James Andrew Chartier - Monness, Crespi, Hardt & Co., Inc., Research Division

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

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Quiksilver Inc. Fiscal 2014 First Quarter Financial Results Conference Call. [Operator Instructions] I'd like to remind everyone that this conference is being recorded.

And I'd now like to introduce Robert Jaffe, Investor Relations for Quiksilver, who will host this afternoon's call. Please go ahead, sir.

Robert Jaffe

Thank you, operator. Good afternoon, everyone, and welcome to the Quiksilver fiscal 2014 first quarter earnings conference call. Our speakers today are Andy Mooney, President and Chief Executive Officer; and Richard Shields, Chief Financial Officer.

Before we begin, I'd like to make -- 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. Actual 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 and in our quarterly reports on Form 10-Q. All forward-looking statements made on this call speak only as of today's date, March 6, 2014, 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 on our website at www.quiksilverinc.com.

With that, I'd like to 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 some comments on our first quarter financial performance and share insights and elements of the Profit Improvement Plan. Rich will follow with details on the Q1 financial results.

The first quarter pro forma adjusted EBITDA increased by $3 million over the prior year first quarter. The increase was driven by our cost reduction initiatives. Q1 was the third consecutive quarter of pro forma adjusted EBITDA growth. Similar to results in the second half of last year, we were able to generate increased pro forma adjusted EBITDA in Q1 despite decreased net revenues.

First quarter net revenues were down 2% in constant currency driven by reduced wholesale channel sales, most notably in the developed markets of North America and Europe, our smaller wholesale accounts in North America and Europe faced and we expect will continue to face competitive challenges from larger traditional competitors as well as online competitors.

We expect to see some continued fallout in these smaller wholesale accounts. However, we also believe that we have opportunities to increase sales to the larger wholesale accounts in these markets by focusing on appropriately segmented product collections.

In contrast to the decline in wholesale sales, our emerging markets and direct-to-consumer channels offshore continued strength. In constant currency, revenues from our retail stores and e-commerce channels were up 4% and 16%, respectively, and revenues from our emerging markets increased 32%.

Coming to our Profit Improvement Plan. During the quarter we continued to reduce costs and make progress in optimizing supply chain and laying the foundation for stabilizing and growing revenues.

From cost reductions and rightsizing, we further reduced headcount primarily in the Americas and EMEA, recording severance of $3 million in Q1.

We made good progress with our indirect procurement efforts and have seen substantial cost reductions in the expense categories that we have since put out to bid.

We continued to evaluate the size of our athlete roster and scope of our event sponsorships and saw reductions in those expenses in Q1 as well.

In the area of supply chain optimization, we further aligned the merchandising and design functions with production and sourcing, further reduced the vendor roster and style counts, continued to refine our product development calendar and improved the processes for global inventory management.

From a systems perspective, we went live on the first phase of the global demand planning system and made good progress in implementing SAP modules related to sourcing operations.

We also developed a detailed plan for improving efficiency and reducing costs and distribution on logistics. As we've said before, optimizing our global supply chain will positively impact our gross margins as well as operating margins. We view efforts in this area as the largest opportunity for improvement and continue to allocate resources to these initiatives.

Coming to the revenue growth part of our plan. We made investments in our high-growth emerging markets, specifically Brazil, Russia, Mexico and Indonesia. And we made progress building out our e-commerce platform and team.

We continued to restructure our wholesale sales force in the Americas and are developing a detailed plan to reorganize the sales structure in Europe.

We also continue to focus our product assortment, which will include the addition of entry-level price point products in DC Shoes.

And lastly, we're excited about the upcoming marketing launch for the AG 47 line for Quiksilver.

Additionally, we selected a global advertising agency, initiated SMU programs with key national accounts in the Americas and EMEA and developed special programs for our cathedral core accounts.

In summary, we continue to reduce costs, centralize and streamline processes and procedures and integrated key functions. We've begun laying the foundation for stabilizing and growing sales, and I remain confident that we're heading in the right direction.

And with that, I'd like to turn the call over to Rich to discuss our financial performance in Q1 in more detail.

Richard J. Shields

Thanks, Andy, and thanks, everyone, for taking the time to join us this afternoon. My comments will refer to our continuing operations in the press release.

First quarter net revenues were $393 million, down 2% or $9 million on a constant currency basis. The revenue decline was focused in the wholesale channels in the Americas and EMEA region, where revenues decreased by $8 million and $14 million, respectively.

The Asia Pacific region wholesale channel generated revenue growth. Revenue was also increased globally in our retail stores and in our e-commerce channel.

The product lines that we discontinued in 2013, Quiksilver Women's, Summer Teeth and VSTR, contributed approximately $5 million of revenues in Q1 last year versus none in the current year. These items are not part of our discontinued operations and, therefore, make up a portion of the revenue decline this quarter, mostly in the wholesale channel.

Our retail stores generated positive comparable store sales growth of 2% in Q1. Comps were positive in our Americas and our EMEA regions and flat in the APAC region. Comps were positive in both our full price and factory outlet locations. We ended the first quarter with 30 additional stores versus Q1 last year, with most of those new stores located in our Asia Pacific region. The increased store counts, combined with the positive comparable store sales growth, delivered total retail channel revenue growth of 4%.

We controlled expenses effectively in our retail stores and saw their contributions, as a percent of retail sales, increase meaningfully in the first quarter.

Revenues in our e-commerce channel increased 16%, driven mostly by strong growth in the EMEA and APAC online sales.

Americas online sales were basically flat. We are making significant investments in our Americas website infrastructure, which we believe should support increased online revenues in this region. We plan to leverage the e-comm technology platform we've established in Europe and extend that platform as a global platform. The North America e-comm website should be upgraded to the new platform later this year.

Similar to our retail stores, contribution margin in our e-commerce channel increased meaningfully versus Q1 last year.

In the wholesale channel, we saw revenues decrease in the Americas and in EMEA. In those regions, Quiksilver and DC brands declined, but Roxy brand revenues increased. APAC wholesale channel revenues increased in Quiksilver, Roxy and DC brands.

Revenues from our emerging markets increased 32%, with good growth in Brazil, Russia, Mexico and Indonesia continuing in Q1. Emerging market revenues increased in all 3 brands and in all 3 sales channels.

Looking at our revenue from a broader perspective, there are some noteworthy trends that shape how we plan to build our revenue moving forward.

We've seen pressure on revenues in the wholesale channels in the developed markets, specifically and particularly with smaller wholesale accounts.

In the emerging markets, we continue to see strong revenue growth. Our e-commerce channel continues to expand. And we believe we have opportunities to continue to expand our retail store count, both for company-owned stores and in emerging markets with licensed stores as well. So SMU programs, focused on larger wholesale accounts, development of emerging markets and investments in direct-to-consumer channels, are areas we intend to pursue.

Moving to gross margin, which was flat at 50.9%. Margins in the wholesale channel decreased for each brand with somewhat greater impact in the EMEA region.

Wholesale margins were negatively impacted by clearance activity as well as currency rates. Margins were basically flat in the retail and e-commerce channel. The favorable gross margin impact of the sales mix shift towards the retail and e-comm channels offset the margin erosion in the wholesale channel.

SG&A decreased by $13 million. Q1 SG&A included $6 million of severance and other restructuring costs this year versus $3 million last year. Excluding those items, SG&A was down $15 million in Q1. This decrease was driven by reductions in employee compensation, including wages and salaries, incentive compensation and employee benefits, as well as reductions in costs related to sponsored athletes and events.

In upcoming quarters, our year-over-year SG&A variances will begin to compare against the periods of heavy staff reductions last year, but we are pleased with the SG&A reduction in Q1.

Q1 pro forma adjusted EBITDA of $16 million increased by $3 million compared with the first quarter of last year, as our SG&A reductions more than offset the decrease from top line revenues.

The income tax line from continuing operations deserves a brief explanation. Income from discontinued operations includes the gain on sale from divesting Mervin and Hawk in Q1. These divestitures generated income tax expense of approximately $10 million, which is netted against the gain on sale on the discontinued operations line.

However, we were able to utilize tax losses to offset the tax on these divestitures. The utilization of those tax losses, a benefit of approximately $10 million, was recorded in our tax provision for continuing operations. And consequently, in Q -- in total, we have a tax benefit from continuing operations.

Moving to the balance sheet. Inventory decreased by $42 million versus last January, and inventory days on hand decreased by 11 days. The quality of our inventory improved as we continued to liquidate aged inventory. And aged inventory, as a percent of total inventory at the end of Q1, was again down versus the prior year quarter.

Regarding liquidity, we ended Q1 with $92 million available to draw on our credit facilities, in addition to $131 million in cash and $56 million available for EMEA letters of credit.

Our bond indentures include some restrictions regarding the use of proceeds from divestitures, so $61 million of the cash generated from the sale of Mervin and Hawk is reflected as restricted cash. We can use these funds for capital expenditures and other investments in our business and expect to have moved through these restrictions in the upcoming year.

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

Andrew P. Mooney

Thanks, Rich. So just to recap, we've made good progress in lowering costs, strengthening our team, integrating key functions and processes, reducing SKU count and laying the foundation for future growth. And our entire team remains focused on the successful execution of the Profit Improvement Plan.

Robert Jaffe

Operator, we're now ready for the question-and-answer session.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Taposh Bari.

Taposh Bari - Goldman Sachs Group Inc., Research Division

I know there's a lot of -- I know you're still kind of in the midst of the restructuring plan, but I know there's a decent amount of optimism out there around how the fall/winter business is going to shape up for your company. And I was hoping you can provide some more context into how your order book is kind of working through at this point in the season?

Andrew P. Mooney

Well, the -- you really need to kind of break the revenue components into a series of subsets. I think as was evidenced in the last few quarters, we feel very good about our direct-to-consumer business and we feel very good about our emerging markets business, and are anticipating continued strength in those sectors. We see continued headwinds in the smaller account base wholesale markets, particularly in North America and EMEA. And there, all the data that we've got on our current position suggests that we're either holding market share, or in the case of Roxy, I would say growing market share, again as evidenced by our performance during this quarter. But we're continuing to see kind of systemic contraction within that channel. The larger accounts increasingly are working on an SMU basis, and that is a much closer to market scenario, which we've now geared the sales up where it's largely SMU-driven. It's a much faster turn and much closer to the market. So all of that is, in a kind of a long way of saying, is that we see continued weakness in the smaller wholesale channel in the developed markets and continued strength by contrast elsewhere.

Taposh Bari - Goldman Sachs Group Inc., Research Division

Okay. Maybe if I could just kind of follow up on that point. Over the past several quarters since you arrived, part of the message has been, don't hold us, the new team accountable, really until the fall '14 season. And as we're getting closer to that point in time, and I guess the question now is, 18 months into your arrival, are you -- how comfortable are you in your ability to grow either sales, gross profit, what have you, in aggregate, taking all the different factors into consideration?

Andrew P. Mooney

Well, the original Profit Improvement Plan was always based on a very conservative top line revenue growth with 2.5% CAGR. We continue to believe that it's possible and are still optimistic that we'll see an inflection point towards the back half of this fiscal year, which would be kind of in line with fall. The mix is -- the mix, we believe, will be slightly different from what we modeled, and that will be stronger in their own B2B business and stronger in their own emerging market business and a little weaker in their smaller account wholesale business in the developed markets.

Operator

And our next question comes from Erinn Murphy with Piper Jaffray.

Erinn E. Murphy - Piper Jaffray Companies, Research Division

Just a quick follow-up, Andy, for you on the sales guidance. If we just think about penciling that out to 2016, it does kind of equate to about a $2.2 billion number by then. I mean, can you just help us think about the past a little bit more over the balance of the 3 years we have in your 5-year plan, I can kind of appreciate the potential inflection as we progress throughout the back half of this year? But just really trying to understand some of the key building blocks to get to that number?

Andrew P. Mooney

Well, if you take -- there's probably -- there's at least 4 significant revenue drivers geographically, so even in this quarter, as was witnessed by the 32% growth in emerging markets, we see -- we're experiencing very strong growth in Russia. So we're hoping everything stays calm there. We're experiencing very strong growth in Brazil. And now that we have full ownership of that region from last consecutive quarters, that's an area that we're going to invest in. And what's great about the Brazilian market is that the prevailing model is through franchising partnerships. So we believe that we can get some substantial growth in Brazil without us -- a huge consumption of capital in the process. At this point in time, you're not seeing a dollar of revenue in our financials from greater China. And Greater China is now the second-largest action sports industry -- sorry, second-largest sports geography in the world. We are in conversations with a joint venture partner there to figure out a way to substantially improve our performance in China. And that will be a big factor in recognizing our top line growth there. And for us, Indonesia has been a strong market. We continue to grow there. So there's a blend in that market of owned and operated retail, but a lot of it is also done through franchising. So it is really -- the break for us is the same as break for everybody else. But I think in our case, in the case of Mexico that we now own our marks there, 100% outright, and Indonesia. And that will be the single-biggest top line contributor of growth along with continued growth in our direct-to-consumer business in the direct markets, particularly on the e-comm side.

Erinn E. Murphy - Piper Jaffray Companies, Research Division

So then -- okay. That's helpful. And so then in terms of just the pace of that growth, I mean, we're starting the year off a little bit weaker and then we kind of anticipate a little bit of a build in the back half. But then that would really assume that those -- as those kind of the emerging markets scale and some of the direct-to-consumer initiatives really grow, that's a pretty healthy acceleration in both '15 and '16. Is that how we should be thinking about it as we kind of pencil out our models?

Andrew P. Mooney

Yes, I think so because, as I say, we've only literally got our hands on the steering wheel in Brazil and Mexico in the current quarter, and we don't have our hands in the steering wheel at all yet in China. And every dollar in China is a dollar of upside in terms of reported revenues and ultimate profitability for our company.

Erinn E. Murphy - Piper Jaffray Companies, Research Division

Okay. And if I could just follow up with Rich briefly. On the gross margin being a bit -- being flattish in the quarter, can you just talk a little bit more about some of the puts and takes there? I mean, what was kind of the contribution from higher penetration of direct-to-consumer, the SKU rationalization efforts you guys have had versus some of the promotional pressure and the competitive pressure that Andy talked about in his prepared remarks? I'm just trying to understand the nuances there.

Richard J. Shields

Yes. So margin was flat at 50.9%. Again, we saw margin erosion in the wholesale channel across all 3 brands, a little bit heavier in Europe than in Americas and APAC. The drivers on the wholesale, and I mentioned on the inventory, my inventory notes that we continue to bring the aged inventory down largely through wholesale. Currency, it has moved against us a little bit. And then the shift toward the direct-to-consumer channels, where we had good growth and 4% growth in retail, and we had 16% growth in e-comm, those are higher-margin channels as we got the direct-to-consumer pricing. The benefit of that shift, which was maybe in the 75 basis-points range, offset the decrease in the wholesale margin. And I would add just one thing to Andy's comments about the -- how we look forward at revenue. I think we absolutely feel bullish about e-comm and BRIC. But we also -- while we've shared some thoughts and Andy mentioned that we see some pressure on the wholesale channel in the developed markets and, specifically, on some of the smaller accounts in the wholesale market, we continue to believe that we've got great opportunities with specific collections, more SMU collections, in the larger multi-door accounts in wholesale. And that's part of our plan as well.

Andrew P. Mooney

Just maybe if I could just add to that. I think one thing I can say that's really fundamentally encouraging in our results, is that I think we're maybe one of the very few teen apparel retailers, if that's what we have to be categorized as, we actually experienced comp again through what was otherwise a pretty brutal promotional period in the back half of the holiday season of last year, and I think particularly in the developed markets. So we feel good that our brands are still resonating there, and in our own retail environment, we're really able to put our best foot forward and consumers are responding to that.

Operator

And our next question comes from Karru Martinson with Deutsche Bank.

Karru Martinson - Deutsche Bank AG, Research Division

I guess on that same vein, I mean, how much do you feel that the comps were hurt by the extreme weather that we had in the quarter, and how has that kind of continued here at the start? We've heard a number of guys talk about February and March, just on a weather basis, being very challenging.

Andrew P. Mooney

Well weather is a constant variable for us because clearly in the summer, we're very much a summer brand, and in the winter, because of ski and snowboarding, we're very much a winter brand. So in the U.S., we are predominantly a summer brand. And we actually don't have as developed a business in cold weather locations as we have in Europe. In Europe, we're basically a 50/50 balanced spring, summer, fall, winter business. And the weather in Europe through the season was -- I'd say neutral to our business, neither kind and not particularly bad. The really tough winters that the East Coast, in particular, experienced didn't really have that material effect on our own retail organization. It may have had some effect, particularly I would say more on the West Coast retailers in the fall/winter period because they just really didn't get snow at the time that they most needed it. So I'd say it probably had some negative effect, but I wouldn't cast it as that significant in the results in Q1.

Karru Martinson - Deutsche Bank AG, Research Division

Okay. And when you guys look at the creation of common entry-level price point for DC Shoes, I mean, what are you guys thinking in terms of what's the size of that entry-level market and what can that do to the brand in terms of, call it, 12, 24 months out from now?

Andrew P. Mooney

Well, the $45 to $55 retail price segment for canvas vulcanized footwear worldwide is conservatively a 120 million pair market. So take half of -- if you do the math and take half of that per pair wholesale, that tells you the size of the prize, if you like. DC has never actually participated in that segment ever. Open price points in the DC plan start at $55 and above. And we are definitely going to continue to operate in that sphere, too, and, in fact, even more aggressively with the launch of Nyjah Houston's signature collection in the kind of $70 prices on to compete with Nike's Janowski at $80. So we're going to continue to be very aggressive in the upper-priced tiers of skateboarding footwear. But we've never really even been present in what I would describe as the lifestyle segment. And there's been a lot of discussion within the industry about whether that is a fashion trend that is about to win. My feeling is that it's much more sustainable than that in that I think there is a large swath of the population in both America and Europe these days, young men and women who, based on their economic circumstance can only really only afford to pay $45 to $55 for a branded athletic footwear. So I see it as being a much more sustainable trend as an underpinning of economic circumstance and not just fashion vagaries.

Karru Martinson - Deutsche Bank AG, Research Division

Okay. And then just lastly, in terms of the proceeds you guys received for the asset divestitures, when you talk about investments in the business, is this more of the same kind of streamlining, simplifying supply chains, and those kinds of investments? Or are we talking about going out, perhaps looking at some bolt-on brands to build the portfolio?

Andrew P. Mooney

We're -- I would kind of break them into probably only 2 buckets short-term and a third bucket longer-term, which is short-term, we're really, really interested in continuing to invest in systems upgrades that will help us execute our Profit Improvement Plan and retail stores and e-comm, IT infrastructure that would help us generate on the revenue aspects of our plan. We're not looking at any brand acquisitions at this point. And if there were -- as we start to generate surplus cash flow, it will -- it would all go to paying down debt.

Operator

[Operator Instructions] We'll take our next question from Kelly Halsor with BB&T Capital Markets.

Kelly L. Halsor - BB&T Capital Markets, Research Division

I just wanted to expand further on Taposh's question regarding visibility into sales in the back half of the year. I imagine at this point, management's touched the product, the new product at this point, and has gone to market with that? Could you just expand on any feedback you've gotten from your retail customers? And then on that same note, in your profitability improvement, longer-term, what is implied for the growth rate in the developed market wholesale channel?

Andrew P. Mooney

So let me deal with -- the 2 factors of that is the percentage of total revenues that are made up by the smaller account wholesale retailers, the smaller retailer, co-retailers, actually varies really dramatically by country. So if you are in a country like the U.S., it really only represents about 19% of our total revenues. If you look at Europe, it's more like 40%, 45%. So I think, increasingly, quoting a percentage of bookings on the order book -- well, if you're in Mexico, it's under 5%. That said increasingly quoting the percentage on the order book in that segment book for business is not really a meaningful number. The overall reaction to the line has been exceedingly positive. But as I said, I am -- I am kind of balanced on my outlook on that channel because, as I say, when I look at all of the available data on market share, and there's not a great deal of it to be candid, there is some in the U.S., there's less in Europe, everything points for us -- to us, even with the existing product line, to be either holding share or gaining share. Yet we're seeing weakness in the revenue side of the business. That signals to me that we've got a kind of ongoing erosion in the account base, either in terms of the sales across that account base or the actual absolute numbers of accounts that we have in that base. Both are certainly true in Europe. So as I see increasingly, really, consumer-driven more than anything else. The consumer is looking for our brand increasingly, either direct or through larger big-box retailers or through pure play e-comm players, some of the predictable players here in the U.S, but some of the companies that we even owned, in the case of Europe with Surfdome.

Kelly L. Halsor - BB&T Capital Markets, Research Division

Okay. Great. And Rich, just help us understand the Q2 impact to gross margin last year. You had the SAP blowup that margins were down, I think, almost 500 basis points last year. So can you just help us think about Q2 gross margins and the impact from SAP last year?

Richard J. Shields

Yes. The SAP implementation was Q2 last year. So it really did impact the Q1 results. The real drivers on the Q1 results were the --we saw the favorable impact of the mix shift into the direct-to-consumer channels, and we saw a little bit of currency and discounting drain on the wholesale channels. And again, that was a little bit more pronounced in Europe than it was in the Americas.

Kelly L. Halsor - BB&T Capital Markets, Research Division

Okay. I guess to ask a different way, I mean, should we see a meaningful recovery in the European gross margins year-over-year given that -- what happened to SAP last year in Europe is obviously not going to repeat this year?

Richard J. Shields

Yes. I think I'd rather kind of stay on the longer-term trajectory that we've talked about in the Profit Improvement Plan. We've always said that the benefits that we will generate from the work that we're doing in the supply chain will happen in kind of the later part of the Profit Improvement Plan. I think that's -- I think we feel good about the traction that we see with the supply chain team. Andy and I are actually on the way to Hong Kong to meet with a vendor summit next week, so I think we feel good about the traction on the supply chain. That's naturally something that's going to happen a little bit, and it was always planning to happen in kind of the back part of the Profit Improvement Plan. And I think we feel good about the traction there.

Operator

Our next question comes from Andrew Burns with D.A. Davidson.

Andrew Burns - D.A. Davidson & Co., Research Division

On the margin erosion in wholesale, how much -- if you can help us better understand, how much of the current margin weakness is easily addressable through new product initiatives in your turnaround strategy versus your weakness that you see right now that is, closer tied to the retail environment or in channel or industry issues?

Andrew P. Mooney

Well, I think that's not an easy question to answer in any kind of definitive way. I mean, I would say that part of the margin erosion that you've seen particularly in Europe was a function of us having to either accept returns to keep the channel clear or to negotiate markdowns and partnerships with those guys to keep the products moving through the channels. Because, as I say, I think what you're witnessing is the consumer increasingly rotating out of those channels into multiple other options. Thankfully, they're still looking for our brand. But increasingly, they're looking for it in the other places. But I think in order to retain our margins at historic levels, what we have putting the supply chain initiatives to one side from kind of sustainable margins, we have to kind of manage our inventory in and out of that channel better than we've ever done before. So that we don't have to go through end of season markdowns and be even more disciplined in the wholesale selling process. And that's part of really why we've introduced a number of very professional sales leaders into the wholesale regions to do exactly that.

Andrew Burns - D.A. Davidson & Co., Research Division

Okay. In the past, Quiksilver kind of hung its hat on the core channel as one of the largest indicators of brand health. When I listen to the comments today specifically around opportunities with larger accounts, it sounds like you take a broader view of the world. So given the retail environment's constantly evolving, do you still view these smaller accounts as critical to the story and an indicator of brand health?

Andrew P. Mooney

The smaller accounts are absolutely important to us. I just think there's going to be fewer of them. We have in place what we call a cathedral account program, where -- with those retailers that we believe are really influential to the broader community and to the consumer, that we're completely in lockstep with them in terms of planning their health and our health along with it. I think, increasingly, the kind of multi-door, either mall-based keen retailers in North America, the PacSun, Tilly's & the Zumiez of the world, all of which are very good retailers, along with the bigger-box retailers in Europe, like Decathlon or Sports Direct increasingly, what they are really looking for is a fashion-right, price-right product that's on a very fast turn cycle. As an organization, we haven't really been set up to service that channel the way it needs to be serviced in today's kind of faster-pace, faster-moving environment. We put a lot of energy into that in the last 6 months. And I've personally met with all of those kind of CEOs and meet with buyers of those organizations to kind of discuss exactly how we want to improve our business going forward. So we've set ourselves up to take advantage of it. I'd say that the correlation between the smaller core channel and those larger channels is perhaps not as strong as it historically was, and that you need to be competent in both. You can't just simply be good in the core accounts and expect to do a good fashion business and an account like PacSun. You have to be fashion-right and price-right in the mall because they're the competitive set for a retailer like PacSun or other very strong vertical players like H&M or Zara. And they can charge a premium and we can charge a premium in there, but the premium has to be reasonable for the consumer. We're in the specialty channel. I continue to emphasize that the keyword is special, is that those retailers should keep focused on making the presentation levels, especially the products that's in their special, and the service really special. But increasingly, I think you're going to see a bifurcation of the product line and the business models, is that the product line in specialty will be premium-priced. And the presentation of the brand -- of brands in that channel needs to be premium and service needs to be premium. And then in the mall or the big-box retailers in Europe, it has to be fast and it has to be fashionable.

Operator

And our next question comes from Jeffrey Van Sinderen with B. Riley & Company.

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

And since we're on the topic of some of your retail doors, I'm just wondering if you could talk a little more about margins in your direct channel. I think you mentioned positive comps and your contribution margin up in your own stores. So just kind of wondering how that fleshed out. Were you more or less promotional? Were your merchandise margins up or down?

Richard J. Shields

Yes. The gross margin picked up a bit in our direct-to-consumer channel, both on e-comm side and retail. And then we also saw in the -- in both -- well, in retail, we saw a leverage against store costs and store labor. And so we saw contribution margin retail move up. In e-commerce, there's a fixed cost base within the e-commerce business, and so they increased in revenue and revenue was up 16% in e-comm, leveraged against some of that fixed cost base. And that helped drive the contribution in the e-commerce business up as well.

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

Okay. Got it. And then since direct is a growing part of your business, I'm just wondering how you're thinking about omni channel, and if anything changed in your way of thinking or your approach to that after kind of what the whole industry experienced in the holiday of 2013.

Andrew P. Mooney

Well, I hope I'm quoting the statistics accurately because I certainly use it a lot around the buildings here, which is I think there was a Bloomberg report a few months back that said teen -- disposable teen income in North America, 50% of it went to brands, Samsung and Apple. So clearly, what that's signaling to me is that those -- that generation of consumers increasingly will be buying through their mobile devices, possibly not even tablets, but straight through their telephones, which in the case of Samsung, size-wise, are becoming pretty close to tablets. So I think you have to be thinking about your mobile business. You've got to be thinking about your e-comm business, generally. You've got to be thinking about all of it, holistically, if you really want to appeal to a teen consumer these days. So we're very much committed to that and investing in that because not only will we inevitably, I think, do more business there, but it basically becomes a marketing platform to promote our brands across our entire network of partners, including our wholesale partners.

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

Okay. And then given what sounds to be a strong reception to your fall line, I mean, do you think is it feasible for a substantial increase in business with some of your larger retail partners? Is that possibly a second half calendar 2014 event?

Andrew P. Mooney

Well, you see I think increasingly, the larger retailers aren't really interested in what our line is. What they're interested in is what their line is. Each of those retailers are increasingly looking for custom-design lines that appeal to both their unique consumer as they see it, and certainly their business objective. One of my kind of experiences during the 20 years in Nike was really to kind of give birth to the SM, special makeup division at Nike. Because at that time, when that division was birthed, I mean, essentially Nike was offering a same line to all retailers in the mall, in fact, all retailers period. And what happened really was that retailers just started to do what retailers do with Coca-Cola. They just beat each other up on price, and we had a war in terms of garnering open-to-buy. So that move towards doing custom products for custom retailers was a little bit of a gate-opener for both building share because the retail itself is able to devote a higher percentage of open-to-buy to Nike because they could control their own margin destiny. That's now become the norm. Every retailer in the mall is looking down the mall to see what the competitor has from the same brand. And if they have something similar, they're not particularly interested in carrying that brand. So that requires an organizational setup, people who are adept to doing footwear under [indiscernible] and that's a particular breed of cat. You need a supply chain that can get both in printed goods and cut and sold goods to market on a quicker pace than you would do for the traditional channel. And we set ourselves up to do that. But we won't know the results of that even for fall until we get closer to the markets because they're not allocating open-to-buy until it's closer to the event. But we've set ourselves up to take full advantage of it, and at least in the conversations that we've had with the retailers today, they are open for it. We just have to execute on the product front to give them what they need.

Operator

And our next question comes from Eric Tracy at Janney Capital Markets.

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

Andy, I appreciate all the color that you've given. And they kind of keep asking, maybe in a different way. I do think it's really important this -- if you call it may be a bit of strategic shift away from the core, specialty doors that is sort of in the heart of the Quiksilver brand, towards some of these bigger retailers? And you used the word fast fashion. I guess, how do you balance maintaining the authenticity of Quiksilver as an action sports or brand while somewhat massing up in positioning in -- via department stores or even mall-based retailers? I think about this awesome combination we're pulling back on the -- as a big sponsorship, which is also supported for the authenticity of the brand. So just trying to understand the Quiksilver, DC, Roxy brand positioning as you sort of migrate to this different strategy.

Andrew P. Mooney

Well, just to be abundantly clear, we are as focused on the core as we've ever been. The core is just shrinking. It's just -- it's -- as I say, it's -- if you look at all of the evidence across the entire industry, the data would suggest that there's been a systemic and gradual decline in the core market. There continues to be -- if you like a core within a core that we refer to as cathedral accounts, players who are kind of the gold standard in their industry that are going to be around for the very long run. And we have deep relationships with them. And we're going to continue to invest in them. And in fact, maybe we can invest in them in even higher levels than we ever have. On the athlete front, again, you have to put the athlete cuts in perspective. I believe, if I'm not mistaken, we have 450 athletes under contract. To say that we have too many is a kind of massive understatement. So we're getting closer to what we believe is the right number because again, to put it into perspective, there are 24 male athletes -- sorry, 36 male athletes who will participate in the SAP surf tour. And no brand, one would expect, is going to get all 36 of them. So when you start to consider how many surfers, male and female, how many skaters, you need to really continue to build great products around great personalities that are influential in the community, it's still less than the number that we have signed today. So as I say, I say all of that to say that we're every bit as committed to retaining the authenticity that's been honed out over the last 4 years in the case of Quiksilver, in 25, in the case of DC. But we simply can't sit back and ignore that in the mall or in the big-box retailers in Europe that that's not all they're looking for because the competitive set for them has changed quite dramatically. And I think there, it is possible to walk and chew gum at the same time because I think if you look at brands like Nike and their world, brands like Vans in our world, I think they do both. They connect to the core and they're very connected to the music and arts community, which is something that's strangely not within our DNA 4 years ago in Quiksilver and then in our DNA with DC, 25 years ago, but it has not been as strong a focus for, as I would say, in the last decade. And it's just -- in some ways, this is déjà vu all over again for these brands. We're just going back to what we did when we first started, which is we were both functional and fashionable at the same time.

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

And then I guess a follow-on to that, you keep using, sort of, Nike and your experience there as a benchmark. But at some point, they did develop the supply chain and they did product segmentation as you alluded to, to make sure that they could sort of handle and distribute the product in the right way. Obviously, with the start of this product and driven plan, pushing it all as much as you can on the supply chain, when should we sort of believe that, that is in place to support more of a fast fashion business, if you will, understanding that you have control of the product since back half '14? But when is the supply chain ready to support that?

Andrew P. Mooney

The supply chain is ready now. What we really need to do is -- this is -- as it relates to building or rebuilding, I would characterize it as business with these larger multi-door retailers, so 0-sum gains, somebody has to get kicked off the shelf for us to get in. So it's not like all of a sudden, these retailers are going to turn around and say, come on down, we love you. They have expressed a lot of positive comments about us, but we're going to have to earn the stripes, kind of one product at a time. So I guess it's not going to be a kind of fast ramp -- ramp-up, instant increase to the top line. It's going to be a hard-fought, competitive, get it right, one SKU at a time and build from there. But as it relates to your supply chain question, we're set up to do it now.

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

Okay. And then I guess if I could just lastly translate this to again the '15 -- excuse me the '16 target. You talked about sort of the revenue side of it, obviously being backloaded and I would argue, too, on the margin side as well. But coming off the '13 base, '14 now a little bit lower, walk me through again the step-function that keeps you comfortable, holding intact that EBITDA margin of 13% plus. Because I think, at this point, that implies a 35% CAGR for the next 3 years on an EBITDA basis growth. So is it walking through the various pieces to get you and us sort of comfortable with that ramp?

Richard J. Shields

Well, I think we've talked to a little bit about our forward view about how we deliver the growth towards the $2.2 billion top line. It's going to be built around direct-to-consumer from a channel perspective. It's going to be built around the emerging markets, as well as -- largely in the emerging markets, but with growth in the developed markets, as well. I think Andy walked through that. And we think we've got great opportunities in all 3 of the brands. We've shared how we intend to execute in the supply chain. And I think that the opportunities in the supply chain are obvious. And we're making good progress against that. And then I think that what you've seen us do with the SG&A, I think gives an indication that we're not shy about making changes in the SG&A structure. We've done some last year. We're talking about activities this year. Andy mentioned in his comments around that we are further downstream in the -- reshaping the U.S. sales force. We're well into that. We're doing the planning around the European sales force. So I think that we feel good about the plans on SG&A and that leads us to the P&L model that we outlined in the Profit Improvement Plan.

Operator

And our next question comes from Jim Duffy with Stifel.

Jim Duffy - Stifel, Nicolaus & Company, Incorporated, Research Division

I'm particularly pleased to see the improvement in the inventories. Rich, typically, it's fair to interpret improvement in both levels and quality of inventory as a leading indicator on gross margin improvement. Is that an appropriate way to think about the progress that you're making in your business?

Richard J. Shields

Well, I think that you -- we mentioned that we continue to bring aged inventory down, and we brought and aggregate inventory down. Andy mentioned in his comments that we've put -- we continue to improve the processes and we're putting some systems support around inventory and buy-planning. Those are all favorable to us. But we think that there's opportunities to take cash off the balance sheet and inventory and obviously, better inventory and lower inventory is going to be a harbinger of margin benefits to come.

Jim Duffy - Stifel, Nicolaus & Company, Incorporated, Research Division

Great to hear. And then what's the potential margin and working capital implications of a shift to these larger accounts and increased emphasis on SMUs?

Andrew P. Mooney

Well, let's deal with the 2 subsets. I would say that from a going -- if you want to put it this way, from a gross margin going-in perspective, usually margins are tighter on SMUs than they are in dealing with the traditional channel. In my experience, they've always been better coming out because you're not -- it's usually direct ship. You're not carrying any inventory. You're not really dealing with markdowns, if the product is right. So lower going in, equal or possibly even better coming out. And it certainly from the capital side because you're not tying up any capital and inventory backup for those store events.

Jim Duffy - Stifel, Nicolaus & Company, Incorporated, Research Division

Okay. Good to hear. And then last question relates to the performance in the retail stores through what was a choppy environment. Andy, can you maybe speak to some of the specific initiatives in the retail stores supporting that type of improvement?

Andrew P. Mooney

Yes. Maybe I'll address a couple. There's probably one that's going kind of systemic, and it's going to be evident in our -- improved recently from a number of quarters, which is we continue to improve the quality of our retail portfolio, trade our underperforming stores in the lower quartile for better-performing locations that are going to be in the upper quartile. So that's systemic. So some of that's still left to do, not as much as we've had in the past. Within the stores themselves, we have historically had a very high percentage of our stores, have been dual-branded. We've carried Quiksilver and Roxy only. And following the successful experimentation of our European retail team, now our Global Head of Retail who, over the last few years, has added DC to those stores, and every time that he's added a DC to those stores, he's got an uplift, a sustained uplift because it just brings a different consumer across the threshold, makes the environment even more appealing than it does with the 2 brands. We're converting an increasingly large portfolio for stores in supply-branded and we're seeing an uplift there. We recently did it in our Santa Monica store, in fact, here, which we should we could as a lab over the last month and saw exactly the same occurrence there. And then finally, we have an interesting dynamic that you don't usually see but we have, in our U.S. stores, we have Waterman's, which is a subset of Quiksilver that's targeting a slightly older consumer, but still very active consumer. Because they're slightly older they have more disposable income. We found that we were able to take the price points up there within the stores on some key items. And in fact, what happened when we took the prices up is we sold more. I wish I could have a lot more of those type of experiences, but that's exactly what happened in the case of Waterman. So it's a combination of tactical moves that we're experimenting with A/B testing all the time, and it's a systemic improvement in the quality of our overall portfolio.

Operator

And our next question comes from Christian Buss at Crédit Suisse.

Christian Buss - Crédit Suisse AG, Research Division

I was wondering if you could provide some perspective on how your retail model is evolving. You had talked about potentially adding more of the flagship concepts to the mix. Could you talk to me about how that's developing and when we should expect to see some incremental doors potentially?

Andrew P. Mooney

Well, we're -- we see a range of different formats that we believe could be successful. We've talked about our Boardriders format, which is a tri-brand format, larger scale, very experiential in the 6 stores that we have in that format in Europe, have a restaurant, bar, barbershop, performing stage, and they continue to be extremely viable and profitable stores. Usually, flagship retail equates to nonprofitable retail. And in our case, those stores are very profitable. So we see the potential to have a judicious amount of those -- increasing those number of stores worldwide. So for example, in the U.S., I could see 3 locations for that type of store, in Miami -- South Beach, Miami, New York and somewhere in the Greater Los Angeles area. But probably not more than 3. But in Brazil, we could see 1 in São Paulo, you could see 1 in Rio. Also when you start looking around the various kind of capitals of the world for Boardriders, there's the potential to add double-digit numbers of stores, but certainly not triple digits. We have opened what we call, Boardriders Lite. We opened that in a suburban mall in Russia, of all places, stripped out the performing stage, the barbershop, the restaurant and the bar, but kept all of the other kind of aesthetics of the store. And that is doing really well and has really become the template for our store designs. So we see tri-branded stores of various sizes in good locations around the world, definitely being part of the mix. But increasingly, we also see, I think, an opportunity for smaller-format stores, small-format DC stores, which we already have up and running in Japan. Small-format Roxy stores, particularly and again in emerging markets. Half of our business in Japan, for example, is Roxy. And we have no freestanding Roxy stores there whatsoever. So we see an opportunity in Brazil, Mexico, possibly Russia, but definitely Southeast Asia and Japan for Roxy stores. And then we also see location. Again, if you think of Brazil and Mexico for that matter and the scale of their cost line, we see an opportunity for small-format Quik and Roxy stores that are on the beach, delivering products that are buy-now, wear-now in those types of locations. And again, in a country like Brazil, we see that as being a perfect franchiseable format, and look at other brands in that region as we have done hundreds of these types of stores in that geography and have done them very profitably. We see lots of potential for various formats with or without our own use of capital, particularly in the BRIC markets.

Operator

And our next question comes from Jim Chartier with Monness, Crespi & Hardt.

James Andrew Chartier - Monness, Crespi, Hardt & Co., Inc., Research Division

The first question, just how many stores do you plan to end the year with? And then the second question is on the demand creation spend. When should we start to see an increase in demand creation marketing spend this year, and what formats will that take initially?

Richard J. Shields

Yes. We ended Q1 with 645 company-owned retail stores. We haven't given a specific number of growth through the end of the year, but it would be -- I think we'll end with less than 700. So we will be opening some stores, but haven't -- have a specific number that gives you kind of a general construct. And Andy, for demand creation?

Andrew P. Mooney

Yes. So again, as part of our Profit Improvement Plan, our goal is to inch up, as a percentage of total revenue, the absolute -- the absolute dollars in the percentage of total revenues ideally from 5% to 8% over the time period through 2016. But I think even more importantly, what we've been able to do this year is what's certainly available, roughly at $100 million that we have to spend in marketing money. As was communicated in the Profit Improvement Plan, the lion's share of that money was spent on athlete endorsements and event participation, headcount, and very little money was actually left for demand creation, under $10 million. In fact, print media was definitely even to $10 million. So with all of the restructuring that we've done this year, reduced the number of athletes. We still have plenty. The number of events, we're still involved in the key ones, and reduced headcount. We have been able to kind of potentially increase our effective marketing budget from about $10 million to $52 million. You'll start to see the impact of that as early as April, May of this year, around the launch of what we call an AG 47, which is a performance collection within Quiksilver, some in even board shorts, in support of Roxy and then in support of -- in multiple categories and in support of our Nyjah Houston signature collection, which we think is a very, very solid product with premium pricing, but at a price point that's now being kind of firmly established in the marketplace. So really, I'm kind of looking forward to the fall season because it will -- from my viewpoint, it will be the first significant marketing that the company has really been able to do since the Rossignol. And it's all a function of the hard work that the team has done in restructuring the marketing resource allocation over the last 9 months.

Operator

And our final question comes from Mitch Kummetz with Robert W. Baird.

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

I guess I had a few ones. I'll try to be quick. On your retail outlook, which I think you said 645 stores, that was about 30 units from last year, that's about 5% growth in terms of units. It sounds like that might actually accelerate as we go through the year. I mean, is that sort of the kind of the run rate we should be thinking about in terms of retail units as we kind of map out the business into fiscal 2018, that kind of -- maybe mid, high single-digit level?

Andrew P. Mooney

Well, as I mentioned earlier, now that we have full ownership of Brazil and Mexico, and we believe, ultimately, ownership of Greater China, the prevailing model there is licensed -- or franchised, rather. So you could see a very rapid uptick in the Brazilian business driven by that model without any significant consumption for capital. Historically, we have -- it's not easy to build your model under this, but that's why you get paid the big bucks, right? A lot of the whole -- a lot of the business that we do into the franchise retail channel gets recorded as wholesale sales because we sell them as a wholesale. And it shows up in the wholesale side of the business. So one of the things Rich and I are contemplating is figuring out if we can break that out so that we get more visibility to everyone, internally and externally, to show how important that subset of our business is becoming to us. So as I say, I think we'd have to separate thinking on how much retail expansion is going to be funded by the use of our own capital as opposed to how much retail expansion is going to be funded by our third parties in particularly, the high-growth markets of Brazil, China and until last week, in Mexico.

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

Okay. And then on emerging markets, obviously you had business pretty nicely in the quarter, and you have a lot of optimism and continued growth there. Is there any way you can give us some context as to how big that business is. I mean, you don't break it out as part of your geographic segment? Is it 5%, 10% of your overall business at this point?

Richard J. Shields

When we think about the emerging markets, just for Q1, I think in the range of -- I think in the range of $60 million, just for Q1.

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

Okay. All right. That's helpful. And then I guess -- lastly, I know that in terms of your Profit Improvement Plans, SKU count reduction is sort of a key component of that, both in terms of gross margin and SG&A. I'm just trying to have a -- I'm trying to understand how to reconcile that we these SMU programs now. I mean is that -- I mean, your SKUs, I would think with these SMU programs, those are all separate SKUs versus sort of in-line products. So are overall SKUs still coming down or SKUs going up because of the SMUs? I mean, how do I think about that, especially as it relates to the Profit Improvement Plan?

Andrew P. Mooney

It's a good question. So as it relates to in-line, even less the 40% reduction that we've gone through, our own retail stores are only able to showcase half of the products that we develop. So in my view, considering how much volume you do on a per-unit basis across the retail store relative to how much volume we do on a per-store basis for our wholesale account, the SKUs that show up in our retail stores should increasingly be close to 100% of the universe of available SKUs. That's a long way of saying that we probably have room to cut SKUs in line by another 40%. So I think in relation to our original Profit Improvement Plan, I think net-net, we'll still end up with significantly less SKUs than we even modeled in the plan and then plenty of room within that to do the type of SMU programs, which they tend to be key-item programs, particularly apparel SMU or footwear for that matter for these larger accounts, if they generally prefer to go narrow and deep as opposed a lot of the specialty retailers who are more collection-oriented and then have like a much broader selection.

Operator

And there are no further questions in the queue.

Robert Jaffe

That concludes today's call. On behalf of everyone here at Quiksilver, thank you for participating. We'll be providing our fiscal 2014 second quarter results in June.

Andrew P. Mooney

Thank you.

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