Quiksilver's (ZQK) CEO Andy Mooney on Q3 2014 Results - Earnings Call Transcript

Sep. 4.14 | About: Quiksilver, Inc. (ZQK)

Quiksilver, Inc. (NYSE:ZQK)

Q3 2014 Earnings Conference Call

September 04, 2014 04:30 pm ET

Executives

Robert Jaffe - Investor Relations

Andy Mooney - President, Chief Executive Officer, Director

Richard Shields - Chief Financial Officer

Analysts

Taposh Bari - Goldman Sachs

Jeff Van Sinderen - B. Riley

Joe Bess - Roth Capital Partners

Andrew Burns - D.A. Davidson

Christian Buss - Credit Suisse

Operator

Good day, everyone. Welcome to the Quiksilver Incorporated Fiscal 2014 Third Quarter Financial Results Conference Call. Today's call is being recorded.

At this time, I would like to turn the call over to Robert Jaffe. Please go ahead, sir.

Robert Jaffe

Thank you, operator. Good afternoon, everyone, and welcome to the Quiksilver fiscal 2014 third 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 would like to briefly review the Company's Safe Harbor statement. Throughout our call today, items may be discussed that are not based on historical facts and are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

In particular, statements regarding Quiksilver's business outlook and future performance constitute forward-looking statements. 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, September 4, 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.

Andy Mooney

Thank you, Robert. Welcome everyone, and thank you for joining our call today. I will begin by updating everyone on progress, data, key initiatives and our profit improvement plan, comment on our Q3 performance and then discuss the spring '15 order book. Rich will then discuss the Q3 financial results in more detail.

We have now globalized every function of the company and product, we have one global design center for all three brands in apparel in St. Jean de Luz, France and and one design center for all three brands in footwear in Huntington Beach. As spring '15 product lines were the first to be developed in these design centers and response to the product offering from retailers has been positive.

We expect our product offerings to get stronger and stronger from here and I'm excited by our fall '15 product lines, which are close to being finalized already.

We fully globalized supply chain, including sourcing and demand planning. From spring '15, we will serve needs for accounts in terms of order fulfillment and on-time delivery better than ever in our history.

We have now globalized marketing, we now manage our brands globally, develop global ad campaigns and execute locally. We continued to restructure the composition of our marketing spending and will increase media spending by 50% in spring 2015. We fundamentally restructured a wholesale sales team in each region to create dedicated teams focused on core independent retailers, distinct from dedicated teams focused on multi-door key accounts such as Macy's, Dick's or [sports check] in North America, or El Corte Ingles or Decathlon in Europe, and we moved the large number of small independent accounts to a B2B service model.

We appointed a Global Head of Sales, [Alan]. Alan is working with the regional sales leaders to create consistent global processes to improve both, the efficiency and the effectiveness of our sales teams. It' has been a pretty busy summer, so as expected however the quarter itself proved to be challenging.

A positive note in Q3, we delivered continued growth in B2C businesses, driven by lower single digit comps in their own retail stores and double-digit growth in our e-commerce businesses.

Emerging market revenues in Brazil, Russia, Indonesia, China and Mexico combined grew 4% year-to-date. Emerging market revenues for the trailing 12 months totaled $208 million 29% over the prior year. Asia-Pacific will overall return to growth for the quarter and is positioned well for future growth.

This however was more than offset by decline of 30% in our wholesale business in North America after adjusting for the transition of kid's apparel business to license model and a decline of 32% on our wholesale business in Europe.

I want to take a few minutes to address the decline in our wholesale businesses in both regions and then speak to the initiatives in place to return the company to top-line and to bottom-line growth.

There were a number of factors contributing to the Q3 decline in our wholesale in revenues North America. We transitioned DC and Quiksilver kid's apparel to a licensed business model beginning in Q3. These businesses contributed $11 million in revenues prior year in North America and accounted for 16% of our wholesale decline there for Q3.

We continue to make progress on licensing as initiative. Having license categories historically have generated approximately a $100 million in global revenues as well as licensing new categories that would generate highly incremental revenues in the future. By way of remainder of profit improvement plan identified categories generating 10% of the revenues is having the potential to be licensed.

We believe then and continue to believe, the licensing these categories to world-class partners would enable us to focus internal resources contribute to our overall plan to reduce SKUs, reduce SG&A and generate EBITDA gains. After considering the licensing of kids apparel, DC Quiksilver and Roxy brand revenues North America declined 44%, 19% and 13%, respectively.

In the case of DC, we continued to peer back distribution to the appropriate number of accounts and doors to improve sell-through rates and brand equity, including reducing low-margin sales to the clearance channels. In the case of Quiksilver and Roxy, the declines reflect reduced fall '14 orders as a result slow sell-through of prior collections.

Moving to Europe, our whole order book for fall '14 was 12% down, driven largely by reduced Quiksilver and Roxy preorders also results of slow prior season sell-through. Additionally, we experienced late deliveries in both regions, but particularly in Europe as a result of transitioning from regional to global demand planning with some of these revenues in both regions moving into Q4.

We made significant changes in demand planning process address late deliveries we experienced in Q3 and are confident will deliver us spring '15 order book on time and in full. Looking ahead to spring '15 as communicated in our Q2 call, we initiated a key item pricing strategy establishing more competitive wholesale catalog pricing for spring '15 to improve full season sell-through, reduced late-season markdowns and end of season returns.

To be clear, the adoption of the key item pricing strategy was not dilutive to initial gross margins and apparel as we were able to trade the [FOB] benefits gained by sourcing fewer SKUs across fewer factories into higher quality product at more competitive pricing. We believe the spring

15 product lines are much improved over prior seasons in responsible to both, the product lines and the pricing strategy has been quite positive.

A key challenge was to stabilize DC footwear and we have made good progress here. A key initiative was to enter the accessibly priced canvas footwear's market, a $200-plus million peer segment worldwide. We did this for spring '15 with the style called [Trestles]. Orders in hand on the Trestles for spring have exceeded 0.5 million payers making it the most successful product launch in DC history.

As a result, we anticipate DC brand revenues in North America and Europe being down only single digits in the spring. Our order book for Quik and Roxy for spring '15 doesn't close until later this month, but currently we anticipate Quik and Roxy revenues in the U.S. and Europe being down in the mid to high single-digit range, adjusted for wholesale revenues that will be reported as licensing revenues in 2015.

Let me now outline the path to stabilize and grow top-line revenues. The principal objective is to rebuild a core wholesale business in North America and Europe and we have taken a number of steps to achieve this. The first is product. We believe our spring '15 product line is both, fashion-right and priced-right. I am confident that they will perform at retail.

Second is marketing. We will increase advertising by over 50% for spring, with the renewed focus on core media both print and digital, recommitting to grassroots marketing and reinvesting in point-of-sale substantially increased levels. As distribution, we begun the process of cleaning up distribution for DC and Quiksilver, particularly in North America and paid a particular attention to improving a Quiksilver distribution in the island of Hawaii and Puerto Rico.

We have also made the decision to significantly scale by price promotions in our owned branded e-commerce sites. We are currently communicating all of these initiatives to our core accounts in both regions including this week in the U.S. at Surf Expo in Florida, and we believe that in combination these steps will significantly improve our relationships and our business for core wholesale partners.

Our owned retail business remained strong. We anticipate retail revenues to represent 27% of total in 2014 and are on pace to open 60 net new stores this year that will be annualized in 2015 to grow retail revenues. Almost all of these stores will be opened outside of North America and Europe, where we are focused on rebuilding our wholesale business.

Our e-commerce business also remained strong and will expand internationally in 2015. We anticipate generating top-line growth in our e-commerce business in excess of organic growth rates within the industry as a result of the investments we made in 2014. We believe, we have significant international growth opportunities as sales in emerging markets which include Brazil, Russia, Indonesia and Mexico continued to perform well.

We believe these countries can continue to grow at double-digit rates in 2015, and we are particularly optimistic about growth in Brazil, where we will begin to franchise retail concepts in 2015. Finally, we believe, we will soon be able to unlock the potential for Roxy and Quiksilver brands in China, the second-largest actions sports market in the world.

With that, I would now turn the call over to Rich, to review the Q3 financials in more detail.

Richard Shields

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

Third quarter net revenues were $396 million, down $96 million in constant currency compared to Q3 last year. This decrease was entirely in the wholesale channels in the Americas and EMEA regions.

In the Americas, wholesale revenues decreased by $68 million, with DC contributing $47 [million] of the decrease, Quiksilver $14 million and Roxy $7 million.

The decrease in DC was driven by several factors. First, we had lower sales into the wholesale clearance channel in Q3, largely due to our efforts last year to clear inventory. Sales to key players in this channel were down $10 million for the quarter.

Second, we took action to improve the quality of DC distribution, sales to key players in the mid-tier family channel decreased by $16 million in Q3.

Third, we licensed Quiksilver and DC children's apparel in North America. Under that agreement, we transition responsibility for wholesale sales of these products to our licensee for fall 2014. We saw a reduction of approximately 5 million in our shipments of these products in Q3, as our wholesale customers focused on selling through the earlier product seasons and anticipated taking fall '14 product from our licensee.

Last, we saw DC sales decrease by approximately $10 million in the team specialty channel. We believe, we can reverse this trend where there are entry price point DC shoes and SMU programs for key accounts.

Moving to the Quiksilver brand in the Americas wholesale channel, of the $14 million decline in total revenues, $6 million was related to the impact of licensing Quiksilver children's apparel. We saw revenue erosion in our larger department store accounts of approximately $3 million and the rest of the erosion reflected difficulties in the smaller independent wholesale accounts.

Moving to the Roxy brand and Americas wholesale channel, of the $7 million decline in revenues, $2 million was due to reduced sales in the clearance channel. We saw erosion of perhaps $2 million in the larger department stores and the rest of the decrease from smaller independent wholesale accounts.

For all three brands, late product deliveries as well as unfilled orders due to inventory mismatch versus the order book, negatively impacted our revenue results. We continue to see positive comp store sales growth in the Americas. Comps were plus-2% for the third quarter, the fifth consecutive quarter of positive comps in the Americas.

Comps were stronger in the full priced stores than in the outlet locations. Also, the emerging markets in the Americas region Mexico and Brazil also both, continued to increase revenues.

In EMEA, wholesale revenues decreased by $30 million with Quiksilver brand contributing $15 million of the decrease, Roxy $7 million and DC $10 million.

Similar to the Americas, we saw decreased order flow from EMEA smaller wholesale customers as well as late product delivery and inventory mismatch versus the order book. Also, Q3 sales last year benefited from some orders scheduled for Q2 being shipped in Q3, due to the SAP implementation last year and we anticipate that some orders scheduled for Q3 this year will ship in Q4 due to the timing of product receipt into our distribution centers.

EMEA direct to consumer revenues continue to expand and we saw a continued growth in Russia a well.

Asia-Pacific revenues increased modestly in Q3, due to the growth in direct-to-consumer channels and emerging markets partially offset by a reduction in DC wholesale sales. Globally our retail stores generated positive comp with low single-digit positive comps in the Americas and Asia-Pacific and modest negative comps in EMEA.

We ended the third quarter with 26 additional stores versus Q3 last year, with all of the new stores located in the Asia-Pacific region. The new stores in the APAC region are predominantly shop in shops configurations which are smaller footprint locations.

The global e-commerce revenues increased 10% with double-digit percentage growth in EMEA and Asia-Pacific, offset by decreased volume in the Americas. We are making significant investment in America's website infrastructure to better support online revenue growth in this key market.

Gross margin decreased to 130 basis points to 47.8% in Q3. Margins in the wholesale channel decreased in both, the Americas in EMEA. In EMEA, late product deliveries and product substitutions due to workbook mismatch drove higher discounting levels. Americas' wholesale margins were also impacted by higher discounting, but favorably impacted by lower clearance activity.

The sales shift toward direct-to-consumer channels and to the EMEA region as well as increased margins from Asia-Pacific, offset some of the unfavorable wholesale margin comparisons. SG&A decreased by $2 million. Q3 SG&A included $4 million of severance and other restructuring costs this year versus $13 million last year.

Excluding those items SG&A increased $6 million versus Q3 last year. This increase was driven by the timing of incentive compensation expense. Within SG&A, expenses for athletes and events decreased, while advertising expense in other areas including media increased.

Selling expenses decrease in dollar terms in both, retail and e-commerce channels even with the revenue growth of those channels. Selling costs decrease in dollar terms for the wholesale channel, but increased as a percent of revenue in Q3.

Q3 asset impairments include in non-cash charge of $182 million to write-down the goodwill in our in EMEA region. The majority of this goodwill relates back to the acquisition of Rossignol. Rossignol was integrated into Quiksilver regional reporting segments a portion of the Rossignol goodwill remained even after the disposal of that business.

Moving the balance sheet, inventory decreased by $39 million or 10% versus last July. However, our inventory days on hand increased by 11 days. Aged inventory is well down versus Q3 last year and we will continue to focus on moving through prior season's inventory.

We ended July 2014 with $108 million in cash of which $24 million is restricted. We anticipate using all or the significant majority of the remaining restricted cash by the end of January 2015 for planned capital expenditures.

The July 2013 balance sheet included $409 million of restricted cash, which represents funds held in escrow to repay the notes we refinanced last year.

Regarding liquidity, we ended Q3 with $94 million available on our credit facilities. The $94 million available on our credit facilities combined with our cash on hand reflects liquidity of $202 million at the end of Q3. This compares to $210 million at the beginning of Q3.

To be conservative, when we calculate amounts available on our credit facilities, we disregard the final $15 million of our credit facilities on our ABL.

Our nearest debt maturity is in December 2017 or 40 months from now, when the $200 million euro notes are due and we have no maintenance covenants and affect on our credit facilities.

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

Andy Mooney

Thank you, Rich. We continued to make meaningful progress in the key initiatives outlined in the profit improvement plan. We are very focused on improving the quality, value and consumer relevance of the product lines we have for all three brands and marketing of brands consistently worldwide that significantly elevated levels.

The path forward is straightforward. We must stabilize North America and Europe wholesale, drive growth in direct-to-consumer in emerging markets and continue to significantly reduce SG&A.

We reduced normalized SG&A by $40 million in 2013, and expect to achieve another $40 million in normalized SG&A reductions this year as well and we believe further significant savings are achievable.

We update our strategic plan in the summer annual, with the Q4 call or shortly thereafter we intend to provide a detailed update on a profit improvement plan at an initiative level as we did in May of last year.

With that, I will turn the call over to Robert.

Robert Jaffe

Thanks, Andy. Operator, we are now ready for the question and answer session.

Question-and-Answer Session

Operator

(Operator Instructions) We will go first to Taposh Bari from Goldman Sachs.

Taposh Bari - Goldman Sachs

Hi. Good afternoon. I was hoping Andy, if you could talk more about the sell-through of the fall '14. I know last quarter you had spoken about looking at the progression of how that sell-through evolved and kind of how that perform would dictate future orders also. I know you had the new collection like the Nyjah Vulc at DC and the AG47 sportswear collection with Quiksilver. I was hoping to get some more color there.

Andy Mooney

Thank you. Yes, I would say our apparel sell-throughs generally have been good, not great but not either. I think, they have been generally good. Sell-throughs in DC have been, I would say they would be fair too. Also, now they have been spectacular.

Nyjah Vulc was not the success that we hope that it would be. I think it's really the price, I think, was an inhibiting factor on it, so that's why we are much more optimistic about the success of the Trestles I think than we currently have on the Nyjah Vulc.

Taposh Bari - Goldman Sachs

Can you maybe provide some more color on how the Trestles is different from the bulk? Is it the price point, is it the style and the optimism that you have for the spring '15 collection. What is that rooted in? I am assuming that your sharper price points and better product if you can just elaborating. Also just on the, I think, you had mentioned that Quik and Rocky brands are going to be down for spring at wholesale. Is that entirely driven by the licensing out of the kids business or would it actually be down regardless?

Richard Shields

Well, let me answer the various components. As it relates to DC, the 200 million payers that I talk about in the canvas market, the retail price parameters for that payer is just between $45 retail and $50 retail. The market is really compressed and there has only really been one significant breakout product from Nike that has produced any type of Volume above that.

We were optimistic that with the Nyjah Vulc, which is outside of that price range that we could do some volume with that product. The product is selling okay, but it we don't believe at this point is going to be a breakout model.

However the Trestles is priced to $45. It's completely in the sweet spot of volume potential, so that's really why we are much more optimistic about the Trestles than Nyjah Vulc.

Taposh Bari - Goldman Sachs

The spring '15 comment around the wholesale trends, is that strictly a function of the licensing out of those kids business or is there something else going on there?

Andy Mooney

Well, two things. As we said in the opening remarks, we have now licensed categories that in total have historically generated approximately $100 million in wholesale revenues, so as we model one season against another, those have to be taken into consideration.

The reason that we did that, just to reiterate, what's in the remarks is, because we believed that by licensing those categories to really capable partners, we are focused on those categories - they will generate volume in those categories or as to refocus or organization to where we felt there was the some significant growth opportunities and it would elevate our net EBITDA as a result.

We believe that and we still believe that now the numbers that we quoted in terms of the order book for spring '15 for Quiksilver, Roxy and DC relate to the North American and European wholesale statements solely, not the globe and its entirety.

Again, as I said in the remarks, we continued to see robust growth available in emerging markets, growth in our B2C business, our own brick-and-mortar business, the Asia-Pacific region has stabilized and returned to growth, but we do continue to see based on the order book very reduced declines in the order book at this stage across all three brands in European and North American market.

Taposh Bari - Goldman Sachs

Okay. Thank you for the detail. Best of luck.

Richard Shields

Andy, I would just add in one other item there. When we talk about the order book that is on an apples-to-apples basis versus for the items that we have licensed, and maybe just to share a couple of items around that we have had some press releases on the things that we have licensed, Andy mentioned that we have licensed out approximately $100 million, which was our historical wholesale sales on those, and I will kind of chunk those into a couple of large groups just to share.

We mentioned that on the Quiksilver and DC license business, that's the transition on that is happening in the current quarter and then coming up on the upcoming quarter. If we look at the revenue in Q3 last year that was the Quiksilver and DC children's business, as I mentioned my remarks you got about $6 million in Q3 last year for DC and about $5 million on Quiksilver for $11 million altogether and that's a pretty good estimate of the annual run rate of that business. That was about $50 million business.

We've also announced that we have licensed out so Roxy children's, the transition point on that will be Q1 '15. Then likewise, bags and backpacks will also be later on next year Q3 '15. The rough estimates size of our historical wholesale business on those categories is about $20 million for Roxy children and maybe $15 million for bags and backpacks.

Taposh Bari - Goldman Sachs

Okay. Thanks, Rich.

Operator

We'll go next to Jeff Van Sinderen from B. Riley.

Jeff Van Sinderen - B. Riley

Good afternoon. Maybe you can talk a little bit more about in the wholesale business, the promotional activity, the discounting levels in Q3, or do you want to talk about that sequentially versus Q2 or year-over-year comparison. Also, I think you touched on sell-through, but it wasn't clear to me, because you were sort of talking about licensing. If you can just maybe talk about sell-through rates you have been seeing in wholesale. Then I guess sort of the end question is, I know you talked about the spring business for wholesale generally being down, but when do you think that business hits spot on the overall wholesale business and then I have a follow-up to that.

Andy Mooney

We are still early in the fall season, but I guess our sell-throughs in our old brands and our wholesale business seem to be, I would say, average not particularly better or a particular the worse than we have historically seen. The operating part of the industry, which we really actively addressed, we believe, for spring '15 is, we believe that their price points for the industry has been operating in multi-brand wholesale have been a little too high for the market, so all of the brands have got in with price points that are too high.

The take markdowns mid-season sometimes too late in the season to effectively drive sell-throughs, and then they clear up all of the merchandise at the end of the season as I have got additional markdowns or returns. We believe those are very inefficient model. Over the course of the season, you were seeing both, reductions in the revenue from the order book and the margin from the order book.

We feel that for spring '15, we really needed to go and being priced right on day one. We were able to do that without diluting margins, so at this point we are actually looking at unit gains in both, apparel and footwear for spring '15, but single-digit revenue declines in the order book. That's the order book.

We believe that will come through the season although this has yet to be proven, because we will need to go through an entire cycle to see the result of it, but we believe will come through the season with high velocity of sell-through by being priced right going in the front end of the season reduced, in-season lockdowns and reduced end of season returns and our objective is to net out at the end of the season with higher margins than we historically have been able to do.

Jeff Van Sinderen - B. Riley

Okay, but I guess or it's not clear to me. I know that on the last call you talked about sell-through rates through your retail partners for your wholesale segment is generally being poor. Now I hear you saying that the sell-through rates are not any better or any worse than what you have experienced historically, so should I assume that or should we assume that your sell-through rates are still poor or are they improved, I guess, that's what I am trying to get at.

Richard Shields

Well, I think, they improved over prior seasons, but they are still not where we would like them to be.

Jeff Van Sinderen - B. Riley

Okay. Then as we look forward, I know you have given some sense of where you see wholesale sales rate tracking. I mean, do you think we are looking at second half of the fiscal year for a potential revenue and EBITDA inflection point the next year I mean or how you think about that or is it just too early to know?

Richard Shields

Well, you have to look at the total picture. I mean, the wholesale declines of equal to the gateway for the North American and EMEA wholesale business only. The declines that we experienced this quarter were exacerbated by late delivery situation that situation will significantly abate in Q4 and going into Q1 and we talked specifically about where we believe the order book is for Q.

Essentially spring for us will be predominantly in Q2, fiscal Q2 of next year. When you take the revenue picture in combination and you look at the EBITDA scenario in combination, we are still very optimistic about the potential for growth on both, the top-line and the bottom-line.

Jeff Van Sinderen - B. Riley

Okay. Then since you touched on the late deliveries, is there a way to quantify how much was impacted by those late deliveries and maybe how much was impacted by discounting? Just trying to get a sense of, was it product rejected, was it all just kept in discounted, how much fallout there was.

Richard Shields

Yes, Jeff. This is Rich. Let me answer that two ways. First, on the sales side, we do anticipate that we will see some sales scheduled for Q3 move to Q4. Andy talked about the order book being down kind of high part of single digits on a dollar basis for spring, so I think that we should be looking at kind of the run rate moving from where we are in Q3 and improving as we start to move that spring order book number.

Then if I think about discounting, we definitely saw discounting in Q3, dealing with late deliveries and inventory mismatch, if I think about the 130 basis points of margin erosion, I would say that 280 basis points are due to increased wholesale discounting are largely around the late deliveries.

Clearance, where we had lower volume of clearance activity which is good news, but the recovery on inventory that we cleared moved down a little bit. Then on the positive side on margin, we saw licensing being favorable to us, then the continued mix shift toward our direct-to-consumer channels and towards the EMEA region was favorable by 160 basis points.

Jeff Van Sinderen - B. Riley

Okay. That's helpful. Thanks very much and good luck.

Richard Shields

Thank you.

Operator

We will take our next question from Dave King - Roth Capital Partners.

Joe Bess - Roth Capital Partners

Gentlemen, this is Joe Bess on for Dave. I guess my first question is, could you give us a bit of an update on some of the progress you are making with your SMU program. Then maybe just provide us with a little bit of color and quantify a bit in terms of what the growth outlook you guys are kind of project over the next couple of years for that?

Andy Mooney

We haven't provided any guidance as to a specific breakout of SMU growth. It's not really an approach that we have kind of taken to looking at the business.

Richard Shields

Yes. I think that we've got the conversations about making sure that we have tight partnerships with our larger accounts continue with in both wholesale and the Americas and in Europe, so we feel good about building relationships and continuing that, but we have never kind of broken out specific revenues on SMU.

Then as Andy mentioned, annually we go through our strategic plan deeper views in the summertime and we are looking forward to going into a lot of detail initiative-by-initiative as we give you an update on the profit improvement plan. We will do that to either with or shortly after our Q4 results.

Joe Bess - Roth Capital Partners

Okay. Perfect. Then, I guess, Andy, as you think about the business longer-term how much do you think total revenue at this point in time could potentially be licensed out. Then could royalties be more than maybe half-year revenues at some point in time? Then as you look at each category really, how do you evaluate whether to produce it in-house versus license it out?

Andy Mooney

Well, as we identify the profit improvement plan and reiterated a little here today, and the profit improvement plan, we identified categories that historically have constituted about 10% of total revenues as being categories that would be better off license to a capable third parties, so we are well on our path towards attaining that number and still have some more work to do but we are well on our path.

The rationale of the criteria for doing that is, do we believe, A, the partner has a specific expertise in that category that is greater than others or is there a distribution nuance that would be better handled by someone else, so classic case in point would be eyewear and timing for example where both of those categories which we believe have great potential for our brands really require different development cycles, different sourcing capabilities, different sales service. That's the type of category that we identified as being one that would be ideal to license.

Joe Bess - Roth Capital Partners

Okay. Great. Thank you.

Andy Mooney

Thank you.

Operator

We will go next to Andrew Burns from D.A. Davidson.

Andrew Burns - D.A. Davidson

Thanks. Good afternoon. I was hoping you might be able to quantify the potential SG&A cuts related to the licensing initiatives as well as whether those product categories which - so it looks like total of about $100 million revenue, the gross margin was that in line with the company average above below? Thank you.

Richard Shields

Within the $80 million in normalized SG&A cuts that we've made over the last couple years, some of the cuts have already related to some of the license initiatives that we put in place. In other words, some of the folks who were working on the development of those products were part of the rightsizing of our organization over the last 12 months in particular.

The margin profile generally of the categories that we have licensed would be below the average of the company overall, but the bigger thing really is that we feel that in the hands of a capable licensee that there is significant growth potential for those businesses if they are managed by very capable licensee who is singularly focused on them.

Again I would come back I learned on timing is it is perfect example is that in those categories, the channels that we are currently servicing have some limitations on the volume potential that we can generate within those channels. We are going to continue to service those channels through our sales organization to support our licensing partners, but we have access to accounts and to doors that they can service that we just wouldn't have any access to.

Andrew Burns - D.A. Davidson

Okay. During the prepared remarks, there was a discussion about cleaning up distribution. I was hoping that you could spend a little more time on that perhaps by brand, and if possible, gauge the peak to trough sort of the rationalization of distributions. Is 30% of doors, 50%, 10% any metrics you could put around that would be helpful.

Andy Mooney

Well, I think, we have the most work to do really in North America, and the part of the of the refocusing of distribution is simply a reduction in distressed inventory that we would push through the clearance channels, because clearly through a function of licensing product categories that historically we would have built inventory for. Then managing the inventory on the categories that we have focused on much more tightly than we have done in the past, we believe that we will have fundamentally less clearance channel inventory out there.

Then it's really a question of having segmented lines by channel that would include an SMUs strategy to make sure that all of our accounts can kind of peacefully co-exist with products that are right for the consumers across their channel. The cleanup is really a function of making is both, the realignment of products by channel is also a significant reduction in distress inventory that would go through the clearance channels.

Andrew Burns - D.A. Davidson

Thanks. Then last one if you could just elaborate a little bit more about opportunities in China for Roxy and DC, how is Quiksilver performing there and what does this mean for your relationship with the JV of the Glorious Sun.

Andy Mooney

As I mentioned in the Q2 call, we are in litigation with our JV partner Glorious Sun, so I can't comment too much on that except to say that is obviously China being the second largest market in the world for action sports offer significant opportunity for us and it would not be an understatement to say that we are nowhere close to realizing the opportunity for those two brands within the within the confines of the JV right now.

Andrew Burns - D.A. Davidson

Thanks. Good luck.

Andy Mooney

Thank you.

Operator

We will take our next question from Jim Duffy from Stifel.

Jim Duffy - Stifel

Good afternoon. I am sorry, business has been so difficult for what it's worth. Rich, the tough 3Q looks so eroded some of the cushion, what's the base level of cash you need in the business. Then it looks quite likely, you will be borrowing money to make the interest payments if that's not the case, can you explain how that's not the case?

Richard Shields

We end the quarter with $202 million in cash and that's even with the quarter with zero EBITDA, where at we are down $8 million from where we begin the quarter, so we have been spending a lot of time looking at liquidity, because that's just part of the job of managing a company.

We are looking at in a short-term, mid-term, long-term, I am quite comfortable that we can continue to execute the profit improvement plan. The interest payments are something that we built into the forecast. We made the last interest payment without borrowing as we are generating cash through the working capital improvement during Q3, so when continually talk about each in my comments liquidity and in my queue my comments and want to walk to that today was a little more granularity as I think that we have a tough quarter people will ask liquidity question, but we are focused on it and comfortable with it. We have got liquidity to manage forward.

Jim Duffy - Stifel

Okay. Good to hear. If business does remain difficult for another few quarters, what's the board's thought process on capital structure? I am certain there has been discussion of this.

Andy Mooney

I don't think we can really speak for the board in terms of their thoughts on capital structure.

Richard Shields

Yes. I think the best way to answer that Jim is to say that to represent the shareholders well, Andy and I consistently look at that forecast scenarios that we believe are our downside and pessimistic forecast scenarios did that include all note that include rob a broad range of activities that that are favorable and even with pessimistic scenarios we are comfortable that we have got liquidity to manage forward and we have shared those detailed forecast with the board and had an active dialogue with them about that.

Jim Duffy - Stifel

Fair enough. Thank you. Then last question, I just want to make sure I understand the demand planning and inventory misallocation correctly. Is a function of consolidating to a global core? Then not having appropriate inventory to meet orders in certain markets in certain brands. Is that accurate?

Richard Shields

It's really was just two facets to, if you like, one is we took a conscious decision not to order any products that were below minimum order quantities at factory and so that eliminates a expect a portion of the order book.

Usually on those products we pay substantial up charges, so they are usually the lowest margin products in the portfolio, so that was one part of the mismatch.

The more fundamental part though which is really the thing that some, both late deliveries and some of those movements to swing from Q3 to Q4 was that it took is longer than we expected in the transition from regional demand planning to aggregate the global orders and place of the factories.

We see that very much as the one-off cost of transition, if you like, from regional planning to global planning. As I said in my remarks, remarks we are very confident that not only will we deliver the order book in field and on time for spring, but will deliver on time for spring, but we will deliver earlier in the season than we have ever done historically.

Jim Duffy - Stifel

Very good. Thanks for that additional perspective.

Richard Shields

Thank you.

Operator

We will go next to Christian Buss from Credit Suisse.

Unidentified Analyst

Hi. This is (Inaudible) sitting in for Christian. Just had a question about the divergence trend between the owned, retail and wholesale channel. It looks like comps held up pretty decently, modest low-single digits for several quarters now, but the wholesale this has been on the decline. I was just wondering if you could understand why that's the case. Is it a function of the product being merchandised more effectively within the owned channel or perhaps differentiated product within the owned channel? Just wondering if there is an opportunity to leverage some of those earnings or capabilities and translate that into the wholesale channel.

Richard Shields

What we found in the developed markets in particular, less so outside of North America and Europe. Generally speaking, the consumers across is the threshold of the one stores is de facto to a fan of the brand and is really looking to see if he or she can find a product from one of our brands that fits their needs and thankfully generally speaking they are doing exactly that.

I would say that the consumer crosses the threshold of a multi-brand store of any shape or form these days From Macy's to especially Surf shop, they are very actively shopping brands in place. I think that we definitely had room to improve on both, the product front and price front and arguably the marketing fund too.

We believe, we have addressed all of those issues for spring '15 and it's starting to reflect itself from the book. We believe it will also reflect itself through then we can start to build on that from spring '15 onwards.

Unidentified Analyst

Great. That's helpful. Then one more question if I may. Last quarter, you had mentioned that some of the challenges in wholesale channel were due to account closures of some of the smaller retailers. I am wondering is there an update there? Are you continuing to see these smaller doors go dark as the phenomenon or perhaps stabilizing?

Richard Shields

I think there's going to be an ongoing very modest decline in the number of core doors that are open, but we believe that businesses it's rotating or migrating and will go back into other core doors that remain viable in business or to sporting goods accounts to continue to grow and are servicing more sports categories increasingly well or to pure play retailers like Amazon and in U.S. or Surf door in Europe, both pure play retailers were focused singularly on more sports or once or more generally focused on e-commerce like Amazon. We really don't see that being and inhibiting factor for growth, but we do see a continuing trend in that that is very modest contraction in the core channel.

Unidentified Analyst

Okay. Great. Best of luck.

Operator

At this time, I would like to turn the call back over to Robert Jaffe for any additional or closing remarks.

Robert Jaffe

Thanks, Anne. That concludes today's call. On behalf of everyone here at Quiksilver, thank you for participating and we look forward to providing our fiscal 2014 fourth-quarter results December. Thanks, everyone.

Operator

This does conclude today's conference. We thank you for your participation.

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