Business Context and Reporting Period
Company: Deckers Outdoor Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2005
Business Overview: Deckers is a leading producer and brand manager of innovative footwear, operating three primary brands: Teva (sport sandals), UGG (luxury sheepskin boots), and Simple (casual footwear). The company sells through wholesale channels and its own Internet/catalog retailing business. The business is highly seasonal, with Teva sales peaking in Q1/Q2 and UGG sales peaking in Q3/Q4.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended June 30, 2005 |
Three Months Ended June 30, 2004 |
Six Months Ended June 30, 2005 |
Six Months Ended June 30, 2004 |
|---|---|---|---|---|
| Net Sales | $40,341 | $40,546 | $104,604 | $84,818 |
| Gross Profit | $15,969 | $18,906 | $45,536 | $39,312 |
| Gross Margin % | 39.6% | 46.6% | 43.5% | 46.3% |
| Income from Operations | $4,677 | $9,274 | $19,076 | $18,902 |
| Net Income | $2,732 | $5,087 | $11,619 | $10,469 |
| Diluted EPS | $0.21 | $0.43 | $0.90 | $0.91 |
| Cash & Equivalents | $11,102 (as of June 30, 2005) | |||
| Working Capital | $81,725 (as of June 30, 2005) | |||
| Debt Outstanding | $0 (Revolving credit facility unused) |
Material Changes vs. Prior Period
- Revenue Trends: For the three months ended June 30, 2005, net sales were flat (-0.5%) compared to the prior year, driven by a 9.3% decline in Teva wholesale sales due to unseasonably cold weather and a shift in consumer preference away from open-toe sandals. This was offset by a 36.8% increase in UGG wholesale sales and a 17.4% increase in Simple sales. For the six-month period, net sales grew 23.3% year-over-year, primarily fueled by UGG growth (+169.4%).
- Profitability Compression: Gross margin declined significantly in the second quarter (from 46.6% to 39.6%) due to increased closeout sales, inventory write-downs, and a shift in sales mix toward lower-margin UGG products. Operating income for the quarter dropped 49.6% to $4.7 million, while operating income for the six-month period remained relatively flat (+0.9%).
- Expense Growth: Selling, General, and Administrative (SG&A) expenses increased 17.2% in the quarter and 29.6% for the six months. This was attributed to the addition of a new distribution center, increased marketing spend, and costs associated with Sarbanes-Oxley compliance.
- Inventory Build: Inventories surged 120.3% to $66.7 million as of June 30, 2005, compared to $30.3 million at year-end 2004. This was a strategic build-up of UGG inventory ($42.5 million increase) to meet anticipated Fall/Winter demand and resolve previous supply shortages.
- Cash Flow: Operating cash flow turned negative for the six-month period (-$13.7 million) compared to positive $12.8 million in the prior year, primarily due to the significant cash outflow for inventory purchases. Investing activities provided $13.1 million, largely from the sale of short-term investments.
Guidance, Outlook, and Risks
- Seasonality Outlook: Management expects the trend of higher sales in the second half of the year to continue, driven by the UGG brand's peak season in Q3 and Q4. Teva sales are expected to be lower in the second half as they are concentrated in the first half.
- Supply Chain Risks: The company faces significant risks regarding the supply of top-quality sheepskin for UGG products. Supply is limited, and prices are rising. Shortages could lead to lost sales and strained retailer relationships. Additionally, the company relies on independent manufacturers in China; currency revaluation (July 2005) and potential labor or quality issues pose risks.
- Brand Risks: The company highlights the risk that UGG sales may not continue to grow at recent rates due to fashion fluctuations. There is also a risk of counterfeiting and intellectual property infringement, which could harm brand image and sales.
- Accounting Changes: The company is preparing to adopt SFAS No. 123R (Share-Based Payment) effective January 1, 2006, which will require recognizing stock-based compensation expense based on fair value, potentially impacting future reported earnings.
- Liquidity: The company maintains a $20 million revolving credit facility with no outstanding borrowings as of June 30, 2005. Management believes internal funds and available credit are sufficient to meet working capital needs.
Investor Verification Checklist
- Inventory Valuation: Verify the adequacy of inventory reserves given the 120% increase in inventory levels and the history of write-downs cited in the filing.
- UGG Demand Sustainability: Assess whether the 169% year-over-year growth in UGG wholesale sales is sustainable or if it is cannibalizing future demand due to the aggressive inventory build.
- Gross Margin Recovery: Monitor if gross margins can recover in the third and fourth quarters as the sales mix shifts back to higher-margin Teva products (if applicable) or if UGG margins stabilize.
- Sheepskin Supply: Confirm the company's ability to secure sufficient raw materials at current price points to fulfill the built-up inventory orders for the Fall/Winter season.
- Operating Leverage: Evaluate the impact of the new distribution center and increased SG&A on long-term operating leverage as sales volumes fluctuate.