1. finance

Report on International Financial Operations
MBAF 648 | April 28, 2009
Prepared by
Hilary Fahlsing
Laura Francis
Brian Gooding
Trevor Zink
Overview
Background
 Foreign Exchange Exposure
 Foreign Capital Investment

 Analysis of risk
Cost of Capital and Capital Structure
 Working Capital Management
 Recommendations

Background

Started in 1969 in Torquay, Australia
 Alan Green, Carol McDonald, Tim Davis

Quick expansion
 First export in 1974
 Bought factory in 1976

Expanded to U.S. in 1976
 License agreement with pro surfer/entrepreneur Jeff Hackman

Added Roxy in 1993, DC Shoes in 2004

IPO in 1986 on NASDAQ, moved to NYSE in1998
Background

Today, premier surf, skate, and board apparel
brand
 Brand awareness through sponsorship of events and
top athletes

Goal: Become the leading global youth apparel
company

Sold in 90 countries
 Surf shops, dept stores,
Quiksilver stores
Background

Core brands
 Quiksilver, Roxy, DC Shoes, Quicksilver Women’s
 Increased focus for 2009

Non-core brands
 LibTech, GNU (snowboard mfg)
 Bent Metal (bindings mfg)

Divested brands
 LOOK, Lange, Dynastar, Rossignol
Background

Management’s goals and recent actions
 Improved liquidity and capital structure
 Adapted organizational structure
 Refocused brand integrity and quality
 Positioning for improved operating margins and
cash flows upon economic rebound
 Improved cost structure by $325 million annually
 Expense savings of $40 million annually
Foreign Exchange Exposure





Operates in the North America, Europe, and
Asia/Pacific regions
Exchange rates have significant effect on
financials
Assets and liabilities translated at balance
sheet date exchange rate
Revenues and expenses use the average
exchange rate for the period
Translation gains/losses from foreign
subsidiaries included in accumulated other
comprehensive income or loss.
Foreign Exchange Exposure

Hedging activities
 Forward contracts
 Inter-company loans
 Currently hedging $20.5 million through 2010

Subsidiary translation hedging
 Forward contracts
 Inter-company loans
 Not actual translation of terms
Foreign Capital Investment

Determine how much total budget for all global
operations

Collect market forecasts from sales/marketing
organizations

Combine these forecasts to create world
analysis of the industry

Take into consideration current economic
environment and specific demands in each
region
Risk Analysis

Quiksilver's Major Risks
 Relative Growth and Contraction of Apparel Industry
 Market Share gains and Losses
 Real Estate Risk
 Economic Fluctuations
○ The occurrence or consequences of any of these risks affects
Quiksilver's ability to operate profitably and can harm its
financial condition
Growth/Contraction of Apparel
Industry

Considerable variability in consumer demands
and tastes for products

Operates in over 100 countries, all with different
preferences

Have to fulfill different needs at production stage

Mitigate risk by expanding brand
reach
 Creating line of Roxy headphones
partnership with JBL, Inc.
Market Share Gains and Losses

Competition present in all of their regions

Quiksilver tries to maintain position as top
performer in all of its regions

Only invest in projects with high degree of
probability
 In Latin America, surf/skate industry thriving
 Bought out JV in Latin America and continuing to
develop

Important to recognize growing markets and
invest before competition
Real Estate Risk
 Always risky to operate international
facilities
 Track sales and performance at all stores
 Target under performing stores for
closure
 Once expired, discontinue lease
 Sometimes have to negotiate buy-out of
lease or stay open until lease expires
Economic Fluctuations

This risk factor is intertwined with all
Quiksilver's other risks

Quiksilver realizes that it is not mandatory
to invest when the economy is in peril

Because the U.S. and Western European
markets are struggling, they weigh much
more heavily the need to invest at all at this
time
Cost of Capital | Capital Structure

Five key metrics:
 Cost of equity
 Before tax cost of debt
 Average tax rate
 Debt ratio
 Equity ratio
Cost of Capital | Capital Structure

Cost of equity -> CAPM
 E(r)ZQK = rf +β(rm - rf)

Risk Free Rate
 30-year US bond yield (3.67%)
○ Long time period most appropriate

Beta = 2.03
 Linear regression analysis of Quiksilver’s stock returns from
past ten years vs. S&P over the same period

rm = 7.37%
 S&P 500 from past 30 years
 Cost of Equity = 11.33%
Cost of Capital | Capital Structure

Before-tax cost of debt
 Total interest expense
Total long term debt
 $45,327,000 in interest expense
 $790,097,000 of long-term debt
 Before-tax cost of debt = 5.737%
 Tax rate
 Total income taxes paid ($33,027,000) over
income before taxes ($98,571,000)
 Tax rate = 33.5%
Cost of Capital | Capital Structure

Debt/Equity Mix
 Debt Ratio
○ Long-term debt ($790,097,000) over long-term
debt and the market value of shareholders equity
($987,355,600
○ Debt ratio = 80.02%
○ Equity ratio = 19.98%
Cost of Capital | Capital Structure

After-tax WACC
 Use metrics mentioned
 WACC = rd(1-Tax Rate)(D/V) + re(E/V)
 Overall cost of capital = 5.31%
Cost of Capital | Capital Structure

Cost of capital in foreign projects
 Similar, with techniques to isolate foreign project cost
 Slightly higher cost abroad than domestically

Highly Leveraged
 Debt/Equity ratio = 4:1
 Insufficient cash reserves and excessive short term debt
 Stock price fell 90% since late 2007

Long-term sources of funds
 Long-term debt
 $790M in long-term debt
Working Capital Management

Capital Expenditures
 Quiksilver finances its working capital and capital
expenditure needs with operating cash flows and
bank revolving lines of credit
 Working capital was $631.3 million in 2008, which is
less than a one percent decrease from the prior year
 Contracts with independent contractors have helped
the company avoid high levels of capital
expenditures
 In 2008, the company spent $93.7 million on capital
expenditures
○ Quicksilver estimates that capital expenditures with
decrease in 2009 to approximately $60-$70 million
Working Capital Management

Trade Accounts Receivables
 A/R have decreased to $470.1 million in 2008 from $478
million in 2007
○ Part of the decrease ($36.6 million) is due to fluctuations in
currency exchange rates
 Receivables in the Americas increased 12%, while
European and Asia/Pacific receivables decreased 10% and
22%
 Quiksilver performs credit evaluations of their customers
to adjust credit limits based on payment history and
current creditworthiness
 Products are sold to customers in the Americas on a net-
30 to net-60 day basis, and net-30 to net-90 terms in
Europe and Asia/Pacific depending on the country and
whether the products are sold directly to a retailer or
through a distributor
Working Capital Management

Inventory
 Value is based on the cost to purchase and/or
manufacturer or estimated market value, whichever
is lower
 Demand for the products can vary significantly,
especially due to weakening economic conditions
when consumers tend to purchase less
○ If Quiksilver overestimates the need for certain products, it
will distribute the additional products through outlet stores
and secondary distribution channels
 Consolidated inventories decreased approximately
5% in 2008 - totaling $312.1 million
○ Approximately $24 million decrease in inventories is due to
fluctuations in currency exchange rates
Working Capital Management

Short-term funds
 Existing lines of credit with several banks throughout
the United States, Europe and Asia/Pacific
 Short-term lines of credit total over $248.9 million
 Total maximum for cash borrowings and letters of
credit is approximately $826.3 million
 Senior notes
○ Covenants limit Quiksilver’s ability to incur additional debt,
which keeps them from seeking additional short-term lines
of credit
Working Capital Management

Dividend Policy
 Board of Directors determines the dividend
policy
○ Policy is based on several factors: total earnings,
financial requirements and condition, opportunities for
reinvesting earnings, business conditions and other
factors.
 Quiksilver has never paid a cash dividend and all
earnings are reinvested in the business
 Senior notes and credit agreements
○ Covenants limit the ability to pay dividends on capital
stock or repurchase capital stock
○ Also, limits dividends or other payments by the
subsidiaries to the Company
Recommendations

Invest in in emerging/thriving surf/skate areas
 Latin America, Eastern Europe, domestic submarkets such as Washington
D.C.)

Focus on successful core brands (Quiksilver, DC, Roxy)
 Invest in these brands
 Divest any remaining non-core business units and brands.

Invest only in projects with high probability of success
 Debt structure and senior notes dictate the need for extreme risk aversion.

Debt reduction
 Over $1 billion in short and long term debt
○ Coming due in the next five years
○ Too highly leveraged for its current size and revenue
 Immediate action to reduce debt or renegotiate debt terms.