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Quiksilver Inc. (NYSE:ZQK)

F3Q08 (Qtr End 7/31/08) Earnings Call

September 4, 2008 4:30 pm ET

Executives

Bruce Thomas - VP, IR

Bob McKnight - Chairman, President and CEO

Joe Scirocco - CFO

Marty Samuels - President, Quiksilver Americas

Analysts

Jeff Klinefelter - Piper Jaffray

Anna Andreeva - JPMorgan

Jeff Van Sinderen - B. Riley & Company

Bill Reuter - Banc of America

Mitch Kummetz - Robert W. Baird & Co., Inc.

David Glick - Buckingham Research

Jim Duffy - Thomas Weisel Partners

Todd Slater - Lazard Capital

Julie Bryan - Jennifer Black & Associates

Jeff Mintz - Wedbush Investment

Operator

Good afternoon ladies and gentlemen. (Operator Instructions). I would like to remind everyone this conference is being recorded. I would now like to introduce, Bruce Thomas, Quiksilver's Vice President of Investor Relations. Who will chair this afternoon's call?

Bruce Thomas

Thanks operator. Good afternoon everyone and welcome to the Quiksilver's third quarter fiscal 2008 Earnings Call. Joining me today are Bob McKnight, our Chairman, President and Chief Executive Officer, Joe Scirocco, our Chief Financial Officer and I believe most of you also know, Marty Samuels, President of Quiksilver Americas.

Before we begin, I would like to briefly review the company's Safe Harbor language. Throughout our call today, items may be discussed that are not based on historical facts and are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In particular, statements regarding Quiksilver's business outlook and future performance constitute forward-looking statements and results could differ materially from those stated or implied by these forward-looking statements as a result of risks, uncertainties, and other factors, including those identified in our filings with the Securities and Exchange Commission specifically under the section titled 'Risks Factors' in our most recent annual report on Form 10-K. All forward-looking statements made on this call speak only as of today's date and the company undertakes no duty to update any forward-looking statements.

In addition, this presentation may contain references to non-GAAP financial information. And finally an electronic copy of our press release can be found on our website at www.quiksilverinc.com. With that out of the way, I would like to turn the call over to Bob McKnight.

Bob McKnight

Thanks Bruce. Good afternoon everyone and thanks for joining us for our third quarter conference call. I am very pleased to be able to speak with you on the heals of our announcement last week about the pending Rossignol sale, and on top of that we had a pretty decent quarter, given how tough the retail environment is around the world.

I would like to begin by repeating the really good news from last week, that we have received a binding offer for the sale of all of Rossignol including the equipment and apparel businesses. Delivering on our plan to sell Rossignol has been our highest priority objective and I am really pleased that we achieved last weeks milestone under challenging circumstances.

We expect the transaction to close in the fall and once completed we will be in a much better position in terms of our debt leverage, our ability to reposition our balance sheet and the time and attention that our management group will have to devote to our core businesses.

Let's now turn to the high level financial highlights in the third quarter, focusing on our core apparel and footwear brands which now comprise our continuing operations. Consolidated net revenues for the third quarter of fiscal 2008, grew 7% to $565 million. Consolidated gross profit grew 270 basis points to 50.4% of sales, while expenses during the quarter increased 430 basis points to 41.1% of revenue.

In total our continuing operations delivered operating profit of 9.3% of revenue or $53 million. Income from continuing operations for the third quarter was $33 million, compared to $36 million in the third quarter of 2007. Our performance overall was in line with our expectations, and it was reassuring to be in this range given the negative results we've all witnessed during the quarter in the retail environment.

I would like to discuss for a moment the dynamics that caused gross margins and SG&A to change the way they did in comparison to the third quarter a year ago. First, our gross margins in the quarter benefited from a higher portion of our revenues coming from Europe at our own retail stores than in the prior year. Both of these components are higher gross margin businesses.

Secondly, we again achieved some improvements in sourcing margins, and remain on track in this important area. It should be noted however that further gross margin improvements may be more difficult to deliver over the short-term, due to rising inflation in sourcing countries and pressure on our ultimate selling prices.

Just as our higher proportion of business from Europe and our retail stores drove gross margin higher in the quarter, it also drove our expense ration higher. In addition negative comparable store results across our global business together with conservative ordering by our wholesale customers led to some deleveraging of expenses, despite the fact that expenses in total were in line with our expectations.

For some time now, the tough selling climate in our key US markets of California, Florida, Nevada and Arizona has been a real challenge. More recently economic weakness in Hawaii and our major European markets of Spain, France and the UK has become evident. Our customers are ordering more conservatively to accommodate their softer performance of retail.

We believe that this buying pattern reflects the broader market trend and our market share remains intact. In fact we believe that our product offerings are strong and that retailers will rely on us as a market leader in these challenging times. With three of the top brands in global action sports and the size and scale to support the business and our retail partners we are in a very good position to not only hold our dominant position, but actually take market share during a difficult market. If times like this that customers and retailers look for brands that offer great styling, great value, authenticity to the surf, skate and snow lifestyles, quality, dependability, and a recognizable brand name.

Quiksilver Roxy and DC are such brands. Each one is uniquely positioned in the market and epitomizes their respective spaces. Quiksilver, the original and most recognizable global lifestyle boardsports brand. Roxy, the original female outdoor fashion brand that expresses the coastal and mountain casual lifestyle, and transcends geography, and DC the edgy, technical skate brand that bridges skate performance with street fashion.

Despite their leading positions, each brand continues to have tremendous growth potential around the globe. While yes, the overall environment is tough, the action sport lifestyle continues to gain global mainstream popularity, and kids are seeking out our brands around the world. We couldn’t be happier about our position in the marketplace and our ability to manage our business during tougher times, and grow the business over the long-term.

And lastly, the early feedback on our spring lines are Quiksilver Roxy and DC have been very positive, and the product looks fantastic. In other exciting news, we launched our new Quiksilver women's collection in the third quarter with a global campaign that included a new interactive website, a number of retail events and an ad campaign in major fashion and lifestyle publications including EL magazines. By EL indications, sale through retail has been strong and the feedback has been very positive. The volumes are currently small, and we are proceeding deliberately with the rollout, because we believe strongly that this line has great longer term potential. So together, the encouraging sale through and positive reviews give us confidence as we continue with the development of rollout of this exciting new line.

Also, we successfully launched the new DC e-commerce site during the third quarter, which means that now consumers can buy product from all three of our core brands online and in time for the upcoming holiday shopping season.

Amidst all the economic lows, we continue to be inspired by the performance of our athlete to connect us to the board sports culture, and established through their performances, excitability, authenticity and global appeal of our great brands.

Among the recent highlights, Kelly Slater again leads the way after winning his fourth title on the ASP World Tour out of the season’s first six events. This is a stretch of performance of the sport has never before seen and Kelly continues to amaze everyone with his determine to solve on an unprecedented ninth world title.

And some of our younger athletes are beginning to make headlines with their strong performances. At only 17 years old Roxy’s very own, surf team rider, Sally Fitzgibbons from Australia has already secured the 2008 WQS title, after only nine events, and in July Roxy’s surf team rider [Theresa More] from Hawaii won the ASP Roxy Pro junior in Beirut, France.

In the world DC, skateboard veteran and DC team rider Danny Way stunned crowd after taking one of the worst crashes at X Game history. Danny not only went on to win a Big Air silver medal, but was awarded the athlete of X Games XIV, the competition’s highest honor.

DC athletes won an impressive 13 medals at this year’s competition, bringing DC’s career medal total in the X games to 75.

So in summary, we are relatively pleased with our solid third quarter financial results, especially given the global nature of the economic downturn, and we're gratified to see the continued progress of our margin expansion initiatives, which we'll need in the future to offset some of the inflationary headwinds, we expect to encounter in future quarters.

And now the Quiksilver's continued operations are [front and center] in the context of the pending sale of Rossignol. It becomes increasingly clear that our broadly diversified mix of brands, products, geographies, and distribution channels, position us well in this challenging economic climate.

Thank you and now Joe will take you through the financial details.

Joe Scirocco

Thanks Bob, good afternoon everyone. You'll recall that beginning with last quarter's results, we began to treat the Rossignol group as a discontinued operation. Recede of the binding offer last week, reinforces their classification, and you will see that same treatment in the tables that were included in our press release this afternoon.

For our continuing operations, consolidated net revenue grew 7%, to $564.9 million in the third quarter of fiscal 2008 compared with $528.6 million in the third quarter a year ago. Virtually all of this increase was attributable to favorable foreign currency rates. In constant currency, revenue growth in Europe of 8% was aided by some early deliveries we previously expected to fall into the fourth quarter.

Third quarter revenues in the Americas region, declined by about 4% when compared to the same quarter a year ago for two reasons, retails comps in the region were softer than expected, and we experienced the delay of one to two weeks in shipping some product from our new distribution center in Mira Loma, California.

You may recall that for the last year, we've been migrating our wholesale business from our distribution centers in Huntington Beach in district California to Mira Loma and this represented the first quarter in which our entire range of products shipped from the new facility. We expect that these growing pains will be quickly behind us.

Gross margins in our core apparel and footwear business increased 270 basis points to 50.4% of sales, up from 47.7% a year ago. The improved gross margin was primarily due to a proportionally higher contribution from the higher margin retail and European businesses. Each of the three regions saw improvements in the sourcing margin component of their respective gross margins, which reinforces our belief that the regional and brand specific sourcing initiatives that we've often spoke of during the past year are delivering as planned.

But as Bob indicated, further gross margin improvements are becoming more difficult to deliver over the short-term due to rising inflation in sourcing countries and pricing pressures. In our continuing operations, third quarter SG&A expenses moved to $232.1 million from $194.3 million a year ago.

As a percentage of revenue, SG&A grew by 430 basis points to 41.1% of sales in the third quarter, up from 36.8% a year ago. This partially reflects mix of our business. And approximately $15 million of the increase was attributed to currency translation, while much of the remainder is attributed to supporting 94 more stores and concession shops than we had at the end of the third quarter last year.

In addition, the somewhat softer sales across our global business led to some de-leveraging of expenses, although expenses in total were in line with our expectations. Primarily, as a result of expense deleveraging, the operating margin in our core business declined to 9.3% of sales in the third quarter compared to 10.9% in the same quarter a year ago.

Interest expense for the quarter was $11.8 million this year, approximately the same as it was last year. Our tax rate on continuing operations for the third quarter were substantially lower than expected and decreased from 22% last year to 21% this year. The tax provision was favorably impacted by approximately $0.03 in the quarter from the new accounting standard that requires companies to release certain provisions for contingent tax liabilities in the quarter in which they failed to materialize.

As we previously noted, these kinds of adjustments whether favorable or unfavorable can emerge from time-to-time. Consolidated income from continuing operations for the third quarter was $33.1 million or $0.25 per share, compared to $35.7 million or $0.28 per share in the same quarter a year ago. And for completing this, we should note that our consolidated net income including the discontinued operations was $0.02 per year this year compared to a loss of $0.06 per share a year ago.

I'd now like to turn your attention to the balance sheet for a few moments. Accounts receivable at $491 million are 10% higher than for the same period last year but only 3% higher in constant currency terms. On an overall basis, DSOs increased by one day to 73 this year compared to 72 in the third quarter a year ago.

Inventory at quarter end was $359 million, up 14% compared to the same period last year were up about 6% in constant currency. Inventory remains well controlled and the increase is primarily to support the new stores added since last year.

Now let me address our debt levels. With the binding offer on Rossignol, we now have a better idea of what our near term capital and financing needs will be and we are in a better position to realign our debt. Here are a few details.

We finished the third quarter with $1.70 billion in debt. Broadly speaking we need $100 million to build Rossignol's working capital assuming we close the transaction on October 31. This is equal to the roughly $100 million in net cash proceeds that we expect from the sale.

So assuming that we close on October 31, our debt would remain comparable to the Q3 balance at approximately $1.70 billion. Although debt will not be reduced in absolute terms, our leverage is expected to improve dramatically to a number below four times as EBITDA approximates $280 million with the elimination of Rossignol's losses. Thereafter, we would expect to resume the company's historical pattern of generating free cash flow from our core businesses, which we would use to reduce debt.

We've taken three recent actions to help support our liquidity requirements. First, we moved to €50 million term loan, out from under the Rossignol structure, so that it is directly under another Quiksilver entity. By doing this we extended the loans maturity through 2010, and removed the performance covenant.

Second, we extended the maturity date of a €70 million line from September 14 until October 31, to coincide with the expected closing date of the proposed Rossignol sale. And third, last week we entered into a three year €100 million financing arrangement through Quiksilver Europe, which is intended to fund the Rossignol working capital build in Q4.

So, to sum up the situation we believe that we have adequate borrowings available to finance the projected working capital requirements of the business, and we plan to use some of this flexibility to realign our current debt structure in the coming months.

As a heads up, we expect to record a significant non-cash loss upon the final sale of Rossignol. This result's because the sale price is below the projected carrying value of the working capital. Our current estimate for the size of this non-cash charge is in a range between $150 million and $200 million.

Now let us turn our attention to the outlook for the remainder of the fiscal year. As you know, the current environment is challenging and our visibility remains somewhat limited. But with that said, we continue to believe, we've taken a realistic view of our business and are focused on delivering the results that we laid out on the last conference call.

So, our outlook for continuing operations is unchanged. For the full fiscal year, we continue to believe, we can achieve sales growth of approximately 10% to $2.25 billion and earnings per share of slightly below $0.90. This includes the $0.03 favorable tax adjustment in the third quarter, partially offset by expected declines in foreign currency translation rates.

And with that I'll turn the call back to Bob for closing comments.

Bob McKnight

Thanks, Joe. As we've mentioned, the business climate in the third quarter was marginally worse than we expected, and we see no signs yet that the trends are improving. Our customers continue to place orders more conservatively to compensate for softness in the retail channel. As we compare our results to our peers, we believe that this buying pattern reflects the broader market. But our brands remain strong and we believe retailers will rely on us as a market leader in these challenging times.

So, as we approach our company's 40 year anniversary, our Quiksilver Roxy and DC brands comprise one of the strongest portfolios in the industry and we continue to believe there are tremendous opportunities for growth and profitability ahead of us.

Operator that concludes our prepared comments today, we are now ready for questions and answers.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And the first question comes from Jeff Klinefelter with Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

Yes, thank you. Just couple of questions for you guys. One is on the brand detail. Can you share any more with us on brand dynamics in your three major global regions, Bob, and both, how it's been trending here through this year, and then more importantly how you are expecting it to track through the next couple of fiscal quarters?

Marty Samuels

Jeff, its Martin and I'll address the trends with the brands in the Americas. Obviously as we've been saying all through the year, DC is the strongest of the three brands. Their footwear business remains very, very strong. They are gaining a lot of traction in market share with their apparel accessory business, and they've had some really good initiatives with their Boys business, even though overall the Kids market has been one of the tougher markets, they're gaining market share there.

I would say that Quiksilver has had a decent year. The Men's business and apparel is clearly not as difficult as the Women's business. I think that's been stated throughout the marketplace. And for Roxy, I think in the Americas, Roxy's had some challenges this year in our largest customer for Roxy, Pacific Sunwear has been going through lot of strategic changes but I think have impacted most of their suppliers on the female side of the business. But we're very encouraged about the Roxy product lines going forward, and I think that for 2009, we're pretty optimistic about Roxy in the US.

Jeff Klinefelter - Piper Jaffray

Martin, what about distribution in the US? Sounds like, would you characterize DC at this point still gaining distribution points, as well as space within distribution and then Quiksilver Roxy more as maintaining or even calling distribution or how would you describe that?

Bob McKnight

Well, I think, DC is definitely gaining more doors, and in particular, I would say in the apparel piece of the business in the department stores. That was an area where we really didn't have much presence and that's a good opportunity to build our business as Macy's is quite strong with DC.

I think for Quiksilver and Roxy, there maybe some slight, new doors, some lost doors but basically the same distribution footprint. The other new element for us in the America's is our direct business, our online business, which is now up and running for all three brands, and has been exceeding our expectations.

Joe Scirocco

Jeff, its Joe. Hi.

Jeff Klinefelter - Piper Jaffray

Hi, Joe.

Joe Scirocco

So, sort of in Europe and elsewhere in the world, we focus different markets, timing can affect brand sales on a quarterly basis, but just thinking about it on a year-to-date basis, I think, Quiksilver and Roxy are sort of up low single digits I would say on a constant currency basis. And the real story of growth, particularly in Europe on a brand basis is DC. I mean our business is just really gaining the kind of traction that we saw in the earlier days here, and its growth rates are really very strong. So, we are very encouraged by that.

Jeff Klinefelter - Piper Jaffray

Okay. Joe, going forward, what are your assumptions, one, for the exchange rate, within the sort of Q4 guidance, and what are just your general assumptions going forward? And then, what would be your growth rate expectations for the brands globally over the next several quarters?

Joe Scirocco

Those are a couple of tough questions in the context of the current environment, but, to answer the first one, I think our average rate in Q3 on the euro was about 155 or 156, something like that, and on the Australian dollar, about 85. So, we already see today, the euro was up like 143, 144, so obviously there is a change going on there. It's a little bit tough to know where that's going to go, but clearly we would anticipate some adverse impact on Q4, which we think will partially give back some of that $0.03 improvement that we saw in taxes. And that's why we're keeping our outlook for the full year unchanged recognizing that that's a little bit of a market factor that's beyond our control.

Thinking longer term about the brands, again as Bob said, we feel really good about the direction they have in the market share, maintaining the market share, and most importantly the product lines we think look really good, but it's a little bit tough to tell as we are selling spring now. We have ASR coming up. So, I don't think we really have a great feel for with the next few quarters might look like, but clearly, we'll be watching. We come out with an outlook for next year after our fiscal year end in October.

Jeff Klinefelter - Piper Jaffray

Okay. Just one last clarification, you commented on IMU and your margin expansion potential there, but Joe, I think you also mentioned that you're facing the obvious inflationary pressures and cost increases. When you put those two together and again look out over a few quarters and generally speaking, where do we stand on opportunities to expand product margins through the skew rationalization and vendor reduction or supplier reduction versus this inflationary environment we're in.

Joe Scirocco

Well, the initiatives continue, and we're pushing full steam ahead. I think for the balance of this year the buys are made, so that's not really a question. We've achieved the sourcing margin improvement that we anticipate. The question will be; what kind of prices can be sustained at retail and in the marketplace, and that's the thing that has the potential to give some of that back. Our outlook for the fourth quarter will include a very slight gross margin expansion, and that's principally because of market conditions upon sale.

We've also begun to place buys for spring, and we seem to continue to make progress and to hold price in terms of key items, and select price that has been placed thus far, but clearly the clouds are on the horizon for inflation, and as we go and look for the fall buy, its going to be more challenging in the context of what's going in China and elsewhere in the world. I don't know if Marty wants to add…

Marty Samuels

I think that like Joe said, we've made our buys for probably most of the first half of fiscal '09, and when our merchants and sourcing people went overseas, they were met with the attempt to raise prices, but we were very aggressive in our negotiations, and we made some accommodation in terms of changes in trend, things that won't effect the cosmetics or the garment.

As we work on the back half of the year, I think one of our key initiative is to look for sourcing alternatives to China, which is well documented, what's happening in that marketplace, so we're looking at other parts of Asia and we're looking at Mexico and Central America and our European teams are looking at Eastern Europe and Southern Europe and Northern Africa and we are just going to continue to improve our factory base and we are going to continue on the ski reduction and the vendor consolidation. So it's definitely a battle.

Jeffrey Klinefelter – Piper Jaffray

All right. Thank you very much.

Operator

Next question comes from Anna Andreeva of JPMorgan.

Anna Andreeva - JPMorgan

Hi great thanks so much. My first question just given your more cautious comments on Europe and I understand visibility is so low now-a-days, but what kind of growth do you think we should assume out of Europe organically in the fourth quarter and maybe also over the next couple of quarters? And could you also give us a little bit more color on the current environment? Can you maybe steer the comp trends in your own stores just how you saw that stake out through the summer and now trending for the fall that will be really helpful.

Joe Scirocco

Sure Anna, hi.

Anna Andreeva - JPMorgan

Hi.

Joe Scirocco

Well, let me try to answer you this way, because we are not in a position right now to forecast next year and as we said we will give that outlook at the end of the fiscal year. But our overall assumption on the current year revenue $2.25 billion is just kind of a target. But that implies a low single-digit overall growth rate in the fourth quarter and I think its fair to say that Europe would be leading that just by virtue of currency and its trajectory.

Having said that with respect to our own retail stores, which I think that investors should regard them more as a barometer of what's happening in our marketplace and not for to fine a point on comp store sales in our own retail stores, because we are vertical and we are operating within the context of a wholesale business in each of these markets.

So the conditions that drive comp store sales may not be the same for us as they are for other companies, in addition to which we have a significant number of outlook stores which are in place for other strategic reasons besides driving retail growth and so they play a dual role.

So having said that I think if you were to make a broad statement about our performance last quarter, I would say we had sort of low to mid-single digit comp declines as a broad comment around the globe and it differs market-by-market. Some of the markets that we've talked about in particular now with Spain as an example of one, Southern Europe has been hit harder than the others. I'll let Marty speak to the US about that business here.

Marty Samuels

Yeah I think that through the summer, through third quarter our performance comps through our performance was pretty much as Joe described. Trying not to read too much into it August was the best month we've had all year in our retail stores. And we comped in both our full price and our outlet and we saw the comps of the public companies today and we would be in the up a quartile performance for the quarter. So we're a bit encouraged. We got three days in September; same pattern but there is a long way to go.

Anna Andreeva - JPMorgan

Okay, that's great, that's good to know and this is my final question, on SG&A you guys had talked about the $20 million in expense or cost reduction for the year. Did you see any of that benefit in the third quarter and are you still having plans to achieve that for the year?

Joe Scirocco

The answer is yes, and I think that we've gone quite a bit further than we initially laid out back in January when we identified that target number. But also you have to remember the business has changed quite a bit. And we no longer have Cleveland Golf in the mix we have been preparing for the sale of Rossignol and so consequently we've achieved what we set out to do and have gone quite a bit further in terms of the corporate overhead and the corporate infrastructure because again we're preparing to operate a business that returns essentially to our core brands and key markets.

One of the reasons why these numbers might not be so visible in Q3 is because a lot of the expense for headcount and certain other expenses have to be a portion between continuing operations and discontinued operations. But I think the message we would like to make sure people understand is that that we're really focused on running this as a lean operation and we are just looking at everything to enable us to do that continually. And it's a big emphasis as we go into the budget cycle for next year.

Anna Andreeva - JPMorgan

Okay. That's great, very helpful. I appreciate it. Good luck guys.

Joe Scirocco

Thank you.

Operator

Next question comes from Jeff Van Sinderen with B. Riley & Company.

Jeff Van Sinderen - B. Riley & Company

Good afternoon. Well, in to the US segment with packs on and assuming its getting a little bit more promotional. How is your visibility into business or orders with them for the rest of the year? Any color on that you can give us?

Marty Samuels

We really don't like to talk about a specific customer business. There planning is at great degree. But I think that we don't see any particular change in our pattern of the business with either one of those companies.

Jeff Van Sinderen - B. Riley & Company

Okay. Good to hear and then as far as, I know you talked little bit about Europe, but just wondering which regions there, you feel are the most stable or the most encouraging, and then which regions you think in Europe might be subject to a little bit more slowdown.

Joe Scirocco

One, our three big markets there, France, Spain and the UK are clearly challenged right now and for reasons that we all read about in the papers everyday. I think our major initiatives in Europe called for continual sort of healthy growth in those markets and that's really challenging, but the important story about new opportunities in Europe comes from Eastern Europe and new territories, and we continue to make head growths in countries like Italy, and as we move away from the beach, we look at a market like Germany, as really an untapped potential for us.

Jeff Van Sinderen - B. Riley & Company

Okay. And so as we think about the rest of this year, I guess visibility into next year is tough, but is there anything about the rest of this year, should we be thinking that as far as the growth in Europe that's really driven mostly by DC or partially by getting into some new regions.

Joe Scirocco

We've already established our position in the new regions, and so our growth there is something that we will be looking for to leverage our expenses. I think that DC will continue to clearly be the big driver of growth in Europe.

Jeff Van Sinderen - B. Riley & Company

Okay. Good to hear. Thanks a lot and good luck this quarter.

Joe Scirocco

Thank you.

Operator

Moving on to [Bill Reuter] with Banc of America.

Bill Reuter - Banc of America

Good afternoon guys. You talked about that there may have been some early deliveries in the European region in the Quiksilver business. Can you quantify what this might have meant in terms of shift from the fourth quarter into the third?

Joe Scirocco

Yeah, we're, on the order of let's call it $10 million or less in shipping volume.

Bill Reuter - Banc of America

Okay that's useful. In terms of the European gross margin sales pretty strong, can you comment on what the impact of currency, what would have been there and what gross margins would have been on a year-over-year basis, were it not for currency?

Joe Scirocco

Yeah. That's an interesting question and we should clarify some thing. So the way it works in Europe is, approximately 50% to 70% of their inventory purchases are made in US dollars, and they will hedge those dollars on a regular forward basis.

So, basically the currency rate at which Europe was buying inventory has pretty much been fixed for the current year. In fact, it's a number that we lock in on a rolling basis, let's say up to 18 months in advance on average.

So our gross margin is not so directly affected by movements in the currency. There are some exceptions to that because of business we do and say South Africa in the Rand or with the British pound. But apart from that most of our gross margin is unaffected by current movements and currency rate.

The currency effect that investors have to understand for us is really the translation risks associated with bringing European profits and Australian dollars back into US dollars for reporting purposes. So, if you want to think about it this way, if our European business could be expected to earn somewhere in the range of 100 million or so euros in operating profit. A movement of the nickel, lets call it 0.05 on the currency would represent about EUR5 million, plus or minus to our bottom-line. So that's the kind of risk that we face or opportunity that we face in terms of translation, and that represents an unhedged exposure because its not supported by an underlying cash flow because we retain European profits in Europe. So, it basically means that we take the risk on that rather than introducing speculative currency contract into the equation. We accept the risk as part of our budgeting process.

Bill Reuter - Banc of America

Great. So what you're saying is that the gross margin impact is just on the translation as opposed to on the actual fact that you're sourcing in different currency than you're receiving payment. Is that what you mean?

Joe Scirocco

Yeah, that's correct. What we are saying is the reason why gross margin went up this quarter attributed to Europe is because Europe's business constituted a higher percentage of our total business, and Europe generates a higher gross margin than the rest of our business.

Bill Reuter - Banc of America

Okay. In terms of working capital, it looks like it was the use of cash in this quarter. Do you guys have a sense whether in the fourth quarter it will be a source of cash or use once [again]?

Joe Scirocco

Again, we said that for the fourth quarter, the big picture on this is that, we expect that the majority is not all of the working capital bills will be in Rossignol. Let's call it a $100 million. Assuming that we close on October 31, we will, in effect offset that. So apart from that, we're not expecting a significant movement in working capital.

Bill Reuter - Banc of America

Okay. I should be more clear, I mean on the core business, so on the core business we shouldn't see much of a [source]?

Joe Scirocco

I think that's right.

Bill Reuter - Banc of America

Okay. And then lastly, you can have this kind of a housekeeping question. Do you guys have what D&A was in the quarter?

Joe Scirocco

Yeah, we have it somewhere. D&A in the quarter was approximately $15 million.

Bill Reuter - Banc of America

Great, thanks for taking questions guys.

Operator

Our next question comes from Mitch Kummetz with Robert Baird.

Mitch Kummetz - Robert W. Baird & Co., Inc.

Yeah, thanks. Let me start by asking about gross margin. Obviously, you saw some benefit in the quarter based on your sourcing initiatives. I guess you would expect a kind of a counter effect of higher cost and pricing pressure, but could you remind us where are you in the process of implementing those sourcing initiative? What are some of the major steps you've taken so far? What inning are you in at this point in that strategy? And what are the major changes that you still expect to take place there?

Joe Scirocco

I'm not sure how long the game is, so I'm not sure that the inning is really a good measure for us. I think that when we initially laid this out, we laid it out really in the context of few ways of activity and first being an initiative that has been started by the regions really to take local actions in term of their product development cycle and the placement of their buys to improve our margins. The secondary direction was to bring on board an individual to run Quiksilver Asia sourcing with a view towards improving that operation and making it more productive for the company overall and begin to try to leverage certain global buys. I think that second stage of the process is a little bit further off, but we have achieved have a number of reductions in the vendor count, number of factories been used SKUs and that kind of thing.

We do a limited amount of global product here that's something that we will be working towards in the future with product development. But again, our priorities have been to target the local markets and make sure that we are very responsive to customers in each region.

Mitch Kummetz - Robert W. Baird & Co., Inc.

Okay and then second question obviously you guys you know you have come under pressure just from delevering the weaker than expected sales, but also with all the stores that you open. What is kind of the run rate of opening stores now? I think, Joe, you said 94 from Q3 last year. Is that coming down and when might we see less pressure on the SG&A from new stores?

Joe Scirocco

I think it largely depends upon when retail sales pick up. Let me just kind of recap a few numbers for you, so on the current year, we have opened about 20 stores in the US, 20 to 25 in Europe and as just a few less than 5 in Asia-Pacific, and so these were deals that have been put into the works early last year or perhaps even earlier on which we had to fulfill that commitment.

We significantly slowed that down midway through the year and at this point in view of the world economies, we have sort of set the regions unless capital spending is essential or unless you get a really, really good opportunity. And we're not going to be aggressively making investments in retail.

At the same time, since retail is so important to us, particularly in new territories, we have some franchisees and licensees and regional distributors making investments out there on their own, in our brand and in our stores, so if you look at licensed stores around the globe and we've got over 200 of them at quarter end and we see continued expansion in new markets like Latin America, but it's not our capital going into those markets.

So I think in terms of expense leverage, it really depends upon how quickly the economies rebound, because we really do depend upon higher sales productivity. But clearly if we slowdown as we are, a number of new store openings then we shouldn’t have that initial year expense.

We shouldn't have the front loading of 2 to 3 months of store ramps in advance of actually opening the store, which tends to create a real drag and makes it hard to make a profit in the first nine months or so of opening.

Mitch Kummetz - Robert W. Baird & Co., Inc.

Okay. That's helpful and then two other questions. One, I know you quantify the impact on Europe would be early deliveries there. What about on the US with the impact of the (inaudible) delay. I think you said it was a couple of weeks. Could you kind of put a time number to that as well?

Joe Scirocco

Well, the Americas business in the quarter was down about 4% on revenue and so some of that shifted into Q4. I think we could look for about a low to mid single-digit growth in revenue in the Americas in Q4, which would take into account that shipping so its not terribly substantial and importantly we didn't have order cancellations as part of that show.

Mitch Kummetz - Robert W. Baird & Co., Inc.

Okay. Well, that's good to hear. And then lastly just housekeeping, what's embedded in your guidance in terms of interest expense and tax rate for the fourth quarter?

Joe Scirocco

Interest expense should put us on line for a full year of let's call it, round about $48 to $50 million, somewhere around $13 million or so for the fourth quarter. And in taxes, we are reverting back to our earlier outlook for the quarter of somewhere in $32 to $33 range.

Mitch Kummetz - Robert W. Baird & Co., Inc.

Okay, that's great. Thanks and good luck.

Joe Scirocco

Okay.

Operator

Next question comes from David Glick with Buckingham Research.

David Glick - Buckingham Research

Yes, good afternoon. Joe, I was wondering, if you could give us a sense of how we should think about interest expense going forward after the deal is closed. I mean, it's helpful the information you gave on what the pro forma debt level is going to look like, I mean should we think in the $15 million to $16 million a quarter range going forward? Is that a reasonable estimate?

Joe Scirocco

I think, if you were to think about it as $15 million for next year, total of high $50s to $60 million on the year that should be a reasonable estimate, based on the way everything is configured today. And so in the numbers I gave, if we finish the year at $1.70 billion, some odd million dollars of debt, weighted average interest rates kind of in the high-fives, and the assumption that we pay down some of that debt next year. I think if you're in the high $50s to $60 million range, it should be

David Glick - Buckingham Research

Correct.

Joe Scirocco

It's a reasonable assumption.

David Glick - Buckingham Research

That's a good segue into my next question is, the pace of debt pay down, we should expect over the next few years, obviously that's a function of free cash flow, but if you could help us to think about capital expenditures, and the pace of debt pay down over the next couple of years, that would be helpful.

Joe Scirocco

Sure, well, we're not putting an outlook in the market at this point for '09, but I would just say, if you just take the net income assumptions that seem to be out on the street and embedded in consensus, and if you just assume that we do know better for next year, I think it's fair to say that we should be able to generate $75 to $100 million in free cash flow that we would utilize to pay down debt, and that amount would leave us to pretty healthy amount to spend on capital spending.

Now again, we don't have these budgets prepared, but let's just think about it like this. So, depreciation and amortization, which for the current year we're thinking about say, $60 million. That might grow 10% or so, so maybe you go up to the mid to high 60s on DNA.

Stock compensation is another big non-cash charge for us. That's in the area of say, $10 plus million, and then the unknown of course for the future would be working capital movements and CapEx. But even if you assume that working capital build in '09 could be as high as let's say $20 million just depending on how the volume of business goes, you can make your own assumption

But even if they were $20 million and even if we spend $75 million or so on capital, which would be about 20% less than the current year, you can still envision now that our free cash flow would be at least north of 80 and that's just kind of a broad outlook, don't take it as guidance.

But rather just a way of thinking about the fact that we've been executing this strategy in which its all been, its been about continued growth in the core brands but its largely also been about sale of Rossignol, the pay down of debt, the reduction and on the clean-up of the balance sheet in that regard and when we return to the core operation, it should be very healthy in terms of free cash flow.

David Glick - Buckingham Research

That's very helpful. And the last question, corporate overhead, I mean obviously you are making some progress there. Should we think about corporate overhead being, are you guys making some reasonable progress in '09 relative to '08?

Joe Scirocco

I would kind of prefer to wait on the comment.

David Glick - Buckingham Research

Okay.

Joe Scirocco

David, until we put out some more complete outlook for '09.

David Glick - Buckingham Research

Very good, thanks a lot and good luck.

Joe Scirocco

Sure.

Operator

And the next question comes from Jim Duffy of Thomas Weisel Partners.

Jim Duffy - Thomas Weisel Partners

Thanks, couple of questions. Could you guys offer some commentary on what you see as inventory levels in the channel, particularly with the independence and some of the European players that we don't have as much visibility as we might would on the publicly traded companies?

Joe Scirocco

Judging by their buying patters, Jim, we have to believe that they are doing okay. They are pretty conservative with the order stuff.

Marty Samuels

I think I would imagine all around the world, I know certainly in our region the Americas that people are pre-booking very conservatively. They've trimmed their plans and if they do a little bit better, then there are looking to reorder out of the marketplace, but I think, most people are running their inventories at a very prudent manner. And then as a result, our brand inventories at retail are very clean. We've come through summer back-to-school very clean and people are looking to take their holiday and move on. And people are being very timely and liquidating underperforming classifications or items. I think there is a lot of good realism in the market right now.

Jim Duffy - Thomas Weisel Partners

Okay. Good. And then from the standpoint of your own retail stores, are you guys do anything different from a merchandising standpoint to be more competitive in the current environment?

Marty Samuels

Yeah. In the Americas region, we have a new President of our Retail division who joined this August 6 and he is very busy now, meeting all the team and looking at the entire portfolio. And the reason we brought this guy and as because he has a strong history of retail productivity generation on the operating side. And I think that within a couple of months, he is going to have some ideas and adjustments he is going to want to make, but as Joe alluded to earlier, because we're primarily a wholesale company and because we are a full price brands, we are quite limited in the amount of promotion we do in our full price stores and we hope to keep it that way.

Jim Duffy - Thomas Weisel Partners

Okay. And then, Joe, question for you on the working capital. With regards to the growth of your own retail, the percent of mix, what does that do with the cash cycle, obviously it helps you on the DSO. So what's the net effect with inventory?

Joe Scirocco

I think, generally speaking, it would probably increase inventory DSOs by a factor. But we haven't really had a material change, certainly within the year, and with 94 stores added include a number of concessions. I am just trying of think of the amount of inventory, how could you frame it? It's difficult for me to kind of frame the amount that would be attributed directly to them Jim --

Jim Duffy - Thomas Weisel Partners

Okay, taking it a step further may be, where do you see the most opportunity on the working capital? Is it on the inventory?

Joe Scirocco

Our working capital, well, lets talk about the components of it. I mean, on the receivables side, we’ve been very well managed. I think some of the challenges have been that as we go into new markets, particularly in Europe which have traditionally longer payment period. That’s been something that's led to some pressure. Additionally, it won’t surprise you to hear that customers today are being as prudent with their cash as they are with their inventory buys, so we have some DSOs lengthening there.

I think in terms of improvement, and we were always trying to get better. But realistically, we’ve been managing pretty well in terms of the inventory. So we continue to look at it but I wouldn’t expect any major changes there. We think about working capital build up as really being proportionate to sales, so as we forecast next year or whatever, my best advice would be to model it consistent with sales unless we tell you that we've got a particular issue one way or the other.

Jim Duffy - Thomas Weisel Partners

Very good. Thanks and good luck.

Operator

Moving onto to Todd Slater of Lazard Capital

Todd Slater - Lazard Capital

Thanks. Hi guys. I just have a question on the order book. I appreciate your comment on the positive response that you said you have received. I am wondering if you can give us a little more color on how the order book is shaping up relative to your expectation.

Marty Samuels

We are just launching spring basically today at the ASR show. The show started today, so we have done a little bit of pre-aligning with some key customers in advance, but it's going to 6 to 8 weeks before we really have our order book in.

Based on response to the offering, people seem pretty excited, and we seem to have a very strong position relative to competition, but in the current environment that retailers are living in, it's very hard at this time to speculate what their approach is going to be. I believe we are clearly going to gain market share with our spring offerings in all three brands, but that may not lead to growth in the bookings.

Todd Slater - Lazard Capital

Okay. And then, how would you describe your current order book for, lets say, the next quarter relative to your current inventory position?

Marty Samuels

It's a match.

Joe Scirocco

Yes, I mean it is. We have adjusted our buys over the course of year to correspond with what we expect in orders, and everything that's in the order book is baked in to the forecast. So as I said, the implied outlook for the quarter is kind of a low single-digit growth in top line.

Todd Slater - Lazard Capital

Okay. Thanks. That’s helpful. And lastly, on the comment about been in the upper quartile on cost in August, did you mean that might be a positive comp or just a little less negative and some of it---?

Bob McKnight

I said we had a positive comps in August.

Todd Slater - Lazard Capital

Okay, great. And they're continuing in the first few days of September right?

Bob McKnight

Yeah.

Todd Slater - Lazard Capital

Yeah. Okay, great. Just wanted to make sure, I heard that right. Thank you very much.

Operator

And this question comes from Julie Bryan with Jennifer Black & Associates.

Julie Bryan - Jennifer Black & Associates

Hi, good afternoon you all. Just a couple of quick questions. Going back to the retail store openings, did you say whether there are some more stores to be opened in the fourth quarter? And then, when we get to year-end, given the kind of change in the retail versus wholesale, is there a normalized operating margin that you all are looking at as you go forward.

Joe Scirocco

Okay. I'm not sure that we have very many stores opening in the remainder of the year. I think, we've pretty much done what we are going to do for the current year, but there might be a few more that are in the line--

Bob McKnight

I think there is three or four less in order, so it might be, there is 15 around the world.

Joe Scirocco

And in terms of a normalized operating margin going forward, I'm not quite sure how to answer that one. I mean, we've put out a longer term objective of let's say 13% as an objective for operating margin, and we've been in the range of about 10, and so there is obviously a long way to go.

And in the current context, and without having an outlook published for next year, I think it's just pretty hard to answer that question. But I think it's reasonable to retain that as a longer term objective on the assumption that other companies that establish that benchmark could continue to do so themselves.

We got that by reference to a number of our peers and sort of where should we be performing, given the size and strength of the company. So..

Julie Bryan - Jennifer Black & Associates

Okay, great. Thank you.

Joe Scirocco

Okay. I think we've -- Operator, we have time to take one more question if that's okay.

Operator

Okay. That question comes from Jeff Mintz with Wedbush Investment.

Jeff Mintz - Wedbush Investment

Thanks very much. Just one quick question, can you talk a little bit about of what happened in Asia and what you're kind of seeing there? First of all, what was the constant currently change in revenue this year, year-over-year and then what you're seeing in the market there?

Joe Scirocco

In constant currency, we had a decline in revenue in Asia-Pacific and most of that was driven out of Japan. We've had a significant transition going on there over a period of time, and essentially what happened is, beginning in, I think let's go back to '05, '06 timeframe. We had substantially over supplied that market in the wholesale channel and it has really taken us a couple of the years to clean that up and reposition that brands and the distribution in those markets.

So the decline that we saw, which was pretty steep in Japan, which really drove Asia-Pacific decline, was attributed to us during substantially less business in the wholesale channel, as we migrate into retail, which is something that will take place in the months and years ahead. That was really what drove the decline.

The balance of Asia-Pacific was actually the larger part, which is Australia. The good news is, there's been now dramatic decline, such as we've seen elsewhere in world markets but the bad news is, it's been a tough market now for several years. And so the business there continues to wrestle with consumer weakness and weakness in spending.

Jeff Mintz - Wedbush Investment

Great. Thanks very much and good luck.

Bruce Thomas

Okay operator. Well, thank you very much for everyone's participation in today's call. We look forward to updating you all on our next call a quarter from now.

Operator

Thank you. And the replay of this conference will be available starting today at 6.30 PM Central Time, and will run through September 11th. The dial-in number for the replay will be 888-203-1112. Again, that's 888-203-1112 or 719-457-0820, and the confirmation code for the call will be 4752829. Again the confirmation code to enter for the replay will be 4752829. And this concludes today's conference. Thank you for your participation.

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