Quiksilver Continues Struggle With Hardgoods…

Quiksilver, Inc. slipped into the red during their fiscal second quarter ended on April 30, due primarily to seasonal losses in the Rossignol business and declines in the Cleveland Golf business. Quiksilver’s core action sports brands remained strong throughout the quarter, with sales recovering in the Asia Pacific region and continued momentum in Europe and the Americas.

Overall, ZQK net revenue growth remained healthy, with a 17% increase across all brands and regions. Roughly $26 million of the revenue increase was due to currency translations. On a currency-neutral basis, revenues would have increased 11.8% for the period. Footwear and apparel were the primary growth drivers in every region when looking at sales on a currency-neutral basis. Roughly $22 million of the currency benefit came from Europe, with the rest coming from Asia Pacific and the Americas.

The Quiksilver brand grew around the world by approximately 15% and grew 8% in local currencies. This increase was also driven by strong growth in the footwear category. Roxy continued to show growth over 20%, or up over 15% in constant dollars. Like Quiksilver, growth came from all apparel categories, but also from a very strong result in the footwear category. Management pointed out that in the U.S., Roxy is now bigger than the base Quiksilver brand. DC had a 50% increase in revenues, or a 45% increase in constant dollars, driven by continued strength in the footwear. Management said that footwear was their fastest growing category. Overall the footwear business represents slightly more than 20% of ZQK’s business and more than 10% of the Quiksilver/Roxy business.

Bob McKnight, Quiksilver’s chairman and CEO, sparked some analyst attention during the quarterly conference call with some comments he made about “strategic alternatives” for the hardgoods business.

“I've said before and I will say again, we are looking at all of the strategic possibilities to accomplish this, although I can't really comment beyond that at this time,” said McKnight. “We are looking at every possible alternative concerning the hard goods, and like I said before, everything is on the table. But in the meantime, we're definitely focusing on those brands, working on their problems and fixing them.”

Revenue in Rossignol and other winter sports brands declined 1% for the quarter. Management is moving to aggressively reduce inventories and position themselves for recovery in 2008. Management said the vast majority of the operations restructuring is behind them and all they need is “cooperative weather and some time to place and incubate the apparel piece.”

Pre-season orders for snow sports equipment are trending better than expected for Rossignol. The company currently has roughly 80% of their pre-season orders in hand. Previously management was expecting a 20% to 25% decline in orders, but it is trending towards the 20% side of that range.

One key decision management made that will make retailers happy involves cutting back production capacity. Initially, management was going to reduce ski production from 1.2 million pairs down to 1 million pairs, but now Rossignol believes that 800,000 pairs is a better target. This decision, combined with planned production cuts from other manufacturers, should decrease the glut of inventory that has become common in in the snow sport market recently.

The Cleveland Golf business continues to be “very challenging” with revenues for the quarter down approximately 6% and gross margins under pressure. Management said that they view this as a “temporary imbalance of supply and demand at retail.” To fix this Cleveland is looking at operational problems and lengthening its product cycles to give retailers a chance to rationalize inventories. In Q3, the Cleveland golf business has reduced revenue and margin forecasts as it works to bring supply and demand into balance.

Overall, The softgoods business across all brands rose 21.1% for the fiscal second quarter to $519.1 million in the year-ago period. The Americas were up 17.7% and Asia Pacific grew 15.1% for the quarter, while Europe jumped 26.3%, due in part to currency shifts. Hardgoods revenues were down 4.0% for the quarter to $83.5 million. The Americas were down 11.5% and Asia Pacific declined 23.5% in hardgoods, but Europe rose 9.8% for the period.

Interestingly, even though the historically lower-margin hardgoods business declined and softgoods increased for the period, the gross profit margin for the second quarter slipped 50 basis points due to declining margins in the Americas and Europe, partially offset by improvements in Asia Pacific. Over the next five years, Quiksilver management plans to add an average of 100 basis points of operating margin per year, with 300 basis points from improvements in product development and sourcing and 200 basis points from expenses reduction. SG&A expenses were up 160 basis points due to increases in the Americas and Asia Pacific, partially offset by declines in Europe. Currency effects accounted for $12 million of the SG&A increase.

Inventory increased 20% in the Americas to $188.8 million; In Europe, it was up 6% to $205.9 million; and Asia-Pacific was up 37% to $68.6 million. The company reduced inventories in hardgoods but further reductions are an important objective.

ZQK expects to achieve net income for the fiscal year of 53 cents per share on consolidated revenue of approximately $2.5 billion. However, approximately three cents will shift from Q3 to Q4 due to reduced expectations at Cleveland Golf. Now Q3 earnings should be roughly two cents and Q4 should be 53 cents. Imbedded in the guidance are the expectation of a $100 million decline in winter hardgoods revenues and a $50 million pre-tax loss on Rossignol and Cleveland Golf.