Nobody Wants to Talk About Sanuk, But Deckers Has an Outstanding Quarter

That’s not quite true.  I want to talk about Sanuk, though probably for the last time.  There’s not a mention of the once high-flying brand in the conference call, and it only comes up in the 10-Q because, inconveniently I imagine, they have to acknowledge its existence.

For the quarter ended September Sanuk revenue was down 9.4% ($1.43 million) from $15.22 million in last year’s quarter to $13.80 in this year’s.  The Sanuk wholesale business had an operating profit of $291,000 down from $1.23 million in last year’s quarter, a drop of 76.3%.  Add any reasonable allocation of overhead, taxes, interest and the brand lost money during the quarter.

Here’s their comment on the Sanuk wholesale business from the 10-Q:

“Wholesale net sales of our Sanuk brand decreased due to a lower WASPP [weighted average selling price per pair], primarily driven by lower performance in the domestic surf specialty channel, partially offset by a higher volume of pairs sold driven by higher closeouts.”

Sounds like they are continuing to lose traction in the surf specialty channel- the one place they have to get traction for the brand to regain credibility- and are trying to make up for it by selling more pairs at closeout.  I’d be okay with the revenue decline if it was in the closeout business.

When Deckers finally changed Sanuk’s management and rationalized its structure, I thought and hoped that they might be able to resurrect the brand.  Now, I’m concerned that it’s all over but the shouting.  The shouting may occur among the management team and at the board level when they realize just how little they can sell this brand for compared to what they paid for it.  That will be tempered by the fact that they’ve completely written it off and that the responsible management team has moved on.

Deckers is hardly the only company in our industry that’s bought a brand they didn’t really understand, paid too much for it, expected too much out of it, then sidelined the people who’d made it successful because they didn’t know what didn’t know.  The unknown unknowns will get you every time.  If you’re looking at an acquisition, don’t do that.

Meanwhile, Deckers blew the barn doors off (wonder where that expression came from) reporting net income in the September 30 quarter that rose 50.1% from $49.6 million in last year’s quarter to $74.4 million in this year’s.  They did it while increasing revenue only 4%.

They grew their gross profit margin from 46.7% to 50.2% while reducing SG&A as a percent of revenue from 32.7% to 32.2%.  The improvement in gross profit “…was due to lower air-freight costs for our domestic wholesale business, higher full-priced selling in our wholesale channel, lower input costs as we execute our supply chain initiatives as part of our operating profit improvement plan, and favorable foreign currency exchange rate fluctuations.”

Nothing below operating income changed dramatically, so basically, they accomplished this improvement by operating better.

On the balance sheet, I’d highlight a 7.3% year over year reduction in inventory even as sales rose.  Stockholders’ equity fell 12.6% from $969 to $847 million, though the balance sheet remains solid.  Net cash used in operations for the six months ended September was $161 million.

To focus on one of my pet peeves for a moment, they almost trumpet $125 million in stock they bought back during the quarter, “…which also aided in the upside to earnings per share.”

I understand the math and yes, it’s true that if you have fewer shares to spread your earnings over, the earnings per share rise.  But it has nothing to do with how well you ran your business- for any company buying back its stock.  Another way to put it might be, “We couldn’t think of a way to invest this money in our business that would give us a better return than buying our stock.”  I wonder what would happen to stock buy backs if you could earn 6% in a money market account again.  Maybe we’ll find out.

I once characterized “omnichannel” as the term many legacy brick and mortar retailers were using to sound authoritative as they tried to figure out what the hell to do in the new retail environment.  I’m about ready to add Deckers to a short list of companies that are actively figuring it out.  Let’s look at the things Deckers is doing.

Quarter over quarter, their HOKA brand is up 28.4% from $40.6 to $52.1 million.  “Wholesale net sales of our HOKA brand increased due to a higher volume of pairs sold driven by its continued global growth, primarily in the US and Europe, as well as additional sales generated by updates to key franchises, as well as a higher WASPP driven by product mix and higher full-priced selling.”  In the conference call CEO Dave Powers describes the HOKA success this way:

“…we are growing the HOKA brand through a strategy centered on focused and disciplined growth. All the product and distribution decisions are being made to increase brand awareness, drive brand heat and create long-lasting relationships with our consumers, all with an eye on product quality and performance. This is driving strong full-price selling and increased e-commerce penetration, as well as providing the brand a long runway for future growth.”

The UGG brand’s total revenue fell slightly from $400.2 million in last year’s quarter to $396.3 million in this year’s.  That was purposeful.  CEO Powers says in the conference call, “…UGG is implementing a classic allocation and product segmentation strategy in the U.S. for the fall season. While this impacted a portion of the sell-in this quarter, we believe this change in distribution strategy has the ability to drive a pull model, leading to better sell-through and less promotional activity in the brand’s largest market.”

Further comments from Dave Powers on UGG:

“And as demand continue to strengthen [He’s referring to a specific product] we quickly allocated incremental marketing dollars to fuel the momentum.”

“The swift action by the UGG team to capitalize on the successful product launch shows the changes we’re making to the business are allowing us to be more nimble, leverage our omni-channel capabilities, and quickly react to consumer interest.”

This all sounds very responsive to the competitive environment and the requirements of consumers as I’m starting to understand it.

During the quarter, Deckers’ direct to consumer business rose 2.8% from $91.3 to $93.9 million.  They ended the quarter with 154 retail stores worldwide, “…which includes 88 concept stores and 66 outlet stores. During the six months ended September 30, 2018, we opened one concept store, closed one outlet store, and closed 11 concept stores…”  The company has closed 43 retail stores during the fiscal year as of September 30.

Talking about the brick and mortar strategy, CFO Steve Fasching says in the conference call, “As we’re getting further along in the process and of the cost savings initiatives, we’re finding that there is some improvement in some of these stores. And we’re basically looking at store level evaluating them if they can get above the internal threshold for four wall profitability, which we’ve set at about 20%. We’re going to put those on the re-evaluation list versus closure list.”

What I’d like is some information on exactly how their brick and mortar strategy dovetails with their overall omnichannel strategy.  There’s got to be more to it than closing stores that don’t meet a specified level of profitability.  This is critical in realizing a true omnichannel strategy.  How are they sizing, locating, staffing and inventorying their stores given omnichannel realities?

Deckers notes in the 10-Q that “A significant part of the Company’s business is seasonal, requiring it to build inventory levels during certain quarters in its fiscal year to support higher selling seasons, which contributes to the variation in its results from quarter to quarter.”

That’s not new and it’s true for most companies, but it’s changing as Deckers acknowledges.  Go reread the factors that improved their gross profit margin.  The conference call acknowledges improving their logistics and supply chain.  CEO Powers notes in the conference call, “…  the first thing we’ve been focused on the last couple of years is just better visibility across the organization and holding the teams and ourselves accountable for top and bottom line. We’ve also spent a lot of time on the supply chain process and pre-season planning so that we are efficient how we bring and when we bring product into the DC and to the consumer.”

“…I really think the planning teams and the work that they’ve been with the factories and flowing product differently has and will have a big impact on that going forward, continuity planning, level loading at the factories and just-in-time inventory into the DCs.”

If you look at Deckers’ restructuring programs and their discussions in public information, it seems like they’ve developed a sense of urgency and a point of view about how to be a brand and a retailer.  Their focus on logistics, the supply chain, reacting quickly, managed distribution, putting more marketing money into products that are working, and a financial model that, at least in this quarter, gave them a big bottom line with not much increase in revenue suggests a company in touch with reality.

It’s important, however, that you not think of each of those areas of focus as standing alone.  The secret sauce for all of us is how we change our organizations to take advantage of the synergies of interconnection through employees who have been given some flexibility and have internalized an organization’s more organic way of functioning.