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.

 

 

2 replies
  1. You Know Who
    You Know Who says:

    Interesting to me that there are no comments on this. Guess no one cares about this one anymore or maybe has written it off?

    • jeff
      jeff says:

      Yeah, I was pretty surprised too. Also surprised I didn’t hear from you sooner. Deckers would be way better off if they just admitted that things weren’t going well then describing how they are fixing it. But that’s not the way it works with Wall Street I guess, and of course Sanuk is a tiny part of Deckers’ sales (was supposed to be more by now) and everybody focuses on UGG.

      J.

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