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Volcom Inc. (NASDAQ:VLCM)

Q2 2008 Earnings Call

July 23, 2008 4:30 pm ET

Executives

Hoby Darling - VP of Strategic Development and General Counsel

Richard Woolcott - President and Chief Executive Officer

Doug Collier - Chief Financial Officer

Jason Steris - Chief Operating Officer

.

Analysts

Shawn Martin - Piper Jaffray

Jim Duffy - Thomas Weisel Partners

Jeff Mintz - Wedbush Morgan

Mitch Kummetz - Robert W. Baird & Co

Presentations

Operator

Welcome everyone to the Volcom’s second quarter 2008 conference call. (Operator Instructions) I would now like to introduce Hoby Darling, Vice President of Strategic Development and General Counsel, for Volcom Inc., to begin the call.

Hoby Darling

Good afternoon everyone and thank you for joining us today to discuss Volcom's 2008 second quarter financial results. Joining me on the call today are Richard Woolcott, Volcom's Chairman and Chief Executive Officer; Jason Steris, Volcom's President and Chief Operating Officer and Doug Collier, Volcom's Chief Financial Officer.

First, some quick housekeeping items before we start. If you would like to be added to Volcom's e-mail distribution list to receive company information or if you'd like to change your contact information, please contact Evan Pondel at Pondel Wilkenson at 310-279-5975. In addition, be advised that this conference call is being broadcast live on the internet at volcom.com as well as earnings.com. A playback of this call will be available for one year and may be accessed on the internet at both websites.

Please note that all information discussed on today's call is covered under the Safe Harbor provisions of the Litigation Reform Act. The company's discussion today will include forward-looking information reflecting management’s current forecast of certain aspects of the company's future. In particular, statements about the future regarding our guidance, outlook for future business margins, financial performance, customer demand, growth and profitability all constitute forward-looking statements.

These forward looking statements are all based on management's current expectations, but they involve a number of risks and uncertainties. Actual results could differ materially from those stated or implied by these forward-looking statements. The company disclaims any intent or obligation to update these forward-looking statements except as required by law. All forward-looking statements from today's call are qualified in their entirety by the foregoing cautionary statement. With that said, it's my pleasure to turn the call over to Richard.

Richard Woolcott

We are no more than half way through the year and I feel good about the progress that we have made managing our business in the U.S. running our new European operation and integrating Electric. The power of Volcom brand continues to capture the attention of consumers around the world and we are excited about the global opportunities that lay ahead.

The current retail environment does pose its challenges and while we anticipate that the general economic weakness will continue to put pressure on retail. We are confident that the strength of our brand and our growth strategy will help successfully guide us though this period. As we have mentioned on our last call diversification is fundamental to our strategy. It also is critical for us to maintain brand integrity, increase shareholder value and promote the right balance within the company as we continue to grow.

To leverage our strengths we recently named Jason Steris, President of the company. In addition to is role as Chief Operating Officer. Jason joined Volcom in 1993 and served in various roles, including sales manager. I’m very excited the Jason has taken on his responsibility and value the expertise that he brings to the position. There is no doubt in my mind that he is the man for the job.

Now before I provide an update on our activities during the quarter, I’d like to reiterate the five pillars of our diversification strategy. They include brand and marketing, product, distribution, international and acquisition. I would now like to hit some of the highlights form the quarter in context to these initiatives.

I believe the success of our domestic and global expansion is tied directly to the strength of our brand and marketing attack. Our number initiative at Volcom is to make sure that we are focused on the core fundamentals that drive the business and that we are doing everything we can to strengthen our presence in the marketplace. Part of this focus directly relates to our marketing initiatives, ranging from our team riders, our advertising, tours and demos, Volcom branded events and our music and film production offerings.

I believe our marketing teams are on their game with good momentum going into the second half of the year. During the quarter some of the highlights included the Peanut Butter and Rail Jam Snowboarding Championships in Mammoth, California. The VQS Crustaceous championships in Newport Beach, California and the beginning our international Wild in the Parks skateboarding contest tour, which will be running all summer.

Also coming up this summer is the soak out Tranny skate park tour featuring our top professional skateboarders and in the fall we will kick off the Volcom rock tour with acts including Motorhead, the Misfits, Airbourne, Valient Thorr and Year Long Disaster. Overall I am very satisfied with our marketing efforts and believe we have a solid infrastructure to support and maintain our brand magic.

I would now like a talk a little bit about our products. Our product categories include men’s, girl’s, boys, snow, girl swim, sandals and slippers and eyewear. The diversification of our product line is among our core growth initiatives and we are constantly striving to keep our products fresh, existing and on trend. Product quality and brand integrity are our primarily focus as well as maintaining good relationships with our retails and vendors.

Recently we began introducing our Stone Age line to our core retailers providing a limited collection of apparel and accessories available exclusively at select authorized Volcom dealers. We feel that programs such a Stone Age give our core retailers something special in addition to providing a draw for our consumer to shop at these stores.

Our goal is to make sure that we continue to stay relevant and exciting in the marketplace. In tough times it all about product and we intend to do everything we can till deliver the best product possible.

I just reviewed our spring line that will debut next week at our sales meeting and I was impressed with the collection. Its looks great and it’s just what we need as we begin to build for next year. We’ve also been pre-lining the collection with some of our key accounts and the feedback has been solid.

I’d now like to take a moment and talk about Electric. Last quarter we added the full product line from Electric, which includes sunglass, goggles, soft goods and accessories. During this period we launched three new sunglass styles, the Technician XL in May and the Detroit and Hoodlum the last week of June. So far the initial sell-through on all three styles has been very positive and we look forward to continuing to build on this excitement.

In terms of the integration we have been working diligently to integrate the appropriate departments and so far both teams are successfully settling in to the new relationship. The overall eyewear business has been somewhat tough due the economy, but we believe over the long run the strength and momentum of Electric will perform to our expectations. This is great young brand with plenty of future potential.

Another core gross initiative is our distribution, from independent shops to specialty retailers and department stores we believe our distribution platforms is well rounded and on solid footing to maintain and grow the business.

Our distribution make up is relatively unchanged from the last call and is expected to remain steady for the balance of the year. During the quarter we experienced solid gains with our PacSun business and as we have discussed, we continue to work closely with PacSun, Zumiez and our other national retailers providing the needed of support that goes hand-in-hand with a long standing relationship.

This same goes with our core shops that are also battling the elements of the slowdown. We maintain close working relationship with all of our retailer partners and help out where we can. We do believe there are opportunities for our brand to continue to grow through our existing distribution channels and mining those bright spots in our distribution platform is particularly important given the retail environment. In many ways the stated of the economy helps us exploit various strengths and weakness, enabling us to better prioritize the business.

Our main priority right now is to stay focused on the core building blocks that make up the manufacture, retailer relationship and to do our best to write off the current economic storm. All in all we believe our diverse distribution platform will help us mitigate long-term risk. I’d now like to turn our attention to our international business.

When looking at Europe the core of our business is being done at France, Germany, Spain, Italy and United Kingdom. We have strong routes in these countries and continue to invest then for the long-term. So for we are please with our strategy and believe have the right team and infrastructure in placed to go the business. As many of you know Europe has been feeling some of the economic pressure and while there are certainly some bright spots we are closing monitoring the situation and believe that our brand position will help us endure these conditions should they continue to get worse.

During the last call I mentioned that we also have been working closely with our partners in Japan and Australia. Both of these territories are very important to our global strategy and we continue to focus our attention on them. Specifically, we have just hired a new General Manager to oversee our Japanese business, which is still run through a distributor and we have recently sent one of our key executives from the U.S. to Australia for a year to work with our licensee internal team. We believe these initiatives will help strengthen our brand in these territories as well as the surrounding regions.

The fifth and final pillar of our growth strategy is acquisitions. Our most recent initiatives here, was the agreement to purchase Laguna Surf & Sport which we anticipate to close later this month. LS&S has been a core retail partner of Volcom in Southern California for 15 years, operating two stores serving in the Laguna Beach and the Aliso Viejo health communities. These stores along with our Volcom branded stores enable us to further develop a strong relationship with the consumer as well as showcase our brand in highly desirable locations.

The multi branded concept of the LS&S stores is a little different for us, but we believe it helps diversify our retail business by providing us with greater insight about our customers and market trends. It also brings an experience team to the company adding strength to our overall retail infrastructure. We plan to keep these stores operating under the LS&S name with the same employees, management and general product and brand mix.

In terms of Volcom branded retail, during the quarter we opened stores in Soho, New York and Boulder, Colorado. We are also working on a Bruce Iron, signature store in Waikiki, Hawaii, and a store Miracle Mile in Los Vegas Nevada. We planned to have both stores opened in the fourth quarter of this year. With the two new Laguna Surf & Sport stores, Volcom now expects to have a total of 12 U.S. based retail stores at the end of 2008. Internationally as we discussed last quarter we opened one new licensed store earlier this year in Indonesia and reopened the Volcom store in Hossegor France. We plan to open another store in Europe, two additional licensed stores in South Africa and one more licensed store in Thailand later this year.

By year end our total international store count should be approximately 11 stores of which nine are licensed. Two in Europe, two in Thailand, two in Indonesia, one in Japan, three in South Africa and one in Brazil. We planed to continue to build our retail business slowly, seeking our geographic locations that make sense as well as taking into account the locations of our current retailers. Overall I’m excited about our store openings and believe they serve an important role in our diversification.

Looking back at our marketing programs our product, our infrastructure, along with our overall diversification of our business I am pleased with the progress we have made. Our strength and ability to perform under challenging economic conditions is a testament to the commitment and talents of our team and brand, we have talked a lot about our growth strategy and I can say with confidence that we are well positioned and right on course as we moved into the second half of the year.

It’s all about execution right now and keeping the brand healthy. This is a time of opportunity and a chance for Volcom to get stronger and better our position for when things turnaround. For us it’s an exciting time that keeps us motivated and on our toes. Our passion is as strong as ever and I believe that’s the most important ingredient for long-term success. As always I would like to thank the entire Volcom family, our affiliates, retailers and shareholders for their continued support and commitment to the brand, and now I’d like to turn the call over to our CFO, Doug Collier to review our financial results for the second quarter. Doug?

Doug Collier

Thanks Richard and good afternoon, Volcom has been doing business in a difficult retail environment through the first half of 2008, but for the most part we have been able keep phase and in some areas exceed our financial expectations. At the media remark our results have been solid and a test to the strength of the brand. For Q2 we exceeded the high-end of our revenue guidance by approximately $2.5 million. We also exceeded the high-end of our EPS guidance by $0.03, primarily due to revenue that was ahead of plan along with the lower than anticipated effective tax rate for the quarter.

While we have generally maintained our revenue outlook we have had to reduce our earnings outlook for the remainder of the year due to our tempered view of the retail environment. However, we will continue to have the power of the However, we will continue to have the power of this stone in our arsenal and it is this iconic logo, along with the powerful Volcom brand that continue to provide us with a distinct advantage in this marketplace. For the first quarter end of June 30th, 2008 total consolidated revenue increased 25.6% to $72.5 million, compared with $57.7 million in the second quarter of 2007.

I’ll now breakdown our Q2 revenue by each of our three business segments; The U.S., Europe and Electric. First, let’s look at the U.S. segment. Please note that this segment includes the revenue from the U.S., Canada, Japan, and most other international territories outside Europe, as well as our Volcom branded retail stores.

Looking at our revenue by distribution channel, revenue from our five largest accounts increased 15% to $27.5 million in the 2008 second quarter, representing 46% of U.S. segment product sales. Revenue from PacSun, our largest customer, increased 17% to $15.8 million for the quarter or 27% of U.S. segment product revenue, compared with $13.5 million or 25% of our U.S. segment product revenue for the comparable period in 2007.

Our business with PacSun in the second quarter was better than anticipated, primarily reflecting strength with men’s product, which increased 66% in Q2. Excluding PacSun revenue from our next four largest accounts increased 13% for the quarter. In Q2, revenue from accounts outside our five largest accounts, which represented 54% of total U.S. segment product revenue for the quarter, increased 5% to $32.1 million.

While the difficult retail environment prevents challenges from many of our retailers. We are encouraged to see growth outside our five largest accounts. This group of retailers includes independent core stores that are geographically diverse and tend to cater to influential customers that can drive growth in other distribution channels.

Now let’s look for to revenue from the Europe segment. As a reminder comparisons to the prior year are not yet useful as this segment did not begin full operation until Q3 of last year. Also please note that the revenue in Europe is seasonal and is concentrated primarily in Q1 and Q3.

Product revenue from Europe, totaled $5.9 million for the second quarter of 2008. This was about 900,000 ahead of guidance and was due primarily to a foreign currency translation of the euro to U.S. dollars.

In Q2, the revenue by category in Europe is as follows; men’s was $4.7 million, representing 80% of the segment revenue. Girl’s was $1 million representing 18%. The balance of the Europe segment product revenue was primarily made up of Boy’s and Creedlers which were 108,000 and 107,000 respectively.

Finally, revenue from our third business segment Electric was $6.4 million for the quarter about 600,000 below plan. This short fall was primarily the result of the soft retail environment both the North America and Europe. Also contributing to the short fall France and Spain Electric’s two biggest markets in Europe experienced cold rainy weather during April and May.

Turning to the gross margin, on a consolidated basis Q2 gross profit, as a percentage of total revenue was 48% compared with 48.2% in the same period in 2007. In our U.S. segment Q2 gross margin on product decreased 310 basis points to 45.6%, compared to 48.7% in Q2 of 2007. U.S. segment gross margin in Q2 was lower than last year primarily due to the continued soft retail environment resulting in an additional discounts and increased liquidation sales during the quarter.

In our Europe segment gross margin was 57.6% versus 28.1% last year. Again please recall that Europe was fully operating in Q2 of last year. Gross margin in the Electric segment was 56.8%. We continue to be encouraged by the high margins of our eyewear business.

Selling, general and administrative expenses on a consolidated basis were $27.9 million in the second quarter of 2008 versus $18.9 million for the same period of 2007. As a percentage of sales consolidated SG&A expenses was approximately 38.5% of total revenue for the second quarter of 2008 compared with 32.8% for the same period in 2007.

For the U.S. segment SG&A expenses in the second quarter increased 16% to $18.5 million, compared with $16 million in Q2 of 2007. For the Europe segment SG&A expenses in Q2 were $5.6 million compared to $2.9 million in Q2 of 2007. Please note that during Q2 of 2007 Europe will still in its starter phase. For Q2 of this year Europe was a fully operating business.

In our Electric segment, SG&A in Q2 was $3.7 million, which includes non-cash acquisition related amortization of approximately $500,000. Consolidated operating income for the second quarter was $6.9 million, compared with $8.8 million for the same period in 2007. Consolidated operating margin was 9.5% for the second quarter compared with 15.3% in the second quarter of 2007. For the U.S. segment operating income for the second quarter decreased 19% to $9.2 million compared with $11.3 million for the same period in 2007.

Operating margin for the U.S. segment was 15.3% for the quarter compared to 20.5% in the second quarter of 2007. This drop in operating margin was anticipated, as we continue to allocate resources to growth and brand building initiatives. This allocation of resources was made despite revenue growth for the year that is projected to be lower than historic levels due primarily to the anticipated soft retail environment.

In the Europe segment operating loss for the most recent quarter was $2.2 million compared to an operating loss of $2.5 million for the same period in 2007. As we have stated previously, revenue for Europe is concentrated primarily in Q1 and Q3 while the run rate for expenses is much more constant throughout the year. Thus the operating loss for Europe in Q2 was inline with expectations.

In the Electric segment operating loss in the second quarter was $90,000 again this includes non-cash acquisition related amortization of approximately $500,000. On a consolidated basis the company recorded a provision for income taxes for the second quarter using a 33.5% tax rate. As we now expect our annual effective tax rate to be 35.5%.

Net income for the second quarter of 2008 was $4.8 million or $0.20 per diluted share compared with net income of $6.2 million or $0.25 per diluted share in the second quarter of 2007.

Turning to the consolidated balance sheet at June 30th 2008, the company had approximately $71 million in cash, no significant debt and stock holders equity of approximately a $191 million. Consolidated accounts receivable increased $19.6 million to $60.9 million at the end of the quarter compared with $41.3 million at June 30th 2007. The consolidated receivable balance at June 30th represents days sales outstanding of 72 days. It should be noted that of the $19.6 million consolidated increase $15 million was the incremental increase related to Europe and Electric.

Excluding Europe and Electric AR increased $4.7 million or 12% compared to June 30th 2007. Consolidated inventory totaled $36.9 million at June 30th compared with $19.4 million a year before. The inventory at the end of Q2 includes $13.6 million of incremental inventory related to Europe and Electric, including Europe and Electric the inventory churn rate calculates to 5.3 times per year or once every 69 days.

I’ll now turn to our financial guidance for the third quarter and full-year of 2008. In putting forth our guidance, we have taken the following among other things into consideration. The general caution we are hearing for retailers given the overall soft retail environment, which we believe we’ll continue to put pressure on our gross margin during the back half of the year.

Our revised estimate that PacSun business will increase slightly in 2008 compared to last year; this is up from previous estimate that our revenue from PacSun would be down 10% for 2008. The inclusion of Electric and LS&S in our 2008 projections, we forecast that Electric will be slightly accretive this year. We also forecast that the LS&S acquisition, which is anticipated to close later this month and will be included as part of our U.S. segment will add approximately 900,000 of revenue in the back half and will be earnings neutral in 2008 and that Europe will be fully operational for the entire year versus primarily in the second half of 2007.

In considering these points, consolidated 2008 third quarter revenue is expected to be between approximately $109 and $110 million for an increase of approximately 20% to 21%. This includes anticipated revenue of approximately $69 to $70 million from the U.S. segment approximately $32 million from our Europe segment and approximately $8 million from Electric. In Q3 we expect revenue from PacSun to be up approximately 65% compared with Q3 of 2007 before which was approximately $10.3 million.

EPS for the third quarter of 2008 is anticipated to be between approximately $0.63 and $0.64. For the full-year of 2008 projected consolidated revenue is expected to be approximately $344 million to $347 million. Broken down by business segment, this includes projected revenue of approximately $241 to $243 million in the U.S., approximately $76 to $77 million in Europe and approximately $27 million from Electric.

As we stated on our last call, in 2008 we will incur approximately $2 million of incremental expenses as we transition into our new warehouse facility in Irvine, California. Of this incremental amount approximately $1 million is non-cash depreciation expense of capital equipment that has been purchased and paid in full. We expect to be fully transitioned into our new warehouse by the end of 2008.

At this time we will close our existing warehouse facility and we project to realize full operational efficiencies. This new warehouse is expected to meet all of our domestic warehouse needs for the next 10 years. EPS for the year is expected to be in the range of approximately $1.50 to $1.53, a decrease from our previous guidance of $1.56 to $1.59.

We expect that Q3 and full year 2008 tax rate to be approximately 35.5%. Fully diluted shares outstanding for the third quarter and full year of 2008 are expected to be approximately $24.5 million. In putting forth this outlook we want to remind everyone of the complexity of accurately accessing future earnings and revenue growth, given the difficulty and predicating sales of our products by key retailers including PacSun, changes in fashion trends and consumer’s preferences, sourcing cost and general economic conditions.

With that we will open the call for questions.

Question-and-Answer

Operator

(Operator Instructions) Your first question comes from the line of Mitch Kummetz with Robert Baird.

Mitch Kummetz - Robert W. Baird & Co

I’ve got a number of questions, I’ll try to go through these quickly. What visibility do you guys now have into the back half, in terms of your order books and kind of what you are assuming in terms of reorders and what you might expect in terms of fallout on our order? I mean how do kind of size up the back half in terms of visibility that you have to kind of give us confidents in your revised outlook?

Jason Steris

Mitch this is Jason, I’ll shout some light on that question for you. Where we are said right now and looking at our guidance? We are just in the beginning of the back-to-school season right now. So it’s little too soon to tell how that back-to-school season is going to fall out in terms of that reorder business, but there is some early signs and we are taking those into the consideration in terms of managing our inventory levels and the one indicated that we did get back in May was our holiday pre-books.

Mostly at the core level and some of our larger customers in terms of just the way that they are ordering, a little lighter in terms of pre-books and waiting for little more in-season business and that’s sort of the trend that we are seeing across the board. So we are talking all out in consideration as we are planning our inventory.

However, we are looking at doing some potential reorder business continued in the back half year, but we’ve worked that all into our guidance and the main point I’m trying to make is, we are really trying to keep our inventory level manageable and sort of our strategy as we’re getting out there with our Spring line here in the next couple of weeks, which we’ve had a great response to in last couple of weeks in terms of pre-lining, and we will, bringing some of those Spring products a little bit earlier for our 12 - 1 start.

So we will have holiday inventory available for some reorder business, but it won’t be still in the warehouse, stuck with a tone of excess inventory anticipating larger reorders and we’ll shift those into spring inventories. That’s sort of our strategy right now, so I think we’ve got our fall bookings a little bit of reorder in our plan. We’ve got our holiday pre-books, which we are seeing a little bit lighter than historically, but inline with kind of that what we are feeling out there.

A little bit reorder availability, and then really just getting out there with that spring line here in the next couple of weeks, and looking at the 12 - 1 start to shift and again like I said, we’ve got a really good lead vein on our product, our girls were just up at Zumiez yesterday and had a great response, so we feel really good about our product line up moving forward and that’s the main visibility we have.

Then on the PacSun’s side, looking at that number we’ve got our bookings, and then there is a projection that we are working closely. With their buying teams on, and they feel confident in those numbers and our teams are going back and forth working on it with the buyers down to the category level and so that’s a big chunk of that business that we have good visibility on and we feel confident and so. We picked everything into our plan, and we feel like it’s a realistic goal and we’re charging forward.

Mitch Kummetz - Robert W. Baird & Co

Okay, and then just a couple of quick follow-ups on that. I don’t know if you want to take them or maybe Doug, but on the PacSun business, Doug you mentioned, up slightly for the year. I think if I heard you correctly, up 65% in Q3?

Douglas Collier

That’s correct.

Mitch Kummetz - Robert W. Baird & Co

So, I haven’t done the math yet, but what does that imply for Q4 and where do you expect to see that big of an increase in the increase in third quarter with that?

Douglas Collier

With PacSons?

Mitch Kummetz - Robert W. Baird & Co

Yeah.

Jason Steris

Yea, on that PacSon increase, we had spoke a little on the last call, our Junior’s business being down in the first half and getting that back up and running and our teams are really focused in on that Junior’s business for Q3. So, there is a big spike there and then our continued program with the men’s, that’s that backbone driver for us specifically with those core programs that we have in there right now with that Puccino short, the Polo Shirt. We have a crew of t-shirt in there now and we’ve got a thermal program that are all core items with flows that are continuing to do well at retail and so those have performed a little bit better than expected, and then the T-shirt business, continue to get reorder there.

So big spike in the Junior’s for Q3 and then just continuing to push that men’s business and it’s performing really well. So, it’s a good vein for us especially on a national level of seeing how well the Vocom brand is performing and we are very encouraged by the results

Douglas Collier

And Mitch on the numbers I think that works out to be something like $16.9 million this year in Q3 versus about $10.3 million last year.

Mitch Kummetz - Robert W. Baird & Co

Okay and then, again does that that suggest that you’re down or up in the fourth quarter with Pac?

Jason Steris

Yes, this is Jason here. At this point we are projecting to be down for the fourth quarter and mainly because there will be a shift, we’re seeing the shift in some of the spring assortments whether it’s sports shorts, swimwear, when we had that product as in December ship last year. So at this point we see some of those received, being shifted in the February, maybe in January but at this point probably February. So, up to 65 for Q3 and then slight down a bit for Q4 and then overall for the year we are projecting to be up a little bit.

Mitch Kummetz - Robert W. Baird & Co

Two last questions. Inventory, Doug you explained that the bulk of the increases is coming out of Europe and Electric, but how does the balance of the inventory stand, I mean how excess is there at quarters end and what is that mean for margins going forward?

Doug Collier

Well I think there is definitely margin hit, and we sort of build that into our back half of our guidance and it’s why you see the EPS comedown in the back half, but it also means that means that we are getting rid of that inventory as it comes up or being aggressive with that in the op-price channels and doing our best to get rid of that, so we are not stuck with that and to-date we’ve been really successful with that. So, we are seeing it a little bit in the margin, but we don’t really foresee a problem going forward with the inventory.

Mitch Kummetz - Robert W. Baird & Co

Okay and then last question, you now have 12 months of European business under your belts and if I am doing the maths correctly, it likes it’s about a 24% operating margin. Can you just talk about what are your goals for that business in terms of the margins or where the opportunities. Obviously that’s a great margin and then if I back it out of your overall numbers, it looks like your U.S. business over the last 12, four quarters is about 16% operating margin, which is definitely down for where it was a few years ago. Can you talk a little bit about, how you see that, obviously you had some pressure on the gross margins and there has been some expense and how you sort of dealing the kind of the operating margin on the core business and what the potential is for that?

Doug Collier

Yes, I think I’m just looking at the U.S. business first. I mean that’s something that we’ve talked about. We went ahead and sent on some growth initiative this year. We specifically talked about the warehouse and things related to branding and improving our company. We didn’t really cut back on some of those, despite revenue growth in the U.S. that we think is going abnormally low when compared to historical levels, and we think that’s really due to the rough economic environment that we’re in right now.

So that’s the case in the U.S., now we’ve been hit a little bit more on that with the gross margin pressure as well. Looking at Europe I mean that’s still a business that’s developing for us we are really encouraged by those margins there particularly at the gross margin level. So we think that’s the great opportunity there in a little bit different of the growth cycle earlier in the growth curve than we are. I guess the only thing that we got to be conscious about there is the economic environment getting a little tougher over there as well.

Mitch Kummetz - Robert W. Baird & Co

Great, thanks and good luck.

Operator

Your next question comes from the line of Jeff Van Sinderen with B. Riley.

Jeff Van Sinderen - B. Riley

I guess, just kind of a follow up to Mitch just talking about in terms of overall feedback from some your major retail accounts like PacSun and Zumiez. What do you hearing in terms of feedback on the sell-through with them, it sounds like your Junior’s business is the major part of the increase for Q3 with PacSun. Are you hearing that the sell-through with the stuff that you have in Junior’s now are stronger or maybe if you can just give us a little more color on that would be helpful.

Jason Steris

Yes, sure Jeff. I’ll comment on Volcom brand in our stores rather than commenting on that their business in general, but from what we hear talking with both PacSun and Zumiez we continue to be one of their strongest brands and that’s across all product categories that we participate in which for PacSun it would be the men’s business and the girl’s business, sportswear and accessories and then Zumiez have to cross all product categories men’s, girl’s, boy’s, snow and accessories.

On the Junior’s side, from what we’re hearing right now, looking at the – we got a little bit of a later back half with PacSun on the Junior’s side and that was transitioning out of some issues that we had in the past on some fits and just missed opportunities. However, our teams, our design and sales team has just been working really close with their buying teams, finding a right product mix, working on the right fits and the product mix and we are getting traction again and that just momentum, its just the teams hard work and put their hands together and find the right product. So the power of the brand is there, just hitting the home run. When it comes down to the girl’s products on just hitting trend and color and fit and all that so, hope that answers your question?

Richard Woolcott

Jeff this is Richard. Just a kind of follow up for Jason on kind two point. First were just having launch about an hour going and as we mentioned early we got really good feedback on our girl’s line for spring from the Zumiez team yesterday, which is very encouraging because that’s as we go into our sales meeting next week to have that momentum.

We’ve heard it from other retailer too, so from all the feedback that we’ve been getting moving with the spring line it’s been really positive. Now when you look at the business in general today outside of our big accounts we look at kind of our smaller accounts and medium size accounts across the country. I mean we are getting really good feedback and good sell through reports in the majority of our territories and particularly when compared to what’s going on in the market.

So right now even though, there is pressure on the economy and all the macro economic stuff that we all see every day, we are very encouraged with how strong the brand is right now in the market and how much momentum we’ve got in this environment. So today we feel really good and then just has importantly and more importantly what we are about to put out there in the marketplace moving forward. We feel really good about it too and we were getting good feedback, so we got a lot of good indicators on our plate right now. It keeps us motivated and fired up so, it’s a good report from out in the field.

Jeff Van Sinderen - B. Riley

That’s great to hear. Let me ask you as far as you owned your companies on retails stores anything happening there that’s worth talking about that might be different from what’s happening in another places?

Richard Woolcott

You know what I have seen just recently, just kind of strength across the Boards because we look at, we are looking at our reports daily and from month-to-month and kind of tracking how sales are doing in compared it to what was the feedback we are getting.

What I’ve seen just recently is encouraging and looking at all our stores in general they are tracking well especially in the last couple of months past, since July 4th, and going through these last couple of weeks, which is encouraging because as Jason mentioned earlier, I mean the real feedback we are looking for now, the next piece of information about to unfold is how back to school performance, and that will have a direct relationship to reorder business, to how holiday unfolds and how the compel confidence to consumers. Particularly the retailers are going to be when they are ordering for spring.

So, we’ve got a lot of dynamics happening right now that or going to making impact on the future of our business in the next down 6 months. So, we are trending in the right direction. I think on the next call we’ll definitely have a much clear picture and visibility on how the rest of the year and spring ’09 is going to clay out.

Jeff Van Sinderen - B. Riley

Okay and on the Laguna store accusation, are you. Should we be thinking that your planning to modify the assortment there, to have more waiting or how should we think about that?

Richard Woolcott

I thinks at this point with the LS&S acquisition they’ve got two stores, one of them by the beach that’s more surf related and the other one just in land that is more skate related and at the product mix in there is good. I mean Volcom’s got good presence in there and so our intention is just to keep those stores strong with the healthy mix and balanced and just kind of keep that energy going on in the store the same.

These stores have a very unique and special energy, they’re very important in our backyard and when the opportunity arose we looked at it and said “hey, this is something special and interesting and additive to our retail play” and we are really excited about it and these are right here right down the street from where we are at we’re relatively close.

Operator

Your next question comes from the line of Jeff Mintz with Wedbush Morgan.

Jeff Mintz - Wedbush Morgan

Thanks very much; just a follow-up on the surfing sport. Is the strategy there to start opening these stores under out that kind of multi brand channel or is it more just to run those two stores at this kind of a test.

Richard Woolcott

Jeff it’s a great question. Let me back up just for a moment and maybe clarify little bit and why we jumped into type of opportunity, because it’s something new for us, it’s something we’ve really haven’t talked about.

What we’ve seen in our industry here in the U.S and also on a national level is that we’re seeing some of close competitors beginning to partner with the retailers and kind of building synergies there and we look at that today and that’s an interesting concept moving forward, somewhat like a consolidation that’s happening and we’ve that at the back of minds as we built our branded retail, roll out and when this opportunity came it long it may a lot of sense for us, because number one its in our backyards, so it’s a very strategic play and some opportunity for us to get our foot in the door to kind of test, our infrastructure with a multi-branded infrastructure. So I think its a good first step for us.

Now in terms of rolling out more or less in the stores, we’ve talked a little bit about that, maybe there’s one or two more stores at some point, but we don’t have a large in-depth strategy to do something like that right now. I think, first is to integrate this multi-branded type store model into our family. This store brings a lot of experienced management which I think is going to play a great role overall in our retail infrastructure and once you kind of get it set in place and then see what the opportunities are as we’re moving forward. So, I think a good healthy first step, a good opportunity, not a lot of risk involved and really testing the waters.

Jeff Mintz - Wedbush Morgan

Okay, great thanks, that’s really helpful, and then probably for you Doug on the changing guidance, was there any incremental SG&A that you had come up over the last quarter, so that led to that impact or was it primarily the gross margin line?

Doug Collier

It’s primarily the gross margin line, along with bringing the sales down a little bit in the back half of the year. In fact, we did take a good look at our SG&A, we’re actually in some areas we’re able to make a little bit of cut, so really it’s just forecasting in the environment that we’re in and sharing what’s going on and seeing a little bit of cancellations here and there across all of our business segments. We just reevaluated our gross margin and took really worsening environment into account for the back half of the year.

Jeff Mintz - Wedbush Morgan

Okay great, and then finally Jason can you comment a little bit on what you’re seeing for the snow business coming up on the winter here and kind of where you feel that business is going this year?

Jason Steris

Yes, definitely Jeff. I can’t predict the snow fall, I wish I could, but in terms of our delivery and we’re gearing up for the majority of our products our ships in Q3. So, we’ll start shipping the snow product here in the late August, early September that’s our window there.

Everything looks good there and we were on track to get that product out there and it hasn’t really kicked off yet in terms of the retail excitement that really happens right here in the next couple of three to four weeks when people start getting their deliveries and building their floor sets and talking about it and the new movies come out and so we’re kind of just buzzing a little bit of the SIA show back in January, which we talked about and a lot of it really has to do with the snow fall and hopefully we get an early season of snow and it’s really that’s what it comes down to, that product relies on the weather and that’s the bottom line. So, we’re geared up try to get our product out on the floor and we are hopping for great season.

Richard Woolcott

And also I think with our inventories, our inventories are very closely cut the order, so there isn’t a lot of risk in terms of carrying extra inventory.

Jason Steris

That’s correct.

Jeff Mintz - Wedbush Morgan

Okay so you continue just to mostly cut to order on the snow business?

Jason Steris

Absolutely.

Operator

Your next question comes from the line of Shawn Martin with Piper Jaffray.

Shawn Martin - Piper Jaffray

And then first as a housekeeping question; is it possible for you to break down the U.S. segment by country; I know you do that in the Q, but I’m just wondering if you have that data as well on the revenue side?

Richard Woolcott

I think we’ve got here.

Shawn Martin - Piper Jaffray

I think you said Canada, Asia Pacific and other?

Richard Woolcott

Yes, I can just go over there. Okay international sales in the U.S. increase 7% to $12.3 million.

Shawn Martin - Piper Jaffray

Okay, and then also on the sourcing side, I know a lot of people have talked about sourcing pressures coming for next year; what have you guys seen in kind of your ordering from Asia and are you guys building in -- how are you planning that business for next year?

Jason Steris

Hey, Shawn I will answer that for you this is Jason here. It’s definitely a hotspot right now in the company. As you guys noticed there’s a lot of pressure over there with the currency, labor charges, increased raw material due to the oil pricing, so it definitely on our radar. Our goal first and fore most is to maintain our quality and our delivery and not take any production risks and what we’re doing right now is we are looking at other countries such as Vietnam, Cambodia and some South America countries, such as like Honduras. There are some programs that we’re potentially looking at for next year.

For this year we’ve been able for the most part maintain our costs with products that have been costed early on in the process and are a kind of fixed cost, some things like that. We are starting to really see a little more pressure as we go into building our 2009 products and our goal is really to look at opportunities in other countries that make sense without taking big risks.

Then really going back our first goal is really to go back and look at the efficiencies that we can do with our current group; I believe China where we do have, great partners that are able to delivery that quality product on time and some of those examples would be working closer with our subsidiaries, looking with Europe a lot more in terms of buy plans, consolidating those style together and now that we have Electric we’ve got some more, economies of scale there, we can bring in, we’re working closer with our Austria group on shared style, so as much as we can grow that business with our vendors, we can also ask for better pricing, much more focused on our styles and to planning right now and projecting out on core styles versus doing multiple buys, looking at more dropped shipments with some of our larger customers to help bring down our overall expenses in our warehouse.

So, I mean across the board from our current group we’re looking at it as well as our team is out there sourcing other countries as well and again we’re going to focus on quality and delivery and do what's right for the brand long-term. So, there is a lot of good stuff in the works, but it’s definitely a challenging environment.

Shawn Martin - Piper Jaffray

Good and then on the SG&A line, how quickly can you react to that. I noticed that it was growing a little bit faster than sales this quarter year-over-year, is there anything you can do and Doug, mentioned that you did take some cuts when you looked at the second half of the year, but are there things that you could readjusted mid-quarter potential as well or is that going to be pretty much set install now?

Richard Woolcott

No, there are something that we can do. We continue to look at it. We’ve made one pass through and yes that something that given the outlook for the back half of the year that’s something we’re going to look out and there are -- I don’t there going to be huge, cuts that we can make but I think there are some areas, where we can cut some expenses definitely.

Richard Woolcott

Hey Shawn, this is Richard. That is definitely topic that, we’ve been working on and even now as we are officially moving into the back half now, again it’s definitely on our radar monitoring how the business is doing out there and then we’ll definitely look inside at our infrastructure on ways to keep the balance and our initiative, main initiative is to keep the company healthy and balanced through this environment, so definitely something on our plate that we’re working on.

Shawn Martin - Piper Jaffray

Okay, the last question; just on the U.S. growth margin, looks like it was down about 300 basis points you mentioned; are there particular buckets in there, were there big buckets in there with specific to potentially inventory liquidation or markdown throughout that you had to do or freight; is there anything specific in that that we should be looking at?

Jason Steris

Hey Shawn, this is Jason again. Yes, there is three main points there and one being, as we become a larger part of partners with some of our larger accounts, the pressure on increasing IMU’s for some of our retailers, that being one of them.

Another area would just being more in season business with some more lighter pre-books where retailers are looking to improve their margin on some of these reorders and then the third one being us just being a little more proactive with our inventory level at the end of each season and not getting stuck with inventory and just putting the season to bed as we’re seeing sow moving styles and just moving forward, so it’s a combination of all of those three.

Operator

(Operator Instructions) your next question comes from the line of Jim Duffy with Thomas Weisel.

Jim Duffy - Thomas Weisel Partners

So, looking at the U.S. business, you guys are seeing more progress with PSun and if I’m remembering correctly your outlook for U.S. revenue means is about the same as it was come out of Q1, is it the independent where you’re seeing business soften or are you seeing it with some of your key accounts?

Jason Steris

Yes hey Jim, its Jason. I would say kind of across the Board, the read we’re getting, sort of the consensus at core retails, its tough out there, but you got some spots, some guys are doing better than others, you got some spots for guys who are down, some guys are flat, we kind of call it a bit of a mixed back kind of that core level on a national…

Jim Duffy – Thomas Weisel Partners

Is it geographical?

Jason Steris

But, I think overall you’re seeing a little bit of the smaller open to buy, budgets are tightened and up a little bit and then I think the retailer are waiting just to see how that end season business unfolds and the reorder on products when they are selling through there, so that’s kind of what we’re seeing overall, but the bright spot in all of that is we are seeing that the Volcom brand is performing well and continues to; we feel so. It’s probably a little bit better than what’s happening out there and so we’re encouraged by that.

Jim Duffy – Thomas Weisel Partners

Okay, good. Are you seeing kind of geographical differences?

Jason Steris

One thing we have noticed a little bit as it seems to be closed store, more kind of the closed store beats accounts and might be doing a little bit better, but it’s kind of a hotspot on California and then I think maybe just kind of it hit California first and now it’s sort of spread everywhere, but it’s seems like it’s been little bit better on the closed store accounts.

Richard Woolcott

Jim what Jason was talking about what the mix is that, we’ve actually when talking to retailers -- I mean takes for instance a retailer has got multiple doors. They’ll say “hey this one door, my best performing door is maybe down a little bit, the door that’s usually down is up and it’s other one is flat” and they’re just -- it’s kind of like, its tough, there is rimier reason out there.

It’s like you’ve got some territories spike up, some weak ends spike up, you talked one person the store was up and it was flat, but the general mood I think overall is that the retailers out there, they have accepted the fact of the environment, they’re buckling down. They know that it’s “hey this is a time that we really got buckle down on our business and analyze our business and manage ourselves the right way through this.”

The spirit in general is pretty good. I mean no body likes it, you can talk economic environment but at the same time it also makes you a stronger company and if you approach it with the right attitude, I think you can come out of it with better tools and resources and ways to manage your business and everyone’s kind of in that now and I think that’s what we see going as we are moving into the second half. I think people are just buckling down a little bit more, playing more of the conservative -- having a more conservative approach and waiting to see how things unfold with the consumer and their business.

Jim Duffy - Thomas Weisel Partners

It seems like everybody’s trying to keep from getting on the wrong side of inventory

Richard Woolcott

Absolutely yes.

Jim Duffy - Thomas Weisel Partners

And in your balance sheet you’re seeing a bit of a slowing of the inventory turn; is that a function of the environment or is it a dynamic related to some of the change that you’re seeing in product mix?

Jason Steris

Jim I think one of the biggest things we’re seeing is just a change in the way our company is set up. I mean we’ve got two new companies on board now with Europe and Electric. Electric being an eyewear a company a little bit more of a replenishment business, so they naturally carry more inventory, but their inventory, its not seasonal. I mean sometime they don’t a carry a style for -- it can be a couple of years some time, so it’s not really that kind of risk there is with the apparel, so I guess just our business is changing, it’s probably is one of the biggest factors.

Jim Duffy - Thomas Weisel Partners

Okay and then I was looking at the model similar to mix and what you were speaking about earlier seems like contribution to earning from the U.S. business coming down. I understand you’re making investments, but how do you quantify the growth opportunities that justify those investments in the future?

Richard Woolcott

Well, I think something that we’ve got to look at absolutely. I think our situation is not over reacting and cutting programs and things that are going to affect us longer-term versus delivering current results. Probably at this point, we do need to look at those expenses a little bit and maybe there are some things that we’ve got to cut.

Jim Duffy - Thomas Weisel Partners

And Richard, you mentioned kind of coming out of the stronger, which made some sense, but are you looking at as an opportunity to maybe take some share gains from some capacity rationalization or are there any competitors where you see opportunities to take share from them, because they’re in particularly weak conditions?

Richard Woolcott

Jim I think when you look at our environment out there, I think in this type of mode or mood, it’s going to be the company that’s got the strongest product, best delivery, best customer service. The ones that are really focused on the details and going the extra 10%, and extra 10% starts within your infrastructure and so when I say come out stronger I really, I look at that as at the end of the day our presentation in the store, I believe is going to be stronger and I think that next to your competition the one who’s got the strongest presentation in the store is the one who wins.

In terms of product, merchandizing, marketing, kind of wide excitement and I think we’ve got a very competitive marketplace out there, we’ve got a lot of good companies, that we compete with, they’re very sophisticated, they’ve been doing it a long time, but I feel we’re right at that level and it’s we’re going to take market share away from one another and that’s kind of a whole big fun of it. At the end of the days it’s competing and being good at what you do. So, I look at this as just motivating us; like there is no room for air and to be second best.

I mean we going to put 110% effort in everything we’re doing and that’s going to push us to be a better company and as Jason mentioned with the Spring, I mean at the end of the day it’s really going to be in your product and everything that surrounds your product, and that’s how we’re competing and that’s how when I say I think we’re going to be a better company, it’s with that end and then also with just making sure that we keep our eye on our financials and balance sheet, inventory, how we’re managing each one of the seasons and you just can’t have any waste, particularly an environment like this. So, we’re sharpening our pencils and it’s going to make us the sharper company.

Operator

There are no further questions at this time. Do you have any closing remark?

Richard Woolcott

Yes, I just want to say, thank you everyone for being on the call and for the support and your commitment to the brand and we look forward to talking with you again on the next call. Thank you.

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Source: Volcom, Inc. Q2 2008 Earnings Call Transcript
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