Deckers Has a Strong Quarter; Sanuk Shows More Signs of Life

A revenue increase of 6.6% from $760 to $810 million for the quarter ended December 31st compared to last year’s quarter is a pretty good result these days.  When you couple that with gross margin rising from 50.5% to 52.2% and reduce your SG&A expense 30.3% from $330 to $230 million, you get a pretax income that rises 279% from $50.9 million to $193 million.  Net income “only” rose from $41 to $86 million due to a jump in income tax expense from $9.9 to $107 million.  The new tax law (I refuse to call it a “reform”) is largely responsible.

Let’s remember that the UGG brand dominates Deckers’ results, generating $735 million of revenue for the quarter- almost 91%.  60% of the quarters $50 million revenue increase ($30 million) was the result of UGG’s growth.

As much as $30 million of the revenue increase was influenced by favorable weather conditions.  CFO Thomas George said, “$20 million was from the timing of wholesale orders originally scheduled for delivery early in our fourth quarter that our wholesale partners requested to be shipped sooner due to the strong third quarter sell through. $10 million of better than expected DTC performance as a positive 1.7% comp compared favorably to our expectations of negative low single digits and $3 million from foreign exchange fluctuations.”

The increase in gross margin “…was 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, as well as favorable foreign currency fluctuations compared to the prior period.”

I’d be curious what the currency benefit was.  Also, remember Deckers undertook a restructuring plan two years ago and they credit the plan with some of their overall improvement.  It’s cost them $55 million since it began.  Charges for the plan were $149,000 this quarter and $4.9 million in last year’s quarter.

The big number in the decline of SG&A expenses was the $118 million charge for Sanuk goodwill and patent in last year’s quarter.  Ignoring that, you’ll see an increase in SG&A expense.  Page 28 and 29 of the 10-Q breaks down the other increasing and decreasing components of SG&A  You can see that here.  Mostly, I view the increases as being for positive things.

At December 31st, Deckers had 168 retail stores worldwide.  101 they call concept stores and 67 outlets.  As part of their restructuring plan, they’ve closed 27 retail stores.  Long term, they see their total number of stores stabilizing at 125.

The balance sheet is strong, with cash rising from $296 to $493 million.  The current ratio is 3.24, up from 2.93 times.  Except for a $31 million mortgage, there’s no long-term debt and effectively no short-term borrowings.  Total liabilities as a percent of equity is 48%.  For nine months, cash provided by operating activities was $253 million, up from $168 million in last year’s nine months.

Let’s talk about Sanuk.  Deckers bought Sanuk back in 2011 for an amazing price- $120 million plus a big earnout for a company doing $43 million in revenue.  Here’s a link to what I wrote at the time.

I’ve never thought Deckers knew exactly what they bought or what to do with it.  They got rid of the entire team that had made Sanuk successful.  As a public company, they had to push it to grow to justify the somewhat unbelievable price they’d paid.  They pushed it in the wrong way and towards the wrong places.  We all spent the next five years or so watching things go bad.

Finally, eighteen months ago, Magnus Wedhammar was brought in to run Sanuk.  I have no idea why the management change didn’t happen sooner given Sanuk’s results, but we are seeing progress now.

First, Sanuk’s revenues for the quarter were more or less constant at $13.88 million.  Those results included a small increase in wholesale and a small decline in direct to consumer.  The operating loss for Sanuk’s wholesale business was $350,000.  In last year’s quarter it was $120 million, but that included the $118 million asset write down.  Let’s estimate the proforma operating loss has been reduced from $2 million in last year’s quarter to $350,000.

I’m not concerned that revenues didn’t rise.  Remember, Sanuk had a massive inventory problem that we’re no longer hearing about every quarter.  They also had to clean up their distribution which had a bit of a hangover from the failed growth binge.  SG&A expense for the brand has been reduced by $1.1 million, and we’re told that the gross margin rose.

Here’s how CEO Dave Powers talked about Sanuk in the conference call:

“As for Sanuk, sales were flat to last year, which surpassed expectations, while the brand continues to rationalize international distribution and clean the market place. Sanuk recently launched the Chiba Quest for both men and women, which is an extension to the Sidewalk Surfer franchise. The initial offering was exclusive to our DDC channel and will be available through our wholesale partners in our fourth quarter. The design and distribution plan for the Chiba Quest is focused around the core center consumer and we’re very encouraged with the initial feedback.”

What’s interesting and positive is that a CEO at Deckers is finally, actually, talking about Sanuk.

Deckers is finally acknowledging what Sanuk is and what it can be (and what it can’t be).  With the CEO responsible for the purchase of Sanuk and its performance while he was CEO gone and the investment written off, there’s no pressure to show growth to justify the purchase price.

So, you clean up your inventory and distribution, cut expenses, refocus on the product and what the brand stands for.  Maybe, just maybe, you can salvage some of the brand’s cache and see some growth and certainly a positive bottom line.

The most important thing Deckers corporate can do is leave Sanuk alone.  I hope Magnus keeps an inflatable bat by his desk with which to beat upon any suit from corporate who shows up to ask him to grow revenues faster.  Maybe the bat should be hickory rather than inflatable.

I don’t have a sense of just how much growth Sanuk can reasonably expect as it focuses on brand rebuilding and its market position.  Perhaps not enough to make it a serious contributor to Deckers’ earnings per share.  If that’s the case, it wouldn’t surprise me to see it sold to private equity once the brand is solid and the bottom line positive.

The changes going on at Sanuk are going on at Deckers’ other brands as well.  The conference call is replete with references to changes in inventory and supply management, distribution, and spending.  Even if part of the revenue increase turns out to be a one-time event, I’m expecting further long-term improvement in Deckers’ bottom line as the benefits of the restructuring plan are realized.