DECK

Business Context and Reporting Period

Company: Deckers Outdoor Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 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 footwear), and Simple (casual athletic footwear). The company sells through wholesale channels and its own Internet/catalog retailing business. Operations are 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 Growth: Net sales increased 24.0% in Q3 and 23.6% for the nine-month period compared to the prior year. This was driven primarily by a 57.3% increase in UGG wholesale sales ($55.5M in Q3) and a 84.7% increase for the nine months.
• Profitability: Net income rose 40.0% in Q3 and 21.3% for the nine months. Operating income increased 49.8% in Q3 due to higher gross profit and SG&A expenses decreasing as a percentage of sales (21.8% vs 23.1% in Q3).
• Segment Performance:
  • UGG: Significant growth due to improved inventory availability, timely deliveries, and the launch of the new Fashion Collection.
  • Teva: Wholesale sales declined 21.0% in Q3 and 3.7% for the nine months due to an unseasonably cold spring, increased competition, and a lack of product innovation.
  • Simple: Wholesale sales declined 56.7% in Q3 following the discontinuation of the Simple Sheep program.
  • Internet/Catalog: Sales decreased 37.7% in Q3 as improved wholesale availability reduced the need for direct-to-consumer purchases.
• Liquidity and Inventory: Inventories surged 120.6% to $66.8M (from $30.3M at year-end 2004), primarily due to a $43.1M increase in UGG inventory to meet Fall/Winter demand. Operating cash flow turned negative ($17.7M used) for the nine months due to this inventory build-up and increased receivables.

Guidance, Outlook, and Risks

• Outlook: Management expects UGG inventory levels to decrease substantially by year-end 2005. They anticipate improved cash flow for the remainder of 2005 and early 2006 as inventory builds are expected to occur later in 2006 due to improved supply chain confidence.
• Teva Strategy: The company is dedicating greater resources to product development and marketing for Teva, anticipating continued challenges in 2006 with a return to growth expected in Spring 2007.
• Key Risks:
  • Supply Chain: Dependence on four suppliers for top-quality sheepskin; risks of shortages, price increases, or disease (hoof and mouth) affecting supply.
  • Seasonality: Significant fluctuations in working capital requirements based on seasonal sales cycles.
  • Intellectual Property: Ongoing disputes regarding counterfeit products and unauthorized trademark use globally.
  • Foreign Currency: Potential impact of the Chinese currency revaluation (July 2005) on manufacturing costs, though transactions are currently denominated in USD.
  • Accounting Changes: Adoption of SFAS No. 123R (Share-Based Payment) effective Jan 1, 2006, which will require fair value recognition of stock options, potentially reducing reported net income.

Investor Verification Checklist

• Inventory Turnover: Verify the ability to sell the significant UGG inventory build-up ($43M increase) without excessive markdowns or write-downs in Q4.
• Teva Recovery: Monitor Q4 and Q1 2006 sales data to confirm if the new product development and marketing initiatives are reversing the Teva sales decline.
• Cash Flow: Track operating cash flow in Q4 to ensure the inventory build-up does not lead to sustained negative cash flow or increased reliance on the credit facility.
• Sheepskin Supply: Assess any announcements regarding raw material costs or supply constraints for the UGG brand.
• Effective Tax Rate: Monitor the impact of potential foreign earnings repatriation under the American Jobs Creation Act on the Q4 effective tax rate.