Nobody Wants to Talk About Sanuk, But Deckers Has an Outstanding Quarter

That’s not quite true.  I want to talk about Sanuk, though probably for the last time.  There’s not a mention of the once high-flying brand in the conference call, and it only comes up in the 10-Q because, inconveniently I imagine, they have to acknowledge its existence.

For the quarter ended September Sanuk revenue was down 9.4% ($1.43 million) from $15.22 million in last year’s quarter to $13.80 in this year’s.  The Sanuk wholesale business had an operating profit of $291,000 down from $1.23 million in last year’s quarter, a drop of 76.3%.  Add any reasonable allocation of overhead, taxes, interest and the brand lost money during the quarter.

Here’s their comment on the Sanuk wholesale business from the 10-Q:

“Wholesale net sales of our Sanuk brand decreased due to a lower WASPP [weighted average selling price per pair], primarily driven by lower performance in the domestic surf specialty channel, partially offset by a higher volume of pairs sold driven by higher closeouts.”

Sounds like they are continuing to lose traction in the surf specialty channel- the one place they have to get traction for the brand to regain credibility- and are trying to make up for it by selling more pairs at closeout.  I’d be okay with the revenue decline if it was in the closeout business.

When Deckers finally changed Sanuk’s management and rationalized its structure, I thought and hoped that they might be able to resurrect the brand.  Now, I’m concerned that it’s all over but the shouting.  The shouting may occur among the management team and at the board level when they realize just how little they can sell this brand for compared to what they paid for it.  That will be tempered by the fact that they’ve completely written it off and that the responsible management team has moved on.

Deckers is hardly the only company in our industry that’s bought a brand they didn’t really understand, paid too much for it, expected too much out of it, then sidelined the people who’d made it successful because they didn’t know what didn’t know.  The unknown unknowns will get you every time.  If you’re looking at an acquisition, don’t do that.

Meanwhile, Deckers blew the barn doors off (wonder where that expression came from) reporting net income in the September 30 quarter that rose 50.1% from $49.6 million in last year’s quarter to $74.4 million in this year’s.  They did it while increasing revenue only 4%.

They grew their gross profit margin from 46.7% to 50.2% while reducing SG&A as a percent of revenue from 32.7% to 32.2%.  The improvement in gross profit “…was due to lower air-freight costs for our domestic wholesale business, higher full-priced selling in our wholesale channel, lower input costs as we execute our supply chain initiatives as part of our operating profit improvement plan, and favorable foreign currency exchange rate fluctuations.”

Nothing below operating income changed dramatically, so basically, they accomplished this improvement by operating better.

On the balance sheet, I’d highlight a 7.3% year over year reduction in inventory even as sales rose.  Stockholders’ equity fell 12.6% from $969 to $847 million, though the balance sheet remains solid.  Net cash used in operations for the six months ended September was $161 million.

To focus on one of my pet peeves for a moment, they almost trumpet $125 million in stock they bought back during the quarter, “…which also aided in the upside to earnings per share.”

I understand the math and yes, it’s true that if you have fewer shares to spread your earnings over, the earnings per share rise.  But it has nothing to do with how well you ran your business- for any company buying back its stock.  Another way to put it might be, “We couldn’t think of a way to invest this money in our business that would give us a better return than buying our stock.”  I wonder what would happen to stock buy backs if you could earn 6% in a money market account again.  Maybe we’ll find out.

I once characterized “omnichannel” as the term many legacy brick and mortar retailers were using to sound authoritative as they tried to figure out what the hell to do in the new retail environment.  I’m about ready to add Deckers to a short list of companies that are actively figuring it out.  Let’s look at the things Deckers is doing.

Quarter over quarter, their HOKA brand is up 28.4% from $40.6 to $52.1 million.  “Wholesale net sales of our HOKA brand increased due to a higher volume of pairs sold driven by its continued global growth, primarily in the US and Europe, as well as additional sales generated by updates to key franchises, as well as a higher WASPP driven by product mix and higher full-priced selling.”  In the conference call CEO Dave Powers describes the HOKA success this way:

“…we are growing the HOKA brand through a strategy centered on focused and disciplined growth. All the product and distribution decisions are being made to increase brand awareness, drive brand heat and create long-lasting relationships with our consumers, all with an eye on product quality and performance. This is driving strong full-price selling and increased e-commerce penetration, as well as providing the brand a long runway for future growth.”

The UGG brand’s total revenue fell slightly from $400.2 million in last year’s quarter to $396.3 million in this year’s.  That was purposeful.  CEO Powers says in the conference call, “…UGG is implementing a classic allocation and product segmentation strategy in the U.S. for the fall season. While this impacted a portion of the sell-in this quarter, we believe this change in distribution strategy has the ability to drive a pull model, leading to better sell-through and less promotional activity in the brand’s largest market.”

Further comments from Dave Powers on UGG:

“And as demand continue to strengthen [He’s referring to a specific product] we quickly allocated incremental marketing dollars to fuel the momentum.”

“The swift action by the UGG team to capitalize on the successful product launch shows the changes we’re making to the business are allowing us to be more nimble, leverage our omni-channel capabilities, and quickly react to consumer interest.”

This all sounds very responsive to the competitive environment and the requirements of consumers as I’m starting to understand it.

During the quarter, Deckers’ direct to consumer business rose 2.8% from $91.3 to $93.9 million.  They ended the quarter with 154 retail stores worldwide, “…which includes 88 concept stores and 66 outlet stores. During the six months ended September 30, 2018, we opened one concept store, closed one outlet store, and closed 11 concept stores…”  The company has closed 43 retail stores during the fiscal year as of September 30.

Talking about the brick and mortar strategy, CFO Steve Fasching says in the conference call, “As we’re getting further along in the process and of the cost savings initiatives, we’re finding that there is some improvement in some of these stores. And we’re basically looking at store level evaluating them if they can get above the internal threshold for four wall profitability, which we’ve set at about 20%. We’re going to put those on the re-evaluation list versus closure list.”

What I’d like is some information on exactly how their brick and mortar strategy dovetails with their overall omnichannel strategy.  There’s got to be more to it than closing stores that don’t meet a specified level of profitability.  This is critical in realizing a true omnichannel strategy.  How are they sizing, locating, staffing and inventorying their stores given omnichannel realities?

Deckers notes in the 10-Q that “A significant part of the Company’s business is seasonal, requiring it to build inventory levels during certain quarters in its fiscal year to support higher selling seasons, which contributes to the variation in its results from quarter to quarter.”

That’s not new and it’s true for most companies, but it’s changing as Deckers acknowledges.  Go reread the factors that improved their gross profit margin.  The conference call acknowledges improving their logistics and supply chain.  CEO Powers notes in the conference call, “…  the first thing we’ve been focused on the last couple of years is just better visibility across the organization and holding the teams and ourselves accountable for top and bottom line. We’ve also spent a lot of time on the supply chain process and pre-season planning so that we are efficient how we bring and when we bring product into the DC and to the consumer.”

“…I really think the planning teams and the work that they’ve been with the factories and flowing product differently has and will have a big impact on that going forward, continuity planning, level loading at the factories and just-in-time inventory into the DCs.”

If you look at Deckers’ restructuring programs and their discussions in public information, it seems like they’ve developed a sense of urgency and a point of view about how to be a brand and a retailer.  Their focus on logistics, the supply chain, reacting quickly, managed distribution, putting more marketing money into products that are working, and a financial model that, at least in this quarter, gave them a big bottom line with not much increase in revenue suggests a company in touch with reality.

It’s important, however, that you not think of each of those areas of focus as standing alone.  The secret sauce for all of us is how we change our organizations to take advantage of the synergies of interconnection through employees who have been given some flexibility and have internalized an organization’s more organic way of functioning.

Deckers Has Strong Quarter- Sanuk Feels Like an Afterthought

With its restructuring expenses largely behind it ($55.3 million since February 2016) and net sales up 19.5% for the quarter ended June 30 compared to the same quarter last year, Deckers reported a good result.  Sanuk continues to be the laggard, and I still won’t be surprised to see Deckers management sell the brand, though for orders of magnitude less than they paid for it.

Revenue rose to $251 million from $210 million in last year’s quarter.  The chart below compares revenues for both quarters and shows the percentage change for each brand.  Also included is the breakdown between international and U.S. revenues.





















Note the continued dominance of the UGG brand and the revenue growth of all the brands except Sanuk, which was down 6.6%.  They report in the 10-Q that “Wholesale net sales of our Sanuk brand decreased due to a lower volume of pairs sold primarily driven by lower performance in the US surf specialty channel and lower international sales in connection with our strategic focus on US markets for this brand.”

The gross profit margin rose from 43.2% to 45.9%.  The increase “…primarily driven by favorable foreign currency exchange rate fluctuations, improved full-price selling compared to the prior period, and lower input costs as we execute our supply chain initiatives as part of our operating profit improvement plan.”

SG&A expenses fell from 70% to 61.6% of revenue while growing in dollars from $147 to $154 million.  The pretax loss declined 30.9% from $56.6 to $39.1 million.  The net loss fell from $42.1 to $30.4 million, or by 27.8%.  Note that about $10 million of revenue was shipped early and had been expected to be part of the current quarter.  The question is whether that means the current quarter’s revenue will be $10 million below what it would otherwise have been.  There were also “certain operating expenses” shifted to the current quarter.  They don’t say how much.

Remember that corporate tax rates are lower this year.  As with other companies, this is Deckers’ weakest quarter.

Below is a table showing the operating income by brand and the change from last year’s quarter.  Note that all the brands are up except poor Sanuk.  Deckers also has some work to do on its direct to consumer business and has been busily rationalizing its brick and mortar footprint, and this may lead to some further charges.

“At June 30, 2018, we had a total of 160 retail stores worldwide, which includes 93 concept stores and 67 outlet stores. During the three months ended June 30, 2018, we opened one and closed six concept stores… Management continues to target an overall reduction in our worldwide retail store count.”









They make a comment that Sanuk’s lower operating profit was the result of lower sales offset by higher gross margins.  Hopefully, that’s in indication of distribution getting cleaner.

The balance sheet is solid, and I’d note a small inventory decrease from $442 to $436 million even with the sales increase.  I love the turnaround in cash from operations.  It was a negative $7.35 million in last year’s quarter.  It’s a positive $8.07 million in this year’s.

Deckers has improved their spending efficiency, and the benefits will continue to grow into fiscal 2020.  They’ve improved their distribution.  CEO Dave Powers says, “We have closed a few hundred doors over the last 18 months, and are really focusing on the top 15 strategic accounts that are driving the majority of the volume.  We’ll continue to do that.  And I think naturally there’ll be some accounts that will close on their own, just continuing through the marketplace disruption that’s happening out there…”

There’s a lot of that kind of distribution consolidation going on.  Advantage, big players.

Deckers is continuing to rationalize its brick and mortar business.  I’d feel better if I heard them talk more about how they are tying it to ecommerce.

Higher sales with a higher gross margin, improved distribution, and lower SG&A as a percent of revenues is a good thing.  Sanuk is a bit of a fly in the ointment and I wonder if its potential justifies it being part of a public company.

Deckers’ Results for the Year; Sanuk Continues in Cleanup Mode

For the year and quarter ended March 31, Deckers improved its results as discussed below.  Related to that improvement is the progress of its restructuring and operating profit improvement plans.  As we review these results, we’ll see that Deckers is confronting the same issues other brands/retailers are confronting as the internet changes the role of stores and the way people shop.

In the year ended March 31, Deckers reported a revenue increase of 6.3% from $1.79 to $1.903 billion.  The UGG brand, at $1.507 billion for the year, represented 79.2% of Decker’ total revenues.  Sanuk’s revenues fell slightly from $91.8 to $90.9 million.  The brand’s wholesale revenue rose from $77.6 to $78.3 million.  Direct to consumer fell from $14.2 to $12.6 million.  Just to put that into perspective, Sanuk’s wholesale revenues by themselves, for the year ended December 31, 2013 were $94.4 million.

CEO Dave Powers, explaining Sanuk’s result, said it “…was driven by mid-single digit growth in US wholesale, offset by the planned decline internationally as the brand is in the process of resetting its distribution.”

“We also significantly reduced the amount of closeouts in an effort to clean up the marketplace and drive margin improvements.”

I’ve got no problem at all with revenue stalling if it means a higher gross margin and cleaner, more appropriate, distribution.  That’s how you build, or I guess I mean rebuild, the brand.  What took them so long?

Sanuk’s operating profit on its wholesale business only was $14.5 million, up from a loss of $110.6 million the previous year.  As explained in the 10K, “The increase in income from operations of Sanuk brand wholesale was primarily due to impairment charges for goodwill and long-lived assets incurred in the prior period, as well as higher sales at higher gross margins in the current period.”  For none of their brands do they give an operating profit that includes direct to consumer.  At best, it would be very difficult to calculate- probably meaningless.

Deckers’ overall gross margin rose from 46.7% to 48.9% “…primarily driven by lower input costs as we execute our supply chain initiatives through our operating profit improvement plan, a higher proportion of full-priced selling partly due to favorable weather conditions, as well as favorable foreign currency fluctuations compared to the prior period.”

Weather and currency fluctuations, of course, are outside of Deckers’ control.  We don’t find out how much of the increase was from company controlled “lower input costs.”

SG&A expenses declined 15.3% from $837 to $709 million and, as a percent of revenue, from 46.8% to 37.3%.  BUT that includes $118 million of Sanuk related impairment charges from the previous year.  Total impairment and depreciation charges last year were $138 million.

Pretax income improved from a loss of $7 million to a profit of $221 million.  Big improvement even taking in to account last year’s big charge offs.  Net income rose from $5.7 to $114 million.  This year’s net income would have been higher, but the tax provision rose from a benefit last year of $12.7 million to an expense this year of $106.3 million.  As a result of the so-called Tax Reform Act, Deckers “…recorded provisional US federal and state tax estimates for the one-time mandatory deemed repatriation of foreign earnings of $59,114 [$59.1 million] …”

For the March 31 quarter, revenue rose 8.7% from $369 million in last year’s quarter to $401 million.  The gross profit margin rose from 43% to 48%.  CFO Thomas George tells us in the conference call that the increase “…was largely due to fewer closeout sales and an improved promotional environment in the quarter, which contributed 160 basis points, continued realization of significant progress on our supply chain improvements worth approximately 170 basis points and 120 basis points from FX, with the balance being driven by favorable channel mix.”  Again, it’s important to recognize how much of the improvement was the result of factors out of Deckers’ control.

Last year’s quarter had a loss of %15.7 million.  In this year’s, net income was a positive $20.6 million.  Last year’s quarter included restructuring charges of $29 million.  Comparable charges this year were $1.7 million.

Starting in February 2016, Deckers implemented, and continues to implement, a restructuring and, a year later, an operating profit improvement plan.  The goal of the restructuring plan is to “…streamline brand operations, reduce overhead costs, create operating efficiencies and improve collaboration.”  The operating profit improvement is to come from “…reducing product development cycle times, optimizing material yields, consolidating our factory base, and continuing to move product manufacturing outside of China.”  As they describe it, the plans are working with the savings and improvements already significant.

As part of the plans, Deckers is reevaluating its retail stores.  They ended the year with 165 of them worldwide, having already closed 32 as part of their plans.  Their long-term plan is to further reduce that number to 125.  Talking about the stores, the 10K says the following.  “While we are seeing initial signs of improvement, our decision to open or close store locations will be evaluated based on the operating results of each store and our retail store and fleet optimization strategies, which may ultimately impact our global retail store count.”

Then, talking about their direct to consumer strategy, they state, “…we believe that our retail stores and websites are largely intertwined and interdependent. We believe that many consumers interact with both our brick and mortar stores and our websites before making purchasing decisions. For example, consumers may feel or try on products in our retail stores and then place an order online later. Conversely, they may initially research products online, and then view inventory availability by store location and make a purchase in store.”

No kidding.

One of their risk factors is about opening retail stores.  It says, “It may be difficult to identify new retail store locations that meet our requirements, and any new retail stores may not realize returns on our investments.”  Risk Factors have tended to become blinding glimpses of the obvious, so that’s fine.  However, the discussion of this factor takes a business as usual approach to store opening decisions; no mention of ecommerce.

Maybe some retailers need a new risk factor: “If we don’t figure out how to think about and manage our stores and ecommerce as if they are one and the same, we’re screwed!”  Probably some lawyer will stop them from putting it quite that way.

Let me go on and quote for you some of their Trends Impacting Our Overall Business.

“• We believe there has been a meaningful shift in the way consumers shop for products and make purchasing decisions. In particular, brick and mortar retail stores are experiencing significant and prolonged decreases in consumer traffic as customers continue to migrate to shopping online.”

“• In light of the shift in consumer shopping behavior, we are seeking to optimize our brick and mortar retail footprint. In pursuing store closures, we have been impacted by costs to exit lease agreements, employee termination costs, retail store fixed asset impairments, and other closure costs. However, we do not expect to continue incurring significant incremental store closure costs, primarily because the majority of our remaining store closures are expected to occur as store leases expire to avoid incurring additional lease termination costs.”

“• We expect our E-Commerce business will continue to be a driver of long-term growth…”

All I know, of course, is what I read in the SEC filings and conference call transcripts.  Perhaps their ongoing reduction in stores is their thought-out response to the integration of ecommerce with brick and mortar, but I can’t tell that from the information I have available.

What I want you to take away from the above discussion about their brick and mortar strategy and risk factors is that while they give lip service to the integration of brick and mortar and ecommerce, they don’t give us much information on just how their “fleet optimization strategy” relates to their ecommerce strategy.

Deckers has a solid balance sheet, great cash flow, and is making money.  Their restructuring and profit improvement plans seem to be working.  I (mostly) like what they are doing with Sanuk.  It seems like they’ve figured out what the brand can, and cannot, be.  They grew their revenue last year and did it in the right ways.  CEO Powers says in the conference call, “…we are making strategic decisions that will generate some topline pressure in the current year but are in the best interests of the brand’s long-term success.”

You know I love that approach.

But from Deckers, and from any retailer by the way, I need to know what exactly the “optimization” of their brick and mortar footprint means.  When a retailer finally starts to talk in some detail about how brick and mortar and ecommerce are one revenue stream, I know they’re making progress.

To Have or Not to Have Stores; That is the Question. Deckers’ June 30 Quarter

The 10-Q reads this way:

“…in light of the recent and continuing changes in the retail environment, we also believe it is prudent to further reduce our global brick and mortar footprint. We expect to continue to reduce our footprint through a combination of store closures and the conversion of owned stores to partner retail stores, and, accordingly, we anticipate generating future cost savings. We are currently targeting a worldwide retail store count of approximately 125 owned stores by the end of fiscal year 2020.”

At June 30, Deckers had 96 concept stores and 63 outlet stores for a total of 159.  These are “predominantly” UGG stores.  Getting down to 125 stores will be a reduction of 21.4%.  Some of the decline will be due to converting owned to partner stores.  Partner stores “…are branded stores that are wholly-owned and operated by third parties. Upon conversion or opening of new partner retail stores, each of these stores become wholly-owned and operated by third parties.”

One can’t help but ask why, if Deckers doesn’t want to own these stores because of “changes in the retail environment,” the potential partners will.  Perhaps that suggests these will mostly be store closures.

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Deckers Under Pressure from Outside Investor

Marcato Capital Management has taken what is now a 6% position in Deckers’ common stock.  That Marcato was buying Deckers’ shares first became public knowledge towards the end of May.  Partly in response to this and, apparently, to growing unhappiness on the part of other large shareholders, Deckers has undertaken a strategic review process to determine what should happen to the company.

Recently, Marcato sent Deckers’ Board of Director a letter saying that if the review process didn’t lead to an attractive sale of the company, “…we will be prepared to seek significant Board change at the Company’s next annual meeting by nominating a slate of director candidates to replace the entire Board.”

Here’s a link to the letter in its entirety.  It’s pretty damning of Deckers’ management and board and, if the letter is accurate, they aren’t the only ones unhappy.  I can see why they might be concerned that Angel Martinez, the former CEO and still Chairman of Deckers, is running for Mayor of Santa Barbara rather than focusing on the company.

I guess I see this as the final denouement in the purchase and destruction of the Sanuk brand.  That might not have been the only problem Deckers has, but it’s certainly a major and public symptom of what went wrong.

If I were to read between the lines of the Marcato letter, what I hear them saying is, “Look, UGG is a great brand with real potential, but your attempts to make the company into a big footwear player by buying all these smaller brands has fallen flat on its face.  It’s cost you a pile of money, time, and focus.  Get rid of them or sell the company or we’ll come in and do it for you.”

I will be interested in watching how this moves forward.

A Discussion of Retail Prompted by Deckers’ 10-K

When I report on a public company’s results, it’s always important to review the numbers. But the more I do that the more I realize my focus needs to be on how companies are trying to transition to the new retail environment in circumstances of high uncertainty. That is, they must transition to something they can’t solidly identify yet. That’s awkward.

Deckers ended their March 31st fiscal year with 160 retail stores worldwide. 96 of them were what they call concept stores and the remainder outlet stores. “During fiscal year 2017,” they report in the 10-K, “we opened 17 new stores, reclassified 12 European concession stores as owned stores, converted two owned stores to partner retail stores, and closed 20 stores.” Over the next two years, we learn in the conference call from President Dave Powers, “In regards to our global retail fleet, as we look out over next two years, we are planning to reduce our global company own brick-and-mortar footprint back 30 to 40 stores.”

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Deckers’ Quarter: More Sanuk Travails and the Public Company Conundrum.

I’ve reviewed Deckers’ 10Q for the three months ended December 31, 2016 and their conference call.  The company earned $41 million on sales of $760 million in the quarter, which isn’t bad.  But that’s down from net income of $157 million on revenues of $796 million in the same quarter last year.

The problem?  I’m sure regular readers already know.  Yup, it’s mostly Sanuk again.  But’s let start at the company’s top line.

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Finally, a Sign of Life at Sanuk: Deckers’ September 30 Quarter

Deckers, as you know, owns Ugg, Teva, and Hoka as well as Sanuk and some other smaller brands.  Their second quarter kind of reflected the economic and competitive conditions we’re seeing as most companies report their results.  However, Deckers is making a solid overall profit.

Total revenue at $485.9 million didn’t change much.  It was $1 million higher than last year’s quarter.  Contrary to what we’re seeing in other companies, U.S. business rose $312.3 million, up from $301.5 million.  International fell from $185.3 to $173.7 million.  Wholesale revenues were $400 million and direct to consumer $86.0 million, both down very slightly.

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Deckers’ June 30 Quarter; Continuing Problems with Sanuk

This is the first earnings release and conference call since Dave Powers, who was previously President, took over as CEO from Angel Martinez at the end of May.  He steps into the position at a time when Deckers, as well as other brands and retailers, are suffering from general economic conditions and the continuing growth of online.

Deckers’ sales for the quarter fell 18.4% from $214 million in last year’s quarter to $174 million in this years.

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