Is Everybody Pursuing the Same Strategies? Deckers’ Year and Quarter

The quarter and year ended March 31st weren’t great for Deckers.  Mostly, you’ve probably noticed, they haven’t exactly been great for companies I’ve written about in general.  What somehow got my focus as I read Deckers’ 10-K was the continued and, indeed, increasing sameness of what all the public companies are saying.

Let’s start with a review of Deckers’ strategies and goals before we move on to the financial results including a look at Sanuk’s continuing problems as part of Deckers.

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Deckers’ (and Sanuk’s) Results

Deckers published its 10-Q for the quarter and nine months ending December 31 a couple of days ago. In the environment we’re in, where general expectations seem low, being a company with a solid balance sheet (though inventory was up 26% over a year ago) that’s nicely profitable and more or less holding its level of profitability is a pretty good thing.

Deckers owns the UGG, Teva and Sanuk brands, though their results are dominated by UGG. For the quarter, revenues were up 1.4% to $796 million. The gross margin took a hit, falling from 52.9% to 49.1%. 1.1% of the decline was the result of issues around foreign currency. The rest, which was $21 million, “…was driven by increased promotional activity…”

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Deckers June 30 Quarter and Some Perspective on Sanuk

It wasn’t a great quarter for Deckers, the owner of UGG and Teva as well as Sanuk, though let me start out by reminding you that seasonality means this is always Deckers’ worst quarter.

Sales rose 1.1% from $211.5 to $213.8 million. The gross profit margin fell slightly from 41% to 40.5%. SG&A expenses rose steeply from $37.3 to $47.3 million. The operating loss jumped 26% from $50.5 to $63.7 million.

The net loss also rose from $37.1 to $47.3 million, or by 27.5%. It’s less than the operating loss due to tax benefits of $13.7 million in last year’s quarter and $17.4 million in this year’s.

Sanuk, we find further on, had wholesale revenues for the quarter of $28.5 million, down 11.6% from $32.3 million in last year’s quarter. Operating income on that wholesale business fell 22.6% from $6.9 to $5.3 million.

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Deckers’ Annual Report: Can Niche Brands Become Global Lifestyle Brands?

Deckers (owner of Sanuk) has gone and changed their year end from December 31st to March 31st. So the recently released 10K reports on the year that ended March 31st, 2015 compares it to the year ended December 31st, 2013 as well as reporting on the quarter that ended March 31st 2015. I’ll compare the two annual results, each of which covers 12 months.

As usual, we’ll focus mostly on what’s going on with Sanuk. Here’s the link to the 10-K if you want to peruse it yourself.

Deckers’ revenues rose 16.7% from $1.557 billion in the year ended December 31st 2013 to $1.817 billion in the year ended March 31, 2015. Their five largest customers were 22.2% of worldwide sales and none were 10%. They ended the year with 142 stores (mostly in the U.S. and China) up from 113 in the previously reported year.

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Deckers Has a Pretty Good Quarter. Sanuk, Not So Much.

The overall numbers for Deckers for the quarter look pretty good. But some of the comments left me a bit perplexed. Meanwhile, Sanuk is still not performing the way Deckers must have expected when they bought it.

Overall Results

In the quarter ended December 31, Deckers’ revenue rose 6.6% from $736 to $785 million. The gross profit margin rose from 51.1% to 52.9%. Part of the increase was due to their acquiring their German distributor. Net income was up 11.2% from $141 to $157 million. It would have been stronger, but revenue came in 3% below expectations.

CEO Angel Martinez explained the revenue miss in the conference call.

“As temperatures turned colder across the U.S. with the exception of the West Coast, which has remained unseasonably warm, demand for our weather collections spiked. We experienced strong gains in technical boots, fashion waterproof boots and boots with rain application. In total, sales of our weather offerings grew over 70%.”

“In many instances, demand for casual and weather boots [due to early cold weather] exceeded our inventory investments . As a result, we believe we missed nearly $7 million to $10 million in sales from domestic wholesale reorders as we were unable to fulfill 100% of the demand for these collections. We also believe that we missed approximately $2 million in online sales due to sellout of weather and casual boot product.”

“This shift to expanded categories has highlighted the need to further improve our ability to plan and manage our product and inventory strategy against these consumer purchasing trends. This also requires some adjustments in our product and marketing strategies at both wholesale and in our DTC channels, which we are currently implementing.”

This is a little confusing to me. If they were projecting revenues 3% higher, I would have expected them to have the required inventory on hand. But above he’s saying they missed $9-$12 million in revenue because they didn’t have inventory. Is that on top of the 3% miss?

At some level, this is a great problem to have as a CEO. Sure, we can all stand to work on improving our flexibility in getting the right product to the right market at the right time and to respond more quickly to changing market conditions. But I doubt either Mr. Martinez or any of Deckers’ other executives are going to get any better at predicting the weather.

Meanwhile, the gross margin rose and, as I’ve argued a bunch of times before, I bet a little scarcity wasn’t completely a bad thing for the brand. I might even connect some of the gross margin improvement with the scarcity. We do learn that, “…closeout sales decreased as a percentage of overall sales and had higher margins compared with the same period last year.”

But then he goes on and confuses me some more.

“Classics had a very good second quarter, both from a sell-in and sell-through perspective, which created some bullish expectations among our retailers and internally for the third quarter. This was the main driver behind our decision to raise guidance on our last earnings call. Unfortunately, most of November, with the exception of Black Friday and Cyber Monday weekend, was below plan, which we believe was a result of mild temperatures in certain markets and weak store traffic trends across the industry. Sales trends accelerated as the quarter progressed. However, it wasn’t enough to offset the slow start, which eventually led to some cancellations primarily in our domestic wholesale channels in December.”

You can, I think, see my confusion. On the one hand, Deckers missed some sales because of cold weather. On the other hand, they missed some because of warm weather. And all in the same quarter. I guess they are talking about different geographic markets and products, but a little clarity would be nice.

The UGG brand is branching out. You might check out their web site and note the UGG branded products under categories such as loungewear, handbags and home.

$402 million of the quarter’s revenue, or 51%, came from the UGG wholesale business. But that was up only half a percent from last year’s quarter. Total wholesale business for the quarter was $445 million, up from $441 million in last year’s quarter.

But revenues from ecommerce rose 25.2% from $117.3 to $146.9 million. And retail store revenue was up 8.3% from $178 to $193 million, though comparative store sales declined in the high single digits. They are working on improving store performance, but in the meantime have “…decided to moderate and assess the pace of new store openings.”  They ended the quarter with 138 stores worldwide.

Sanuk

Sanuk’s total revenue for the quarter came in at $20.5 million, down 7.9% from $22.2 million in last year’s quarter. Sales for nine months rose 6.7% to $75.4 million from $70.7 million in the same nine months last year. Happily for Deckers, Sanuk’s revenue represents just 2.26% of the quarter’s total.

Its wholesale revenue for the quarter fell 11.1%, from $19.97 to $17.76 million. For nine months, wholesale revenues have risen slightly from $64.4 to $66 million.

“Wholesale net sales of our Sanuk brand decreased primarily [for the quarter] due to a decrease in the weighted-average wholesale selling price per pair as well as a decrease in the volume of pairs sold.” Volume and price both down. Not so good.

Sanuk’s operating profit from wholesale revenues for the quarter fell from $1.085 million to a loss of $282,000. For the nine months period, it’s down 17.1% from $11.2 to $9.3 million.

The last piece of the earn out for Sanuk has to be paid by Deckers based on 2015 results and equals 40% of the total gross profit Sanuk earns in calendar year 2015. As of December 31, Deckers is estimating that amount to be $27.7 million. That’s down from $30 million at the end of March, 2014. If you knew what Sanuk’s gross profit was, you could pretty much calculate Sanuk’s projected sales this year, though that calculation is complicated by the fact that the estimated earn out is discounted at 7% to allow for the time value of money.

Oh hell, I can’t resist, but I’m going to ignore the 7% discount rate. If GP is Sanuk’s total projected gross profit for 2015, then .4 x GP = the earn out, or $27.7 million. Dividing both sides of the equation by 0.4, we see that total projected gross profit for Sanuk in 2015 is $69.25 million.

We know that Sanuk did $102 million in all of 2013. In nine months of fiscal 2015, it’s had revenue of $75 million (Deckers changed its fiscal year to March 31 last year).  In the first calendar quarter of 2014, Sanuk’s revenues were $30.7 million. If it did the same in this quarter, total Sanuk revenues for the fiscal year ending March 31, 2015 would be $105.7 million.

And just to finish up this little exercise in speculative financial analysis, if sales did come in at $105.7 million and gross profit were $69.25 million, the Sanuk gross margin would be 66%. Wow.

But how can that be with a $660,000 operating loss for the quarter on Sanuk’s wholesale business when ecommerce and brick and mortar sales of the brand total only $2.7 million? Perhaps the quarter isn’t indicative of business for the year.

Okay, I have got to stop this. But this is what happens when I get curious about something and there’s no information provided; I try to figure it out from what I’ve got.   See, the 10Q shows business segment assets for the Sanuk wholesale business of $208.8 million. The similar number for UGG wholesale is $334.9 million, or about 1.6 times Sanuk. But UGG’s wholesale revenues were 22.6 times greater than Sanuk’s during the quarter.

This is the best I can do with what I’ve got, but it doesn’t completely make sense to me. Perhaps some of you wise people out there can help me out?

Based on Sanuk’s performance since the acquisition, it’s pretty clear they overpaid for the brand and I wonder if that might have to be acknowledged by one of those noncash write downs of intangible assets.  We’ll see.

Anyway, Deckers has a strong balance sheet, they grew revenue and profit, and I’m intrigued by some of the brand extensions they are doing with UGG. We’ll see how that works out as we follow Sanuk.

Deckers Turns in an Impressive Quarter (Except for Sanuk)

Deckers, the owner of Sanuk, not to mention UGG and Teva, had a great quarter. Revenue rose 24.2% to $480.3 million from $386.7 million in last year’s quarter. The gross margin was up from 43.2% to 46.6%. The acquisition of their brand distributor in Germany and a decline in the cost of sheep skin had a lot to do with the gross margin increase. SG&A expense was up 36.5% from $120.4 to $164.3 million. Net income was up 23% to $40.7 million from $33.1 million.

Here, from the 10Q is a breakdown of revenue and operating income.

Decker1 9-30quarter

 

 

 

 

 

 

 

 

 

 

 

 

You’ll note right away that Sanuk’s wholesale business fell by 4.2% and that operating income for that wholesale business was down 16.8% from $3.66 to $2.68 million. But in the chart below, you’ll see that Sanuk’s total revenues were up 3.2% due to some growth in e-commerce and retail store sales. I’ve included Decker’s other brands and segments to give you a picture of the whole company, and so you see how dominant the UGG brand is.

Decker2 9-30 quarter

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

You’ve probably noticed way before now- and it’s certainly not unique to Deckers- that international growth is higher than U.S. growth. I expect that to continue for many companies, though the increasing strength of the U.S. dollar may impact it. In case you haven’t noticed, we’re threatening to be in the middle of a currency war, though “a series of competitive devaluations” sounds much more benign.

What do you think your sales in Japan are going to look like when the Yen gets to 200 to the dollar?

Now, let’s focus on Sanuk’s wholesale decline for a minute. Inevitably, the decline in the number of specialty action sports retailers has impacted wholesale revenues of action sports based brands including, I suspect, Sanuk.

And I hypothesize that as you replace that revenue with revenue from larger retail chains, you’ll find your margin impacted. How do you manage that? By focusing on e-commerce and by becoming a retailer yourself. There’s plenty of both going on. Deckers opened one concept and one outlet Sanuk store in 2013.

Here’s what Deckers says about the decline in Sanuk’s wholesale revenues: “Wholesale net sales of our Sanuk brand decreased primarily due to a decrease in the weighted-average wholesale selling price per pair as well as a slight decrease in the volume of pairs sold. The decrease in average selling price was primarily due to a shift in product mix.”

They go on later: “The decrease in income from operations of Sanuk brand wholesale was primarily the result of a 7.1 percentage point decrease in gross margin as well as a decrease in net sales, partially offset by decreased operating expenses of approximately $500. The decrease in gross margin was primarily due to a decrease in margin on closeout sales as well as increased sales discounts.”

We also learn that Sanuk inventory was 39.2% higher than a year ago. Yikes! Remember, Sanuk’s revenues were only up 3.2%. Perhaps they shipped in some extra in case of a port strike, but that’s still a big increase.

Sanuk sold, then, fewer pairs at a lower price in its wholesale business, took a big margin hit due to discounts and closeouts, and appears to have a bit too much inventory; hence discounts and closeouts. That’s not good.

Deckers ended the quarter with 130 retail stores worldwide (45 are outlet stores) and expects to open an unspecified number of additional stores this year. As you may have noticed in the chart, they had an operating loss of $7.1 million on their retail stores, up from a loss of $2.3 million in last year’s quarter.

Deckers is one of the companies that is very actively engaged in figuring out the omnichannel. CEO Angel Martinez puts it this way:

“…the changes taking place in the retail environment are nothing short of dramatic. The consumer is now completely in charge and is dictating what distribution models will work and what models will fail at a rapid pace. The days of visiting the mall to peruse and shop have changed and are evolving. Now it’s all about building strong brands and creating access to product through integrated multi-channel distribution platforms that make it as convenient as possible for consumers to review and purchase the products they want. “

A great quarter for Deckers, but Sanuk still seems to be struggling, and is certainly not measuring up to the price Deckers paid, and is still paying, for the company. Nobody asked about that in the conference call. Probably because Sanuk was only 4% of Decker’s total revenues for the quarter.

Thoughts on the Omnichannel; Decker’s June 30 Results and Sanuk’s Impact

Deckers is mostly of interest to us because of their ownership of Sanuk. We’ll talk about how Sanuk is doing. But Deckers management say some interesting, perhaps even insightful, things about online business and the omnichannel and I want to focus on those as well. Let’s start by getting some of the numbers out of the way. 

In a quarter that Deckers management describes as being historically their weakest, the company had a sales gain of 24.1%, with sales rising to $211 million from $170 million in the same quarter last year. “The increase in overall net sales was primarily due to an increase in our UGG brand sales through our wholesale channel and retail stores as well as an increase in our Teva brand wholesale sales,” says the 10Q.
 
But Tom George, the CFO, tells us in the conference call, that “Nearly half the upside revenue was attributed to the timing of wholesale and distributor sales and the other half with some higher than expected sales. The higher than expected sales contributed approximately $0.05 to the EPS while the other $0.21 was due to the timing of sales and operating expenses.”
 
So half of the revenue increase was just timing differences that don’t change their estimate of total revenue for the year. That is, the revenue was booked in the June 30 quarter instead of the September 30 quarter. But the other half of the revenue increase is from higher than expected sales.
 
In spite of that sales gain, the net loss rose from $29.3 to $37 million. How’d that happen?
 
There was a very minor decline in the gross margin from 41.1% to 41.0%. Gross profit basically rose with sales from $69.8 to $86.8 million. I guess that’s not it.
 
Ah, here we go. Selling, general and administrative expenses were up 21.9% from $112.6 to $137.3 million. That increase included $11 million for opening 37 new stores (they’ve got 126 stores worldwide), $4 million for marketing and promotions related to the UGG and Hoka brands, $3 million for “information technology costs,” and $3 million for ecommerce. As a percentage of sales, it fell from 66.2% to 64.9%.
 
Sanuk’s wholesale revenues were $32.3 million, up 16.4% from $27.8 million in last year’s quarter. That represented 21% of Decker’s total whole sale business of $154 million in the quarter. UGG was $74 million and Teva, $35.6 million at wholesale. Deckers tells us that “Wholesale net sales of our Sanuk brand increased primarily due to an increase in the volume of pairs sold, partially offset by a decrease in the weighted-average wholesale selling price per pair. The decrease in average selling price was primarily due to a shift in product mix.” They gained $7 million in revenue in higher volume but lost $2 million due to lower selling prices.
 
Sanuk’s total sales for the quarter were $36 million, up 19.6% from $30.1 million a year ago. That includes ecommerce sales of $2.71 million up from $2.09 million in last year’s quarter and sales in Decker’s retail stores of $243,000, up from $22,000.  We’re told in the conference call by President and CEO Angel Martinez that, “Sanuk had a strong quarter due in large part to the continued success of women’s sandals, most notably the Yoga Sling Series.” The brand is also being expanded into “…the broader selection of casual shoes and boots that can be comfortably worn during colder weather.”
 
He talks further about this in response to an analyst’s question. “…when we acquired that brand, the brand really was 70% men’s, 30% women’s. It was primarily distributed in surf shops and actions sports distribution. And we knew that the gender profile of the brand would need to alter significantly, if we would to have any hope of selling product in department stores for examples. So one of the things we are seeing with Sanuk is a major transition to a much more compelling women’s product offering.”
 
Even though its revenues are the smallest of Decker’s three biggest brands, Sanuk’s operating income, at $6.9 million, was larger than that of either UGG or Teva which, respectively, had operating income of $2.7 million and $4.8 million. That’s an operating profit margin of 21.4% for Sanuk compared to 13.4% for Teva and 3.6% for UGG.
 
In what can only be acknowledged to be a blinding glimpse of the obvious, I’d say Deckers needs to get that operating margin for UGG up. I suppose they are as the UGG brand had an operating loss of $510,000 in last year’s quarter. Decker’s marketing spend has increased from 5% to 6% of sales, with the majority “…being directed towards the UGG brand with the incremental dollars going towards the combination of digital programs and tactics aimed at broadening brand awareness and driving traffic to our direct-to-consumer channel.”
 
We’re also told that, “The increase in income from operations of Sanuk brand wholesale was primarily the result of the increase in net sales offset by a 5.1 percentage point decrease in gross margin as well as increased operating expenses of approximately $500. The decrease in gross margin was primarily due to a shift in sales mix as well as an increased impact from closeout sales.”
 
As you recall, when Deckers acquired Sanuk In July of 2011, there were some big contingent payments required. The last year of the earn out is calendar year 2015 and that earn out will be 40% of Sanuk’s gross profit. Deckers has a long term contingent liability of $28 million booked for that. There was an earn out due and paid in 2013 (I think it was less than 40%- maybe 35%), but there is none due in 2013. 
 
Meanwhile, Deckers ecommerce revenue rose from $10.7 million to $15.4 million. But operating income for that segment fell from $1.7 million to $809,000. Retail store revenues rose 29.4% from $32.5 to $42.0 million but the operating loss on those retail operations climbed from $9.8 million in last year’s quarter to $15.9 million.
 
The balance sheet remains in pretty good shape, though current ratio has declined just slightly and total liabilities to equity is up a bit compared to year ago. I’d note that they managed to reduce their inventory very slightly even as sales rose even while bringing some $17 million in product in early due to concern about a West Coast port strike.   Cash is up a bunch from $49.1 to $158 million.
 
Given the increase in cash, I find it interesting that after the June 30 balance sheet date, they took a mortgage on their corporate headquarters for $33.9 million. They expect to use those proceeds “…for working capital and other general corporate purposes.” I’m not clear why they did that.
 
Okay, on to interesting omnichannel stuff. 
 
Dave Powers, Decker’s President, Omni-Channel, tells us that total direct to consumer (DTC) was up 33% in the quarter compared to the same quarter last year.   But that includes 37 new retail stores and, as we’ve already noted, the loss from their retail stores was larger than in last year’s quarter.
 
Comparable DTC sales were up 10%, but that included a 39% increase in e-commerce sales and a “…low single-digit comparable store sales decline.”
 
As I’ve discussed a few times before, the holy grail of e-commerce is when the brick and mortar and online activities support each other. The sum has to be bigger than the parts or the rather significant investment in omnichannel activities just doesn’t make sense. Right now, we see Decker’s brick and mortar comparable store sales down, while e-commerce is up. How do you know when your e-commerce isn’t cannibalizing your brick and mortar?
 
Deckers knows this is important. Dave Powers says, “We now know that brick-and-mortar locations fuel e-ecommerce and vice versa. And we believe that a portion of our e-commerce growth is fueled by our increasing store base. We see the internet UGG program and similar omni-channel initiatives providing increased contribution to overall DTC comps going forward as we further tie our stores and website.”
 
He goes on, “The key next step of our omni-channel evolution will be the opening of a smaller concept omni-channel store in Tysons Galleria this fall. That will feature new in-store web technology such as interactive displays and the ability to reserve online and pickup in-store.”
President and CEO Angel Martinez notes that their average cost to build out stores is down 30%. He doesn’t attribute that all to smaller stores and omni-channel related stuff, but I imagine it’s had some impact. In another comment, he notes that stores may no longer need the back room. Obviously, that’s omnichannel related and has implications for further reducing real estate costs.
 
The devil, as always, is in the details, and here are a few of those. They are rolling out something they call Infinite UGG which “…gives us the ability to offer our retail customers every skew available from the UGG brand to our in-store POS system…Our UGG by You customization program will include additional files and design details for the consumers to choose from such as the popular daily bow and daily button…we’re also extending retail inventory online or RIO, a new tool launched this past spring in select stores in North America and EMEA advance of the fall and holiday selling season. RIO provides customers with visibility into store inventory, helping them to efficiently locate the product they want prior to visiting the store.”
From what I know, this isn’t unique to Deckers, but it certainly feels to me that they are doing the right things. CEO Martinez talks about this from a more strategic perspective.
 
“…just a few short years ago we were a wholesale vendor that delivered product twice a year and our success was largely driven by how well buyers, wholesale buyers responded to our collections at industry tradeshows. The consumer had very little influence in shaping our future direction. This dynamic has been turned completely upside down. The consumer is now the gatekeeper and we’ve transformed our business model to not only adapt to the new retail paradigm but also to thrive and to grow.”
 
“We now drop product more than 10 times a year and communicate with consumers on a much more frequent and personal basis. This constant flow of information is reshaping our growth strategies including our product development and store expansion plans, as we now have much better insight into pinpointing demand and directing capital towards what we believe will be high return, high productivity locations.”
 
Dave Powers adds to this when responding to an analyst’s question:
 
“So we’re starting to think about the stores as not just the store in a four-wall P&L but a store that impacts the overall macro environment of our brand in that metro area. The inverse of that is that we have the ability now through analytics and increasingly CRM and loyalty programs through e-commerce to better target customers in those metro areas we know where they are. And we can send them through merchandising and marketing initiatives digitally back to the store.”
Sorry for the long quotes, but I couldn’t say this important thing any better.   And I could go on with more quotes, but I think you get the picture. Deckers is making a big bet on the omnichannel. Well, who isn’t? But their conception seems particularly well thought out.
 
When Deckers first bought Sanuk, I suggested that they didn’t quite know what they’d bought and what to do with it. Given the price they paid, I have to believe they are not completely happy with the results to date. To justify the purchase price, they have to be able to take it from a quirky surf, beach, action sport brand to one that will sell well in broader distribution. But of course they have to do that without losing the quirkiness. 
 
Quite a challenge and the 5% decline in Sanuk’s gross margin during the quarter gives me pause.   So here we are again. Can a brand owned by a public company grow fast enough to satisfy Wall Street without damaging the brand? I hope the crew at Sanuk is following what Skullcandy is trying to do.

 

 

Deckers’ Full Year Results and Some Insights on Sanuk

We’ve all been interested in Deckers since they bought Sanuk. I want to start by pulling what we can on Sanuk out of the 10K and conference call. But Deckers also said some interesting things about direct to consumer business and how brick and mortar integrates with online. Finally, of course, I’ll look at their numbers for the quarter and the year.

Sanuk’s Results
 
Let’s go right to this chart from the bowels of the 10K (which you can see here) for Sanuk’s numbers for the year ended December 31, 2013 (in millions of dollars).   The first column is 2013, the second 2012, the third the amount of the change ($ millions) and the fourth the percent change.
 
 
Still not the kind of increases they were hoping for when they bought the brand I imagine. Now, somewhere else in the middle of the 10K we are reminded that the earnout for Sanuk was, without any limit, “…36.0% of the Sanuk brand gross profit in 2013, which was approximately $18,600…” That’s $18.6 million, just to be clear.
 
If $18.6 million is 36% of the gross profit, then 100% of the gross profit is $51.7 million. Sanuk’s gross profit percentage, then, was 50.8%. Here’s what they say about Sanuk’s wholesale business. Ecommerce and retail margins would be higher I assume.
 
“Wholesale net sales of our Sanuk brand increased primarily due to an increase in the volume of pairs sold, partially offset by a decrease in the weighted-average wholesale selling price per pair. The decrease in average selling price was primarily due to an increased impact of closeout sales. For Sanuk wholesale net sales, the increase in volume had an estimated impact of approximately $10,000 and the decrease in average selling price had an estimated impact of approximately $5,000.”
 
Those numbers are in millions of dollars as well.
 
The next thing they tell us is that Sanuk’s operating income on its wholesale business only was $20.6 million, up from $14.4 million the previous year. That’s an increase of 43% and is 21.8% of wholesale revenues, up from 16% a year ago. By way of comparison, the UGG operating income on its wholesale business as a percentage of revenue in 2013 was 27.5%.
 
But there’s a catch. A pretty big catch, actually. I’ll let the folks at Deckers explain it to you.
 
“The increase in income from operations of Sanuk brand wholesale was primarily the result of decreased expense related to the fair value of the Sanuk contingent consideration liability of approximately $8,000, which was primarily due to changes made during 2012 to the brand’s forecast of sales and gross profit through 2015, which increased the expense in 2012 without a comparable increase in 2013. In addition income from operations increased due to the increase in net sales, partially offset by a 1.4 percentage point decrease in gross margin due to increased closeout sales as well as an increase in sales expenses of approximately $2,000.” That’s $2 million.
 
So they’d booked $8 million as an expense for the contingent payout they expected to have to make. But the brand didn’t perform as projected, so they don’t have to pay that. Without that $8 million they got to add back in in 2013, I guess operating income would actually have fallen on rising sales. Meanwhile, the gross margin fell and they had higher closeout sales. One wonders to what extent the sales increase was due just to closeout sales. And they had to spend an extra $2 million to do this.
 
Granted, Sanuk is only 8.9% of Deckers’ total revenues for the year, but it still annoys me when they make it this hard to figure out what’s actually going on. If I’d paid as much for the brand as they paid and it was performing like this, I’d probably do the same thing.
 
The Omni Channel
 
We’re all speculating about the integration and evolution of online and brick and mortar. Deckers has David Powers as the President of Omni-Channel for them. He had some interesting things to say about what they’re doing.
 
He says they are starting to open stores that are a couple of hundred square feet smaller than usual. This is driven by the realization that ecommerce and quicker delivery is going to start to reduce the need for as much square footage, if only because one third of a store’s footprint won’t be needed to hold inventory. I think they are right about that.
 
I’ve raised the issue that ecommerce has to generate enough incremental sales to offset the cost of the ecommerce function or it will reduce the bottom line. But that isn’t necessarily true if direct to consumer sales evolve in such a way that your expense in brick and mortar declines due to technology reducing staffing costs, lease costs falling because you need fewer square feet, and reduced inventory due to more flexibility in your inventory systems.
 
Dave Powers put it this way:
 
“We will continue to leverage technology to transform the shopping experience into one that is personalized and efficient for our customers driving conversion and long-term growth for Deckers. We need to continue to strengthen our understanding of who our customers are and use that information to develop deeper relationships with them. We are actively working on a unified system to connect and communicate to our customers as they move between our stores and E-Commerce sites.”
 
He goes on to describe their first multi-brand retail store:
 
“The store will serve as the showcase for our expression of Omni-Channel retail and a test lab for new concepts, utilizing the latest technology combined with compelling merchandising to elevate the customer experience. Our customers have the ability to shop in-store using digital touch screens, customize their products, and order online, ship direct to their home free of charge or to pick up in stores.”
 
In general, this feels like exactly the right approach. They are going to learn a lot of interesting things and I look forward to hearing about what works and what doesn’t and how the concept evolves.
 
The Numbers
 
Total sales for the year rose 10% from $1.41 to $1.57 billion. The sales are broken down in the table below by brand at wholesale and for other channels. The left column is 2013, the right 2012.
 
 
You can see that UGG represents about 53% of total revenues, and fell very slightly  at wholesale for the year, though it was up 10% overall. Direct to consumer is 32% of revenues. At the end of the year, they had 117 retail stores worldwide, 40 of which were opened during the year. U.S. sales for the year were $1.04 billion, up 7.1% for the year. International sales grew 16.5%. 
 
The gross profit margin rose from 44.7% to 47.3%. “Gross profit increased by approximately 1.5 percentage points due to reduced sheepskin costs and increased use of UGG Pure, real wool woven into a durable backing used as an alternative to table grade sheepskin in select linings and foot beds, as well as an increased mix of retail and E-Commerce sales, which generally carry higher margins than our wholesale segments, of approximately 1.2 percentage points.”
 
You may remember that Deckers got hit pretty hard when sheepskin prices rocketed and they tried, but weren’t able to push the price increases through to consumers. Those prices have come down some, but what I like is the UGG Pure idea. It’s allowed them to respond in a realistic way to market forces and general economic conditions by continuing to offer a quality product but at some lower price points. As CEO Angel Martinez put it, UGG Pure allowed them “…to offer our consumers luxurious quality at appropriate price points and extend into new categories.” 
 
I’d also like you to notice that the gross margin on the direct to consumer sales is only about 1.2% higher than wholesale. That’s additional margin worth having, but it’s nowhere near what people used to think it would be. It costs a lot to run direct to consumer operations. But remember that gross margin in direct to consumer operations is after a bunch of operating expenses. That is, it’s not just product gross margin.
 
Selling, general and administrative expense was up from $446 to $529 million. As a percentage of sales, it rose from 31.5% to 33.9%. The biggest piece of this increase ($53 million) came from the opening of new stores. SG&A expense includes $86.5 million in advertising, marketing, and promotion costs. That’s up from $78.5 million the previous year.    
 
Net income was up from $129 to $146 million.
The balance sheet is in good shape and strengthened over the year. I particularly note an increase in cash from $110 to $237 million (I like cash) and a reduction in inventory from $300 to $261 million even as sales rose. The decrease is mostly due to a decline of 18% in UGG inventory.
 
Deckers’ financial results are improving, and it looks like they might be taking the lemons the higher sheepskin prices gave them and turning them into lemonade through the UGG Pure and some other things they are doing. I also like their approach to DTC.
 
They are expanding the UGG brand into outerwear and a home fashion line starting this fall. Men’s’ and women’s lounge wear tops and bottoms are part of the line. Omni-Channel President David Powers noted in the conference call, “I think the real win here is the combination of loungewear and slippers and home together as a full lifestyle expression, and I think we’re learning what the best way to showcase that in our stores is.” We’ll see how that goes.
 
To end where we started, Deckers still seems to have some work to do with Sanuk, but perhaps their recent hiring is an indication that things are going to start improving if those people are allowed to run the brand.

 

 

How’s Sanuk Doing? Decker’s Quarterly Results

So I guess I’ll start by telling you what Deckers says about Sanuk. In the 10Q for the quarter ended March 31, 2013 they provide this Sanuk Brand Overview (page 17). I’ve highlighted the phrase I want you to pay attention to. 

“The Sanuk brand was founded 15 years ago, and from its origins in the Southern California surf culture, has grown into a global presence. The Sanuk brand’s use of unexpected materials and unconventional constructions has contributed to the brand’s identity and growth since its inception, and led to successful products such as the Yoga Mat sandal collection and the patented SIDEWALK SURFERS®. We believe that the Sanuk brand provides substantial growth opportunities within the action sports market, as well as other domestic and global markets and channels in which Deckers is already established.”
 
In the June 30, 2013 10Q the Sanuk Brand Overview (page 17 again) says exactly the same thing, but they’ve added the following sentence at the end (which I’ve highlighted): 
 
“However, we cannot assure investors that our efforts to grow the brand will be successful.”
 
They say exactly the same thing in the current 10Q (September 30 quarter). I’m kind of embarrassed I was a quarter late noticing it. But I’m also kind of concerned I noticed it at all. I have so got to get a life. 
 
Why did they think they had to add it?
 
Decker’s management paid $120 million in cash for Sanuk (subject to adjustments at closing) plus earn outs. The deal closed in July of 2011. In its last complete year as an independent company, Sanuk did $43 million in sales. I don’t recall what Deckers has paid out so far for the earnout, but as of September 30, 2013, they estimate the discounted value of the remaining required payout at $47 million (page 7 of the 10Q which you can see here). That payout assumes a “compound annual growth rate” of 16.9%.  They used 17.3% last quarter.
 
Below, from the 10Q, is a table showing Sanuk’s sales by channel and the change from last year’s quarter. Column one is this year’s quarter, and column two last year’s. The last two columns are the dollar and percentage changes (dollars in 000’s). You can see that total sales were up by just $85,000, and they fell in the wholesale channel. 
 
 
And here are the numbers for the 9 months ended September 30 compared to last year. 
 
 
With 9 month revenue of $79.4 million, Deckers has certainly gotten some good growth out of Sanuk in a bit over two years, though growth has now slowed. 
 
Sanuk’s income from operations from its wholesale business rose from $2.86 million to $3.66 million during the quarter and from $16.2 million to $19.5 million for the nine months. Here’s what they say about why the operating income increased in the quarter:
 
“The increase in income from operations of Sanuk brand wholesale was primarily the result of decreased expense related to the fair value of the Sanuk contingent consideration liability and decreased marketing and promotional expenses. The decrease in expenses was partially offset by the decrease in net sales and resulting gross profit.”
 
Let me translate- We cut expenses and, because the brand isn’t performing as well, didn’t have to book at much for the earn out. That helped, but with sales and gross margin down, not as much as we would have liked.
 
We aren’t provided with operating income for the direct to consumer sales. Here’s what they have to say about Sanuk’s wholesale results for the quarter.
 
“Wholesale net sales… decreased primarily due to a decrease in the average selling price, partially offset by an increase in the volume of pairs sold. The decrease in average selling price was primarily due to increased closeout sales in the US, partially offset by increased average selling prices outside the US primarily due to the addition of international wholesale sales, which generally carry higher price points than distributor sales. The increase in volume of pairs sold was primarily due to our wholesale customers in the US and UK, as well as our distributors throughout Europe and wholesale customers in France, Japan and Benelux. These increases in volume were partially offset by a decrease in volume to our distributors throughout Asia. For Sanuk wholesale net sales, the decrease in average selling price had an impact of approximately $2,500 and the overall increase in volume had an impact of approximately $2,000.”
 
Go back and read that carefully. Note that when they talk about the decrease in average selling price in the US, they say it’s “partially offset” by increased prices outside the US. But that’s because they apparently changed some distribution from distributor to wholesale. I mean, it’s true that you get higher margins selling at wholesale than through a distributor, but you also incur more expenses in getting the sale.
 
Net, is this a good thing? Well, we don’t really know, though obviously they think it made sense to change the distribution or they wouldn’t have done it. But they try and spin it as a counterbalance to lower prices due to closeouts in the US, though I don’t think it isEverything they say is no doubt true, accurate, and complete as interpreted by a squad of lawyers.
 
Here endeth the daily lesson on the care you have to take when reading SEC filings (and press releases and conference calls even more) for any company. Especially when they have to share some bad news.
 
One symptom of the problems Deckers seem to be having with Sanuk is that “…Sanuk brand inventory increased $3.9 million to $12.5 million.” That’s a 45% increase from $8.6 million a year ago. 
 
Deckers, as you know, also own UGGs and Teva, as well as some smaller brands. Total company sales rose 2.75% during the quarter compared to last year’s quarter from $376.4 million to $386.7 million. The gross profit rose from 42.3% to 43.2%. This increase was “…primarily attributable to a shift in the mix of channel revenue with a greater contribution coming from our Direct to Consumer division…”
 
Once again, I feel obligated to point out that you get higher margins from direct to consumer business but also incur higher expenses. The question for any company is whether there’s any of that extra gross margin left after you cover those higher costs.
 
Deckers reported an increase in selling, general and administrative expenses of 20.8% from $99.7 to $120.4 million. About $12 million of the increase was for 37 new retail stores that weren’t open a year ago. Operating income from retail stores for the quarter fell from $321,000 to a loss of $2.26 million. Same store sales revenues rose 1.9% for the quarter. For nine months, operating income from retail fell from $8.5 million in 2012 to a loss of $1.6 million in 2013.  
 
Largely as a result of that SG&A increase, Decker’s income from operations for the quarter declined from $59.6 to $46.5 million. Net income was down from $43 million $33 million.
 
Overall, Deckers is suffering from the same worldwide economic problems that are afflicting everybody else. They also got hammered when their UGG brand, which accounted for 87% of total revenues during the quarter, was hit by spiking sheepskin prices over the last couple of years. My perception is that they’ve managed that pretty well after initially trying to push through more of the cost increase than the consumer would accept.
 
But they are having trouble with Sanuk, and I’m starting to believe that some of that trouble is of their own making. Growth has slowed, they’re having to close out some excess inventory and, probably inevitably, gross margin is down. They’ve cut spending in response.   
 
I’d remind Deckers management of Nike’s various attempts to enter the action sports business some years ago. They were pretty certain of their success, thought they could buy their way in and that they understood the business. As I’ve noted, we went to their parties, ate their food, drank their beer, but for a long time didn’t buy their product.
 
Then Nike figured out that they didn’t understand this business after all. They got humble (or maybe just more determined), developed some patience, hired a few people who knew what was up, and left them alone. They backed them up with their balance sheet and logistic resources even when they weren’t quite sure what the hell those guys were doing and it worked.
 
The situation isn’t the same, and the market has changed. Still, there’s a lesson there somewhere for Deckers and how they might consider managing Sanuk.

 

 

What’s Up at Sanuk? Oh- And Decker’s June 30 Quarter

Deckers, as you know, owns UGG, Teva and some other smaller brands as well as Sanuk. At June 30, they had 89 retail stores as well. 

In the quarter ended June 30, Deckers reported sales that fell 2.5% to $170 million compared to last year’s June 30 quarter. The gross profit margin declined from 42.2% to 41.1%. Selling, general and administrative expenses rose 10.1% from$102.3 million to $112.6 million. There was a net loss of $29.3 million, up from a loss of $20.1 million in last year’s quarter.
 
With that cheery news behind us, let’s jump right to a breakdown of Decker’s revenue and operating income by segment taken right from their 10Q, which you can view, if you’d like, right here. The chart below is from page 9.
 
 
You can see that UGG wholesale business was down 20.7% and Teva wholesale fell 9.5%. Sanuk was up 4% at wholesale, ecommerce grew 34% and retail 29% due to new store openings since last year. Sanuk’s ecommerce sales rose from $1.26 million to $2.09 million. Their sales through Decker’s retail stores were up from $0 to $218,000. Total Sanuk sales in the quarter were $30.1 million.
 
It always intrigues me that there’s never a discussion of how, for better or worse, the direct to consumer business impacts wholesale business. It almost seems like there’s a conspiracy of assuming that it’s inevitably a good thing. I suppose, in the case of ecommerce, brands have no choice but to be involved in it, so you might as well assume that’s true. In the case of retail, I’m not quite so sure and never have been. I’d love to be a fly on the wall as companies try and decipher how their wholesale and direct to consumer businesses influence each other.
 
Back to the chart. In its bottom part, we see income from operations for each segment. Only ecommerce and Sanuk grew their operating profit. UGG actually lost a little money, and the retail stores more than tripled their operating loss. Opening more stores and losing more money doesn’t seem like a good plan.
 
But back to Sanuk’s wholesale results. You can see they grew operating profit during the quarter by 143% from $2.7 to $6.5 million even though sales were up only 4% or $1 million. How’d they do that?
 
Off to the fine print.
 
As background, Deckers acquired Sanuk in July 2011 for, uh, a lot of money. The contingency payments include 36% of Sanuk’s gross profit in 2013 and 40% in 2015 with no upside limit (no payment in 2014). Deckers has to estimate what these payments may be. They are included on the balance sheet in other accrued expenses and long term liabilities. At least some of the amount impacts the income statement. It’s interesting, given Sanuk’s recent results, that “The estimated sales forecast [for Sanuk] includes a compound annual growth rate (CAGR) of 17.3% from fiscal 2012 through fiscal 2015.”
 
Anyway, Sanuk’s big operating income improvement “…was partially the result of decreased expense related to the fair value of the Sanuk contingent consideration liability of approximately $5,000,000 partially offset by increased selling and marketing expenses of approximately $3,000,000. The increase in income from operations was also due to the increase in net sales and resulting gross profit.”
 
To some extent, then, Sanuk’s improved operating profit  from its wholesale business during the quarter is partly the result of Decker’s reduced expectations for the brand through 2015, resulting in a reduced accrual of the earn out. Isn’t accounting wonderful?
 
I’d also note that of the net goodwill of $128.7 million carried on Decker’s balance sheet, $113.9 million is related to Sanuk. At some point, if Sanuk’s performance doesn’t meet expectations, that will have to be written down. Don’t know how much. It would be a noncash charge, but still a hit to income.
 
We also learn that Sanuk’s wholesale sales “…increased primarily due to an increase in the volume of pairs sold, partially offset by a decrease in the average selling price. The decrease in average selling price was primarily due to increased closeout sales, as well as a change to the discount program for prebook and re-orders.” The volume increase was about $1.5 million, but the discounting cost them $500,000.
 
I’ve been writing and speaking lately about how hard it seems to be a public company in our space. I’m beginning to worry that Sanuk is another example of what happens when an excellent brand is acquired for a high price by a public company that has to meet Wall Street growth expectations, but doesn’t really understand our space.
 
Deckers CEO Angel Martinez, in the conference call, talks about Sanuk this way:
 
“…the Sanuk brand started off as a predominantly male one-season surf brand when we acquired them in 2011. Now we’re transitioning the Sanuk brand into a lifestyle brand that will be featured in department stores, sporting goods and outdoor retailers in 2014.”
 
He says that so easily. But as I think about why Sanuk succeeded and what the brand stands for, I think he may be surprised just how hard it is to accomplish that transition without damaging the brand. It’s not that it can’t be done; I am just not sure it can be done as quickly as a public company might require. I am sure that “department stores, sporting goods and outdoor retailers” is way too broad a definition of the target market to be useful, and I assume appropriate slicing and dicing is ongoing at Deckers. 
 
Deckers is taking Sanuk into new markets, they are taking it into new, broader distribution, they are trying, according to CEO Martinez, to “…allow our Sidewalk Surfer-loving customers the ability to wear their favorite styles deeper into the year [UGG by Sanuk?],” and, he says, they want to “transition the brand from primarily hanging footwear merchandise brand to a meaningful player on the footwear wall in our surf, outdoor and footwear specialty channels, during what has traditionally been the brand’s off season.”
 
I seem to remember a successful, fast growing, quirky, male surf brand called Sanuk. Whatever happened to that brand anyway?
 
It feels like Deckers is trying to change and grow Sanuk to meet Wall Street requirements and to justify the price they paid for the brand. But they now expect Sanuk sales during the year “…to grow approximately 5% versus our previous expectation of between 10% and 13%.” My hope is that they don’t see the reduced sales expectations as a reason to push some of these transitions even more quickly. I’d suggest they consider that some part of the lower sales is the result of what they’ve done already. Hope I’m wrong and that they listen to the people they’ve recently hired.