Deckers Outdoor Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012. Financial figures below are in U.S. dollars; amounts are rounded to millions unless stated otherwise. Deckers designs and sells footwear and accessories under UGG, Teva, Sanuk and other brands, through wholesale, eCommerce and company-operated stores. The business is seasonal: UGG sales are concentrated in the third and fourth quarters, while Teva and Sanuk are strongest in the first and second quarters.
Financial performance
- Revenue: $246.3 million, up 20.2% from $204.9 million. The increase primarily reflected Sanuk, acquired in July 2011, and higher UGG retail sales. International sales were 30.8% of revenue versus 27.7% a year earlier.
- Profitability: Gross profit was $113.3 million, up 10.5%, but gross margin fell to 46.0% from 50.0%. Operating income declined 57.7% to $11.9 million; operating margin was 4.8% versus 13.8%. Net income was $8.0 million versus $19.8 million; income attributable to Deckers was $7.9 million versus $19.2 million. Diluted EPS was $0.20 versus $0.49.
- Drivers: Higher sheepskin and other material costs and more closeout sales pressured gross margin. SG&A increased 36.4% to $101.4 million, including costs related to Sanuk, 19 additional retail stores, marketing and international expansion.
- Cash flow: Operating cash flow was $27.1 million, compared with $3.6 million. Investing cash outflow was $11.2 million, primarily property and equipment purchases; financing cash outflow was $51.9 million, mainly Sanuk contingent consideration and share repurchases. Cash declined $35.0 million during the quarter to $228.6 million.
- Liquidity and debt: Current assets were $647.7 million and current liabilities $95.1 million; working capital was $552.5 million. There were no borrowings under the $200 million revolving credit facility, with $199.8 million available after letters of credit. Deckers reported compliance with covenants. Long-term liabilities were $52.1 million; the filing does not separately identify all components as conventional debt.
Material changes and business developments
- Sanuk contributed $32.4 million in sales and $10.6 million in segment operating income; it was not included in Q1 2011 results.
- UGG sales rose 6.5% to $158.1 million, led by retail-store growth; UGG wholesale sales were nearly flat, and eCommerce sales declined. Teva sales declined 1.1% to $49.8 million. Total retail-store sales increased 30.6% to $46.2 million, while eCommerce sales fell 7.5% to $21.7 million.
- Consolidated operating income fell despite revenue growth. UGG and Teva wholesale operating income declined, and unallocated overhead costs rose to $41.4 million from $33.8 million.
- On April 2, 2012, Deckers purchased Stella International’s remaining 49% interest in its already-consolidated China joint venture for $20 million.
- Deckers repurchased approximately 274,000 shares for $20 million during the quarter under a new $100 million authorization. Subsequent to quarter-end, it repurchased another 276,000 shares for $14.7 million.
Outlook, risks and contingencies
- Management expected continued gross-margin pressure during 2012, primarily from higher sheepskin costs. The filing reports sheepskin costs rose 27% in 2011 and forecasts a further 40% increase in 2012; management cautioned it may not be able to raise prices enough to offset cost increases.
- Management expected the full-year 2012 effective tax rate to be higher than 2011’s 29.2%, but lower than Q1 2012’s 34.9%. Q1 included approximately $0.8 million of discrete tax expense related to the China joint venture. Approximately $53 million of cash held outside the U.S. was not planned for repatriation.
- Management anticipated 2012 capital expenditures of approximately $70–$75 million, including headquarters construction and new stores. It said cash, operating cash generation and available credit should be sufficient for at least 12 months, subject to business and market risks.
- Seasonality and consumer demand, product availability, brand performance, inventory management, receivable collection, and international expansion remain risks. Production is concentrated among independent factories in China; sheepskin sourcing is also concentrated and exposed to supply and price changes. Foreign-exchange movements and international market risks may affect results.
- The IRS asserted approximately $55 million of additional taxable income in a transfer-pricing dispute, corresponding to approximately $27 million of additional federal taxes and penalties, excluding interest. Deckers disagreed; IRS Appeals discussions were ongoing, and the ultimate effect was uncertain.
- Sheepskin purchase commitments included a remaining commitment net of deposit of approximately $66.8 million at March 31, 2012; the contract was subsequently amended, extending its target date and increasing the total minimum commitment. Sanuk acquisition contingent consideration was estimated at $62.8 million and has no maximum for specified years; its fair value depends on forecasts and could change materially.
- Management did not expect routine legal proceedings or intellectual-property indemnification matters to have a material effect. The filing reported no material changes to previously disclosed risk factors and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether revenue growth can translate into recovered gross and operating margins given sheepskin costs and closeout activity.
- Sanuk’s future contribution and the variability of its uncapped contingent consideration.
- The outcome of the IRS transfer-pricing dispute and any resulting tax, penalty or interest exposure.
- Execution and returns on planned capital spending, store expansion and the international wholesale/eCommerce businesses.
- Cash needs and liquidity through seasonal inventory cycles, including the scale and terms of purchase commitments.