Deckers Outdoor Corporation — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited results. Deckers designs and markets footwear and accessories, led by UGG and Teva, with other wholesale brands, eCommerce and retail stores. Sales are seasonal: UGG is strongest in the second half; Teva is strongest in the first half.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $154.2 million | $137.1 million | $359.1 million | $293.0 million |
| Gross profit / margin | $65.9 million / 42.7% | $60.7 million / 44.3% | $168.4 million / 46.9% | $138.7 million / 47.3% |
| Operating income (loss) | $(10.8) million | $13.2 million | $17.4 million | $42.0 million |
| Net income (loss) attributable to Deckers | $(7.3) million | $9.0 million | $11.8 million | $26.9 million |
| Diluted EPS | $(0.19) | $0.23 | $0.30 | $0.69 |
| Operating cash flow | Six months: $(78.4) million | Prior-year six months: $4.2 million |
Liquidity and debt: June 30 cash was $325.2 million, down $120.1 million from year-end 2010. Current assets were $691.7 million and current liabilities $133.1 million; working capital was $558.7 million. There were no revolver borrowings and $19.3 million remained available under the $20 million Comerica facility. The facility expires June 1, 2012. The filing reports no material outstanding debt beyond current and long-term liabilities shown in the balance sheet.
Changes and operating drivers
- Quarterly sales grew 12.5%; first-half sales grew 22.6%. First-half growth came principally from UGG and Teva, higher selling prices and expanded retail sales. US sales rose 26.7% and international sales 15.7% in the first half.
- Quarterly operating results swung to a loss despite higher sales. SG&A rose 61.4% in Q2 and 56.3% for the first half, driven by new stores, international expansion, brand spending, marketing and legal costs. Gross margin declined, reflecting nonrecurring prior-year duty refunds, production costs, closeouts and inventory write-downs.
- UGG wholesale sales declined in Q2, mainly due to timing shifts following European distributor-to-wholesale conversions; first-half UGG sales increased. Teva sales increased in both periods. Other-brand sales declined in the first half, with Simple closeouts and write-downs weighing on margins. Retail-store sales rose 67.7% in the first half, including sales from 11 stores added since June 2010.
- Operating cash use reflected an $88.1 million inventory increase, tax receivable and reductions in accrued expenses, partly offset by increased accounts payable and collections. Inventory was $210.0 million, up 68.0% from year-end, in part to support expected second-half sales and new stores.
Outlook, risks and unusual items
- No specific full-year revenue or earnings guidance is provided. Management expected full-year SG&A as a percentage of sales to be closer to 2010 levels and the 2011 effective tax rate to be significantly below 2010’s 35.9%. Management noted that second-quarter SG&A ratios are typically elevated due to seasonality.
- Management expected to complete a syndicated credit facility in Q3 2011 and stated that available cash, internal funds and credit were expected to cover liquidity needs for at least 12 months. Estimated remaining 2011 capital expenditures were $40–45 million.
- After quarter-end, on July 1, Deckers completed its Sanuk acquisition, paying approximately $126.6 million in cash, subject to adjustments, plus contingent consideration over five years. Some future participation payments have no stated maximum. Sanuk’s results are not included in this quarter’s statements; acquisition valuation and pro forma financial information were not available.
- Sheepskin supply and pricing are significant risks. A pre-existing purchase arrangement could require an approximately $23 million refundable deposit; a subsequent agreement includes a $20 million advance deposit against a roughly $40 million minimum commitment. The company expected factory purchases to satisfy the commitments.
- The IRS proposed transfer-pricing adjustments asserting about $55 million of additional taxable income and approximately $27 million in federal taxes and penalties, excluding interest. Deckers disagreed and intended to appeal if unresolved. The timing and financial impact were uncertain.
- Other disclosed risks include dependence on a limited number of contract factories and sheepskin sources, foreign-exchange exposure, consumer demand and fashion trends, and customer and financial-market risks. Management did not expect routine legal matters in aggregate to have a material adverse effect. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether second-half seasonal sales and margins recover sufficiently to offset the first-half decline in operating income and earnings.
- Inventory sell-through, inventory write-downs, and cash conversion given the substantial inventory build and negative operating cash flow.
- Sanuk’s final purchase accounting, contingent consideration, integration costs and contribution to results.
- Outcome and potential cash or earnings impact of the IRS transfer-pricing examination.
- Completion and terms of the planned syndicated credit facility, and cash requirements for capital expenditures and sheepskin deposits.