Deckers Outdoor Corporation — Q2 FY2015 Form 10-Q
Reporting period: Three and six months ended September 30, 2014; comparative periods ended September 30, 2013. Financial statements are unaudited. The company changed its fiscal year-end from December 31 to March 31, so the six-month period includes the seasonally weaker June quarter and the stronger UGG selling season.
Financial performance
| Metric | Three months 2014 | Three months 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $480.3 million | $386.7 million | $691.7 million | $556.8 million |
| Gross profit / margin | $223.9 million / 46.6% | $166.9 million / 43.2% | $310.6 million / 44.9% | $236.7 million / 42.5% |
| Operating income / margin | $59.6 million / 12.4% | $46.5 million / 12.0% | $9.1 million / 1.3% | $3.7 million / 0.7% |
| Net income | $40.7 million | $33.1 million | $3.7 million | $3.8 million |
| Diluted EPS | $1.17 | $0.95 | $0.10 | $0.11 |
- Second-quarter sales rose 24.2% and net income rose 23.2%. Six-month sales rose 24.2%, but net income declined 3.1%; the June-quarter operating loss left first-half operating income at only $9.1 million.
- Quarterly sales growth was led by UGG wholesale (+24.2%), other-brand wholesale (+70.2%), and E-Commerce (+45.1%). Sanuk wholesale sales fell 4.2%. UGG accounted for $417.1 million of quarterly sales.
- For the six months, all brand/channel groupings reported higher sales. International sales increased 30.0% and represented 39.1% of revenue, versus 37.3% a year earlier.
- Quarterly gross margin improved mainly from a higher wholesale share relative to distributor sales, lower sheepskin costs, and increased use of UGGpure. SG&A rose 36.5%, reflecting store growth, marketing, international expansion, currency effects, and infrastructure.
Cash flow, liquidity and debt
- Cash and cash equivalents were $114.7 million at September 30, down from $245.1 million at March 31. Current assets were $938.4 million and current liabilities $421.0 million; net working capital was $517.3 million.
- Operating cash flow was negative $259.4 million for the six months, compared with negative $171.2 million in 2013. The principal uses were increases in inventory ($269.5 million) and receivables ($158.7 million), partly offset by higher payables.
- Investing cash flow was negative $48.0 million, including $38.5 million of property and equipment purchases. Management estimated approximately $100 million of capital expenditures over the next 12 months.
- Financing cash flow was positive $180.4 million, primarily from short-term borrowings and a new headquarters mortgage. At quarter-end, short-term borrowings were $154.6 million and mortgage debt was $33.4 million. The revolving facility had $146 million drawn and approximately $231.2 million available to borrow after borrowing-base and leverage limits; China facility borrowings were approximately $8.1 million.
- The July mortgage was approximately $33.9 million at a fixed 4.928% rate, with a 15-year maturity and an approximately $23.4 million balloon payment. The company reported compliance with its debt covenants. Management believed available cash, internal funds, and credit facilities would meet liquidity needs for at least 12 months.
Outlook, commentary and risks
- Management expected FY2015 gross margin to increase versus FY2014, citing lower sheepskin contract pricing, greater use of UGGpure, and sales mix. It anticipated an effective tax rate comparable to FY2014’s 29.1%. The filing provides no specific revenue or earnings forecast.
- Same-store sales declined 8.8% in the quarter and 6.7% for the six months. Management attributed the declines to warmer-than-average weather in parts of the U.S. and Europe and a mix shift toward lower-priced casual styles. Retail-store operating losses widened as the store base and related costs expanded.
- Key exposures include seasonal demand and weather, changing consumer preferences, sheepskin availability and pricing, reliance on a limited number of independent Asian factories and two principal sheepskin tanneries, foreign exchange, customer collections, inventory management, and international expansion costs. A 10% currency-rate change was estimated to affect the fair value of designated currency contracts by approximately $4 million.
- Sanuk acquisition contingent consideration was estimated at $25.8 million on the balance sheet; the fair value of total acquisition contingent consideration was $27.5 million. The Sanuk payment is tied to 2015 gross profit and has no maximum; management noted that a 5% change in its estimated sales CAGR would change the liability by approximately $2 million.
- The company recorded approximately $2.0 million for uncertain tax positions and $1.1 million for related interest and potential penalties during the quarter. Approximately $0.3 million of uncertain tax positions could be settled within 12 months. Management did not expect ordinary-course legal matters to materially affect results; a shareholder derivative case had been dismissed, with further review deadlines pending.
- Seven China retail stores were converted to third-party-operated partner stores. Subsequent to quarter-end, the company repurchased approximately 157,000 shares for $13.3 million, and revolving-credit borrowings increased to $182 million through November 10, 2014.
Important facts for investors to verify
- Whether seasonal inventory and receivables convert to cash as expected, given the substantial first-half operating cash outflow and increased borrowing.
- Whether UGG demand and the gross-margin improvement persist, and whether retail same-store sales recover from declines tied to weather and product mix.
- Whether store expansion, international growth, and planned capital expenditures generate returns sufficient to offset higher operating costs and debt service.
- The assumptions underlying Sanuk contingent consideration, tax reserves, and management’s 12-month liquidity assessment.
- Any subsequent changes in debt balances, share repurchases, covenant headroom, or the pending legal matter.