Deckers Outdoor Corporation — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended September 30, 2017. The filing was submitted November 9, 2017. Financial statement amounts below are in U.S. dollars; millions are used for readability.
Business context and results
Deckers designs, markets and distributes footwear, apparel and accessories, primarily under UGG, Teva, Sanuk, Hoka and Koolaburra. It sells through wholesale customers and its direct-to-consumer (DTC) retail stores and websites. Results are seasonal, particularly for UGG, and the interim results are not necessarily indicative of full-year performance.
- Quarter: Revenue was $482.5 million, down 0.7% year over year. Gross profit was $225.1 million and gross margin was 46.7%, up from 44.5%. Operating income was $67.4 million versus $54.0 million; net income was $49.6 million versus $39.3 million. Diluted EPS was $1.54 versus $1.21.
- Six months: Revenue was $692.2 million, up 4.8%. Gross profit was $315.7 million and gross margin was 45.6%, up from 44.3%. Operating income was $11.1 million, compared with an operating loss of $24.3 million; net income was $7.4 million, compared with a net loss of $19.6 million. Diluted EPS was $0.23 versus a loss of $0.61 per share.
- Revenue mix: Quarter revenue was pressured mainly by lower UGG wholesale sales, while DTC increased 6.2%; Hoka-led other-brand sales and Teva also grew. For the six months, DTC rose 8.5%, other brands 30.1% and Teva 14.0%; Sanuk sales fell 9.2%. International revenue rose 12.7% for the six months and represented 38.8% of sales.
- Cash flow and investment: Six-month operating cash flow was negative $182.8 million, versus negative $288.5 million a year earlier, reflecting seasonal working-capital needs, including inventory and receivables. Investing cash outflow was $10.2 million, mainly capital spending; financing provided $131.0 million, including net short-term borrowing. Cash declined by $61.2 million to $230.6 million.
- Liquidity and debt: At September 30, cash was $230.6 million. Short-term borrowings were $133.5 million and mortgage debt was $32.4 million, for approximately $165.8 million of reported borrowings and mortgage principal. Domestic, China and Japan facilities had stated available capacity of about $296.5 million, $24.0 million and $40.0 million, respectively. The company reported covenant compliance.
- Balance sheet: Receivables were $306.6 million and inventory was $555.6 million at September 30, up from $158.6 million and $298.9 million, respectively, at March 31, consistent with seasonal working-capital buildup.
Material changes and management commentary
- Management attributed improved margins to fewer closeout sales, lower input costs from supply-chain initiatives and a higher DTC mix. Six-month operating results also benefited from higher sales and lower SG&A, while increased performance-based compensation and warehouse/logistics costs partly offset savings.
- DTC comparable sales rose 3.7% for the quarter and 7.8% for the six months on a constant-currency basis, driven by e-commerce growth; company retail-store sales declined.
- The multi-year restructuring plan had incurred $55.3 million in charges through September 30, 2017. Six-month charges were $1.5 million; none were incurred in the quarter. Twenty-six retail stores had been closed under the plan, and management anticipated further restructuring charges as stores are closed or converted to partner-operated locations.
- The Savings Plan targets approximately $100 million of annual operating-profit improvement from fiscal 2017 through fiscal 2020, before considering anticipated reinvestments. Management said it expected e-commerce to remain a long-term growth driver and estimated an optimal owned-store count of about 125; the company had 163 stores at September 30.
- Subsequent to quarter-end, the board authorized a new $335 million repurchase program, bringing total authorized repurchases, including remaining prior authorization, to approximately $400 million. No shares were repurchased under the earlier program during the six-month period.
- The company completed its formal review of strategic alternatives after quarter-end and said it was not actively pursuing a sale at that time.
Risks, contingencies and unusual items
- Seasonality, weather, changing consumer shopping behavior, wholesale order timing, inventory management and retail-footprint changes may materially affect sales and cash needs. The company depends on independent manufacturers and a limited supplier base, including two principal sheepskin tanneries.
- Foreign exchange is a material exposure: 33.2% of quarterly sales and 30.3% of six-month sales were denominated in foreign currencies. A hypothetical 10% currency movement was estimated to change the fair value of currency instruments by approximately $6 million.
- One customer represented at least 10% of sales during the quarter and six-month period; two customers represented 11.9% and 10.4% of receivables at September 30. The filing notes increased bad-debt expense related to an unsettled customer account.
- Material commitments included approximately $77.2 million of future minimum lease payments for the expanded and extended Moreno Valley distribution-center lease, approximately $16.1 million of future capital-expenditure commitments, and estimated remaining fiscal 2018 capital expenditures of $33–$35 million.
- Marcato Capital and affiliates sued the company and its directors in October 2017, alleging fiduciary-duty and proxy-statement violations and seeking injunctive relief. The company said it would defend the case and that the outcome and potential financial impact could not yet be predicted. A separate UGG trademark dispute remained unresolved; the company said an adverse ruling invalidating the U.S. trademark could materially harm the business, and it could not estimate a potential loss.
- Other items include $12.9 million of net unrecognized tax benefits and associated interest and penalties, with $3.1 million potentially settling within 12 months. Management identified no material change in the previously disclosed risk factors except the added risk from activist-stockholder actions and the proxy contest.
- Management reported effective disclosure controls as of September 30, 2017, and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether seasonal inventory and receivables convert into cash as the fall and winter selling period progresses, and how borrowing levels evolve.
- Whether gross-margin gains, cost savings and the $100 million Savings Plan target are achieved without impairing brand demand or requiring significant reinvestment.
- Growth and profitability trends by brand and channel, especially UGG wholesale, Hoka/other brands, Sanuk and e-commerce versus owned retail.
- The outcome and costs of the Marcato litigation and proxy contest, the UGG trademark case, and any effects on governance, financing agreements or employee awards.
- The scale and timing of future store closures, restructuring charges, capital spending and the proposed share repurchases relative to liquidity needs.
- Potential effects of currency movements, customer credit risk, supplier concentration and tax settlements on earnings and cash flow.