While Deckers reported strong top-line growth in Q2 and impressed Wall Street with better than expected results, lower gross margins caused a considerable decline in operating margins for the period. Overall sales growth was driven by across-the-board gains in consumer direct sales through Deckers on-line stores and Uggs growing owned-retail network. Considerable gains in international sales for both Teva and Ugg contributed to the higher sales. This was partially offset by declines in Simple and lower-than-expected sales of Teva product domestically. Gross margins declined due to an increase in sales to international distributors, which carry a lower margin. SG&A dollar amount increased as a result of increased personnel, marketing, and stock compensation costs, but was down as a percentage of sales.
Deckers management pointed out that the majority of their SG&A expenses are distributed evenly throughout the year and they expect better leverage against this expense in Q3 and Q4. Operating margin for the second quarter of 2007 was 5.7% of net sales compared to 9.6% last year. On the balance sheet, overall inventories increased to $66.3 million versus $45.2 million at June 30, 2006.
UGG sales increased 65% to $26.3 million compared to $15.9 million last year. Sales were driven by strong sell-through of Uggs spring line, primarily sandals, which resulted in a strong re-order business. Deckers CEO Angel Martinez pointed out that Ugg saw a “meaningful increase” in Q2 scheduled deliveries versus the same period last year when UGG's performance was largely driven by reorder business. He said this indicates, “growing confidence in the spring line, as well as consumer acceptance of UGG as a year-round brand.” The brand also benefited from early delivery of fall product at the end of Q2. Internationally, Ugg sales were strongest in its key markets – the U.K. and Canada. Management said that they are “very pleased” with new distributors' efforts to properly market and position the brand. Early shipments of fall product also increased international sales.
UGG inventories increased to $51.9 million compared to $32.2 million last year due to the earlier arrival of fall '07 inventory in anticipation of increased sales in the third quarter. Last year, Ugg was unable to deliver some fall product because of higher than expected re-orders.
Teva is still in the midst of a multi-year repositioning effort in the U.S. Managements goal for 2007 was to stop Tevas sales decline and they seem to have accomplished that with an 11.6% increase in sales in the first quarter and a 5.6% increase in this quarter. More than 70% of the spring 2007 line was made up of new styles, many of which are selling at higher price points than previously achieved by the brand. Management said that sales would have been higher in Q2 without a “six week hit” from unfavorable weather. Management is optimistic about Teva going forward for a number of reasons including one of the brand's key retailers recently committing to a much broader assortment and additional doors for next year after pre-lining the Spring 08 line and the brand just having opened Bass Pro Shops for next year.
Teva inventories increased to $11.1 million at June 30, 2007, compared to $7.2 million a year ago due to the lower than expected spring sales. The bulk of the inventory is from the spring line due to the lower than expected sales in the United States.
Simple was negatively impacted by timing shifts in Q2 and Q3 shipments. Net sales declined approximately 21% due to a lack of reorders caused by delayed industry-wide selling season and a shift in international shipments to the third quarter.
Management said that Simple saw “solid sell-through” during the quarter, but retailers wanted to exit June with clean inventory levels and were very cautious with reorders. In spite of this overall decline, Simple's second quarter consumer direct business was up 54% over the previous year. Simple inventories decreased to $3.2 million at quarter-end compared to $5.8 million at the same time last year.
The Consumer Direct business for all brands, including e-commerce and owned retail, posted a 54% top line gain in the second quarter with owned-retail stores, particularly the UGG flagship store in New York, showing the strongest results. Deckers will be opening three new owned-retail locations in the back half of the year.
Total international sales doubled during the quarter due to increases in both Ugg and Teva sales. Results were strongest in the U.K., Canada, Benelux and Singapore.
Net income and diluted EPS were down for the quarter due to the lower gross margins and operating margins as well as seasonally low leverage on SG&A expenses.
Based on the Q2 results, DECK raised its FY 2007 guidance and now expects revenues to increase approximately 35%, up from previous guidance of approximately 25% growth. Diluted earnings per share are expected to increase approximately 25% for the year over 2006, up from previous guidance of 15% growth.
