Volcom Q3 2007 Earnings Call Transcript

Oct.29.07 | About: Volcom, Inc. (VLCM)

Volcom, Inc (NASDAQ:VLCM)

Q3 2007 Earnings Call

October 29, 2007 5:00 pm ET

Executives

Hoby Darling - Vice President of Strategic Development andGeneral Counsel

Richard Woolcott - President and Chief Executive Officer

Doug Collier - Chief Financial Officer

Jason Steris - Chief Operating Officer

Analysts

Jim Duffy - Thomas Weisel Partners

John Rouleau - Wachovia Securities

Eric Tracy - BB&T Capital Markets

Jeffrey Klinefelter - Piper Jaffray

Mitch Kummetz - Robert W. Baird

Jeff Mintz - Wedbush Morgan

Operator

Good afternoon. My name is Sarah, and I will be yourconference operator today. At this time I would like to welcome everyone to theVolcom, Incorporated, 2007 Third Quarter Financial Results Conference Call.

All lines have been placed on mute to prevent any backgroundnoise. After the speaker's remarks there will be a question and answer session(Operator Instructions).

I would like to introduce Mr. Hoby Darling, Vice Presidentof Strategic Development and General Counsel, Volcom Inc., to begin the call.Go ahead, Mr. Darling.

Hoby Darling

Thank you Sarah. Good afternoon, everyone, and thank you forjoining us today to discuss Volcom's 2007, third quarter financial results.Joining me on the call today are, Richard Woolcott, Volcom's President andChief Executive Officer, Doug Collier, Volcom's Chief Financial Officer, andJason Steris, Volcom's Chief Operating Officer.

First, some housekeeping items before we begin. If you wouldlike to be added to Volcom's e-mail distribution list to receive Companyinformation or if you'd like to change your contact information, please contactDavid Stankunas at Pondel Wilkenson at 310-279-5975.

In addition please be advised that this conference call isbeing broadcast live on the Internet at volcom.com as well as earnings.com. Aplayback will be available for one year and may be accessed on the Internet atboth websites.

Please also note that all of the information discussed ontoday's call is covered under the Safe Harbor provisions of the LitigationReform Act. The Company's discussion today will include forward-lookinginformation reflecting managements current forecast of certain aspects of thecompany's future.

In particular statements about the future regarding ourguidance, outlook for future business, margins, financial performance, customerdemand, growth and profitability, all institute forward-looking statements.

These forward-looking statements are based on management'scurrent expectations, but they involve a certain number of risks anduncertainties.

Actual results could differ materially from those stated orimplied by these forward looking statements, due to risks and uncertaintiesassociated with the Company's business.

Certain risk factors associated with Volcom's business areset forth in its form 10-K for the year ended December 31, 2006 andsubsequently filed quarterly reports submitted on form 10-Q.

The Company disclaims any intent or obligation to updatethese forward-looking statements except as required by law. All are forwardlooking statements from today's call are qualified in their entirety by theforegoing cautionary statement.

With that said, it's my pleasure to turn the call over toRichard Wolcott, our President and Chief Executive Officer.

Richard Woolcott

Thank you, Hoby, and good afternoon everyone. I am proud toannounce that we have once again delivered solid financial results thisquarter, and as we close in on the end of the year, we remain focused in ongrowing our business while maintaining the strength of the Volcom brand.

In terms of the third quarter, we met the top end of ourrevenues expectations with total revenues of $91 million, up 49% over lastyear. We also beat our earnings guidance with net income of $14.5 million,translating to diluted earnings per share of the $0.59.

Year-to-date our Company has shown strong growth, withrevenues up 34% compared with last year, net income up 24% to $26.2 million,and EPS growth of 23% to $1.07.

I believe these results are a refection of our team's effortto promote growth while maintaining brand quality and integrity. Volcom isextremely well positioned and continues to experience solid sell-through atretail.

Our unique marketing initiatives and innovative products havekept us at the forefront of our industry despite the competitive environment.Many of the recent analyst surveys, magazine polls and channel checks onceagain report Volcom as one of the best, if not the best, performing brand inaction sports.

We have had a number of home runs this year and I am proudof our team's accomplishments both here in the U.S. and Europe.

I would first like to talk about our biggest project thisyear, the successful launch of Volcom Europe. The third quarter featured ourfirst full quarter shipping product in Europe and the results were on right ontarget.

Our European distributors are excited to be back with theVolcom mother ship and looking forward to the road ahead. Now that the firstphase is done, we are currently working closely with our European teamregarding the strategy for the next several years.

For 2008, we see the majority of our European growth comingfrom our existing account base. We plan to begin building our in store presenceto our store-in-a-store concepts, racks and displays. We believe this willincrease sales for 2008, but will really set the platform for 2009 and beyond.

With regards to territories of opportunity, we see a lot ofpotential across the board. Right now our top five territories include France,Germany, Austria, Spain and Italy. We are also strong in Switzerland andNorway.

We see opportunity moving forward in the U.K., Italy andSweden to name a few. The eastern European countries, such as Poland, Hungaryand the Ukraine, are just getting going and could be potential growth driversdown the line.

Finally we continue to build our infrastructure and hirepersonnel where needed. Right now, we currently have a team of 85 peopleworking in Europe and both the U.S. and European teams are constantly incommunication and meeting on a regular basis.

Moving on to our domestic business, I believe we have done agood job of diversifying our account base over the last 12 months, allowing theVolcom brand to reach a wide range of consumers, while keeping our corefollowing intact.

Our core accounts, which often cater the most dedicatedcustomers, continue to show solid growth despite a challenging economicenvironment and less than optimal weather conditions.

In the third quarter our business outside of our fivelargest accounts and outside of our European business, grew 26% and for thenine-month period it grew 28%. We continue to be encouraged by the positiveresults in this segment of our distribution.

I believe the biggest improvement we have had this year withthe distribution strategy is lowering the concentration risk with any onecustomer. Our largest customer, PacSun was 27% of the business at the end of2006 and now they are approximately only 17% of our overall business at the endof the third quarter.

The key here is that we have been able to grow our revenuesand our earnings while the concentration risk of our largest customer hasgreatly decreased.

Let me take a now take a moment to further discuss ourbusiness with PacSun and how we are modeling our business with them for theremainder of the year. As most of you know, our business with PacSun has beenlong standing and they are one of our top customers.

We continue to believe that Volcom is a very important brandfor them, and that sell-through has been good, but other the past year we havereported that our visibility into our business with PacSun has becomeincreasingly limited, resulting in quarterly business that has been difficultto predict.

We believe it reflects the ongoing changes with in PacSun.While their team has expressed that we are one of their strongest brands, andwe are performing well in their stores, this shift in PacSun's business has hadan impact on our growth with them.

On our second quarter call; we estimated that our PacSunbusiness would be down approximately 15% in the third quarter compared to thesame period last year. Our PacSun business was in fact down 23% from the thirdquarter of 2006.

When analyzing our PacSun business, we believe that one ofthe reasons we're down is due to PacSun reducing inventories in their stores.This directly affects the amount of Volcom on the floor, resulting in fewerorders.

We've also noticed our girl's business is down, which webelieve is due in part to change in their strategy to bring in more privatelabels within this business. However our men's business is strong right now,including a very successful polo and chino short program.

Given that we continue to be challenged by PacSun's changein strategy and ordering patterns, we are projecting our annual business to bedown approximately 10% versus our original estimate of being down mid singledigits.

This estimate therefore suggests that our fourth quarterPacSun business is expected to be down approximately 20% over the same periodlast year. Finally, I'd like to point out that even though we are going througha challenging time with PacSun, we are excited and committed to working closelywith them.

We have a strong working relationship and we are focused onmaximizing all opportunities moving forward.

An area of distribution that has been picking up steam thisyear has been our Volcom brand of retail program. I am very excited about thisprogram and believe our stores are a great vehicle to showcase the Volcom story.

It's a healthy way to slowly grow our business in areas thatare under distributed and these stores have also shown that they can serve as asolid distribution channel. We currently have five stores in operation and planto open our sixth retail operation in Berkley, California in the next severalmonths.

Our seventh store, which will be located in Waikiki, Hawaii,is planned to open in late spring of next year. We also opened three newlicense locations this year working with our international partners. Theselocations include Tokyo, Japan, Durban, South Africa and Sau Paulo, Brazil.

I would like to note that we have three additionalinternational stores, one in Indonesia, one in Thailand and one in Hossegor,France. Our retail program has been performing well thus far and we are excitedto continue opening additional locations in 2008.

Now let's turn our attention to product. Our productcategories continue to perform well and the read so far for our spring 2008collection has been solid. We believe we have the right product mix and insteadof going into new categories, our strategy is to focus on our existingcategories and strengthen what we are already doing. This is a very excitingtime for Volcom design and we are more passionate than ever to put out the bestproduct possible.

With that said, I would like to take a moment and highlightsome of our categories. With the success of our initial swim launch we wereexcited to hit the road with our complete spring ‘08 collection. This line waswell received at the Miami Swim Show, ASR Arms Expo and will begin hitting thestores in December.

The summer ‘08 collection also looks amazing and the salesteam will be back on the road this week. Overall the swim program is wellpositioned and a great compliment to our girl's product. Since launching ourCreedler footwear nearly a year ago, we have successfully established ourdistribution, strengthened our product mix and developed our in store presence.

I believe our Creedler division is solid and we are primedto capitalize on the strong foundation we have set up. So far, our strongestperforming Creedler category has been the open-toed sandal program and we see agreat deal lot of potential for growth for this particular category.

As for the closed-toe business, we continue to havesell-through in, the overall Volcom slip-on category has slowed. This slowinghas had an impact on our projected slip-on sales, but our overall footwearcategory has grown from last year due to the success of our open-toed sandals.

As we move forward with our Creedler category, the focuswill shift to the sandal category, which is where we feel we can better competeand continue to grow the business.

Turning to our kids and boys lines. We are very pleased withthe support and enthusiasm we are getting for these new categories from ourretailers and customers alike. We see this category as a great area for growthmoving forward.

Another product category I'd like to highlight is our snowbusiness. As many of you might remember, last year was a tough winter for mostregions. Unfortunately, this has caused many of our retailer's outlooks to bemore conservative with outer, wear pre-books. While outer wear is only 11% ofour business, this category is expected to come in lower than we originallyplanned as a result of the prior year's poor weather conditions.

And even with the weak season and poor retail environment,our domestic snow business still grew 15% year-to-date over last year. I alsobelieve that our Volcom outerwear is some of the best in the industry, bothtechnically and aesthetically.

I’d know would just like to briefly touch on marketing. Asmany of you know our marketing and branding initiatives have been relentless.We pride ourselves on our athletes and grassroots programs, and we have workedhard over the years to establish ourselves as an industry leader.

Currently, our marketing programs are going full force andwe have no intention on letting up. We really hit the scene hard this summerand fall with the promotional tours, in-store demo's, Let's Live moviepremieres, the Rock 'N' Roll Tour, our Let the Kids Ride Free contest,advertising campaigns, and general marketing mayhem.

One recent highlight this fall was Ryan Sheckler'ssuccessful new show, Life of Ryan, on MTV. Ryan, who is one of our topskateboarding athletes, has been working hard on the show and it is slotted fora second season and we all look forward to the new episodes. Ryan was also onpoint this summer, winning almost every skateboard event he entered.

As we move into the holiday season our grass roots attackwill be 110%, from the Hawaii House and our rock tour in Europe, to our recenthosting of the Damn Am Skateboarding Finals, last weekend, right here in ourparking lot; our marketing troops are on it. For more information on what isgoing on, please check out our website at www.volcom.com. It has the highlightsand upcoming activities.

Now I'd like to discuss the current business environment andhow we think it will affect Volcom in the future. As we look forward, we arenow faced with a new obstacle that has not been in our path before as a publiccompany.

It appears that we are entering challenging economic timesthat will take patience and extra effort to work through. Due to the state ofthe economy, we have noticed a higher level of caution from our retailers thanin past years and we must strategize accordingly. In order to adjust to thisconsumer slowdown, we will need to lower our revenue and EPS guidance.

While we certainly are not pleased to tighten our financialoutlook, which Doug will discuss in a moment, we have always thought to operatein a straightforward manner, and communicate our challenges along with oursuccesses.

I'd like to make it very clear this is not a reflection ofVolcom's overall performance, but primarily a reflection of our decrease inbusiness with PacSun and an inability to make up the lost closed-toe and outerwear business, due to the soft retail environment.

We believe the Volcom brand is extremely strong with in themarketplace and is positioned correctly for the long term. Ultimately, we arelooking at this as yet another opportunity to grow stronger as a brand and as acompany.

We have always been relentless in our pursuit to be the bestin our operations, our products, marketing and the way we represent theindustry. We are a very passionate group and look forward to charging ahead. Asalways, I would like to thank the entire Volcom family, our athletes, retailersand shareholders for their continued support and commitment to the brand.

And now, I would like to turn the call over to our CFO, DougCollier to review our financial results for the quarter. Doug?

Doug Collier

Thanks, Richard and good afternoon everyone. Third quarterresults were once again solid as the brand continues to perform well despite atough retail environment. In looking at the details of Q3, our Europeanoperation had a significant positive impact on our results, as it completed itsfirst full quarter as an operating business.

Due to the impact I will provide additional informationabout the European business, as I discuss our financial results. In order toprovide clarity into our business we will report financial results today inthree ways.

First, we will give consolidated results. Consolidateresults include both our segment, and our European segment. Second, we willseparately break out results from our U.S. segment. The segment represents ourbusiness in the U.S., our non-European international business primarily inCanada and Japan and our licensing relevance.

And third, where appropriate we will provide the separateresults of our European segment. Please note that only our U.S. segment aredirectly comparable to our 2006 results. With that said, here are some detailsof the third quarter.

For the third quarter ended September 30, 2007, consolidatedrevenues increased 49% compared to $61 million in the third quarter of 2006.Revenues from Volcom U.S. segment were $65.2 million versus $59.9 million inthe third quarter of 2006 representing an increase of 9%.

This lower than expected growth rate is due primarily from adecrease in business from our largest account, PacSun. Europe posted revenuesof $25.8 million for the quarter. This compares to $1.1 million of revenue inQ3 of 2006 attributable to Welcome Distribution our subsidiary that is thedirect distributor of Volcom products in Switzerland.

Getting into the details of revenue by product category, letme first provide a breakdown of revenue on a consolidated basis. Some of thesecategories show significant increases in revenues, due to our Europeanoperation shipping its first full season.

On a consolidated basis, our men's product revenue increased72% to $41.4 million for Q3, compared to $21.4 million for the third quarter oflast year. Girl's product revenue increased 15% to the $21.2 million versus$18.5 million in the third quarter of 2006.

Boy's revenue, which includes our kid's line for boys aged 4to 7 increased 78% to $5.5 million, compared with $3.1 million last year.Revenues from our snow division increased 56% to $20.4 million for the quarter,up from $13.1 million in Q3 of last year.

In new product initiatives, revenue from our girl's swimline was $97,000 for the quarter, and revenues from our Creedler footwear linewas $1.2 million. Since swimwear and Creeler were just recently launched, wedon't have comparables for the same period last year.

Turning to the U.S. segment our results by product categoryare as follows. Men's revenue was $27.4 million, a 16% increase. Girl's revenuedecreased 11% to $16 million. As Richard noted earlier, this decrease reflectsa decline in our PacSun girl's business.

Boy's revenue was $5.1 million, a 69% increase. Snow revenueamounted to $14.3 million, up 11%. Girl's swim revenues were $97,000 andCreedler's revenues were $1 million. Looking at our revenue by distributionchannel, on a consolidated basis, revenue from our five largest accountsdecreased 12% to $21.1 million in the third quarter, representing 23% of totalproduct sales.

This decrease is primarily due to decrease business withPacSun. For reasons mentioned earlier by Richard, revenue from PacSun ourlargest customer, decreased 23% to $10.3 million for the quarter or 11% oftotal product revenue, compared to $13.4 million, or 22% of our product revenuefor last year's comparable period.

Excluding PacSun, revenue from our next four largestaccounts increased 2.6% to $10.8 million. While this percentage growth is belowprevious quarters, year-to-date this business has increased 14%. Revenue fromour non-top five accounts and not including Europe, which represented 48% oftotal product revenue for the quarter, increased 26% to $43.6 million for thequarter.

We continue to be encouraged by the strong growth from thenon-top five accounts as they include core shops that tend to drive growth inother distribution channels. Moving down the income statement, third quarterconsolidated gross profit, as a percentage of total revenue was 50.4% compared with50.6% in the same period last year.

Gross margin for the U.S. segment was 48% versus 50.9 % inthe third quarter of 2006. This lower than anticipated gross margin was due tolarger than expected inventory liquidation during the quarter. Gross margin forour European segment was 56.4%, higher than originally planned due in largepart to stronger than expected foreign exchange gains.

Consolidated, selling, general and administrative expenseswere $22.8 million in the third quarter, of 2007 versus $15.3 million for thesame period last year. As a percentage of sales SG&A expense was flat ascompared to the same period last year, coming in at approximately 25.1% oftotal revenues.

On a consolidated basis operating income for the thirdquarter increased 48% to $23 million, compared with $15.6 million for the sameperiod in 2006. Operating margin was 25.3% for the quarter, compared to 25.5%in the third quarter of 2006. The company recorded a provision for income taxesfor the third quarter of this year using a 39.4% annual effective tax rate.

Consolidated net income for the third quarter of 2007 was$14.5 million, or $0.59 per diluted share, compared with net income of $10.2million or $0.42 per diluted share in 2006. Turning to the balance sheet thecompany had $81 million in cash, no significant debt, and stockholder's equityof approximately $165 million.

Accounts receivable totaled $67.6 million, at the end of thequarter, compared with $34.2 million at December 31st, 2006. An increase of$33.4 million, or 98%. Please note that of this increase, $22.4 million is anincremental increase from the European segment.

For the U.S. segment alone receivables grew $11 million or33%. The consolidated receivable balance at September 30, 2007 represents day'ssales outstanding of 93 days. If we exclude Europe, DSOs are 71 days. Thiscompares with DSOs of 66 days at September 30, 2006.

Inventory totaled $16.7 million at September 30, 2007,compared with $13.2 million at December 31, 2006,an increase of $3.5 million or27%. Inventory at the end of Q3 includes $3.9 million of inventory related toEurope, accounting for a large portion of the increase for the nine-month. WithEurope included our consolidated inventory turn rate calculates to nine timesfor year or once every 41 days. This continues to be well above industryaverages.

I'll now turn to financial guidance for the 2007 fourthquarter and for the full year. In putting forth this guidance please bear inmind our comments on general caution from our retailers to the softenvironment, our business with PacSun, which we are estimating will be downapproximately 10% for the year versus our previous guidance of down midsingle-digits, a less enthusiastic outlook on the outer wear business due to achallenging 2006 snow season and the slowing of the overall Volcom-ized slip-oncategory affecting our footwear business.

With this backdrop, 2007 fourth quarter revenues areexpected to be between $70 and $73 million, or an increase of 20% to 30%compared to Q3 of 2007. This translates to EPS of between $0.30 and $0.32.

For the full year of 2007 we are therefore lowering ourguidance to an increase of revenues of 31% to 33% over 2006, resulting in salesof approximately $270 to $273 million. We currently estimate EPS for the fullyear at approximately $1.37 to $1.39.

We are increasing our revenue guidance for the Europeansegment for the second half of the year from a range of $29 to $31 million toapproximately $32 to $33 million. Given third quarter revenues from Europe of$25.8 million, this translated to $6 to $7 million in the third quarter.

Because fall business is much greater than holiday businessin Europe, the seasonality between Q3 and Q4 is expected. We expect the Q4 andfull year 2007 annual effective tax rate to be approximately 39.4%. Fullydiluted shared outstanding for the fourth quarter, and full year 2007 areexpected to be approximately $24.5 million.

While we are not prepared to provide formal 2008 guidance onthis call, we currently believe that overall, consolidated revenue and earningsgrowth of approximately 20% for 2008 is achievable. This includes our initialestimate that our 2008 business with PacSun will be down approximately 10% from2007.

We intend to provide 2008 guidance when we report our Q42007 results. In putting forth this outlook we want to remind everyone of thecomplexity of accurately assessing future earnings and revenue growth, giventhe difficulty in predicting the sales of our products by key retailers,including PacSun, of ship from a licensee model in Europe to direct control ofthe territory, general economic conditions, changes in fashion trends andconsumer preferences and sourcing costs.

With that, we will open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from theline of Jim Duffy, with Thomas Weisel Partners

Jim Duffy - Thomas Weisel Partners

Thanks, hello.

Richard Woolcott

Hi, Jim.

Jim Duffy - Thomas Weisel Partners

A couple questions for you guys. The snow business, I wassurprised to hear you cite that. I thought most of that was done in thirdquarter going back to my model it looked like you had $2.3 million in snowbusiness in fourth quarter a year-ago.

Richard Woolcott

Yes Jim, this is Richard here. On the snow business, whatnormally happens is you know we do the majority of the pre-book and get intothe season. We do the pre-book and then we jump into the actual snow season andmost of the time, we see ourselves trying to find some fill-in business andmaybe hitting a couple of key areas and extra fleece and beanies and that kindof stuff that can happen.

What happened this year, is we got our pre-books. Pre-bookswere a little bit short than what we had projected and in a normal course ofbusiness we could easily make that up if we had a more favorable environmentwith fill-in with fleece and other winter-type goods.

But as we go into this season and see what is happening withthe soft retail environment, we just don't see that happening. That's why we donot think we will hit that overall projection that we had originally had.

Jim Duffy - Thomas Weisel Partners

Okay. And then Richard you spoke at the outset about beingcomfortable growing with your existing channels of distribution. Is that to sayyou are not looking to expand distribution at this point? I guess, related tothat, what do you see is the opportunity to grow the domestic business withthose existing channels of distribution?

Richard Woolcott

Hey, Jim, I think I was talking about Europe when I saidthat. For next year our domestic -- and that is really what we are looking atwith our Europe partner, first focusing on our current account base and reallybuilding the in-store programs, very similar to the way we did here over thelast couple of years. So that's the first opportunity over in Europe, is todive into our current account base.

Jim Duffy - Thomas Weisel Partners

Okay.

Richard Woolcott

That was specifically for Europe.

Jim Duffy - Thomas Weisel Partners

I guess a question about the opportunity to grow thedomestic business still stands. If we are thinking about Europe building on topof the US business, what should we think of as the great real estate for the USbusiness?

Richard Woolcott

You want to?

Doug Collier

I think it's a little too soon to get into that. We didprovide a little bit of a look into 2008 and we'll come back to you with moredetails on that for 2008 when we report Q4 next year.

Jim Duffy - Thomas Weisel Partners

Okay, but within that 20% you must have a component of whichyou think the US business will contribute? True?

Richard Woolcott

True. But at this time it's premature to get into that andwe look forward to catching you up on that when we report 2007 full year.

Jim Duffy - Thomas Weisel Partners

Okay, I'll let somebody else jump in. Thank you.

Operator

Your next question comes from the line of John Rouleau ofWachovia Securities

Richard Woolcott

Hi, John, how's it going?

John Rouleau - Wachovia Securities

Good. You made the comment around gross margins, that youhad more liquidations this quarter with expected margins. Just wondering aboutthe inventory level and the content now. Will we see that may be continue intothe fourth quarter? Where are you at in being comfortable with the content andlevel of the inventory?

Doug Collier

John, this is Doug we are real comfortable at the end of Q3.You can see those inventory levels were really in line there. When you pulledup the European portion, they looked really good. I think, going into Q4 we seesome potential issues now that we have the potential short fall.

So I think, in looking at sort of the overall consolidatedgross margin we see it being a little bit softer than Q4 of last year, but withthat said, I think that we do resolve any inventory issues that we had in Q4 sothat we start off 2007 clean.

John Rouleau - Wachovia Securities

In looking at Q3 and Q4 it sounds like maybe you have kindof dealt with the snow side of it and maybe now you are looking at potentialreorders that might not come through because of the state of the overallenvironment. Is that accurate or is there still snow out there to be dealtwith?

Richard Woolcott

John, this is Richard, the snow, the actual outerwearitself, that for the majority of that outerwear that is cut to order business.

John Rouleau - Wachovia Securities

Right. That's what I thought.

Richard Woolcott

But what we try to do if we you are going your snow seasonand that season is favorable, you always try to maximize the fill in businesswith the fleece, the beanies, and other types of more of the soft goods to kindof help ramp it up if there is business out there.

John Rouleau - Wachovia Securities

Got it.

Richard Woolcott

Now, right now our inventories are really clean and it'skind of a balancing act right now. We still want to have inventory in casethere is that reorder business out there. But at the same time we don't want tohave too much inventory and that's you what saw in '03, we've been very, veryconscious of making sure that we are managing the inventory correctly and particularlybecause we are in the slower enviornment or this retail environment.

So you want two things. You want to maximize any opportunityout there that comes your way, but at the same time you don't want to be stuckwith a large chunk of inventory at the end of the year. That’s kind of ourstrategy with it and so far we have really good balance right now. Feel goodgoing into Q4.

John Rouleau - Wachovia Securities

Switching gears a little bit. I mean, you have always talkedabout the core and the top five and it's helpful to hear the different growthand what the segments you are doing. You got a layered kind on Macy's west andDillards with the department store are not really sure. I don't think they areprobably top five quite yet but may be they are twelve.

I'm kind of wondering where those are accounted for in thosetwo groups. Maybe you can give us some idea of how big those are. I am tryingto strip those out a little bit and see what the growth is minus some of thatbusiness at the department stores or some feel for that. That make sense?

Richard Woolcott

Doug?

Doug Collier

Yes, John without getting into too much detail, we can tellyou they are not in our top five so they would fall outside that group.

John Rouleau - Wachovia Securities

So they are accounted for in the core?

Doug Collier

What we call -- we call that core our business outside ofour top five.

John Rouleau - Wachovia Securities

Right.

Doug Collier

And that includes the ones that you're talking about. Andour core business, whether it be the Froghouse, the Surfside Sports all the wayon up, to some of our larger retailers. So, but in that group I think we werelooking at them it makes up a large dollar percent and I think it's a reallygood sampling of where the majority of our growth and the strength of theVolcom brand where it's coming from.

So for us when we look at -- when we back out those top fiveaccounts, we are studying that across the board and I think it's a really goodsampling of where to brand, how the brand is positioned right now and how it'sperforming.

John Rouleau - Wachovia Securities

So if core was up 26% in the third quarter and you had outor backed out the department stores, then you see the rest of it up orsomething fairly similar to that or would it look different?

Richard Woolcott

John, at this time we have not been breaking those out. Welook and the other what is important I think what we're looking at now isparticularly in this general environment we are very focused on that grassroots component or that very, very core component to the brand and putting thateffort, that marketing and support effort into that ground level.

Because we understand that, you know, the success of a brandlong term is how it's performing at those key touch points with that core groupof that customer and those stores that have the hard goods that really are thestores that are super connected to the board sports.

So our focus, from our marketing and our support teams, isto that group, and for the long term and I think that's why we have beensuccessful over the last 15 years. No, there's no change in that focus andwe're going be particularly sensitive to it as we go through this softer retailenvironment. So our teams are on it.

John Rouleau - Wachovia Securities

Fair enough. And than last question again I know you're notgoing get into next year a whole lot, but you mentioned an opportunity for youto fix your Europe. I remember just a few years back we pick that time upopportunity here in the US hence it is accelerated your sales growth and itended up being a nice little boost and secured your place in retail but therewas also a bit of a bump in terms of how much that costs and all that.

Should we be looking at that as kind of even an investmentinto next year or is that more seasonal in nature? Or how should we be lookingat that?

Richard Woolcott

Well, I think that's a great question. And I think as we getinto the next call we will be able to give more clarity on that. But one thingto remember is that we're working with our distributes over there and so insome cases the distributors will be sharing the cost with us as we'redeveloping territories.

John Rouleau - Wachovia Securities

Right.

Richard Woolcott

We have general marketing costs, sales marketing costs,in-store costs, such -- those types of programs. Where we did it here we wereresponsible for the 100%. So it's a little bit of a different dynamic overthere. We are looking what I can tell you is this is not going be a one-yearramp up.

This would be built into our strategy over the next coupleof years over there in Europe and we'll be able to talk about that more on thenext call. But so, you've got a happening over a period of time and then we'vegot support with some of our distributor partners over there too.

John Rouleau - Wachovia Securities

Okay. Thanks very much, good luck.

Richard Woolcott

Thanks, John.

Operator

Your next question comes from the line of Eric Tracy withBB&T Capital Markets.

Eric Tracy - BB&T Capital Markets

Good afternoon, guys.

Richard Woolcott

What's going on, Eric?

Eric Tracy - BB&T Capital Markets

Maybe just to extend a little bit on the PacSun situation,obviously, a tough guard in terms -- just in terms of the magnitude of thedeclines. Can you talk a little bit about, again, being your visibility if itis at all improving with them in terms of the overall Volcom brand goingforward.

Understand that the girl’s is focusing on private label, butthe guys continue to perform so well for them. I am trying to get a handle asto why such a sort of quick year-over-year pull back as opposed sort of abovejust more over proactive approach on year-end to diversify away from them.

Richard Woolcott

We can’t go for the first thing.

Eric Tracy - BB&T Capital Markets

In overall in the retail environment or something specific Imean merchandising strategy at PacSun taking place?

Richard Woolcott

No, I would say right now we are working as close as we canwith PacSun and both of our teams are in constant communication. So, I don'tsee that as an issue. I think where we got caught up, number one is in that inventorychange.

Where they strategically said we are going to pull back oninventories. Which means our orders are going to be effected. So that's thefirst thing. The next thing is the junior's business that we talked about. Andthat’s we have seen a particular slow down in our junior's business with them.

Now in terms of forecasting we're both working on the samenumber together but what we've had difficulties reaching those numbers, andthose difficulties they range in what I was talking about and just, we thinkwe're going to get the business and we get to a certain point and that businessjust we don't get to that specific number.

And that's why we have had to cut back, for the fourthquarter and the year-end. We just don't physically see ourselves at this pointreaching the mid single-digits. I think part of it has been is a the one thingwe've talked about before, ordering enclosure to the window.

Sometimes when those orders come in so close to the deliverywindow we see it's physically impossible for us to produce it in that shortamount of time. So what I cant say is that on our end we are doing everythingthat we physically can to maximize the business.

And I can say between both teams we have -- there's a lot ofgood communication, we're working well together, but sometimes we're not goinghit every single target that we're trying to do, because at the same timePacSun is adjusting what they are doing.

Now I've spoke with them about the long-term and we gave youa figure for next year, the negative 10% that's the first initial number thatwe've -- that we're working on right now. And I think what we'll do, down line,as we really want to see where do we balance out our business with PacSun andwhere are opportunities, moving forward.

But now what we doing is we are trying to maximize the Q4.We've given you what we think it's going be and we're getting the initial readfor '08, which is the negative 10%. So, that is as much visibility as we haveright now.

Eric Tracy - BB&T Capital Markets

Okay just two quick follow-up on that. I mean your sense isit is across the board inventory pullbacks from PacSun, or can you say it'sspecific to some of the larger brands that they're looking at?

Richard Woolcott

Gosh, you know what? In terms of product mix and whatthey're doing with other brands I don't know. I mean the only thing that -- apullback we can re-quantity that pullback in the – in our juniors category.

Eric Tracy - BB&T Capital Markets

Right.

Richard Woolcott

And when you look at for the information that we have gotpublic information on their strategies is that looks like it's how they'rechanging going into more junior labels private label. That's why our juniorbusiness is a part of the reason why our junior's business has been affected.

Eric Tracy - BB&T Capital Markets

Okay…

Richard Woolcott

And the men's business as we said is been really good. Wehave a really strong polo program right now and we got good chino shortprogram. So we are having success in categories with them but I think we'rejust caught in-- they're changing -- they're going through their changes intheir business and I think we're just caught in the middle of it

Eric Tracy - BB&T Capital Markets

Right.

Richard Woolcott

And we just got a we’ve got a work through it.

Eric Tracy - BB&T Capital Markets

And how do you think about as -- as you are going to workthrough in terms of again either layering in or sort of ramping up new productcategories for one to help offset the junior's business weakness.

Two again expand distribution either with other wholesale,retail partners, again more accelerating Ramp up department source sort of abalance that ramping up brand management.

And then thirdly you mentioned briefly maybe just expand onit the retail company owned retail, feel like you have a good a test base inand you’ve got a sense of the success of those, and given the weakness of thewholesale channel in new again step on the accelerator little bit there to trycontrol the distribution? Or has we think about that.

Richard Woolcott

No doubt I think those are great points and the one thingthat I mentioned in my script was what we have -- and we have made a very,very, very conscious effort to work on concentration risk.

And I think if you look at what we've done, I rememberspeaking with everybody last year and you come town to the end of '06, and youlook at our concentration risk with PacSun, our percentage of business was 27%.

And three quarters we’ve been able to go from 27% down toright now, for the third quarter, I believe we are at 17%. I mean that's adramatic decrease in concentration with PacSun.

And we've been able do that working with our other channelsof distribution, some of the new retailers we've been working with, bringing onEurope, looking at some of the new categories and then I look at like we havebeen all able to do that and successfully grow the business.

We've got also a strong bottom line. So I think that we'vebeen very successful in moving in the right direction and we will continue todo that. I think '08 will -- we're going see that concentration become less andI think, hopefully after '08 into '09 our goal is --I guess to get theconcentration risk of any one customer under 10%.

So, we're going continue to keep moving forward because wedon't like having these concentration risks.

Eric Tracy - BB&T Capital Markets

Okay. And then maybe just lastly, despite of this weaknessthere are so have a nice balance sheet and inventory and in a cash position.Here Richard or Doug could you talk little bit about another uses of cash?

When, maybe, you kind of feel like, shares could beattracted potentially to put a buyback program in place?

Doug Collier

I think at this time we're going to look at all the optionsand make the best use for the Company and shareholders and I think anythingthat comes across, we will review. But no definite plans at this time.

Eric Tracy - BB&T Capital Markets

Great, thanks, guys.

Richard Woolcott

Thank you, Eric.

Operator

Your next question comes from the line of JeffreyKlinefelter of Piper Jaffray.

Jeffrey Klinefelter - Piper Jaffray

Hi, guys.

Richard Woolcott

How's it going, Jeff?

Jeffrey Klinefelter - Piper Jaffray

Well. A few quick questions here, first of all juniors incore. I don't know if I missed this, taking away the PacSun business in yourcore subsidiary distribution, what is the trend line in the juniors business?

Jason Steris

Jeff, how's it going? It's Jason here. Are you looking for apercentage?

Jeffrey Klinefelter - Piper Jaffray

No, just curious in terms of growth and how it's tracking inthat core. The reason I ask is coming out of the trade show, it seem there is astrong appetite for juniors in the west coast, life style sector, the boardsport sector.

So I am just curious, in those core shops, when you are notdealing with the private label pressure, what rate is it growing or did it growin Q3?

Jason Steris

Yes, I'll give you a general feel of the division and howit's doing. We're not breaking out that number specifically, but I think you'reright coming off the last trade show and seeing our swim booth incorporated intoour entire booth and with our product line with the girls it really was anadded component to help just build on the entire program.

I think, if you look into the core level across the board,I'd say the juniors business I said steady. I think there's definitely been alittle bit of a, I think, over the last five years, a big ramp up of thatbusiness but I think overall the business is steady but I don't see it growingat the rate in the core as it has in the last five years.

But I think there is a lot of exciting product in the marketplace from all brands. And I think, it's found itself in the core right nowwhere X amount of space is allocated in those stores or just you had in thepast so many years it was knew new and developing and now the allocated floorspace within, each store, where now you are really competing against each brandfor the floor space.

So it really comes down to, who has the best product. Andthen when you look at the swim program for us, on top of that I think that ismore dollars for us within our current account base.

And overall I'd say, generally speaking there is a lot ofexcitement in the junior's business still and it continues to be successful atthe core level.

Jeffrey Klinefelter - Piper Jaffray

Okay. In terms of other U.S. distribution, you have beenasked this a couple different ways on the call but given the PacSun down 10%,down 10% potentially again next year. Can you give any flavor for your secondlargest customer, Zumi, for example or any other way to look at the growthconcepts with in the surf/skate space, how your business is tracking there?

Jason Steris

As far as breaking out the other top five, we're not reallybreaking those out right now, but we talked a little bit about the Macy'sbusiness on the last calls and definitely see some opportunities there movingforward, as we continue to open some of their doors.

We are looking at opening the girl's business here in thefourth quarter, which is new to us. We'll be in about 26 of the Macy's westlocations and about ten of the northwest. So that's growth opportunity for us.

And I think, looking back at some of the moves that we madethis year with Dillards and a handful of couple other new accounts I thinkthose are brand new relationships, we are just finding what product is working.

In our men’s division, juniors, boys, kids, Creedler’s, swimthere is a lot of opportunities for us to ramp up as we moving forward and justfinding what is working for the brand in the retail climate.

I think the new distribution that we have done this year; Ithink there is ample opportunity right there for us to keep working on.

Jeffrey Klinefelter - Piper Jaffray

Okay. And just a last couple quick questions. Doug, youmentioned that Europe was $25.8 million in the third quarter and that wasversus for $1.1 million on a license basis since Q3 last year.

If we get an apples-to-apples number truing that up, shouldwe go off a 6% royalty rate or how do we get a comparable number to last year?

Doug Collier

Yeah. The number is a little top, actually is not $1.1 thatwas not the royalty that was from our Swiss distributorship that we own. Solast year, we would have the royalty revenue and then on top of we’ve gotEuropean business, because we owned that for the whole year we had the Swissdistributorship.

So it's a little tough to compare. I think someone broughtup the point of the difference between the quarters for Europe and how was itin prior years, and the difference is just that we now own this business soit's tough for us to go back and look and how did they run things?

But with that said we have had good growth there and we’vebeen ahead of our own targets. We're already going to be couple million aheadthis year. So margins are better and the teams are doing great so overall thisstart been a real home run for us over there in Europe.

Jeffrey Klinefelter - Piper Jaffray

So margins are better to what extent?

Doug Collier

You know, I think on our last call we said that we weremodeling Europe margins to be down a little bit softer than our domesticmargins. They actually came in better for the third quarter substantially.

Now when you true that up for the back half of the year,they're going come down quite a bit in Q4 just because they are going to shipsamples and things like that, but we did have some good exchange gains in thereso they were pretty significantly better than we hoped.

Jeffrey Klinefelter - Piper Jaffray

Okay. And just last question, in terms of Asia Pacific andother markets to me looking for growth opportunities; can you remind us againwhat the structure is right now in the Asia PAC region?

Any opportunities to extend distribution of licenseagreements to go after bigger parts, particularly, of the Asian market?

Richard Woolcott

Jeff, this is Richard, here. Yes, I do think that there isopportunity over there but before we totally jump in another area outside theEurope, we really are focused on making sure that, we put all our resources onour Europe business right now.

Because even though we have come out of the gate strong nowwe’ve got to get ourselves ramped up for the more longer term strategies forEurope and looking at next year and beyond we actually have our European teamscoming here the first week of November.

Again they're bringing their top key managers who will spendthe week strategizing. So I think there are other opportunities around theworld and we are looking at that international business and we're investing init and working on it, but the first thing we mainly want to make sure we go110% for Europe as we move into this next year.

Not because there are issues or anything wrong but it'sstill a young, fresh business and it's a big one and we want to make sure thatwe are on top of it 110%. So that's the first one. But we're always looking andwe’re continuing to invest, but I don't thing anything significant in the near,near future right now.

Jeffrey Klinefelter - Piper Jaffray

Okay. One last question on Europe, you listed your top fiveaccounts or top strongest accounts, and then three opportunities, could yougive some break down today, Richard of your percent of revenues in those?

We have has that from other brands in the past it's helpfulto appreciate your market share potential in those markets.

Richard Woolcott

Yes, we really aren't ready to break that out yet. Maybe aswe move forward with we can look at that and start to kind of dissect thebusiness, but as of right now when I look at the top five guys it's a majorityof our business, those top five.

Particularly you have got France, Germany and Austria andthen after that you’ve got Italy and so forth. But we could get back to you onthe next call with that on how we want to dissect that. But those top fivethat's the majority of our business.

Jeffrey Klinefelter - Piper Jaffray

Okay, thank you.

Richard Woolcott

Thanks, Jeff.

Jeffrey Klinefelter - Piper Jaffray

All right, thank you.

Operator

Your next question comes from the line of Mitch Kummetz withRobert Baird.

Richard Woolcott

How's it going, Mitch?

Mitch Kummetz - Robert W. Baird

I have several questions still. Let me start with Pac. Yousaid, girls down and guys up, could you say how much in terms of percent?

Jason Steris

Hey, Mitch. How is it going? This is Jason here. All right,if you want to know how much the PacSun business is up?

Mitch Kummetz - Robert W. Baird

Yeah. On the guy's side and how much it was down on thegirl's side. I believe you've given numbers like that before.

Jason Steris

Just give us a second.

Mitch Kummetz - Robert W. Baird

Okay. While you guys are looking that up. In terms of your'08 outlook for Pac I know you guys have said you expect to be down 10% is thatbasically reflect a decrease on the girl's side? I mean would you expect theguy's business to be flattish to may be kind of tracking what you saw in thethird quarter?

Richard Woolcott

As know Mitch, we don’t have we have not gone that deep withthe team at PacSun, we just kind of got an overall first look at the businessfor the new year. After that we just don't have any information from them yeton how that will break down.

Mitch Kummetz - Robert W. Baird

Okay. Fair enough. And then as you've adjusted your outlookon the Pac business for the year which obviously reflects what happened in Q3and what you expect in Q4, does that end up leaving you guys with any excessinventory on your part in terms of special make up product that was intendedfor PAC, or is that purely just an adjustment to what your outlook is and yourwillingness to build product for them?

Richard Woolcott

No, there's no extra product. I mean for PacSun, what we dois we don't go into production unless we've got the orders. It's not like wemade stuff for PacSun and they're not going take it. That's not the case atall.

Mitch Kummetz - Robert W. Baird

I just wanted to clarify that. Okay and then a few things onEurope. Doug, you were kind enough to break out consolidated versus U.S., whichallows us to break out the European business. You did it for sales and grossmargin. Could you say what operating margin was for Europe in the thirdquarter?

Doug Collier

Yeah, I can give you both of those. For Europe youroperating margin is about 37%.

Mitch Kummetz - Robert W. Baird

Okay.

Doug Collier

And what else did you want it for?

Mitch Kummetz - Robert W. Baird

I guess I can back that out of the consolidate.

Doug Collier

And the U.S. is about 21%.

Mitch Kummetz - Robert W. Baird

Okay. 21 for U.S. All right.

Doug Collier

Yes.

Mitch Kummetz - Robert W. Baird

And I went through break out on the product categoriesprobably versus U.S. it would appear you did very little business, or shippedvery little product in terms of boys and footwear in the third quarter.

Are those businesses that you're not really doing in Europeor the distributor is not doing them and is that something that you will bestarting up with spring or at what point will you be starting up or am Ireading that wrong?

Jason Steris

Hey, Mitch. This is Jason. I think you are definitelyreading that correctly. The boys program was started this year and so, we areslowly ramping that up. It's a brand new category for them over there. It's anopportunity moving forward and just getting that off the ground.

And then, same thing with the Creedler program, being thatwe were a licensee before, we didn't offer those programs to them at the time.Those guys, the European team they do have the Creedler program in theirspring, summer '08 range, which will be shipping in the first half of nextyear, and they are having good success with them as well.

Both of those are new programs and opportunity is movingforward.

Mitch Kummetz - Robert W. Baird

Just to make sure I have that correctly, you said, Creedleris in the spring, summer of '08. Is the boys also in spring, summer '08?

Jason Steris

That's correct, boys, not the kids, but the boys.

Mitch Kummetz - Robert W. Baird

Okay.

Richard Woolcott

Not kids. They're not doing kids yet. We first want to getthe boy's ramped up and build that foundation and then look at theopportunities down line for kids, but we're holding off right now.

Mitch Kummetz - Robert W. Baird

And when you say that's available in the program, does thatmean it's available to all of your distributors?

Jason Steris

For the most part.

Mitch Kummetz - Robert W. Baird

Okay.

Jason Steris

Yes.

Mitch Kummetz - Robert W. Baird

And a couple other items on Europe. Doug, I know you don'twant to go out and say what you think the European business is going to do nextyear but is it fair to say that, the sales -- the break out between first halfand second half on Europe should kind of track what the break out has been interms of licensing income in the past.

Where if I look at licensing income over the 12 months endedQ2, it looks like, I think the number I had was 52% of that was in the backhalf of last year versus 48% of the back half of this year. Can I think of therevenue structure on the business now that you guys own it to be kind of asimilar break out in terms of first half, back half to where the licensingincome had tracked previously?

Doug Collier

I think, we are into this fairly new but that seems to makesense to us that it would continue do -- to be like that. We do have verylittle history but I think we do think it about it that way.

Mitch Kummetz - Robert W. Baird

Okay.

Richard Woolcott

And Mitch, with Europe they're a little bit different thanthe way the U.S. is structured from their seasons perspective. You've got thatspring, spring which would be in their Q1 that's a heavy ship, and then they doa fall ship. So unlike, how we have spring and summer and fall and holiday.

Europe is a little heavier. They spring start ships andafter then they've got the fall. So it really have two biggest – big seasons.And then they fill in from there.

Mitch Kummetz - Robert W. Baird

So, Q3 is the big start ship and then Q1 is spring?

Richard Woolcott

Pretty much, how much we've seen from just kind of studying it.I think, it will be easier, obviously a year from now when we have a trackrecord. Because I think you also have to remember that, the business model wehave now is not necessarily like the business model that the licensee did.

So, we are going to be investing more, on the pulse a littlebit more, wanting to improve our operations over there, making sure we aredelivering as close as we can to the start ships. And we just have a differentengine because we have all the manufacturing expertise and relationships andtacking on of orders.

So hopefully, we can improve -- I mean our goal is toimprove the way that we're doing business over in Europe, just because of thesheer size of what we've got in terms of manpower and production capacity.

Mitch Kummetz - Robert W. Baird

Okay. And then, last thing on Europe I know in the past,Doug you've said you are looking at a $0.12 investment in the first half andthen you would expect profits in the back half to more than exceed that, giventhat the sales are tracking little bit better and the margins are better.

What sort of overall profit contribution to the earnings, doyou expect in the back half from Europe at this point?

Doug Collier

Yes, all that is baked into our guidance that we've thrownout there that didn’t make sense. When we are doing more revenue and we'reseeing the gross margin looking better than expected that overall it will dobetter than we thought.

Mitch Kummetz - Robert W. Baird

Okay. Two last items. On the Creedler’s business you havefour quarters of business there where you have Creedler’s in the numbers. Couldyou say how much of that was slip-ons versus open-toe. I mean is it like 25/75,or something live that? How can we think of the slip-on portion of that businessto get an idea or where this might go.

Jason Steris

This is Jason here. In our original projection, and where wecame out, are two things, and I think that is what we talked about with itbeing a saturated category. And as we move forward into '08 and you can alreadysee it in our line plans as we are building the program, we are really focusingon the sandal portion of the business and that will become the driver of thecategory.

We just feel, we are able to compete in the category, and itmakes sense for the brand. And there is just a lot of opportunity for us. Andthen, we will wrap around some of the bedroom slippers, and things like thatfor holiday novelty items and what not.

But if I had to give you a sort of a rough number for thisyear, I'd say it's probably-- I'd rather get back to you on that so I don'tgive you a wrong number.

Mitch Kummetz - Robert W. Baird

Fair enough.

Jason Steris

We are definitely moving forward into more of the sandalprogram.

Richard Woolcott

The majority of the business is absolutely going to be inthe open toe sandal business.

Mitch Kummetz - Robert W. Baird

Okay.

Richard Woolcott

And that is our niche, and like you said, we jumped into thecategory and now we have a year under our belt of seeing how the product reactsin the marketplace and also seeing the tweaking of our own designs internally.

And we have kind of found our niche and from a Volcombranded piece of footwear that open-toed sandal is where we belong and that'sreally what we're focusing on.

Mitch Kummetz - Robert W. Baird

And then lastly, and maybe you can get those PacSun numbersfor me?

Jason Steris

I have them for you.

Mitch Kummetz - Robert W. Baird

You can give them to me.

Jason Steris

So, excluding Europe, the men's business was up 16% in Q3and PacSun was up 2% on the men's side. On the girl's side excluding Europe,the girls business was down 11% and the PacSun business was down 53%.

Mitch Kummetz - Robert W. Baird

Okay and you figure most of that is private label or is ittough say?

Jason Steris

I think it's tough to quantify, but having two things withthe private label and lesser inventories, those are parts of it.

Mitch Kummetz - Robert W. Baird

And last question. Doug, if I look at the Q4 guidance salesand earnings, and I kind of plug those into a model, it gets me to an operatingmargin that is down about 400 bits (ph) from last year, if I am doing the mathright. Can you give us some sense kind of qualitatively; is it more grossmargin more SG&A?

It could be a little bit of both with the European samplesand European business isn't going to be huge in the fourth quarter, I wouldimagine that could be unprofitable in the fourth quarter, although I haven'tworked through the math to confirm that. Could you going to give us a sense, isit half and half SG&A and gross margin or where does it shake out?

Doug Collier

So you are talking, overall consolidated for Q4?

Mitch Kummetz - Robert W. Baird

Yes.

Doug Collier

Okay, So, was it more attributable to being gross margin orSG&A?

Mitch Kummetz - Robert W. Baird

Yes, in terms of the contraction in operating margin that isimplied in your guidance?

Doug Collier

Looking at this really quickly, it looks like it's more onthe gross margin side. It's about 50/50 actually. You have some on the marginand on the SG&A side.

Mitch Kummetz - Robert W. Baird

That's very helpful. Thanks guys. Good luck.

Doug Collier

Thanks, Mitch.

Operator

(Operator Instructions) Your next question comes from theline of Jeff Mintz with Wedbush Morgan.

Jeff Mintz - Wedbush Morgan

Hi, guys. How are you?

Richard Woolcott

Hi, Jeff. How are you doing?

Jeff Mintz - Wedbush Morgan

Well, I just a couple more questions on Europe. Not to beata dead horse here. Can we assume that this slightly improved numbers for thefourth quarter on Europe are good early sell through? If not are you guyshearing good numbers on sell through there?

Richard Woolcott

Hey, Jeff, this is Richard. Well I think the first thing isjust I know that the distributors and the retailers are thankful and excitedthat the transition worked. As far as actual numbers on the retail level, Idon't have any reports on that yet. We will probably get that, as I saidearlier we have the whole Europe team coming over at the beginning of Novemberto strategize for next year.

What I have seen is now we are breaking down territories weare looking at our distributors. We are very organized in the way we arestrategizing moving forward and I know that people are just excited that weshipped and the fourth quarter is just a fill in ship a little bit of stuff forthe holiday.

Well, I think the real measure of the success will be as wego into spring and fall of '08, how much opportunity there is moving forwardand really getting a read on how the products are moving through the retailbase, but we'll have a read for the next call. It's still kind of soon becausewe just basically finished shipping.

Jeff Mintz - Wedbush Morgan

Okay, great.

Richard Woolcott

I hope that helped.

Jeff Mintz - Wedbush Morgan

Yes it help absolutely. Thank you. And then maybe a questionfor Jason on product, when you look at the European line versus the U.S. line,how much would you say in Europe is totally different than the U.S. and howmuch is just the same or a derivative of?

Jason Steris

Yeah, hey, Jeff. Yes, really a small part of the line isdifferent anyway. For the most part they take about 98% of that lines and theywill make tweaks on that stuff. They will beef up a sweater or do a heavierquilting on a jacket category or two, but for the most part all categories arepulls directly from our products. The only difference is that our line is muchlarger so they will take from our line and build a little bit of a smallercapsule.

Jeff Mintz - Wedbush Morgan

Sure. Okay. And then turning to the girl's swim category aswe go into this spring, did PacSun take any of the girl's swim business lastyear? I guess my question, is there a risk to that business from the PacSundecline on the girl's side or is that more of an opportunity going forward?

Jason Steris

Yes, I can tell you that the last capsule that we did withthem for the initial launch in summer, they did two styles or they did two, onetop, one bottom two different colors, four units total and what we're lookingat moving into spring 2008 is we have a follow-up package building on that samething so, I think, we will comp those numbers moving forward.

And I think moving forward this is a lot of opportunity inthat category in general as we become more of an established swim player. Doesthat answer your question?

Jeff Mintz - Wedbush Morgan

Absolutely. That's great. And then Doug, I just want to makesure that I have my numbers right. When you initially guided for Europe thisyear you guided $33 to $35 million and are you saying it will be $36 to $37million full year?

Doug Collier

That is; yes, like $35.9 million, $36.9 million, somethinglikes that. Yes.

Jeff Mintz - Wedbush Morgan

Okay. I will take that 100,000 and add it in. Thanks verymuch and good luck.

Doug Collier

Thank you, Jeff.

Operator

There are no further questions at this time. Are there anyclosing remarks?

Richard Woolcott

Just wanted to say thank you to everybody for being on thecall and we are look forward to talking with you again on the next call. Thankyou again guys and have a nice day.

Operator

This concludes today's conference call. You may nowdisconnect.

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