Decker’s Quarter: The Issue is Not with Sanuk

The September 30 quarter (here’s the link to the 10Q) was not one of great happiness for Decker, the owner of UGG, Teva and, of special interest to us, Sanuk. But perhaps we should be interested in their other brands as well. Most of you who sell shoes and sandals are competing directly in the broader casual footwear market after all. 

Anyway, Decker’s sales fell 9.2% from $414 million to $376 million. In last year’s quarter, the gross profit margin was 49%. This year, it came in at 42.3%. Net income was down from $62.3 million to $43.1 million. What happened?
 
Well, it’s not Sanuk’s fault. Its sales for the quarter grew $15.6 million to $18.3 million, or by 17.3%. $1.3 million of these sales were on line. Sanuk is not sold in Decker’s retail stores. The brand’s sales for the whole year are projected to be $95 million. 
 
Sanuk’s operating income was up nicely from $1.5 million to $3.2 million. However, that increase “was primarily the result of a $1,400 reduction in accretion expense related to the contingent consideration liability from the Company’s purchase of the brand, a $900 reduction in amortization expense largely related to an order book that was fully amortized in 2011, and $500 of increased gross profit, partially offset by approximately $600 of increased marketing and promotional expenses.” After reading that closely, it’s hard to conclude that the operating income increase was primarily the result of selling more product.
 
Sanuk’s wholesale sales growth was the result of an increased selling price “…partially offset by a decrease in the volume of pairs sold.” Apparently they didn’t just increase prices for Sank. There was a shift in the product mix (sorry, no details given) and the introduction of a new shoe and boot line with higher prices.   
 
Unhappily for Deckers, Sanuk’s wholesale business represented only 4.9% of total revenue during the quarter. UGG, with revenues in the quarter of $284 million (down from $334 million), represented 76% of quarterly revenues.
 
Sheepskin is a primary material in UGG products. The cost of said sheepskin was up 30% in 2011 and another 40% in 2012. Obviously this sent the costs of UGG products through the roof. Deckers responded by raising prices and found that, as Chairman, CEO and President Angel R. Martinez put it“…our price increases over the past 2 years had pushed us above the consumer’s price value expectations for the UGG brand.” The warmest winter in the U.S. since they started keeping records didn’t help either.
 
There was probably no good answer for Deckers in the short term. Either they could hold their prices and see their gross profit go to hell, or they could raise prices to hold margins and see their sales drop. Not a happy place to be. The lesson for all of us, and I think it’s especially important these days, is that no matter how sophisticated your strategy, how well thought out your competitive positioning, how differentiated by marketing and features your product, and how many people “like” you on Facebook, every product can be substituted for and sometimes the stuff just costs too much.
 
Deckers sees sheepskin prices coming down some, and they “…made the decision to adjust our domestic pricing in mid-September on select classic styles, retroactive to all orders shipped since July 1.” They reversed some, but not all of their price increases. The issue is whether they can make enough of the price increases stick so that, given a decline in raw material costs that it sounds like will be less than the initial increase, they can recover their gross margins. Price increases, even when justified, have to be gradual I think.
 
Mr. Martinez goes on to say, “The price adjustment has been mischaracterized in recent industry coverage as “discounting.” But in fact, it’s an important strategic decision that we believe is in the best interest of the brand for the long term.” The good thing is that it sounds like they didn’t close this product out or take it to other channels. They worked with their existing retailers for everybody’s benefit, which is something we in the action sports world perhaps haven’t always done as well as we could. But I wonder where that high quality strategic analysis was when they raised their prices so much in the first place. Maybe subsumed by some pressure to make the quarter?
 
Deckers has hit what we hope is a one time bump in the road due to the large and rapid increase in the price of sheepskin. Sanuk seems to be doing fine. Given the price Deckers paid for it, I imagine they will push the brand for even better results. Please don’t push too hard.