Business Context and Reporting Period
Company: Deckers Outdoor Corp.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 1998
Business Overview: The Company designs and markets innovative footwear and apparel under four primary brands: Teva (sports sandals and apparel), Simple (casual footwear), Ugg (sheepskin boots), and Picante (casual apparel). In 1998, the Company sold approximately 3.94 million pairs of footwear. Teva products accounted for 66.5% of net sales, up from 58.0% in 1997.
Key Financial Metrics
| Metric (in thousands) | 1998 | 1997 |
|---|---|---|
| Net Sales | $102,172 | $106,713 |
| Gross Profit | $36,580 | $44,260 |
| Gross Margin | 35.8% | 41.5% |
| Operating Loss | $(2,798) | $8,112 |
| Net Loss | $(2,907) | $4,524 |
| EPS (Basic) | $(0.34) | $0.50 |
| Working Capital | $42,135 | $39,222 |
| Cash and Equivalents | $263 | $3,238 |
| Total Debt (Long-term + Current) | $21,435 | $8,090 |
| Operating Cash Flow | $(10,156) | $8,901 |
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 4.3% to $102.2 million. While Teva sales grew 9.8% to $67.9 million, Simple sales plummeted 31.0% to $19.9 million due to declining demand and competition. Ugg sales increased 16.8% to $10.7 million.
- Profitability Reversal: The Company reported a net loss of $2.9 million in 1998 compared to net earnings of $4.5 million in 1997. Operating margin turned negative (-2.7%) from positive (7.6%).
- Gross Margin Compression: Gross margin dropped 570 basis points to 35.8%. This was driven by inventory write-downs on excess Simple inventory, increased closeout sales, write-downs of Teva raw materials following the closure of the Mexican manufacturing facility, and higher airfreight costs.
- Expense Increases: Selling, general, and administrative (SG&A) expenses rose 10.5% to $39.4 million (38.5% of sales), driven by increased advertising ($1.9 million increase), R&D ($0.6 million increase), and warehouse costs.
- Liquidity Strain: Cash used in operating activities was $10.2 million, a significant reversal from the $8.9 million generated in 1997. Cash on hand dropped from $3.2 million to $0.3 million.
Guidance, Outlook, Risks, and Contingencies
- Teva License Expiration: The exclusive license for the Teva brand (66.5% of sales) expires August 31, 2001. The licensor, Mark Thatcher, has engaged a financial advisor to explore strategic options. Failure to renew or purchase the rights would have a material adverse impact on operations.
- Outlook: Management expects Teva and Ugg sales to increase in 1999, while Simple sales are expected to remain lower than 1998 levels. SG&A expenses are expected to decrease as a percentage of sales in 1999.
- Legal Proceedings: A jury verdict announced March 17, 1999, awarded $1.785 million to plaintiffs in a trade secret case (Molly Strong-Butts). The Company is appealing and does not believe the outcome will be material. A separate dispute regarding the sale of Trukke was settled in February 1999.
- Trade Risks: The European Commission has enacted 49.2% anti-dumping duties on certain footwear from China. Dutch Customs has opined that certain Teva styles are covered, potentially exposing the Company to $500,000 in prior duties and future sourcing disruptions.
- Year 2000 Compliance: The Company is in the testing phase of its Year 2000 compliance strategy, with estimated costs exceeding $550,000. Risks include potential failures of key suppliers or customers to become compliant.
- Financing: On January 21, 1999, the Company replaced its credit facility with a new $50 million revolving line. The facility includes a tangible net worth covenant of $30 million, which the Company met at year-end ($31.3 million).
Investor Verification Checklist
- Teva License Status: Verify the outcome of negotiations with Mark Thatcher regarding the renewal or acquisition of the Teva trademark, given its dominance in revenue.
- Simple Brand Turnaround: Assess the effectiveness of the repositioning strategy for the Simple brand following a 31% sales decline and significant inventory write-downs.
- Cash Flow Sustainability: Monitor operating cash flow trends, as the Company shifted from positive to negative cash flow and reduced cash reserves significantly.
- European Trade Exposure: Confirm the resolution of the Dutch Customs anti-dumping duty dispute and its impact on European margins and sourcing.
- Debt Covenants: Ensure continued compliance with the tangible net worth covenant ($30 million) under the new credit facility.