Deckers June 30 Quarter and Some Perspective on Sanuk

It wasn’t a great quarter for Deckers, the owner of UGG and Teva as well as Sanuk, though let me start out by reminding you that seasonality means this is always Deckers’ worst quarter.

Sales rose 1.1% from $211.5 to $213.8 million. The gross profit margin fell slightly from 41% to 40.5%. SG&A expenses rose steeply from $37.3 to $47.3 million. The operating loss jumped 26% from $50.5 to $63.7 million.

The net loss also rose from $37.1 to $47.3 million, or by 27.5%. It’s less than the operating loss due to tax benefits of $13.7 million in last year’s quarter and $17.4 million in this year’s.

Sanuk, we find further on, had wholesale revenues for the quarter of $28.5 million, down 11.6% from $32.3 million in last year’s quarter. Operating income on that wholesale business fell 22.6% from $6.9 to $5.3 million.

Sanuk’s total revenue for the quarter was $33.4 million, down 7% from last year’s quarter. Direct to consumer, which includes stores and online, rose from $3.65 to $4.94 million.

For some perspective, let me remind you that Deckers bought Sanuk in the third quarter of 2011. The purchase price was something like $120 million, though the final purchase price won’t be known until the last payment is made after this year. The first June 30 quarter in which Deckers owned Sanuk was in 2012. In that quarter, Sanuk’s total revenues were reported to be $28 million. Its wholesale revenue was $26.7 million and the operating income on wholesale $3.03 million.

Just looking at the June 30, 2012 and 2015 quarters, which may or may not be a fair thing to do, Sanuk’s total revenues have risen 19.3% in three years. Wholesale revenue is up from $26.7 to $28.5 million, or by just 6.74% over those same three years. Operating income on that whole sale business has done better, rising from $3.0 to $5.3 million, or 77%.

They didn’t achieve the operating income increase based on the sales increase. I suspect expense sharing after the acquisition (accounting systems, warehousing, sourcing, etc.) explains a bunch of it. I also wouldn’t be surprised if they saved some salary dollars when they didn’t retain the team that built the brand. File that one under penny wise and pound foolish.

Well, look, pretty clearly Deckers didn’t pay $120 million (or whatever the number turns out to be when the earn out is completed) expecting this kind of performance. What happened?

As I’ve written since the acquisition, Deckers’ management made some comments in their filings and conference calls that suggest they didn’t quite know what they’d bought or what the “secret sauce” was. If they had, or if they’d at least known they didn’t know, they would have kept the management team intact and provided financial and back office support. I’m pretty sure they’d be looking at a way better result if they done that. It’s not an uncommon approach in the industry.

But let’s dig a little deeper here. Here’s how Deckers describes Sanuk in their 10Q: “Innovative action sport footwear brand rooted in the surf community.” Certainly that was a solid description at the time of the acquisition. But anybody who tries to grow an activity based action sports brand knows it gets harder the further you get from your core distribution. Once you get into that wider distribution, if I can quote myself, “They may know your brand, but they don’t know your story.”

In the Sanuk Brand Overview, Deckers goes on to say,

“The Sanuk brand was founded 17 years ago, and from its origins in the Southern California surf culture, has grown into a global brand with an expanding fan base and growing presence in the relaxed casual shoe and sandal categories. The Sanuk brand’s use of unexpected materials and unconventional constructions combined with its fun and funky branding has contributed to the brand’s identity and growth since its inception….We believe that the Sanuk brand provides substantial growth opportunities, especially within the casual sneaker markets, supporting our strategic initiatives spanning new product launches, Omni-Channel development and global expansion. However, we cannot assure investors that our efforts to grow the brand will be successful.”

I think the brand has/had that opportunity as well. And while a 10Q has an awfully big legal component, the last sentence suggests some ambivalence about the brand’s potential from management at this point in time. The sentence isn’t new, by the way.

Now, let’s move on to what Deckers CEO Angel Martinez says about the brand in the conference call.

“Sanuk sales were down 7% in constant currency. These results were in large part due to industry headwinds in the core action sports specialty channel. While we’re not pleased with these results, the brand performed well at its national accounts, which includes an expanded door count of department stores and footwear retailers. Our focus has been on growing our national accounts business to bring more diverse consumers into the franchise.”

Dave Powers, the President of Deckers Brands, second this.

“For Sanuk, their penetration of national retailers like Tilly’s, Journey’s and Dillard’s is providing a great foundation for sustainable growth.”

But CFO Tom George tells us that, “Sanuk was below last year and lower than expected due to industry headwinds in the core action sport specialty channel…” I would so love to have him explain in some detail “industry headwinds.” Is he saying that the whole decline was in the “core” space?

I’ll stop quoting soon, but here’s one more short one from the 10Q. “Wholesale net sales of our Sanuk brand on a reported and constant currency basis decreased primarily due to a decrease in the volume of pairs sold. For Sanuk wholesale net sales, the decrease in the volume of pairs sold had an impact of approximately $3,000.”

We are, as they say, where the rubber hits the road. If you can keep the core and expand your distribution, you’re Vans. If you lose the core as you expand distribution you’re OP or Airwalk or some other more current examples. Tilly’s, Journey’s and Dillard’s are not a foundation for sustainable, long term growth on their own. They will not make the brand credible with the target customers. Especially for an activity based brand like Sanuk, there’s an intricate dance that has to be performed in deciding what product should be sold where.

The “core” may seem like small dollars for a public company, but it’s still important to the brand’s credibility and future. Deckers need dancing lessons for Sanuk.