DECK

Business Context and Reporting Period

Company: Deckers Outdoor Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2006
Business Overview: Deckers designs, produces, and manages footwear brands including Teva (sport sandals), UGG (luxury sheepskin), and Simple (casual footwear). The company operates through wholesale and Consumer Direct channels. The business is seasonal, with Teva sales peaking in Q1/Q2 and UGG sales peaking in Q3/Q4.

Key Financial Metrics

Amounts in thousands, except per share data.

Material Changes vs. Prior Period

• Revenue Trends:
  • Three Months: Net sales increased 3.4% to $41.7M, driven by UGG (+20.9%) and Simple (+39.0%) growth, offset by a 10.2% decline in Teva wholesale sales.
  • Six Months: Net sales decreased 6.6% to $97.7M. UGG wholesale sales fell 12.4% (due to timing of prior year holiday shipments), and Teva fell 11.3%. Simple sales grew 45.6%.
• Profitability:
  • Three Months: Operating income decreased 14.3% to $4.0M despite a gross margin expansion to 45.6%. This was due to a 33.1% increase in SG&A expenses (marketing, payroll, bad debt).
  • Six Months: Operating income decreased 32.3% to $12.9M. Net income dropped 27.9% to $8.4M. Gross margin improved to 44.8% due to fewer closeouts, but was outweighed by higher SG&A and lower sales volume.
• Cash Flow:
  • Operating cash flow turned positive at $11.8M for the six months ended June 30, 2006, compared to a use of $13.7M in the prior year. This improvement was driven by tighter inventory management.
  • Investing activities used $54.5M, primarily due to net purchases of short-term investments.
• Balance Sheet:
  • Inventory increased 35.6% to $45.2M, largely due to UGG build-up for the fall season.
  • Accounts receivable decreased 39.8% to $24.6M due to seasonality.

Guidance, Outlook, and Risks

• Brand Outlook:
  • Teva: Management does not expect growth in 2006 due to lack of innovation and competition but anticipates a return to positive growth in Q1 2007 following new product launches and increased marketing.
  • UGG: International sales grew 57.6% in the first half. Management expects continued growth but notes fashion risks.
  • Simple: Strong growth expected driven by the "Green Toe" sustainable collection and expanded distribution.
• Capital Expenditures: Estimated remaining capex for 2006 is $4.0M–$5.0M for distribution center upgrades and new retail stores.
• Liquidity: The company has a $20M revolving credit facility with $19.9M available. No borrowings were outstanding as of June 30, 2006.
• Risks and Contingencies:
  • Impairment Risk: Continued decline in Teva sales could trigger an impairment charge on goodwill and intangible assets.
  • Intellectual Property: Ongoing litigation regarding counterfeit products and unauthorized trademark use for Teva and UGG.
  • Accounting Changes: Adoption of SFAS 123R (Share-Based Payment) reduced net income by $139k for the six months ended June 30, 2006.

Investor Verification Checklist

• Teva Turnaround: Verify the effectiveness of new product launches and marketing spend in reversing the 11.3% YTD sales decline.
• UGG Sustainability: Assess whether UGG sales growth can be sustained outside of the holiday season and in international markets.
• SG&A Leverage: Monitor if SG&A expenses (up 16.5% YTD) can be controlled as sales volumes fluctuate.
• Inventory Levels: Confirm that the 35.6% increase in inventory aligns with sell-through rates to avoid future write-downs.
• Goodwill Valuation: Review the carrying value of Teva intangible assets against future cash flow projections given the current sales trend.