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Executives

Bob McKnight - President and CEO

Joe Scirocco - CFO

David Morgan - COO

Martin Samuels - President, Quiksilver Americas

Analysts

Jeff Klinefelter - Piper Jaffray

Brian McGough - Morgan Stanley

Brad Stephens - Morgan Keegan

Kate Mcshane - Citigroup

Eric Tracy - BB&T Capital Market

Jeff Van Sinderen - B. Riley

Gretchen Hailey - JPMorgan

David Glick - Buckingham Research

Quiksilver Inc. (ZQK) F1Q08 (Qtr End 01/31/08) Earnings Call March 7, 2008 8:30 AM ET

Operator

Good morning ladies and gentlemen, thank you for standing by. Welcome to the Quiksilver fiscal 2008 first quarter Earnings Call. (Operator Instructions)

Before we begin, I would just like to 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 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 the non-GAAP financial information to the most directly comparable GAAP financial information is included in our press release located at our website at www.quiksilverinc.com.

With that out of the way, I would like to introduce Bob McKnight, the company's Chairman, President and Chief Executive Officer. Please go ahead, sir.

Bob McKnight

Good morning and thanks for joining us for our first quarter conference call. With me today is Joe Scirocco, our Chief Financial Officer, as well David Morgan, our Chief Operating Officer, Martin Samuels and Steve Dudley who many of you know.

Lets begin with a high level financial highlights from first quarter. Consolidated net revenues increased 14% to $605 million. Our core apparel business saw solid top line growth of 19%. Consolidated gross profit fell to 45.5% from 47.1% last year. Gross profit in the core apparel and footwear business however rose to 48.5% from 47.4% last year.

Expenses during the quarter increased 26% to $280 million versus $222 million in the same quarter last year. Joe will elaborate on this, but I will say clearly we need better leverage on our expenses. We reported an operating loss for the quarter of $4 million versus a year ago profit of $27 million.

Operating profit in the core apparel business, including the impact of corporate operations was down $2.5 million to $17.1 million from $19.6 million last year. Our reported loss per share from continuing operations for the quarter was $0.12 this was within the range of our January update.

Before we get into it, I would like to say that I am really excited to be back in the role of President of Quiksilver and we are all fully committed to getting back to basics and driving improvement and efficiencies across the organization. I am sure all of you can appreciate how tough it has been for our company and for me personally, to have been through the last couple of years. We also recognize that it has been extremely difficult and frustrating by all of you in and the investment community, as well, but let me assure you we have endured tough times before, only to reemerge stronger and more committed than ever, and we will again do it.

I have been extremely fortunate for new getting, and still today to work with incredible people to build our company. In creating value for Quiksilver by employees and our shareholders we have created a whole industry and build great relationships. Quiksilver remains a unique and special company. There is no question that we have some hard work ahead. A lot of it simply involves getting back to what we know and have passion for.

Unwinding our involvement in the hard goods business is the obvious first step. The equipment business lost about $38 million on an operating basis last year. We have given you the new segment breakdown, so you can see for yourself how it has affected the results. It has also put a lot of pressure on our balance sheet.

Nonetheless, as we continue to evaluate potential transactions, I think its clear that what we've done for the equipment business in terms of eliminating redundancy and upgrading the operations and raising the profile of the Rossignol brand has real value. Even though at every level in the company, we have been distracted by Rossignol's difficulties, the core businesses of Quiksilver are in good shape.

Having said that, we know we have to refocus and improve our gross margin and expense leverage. On the gross margins side, we continue to implement sourcing initiative to consolidate vendors and improve productivity.

Gaining expense leverage is a bit more difficult, but there are solutions. A significant piece of our expense structure is associated with retail store development. We've got more aggressive in opening retail stores over the last few years and while we continue to believe in the long-term liability of growing our retail store base. We recognize the need to preserve our capital and improve our cash flow in order to pay down debt.

This is not to say, we are going to stop opening stores. Particularly, as we work our way into new markets, there is some opportunities that are exceptional and in some low cases that are necessary. However, we will be more focused on our capital structure going forward.

There will be some gradual improvement in expense leverage that will happen overtime. We've made some significant investments in distribution capability, with new facilities both in the Americas and in Europe.

We haven't reached the tipping point on this investment yet, from a leverage standpoint, but with the continued growth we expect from Quiksilver, Roxy and DC brand, this will happen overtime.

Beyond numbers there is certainly a time and attention issue at play in our results. Taking on the Rossignol acquisition has been very demanding on our Management team. We're really looking forward to getting back to the point we can focus in exclusively on our core businesses. Quiksilver, Roxy and DC have grown tremendously over the last couple of years. But frankly, we haven't captured the full benefits of that. This is now our number one mission to make these core businesses really efficient and keep growing what we have.

Our Quiksilver brand after 35 years plus is still dynamic. We have lots of real opportunities by the region, by category and particular by gender, with a new Quiksilver Women's business which shipped in the stores in June.

Opportunities for Roxy which is at this point looking to equip Quiksilver in terms of volume are probably even wider. Roxy is an incredible phenomenon, and we are excited to take it to the next level globally.

DC is perhaps our single largest growth opportunity. We believe the DC has already, like Quiksilver did, transcended its route in a relatively narrow range of product, is on its way to becoming a truly iconic lifestyle brand. In the right retail environment, the potential for DC's retail expansion is obvious.

Still there is no question that in the short-term, the current retail environment in the US and in Europe is going to pose some real challenges. We want to be very careful with our inventory planning. Right now, our inventories are in good shape and we are comfortable with our position, but this is a time to be diligent. The equipment business is going to be challenging this year as well, and we said reorder business is very slow versus our initial expectation. As a result, we now think the losses in the equipment business in fiscal 2008 to be comparable to fiscal 2007.

Joe will go into more detail on the outlook in a few moment, but we are confident that we will weather these issues and emerge a strong focused company with an improved level of profitability and continued growth opportunity.

I know that you are all interested in the rising of sale process, so let me make a few points on that topic. Since we announced the exploration of strategic alternatives, we have significant interest from both strategic and financial players in the US and internationally. We are working hard on this process with our bankers, advisors and lawyers, and are reaching the end of the proprietary stage.

As expected, we are focused on getting the best price and term, and therefore expect that this will be a full auction process. We won't speculate on timing and we believe it's too early to have a definitive view on valuation. In any event, we would not comment on that. Please understand that this is an ongoing process, so I can only give you the details above. We will not entertain any additional questions on this subject.

This quarter featured incredible achievements by our Quiksilver, Roxy and DC sponsored athletes around the world. When you consider the scope of their achievements, you can appreciate our distinction as a company of authentic global brands.

For the Quiksilver snowboard team, Travis Rice won the inaugural Quiksilver Natural Selection Snowboard contest in Jackson Hole. Jacob Wilhelmson won the sixth Quiksilver Nanshan Open Snowboard contest in Beijing and [Matthew Krupel] won the 12th Snowboard Contest in Europe. And earlier this week on the Golf Coast of Austria, Kelly Slater won the Quiksilver Pro with Jeremy Flores finishing closing behind in third place.

Roxy team-riders Sarah Burke won the gold medal and Torah Bright took the silver medal at the X-Game SuperPipe of Skiing and Snowboarding in Aspen, Colorado. On the marketing front, Roxy also premiered its latest ski and snowboard movie entitled "Labor of Love" around the world.

DC team-rider Torstein Horgmo also won a Winter X Games gold medal in the Snowboarding Big Air competition. DC Europe launched the snow season with sponsorship of the Air & Style contest followed up by the opening of DC snow parks in France, Austria and Spain. In addition, the reality TV show Robin Big entered a third season as one of MTV's highest rated shows.

This has been a difficult quarter, but I have no doubt we are moving in the right direction. The executive team continues to focus on our productivity goals within our design, marketing, and sales teams continue to work hard in growing the brand.

Positive changes are happening internally and our team is primed for the challenges ahead. I have been with this business through all kinds of environments, a long-listed strategic situations and more than a few very really challenging times. We've always come out of those challenges better ask to them, can we learn from them, looking to a brighter future. This time isn't going to be different. The team here is deep and totally committed and I think very excited to get back on our original track.

Thank you. And Joe will now take you through the details of financial statements and segment data.

Joe Scirocco

Thanks, Bob, and good morning, everyone. The press release table includes a new segment data for wintersports equipment. We also know software activities remain in the apparel and footwear segment where they are managed. We also provided reclassified data for each quarter of last year, so that you can think about the business in consistent terms from year-to-year.

As Bob said, we preview results for this quarter in a press release and at the ICR conference in mid January. Results came in within our expected range, although slightly worse than we had hope for due to performance of the equipment business as I'll explain in a minute.

Net revenues in our global apparel and footwear segments increased 19% to $500.5 million in the first quarter of fiscal 2008 compared with $421.5 million for the first quarter of last year. Approximately $27.7 million of this increase was attributable to favorable foreign currency rates.

The wintersports equipment segment's net revenues decreased 2% to $104.8 million in the first quarter of fiscal '08 from $107.1 million a year ago, even though revenues in this segment benefited from an increase of approximately $10.2 million attributable to currency.

Gross margins in our apparel and footwear segments increased 110 basis points to 48.5% from 47.4% a year ago. Improved wholesale margins were partially offset by softer business in our retail stores. In wintersports lower reorder volumes and pricing pressure compressed segment gross margins to 31.3%. And this shows the consolidated gross margin down by 160 basis points to 45.5% from 47.1% a year ago.

In our apparel and footwear segments, including corporate operations, SG&A grew by 25% to $225.8 million this year from $180.3 million last year. Approximately $12 million of the increase was attributed to currency movements. As a percentage of revenue, SG&A in the apparel and footwear segments increased by 230 basis points to 45.1% from 42.8% last year.

A significant portion of this increase was attributed to the opening or acquisition of 127 retail stores and shops, since the end of first quarter of last year. With the slowdown in retail business that we talked about in our January update, we have lost some leverage on these expenses. Additionally, we incurred higher costs in newly acquired territories and in the development of DC and Rossignol soft goods.

During the quarter, we began acquired costs cutting actions to reduce planned expenses by approximately $20 million for the year. The sufficiency of these reductions will depend upon business conditions for the remainder of the year and we will monitor the situation closely.

In our equipment segment SG&A expenses grew by 31% to $54.1 million this year from $41.3 million last year, with approximately $4.8 million of the increase attributable to currency. As a percentage of revenue, SG&A in the equipment segment increased 1300 basis points to 51.6%. A significant portion of the increase was attributable to the timing of certain marketing expenses and other provisions that resulted in lower than normal expenses in the pervious year.

Taking these factors in to account our operating margin in the apparel and footwear segments was 3.4% this year, compared to 4.7% a year ago. Well, lower than we would have liked, this is a seasonally smaller quarter than those latter in the year and was a tough one at retail. Let me say for clarity, that the operating income of the apparel and footwear segments includes 100% of the cost of our corporate operations.

Our equipment segments incurred an operating loss for the quarter of $21.4 million, compared to an operating income of $7.7 million last year, which caused an overall operating loss of $4.3 million for the quarter.

Interest expense for the quarter was $14.6 million this year compared to $14.8 million a year ago. We also recognized the tax benefit of 19.8% for the quarter, although we forecasted a rate of 35%. Our quarterly tax provisions are becoming more difficult to forecast for several reasons, including the adoption of FIN 48 this quarter. The difference this quarter was caused by the unpredictable mix of income or losses that we incurred in various tax jurisdictions around the world. We continue to believe however that is appropriate to use an estimated tax rate of 35% for the full fiscal year.

I would like to turn your attention to the balance sheet for a few moments. Receivables at $639 million are 13% higher than last year or about 4% higher in constant currency. On an overall basis DSOs decreased by one day to 88 this year, compared to 89 a year ago. We are seeing a continuous decline of aged accounts in our equipment business and we believe that we are adequately reserved or insured against collection problems.

Inventory increased 11% to $490 million at quarter end or about 2% in constant currency. This is well controlled in relation to our projected sales growth on an overall basis. At quarter end our net debts stood at $957 million reflecting debt paid down with proceeds of the Cleveland Golf sale in December. Our aggregate liquidity as of January 31st under regional lines of credit and including cash on hand was over $300 million.

Now, let's turn our attention to the outlook for the full fiscal year. We have to qualify this by reminding everybody that we don't fully book orders for the equipment business until the May-June time frame, so it's very difficult to forecast that part of your business.

On the apparel side, the environment is challenging and we have yet to complete order books for fall. As we commented in our press release, we note the First Call consensus estimates for revenues of $2.6 billion and EPS of $0.58 for the full fiscal year 2008. To be clear, these amounts relate to continuing operations and exclude Cleveland Golf. Notwithstanding our lower visibility, we believe that at this point this estimate should be achievable.

Let us tell you our key assumptions. In the apparel and the footwear segments, our assumptions are for 10% revenue growth from $2.08 billion to $2.29 billion and for 50 basis point increase in operating margin, driven primarily from gross margin improvement from 9.3% last year to 9.8% this year. That gives us an operating income assumption of around $224 million.

Underlying this is an assumption for continued softness in world economies offsetting the benefits of approximately $20 million in expense reduction. In the equipment segment, our visibility remains particularly limited for another 3 to 4 months. Our assumptions call for revenue of $385 million, up about 10% from $349 million last year and for an operating loss in line with last year's on a constant currency basis.

Taking into account currency changes, we are assuming an operating loss of around $41 million versus a loss of $38 million last year for the equipment business. We expect to incur interest expense of approximately $64 million this year and our projected tax rate is 35% for the full fiscal year.

Our cash flow forecast depends of course on our success with the sale of Rossignol. I won't comment or speculate on that, but as currently configured, we believe we could generate free cash flow in the range of between $135 million and $150 million this year, including the sale of Cleveland Golf.

So let me address some of our assumptions in this regard. Depreciation and amortization for the full year is estimated at $80 million, slightly higher than our prior forecast because of currency impacts. Non-cash stock compensation expense for the year is expected to be approximately $30 million, capex is expected to be approximately $150 million and we recently reduced our capital spending estimate by $10 million and we'll continue to look for further reductions. We are also pursuing other opportunities to monetize certain assets.

We will require approximately $30 million in cash to fund the final earn-out payment for the DC acquisition and for our prior retail store acquisition in Australia and an additional interest in our Brazilian joint venture.

Our working capital assumption is totally dependent on the status of the equipment business, and therefore difficult to model. Just for some perspective, the Rossignol Group including hard goods and soft goods had average working capital of approximately $300 million throughout the last fiscal year and peak at year end at about $350 million.

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

Bob McKnight

As mentioned, the environment remains challenging. However, the stores are not panicking and inventories are well controlled. We just came off the trade show circuit and the bookings are coming in on plan and our payroll and footwear outlook for the year remains healthy.

So while we are certainly not immune to the overall environment, our inventories are well managed and our brands remain leaders across the industry.

So let me just reiterate my enthusiasm for the business and getting back into the role of President. Our portfolio brand is one of the strongest in the industry and we continue to believe their tremendous growth and productivity opportunities ahead of us.

Thank you. Operator, we are now ready for questions and answers. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We'll go to Jeff Klinefelter of Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

Yes. Hi guys. Thanks for the information this morning. The first question is really on that 10% of payroll growth Joe that you mentioned. Can we get any more color on that as it relates to the brand growth that you are expecting between DC, Quik, and Roxy just very generally speaking? And then also between international and domestic, that just it would be helpful in comparing that to overall expectations for growth in those markets and economic news coming out of the various major markets?

Joe Scirocco

Sure Jeff. We typically don't break brand forecast down or even actual results on a quarterly basis. I would tell you that generally speaking you can think about the Quiksilver brand which did little over $850 million in fiscal '07. We think about that as sort of a high single digit grower over the next few years 6% lets say. Roxy, which did about $750 million in volume in fiscal '07, we think about that as growing slightly faster, somewhere in the 8% to 12% range, and DC, which generated $350 million in sales last year, we think about as somewhere in the range of 20% plus for the next couple of years.

Jeff Klinefelter - Piper Jaffray

Could you give a little color, Joe, as well on domestic versus international, given all the various economic news that we are hearing? Are you looking for faster growth coming out of Europe right now, versus domestic?

Joe Scirocco

I think, that's generally a fair assumption. Europe has been growing faster in terms of its store opening plans and currency has also been boosting that. But on an underlying brand basis growth is comparable.

Jeff Klinefelter - Piper Jaffray

Okay. In terms of the US market and maybe if Marty is on, he could jump in, couple of things, one, DC as it relates to some changes going on at PacSun in terms of scaling back their footwear business, any sort of changes, in terms of major market or a major account focus? And then just in general as Joe you mentioned that your visibility is relatively low for fall bookings. Can you give us a sense for what you are hearing from your retailers, so are they simply unwilling to commit at this point, are they committing very conservatively, are they are asking you to hold and chase? Can you give us a sense for the current domestic environment?

Martin Samuels

Okay. Well first of on the DC issue, obviously PacSun going out of the shoe business is a fairly significant impact, but as we are analyzing it, we feel that we are going to make up about half of the loss of the footwear business with increased apparel and accessories business at PacSun. Although net-net that would probably leave PacSun business a little bit below last year. But we believe we will make up all of that loss business with improvements in the core market and in the specialty footwear channels. and we've already seen an accelerated order booking, as some of PacSun's competitors are looking to capitalize on opportunities, where you see in the mall for footwear.

And then we are going to make that bounce to that business with the strength of the apparel and accessory business in the core market and in new channels of other specialty channels and department stores. Also PacSun is staying in the sandal business, which is really positive for, both Roxy and Quiksilver. The general condition, as far as how booking are going, we are actually quite pleased with the pace of bookings, especially on the DC side. DC is definitely bucking the microeconomic trends. There are always a couple of brands out there in the world no mater what's going on in general that have their own mojo going and that's what's happening with DC right now. And we don't see any change in that, their momentum at retail continues in terms of current performance and the bookings outlook.

Generally speaking out, the retail community is conservative. But they are not panicked as, Bob mentioned earlier. I think particularly in our brands, our retail and wholesale inventory is very tightly controlled. Retailers are taking a conservative outlook, but they are looking to brands, solid brands, strong brands, stable brands in this kind of an environment, and all three of our brands are considered to be those kind of brands. We are definitely cornerstone brands, people know we're going to ship. People know we're going to perform.

Well we've seen difficulties in reorder activity, but the jury is clearly out on what spring break, Easter, and the new season is going to look like. The early indications on spring products are very good, especially where color is concerned. And clearly, February was better than December and January for us in our retail stores and from what we're hearing from the customers. So, yeah, it's tough out there, but we're definitely holding our own.

Jeff Klinefelter - Piper Jaffray

Okay, great. Thank you.

Operator

We'll go next to Brian McGough of Morgan Stanley.

Brian McGough - Morgan Stanley

Yeah, hi, thanks a lot. Bob, welcome back to a 5:30 am conference call.

Bob McKnight

Thank you.

Brian McGough - Morgan Stanley

So you are coming back after just a really dark period for the company. I mean margins are about a half way they were four years ago, and the balance sheet is certainly not what it used to be. And the only thing that is were it used to be is the stock price, and that's not really too good either.

You and the Board have really taken a lot of good steps over the past year, you have changed management, starting to unwind the portfolio, but that maybe gets us to where we are now. When you look forward, and the Board looks forward two to three years, what specific factors will the Board hold you and the team accountable for?

Bob McKnight

Well, first of all, I'm stepping back in the role of President, but I've been here at work during this period and we have really good team in America and in the Europe and in Asia/Pacific. So, if I like there is a (inaudible) he is going to follow for Cliff and all that kind of stuff with Bernard's departure that you are talking about.

But I think that my main job is going to be to get back -- will be to get back to blocking and tackling in regular business as usual for this company, in terms of driving our brands, really working on the margin improvement which we initiated a year or so ago and that continue as there is some benefit today and going forward and reducing SG&A and really working on generating cash for the company to reduce debt and increasing profitability for the company.

Those are the three or four measures that I will be judged by, our Board is focused and so our management teams around the world. Luckily we have, I mean fortunately I used not luck, but fortunately we have three great brand engines to drive our overall health of the company in Quiksilver, Roxy and DC. And I would like to return the company to 13% or something overall operating profit.

Brian McGough - Morgan Stanley

When you look at how you get there about, I mean we can for a now or about all the different leverage you can pull, but it seems like it all comes back down to one team which is really changing some of the D&A that's inherent to the company and just about how the different regions work, how you source product and it's pretty difficult for most companies to do that, those do at huge, but it does take time. Could you just talk a little bit about how may be you are changing the incentive structure in order to get there, maybe David has a bit of color given that he has been on the case for about a year on that?

Bob McKnight

Well, I'll let David speak to the margin part of that you talked about and then I will come in after that. Go ahead David.

David Morgan

So in terms of the gross margin, we thought now it's about 9 to 12 months about -- it's being bit through improved sourcing and notably in terms of starting off with the vendor consolidation program. And as it stands today, we are happy with the way that program is developing.

We said we would do it in three ways starting with spring summer of this year working through number. As it translated consolidation is online and is working well. As an example in the Americas we had round about 300 vendors there a year ago. We are down under 240, we should do see sales coming down to about 200 and below and we have the same kind of evolution happening in Europe.

We are seeing the benefits of that in terms of the initial gross margins. We are starting to have visibility in to those results and that align with that is the fact that nobody waited for the vendor consolidation program to start to improve the gross margin and Americas had already some initiatives and we're starting to see the benefit of that in terms of results and in fact even in the first quarter of this year, you will notice that the gross margin has improved and part of that is due to the results of some of these activities.

Going forward, we talked about the fact that we'll have increased sourcing through the central Asian office and we were at 10% a couple of years ago. We should see those going towards down 25% of our (inaudible) through that in the current year and going up towards 40% in next couple of years. Some of the challenges include the fact that they have been talked about and it's the fact that Chinese sourcing is becoming more expensive in dollars, but we've managed to in sense of the what we managed to negotiate, we are not seeing the impact of being negative but rather improvement despite those effects.

And wall space is definitely an area of an issue for the Americas because the dollar is not working in the favor. We have to understand that for the European sourcing that accounts availing, account effects which is the fact that the European currency is strengthening against Euro but even with these challenging factors either through currency effects or through better purchasing, through the impact of the vendor consolidation, we are seeing at least for the year ahead improvements in our initial margin.

And we are also taking actions to mitigate some of those factors by moving some of our sourcing for example in Americas the sourcing will increase the amount that is going through South America and Mexico. So, the overall basically we are happy the way the things are progressing. We are getting good visibility for a year coming ahead in initial margins. So, we feel we are making progress.

Brian McGough - Morgan Stanley

Okay.

Joe Scirocco

Hey, Brian, it's Joe. Just to talk a little bit about the incentive, I think you are familiar with the history of recent years which has been principally focused on revenue targets and earnings before tax with each of the region operating autonomously in that regard. And as you know we revised incentives more recently to also include the focus on cash flow and working capital management, and I think good things are there.

People are changing the Lexicon in terms of how they think about the business. And cash flow is something that's discussed much more fully and openly, particularly as we pull together, to deal with some of the global debt management issues and that kind of things.

I think as we go forward, we're talking about potential modifications to the incentive plans to focus on our new metrics that would include for example, growth in operating income percentage or EBIT percentage rather than just absolute amounts. And so, these are the kinds of things we're talking about. But the global management structure is essentially in place to do that.

Brian McGough - Morgan Stanley

Okay. And if I may just sneak a quick one, just that I think it's important. But Joe before the hard goods came in to the equation here you had your days inventory on hand that were running at around 90 days now it's about 130, 140. If I look at that delta, I mean that alone is in between $150 million to $200 million in cash, and that's not even accounting towards the negative swing we've seen in your receivable, is there any reason to think that once hard goods are no longer a part of the equation, and just given the working capital swing alone, we won't see a multi $100 million used in our cash flow?

Joe Scirocco

Well, we tried to get ahead of that question by actually putting something into the script. But just to repeat, that a way to think about Rossignol which has been very weather dependent and consequently somewhat unpredictable over the past couple of years, but like for the last fiscal year working capital at Rossignol hard goods and soft goods combined totaled about $300 million on average and it peaked at about $350 million at year end.

So, the swing could be $100 million to $150 million from peak to trough in any given year, in that business. Yeah, and so in the absence of that from back to more normalcy swing, I think you have to consider some slight changes to the profile of collections and DSOs, because of movements, say in the growth within Europe each of the various countries tend to have different payment patterns and timeframes in which they work. So, we could get some variability but, yeah, it's reasonable to assume it's come to a more normalize pattern with the apparel businesses.

Brian McGough - Morgan Stanley

Great, thank you guys.

Joe Scirocco

Thank you.

Operator

We'll go next to (inaudible) of Robert W Baird.

Unidentified Analyst

Yeah, thanks, two questions here, let me start out Joe you mentioned in your prepared remarks $20 million worth of expense reduction, could you elaborate on that and how that might flow over the course of the year?

Joe Scirocco

Yeah, it was a question of doing a number of different things in each of the regions around the globe but we froze a pretty significant number of open positions, we still have hiring for select positions, we've taken a big bite out of travel, out of T&E spending. We looked at global marketing spend in relation to the various regions and try to eliminate redundancies.

And we've taken up a good bit of cost out of the corporate structure as well. One of the other things, just in terms of cash flow there, is taking a look at the retail growth, to see what we could do in terms of preserving cash, because while we believe in retail, obviously in the period of significant store openings it is just dilutive to operating margins.

The consequence there was that because of commitments, preexisting commitments on leases and stuff, we were able to take $10 million out of the equation. And we will continue to look for more. But I think those savings in terms of cash should come more in the early part of 2009.

Unidentified Analyst

So, what is your store opening plan for the year and how many you are on top?

Joe Scirocco

We have still got on the order of about 20 (inaudible) or so in the US and that's for the full year. Europe is slightly more than that. I think somewhere in the 25 to 30 store range and then we have a few in Asia-Pacific. Most of the openings there are really shop corners and that sort of things.

Unidentified Analyst

Okay. And then also, Joe you mentioned that you would expect about 50 basis points of improvement in the operating margin to the apparel business, obviously in the first quarter that margin there is down. So, when would we expect to start to see the improvement? Would you expect to see the operating margin on the apparel business up in Q2 and then continue to improve over the balance of the year? How should we be thinking about that?

Joe Scirocco

Well, you should probably regard the improvements more as back half loaded and that's largely because the sourcing initiatives that we talked about really are expected in late fiscal '08 and into 2009. That should be the big driver there.

Unidentified Analyst

Okay.

Joe Scirocco

The other factor of course is just the seasonality. So, you look at Q1 in which we did probably 20% below below the average quarterly volumes. So as volumes improves, operating margin expands.

Unidentified Analyst

Okay. And then on the equipment business I know you mentioned you said about $41 million loss for the year. Obviously through the first quarter you are running well below from a profit standpoint than you were last year. I'm starting to get arms around. What do you make that up, and would you expect similar losses to a year ago in Q2 and Q3 and then expect a big bump in the first quarter as you are shipping next year's fees?

Bob McKnight

I mean I will let David speak to it, as he cares to elaborate but essentially it is volume driven and yes Q2 and Q3 are sort of clean up quarters and a truly back-end loaded.

David Morgan

Yeah, I mean basically you have two quarters in the year in which you have essential substantial sales is the first quarter and primarily the fourth quarter. So this year, we have the first quarter the tail end of the impact of loss is about season and the fourth quarter of this year is looking forward to the season early '09 where the situation is that we believe that the sale through with a good weather conditions and the better snow and retailers working for them, that we should have better order books next year and obliviously we have the last year and that's translates into the fourth quarter and issue orders and that's going into that sales and marketing.

Unidentified Analyst

Okay. Two last questions. One the Asia-Pac business performed very well in the quarter and the operating profit was up substantially year-over-year. I know it's still fairly small business for you guys relative to the overall company but what was driving that?

Bob McKnight

First of all, there is a good performance in Australia where the business continues to be on track. The second thing is the Japan which is the next site with chunk of business there, had a tough quarter this time last year in terms of revenue and margin. This year we came back to reasonable modest growth and a good improvement in the gross margins, which cut down into the bottom line.

Unidentified Analyst

Okay. And then lastly, maybe if we could get Steve tell us the comment on the Quiksilver Women's business. Obviously, you guys have gone through the trade shows with that new business and I'm sure you met with a lot of key accounts and discussing the plans for that. Can you just talk about how it's been received and what you might be projecting for this year?

Bob McKnight

Yeah. We're very pleased. We're launching -- we launched our new women's lines, you mentioned in the trade shows and one other things we're happy about it, we are in the research, it's been validated the research we did in that year we're achieving that kind of multi-layer strategy in our distribution and that is -- it was selling the top of the pyramid, certain specialty accounts and existing accounts, those that are in this business already. We're complementing what they're doing, in fact giving them the sense to grow this category and taking into anchor role young contemporary category.

We are getting great acceptance from new channel distribution in the key women's and peaks around the country. We are very pleased about that, some key stores and key territories you'll see the Quiksilver women's line.

And then at the department store level, we've conformation that we're on Board with [Norstrum] and we're very close with [Maxis]. In fact, [Maxis], they are talking about creating a new department within their women's area in between their junior section and their impulse section. They cater specifically to this customer. One of this refining is that she is underserved, category is underserved so we are building brands, it's going to take some time but we think we are on target and we are pleased so far.

Unidentified Analyst

Okay, that's good to hear. That's it for me. Good luck.

Bob McKnight

Thanks.

Operator

We'll go next to Brad Stephens of Morgan Keegan.

Brad Stephens - Morgan Keegan

Hey, good morning. First question on the SG&A side within the apparel business. I know you expect some cost cutting in the back half, but it's still -- a massive improvement in the SG&A spend. I think it's at 9.8% goal. Can you give us some bigger bucket where this is going to fall into?

Joe Scirocco

Well, Brad, I mean just to clarify as we talk about this year and planned improvements, gross margin is really the driver of our operating leverage over the next couple of years. In SG&A, we look at expenses and we enumerated them higher retail costs associated with all the store development both in the US and in Europe, higher costs to support the new regions that we've gone into and places where we've expanded development costs on DC and Rossignol soft goods.

So part of it is the maturity of some of these new territories and businesses that we've gone into. We are going to take the hard work at retail costs considering productivity and that type of things and we'll go after that in a big way. But really the issue is going to be setting aggressive the reasonable expectations for SG&A business we have done for gross margin in the course of the past year. So we will have more to say about it as we go down the road.

Brad Stephens - Morgan Keegan

Okay. Can you break out D&A and CapEx by hard goods versus soft goods for us?

Joe Scirocco

Yeah, CapEx, just give me a second.

Brad Stephens - Morgan Keegan

And may be one last one while you're added. The $300 million in working capital that's a tight up in the hard goods business. Could you maybe give us just a little more color on that between inventory and receivables and maybe what percent of those receivables are insured?

Joe Scirocco

I have to find the general ledger here with.

Brad Stephens - Morgan Keegan

We can go over offline if not, you can give me the D&A.

Joe Scirocco

I think the best way to answer you is, D&A in the Rossignol business is on the order of like $20 million. Capital spending in the hard goods business is on the order of $20 million to $25 million each year for molds and retooling factories, and that type of things. And in terms of the details on working capital for the hard goods, lets take that one offline, while we have a look at some --

Brad Stephens - Morgan Keegan

That's great, well congrats on a very good apparel quarter again. Good luck.

Joe Scirocco

Okay. Thanks.

Operator

We will go next to Kate Mcshane of Citigroup.

Kate Mcshane - Citigroup

Hi good morning thank you. With the addition of Quiksilver women it sounds like, your department stores exposure is going to increase. And I was wondering what the markdown environment is like right now? Have you seen a real push by the department stores asking for more markdown in the current environment?

Martin Samuels

First of all I cant -- I am not going to accept the premise that we're going to have more exposure in the department stores regarding women's launch, because the distribution profile is very similar to our other businesses. And its going to be very heavily specialty store driven, specialty surf, and specially fashion apparel, and selected department [store doors]. But that aside obviously after a tough holiday season department stores were quite aggressive about picking some aid at the end of the season. But as we've always done, we plan those businesses and lot of them very through the year. And we did not see a huge change in the level of participation that we had, because we were controlling our inventories through the season.

I also think that probably the department store has experienced more pushback than they used to from the manufacturing community, because not only were retailers experiencing a difficult season, but manufacturers were as well. So, possibly that cause them to be a little more aggressive in their approach, but we tend to hold the line. And if you look at the department store distribution as a total to our global business as we said before it's very small.

Kate Mcshane - Citigroup

Okay. Thank you. And on unrelated a node with ramping of apparel initiatives, how does that strategy play out now that you have made the decision to unwind the of hard goods business?

Joe Scirocco

What we have said is it's part of the company and it would go with it. We have been asked the question about our views on taking back an apparel license and what we've said is it's not our overriding intention to do that, but if that facilitates the deal and that makes sense, I guess we would consider it.

Kate Mcshane - Citigroup

Okay. Thank you.

Operator

We will go next to Eric Tracy of BB&T Capital market.

Eric Tracy - BB&T Capital Market

Yeah. Thanks. May be if you guys can just touch, you mentioned with respect to the footwear PacSun, about Roxy and that business within PacSun, given their strategy to focus more on private label. May be not as much from a contribution, but really just is that in anyway a statement as to what that consumer is more focused on less -- concerned with brands in that space.

Martin Samuels

Yeah, well, I think historically the women's business is a little less brand sensitive and more fashion sensitive than the men's business, that's nothing new. I think PacSun has been going through a period of evaluating their business model and there competition, and clearly they have planned it on their primary competition, there is Abercrombie and Hollister, the vertical guys, and they are looking to do more vertical; business.

Also their model and PacSun has been more men's than women's. They see their competitors with more women's than men's and they are moving forward with that model. I think in the short run it is putting some pressure on the brands, in this space at PacSun, but then again it's creating opportunities for some of their competitors to take a stronger position with the brands.

I think that in the first half of the year there is some pressure on Roxy at PacSun and I've seen and heard that that's the case with all of the branded suppliers in women's to PacSun. I think in the second half of the year people are expecting to see better growth with the brands. I think PacSun is still committed to brands, at least that's what they have stated publicly and privately.

Eric Tracy - BB&T Capital Market

Okay. So is there something much more specific to them as any overall statement for the junior's category?

Martin Samuels

Yeah, I think that this is a change in their particular business strategy, like I said at the beginning the brands to start will be less important.

Eric Tracy - BB&T Capital Market

Yeah.

Joe Scirocco

Men's but still important.

Eric Tracy - BB&T Capital Market

Yeah, fair enough. Joe maybe if you could just remind us of the debt structure that's in place, if there's any sort of flexibility, I know there's a portion of splitting rate debt to benefit from more favorable interest rate environment?

Joe Scirocco

Yes. As we said here, we are little more than 50% fixed at this point in time. We have a few moving parts with this and it's of course as you would expect the question is connected to what happens with Rossignol. Our overwriting objective is to sort of pay significant amount down with proceeds from net sale, and in doing that that will be our opportunity to revisit this. We have been financing Rossignol, as I have said before largely with the sort of short term uncommitted lines and that something that we would like to reposition and have been repositioning over the course of the past six months, so we'll be looking at that as we go forward as well.

Eric Tracy - BB&T Capital Market

Okay, great. Thanks guys. Best of luck.

Operator

We will go next to Jeff Van Sinderen of B. Riley.

Jeff Van Sinderen - B. Riley

Good morning. Can you give us some more detail on the performance of your retail stores, in terms of maybe comp trends, full price selling levels, marked downs, merchandised margin trends, and inventory turns, and maybe even operating margin trends on a follow up basis? And then as a follow up to that, how do you expect that business to trend for the next quarter or two all those being equal?

Bob McKnight

Yeah, the retail business is very important to us and is growing as a percentage of our total. But frankly, we are not at a point in its development or in the nature of these operations where we plan to start reporting that kind of detail, the way that traditional retailer would do. We have some limitations on our ability and frankly willingness to do that because it's a different kind of business.

For one thing, we have a multitude of formats in various geographies around the world. So there's a lot of variation in the portfolio. We have a combination of price and outlet stores and the outlet stores really do run as outlet as compared to vertical, and we have to respect retailer relationships in the various markets in which we operate.

So in terms of markdown, cadence, and type of things we are just not really comparable with other retailers. We have had a history here in all of our geographies quarter-by-quarter of positive comp store growth, the numbers have been strong. We did have challenges as we said in the November-December time period when clearance time came in January. We did very well. And so we were able to clean up inventory and generate some positive comps in that time period, but beyond that we're really not prepared to report that way.

Jeff Van Sinderen - B. Riley

Okay. Can you go into a little more detail on what you're seeing in your domestic wholesale business in terms of what's driving the growth there maybe in terms of which channels, store growth, categories or penetration expansion, any more color? And that would be helpful.

Bob McKnight

Okay. Well on the DC brands, the growth is coming through greater penetration with the footwear business in footwear specialty stores in the core market. The department store channel had tremendous rates of growth in the apparel and accessory business across all the channels with the special focus on new growth with department stores there.

On the Quiksilver and Roxy business, the distribution model is not changing much and growth is coming from our key categories, especially in the spring-summer season. We are very strong in swim wear. We are very strong in board shorts. We are very strong in walk shorts. We are very strong in T-shirts. We are very strong in sandals. And with the introduction of color as a significant new trend in both women's and men's, we are seeing really early response to that. I think that's what's going to drive business here for spring and summer and into back-to-school.

And our retail business just, not to get into too much detail, but clearly, the trends in February were much improved to over what happened in November, December, January and while February is not a gigantic month, the trends are positive relative to where they were and we are very anxious to see how business shapes out here in March and April. I think we are going to have a lot better sense about how the balance of the year shapes out when we get through March, April and see how spring break and Easter impact the business.

Jeff Van Sinderen - B. Riley

Okay. That's helpful. Thanks very much. And good luck this quarter.

Bob McKnight

Thank you.

Operator

We'll go next to Carla Casella of JPMorgan.

Gretchen Hailey - JPMorgan

Hi, this is actually [Gretchen Hailey] for Carla Casella. Just wondered, if you could expand a little bit more on the rise of SG&A this quarter and if there are any unusual or non-recurring items in it?

Bob McKnight

Well, I think it sort of varies by business. We had some commentary in the script which indicated that certainly with respect to the hard goods business, expenses were lower than normal last year, so that by comparison we saw an increase. I think that it's just, we have to go back to the very significant number of stores that have been opened since last year.

And then the softer retail environment how that played in terms of the de-leveraging of store expenses. We do plan during the course of the year to have, in connection with some cost reductions that we talked about. But we will have some charges to take, but we plan to absorb those as part of normal SG&A and not to break them out as separate one-time charges, just to try to keep the earnings and the results, as plain as possible, in terms of limiting the number of non-recurring items that we have.

Gretchen Hailey - JPMorgan

Okay. Great. Thanks.

Operator

And we will take our final question from [Jonathan Harte] of Buckingham Research.

David Glick - Buckingham Research

Good morning it is David Glick from Buckingham. Most of my questions have been answered. Just one quick one, Marty, can you give us some sense of what is happening in the cores surf, skate business in those mom and pop stores that are not necessarily the specialty channel, but stores that are really regionally located or concentrated in California, Florida. Are you seeing any weakness there you just from the macro trends going on or is that channel kind of weathering the storm here.

Martin Samuels

I think that they are having the same experience based on macro conditions, most of stores are. But the difference is they are all private companies. They are all kind of family owned companies. Most of them have been in business for 20 plus years. They have been through the ups and downs. They are not panicking. They are managing their businesses better. They have being careful on inventory and purchasing. They are controlling expenses. And they have realistic expectations about the season, and they are trying to stay liquid, so they can respond to things better and so that they are not at risk if things are worse.

And again it is a mixed bag, as you see with the big boys. Some are doing very well and I would see the buckle outperforming the marketplace and that's happening with some of the guys and then some of them are at standard or below standard, but I don't think there is any major difference with what's going on in core specialty than what's happening in the general marketplace.

David Glick - Buckingham Research

Okay, great. Thanks a lot. Good luck guys.

Bob McKnight

Okay. Thanks again for your time today everybody. Our annual meeting is coming up on March 28th so hopefully we will see some of you there. In the mean time if you have any additional questions, please don't hesitate to call myself or Joe. We look forward to speaking to you again when we report our second quarter results in about three months. Thank you very much and have a good day.

Operator

That concludes today's conference call. We thank you for your participation. You may disconnect at this time.

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Source: Quiksilver Inc. F1Q08 (Qtr End 01/31/08) Earnings Call Transcript
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