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.