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Crocs, Inc. (NASDAQ:CROX)

Q3 2008 Earnings Call

November 12, 2008 4:30 pm ET

Executives

Ronald R. Snyder - President, Chief Executive Officer, Director

Russell C. Hammer - Chief Financial Officer, Senior Vice President - Finance, Treasurer

John P. McCarvel - Chief Operating Officer, Executive Vice President

Analysts

Jeff Klinefelter - Piper Jaffray

Jim Duffy - Thomas Weisel Partners

Reid Anderson - B.A. Davidson

Mitch Kummetz - Robert W. Baird

Sam Poser - Sterne, Agee & Leach

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Crocs Incorporated fiscal 2008 third quarter earnings call. (Operator Instructions)

Before we begin, I would also like to remind everyone of the company’s Safe Harbor language. Please note that some of the information provided in this call will be forward-looking statements within the meaning of Securities laws. These statements concern plans, beliefs, forecasts, guidance, projections, expectations, and estimates for future operations. The company cautions you that a number of risks and uncertainties could cause Crocs' actual results to differ materially from those described on this call, including the retail environment and global economic condition. Crocs has explained some of those risks and uncertainties in the risk factor section of the annual report on Form 10-K and its other documents filed with the SEC and you are encouraged to read that section and all other disclosures appearing on our filings with the SEC.

Crocs intends that all of its forward-looking statements in this call will be protected by the Safe Harbor provisions of the Securities Exchange Act of 1934. Crocs is not obliged to update its forward-looking statements to reflect the impact of future events.

I would now like to turn the conference over to the President and Chief Executive Officer, Ron Snyder. Please go ahead, sir.

Ronald R. Snyder

Thank you. Good afternoon and thank you for standing by. With me on the call today is Russ Hammer, our Chief Financial Officer; and John McCarvel, our Chief Operating Officer.

2008 has obviously been a very tough year as we deal with one of the most challenging global economic and retail environments in some time. As a result, after multiple years of triple digit revenue growth and achieving approximately $850 million in sales in 2007, we have experienced a slow-down in demand for our products in certain regions. Therefore, as the business matures to more normalized levels, we are making strategic adjustments in order to right-size our operations and cost structure to better align with lower projected sales volumes. This includes the restructuring program and additional cost-cutting actions we announced earlier today.

While the impact to our third quarter results was significant, these are primarily non-cash, one-time charges and we believe these actions are in the best interests of the long-term success of the company, our brand, and ultimately our shareholders. To review, we have taken the following cost actions during Q3, resulting in $104 million pretax charge, which we expect will result in annual P&L savings beginning in 2009 of approximately $10 million to $15 million.

We recorded approximately $70 million in inventory write-down, recorded a non-cash goodwill impairment charge of $22.8 million, recorded an $8 million non-cash asset impairment charge on certain toolings, molding, and machinery, completed the shut-down of Canadian manufacturing and compounding operations resulting in a $2.5 million charge in Q3, and initiated closing of our company-owned manufacturing facility in Brazil, which is expected to result in a $1.2 million restructuring charge in Q4.

During the third quarter, we also completed global work force reductions which we expect will result in approximately $11 million in savings in 2009. Some of the cost actions we have taken year-to-date, which we believe will have a positive impact during 2009, include reducing our 2008 capital expenditures by 38% against plan, from $126.6 million to an estimated $78 million; reduced global operations employee count by approximately 2,100 from Q307; completed the shut-down of Canadian manufacturing and compounding operations, resulting in a $21.1 million charge through the first nine months of 2008.

The $70 million inventory write-down is primarily related to certain products that we have discontinued, including core products in colors that we now believe would be difficult to sell at full price. Therefore we have written this portion of our inventory down to reflect a more appropriate value and we are in the process of selling it through select channels and in certain markets throughout the world, where we believe it will not impact our full price business or damage our brand equity. We believe the strategic decision to reduce our operating platform will further improve the long-term health of our balance sheet and allow us to focus more on the resources -- more of our resources on the evolving needs of our business.

I will now turn the call over to Russ to review the financials.

Russell C. Hammer

Thanks, Ron. Good afternoon to each of you and thank you for joining us. I will provide specific detail on our financial results, the impacts of our one-time charges, cost actions, and certain near-term inefficiencies we will incur in Q4 of this year.

First for sales, our total sales for the third quarter were $174.2 million, compared to $256.3 million a year ago, which was below our forecasted range of $195 million to $205 million. We booked $32.7 million in returns and allowances in Q3 2008, an increase of 240% over Q3 2007 returns and allowances of $9.6 million. This was primarily due to a channel inventory rebalancing strategy we enacted in Q3 in order to better position our key customers with the right inventory mix going into the fall and holiday season.

For the quarter, revenues outside the U.S. were $104.7 million, or 60% of our total sales, versus $130.9 million last year. By region, age of sales were $61.4 million, Europe was $29 million, Canada and Mexico were $7 million, and the balance of the $7.3 million was from other international locations. Asia results were up 14% from Q3 2007, primarily driven by growth in new markets and retail. Some of the strongest performing markets were Japan, China, the Middle East, and Korea.

Europe sales were down 50% from Q3 2007. We believe Europe was negatively impacted by bad weather in our prime selling season, negative PR, and a deteriorating retail environment and the increased presence of knock-off and counterfeit product. Domestic sales were $69.5 million, down 45% from Q3 2007, representing approximately 40% of our global business. Due to the weakening retail environment, many of our wholesale accounts continue to be very cautious with their orders, choosing to work down existing inventory to much leaner levels. That said, we are seeing some positive sell-through data from several accounts indicating consumer demand for our products in select regions and channels.

Footwear sales accounted for approximately 91% of revenue and represented 8.1 million units for an average selling price of $19.33. Core products represented 54% of our unit sales. Sales of our classics represented 21% of footwear sales. Sales at full retail price at our Internet sites and company-owned retail stores grew to 28% of our total sales, driving our average selling price higher.

Gross profit for the third quarter of fiscal 2008 was $2.4 million, or 1.4% of revenue, compared to $155.4 million, or 60.6% of revenue in the third quarter of 2007. Inventory write-downs contributed to $70 million of the decrease in gross profit for the third quarter of 2008. While we have removed significant costs from manufacturing and distribution cost structure, we again experienced deleverage during the third quarter, primarily due to the lower-than-expected sales and higher-than-expected seasonal returns.

Q3 SG&A expenses were $104.4 million versus $77.2 million in the corresponding period last year. The effects of realized and unrealized losses related to the changes in foreign currency exchange rates included in SG&A during the third quarter of 2008 were $14.6 million, compared to a foreign currency exchange rate gain of $3.6 million included in SG&A for Q3 2007. The increase in SG&A was primarily driven by operating costs related to our increased number of retail stores, IP litigation, marketing spend, and severance costs associated with personnel reductions.

Including the restructuring charges, we reported a net loss of $148 million, or $1.79 EPS per diluted share in the third quarter of 2008, compared to net income of $56.5 million or $0.66 per diluted share in the third quarter of 2007. This was below our guidance range of diluted earnings per share between $0.01 and $0.05 due to the lower sales volumes, one-time charges, and higher-than-expected costs. The one-time charges included the restructuring, asset impairment, and inventory contributed $104.1 million, or $1.26 per diluted share to our net loss. More specifically, our quarterly operating margin included $14.6 million in FX loss and $19.5 million net impact of our returns rebalancing activities. These items and charges when aggregated contributed $138.2 million to our loss before income taxes in the third quarter of 2008.

Now turning to the balance sheet, we continued our strong balance sheet management. Our inventories decreased 36% to $141 million at September 30, 2008, from $220 million as of June 30, 2008. We also continued to pay down our outstanding borrowings. We ended the third quarter with approximately $19.8 million in outstanding borrowings, a 46% decrease from the approximate $37 million outstanding borrowings as of June 30, 2008 and an approximate 54% decrease from Q1 2008 borrowing levels of $42.8 million.

As of September 30, 2008, we had $56.6 million in cash and cash equivalents, compared to $36.3 million as of December 31, 2007, an increase of approximately $20.3 million. Our net accounts receivable balance as of September 30, 2008, was $71 million, a decrease of $57.1 million, or 45% since last quarter and a 54% decrease from year-end 2007.

Our DSO improved to 37.5 days from 52.3 days as of June 30, 2008 and 70.9 days as of March 31, 2008.

Our Q3 capital expenditures were approximately $17 million, a slight reduction from our second quarter capital expenditures.

Now for the outlook for the remainder of the year -- based on the uncertain global economic crisis that continues to impact our customers and the consumer, we expect the holiday season to continue to reflect these uncertainties and we are lowering our Q4 guidance. Let me go through the specifics.

We now expect Q4 revenue to be in the range of $100 million to $120 million. We expect Q4 diluted loss per share in the range of $0.50 to $0.65. We are not providing further guidance for 2009 at this time due to the uncertainty in the global economies.

I will now turn the call to John McCarvel, our Chief Operating Officer, for some specifics on our markets and our operational cost reduction activities.

John P. McCarvel

Thanks, Russ. As Ron discussed in our previous earnings call, we have been focused on right-sizing our business to better align with our projected volume. Let me go through some of the specific actions we have taken.

We have been actively executing on our factory capacity rationalization plan. We reduced our global manufacturing capacity to levels in line with today’s business. We realigned our operating resources to a more variable cost model as we enter 2009. We are planning our 2009 production plan to be roughly 85% sub-contracted and 15% internal manufacturing. Internal manufacturing will be defined going forward as our Leone, Mexico facility and a small operation at our design center in Italy.

As part of our green initiative with Soles United, we are starting to build some models with 10% recycled materials.

Throughout 2008, we have aggressively reduced our global distribution platform commensurate with our reduced inventory position and we will continue to consolidate and cut costs in 2009.

Some examples are the reduction in European distribution location will generate significant cost savings in 2009. In the United States, we have consolidated our distribution product return centers in the Denver area. We expect this streamlining of operations will allow us to continue to reduce both fixed and variable costs. And in Asia, we continue to shrink our variable distribution costs as we reduce inventory levels in the region. We believe we are making significant and sustained progress towards creating a leaner, more efficient company for the future.

On a positive note, demand for our new fall ’08 and spring ’09 products continue to generate excitement. Our new product introductions with our major accounts have resulted in strong pre-bookings. In fact, 49% of our new products in Q4 2008 and 43% for Q1 2009, thus indicating the ongoing strong consumer demand for our new products, most notably the new version of Mammoth, the Nadia, and [inaudible] products were primarily pre-book drivers for fall/winter 2008.

While the U.S. and European businesses have been adversely impacted by the ongoing economic challenges, I would like to highlight a few areas of our business where we have seen continued strong growth. In Asia, where business grew by 14% versus the same quarter previous year Q3 2007 and 46% versus previous year year-to-date. Compared to 2007, our global retail business grew by 52% in Q3 and our retail locations grew by 40%, primarily fueled by growth in the Asian markets.

Additional highlights from the past quarter include the introduction of our new product lines for 2009. Our new product lines have been enthusiastically received at major trade shows globally. We are introducing new merchandising systems with major retailers in 2009, coupled with enhanced point of sale displays and channel specific consumer marketing campaigns. Today, Crocs has a built strong broad lifestyle brand and markets over 150 unique models. According to NPD for the 12 months ending August 2008, Crocs is the number one casual brand in the athletic specialty sporting goods channel for men, women, and children.

Our global rollout of Crocs retail stores continued in the third quarter as we further concentrate our resources on locations that we can merchandise a larger assortment of footwear and showcase the diversity of our business. We recently opened stores in Toronto, Montreal, Manchester, England, Helsinki, Moscow, Chicago, Waikiki and Portland. We also opened outlet stores in St. Augustine, North Carolina, Chicago, Atlanta, Toronto, and Cleveland. Today we currently have 120 full-priced stores, 121 kiosks, 21 outlet stores, and 180 partner stores worldwide, for a total of 442 Crocs retail locations.

On the brand-building front, we are committed to growing, increasing, and strengthening our brand exposure and brand equity. Crocs has a well-recognized brand name globally. We received tremendous exposure from our advertising campaign during the Beijing Summer Olympics. Our promotions at the 2008 Summer Olympics also provided significant branding opportunities for us in China this summer as well. Crocs remains committed to our soles united program. We have launched the soles united initiative in Asia this past quarter and we are now collecting the used shoes at our retail stores in the region. We donated more than 100,000 pairs in the quarter and more than 1 million pairs in 2008 to those less fortunate around the world.

I will now turn the call back to Ron.

Ronald R. Snyder

As we move towards the end of the year and look out to 2009, our entire team of talented employees around the globe is fully committed to taking the necessary steps to improve the business. Outside of the restructuring initiatives already discussed, we are implementing strategies that we believe will broaden awareness of our entire footwear collection, help drive consumer demand for our innovative and compelling new product offerings, and improve our profitability.

There is much work to be done and while the current macroeconomic environment is creating challenges beyond our control, we continue to be optimistic about the long-term outlook for our company. Meanwhile consumers remain loyal to our brand and products and we are confident that the positive attributes of our proprietary [cross-light] material will allow us to successfully leverage our position into new categories of footwear.

Thank you and I will now turn it over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Jeff Klinefelter with Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

Yes, Russ, a question for you on Q4 -- once you back out the charges to margin and SG&A, can you give us a sense for what would have been your normalized gross margin rate and your SG&A rate against that Q3 revenue?

Russell C. Hammer

You’re asking Q3, Jeff?

Jeff Klinefelter - Piper Jaffray

Yeah, for Q3.

Russell C. Hammer

Yeah, so as I mentioned on the call, if you backed out all the one-time charges, we were just slightly positive on our pretax.

Jeff Klinefelter - Piper Jaffray

Okay, but just for clarity, the gross margin would have been at what rate? I was just trying to figure out if you back off, take the $70 million in write-down and then you also were talking about the FX -- if you back off FX, the write-down, and the impact on gross margins for the return product?

Russell C. Hammer

Jeff, I’ll calculate that and call you back real quick on that.

Jeff Klinefelter - Piper Jaffray

Okay. We can come back to that.

Russell C. Hammer

That’s pretty easy.

Jeff Klinefelter - Piper Jaffray

Okay. The other questions would be on the Q4 guidance, $100 million to $120 million -- can you give us a sense for kind of how that breaks down between U.S., Europe, and Asia? And also just curious -- I think John, you were mentioning the pre-book. Did you say that 50% of that revenue has been pre-booked, or in the new styles pre-book?

John P. McCarvel

Forty-nine percent, Jeff, are for new products in Q4 2008, so of our pre-bookings, 49% are our new products.

Jeff Klinefelter - Piper Jaffray

Okay. What percent of that guidance is actual pre-booked product versus replenishment?

John P. McCarvel

Based on the 100 to 120, about 40%.

Jeff Klinefelter - Piper Jaffray

Okay. Also, just curious on doors at this point -- maybe you’ve been I think attempting to rationalize your door counts over the last quarter or two. Can you give us a sense for how great a reduction you’ve been able to affect there and where you see that in terms of year-end?

John P. McCarvel

We’ve had some door rationalization for some of our under-performing doors. However, we have added some. We added Famous Footwears for our work line and a few other products. They don’t have some of our core products so that’s been a big add. So we’ve added -- we probably dropped 10% or so in the U.S., about the same in Europe and we’ve added a little bit of door, about 1,000 doors in Asia.

Jeff Klinefelter - Piper Jaffray

Okay. One other thing, back to that Q4 top line guidance -- U.S., Europe and Asia, how does it break out generally between the three global regions?

Russell C. Hammer

We’re expecting it’s almost 50%, 50% in Q4 between U.S. and international.

Jeff Klinefelter - Piper Jaffray

Okay, and I would imagine similar trends with Asia and Europe -- Asia growing, Europe still contracting?

Russell C. Hammer

Correct.

Jeff Klinefelter - Piper Jaffray

Okay. Russ, any updates on the receivables, the way you are managing that in terms of the dating? I know you’ve been working on getting the terms down.

Russell C. Hammer

We’ve seen very strong progress in that. As I mentioned, we were up in the 70 DSO days in Q1 and now we are down in the just below 40 or 37. We are just keeping a very tight watch on our credit with our customers during these trying times and we are going to continue that through the fourth quarter.

Jeff Klinefelter - Piper Jaffray

Okay. Great, and then John, you mentioned on manufacturing capacity, you’ll be 80%, 85% sub-contract and that is with no terms whatsoever in terms of guaranteed minimum volumes with those manufacturers?

John P. McCarvel

That’s correct, Jeff.

Jeff Klinefelter - Piper Jaffray

Okay, great. Thanks a lot, guys.

Operator

We’ll take our next question from Jim Duffy with Thomas Weisel.

Jim Duffy - Thomas Weisel Partners

Thanks. Russ, a couple of questions for you -- exclusive of the discontinued expenses, where would you expect the SG&A rate in absolute dollars for the fourth quarter?

Russell C. Hammer

We expect that to be somewhere in the low 90s in the fourth quarter.

Jim Duffy - Thomas Weisel Partners

Okay, and then it would be helpful if you could provide a little bit of clarity on kind of the cash flow and liquidity situation -- exiting the year, what are you expecting cash balances and outstanding borrowings on the credit facility?

Russell C. Hammer

As I said, right now we paid the 19.8, so we’ve already paid down almost 70% of our line this year. We expect that we will be cash positive here in the fourth quarter and we are looking at how much more we’ll be paying down on the lines or not by the end of the year.

Jim Duffy - Thomas Weisel Partners

Okay, and then do you have a target for the inventory position by year-end? Should we expect further improvement or will it build going into the spring season?

Russell C. Hammer

At this time, we’ll continue to reduce our inventory probably another 10% by the end of the year.

Jim Duffy - Thomas Weisel Partners

Okay. And then a final question -- at this stage, maybe looking at 3Q numbers, how much of the revenue is done through Crocs retail doors?

Russell C. Hammer

Our retail, Jim, and our Internet combined made up about [28%] of our global revenues, so it’s growing very nicely.

Jim Duffy - Thomas Weisel Partners

Does that include the partner doors?

Russell C. Hammer

That does not.

Jim Duffy - Thomas Weisel Partners

Do you expect to -- you know, within your CapEx guidance for down 50% next year, are you expecting to continue opening retail doors?

Ronald R. Snyder

Jim, we’re going to continue to look at opening the retail doors in the right regions of the world. We are going to be very discriminate in spending money here over the next couple of quarters, so while we have planned a fairly aggressive launch, we’ve scaled that back now for 2009 and we will address it as we go through the quarters.

Jim Duffy - Thomas Weisel Partners

Very good. Thanks very much. Good luck.

Operator

We’ll take our next question from Reid Anderson with B.A. Davidson.

Reid Anderson - B.A. Davidson

Good afternoon. Just a quick follow-up on one of the last questions -- what was your owned retail a year ago? You said it was 28% of global this quarter -- what was it a year ago?

Russell C. Hammer

About 19%.

Reid Anderson - B.A. Davidson

Nineteen? Okay, and then another question, Ron, just if you could comment on kind of your license business, because you go into Walmart and you see a lot of knock-off product but with a Disney character or Nickelodeon. I’m just curious what your thoughts on that and just that license business in general.

Ronald R. Snyder

Our license business has continued to perform rather well. We don’t have -- Walmart can sell licensed product as well. They have licenses with some of the same properties that we do. We are going to continue to grow that business and we’ve got a number of new styles and new models that we are introducing both what we introduced for fall ’08 and we have for spring ’09 and at the end of next year as well, so that’s -- that business has contracted a bit with the rest of our business and what we are going to do is we are going to start bringing some of that product out into the mass channel over time, as a Jibbitz branded product.

Reid Anderson - B.A. Davidson

Okay, so as you’ve -- but as you’ve seen like them specifically ramp up that piece, have you seen a direct impact, do you think?

Ronald R. Snyder

It’s kind of hard to tell what the impact would have been. We have -- we are not really seeing any competition on the sports license side. On the entertainment license side, we have seen some. I mean, frankly our better products that look like nice products for kids to wear do fairly well and some of the other ones don’t.

Reid Anderson - B.A. Davidson

And then as it pertains to Mammoth, I mean, regardless of how you want to look at it, if you just look at that product line, whether it’s just adding new product or new models this year versus last year, what year-over-year growth makes sense just for Mammoth this year versus last year? Because it was such a key piece of last year’s fourth quarter.

Ronald R. Snyder

You know, we don’t know yet. We’ve got a lot of business between now and the end of the year last year at Mammoth, tremendous bookings, so we don’t know how that’s going to play out. We do know that our bookings so far at Mammoth are very, very strong. We haven’t -- they are not at the level we were at for the full year, the fourth quarter of last year but they are very strong.

Reid Anderson - B.A. Davidson

Would the Mammoth bookings be bigger than the overall number that was given previously, the 49%?

Ronald R. Snyder

No.

Reid Anderson - B.A. Davidson

Okay, and then last one, Russ, on the FX piece, I mean, is that just some hedging issues or is that just timing related to currency? What happened and what can you do to mitigate it?

Russell C. Hammer

The FX is the realized and unrealized gains just due to translation and at this point in time, we’re looking at different options to try to mitigate it but as you know, we do business all over the world globally and we have a lot of different natural hedges in place just from the mix of our business.

Reid Anderson - B.A. Davidson

But specifically more was it Asia relative to Europe in this particular quarter?

Russell C. Hammer

Europe and Brazil were the two big currencies.

Reid Anderson - B.A. Davidson

Okay. All right, thanks.

Operator

We’ll take our next question from Mitch Kummetz with Robert Baird.

Mitch Kummetz - Robert W. Baird

Thanks. Just a follow-up to Reid’s question on the FX. I mean, obviously you had a big loss in the quarter there and you called it out as such, which I think is understandable, given the size of it, although in the past it was just included in the SG&A. How should we be thinking about that piece going forward, given where currencies are now? And is the guidance of the $0.50 to $0.65 loss in Q4, is that -- is there an FX component that’s incorporated in that guidance or is that kind of adjusting for an FX impact?

Russell C. Hammer

So on the breakout schedules, what we have done for you is we have broken out SG&A with what the true operating SG&A is and the FX piece, so you have clear visibility to that. And then in regards to your question on what we have in the fourth quarter, we do have $10 million of FX built into our guidance that we have given. But of course we don’t forecast -- you know, currency rates changing all the time.

Mitch Kummetz - Robert W. Baird

Okay, so you said you built in a $10 million loss on FX in the Q4?

Russell C. Hammer

Correct.

Mitch Kummetz - Robert W. Baird

All right, and then I just kind of want to run through maybe performance of your business in the U.S. in the quarter. I think you said it was down 40% plus, nearly 50%, I think. When you look at the business, in a variety of buckets, whether it’s men’s, women’s, kids or classics versus kind of core styles versus newer styles, how do you see the performance or what was kind of the trend of that performance in the quarter that kind of led to that big drop?

Ronald R. Snyder

We think that -- I mean, we can see from our kids shoe sizes that the kids business continued to be fairly strong. It’s kind of hard to tell when you get up into the larger size kids whether they are women’s or kids. The men’s and women’s business were less.

What happened last year too it was such a strong year, such a strong year for our brand. A lot of customers did take product all the way through the quarter, where with the economic environment this year being difficult, customers stopped ordering as much as they did say in September of last year, still taking a lot of product. This year September was not robust, so that was -- that really -- so it wasn’t a full impact at retail of that 40% plus. As Russ said, we still saw fairly good sell-through in a number of our larger doors where they had the right product mixes but overall we’re down 40%.

Mitch Kummetz - Robert W. Baird

And then last question, on the call you have talked about it and in the press release you mentioned it, that you are looking to further right-size the business, the cost structure of the business -- how do you really think about -- I mean, do you kind of put it in terms of -- do you have sort of a volume expectation in mind and then you kind of want to get the SG&A to a level where you can be profitable and -- how do you think about where you can cut costs, to what degree you need to cut costs so that at a certain volume level, you are going to be operating in a better way?

Russell C. Hammer

Mitch, if you look at the economy right now and the business, we think it’s probably wise to plan our business at flat to down volumes in these uncertain economies. You know, the economy is impacting everybody in retail and all of our consumers and all of our customers, so we are going to plan our expenses, our cost, our capital, at a lower volume going into next year. We are going to plan our capacity at that as well so that we just baton down the hatches so when the volume returns, then we will leverage it. I think it would be unwise for us to plan at a higher volume and have the cost structure deleverage next year.

Mitch Kummetz - Robert W. Baird

And where are the levers that you can pull as you plan the business for a lower level of volume? Where is the low-hanging fruit, if there is any, in the cost structure that you can really attack?

Russell C. Hammer

So we’re looking at a number of areas -- we’ve already done a number of areas. As we mentioned before, we did reduce our work forces in the U.S. and in Europe. We are also reducing a lot of our administrative expenses in the legal, finance, marketing area, particular we are going to be adjusting and you will see some results of that starting up here pretty soon, the next couple of quarters. There’s really all areas we are looking at. Besides that, we are looking at, as John mentioned, our warehouse distribution space as we work down or continue to work down our inventory. We shut down the third-party warehouse and that cost comes right off immediately. Longer term though, as we mentioned on the last earnings call, it is going to take us nine to 12 months to be working down our inventory and get the full realization of the shut-down of our third-party warehouses.

Mitch Kummetz - Robert W. Baird

Okay, great. Thank you and good luck.

Operator

(Operator Instructions) We’ll take our next question from Sam Poser with Sterne Agee.

Sam Poser - Sterne, Agee & Leach

Good afternoon. A quick question on the inventory levels -- your comment -- what is the breakout of core versus new in the inventory levels as it relates to the future, to the pre-books?

Russell C. Hammer

On the pre-books, John mentioned that our pre-books were around 40% going out into the fourth quarter and the core products are running at around 23% of our mix right now, so we expect that to be a little lower in the fourth quarter though just due to seasonality.

Sam Poser - Sterne, Agee & Leach

But what about the -- you know, of the inventory, of the current inventory levels, what is the -- of the $141 million in inventory, what percentage of that is core right now? Because I believe at the beginning of the year you had about 70% in the core of the makeup of the inventory. Is it more built around what people are asking for now or is it still a lot of core inventory in there?

Russell C. Hammer

Sam, the core inventory that we have now is over 50% of our inventory is in core right now.

Sam Poser - Sterne, Agee & Leach

And it’s running at about 28% of the sales, so is that part of the stuff you need to reduce down out of, which will be a margin challenge in the next quarter?

John P. McCarvel

Maybe we have to clarify a little bit, Sam -- so about 40% of our pre-book for Q1 of next year is in core products. In the classic -- in our classics, which would be just basically [beach game] and [kids game], that still runs about 23%, 24%. Does that help you model that? So 40% of our business in pre-book is still in our core products and about 54% of our inventory is in core products.

Ronald R. Snyder

And Sam, all the [out months] business we get is in core products still, so people know we have the inventory. They are not pre-booking it.

Sam Poser - Sterne, Agee & Leach

Right, and then what percentage -- I mean, you might have said this, what percentage of your business right now is kids versus adult? I mean, has that -- because that has swung I assume in the last couple of years fairly dramatically.

Ronald R. Snyder

No, we still think it’s about -- it’s a little bit less than 30% still. And like I say, we can’t really tell on the small, some of the medium-sized shoes that we make but we think it’s still about 30%.

Sam Poser - Sterne, Agee & Leach

Thank you very much.

Operator

Ladies and gentlemen, we have no further questions. That will conclude today’s conference call. We would like to thank you all for your participation. Have a great day.

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Source: Crocs Q3 2008 Earnings Call Transcript
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