DECK

Business Context and Reporting Period

Company: Deckers Outdoor Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2006
Business Overview: Deckers designs, produces, and manages footwear brands including Teva (sport sandals), UGG (luxury sheepskin boots), and Simple (casual footwear). The company operates through wholesale channels and a Consumer Direct business (internet, catalog, and retail outlets). The business is highly seasonal, with Teva sales peaking in Q1/Q2 and UGG sales peaking in Q3/Q4.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 12.9% to $56.0 million. This was driven by a 33.7% drop in UGG wholesale sales (due to timing of holiday shipments in the prior year) and a 12.0% drop in Teva wholesale sales (due to wet weather and competition). These declines were partially offset by a 51.5% increase in Simple wholesale sales and a 31.6% increase in Consumer Direct sales.
• Profitability Compression: Income from operations fell 38.1% to $8.9 million. Gross margin declined 1.9 percentage points due to increased closeout sales and inventory write-downs. Selling, General, and Administrative (SG&A) expenses increased 4.1% in absolute terms, rising from 23.6% to 28.2% of net sales due to higher marketing and payroll costs.
• Cash Flow Shift: Operating cash flow turned positive at $11.6 million (compared to a $7.96 million use of cash in Q1 2005), driven by a significant reduction in receivables and inventory levels. However, investing activities consumed $52.6 million primarily due to net purchases of short-term investments.
• Accounting Change: The company adopted SFAS 123R (Share-Based Payment) on January 1, 2006, resulting in a $75,000 reduction in pre-tax income and $45,000 reduction in net income for the quarter.

Guidance, Outlook, and Risks

• Outlook: Management does not expect growth for the Teva brand in 2006 but anticipates a return to growth beginning with the Spring 2007 season following increased investment in product development. UGG sales are expected to continue growing, though not at the historical pace, with a focus on international expansion and new product lines. Simple is expected to grow as distribution channels expand.
• Liquidity: The company maintains a $20 million revolving credit facility with Comerica Bank, with $19.9 million available as of March 31, 2006. Management believes internal funds and available credit are sufficient for the next 12 months.
• Key Risks:
  • Supply Chain: Reliance on a limited number of suppliers for top-grade sheepskin (UGG) and independent manufacturers in China creates risks of shortages, price increases, and production delays.
  • Intellectual Property: Ongoing challenges to the "UGG" trademark in Australia and global counterfeiting efforts pose threats to brand integrity and sales.
  • Seasonality & Weather: Sales are highly sensitive to weather conditions (e.g., wet springs hurt Teva; warm winters hurt UGG).
  • Customer Concentration: The five largest customers accounted for 27.0% of net sales in 2005.

Investor Verification Checklist

• Verify the sustainability of the UGG brand's growth rate given the significant year-over-year sales decline in Q1 2006.
• Monitor the impact of sheepskin raw material costs and availability on future gross margins.
• Assess the effectiveness of new product launches for Teva and Simple in offsetting the decline in core wholesale sales.
• Review the status of intellectual property litigation, particularly regarding the UGG trademark in Australia.
• Track inventory turnover and write-down levels to ensure excess inventory does not further compress margins.