VLCM Valcom (MM)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2007

or

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

For the transition period from                      to                     

Commission file number: 000-51382

Volcom, Inc.

(Exact name of registrant as specified in its charter)

Volcom, Inc.
1740 Monrovia Avenue
Costa Mesa, CA 92627
(Address of principal executive offices, including zip code)

(949) 646-2175
(Registrant’s telephone number, including area code)

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

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

Large Accelerated Filer þ                     Accelerated Filer o                     Non-Accelerated Filer o

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

As of November 1, 2007, there were 24,349,520 shares of the registrant’s common stock, par value $0.001, outstanding.

 

 

VOLCOM, INC.

FORM 10-Q
INDEX

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements			3
Condensed Consolidated Balance Sheets (unaudited) as of September 30, 2007 and December 31, 2006			3
Condensed Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2007 and 2006			4
Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2007 and 2006			5
Notes to Condensed Consolidated Financial Statements (unaudited)			6 – 14
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			15 – 28
Item 3. Quantitative and Qualitative Disclosures About Market Risk			29
Item 4. Controls and Procedures			29 – 30
Item 4T. Controls and Procedures			30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			31
Item 1A. Risk Factors			31 – 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			32
Item 3. Defaults Upon Senior Securities			33
Item 4. Submission of Matters to a Vote of Security Holders			33
Item 5. Other Information			33
Item 6. Exhibits			33
SIGNATURES			34
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

PART I. FINANCIAL INFORMATION

See accompanying notes to condensed consolidated financial statements

Supplemental disclosures of noncash investing and financing activities:

     At September 30, 2007 and 2006, the Company accrued for $294,000 and $256,000 of property and equipment purchases, respectively.

See accompanying notes to condensed consolidated financial statements

VOLCOM, INC. AND SUBSIDIARIES

VOLCOM, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (continued)

      Stock Compensation Plans — In June 2005, the Company’s Board of Directors and stockholders approved the 2005 Incentive Award Plan (the “Incentive Plan”), as amended in February 2007. A total of 2,300,000 shares of common stock were initially authorized and reserved for issuance under the Incentive Plan for incentives such as stock options, stock appreciation rights, restricted stock awards, restricted stock units, performance shares and deferred stock awards. The actual number of awards reserved for issuance under the Incentive Plan automatically increases on the first trading day in January of each calendar year by an amount equal to 2% of the total number of shares of common stock outstanding on the last trading day in December of the preceding calendar year, but in no event will any such annual increase exceed 750,000 shares. As of September 30, 2007, there were 2,638,665 shares available for issuance pursuant to new stock option grants or other equity awards. Under the Incentive Plan, stock options have been granted at an exercise price equal to the fair market value of the Company’s stock at the time of grant. The vesting period for stock options is determined by the Board of Directors or the Compensation Committee of the Board of Directors, as applicable, and the stock options generally expire ten years from the date of grant or 90 days after employment or services are terminated.

      Stock Option Awards — In June 2005, the Company’s Board of Directors approved the grant of 586,526 options to purchase the Company’s common stock. The Company granted these options under the Incentive Plan at the effective date of the Company’s initial public offering at an exercise price of $19.00, which was equal to the initial public offering price. The stock options have vesting terms whereby 10,526 options vested immediately, 210,000 options vested on December 15, 2005 and the remaining 366,000 options vest 20% per annum over 5 years. The fair value of these awards was calculated through the use of the Black-Scholes option-pricing model assuming an exercise price equal to the fair market value of the Company’s stock and the following additional significant weighted average assumptions: expected life of 4.2 years; volatility of 47.5%; risk-free interest rate of 3.73%; and no dividends during the expected term.

     In May 2007, the Company’s Board of Directors approved the grant of 2,000 options to purchase the Company’s common stock to each independent member of the Company’s Board of Directors (10,000 options in total). The Company granted these options at the fair market value of the Company’s common stock on the date of grant. The stock options vest one year from the date of grant. The fair value of these awards was calculated through the use of the Black-Scholes option-pricing model assuming an exercise price equal to the fair market value of the Company’s stock and the following additional significant weighted average assumptions: expected life of 2.0 years; volatility of 55.7%; risk-free interest rate of 4.68%; and no dividends during the expected term.

     A summary of the Company’s stock option activity under the Incentive Plan for the nine months ended September 30, 2007 is as follows:

     As of September 30, 2007, there was unrecognized compensation expense of $1.8 million related to unvested stock options, which the Company expects to recognize over a weighted-average period of 2.7 years. The aggregate intrinsic value of options exercised during the nine months ended September 30, 2007 and 2006 was $1.0 million and $345,000, respectively. The aggregate intrinsic value of options outstanding and options exercisable as of September 30, 2007 was $10.2 million and $5.4 million, respectively. Cash received from the exercise of stock options totaled $971,000 and $543,000 for the nine months ended September 30, 2007 and 2006, respectively. The Company issues new shares upon the exercise of options or granting of restricted stock.

     Additional information regarding stock options outstanding as of September 30, 2007 is as follows:

     As of September 30, 2007, the total number of outstanding options vested or expected to vest (based on anticipated forfeitures) was 433,178, which had a weighted-average exercise price of $19.53. The weighted-average remaining life of these options was 7.8 years and the aggregate intrinsic value was $10.0 million at September 30, 2007.

      Restricted Stock Awards — The Company’s Incentive Plan provides for awards of restricted shares of common stock. Restricted stock awards have time-based vesting and are subject to forfeiture if employment terminates prior to the end of the service period. Restricted stock awards are valued at the grant date based upon the market price of the Company’s common stock and the fair value of each award is charged to expense over the service period.

     In 2005, the Company granted a total of 20,000 shares of restricted stock to employees. The restricted stock awards have a purchase price of $.001 per share and vest 20% per year over a five-year period. The total fair value of the restricted stock awards is $660,000, of which $99,000 was amortized to expense during each of the nine month periods ended September 30, 2007 and 2006.

     In 2006, the Company granted a total of 15,000 shares of restricted stock to employees. The restricted stock awards have a purchase price of $.001 per share and vest 20% per year over a five-year period. The total value of the restricted stock awards is $405,000, of which $61,000 and $35,000 was amortized to expense during the nine months ended September 30, 2007 and 2006, respectively.

     Restricted stock activity for the nine months ended September 30, 2007 is as follows:

     As of September 30, 2007, there was unrecognized compensation expense of $663,000 related to all unvested restricted stock awards, which the Company expects to recognize on a straight-line basis over a weighted average period of approximately 3.2 years.

VOLCOM, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (continued)

Note 3 — New Accounting Pronouncements

     In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. As a result of the implementation of FIN No. 48, the Company recognized a $128,000 increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. See Note 11 to the Condensed Consolidated Financial Statements.

     In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company does not expect the adoption of SFAS No. 157 to have a material effect on its consolidated financial position or results of operations.

     In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of SFAS No. 115 . SFAS No. 159 provides reporting entities an option to measure certain financial assets and liabilities and other eligible items at fair value on an instrument-by-instrument basis. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS No. 159 to have a material effect on its consolidated financial position or results of operations.

VOLCOM, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (continued)

     In February 2007, the Company completed the construction of its European headquarters in Anglet, France. Costs incurred related to such construction totaled approximately 4.6 million Euros (approximately $6.6 million based on a 1 Euro to $1.4272 U.S. dollar exchange rate as of September 30, 2007).

     The Company has applied for and received approval to obtain local government grants totaling approximately 800,000 Euros (approximately $1.1 million based on a 1 Euro to $1.4272 U.S. dollar exchange rate as of September 30, 2007). Such grants will be paid to the Company at various times during and after the European headquarters construction period and generally require the Company to maintain and operate the European headquarters for five years. To the extent that the Company does not maintain and operate the European headquarters for a five year period, certain amounts of the grants will have to be repaid to the local government at that time. As of September 30, 2007, the Company has received approximately 489,000 Euros (approximately $698,000 based on a 1 Euro to $1.4272 U.S. dollar exchange rate as of September 30, 2007) with respect to such grants. The Company has recorded $478,000 of the cash received for these grants against property and equipment, as these grants support the construction of the European headquarters and will offset depreciation expense over the estimated useful life of the European headquarters, and $220,000 as an other long-term liability, as this grant relates to the Company’s employment requirements over the next five years, and will be amortized against operating expenses on a straight-line basis over the five-year period of the employment requirements.

     On February 7, 2007, the Company purchased real property on the North Shore of Oahu (the “Pipe House”) for $4.2 million in cash. The Pipe House will generally be used as a residence for the Company’s surf team riders and for other Company marketing activities.

Note 6 — Investments in Unconsolidated Investees

     Since 1998, the Company has held an ownership interest in the common stock of Volcom Australia, a licensee of the Company’s products located in Australia. In March 2004, the Company purchased an additional 4.8% ownership interest in Volcom Australia for $261,000, which brought the Company’s total ownership interest to 13.5%. The investment is accounted for under the cost method, as the Company does not have the ability to exercise significant influence over the financial and operating policies of the investee. At September 30, 2007 and December 31, 2006, the Company’s investment in Volcom Australia was $298,000.

Note 7 —Intangible Assets

     Intangible assets are as follows:

     Intangible assets other than goodwill are amortized by the Company using estimated useful lives of 6 months to 10 years with no residual values. Fluctuations in the gross carrying amounts of intangible assets are due to the effect of changes in foreign currency exchange rates. Intangible amortization expense for the nine months ended September 30, 2007 and 2006 was approximately $35,000 and $137,000, respectively. Annual amortization expense is estimated to be approximately $46,000 in the fiscal years ending December 31, 2007 through 2011.

Note 9 — Commitments and Contingencies

      Litigation — The Company is involved from time to time in litigation incidental to its business. In the opinion of management, the resolution of any such matter currently pending will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

      Indemnities and Guarantees — During its normal course of business, the Company has made certain indemnities 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 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 on the maximum potential future payments the Company could be obligated to make. The Company has not been required to record nor has it recorded any liability for these indemnities, commitments and guarantees in the accompanying condensed consolidated balance sheets.

Note 10 — Earnings Per Share

     The Company calculates net income per share in accordance with SFAS No. 128, Earnings Per Share , as amended by SFAS No. 123(R). Under SFAS No. 128, basic net income per common share is calculated by dividing net income by the weighted average number of common shares outstanding during the reporting period. Diluted net income per common share reflects the effects of potentially dilutive securities, which consists solely of restricted stock and stock options using the treasury stock method. A reconciliation of the numerator and denominator used in the calculation of basic and diluted net income per share is as follows:

     For the three and nine months ended September 30, 2007, stock options of 10,000 were excluded from the weighted-average number of shares outstanding because their effect would be antidilutive.

VOLCOM, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) — (continued)

Note 11 — Income Taxes

     The Company adopted the provisions of FIN No. 48 on January 1, 2007. Upon the adoption of FIN No. 48, the Company recognized a $128,000 increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings.

     At September 30, 2007, the Company has $134,000 of total unrecognized tax benefits, all of which, if recognized, would favorably affect the effective income tax rate in any future periods. It is reasonably possible that a change in the unrecognized tax benefits could occur within the next 12 months. However, the Company anticipates that any change would not be significant and would not have a material impact on the consolidated statement of operations or consolidated balance sheet.

     The Company and its subsidiaries file tax returns in the U.S. Federal jurisdiction and in many state and foreign jurisdictions. The Company is no longer subject to U.S. Federal income tax examinations for years before 2003 and is no longer subject to state and local or foreign income tax examinations by tax authorities for years before 2002. The Company is currently not undergoing an audit in any jurisdiction.

     The Company recognizes interest and/or penalties related to unrecognized tax benefits in income tax expense. As of the date of adoption, the Company recorded $2,000 of interest and penalties, which is included in the $128,000 liability for unrecognized tax benefits noted above. During the nine months ended September 30, 2007, the Company recognized approximately $6,000 of interest and penalties associated with uncertain tax positions.

     At September 30, 2007, the Company had $8,000 accrued for interest and penalties. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.

Note 12 — Segment Information

     Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company operates exclusively in the consumer products industry in which the Company designs, produces and distributes clothing, accessories and related products. The Company’s license agreement with Volcom Europe, the licensee of the Company’s products in France, expired on December 31, 2006. In anticipation of the expiration of this license agreement, the Company established subsidiaries in France and Switzerland in order to take direct control of its European operations. Based on the nature of the financial information that is received by the chief operating decision maker, the Company now operates in two operating and reportable segments, the United States and Europe. The United States segment primarily includes revenues generated from customers in the United States, Canada, Asia Pacific and South America that are served by the Company’s United States operations, while the European segment primarily includes revenues generated from customers in Europe that are served by the Company’s European operations. All intercompany revenues and expenses are eliminated in consolidation and are not reviewed when evaluating segment performance. Each segment’s performance is evaluated based on revenues, gross profit and operating income. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

     Although the Company operates within two reportable segments, it has several different product categories within each segment, for which the revenues attributable to each product category are as follows:

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

The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements due to known and unknown risks, uncertainties and other factors. The section entitled “Risk Factors” set forth in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2006, as supplemented by “Part II, Item 1A Risk Factors” of our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2007 and June 30, 2007 and by similar discussions in our other Securities and Exchange Commission, or SEC, filings, discuss some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the information in this report and in our other filings with the SEC, before deciding to purchase, hold or sell our securities. We do not have any intention or obligation to update forward-looking statements included in this Quarterly Report on Form 10-Q after the date of this Quarterly Report on Form 10-Q, except as required by law. In addition, the following discussion should be read in conjunction with the information presented in our audited consolidated financial statements and related notes contained in our Annual Report on Form 10-K for our fiscal year ended December 31, 2006.

Overview

     We are an innovative designer, marketer and distributor of premium quality young mens and young womens clothing, accessories and related products under the Volcom brand name. We seek to offer products that appeal to participants in skateboarding, snowboarding and surfing, and those who affiliate themselves with the broader action sports youth lifestyle. Our clothing, which includes t-shirts, fleece, bottoms, tops, jackets, boardshorts, denim and outerwear, combines fashion, functionality and athletic performance. Our designs are infused with an artistic and creative element that we believe differentiates our products from those of many of our competitors. We develop and introduce products that we believe set the industry standard for style and quality in each of our product categories.

     We have recently launched new product extensions to complement our current product offerings. These new product extensions include a complete line of sandals and slip-on footwear, branded Creedlers; a complete collection of kids clothing for young boys ages 4 to 7; and a girls swimwear line. The Creedlers and kids line began shipping in December 2006, and the girls swimwear line began shipping in February 2007.

     Volcom branded products are currently sold throughout the United States and in over 40 countries internationally by either us or international licensees. We serve the United States, Europe, Canada, Latin America, Asia Pacific and Puerto Rico through our in-house sales personnel, independent sales representatives and distributors. In these areas, Volcom branded products are sold to retailers that we believe merchandise our products in an environment that supports and reinforces our brand image and provide a superior in-store experience. As of September 30, 2007, our customer base of retailers included approximately 2,250 accounts that operated approximately 4,800 store locations (of which approximately 1,150 accounts that operated approximately 2,950 stores are located in the United States) and 37 distributors in countries not serviced by our licensees. Our retail customers are primarily specialty boardsports retailers and several retail chains. Except for sales made in Europe and Canada, all of our sales are denominated in U.S. dollars.

     In Australia, Indonesia, South Africa and Brazil, we have entered into licensing agreements with entities that we believe have local market insight and strong relationships with retailers in their respective territories. Products sold by our licensees can be found in approximately 600 store locations in Australia, over 460 store locations in Brazil, approximately 100 store locations in South Africa and approximately 90 store locations in Indonesia. We receive royalties on the sales of Volcom branded products sold by our licensees. Our license agreements specify design and quality standards for the Volcom branded products distributed by our licensees. Our licensees are not controlled and operated by us, and the amount of our licensing revenues could decrease in the future. As these license agreements expire, we may assume direct responsibility for serving these licensed territories. Our license agreement with our European licensee expired on December 31, 2006. Pursuant to an agreement between us and Volcom Europe (our ex-European licensee), Volcom Europe produced and distributed the Spring 2007 Volcom line in Europe and paid us our same royalty rate as required under the license agreement. In anticipation of the expiration of our license agreement with Volcom Europe, we have established our own operations in Europe in order to take direct control of

the Volcom brand in Europe. As a result, we will continue to experience a decrease in our licensing revenues and an increase in our selling, general and administrative expense while we continue to build the necessary infrastructure and hire employees to further establish our own operations in Europe. However, our product revenues should increase in Europe as we have begun to recognize revenue from the direct sale of our products in this territory.

     As part of our strategy to take direct control of our European operations, we constructed a new European headquarters in Anglet, France, which was completed in February 2007 and delivered our first full season product line during the third quarter of 2007. We continue to build the necessary infrastructure to support these European operations. Our current European team consists of 85 employees made up of design, production, sales, information technology and management positions.

     Our revenues increased from $57.1 million in 2002 to $205.3 million in 2006. Our revenues were $199.5 million for the nine months ended September 30, 2007, an increase of $50.8 million, or 34.2%, compared to $148.7 million for the nine months ended September 30, 2006. In June 2007, we began direct distribution of our product in Europe, which contributed to our increase in sales for the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006. Additionally, based upon our experience and consumer reaction to our products and brand image, we believe that the increase in our revenues during these periods resulted primarily from increased brand recognition and growing acceptance of our products at existing retail accounts. We believe that our marketing programs, product designs and product quality, and our relationships with our retailers contributed to this increased demand and market penetration. In addition, the increase in our revenues can be attributed to sales of our recently introduced Creedlers and girls swim product, as well as some additional distribution. Further, several of our largest retailers have opened additional stores and those store openings likely have contributed to an increase in our product revenues; however, period-over-period increases in our product revenues as judged solely by additional store openings by our largest retailers may not be a useful or accurate measure of revenue increases because our products may not be carried in every new store. Growth of our revenues will depend in part on the demand for our products by consumers, our ability to effectively distribute our products and our ability to design products consistent with the changing fashion interests of boardsports participants and those who affiliate themselves with the broader action sports youth lifestyle.

     Sales to Pacific Sunwear decreased 5.9%, or $2.2 million, for the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006. We may continue to see sales to Pacific Sunwear decline, and we currently project an approximate 10% decrease in sales to Pacific Sunwear for 2007 compared to 2006. We have also provided preliminary guidance that we also expect Pacific Sunwear sales to be down approximately 10% in 2008 compared to 2007. It is unclear where our sales to Pacific Sunwear will trend in the longer term. Pacific Sunwear remains an important customer for us and we are working both internally and with Pacific Sunwear to maximize our business with them. We believe our brand continues to be an important part of the Pacific Sunwear business. We also recognize that any customer concentration creates risks and we are, therefore, assessing strategies to lessen our concentration with Pacific Sunwear.

     Our gross margins are affected by our ability to accurately forecast demand and avoid excess inventory by matching purchases of finished goods to pre-season orders, which decreases our percentage of sales at discount or close-out prices. Gross margins are also impacted by our ability to control our sourcing costs and, to a lesser extent, by changes in our product mix and geographic distribution channel. Our gross margins have also historically been seasonal, with the first quarter having the highest margin. However, with the introduction of our direct European business, the seasonality of our gross margin may change. If we misjudge forecasting inventory levels or our sourcing costs increase and we are unable to raise our prices, our gross margins may decline.

     We currently source the substantial majority of our products from third-party manufacturers located primarily in China, Mexico and Macau. As a result, we may be adversely affected by the disruption of trade with these countries, the imposition of new regulations related to imports, duties, taxes and other charges on imports, and decreases in the value of the U.S. dollar against foreign currencies. We seek to mitigate the possible disruption in product flow by diversifying our manufacturing across numerous manufacturers and by using manufacturers in countries that we believe to be politically stable. We do not enter into long-term contracts with our third-party manufacturers. Rather, we typically enter into contracts with each manufacturer to produce one or more product lines for a particular selling season. This strategy has enabled us to maintain flexibility in our sourcing.

     Our products manufactured abroad are subject to U.S. customs laws, which impose tariffs as well as import quota restrictions for textiles and apparel. Quota represents the right, pursuant to bilateral or other international trade arrangements, to export amounts of certain categories of merchandise into a country or territory pursuant to a visa or license. Pursuant to the Agreement on Textiles and Clothing, quota on textile and apparel products was eliminated for World Trade Organization, or WTO, member countries, including the United States, Canada and European countries, on January 1, 2005. During 2005, the United States and China agreed to a new quota arrangement, which will impose quotas on certain textile products that will impact our business through 2008. While we do not believe the limitations on imports from China will have a material effect on our operations, we intend to closely monitor our sourcing in China to avoid disruptions.

     Over the past five years, our selling, general and administrative expenses have increased on an absolute dollar basis as we have increased our spending on marketing, advertising and promotions, strengthened our management team and hired additional personnel. As a percentage of revenues, however, our selling, general and administrative expenses have decreased from 31.7% in 2002 to 28.5% in 2006. This decrease was largely because some of our expenses were fixed and did not increase at the same rate as that of our revenues. However, selling, general and administrative expenses as a percentage of revenues have increased from 29.2% for the nine months ended September 30, 2006 to 30.1% for the nine months ended September 30, 2007. This increase was primarily due to the hiring of additional personnel as we continue to develop our infrastructure domestically and abroad and costs related to the transition of our European operations from a licensee model to a direct control model without having a full-year of revenue to offset or leverage the additional expenses in Europe.

Critical Accounting Policies

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

Revenue Recognition

     Revenues are recognized upon shipment, at which time transfer of title occurs and risk of ownership passes to the customer. Generally, we extend credit to our customers and do not require collateral. Our payment terms are typically net-30 with terms up to net-120 for certain products. None of our sales agreements with any of our customers provides for any rights of return. However, we do approve returns on a case-by-case basis at our sole discretion to protect our brand and our image. Allowances for estimated returns are provided when product revenues are recorded based on historical experience and are reported as reductions in product revenues. Allowances for doubtful accounts are reported as a component of selling, general and administrative expenses when they arise.

     Licensing revenues are recorded when earned based on a stated percentage of the licensees’ sales of Volcom branded products.

Accounts Receivable

     Throughout the year, we perform credit evaluations of our customers, and we adjust credit limits based on payment history and the customer’s current creditworthiness. We continuously monitor our collections and maintain an allowance for doubtful accounts based on our historical experience and any specific customer collection issues that have been identified. Historically, our losses associated with uncollectible accounts 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 lower of the cost or the current estimated market value of the inventory. 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:

	•		changes in consumer preferences;
	•		buying patterns of our retailers;
	•		unseasonable weather; and
	•		weakened economic conditions.

     Some events, including terrorist acts or threats and trade restrictions and safeguards, could also interrupt the production and 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 market value could be inaccurate, which could result in excess or obsolete inventory.

Goodwill and Intangible Assets

     We account 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. As required by SFAS No. 142, we evaluate the recoverability of goodwill 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 the fair value, then the second step of the impairment test is performed to measure the amount of any impairment loss. Fair value is determined 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 an impairment loss in the future. Any impairment losses will be reflected in operating income.

Long-Lived Assets

     We acquire assets in the normal course of our business. We evaluate the recoverability of the carrying amount of these long-lived assets (including fixed assets) whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. An impairment loss would be recognized when the carrying value exceeds the undiscounted future cash flows estimated to result from the use and eventual disposition of the asset. Impairments, if any, would be 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.

Investments in Unconsolidated Investees

     We account for our investments in unconsolidated investees using the cost method if we do not have the ability to exercise significant influence over the operating and financial policies of the investee. We assess such investments for impairment when there are events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. If, and when, an event or change in circumstances that may have a significant adverse effect on the fair value of the investment is identified, we estimate the fair value of the investment and, if the reduction in value is determined to be other than temporary, we record an impairment loss on the investment.

     We account for our investments in unconsolidated investees using the equity method of accounting if we have the ability to exercise significant influence over the operating and financial policies of the investee. We evaluate such investments for impairment if an event or change in circumstances occurs that may have a significant adverse effect on the fair value of the investment. If, and when, an event is identified, we estimate the fair value of the investment and, if the reduction in value is determined to be other than temporary, we record an impairment loss on the investment.

Athlete Sponsorships

     We establish relationships with professional athletes in order to promote our products and brand. We have entered into endorsement agreements with professional skateboarding, snowboarding and surfing athletes. 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 precise amounts we will be required to pay under these agreements, as they are subject to many variables. The actual amounts paid under these agreements may be higher or lower than expected due to the variable nature of these obligations. We expense these amounts as they are incurred.

Income Taxes

     We adopted the provisions of Financial Accounting Standards Board Interpretation No. 48 (FIN No. 48), Accounting for Uncertainty in Income Taxes , on January 1, 2007. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Under FIN No. 48, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. As a result of the implementation of FIN No. 48, we recognized a $0.1 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. See Note 11 to the Condensed Consolidated Financial Statements for further discussion.

     We record a provision and liability for Federal and state income taxes using an annual effective tax rate. Deferred income taxes are recorded at our effective tax rate. Management’s judgment is required in assessing the realizability of our deferred tax assets. 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 that 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

     Since January 1, 2006, we have accounted for stock-based compensation in accordance with SFAS No. 123 (revised 2004), Share-Based Payment . SFAS No. 123(R) requires that we account for all stock-based compensation transactions using a fair-value method and recognize the fair value of each award as an expense over the service period. The fair value of restricted stock awards is based upon the market price of our common stock at the grant date. We estimate the fair value of stock option awards, as of the grant date, using the Black-Scholes option-pricing model. The use of the Black-Scholes model requires that we make a number of estimates, including the expected option term, the expected volatility in the price of our common stock, the risk-free rate of interest and the dividend yield on our common stock. If our expected option term and stock-price volatility assumptions were different, the resulting determination of the fair value of stock option awards could be materially different. In addition, judgment is also required in estimating the number of share-based awards that we expect will ultimately vest upon the fulfillment of service conditions (such as time-based vesting). If the actual number of awards that ultimately vest differs significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted.

Foreign Currency Translation

     We own subsidiaries in Switzerland and France, which operate with the Swiss Franc and Euro as their functional currency, respectively. Our international subsidiaries generate revenues and collect receivables at future dates in the customers’ local currencies, and purchase inventory primarily in U.S. dollars. Accordingly, we are exposed to gains and losses that result from the effect of changes in foreign currency exchange rates on foreign currency denominated

transactions. 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.

     A portion of our sales are made in Canadian dollars. As a result, we are exposed to transaction gains and losses that result from movements in foreign currency exchange rates. As our Canadian sales, accounts receivable, accounts payable and cash balances have historically been a small portion of our revenues, assets and liabilities, we do not generally hedge our exposure to foreign currency rate fluctuations, and therefore we are exposed to foreign currency risk. Changes in our assets and liabilities that are denominated in Canadian dollars are translated into U.S. dollars at the rate of exchange on the balance sheet date, and are reflected in our statement of operations.

General

     Our revenues consist of both our product revenues and our licensing revenues. Our product revenues are derived primarily from the sale of young mens and young womens clothing, accessories and related products under the Volcom brand name. We offer apparel and accessory products in six main categories: mens, girls, boys, footwear, girls swim and snow. Product revenues also include revenues from music and film sales. Amounts billed to customers for shipping and handling are included in product revenues. Licensing revenues consist of royalties on product sales by our international licensees in Europe (through delivery of our Spring 2007 line), Australia, Indonesia, South Africa and Brazil.

     Our cost of goods sold consists primarily of product costs, retail packaging, freight costs associated with shipping goods to customers, quality control and inventory shrinkage. There are no cost of goods sold associated with our licensing revenues.

     Our selling, general and administrative expenses consist primarily of wages and related payroll and employee benefit costs, handling costs, sales and marketing expenses, advertising costs, legal and accounting professional fees, insurance, utilities and other facility related costs, such as rent and depreciation.

Results of Operations

     The following table sets forth selected items in our consolidated statements of operations for the periods presented, expressed as a percentage of revenues:

Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006

Revenues

     Revenues were $91.0 million for the three months ended September 30, 2007, an increase of $30.0 million, or 49.1%, compared to $61.0 million for the three months ended September 30, 2006. Revenues from our European operations were $25.8 million for the three months ended September 30, 2007, an increase of $24.7 million, compared to $1.1 million for the three months ended September 30, 2006. The increase in revenues from our

European operations was a result of the transition of our European operations from a licensee model to a direct control model. Revenues from our top five customers were $21.1 million for the three months ended September 30, 2007, a decrease of $2.9 million, or 12.0%, compared to $24.0 million for the three months ended September 30, 2006. Excluding revenues from Pacific Sunwear, which decreased $3.1 million, or 23.5%, to $10.3 million, total revenues from our remaining top five customers increased $0.2 million, or 2.6%, to $10.8 million for the three months ended September 30, 2007 from $10.6 million for the three months ended September 30, 2006. We believe the decrease in revenues from Pacific Sunwear was generally due to a change in Pacific Sunwear’s product mix and Pacific Sunwear’s effort to reduce their overall inventory levels, which caused Pacific Sunwear’s purchases of our product to slow. It is unclear where our sales to Pacific Sunwear will trend in the longer term. We believe our overall domestic revenue growth was driven primarily by the increasing popularity of our brand across our target market and increasing acceptance of our products at retail as a result of marketing and advertising programs that effectively promoted our brand, a compelling product offering, high quality standards and strong relationships with our retailers. In addition, the increase in our revenues can be attributed to sales of our recently introduced Creedlers and girls swim product, as well as additional distribution. Further, several of our largest retailers have opened additional stores over the last year and those store openings likely have contributed to an increase in our product revenues; however, period-over-period increases in our product revenues as judged solely by additional store openings by our largest retailers may not be a useful or accurate measure of revenue increases because our products may not be carried in every new store.

     Product revenues were $90.5 million for the three months ended September 30, 2007, an increase of $30.8 million, or 51.6%, compared to $59.7 million for the three months ended September 30, 2006. Of the $30.8 million increase in product revenues, increases in mens products and girls products accounted for $20.1 million of that increase. Revenues from mens products increased $17.3 million, or 71.9%, to $41.4 million for the three months ended September 30, 2007 compared to $24.1 million for the three months ended September 30, 2006 and girls products increased $2.8 million, or 15.0%, to $21.3 million for the three months ended September 30, 2007 compared to $18.5 million for the three months ended September 30, 2006. Revenues from snow products increased $7.3 million, or 55.7%, to $20.4 million for the three months ended September 30, 2007 compared to $13.1 million for the three months ended September 30, 2006. Revenues from boys products, which includes our new line of kids clothing for young boys ages 4 to 7, increased $2.4 million, or 77.8%, to $5.5 million for the three months ended September 30, 2007 compared to $3.1 million for the three months ended September 30, 2006. Revenues from our recently introduced Creedler footwear line and girls swim line were $1.2 million and $0.1 million, respectively, for the three months ended September 30, 2007. There were no sales of these product lines during the three months ended September 30, 2006.

     Licensing revenues decreased 60.6% to $0.5 million for the three months ended September 30, 2007 from $1.3 million for the three months ended September 30, 2006. The decrease in licensing revenues was a result of the transition of our European operations from a licensee model to a direct control model.

     Product revenues in the United States were $48.8 million, or 53.9% of our product revenues, for the three months ended September 30, 2007, compared to $47.1 million, or 78.8% of our product revenues, for the three months ended September 30, 2006. Product revenues in Europe were $25.8 million, or 28.5% of our product revenues, for the three months ended September 30, 2007, compared to $1.1 million, or 1.9% of our product revenues, for the three months ended September 30, 2006. Product revenues in the rest of the world consist primarily of product revenues from sales in Canada and Japan and do not include sales by our international licensees. Such product revenues in the rest of the world were $15.9 million, or 17.6% of our product revenues, for the three months ended September 30, 2007 compared to $11.5 million, or 19.3% of our product revenues, for the three months ended September 30, 2006.

Gross Profit

     Gross profit increased $15.0 million, or 48.4%, to $45.9 million for the three months ended September 30, 2007 compared to $30.9 million for the three months ended September 30, 2006. Gross profit as a percentage of revenues, or gross margin, decreased 0.2% to 50.4% for the three months ended September 30, 2007 compared to 50.6% for the three months ended September 30, 2006. Gross margin related specifically to product revenues increased 0.6% to 50.1% for the three months ended September 30, 2007 compared to 49.5% for the three months ended September 30, 2006. The overall gross margin decrease is due to lower licensing revenues as we have established our own operations in Europe in order to take direct control of the Volcom brand in Europe and we have begun to recognize

revenue from the direct sale of our products in this territory. The increase in gross margin on product is primarily due to strong full-price sell through and foreign currency gains associated with our European operations, offset by a larger than expected inventory liquidation during the three months ended September 30, 2007.

Selling, General and Administrative Expenses

     Selling, general and administrative expenses increased $7.5 million, or 48.8%, to $22.8 million for the three months ended September 30, 2007 compared to $15.3 million for the three months ended September 30, 2006. The increase in absolute dollars was due primarily to increased expenses of $4.2 million related to the transition of our European operations from a licensee model to a direct control model. We also had increased advertising and marketing expenses of $1.2 million, increased payroll and payroll-related expenses of $1.1 million due to expenditures on infrastructure and personnel, increased sales commission expenses of $0.3 million resulting from our increased product revenues, increased depreciation and amortization expense of $0.3 million, and increased rent expense of $0.4 million. The net increase in various other expense categories was not significant. As a percentage of revenues, selling, general and administrative expenses remained consistent at 25.1% for the each of the three months ended September 30, 2007 and September 30, 2006. We believe our selling, general and administrative expenses will continue to increase in absolute dollars as we grow our infrastructure domestically and abroad.

Operating Income

     As a result of the factors above, operating income for the three months ended September 30, 2007 increased $7.4 million to $23.0 million compared to $15.6 million for the three months ended September 30, 2006. Operating income as a percentage of revenue decreased to 25.3% for the three months ended September 30, 2007 from 25.5% for the three months ended September 30, 2006.

Other Income

     Other income primarily includes net interest income and foreign currency gains and losses. Interest income for each of the three months ended September 30, 2007 and 2006 was $1.0 million. Foreign currency gain (loss) decreased to a $0.3 million loss for the three months ended September 30, 2007 compared to a $0.1 million gain for the three months ended September 30, 2006 due primarily to fluctuations in the Euro and Canadian dollar exchange rates against the U.S. dollar.

Provision for Income Taxes

     We adopted the provisions of FIN No. 48 on January 1, 2007. As a result of the implementation of FIN No. 48, we recognized a $0.1 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. See Note 11 to the Condensed Consolidated Financial Statements for further discussion.

     We have computed our provision for income taxes for the three months ended September 30, 2007 using an estimated effective annual tax rate of 39.4%. The provision for income taxes increased $2.7 million to $9.3 million for the three months ended September 30, 2007 compared to $6.6 million for the three months ended September 30, 2006.

Net Income

     As a result of the factors above, net income increased $4.3 million, or 42.9%, to $14.5 million for the three months ended September 30, 2007 from $10.2 million for the three months ended September 30, 2006.

Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

Revenues

     Revenues were $199.5 million for the nine months ended September 30, 2007, an increase of $50.8 million, or 34.2%, compared to $148.7 million for the nine months ended September 30, 2006. Revenues from our European operations were $29.9 million for the nine months ended September 30, 2007, an increase of $27.4 million, compared to $2.5 million for the nine months ended September 30, 2006. The increase in revenues from our European operations was a result of the transition of our European operations from a licensee model to a direct control model. Revenues from our top five customers were $63.8 million for the nine months ended September 30, 2007, an increase of $1.4 million, or 2.4%, compared to $62.4 million for the nine months ended September 30, 2006. Excluding revenues from Pacific Sunwear, which decreased $2.2 million, or 5.9%, to $34.2 million, total revenues from our remaining top five customers increased $3.6 million, or 14.0%, to $29.6 million for the nine months ended September 30, 2007 from $26.0 million for the nine months ended September 30, 2006. It is unclear where our sales to Pacific Sunwear will trend in the longer term. We believe our overall domestic revenue growth was driven primarily by the increasing popularity of our brand across our target market and increasing acceptance of our products at retail as a result of marketing and advertising programs that effectively promoted our brand, a compelling product offering, high quality standards and strong relationships with our retailers. In addition, the increase in our revenues can be attributed to sales of our recently introduced Creedlers and girls swim product, as well as additional distribution. Further, several of our largest retailers have opened additional stores over the last year and those store openings likely have contributed to an increase in our product revenues; however, period-over-period increases in our product revenues as judged solely by additional store openings by our largest retailers may not be a useful or accurate measure of revenue increases because our products may not be carried in every new store.

     Product revenues were $196.8 million for the nine months ended September 30, 2007, an increase of $51.1 million, or 35.1%, compared to $145.7 million for the nine months ended September 30, 2006. Of the $51.1 million increase in product revenues, increases in mens products and girls products accounted for $31.3 million of that increase. Revenues from mens products increased $20.7 million, or 27.8%, to $94.9 million for the nine months ended September 30, 2007 compared to $74.2 million for the nine months ended September 30, 2006 and revenues from girls products increased $10.6 million, or 22.2%, to $58.6 million for the nine months ended September 30, 2007 compared to $48.0 million for the nine months ended September 30, 2006. Revenues from snow products increased $7.9 million, or 59.7%, to $21.0 million for the nine months ended September 30, 2007 compared to $13.1 million for the nine months ended September 30, 2006. Revenues from boys products, which includes our new line of kids clothing for young boys ages 4 to 7, increased $4.4 million, or 51.9%, to $12.9 million for the nine months ended September 30, 2007 compared to $8.5 million for the nine months ended September 30, 2006. Revenues from our recently introduced Creedler footwear line and girls swim line were $5.0 million and $2.7 million, respectively, for the nine months ended September 30, 2007. There were no sales of these product lines during the nine months ended September 30, 2006.

     Licensing revenues decreased 9.5% to $2.7 million for the nine months ended September 30, 2007 from $3.0 million for the nine months ended September 30, 2006. The decrease in licensing revenues was a result of the transition of our European operations from a licensee model to a direct control model primarily in the second half of 2007.

     Product revenues in the United States were $127.4 million, or 64.7% of our product revenues, for the nine months ended September 30, 2007, compared to $114.4 million, or 78.5% of our product revenues, for the nine months ended September 30, 2006. Product revenues in Europe were $29.9 million, or 15.2% of our product revenues, for the nine months ended September 30, 2007, compared to $2.5 million, or 1.7% of our product revenues, for the nine months ended September 30, 2006. Product revenues in the rest of the world consist primarily of product revenues from sales in Canada and Japan and do not include sales by our international licensees. Such product revenues in the rest of the world were $39.5 million, or 20.1% of our product revenues, for the nine months ended September 30, 2007 compared to $28.8 million, or 19.8% of our product revenues, for the nine months ended September 30, 2006.

Gross Profit

     Gross profit increased $24.8 million, or 32.8%, to $100.1 million for the nine months ended September 30, 2007 compared to $75.3 million for the nine months ended September 30, 2006. Gross profit as a percentage of revenues, or gross margin, decreased 0.6% to 50.1% for the nine months ended September 30, 2007 compared to 50.7% for the nine months ended September 30, 2006. Gross margin related specifically to product revenues decreased 0.2% to 49.5% for the nine months ended September 30, 2007 compared to 49.7% for the nine months ended September 30, 2006. The gross margin decreased primarily due to larger than expected inventory liquidations and shipping samples to the European sales teams and distributors at very low gross margins. These margin pressures were partially offset by strong full-price sell through and foreign currency gains associated with our European operations shipping their first full season of product in the third quarter of 2007.

Selling, General and Administrative Expenses

     Selling, general and administrative expenses increased $16.7 million, or 38.5%, to $60.1 million for the nine months ended September 30, 2007 compared to $43.4 million for the nine months ended September 30, 2006. The increase in absolute dollars was due primarily to increased expenses of $8.4 million related to the transition of our European operations from a licensee model to a direct control model. We also had increased payroll and payroll-related expenses of $3.3 million due to expenditures on infrastructure and personnel, increased advertising and marketing expenses of $1.9 million, increased sales commission expenses of $0.7 million resulting from our increased product revenues, increased depreciation and amortization expense of $0.7 million, increased rent expense of $0.7 million, and an increase of $1.0 million in various other expense categories. As a percentage of revenues, selling, general and administrative expenses increased to 30.1% for the nine months ended September 30, 2007 from 29.2% for the nine months ended September 30, 2006, which was due primarily to the factors mentioned above. We believe our selling, general and administrative expenses will continue to increase in absolute dollars as we grow our infrastructure domestically and abroad; however, as we believe our revenues in Europe should continue to increase, we believe that our selling, general and administrative expenses will decrease as a percentage of overall sales.

Operating Income

     As a result of the factors above, operating income for the nine months ended September 30, 2007 increased $8.0 million to $39.9 million compared to $31.9 million for the nine months ended September 30, 2006. Operating income as a percentage of revenue decreased to 20.0% for the nine months ended September 30, 2007 from 21.5% for the nine months ended September 30, 2006.

Other Income

     Other income primarily includes net interest income and foreign currency gains and losses. Interest income for the nine months ended September 30, 2007 and 2006 was $3.1 million and $2.8 million, respectively. This increase in interest income was due to higher interest returns on invested cash. Foreign currency gain decreased to $0.3 million for the nine months ended September 30, 2007 compared to $0.4 million for the nine months ended September 30, 2006 due primarily to fluctuations in the Euro and Canadian dollar exchange rates against the US dollar.

Provision for Income Taxes

     We adopted the provisions of FIN No. 48 on January 1, 2007. As a result of the implementation of FIN No. 48, we recognized a $0.1 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. See Note 11 to the Condensed Consolidated Financial Statements for further discussion.

     We have computed our provision for income taxes for the nine months ended September 30, 2007 using an estimated effective annual tax rate of 39.4%. The provision for income taxes increased $3.1 million to $17.1 million for the nine months ended September 30, 2007 compared to $14.0 million for the nine months ended September 30, 2006.

Net Income

     As a result of the factors above, net income increased $5.1 million, or 24.1%, to $26.2 million for the nine months ended September 30, 2007 from $21.1 million for the nine months ended September 30, 2006.

Liquidity and Capital Resources

     Our primary cash needs are working capital and capital expenditures. These sources of liquidity may be impacted by fluctuations in demand for our products, ongoing investments in our infrastructure and expenditures on marketing and advertising.

     The following table sets forth, for the periods indicated, our beginning balance of cash and cash equivalents, net cash flows from operating, investing and financing activities and our ending balance of cash and cash equivalents:

     Cash used in investing activities was $12.5 million and $5.9 million for the nine months ended September 30, 2007 and 2006, respectively. The increase in cash used in investing activities was primarily due to payments for the construction of our European headquarters in Anglet, France, the purchase of real property on the North Shore of Oahu, or the Pipe House, for $4.2 million, capital expenditures pertaining to our new off-site distribution center and the implementation of the new warehouse management system, and the ongoing purchase of investments in computer equipment, warehouse equipment, marketing initiatives and in-store buildouts at customer retail locations.

     Cash provided by financing activities was $1.6 million and $0.6 million for the nine months ended September 30, 2007 and 2006, respectively, and is primarily due to the proceeds and excess tax benefits related to the exercise of stock options and cash received from government grants.

     We currently have no material cash commitments, except our normal recurring trade payables, expense accruals, operating leases, capital leases and athlete endorsement agreements. We believe that our cash and cash equivalents, cash received from our initial public offering, cash flow from operating activities and available borrowings under our credit facility will be sufficient to meet our capital requirements for at least the next twelve months.

Credit Facilities

In July 2006, we entered into a $20.0 million unsecured credit agreement with Bank of the West (which includes a line of credit, foreign exchange facility and letter of credit sub-facilities). The credit agreement, which expires on August 31, 2008, may be used to fund our working capital requirements. Borrowings under this agreement bear interest, at our option, either at the bank’s prime rate (7.75% at September 30, 2007) or LIBOR plus 1.50%. Under this credit facility, we had $1.6 million outstanding in letters of credit at September 30, 2007. At September 30, 2007 there were no outstanding borrowings under this credit facility, and $18.4 million was available under the credit facility. The credit agreement requires compliance with conditions precedent that must be satisfied prior to any borrowing, as well as ongoing compliance with specified affirmative and negative covenants, including covenants related to our financial condition, including requirements that we maintain a minimum net profit after tax and a minimum effective tangible net worth. At September 30, 2007, we were in compliance with all restrictive covenants.

Contractual Obligations and Commitments

     We did not have any off-balance sheet arrangements or outstanding balances on our credit facility as of September 30, 2007. The following table summarizes, as of September 30, 2007, the total amount of future payments due in various future periods:

     We lease certain land and buildings under non-cancelable operating leases. The leases expire at various dates through 2018, excluding extensions at our option, and contain 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 lease computer and office equipment pursuant to capital lease obligations. These leases bear interest at rates ranging from 3.4% to 13.7% per year and expire at various dates through October 2009.

     We establish relationships with professional athletes in order to promote our products and brand. We have entered into endorsement agreements with professional skateboarding, snowboarding and surfing athletes. 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 precise amounts that we will be required to pay under these agreements as they are subject to many variables. The amounts listed above are the approximate amounts of the minimum obligations required to be paid under these contracts. The additional estimated maximum amount that could be paid under our existing contracts, assuming that all bonuses, victories and similar incentives are achieved during a five-year period ending September 30, 2012, is approximately $1.9 million. The actual amounts paid under these agreements may be higher or lower than the amounts discussed above as a result of the variable nature of these obligations.

     Our contractual letters of credit have maturity dates of less than one year. We use these letters of credit to purchase finished goods.

Seasonality

     Historically, we have experienced greater revenues in the second half of the year than those in the first half due to a concentration of shopping around the fall and holiday seasons and pricing differences between our products sold during the first and second half of the year, as products we sell in the fall and holiday seasons generally have higher prices per unit than products we sell in the spring and summer seasons. We typically sell more of our summer products (boardshorts and t-shirts) in the first half of the year and a majority of our winter products (pants, long sleeve shirts, sweaters, fleece, jackets and outerwear) in the second half of the year. We anticipate that this seasonal impact on our revenues is likely to continue. During the two-year period ended December 31, 2006, approximately 58% of our revenues, 57% of our gross profit and 63% of our operating income were generated in the second half of the year, with the third quarter generally generating most of our operating income due to fall, holiday and snow shipments. Accordingly, our results of operations for the first and second quarters of any year are not indicative of the results we expect for the full year.

     As a result of the effects of seasonality, particularly in preparation for the fall and holiday shopping seasons, our inventory levels and other working capital requirements generally begin to increase during the second quarter and into the third quarter of each year. Based on our current cash position we do not anticipate borrowing under our credit facility in the near term.

Inflation

     We do not believe inflation has had a material impact on our results of operations in the past. There can be no assurance that our business will not be affected by inflation in the future.

Vulnerability Due to Concentrations

     As of September 30, 2007, our customer base of retailers located in the United States, Europe, Canada and South America included approximately 2,250 accounts that operate approximately 4,800 store locations and 37 distributors in international territories not serviced by one of our licensees. One customer, Pacific Sunwear, accounted for approximately 26% of our product revenues in 2006 and approximately 17% of our product revenues for the nine months ended September 30, 2007. No other customer accounted for more than 10% of our product revenues in 2007 or 2006.

     Sales to Pacific Sunwear decreased 5.9%, or $2.2 million, for the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006. We may continue to see sales to Pacific Sunwear decline, and we currently expect an approximate 10% decrease in sales to Pacific Sunwear for 2007 compared to 2006. It is unclear where our sales to Pacific Sunwear will trend in the longer term. Pacific Sunwear remains an important customer for us and we are working both internally and with Pacific Sunwear to maximize our business with them. We believe our brand continues to be an important part of the Pacific Sunwear business. We also recognize that any customer concentration creates risks and we are, therefore, assessing strategies to lessen our concentration with Pacific Sunwear.

     We do not own or operate any manufacturing facilities and source our products from independently-owned manufacturers. During 2006, we contracted for the manufacture of our products with approximately 30 foreign manufacturers and five domestic screen printers. Purchases from Dragon Crowd and Ningbo Jehson Textiles totaled approximately 15% and 12%, respectively, of our product costs in 2006, and approximately 18% and 14%, respectively, of our product costs for the nine months ended September 30, 2007.

Recent Accounting Pronouncements

     In June 2006, the FASB issued FIN No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. As a result of the implementation of FIN No. 48, we recognized a $0.1 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. See Note 11 to the Condensed Consolidated Financial Statements.

     In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. We do not expect the adoption of SFAS No. 157 to have a material effect on our consolidated financial position or results of operations.

     In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of SFAS No. 115 . SFAS No. 159 provides reporting entities an option to measure certain financial assets and liabilities and other eligible items at fair value on an instrument-by-instrument basis. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We do not expect the adoption of SFAS No. 159 to have a material effect on our consolidated financial position or results of operations.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Foreign Currency Risk

     We own subsidiaries in Switzerland and France, which operate with the Swiss Franc and Euro as their functional currency, respectively. Our international subsidiaries generate revenues and collect receivables at future dates in the customers’ local currencies, and purchase inventory primarily in U.S. dollars. Accordingly, we are exposed to gains and losses that result from the effect of changes in foreign currency exchange rates on foreign currency denominated transactions. 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.

     A significant portion of our sales have been made in U.S. dollars except for sales made in Canada, which are made in Canadian dollars. For the nine months ended September 30, 2007 and September 30, 2006, we derived 13.1% and 12.8%, respectively, of our product revenues from sales in Canada. As a result, we are exposed to fluctuations in the value of Canadian dollar denominated receivables and payables, foreign currency investments, primarily consisting of Canadian dollar deposits, and cash flows related to repatriation of those investments. A weakening of the Canadian dollar relative to the U.S. dollar could negatively impact the profitability of our products sold in Canada and the value of our Canadian receivables, as well as the value of repatriated funds we may bring back to the United States from Canada. Account balances denominated in Canadian dollars are marked-to-market every period using current exchange rates and the resulting changes in the account balance are included in our income statement as other (expense) income. We do not believe that a 10% movement in all applicable foreign currency exchange rates would have a material effect on our financial position.

     As our directly controlled European operations have been just recently established, and our Canadian accounts receivable, accounts payable and cash balances represent a small portion of our total assets and liabilities, we do not generally hedge our exposure to foreign currency rate fluctuations. We may enter into future transactions in order to hedge our exposure to foreign currencies.

     We generally purchase finished goods from our manufacturers in U.S. dollars. However, we source substantially all of these finished goods abroad and their cost may be affected by changes in the value of the relevant currencies. Price increases caused by currency exchange rate fluctuations could increase our costs. If we are unable to increase our prices to a level sufficient to cover the increased costs, it could adversely affect our margins and we may become less price competitive with companies who manufacture their products in the United States.

Interest Rate Risk

     We maintain a $20.0 million unsecured credit agreement (which includes a line of credit, foreign exchange facility and letter of credit sub-facilities) with no balance outstanding at September 30, 2007. The credit agreement, which expires on August 31, 2008, may be used to fund our working capital requirements. Borrowings under this agreement bear interest, at our option, either at the bank’s prime rate (7.75% at September 30, 2007) or LIBOR plus 1.50%. Based on the average interest rate on our credit facility during 2006, and to the extent that borrowings were outstanding, we do not believe that a 10% change in interest rates would have a material effect on our results of operations or financial condition.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

     We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Our management, including our Chief Executive Officer and our Chief Financial Officer, does not expect that our disclosure controls or procedures will

prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Volcom have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

     We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2007, the end of the quarterly period covered by this report. The evaluation of our disclosure controls and procedures included a review of the disclosure controls’ and procedures’ objectives, design, implementation and the effect of the controls and procedures on the information generated for use in this report. In the course of our evaluation, we sought to identify data errors, control problems or acts of fraud and to confirm the appropriate corrective actions, including process improvements, were being undertaken.

     Based on the foregoing, our Chief Executive Officer and our Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective and were operating at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

     There has been no change in the Company’s internal controls over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

Item 4T. Controls and Procedures.

      Not applicable.

PART II.

OTHER INFORMATION

near or long term. Because Pacific Sunwear has represented such a significant amount of our product revenues, our results of operations are likely to be adversely affected if Pacific Sunwear continues to decrease its rate of purchases of our products. A continuing decrease in its purchases of our products, a cancellation of orders of our products or a change in the timing of its orders will have an additional adverse effect on our operating results.

The current uncertainty surrounding the United States economy coupled with cyclical economic trends in apparel retailing could have a material adverse effect on our results of operations.

     The apparel industry historically has been subject to substantial cyclicality. As the economic conditions in the United States change, the trends in discretionary consumer spending become unpredictable and discretionary consumer spending could be reduced due to uncertainties about the future. When discretionary consumer spending is reduced, purchases of premium apparel and related products may decline. Due to the current uncertainty surrounding the United States economy, we have noticed a higher level of caution from our customers than in past years. This caution may result in lower than expected orders and increased inventory controls by some of our customers. A recession in the general economy or continued uncertainties regarding future economic prospects could have a material adverse effect on our results of operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

     We did not sell any unregistered equity securities or purchase any of our securities during the period ended September 30, 2007.

     We effected the initial public offering of our common stock pursuant to a Registration Statement on Form S-1 (File No. 333-124498) that was declared effective by the Securities and Exchange Commission on June 29, 2005. To date, we have used $20.0 million of the net proceeds from the offering to distribute our estimated undistributed S corporation earnings to our S corporation stockholders, $1.5 million to acquire all of the outstanding common stock of Welcom Distribution SARL, the sole distributor of Volcom branded products in Switzerland, and $12.8 million for developing our infrastructure in Europe. We intend to use the remaining net proceeds for the continual development of our infrastructure in Europe, facility upgrades, marketing and advertising, enhancing and deploying our in-store marketing displays for our retailers, and working capital and other general corporate purposes. In addition, we may use a portion of the remaining proceeds to acquire products or businesses that are complementary to our own.

SIGNATURE

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

		Volcom, Inc.
Date: November 9, 2007		/s/ Douglas P. Collier   Douglas P. Collier
		Chief Financial Officer, Secretary and Treasurer
		(Principal Financial Officer and Authorized Signatory)

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