A Discussion of Retail Prompted by Deckers’ 10-K

When I report on a public company’s results, it’s always important to review the numbers. But the more I do that the more I realize my focus needs to be on how companies are trying to transition to the new retail environment in circumstances of high uncertainty. That is, they must transition to something they can’t solidly identify yet. That’s awkward.

Deckers ended their March 31st fiscal year with 160 retail stores worldwide. 96 of them were what they call concept stores and the remainder outlet stores. “During fiscal year 2017,” they report in the 10-K, “we opened 17 new stores, reclassified 12 European concession stores as owned stores, converted two owned stores to partner retail stores, and closed 20 stores.” Over the next two years, we learn in the conference call from President Dave Powers, “In regards to our global retail fleet, as we look out over next two years, we are planning to reduce our global company own brick-and-mortar footprint back 30 to 40 stores.”

So, opening, closing, and reclassifying. Keep that in mind.

Meanwhile, one of their risk factors- and it’s the first time I recall seeing one stated quite like this for any company- is, “It may be difficult to identify new retail store locations that meet our requirements, and any new retail stores may not realize returns on our investments.”

What’s wrong with this picture? Nothing if you have the correct perspective. Einstein taught us that motion was relative to the position of the observer. To my mind, this risk factor is only a “risk factor” if you’re observing the retail environment from the same old perspective.

That is, if you still believe that retail success is a function of the number of stores you open, you see this as a risk. Can anybody think of a huge retailer that’s getting along okay without a lot of stores (so far)?

Time for a quick look at Deckers’ number for the year and quarter ended March 31, 2017. During the quarter, sales fell 2.4% from $378.6 million in last year’s quarter to $369.5 million in this year’s. The reported loss for the quarter fell from $23.7 million to $15.7 million.

For the whole year, revenue fell 4.5% from $1.875 to $1.790 billion. Gross profit fell by 1.4% despite a gross margin increase from 45.2% to 46.7%. Pretax income plummeted from a profit of $156.9 million last year to a loss of $7 million this year. Net income fell from $122.3 to $5.7 million.

I also want you to focus on the fact that wholesale revenue for UGG, Teva and Sanuk all declined. Direct to consumer business, “…increased 3.4% to $666,340 primarily due to an increase in net sales from our E-Commerce business of approximately $29,200, offset by a decrease in net sales from our retail store business of approximately $7,200.”

The only revenue growth they got for the year was from e-commerce and their “other” brands.

The stock closed at $56.57 the day they released their earnings on May 25 (earnings were released after the close) but as I write this on June 6, it’s at $71.13, up 25.7% in 7 trading days. Apparently, investors think there’s something positive going on here.

There is. A few things actually. Least important to me is that during the year, as I’ve already reported in my review of their quarters, Deckers took a $118 million non-cash impairment against Sanuk. It’s part of their SG&A expense for the year. You need to look at the swing in pretax earnings with that in mind.

Second, Deckers took $29.1 million in charges for a restructuring program during the year. That plan “…included a retail store fleet optimization and office consolidations, including the closure of facilities and relocation of employees to realign our brands across our Fashion Lifestyle and Performance Lifestyle groups. This restructuring plan is intended to streamline brand operations, reduce overhead costs, create operating efficiencies and improve collaboration.”

Accrual for that restructuring, which apparently people thought was a good idea, is mostly complete. As in, no more income statement hits. If you think is appropriate to add those two items back in, you might conclude the results weren’t bad as reported and that expected results going forward would improve.

Deckers also announced a Review of Strategic Alternatives in April. “…our Board of Directors has initiated a process to review a broad range of strategic alternatives. This review process includes an exploration and evaluation of strategic alternatives to enhance stockholder value, which may include a sale or other transaction.”

Notice there’s no guarantee there will be any transaction at all, and “a sale” could mean the sale of a brand rather than the whole company. But announcements like that tend to generate some excitement in a company’s stock.

If you look at Deckers’ revenue sources, you will note that 81% ($1.45 billion) come from the UGG brand. Teva’s revenue for the year fell from $133 to $118 million. Sanuk declined from $106 to $92 million, continuing its implosion. Their “other” brands (Hoka, Koolaburra, Ahnu) rose from $112 to $130 million. Ahnu was discontinued during the year.

If I were on Deckers’ board of directors, I might ask, “Hey, why are we screwing around with any of these brands that aren’t named UGG?”

It seems to me that Deckers might own four brands that would be better off owned by a private company. You know- my usual argument that there’s a conflict between being public and building a niche brand.

I think I can suggest some people who might be interested in Sanuk- though not at near the price Sanuk paid them for it. I got to believe that Sanuk has left a bad taste in Deckers’ mouth. They expect its revenue to be down five to ten percent this year.

Deckers’ retail stores “…are predominantly UGG brand concept and outlet stores.” In talking about U.S. distribution, they say, “…our sales force is generally separated by brand, as each brand generally has certain specialty consumers. However, there is some overlap between the sales teams and customers, and we are aligning our brands’ sales forces to position them for the future of the brands.”

Understandably, Deckers’ focus is on UGG. I get this sense that the smaller brands are something of a pain in the ass and distraction.

To try and pull this together, let’s start with the observation that Deckers is closing and opening stores all at the same time. They feel a need to warn us that it’s hard to find new locations and they may not work out as well as they have in the past. That’s a risk factor? The bigger risk would be if they didn’t know that!

The question Deckers, and all of us, are asking ourselves is what is the connection between brick and mortar stores and e-commerce? How many stores (and where and in what configuration) do you need to maximize revenue? If you can get by with fewer brick and mortar stores, you’ll be doing great. What stores and where can you close but not give up revenue? If you give up some revenue but reduce the brick and mortar related expenses, thereby boosting the bottom line, won’t you be better off?

You can’t just ask any more if a store will be profitable. You have to ask what the impact of opening (or closing) it is on overall direct to consumer revenues.

What’s the relationship between brand strength and the number and location of stores in the days of e-commerce? Retailers have become brands (especially when you’re a retailer like Deckers and its stores are branded UGG). Are you better off with fewer stores to create some perceived scarcity? I’m not sure what scarcity means when online is at our fingertips. Deckers plans to have an “…optimized company-owned fleet of approximately 125 stores globally.” by fiscal year 2020.

Deckers has four strategic priorities; “…developing compelling product, focusing on digital, optimizing distribution, and implementing cost savings.” Let’s spend a moment on optimizing distribution.

Deckers has closed about 400 accounts in North America. We can assume that has something to do with the decline in their wholesale business. “Over time,” they “…will be closing more smaller accounts.”

It was a long time ago we first discussed that with growth, the percentage increase in revenue and profit you can get from smaller accounts inevitably declines and they become less important to the overall business. That fact, and their distribution strategy, makes it seem even more likely to me that some of their smaller brands, especially Sanuk, might be sold. If you aren’t really interested in the kinds of stores where Sanuk has its roots and is most likely to be successful, why own it?

President Powers says, “I think that we have landed on a nice stabilization of core accounts that are driving the majority of the volume.” They are investing, he says later, “…in the long-term health of the UGG brand.” Doesn’t mention investing in any of the other brands.

Dave does not mean “core” the way we who have been in the industry a long, long time mean it.

Deckers’ wholesale business will be focused on larger accounts that they believe can represent the brands (mostly UGG) best. Their declining number of stores will be mostly concept stores (there are still some outlets- don’t know how many) that will support the brand positioning. My sense is that they expect a lot of e-commerce growth. Given this focus, I expect at least the sale of one or more of their smaller brands.

They are taken, or have taking, the requisite steps everybody else has taken to reduce expenses and optimize their organization.

Given their brand and distribution strategy and the acknowledgement that some scarcity is a good thing, one wonders if Deckers, even if reduced to just the UGG brand, should be public.
We’ve got a stock that may have popped because of the restructuring or the possibilities inherent in a strategic review (probably the later). What I hoped made it pop, however, is a recognition that Deckers seems to be acknowledging that it’s time to look at brick and mortar in a different way. It’s time for the tail to start wagging the dog.