Deckers Outdoor Corporation — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Financial amounts below are in millions of dollars unless stated otherwise; the filing presents amounts in thousands. Deckers designs and markets footwear and accessories under UGG, Teva, Sanuk and other brands. Results include Sanuk from its July 1, 2011 acquisition. UGG sales are seasonally strongest in the third and fourth quarters.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $414.4 | $277.9 | $773.4 | $570.9 |
| Gross profit / margin | $202.9 / 49.0% | $131.0 / 47.1% | $371.2 / 48.0% | $269.6 / 47.2% |
| Operating income / margin | $90.7 / 21.9% | $66.3 / 23.9% | $108.1 / 14.0% | $108.4 / 19.0% |
| Net income attributable to Deckers | $62.5 | $42.1 | $74.3 | $69.0 |
| Diluted EPS | $1.59 | $1.07 | $1.89 | $1.76 |
Q3 sales rose 49.1% and attributable net income rose 48.3%. Growth reflected UGG sales, Sanuk’s contribution, European distributor-to-direct-wholesale conversions, and retail store expansion. Nine-month sales increased 35.5%, but operating income was essentially flat and operating margin fell to 14.0%, as SG&A grew 63.2%, faster than revenue. Higher retail, international infrastructure, marketing, legal, and acquisition-related costs contributed. Gross margin improved in both comparisons, partly from direct wholesale conversions and retail mix, but higher sheepskin, materials, and factory costs offset some of the benefit.
UGG remained the largest business: nine-month sales were $633.4 million, up 37.6%. Retail-store sales rose 69.3%; same-store sales increased 11.5% for the first nine months. International sales were 36.8% of nine-month revenue versus 32.2% a year earlier. Sanuk contributed $15.6 million in sales after acquisition and $1.5 million of wholesale segment operating income for the post-acquisition period. Simple distribution is planned to cease after December 31, 2011; closeout sales and inventory write-downs pressured the other-brands segment.
Cash, liquidity and capital
Cash and cash equivalents were $90.4 million at September 30, down from $445.2 million at year-end. Nine-month operating cash flow was negative $222.3 million, versus negative $61.9 million in 2010, mainly due to seasonal increases in inventory, receivables and prepaid expenses. Inventory was $356.9 million, up from $125.0 million at year-end; management cited expected fourth-quarter UGG demand, international inventory, store expansion, and higher input costs. Investing cash flow was negative $152.3 million, including $126.6 million for acquisitions and $21.5 million in property and equipment.
Deckers had $45.0 million outstanding under its new five-year, $200 million secured revolving facility and $154.8 million available at quarter-end; it repaid $20.0 million after quarter-end. The company was in compliance with credit covenants. Current assets were $749.4 million and current liabilities $260.8 million. Management said cash, internally generated funds, and available credit should meet requirements for at least 12 months, while noting that business conditions, inventory management, collections, acquisitions, and market volatility could affect liquidity.
During the nine months, the company repurchased approximately 245,000 shares for about $20.0 million, completing its $50 million repurchase authorization. It agreed to buy land for a new headquarters for approximately $20.4 million and estimated remaining 2011 capital expenditures, including land, at $35–$40 million.
Acquisition, outlook and risks
Sanuk’s preliminary total consideration was $206.8 million, including $126.6 million cash paid and $84.3 million of fair-valued contingent consideration. The contingent payments depend on future Sanuk results; certain 2012, 2013 and 2015 payments have no stated maximum. Purchase accounting and working-capital adjustments remained provisional. Acquisition-related transaction costs were about $4.0 million, and Sanuk contributed $2.99 million of acquired-intangible amortization and $1.39 million of contingent-consideration accretion expense in the reported period.
The filing provides no specific full-year revenue or earnings guidance. Management expected the 2011 effective tax rate to be significantly below 2010’s 35.9%, citing a greater share of foreign pretax income; the nine-month effective rate was 31.0%. Management also expected a significant increase in sheepskin costs in 2012 and cautioned that selling prices may not rise enough to offset material-cost increases. Other risks include seasonal demand, changing consumer preferences, overseas production and sourcing concentration, foreign-exchange movements, economic conditions, and the availability and price of sheepskin. The IRS was examining 2006–2009 returns and proposed transfer-pricing adjustments involving about $27 million of additional federal taxes and penalties, excluding interest; the company disputed the proposal. Management said routine legal proceedings were not expected to have a material effect and reported no material change to previously disclosed risk factors.
Important facts for investors to verify
- Whether elevated inventory and negative operating cash flow convert into expected seasonal sales and collections.
- Sanuk’s final purchase accounting, working-capital adjustment, performance and potentially uncapped contingent payments.
- Sheepskin supply, 2012 cost increases, and the effect of input costs on margins.
- Progress and outcome of the IRS transfer-pricing examination and the company’s related tax estimates.
- Whether operating expenses, especially retail and international infrastructure costs, moderate enough to support margins.