Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Quiksilver (NYSE:ZQK)

Q2 2011 Earnings Call

June 02, 2011 4:30 pm ET

Executives

Craig Stevenson - President of Quiksilver South Pacific and President of Quiksilver Americas

Joseph Scirocco - Chief Operating Officer, Chief Financial Officer and Executive Vice President

Bruce Thomas - Vice President of Investor Relations

Robert McKnight - Co-Founder, Executive Chairman, Chief Executive Officer and President

Analysts

Spenser Samms - BofA Merrill Lynch

Eric Tracy - FBR Capital Markets & Co.

Mitchel Kummetz - Robert W. Baird & Co. Incorporated

Andrew Burns - D.A. Davidson & Co.

Jeffrey Klinefelter - Piper Jaffray Companies

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

Jeffrey Van Sinderen - B. Riley & Co., LLC

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. [Operator Instructions] I would like to remind everyone that this conference is being recorded. And now, I'd 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 Second Quarter Fiscal 2011 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'd 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 annual report on Form 10-K .

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

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

Robert McKnight

Thanks, Bruce. Good afternoon, everyone, and thanks for joining us for our second quarter conference call. I want to start by saying that we're very pleased to have exceeded expectations for the second quarter despite several natural disasters that have unfortunately, impacted the Asia Pacific region over the past few months. Our Americas and European businesses delivered very solid performance coming at ahead of plan and offsetting the near-term impact of these natural disasters.

As such, I am pleased to report solid second quarter results that were better than we expected when the quarter began. Revenues of $478 million in the second quarter exceeded our plan, and were up when compared to the second quarter of 2010. Gross profit of $262 million was up 5% this quarter compared to a year ago, demonstrating that our business is performing considerably better. Gross margins expanded 160 basis points to a Q2 record, 54.8% of revenues as we benefited from continued improvements in our U.S. retail stores and less discounting in the wholesale channel. Pro forma adjusted EBITDA was $62 million in the second quarter, in line with last year, as gross profit gains were offset by increased spend ahead of revenue generation. And finally, our net debt at April 30 was $594 million, representing 2.9x pro forma adjusted EBITDA, that's down 19% over the last 12 months, reflecting the enormous progress we've made in improving our balance sheet.

Taken together, the solid second quarter performance resulted from us continuing to do what we do best: Developing and delivering exciting, innovative, authentic, quality products and connecting with our consumer base with creative and impactful marketing campaigns. Signs of improvement are evident in many areas of our business and we believe we are well positioned to capitalize on growth opportunities within our 3 strong global action sports brands and our many markets around the world.

Our European business performed better than expected in Q2, despite weaker sales in markets such as the U.K. and Spain. Our business is much better now in France and sales were strong in our emerging European markets where investments made to further develop our business are driving profitable growth in all 3 brands, Quiksilver, Roxy and DC, are doing well.

On the European retail front, we're delighted with our new concept stores. We've had great reaction and strong performance from the new store formats in the core markets of Capbreton and Hossegor in Southwest France, as well as the incredible Bercy Village store in Paris. These stores feature broad offerings from each of our brands, together with a deep stock of surfboards, wetsuits, skateboards and other products that reinforce our heritage and authenticity to the consumer in a way that other brands simply cannot.

The Capbreton store features an athlete training center, and like the Bercy Village store in Paris, is used for many of our events and promotions. Events at our Capbreton store include a summer concert series, as well known French artists and frequent guests include many of our team riders, their peers, as well as many well-known sports stars and personalities. In the same spirit and direction, we have retrofitted several other the key stores and the plans to refit or, at least, update the feel of many more of our European stores before the end of the year. And we plan to further own the Atlantic coast and the French Alps, as we take the same store concept to other key European surf and snow destinations that include Ericeira in Portugal, Distro Beach[ph] in the U.K. and the heart of the Alps in Chamonix. These stores will reinforce our marketing -- our market-leading position on the continent.

Looking forward, we're very encouraged that the fall/winter order books in Europe for each of our brands, Quiksilver, Roxy and DC, are up over last year and support our growth plans. The return to growth in Roxy fall orders indicates that the changes we made to design and merchandising for spring 2011 have resonated with the consumer, and that confidence is back in Roxy, which remains the leading surf brand for girls.

In the Americas, revenues were up compared to the same quarter last year as improvements we made to our company-owned retail stores have driven higher levels of performance. Our progress was reflected once again by solid double-digit positive comps in the second quarter. Our Wholesale business in the Americas was up compared to last year with DC providing the strongest growth and our business in both Brazil and Mexico was up nearly 20% in Q2, Quiksilver and DC, both growing aggressively. Both of these are profitable markets for us that show even greater promise. Our business in Brazil, for example, generates about $50 million in revenue, on an annual basis, solely through on wholesale accounts. We believe that further penetration of the market requires us to better showcase our brands to the consumers. And so we are very pleased to have signed for our first retail store in Rio de Janeiro, which should open by September.

We're also planning to import the same concept store design, I spoke about earlier, into the U.S. market with our first such freestanding store in Venice, California, opening in the fourth quarter.

As with Europe, we plan to take the concept to other select markets around the U.S. in the years ahead.

Turning now to Asia. Despite the recent natural disasters and the resulting weak economies in Japan, Australia and New Zealand, we remain convinced that our investments elsewhere in Asia, especially in markets like China, Taiwan, South Korea and Indonesia, will drive meaningful growth for us in the region, and we fully believe that Japan and South Asia Pacific will recover in due course.

We've recently hired a new Country Manager to concentrate on our DC brand growth in China and we're making other investments in order to address opportunities across the region. In this context, it's unfortunate that events in Japan triggered an accounting impairment in this quarter. Joe will provide some additional details in his remarks. I just want to be clear that for the longer term, our growth outlook for the region is unchanged.

Let me mention one other newer market opportunity. I'm excited to announce that Quiksilver is now doing business in India. We entered into a license agreement for the Quiksilver, Roxy brands with the Reliance Group, India's largest private company. We're convinced that Reliance was the right partner for us there, and they opened the first store recently in New Delhi. Our current plans call for 10 new stores to open in India within the next 12 months, and we see broad opportunities in this developing market.

Let me now take a brief moment to highlight our brands. I'll start with Quiksilver, which, as you know, is the biggest and most respected action sports lifestyle brand in the world. Quiksilver's global brand revenues grew again in Q2 as many success stories emerged from our spring 2011 range. Many of the best-selling categories were grounded in and product design and innovative leadership and we've continued to set the standard for the action sports industry.

Quiksilver apparel and footwear that took market share and were retail performance leaders in their respective categories included board shorts, walk shorts, wetsuits, hanging footwear, many items within the Quiksilver Waterman's Collection, as well as Amphibians. The Amphibian is a walk short silhouette that utilizes board short fabrication. The result is a very functional garment that works both in and out of the water. Quiksilver is at the forefront of the Amphibian trend and it's been a very strong selling category of ours for spring and summer. We'll continue to innovate and grow our Amphibian offering to capitalize on this new product category.

Regarding our new girl's line under the Quiksilver label, spring deliveries began in February, and we're receiving great feedback from our retailers and customers. We've developed and deployed a cohesive branding, point-of-purchase, window and imagery strategy in the stores and online that has driven strong sellthrough to both Quiksilver Girls and Quiksilver Women's, our women's line at retail and through our e-commerce channel. In fact, several of the items in the Quiksilver Girls spring line have been listed among the most popular items ordered on quiksilver.com during the period. Our first full season will begin shipping later this month and the early buzz is very favorable.

The fall order book for the Quiksilver brand in the Americas and the corresponding fall/winter book in Europe are both up over last year, supporting our plan to grow revenues in the second half of the fiscal year.

Let's turn now to Roxy, the largest most respected and most recognized girl action sports brand in the world. The Roxy business continues to build momentum on the strength of the current spring/summer offering and marketing campaign that repositions Roxy as the iconic, California-inspired surf lifestyle brand. We've been focusing Roxy product and marketing strategies around go-to categories and have seen overall performance improvements in Q2.

Iconic warmer weather Roxy apparel and footwear are once again driving sales as beach pants, swimwear, sandals, beach dresses, casual footwear and canvas bags are most popular. We're very encouraged that Roxy sportswear is, again, part of the brand's driving force. This is coming back in our key markets of Florida, Hawaii and Southern California. And we're really encouraged by Roxy's performance in the specialty channel of distribution. With the emphasis on leveraging our brand heritage, we're seeing strong performance in all product categories in this channel and we anticipate continued positive results as we move forward into the summer season.

Looking ahead, Roxy's solid fall bookings in the U.S. are up mid-single-digits over last year, while the reaction to the new Winter '11 range has been very good. Similarly, high single-digit growth in Roxy's fall/winter order book in Europe is also a good indicator of a positive momentum of the brand there in Europe. With its core in board sports, Roxy's return to its roots have clearly helped drive the brand's resurgence as our surf authenticity and iconic Roxy heritage are, once again, unmistakable.

Turning now to our powerful and incredibly popular brand, DC. DC is dedicated to being the most sought-after, skate-driven, action sports brand in the world. As we pursue this goal, we continue to see solid returns on the investments we're making in the DC brand. DC's mid-single-digit growth in the second quarter was on plan, and strong forward orders in each of the regions around the world confirmed DC's expanding global traction. Revenues from core skate and surf shops are strong and continue to grow, demonstrating the success of our commitment to style, innovation and the brand's heritage.

Furthermore, we saw a strength all across DC's range of footwear from casual lightweight canvas on the low end to our $90 to $100 high-end skate shoes featuring Viz Air technology.

We launched a new skate logo in the second quarter that leverages our tradition and now acts as our rallying flag for our team riders and fans of the DC brand. These skateboarding enthusiast recently came out in force to help us launch the second season of The Street League DC Pro Tour Skateboarding Competition. The new season kicked off with a hugely successful event in Seattle, and the finals were broadcast live on ESPN. The new event in the Street League series will take -- I'm sorry the next event of the Street League series will take place in Kansas City on June 11 and 12.

We're also continuing to position DC for expansion beyond our core skate market. We've concluded the end of a very successful season of motocross sponsorship recently with the AMA Supercross season final in Las Vegas. DC was the official and exclusive shoe sponsor of the very popular Supercross Series. With 15 events nationwide, DC's exposure soared amid sold out venues and hundreds of thousands of motocross fans. DC team rider Trey Canard won 3 times this year and was named the 2011 Rookie of the Year. DC has been a supporter of the motocross industry for some time, and we support several of the sports league athlete including the legendary Jeremy McGrath. This partnership with the Supercross Series, not only shows our support in helping the sport continue to grow, but it's also a great chance for DC to interact with the most loyal and enthusiastic consumers in action sports.

DC's ability to connect with consumers is vital to being recognized as the most sought-after, skate-driven action sports brand in the world. Our digital marketing efforts across the milestone in Q2 when DC's Facebook page registered its 5 millionth fan. According to this measure, DC remains the number one action sports brand on Facebook. In fact, DC has many more Facebook followers than any other company in the sporting apparel industry.

Turning now to our athletes. A substantial contributor to our success and our proved performance is our stable of athletes that surf, skate, snowboard, drive, paddle, climb, hike and otherwise ride in the name of our brands.

The athletes we sponsor not only embody our involvement in the action sports in which they excel, but they also attract a great deal of attention to our brands, and most importantly, they move product. We have assembled an amazing array of athletes who are particularly influential within their sport. And we couldn't be happier that many of these hugely popular athletes are actively engaged in product input and design, and they help create their own style media in our marketings. If given a chance, they join our best-in-class teams because they see how we operate. They know we involve our riders in the specification and design of our technical product, and they know that our teams are all about family.

A few of these athletes have recently made some news. I'll begin with 25-year old Quiksilver surfer Dane Reynolds. We re-signed Dane to a 6-year deal with the Quiksilver team to contribute to the design and develop of a new signature line of products. Dane is thought by many to be the most influential surfer in the world today.

We also re-signed 23-year old French surfer, Jeremy Flores, to a new endorsement contract. Sponsored by Quiksilver since the age of 9, Jeremy was the youngest surfer to ever qualify for the ASP Tour back in 2007. In December, Jeremy became the first European surfer to win the prestigious Pipe Masters contest in Hawaii, which helped him finish 9th in the ASP World rankings last year.

Australian Roxy surfer, Sally Fitzgibbons, has won 2 of the first 5 events in 2011 ASP Women's World Tour and is currently ranked number 2 in the world.

Also, we re-signed 20-year old Australian surf sensation, Craig Anderson, to our Quiksilver surf team and added him into the DC team as well, Ando was named the Breakthrough Performer of the year at this year's Surfer Poll Awards.

And we further strengthened the DC global skate team in Q2 by signing Mikey Taylor, one of the most popular and influential skaters who's known for his ability to skate all types of skate spots with an easy and polished style.

And finally, I want to remind those of you on the East Coast that Quiksilver will be bringing the sport of surfing and our entire stable of action sports influence to New York City this summer. Quiksilver Pro New York is set to take place on Long Beach, I'm sorry, Long Island's Long Beach from September 4 through 15. This event will be the sixth stop on the ASP 2011 World Tour and the first-ever World Championship Tour stop on the East Coast of the United States.

The surf contest will coincide with the series of events conducted by Quiksilver, Roxy and DC in and around the New York metro area beginning on September 2, that will comprise of major brand-building effort as we host enthusiasts of surf, skate, art, fashion and music who will gather in New York as summer comes to a close. We'll provide more details as we get closer to the event.

It's evident from the improvement in our financial results and the momentum in our business that we are now operating at a higher level. To provide more color on our progress, Joe will now take you through our second quarter financial details.

Joseph Scirocco

Thanks, Bob. Good afternoon, everybody. As reported, consolidated second quarter net revenue at $478 million were up 2% the last year and were better than we expected a quarter ago, driven by higher-than-expected sales in the Americas region.

In the Americas, revenues were up 5% compared to last year, fueled largely by our Retail business, which grew nearly 20% despite having 6 fewer stores. Our company-owned retail store comps were up 23% in the second quarter, while our Americas E-commerce business grew 68%. Wholesale revenues in the Americas were on plan and a couple of percentage points higher than last year.

European revenues were down 1% because of weaker sales in markets such as the U.K. and Spain. By contrast, sales were strong in Germany and Russia and held steady in other markets. Bob mentioned the new concept stores that we've rolled out in Capbreton and in Paris, which will be followed by the refitting or upgrade of 2/3 of our European stores to one degree or other. We are already seeing improved sales trends in these stores especially in France.

Asia Pacific revenues, as reported, were approximately the same as last year, but were down 12% in constant currency, primarily due to the effects of the various natural disasters on top of already weak consumer spending. It's a bit of a challenge to anticipate the timing of recovery in the region. However, we want to be clear that we remain optimistic and have not reduced our outlook over a 5-year horizon. Having said that, I'd like to explain the impairment charge in this quarter's results.

Our goodwill in the Asia Pacific region was established between 2003 and 2005 when we acquired our licenses in Japan and Australia along with the retail chain. The effects of the earthquake and its aftermath in Japan required us to test for a possible impairment this quarter instead of at year end as we normally would. Measurement of the impairment is very rule-driven and the accounting result is that we've taken a one-time, noncash goodwill impairment charge of $74 million. We also provided valuation allowances against tax assets totaling $26 million. These charges have no effects on our operations, cash flows or on any debt covenants.

Turning back now to our consolidated results. We expanded gross margins by 160 basis points to a second fiscal quarter record of 54.8%. The increase was fueled by higher contribution from our retail stores in the U.S., a strong improvement in our high-margin E-commerce business and better margins in Europe. Our Americas business delivered the largest improvement, 250 basis points, while Europe's margin also expanded to an impressive 62% of revenues. Our Asia/Pacific business saw margins down 40 basis points.

Overall, SG&A expenses were $217 million, up approximately $10 million from last year, largely resulting from higher spending on product development and marketing for new growth initiatives, as well as higher level of variable expenses associated with our growing E-commerce business. In constant currency terms, SG&A was up only $3 million compared to the second quarter last year.

We continue to focus our attention on EBITDA as a key measure of our performance. We generated second quarter pro forma adjusted EBITDA of $62 million or 13% of sales, approximately the same as a year ago.

Interest expense was $15 million in the quarter, down from $21 million last year based on our improved debt structure. After interest and taxes, our pro forma consolidated income for the second quarter was $17 million or $0.09 a share compared to $16 million or $0.11 a share in the same quarter a year ago.

I'll now turn your attention to the balance sheet for a few moments, and in particular, to the dramatic improvement in our capital structure compared to a year ago. Accounts receivable at $342 million or 4% lower than for the same period last year in constant currency. On an overall basis, DSOs decreased by one day to 59 days this year compared to 60 days in the second quarter a year ago.

Inventory at quarter end was $290 million. That's up 18% in constant currency. Consistent with industry practice these days, we bought inventory in advance to ensure timely production and delivery. And also to a degree, the increase represents a restocking relative to very lean inventories a year ago. If you recall, last year at this time, inventory was down 30% in constant currency year-over-year.

CapEx was $16 million in the quarter, up $5 million compared to a year ago with the increase driven primarily by spending related to our ERP system implementation as planned.

We ended the quarter with approximately $594 million of net debt. That's a 19% reduction from the $733 million of net debt a year ago. Cash on hand at the end of the quarter was $139 million. As a result of our significant progress in improving our capital structure this year, the ratio of our net debt to pro forma adjusted EBITDA for the 12 months ended April 30, was 2.9x compared to 3.8x a year ago.

Now that we're nearing the end of fiscal 2011, we'd like to reassure investors that we remain focused on the longer-term growth and profitability of our business and are taking the necessary actions to achieve our objectives. Consistent with this direction, we do not plan to comment on the short-term outlook. However, we would like to reiterate that we remain on track to achieve our longer-term financial objectives of generating annual revenues between $2.5 billion and $3 billion and at least $350 million of annual EBITDA.

And with that, I'll turn the call back over to Bob for closing remarks.

Robert McKnight

In summary, we're pleased with our solid results in the second quarter, as the performance of our Americas and European businesses more than offset the impact of events in the Asia Pacific region. Despite the difficulties, we're confident in the growth opportunities throughout Asia and in the recovery of our business in Japan, Australia and New Zealand. The initiatives we set into motion are gaining traction and we remain on track to successfully transition to stronger growth in the future.

Thanks again for participating in our call this afternoon.

Bruce Thomas

Operator, that concludes our prepared comments. We're now ready to start the question-and-answer session.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Jeff Klinefelter with Piper Jaffray.

Jeffrey Klinefelter - Piper Jaffray Companies

[Technical Difficulty] Let me just start with a question here about the outlook. You shared some thoughts on the bookings, going forward, for the 3 brands. Is that color intended to give a sense, at least, over the next couple of years or the balance of this fiscal year of a general top line growth rate? I'm just trying to determine whether or not that should be interpreted as some type of a top line guide or top line opportunity. And then I have a couple other follow-ups.

Joseph Scirocco

Jeff, I would say it's a general indicator. But I need to explain, as we typically would, what the limitations are in an order book. So for those who follow this, you know that the order book covers only forward bookings on the Wholesale business and the Retail business, which comprises a significant part of our operations, particularly during the summer months is, of course, not subject to that. Additionally, with respect to our DC business, in Footwear, we find that only about 60% to 70% of the actual revenues are registered in order books. So the Reorder business, the in-season fulfillment is a very significant component of that business. So with those few limitations, I would say, yes, the outlook can be derived in part from look-at orders. And again, the main thing here that we've looked at and which has given us such confidence is that the Roxy order book has returned to growth. This is something we've been looking for, for a number of quarters as I'm sure you were.

Jeffrey Klinefelter - Piper Jaffray Companies

Yes, absolutely. That's helpful. Thank you, Joe. One other thing on the forward view here. I guess, your own comps are, obviously, a way for you to gauge kind of current business trends or near-term business trends. You want to put that comp of about 23% in context with maybe last year's comparisons just to give a sense for how your tracking?

Joseph Scirocco

Sure, we can do that. So just thinking about it like this, this year, our Americas' comps were in the 23% range. Last year, it was mid-single-digit number. So considerably better. And the thing we found about our Americas' Retail business, just another area that's needed attention over the past couple of years, is that we are benefiting and we did benefit in the quarter from some improvement in consumer spending relative to a year ago. But in addition, we've done a number of operational things, which include changes in merchandising, some changes in key personnel and various components of that business. And we think we're operating a lot more efficiently. So...

Craig Stevenson

It's Craig Stevenson, President of the Americas. I could probably add a little bit more color to that. The planning and allocation system that we've talked about here in the past, we've really fully implemented in it -- excuse me, fully implemented now and it really does allow us allocation and replenishment brought down to size level. So we get a really good indication from a reap point of view. We've also done some store profiling, which really does optimize the assortments by division and specifically, for different regional areas within the Americas.

Robert McKnight

It doesn't really need to the said but, obviously, the Memorial Week and the weekend were fantastic for business, all around.

Jeffrey Klinefelter - Piper Jaffray Companies

Okay. That's helpful. A couple other things just quickly, Joe, one would be on just overall kind of big expense leverage, maybe you could just give a little bit of an update and how you see that contributing to your longer-term up margin goal. Where are there points of potential leverage now, obviously, top line growth is key to that, but what other areas or major buckets can you, maybe, either reduce or leverage faster than others? And then just on DC to clarify. DC, you're going direct in mainland China, is that correct? And you still have Glorious Sun for your JV and the rest of the business?

Joseph Scirocco

That is correct. So, yes, working backwards on your questions. DC is a direct country for us in China -- sorry, China's a direct country for DC. And we have just brought on a new Manager to take that on and building out a very comprehensive business plan that we'll talk about more in the near future. And then as far as expense leverage, I would say the 2 areas where we stand the most opportunity to improve would be in the area of retail stores, which we are now seeing that leverage in the Americas region. We could benefit from improvement elsewhere in the world as those regions come back to positive comps. And also in the E-commerce area, this is a very significant one for us. As you know, we have a relatively small E-commerce business now, although it is probably ahead of where our direct competitors are. We think we have a lot further to go. And over the 5-year plan that we're building, E-commerce is a very substantial part of that growth. So our goal remains to add at least 200 basis points of leverage. And those are 2 primary areas where it's coming. Couple of other points on that is that within our regions, even within the Americas region, if you look at the Latin American business, tends to be a bit of a higher-margin business than the domestic U.S. market. So we have pockets like that, which we believe we can leverage as well.

Operator

And next, from D.A. Davidson, we'll move to Andrew Burns.

Andrew Burns - D.A. Davidson & Co.

I wanted to talk a little bit about the owned retail and some of the comments there about refreshing 2/3 of the European store base. Could you talk about the timeline there and the cost, the CapEx? And then secondly, the new concept store seems to be working well. Can you talk about what is different versus previous concepts, and the long-term potential for putting those stores into key markets?

Joseph Scirocco

Sure. Let me just tell you a bit more about Europe to kind of elaborate on that. And then I think Craig would probably like to make some comments about what that implies for the U.S. market. But essentially, we have over 250 stores of our own in Europe, not counting other franchise and other opportunities. So within Europe, we have started with this new concept store, and really want to put it in the key markets to totally own the Atlantic Coast. And we are currently the leader in that market. But we think that the new concept store will solidify. So we've mentioned a few locations all the way from the U.K., South to Portugal and then exporting that to the -- or installing that also in the French Alps to kind of tie the mountains and coastal areas together. The upgrade is well covered by our existing CapEx budget of which, in our European business, is on the order of $25 million to $30 million for the year and more than covers our capital spend. In certain locations, these upgrades can be as little as completely new visual marketing packages. In others, they represent major renovations such as in the Paris Bercy store.

Craig Stevenson

Andrew, Craig Stevenson. Just a quick snapshot, really, on the Venice store and what we're trying to do there. It's 1,000 square meters with 10,000 square feet. And it really does give us an opportunity to showcase all our brands in one store all the way from hard goods to soft goods. There's not many stores in the Americas where we've had a chance to do this that really does offer a holistic brand experience of what we're all about. And I think that I hope you get around to Venice some time and check it out. It's actually on the corner of Venice Boulevard and Abbot Kinney. So it's in a really cool place that reflects who we are. And obviously, it's going to be a -- profitability is a big part of it. It's just not about marketing and brand experience. There won't be any loss leaders there.

Andrew Burns - D.A. Davidson & Co.

Great. And then just a follow-up here, if I heard correctly, DC for all-in was up mid-single-digits. If I heard that correctly, could you walk through anything that was potentially was a headwind to the brand in terms of by region or in timing of shipments or anything that kept that a bit low its long-term growth potential?

Joseph Scirocco

No. I mean other than timing of shipments around the quarter's ends. But from a directional standpoint, and again, with the exception of Asia Pacific, which had some challenges this quarter, the DC brand is fully on track.

Operator

Next we'll hear from Jeffrey Van Sinderen with B. Riley.

Jeffrey Van Sinderen - B. Riley & Co., LLC

I know you're investing in some growth initiatives and that impacts 2011 profitability. But are you still thinking about second half of this year as a transitional period? Or could you start to leverage the P&L in the second half this year? Or should we wait to think about the P&L leverage until next year? And then also maybe if you can speak to some more of the growth initiatives. I think you mentioned ERP system and some other things that you've done in terms of software for your Retail business. How some of those investments are going and evolving? And how -- and have you seen any of those initiatives start to have a positive impact on your business yet?

Joseph Scirocco

Sure. I think 2011 is very much a year in which we are transitioning to a new period of growth for the company beginning in 2012, and leverage should follow that. In terms of some of the other initiatives you mentioned, I mean, the real focus is on returning to growth and positioning markets like China, like Korea, like Latin America, especially Brazil and the eastern block for future growth. So that's where the main focus is. On the operational side, with respect to the ERP implementation, we are in the probably 2/3 complete with our first phase of it. First phase being one of the brands here in the U.S. is expected to go on to SAP by the end of the fiscal year. So that's being staged appropriately. And then from there, we plan to take the ERP to the rest of the Americas early next year and to Europe probably towards the end of 2012 or beginning of '13. So that's a longer-term program. But we do think it will give us much better visibility into the supply chain and efficiencies, and bring us up to speed with the rest of the better players in the Apparel business.

Jeffrey Van Sinderen - B. Riley & Co., LLC

Okay. And clearly, your company owned Retail business in the U.S. has improved dramatically. And I think you mentioned that you're up against single-digit comps last year. When do the comps start to get -- when do the comparison start to get more difficult in the Retail business?

Joseph Scirocco

Probably in the first quarter of next fiscal year. Last quarter, which was our first quarter. I think we comped up in the mid-teens in the U.S.

Jeffrey Van Sinderen - B. Riley & Co., LLC

Okay. All right. And then any -- it sounds like you had a good Memorial Day weekend. Was there anything outstanding about the progression from April to May? Some of the retailers that reported today, they saw their business fade in May. Just wondering if you have any thoughts on what you saw there.

Craig Stevenson

Yes, I really think the weather was a really big part of it too. What we've seen -- it's followed the weather, really, for that Memorial Day weekend. Really solid board shorts sales, which was really exciting and anything to do really with the beach really was the Quiksilver Girls beach pants, swimwear. Roxy swimwear was fantastic. Sandals, we saw a real pickup in sandals, and Roxy footwear, in particular. So we're really excited about more sunshine. And we really noticed that on the -- in Florida, in Hawaii, the mid-Atlantic South, there was really good indicators there. So the catch-up is going to come now. In the mid-Atlantic to the Northwest -- Northeast, sorry, and really exciting.

Jeffrey Van Sinderen - B. Riley & Co., LLC

Okay, good to hear. And what about -- I'm not sure what you said about DC apparel? Any comments there?

Craig Stevenson

Yes. DC apparel, we've have some really strong indicators there. The traditional categories of T-shirts, hats and fleeces sold really well. In particular, what really put some emphasis into is walk shorts and now board shorts, which are categories that we're really taking advantage of. We're seeing some great improvement in sales there.

Operator

Moving on to Jim Duffy with Stifel, Nicolaus.

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

Joe, a subject which has been top of mind for investors, product costs and your strategies to manage the costs. Can you share some perspective on that, please?

Joseph Scirocco

Yes. Nothing's really changed in the near term. And we've talked for several quarters now about what's been coming down the pipe and the higher pricing coming out of Asia is expected to be felt for fall, really the first material impact in fall and winter. And we are seeing the same level of price increases that we have been talking about. We think kind of in the 10% to 15% range. From an adjustment standpoint, there's 3 things or -- sorry, from a compensation standpoint, there's 3 things we're doing. One is of course, like everybody else, selectively raising prices where we can. Secondly, we have a long-term hedging program in place, which is protecting a substantial amount of our purchases, specifically, those coming out of Europe and out of Asia Pacific where we've hedged forward against the dollar because most of our apparel is transacted in dollars. And then third, we've been doing our best to consolidate purchases among the regions through our in-house buying office. And the combination of those 3 things is expected to help us significantly towards offsetting these cost increases. And then from there, we'll see how it goes. Obviously, commodity prices vary. So we'll talk about it when we get to the spring/summer buys for next year.

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

Okay. That's helpful. And then can you remind me of that CapEx outlook for the year? And then maybe share some thoughts on where you expect inventories at year end? And any objectives you have for free cash flow?

Joseph Scirocco

Yes. CapEx is looking like somewhere in the range of $80 million to $85 million. And we expect working capital, in general -- I think last time we talked we had said that we expected working capital to build by maybe $10 million over the course of the year. Just judging on what we're having to do to manage supply, I think we could use up to $20 million in working capital just mostly in the building inventories. So I think that probably just under $50 million would be a good target for free cash flow, taking into account CapEx and a number of other factors.

Operator

And from Robert Baird, we'll move on to Mitch Kummetz.

Mitchel Kummetz - Robert W. Baird & Co. Incorporated

Let me begin by following up on Jim's question about gross margins. I'm curious, your gross margins through the first half of the year is up 140 basis points, if I'm doing the math right. You're not giving guidance anymore for the year. But I know as of Q1, your gross margin guidance was flat for the year. So kind of suggest that you're thinking gross margin is down in the back half, which is understandable, given the input cost increases. But I'm just kind of curious how you think about that? How much of those input cost increases do you think you can get back in the back half of the year, given some of those offsets that you mentioned, Joe? And I would imagine that mix would be a benefit to you in the back half, as well, assuming that retail continues to outpace the wholesale?

Joseph Scirocco

I mean the short answer is I think that you could see a slight downtick in gross margins on the back half of the year and for all of the reasons we've talked about. It's just a function of the pricing power and assumptions about the retail mix in relation to cost increases. But our feeling on this hasn't changed. So it's comparable to what we -- anything we've been discussing.

Mitchel Kummetz - Robert W. Baird & Co. Incorporated

But is it fair to say that you're ahead of plan on gross margins with the first half of the year?

Joseph Scirocco

I mean, I think that's been the result, yes.

Mitchel Kummetz - Robert W. Baird & Co. Incorporated

Okay, and then on the brands, you mentioned DC, up mid-single-digits on the quarter. I think you said that Quiksilver was up. Is that something you might be able to clarify the Quiksilver piece, I don't know if it was up low single-digits. And then Roxy, you didn't say -- I know that the forward orders look good. But I would assume, given the sales on the quarter, that Roxy probably was down a little bit. Could you just clarify the Quiksilver and Roxy pieces for Q2?

Joseph Scirocco

Yes, Quiksilver was up in kind of the low single-digit range and Roxy down in the mid-singles. And that's consistent with what we had been seeing at the time for forward orders for spring/summer, so no real surprises there.

Mitchel Kummetz - Robert W. Baird & Co. Incorporated

And what did you see in terms of the performance across the brands within your own stores on the quarter? Did you see Roxy stronger? I would guess you would seen Roxy stronger in your retail than what's reflected at wholesale?

Craig Stevenson

Absolutely. It reflected really the core store business, which Roxy had significant uplift. And again, same categories selling really well. What we've done with Roxy is we've put a real focus on swimwear for the 12 months of the year. And we've found a real demand for that. And it's really positive with the -- how that -- it's comped up some 48% just swimwear alone. And so we're putting a deep focus on that this summer with Roxy now in stores. And I think you'll see the numbers reflect that.

Mitchel Kummetz - Robert W. Baird & Co. Incorporated

Okay. And then just last question, just housekeeping. I know, again, you're not giving guidance on the year. But, Joe, I think you'd said previously in terms of tax and interest tax, I think you said just under $50 million. I wonder if that still holds, and then interest I think you said around $58 million for the year. I'm just kind of wondering about those 2 pieces.

Joseph Scirocco

They're both unchanged, yes.

Operator

Next, we'll move on to Eric Tracy with FBR Capital Markets.

Eric Tracy - FBR Capital Markets & Co.

If I could follow-up just to clarify on the kind of guidance. Not really changing off of the flat EBITDA, annual EBITDA guidance, does that still hold?

Joseph Scirocco

No, Eric. What we said was we're not commenting.

Eric Tracy - FBR Capital Markets & Co.

Okay, so all right. And I guess just as we think about the product cost side of things, cost up 10% to 15%, how you guys are sort of modeling or sort of projecting potential impacts on unit volumes? The elasticity, obviously, a big area focus here, what you guys -- or the assumptions around that. If you could provide any color and that would be helpful.

Joseph Scirocco

I mean, we start shipping fall in about 25 days or so. So the goods have been purchased for an extended period of time. And this has been well in the works. We bought to the plans that we've talked about. We think we have sufficient goods to satisfy the order books certainly. And we'll see how it goes. I think the price elasticity is very difficult to estimate. But we've done our best in making the buys for the back half. I'm not sure how to really answer it any better.

Eric Tracy - FBR Capital Markets & Co.

Okay. I just didn't know if you have a sense in sort of working with your retail partners in terms of forecasting that if they've given some. I was just curious on that, that's fine.

Joseph Scirocco

Yes. I mean, I think one thing is clear. I mean we've gotten higher open-to-buy dollars, obviously, on Roxy, right, because the order books are up. So retailers are feeling good about the brands. They're feeling good about Roxy, in particular, after the great success with spring/summer. And the open-to-buy dollars are there for us. We have increased prices in some categories to various degrees. So unit volumes have been adjusted accordingly.

Eric Tracy - FBR Capital Markets & Co.

Okay. Fair enough. And then -- and I guess just lastly on, with respect to the balance sheet, clearly continuing to improve there. Joe, is there sort of an optimal cash structure you guys have in place now right around 3x on the adjusted EBITDA basis? Where do you kind of settle in as an optimal level?

Joseph Scirocco

Well, in terms -- we're focused mostly on the debt leverage, or the net debt leverage, rather. So the way we think about this is the ratio of net debt to EBITDA, over time, should come down below 2x. We're at 2.9x this quarter, that's 19% better than it was a year ago. And if we achieve the plans that we've laid out, which we expect to, we should get down below 2x in the not-too-distant future.

Operator

And from Bank of America Merrill Lynch, we'll move on to William Reuter.

Spenser Samms - BofA Merrill Lynch

This is actually Spenser in for Bill. I was wondering if you guys could comment on how you guys feel about your inventory? And maybe if you have any specific things to say by brand if there's particular brands that were maybe up too little or too much?

Joseph Scirocco

No, I think, as we said, it's up about 18% to last year, which obviously, is up ahead of sales. But the reason is that's what people have to do these days to protect against supply disruption and that kind of thing. So we believe that it's well in line. And we expect to probably maintain this slightly higher level in relation to revenue going forward for the rest of the year. That's the reason why I suggested earlier that from a balance sheet standpoint, we'd probably need an extra $10 million for working capital

Spenser Samms - BofA Merrill Lynch

Sure. And then also with the success of your retail stores, have you guys changed at all about how you think about the opportunity of the number of stores, maybe, by geography it's changed a little bit?

Joseph Scirocco

Well, what we're really focusing on is the concept in key markets and protecting and enhancing the brands in each of the markets. This is not so much -- it's not a return to the old strategy of rolling out a whole bunch of mall stores. So I don't expect that our CapEx plans are going to change much over time in this area. I think, if anything, the areas that we'd like to see pickup and the new way to reach consumers for us would be to build out the E-commerce business because the main focus of our operations now is to drive higher operating margins. And so anything that we can do to gain that leverage, we remain focused on the 2x net debt-to-EBITDA. And I don't expect like a major blowout of retail stores around the globe. What we're talking about is key markets and really establishing control.

Bruce Thomas

Looks like we've reached the end of our allotted time today. So I'd like to thank everybody for their participation in today's call. And we look forward to providing our fiscal third quarter results in early September.

Operator

Ladies and gentlemen, that does conclude today's conference. Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Quiksilver's CEO Discusses Q2 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts