Deckers Outdoor Corporation — Q3 2013 Form 10-Q
Business context and period. The filing covers the quarter and nine months ended September 30, 2013. Deckers designs and sells footwear, apparel, and accessories, principally under UGG, Teva, and Sanuk, through wholesale, eCommerce, and company-operated stores. Results are seasonal: UGG sales are concentrated in the third and fourth quarters, while Teva and Sanuk peak earlier in the year. Unless noted otherwise, amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $386.7 | $376.4 | $820.6 | $797.1 |
| Gross profit / margin | $166.9 / 43.2% | $159.3 / 42.3% | $360.3 / 43.9% | $346.2 / 43.4% |
| Operating income / margin | $46.5 / 12.0% | $59.6 / 15.8% | $6.4 / 0.8% | $42.8 / 5.4% |
| Net income | $33.1 | $43.1 | $4.8 | $31.0 |
| Diluted EPS | $0.95 | $1.18 | $0.14 | $0.81 |
- Sales mix and drivers: Q3 sales increased 2.7%; international sales rose 10.3% to $147.9 million, while U.S. sales declined 1.4%. UGG wholesale sales fell 3.7%, partly offset by UGG retail-store growth of 33.8%. Total retail-store sales rose 34.5% and eCommerce sales rose 12.2%. For the nine months, UGG wholesale fell 7.9%, while retail stores rose 34.5% and eCommerce rose 21.6%.
- Margins and earnings: Q3 gross margin improved, largely from a higher direct-to-consumer mix, but closeout sales reduced margin. Nine-month gross margin was also slightly higher. SG&A grew 20.8% in Q3 and 16.7% year to date, outpacing sales; added store and infrastructure costs, performance-based compensation, and Hoka expenses were cited. Operating income declined 22.0% in Q3 and 85.1% year to date.
- Cash flow: Nine-month operating cash flow was negative $155.5 million, versus negative $183.4 million in 2012. Investing cash outflow was $56.5 million, including $55.8 million of property and equipment purchases. Financing cash inflow was $186.0 million, primarily from borrowings. Cash declined $26.1 million to $84.1 million. Inventory increased $144.4 million from year-end to $444.6 million.
- Debt and liquidity: Short-term borrowings were $245.5 million, compared with $33.0 million at December 31, 2012. The revolving credit facility had $239.0 million drawn and $110.6 million available to borrow after borrowing-base and leverage limitations; the weighted-average borrowing rate was 1.69%. The China facility had $7.0 million outstanding at quarter-end. Management reported covenant compliance and said available cash, internally generated funds, and credit were expected to meet needs for at least 12 months.
Material changes and management outlook
- Nine-month sales rose 2.9%, but net income attributable to Deckers fell 84.4%. The company attributed the earnings decline chiefly to higher SG&A and lower operating income. Q3 net income declined 23.2% year over year.
- Management expected full-year 2013 gross margin to improve versus 2012, with most of the improvement anticipated in Q4, citing lower negotiated sheepskin costs and use of UGGpure in selected products. It expected a 2013 full-year effective tax rate of 31%–32%, compared with 29.9% in 2012. The filing gives no clear full-year sales or earnings forecast.
- Management estimated remaining 2013 capital expenditures of $25–$30 million, primarily for new corporate facilities and retail stores. It reported 105 retail stores worldwide and planned further openings, mainly internationally.
- Other notable items: Sanuk acquisition contingent consideration had no maximum and was estimated at $45.2 million at quarter-end; its valuation depends on future gross-profit assumptions. The company had $272.2 million of contractual purchase obligations, including sheepskin commitments. No shares were repurchased in the first nine months of 2013; approximately $79.3 million remained under the authorization.
Risks, contingencies, and other disclosures
- Key business risks include seasonal demand, economic and consumer-preference changes, competition, sheepskin availability and price volatility, reliance on a limited number of independent manufacturers and material sources, foreign-currency movements, and inventory and receivables management.
- The company used foreign-exchange forwards with approximately $60 million in total notional amount. Management estimated a 10% exchange-rate change could alter derivative fair value by approximately $4 million. It stated a 1% interest-rate increase on current borrowings would not materially affect pretax income.
- Management said ordinary-course legal matters were not expected to have a material effect. A shareholder derivative case dismissed with prejudice was on appeal; the company reported no material changes to the risk factors in its 2012 Form 10-K.
- Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported during the quarter.
Important facts for investors to verify
- Whether Q4 seasonal UGG demand and the anticipated gross-margin improvement materialized, given the company’s reliance on the holiday selling season.
- Whether elevated inventory converts to sales without further discounting, and whether inventory turnover improves as management expected.
- Whether new-store and corporate-facility spending produces adequate returns and whether SG&A growth moderates.
- Future borrowing levels, covenant headroom, and liquidity needs as seasonal working capital and capital expenditures continue.
- The assumptions and ultimate cash payments underlying Sanuk contingent consideration, sheepskin purchase commitments, and the pending derivative-litigation appeal.