Business Context and Reporting Period
Company: Deckers Outdoor Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2007
Business Overview: Deckers is a designer and brand manager of footwear, operating three primary brands: Teva (sport sandals), UGG (luxury sheepskin), and Simple (sustainable footwear). The company sells through wholesale channels and a growing Consumer Direct business (retail stores and e-commerce).
Restatement Notice: The financial statements for the three and nine months ended September 30, 2006, have been restated due to material misstatements involving underreported payroll expenses and underpaid tax obligations by a foreign subsidiary in China.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2007 | Nine Months Ended Sep 30, 2007 |
|---|---|---|
| Net Sales | $129,381 | $254,686 |
| Gross Profit | $58,715 | $113,821 |
| Gross Margin | 45.4% | 44.7% |
| Income from Operations | $30,660 | $48,596 |
| Net Income | $19,330 | $31,048 |
| Diluted EPS | $1.47 | $2.37 |
| Cash and Cash Equivalents | $39,308 | $39,308 (as of Sep 30) |
| Short-term Investments | $35,405 | $35,405 (as of Sep 30) |
| Working Capital | $194,692 | $194,692 (as of Sep 30) |
| Debt | $0 (No outstanding borrowings) | $0 |
Material Changes vs. Prior Period
- Revenue Growth: Net sales increased 57.2% for the quarter and 41.5% for the nine months compared to the prior year. This was driven primarily by a 65.1% increase in UGG wholesale sales and a 10.4% increase in Teva wholesale sales.
- Profitability: Net income surged 86.2% for the quarter and 68.9% for the nine months. Operating income increased 78.4% (quarter) and 62.4% (nine months), aided by higher sales volumes and slightly improved gross margins.
- Inventory Build: Inventories increased 172.0% to $88.05 million, primarily due to seasonal buildup of UGG inventory for the Fall/Winter season.
- Cash Flow: Net cash used in operating activities was $33.7 million for the nine months, compared to $6.5 million used in the prior year. This increase was due to significant investments in inventory and accounts receivable to support sales growth.
- Restatement Impact: The 2006 comparative figures were adjusted downward for net income due to the accrual of payroll and tax liabilities in China. The restatement reduced 2006 net income by $219,000 for the quarter and $601,000 for the nine months.
Guidance, Outlook, and Risks
- Full Year 2007 Outlook:
- Sales: Expected to be approximately 39% higher than 2006.
- EPS: Diluted earnings per share expected to be approximately 35% higher than 2006 on a pro-forma basis (excluding restatement and impairment charges). Including the effects of the 2006 restatement and a $15.3 million Teva trademark impairment recorded in Q4 2006, EPS is expected to be approximately 85% higher than 2006.
- Margins: Gross margin expected to be approximately 45.0% for the full year. SG&A expected to be 20% to 25% of net sales.
- Brand Specifics: UGG sales expected to grow ~50% for the full year; Teva ~10%; Simple in the low teens.
- Internal Controls: Management concluded that disclosure controls and procedures were not effective as of September 30, 2007, due to the restatement issues. Remediation efforts are underway, including personnel changes and enhanced oversight of the China subsidiary.
- Risks:
- Restatement Contingency: A range of loss of $4.5 million to $7.4 million has been estimated for the China tax/payroll matter; the lower end ($4.5 million) has been accrued. This amount may increase due to penalties and interest.
- Seasonality: UGG sales are heavily concentrated in Q3 and Q4; Teva in Q1 and Q2.
- Supply Chain: Production is concentrated in China, Australia, and New Zealand, exposing the company to foreign currency fluctuations and geopolitical risks.
Investor Verification Checklist
- Restatement Details: Verify the final settlement amount of the China payroll and tax liabilities, as the current accrual ($4.5 million) is the low end of a $4.5M-$7.4M estimated range.
- Inventory Levels: Monitor the $88 million inventory balance to ensure it converts to sales without significant markdowns, given the 172% year-over-year increase.
- Internal Control Remediation: Track the progress of the remediation plan regarding internal controls over financial reporting to ensure future compliance and effectiveness.
- UGG Brand Sustainability: Assess whether the 65% growth rate in UGG sales is sustainable or if it faces saturation, given the company's reliance on this brand for the majority of profits.
- Simple Brand Performance: Watch for resolution of production delays affecting the "ecoSNEAKS" line and the impact on Simple's sales trajectory.