Interesting Comments From Deckers; What Will They Do With Sanuk?

Deckers, the owner of UGG and Teva as well as Sanuk, filed their 10K annual report with the SEC and I’ve been through it. As you may remember, Deckers bought Sanuk on July 1, 2011 so the year ended December 31, 2012 is the first complete year with Sanuk included. 

For the year, revenue rose 2.8% to $1.41 billion, but net income fell 36% from $202 million to $129 million. The biggest reason for the decline was a gross profit margin that fell from 49.3% to 44.7%. The big problem was the cost of sheepskin, which was 40% higher than in 2011. By itself, that hit the gross margin by 4.5%. Deckers tried to push a chunk of this cost increase through to consumers and found they had pushed too hard. Consumers became reluctant to buy the product. With sheepskin prices declining some, Deckers expect things will start to get better in 2013.
 
UGG wholesale revenues were down 10.5% to $819 million. Teva at wholesale fell 8.5% to $109 million. Sanuk at wholesale was up from $26 to $90 million, but remember that last year Deckers only owned Sanuk for half a year, and Sanuk’s strongest quarters are the first two of the year. 
 
Decker’s other brands at wholesale were down about $1.5 million to $20 million at wholesale.
 
Ecommerce sales, on the other hand, grew 22.6% during the year from $106.5 to $130.6 million. Sales at retail stores rose 30% from $189 to $246 million.
 
Looking at brand sales across all channels, UGG was down 1.5% from $1.20 to $1.18 billion. Teva fell 7.2% from $125 to $116 million. Sanuk was up from $26.6 million to $94 million. They are selling almost no Sanuk ($20,000) in their retail stores, but ecommerce sales were up from $539,000 to $4.17 million. Other brands fell from $24.1 to $21.3 million. 
 
Without Sanuk, then, total revenues would have fallen from $1.35 to $1.32 billion.
 
I’ll get back to Sanuk. Decker’s presentation got me thinking strategically about the intersection of wholesale, ecommerce, and retail. The question is simply this; to what extent does growth in one of those three channels support or diminish sales in one or more of the others?
 
Thoughts on Ecommerce and Brick and Mortar
 
Deckers certainly believes that their net profit is higher because they are in brick and mortar and ecommerce than it would be if they weren’t. But I doubt they, or any other brand, would try and convince me that there isn’t some cannibalization among channels. And they’d also assert that the channels are supportive of the brand and, hopefully, ultimately, revenue growth.
 
Where’s the balance? What are the “things to consider” as we think about the intersection of wholesale, retail, and ecommerce. 
 
First, being on the internet and participating in ecommerce is somewhat defensive. I really don’t think you have a choice but to be there.
 
Second, a brand opening stores is a choice, not a requirement. A few stores are probably a good idea if only because of what you will learn about your brand, what sells, and why. A lot of stores is a whole different management challenge and should not be undertaken solely for financial reasons. Those few extra margin points can turn out to be illusionary if you aren’t very, very careful.
 
Third, opening stores and ecommerce should not be what you do because you can’t figure out how to grow your business any other way. This, I think, has particularly been a public company problem.
 
Fourth, stores and a good ecommerce presence may help your brand beyond countering what your competitors are doing, but if you’re brand isn’t already strong and well defined with your customers, it’s not a solution. Being everywhere can still be being nowhere. There’s a certain almost circular, unsatisfying, and ambiguous logic here. As we watch the evolution of brands, ecommerce and brick and mortar, I guess the winners will be the ones who are best at quantifying without deluding themselves the impact of each channel on the other.
 
Fifth, this ecommerce and brick and mortar stuff costs a whole lot of money. See point four again. You better know why you’re doing it and how it will impact your overall business. “To grow” isn’t a good answer.
 
Finally, once companies start opening stores, they seem to keep opening them. We can all think of some instances where that hasn’t worked out too well. Deckers had 77 stores worldwide at the end of the year. In 2012, they opened seven stores in the U.S. (giving them a total of 26) and 23 internationally. At end of the year, they had 56 UGG Australia concept stores and 21 UGG outlet stores worldwide. They expect to open more in 2013 and beyond. Same store sales were down 3.4% during the year.
 
Plans for Sanuk
 
Deckers paid around $200 million for Sanuk. That’s $123 million in cash plus additional contingency considerations that they are presently estimating to be $70 million for a company that was doing around $40 million at the time it was acquired. So I’m thinking they’d like to see it do well.
 
In 2012, Sanuk’s wholesale operating profit was 17.3% of revenue. That was well below UGG’s at 32.7% but better than Teva’s 9.3%.
 
“We believe,” they say, “that the Sanuk brand provides substantial growth opportunities within the action sports market, as well as other domestic and global markets and channels.”
 
They go on to say in, “Sanuk brand complements the Company’s existing brand portfolio with its unique market position…The Sanuk brand also brings additional  distribution channels to the Company, as it sells to hundreds of independent specialty surf and skate shops throughout the US that were not significantly in the Company’s existing customer portfolio.”
 
In the conference call, we’re told, “The acceptance of the Sanuk brand expanded collection of cold-weather shoes- colder weather shoes rather, and boots was very positive…” They want to “…evolve the Teva and Sanuk brands into year-round businesses.”
 
I’m looking the Sanuk web site right now, and I can’t find any boots or colder weather shoes so I’m not quite sure what it was that was well accepted. I guess I can understand why Deckers management might try to steer Sanuk towards boots and colder weather. UGG is by far the dominant brand in the company, and you can imagine that Deckers is confident in that market. And they’ve got to justify that $200 million purchase price.
 
Let’s just say I’m a little nervous about Deckers trying to expand the Sanuk franchise that way too fast. I have just three words for Decker’s management: Reef skate shoes. If you don’t know what I mean, then I’m right to be worried.
 
For 2013, Deckers is expecting a 15% increase in Sanuk, but only 4% for UGG and 6% for Teva. When you first see that comparison, you think, “Gee, Sanuk is doing well.” But when you think about it, it feels like Sanuk’s growth has slowed rather precipitously. I know big percentage increases are harder to come by as you grow, but that feels like too much slowing too quickly. What’s going on?
 
Other Deckers Stuff
 
Revenues in Decker’s fourth quarter rose 2.2% to $617 million. But the gross profit margin fell from 51% to 46.3%. As a result, net income was down from $124.5 million to $98 million.
 
Most of their production is done in China, but since 2009, they have started to source in other parts of the world. In 2011, they opened manufacturing locations in the U.S. and Latin America.
 
Their December 31, 2012 backlog was $323 million, down 16.5% from a year ago. They acknowledge an ongoing change in the inventory cycle, and think it’s “…likely that an even higher percentage of classic and cold-weather product sales are going to be concentrated in the fourth quarter. We are adjusting our supply chain resources accordingly, while also introducing new fall products for the transitional period between summer and the holiday selling season.” Anybody who sells winter product is going to have to think about that.
 
They are also looking at distribution, especially domestically. CEO Angel Martinez put it this way in the conference call.
 
“As the brand has evolved…it requires a commitment of inventory, it requires a commitment on the brand by a retailer. And where we get those commitments and we see that kind of support for the brand, we have partners for life, if you will. However, there are some environments where we don’t — we’re not happy with the brand presentation, we’re not happy with the support for the year-round elements of the business and the support for the men’s product, so we have to reevaluate whether or not those are long-term participants in the brand success going forward. Consumers today expect a full brand experience when they have a brand they love like UGG. They don’t want to see a piecemeal representation and a brand that gets cherry picked and put out there at retail.”
 
Well, obviously, you can’t blame him for feeling that way. But if every brand were to expect all its retailers to offer a “full brand experience” and carry the inventory that required, the smallest specialty shop would be 30,000 square feet. Either that or it would just be a brand retail shop. Opps.
 
Deckers highlights, and is addressing, some of the issues we’re all facing. More interesting to me is how they are going to manage Sanuk. The brand is highly credible in its market. If they try and push it into other markets too quickly, bad things could happen.