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Quiksilver, Inc. (NYSE:ZQK)

F3Q2010 Earnings Call Transcript

September 2, 2010 4:30 pm ET

Executives

Bruce Thomas – VP, IR

Bob McKnight – Chairman, President and CEO

Joe Scirocco – CFO and COO

Steve Tully – President, Quiksilver Americas

Analysts

Todd Slater – Lazard Capital Markets

Jeff van Sinderen – B. Riley & Co.

Sean Naughton – Piper Jaffray

Mitch Kummetz – Robert W. Baird & Company

Jim Duffy – Stifel Nicolaus

Claire Vondro [ph] – Jennifer Black & Associates

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. Instructions will be provided at that time for you to queue up for your questions. If you have difficulties hearing the conference please press star then zero for operator assistance at any time. I would like to remind everyone this conference is being recorded. I would now like to introduce Bruce Thomas Quiksilver's Vice President of Investor Relations who will chair this afternoon's conference.

Bruce Thomas

Thanks, operator. Good afternoon everyone and welcome to the Quiksilver’s third quarter fiscal 2010 earnings conference call. Our speakers today are Bob McKnight, our Chairman, President And Chief Executive Officer and Joe Scirocco, our Chief Financial and Operating Officer.

Before we begin, I would like to briefly review the company's Safe Harbor language. Throughout our call today, items may be discussed that are not based on historical facts, and are considered forward-looking statements, within the meaning of the private securities litigation reform act of 1995. In particular, statements regarding Quiksilver's business outlook and future performance constitute forward-looking statements, and results could differ materially from those stated or implied by 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 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 would like to turn the call over to Bob McKnight.

Bob McKnight

Thanks, Bruce. Good afternoon everyone. And thanks for joining us for our third quarter conference call. Over the past two years, we have made many changes within Quiksilver to create a leaner organization that is capable of expanding our leadership of a global action sports industry, while possessing the flexibility to quickly adapt to changes in the worldwide market place.

Dealing with these changes has made us a better company, as we continually strive to make better product and achieve higher levels of operating efficiency. We have risen to the occasion to become sharper, and better. We have become more creative, in leveraging resources and our designs have transformed our vision into innovative new fabrics and constructions. And each season we reinforce our industry-wide product leadership. And despite the economic charge challenges facing the world's economies we're pleased that the action sports industry is very much alive and gaining momentum.

We have seen some great recent examples of action sports becoming more and more prevalent in today's society. Whether it is snowboarding competition, show cased at the Olympics, or Tony hawk attracting tens of thousands of fans in Barcelona, and in Rome during his recent European skate tour, the X Games in Los Angeles, or even the huge crowds at the US Open of surfing here in Huntington Beach, it is clear that the popularity of action sports is growing around the world.

With action sports and the outdoor sports life style as our playing field, we're very pleased to again deliver financial results that exceeded our prior expectations. Our team executed well, in an economic environment that continues to present significant challenges around the world.

Let's now turn to the high level financial highlights from the third quarter. First, pro forma adjusted EBITDA in the quarter was $54 million compared to $44 million in the third quarter of fiscal 2009. That's 23% higher EBITDA despite a 12% revenue decline.

The second highlight is our 560 point basis expansion of gross margin, to 52.3%, compared to 46.7% last year.

Third, operating income in our Americas region, was 11.8% of revenues, as gross margin improved 900 basis points to 46.7%, from 37.7% in Q3 of fiscal 2009.

And fourth, in regard to our improved balance sheet, net debt at quarter's end was $687 million, reflecting a reduction of $183 million or 21% compared to a year-ago.

We're also delighted to report continued substantial improvement to our capital structure especially after completing the debt for equity exchange with Rhone in early August. You know, we were really grateful a year-ago when Rhone offered a senior term debt that we needed to solve our liquidity issues. They saw the value in our business, believed in it and have contributed significantly as Board members.

What they did recently by converting $140 million of debt into equity, at $4.50 per share, was even more impactful. Their equity investment speaks to the confidence they have in our business, and in our management team, and I just want to say how stoked we are to have them as partners.

Let me now take a moment to focus on our brands. I will start with Quiksilver which as you know is by far and away the biggest and most respected action sports life style brand in the world. In fall 2010 – I'm sorry; our fall 2010 line of Cypher Diamond Dobby Board Shorts began arriving in June. We have had great response to these new styles, new prints and new colors which represent best in class innovation and technical fabric and features as well as superior construction.

Our strategy to associate our premium team riders with particular styles of board shorts is working very well, as the Dane Reynolds brigg style has constantly been one of the very best-selling board shorts in the world, but those associated with Kelly Slater, Jeremy Flores and Julian Wilson have also been solid performers at retail.

One of the Quiksilver brands greatest strengths that is we have a broad product offering of – creatively conceived and well made products. Quiksilver’s seasonally popular best sellers in the quarter were wear-now items including walk shorts, woven, T-shirts, lycra, sandals and the aforementioned board shorts.

It is also worth mentioning that we also have an all new category of board short, walk short combos we call amphibian combining Diamond Dobby fabric with board short construction, but these shorts have pockets and belt loops.

We have seen particular interest in our fall core surf collection and our new hanging footwear cruiser boat shoe has had exceptional sell-through in core surf shops online and in mall teen retail chains and in Quiksilver stores.

Retail selling boards [ph] have recently begun the transition to heavier fall product and flannel shirts, fleece and denim are teed up and look fantastic in the stores and we anticipate the arrival of cooler weather. And to no one's surprise our ultra popular backpacks have been flying off the shelves as students prepare themselves for the new school year.

We have always looked for innovative ways to diversify our offerings and to fulfill the needs of our customers. And after nearly three years of consumer studies, market research, conversation, and our best accounts, we – and making sure our global partners were on board with this new project, we come to realize that there is tremendous potential in the juniors market for our globally powerful Quiksilver brand. So in August, we officially launched our Quiksilver Girls line of modern coastal classics.

We outsourced the design to an outsized firm in Los Angeles that we really admire and asked them for an independent look to explore our Quiksilver brand history, to search through our archives of style and print and to create a girls line from the authentic Quiksilver DNA. They did a fantastic job with the design, and have created a line that is completely different than Roxy and anything else in the market today.

Think of it this way. Roxy is all about the girl that lives at the beach more actively based colorful and happy, wild at heart. Think of Quiksilver Girl this way, a timeless classic aesthetic with a modern twist. It is iconic, drawing on 40 years of surf history, more style versus fashion, but still on trend.

Quiksilver Girls is more subdued, a bit more romantic and timeless. Through our extensive focus groups and research, we know that 95% of our customer base isn't aware at all that Roxy is related to Quiksilver. It is, in fact, a stand-alone brand.

The new line, which will debut in spring of 2011, was designed to appeal to the 18 to 24-year-old girl, with a coastal mindset and independent spirit. Built on a classic understated aesthetic with great washes and great quality fabrics, finishing and fit, this line will appeal to a girl with a more timeless aesthetic. The coastal spirit will be built into every garment, giving it an authentic edge. Priced in the mid tier range of the juniors market at 24 to $88, the new line will be available at select surf specialty retailers. Quiksilver stores and online retailers, and will complement the Quiksilver women's collection. The line is has just debuted to a very positive feedback and we have used a really creative and innovative way of launching – a launching mechanism to maximize productivity and inspire our accounts.

We provided our top accounts with preconfigured apple iPads in order to best display brand and product imagery and to enable them to place and track orders for the new line. The stores are absolutely thrilled with this roll-out and early response to the new line, as I said, has been terrific from both retailers and the press. And we're very excited about the prospects for this new venture.

Now that we have defined the Quiksilver Girls style as modern coastal classic with an understated aesthetic, let's turn now to Roxy, the younger sibling who has got sand in her pockets from her time on the beach, she is fun and alive, daring and confident, naturally beautiful. The Roxy brand is the largest and most respected and most recognized girls' action sports brand in the world. Despite our position as market leader, we continue to see fast fashion, and price-driven goods impact the branded segment of the juniors market for all surf, skate and snow companies.

Retailers continue to order cautiously and are planning their businesses conservatively overall so that they can respond to in season trends. The sportswear category continues to be challenging at retail, but Roxy's broadly diversified offering competes in many different segments around the world and creates a substantial size difference for our Number one girls action sports brand as compared to our nearest competitor in the space.

For fall 2010, backpacks, dresses and swimwear have driven our sales number while our younger Roxy Girl line saw improvement early in the back-to-school season. Our overall ongoing performance of Roxy appears to be in line with the current market, especially with regard to seasonal wear-now items such as sandals, fashion knits and accessories which are selling well.

The comprehensive core marketing, market strategy for Roxy that we launched earlier this year has been well received by core shops and we saw instances of slightly better sales as a result. We expect a viral marketing in-store presence and additional marketing within the core community will successfully drive further traction for this important initiative.

And, during the recent trade show season in August, we began to show the refocused Roxy line for spring 2011. The product looks great and is reminiscent of the original surf-inspired Roxy with modern fabric and touches of updated styling. Reaction to the line has been strong and we look forward to the remainder of the selling season for spring. For the time being, the juniors market continues to be a challenge for branded girls' surf apparel.

Nonetheless we will continue to create exciting and innovative products and reach out to our loyal customer base in new and interesting ways, while partnering with our core accounts. And we will remain true to the Roxy brand heritage as we ride it out.

Turning now to our powerful and incredibly popular brand DC. Focused on innovation and thorough understanding of the skate, snow, street and moto markets, DC continues to impress retailers with their new products and their ability to attract attention. The third quarter for D.C. grew progressively better with strong footwear and apparel selling, driven by the back-to-school season. DC 's core surf strategy rolled out earlier this year, as we unified our effort to return to the brand’s heritage as a leader within the skate shop community.

DC sales at core retailers grew more than 20% in Q3, and we look forward to continued strong traction within this key segment of our distribution. Demand for products from our multi-logo TeamWorks collection has grown even stronger in the third quarter. This line of integrated footwear and apparel features action sports athlete such as professional rally driver Ken Block. Motocross icon and rally driver Travis Pastrana and BMX legend conditional Dave Mirra. Sell-through has been very strong for these items and the back-to-school season has provided even further acceleration.

And we expect another spark of inspiration from the TeamWorks line with the release of Ken Block's new Gymkhana 3 sales. As an example of truly awesome online exposure, collectively, the sensational Gymkhana related viral videos have been viewed nearly 30 million times on YouTube.

Before we move on to the financial details I would like to mention a few of our athletes and events that helped to boost our world wide exposure in the third quarter. First, somewhat I mentioned earlier, legendary skateboarder and Quiksilver skate team rider Tony Hawk was very busy this summer, entertaining fans around the world, and attracting attention to skateboarding and to Quiksilver.

The Tony Hawk and Friends – European Skateboard Tour hit a number of major cities like Paris, Berlin, Brighton and Rome. The tour culminated with Tony leading – I'm sorry, landing his signature trick in front of 25,000 screaming fans at the plaza Del Mar beach in Barcelona. Tony returned to the States to headline jam-packed events at downtown Disney in Anaheim, and in support of our customer (inaudible) somewhere at their summer solstice event in Santa Monica.

Tony is a great ambassador for skateboarding and for Quiksilver. He's very well connected to today's youth through his website and his enormous twitter following now numbering over 2.1 million followers. He's easily the most widely recognized of our athletes and is perhaps the most visible and globally recognized action sports star ever.

In August, in conjunction with Red Bull, we hosted the world premiere of the innovative

New movie Scratching The Surface starring Quiksilver rider and Australian phenom Julian Wilson. This movie is packed with amazing surf footage and does a great job of show casing Julian and our Quiksilver logo and brand.

Legendary Quiksilver surf team rider Kelly Slater remains in the running for an unprecedented 10th world title after his victory earlier this year at Bells Beach in Australia and a second place finish in Brazil.

Soul Surfer Dane Reynolds our surf team rider for Quiksilver and for DC has done a remarkable job of translating his talent as the world's most creative free-thinking, free surfer into success on the ASP World Tour and is currently ranked fourth in the world. Through his amazing aerials in the water and his unique creativity on land, Dane has become one of the most popular action sports personalities on the planet.

On the women's side, our Roxy Jam and Biarritz drew 25,000 fans for five days of competition, competitive surfing, music concerts and art exhibitions on the shores of South France. And in 2002, as you remember, the feature film Blue Crush inspired and attracted thousands of teenage girls to the sport of surfing. So in an effort to reach a new generation of young girls Roxy has partnered with universal pictures for the new feature movie Blue Crush 2. This is sequel to the epic original that was shot in South Africa and follows the story of a young woman on a journey of self discovery through a passion for surfing. Featuring Roxy surfer Sally Fitzgibbons, Laura Enever and Rosy Hodge in action, the movie is set to premiere in June of 2011.

These athletes and events provide just a glimpse of our involvement in the action sports landscape and we have done well to associate our brands with personalities that attract attention in a broad and positive fashion. In addition, we work hard to handpick the events and projects that we invest in, to maximize our reach and position ourselves to benefit from the popularity of the sports as they evolve.

We have also expanded some events to include music, fashion, food, and other art forms, to better connect to our core demographic of culturally aware teenagers, with diverse interests.

So, in summary, we're delighted that the changes we have made over the last two years to improve our business and better leverage our resources, continue to payoff. And have again helped us to deliver better than expected results.

Joe will now take you through the financial details.

Joe Scirocco

Thanks, Bob. Good afternoon everyone. As reported, consolidated net revenues declined 12% to $441 million in the third quarter in line with the outlook we provided a quarter ago.

Revenues were down 10% in constant currency. Note that we translated the euro at $1.39 last year versus $1.25 this year and the Australian dollar at $0.79 last year versus $0.87 this year.

In the Americas, revenues were down 9% compared to last year with contraction in the whole sale channel being slightly offset by modest growth in our retail stores. Quiksilver brand revenues were up modestly in the quarter and revenues for DC were down somewhat while Roxy’s decline was consistent with the continued challenges that the juniors business represents for us and for our peers in the industry.

Our own retail store comps in the US were again modestly positive overall in Q3, and we were encouraged to see strong in-store gains in the Quiksilver and DC brands, for the second consecutive quarter.

Note that we closed a net of 12 underperforming company-owned retail stores in the Americas since the end of the third quarter, 2009 including two stores that we closed in the third quarter. European revenues were down 11% in constant currency for the quarter, and were roughly in line with our prior expectations with reductions in all three of our major brands.

As much of the world's attention continues to focus on the economies of Europe, consumer spending remains a concern in certain markets, such as Spain and particularly in the UK. However, we remain confident that these economic pressures are not threatening our leading market positions in Europe. Our retail comps were down in the mid single digits on a percentage basis for the quarter with June standing out as clearly the toughest month for our business there.

We opened a net of 12 new shops and concessions in Europe over the last year. But the number of company-owned stores in Europe did not change during the third quarter, as we opened as many stores as we closed.

Asia-Pacific revenues as reported were virtually unchanged compared to last year and down approximately 10% in constant currency, primarily due to market weakness in Australia. For the entire region, we added a net of nine new shops in the quarter and 37 net new shops concessions, and shop-in-shops during the past year. Over an extended period our business in the region has migrated to a retail model, in which our own stores contribute approximately 40% of our revenues.

We expanded consolidated gross margins by 560 basis points to 52.3% for the quarter, somewhat better than we expected. We continue to control inventories in line with demand, resulting in significantly lower levels of discounting and clearance sales than we experienced a year-ago. In addition, we continue to deliver on our key sourcing initiatives.

Our Americas business again delivered the largest improvement in margins, 900 basis points, while Europe's margin expanded 310 basis points.

We reduced our pro forma SG&A expenses in Q3 by $7 million in constant currency. Included in pro forma SG&A, was $1.9 million in restructuring charges, mostly related to the relocation of DC's facilities from Vista, California, to our headquarters location in Huntington Beach.

Also, the reductions occurred in the Americas region, while in Europe we cut costs in our wholesale business, but incurred incremental costs associated with new retail stores, open during the past 12 months. We also recorded $3.2 million of asset impairment charges.

As a result of these factors, we generated pro forma operating income of $40 million in the third quarter or 9% of sales up from $31 million or 6% of sales in the same quarter a year-ago. And we continue to focus our attention on EBITDA as a key member – key measure of our performance, so we're pleased that we generated pro forma EBITDA of $54 million, or 12% of sales, compared to $44 million, or 9% of sales a year-ago.

Interest expense was $21 million in the quarter, up from $15 million last year and in line with our expectations. Our tax provision in the quarter of $5 million was lower than expected, due to the timing of recognition of some charges that we now expect will hit in Q4. After interest and taxes, our pro forma consolidated income from continuing operations for the third quarter, was $13 million or $0.08 per share compared to pro forma income of $4 million, or $0.03 per share in the same quarter a year-ago.

I would now like to turn your attention to the balance sheet for a few moments, and in particular, the continued improvement in our working capital position.

Receivables at $341 million are 20% lower than for the same period last year and down 18% in constant currency. On an overall basis, DSOs decreased by six days to 65 days this year, compared with 71 days in the third quarter a year-ago.

Additionally, inventory at quarter-end was $271 million, down 19% as reported and down 18% in constant currency, compared to the same period last year. Our Americas business accounted for approximately two-thirds of the reduction. As evidenced by our performance, particularly over the past three quarters, we continue to successfully reduce inventory on a global basis, bringing supply and demand into balance.

CapEx was $11 million in the quarter, somewhat below our plans. We ended the quarter with approximately $167 million of availability under our credit lines, approximately $156 million of unrestricted cash, and we reduced our total debt to approximately $843 million.

Just after the quarter ended, in early August, we completed a debt for equity exchange with Rhone in which we exchanged $140 million of our term debt, or 31.1 million shares of common stock, priced at $4.50 per share. In addition, to further reducing our debt to approximately $700 million, this transaction also reduces annual interest expense by about $26 million.

The significant progress we have made over the past year, in improving our profitability, while reducing our debt has driven our leverage ratio of 5.4 times a year-ago down to 3.4 times, after taking into account, the debt for equity exchange. Clearly, we have made enormous progress in improving our capital structure.

Our improved balance sheet coupled with improved bank market conditions, has also led to a better position with respect to our other financings. As we announced earlier today, we have amended and expanded our asset-backed line of credit in the Americas under substantially better terms.

In addition, we expect to replace the remaining $24 million stub of the Rhone term loans with new term debt under significantly better terms before the end of the fiscal year.

Now let's turn our attention to our outlook. We expect fourth quarter now, revenues to be down. 15% after accounting for a weaker translation rate on the euro and the marked decline in consumer demand in the Asia-Pacific region. Considering that our inventory levels are well aligned with demand and given our continued progress on initial product gross margin initiatives we expect to be able to deliver between 400 and 450 basis points of gross margin improvement in the fourth quarter compared to last year's margins.

Pro forma operating expenses in the fourth quarter are expected to be as much as 7% lower than in the fourth quarter of fiscal 2009 when pro forma SG&A was approximately $218 million and we're anticipating interest expense of about $14 million in the quarter, after adjusting for the impact of the debt for equity exchange.

We expect that our tax provision in the fourth quarter will swing in the opposite direction than it did in Q3, because of the timing of recognition of some charges I spoke of earlier. As a result, we expect taxes in Q4 to be approximately $11 million.

Summing up the parts therefore, we expect to generate EPS on a diluted basis in the mid-single digit range in our fourth fiscal quarter. And I'm sure that many of you are thinking ahead to fiscal 2011. We will provide our 2011 outlook when we report the fourth quarter. But in the meantime, I would like to comment on two of the underlying trends and assumptions that we know are on your radar screens.

First, everyone has been reading about rising costs in Asia sourcing countries, including both FOB value of goods and freight costs. We have already bought goods for the spring season, so this could affect us later in 2011. To frame the issue, a 5% increase in the landed price of Asian goods could produce a 20 to $25 million change in EBITDA for 2011. Assuming that none of the change would be passed along to consumers through higher prices. This is still to be determined.

Second, it now looks like the average exchange rate for translating the euro for the current fiscal year will be around $1.32. And most analysts are predicting that the rate will move lower. Keep in mind that a nickel move in the exchange rate like from 1.32 down to 1.27 translates to roughly $25 million of revenue for Europe, approximately $4 million of EBITDA and roughly one penny of earnings.

One final note, when we account for the debt for equity exchange in the fourth quarter, we will have to record the write-off of warrant value and deferred debt issuance costs, associated with the Rhone’s term loan financing. These amounts total approximately $33.2 million, provided we have refinanced the remaining stub as expected. And this would be reported as special charges. The charges would be non-cash, non-operating in nature and have no effect on our operations or debt covenants.

With that I will turn the call back to Bob for closing comments.

Bob McKnight

We're delighted with our better than expected financial performance in the third quarter. Significant changes we have made over the past two years to align our business with today's markets have us well positioned for future opportunity.

We have enabled higher levels of operating efficiency that are driving dramatic improvements in execution. Through and all, we have continued to produce great products through innovation, and have an intimate understanding of our markets and I am proud of our continued leadership in the action sports markets driven by our great Quiksilver, Roxy, and DC brands.

Thank you.

Bruce Thomas

Operator, that concludes our prepared comments. We are now ready for the questions and answer session

Questions-and-Answer Session

Operator

(Operator Instructions) We will go first to Todd Slater with Lazard Capital Markets.

Todd Slater – Lazard Capital Markets

Thanks very much. Good afternoon everybody. I wonder if you could just give us a sense how things have been tracking in August, relative to the trends that you saw in June and July and with regard to your fourth quarter outlook down mid-teens could you give us a sense how much of that is sports-related and how much is brand weakness and make provide some color on the outlook in terms of the changes up or down in the three core brands? And also if you could just talk a little bit more about what's happening in the Asia-Pacific region, specifically? Thank you.

Bob McKnight

Okay so maybe so, Steve, you want to just take current trends?

Steve Tully

I will take the first part. I think your question was retail trends in terms of pace. Recently as compared to early August? Is that what you asked?

Todd Slater – Lazard Capital Markets

No – yes recently, in the month of August versus July and June.

Steve Tully

Yeah.

Todd Slater – Lazard Capital Markets

I think you said June was your toughest month of the quarter?

Steve Tully

Yeah. July was challenging as well. August, a little bit of a sluggish start but recently in particular, in the last couple of weeks, we have seen a market pick-up from the back-to-school sales. Now we're in September, we have even had, you know quite a few – a couple pretty good days in September so, summary, I think we have seen it pick-up towards the end of August and early September.

Joe Scirocco

I think the same is true outside the US. We see pretty consistent performance in the retail stores. There has been a market decline in the Asia-Pacific business, and that's obviously in our forecast going out.

I think you asked about that one specifically, so, you know, I mean, we can confirm what you have been hearing and readings and with others about business in the Australian market for sure. What were some of the other parts of your question?

Todd Slater – Lazard Capital Markets

Well, just if you take – if you look at your fourth quarter outlook, you talk about the changes, the brands, the three core brands sort of where the biggest weakness or where there is – maybe some improvement in that guidance?

Joe Scirocco

Sure. So, just to frame the issues, our European business in the fourth quarter probably would do somewhere in the range of 140 million or so in Euros. So that, – the change in currency, which is now down in the 1.20s as compared to last year when we were probably somewhere in the high 1.30s will have an adverse impact and that's below what we were estimating. That's part of the change.

Also in Asia-Pacific, in Q4, typically we do around 90 to AUD100 million, so, we do get a little bit of a tick-up there in terms currency but that business is down substantially because of the market fall-off. So, those are kind of the forces that we're dealing with.

And then, as we look out in Q4, no real change in terms of the brand performance and expectations. It is kind of in line with trends that we have talked about previously. So, looking at Quiksilver, sort of down mid-single digits across the globe; Roxy is the toughest business, and the majority, you know, of the decline is in the Americas region, but this negative juniors trend is happening really globally.

And then DC continues to perform well. We look at Q4 and we see it down in the US and Asia-Pacific, consistent with bookings because we have tightened up distribution quite a bit this year and a lot of the reduction in volume is reduction in clearance sales, and reduction in – it is just an improvement in the overall quality of sales.

So that is what is driving the gross margin improvement. Bottom line on all of this really is that, juniors business is challenged but the brands remain very strong, and a lot of the contraction that we're seeing this year in volume is intentional. It is done as part of our plan to clean up distribution, to get better, higher quality sales and it is coming through very strongly in the gross margin.

Todd Slater – Lazard Capital Markets

That's great. Thank you, Joe and good luck in the quarter.

Joe Scirocco

Thanks.

Operator

Next, we will move on to Jeff van Sinderen with B. Riley & Co.

Jeff van Sinderen – B. Riley & Co.

Hi, good afternoon. I know you guys said that your comps increased in your domestic retail stores. Just wondering what you experienced with traffic in terms of throughout the quarter. I know you mentioned back-to-school has started to get better. Also what your promotional cadence was like this year and merchandise margins in your own domestic retail stores and also, if you have anything you have been hearing on mall traffic in general?

Steve Tully

Yeah. Hey, Jeff, Tully here. I will just address the mall traffic. I think it is probably –remains the most difficult channel for us – is the mall business. We – everyone knows the weather patterns on the east coast, so our specialty business on the east coast in particular has remained strong throughout spring/summer, remained strong, the hurricane not withstanding for back-to-school, depends on where you really are on the west coast, a bit up-and-down again because of the weather but specialty based channel, I think it is safe to say that retailers are on plan and inventories are in line and our brands are holding their own in that channel.

But mall-base continues to be challenged and in particular the department store channel continues to be challenged. More so on the junior side, making plans on the men's side of the business but more so on the juniors side.

Jeff van Sinderen – B. Riley & Co.

Okay good. That's helpful. And then in terms of the Roxy brand. I know it is a very tough environment and has been for really all brands in your space, but where do you feel like you are at this point in terms of evolving Roxy with brand positioning, style content and everything else that you feel like you need to evolve, in terms of turning that business around?

Steve Tully

Well, Bob mentioned some things in our prepared remarks but I would say that, not to be redundant but, you know, we're coming to market with a refreshed product line and refreshed image, total coordinated effort internally here. We're focusing on key iconic products within the brand that include swimwear and board shorts, beach and active sandals, beach dresses, we have a beach pant.

For the first time ever, you're going to see us market specific products under the Roxy brand and we're feeling like, and I should mention also that sportswear is the biggest challenge within the brand. But you know we have a diversified product offering and our sandal and footwear business, in fact, is very good. Our swimwear business held its own at the specialty channel, challenged at the larger mall channel but held their own in the specialty channel and our accessories in the little girls' business remains fairly good and on plan.

It is the sportswear – broader-based sportswear line where we have the most challenge and, as we said, we believe in this brand, this business. We are still the market leader and we still have the process – we're beginning this process with spring, and you know we're – our products represent quality branded products and so, a lot of stuff going on out there isn't so focused on quality. It isn't so – doesn't have the brand heritage that we do so, we certainly think that could be short-lived and our products are going to represent quality and long-term growth for our customers.

Jeff van Sinderen – B. Riley & Co.

Okay, good. And then can you elaborate a little more on trends you're seeing with DC and how you expect that business to evolve over the next couple of quarters?

Bob McKnight

Yeah. I mean, as you know, we have worked real hard with DC to make sure it is back in the core in a really positive way. We're also – shoes notwithstanding, I mean, we have added the vulcanized area and different price points now (inaudible) a real focus on a certain price point and certain technology. Now we’re – with varying technology with different price points; that has really helped our focus on the core customer, but, this whole moto thing is really exploding. And we're very relevant in that area with our riders, and our focus, and our product ranges that are – they are gravitated around different stars within those sports – Ken Block, Travis Pastrana like I talked about. So DC is doing very well.

There are still some – a lot of markets that we have not really forged a lot of distribution that we're doing now so it has a lot of global growth to go, like I say, we have done a great job in America. A little bit more of a, you know that we have been here for awhile so it's a more mature market for us but there certainly is tons of growth for DC in the moto area, especially when you start talking about apparel for girls and guys to that customer. So we're pretty excited about the prospects.

Jeff van Sinderen – B. Riley & Co.

Okay, great to hear. Thanks very much. And good luck for the rest of the quarter.

Bob McKnight

Thank you.

Operator

And then from Piper Jaffray, Sean Naughton.

Sean Naughton – Piper Jaffray

My question. On the European segment, Joe, I think you mentioned that Spain and the UK had been relatively difficult markets. You have got, I think a relatively large business in France as well. Could you just talk about how those other businesses are performing and whether you're seeing weakness both in the retail seg – your old retail segment there and any of your wholesale partners as well?

Joe Scirocco

Sure, sure. Well, although, France was, as a country, was reported lower revenues, somewhat lower revenue in the quarter, that is in line with bookings that we have expected. We do see in France, and we expect positive orders, on the men's side of the business for spring and summer. So we're feeling much better about that.

We talked a little bit about, yes, about in the Americas, cutting back on certain distribution, to clean it up and to focus on better quality sales and that is part of what is driving the lower volume in Europe as well so, again you saw 310 basis point improvement in margin. In the UK, I guess there are really a couple of issues there that are unique to that market. One is, the pricing pressures because of prevalence of discounters that exist in the market.

You also have a little bit of a style preference that – other alternatives for consumers that take them away from the surf lifestyle apparel.

And on the retail side, since you mentioned, that is a particularly tough market for us because the rents are high and the rent deals are somewhat rigid. So, it makes it a tough market in which to compete as a retailer.

Other than the UK though, we feel very good about the continuing prospects there. I mean, the Czech Republic, Russia, Switzerland, Germany are recovering nicely. Business is coming back. We feel pretty positive about what to expect for the spring/ summer bookings which are currently underway so that's all good stuff.

Sean Naughton – Piper Jaffray

Yes, okay. And then in terms of – in the Americas region, by channel, can you talk about the trends with your core and independent shops kind of across the US and have you seen any improvements in the channels sequentially from Q2? It sounded like DC was pretty strong in the quarter but with Quiksilver and Roxy experiencing some of those benefits as well, and then secondly, I think Steve, you talked about the specialty mall-based retailers having a little more difficulty but is your wholesale business with the department store channel, in the mall, getting a little bit better? Thanks.

Steve Tully

Yeah, well, I will answer the first part. I think it's the part – there are several types of retailers in the malls as we know with department stores I would say that our Quiksilver business to the extent we have a DC business there we're on plan. I think it is in different areas of Roxy is a different story but we're on plan. I think we're challenged as I mentioned earlier in the sportswear area and challenged a little bit in the girls area but I was remiss in not pointing out how good our DC business is in what we refer to as the team change. It is very good,

Bob mentioned the moto efforts that we're making with the Ken Block, Ford Motor Company product.

Again, it's sort of understating but that business is very good for us. The new footwear products introduced at that channel, so, in terms of – yeah and in our DC business is up in our own stores as well which is a great barometer of how things are going.

In terms of channels, I'm trying to think of different from what I said before but – or I would say it this way. Our Quiksilver business is holding its own in making plans pretty much nationally, same for DC and pretty much all channels for distribution, the best channel is the specialty – surf specialty channel out there right now.

Sean Naughton – Piper Jaffray

Okay. And then Joe, maybe lastly, I might have missed this. But I think you talked – you just renegotiated part of your line here domestically. You know what benefit could we potentially be seeing on the interest expense line moving forward here? Thank you.

Joe Scirocco

Well, it is a $150 million line. And these commitment fees are a 50 basis point savings on that so we're not drawing on the line yeah but depending on how we go towards the end of the year, we could be drawing.

And when we do, we have brought interest rates in by 150 to 200 basis points depending on our grading. So it could be on the order of $1 million or so over the course of the year but I think the important thing about it is that we now have something in place for four years, that's sized appropriately for us, that is lower cost, it's more flexible, and is just an indication of the improvements that we have made.

And we have more to go, just alluded to the fact that, we have a remaining stub on the Rhone loan debt which is $23 million and we're looking to take that out with some additional term debt very soon, this quarter. And, we would expect probably, to come down from the 15% interest rate, probably take 800 basis points off of that.

Sean Naughton – Piper Jaffray

Okay, great, thank you.

Operator

And from Robert Baird, Mitch Kummetz.

Mitch Kummetz – Robert W. Baird & Company

Yeah, thank you. A few questions, first for Steve. On the juniors business, I know you guys have been at trade shows over the last month and that continues next week but as you're talking to retailers and taking orders, how are they thinking become juniors for spring 2011?

Are they still taking a caution stance on that business based on what trends have been or are they starting to get a little more optimistic about it given maybe some events that might transpire next year with Blue Crush 2 and Soul Surfer? Can you just talk a little bit about that?

Bob McKnight

Yeah, I think they are continuing to take a cautious approach just for all the current economic reasons but I do believe as we talk about next year and as we talk about some of those things that you mentioned there is reason to be optimistic.

And most importantly, they are very eager to see how we're approaching it in terms of our product, and our marketing, and our general approach with the Roxy business and they are pleased with what they see. I think it is probably fair to say that business has reached a point where the decline is slowing, their inventories are in line.

So, there is not as much – there is not really any more shrinkage in terms of the floor space that is allocated to juniors. I don't think anybody is getting out of the juniors business. I think everybody is anxious to start to move the thing in the other direction and looking to companies like ours to provide that impetus.

Mitch Kummetz – Robert W. Baird & Company

Okay that is helpful. And then Joe, a few questions for you. First of all, this is housekeeping what's the share count that is baked into the guidance for Q4?

Joe Scirocco

About 180 million.

Mitch Kummetz – Robert W. Baird & Company

Okay. And then on the gross margin improvement that you saw in the quarter, I think you said about 560 basis points. Could you say how much of that was, just fewer close-outs based on a better inventory position, versus the sourcing and then maybe how those two will impact the gross margin improvement that you are expecting in the fourth quarter?

Joe Scirocco

Yes, I – the vast majority of it is in fact, a better mix of sales because we have cleaned inventory so well. We were liquidating goods very heavily last year in the fourth quarter of 2009. We were pushing a ton of goods through our outlet stores. And so as we look at the outlet business in the third quarter and we saw – it was probably about – between 700 and 900 basis points improvement in gross margin, just in that distribution.

So that's the vast majority of it. A lot of the sourcing initiatives that we've put in place, at this point, have been anniversaried and contribute a somewhat declining measure of the gross margin improvement although we have bought goods through spring and we see that benefit continuing. I think when you get beyond spring, it is a little more of an open question as to what to expect.

Mitch Kummetz – Robert W. Baird & Company

Okay. And then lastly, Joe, on the SG&A, I'm not sure I caught exactly what you said in terms of the guidance. You said down 7% from last year but I think you put a number out for last year that isn't necessarily what I have in the model. Can you just repeat what you were saying there and what is driving the drop in SG&A?

Joe Scirocco

Well, first of all, I think I may have misspoken on the prepared remarks. I think I said that a special charge was included in SG&A for the quarter, and I – what I meant to say, excluded. As we look out to SG&A for Q4, last year, we reported 218 million on a pro forma basis excluding impairments and special charges, and so this year we're looking at something in the range to 200 to 205, so about 7% down.

Mitch Kummetz – Robert W. Baird & Company

Okay. And where are you seeing a drop in the SG&A, are certain areas where you really focused on cutting costs or –?

Joe Scirocco

We have not yet fully anniversaried the cost reductions in the Americas region. That was the biggest region of cuts and we implemented them pretty much on November 1 of this fiscal year. So, the fourth quarter is the last quarter of those and that improvement is going to drive this difference.

In absolute dollars, in terms of the SG&A, we also have an improvement that comes from the currency translation of our European business, offset a little bit by currency going the other way in South-Pac. So the bottom line is the major reduction is coming out of the Americas region.

Mitch Kummetz – Robert W. Baird & Company

Got it. Okay, thanks good luck.

Joe Scirocco

Thank you.

Operator

Jim Duffy from Stifel Nicolaus with our next question.

Jim Duffy – Stifel Nicolaus

Thanks. Good afternoon everyone. Joe, the balance sheet is in a much better place. Nice work with that. Related to this, you had mentioned an effort to focus on higher-quality revenue clearly walking away from some of the lower quality revenues helped the gross margins and the working capital demands. Are you at the right run-rate now or as you look out to 2011, are there further plans to intentionally walk away from some lower quality revenue?

Joe Scirocco

Well, I think we have got the inventory supply in line with demand at this point, and we're at a much more normalized level.

Jim Duffy – Stifel Nicolaus

Okay so, you would look like this as a normalized level from here.

Joe Scirocco

Yes, I mean, look, we always try to improve but we don't have major work to do at this point.

Jim Duffy – Stifel Nicolaus

Okay. That's helpful. Thanks. And then on the SG&A line, is there further room to pull back here? Or, looking forward is really growing gross profit dollars the key to operating leverage?

Joe Scirocco

Well, I think the key to operating leverage frankly is getting higher sales through the retail channel – through our own retail stores. And those areas of the business in which we have a fixed cost infrastructure. So, it is basically retail stores and eCommerce are going to be the two areas at which we can most drive leverage.

In terms of gross margin leverage, I would just again repeat the commentary about expected cost increases. And 2011 is a bit of a question mark on what's going to happen there. But, we have taken out essentially all the costs that we can without some further investment in new systems, to give us the ability to be more efficient operationally. We can't continue to cut the way we have cut without some investment in infrastructure.

Jim Duffy – Stifel Nicolaus

Okay. That's helpful. And then last question, maybe best directed to Steve. The preliminary discussions you've had with retailers about inflationary pressures and pricing, what is the kind of the chatter around the industry? Is – does everyone expect to take price? Clearly, it is a competitive landscape, pulling out your crystal ball, how would you see that sorting out?

Steve Tully

Yeah boy, I am just trying to figure out how to answer that because no one wants to pay more money. I think it really depends on the product category what the market will bear, the demand for the product category from the consumer and obviously, if we gauge that, that demand is high, it gives us a little more leverage to do that.

Jim Duffy – Stifel Nicolaus

With the products maybe where you have more differentiation, there is more room on pricing?

Steve Tully

Yeah, for example, technical (inaudible) shorts will be one of those areas where we think there is a reason the consumer will pay more for those and there is more added value and so forth. But it is very competitive out there as you know.

Jim Duffy – Stifel Nicolaus

Okay, great, thanks.

Bruce Thomas

Okay operator, I think we have time for one more question.

Operator

Thank you. We will take that from Jennifer Black with Jennifer Black & Associates.

Claire Vondro – Jennifer Black & Associates

Hi, this is Claire Vondro [ph] for Jennifer Black.

Joe Scirocco

Hi, Claire.

Claire Vondro – Jennifer Black & Associates

Hi, I saw your upcoming lines at ASR and they look fantastic. And I know you have had a good response to them so I wondered if you have any further insights into late spring and early summer?

Bob McKnight

Well, Claire, I don't know that we have much further since the Action Sports Show couple weeks ago. All of our sales teams are out there collecting spring 2011 April I would say, I would say as we've said on the call we're very pleased with the reaction we have gotten.

One thing, perhaps we didn't say about the juniors marketplace, in – how challenge it is, but our retailers have also said, show us something new, we want to see something new and we have done that with our Quiksilver Girls line that we're out there debuting right now, if you do get a chance to take a peek at that.

Claire Vondro – Jennifer Black & Associates

Yeah, I did; it looks really good.

Bob McKnight

Yeah. And so, the reaction we have gotten across the board has been consistent, and we're very pleased about that. I think the next 30 to 45 days will tell in terms of the order book coming in. And I think that's discussions from my colleagues that it's the same way around the Europe as well.

Claire Vondro – Jennifer Black & Associates

Okay, great. Thank you so much.

Bruce Thomas

Okay, that concludes our call today. On behalf of everyone here at Quiksilver, thank you for participating. And we look forward to providing our fourth quarter and full year fiscal 2010 results in December.

Operator

Ladies and gentlemen, that does conclude today's conference. We thank you for your participation.

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