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.

 

 

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