Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2012

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-14229

 

 

QUIKSILVER, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		33-0199426
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

15202 Graham Street

Huntington Beach, California

92649

(Address of principal executive offices)

(Zip Code)

(714) 889-2200

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of Registrant’s Common Stock,

par value $0.01 per share, at

September 3, 2012 was 165,926,795

 

 

 

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QUIKSILVER, INC.

FORM 10-Q

INDEX

 

		Page No.
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Quiksilver, Inc. Condensed Consolidated Statements of Operations Three Months Ended July  31, 2012 and 2011			2
Quiksilver, Inc. Condensed Consolidated Statements of Comprehensive Income (Loss) Three Months Ended July 31, 2012 and 2011			2
Quiksilver, Inc. Condensed Consolidated Statements of Operations Nine Months Ended July  31, 2012 and 2011			3
Quiksilver, Inc. Condensed Consolidated Statements of Comprehensive Income (Loss) Nine Months Ended July 31, 2012 and 2011			3
Quiksilver, Inc. Condensed Consolidated Balance Sheets July 31, 2012 and October 31, 2011			4
Quiksilver, Inc. Condensed Consolidated Statements of Cash Flows Nine Months Ended July  31, 2012 and 2011			5
Quiksilver, Inc. Notes to Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations:
Results of Operations			28
Three Months Ended July 31, 2012 Compared to Three Months Ended July 31, 2011			29
Nine Months Ended July 31, 2012 Compared to Nine Months Ended July 31, 2011			30
Financial Position, Capital Resources and Liquidity			32
Critical Accounting Policies			33
New Accounting Pronouncements			35
Forward-Looking Statements			35
Item 3. Quantitative and Qualitative Disclosures About Market Risk			36
Item 4. Controls and Procedures			37
Part II – OTHER INFORMATION
Item 6. Exhibits			38
SIGNATURES			40

 

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

QUIKSILVER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Three months ended July 31,
In thousands, except per share amounts		2012				2011
Revenues, net		$	512,439			$	503,317
Cost of goods sold			258,951				248,199
Gross profit			253,488				255,118
Selling, general and administrative expense			225,788				221,172
Asset impairments			141				—
Operating income			27,559				33,946
Interest expense			14,834				15,663
Foreign currency gain			(2,242	)			(1,456	)
Income before provision for income taxes			14,967				19,739
Provision for income taxes			2,508				8,996
Net income			12,459				10,743
Net loss (income) attributable to non-controlling interest			151				(306	)
Net income attributable to Quiksilver, Inc.		$	12,610			$	10,437
Net income per share attributable to Quiksilver, Inc.		$	0.08			$	0.06
Net income per share attributable to Quiksilver, Inc., assuming dilution		$	0.07			$	0.06
Weighted average common shares outstanding			164,518				162,822
Weighted average common shares outstanding, assuming dilution			173,899				183,488

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

		Three months ended July 31,
In thousands		2012				2011
Net income		$	12,459			$	10,743
Other comprehensive (loss) income:
Foreign currency translation adjustment			(34,141	)			(6,603	)
Net unrealized gain on derivative instruments, net of tax of $3,080 (2012) and $3,283 (2011)			6,021				6,483
Comprehensive (loss) income			(15,661	)			10,623
Comprehensive loss (income) attributable to non-controlling interest			151				(306	)
Comprehensive (loss) income attributable to Quiksilver, Inc.		$	(15,510	)		$	10,317

See notes to condensed consolidated financial statements.

 

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QUIKSILVER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		Nine months ended July 31,
In thousands, except per share amounts		2012				2011
Revenues, net		$	1,454,273			$	1,407,860
Cost of goods sold			730,686				667,103
Gross profit			723,587				740,757
Selling, general and administrative expense			680,213				648,356
Asset impairments			556				74,610
Operating income			42,818				17,791
Interest expense			45,464				59,727
Foreign currency gain			(4,701	)			(5,886	)
Income (loss) before provision for income taxes			2,055				(36,050	)
Provision for income taxes			14,913				49,937
Net loss			(12,858	)			(85,987	)
Net income attributable to non-controlling interest			(2,257	)			(3,169	)
Net loss attributable to Quiksilver, Inc.		$	(15,115	)		$	(89,156	)
Net loss per share attributable to Quiksilver, Inc.		$	(0.09	)		$	(0.55	)
Net loss per share attributable to Quiksilver, Inc., assuming dilution		$	(0.09	)		$	(0.55	)
Weighted average common shares outstanding			163,930				162,198
Weighted average common shares outstanding, assuming dilution			163,930				162,198

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

		Nine months ended July 31,
In thousands		2012				2011
Net loss		$	(12,858	)		$	(85,987	)
Other comprehensive (loss) income:
Foreign currency translation adjustment			(66,192	)			21,092
Net unrealized gain (loss) on derivative instruments, net of tax of $9,388 (2012) and $(7,616) (2011)			17,041				(17,456	)
Comprehensive loss			(62,009	)			(82,351	)
Comprehensive income attributable to non-controlling interest			(2,257	)			(3,169	)
Comprehensive loss attributable to Quiksilver, Inc.		$	(64,266	)		$	(85,520	)

See notes to condensed consolidated financial statements.

 

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QUIKSILVER, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

In thousands, except share amounts		July 31, 2012				October 31, 2011
ASSETS
Current assets:
Cash and cash equivalents		$	81,903			$	109,753
Trade accounts receivable, less allowances of $43,468 (2012) and $48,670 (2011)			398,522				397,089
Other receivables			31,444				23,190
Income taxes receivable			—				4,265
Inventories			391,052				347,757
Deferred income taxes			14,691				32,808
Prepaid expenses and other current assets			32,678				25,429
Total current assets			950,290				940,291
Fixed assets, less accumulated depreciation and amortization of $261,342 (2012) and $255,267 (2011)			233,842				238,107
Intangible assets, net			136,745				138,143
Goodwill			258,815				268,589
Other assets			48,267				55,814
Deferred income taxes			99,125				123,279
Total assets		$	1,727,084			$	1,764,223
LIABILITIES AND EQUITY
Current liabilities:
Lines of credit		$	15,032			$	18,335
Accounts payable			233,523				203,023
Accrued liabilities			111,140				132,944
Current portion of long-term debt			44,640				4,628
Income taxes payable			3,652				—
Total current liabilities			407,987				358,930
Long-term debt, net of current portion			723,772				724,723
Other long-term liabilities			32,249				57,948
Total liabilities			1,164,008				1,141,601
Commitments and contingencies – Note 9
Equity:
Preferred stock, $.01 par value, authorized shares – 5,000,000; issued and outstanding shares – none			—				—
Common stock, $.01 par value, authorized shares – 285,000,000; issued shares – 168,664,496 (2012) and 168,053,744 (2011)			1,687				1,681
Additional paid-in capital			539,124				531,633
Treasury stock, 2,885,200 shares			(6,778	)			(6,778	)
Accumulated deficit			(47,680	)			(32,565	)
Accumulated other comprehensive income			66,976				116,127
Total Quiksilver, Inc. stockholders’ equity			553,329				610,098
Non-controlling interest			9,747				12,524
Total equity			563,076				622,622
Total liabilities and equity		$	1,727,084			$	1,764,223

See notes to condensed consolidated financial statements.

 

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QUIKSILVER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Nine months ended July 31,
In thousands		2012				2011
Cash flows from operating activities:
Net loss		$	(12,858	)		$	(85,987	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization			39,437				40,154
Stock-based compensation			17,272				9,916
Provision for doubtful accounts			1,601				8,612
Loss (gain) on disposal of fixed assets			178				(2,657	)
Foreign currency (gain) loss			(2,472	)			93
Asset impairments			556				74,610
Non-cash interest expense			2,814				18,067
Equity in earnings			(19	)			(630	)
Deferred income taxes			9,349				45,915
Changes in operating assets and liabilities, net of the effects from business acquisitions:
Trade accounts receivable			(25,705	)			(19,085	)
Other receivables			11,043				20,453
Inventories			(55,684	)			(83,339	)
Prepaid expenses and other current assets			(11,068	)			(10,001	)
Other assets			885				(5,488	)
Accounts payable			33,845				55,676
Accrued liabilities and other long-term liabilities			(17,099	)			(1,956	)
Income taxes payable			(8,956	)			(17,180	)
Net cash (used in) provided by operating activities			(16,881	)			47,173
Cash flows from investing activities:
Capital expenditures			(47,177	)			(46,688	)
Business acquisitions, net of cash acquired			(9,117	)			(5,578	)
Net cash used in investing activities			(56,294	)			(52,266	)
Cash flows from financing activities:
Borrowings on lines of credit			11,377				14,807
Payments on lines of credit			(12,326	)			(29,172	)
Borrowings on long-term debt			127,034				292,467
Payments on long-term debt			(57,513	)			(260,818	)
Payments of debt issuance costs			—				(6,308	)
Stock option exercises and employee stock purchases			1,335				4,116
Transactions with non-controlling interest owners			(11,000	)			—
Net cash provided by financing activities			58,907				15,092
Effect of exchange rate changes on cash			(13,582	)			(4,382	)
Net (decrease) increase in cash and cash equivalents			(27,850	)			5,617
Cash and cash equivalents, beginning of period			109,753				120,593
Cash and cash equivalents, end of period		$	81,903			$	126,210
Supplementary cash flow information:
Cash paid during the period for:
Interest		$	38,836			$	32,563
Income taxes		$	13,100			$	16,784

See notes to condensed consolidated financial statements.

 

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QUIKSILVER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statement presentation.

Quiksilver, Inc. and its subsidiaries (the “Company”), in its opinion, has included all adjustments, consisting only of normal and recurring adjustments, necessary for a fair presentation of the results of operations for the three and nine months ended July 31, 2012 and 2011. The condensed consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements and notes for the year ended October 31, 2011 included in the Company’s Annual Report on Form 10-K. Interim results are not necessarily indicative of results for the full year due to seasonal and other factors.

 

2.

New Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-05, “Presentation of Comprehensive Income.” ASU 2011-05 requires the components of net income and other comprehensive income to be either presented in one continuous statement, referred to as the statement of comprehensive income, or in two separate, but consecutive statements. An entity is also required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. This new guidance is effective for the Company beginning November 1, 2012 and requires retrospective application. As this guidance only amends the presentation of the components of comprehensive income, the adoption will not have an impact on the Company’s consolidated financial position or results of operations.

In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment.” ASU 2011-08 allows entities testing goodwill for impairment the option of performing a qualitative assessment to determine the likelihood of goodwill impairment and whether it is necessary to perform the two-step impairment test currently required. The updated guidance is effective for the Company on November 1, 2012, however early adoption is permitted. Based on the Company’s evaluation of this ASU, the adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

 

3.

Earnings per Share and Stock-Based Compensation

The Company reports basic and diluted earnings per share (“EPS”). Basic EPS is based on the weighted average number of shares outstanding during the period, while diluted EPS additionally includes the dilutive effect of the Company’s outstanding stock options, warrants and shares of restricted stock computed using the treasury stock method.

 

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QUIKSILVER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The table below sets forth the reconciliation of the denominator of each net income (loss) per share calculation:

 

		Three months ended July 31,								Nine months ended July 31,
In thousands		2012				2011				2012				2011
Shares used in computing basic net income (loss) per share			164,518				162,822				163,930				162,198
Dilutive effect of stock options and restricted stock(1)			1,918				5,044				—				—
Dilutive effect of stock warrants(1)			7,463				15,622				—				—
Shares used in computing diluted net income (loss) per share			173,899				183,488				163,930				162,198

⁽¹⁾ For the three months ended July 31, 2012 and 2011, additional stock options outstanding of 11,958,000 and 10,493,000, respectively, and additional warrant shares outstanding of 18,191,000 and 10,032,000, respectively, were excluded from the calculation of diluted EPS, as their effect would have been anti-dilutive based on the application of the treasury stock method. For the nine months ended July 31, 2012 and 2011, the shares used in computing diluted net loss per share do not include 3,345,000 and 5,185,000, respectively, of dilutive stock options and shares of restricted stock, nor 11,826,000 and 15,305,000, respectively, of dilutive warrant shares as the effect is anti-dilutive given the Company’s loss. For the nine months ended July 31, 2012 and 2011, additional stock options outstanding of 10,995,000 and 10,679,000, respectively, and additional warrant shares outstanding of 13,828,000 and 10,349,000, respectively, were excluded from the calculation of diluted EPS, as their effect would have been anti-dilutive based on the application of the treasury stock method.

The Company accounts for stock-based compensation under the fair value recognition provisions of ASC 718 “Stock Compensation.” Stock-based compensation expense is included as selling, general and administrative expense for the period.

In June 2011, the Company granted performance based options and performance based restricted stock units to certain key employees and executives. In addition to a required service period, the vesting of the options is contingent upon a combination of the Company’s achievement of specified annual performance targets and specified common stock price thresholds, while the vesting of the restricted stock units is contingent upon a required service period as well as the Company’s achievement of a specified common stock price threshold. In May 2012, the Company granted additional performance based restricted stock units. The Company believes that the granting of these awards serves to further align the interests of its employees and executives with those of its stockholders. Based on the vesting contingencies in the awards, the Company used a Monte-Carlo simulation in order to determine the grant date fair values of the awards. For the June 2011 grant, the assumptions used in the Monte-Carlo simulation for the options and restricted stock units included a risk-free interest rate of 3.0% and 1.7%, respectively, volatility of 67.3% and 82.0%, respectively, and zero dividend yield. The exercise price of the performance based options is $4.65. For the May 2012 grant, the assumptions used in the Monte-Carlo simulation for the restricted stock units included a risk-free interest rate of 0.7%, volatility of 91.4%, and zero dividend yield. Additionally, the options were assumed to be voluntarily exercised, or canceled if underwater, at the midpoint of vesting and the contractual term (the expected life assumption). The weighted average fair value of the options was $3.21 and the weighted average fair value of the restricted stock units was $3.88 for the June 2011 grant and $2.27 for the May 2012 grant.

 

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QUIKSILVER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Activity related to performance based options and performance based restricted stock units for the nine months ended July 31, 2012 is as follows:

 

		Performance Options				Performance Restricted Stock Units
Non-vested, October 31, 2011			936,000				7,520,000
Granted			—				700,000
Vested			—				—
Canceled			—				(590,625	)
Non-vested, July 31, 2012			936,000				7,629,375

As of July 31, 2012, the Company had approximately $2.0 million and $8.3 million of unrecognized compensation expense, net of estimated forfeitures, related to the performance options and the performance restricted stock units, respectively. This unrecognized compensation expense is expected to be recognized over a weighted average period of approximately 3.1 years and 0.7 years, respectively.

For non-performance based options, the Company uses the Black-Scholes option-pricing model to value compensation expense. Expected forfeitures are estimated at the date of grant based on historical rates and reduce the compensation expense recognized. The expected term of options granted is derived from historical data on employee exercises. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the date of grant. Expected volatility is based on the historical volatility of the Company’s stock. For the nine months ended July 31, 2012 and 2011, options were valued assuming a risk-free interest rate of 1.1% and 1.9%, respectively, volatility of 76.5% and 82.4%, respectively, zero dividend yield, and an expected life of 7.1 and 5.3 years, respectively. The weighted average fair value of options granted was $2.58 and $3.39 for the nine months ended July 31, 2012 and 2011, respectively. The Company records stock-based compensation expense using the graded vested method over the vesting period, which is generally three years. As of July 31, 2012, the Company had approximately $3.0 million of unrecognized compensation expense, for non-performance based options, expected to be recognized over a weighted average period of approximately 1.6 years.

Changes in shares under option, excluding performance options, for the nine months ended July 31, 2012 are as follows:

 

Dollar amounts in thousands, except per share amounts		Shares				Weighted Average Price				Weighted Average Life				Aggregate Intrinsic Value
Outstanding, October 31, 2011			13,399,381			$	4.40
Granted			375,000				3.66
Exercised			(104,664	)			2.17							$	153
Canceled			(834,302	)			3.98
Outstanding, July 31, 2012			12,835,415			$	4.42				5.4			$	4,286
Options exercisable, July 31, 2012			7,199,073			$	5.23				3.9			$	2,072

 

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QUIKSILVER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Changes in non-vested shares under option, excluding performance options, for the nine months ended July 31, 2012 are as follows:

 

		Shares				Weighted- Average Grant Date Fair Value
Non-vested, October 31, 2011			7,356,508			$	1.81
Granted			375,000				2.58
Vested			(2,022,824	)			2.06
Canceled			(72,342	)			1.78
Non-vested, July 31, 2012			5,636,342			$	1.77

In March 2007, the Company’s stockholders approved an amendment to the 2000 Stock Incentive Plan whereby restricted stock and restricted stock units can be issued from such plan. Stock issued under these plans generally vests from three to five years. In March 2010, the Company’s stockholders approved a grant of 3,000,000 shares of restricted stock to a Company sponsored athlete, Kelly Slater. In accordance with the terms of the related restricted stock agreement, 2,400,000 shares have already vested, with the remaining 600,000 shares to vest in April 2013. In March 2011 and 2010, the Company’s stockholders approved an amendment to the 2000 Stock Incentive Plan that increased the maximum number of total shares and the maximum number of restricted shares issuable under the plan by 10,000,000 shares and 300,000 shares, respectively.

Changes in restricted stock for the nine months ended July 31, 2012 are as follows:

 

		Shares
Outstanding, October 31, 2011			1,911,669
Granted			105,000
Vested			(875,002	)
Forfeited			(60,000	)
Outstanding, July 31, 2012			1,081,667

Compensation expense for restricted stock is determined using the intrinsic value method and expected forfeitures are estimated at the date of grant based on historical rates and reduce the compensation expense recognized. As of July 31, 2012, the Company had approximately $0.7 million of unrecognized compensation expense expected to be recognized over a weighted average period of approximately 1.1 years.

 

4.

Inventories

Inventories consist of the following:

 

In thousands		July 31, 2012				October 31, 2011
Raw materials		$	6,144			$	9,130
Work in-process			1,266				2,647
Finished goods			383,642				335,980
		$	391,052			$	347,757

 

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QUIKSILVER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

5.

Intangible Assets and Goodwill

A summary of intangible assets is as follows:

 

		July 31, 2012												October 31, 2011
In thousands		Gross Amount				Amorti- zation				Net Book Value				Gross Amount				Amorti- zation				Net Book Value
Amortizable trademarks		$	19,819			$	(10,296	)		$	9,523			$	20,174			$	(9,782	)		$	10,392
Amortizable licenses			14,082				(13,612	)			470				14,380				(12,822	)			1,558
Other amortizable intangibles			8,069				(5,360	)			2,709				9,029				(5,987	)			3,042
Non-amortizable trademarks			124,043				—				124,043				123,151				—				123,151
		$	166,013			$	(29,268	)		$	136,745			$	166,734			$	(28,591	)		$	138,143

Certain trademarks and licenses will continue to be amortized by the Company using estimated useful lives of 10 to 25 years with no residual values. Intangible amortization expense for each of the nine month periods ended July 31, 2012 and 2011 was $2.3 million. Annual amortization expense is estimated to be approximately $2.9 million in the fiscal year ending October 31, 2012 and approximately $1.6 million in the fiscal years ending October 31, 2013 through October 31, 2017.

Goodwill related to the Company’s operating segments is as follows:

 

In thousands		July 31, 2012				October 31, 2011
Americas		$	75,946			$	76,048
Europe			176,662				186,334
Asia/Pacific			6,207				6,207
		$	258,815			$	268,589

Goodwill decreased approximately $9.8 million during the nine months ended July 31, 2012. Goodwill decreased by $0.1 million in the Americas segment as a result of the effect of changes in foreign currency exchange rates and decreased by $9.7 million in the European segment as a result of a decrease of $17.2 million due to the effect of changes in foreign currency exchange rates, partially offset by an increase to goodwill of $7.5 million related to acquisitions. Goodwill remained unchanged in the Asia/Pacific segment.

 

6.

Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income include changes in fair value of derivative instruments qualifying as cash flow hedges and foreign currency translation adjustments. The components of accumulated other comprehensive income, net of tax, are as follows:

 

In thousands		July 31, 2012				October 31, 2011
Foreign currency translation adjustment		$	58,038			$	124,230
Gain (loss) on cash flow hedges			8,938				(8,103	)
		$	66,976			$	116,127

 

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QUIKSILVER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

7.

Segment Information

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Company’s management in deciding how to allocate resources and in assessing performance. The Company operates in the outdoor market of the sporting goods industry in which the Company designs, markets and distributes clothing, footwear, accessories and related products. The Company currently operates in three segments: the Americas, Europe and Asia/Pacific. The Americas segment includes revenues from the U.S., Canada and Latin America. The European segment includes revenues primarily from Europe, the Middle East and Africa. The Asia/Pacific segment includes revenues primarily from Australia, Japan, New Zealand and Indonesia. Costs that support all three segments, including trademark protection, trademark maintenance and licensing functions, are part of corporate operations. Corporate operations also includes sourcing income and gross profit earned from the Company’s licensees. The Company’s largest customer accounted for approximately 3% of the Company’s net revenues from continuing operations for the nine months ended July 31, 2012 and 2011.

Information related to the Company’s operating segments is as follows:

 

		Three Months Ended July 31,
In thousands		2012				2011
Revenues, net:
Americas		$	286,136			$	260,159
Europe			154,076				176,438
Asia/Pacific			71,623				65,495
Corporate operations			604				1,225
		$	512,439			$	503,317
Gross profit:
Americas		$	126,101			$	115,065
Europe			88,136				106,451
Asia/Pacific			39,258				34,347
Corporate operations			(7	)			(745	)
		$	253,488			$	255,118
SG&A expense:
Americas		$	92,781			$	87,984
Europe			80,862				85,402
Asia/Pacific			37,747				36,314
Corporate operations			14,398				11,472
		$	225,788			$	221,172
Asset impairments:
Americas		$	141			$	—
Europe			—				—
Asia/Pacific			—				—
Corporate operations			—				—
		$	141			$	—
Operating income (loss):
Americas		$	33,179			$	27,081
Europe			7,274				21,049
Asia/Pacific			1,511				(1,967	)
Corporate operations			(14,405	)			(12,217	)
		$	27,559			$	33,946

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

		Nine Months Ended July 31,
In thousands		2012				2011
Revenues, net:
Americas		$	712,519			$	664,618
Europe			518,504				548,578
Asia/Pacific			220,242				190,636
Corporate operations			3,008				4,028
		$	1,454,273			$	1,407,860
Gross profit:
Americas		$	311,738			$	308,032
Europe			298,905				332,083
Asia/Pacific			113,361				101,842
Corporate operations			(417	)			(1,200	)
		$	723,587			$	740,757
SG&A expense:
Americas		$	270,669			$	256,117
Europe			250,160				250,388
Asia/Pacific			114,988				108,961
Corporate operations			44,396				32,890
		$	680,213			$	648,356
Asset impairments:
Americas		$	556			$	465
Europe			—				—
Asia/Pacific			—				74,145
Corporate operations			—				—
		$	556			$	74,610
Operating income (loss):
Americas		$	40,513			$	51,450
Europe			48,745				81,695
Asia/Pacific			(1,627	)			(81,264	)
Corporate operations			(44,813	)			(34,090	)
		$	42,818			$	17,791

 

		July 31, 2012				October 31, 2011
Identifiable assets:
Americas		$	580,941			$	577,643
Europe			734,332				750,378
Asia/Pacific			213,886				231,879
Corporate operations			197,925				204,323
		$	1,727,084			$	1,764,223

 

8.

Derivative Financial Instruments

The Company is exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to certain sales, royalty income and product purchases of its international subsidiaries that are denominated in currencies other than their functional currencies. The Company is also exposed to foreign currency gains and losses resulting from domestic transactions that are not denominated in U.S. dollars. Furthermore, the Company is exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in the Company’s consolidated financial statements due to the translation of the operating results and financial position of the Company’s international subsidiaries. As part of its overall strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates, the Company uses various foreign currency exchange contracts and intercompany loans.

 

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The Company accounts for all of its cash flow hedges under ASC 815, “Derivatives and Hedging,” which requires companies to recognize all derivative instruments as either assets or liabilities at fair value in the consolidated balance sheet. In accordance with ASC 815, the Company designates forward contracts as cash flow hedges of forecasted purchases of commodities.

For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (“OCI”) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. As of July 31, 2012, the Company had hedged forecasted transactions expected to occur through October 2013. Assuming July 31, 2012 exchange rates remain constant, $8.9 million of gains, net of tax, related to hedges of these transactions are expected to be reclassified into earnings over the next fifteen months.

For the nine months ended July 31, 2012 and 2011, the effective portions of gains and losses on derivative instruments in the condensed consolidated statements of operations and the condensed consolidated statements of comprehensive income (loss) were as follows:

 

		Nine Months Ended July 31,
In thousands		2012				2011				Location
		Amount
Gain (loss) recognized in OCI on derivatives		$	23,613			$	(25,869	)		Other comprehensive income
Loss reclassified from accumulated OCI into income		$	(1,377	)		$	(2,994	)		Cost of goods sold
Loss reclassified from accumulated OCI into income		$	—			$	(1,033	)		Interest expense
(Loss) gain reclassified from accumulated OCI into income		$	(480	)		$	501			Foreign currency gain
Loss recognized in income on derivatives		$	(271	)		$	—			Foreign currency gain

On the date the Company enters into a derivative contract, management designates the derivative as a hedge of the identified exposure. Before entering into various hedge transactions, the Company formally documents all relationships between hedging instruments and hedged items, as well as the risk-management objective and strategy. In this documentation, the Company identifies the asset, liability, firm commitment, or forecasted transaction that has been designated as a hedged item and indicates how the hedging instrument is expected to hedge the risks related to the hedged item. The Company formally measures effectiveness of its hedging relationships both at the hedge inception and on an ongoing basis in accordance with its risk management policy. The Company would discontinue hedge accounting prospectively (i) if management determines that the derivative is no longer effective in offsetting changes in the cash flows of a hedged item, (ii) when the derivative expires or is sold, terminated, or exercised, (iii) if it becomes probable that the forecasted transaction being hedged by the derivative will not occur, (iv) because a hedged firm commitment no longer meets the definition of a firm commitment, or (v) if management determines that designation of the derivative as a hedge instrument is no longer appropriate.

The Company enters into forward exchange and other derivative contracts with major banks and is exposed to exchange rate losses in the event of nonperformance by these banks. The Company anticipates, however, that these banks will be able to fully satisfy their obligations under the contracts. Accordingly, the Company does not obtain collateral or other security to support the contracts.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

As of July 31, 2012, the Company had the following outstanding derivative contracts that were entered into to hedge forecasted purchases and future cash receipts:

 

In thousands		Commodity		Notional Amount				Maturity		Fair Value
United States dollars		Inventory		$	265,870			Aug 2012 – Oct 2013		$	15,793
Swiss francs		Accounts receivable			3,168			Aug 2012 – Oct 2012			(134	)
British pounds		Accounts receivable			22,777			Aug 2012 – Oct 2013			(1,171	)
				$	291,815					$	14,488

ASC 820, “Fair Value Measurements and Disclosures,” defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. ASC 820 also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:

 

•

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 assets and liabilities include debt and equity securities traded in an active exchange market, as well as U.S. Treasury securities.

 

•

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

•

Level 3 – Valuation is determined using model-based techniques with significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of third party pricing services, option pricing models, discounted cash flow models and similar techniques.

The Company’s derivative assets and liabilities include foreign exchange derivatives that are measured at fair value using observable market inputs such as forward rates, interest rates, the Company’s credit risk and the Company’s counterparties’ credit risks. Based on these inputs, the Company’s derivative assets and liabilities are classified within Level 2 of the valuation hierarchy.

The following tables reflect the fair values of assets and liabilities measured and recognized at fair value on a recurring basis on the accompanying condensed consolidated balance sheets:

 

		Fair Value Measurements Using												Assets at Fair Value
In thousands		Level 1				Level 2				Level 3
		July 31, 2012
Derivative assets:
Other receivables		$	—			$	21,566			$	—			$	21,566
Other assets			—				—				—				—
Derivative liabilities:
Accrued liabilities			—				(5,774	)			—				(5,774	)
Other long-term liabilities			—				(1,304	)			—				(1,304	)
Total fair value		$	—			$	14,488			$	—			$	14,488

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

		Fair Value Measurements Using												Assets at Fair Value
In thousands		Level 1				Level 2				Level 3
		October 31, 2011
Derivative assets:
Other receivables		$	—			$	1,031			$	—			$	1,031
Other assets			—				1,610				—				1,610
Derivative liabilities:
Accrued liabilities			—				(12,297	)			—				(12,297	)
Other long-term liabilities			—				(688	)			—				(688	)
Total fair value		$	—			$	(10,344	)		$	—			$	(10,344	)

 

9.

Litigation, Indemnities and Guarantees

The Company is involved from time to time in legal claims involving trademarks and intellectual property, licensing, employee relations and other matters incidental to its business. The Company believes the resolution of any such matter currently pending will not have a material adverse effect on its financial condition, results of operations or cash flows.

During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These include (i) intellectual property indemnities to the Company’s customers and licensees in connection with the use, sale and/or license of Company products, (ii) indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease, (iii) indemnities to vendors and service providers pertaining to claims based on the negligence or willful misconduct of the Company, and (iv) indemnities involving the accuracy of representations and warranties in certain contracts. The duration of these indemnities, commitments and guarantees varies and, in certain cases, may be indefinite. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential for future payments the Company could be obligated to make. As of July 31, 2012, the Company had not recorded any liability for these indemnities, commitments and guarantees in the accompanying condensed consolidated balance sheets.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

10.

Income Taxes

Each reporting period, the Company evaluates the realizability of all of its deferred tax assets in each tax jurisdiction. As of July 31, 2012, the Company continued to maintain a full valuation allowance against its net deferred tax assets in the United States as well as certain jurisdictions in its Asia/Pacific segment. As a result of the valuation allowances recorded in the United States and certain jurisdictions in the Asia/Pacific segment, no tax benefits have been recognized for losses incurred in those tax jurisdictions.

On July 31, 2012, the Company’s liability for uncertain tax positions was approximately $10.8 million resulting from unrecognized tax benefits, excluding interest and penalties. During the nine months ended July 31, 2012, the Company increased its liability for uncertain tax positions, exclusive of interest and penalties, by $0.4 million.

If the Company’s positions are favorably sustained by the relevant taxing authority, approximately $9.5 million, excluding interest and penalties, of uncertain tax position liabilities would favorably impact the Company’s effective tax rate in future periods.

 

11.

Restructuring Charges

In connection with its cost reduction efforts, the Company formulated the Fiscal 2011 Cost Reduction Plan (the “2011 Plan”). The 2011 Plan covers the global operations of the Company, but is primarily concentrated in the United States. During the nine months ended July 31, 2012, the Company recorded $5.0 million in severance charges and $0.8 million in lease loss charges under the 2011 Plan as well as an additional $1.9 million in severance charges outside the scope of the 2011 Plan. The Company continues to evaluate its facilities, as well as its overall cost structure, and may incur future charges under the 2011 Plan.

Activity and liability balances recorded as part of the 2011 Plan are as follows:

 

In thousands		Workforce				Facility & Other				Total
Balance, November 1, 2010		$	—			$	—			$	—
Charged to expense			1,389				6,649				8,038
Cash payments			(313	)			(417	)			(730	)
Balance, October 31, 2011		$	1,076			$	6,232			$	7,308
Charged to expense			5,039				753				5,792
Cash payments			(3,381	)			(1,143	)			(4,524	)
Balance, July 31, 2012		$	2,734			$	5,842			$	8,576

 

12.

Debt

A summary of lines of credit and long-term debt is as follows:

 

In thousands		July 31, 2012				October 31, 2011
Asia/Pacific short-term lines of credit		$	15,032			$	18,335
Americas Credit Facility			61,700				21,042
Americas long-term debt			15,500				18,500
European credit facility			34,714				2,306
Senior Notes			400,000				400,000
European Senior Notes			245,489				282,925
Capital lease obligations and other borrowings			11,009				4,578
		$	783,444			$	747,686

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

As of July 31, 2012, the Company’s credit facilities allowed for total maximum cash borrowings and letters of credit of $371.9 million. The Company’s total maximum borrowings and actual availability fluctuate depending on the extent of assets comprising the Company’s borrowing base under certain credit facilities. The Company had $111.4 million of borrowings drawn on these credit facilities as of July 31, 2012, and letters of credit issued at that time totaled $51.9 million. The amount of availability for borrowings under these facilities as of July 31, 2012 was $117.4 million, $57.6 million of which could also be used for letters of credit in the United States. In addition to the $117.4 million of availability for borrowings, the Company also had $91.1 million in additional capacity for letters of credit in Europe and Asia/Pacific as of July 31, 2012. Many of the Company’s debt agreements contain customary default provisions and restrictive covenants. The Company is currently in compliance with such covenants.

In December 2010, Boardriders SA, a wholly owned subsidiary of the Company, issued €200 million (approximately $265 million at the date of issuance) in senior notes (“European Senior Notes”), which bear a coupon interest rate of 8.875% and are due December 15, 2017. The Company used the proceeds from the European Senior Notes to repay its then existing European term loans and to pay related fees and expenses. As a result, the Company recognized non-cash, non-operating charges during the nine months ended July 31, 2011 of approximately $13.7 million, included in interest expense, to write-off the deferred debt issuance costs related to such term loans.

The estimated fair values of the Company’s lines of credit and long-term debt are as follows:

 

In thousands		July 31, 2012
		Carrying Amount				Fair Value
Lines of credit		$	15,032			$	15,032
Long-term debt			768,412				749,508
		$	783,444			$	764,540

The fair value of the Company’s long-term debt is calculated based on the market price of the Company’s publicly traded Senior Notes, the trading price of the Company’s European Senior Notes and the carrying values of the majority of the Company’s other debt obligations. For the Company’s Senior Notes and European Senior Notes, the fair value is classified as a Level 1 measurement as the values are based on quoted market prices in active exchange markets.

The carrying value of the Company’s trade accounts receivable and accounts payable approximates fair value due to their short-term nature.

The Company’s non-financial instruments, which primarily consist of goodwill, other intangible assets and property and equipment, are not required to be measured at fair value on a recurring basis and are reported at carrying value. However, on a periodic basis, or whenever events or changes in circumstances indicate that their carrying value may not be fully recoverable, non-financial instruments are assessed for impairment and, if applicable, written-down to and recorded at fair value, considering both Level 2 and Level 3 valuation inputs.

 

13.

Condensed Consolidating Financial Information

The Company has $400 million in publicly registered Senior Notes. Obligations under the Company’s Senior Notes are fully and unconditionally guaranteed by certain of its domestic subsidiaries. The Company is required to present condensed consolidating financial information for Quiksilver, Inc. and its domestic subsidiaries within the notes to the condensed consolidated financial statements in accordance with the criteria established for parent companies in the SEC’s Regulation S-X, Rule 3-10(f). The following condensed consolidating financial information presents the results of operations, financial position and cash flows of Quiksilver Inc., its

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

guarantor subsidiaries, its non-guarantor subsidiaries and the eliminations necessary to arrive at the information for the Company on a consolidated basis as of July 31, 2012 and October 31, 2011 and for the three and nine month periods ended July 31, 2012 and 2011. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions. The Company has applied the estimated consolidated annual effective income tax rate to both the guarantor and non-guarantor subsidiaries, adjusting for any discrete items, for interim reporting purposes. In the Company’s consolidated financial statements for the fiscal year ending October 31, 2012, management will apply the actual income tax rates to both the guarantor and non-guarantor subsidiaries. These interim tax rates may differ from the actual annual effective income tax rates for both the guarantor and non-guarantor subsidiaries.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended July 31, 2012

 

In thousands		Quiksilver, Inc.				Guarantor Subsidiaries				Non- Guarantor Subsidiaries				Eliminations				Consolidated
Revenues, net		$	117			$	258,595			$	285,858			$	(32,131	)		$	512,439
Cost of goods sold			—				152,405				130,167				(23,621	)			258,951
Gross profit			117				106,190				155,691				(8,510	)			253,488
Selling, general and administrative expense			13,533				81,506				137,695				(6,946	)			225,788
Asset impairments			—				141				—				—				141
Operating (loss) income			(13,416	)			24,543				17,996				(1,564	)			27,559
Interest expense			7,253				1,245				6,336				—				14,834
Foreign currency (gain) loss			(185	)			22				(2,079	)			—				(2,242	)
Equity in earnings			(33,094	)			—				—				33,094				—
Income before provision for income taxes			12,610				23,276				13,739				(34,658	)			14,967
Provision for income taxes			—				513				1,995				—				2,508
Net income			12,610				22,763				11,744				(34,658	)			12,459
Net loss (income) attributable to non-controlling interest			—				234				(83	)			—				151
Net income attributable to Quiksilver, Inc.		$	12,610			$	22,997			$	11,661			$	(34,658	)		$	12,610

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Three Months Ended July 31, 2011

 

In thousands		Quiksilver, Inc.				Guarantor Subsidiaries				Non- Guarantor Subsidiaries				Eliminations				Consolidated
Revenues, net		$	116			$	216,614			$	302,377			$	(15,790	)		$	503,317
Cost of goods sold			—				122,044				133,825				(7,670	)			248,199
Gross profit			116				94,570				168,552				(8,120	)			255,118
Selling, general and administrative expense			11,366				75,528				140,199				(5,921	)			221,172
Operating (loss) income			(11,250	)			19,042				28,353				(2,199	)			33,946
Interest expense			7,225				1,197				7,241				—				15,663
Foreign currency gain			(23	)			(646	)			(787	)			—				(1,456	)
Equity in earnings			(28,889	)			—				—				28,889				—
Income before provision for income taxes			10,437				18,491				21,899				(31,088	)			19,739
Provision for income taxes			—				1,223				7,773				—				8,996
Net income			10,437				17,268				14,126				(31,088	)			10,743
Net income attributable to non-controlling interest			—				(306	)			—				—				(306	)
Net income attributable to Quiksilver, Inc.		$	10,437			$	16,962			$	14,126			$	(31,088	)		$	10,437

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Nine Months Ended July 31, 2012

 

In thousands		Quiksilver, Inc.				Guarantor Subsidiaries				Non- Guarantor Subsidiaries				Eliminations				Consolidated
Revenues, net		$	353			$	615,658			$	919,474			$	(81,212	)		$	1,454,273
Cost of goods sold			—				366,655				422,012				(57,981	)			730,686
Gross profit			353				249,003				497,462				(23,231	)			723,587
Selling, general and administrative expense			43,318				233,937				425,162				(22,204	)			680,213
Asset impairments			—				556				—				—				556
Operating (loss) income			(42,965	)			14,510				72,300				(1,027	)			42,818
Interest expense			21,732				3,930				19,802				—				45,464
Foreign currency (gain) loss			(298	)			31				(4,434	)			—				(4,701	)
Equity in earnings			(49,284	)			—				—				49,284				—
(Loss) income before provision for income taxes			(15,115	)			10,549				56,932				(50,311	)			2,055
Provision for income taxes			—				945				13,968				—				14,913
Net (loss) income			(15,115	)			9,604				42,964				(50,311	)			(12,858	)
Net income attributable to non-controlling interest			—				(1,886	)			(371	)			—				(2,257	)
Net (loss) income attributable to Quiksilver, Inc.		$	(15,115	)		$	7,718			$	42,593			$	(50,311	)		$	(15,115	)

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

Nine Months Ended July 31, 2011

 

In thousands		Quiksilver, Inc.				Guarantor Subsidiaries				Non- Guarantor Subsidiaries				Eliminations				Consolidated
Revenues, net		$	348			$	532,662			$	910,923			$	(36,073	)		$	1,407,860
Cost of goods sold			—				289,527				392,799				(15,223	)			667,103
Gross profit			348				243,135				518,124				(20,850	)			740,757
Selling, general and administrative expense			29,960				220,425				416,353				(18,382	)			648,356
Asset impairments			—				465				74,145				—				74,610
Operating (loss) income			(29,612	)			22,245				27,626				(2,468	)			17,791
Interest expense			21,646				2,970				35,111				—				59,727
Foreign currency loss (gain)			34				(245	)			(5,675	)			—				(5,886	)
Equity in earnings			37,864				—				—				(37,864	)			—
(Loss) income before (benefit) provision for income taxes			(89,156	)			19,520				(1,810	)			35,396				(36,050	)
(Benefit) provision for income taxes			—				(616	)			50,553				—				49,937
Net (loss) income			(89,156	)			20,136				(52,363	)			35,396				(85,987	)
Net income attributable to non-controlling interest			—				(3,169	)			—				—				(3,169	)
Net (loss) income attributable to Quiksilver, Inc.		$	(89,156	)		$	16,967			$	(52,363	)		$	35,396			$	(89,156	)

 

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QUIKSILVER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING BALANCE SHEET

At July 31, 2012

 

In thousands		Quiksilver, Inc.				Guarantor Subsidiaries				Non- Guarantor Subsidiaries				Eliminations				Consolidated
ASSETS
Current assets:
Cash and cash equivalents		$	15			$	2,421			$	79,467			$	—			$	81,903
Trade accounts receivable, net			—				172,969				225,553				—				398,522
Other receivables			25				5,053				26,366				—				31,444
Inventories			—				118,236				274,380				(1,564	)			391,052
Deferred income taxes			—				(1,182	)			15,873				—				14,691
Prepaid expenses and other current assets			2,373				12,237				18,068				—				32,678
Total current assets			2,413				309,734				639,707				(1,564	)			950,290
Fixed assets, net			18,384				69,887				145,571				—				233,842
Intangible assets, net			3,134				48,025				85,586				—				136,745
Goodwill			—				112,216				146,599				—				258,815
Other assets			3,175				3,177				41,915				—				48,267
Deferred income taxes			—				(16,682	)			115,807				—				99,125
Investment in subsidiaries			1,083,565				—				—				(1,083,565	)			—
Total assets		$	1,110,671			$	526,357			$	1,175,185			$	(1,085,129	)		$	1,727,084
LIABILITIES AND EQUITY
Current liabilities:
Lines of credit		$	—			$	—			$	15,032			$	—			$	15,032
Accounts payable			2,192				98,037				133,294				—				233,523
Accrued liabilities			13,033				29,118				68,989				—				111,140
Current portion of long-term debt			—				8,594				36,046				—				44,640
Income taxes payable			—				(7,199	)			10,851				—				3,652
Intercompany balances			142,117				(82,808	)			(59,309	)			—				—
Total current liabilities			157,342				45,742				204,903				—				407,987
Long-term debt, net of current portion			400,000				75,700				248,072				—				723,772
Other long-term liabilities			—				20,515				11,734				—				32,249
Total liabilities			557,342				141,957				464,709				—				1,164,008
Stockholders’/invested equity			553,329				376,788				708,341				(1,085,129	)			553,329
Non-controlling interest			—				7,612				2,135				—				9,747
Total liabilities and equity		$	1,110,671			$	526,357			$	1,175,185			$	(1,085,129	)		$	1,727,084

 

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QUIKSILVER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING BALANCE SHEET

At October 31, 2011

 

In thousands		Quiksilver, Inc.				Guarantor Subsidiaries				Non- Guarantor Subsidiaries				Eliminations				Consolidated
ASSETS
Current assets:
Cash and cash equivalents		$	17			$	1,331			$	108,405			$	—			$	109,753
Trade accounts receivable, net			—				150,782				246,307				—				397,089
Other receivables			122				5,918				17,150				—				23,190
Income taxes receivable			—				21,338				(17,073	)			—				4,265
Inventories			—				115,456				234,266				(1,965	)			347,757
Deferred income taxes			—				(1,182	)			33,990				—				32,808
Prepaid expenses and other current assets			2,378				8,525				14,526				—				25,429
Total current assets			2,517				302,168				637,571				(1,965	)			940,291
Fixed assets, net			17,602				64,943				155,562				—				238,107
Intangible assets, net			3,007				48,743				86,393				—				138,143
Goodwill			—				112,216				156,373				—				268,589
Other assets			4,457				3,936				47,421				—				55,814
Deferred income taxes			—				(16,682	)			139,961				—				123,279
Investment in subsidiaries			1,082,427				—				—				(1,082,427	)			—
Total assets		$	1,110,010			$	515,324			$	1,223,281			$	(1,084,392	)		$	1,764,223
LIABILITIES AND EQUITY
Current liabilities:
Lines of credit		$	—			$	—			$	18,335			$	—			$	18,335
Accounts payable			2,510				88,280				112,233				—				203,023
Accrued liabilities			6,673				30,088				96,183				—				132,944
Current portion of long-term debt			—				3,000				1,628				—				4,628
Intercompany balances			90,729				(44,001	)			(46,728	)			—				—
Total current liabilities			99,912				77,367				181,651				—				358,930
Long-term debt, net of current portion			400,000				36,542				288,181				—				724,723
Other long-term liabilities			—				41,219				16,729				—				57,948
Total liabilities			499,912				155,128				486,561				—				1,141,601
Stockholders’/invested equity			610,098				347,995				736,397				(1,084,392	)			610,098
Non-controlling interest			—				12,201				323				—				12,524
Total liabilities and equity		$	1,110,010			$	515,324			$	1,223,281			$	(1,084,392	)		$	1,764,223

 

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QUIKSILVER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

Nine Months Ended July 31, 2012

 

In thousands		Quiksilver, Inc.				Guarantor Subsidiaries				Non- Guarantor Subsidiaries				Eliminations				Consolidated
Cash flows from operating activities:
Net (loss) income		$	(15,115	)		$	9,604			$	42,964			$	(50,311	)		$	(12,858	)
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization			1,598				13,338				24,501				—				39,437
Stock-based compensation			17,272				—				—				—				17,272
Provision for doubtful accounts			—				(2,530	)			4,131				—				1,601
Asset impairments			—				556				—				—				556
Equity in earnings			(49,284	)			—				(19	)			49,284				(19	)
Non-cash interest expense			1,111				1,190				513				—				2,814
Deferred income taxes			—				—				9,349				—				9,349
Other adjustments to reconcile net (loss) income			(322	)			36				(2,008	)			—				(2,294	)
Changes in operating assets and liabilities:
Trade accounts receivable			—				(19,657	)			(6,048	)			—				(25,705	)
Inventories			—				(3,095	)			(53,616	)			1,027				(55,684	)
Other operating assets and liabilities			4,623				416				3,611				—				8,650
Net cash (used in) provided by operating activities			(40,117	)			(142	)			23,378				—				(16,881	)
Cash flows from investing activities:
Capital expenditures			(2,861	)			(18,736	)			(25,580	)			—				(47,177	)
Business acquisitions, net of cash acquired			—				—				(9,117	)			—				(9,117	)
Net cash used in investing activities			(2,861	)			(18,736	)			(34,697	)			—				(56,294	)
Cash flows from financing activities:
Borrowings on lines of credit			—				—				11,377				—				11,377
Payments on lines of credit			—				—				(12,326	)			—				(12,326	)
Borrowings on long-term debt			—				80,500				46,534				—				127,034
Payments on long-term debt			—				(43,856	)			(13,657	)			—				(57,513	)
Stock option exercises and employee stock purchases			1,335				—				—				—				1,335
Transactions with non-controlling interest owners			—				(11,000	)			—				—				(11,000	)
Intercompany			41,641				(5,676	)			(35,965	)			—				—
Net cash provided by (used in) financing activities			42,976				19,968				(4,037	)			—				58,907
Effect of exchange rate changes on cash			—				—				(13,582	)			—				(13,582	)
Net (decrease) increase in cash and cash equivalents			(2	)			1,090				(28,938	)			—				(27,850	)
Cash and cash equivalents, beginning of period			17				1,331				108,405				—				109,753
Cash and cash equivalents, end of period		$	15			$	2,421			$	79,467			$	—			$	81,903

 

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QUIKSILVER, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

Nine Months Ended July 31, 2011

 

In thousands		Quiksilver, Inc.				Guarantor Subsidiaries				Non- Guarantor Subsidiaries				Eliminations				Consolidated
Cash flows from operating activities:
Net (loss) income		$	(89,156	)		$	20,136			$	(52,363	)		$	35,396			$	(85,987	)
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization			1,190				14,945				24,019				—				40,154
Stock-based compensation			9,916				—				—				—				9,916
Provision for doubtful accounts			—				2,699				5,913				—				8,612
Asset impairments			—				465				74,145				—				74,610
Equity in earnings			37,864				(158	)			(472	)			(37,864	)			(630	)
Non-cash interest expense			1,034				1,291				15,742				—				18,067
Deferred income taxes			—				1,586				44,329				—				45,915
Other adjustments to reconcile net (loss) income			33				484				(3,081	)			—				(2,564	)
Changes in operating assets and liabilities:
Trade accounts receivable			—				(21,912	)			2,827				—				(19,085	)
Inventories			—				(21,504	)			(64,303	)			2,468				(83,339	)
Other operating assets and liabilities			5,277				3,200				33,027				—				41,504
Net cash (used in) provided by operating activities			(33,842	)			1,232				79,783				—				47,173
Cash flows from investing activities:
Capital expenditures			(9,195	)			(22,177	)			(15,316	)			—				(46,688	)
Business acquisitions, net of cash acquired			—				(528	)			(5,050	)			—				(5,578	)
Net cash used in investing activities			(9,195	)			(22,705	)			(20,366	)			—				(52,266	)
Cash flows from financing activities:
Borrowings on lines of credit			—				—				14,807				—				14,807
Payments on lines of credit			—				—				(29,172	)			—				(29,172	)
Borrowings on long-term debt			—				21,500				270,967				—				292,467
Payments on long-term debt			—				(1,675	)			(259,143	)			—				(260,818	)
Payments of debt issuance costs			—				—				(6,308	)			—				(6,308	)
Stock option exercises and employee stock purchases			4,116				—				—				—				4,116
Intercompany			39,034				(37,124	)			(1,910	)			—				—
Net cash provided by (used in) financing activities			43,150				(17,299	)			(10,759	)			—				15,092
Effect of exchange rate changes on cash			—				—				(4,382	)			—				(4,382	)
Net increase (decrease) in cash and cash equivalents			113				(38,772	)			44,276				—				5,617
Cash and cash equivalents, beginning of period			164				39,172				81,257				—				120,593
Cash and cash equivalents, end of period		$	277			$	400			$	125,533			$	—			$	126,210

 

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PART I – FINANCIAL INFORMATION

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Unless the context indicates otherwise, when we refer to “Quiksilver”, “we”, “us”, “our”, or the “Company” in this Form 10-Q, we are referring to Quiksilver, Inc. and its subsidiaries on a consolidated basis. The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and related notes thereto contained elsewhere in this report. The information contained in this quarterly report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our securities. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended October 31, 2011 and subsequent reports on Form 10-Q and Form 8-K, which discuss our business in greater detail. The section entitled “Risk Factors” set forth in Item 1A of our Quarterly Report on Form 10-Q for the quarter ended April 30, 2012, filed with the SEC on June 11, 2012, and similar disclosures in our other SEC filings, discuss some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the information in this report and in our other filings with the SEC, before deciding to purchase, hold or sell our securities.

Over the past 42 years, Quiksilver has established itself as a global company representing the casual, youth lifestyle associated with boardriding sports. We began operations in 1976 as a California company making boardshorts for surfers in the United States under a license agreement with the Quiksilver brand founders in Australia. Our product offerings expanded in the 1980s as we expanded our distribution channels. After going public in 1986 and purchasing the rights to the Quiksilver brand in the United States, we further expanded our product offerings and began to diversify. In 1991, we acquired the European licensee of Quiksilver and introduced Roxy, our surf brand for teenage girls. We also expanded demographically in the 1990s by adding products for boys, girls, toddlers and men, and we introduced our proprietary retail store concept that displays the heritage and products of Quiksilver and Roxy. In 2000, we acquired the international Quiksilver and Roxy trademarks, and in 2002, we acquired our licensees in Australia and Japan. In 2004, we acquired DC Shoes, Inc. to expand our presence in action sports inspired footwear.

We operate in the outdoor market of the sporting goods industry in which we design, develop and distribute branded apparel, footwear, accessories and related products. Our products are sold throughout the world, primarily in surf shops, skate shops, snow shops, specialty stores, sporting goods stores, select department stores, our own retail stores and through various e-commerce channels. We currently operate in three segments: the Americas, Europe and Asia/Pacific. The Americas segment includes revenues from the U.S., Canada and Latin America. Our European segment includes revenues primarily from Europe, the Middle East and Africa. Our Asia/Pacific segment includes revenues primarily from Australia, Japan, New Zealand and Indonesia. Our net revenues in each of the Americas, Europe and Asia/Pacific segments include apparel, footwear, accessories and related product lines for our Quiksilver, Roxy, DC and other brands, which primarily include Hawk, Lib Technologies, and Gnu. Royalties earned from various licensees in other international territories are categorized in corporate operations along with revenues from sourcing services for our licensees.

We operate in markets that are highly competitive, and our ability to evaluate and respond to changing consumer demands and tastes is critical to our success. If we are unable to remain competitive and maintain our consumer loyalty, our business will be negatively affected. We believe that our historical success is due to the development of an experienced team of designers, artists, sponsored athletes, technicians, researchers, merchandisers, pattern makers and contractors. Our team and the heritage and current strength of our brands has helped us remain competitive in our markets. Our success in the future will depend, in part, on our ability to continue to design products that are desirable in the marketplace and competitive in the areas of quality, brand image, technical specifications, distribution methods, price, customer service and intellectual property protection.

 

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Results of Operations

The table below shows certain components in our statements of operations and other data as a percentage of revenues:

 

		Three Months Ended July 31,								Nine Months Ended July 31,
		2012				2011				2012				2011
Statements of Operations data
Revenues, net			100.0	%			100.0	%			100.0	%			100.0	%
Gross profit			49.5				50.7				49.8				52.6
Selling, general and administrative expense			44.1				43.9				46.8				46.1
Asset impairments			0.0				0.0				0.0				5.3
Operating income			5.4				6.7				2.9				1.3
Interest expense			2.9				3.1				3.1				4.2
Foreign currency gain			(0.4	)			(0.3	)			(0.3	)			(0.4	)
Income (loss) before provision for income taxes			2.9				3.9				0.1				(2.6	)
Other data
Adjusted EBITDA(1)			9.2	%			10.5	%			7.1	%			10.3	%

⁽¹⁾ Adjusted EBITDA is defined as net income (loss) attributable to Quiksilver, Inc. before (i) interest expense, (ii) provision for income taxes, (iii) depreciation and amortization, (iv) non-cash stock-based compensation expense and (v) asset impairments. Adjusted EBITDA is not defined under generally accepted accounting principles (“GAAP”), and it may not be comparable to similarly titled measures reported by other companies. We use Adjusted EBITDA, along with other GAAP measures, as a measure of profitability because Adjusted EBITDA helps us to compare our performance on a consistent basis by removing from our operating results the impact of our capital structure, the effect of operating in different tax jurisdictions, the impact of our asset base, which can differ depending on the book value of assets, the accounting methods used to compute depreciation and amortization, the existence or timing of asset impairments and the effect of non-cash stock-based compensation expense. We believe EBITDA is useful to investors as it is a widely used measure of performance and the adjustments we make to EBITDA provide further clarity on our profitability. We remove the effect of non-cash stock-based compensation from our earnings which can vary based on share price, share price volatility and expected life of the equity instruments we grant. In addition, this stock-based compensation expense does not result in cash payments by us. We remove the effect of asset impairments from Adjusted EBITDA for the same reason that we remove depreciation and amortization as it is part of the impact of our asset base. Adjusted EBITDA has limitations as a profitability measure in that it does not include the interest expense on our debts, our provisions for income taxes, the effect of our expenditures for capital assets and certain intangible assets, the effect of non-cash stock-based compensation expense and the effect of asset impairments. The following is a reconciliation of net income (loss) attributable to Quiksilver, Inc. to Adjusted EBITDA:

 

In thousands		Three Months Ended July 31,								Nine Months Ended July 31,
		2012				2011				2012				2011
Net income (loss) attributable to Quiksilver, Inc.		$	12,610			$	10,437			$	(15,115	)		$	(89,156	)
Provision for income taxes			2,508				8,996				14,913				49,937
Interest expense			14,834				15,663				45,464				59,727
Depreciation and amortization			12,312				12,684				39,437				40,154
Non-cash stock-based compensation expense			4,872				4,935				17,272				9,916
Non-cash asset impairments			141				—				556				74,610
Adjusted EBITDA		$	47,277			$	52,715			$	102,527			$	145,188

 

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Three Months Ended July 31, 2012 Compared to Three Months Ended July 31, 2011

Our total net revenues for the three months ended July 31, 2012 increased 2% to $512.4 million from $503.3 million in the comparable period of the prior year. In constant currency, net revenues increased 8% compared to the prior year.

In order to better understand growth rates in our operating segments, we make reference to constant currency. Constant currency improves visibility into actual growth rates as it adjusts for the effect of changing foreign currency exchange rates from period to period. Constant currency is calculated by taking the ending foreign currency exchange rate (for balance sheet items) or the average foreign currency exchange rate (for income statement items) used in translation for the current period and applying that same rate to the prior period. The following table presents revenues by segment in both historical currency and constant currency for the three months ended July 31, 2012 and 2011:

 

In thousands		Americas				Europe				Asia/Pacific				Corporate				Total
Historical currency (as reported)
July 31, 2011		$	260,159			$	176,438			$	65,495			$	1,225			$	503,317
July 31, 2012			286,136				154,076				71,623				604				512,439
Percentage increase (decrease)			10%				(13%)				9%								2%
Constant currency (current year exchange rates)
July 31, 2011			255,553				153,834				63,516				1,199				474,102
July 31, 2012			286,136				154,076				71,623				604				512,439
Percentage increase			12%				0%				13%								8%

Net revenues in the Americas segment increased 10% to $286.1 million for the three months ended July 31, 2012 from $260.2 million in the comparable period of the prior year, while European segment net revenues decreased 13% to $154.1 million from $176.4 million and Asia/Pacific segment net revenues increased 9% to $71.6 million from $65.5 million for those same periods. In constant currency, Americas segment net revenues increased 12%, European segment net revenues increased slightly and Asia/Pacific segment net revenues increased 13%.

On a consolidated basis in constant currency, net revenues in our wholesale distribution channel increased 4% for the three months ended July 31, 2012 compared to the three months ended July 31, 2011, while retail channel net revenues increased 7% and e-commerce channel net revenues increased 180% for those same periods. The increase in e-commerce channel net revenues resulted from both organic, continuing growth on pre-existing platforms, as well as sales from new websites.

On a consolidated basis in constant currency, net revenues for our Quiksilver brand increased 4% for the three months ended July 31, 2012 compared to the three months ended July 31, 2011, while Roxy brand net revenues increased 5% and DC brand net revenues increased 16% for those same periods. Fluctuations in quarterly brand revenues are highly dependent on the timing of shipments, replenishments of inventory in the retail channel and special order sales, and therefore, are not necessarily indicative of longer trends. Also, decisions regarding customer segmentation and distribution within our wholesale channel may effect net revenues in a manner that is not consistent from period to period.

Our consolidated gross profit margin for the three months ended July 31, 2012 decreased to 49.5% from 50.7% in the comparable period of the prior year. The gross profit in the Americas segment decreased slightly to 44.1% from 44.2%, our European segment gross profit margin decreased to 57.2% from 60.3%, and our Asia/Pacific segment gross profit margin increased to 54.8% from 52.4% for those same periods. The decrease in our consolidated gross profit margin was primarily the result of higher levels of clearance business, discounting, a shift in channel mix and the impact of fluctuations in foreign currency exchange rates. These factors also, in various degrees, had an impact on each segment’s gross margin.

 

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Our selling, general and administrative expense (“SG&A”) for the three months ended July 31, 2012 increased 2% to $225.8 million from $221.2 million in the comparable period of the prior year. SG&A increased 7% in constant currency. The increase in our consolidated SG&A was primarily due to costs associated with staff eliminations, as during the three months ended July 31, 2012, we enacted personnel reductions in all three of our operating segments to reduce our SG&A in the future. These increases in SG&A were partially offset by a reduction in our marketing expenses. As a percentage of revenues, our consolidated SG&A increased slightly to 44.1% for the three months ended July 31, 2012 from 43.9% for the three months ended July 31, 2011.

Asset impairment charges for the three months ended July 31, 2012 were $0.1 million, compared to no impairment charges in the comparable period of the prior year.

Interest expense for the three months ended July 31, 2012 decreased to $14.8 million from $15.7 million in the comparable period of the prior year, primarily as a result of the translation effects of the stronger U.S. dollar in comparison to the euro for those same periods.

Our foreign currency gain amounted to $2.2 million for the three months ended July 31, 2012 compared to $1.5 million in the comparable period of the prior year. This gain resulted primarily from the foreign currency exchange effect of certain non-euro denominated assets of our European subsidiaries.

Our income tax expense for the three months ended July 31, 2012 was $2.5 million compared to $9.0 million in the comparable period of the prior year. This decrease resulted primarily from a shift in the mix of income before tax between tax jurisdictions. As a result of our valuation allowance against deferred tax assets in the United States, no tax provision was recognized for income generated in the United States during the three months ended July 31, 2012.

Our net income for the three months ended July 31, 2012 increased to $12.6 million or $0.07 per share on a diluted basis, compared to $10.4 million, or $0.06 per share on a diluted basis, in the comparable period of the prior year. Adjusted EBITDA decreased to $47.3 million from $52.7 million for those same periods, primarily driven by the decrease in consolidated gross profit margin.

Nine Months Ended July 31, 2012 Compared to Nine Months Ended July 31, 2011

Our total net revenues for the nine months ended July 31, 2012 increased 3% to $1,454.3 million from $1,407.9 million in the comparable period of the prior year. Net revenues increased 7% in constant currency.

The following table presents revenues by segment in both historical currency and constant currency for the nine months ended July 31, 2012 and 2011:

 

In thousands		Americas				Europe				Asia/Pacific				Corporate				Total
Historical currency (as reported)
July 31, 2011		$	664,618			$	548,578			$	190,636			$	4,028			$	1,407,860
July 31, 2012			712,519				518,504				220,242				3,008				1,454,273
Percentage increase (decrease)			7%				(5%)				16%								3%
Constant currency (current year exchange rates)
July 31, 2011			656,164				510,222				192,485				3,988				1,362,859
July 31, 2012			712,519				518,504				220,242				3,008				1,454,273
Percentage increase			9%				2%				14%								7%

Net revenues in the Americas segment increased 7% to $712.5 million for the nine months ended July 31, 2012 from $664.6 million in the comparable period of the prior year, while European segment net revenues decreased 5% to $518.5 million from $548.6 million and Asia/Pacific segment net revenues increased 16% to $220.2 million from $190.6 million for those same periods. In constant currency, Americas segment net revenues increased 9%, European segment net revenues increased 2% and Asia/Pacific segment net revenues increased 14%. The increase in Asia/Pacific net revenues was primarily driven by improved performance in Japan, where net revenues in the nine months ended July 31, 2011 were significantly impacted by the earthquake and related tsunamis in the region.

 

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On a consolidated basis in constant currency, net revenues in our wholesale distribution channel increased 3% for the nine months ended July 31, 2012 compared to the nine months ended July 31, 2011, while retail channel net revenues increased 8% and e-commerce channel net revenues increased 158% for those same periods. The increase in e-commerce channel net revenues resulted from both organic, continuing growth on pre-existing platforms, as well as sales from new websites.

On a consolidated basis in constant currency, net revenues for our Quiksilver brand increased 6% for the nine months ended July 31, 2012 compared to the nine months ended July 31, 2011, while Roxy brand net revenues increased 6% and DC brand net revenues increased 10% for those same periods.

Our consolidated gross profit margin for the nine months ended July 31, 2012 decreased to 49.8% from 52.6% in the comparable period of the prior year. The gross profit margin in the Americas segment decreased to 43.8% from 46.3%, while our European segment gross profit margin decreased to 57.6% from 60.5%, and our Asia/Pacific segment gross profit margin decreased to 51.5% from 53.4% for those same periods. The decrease in our consolidated gross profit margin was primarily the result of higher levels of clearance business, discounting, higher input costs and the impact of fluctuations in foreign currency exchange rates. These factors also, in various degrees, had an impact on each segment’s gross margin.

Our SG&A for the nine months ended July 31, 2012 increased 5% to $680.2 million from $648.4 million in the comparable period of the prior year. SG&A increased 7% in constant currency. The increase in our consolidated SG&A was primarily due to additional fulfillment costs in support of higher revenues and increased expenses in our growing retail and e-commerce businesses. Our SG&A also increased due to an additional $7.4 million of non-cash stock-based compensation expense recorded in the nine months ended July 31, 2012 compared to the nine months ended July 31, 2011. These increases in SG&A were partially offset by a reduction in our marketing expenses. As a percentage of revenues, our consolidated SG&A increased to 46.8% for the nine months ended July 31, 2012 from 46.1% for the nine months ended July 31, 2011.

Asset impairment charges for the nine months ended July 31, 2012 were $0.6 million, compared to $74.6 million in the comparable period of the prior year. For the nine months ended July 31, 2011, these charges primarily consisted of a $74.1 million goodwill impairment charge recorded in our Asia/Pacific segment.

Interest expense for the nine months ended July 31, 2012 decreased to $45.5 million from $59.7 million in the comparable period of the prior year, primarily due to the inclusion in the prior year of approximately $13.7 million to write-off the deferred debt issuance costs associated with our European term loans that were paid off during the prior year upon the issuance of our European senior notes.

Our foreign currency gain amounted to $4.7 million for the nine months ended July 31, 2012 compared to $5.9 million in the comparable period of the prior year. The current year gain resulted primarily from the foreign currency exchange effect of certain non-euro denominated assets of our European subsidiaries and, to a lesser extent, US dollar denominated liabilities of our foreign subsidiaries.

Our income tax expense for the nine months ended July 31, 2012 was $14.9 million compared to $49.9 million for the nine months ended July 31, 2011. During the nine months ended July 31, 2011 we increased tax expense to establish a valuation allowance against deferred tax assets in our Asia/Pacific segment. As a result of this valuation allowance, and the valuation allowance previously established in the U.S., no tax benefits were recognized for losses in those tax jurisdictions.

Our net loss for the nine months ended July 31, 2012 was $15.1 million, or $0.09 per share on a diluted basis, compared to $89.2 million, or $0.55 per share on a diluted basis, in the comparable period of the prior year. Adjusted EBITDA decreased to $102.5 million from $145.2 million for those same periods, primarily driven by the decrease in consolidated gross profit margin.

 

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Financial Position, Capital Resources and Liquidity

In fiscal 2005, we issued $400 million of unsecured senior notes. In December 2010, we issued €200 million (approximately $265 million at issuance) in additional unsecured senior notes to repay our then existing European term loans. The 2010 transaction extended virtually all of our short-term maturities to a long-term basis. We generally finance our working capital needs and capital investments with operating cash flows and bank revolving lines of credit. Multiple banks in the United States, Europe and Australia make these lines of credit available to us. Term loans are also used to supplement these lines of credit and are typically used to finance long-term assets.

As of July 31, 2012, we had a total of approximately $783.4 million of indebtedness compared to a total of approximately $747.7 million of indebtedness at October 31, 2011.

Cash Flows

Operating activities used cash of $16.9 million in the nine months ended July 31, 2012 compared to cash provided of $47.2 million in the nine months ended July 31, 2011. The $64.1 million decrease in cash provided was primarily due to decreases in cash provided by our net loss adjusted for other non-cash charges of $52.2 million, and increases in cash used for working capital of $11.9 million.

Capital expenditures totaled $47.2 million for the nine months ended July 31, 2012, compared to $46.7 million in the comparable period of the prior year. These investments include company-owned stores and ongoing investments in computer and warehouse equipment, including our new global enterprise-wide reporting system.

During the nine months ended July 31, 2012, net cash provided by financing activities totaled $58.9 million, compared to $15.1 million in the comparable period of the prior year. Net cash provided primarily resulted from borrowings on our Americas and European credit facilities.

The net decrease in cash and cash equivalents for the nine months ended July 31, 2012 was $27.9 million compared to a net increase of $5.6 million in the comparable period of the prior year. Cash and cash equivalents totaled $81.9 million at July 31, 2012 compared to $109.8 million at October 31, 2011, while working capital was $542.3 million at July 31, 2012 compared to $581.4 million at October 31, 2011.

Trade Accounts Receivable and Inventories

Our trade accounts receivable increased slightly to $398.5 million at July 31, 2012 from $397.1 million at October 31, 2011. Accounts receivable in our Americas segment increased 9% to $223.0 million at July 31, 2012 from $204.8 million at October 31, 2011, European segment accounts receivable decreased 11% to $131.5 million from $148.0 million and Asia/Pacific segment accounts receivable decreased 1% to $44.0 million from $44.3 million for those same periods. Compared to July 31, 2011, accounts receivable increased 10% in the Americas segment, decreased 12% in our European segment and increased 28% in our Asia/Pacific segment. In constant currency, consolidated trade accounts receivable increased 10% compared to July 31, 2011. The increase in consolidated trade accounts receivable was primarily the result of higher levels of revenues. Included in accounts receivable at July 31, 2012 are approximately $25.1 million of value added tax and goods and services tax related to foreign accounts receivable. Such taxes are not reported as net revenues and as such, are deducted from accounts receivable to more accurately compute days sales outstanding. Overall average days sales outstanding increased by approximately one day at July 31, 2012 compared to July 31, 2011.

Consolidated inventories increased 12% to $391.1 million at July 31, 2012 from $347.8 million at October 31, 2011. Inventories in the Americas segment increased 3% to $158.8 million from $154.3 million at October 31, 2011, European segment inventories increased 37% to $158.9 million from $116.1 million and Asia/Pacific segment inventories decreased 5% to $73.3 million from $77.3 million. Compared to

 

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July 31, 2011, inventories increased 2% in the Americas segment, 16% in our European segment and 3% in our Asia/Pacific segment. In constant currency, our consolidated inventories increased 15% compared to July 31, 2011. The increase in consolidated inventories was primarily the result of lower revenues than we had planned in our European segment and, to a lesser extent, higher input costs. Consolidated average annual inventory turnover was approximately 2.6 times at July 31, 2012 compared to approximately 2.9 times at July 31, 2011.

Income Taxes

During the nine months ended July 31, 2012, our liability for uncertain tax positions, exclusive of interest and penalties, increased by $0.4 million to approximately $10.8 million. If our positions are favorably sustained by the relevant taxing authority, approximately $9.5 million, excluding interest and penalties, of uncertain tax position liabilities would favorably impact our effective tax rate in future periods.

Commitments

There have been no material changes outside the ordinary course of business in our contractual obligations since October 31, 2011.

Critical Accounting Policies

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. To prepare these financial statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities. These estimates also affect our reported revenues and expenses. Judgments must also be made about the disclosure of contingent liabilities. Actual results could be significantly different from these estimates. We believe that the following discussion addresses the accounting policies that are necessary to understand and evaluate our reported financial results.

Revenue Recognition

Revenues are recognized when the risk of ownership and title passes to our customers. Generally, we extend credit to our customers and do not require collateral. None of our sales agreements with any of our customers provide for any rights of return. However, we do approve returns on a case-by-case basis at our sole discretion to protect our brands and our image. We provide allowances for estimated returns when revenues are recorded, and related losses have historically been within our expectations. If returns are higher than our estimates, our results of operations would be adversely affected.

Accounts Receivable

Throughout the year, we perform credit evaluations of our customers, and we adjust credit limits based on payment history and the customer’s current creditworthiness. We continuously monitor our collections and maintain a reserve for estimated credit losses based on our historical experience and any specific customer collection issues that have been identified. We also use insurance on certain classes of receivables in our European segment. Historically, our losses have been consistent with our estimates, but there can be no assurance that we will continue to experience the same credit loss rates that we have experienced in the past. It is not uncommon for some of our customers to have financial difficulties from time to time. This is normal given the wide variety of our account base, which includes small surf shops, medium-sized retail chains, and some large department store chains. Unforeseen, material financial difficulties of our customers could have an adverse impact on our results of operations.

Inventories

We value inventories at the cost to purchase and/or manufacture the product or the current estimated market value of the inventory, whichever is lower. We regularly review our inventory quantities on hand, and adjust inventory values for excess and obsolete inventory based primarily on estimated forecasts of product demand and market value. Demand for our products could fluctuate significantly. The demand for our products could be negatively affected by many factors, including the following:

 

•

weakening economic conditions;

 

•

terrorist acts or threats;

 

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•

unanticipated changes in consumer preferences;

 

•

reduced customer confidence; and

 

•

unseasonable weather.

Some of these factors could also interrupt the production and/or importation of our products or otherwise increase the cost of our products. As a result, our operations and financial performance could be negatively affected. Additionally, our estimates of product demand and/or market value could be inaccurate, which could result in an understated or overstated provision required for excess and obsolete inventory.

Long-Lived Assets

We acquire tangible and intangible assets in the normal course of our business. We evaluate the recoverability of the carrying amount of these long-lived assets (including fixed assets, trademarks, licenses and other amortizable intangibles) whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss is recognized when the carrying value exceeds the undiscounted future cash flows estimated to result from the use and eventual disposition of the asset. Impairments are recognized in operating earnings. We continually use judgment when applying these impairment rules to determine the timing of the impairment tests, the undiscounted cash flows used to assess impairments, and the fair value of a potentially impaired asset. The reasonableness of our judgment could significantly affect the carrying value of our long-lived assets.

Goodwill

We evaluate the recoverability of goodwill at least annually based on a two-step impairment test. The first step compares the fair value of each reporting unit with its carrying amount, including goodwill. We have three reporting units under which we evaluate goodwill for impairment, the Americas, Europe and Asia/Pacific. We estimate the fair value of our reporting units using a combination of a discounted cash flow approach and market approach. Material assumptions in our test for impairment include future cash flows of each reporting unit, discount rates applied to these cash flows and current market estimates of value. The discount rates used approximate our cost of capital. Future cash flows assume future levels of growth in each reporting unit’s business. If the carrying amount exceeds fair value under the first step of our goodwill impairment test, then the second step of the impairment test is performed to measure the amount of any impairment loss.

As of October 31, 2011, the fair values of our Americas, Europe and Asia/Pacific reporting units substantially exceeded their carrying values. Based on the uncertainty of future growth rates and other assumptions used to estimate goodwill recoverability in our reporting units, future reductions in our expected cash flows for a reporting unit could cause a material impairment of goodwill.

Stock-Based Compensation Expense

We recognize compensation expense for all stock-based payments net of an estimated forfeiture rate and only recognize compensation cost for those shares expected to vest using the graded vested method over the requisite service period of the award. For option valuation, we determine the fair value using the Black-Scholes option-pricing model which requires the input of certain assumptions, including the expected life of the stock-based payment awards, stock price volatility and interest rates. For performance based equity awards with stock price contingencies, we determine the fair value using a Monte-Carlo simulation, which creates a normal distribution of future stock prices, which is then used to value the awards based on their individual terms.

Income Taxes

Income tax expense for interim periods is recognized based on the estimated annual effective tax rate applied to pretax income. A deferred income tax asset or liability is established for the expected future consequences of temporary differences in the financial reporting and tax bases of assets and liabilities. We consider future taxable income and ongoing prudent and feasible tax planning strategies in assessing the value of our deferred tax assets. If we determine that it is more likely than not that these assets will

 

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not be realized, we would reduce the value of these assets to their expected realizable value, thereby decreasing net income. Evaluating the value of these assets is necessarily based on our judgment. If we subsequently determine that the deferred tax assets, which had been written down would, in our judgment, be realized in the future, the value of the deferred tax assets would be increased, thereby increasing net income in the period when that determination was made.

On November 1, 2007, we adopted the authoritative guidance included in ASC 740, “Income Taxes” which clarifies the accounting for uncertainty in income taxes recognized in the financial statements. This guidance provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits of the tax position. We recognize accrued interest and penalties related to unrecognized tax benefits as a component of our provision for income taxes. The application of this guidance can create significant variability in our tax rate from period to period based upon changes in or adjustments to our uncertain tax positions.

Foreign Currency Translation

A significant portion of our revenues are generated in Europe, where we operate with the euro as our primary functional currency, and a smaller portion of our revenues are generated in Asia/Pacific, where we operate with the Australian dollar and Japanese yen as our primary functional currencies. Our European revenues in the United Kingdom are denominated in British pounds, and substantial portions of our European and Asia/Pacific product is sourced in U.S. dollars, both of which result in exposure to gains and losses that could occur from fluctuations in foreign currency exchange rates. Revenues and expenses that are denominated in foreign currencies are translated using the average exchange rate for the period. Assets and liabilities are translated at the rate of exchange on the balance sheet date. Gains and losses from assets and liabilities denominated in a currency other than the functional currency of the entity on which they reside are generally recognized currently in our statement of operations. Gains and losses from translation of foreign subsidiary financial statements into U.S. dollars are included in accumulated other comprehensive income or loss.

As part of our overall strategy to manage our level of exposure to the risk of fluctuations in foreign currency exchange rates, we enter into various foreign currency exchange contracts generally in the form of forward contracts. For all contracts that qualify as cash flow hedges, we record the changes in the fair value of the derivative contracts in other comprehensive income or loss.

New Accounting Pronouncements

See Note 2 to our condensed consolidated financial statements for a discussion of pronouncements that may affect our future financial reporting.

Forward-Looking Statements

All statements included in this report, other than statements or characterizations of historical fact, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, but are not limited to, statements regarding the trends and uncertainties in our financial condition, liquidity and results of operations. These forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs, and certain assumptions made by us and speak only as of the date of this report. Forward-looking statements can often be identified by words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “likely,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” and similar expressions, and variations or negatives of these words. In addition, any statements that refer to expectations, projections, guidance, forecasts or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. These statements are not guarantees of future results and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statement as a result of various factors, including, but not limited to, the following:

 

•

our ability to achieve the financial results that we anticipate;

 

•

future expenditures for capital projects, including the implementation of our global enterprise-wide reporting system;

 

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•

increases in production costs and raw materials, particularly with respect to labor costs;

 

•

deterioration of global or regional economic conditions and credit and capital markets;

 

•

our ability to continue to maintain our brand image and reputation;

 

•

foreign currency exchange rate fluctuations;

 

•

our ability to remain compliant with our debt covenants;

 

•

payments due on contractual commitments and other debt obligations; and

 

•

changes in political, social and economic conditions and local regulations, particularly in Europe and Asia.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks and uncertainties, we cannot assure you that the forward-looking information contained herein will, in fact, transpire.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to a variety of risks, including foreign currency exchange rate fluctuations.

Foreign Currency and Derivatives

We are exposed to financial statement gains and losses as a result of translating the operating results and financial position of our international subsidiaries. We translate the local currency statements of operations of our foreign subsidiaries into U.S. dollars using the average exchange rate during the reporting period. Changes in foreign currency exchange rates affect our reported results and distort comparisons from period to period. By way of example, when the U.S. dollar strengthens compared to the euro, there is a negative effect on our reported results for our European segment because it takes more profits in euros to generate the same amount of profits in stronger U.S. dollars. The opposite is also true. That is, when the U.S. dollar weakens there is a positive effect on the translation of our reported results from our European segment. Similarly, the statements of operations of our Asia/Pacific segment are translated from local currency into U.S. dollars, and there is a negative effect on our reported results for our Asia/Pacific segment when the U.S. dollar is stronger in comparison to those local currencies, such as the Australian dollar or Japanese yen.

European net revenues increased 2% in local currency during the nine months ended July 31, 2012 compared to the nine months ended July 31, 2011. As measured in U.S. dollars and reported in our condensed consolidated statements of operations, European net revenues decreased 5%, primarily as a result of a weaker euro versus the U.S. dollar in comparison to the prior year.

Asia/Pacific net revenues increased 14% in local currency during the nine months ended July 31, 2012 compared to the nine months ended July 31, 2011. As measured in U.S. dollars and reported in our condensed consolidated statements of operations, Asia/Pacific net revenues increased 16%, primarily as a result of a stronger Japanese yen versus the U.S. dollar in comparison to the prior year.

Our other foreign currency and interest rate risks are discussed in our Annual Report on Form 10-K for the year ended October 31, 2011 in Item 7A.

 

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Item 4. Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our disclosure controls and procedures are designed to provide a reasonable level of assurance of reaching our desired disclosure control objectives.

We carried out an evaluation under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of July 31, 2012, the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective and were operating at the reasonable assurance level as of July 31, 2012.

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended July 31, 2012 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

However, we have now begun the implementation of the new enterprise resource planning (“ERP”) system, SAP, in our European segment. Management continues to review and evaluate the design of key controls in SAP and the accuracy of the data conversion that is taking place during its implementation, and thus far has not uncovered a control deficiency or combination of control deficiencies that management believes meet the definition of a material weakness in internal control over financial reporting. Although management believes internal controls will be maintained or enhanced by SAP, it has not completed its testing of the operating effectiveness of all key controls in the new system. As such, there is a risk such control deficiencies may exist that have not yet been identified and that could constitute, individually or in combination, a material weakness. Management will continue to evaluate the operating effectiveness of related key controls during subsequent periods.

 

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PART II – OTHER INFORMATION

Item 6. Exhibits

 

2.1		Stock Purchase Agreement between the Roger Cleveland Golf Company, Inc., Rossignol Ski Company, Incorporated, Quiksilver, Inc. and SRI Sports Limited dated October 30, 2007 (incorporated by reference to Exhibit 2.3 of the Company’s Annual Report on Form 10-K for the year ended October 31, 2007).
2.2		Amendment No. 1 to the Stock Purchase Agreement between the Roger Cleveland Golf Company, Inc., Rossignol Ski Company, Incorporated, Quiksilver, Inc. and SRI Sports Limited dated December 7, 2007 (incorporated by reference to Exhibit 2.4 of the Company’s Annual Report on Form 10-K for the year ended October 31, 2007).
2.3		Stock Purchase Agreement dated November 12, 2008, by and among Quiksilver, Inc., Pilot S.A.S., Meribel S.A.S., Quiksilver Americas, Inc., Chartreuse et Mont Blanc LLC, Chartreuse et Mont Blanc SAS, Chartreuse et Mont Blanc Global Holdings S.C.A., Macquarie Asset Finance Limited and Mavilia SAS (incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on November 18, 2008).
2.4		Amendment No. 1 to Stock Purchase Agreement dated October 29, 2009, by and among Quiksilver, Inc., Pilot S.A.S., Meribel S.A.S., Quiksilver Americas, Inc., Chartreuse et Mont Blanc LLC, Chartreuse et Mont Blanc S.A.S., Chartreuse et Mont Blanc Global Holdings S.C.A., Macquarie Asset Finance Limited and Mavilia S.A.S. (incorporated by reference to Exhibit 2.1 of the Company’s Current Report on Form 8-K filed on October 30, 2009).
3.1		Restated Certificate of Incorporation of Quiksilver, Inc., as amended (incorporated by reference to Exhibit 3.1 of the Company’s Annual Report on Form 10-K for the year ended October 31, 2004).
3.2		Certificate of Amendment of Restated Certificate of Incorporation of Quiksilver, Inc. (incorporated by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended April 30, 2005).
3.3		Certificate of Designation of the Series A Convertible Preferred Stock of Quiksilver, Inc. (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on August 4, 2009).
3.4		Certificate of Amendment of Restated Certificate of Incorporation of Quiksilver, Inc. (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on April 1, 2010).
3.5		Amended and Restated Bylaws of Quiksilver, Inc. (incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed on November 2, 2010).
4.1		Indenture for the 6 7/8% Senior Notes due 2015 dated July 22, 2005, among Quiksilver, Inc., the subsidiary guarantors set forth therein and Wilmington Trust Company, as trustee, including the form of Global Note attached thereto (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed July 25, 2005).
4.2		Indenture, dated as of December 10, 2010, by and among Boardriders S.A., Quiksilver, Inc., as guarantor, the subsidiary guarantor parties thereto, and Deutsche Trustee Company Limited, as trustee, Deutsche Bank Luxembourg S.A., as registrar and transfer agent, and Deutsche Bank AG, London Branch, as principal paying agent and common depositary (incorporated by reference to Exhibit 4.1 of the Company’s Current Report on Form 8-K filed December 13, 2010).

 

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31.1		Rule 13a-14(a)/15d-14(a) Certifications –Principal Executive Officer
31.2		Rule 13a-14(a)/15d-14(a) Certifications –Principal Financial Officer
32.1		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Chief Executive Officer
32.2		Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Chief Financial Officer

101.INS*		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document

 

*

Pursuant to Rule 405(a)(2) of Regulation S-T, the registrant is relying upon the applicable 30-day grace period for the initial filing of its first Interactive Data File required to contain detail-tagged footnotes or schedules. The registrant intends to file the required detail-tagged footnotes or schedules by the filing of an amendment to this Quarterly Report on Form 10-Q within the 30-day period.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

				QUIKSILVER, INC., a Delaware corporation
September 10, 2012				/s/  Richard Shields
				Richard Shields
				Chief Financial Officer (Principal Financial Officer and Authorized Signatory)

 

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