Item 1. BUSINESS
Unless the context indicates otherwise, when we refer to “we”, “us”, “our”, or the “Company” in this Form 10-K, we are referring to Quiksilver, Inc. and its subsidiaries on a consolidated basis. Quiksilver, Inc. was incorporated in 1976 and was reincorporated in Delaware in 1986. Our fiscal year ends on October 31, and references to fiscal 2007, fiscal 2006 and fiscal 2005 refer to the years ended October 31, 2007, 2006 and 2005, respectively.
Introduction
We are a globally diversified company that designs, produces and distributes branded apparel, wintersports equipment, footwear, accessories and related products. Our apparel and footwear brands represent a casual lifestyle for young-minded people that connect with our boardriding culture and heritage, while our wintersports brands symbolize a long-standing commitment to technical expertise and competitive success on the mountains. We believe that surfing, skateboarding, snowboarding, skiing and other outdoor sports influence the apparel choices made by consumers as these activities are communicated to a global audience by television, the internet, movies and magazines. People are attracted to the venues in which these sports are performed and the values they represent, including individual expression, adventure and creativity.
Over the past 37 years, Quiksilver has been established as a leading global brand representing the casual, youth lifestyle associated with boardriding sports. Based on our fiscal 2007 revenues, we are the largest of the apparel and equipment companies that are identified with the sports of surfing, skateboarding and snowboarding. In July 2005, we acquired Skis Rossignol S.A. This acquisition added a collection of leading ski equipment brands to our company that we believe can be the foundation for a full range of technical ski apparel, sportswear and accessories. Rossignol is one of the world’s leading manufacturers of alpine skiing equipment, including skis, boots, bindings and poles. Also, as part of the acquisition, we acquired a majority interest in Roger Cleveland Golf Company, Inc. Our golf equipment operations were subsequently sold in December 2007 and are reported as discontinued operations in our consolidated financial statements.
We believe that our multiple authentic brands enable us to produce and market apparel, equipment, footwear, accessories and related products for consumers in a broad cross section of the outdoor market. Furthermore, we believe that our operations provide us with a diversified platform for continued growth and enhanced operating efficiencies.
Our products are sold in over 90 countries in a wide range of distribution channels, including surf shops, ski shops, skateboard shops, snowboard shops, our proprietary Boardriders Club shops, other specialty stores and select department stores. Our corporate and Americas’ headquarters are in Huntington Beach, California, while our European headquarters are in St. Jean de Luz and Moirans, France, and our Asia/Pacific headquarters are in Torquay, Australia.
In 2000, we acquired the international Quiksilver and Roxy trademarks from Quiksilver’s founders, and, in 2002, we acquired our licensees in Australia and Japan. Since 2000, we also have made several small acquisitions of other Quiksilver licensees. In May 2004, we acquired DC Shoes, Inc. to expand our presence in action sports-inspired footwear.
In October 2007, we entered into an agreement to sell our golf equipment business for a transaction value of $132.5 million. This transaction was completed in December 2007. As a result of this disposition, the following information has been adjusted to exclude our golf equipment operations. The golf equipment business has also been classified as a discontinued operation in our consolidated financial statements for all periods presented in this report.
Segment Information
We operate in the outdoor market of the sporting goods industry. We have three operating segments, the Americas, Europe and Asia/Pacific. The Americas segment includes revenues primarily from the U.S. and Canada. The European segment includes revenues primarily from Western Europe. The Asia/Pacific segment includes revenues primarily from Australia, Japan, New Zealand and Indonesia. Royalties earned from various licensees in other international territories are categorized in corporate operations. For information regarding the revenues, operating profits and identifiable assets attributable to our operating segments, see Note 15 of our consolidated financial statements.
Products and Brands
Our brands are focused on different sports within the outdoor market. Quiksilver and Roxy are rooted in the sport of surfing and are leading brands representing the boardriding lifestyle, which includes not only surfing, but also skateboarding and snowboarding. DC’s reputation is based on its technical shoes made for skateboarding. We have developed a portfolio of other brands also inspired by surfing, skateboarding and snowboarding. Our wintersports brands include Rossignol, Dynastar, Look, Lange and Kerma, which are focused on equipment for alpine skiing but have extended into other areas of wintersports, including snowboarding, freestyle skiing, Nordic skiing and technical outerwear.
Quiksilver
We have grown our Quiksilver brand from its origins as a line of boardshorts to now include shirts, walkshorts, t-shirts, fleece, pants, jackets, snowboardwear, footwear, hats, backpacks, wetsuits, watches, eyewear and other accessories. Quiksilver has also expanded its target market beyond young men to include boys, toddlers and infants. Quiksilveredition is our brand targeted at men. In fiscal 2007, the Quiksilver brand represented approximately 35% of our revenues.
Roxy
Our Roxy brand for young women is a surf-inspired collection that we introduced in 1991, and later expanded to include girls, with the Teenie Wahine and Roxy Girl brands, and infants. Roxy includes a full range of sportswear, swimwear, footwear, backpacks, snowboardwear, snowboards, snowboard boots, skis, ski boots, fragrance, beauty care, bedroom furnishings and other accessories for young women. In fiscal 2007, the Roxy brand accounted for approximately 31% of our revenues.
Rossignol and Other Wintersports Brands
Our Rossignol and other wintersports brands cover all of the major product categories in the ski and snowboard markets, including skis, bindings, boots and poles in the alpine category; skis, boots and bindings in the cross-country category; snowboards, snowboard boots and bindings; and technical ski apparel. With a long history of success in ski racing, these brands have developed a reputation for excellence, innovation and technical knowledge that have enabled them to appeal to multiple styles of skiing, including racing, all-mountain, freeride and freestyle. In fiscal 2007, the Rossignol and other wintersports brands accounted for approximately 16% of our revenues.
Our other wintersports brands include the following:
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Dynastar-Dynastar symbolizes technically specific skis for committed skiers to use in all the different experiences of alpine sports. Dynastar has a heritage of racing and performance.
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Lange-Lange is a ski boot brand, combining its race boot prowess with a commitment to building better, more comfortable boots for dedicated skiers of every type.
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Look-Look bindings have a winning history in alpine ski racing. The focus of the Look brand is the production of high quality, innovative release bindings that perform at the highest level.
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Kerma-We produce poles that complement our ski products from both a technical and aesthetic viewpoint under the Kerma brand.
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Lib Technologies, Gnu, Bent Metal-We address the core snowboard market through our Lib Technologies and Gnu brands of snowboards and accessories and Bent Metal snowboard bindings.
DC
Our DC brand specializes in performance skateboard shoes, snowboard boots, sandals and apparel for both young men and juniors. We believe that DC’s skateboard-driven image and lifestyle is well positioned within the global outdoor youth market and has appeal beyond its core skateboard base. In fiscal 2007, the DC brand accounted for approximately 15% of our revenues.
Other Apparel Brands
In fiscal 2007, our other apparel brands represented approximately 3% of our revenues.
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Raisins, Radio Fiji, Leilani-Raisins and Radio Fiji are swimwear labels for the juniors market, while Leilani is our contemporary swimwear label.
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Hawk-Tony Hawk, the world-famous skateboarder, is the inspiration for our Hawk brand. Our Hawk brand targets boys and young men who identify with the skateboarding lifestyle and recognize Tony Hawk from his broad media and video game exposure.
Product Categories
The following table shows the approximate percentage of revenues from continuing operations attributable to each of our major product categories during the last three fiscal years:
Although our products are generally available throughout the year, demand for different categories of product changes in the different seasons of the year. Sales of shorts, short-sleeve shirts, t-shirts and swimwear are higher during the spring and summer seasons, and sales of pants, long-sleeve shirts, fleece, jackets, sweaters, wintersports equipment and technical outerwear are higher during the fall and holiday seasons.
We believe that the U.S. retail prices for our apparel products range from approximately $21 for a t-shirt and $48 for a typical short to $200 for a typical snowboard jacket. For European products, retail prices range from approximately $42 for a t-shirt and about $90 for a typical short to $280 for a basic snowboard jacket. Asia/Pacific t-shirts sell for approximately $40, while shorts sell for approximately $55 and a basic snowboard jacket sells for approximately $230. Retail prices for a typical skate shoe range from approximately $65 in the U.S. to approximately $105 in Europe. The typical price for adult skis with bindings ranges from $350 to $1,350.
Product Design
Our apparel, footwear and related accessories are designed for young-minded people who live a casual lifestyle. Innovative design, active fabrics and quality of workmanship are emphasized. Our design and merchandising teams create seasonal product ranges for each of our brands. These design groups constantly monitor local and global fashion trends. We believe our most valuable input comes from our own managers, employees, sponsored athletes and independent sales representatives who are actively involved in surfing, skateboarding, skiing, snowboarding and other sports in our core market. This connection with our core market continues to be the inspiration for our products and is key to our reputation for distinct and authentic design. Our design centers in California, Europe, Australia and Japan develop and share designs and merchandising themes and concepts that are globally consistent while reflecting local adaptations for differences in geography, culture and taste.
Rossignol has been successful over its history in developing technical enhancements in ski equipment. We will continue research and development efforts for our wintersports business enabling us to design
and launch new products in response to changing demands and market expectations. We intend to continue to rely on the strong culture of technical expertise in the development of our products at our own facilities and at sub-contractor facilities.
Promotion and Advertising
The strength of our brands is based on many years of grassroots efforts that have established their legitimacy. We have always sponsored athletes that use our products in their outdoor sports, such as surfing, skiing, snowboarding, skateboarding and windsurfing, and have sponsored events that showcase these sports. Our technical excellence and the innovation of our products are validated when professional athletes compete with our equipment and succeed at a world-class level. Over time, our brands have become closely identified not only with the underlying sports they represent, but also with the way of life that is associated with those who are active in such sports. Accordingly, our advertising efforts are focused on promoting the sports and related lifestyle rather than advertising a specific product. As our sports and lifestyle have grown in popularity, not only in the United States but also internationally, the visibility of our brands has increased.
We have relationships with athletes worldwide. These include such well-known personalities as Kelly Slater, Lisa Andersen, Tom Carroll, Sofia Mulanovich, Chelsea Georgeson, Tony Hawk, Danny Way, Robbie Naish, Dave Mirra and Ricky Carmichael. Our relationships with athletes in the snow category include Alberto Tomba, Ted Ligety, Julia Mancuso, Manu Gaidet, Danny Kass, Todd Richards and Travis Rice. Along with these athletes, many of whom have achieved world champion status in their individual sports, we sponsor many amateurs and up-and-coming professionals. We believe that these athletes legitimize the performance of our products, form the basis for our advertising and promotional content, maintain a real connection with the core users of our products and create a general aspiration to the lifestyle that these athletes represent.
The events and promotions that we sponsor include world class boardriding events, such as Quiksilver’s Big Wave Invitational, which we believe is the most prestigious event among surfers, and the Roxy Pro, which we believe is the most visible women’s surf event of the pro season. We also sponsor many events in Europe, including the Slopestyle Pro snowboarding event and the Bowlriders skateboarding event, and our DC and Quiksilver athletes participate regularly in the Summer and Winter X-Games. Rossignol and our other wintersports brands receive international acclaim for winning on the world stage. In the 2006 Winter Olympics, our wintersports athletes won 36 medals, including 10 gold. In the 2007 Ski World Cup, our wintersports athletes won 35 medals, including 7 gold. Our wintersports brands continue to benefit from the publicity generated as sponsored athletes compete in the Ski World Cup, Winter Olympics, Freeride World Cup and Winter X-Games. In addition, we sponsor many regional and local events, such as surf camps and ski racing camps for beginners and enthusiasts, that reinforce the reputations of our brands as authentic among athletes and non-athletes alike.
Our brand messages are communicated through advertising, editorial content and other programming in both core and mainstream media. Coverage of our sports, athletes and related lifestyle form the basis of content for core magazines, such as Surfer, Surfing, Snowboard Canada, Transworld Skateboarding, Powder, Skieur and Freeride. Through our Quiksilver Entertainment division, we are bringing our lifestyle message to an even broader audience through television, films, books and co-sponsored events and products.
Customers and Sales
We sell our products in over 90 countries around the world. We believe that the integrity and success of our brands is dependent in part upon our careful selection of the retailers to whom we sell our products. Therefore, we maintain a strict and controlled distribution channel to uphold and grow the value of our brands.
The foundation of our business is the distribution of our products through surf shops, ski shops, skateboard shops, snowboard shops and our proprietary Boardriders Clubs shops where the environment communicates our brand messages and the sale of equipment is supported with technical
knowledge and experience. This core distribution channel serves as a base of legitimacy and long-term loyalty to us and our brands. Most of these stores stand alone or are part of small chains.
Our products are also distributed through independent specialty or active lifestyle stores and specialty chains. This category includes chains in the United States such as Pacific Sunwear, Nordstrom, Zumiez, Chicks Sporting Goods and Journeys, as well as many independent active lifestyle stores and sports shops in the United States and around the world. A limited amount of our apparel, footwear and accessories products are distributed through select department stores, including Macy’s and Bloomingdales in the U.S.; Le Printemps and Galeries Lafayette in France; and Corte Ingles in Spain.
Many of our brands are sold through the same retail accounts; however, distribution can be different depending on the brand and demographic group. Our Quiksilver products are sold in the Americas to customers that have approximately 9,800 store locations combined. Likewise, Roxy products are sold in the Americas to customers with approximately 9,600 store locations. Most of these Roxy locations also carry Quiksilver product. In the Americas, DC products are carried in approximately 8,300 stores. Our swimwear brands (Raisins, Leilani and Radio Fiji) are found in approximately 8,800 stores in the Americas, including many small, specialty swim locations, while our wintersports equipment (Rossignol, Dynastar, Look, Lange, Kerma, Lib Technologies, Bent Metal and Gnu) is found in approximately 3,900 stores, including primarily ski and snowboard shops in the U.S. and Canada. Our apparel, footwear and accessories are found in approximately 6,800 store locations in Europe, and in approximately 3,900 store locations in Asia/Pacific, and in both cases primarily include Quiksilver, Roxy and DC. Our wintersports equipment is found in approximately 7,800 store locations in Europe.
Our European segment accounted for approximately 44%, 46% and 41% of our consolidated revenues during fiscal 2007, 2006 and 2005, respectively. Our Asia/Pacific segment accounted for approximately 11%, 11% and 13% of our consolidated revenues in fiscal 2007, 2006 and 2005 respectively. Other fiscal 2007 non-U.S. sales are in the Americas segment (i.e. Canada, Central and South America) and were approximately 7% of consolidated revenues.
The following table summarizes the approximate percentages of our fiscal 2007 revenues by distribution channel:
Our revenues are spread over a large wholesale customer base. During fiscal 2007, approximately 16% of our consolidated revenues were from our ten largest customers, and our largest customer accounted for approximately 4% of such revenues.
Our products are sold by approximately 500 independent sales representatives in the Americas, Europe and Asia/Pacific. In addition, we use approximately 140 local distributors in Europe, which include approximately 90 Rossignol distributors. Our other international businesses use approximately 30 distributors, primarily in Asia/Pacific and South America. Our sales representatives are generally compensated on a commission basis. We employ retail merchandise coordinators in the United States who travel between specified retail locations of our wholesale customers to further improve the presentation of our product and build our image at the retail level.
Our sales are globally diversified. The following table summarizes the approximate percentages of our revenues by geographic region (excluding licensees):
We generally sell our apparel, footwear and related accessories to customers on a net-30 to net-60 day basis in the Americas, and in Europe and Asia/Pacific on a net-30 to net-90 day basis depending on the country and whether we sell directly to retailers in the country or to a distributor. Some customers are on C.O.D. terms. For our wintersports business, our sales terms vary by country, distribution channel and customer. We generally sell our wintersports equipment on net-90 or greater terms. These terms are consistent with terms typically offered in the wintersports market. We generally do not reimburse our customers for marketing expenses, participate in markdown programs with our customers, or offer goods on consignment.
For additional information regarding our revenues, operating profits and identifiable assets attributable to our operating segments, see Note 15 of our consolidated financial statements.
Retail Concepts
Quiksilver concept stores (Boardriders Clubs) are an important part of our global retail strategy. These stores are stocked primarily with Quiksilver and Roxy product, and their proprietary design demonstrates our history, authenticity and commitment to surfing and other boardriding sports. We also have Roxy stores, which are dedicated to the juniors customer, Quiksilver Youth stores, Andaska shops in Europe that carry multiple brands in the outdoor market including our Rossignol brands, and other multibrand stores in Europe. In various territories, we also operate Quiksilver and Roxy shops that are part of larger department stores. These shops, which are typically smaller than a stand-alone shop but have many of the same operational characteristics, are referred to below as shop-in-shops.
We own 406 stores in selected markets that provide enhanced brand-building opportunities. In territories where we operated our wholesale businesses during fiscal 2007, we had 207 stores with independent retailers under license. We do not receive royalty income from these licensed stores. Rather, we provide the independent retailer with our retail expertise and store design concepts in exchange for the independent retailer agreeing to maintain our brands at a minimum of 80% of the store’s inventory. Certain minimum purchase obligations are also required. Furthermore, in our licensed and joint venture territories, such as China and Mexico, our licensees operate 56 Boardriders Clubs. We receive royalty income from sales in these stores based on the licensees’ revenues. We also distribute our products through outlet stores generally located in outlet malls in geographically diverse, non-urban locations. The total number of stores open at October 31, 2007 was 669. The unit count of both company-owned and licensed stores at October 31, 2007, excluding stores in licensed territories, is summarized in the following table:
Seasonality
Our sales fluctuate from quarter to quarter primarily due to seasonal consumer demand patterns for different categories of our products, and due to the effect that the Christmas and holiday season has on the buying habits of our customers. The acquisition of Rossignol in July 2005 significantly increased our revenues, particularly between August and December.
Production and Raw Materials
Our apparel, footwear and accessories are generally sourced separately for our Americas, Europe and Asia/Pacific operations. We own a sourcing office in Hong Kong that manages the majority of production for our Asia/Pacific business and some of our Americas and European production. We believe that as we expand the Hong Kong sourcing operations, more products can be sourced together and additional efficiencies can be obtained. Approximately 86% of our apparel, footwear and accessories are purchased or imported as finished goods from suppliers principally in Hong Kong, China and the far east, but also in Mexico, India, North Africa, Portugal and other foreign countries. After being imported, many of these products require embellishment such as screenprinting, dyeing, washing or embroidery. In the Americas, the remaining 14% of our production is manufactured by independent contractors from raw materials we provide, with a substantial majority of this manufacturing done in the U.S. and the balance in Mexico.
We manufacture wintersports equipment globally for our Americas, Europe and Asia/Pacific operations. Production of alpine skis, cross-country skis and snowboards is shared primarily between France and Spain, with some production in the United States. Alpine bindings are also produced in France with the support of a network of approved subcontractors. Ski boots and ski poles are manufactured primarily in Italy, with certain boot components provided by subcontractors in eastern European countries, primarily Romania. For fiscal 2007, approximately 18% of our wintersports equipment manufacturing was subcontracted. All products are manufactured based upon design specifications that we provide, whether they are purchased or imported as finished goods or produced from raw materials that we provide.
The majority of our apparel, footwear and accessories finished goods, as well as raw materials for apparel, accessories and wintersports equipment must be committed to and purchased prior to the receipt of customer orders. If we overestimate the demand for a particular product, excess production can generally be distributed in our outlet stores or through secondary distribution channels. If we overestimate a particular raw material, it can generally be used in garments for subsequent seasons or in garments for distribution through our outlet stores or secondary distribution channels. If we overestimate a particular raw material for our wintersports equipment production, it also can be used in subsequent seasons.
During fiscal 2007, no single contractor of finished goods accounted for more than 6% of our consolidated production. No single raw material supplier accounted for more than 6% of our expenditures for raw materials during fiscal 2007. We believe that numerous qualified contractors, finished goods and raw materials suppliers are available to provide additional capacity on an as-needed basis and that we enjoy favorable on-going relationships with these contractors and suppliers.
Although we continue to explore new sourcing opportunities for finished goods and raw materials, we believe we have established solid working relationships over many years with vendors who are financially
stable and reputable, and who understand our product quality and delivery standards. As part of our efforts to reduce costs and enhance our sourcing efficiency, we have shifted increasingly to foreign suppliers. We research, test and add, as needed, alternate and/or back-up suppliers. However, in the event of any unanticipated substantial disruption of our relationship with, or performance by, key existing suppliers and/or contractors, there could be a short-term adverse effect on our operations.
Imports and Import Restrictions
We have for some time imported finished goods and raw materials for our domestic operations under multilateral and bilateral trade agreements between the U.S. and a number of foreign countries, including Hong Kong, India and China. These agreements impose quotas on the amount and type of textile and apparel products that are imported into the U.S. from the affected countries. We do not anticipate that these restrictions will adversely affect our operations since we would be able to meet our needs domestically or from other countries not affected by the restrictions.
In Europe, we operate in the European Union (“EU”) within which there are few trade barriers. We also operate under constraints imposed on imports of finished goods and raw materials from outside the EU, including quotas and duty charges. We do not anticipate that these restrictions will materially or adversely impact our operations since we have always operated under such constraints.
We retain independent buying agents, primarily in China, Hong Kong, India, Vietnam and other foreign countries to assist us in selecting and overseeing the majority of our independent third party manufacturing and sourcing of finished goods, fabrics, blanks and other products. In addition, these agents monitor quota and other trade regulations and perform some quality control functions. We also have approximately 250 employees in Hong Kong and China that are involved in sourcing and quality control functions to assist in monitoring and coordinating our overseas production.
By having employees in regions where we source our products, we enhance our ability to monitor factories to ensure their compliance with our standards of manufacturing practices. Our policies require every factory to comply with a code of conduct relating to factory working conditions and the treatment of workers involved in the manufacture of products.
Trademarks, Licensing Agreements and Patents
Trademarks
We own the “Quiksilver”, “Roxy” and famous mountain and wave and heart logos in virtually every country in the world. Other trademarks we own include “Raisins", “Radio Fiji”, “Leilani”, “Quiksilveredition”, “Hawk”, “Lib Tech”, “Gnu” and “Bent Metal”, "DCSHOECOUSA”, the “DC Star” logo and other trademarks. With the acquisition of Rossignol in 2005, we acquired the “Rossignol", “Dynastar", “Lange", “Look” and “Kerma” trademarks in countries around the world.
We apply for and register our trademarks throughout the world mainly for use on apparel, footwear and related accessories and for retail services. Our Rossignol trademarks have been registered for use on wintersports equipment, apparel and related accessories. We believe our trademarks and our other intellectual property are crucial to the successful marketing and sale of our products, and we attempt to vigorously prosecute and defend our rights throughout the world. Because of the success of our trademarks, we also maintain global anti-counterfeiting programs to protect our brands.
Licensing Agreements and Patents
We own rights throughout the world to use and license the Quiksilver and Roxy trademarks in substantially all apparel and related accessory product classifications and we directly operate all of the global Quiksilver and Roxy businesses with the exception of licensees in several countries, including Turkey, Argentina and Mauritius. We have also entered into a few joint venture arrangements with independent third parties to sell and distribute Quiksilver, Roxy and other branded products in various foreign territories, including Mexico and Brazil. In connection with these joint ventures, we license certain of our trademarks for use in connection with the sale and promotion of our products in these territories.
In April 2005, we licensed our Hawk brand in the United States to Kohl’s Stores, Inc., a department store chain with over 700 stores. Under Kohl’s’ license agreement, Kohl’s has the exclusive right to manufacture and sell Hawk branded apparel and some related products in its U.S. stores and through its website. We receive royalties from Kohl’s based upon sales of Hawk branded products. Under the license agreement, we are responsible for product design and Kohl’s manages sourcing, distribution, marketing and all other functions relating to the Hawk brand. The license agreement has an initial term of five years, with three five-year extensions at Kohl’s’ option. We continue to manufacture and sell Hawk branded products outside of the United States.
Our patent portfolio has increased with the acquisition of Rossignol to include ski, ski boot and ski binding patents in addition to our existing patents and applications primarily related to wetsuits, skate shoes, watches, board shorts, snowboards and snowboard boots.
Competition
Competition is strong in the global beachwear, skateboard shoe, casual sportswear and wintersports markets in which we operate, and each territory can have different competitors. Our direct competitors in the United States differ depending on distribution channel. Our principal competitors in our core channel of surf shops and Boardriders Clubs in the United States include Billabong International Pty Ltd, Volcom, Inc., O’Neill, Inc. and Hurley International LLC. Our competitors in the department store and specialty store channels in the United States include Abercrombie & Fitch Co. and its Hollister brand. Our principal competitors in the skateboard shoe market are Sole Technology, Inc. and DVS Shoe Company. In Europe, our principal competitors in the core channel include O’Neill, Inc., Billabong International Pty Ltd., Rip Curl International Pty Ltd., Oxbow S.A. and Chimsee. In Australia, our primary competitors are Billabong International Pty Ltd. and Rip Curl International Pty Ltd. In broader European distribution, and in Asia/Pacific, our competitors also include brands such as Nike Inc., Adidas AG and Levi Strauss & Co. Competition is strong in the wintersports market. Our principal competitors both in the United States and Europe in the wintersports market include Amer Sports Corporation (Atomic, Salomon), Jarden Corp. (K2), Tecnica Group, Head N.V. and Burton Snowboards North America. Some of our competitors may be significantly larger and have substantially greater resources than we have.
We compete primarily on the basis of successful brand management, product design and quality born out of our ability to:
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maintain our reputation for authenticity in the core boardriding and outdoor sports lifestyle demographics;
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continue to develop and respond to global fashion and lifestyle trends in our core markets;
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create innovative, high quality and stylish product at appropriate price points;
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continue to develop leading technologies in ski equipment; and
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convey our outdoor sports lifestyle messages to consumers worldwide.
Future Season Orders
At the end of November 2007, our backlog totaled $652 million compared to $567 million the year before. Our backlog depends upon a number of factors and fluctuates based on the timing of trade shows and sales meetings, the length and timing of various international selling seasons, changes in foreign currency exchange rates and market conditions. The timing of shipments also fluctuates from year to year based on the production of goods and the ability to distribute our products in a timely manner. As a consequence, a comparison of backlog from season to season is not necessarily meaningful and may not be indicative of eventual shipments or forecasted revenues.
Employees
At October 31, 2007, we had approximately 9,600 employees, consisting of approximately 3,900 in the United States and Canada, approximately 3,900 in Europe and approximately 1,800 in Asia/Pacific. None of our domestic employees are represented by trade unions, and less than 50 of our foreign employees are represented by trade unions. Certain French employees are represented by workers councils who negotiate with management on behalf of the employees. Management is generally required to share its plans with the workers councils, to the extent that these plans affect the represented
employees. We have never experienced a work stoppage and consider our working relationships with our employees and the workers councils to be good.
Environmental Matters
Some of our facilities and operations are subject to various federal, state and local environmental laws and regulations which govern, among other things, the use and storage of hazardous materials, the storage and disposal of solid and hazardous wastes, the discharge of pollutants into the air, water and land, and the cleanup of contamination. Some of our manufacturing operations involve the use of, among other things, inks, plastics, solvents and wood, and produce related byproducts and wastes. We have acquired businesses and properties in the past, and may do so again in the future. In the event we or our predecessors fail or have failed to comply with environmental laws, or cause or have caused a release of hazardous substances or other environmental damage, whether at our sites or elsewhere, we could incur fines, penalties or other liabilities arising out of such noncompliance, releases or environmental damage. Compliance with and liabilities under environmental laws and regulations did not have a significant impact on our capital expenditures, earnings or competitive position during the last three fiscal years.
Available Information
We file with the Securities and Exchange Commission (SEC) our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, proxy statements and registration statements. The public may read and copy any material we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet site at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants, including us, that file electronically.
Our corporate website is http://www.quiksilverinc.com. We make available free of charge, on or through this website, our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with the SEC. In addition, copies of the written charters for the committees of our board of directors, our Corporate Governance Guidelines, our Code of Ethics for Senior Financial Officers and our Code of Business Conduct and Ethics are also available on this website, and can be found under the Investor Relations and Corporate Governance links. Copies are also available in print, free of charge, by writing to Investor Relations, Quiksilver, Inc., 15202 Graham Street, Huntington Beach, California 92649. We may post amendments or waivers of our Code of Ethics for Senior Financial Officers and Code of Business Conduct and Ethics, if any, on our website. This website address is intended to be an inactive textual reference only, and none of the information contained on our website is part of this report or is incorporated in this report by reference.
Item 1A.
Item 1A. RISK FACTORS
Our business faces many risks. The risks described below may not be the only risks we face. Additional risks that we do not yet know of, or that we currently think are immaterial, may also impair our business operations or financial results. If any of the events or circumstances described in the following risks actually occurs, our business, financial condition or results of operations could suffer and the trading price of our common stock or our senior notes could decline. You should consider the following risks before deciding to invest in, or maintain your investment in, our common stock or senior notes.
The apparel, sporting goods and footwear industries are each highly competitive, and if we fail to compete effectively, we could lose our market position.
The apparel, sporting goods and footwear industries are each highly competitive. We compete against a number of domestic and international designers, manufacturers, retailers and distributors of apparel, sporting goods and footwear, some of whom are significantly larger and have significantly greater financial resources than we do. In order to compete effectively, we must (1) maintain the image of our brands and our reputation for authenticity in our core boardriding and outdoor sports markets; (2) be flexible and innovative in responding to rapidly changing market demands on the basis of brand image,
style, performance and quality; and (3) offer consumers a wide variety of high quality products at competitive prices.
The purchasing decisions of consumers are highly subjective and can be influenced by many factors, such as brand image, marketing programs and product design. Several of our competitors enjoy substantial competitive advantages, including greater brand recognition and greater financial resources for competitive activities, such as sales and marketing and strategic acquisitions. The number of our direct competitors and the intensity of competition may increase as we expand into other product lines or as other companies expand into our product lines. Our competitors may enter into business combinations or alliances that strengthen their competitive positions or prevent us from taking advantage of such combinations or alliances. Our competitors also may be able to respond more quickly and effectively than we can to new or changing opportunities, standards or consumer preferences. Our results of operations and market position may be adversely impacted by our competitors and the competitive pressures in the apparel, sporting goods and footwear industries.
If we are unable to develop innovative and stylish products in response to rapid changes in consumer demands and fashion trends, we may suffer a decline in our revenues and market share.
The apparel, sporting goods and footwear industries are subject to constantly and rapidly changing consumer demands based on fashion trends and performance features. Our success depends, in part, on our ability to anticipate, gauge and respond to these changing consumer preferences in a timely manner while preserving the authenticity and quality of our brands.
Our future success will depend, in part, upon our continued ability to develop and introduce innovative products reflective of technological advances in the respective markets in which we compete. If we are unable to successfully introduce new outdoor sporting goods products, or if our competitors introduce superior products, customers may purchase outdoor sporting goods products from our competitors, which could adversely affect our revenues and results of operations.
As is typical with new products, market acceptance of new designs and products we may introduce is subject to uncertainty. In addition, we generally make decisions regarding product designs several months in advance of the time when consumer acceptance can be measured. If trends shift away from our products, or if we misjudge the market for our product lines, we may be faced with significant amounts of unsold inventory or other conditions which could have a material adverse effect on our results of operations.
The failure of new product designs or new product lines to gain market acceptance could also adversely affect our business and the image of our brands. Achieving market acceptance for new products may also require substantial marketing efforts and expenditures to expand consumer demand. These requirements could strain our management, financial and operational resources. If we do not continue to develop stylish and innovative products that provide better design and performance attributes than the products of our competitors, or if our future product lines misjudge consumer demands, we may lose consumer loyalty, which could result in a decline in our revenues and market share.
Changes in foreign currency exchange or interest rates could affect our revenues and costs.
We are exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to certain sales, royalty income, and product purchases of our international subsidiaries that are denominated in currencies other than their functional currencies. We are also exposed to foreign currency gains and losses resulting from domestic transactions that are not denominated in U.S. dollars, and to fluctuations in interest rates related to our variable rate debt. If we are unsuccessful in using various foreign currency exchange contracts or interest rate swaps to hedge these potential losses, our profits and cash flows could be significantly reduced. In some cases, as part of our risk management strategies, we may choose not to hedge our exposure to foreign currency exchange rate changes, or we may choose to maintain variable interest rate debt. If we misjudge these risks, there could be a material adverse effect on our operating results and financial position.
Furthermore, we are exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our consolidated financial statements due to the
translation of the statements of income and balance sheets of our international subsidiaries into U.S. dollars. We may use foreign currency exchange contracts to hedge the profit and loss effects of this translation effect; however, accounting rules do not allow us to classify these contracts as hedges, but require us to mark these contracts to fair value at the end of each financial reporting period and translate our revenues and expenses at average exchange rates during the period. As a result, the reported revenues and expenses of our international subsidiaries would decrease if the U.S. dollar increased in value in relation to other currencies, including the euro, Australian dollar or Japanese yen.
Our business could be harmed if we fail to maintain proper inventory levels.
We maintain an inventory of selected products that we anticipate will be in high demand. We may be unable to sell the products we have ordered in advance from manufacturers or that we have in our inventory. Inventory levels in excess of customer demand may result in inventory write-downs or the sale of excess inventory at discounted or closeout prices. These events could significantly harm our operating results and impair the image of our brands. Conversely, if we underestimate consumer demand for our products or if our manufacturers fail to supply quality products in a timely manner, we may experience inventory shortages, which might result in unfilled orders, negatively impact customer relationships, diminish brand loyalty and result in lost revenues, any of which could harm our business.
Future acquisitions and related financings may place a significant debt burden on us.
From time to time, we have pursued, and may continue to pursue, acquisitions which involve the incurrence of additional debt, such as was incurred in connection with our acquisitions of DC Shoes and Rossignol. If one or more acquisitions results in our becoming substantially more leveraged on a consolidated basis, our flexibility in responding to adverse changes in economic, business or market conditions may be adversely affected, which could have a material adverse effect on our results of operations.
Our significant debt obligations could limit our flexibility in managing our business and expose us to certain risks.
We are highly leveraged. Our high degree of leverage may have negative consequences to us, including the following:
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we may have difficulty satisfying our obligations under our senior notes or other indebtedness and, if we fail to comply with these requirements, an event of default could result;
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we have certain short term lines of credit that could be difficult to replace if not renewed;
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we may be required to dedicate a substantial portion of our cash flow from operations to required payments on indebtedness, thereby reducing the availability of cash flow for working capital, capital expenditures and other general corporate activities;
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covenants relating to our indebtedness may limit our ability to obtain additional financing for working capital, capital expenditures and other general corporate activities;
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covenants relating to our indebtedness may limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
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we may be more vulnerable to the impact of economic downturns and adverse developments in our business; and
•
we may be placed at a competitive disadvantage against any less leveraged competitors.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Borrowings under our revolving credit facilities are at variable rates of interest and expose us to interest rate risk. If interest rates increase or interest rate spreads widen, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income and cash flows would decrease.
War, acts of terrorism, or the threat of either could have an adverse effect on our ability to procure our products and on the United States and/or international economies.
In the event of war or acts of terrorism or the escalation of existing hostilities, or if any are threatened, our ability to procure our products from our manufacturers for sale to our customers may be negatively affected. We import a substantial portion of our products from other countries. If it becomes difficult or
impossible to import our products into the countries in which we sell our products, our sales and profit margins may be adversely affected. Additionally, war, military responses to future international conflicts and possible future terrorist attacks may lead to a downturn in the U.S. and/or international economies which could have a material adverse effect on our results of operations.
Our success is dependent on our ability to protect our worldwide intellectual property rights, and our inability to enforce these rights could harm our business.
Our success depends to a significant degree upon our ability to protect and preserve our intellectual property, including copyrights, trademarks, patents, service marks, trade dress, trade secrets and similar intellectual property. We rely on the intellectual property, patent, trademark and copyright laws of the United States and other countries to protect our proprietary rights. However, we may be unable to prevent third parties from using our intellectual property without our authorization, particularly in those countries where the laws do not protect our proprietary rights as fully as in the United States. The use of our intellectual property or similar intellectual property by others could reduce or eliminate any competitive advantage we have developed, causing us to lose sales or otherwise harm our business. From time to time, we resort to litigation to protect these rights, and these proceedings can be burdensome and costly and we may not prevail.
We have obtained some U.S. and foreign trademarks, patents and service mark registrations, and have applied for additional ones, but cannot guarantee that any of our pending applications will be approved by the applicable governmental authorities. Moreover, even if the applications are approved, third parties may seek to oppose or otherwise challenge these or other registrations. A failure to obtain trademark, patent or service mark registrations in the United States and in other countries could limit our ability to protect our trademarks, patents and service marks and impede our marketing efforts in those jurisdictions. The loss of trademarks, patents and service marks, or the loss of the exclusive use of our trademarks, patents and service marks, could have a material adverse effect on our business, financial condition and results of operations. Accordingly, we devote substantial resources to the establishment and protection of our trademarks, patents and service marks on a worldwide basis and continue to evaluate the registration of additional trademarks, patents and service marks, as appropriate. We cannot assure you that our actions taken to establish and protect our trademarks, patents and service marks will be adequate to prevent imitation of our products by others or to prevent others from seeking to block sales of our products as violative of their trademark or other proprietary rights.
Our products may infringe the intellectual property rights of others, which may cause us to incur unexpected costs or prevent us from selling our products.
We cannot be certain that our products do not and will not infringe the intellectual property rights of others. We may be subject to legal proceedings and claims in the ordinary course of our business, including claims of alleged infringement of the intellectual property rights of third parties by us or our customers in connection with their use of our products. Any such claims, whether or not meritorious, could result in costly litigation and divert the efforts of our personnel. Moreover, should we be found liable for infringement, we may be required to enter into licensing agreements (if available on acceptable terms or at all) or to pay damages and cease making or selling certain products. Moreover, we may need to redesign or rename some of our products to avoid future infringement liability. Any of the foregoing could cause us to incur significant costs and prevent us from manufacturing or selling our products.
Our current executive officers and management are critical to our success, and the loss of any of these individuals could harm our business, brands and image.
We are heavily dependent on our current executive officers and management. We believe that our success depends to a significant degree upon the continued contributions of our executive officers and other key personnel, both individually and as a group. The loss of any of our executive officers or management or the inability to attract or retain qualified personnel could delay the development and introduction of new products, harm our ability to sell our products, damage the image of our brands and prevent us from executing our business strategy.
If we are unable to maintain and expand our endorsements by professional athletes, our ability to market and sell our products may be harmed.
A key element of our marketing strategy has been to obtain endorsements from prominent athletes, which contributes to the authenticity and image of our brands. We believe that this strategy has been an effective means of gaining brand exposure worldwide and creating broad appeal for our products. We cannot assure you that we will be able to maintain our existing relationships with these individuals in the future or that we will be able to attract new athletes to endorse our products. Larger companies with greater access to capital for athlete sponsorships may in the future increase the cost of sponsorships for these athletes to levels we may choose not to match. If this were to occur, our sponsored athletes may terminate their relationships with us and endorse the products of our competitors and we may be unable to obtain endorsements from other comparable athletes.
We also are subject to risks related to the selection of athletes whom we choose to endorse our products. We may select athletes who are unable to perform at expected levels or who are not sufficiently marketable. In addition, negative publicity concerning any of our athletes could harm our brand and adversely impact our business. If we are unable in the future to secure prominent athletes and arrange athlete endorsements of our products on terms we deem to be reasonable, we may be required to modify our marketing platform and to rely more heavily on other forms of marketing and promotion, which may not prove to be effective. In either case, our inability to obtain endorsements from professional athletes could adversely affect our ability to market and sell our products, resulting in loss of revenues and a loss of profitability.
We could be negatively impacted if we fail to successfully integrate the businesses we acquire or we could be negatively impacted by any business dispositions.
We have acquired businesses that we believe can enhance our business opportunities and our growth prospects. All acquisitions involve risks that can materially and adversely affect our business and operating results. These risks include:
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distracting management from our business operations;
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losing key personnel and other employees;
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costs, delays, and inefficiencies associated with integrating acquired operations and personnel;
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the impairment of acquired assets and goodwill; and
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acquiring the contingent and other liabilities of the businesses we acquire.
In addition, acquired businesses may not provide us with increased business opportunities, or result in the growth that we anticipate. Furthermore, integrating acquired operations is a complex, time-consuming, and expensive process. Combining acquired operations may result in lower overall operating margins, greater stock price volatility, and quarterly earnings fluctuations. Cultural incompatibilities, career uncertainties, and other factors associated with such acquisitions may also result in the loss of employees. Failing to acquire and successfully integrate our acquired businesses, or failing to achieve the business synergies or other anticipated benefits, could materially adversely affect our business and results of operations.
For example, in July 2005 we acquired Rossignol, and we expect that the acquisition of Rossignol will result in certain synergies, business opportunities and growth prospects. We, however, may never realize these expected synergies, business opportunities and growth prospects. In addition, integrating operations continue to require significant efforts and expenses. Personnel may leave or be terminated because of the acquisition and our management’s time and attention may be diverted from their other responsibilities. If these or other factors limit our ability to successfully integrate the operations of Rossignol on a timely basis, our expectations of future results of operations, including certain cost savings and synergies expected to result from the acquisition, may not be achieved. In addition, if the growth and operating strategies of Rossignol are not effective, it could have a material adverse effect on our business, financial condition and results of operations.
We are also subject to risks and uncertainties as a result of our asset or other business dispositions. For example, we recently sold Roger Cleveland Golf Company, Inc. and certain international affiliates dedicated to our golf equipment business. Asset and business dispositions, such as this, require significant management time and attention, and may not provide the intended benefits to the company that are anticipated at the time of such dispositions. Business dispositions may also negatively affect the cost or other synergies of an otherwise consolidated business. If any of our asset or business
dispositions do not have the benefits intended by such dispositions, our financial condition, results of operating and stock price may be negatively impacted.
Cyclical trends in apparel, sporting goods and footwear retailing could have a material adverse effect on our results of operations.
The apparel, sporting goods and footwear industries historically have been subject to substantial cyclical variations. As domestic and international economic conditions change, trends in discretionary consumer spending become unpredictable and could be subject to reductions due to uncertainties about the future. When consumers reduce discretionary spending, purchases of specialty apparel, footwear and sporting goods may decline. In addition, a general reduction in consumer discretionary spending due to a recession in the domestic and/or international economies or uncertainties regarding future economic prospects could have a material adverse effect on our results of operations.
As a result of our acquisition of Rossignol, we face greater challenges in managing several brands.
While we believe that we have significant experience in managing our apparel and footwear brands and their respective channels of distribution, with our acquisition of Rossignol, we have further penetrated the wintersports markets. If we are unable to effectively manage our multiple product lines in multiple markets, including our wintersports equipment manufacturing business, our profitability and cash flow may be reduced and our image and reputation could be harmed.
Employment related matters, such as unionization, may affect our profitability.
As of October 31, 2007, less than 50 of our employees were unionized, all outside of the United States, and certain French employees are represented by workers’ councils. We have little control over the union activities in these areas and could face difficulties in the future. There can be no assurance that we will not experience work stoppages or other labor problems in the future with our unionized employees, non-unionized employees or employees represented by workers councils or that we will be able to renew the collective bargaining agreements on similar or more favorable terms.
The demand for our products is seasonal and sales are dependent upon the weather.
Our revenues and operating results are subject to seasonal trends when measured on a quarterly basis. For example, sales of apparel products are typically lower during our first fiscal quarter when compared with our other fiscal quarters, while Rossignol’s sales have historically been higher between August and December at the peak of it’s winter equipment shipping activities. These trends are dependent on many factors, including the holiday seasons, weather, consumer demand, markets in which we operate and numerous other factors beyond our control. The seasonality of our business, unseasonable weather during our peak selling periods and/or misjudgment in consumer demands could have a material adverse effect on our financial condition and results of operations. For example, our financial results in the 2007 fiscal year were negatively impacted by unseasonably warm weather and by the lack of snow fall in many parts of the world which caused a significant reduction in our anticipated revenues and income in our wintersports equipment business. We expect these conditions to affect customer orders in the first quarter of fiscal 2008 and our wintersports equipment business continues to be vulnerable to the risk of unseasonable weather during future winter seasons.
Factors affecting international commerce and our international operations may seriously harm our financial condition.
We generate a majority of our revenues from outside of the United States, and we anticipate that revenue from our international operations could account for an increasingly larger portion of our revenues in the future. Our international operations are directly related to, and dependent on, the volume of international trade and foreign market conditions. International commerce and our international operations are subject to many risks, including:
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recessions in foreign economies;
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the adoption and expansion of trade restrictions;
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limitations on repatriation of earnings;
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difficulties in protecting our intellectual property or enforcing our intellectual property rights under the laws of other countries;
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longer receivables collection periods and greater difficulty in collecting accounts receivable;
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difficulties in managing foreign operations;
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social, political and economic instability;
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unexpected changes in regulatory requirements;
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our ability to finance foreign operations;
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tariffs and other trade barriers; and
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U.S. government licensing requirements for exports.
The occurrence or consequences of any of these risks may restrict our ability to operate in the affected regions and decrease the profitability of our international operations, which may harm our financial condition.
We have established, and may continue to establish, joint ventures in various foreign territories, such as Brazil and Mexico, with independent third party business partners to distribute and sell Quiksilver, Roxy and other branded products in such territories. These joint ventures are subject to substantial risks and liabilities associated with their operations, as well as the risk that our relationships with our joint venture partners do not succeed in the manner that we anticipate. If our joint venture operations, or our relationships with our joint venture partners, are not successful, our results of operation and financial condition may be adversely affected.
If the popularity of the sports associated with our brands were to decrease, our revenues could be adversely affected and our results of operations could be impaired.
We generate a significant portion of our revenues from the sale of products directly associated with boardriding and wintersports. The demand for such products is directly related to the popularity of boardriding activities and wintersports and the number of respective participants worldwide. If the demand for boardriding and/or wintersports equipment, apparel, and accessories decreases, our revenues could be adversely affected and our results of operations could be impaired. In addition, if participation in boardriding and/or wintersports activities were to decrease, sales of many of our products could decrease.
Our industry is subject to pricing pressures that may adversely impact our financial performance.
We manufacture many of our products offshore because manufacturing costs are generally less primarily due to lower labor costs. Many of our competitors also source their product requirements offshore to achieve lower costs, possibly in locations with lower costs than our offshore operations, and those competitors may use these cost savings to reduce prices. To remain competitive, we must adjust our prices from time to time in response to these industry-wide pricing pressures. Our financial performance may be negatively affected by these pricing pressures if:
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we are forced to reduce our prices and we cannot reduce our production costs; or
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our production costs increase and we cannot increase our prices.
Changing international trade regulations and the elimination of quotas on imports of textiles and apparel may increase competition in the apparel industry.
Future quotas, duties or tariffs may have a material adverse effect on our business, financial condition and results of operations. We currently import raw materials and/or finished garments into the majority of countries in which we sell our apparel products. Substantially all of our import operations are subject to:
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quotas imposed by bilateral textile agreements between the countries where our apparel-producing facilities are located and foreign countries; and
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customs duties imposed by the governments where our apparel-producing facilities are located on imported products, including raw materials.
In addition, the countries in which our apparel products are manufactured or to which they are imported may from time to time impose additional new quotas, duties, tariffs, requirements as to where raw materials must be purchased, additional workplace regulations or other restrictions on our imports, or otherwise adversely modify existing restrictions. Adverse changes in these costs and restrictions could harm our business. We cannot assure you that future trade agreements will not provide our competitors with an advantage over us, or increase our costs, either of which could have a material adverse effect on our business, results of operations and financial condition.
Our apparel-producing operations are also subject to the effects of international trade agreements and regulations such as the North American Free Trade Agreement, and the activities and regulations of the World Trade Organization, referred to as the WTO. Generally, such trade agreements benefit our apparel business by reducing or eliminating the duties and/or quotas assessed on products manufactured in a particular country. However, trade agreements can also impose requirements that negatively impact our apparel business, such as limiting the countries from which we can purchase raw materials and setting quotas on products that may be imported into the United States from a particular country.
We rely on third-party manufacturers and problems with, or loss of, our suppliers or raw materials could harm our business and results of operations.
Substantially all of our apparel products are produced by independent manufacturers. We face the risk that these third-party manufacturers with whom we contract to produce our products may not produce and deliver our products on a timely basis, or at all. We cannot be certain that we will not experience operational difficulties with our manufacturers, such as reductions in the availability of production capacity, errors in complying with product specifications, insufficient quality control, failures to meet production deadlines or increases in manufacturing costs. The failure of any manufacturer to perform to our expectations could result in supply shortages for certain products and harm our business.
The capacity of our manufacturers to manufacture our products also is dependent, in part, upon the availability of raw materials. Our manufacturers may experience shortages of raw materials, which could result in delays in deliveries of our products by our manufacturers or in increased costs to us. Any shortage of raw materials or inability of a manufacturer to manufacture or ship our products in a timely manner, or at all, could impair our ability to ship orders of our products in a cost-efficient, timely manner and could cause us to miss the delivery requirements of our customers. As a result, we could experience cancellations of orders, refusals to accept deliveries or reductions in our prices and margins, any of which could harm our financial performance and results of operations.
In addition, substantially all of the raw materials for our wintersports equipment are sold to us by unaffiliated suppliers located primarily in Europe and Asia. We have no exclusive or significant long-term contracts with these suppliers and we compete with other companies for such suppliers’ output. Although we believe that we have established good relationships with such suppliers, the inability to maintain such relationships or to find additional sources to cover future growth could have a material adverse effect on our business.
Our failure to comply with, or the imposition of liability under, environmental laws and regulations could result in significant costs.
Some of our facilities and operations are subject to various environmental laws and regulations which govern, among other things, the use and storage of hazardous materials, the storage and disposal of solid and hazardous wastes, the discharge of pollutants into the air, water and land, and the cleanup of contamination. Violations of these requirements could result in significant fines or penalties being imposed on us. Discovery of contamination for which we are responsible, the enactment of new laws and regulations, or changes in how existing requirements are enforced, could require us to incur additional costs for compliance or subject us to unexpected liabilities. Any such costs or liabilities could have a material adverse effect on our business and results of operation.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2.
Item 2. PROPERTIES
As of October 31, 2007, our principal facilities in excess of 40,000 rentable square feet, all of which are leased, are as follows:
*
Includes extension periods exercisable at our option.
As of October 31, 2007, we operated 111 retail stores in the Americas, 201 retail stores in Europe, and 94 retail stores in Asia/Pacific on leased premises. The leases for our facilities required aggregate annual rentals of approximately $95.1 million in fiscal 2007. We anticipate that we will be able to extend those leases that expire in the near future on terms satisfactory to us, or, if necessary, locate substitute facilities on acceptable terms. We believe that our corporate, distribution and retail leased facilities are suitable and adequate to meet our current needs.
Item 3.
Item 3. LEGAL PROCEEDINGS
We are involved from time to time in legal claims involving trademark and intellectual property, licensing, employee relations and contractual and other matters incidental to our business. We believe the resolution of any such matter currently pending will not have a material adverse effect on our financial condition or results of operations.
On February 27, 2007, a class action captioned Burnis L. Simon, Jr. v. Quicksilver, Inc. (sic), Case No. CV07-01326, was filed against us in the United States District Court for the Central District of California. The complaint alleges willful violation of the federal Fair and Accurate Credit Transactions Act (“FACTA”) based upon certain of our retail stores’ alleged electronic printing of receipts on which appeared more than the last five digits of customers’ credit or debit card numbers and/or the expiration of such customers’ credit or debit cards. The complaint seeks statutory damages of not less than $100 and not more than $1,000 for each violation, as well as unspecified punitive damages, attorneys’ fees and a permanent injunction from further engaging in violations of FACTA. The complaint does not allege that any class member has suffered actual damages. Similar complaints have been filed against a number of other retailers. We intend to vigorously defend against the claims asserted. However, the results of any litigation are inherently uncertain and we cannot assure that we will be able to successfully defend against such claims. We are currently unable to assess the extent of damages and/or other relief, if any, that could be awarded to the plaintiff class if it were to prevail.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted for a vote of our stockholders during the fourth quarter of the fiscal year ended October 31, 2007.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the New York Stock Exchange (“NYSE”) under the symbol “ZQK.” The high and low sales prices of our common stock, as reported by the NYSE for the two most recent fiscal years, are set forth below.
We have historically reinvested our earnings in our business and have never paid a cash dividend. No change in this practice is currently being considered. Our payment of cash dividends in the future will be determined by our Board of Directors, considering conditions existing at that time, including our earnings, financial requirements and condition, opportunities for reinvesting earnings, business conditions and other factors. In addition, under the indenture related to our senior notes and under our principal credit agreement with a bank group, there are limits on the dividends and other payments that certain of our subsidiaries may pay to us and we must obtain the note holders and bank group’s prior consent to pay dividends to our shareholders above a pre-determined amount.
On December 18, 2007, there were approximately 740 holders of record of our common stock and an estimated 23,636 beneficial stockholders.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The statement of income and balance sheet data shown below were derived from our consolidated financial statements. Our consolidated financial statements as of October 31, 2007 and 2006 and for each of the three years in the period ended October 31, 2007, included herein, have been audited by Deloitte & Touche LLP, our independent registered public accounting firm. You should read this selected financial data together with our consolidated financial statements and related notes, as well as the discussion under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
jurisdictions, the impact of our asset base, which can differ depending on the book value of assets and the accounting methods used to compute depreciation and amortization, and the effect of non-cash stock-based compensation expense. We believe it is useful to investors for the same reasons. EBITDA has limitations as a profitability measure in that it does not include the loss from discontinued operations, 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 compensation expense and the effect of asset impairments. Following is a reconciliation of income from continuing operations to EBITDA:
(6)
Computed based on income from continuing operations divided by the average of beginning and ending stockholders’ equity.
Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read together with our consolidated financial statements and related notes, which are included in this report, and the “Risk Factors” information, set forth in Item 1A. above.
Overview
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 grew our distribution channels. After going public in 1986 and purchasing the rights to the Quiksilver brand in the United States from our Australian licensor, 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 in the 1990s by adding products for boys, girls, toddlers and men and we introduced our proprietary retail store concept, Boardriders Clubs, which 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 May 2004, we acquired DC Shoes, Inc. to expand our presence in action sports-inspired footwear. In July 2005, we acquired Skis Rossignol, S.A., a wintersports and golf equipment manufacturer. Rossignol offers a full range of wintersports equipment under the Rossignol, Dynastar, Lange, Look and Kerma brands. The acquisition was effective July 31, 2005 and we included the operations of Rossignol in our results beginning on August 1, 2005. Brand building has been a key to our growth, and we have always maintained our roots in the boardriding lifestyle. Today our products are sold throughout the world, primarily in surf shops, snow shops, skate shops and specialty stores.
Over the past 37 years, Quiksilver has been established as a leading global brand representing the casual, youth lifestyle associated with boardriding sports. With our acquisition of Rossignol, we added a collection of leading ski equipment brands to our company that we believe can be the foundation for a full range of technical ski apparel, sportswear and accessories.
In October 2007, we entered into an agreement to sell our golf equipment business for a transaction value of $132.5 million. This transaction was completed in December 2007. As a result of this disposition, the following financial information has been adjusted to exclude our golf equipment operations. The golf equipment business has also been classified as a discontinued operation in our consolidated financial statements for all periods presented.
Over the last five years, our revenues have grown from $972 million in fiscal 2003 to $2.43 billion in fiscal 2007. We operate in the outdoor market of the sporting goods industry in which we design, produce and distribute branded apparel, wintersports equipment, footwear, accessories and related products. We operate in three segments, the Americas, Europe and Asia/Pacific. The Americas segment includes revenues primarily from the U.S. and Canada. The European segment includes revenues primarily from Western Europe. The Asia/Pacific segment includes revenues primarily from Australia, Japan, New Zealand and Indonesia. Royalties earned from various licensees in other international territories are categorized in corporate operations along with revenues from sourcing services for our licensees. Revenues by segment are as follows:
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, engineers, 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 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.
Results of Operations
The table below shows certain components in our statements of operations and other data as a percentage of revenues:
(1)
For a definition of EBITDA and a reconciliation of Income from continuing operations to EBITDA, see footnote (5) to the table under Item 6. Selected Financial Data.
Fiscal 2007 Compared to Fiscal 2006
Revenues
Our total net revenues increased 10% in fiscal 2007 to $2,426.0 million from $2,200.2 million in fiscal 2006 primarily as a result of increased unit sales. Revenues in the Americas increased 16%, European revenues increased 7%, and Asia/Pacific revenues increased 2%. To understand our European fiscal 2007 growth and better assess competitive performance, we believe it is important to consider revenues in euros as well, which is our functional currency in Europe. In euros, revenues decreased 3% in fiscal
2007. This is lower than the 7% growth rate in U.S. dollars because the U.S. dollar was worth less in euros on average in fiscal 2007 compared to fiscal 2006. For consolidated financial statement reporting, Australian dollar results must be translated into U.S. dollar amounts at average exchange rates, but as with our European segment, this can distort performance when exchange rates change from year to year. In Australian dollars, revenues decreased 11% in fiscal 2007. This is lower than the 2% growth rate in U.S. dollars because the U.S. dollar was worth less in Australian dollars on average in fiscal 2007 compared to fiscal 2006.
Our net revenues can be categorized into two general classifications: apparel brands and equipment brands. Our apparel brand revenue classification includes Quiksilver, Roxy, DC and our other apparel brands of Hawk, Gotcha, Raisins, Leilani and Radio Fiji. Our equipment brand revenue classification includes our Rossignol and other wintersports brands, comprising Rossignol, Dynastar, Look, Lange, Kerma, Lib Technologies, Gnu and Bent Metal.
Our apparel brand revenues increased 20% to $2,042.0 million in fiscal 2007 from $1,708.8 million in fiscal 2006. This increase resulted from strength in our DC, Quiksilver and Roxy brands. DC’s growth was primarily in footwear and, to a lesser extent, its apparel and accessories products. Quiksilver and Roxy brand revenue growth came primarily from growth in apparel and, to a lesser extent, accessories and footwear products. Our wintersports equipment brand revenues decreased 22% to $379.2 million in fiscal 2007 from $486.0 million in fiscal 2006. This decrease in revenues was a result of decreased market demand caused by unseasonably warm weather and a lack of snowfall in many parts of Europe and the United States in the 2006/2007 winter season. The 2006/2007 season also had a negative impact on the beginning of the 2007/2008 snow season as preorders were down significantly from the prior year and less reorders are expected on the smaller base of preorders.
In the Americas, our apparel brand revenues for fiscal year 2007 increased 21%, while our equipment brand revenues decreased 14% compared to fiscal 2006. In Europe, our apparel brand revenues for fiscal year 2007 increased 22% while our equipment brand revenues decreased 23% compared to fiscal 2006. In Asia/Pacific, our apparel brand revenues for fiscal 2007 increased 8%, while our equipment brand revenues decreased 45% compared to fiscal 2006.
Gross Profit
Our consolidated gross profit margin increased to 46.3% in fiscal 2007 from 45.7% in the previous year. The gross profit margin in the Americas increased to 40.7% from 39.9%, our European gross profit margin increased to 51.6% from 51.2%, and our Asia/Pacific gross profit margin increased to 47.3% from 45.9%. The increase in the Americas’ gross profit margin was primarily due to lower production costs and a higher percentage of sales through company owned retail stores where higher gross margins are generated. Our European and Asia/Pacific gross profit margin increases were primarily due to higher margins from our apparel brands, primarily as a result of the currency effect of sourcing goods in U.S. dollars, partially offset by lower margins on our equipment brands.
Selling, General and Administrative Expense
Selling, general and administrative expense increased 17% in fiscal 2007 to $971.4 million from $827.0 million in fiscal 2006. In the Americas, these expenses increased 21% to $340.5 million from $281.9 million, in Europe they increased 17% to $465.7 million from $396.9 million; and in Asia/Pacific they increased 13% to $106.3 million from $94.3 million for those same periods. As a percentage of revenues,
selling, general and administrative expense increased to 40.0% of sales in fiscal 2007 compared to 37.6% in fiscal 2006. The increase in selling, general and administrative expense as a percentage of revenues was primarily caused by the cost of opening and operating additional retail stores, increased distribution costs and, to a lesser extent, costs recorded in continuing operations as a result of our termination of a consulting agreement with the former minority shareholder of Cleveland Golf.
Asset Impairments
Asset impairment charges totaled $166.4 million in fiscal 2007 compared to zero in fiscal 2006. Of these charges approximately $156.9 related to Rossignol related goodwill, approximately $6.9 million related to trademark impairment and approximately $2.6 million related to fixed asset impairments. The goodwill and intangible impairment charges were recorded as a result of our annual impairment test, where it was determined that the carrying values of certain Rossignol related asset groups were less than the estimated fair value of those same groups as of October 31, 2007.
Non-operating Expenses
Interest expense increased to $57.0 million in fiscal 2007 compared to $47.4 million in fiscal 2006 primarily as a result of the translation effect of euro denominated interest, higher borrowing levels on our lines of credit to finance increased working capital needs and, to a lesser extent, higher interest rates on our variable-rate debt in Europe and the United States.
Our foreign currency loss amounted to $1.8 million in fiscal 2007 compared to approximately zero in fiscal 2006. This current year loss resulted primarily from the foreign currency contracts that we used to mitigate the risk of translating the results of our international subsidiaries into U.S. dollars and the foreign exchange effect of certain non-U.S. dollar denominated liabilities.
Our income tax rate increased to (32.5)% in fiscal 2007 from 28.4% in fiscal 2006. The current year rate increased significantly due to the non-deductibility of the goodwill asset impairment recorded in fiscal 2007. This increase was partially offset by the higher impact of certain beneficial items included in our tax rate.
Income from continuing operations and EBITDA
Income from continuing operations in fiscal 2007 decreased to a $98.6 million loss, and earnings per share on a diluted basis decreased to a loss of $0.80 compared to income from continuing operations of $94.1 million and diluted earnings per share of $0.74 for fiscal 2006. EBITDA decreased to $232.7 million in fiscal 2007 compared to $262.1 million in fiscal 2006.
Fiscal 2006 Compared to Fiscal 2005
Revenues
Our total net revenues increased 27% in fiscal 2006 to $2,200.2 million from $1,734.5 million in fiscal 2005 primarily as a result of the Rossignol acquisition, increased unit sales and new products. Revenues in the Americas increased 17%, European revenues increased 41%, and Asia/Pacific revenues increased 15%. In euros, European revenues increased 44% in fiscal 2006. This is higher than the 41% growth rate in U.S. dollars because the U.S. dollar was worth more in euros on average in fiscal 2006 compared to fiscal 2005. In Australian dollars, revenues increased 18%. This is higher than the 15% growth rate in U.S. dollars because the U.S. dollar was worth more than the Australian dollar on average in fiscal 2006 compared to fiscal 2005. We completed the acquisition of Rossignol effective July 31, 2005, and these operations are included in our results for only three months in fiscal 2005, but a full year in fiscal 2006, resulting in consolidated revenue growth of 17% in fiscal 2006. Rossignol operates in all three of our operating segments, primarily producing wintersports equipment, and accounted for net revenues of $480.4 million in fiscal 2006 compared to $172.1 million in fiscal 2005.
Our apparel brand revenues increased 10% to $1,708.8 million in fiscal 2006 from $1,552.6 million in fiscal 2005. This increase resulted from strength in our Roxy, DC and Quiksilver brands. Quiksilver and Roxy brand revenue growth came primarily from growth in apparel and, to a lesser extent, footwear and accessories. DC’s growth was primarily in footwear and, to a lesser extent, its apparel and accessories products. Our wintersports equipment brand revenues increased to $486.0 million in fiscal 2006 from
$177.9 million in fiscal 2005. The increase in wintersports equipment revenue was primarily due to the Rossignol acquisition as we had a full year of wintersports equipment operations in fiscal 2006 compared to three months in fiscal 2005.
In the Americas, our apparel brand revenues for fiscal year 2006 increased 10%, while our equipment brand revenues increased 114% compared to fiscal 2005. In Europe, our apparel brand revenues for fiscal year 2006 increased 12% while our equipment brand revenues increased 187% compared to fiscal 2005. In Asia/Pacific, our apparel brand revenues for fiscal 2006 increased 5%, while our equipment brand revenues increased 561% compared to fiscal 2005. The increase in wintersports equipment revenue was primarily due to the Rossignol acquisition as we had a full year of wintersports equipment operations in fiscal 2006 compared to three months in fiscal 2005.
Gross Profit
Our consolidated gross profit margin increased to 45.7% in fiscal 2006 from 45.5% in the previous year. The gross profit margin in the Americas increased to 39.9% from 39.5%, our European gross profit margin increased to 51.2% from 50.9%, and our Asia/Pacific gross profit margin decreased to 45.9% from 49.9%. The increase in the Americas’ gross profit margin was primarily due to lower production costs, improved margins in our DC brand, and a higher percentage of sales through company owned retail stores where higher gross margins are generated, partially offset by higher sales from our wintersports equipment business, which operated at lower margins than our other businesses. Our European gross profit margin increased slightly due to a higher percentage of sales through company-owned retail stores. This increase was substantially offset by the impact of the lower margins from our Rossignol business. In Asia/Pacific, the gross profit margin decrease was primarily due to sales from our lower margin wintersports equipment business and lower margins on our other brands, partially offset by a higher percentage of sales through company-owned retail stores.
Selling, General and Administrative Expense
Selling, general and administrative expense increased 36% in fiscal 2006 to $827.0 million from $607.5 million in fiscal 2005. In the Americas, these expenses increased 22% to $281.9 million from $231.7 million, in Europe they increased 54% to $396.9 million from $257.9 million, and in Asia/Pacific they increased 19% to $94.3 million from $79.5 million for those same periods. As a percentage of revenues, selling, general and administrative expense increased to 37.6% of sales in fiscal 2006 compared to 35.0% in fiscal 2005. The increase in selling, general and administrative expense as a percentage of revenues is primarily due to $20.5 million in stock compensation expense recorded in the current period as a result of adopting Statement of Financial Accounting Standards “SFAS” No. 123(R) “Share-Based Payment” on November 1, 2005, the cost of additional retail stores and, to a lesser extent, a full year of our wintersports equipment business, which operated with slightly higher selling, general and administrative expenses as a percentage of revenues compared to our other businesses.
Non-operating Expenses
Interest expense increased to $47.4 million in fiscal 2006 compared to $20.8 million in fiscal 2005 primarily as a result of debt incurred and assumed in connection with the acquisition of Rossignol.
We had no foreign currency gain in fiscal 2006 compared to a foreign currency gain of $0.2 million in fiscal 2005. This current year change resulted primarily from the net effect of foreign currency contracts that we used to mitigate the risk of translating the results of our international subsidiaries into U.S. dollars.
Our income tax rate decreased to 28.4% in fiscal 2006 from 32.3% in fiscal 2005. This improvement resulted primarily because a higher percentage of our fiscal 2006 profits were generated in countries with lower tax rates and from foreign tax credits.
Income from continuing operations and EBITDA
Income from continuing operations in fiscal 2006 was $94.1 million, and earnings per share on a diluted basis was $0.74 compared to income from continuing operations of $108.3 million and earnings per share on a diluted basis of $0.87 for fiscal 2005. EBITDA increased 18% in fiscal 2006 to $262.1 million compared to $222.0 million in fiscal 2006.
Financial Position, Capital Resources and Liquidity
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. In July 2005, we issued $400 million in senior notes to fund a portion of the Rossignol purchase price and to refinance certain existing indebtedness.
Cash and cash equivalents totaled $74.3 million at October 31, 2007 versus $36.8 million at October 31, 2006. Working capital amounted to $631.9 million at October 31, 2007, compared to $568.6 million at October 31, 2006, an increase of 11%. We believe that our current cash balance, operating cash flows and current lines of credit are adequate to cover our cash needs for at least the next twelve months and that increases in our lines of credit can be obtained as needed to fund future growth. We have generated further liquidity of approximately $105.0 million from the sale of our golf equipment operations in December 2007.
Operating Cash Flows
Operating activities of continuing operations provided cash of $125.9 million in fiscal 2007 compared to cash used of $5.0 million in fiscal 2006. This improvement primarily relates to a decrease in cash used for inventory, accounts receivable and accounts payable of $112.4 million.
Operating activities of continuing operations used cash of $5.0 million in fiscal 2006 compared to cash provided of $6.7 million in fiscal 2005. This $11.7 million increase in cash used was primarily caused by an increase in inventories, net of accounts payable, which used cash of $37.7 million in fiscal 2006 compared to providing cash of $54.9 million in fiscal 2005, and an increase in cash used for other working capital components, which used cash of $70.3 million in fiscal 2006 compared to cash provided of $15.4 million in fiscal 2005. These increases in cash used were partially offset by an increase in cash profits, which provided $190.1 million of cash in fiscal 2006 compared to $162.2 million in fiscal 2005, and a decrease in cash used for accounts receivable growth, which used $87.1 million in cash in the current year compared to $225.8 million in fiscal 2005.
Capital Expenditures
We have historically avoided high levels of capital expenditures for our apparel manufacturing functions by using independent contractors for sewing and other processes such as washing, dyeing and embroidery. We perform the cutting process in-house for certain product categories in the Americas to enhance control and efficiency, and we screenprint a portion of our product in-house in both the Americas and in Europe. In our equipment business where we own and operate manufacturing facilities, our capital expenditures are higher.
Fiscal 2007 capital expenditures were $116.3 million, which was approximately $20.8 million higher than the $95.5 million we spent in fiscal 2006. In fiscal 2007, we increased our investment in company-owned retail stores, manufacturing equipment, warehouse equipment, and computer systems.
New company-owned retail stores are again part of our plans in fiscal 2008. Computer hardware and software will also be purchased to continuously improve our systems. Capital spending for these and other projects in fiscal 2008 is expected to range between $100 million and $125 million, depending on
the pace of our retail expansion. We expect to fund our capital expenditures primarily from our operating cash flows, our credit facilities and also through the sale of certain assets held for sale in certain Rossignol subsidiaries in Europe.
Acquisitions and Dispositions
In connection with the acquisition of Rossignol, we have formulated the Rossignol Integration Plan (the “Plan”). The Plan covers the global operations of Rossignol and our existing businesses, and it includes the evaluation of facility relocations, nonstrategic business activities, redundant functions and other related items. As of October 31, 2007, we had recognized $62.5 million of liabilities related to the Plan, including employee relocation and severance costs, moving costs, and other costs related primarily to the consolidation of Rossignol’s administrative headquarters in Europe, the consolidation of Rossignol’s European distribution, the consolidation and realignment of certain European manufacturing facilities, and the relocation of our wintersports equipment sales and distribution operations in the United States. As of October 31, 2007, we have paid approximately $46.3 million related to these integration activities. If we have overestimated our integration costs, the excess will reduce goodwill in future periods. Conversely, if we have underestimated these costs, additional liabilities recognized will be recorded in earnings. Costs that are not associated with Rossignol but relate to activities or employees of our existing operations are not significant and are charged to earnings. Certain facilities owned by Rossignol are expected to be sold in connection with the Plan, while others are anticipated to be refinanced through sale-leaseback arrangements. Assets currently held for sale, primarily in the United States and France, totaled approximately $15.3 million at October 31, 2007. The sale of these properties is expected to generate approximately $26.0 million in cash in fiscal 2008 and 2009.
In fiscal 2005, we originally acquired a majority of our golf equipment business in connection with the Rossignol acquisition. In September 2007, we acquired the remaining 36.37% minority interest in Roger Cleveland Golf Company, Inc. for $17.5 million plus transaction costs. In October 2007, we entered into an agreement to sell our golf equipment business which includes Roger Cleveland Golf Company, Inc. and certain other related international subsidiaries for a transaction value of $132.5 million. We completed the sale in December 2007 and have used the net proceeds of approximately $105.0 million to repay existing indebtedness.
Effective May 1, 2004, we acquired DC for an initial purchase price of $98.3 million. The sellers also received $33.0 million in fiscal 2005 through fiscal 2007 based on the achievement of certain sales and earnings targets, and we have accrued an additional $19.0 million at October 31, 2007. This amount represents the final payment and is expected to be paid during fiscal 2008. All subsequent payments have been recorded against goodwill.
Debt Structure
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. Term loans are also used to supplement these lines of credit and are typically used to finance long-term assets. In July 2005, we issued $400 million in senior notes to fund a portion of the acquisition of Rossignol and to refinance certain existing indebtedness. Our debt structure includes short-term lines of credit and long-term loans as follows:
In July 2005, we issued $400 million in senior notes, which bear a coupon interest rate of 6.875% and are due April 15, 2015. The senior notes were issued at par value and sold in accordance with Rule 144A and Regulation S. In December 2005, these senior notes were exchanged for publicly registered notes with identical terms. The senior notes are guaranteed on a senior unsecured basis by certain of our domestic subsidiaries that guarantee any of our indebtedness or our subsidiaries’ indebtedness, or are obligors under our existing Credit Facility (defined below). We may redeem some or all of the senior notes after April 15, 2010 at fixed redemption prices as set forth in the indenture. In addition, prior to April 15, 2008, we may redeem up to 35% of the senior notes with the proceeds from certain equity offerings at a redemption price set forth in the indenture.
The indenture for our senior notes includes covenants that limit our ability to, among other things: incur additional debt; pay dividends on our capital stock or repurchase our capital stock; make certain investments; enter into certain types of transactions with affiliates; limit dividends or other payments by our restricted subsidiaries to us; use assets as security in other transactions; and sell certain assets or merge with or into other companies. If we experience specific kinds of changes of control, we will be required to offer to purchase the senior notes at a purchase price equal to 101% of the principal amount, plus accrued and unpaid interest. We currently are in compliance with these covenants. In addition, we have approximately $8.7 million in debt issuance costs included in other assets as of October 31, 2007.
In April 2005, we replaced our line of credit in the Americas with a new revolving credit facility, which has subsequently been amended (the “Credit Facility”). The Credit Facility expires April 2010 and provides for a secured revolving line of credit of up to $300 million (with our option to expand the facility to $350 million under certain conditions). The Credit Facility bears interest based on either LIBOR or an alternate base rate plus an applicable margin. The margin on the LIBOR rate is based on our fixed charge coverage ratio. The weighted average interest rate at October 31, 2007 was 6.7%. We paid certain financing fees that will be amortized over the expected life of the Credit Facility. The Credit Facility includes a $125.0 million sublimit for letters of credit and a $35.0 million sublimit for borrowings in certain foreign currencies. As of October 31, 2007, $164.7 million was outstanding under the Credit Facility in addition to outstanding letters of credit of $58.2 million. Of the amount outstanding, approximately $35.0 million represents outstanding borrowings of Roger Cleveland Golf Company, Inc. and are included in discontinued operations (Note 19).
The borrowing base is limited to certain percentages of our eligible accounts receivable and inventory. The Credit Facility contains customary restrictive covenants for facilities and transactions of this type, including, among others, certain limitations on: incurrence of additional debt and guarantees of indebtedness; creation of liens; mergers, consolidations or sales of substantially all of our assets; sales or other dispositions of assets; distributions or dividends and repurchases of our common stock; restricted payments, including without limitation, certain restricted investments; engaging in transactions with our affiliates and; sale and leaseback transactions. Our United States assets and a portion of the stock of QS Holdings, SARL, a wholly-owned international subsidiary, have been pledged as collateral and to secure our indebtedness under the Credit Facility. As of October 31, 2007, we were in compliance with these covenants.
In Canada, we have arrangements with banks that provide for approximately $22.0 million of short-term lines of credit. These lines of credit will be reviewed by the banks on various dates through 2008, and we believe the banks will continue to make these facilities available with substantially similar terms. The amount outstanding on these lines of credit at October 31, 2007 was $17.8 million at an average interest rate of 6.5%.
In Europe, we have arrangements with several banks that provide approximately $479.0 million for cash borrowings and letters of credit. These lines will be reviewed on various dates through 2008, and we believe that the banks will continue to make these facilities available. The amount outstanding on these lines of credit at October 31, 2007 was $234.6 million at an average interest rate of 4.7%. In addition, we have $33.5 million in letters of credit outstanding as of October 31, 2007.
In Asia/Pacific, we have revolving lines of credit with banks that provide up to approximately $116.0 million for cash borrowings and letters of credit. These lines of credit will be reviewed by the banks on various dates through 2008, and we believe the banks will continue to make these facilities available with substantially similar terms. The amount outstanding on these lines of credit at October 31, 2007 was $61.6 million in addition to $6.4 million outstanding letters of credit at an average interest rate of 3.2%.
These line of credit commitments and agreements in the Americas, Europe and Asia/Pacific allow for total maximum cash borrowings and letters of credit of $917.0 million. Commitments totaling $617.0 million expire in fiscal 2008, while $300.0 million expire in fiscal 2010. We had $478.7 million of borrowings drawn on these lines of credit as of October 31, 2007, and letters of credit issued at that time totaled $98.1 million. Of the borrowings outstanding, $35.0 million relates to debt outstanding from our discontinued golf equipment business which was repaid in December 2007.
In Europe, we also have $216.0 million of long-term debt outstanding as of October 31, 2007. This debt is with several banks and contains covenants that are customary for such long-term indebtedness, including among other things, minimum financial ratios of net debt to shareholders’ equity and term debt to cash flow. At October 31, 2007, the overall weighted average interest rate on this long-term debt is 4.2%. Principal and interest payments are required either monthly, quarterly or annually, and the loans are due at various dates through 2010.
During fiscal 2007, we were out of compliance with certain profitability covenants on a 50.0 million euro term loan of a Rossignol subsidiary in Europe. As of October 31, 2007, this debt was approximately $72.1 million (50.0 million euros). We obtained a waiver from the bank for the fiscal year ended October 31, 2007 and additionally amended the existing agreement to remove these financial covenants through October 2008. Accordingly, we continue to classify this debt as long term as of October 31, 2007.
As part of the acquisition of Rossignol, we deferred a portion of the purchase price. This deferred purchase price obligation is expected to be paid in 2010 and accrues interest equal to the 3-month Euribor plus 2.35% (currently 7.0%) and is denominated in euros. The carrying amount of the obligation fluctuates based on changes in the exchange rate between euros and U.S. dollars. As of October 31, 2007, the deferred purchase price obligation totaled $43.6 million.
Our European and Asia/Pacific segments also have approximately $17.1 million in capital leases and other borrowings as of October 31, 2007.
Our financing activities provided $89.4 million, $95.5 million and $338.1 million of cash in fiscal 2007, 2006 and 2005, respectively, as debt was increased to fund the business acquisitions and capital expenditures discussed above.
Joint Ventures
We have entered into several joint venture arrangements with independent third parties to sell and distribute Quiksilver, Roxy and other branded products in various foreign territories, including Mexico and Brazil. In connection with these joint ventures, we have funded, and may continue to fund, a portion of the working capital required to finance these joint venture operations based on our ownership percentage in each joint venture. In addition, in certain circumstances the joint venture agreements provide that we are required to purchase the equity interests of our joint venture partners. The purchase price applicable to these obligations is typically based on formulas that will be used to value the joint ventures at the time of a purchase. Generally, it is not possible to determine in advance the amounts we may pay for these equity purchases since they are subject to many variables but we expect to purchase a controlling interest in our Brazilian joint venture in fiscal 2008 for a purchase price of approximately $8.0 million, of which 50% will be paid in cash and 50% in shares of our common stock.
Contractual Obligations and Commitments
We lease certain land and buildings under non-cancelable operating leases. The leases expire at various dates through 2017, excluding extensions at our option, and contain various provisions for rental adjustments including, in certain cases, adjustments based on increases in the Consumer Price Index. The leases generally contain renewal provisions for varying periods of time. We also have long-term debt
and obligations related to business acquisitions. The former owners of DC were entitled to future payments if certain sales and earnings targets were achieved through October 31, 2007. In fiscal 2008, $19.0 million is expected to be paid based on the achievement of such targets and is reflected in our balance sheet at October 31, 2007 as a component of accrued liabilities. The former owners of Surfection are entitled to future payments of up to $9.7 million if certain performance targets are achieved through September 2008. In fiscal 2008, $7.4 million is expected to be paid based on the achievement of certain sales and earnings targets and is reflected in our balance sheet at October 31, 2007 as a component of accrued liabilities. Any of these future potential payments will be recorded against goodwill. Our deferred purchase price obligation related to the Rossignol acquisition totals $43.6 million and is included in long-term debt as of October 31, 2007. Our significant contractual obligations and commitments as of October 31, 2007, excluding any additional payments that may be due if these acquired businesses achieve certain performance targets in the future, are summarized in the following table:
(1)
Excludes required interest payments. See Note 7 of Notes to Consolidated Financial Statements for interest terms.
(2)
We establish relationships with professional athletes in order to promote our products and brands. We have entered into endorsement agreements with professional athletes in sports such as skiing, surfing, skateboarding, snowboarding and windsurfing. Many of these contracts provide incentives for magazine exposure and competitive victories while wearing or using our products. It is not possible to determine the amounts we may be required to pay under these agreements as they are subject to many variables. The amounts listed are the approximate amounts of minimum obligations required to be paid under these contracts. The estimated maximum amount that could be paid under existing contracts is approximately $72.3 million and would assume that all bonuses, victories, etc. are achieved during a five-year period. The actual amounts paid under these agreements may be higher or lower than the amounts listed as a result of the variable nature of these obligations.
(3)
Certain other obligations include approximately $98.1 million of contractual letters of credit with maturity dates of less than one year. We also enter into unconditional purchase obligations with various vendors and suppliers of goods and services in the normal course of operations through purchase orders or other documentation or that are undocumented except for an invoice. Such unconditional purchase obligations are generally outstanding for periods less than a year and are settled by cash payments upon delivery of goods and services and are not reflected in this line item. In addition, in certain circumstances we are required to acquire additional equity interests from certain of our joint venture partners. The purchase price applicable to these obligations is typically based on formulas that will be used to value the joint venture operations at the time of purchase. These potential purchase amounts cannot be determined in advance and are not included in this line item, except for approximately $4.0 million related to the cash portion of the purchase of a controlling interest in Quiksilver Brazil which is expected to occur in fiscal 2008.
Trade Accounts Receivable and Inventories
Our trade accounts receivable were $760.4 million at October 31, 2007, versus $674.7 million the year before, an increase of 13%. Adjusting for the effects of foreign currency, accounts receivable increased 3%. Receivables in the Americas totaled $312.2 million, while European receivables totaled $364.3 million and Asia/Pacific receivables totaled $83.9 million. Among all three segments, accounts receivable increased primarily from increased revenue. Included in accounts receivable are approximately $42.4 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, must be subtracted from accounts receivable to more accurately compute days sales outstanding.
Consolidated inventories totaled $447.3 million as of October 31, 2007, versus $389.7 million the year before, an increase of 15%. Adjusting for the effects of foreign currency, inventories increased approximately 7%. Inventories in the Americas totaled $178.3 million, while European inventories totaled $202.7 million and Asia/Pacific inventories totaled $66.3 million. Consolidated average inventory turnover from all businesses was approximately 3.0 at October 31, 2007 and 2006, respectively.
Off Balance Sheet Arrangements
As of October 31, 2007, we did not have any significant off balance sheet arrangements.
Inflation
Inflation has been modest during the years covered by this report. Accordingly, inflation has had an insignificant impact on our sales and profits.
New Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections,” (“SFAS No. 154”) which replaces APB Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 applies to all voluntary changes in accounting principles and requires retrospective application (a term defined by the statement) to prior periods’ financial statements, unless it is impracticable to determine the effect of a change. It also applies to changes required by an accounting pronouncement that does not include specific transition provisions. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We adopted this standard during the fiscal year ended October 31, 2007. The adoption of this standard did not have a material impact on our financial condition, results of operations or cash flows.
In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes ¯ an interpretation of FASB Statement No. 109” (“FIN 48”). This interpretation clarifies the application of SFAS No. 109, “Accounting for Income Taxes,” by defining criteria that an individual tax position must meet for any part of the benefit of that position to be recognized in our financial statements and also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We expect to adopt FIN 48 on November 1, 2007. We are currently assessing the impact the adoption of FIN 48 will have on our financial position and results of operations.
In September 2006, the Securities and Exchange Commission (“SEC”) released Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive guidance on the SEC’s views regarding the process of quantifying materiality of financial statement misstatements. We adopted this standard during the fiscal year ended October 31, 2007. The adoption of this accounting pronouncement did not have a material effect on our consolidated financial position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. We expect to adopt this standard at the beginning of the our fiscal year ending October 31, 2009. The adoption of this accounting pronouncement is not expected to have a material effect on our consolidated financial position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (“SFAS No. 159”), which permits companies to choose to measure certain financial instruments and other items at fair value that are not currently required to be measured at fair value. We expect to adopt this standard at the beginning of our fiscal year ending October 31, 2009. We have not determined the effect that the adoption of SFAS No. 159 will have on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” (“SFAS No. 141(R)”), which requires the Company to record fair value estimates of contingent consideration and certain other
potential liabilities during the original purchase price allocation, expense acquisition costs as incurred and does not permit certain restructuring activities previously allowed under Emerging Issues Task Force Issue No. 95-3 to be recorded as a component of purchase accounting. We will adopt this standard at the beginning of our fiscal year ending October 31, 2010 for all prospective business acquisitions. We have not determined the effect that the adoption of SFAS No. 141(R) will have on our consolidated financial statements but the impact will be limited to any future acquisitions beginning in fiscal 2010.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51,” (“SFAS No. 160”), which causes noncontrolling interests in subsidiaries to be included in the equity section of the balance sheet. We will adopt this standard at the beginning of our fiscal year ending October 31, 2010. We have not determined the effect that the adoption of SFAS No. 160 will have on our consolidated financial statements.
Critical Accounting Policies
Our 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 earnings would be adversely affected.
Accounts Receivable
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 and ski shops, medium-sized retail chains, and some large department store chains. 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 maintain credit insurance for a majority of our European wintersports equipment receivables that protects against the risk of customer default. 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. Unforeseen, material financial difficulties of our customers could have an adverse impact on our profits.
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;
•
unanticipated changes in consumer preferences;
•
reduced customer confidence in the retail market; 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. If the carrying amount exceeds fair value, then the second step of the impairment test is performed to measure the amount of any impairment loss. Fair value is computed based on estimated future cash flows discounted at a rate that approximates our cost of capital. Such estimates are subject to change, and we may be required to recognize impairment losses in the future.
Income Taxes
Current income tax expense is the amount of income taxes expected to be payable for the current year. 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 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 determined 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.
Stock-Based Compensation Expense
Effective November 1, 2005, we adopted the fair value recognition provisions of SFAS 123(R), using the modified prospective transition method, and therefore have not restated prior periods’ results. Under this method we recognize compensation expense for all stock-based payments granted after November 1, 2005 and prior to but not yet vested as of November 1, 2005, in accordance with SFAS 123(R). Under the fair value recognition provisions of SFAS 123(R), we recognize stock-based compensation 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. Prior to SFAS 123(R) adoption, we accounted for stock-based payments under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and accordingly, we were not required to recognize compensation expense for options granted that had an exercise price equal to the market value of the underlying common stock on the date of grant.
Determining the appropriate fair value model and calculating the fair value of stock-based payment awards require the input of highly subjective assumptions, including the expected life of the stock-based payment awards and stock price volatility. We use the Black-Scholes option-pricing model to value compensation expense. The assumptions used in calculating the fair value of stock-based payment awards represent management’s best estimates, but the estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. See Note 10 to the Consolidated Financial Statements for a further discussion on stock-based compensation.
Foreign Currency Translation
A significant portion of our revenues are generated in Europe, where we operate with the euro as our 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 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 exchange rates. Our assets and liabilities that are denominated in foreign currencies are translated at the rate of exchange on the balance sheet date. Revenues and expenses are translated using the average exchange rate for the period. Gains and losses from translation of foreign subsidiary financial statements 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 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 derivatives in other comprehensive income. We also use other derivatives that do not qualify for hedge accounting to mitigate our exposure to currency risks. These derivatives are marked to fair value with corresponding gains or losses recorded in earnings.
Forward-Looking Statement
Various statements in this Form 10-K, or incorporated by reference into this Form 10-K in future filings by us with the SEC, in our press releases and in oral statements made by or with the approval of authorized personnel, constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on current expectations and are indicated by words or phrases such as “anticipate”, “estimate”, “expect”, “seek”, “plan”, “may”, “project”, “we believe”, “currently envisions” and similar words or phrases and involve known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Some of the factors that could affect our financial performance or cause actual results to differ from our estimates in, or underlying, such forward-looking statements are set forth under Item 1A. “Risk Factors.” Forward-looking statements include statements regarding, among other items:
•
our ability to realize the benefits we anticipate from our acquisition of Rossignol;
•
the impact of our substantial leverage on our ability to generate cash flows or obtain financing to fund our anticipated growth strategies, and the cost of such financing;
•
our plans to expand internationally;
•
our intention to introduce new products and enter into new joint ventures;
•
our plans to open new retail stores;
•
payments due on contractual commitments;
•
future expenditures for capital projects;
•
our ability to continue to maintain our brand image and reputation;
•
our ability to remain compliant with our debt covenants;
•
the integration of acquired businesses and future acquisitions;
•
difficulties encountered with asset or subsidiary dispositions;
•
general economic and business conditions;
•
foreign exchange rate fluctuations; and
•
changes in political, social and economic conditions and local regulations, particularly in Europe and Asia.
These forward-looking statements are based largely on our expectations and are subject to a number of risks and uncertainties, many of which are beyond our control. Actual results could differ materially from these forward-looking statements as a result of the risks described in Item 1A. “Risk Factors”, and other factors. 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 in this Form 10-K will, in fact, transpire.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to a variety of risks. Two of these risks are foreign currency fluctuations and changes in interest rates that affect interest expense. (See also Note 16 of our consolidated financial statements).
Foreign Currency and Derivatives
We are exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to certain sales, royalty income and product purchases of our international subsidiaries that are denominated in currencies other than their functional currencies. We are also exposed to foreign currency gains and losses resulting from domestic transactions that are not denominated in U.S. dollars, and to fluctuations in interest rates related to our variable rate debt. Furthermore, we are exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our consolidated financial statements due to the translation of the operating results and financial position of our international subsidiaries. We use various foreign currency exchange contracts and intercompany loans as part of our overall strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates. In addition, we use interest rate swaps to manage our exposure to the risk of fluctuations in interest rates.
Derivatives that do not qualify for hedge accounting but are used by management to mitigate exposure to currency risks are marked to fair value with corresponding gains or losses recorded in earnings. A loss of $1.8 million was recognized related to these types of contracts during fiscal 2007. For all qualifying cash flow hedges, the changes in the fair value of the derivatives are recorded in other comprehensive income. As of October 31, 2007, we were hedging forecasted transactions expected to occur through October 2009. Assuming exchange rates at October 31, 2007 remain constant, $23.8 million of losses, net of tax, related to hedges of these transactions are expected to be reclassified into earnings over the next 24 months.
On the date we enter into a derivative contract, we designate certain of the derivatives as a hedge of the identified exposure. We formally document all relationships between hedging instruments and hedged items, as well as the risk-management objective and strategy for entering into various hedge transactions. We identify in this documentation the asset, liability, firm commitment, or forecasted transaction that has been designated as a hedged item and indicate how the hedging instrument is expected to hedge the risks related to the hedged item. We formally measure effectiveness of our hedging relationships both at the hedge inception and on an ongoing basis in accordance with our risk management policy. We will discontinue hedge accounting prospectively:
•
if we determine that the derivative is no longer effective in offsetting changes in the cash flows of a hedged item;
•
when the derivative expires or is sold, terminated or exercised;
•
if it becomes probable that the forecasted transaction being hedged by the derivative will not occur;
•
because a hedged firm commitment no longer meets the definition of a firm commitment; or
•
if we determine that designation of the derivative as a hedge instrument is no longer appropriate.
We enter into forward exchange and other derivative contracts with major banks and are exposed to foreign currency losses in the event of nonperformance by these banks. We anticipate, however, that these banks will be able to fully satisfy their obligations under the contracts. Accordingly, we do not obtain collateral or other security to support the contracts.
Translation of Results of International Subsidiaries
As discussed above, 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 income of our foreign subsidiaries into U.S. dollars using the average exchange rate during the reporting period. Changes in foreign exchange rates affect our reported profits and can distort comparisons from year to year. We use various foreign currency exchange contracts and intercompany loans to hedge the profit and loss effects of such exposure, but accounting rules do not allow us to hedge the actual translation of sales and expenses.
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 operating segment. 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 our reported results from our European operating segment. Also, our U.S. wintersports equipment business sources their production primarily in euros and transacts their sales in U.S. dollars. If the dollar weakens, there is a negative impact on the profitability of our U.S. wintersports equipment business.
In fiscal 2007, the U.S. dollar weakened compared to the euro and the Australian dollar. As a result, our European revenues decreased 3% in euros compared to an increase of 7% in U.S. dollars. Asia/Pacific revenues decreased 11% in Australian dollars compared to an increase of 2% in U.S. dollars.
Interest Rates
Most of our lines of credit and long-term debt bear interest based on LIBOR and EURIBOR plus a credit spread. Effective interest rates, therefore, can move up or down depending on market conditions. The credit spreads are subject to change based on financial performance and market conditions upon refinancing. Interest expense also includes financing fees and related costs and can be affected by foreign currency movement upon translating non-U.S. dollar denominated interest into dollars for reporting purposes. The approximate amount of our remaining variable rate debt was $504.0 million at October 31, 2007, and the average effective interest rate at that time was 5.1%. If interest rates or credit spreads were to increase by 10%, our income before tax would be reduced by approximately $2.6 million based on these fiscal 2007 levels.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item appears beginning on page 41.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A.
Item 9A. 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 October 31, 2007, 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 October 31, 2007.
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 and year ended October 31, 2007 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:
•
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. Management is responsible for establishing and maintaining adequate internal control over our financial reporting.
Management has used the framework set forth in the report entitled “Internal Control-Integrated Framework” published by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission to evaluate the effectiveness of its internal control over financial reporting. Management has concluded that its internal control over financial reporting was effective as of the end of the most recent fiscal year. Deloitte & Touche LLP has issued an attestation report (see below) on our internal control over financial reporting.
The foregoing has been approved by our management, including our Chief Executive Officer and Chief Financial Officer, who have been involved with the assessment and analysis of our internal controls over financial reporting.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors and Shareholders
Quiksilver, Inc.:
We have audited the internal control over financial reporting of Quiksilver, Inc. and subsidiaries (the “Company”) as of October 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of October 31, 2007, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended October 31, 2007 of the Company and our report dated December 28, 2007 expressed an unqualified opinion on those financial statements and financial statement schedules.
/s/ Deloitte & Touche LLP
Costa Mesa, California
December 28, 2007
Item 9B.
Item 9B. OTHER INFORMATION
None.
PART III
Item 10.
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required to be included by this item will be included under the headings “Election of Directors,” “Executive Compensation and Other Information,” and “Corporate Governance” in our proxy statement for the 2008 Annual Meeting of Stockholders. That information is incorporated herein by reference to our proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of our fiscal year ended October 31, 2007.
We have adopted a Code of Ethics for Senior Financial Officers in compliance with applicable rules of the Securities and Exchange Commission that applies to all of our employees, including our principal executive officer, our principal financial officer and our principal accounting officer or controller, or persons performing similar functions. We have posted a copy of this Code of Ethics on our website, at http://www.quiksilverinc.com. We intend to disclose any amendments to, or waivers from, any provision of the Code of Ethics by posting such information on such website.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The information required to be included by this item will be included under the heading “Executive Compensation and Other Information” in our proxy statement for the 2008 Annual Meeting of Stockholders. That information is incorporated herein by reference to our proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of our fiscal year ended October 31, 2007.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required to be included by this item will be included under the heading “Ownership of Securities” in our proxy statement for the 2008 Annual Meeting of Stockholders. That information is incorporated herein by reference to our proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of our fiscal year ended October 31, 2007.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required to be included by this item will be included under the headings “Related Party Transactions” and “Corporate Governance” in our proxy statement for the 2008 Annual Meeting of Stockholders. That information is incorporated herein by reference to our proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of our fiscal year ended October 31, 2007.
Item 14.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required to be included by this item will be included under the heading “Independent Auditors” in our proxy statement for the 2008 Annual Meeting of Stockholders. That information is incorporated herein by reference to our proxy statement, which will be filed with the Securities and Exchange Commission within 120 days of our fiscal year ended October 31, 2007.
PART IV
Item 15.
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this Annual Report on Form 10-K:
1.
Consolidated Financial Statements
See “Index to Consolidated Financial Statements” on page 42
2.
Exhibits
The Exhibits listed in the Exhibit Index, which appears immediately following the signature page and is incorporated herein by reference, are filed as part of this Annual Report on Form 10-K.
QUIKSILVER, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Quiksilver, Inc.
We have audited the accompanying consolidated balance sheets of Quiksilver, Inc. and subsidiaries (the “Company”) as of October 31, 2007 and 2006, and the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended October 31, 2007. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of October 31, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended October 31, 2007, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Notes 1 and 10 to the consolidated financial statements, the Company changed its method of accounting for stock-based compensation during the year ended October 31, 2006 as a result of adopting Statement of Financial Accounting Standards No. 123(R), “Share-based Payment.”
As discussed in Note 19, in October 2007 the Company entered into an agreement to sell its golf equipment business. The results of operations of this business are included in loss from discontinued operations in the accompanying consolidated financial statements.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of October 31, 2007, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated December 28, 2007 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
QUIKSILVER, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended October 31, 2007, 2006 and 2005
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended October 31, 2007, 2006 and 2005
See notes to consolidated financial statements.
QUIKSILVER, INC.
CONSOLIDATED BALANCE SHEETS
October 31, 2007 and 2006
See notes to consolidated financial statements.
QUIKSILVER, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended October 31, 2007, 2006 and 2005
See notes to consolidated financial statements.
QUIKSILVER, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended October 31, 2007, 2006 and 2005
See notes to consolidated financial statements.
QUIKSILVER, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended October 31, 2007, 2006 and 2005
See notes to consolidated financial statements.
QUIKSILVER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended October 31, 2007, 2006 and 2005
Note 1 - Significant Accounting Policies
Company Business
Quiksilver, Inc. and its subsidiaries (the “Company”) design, produce and distribute branded apparel, wintersports equipment, footwear, accessories and related products. The Company’s apparel and footwear brands represent a casual lifestyle for young-minded people that connect with its boardriding culture and heritage, while its wintersports brands symbolize a long standing commitment to technical expertise and competitive success on the mountains. The Company’s Quiksilver, Roxy, DC Shoes and Hawk brands are synonymous with the heritage and culture of surfing, skateboarding and snowboarding, and its beach and water oriented swimwear brands include Raisins, Radio Fiji and Leilani. The Rossignol, Dynastar, Look, Lange, and Kerma brands are leaders in the alpine ski market, and the Company makes snowboarding equipment under its Rossignol, DC Shoes, Roxy, Lib Technologies, Gnu and Bent Metal labels. The Company’s products are sold in over 90 countries in a wide range of distribution channels, including surf shops, ski shops, skateboard shops, snowboard shops, its proprietary Boardriders Club shops, other specialty stores and select department stores. Distribution is primarily in the United States, Europe and Australia. The Company performs ongoing credit evaluations of its customers and generally does not require collateral.
The Company operates in markets that are highly competitive. The Company’s ability to evaluate and respond to changing consumer demands and tastes is critical to its success. The Company believes that consumer acceptance depends on product, image, design, fit and quality. Consequently, the Company has developed an experienced team of designers, artists, merchandisers, pattern makers, engineers, technicians, researchers and contractors that it believes has helped it remain in the forefront of design and technical expertise in the areas in which it competes. The Company believes, however, that its continued success will depend on its ability to promote its image and to design products acceptable to the marketplace.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Quiksilver, Inc. and subsidiaries, including Pilot, SAS and subsidiaries (“Quiksilver Europe”), Quiksilver Australia Pty Ltd. and subsidiaries (“Quiksilver Asia/Pacific” and “Quiksilver International”). Intercompany accounts and transactions have been eliminated in consolidation.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.
Cash Equivalents
Certificates of deposit and highly liquid short-term investments purchased with original maturities of three months or less are considered cash equivalents. Carrying values approximate fair value.
Inventories
Inventories are valued at the lower of cost (first-in, first-out) or market. Management regularly reviews the inventory quantities on hand and adjusts inventory values for excess and obsolete inventory based primarily on estimated forecasts of product demand and market value.
Fixed Assets
Furniture and other equipment, computer equipment, manufacturing equipment and buildings are recorded at cost and depreciated on a straight-line basis over their estimated useful lives, which generally range from two to twenty years. Leasehold improvements are recorded at cost and amortized over their estimated useful lives or related lease term, whichever is shorter. Land use rights for certain leased retail locations are amortized to estimated residual value.
Long-Lived Assets
The Company accounts for the impairment and disposition of long-lived assets in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” In accordance with SFAS No. 144, management assesses potential impairments of its long-lived assets whenever events or changes in circumstances indicate that an asset’s carrying value 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. The Company recorded approximately $2.6 million in fixed asset impairments as of October 31, 2007 and determined that there was no impairment loss as of October 31, 2006 or 2005.
Goodwill and Intangible Assets
The Company accounts for goodwill and intangible assets in accordance with SFAS No. 142, “Goodwill and Intangible Assets.” Under SFAS No. 142, goodwill and intangible assets with indefinite lives are not amortized but are tested for impairment annually and also in the event of an impairment indicator. The annual impairment test is a fair value test as prescribed by SFAS No. 142 which includes assumptions such as growth and discount rates. The Company recorded approximately $156.9 million in goodwill impairment and approximately $6.9 million in other wintersports equipment brand trademark impairments as of October 31, 2007. Any subsequent impairment losses will also be reflected in operating income. The Company determined that there was no impairment loss as of October 31, 2006 or 2005.
Revenue Recognition
Revenues are recognized upon the transfer of title and risk of ownership to customers. Allowances for estimated returns and doubtful accounts are provided when revenues are recorded. Returns and allowances are reported as reductions in revenues, whereas allowances for bad debts are reported as a component of selling, general and administrative expense. Royalty income is recorded as earned.
Revenues in the Consolidated Statements of Operations include the following:
Promotion and Advertising
The Company’s promotion and advertising efforts include athlete sponsorships, world-class boardriding and skiing contests, magazine advertisements, retail signage, television programs, co-branded products, surf camps, skate park tours and other events. For the fiscal years ended October 31, 2007, 2006 and 2005, these expenses totaled $158.9 million, $156.0 million and $101.3 million, respectively. Advertising costs are expensed when incurred.
Research and Development
The Company engages in research and development activities to enable it to design and launch new products for its wintersports equipment businesses in order to respond to changing demands and market expectations. Research and development costs are expensed as incurred. Included in selling, general and administrative expense is approximately $11.2 million, $11.9 million and $3.1 million of research and development costs for the fiscal years ended October 31, 2007, 2006 and 2005, respectively.
Warranties
The Company generally provides a one-year limited warranty against manufacturer’s defects on its wintersports equipment and records an estimate of such warranty costs when revenue is recorded. The Company’s standard warranty requires it to repair or replace the defective product returned to the Company during such warranty period. In estimating its future warranty obligations, the Company
considers various factors, including its warranty policies and practices, the historical frequency of claims and the cost to replace or repair the products under warranty (see Note 8).
Stock-Based Compensation
Effective November 1, 2005, the Company adopted SFAS No. 123(R) “Share-Based Payment.” As a result, the Company recognizes compensation expense equal to the fair value of stock options or other share based payments. See Note 10 for a description of the impact of this standard on the Company’s financial statements.
Income Taxes
The Company accounts for income taxes using the asset and liability approach as promulgated by SFAS No. 109, “Accounting for Income Taxes.” Deferred income tax assets and liabilities are established for temporary differences between the financial reporting bases and the tax bases of the Company’s assets and liabilities at tax rates expected to be in effect when such assets or liabilities are realized or settled. Deferred income tax assets are reduced by a valuation allowance if, in the judgment of the Company’s management, it is more likely than not that such assets will not be realized.
Net (Loss) Income per Share
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 computed using the treasury stock method. For the years ended October 31, 2006 and 2005, the weighted average common shares outstanding, assuming dilution, includes 5,670,000 and 5,415,000, respectively, of dilutive stock options. For the year ended October 31, 2007 the potential dilutive effect of common stock equivalents was not included in the weighted average shares for the computation of diluted earnings per share, as the effect was antidilutive.
Stock Split
During fiscal 2005, the Company’s Board of Directors approved a two-for-one stock split that was effected May 11, 2005. All share and per share information has been restated to reflect the stock split.
Foreign Currency and Derivatives
The Company’s primary functional currency is the U.S. dollar, while Quiksilver Europe functions in euros and British pounds, and Quiksilver Asia/Pacific functions in Australian dollars and Japanese yen. Assets and liabilities of the Company denominated in foreign currencies are translated at the rate of exchange on the balance sheet date. Revenues and expenses are translated using the average exchange rate for the period.
Derivative financial instruments are recognized as either assets or liabilities in the balance sheet and are measured at fair value. The accounting for changes in the fair value of a derivative depends on the use and type of the derivative. The Company’s derivative financial instruments principally consist of foreign currency exchange contracts and interest rate swaps, which the Company uses to manage its exposure to the risk of foreign currency exchange rates and variable interest rates. The Company’s objectives are to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange and interest rates. The Company does not enter into derivative financial instruments for speculative or trading purposes.
Comprehensive Income
Comprehensive income includes all changes in stockholders’ equity except those resulting from investments by, and distributions to, stockholders. Accordingly, the Company’s Consolidated Statements of Comprehensive Income include net (loss) income and foreign currency adjustments that arise from the translation of the financial statements of Quiksilver Europe and Quiksilver Asia/Pacific into U.S. dollars and fair value gains and losses on certain derivative instruments.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. Such estimates and assumptions affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The carrying value of the Company’s trade accounts receivable and accounts payable approximates its fair value due to their short-term nature. The carrying values of the Company’s lines of credit and long-term debt approximates their fair value as these borrowings consist primarily of a series of short-term notes at floating interest rates.
New Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections,” (“SFAS No. 154”) which replaces APB Opinion No. 20, “Accounting Changes,” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 applies to all voluntary changes in accounting principles and requires retrospective application (a term defined by the statement) to prior periods’ financial statements, unless it is impracticable to determine the effect of a change. It also applies to changes required by an accounting pronouncement that does not include specific transition provisions. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company adopted this standard during the fiscal year ended October 31, 2007. The adoption of this standard did not have a material impact on the Company’s financial condition, results of operations or cash flows.
In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes ¯ an interpretation of FASB Statement No. 109” (“FIN 48”). This interpretation clarifies the application of SFAS No. 109, “Accounting for Income Taxes,” by defining criteria that an individual tax position must meet for any part of the benefit of that position to be recognized in the Company’s financial statements and also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company expects to adopt FIN 48 on November 1, 2007. The Company is currently assessing the impact the adoption of FIN 48 will have on its financial position and results of operations.
In September 2006, the Securities and Exchange Commission (“SEC”) released Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive guidance on the SEC’s views regarding the process of quantifying materiality of financial statement misstatements. The Company adopted this standard during the fiscal year ended October 31, 2007. The adoption of this accounting pronouncement did not have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company expects to adopt this standard at the beginning of the Company’s fiscal year ending October 31, 2009. The adoption of this accounting pronouncement is not expected to have a material effect on the Company’s consolidated financial position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” (“SFAS No. 159”), which permits companies to choose to measure certain financial instruments and other items at fair value that are not currently required to be measured at fair value. The Company expects to adopt this standard at the beginning of the Company’s fiscal year ending October
31, 2009. The Company has not determined the effect that the adoption of SFAS No. 159 will have on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” (“SFAS No. 141(R)”), which requires the Company to record fair value estimates of contingent consideration and certain other potential liabilities during the original purchase price allocation, expense acquisition costs as incurred and does not permit certain restructuring activities previously allowed under Emerging Issues Task Force Issue No. 95-3 to be recorded as a component of purchase accounting. The Company will adopt this standard at the beginning of the Company’s fiscal year ending October 31, 2010 for all prospective business acquisitions. The Company has not determined the effect that the adoption of SFAS No. 141(R) will have on its consolidated financial statements but the impact will be limited to any future acquisitions beginning in fiscal 2010.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51,” (“SFAS No. 160”), which causes noncontrolling interests in subsidiaries to be included in the equity section of the balance sheet. The Company will adopt this standard at the beginning of the Company’s fiscal year ending October 31, 2010. The Company has not determined the effect that the adoption of SFAS No. 160 will have on its consolidated financial statements.
Note 2 - Business Acquisitions
In September 2007, the Company acquired the minority interest of Roger Cleveland Golf Company, Inc. (“Cleveland Golf”), the Company’s U.S. golf equipment operations. The Company had previously acquired 63.63% of Cleveland Golf as part of the acquisition of Rossignol in July 2005. The purchase price for the remaining minority interest of Cleveland Golf, excluding transaction costs, included a cash payment of $17.5 million at closing. The Company accounted for this transaction as a step acquisition and recorded 36.37% of fair value adjustments related to the acquisition of the remaining portion of Cleveland Golf. The Company also agreed to terminate all consulting arrangements with the former minority interest holders of Cleveland Golf and recorded an expense of approximately $3.6 million in contract termination costs. In October 2007, the Company entered into an agreement to sell its golf equipment business (Note 19).
Effective July 31, 2005, the Company acquired Skis Rossignol SA (“Rossignol”), a wintersports and golf equipment manufacturer. Rossignol offers a full range of wintersports equipment under the Rossignol, Dynastar, Lange, Look and Kerma brands. The Company has included the operations of Rossignol in its results since August 1, 2005. The purchase price, excluding transaction costs, included cash of approximately $208.3 million, approximately 2.2 million restricted shares of the Company’s common stock, valued at $28.9 million, a deferred purchase price obligation of approximately $32.5 million, a liability of approximately $16.9 million for the mandatory purchase of approximately 0.7 million outstanding public shares of Rossignol representing less than 5% of the share capital of Rossignol, and a liability of approximately $2.0 million for the estimated fair value of 0.1 million fully vested Rossignol stock options. Transaction costs totaled approximately $16.0 million. The valuation of the common stock issued in connection with the acquisition was based on its quoted market price for the five days before and after the announcement date, discounted to reflect the estimated effect of its trading restrictions. The deferred purchase price obligation is expected to be paid in 2010 and will accrue interest equal to the 3-month euro interbank offered rate (“Euribor”) plus 2.35% (currently 7.0%). The mandatory purchase of the remaining Rossignol shares was required under French law as the Company had obtained over 95% of the outstanding shares of Rossignol through a combination of share purchases, including a public tender offer. The purchase of these shares was completed in the quarter ended October 31, 2005 and the Company now owns 100% of the shares in Rossignol. Upon the future exercise of the Rossignol stock options, the Company will purchase the newly issued shares from the Rossignol stock option holders, retaining 100% ownership in Rossignol. These Rossignol stock options are treated as variable for accounting purposes and subsequent changes in the value of these stock options are recorded as compensation expense in the Company’s consolidated statement of income. Goodwill arises from synergies the Company believes can be achieved integrating Rossignol’s brands, products and
operations with the Company’s, and is not expected to be deductible for income tax purposes. Amortizing intangibles consist of customer relationships, patents and athlete contracts with estimated useful lives of twenty, seven and two years, respectively. The acquired trademarks are non-amortizing as they have been determined to have indefinite lives.
The following table summarizes the fair values of the assets acquired and the liabilities assumed at the date of the Rossignol acquisition in accordance with the purchase method of accounting:
In connection with the acquisition of Rossignol, the Company has formulated the Rossignol Integration Plan (the “Plan”). As of October 31, 2007 the Company has recognized approximately $62.5 million of liabilities related to the Plan. See Note 12 for further description of the Plan.
Effective August 1, 2005, the Company acquired 11 retail stores in Australia from Surfection Pty Ltd, Manly Boardriders Pty Ltd. and Sydney Boardriders Pty Ltd. (“Surfection”). The operations of Surfection have been included in the Company’s results since August 1, 2005. The initial purchase price, excluding transaction costs, included cash of approximately $21.4 million. Transaction costs totaled approximately $1.1 million. The sellers are entitled to additional payments if certain sales and margin targets are achieved. The amount of goodwill initially recorded for the transaction would increase if such contingent payments are made. As of October 31, 2007, approximately $7.4 million was accrued based on the achievement of these targets and additional payments ranging from zero to approximately $9.7 million may be paid through September, 2008. Goodwill arises from synergies the Company believes can be achieved through Surfection’s retail expertise and store presence in key locations in Australia, and is not expected to be deductible for income tax purposes. Amortizing intangibles consist of non-compete agreements with estimated useful lives of five years.
The following table summarizes the fair values of the assets acquired and the liabilities assumed at the date of the Surfection acquisition in accordance with the purchase method of accounting:
The results of operations for each of the acquisitions are included in the Consolidated Statements of Income from their respective acquisition dates. Assuming these fiscal 2005 acquisitions had occurred as of November 1, 2004, unaudited pro forma consolidated net sales would have been $2,036.2 million for the year ended October 31, 2005. Unaudited pro forma net income would have been $19.0 million, respectively, for those same periods, and unaudited pro forma basic and diluted earnings per share would have been $0.16 and $0.15, respectively.
The Company paid cash of approximately $42.6 million during the year ended October 31, 2007, of which $20.2 million relates to a payment to the former owners of DC Shoes, Inc. and the remaining $22.4 million relates primarily to insignificant acquisitions of certain other distributors, licensees and retail store locations.
Note 3 - Allowance for Doubtful Accounts
The allowance for doubtful accounts, which includes bad debts and returns and allowances, consists of the following:
The provision for doubtful accounts represents charges to selling, general and administrative expense for estimated bad debts, whereas the provision for returns and allowance is reported as a reduction of revenues.
Note 4 - Inventories
Inventories consist of the following:
Note 5 - Fixed Assets
Fixed assets consist of the following:
During the year ended October 31, 2007, the Company recorded approximately $2.6 million in fixed asset impairments.
Note 6 - Intangible Assets and Goodwill
A summary of intangible assets is as follows:
As of October 31, 2007 and in connection with its annual goodwill impairment test, the Company remeasured the value of its intangible assets in accordance with SFAS No. 142 and noted that the carrying value was in excess of the estimated fair value. As a result, the Company recorded Rossignol related goodwill impairment charges of approximately $156.9 million and approximately $6.9 million in trademark impairments.
The change in non-amortizable trademarks is due primarily to foreign exchange fluctuations. Other amortizable intangibles primarily include non-compete agreements, patents and customer relationships. 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 the fiscal years ended October 31, 2007 and 2006 was $5.3 million and $4.5 million, respectively. Annual amortization expense, based on the Company’s amortizable intangible assets as of October 31, 2007, is estimated to be approximately $4.0 million in the fiscal years ending October 31, 2008 through 2011 and approximately $3.2 million in the fiscal year ending October 31, 2012.
Goodwill arose primarily from the acquisitions of Rossignol, Quiksilver Europe, Quiksilver Asia/Pacific, DC and Surfection. Goodwill decreased approximately $58.2 million during the fiscal year ended October 31, 2007, with $159.7 million related to the Rossignol impairment. This decrease was offset by approximately $16.9 million related to the DC acquisition, $52.4 million related to foreign exchange fluctuations, and $32.2 million primarily related to other insignificant acquisitions. Goodwill increased $65.1 million during the fiscal year ended October 31, 2006, with $13.4 million related to the Rossignol acquisition, approximately $15.0 million related to the DC acquisition, and $36.7 million primarily related to other insignificant acquisitions and foreign exchange fluctuations.
Note 7 - Lines of Credit and Long-term Debt
A summary of lines of credit and long-term debt is as follows:
In July 2005, the Company issued $400 million in senior notes (“Senior Notes”), which bear a coupon interest rate of 6.875% and are due April 15, 2015. The Senior Notes were issued at par value and sold in accordance with Rule 144A and Regulation S. In December 2005, these Senior Notes were exchanged for publicly registered notes with identical terms. The Senior Notes are guaranteed on a senior unsecured basis by each of the Company’s domestic subsidiaries that guarantee any of its indebtedness or its subsidiaries’ indebtedness, or are obligors under its existing senior secured credit facility (the “Guarantors”). The Company may redeem some or all of the Senior Notes after April 15, 2010 at fixed redemption prices as set forth in the indenture related to such Senior Notes. In addition, prior to April 15, 2008, the Company may redeem up to 35% of the Senior Notes with the proceeds from certain equity offerings at a redemption price set forth in the indenture.
The Senior Notes indenture includes covenants that limit the ability of the Company and its restricted subsidiaries to, among other things: incur additional debt; pay dividends on their capital stock or repurchase their capital stock; make certain investments; enter into certain types of transactions with affiliates; limit dividends or other payments to the Company; use assets as security in other transactions; and sell certain assets or merge with or into other companies. If the Company experiences specific kinds of changes of control, it will be required to offer to purchase the Senior Notes at a purchase price equal to 101% of the principal amount, plus accrued and unpaid interest. As of October 31, 2007, the Company was in compliance with these covenants. In addition, the Company has approximately $8.7 million in debt issuance costs included in other assets as of October 31, 2007.
In April 2005, the Company replaced its line of credit in the Americas with a new revolving credit facility, which was subsequently amended (the “Credit Facility”). The Credit Facility expires April 2010 and provides for a secured revolving line of credit of up to $300 million (with a Company option to expand the facility to $350 million under certain conditions). The Credit Facility bears interest based on either LIBOR or an alternate base rate plus an applicable margin. The margin on the LIBOR rate is based on the Company’s fixed charge coverage ratio. The weighted average interest rate at October 31, 2007 is 6.7%. The Credit Facility includes a $125.0 million sublimit for letters of credit and a $35 million sublimit for borrowings in certain foreign currencies. As of October 31, 2007, $164.7 million was outstanding under the Credit Facility, in addition to outstanding letters of credit of $58.2 million. Of the amount outstanding, approximately $35.0 million represents outstanding borrowings of Roger Cleveland Golf Company, Inc. and are included in discontinued operations (Note 19).
The borrowing base is limited to certain percentages of the eligible accounts receivable and inventory from participating subsidiaries. The Credit Facility contains customary restrictive covenants for facilities and transactions of this type, including, among others, certain limitations on: incurrence of additional debt and guarantees of indebtedness; creation of liens; mergers, consolidations or sales of substantially all of the Company’s assets; sales or other dispositions of assets; distributions or dividends and repurchases of the Company’s common stock; restricted payments, including without limitation, certain restricted investments; engaging in transactions with non-participating subsidiaries of the Company and; sale and leaseback transactions. The Company’s United States assets and a portion of the stock of QS Holdings, SARL, a wholly-owned international subsidiary, have been pledged as collateral and to secure the Company’s indebtedness under the Credit Facility. As of October 31, 2007, the Company was in compliance with such covenants.
In Canada, the Company has arrangements with banks that provide for approximately $22.0 million of short term lines of credit. These lines of credit will be reviewed by the banks on various dates through 2008, and the Company believes the banks will continue to make these facilities available with substantially similar terms. The amount outstanding on these lines of credit at October 31, 2007 was $17.8 million at an average interest rate of 6.5%.
Quiksilver Europe has revolving lines of credit with banks that provide up to $479.0 million for cash borrowings and letters of credit. At October 31, 2007, these lines of credit bore interest at an average rate of 4.7%, and $234.6 million was outstanding in addition to outstanding letters of credit of $33.5 million. The lines of credit will be reviewed by the banks on various dates in 2008, and the Company believes that these lines of credit will continue to be available.
Quiksilver Asia/Pacific has revolving lines of credit with banks that provide up to $116.0 million for cash borrowings and letters of credit. These lines of credit will be reviewed by the banks on various dates through 2008, and the Company believes these lines of credit will continue to be available with substantially similar terms. The amount outstanding on these lines of credit at October 31, 2007 was $61.6 million in addition to $6.4 million outstanding letters of credit at an average interest rate of 3.2%.
Quiksilver Europe also has $216.0 million of long-term debt as of October 31, 2007. This debt is with several banks and contains covenants that are customary for such long-term indebtedness, including among other things, minimum financial ratios of net debt to shareholders’ equity and term debt to cash flow. At October 31, 2007, the overall weighted average interest rate on this long-term debt was 4.2%. Principal and interest payments are required either monthly, quarterly or annually, and the loans are due at various dates through 2010.
During fiscal 2007, the Company was out of compliance with certain profitability covenants on a 50.0 million euro term loan of a Rossignol subsidiary in Europe. As of October 31, 2007, this debt was approximately $72.1 million (50.0 million euros). The Company obtained a waiver from the bank for the fiscal year ended October 31, 2007 and additionally amended the existing agreement to remove these financial covenants through October 2008. Accordingly, the Company continues to classify this debt as long term as of October 31, 2007.
As part of the acquisition of Rossignol, the Company deferred a portion of the purchase price. This deferred purchase price obligation is expected to be paid in 2010 and accrues interest equal to the 3-month Euribor plus 2.35% (currently 7.0%) and is denominated in euros. The carrying amount of the obligation fluctuates based on changes in the exchange rate between euros and U.S. dollars. As of October 31, 2007, the deferred purchase price obligation totaled $43.6 million.
Quiksilver Europe and Asia/Pacific also have approximately $17.1 million in capital leases and other borrowings as of October 31, 2007.
Principal payments on long-term debt are due approximately as follows (in thousands):
Note 8 - Accrued Liabilities
Accrued liabilities consist of the following:
The following table provides a reconciliation of the activity related to the Company’s reserve for warranty expense, which is included in other accrued expenses in the accompanying balance sheets as of October 31:
Note 9 - Commitments and Contingencies
Operating Leases
The Company leases certain land and buildings under long-term operating lease agreements. The following is a schedule of future minimum lease payments required under such leases as of October 31, 2007 (in thousands):
Total rent expense was $95.1 million, $74.5 million and $44.0 million for the years ended October 31, 2007, 2006 and 2005, respectively.
Professional Athlete Sponsorships
We establish relationships with professional athletes in order to promote our products and brands. We have entered into endorsement agreements with professional athletes in sports such as skiing, surfing, skateboarding, snowboarding and windsurfing. Many of these contracts provide incentives for magazine exposure and competitive victories while wearing or using our products. Such expenses are an ordinary part of our operations and are expensed as incurred. The following is a schedule of future estimated minimum payments required under such endorsement agreements as of October 31, 2007 (in thousands):
Litigation
The Company has been named in a class action lawsuit that alleges willful violation of the federal Fair and Accurate Credit Transaction Act based upon certain of the Company’s retail stores’ alleged electronic printing of receipts on which appeared more than the last five digits of customers’ credit or debit card number and/or the expiration date of such customers’ credit or debit card. The Company is currently unable to assess the extent of damages, if any, that could be awarded to the plaintiff class if it were to prevail. The Company intends to vigorously defend itself against the claims asserted. No provision has been made in the Company’s financial statements for the year ended October 31, 2007.
The Company is involved from time to time in legal claims involving trademark and intellectual property, licensing, employee relations and other matters incidental to our business. The Company believes the resolution of any such matter currently pending will not have a material adverse effect on its financial condition or results of operations.
Indemnities and Guarantees
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. The Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets.
Note 10 - Stockholders’ Equity
In March 2000, the Company’s stockholders approved the Company’s 2000 Stock Incentive Plan (the “2000 Plan”), which generally replaced the Company’s previous stock option plans. Under the 2000 Plan, 33,444,836 shares are reserved for issuance over its term, consisting of 12,944,836 shares authorized under predecessor plans plus an additional 20,500,000 shares. The plan was amended in March 2007 to allow for the issuance of restricted stock and restricted stock units. The maximum number of shares that may be reserved for issuance of restricted stock or restricted stock unit awards is 800,000. Nonqualified and incentive options may be granted to officers and employees selected by the plan’s administrative committee at an exercise price not less than the fair market value of the underlying shares on the date of grant. Payment by option holders upon exercise of an option may be made in cash or, with the consent of the committee, by delivering previously outstanding shares of the Company’s common stock. Options vest over a period of time, generally three years, as designated by the committee and are subject to such other terms and conditions as the committee determines. Certain stock options have also been granted to employees of acquired businesses under other plans. The Company issues new shares for stock option exercises and restricted stock grants.
Changes in shares under option are summarized as follows:
The aggregate intrinsic value of options exercised, outstanding and exercisable as of October 31, 2007 is $15.8 million, $78.7 million and $75.7 million, respectively. The weighted average life of options outstanding and exercisable as of October 31, 2007 is 5.7 and 4.8 years, respectively.
Outstanding stock options at October 31, 2007 consist of the following:
Changes in non-vested shares under option for the year ended October 31, 2007 are as follows:
Of the 4.9 million non-vested shares under option as of October 31, 2007, approximately 4.2 million are expected to vest over the life of these non-vested options.
As of October 31, 2007, there were 2,608,373 shares of common stock that were available for future grant. Of these shares, 918,000 are available for issuance of restricted stock.
On November 1, 2005, the Company adopted the fair value recognition provisions of SFAS No. 123(R). Prior to November 1, 2005, the Company had accounted for stock-based payments under the recognition and measurement provisions of Accounting Principles Board (“APB”) Opinion 25 and related interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.” In accordance with APB 25, no compensation expense was required to be recognized for options granted that had an exercise price equal to the market value of the underlying common stock on the date of grant.
Under the modified prospective method of SFAS No. 123(R), compensation expense was recognized during the years ended October 31, 2007 and 2006 and includes compensation expense for all stock-based payments granted prior to, but not yet vested as of November 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123 and compensation expense for all stock based payments granted after November 1, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). The Company’s financial results for the prior periods have not been restated. Compensation expense was included as selling, general and administrative expense for fiscal 2007 and 2006. The impact on cost of goods sold was not significant. The adoption of SFAS No. 123(R) had no impact on the Company’s cash flows.
Consistent with the valuation method used for the disclosure only provisions of SFAS No. 123, the Company is using the Black-Scholes option-pricing model to value compensation expense. 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. The fair value of each option grant was estimated as of the grant date using the Black-Scholes option-pricing model for the years ended October 31, 2007, 2006 and 2005 assuming risk-free interest rates of 4.8%, 4.5% and 4.5%, respectively, volatility of 43.0%, 44.9% and 48.7%, respectively, zero dividend yield, and expected lives of 5.6, 5.2 and 5.1 years, respectively. The weighted average fair value of options granted was $7.16, $6.32 and $7.51 for the years ended October 31, 2007, 2006, and 2005, respectively. The Company records stock compensation expense using the graded vested method over the vesting period, which is generally three years. As of October 31, 2007, the Company had approximately $10.1 million of unrecognized compensation expense expected to be recognized over a weighted average period of approximately 2.6 years.
The reported net income and net income per share for the year ended October 31, 2005 has been presented below to reflect the impact of the adoption of SFAS No. 123(R) had the Company been required to adopt this standard on November 1, 2004.
In March 2006, the Company’s shareholders approved the 2006 Restricted Stock Plan and in March 2007, the Company’s shareholders approved an amendment to the 2000 Stock Incentive Plan whereby restricted shares and restricted stock units can be issued from such plan. Stock issued under these plans vests over a period of time, generally three to five years, and may have certain performance based acceleration features which allow for earlier vesting.
Changes in restricted stock are as follows:
Compensation expense is determined using the intrinsic value method and forfeitures are estimated at the date of grant based on historical rates and reduce the compensation expense recognized. The Company monitors the probability of meeting the restricted stock performance criteria and will adjust the amortization period as appropriate. As of October 31, 2007, there had been no acceleration of the amortization period. As of October 31, 2007, the Company had approximately $8.1 million of unrecognized compensation expense expected to be recognized over a weighted average period of approximately 2.1 years.
The Company began the Quiksilver Employee Stock Purchase Plan (the “ESPP”) in fiscal 2001, which provides a method for employees of the Company to purchase common stock at a 15% discount from fair market value as of the beginning or end of each purchasing period of six months, whichever is lower. The ESPP covers substantially all full-time domestic and Australian employees who have at least five months of service with the Company. Since the adoption of SFAS 123(R), compensation expense has been recognized for shares issued under the ESPP plan. During the years ended October 31, 2007, 2006 and 2005, 92,187, 219,093 and 157,298 shares of stock were issued under the plan with proceeds to the Company of $1.1 million, $2.4 million and $1.6 million, respectively.
During the years ended October 31, 2007 and 2006, the Company recognized total compensation expense related to options, restricted stock and ESPP shares of approximately $16.9 million and $20.5 million, respectively.
Note 11 - Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income include net income, changes in fair value of derivative instruments qualifying as cash flow hedges, the fair value of interest rate swaps and foreign currency translation adjustments. The components of accumulated other comprehensive income, net of tax, are as follows:
Note 12 - Rossignol Integration Plan and Pre-acquisition Restructuring Plan
In connection with the acquisition of Rossignol, the Company formulated the Rossignol Integration Plan (the “Plan”). The Plan covers the global operations of Rossignol and the Company’s existing businesses, and it includes the evaluation of facility relocations, nonstrategic business activities, redundant functions and other related items. As of October 31, 2007, the Company had recognized approximately $62.5 million of liabilities related to the Plan, including employee relocation and severance costs, moving costs, and other costs related primarily to the consolidation of Rossignol’s administrative headquarters in Europe, the consolidation of Rossignol’s European distribution, the consolidation and realignment of certain European manufacturing facilities, and the relocation of the Company’s wintersports equipment sales and distribution operations in the United States. These liabilities were included in the allocation of the purchase price for Rossignol in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” Emerging Issues Task Force (“EITF”) Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination.” As of October 31, 2007, the Company also recognized approximately $1.4 million in inventory impairments relating to the realignment of its European manufacturing facilities. Costs that are not associated with the acquired company but relate to activities or employees of the Company’s existing operations are not significant and are charged to earnings. Certain land and facilities owned by the acquired company are expected to be sold during the next 12 months in connection with the Plan, while others are anticipated to be refinanced through sale-leaseback arrangements. Assets currently held for sale, primarily in France, totaled approximately $15.3 million at October 31, 2007. If the Company has overestimated these integration costs, the excess will reduce goodwill in future periods. If the Company has underestimated these integration costs, additional liabilities recognized will be recorded in earnings.
Activity and liability balances recorded as part of the Plan are as follows:
Prior to the acquisition of Rossignol, a restructuring plan was announced related to Rossignol’s French manufacturing facilities (“Pre-acquisition Restructuring Plan”). The costs associated with the Pre-acquisition Restructuring Plan consist of termination benefits achieved through voluntary early retirement and voluntary termination of certain employees.
Activity and liability balances recorded as part of the Pre-acquisition Restructuring Plan are as follows:
Note 13 - Income Taxes
A summary of the provision for income taxes from continuing operations is as follows:
A reconciliation of the effective income tax rate to a computed “expected” statutory federal income tax rate is as follows:
The components of net deferred income taxes are as follows:
The tax benefits from the exercise of certain stock options are reflected as additions to paid-in capital.
Income (loss) before provision for income taxes includes $(5.4) million, $147.6 million and $124.6 million from foreign jurisdictions for the years ended October 31, 2007, 2006 and 2005, respectively. The Company does not provide for the U.S. federal, state or additional foreign income tax effects on certain foreign earnings that management intends to permanently reinvest. As of October 31, 2007, foreign earnings earmarked for permanent reinvestment totaled approximately $513.2 million.
At October 31, 2007, the Company has U.S. and state net operating loss carryforwards of approximately $2.2 million and $8.1 million, respectively, which will expire on various dates through 2027. In addition, the Company has foreign net operating loss carryforwards of approximately $75.1 million for the year ended October 31, 2007. Approximately $29.9 million will be carried forward until fully utilized, with the remaining $45.2 million expiring on various dates through 2027.
The change in valuation allowance of $4.0 million for fiscal 2007 relates primarily to the change in balances of acquired deferred tax assets that were offset by a full valuation allowance recorded in connection with the Rossignol Acquisition. Additional changes in valuation allowances were recorded in connection with certain net operating losses that were incurred during the year.
Note 14 - Employee Plans
Retirement and additional pension plan benefits
The Company’s Skis Rossignol SAS subsidiary pays employees retirement indemnities in a lump sum at the date of retirement, which are calculated based on years of service and compensation levels. These liabilities are unfunded and are accounted for as a defined benefit obligation under SFAS No. 87, “Employers Accounting for Pensions.”
Pursuant to SFAS No. 87, the Company records a net periodic pension cost in its statement of income, which represents the cost of the pension benefit for the period. There are no unrecognized benefit obligations at October 31, 2007, 2006 and 2005. These amounts are determined using an assumed discount rate of 5.3%, 4.40% and 3.50%, an average salary increase of 2.00%, 2.00% and 2.25%, a turnover rate of 2.00%, and an inflation rate of 1.85%, 1.85% and 1.75% for the years ended October 31, 2007, 2006 and 2005 respectively. The following table summarizes the components of net periodic pension cost and the change in the benefit obligation:
The following represents estimated future gross benefit payments related to the pension plan as of October 31, 2007:
The Company maintains the Quiksilver 401(k) Employee Savings Plan and Trust (the “401(k) Plan”). This plan is generally available to all domestic employees with six months of service and is funded by employee contributions and periodic discretionary contributions from the Company, which are approved by the Company’s Board of Directors. The Company made contributions of $1.0 million, $0.9 million and $0.9 million to the 401(k) Plan for the years ended October 31, 2007, 2006 and 2005, respectively. The Company also made contributions of $0.1 million, $0.1 million and $0.2 million for the years ended October 31, 2007, 2006 and 2005, respectively, to 401(k) plans maintained on behalf of employees in certain Rossignol subsidiaries in the United States.
Employees of certain of the Company’s French subsidiaries including Na Pali SAS, Skis Rossignol SAS, Skis Dynastar SAS and Look Fixations, with three months of service are covered under French Profit Sharing Plans (the “French Profit Sharing Plans”), which are mandated by law. Compensation is earned
under the French Profit Sharing Plans based on statutory computations with an additional discretionary component. Funds are maintained by the Company and vest with the employees after five years, although earlier disbursement is optional if certain personal events occur or upon the termination of employment. Compensation expense of $4.1 million, $2.1 million and $3.2 million was recognized related to the French Profit Sharing Plans for the fiscal years ended October 31, 2007, 2006 and 2005, respectively.
Note 15 - Segment and Geographic 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, produces and distributes clothing, wintersports equipment, footwear, accessories and related products. The Company operates in three segments, the Americas, Europe and Asia/Pacific. The Americas segment includes revenues primarily from the United States and Canada, while the European segment includes revenues primarily from Western Europe, and the Asia/Pacific segment includes revenues primarily from Australia, Japan, New Zealand and Indonesia. Costs that support all three operating 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 sale of products to certain licensees. The Company’s largest customer accounts for approximately 4% of its revenues.
The Company produces different product lines within each geographical segment. The percentages of revenues attributable to each product line are as follows:
Information related to the Company’s operating segments is as follows:
France accounted for 34.5%, 34.1% and 36.2% of European net sales to unaffiliated customers for the years ended October 31, 2007, 2006 and 2005, respectively, while Spain accounted for 16.1%, 14.4% and 15.2%, respectively, and the United Kingdom accounted for 11.2%, 9.9% and 15.5%, respectively. Identifiable assets in the United States totaled $882.1 million as of October 31, 2007.
Note 16 - 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, and to fluctuations in interest rates related to its variable rate debt. 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. In
addition, interest rate instruments are used to manage the Company’s exposure to the risk of fluctuations in interest rates.
Derivatives that do not qualify for hedge accounting but are used by management to mitigate exposure to currency risks are marked to fair value with corresponding gains or losses recorded in earnings. A loss of $1.8 million was recognized related to these types of contracts during fiscal 2007. For all qualifying cash flow hedges, the changes in the fair value of the derivatives are recorded in other comprehensive income. As of October 31, 2007, the Company was hedging transactions expected to occur through October 2009. Assuming exchange rates at October 31, 2007 remain constant, $23.8 million of losses, net of tax, related to hedges of these transactions are expected to be reclassified into earnings over the next 24 months.
On the date the Company enters into a derivative contract, management designates the derivative as a hedge of the identified exposure. The Company formally documents all relationships between hedging instruments and hedged items, as well as the risk-management objective and strategy for entering into various hedge transactions. 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. As a result of the expiration, sale, termination, or exercise of derivative contracts, the Company reclassified into earnings net losses (gains) of $8.3 million, $(0.8) million and $5.3 million during the fiscal years ended October 31, 2007, 2006 and 2005, respectively.
The Company enters into forward exchange and other derivative contracts with major banks and is exposed to credit 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.
A summary of derivative contracts at October 31, 2007 is as follows:
Note 17 - Quarterly Financial Data (Unaudited)
A summary of quarterly financial data (unaudited) is as follows:
Note 18 - Condensed Consolidating Financial Information
In December 2005, the Company completed an exchange offer to exchange the Senior Notes for publicly registered notes with identical terms. Obligations under the Company’s Senior Notes are fully and unconditionally guaranteed by certain of its existing domestic subsidiaries.
The Company is required to present condensed consolidating financial information for Quiksilver, Inc. and its domestic subsidiaries within the notes to the 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 Guarantor subsidiaries, its non-Guarantor subsidiaries and the eliminations necessary to arrive at the information for the Company on a consolidated basis as of October 31, 2007 and 2006 and for the years ended October 31, 2007, 2006 and 2005. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions. During fiscal year 2007, the Company acquired the remaining minority interest share of Roger Cleveland Golf, Company, Inc. a guarantor subsidiary. As a result, Roger Cleveland Golf Company, Inc. is now included with wholly-owned guarantor subsidiaries for all periods presented.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Year Ended October 31, 2007
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Year Ended October 31, 2006
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Year Ended October 31, 2005
CONDENSED CONSOLIDATING BALANCE SHEET
AT OCTOBER 31, 2007
CONDENSED CONSOLIDATING BALANCE SHEET
AT OCTOBER 31, 2006
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Year Ended October 31, 2007
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Year Ended October 31, 2006
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Year Ended October 31, 2005
Note 19 - Discontinued Operations
In October 2007, the Company entered into an agreement to sell its golf equipment business which includes Roger Cleveland Golf Company, Inc. and certain other related international subsidiaries for approximately $132.5 million. Majority ownership in this business was originally acquired in fiscal 2005 as part of the Rossignol acquisition. In September 2007, the Company acquired the remaining 36.37% minority interest in Roger Cleveland Golf Company, Inc. (Note 2). The golf equipment business assets are classified as held for sale and the operations of the golf equipment business are classified as discontinued operations for all periods presented. The Company closed this transaction during December 2007. The Company plans to use the net proceeds from this sale to repay existing indebtedness.
The operating results of discontinued operations included in the accompanying consolidated statements of operations were as follows:
The loss from discontinued operations from fiscal 2007 includes asset impairments of $8.2 million.
The components of assets and liabilities of discontinued operations at October 31, 2007 are as follows:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: December 28, 2007
QUIKSILVER, INC.
(Registrant)
By:
/s/ Robert B. McKnight, Jr.
By:
/s/ Brad L. Holman
Robert B. McKnight, Jr.
Brad L. Holman
Chairman of the Board and
Vice President of Accounting and
Chief Executive Officer
Financial Reporting
(Principal Executive Officer)
(Principal Accounting Officer)
KNOW ALL PERSONS BY THESE PRESENTS, that each of the persons whose signature appears below hereby constitutes and appoints Robert B. McKnight, Jr. and Brad L. Holman, each of them acting individually, as his attorney-in-fact, each with the full power of substitution, for him in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming our signatures as they may be signed by our said attorney-in-fact and any and all amendments to this Annual Report on Form 10-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
EXHIBIT INDEX
DESCRIPTION
(1)
Management contract or compensatory plan.