Crocs, Inc. Q1 2008 Preliminary Guidance Earnings Call Transcript

Apr.16.08 | About: Crocs, Inc. (CROX)

Crocs, Inc. (NASDAQ:CROX)

Q1 2008 Preliminary Guidance Call

April 15, 2008 8:00 am ET

Executives

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

Analysts

Jeff Klinefelter - Piper Jaffray

Jim Duffy - Thomas Weisel Partners

Mitch Kummetz - Robert W. Baird

Jeff Mintz - Wedbush Morgan

Analyst for Robert Samuels – JP Morgan

Operator

Welcome to the Crocs, Inc. conference call to discuss the company’s revised guidance for the first quarter and full year. (Operator Instructions)

Before we begin, I would 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 the securities laws. These statements concern plans, forecasts, guidance, projections, expectations, and estimates or objectives 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. Crocs has explained some of those risks and uncertainties in the Risk Factors 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 impacted future events.

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

Ronald R. Snyder

With me today on the call is Russ Hammer, our Chief Financial Officer. As you saw from our release, yesterday after the close, we have revised our outlook for the first quarter and the remainder of the year.

We also announced the shutdown of our Canadian manufacturing operations. Finally, we increased our share repurchase program. We’ll discuss each of these topics, keeping our prepared remarks relatively short to provide sufficient time for any or all questions.

With regard to the first quarter, we now expect sales to be in the approximate range of $195 to $200 million versus our previous guidance of approximately $225. While this is an increase of between 37% and 41% year-over-year, it is below our initial guidance.

The shortfall in our top line was primarily attributable to weaker than expected domestic sales due to the challenging retail environment. In addition, colder than normal temperatures across much of the US have delayed the starts to the spring season, which have impacted sales of sandals and other open-toed footwear throughout the industry, evidenced by the recent Sports Scan data.

I think it is important to note that in years past, we have typically seen a nice uptick in sales at the end of the first quarter, but this year we experienced a deceleration towards the end of March, which is consistent with industry commentary about March same store sales results.

We now expect to report diluted earnings per share on an operational basis in the range of $0.08 to $0.13. Additionally, in an effort to proactively reduce expenses, we made the strategic decision to close down our Canadian manufacturing operations and consolidate our production at our lower-cost company-owned and third party facilities.

Therefore, as a result of the shutdown, we incurred a portion of the onetime pre-tax charge in the first quarter equaling $16 million, or $0.13 per diluted share. Including this portion of the charge, we expect to report EPS in the range of negative $0.05 to breakeven.

Canada remains an important market for us, and we will be maintaining our sales and marketing office and retail store in Quebec City and we’ll be expanding our presence throughout the country including the opening of four additional Crocs branded stores this year.

The shortfall in earnings was driven by lower gross margin percentage and higher operating expenses. Gross margin is expected to decrease to approximately 45% for the quarter. Approximately 50% of that decrease is attributable to lower sales volume and the other 50% to underutilized factory capacity in our company-owned manufacturing facilities and distribution centers.

SG&A is also expected to increase to 39% of sales for the quarter. This is primarily result of increased marketing and sales span for global brand building including a spot on “The Apprentice”, a heavy trade show season and some additional headcount in our international offices.

We now estimate inventories at March 31, 2008 to increase approximately 5% to 10% compared with December 31, 2007. The expected increase is due primarily to our sales shortfall during the quarter. As was the case at the end of year, inventory is aligned geographically to meet our sales forecast in each region. We anticipate our inventory mix at the end of Q1 to be very similar to that at yearend consisting of approximately 70% of our core styles, which aligns well with our bookings trends for Q2 and Q3.

Looking ahead, we remain very focused on further aligning our inventories with expected demand around the world, and continue to anticipate that inventory levels will decrease slightly during Q2 and continue to come down during Q3.

Now to our outlook for the remainder of the year, for the second quarter, we now expect sales to range between $250 and $260 million, an increase of approximately 11% to 16% over the second quarter of 2007 with diluted earnings per share of $0.45 to $0.50.

We will include a portion of the one-time charge associated with the Canadian shutdown equaling $4 million or $0.03 per diluted share during Q2. Including this charge we expect diluted earning per share to be between $0.42 and $0.47. Our guidance includes gross margin in the range of 54% to 56%, and SG&A as a percent of sales decreasing to historical level in the low 30s.

For the full year we now expect sales to increase approximately 15% to 20% over 2007 levels, and diluted earning per share from operations to be $1.70 to $1.80. Including the total one-time, pre-tax charge associated with the shutdown of $20 million or $0.16, diluted earnings per share is expected to be $1.54 to $1.64.

Despite the first quarter gross margin decline, we are still targeting gross margins of approximately 55% for 2008, due to the forecasted increase in volume coupled with cost reductions in manufacturing and capital expenditures.

Regarding SG&A, we are taking cost out where appropriate. However, we will continue to spend in order to build our brand in all markets around the world and expect SG&A as a percent of sales to be in the 30% range.

This will include brand- spending initiatives, which came in at about 8% in Q1 and is forecasted to be 6% for the year. We feel these investments are important as we continue to launch the brand on a global basis. We are obviously very cognizant of today’s economic climate and our guidance reflects the current macro trend in the environment.

In the near term, we’re aggressively sizing our business to meet the expected demand, which include the following actions: closing our Canadian manufacturing operations; reducing discretionary expenses in all areas around the world to better align with expected forecast; delaying certain infrastructure spend where appropriate; and continuing to concentrate on minimizing airfreight.

Regarding the share purchase program, as noted in our press release, we also announced the Board has authorized the new share repurchase program of up to 5 million shares, which will be in effect after our earnings announcement on or about May 7.

I also want to take a minute to discuss our legal activities, specifically in the area of intellectual property. We have had great success enforcing our patents in a number of areas around the world, including Europe, Israel and South Africa to name a few. Other regions have been more difficult as the enforcement process vary significantly from country-to-country. In the US, we currently have IT matters pending in both the International Trade Commission (the ITC), and US District Court.

We have now received a preliminary decision in the ITC matter and the administrative law judge issued an initial determination in favor of the respondent. This is an initial determination and Crocs will be filing a motion for review by the full commission, at which point we’ll be seeking to have the commission overturn the determination. Crocs was successful in a similar motion to review previously.

I believe that there are good grounds for overturning the present decision. In any case, this decision will not render a final determination with respected the vital solidity of our patents and we will continue to pursue claims of infringement against respondents in a previously filed district court action.

On a positive note, we recently had US designed patents issued on both the Mary Jane and the Off Road models. We are evaluating infringement of these models as well as new infringements of the Beach patent. And we will continue to enforce our IP, as we deem appropriate.

Well we are obviously disappointed with out recent results. It is important to remind everyone that we have always taken a long-term view of our business and we remain optimistic about the future.

Domestically, our brand and products continued to grow despite a very difficult environment up 13% in Q1 and expect to grow between 5% and 10% for the year. Domestic sell-through was strong in Q1 with two of our largest sports retailers both experiencing a 40% increase in sales over Q1 ‘07.

On the international front, we remained very encouraged about our business evidenced by a strong first quarter. We believe we are under-penetrated in most markets and expect to grow at a 30% plus rate outside the US this year. We remain pleased with selling and sell-through of new products, which highlights the diversification of our business over the past year.

We now have 48 of more than 128 total Crocs styles or we have the year-to-date 2008 bookings of over 50,000 units. And that is up 100% over the same period last year. We continue to diversify our product portfolio.

Our brand remains very strong around the world and even with our revised guidance, we are projecting industry-leading growth this year and we’re on track to reach sales of almost $1 billion. In the near-term we are taking the necessary steps to limit our cost where appropriate. Longer-term we remain confident that we still have significant prospects ahead.

I’d like now to open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Jeff Klinefelter - Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

On this guidance for Q2, given that your first quarter is coming in at a 45% gross margin and 39% SG&A, you’ve now reduced Q2 pretty significantly as well in terms of revenue. How so quickly can you anticipate getting back to the mid-50s gross margin and low-30s SG&A? How can you move that fast? And how much of it is the adjustment from the Canadian business?

Ronald R. Snyder

We feel that we’ve looked through our numbers and as we move into Q2 we’ve reforecast our sales in each region and our expenses, of course, and we feel very comfortable with the numbers that we’ve given.

It does help quite a bit, taking out a factory that we weren’t utilizing and had higher costs than any other factory that we had in the world. We’ll save in the range of over $5 million, $6 million for the quarter by taking out that factory and it could be a little bit more than that.

Jeff Klinefelter - Piper Jaffray

But the lower sales volume as well that you are experiencing, you’re still just by taking out the Canadian facility, you are able to cut the de-leverage to that extent within one quarter, is that right?

Ronald R. Snyder

Yes. We delayed the addition of heads relative to our plan that we had in-house, but we’ve also moved some of our capital expenditures, business improvement systems into later in the year and into 2009. So we feel comfortable with the guidance that we have now given for Q2 and the remainder of the year.

Jeff Klinefelter - Piper Jaffray

In terms of the inventory up 55 to 10%, that seems modest in comparison to the sales miss in Q1 and the forecasted sales miss in Q2 from prior guidance so can you give us some color on how you keeping it contained at that level. For example, what was the actual manufacturing that you did during Q1, new manufacturing? And/or any updates at all on your excess inventory disposition strategies, is it going out to any authorized channels or are you discounting any product at this point?

Ronald R. Snyder

We’re not really discounting any product at this point, except we sold a little bit of end of life product that’s not our standard. That’s not in any of our core style that we speak of, some old styles that we had from years past. We sold a little bit to TJ Maxx at the end of the quarter.

Jeff Klinefelter - Piper Jaffray

What was your manufacturing during the course?

Ronald R. Snyder

We’re going to have more that in the earnings call, exactly what some of our manufacturing was. I can tell you that what we’ve done is we’ve aligned our production to the current demand in the marketplace. As we stated before, we’ve built up inventory in order to meet expected uptick in demand that we still expect in Q2 and Q3 of this year. However, we’ve looked at all of our pre-books, our forecast and we’ve aligned our production in our factories all over the world to more closely match that.

Jeff Klinefelter - Piper Jaffray

Question on your domestic forecast for Q2 embedded within your revenue guidance where you’re looking for the domestic account or the domestic business in total. And then any other color you can provide beyond the two sporting goods retailers. What’s happening in your department store channel? What’s happening in the independent channel right now?

Ronald R. Snyder

What we’re hearing, we get some data and some of it is only word of mouth. We’re hearing we’re still one of the best selling items in the footwear category and really every retail that we are in whether it be shoe stores, independent department stores or sporting goods. So, we’ve been very optimistic on that.

Now as you can see by the numbers in a very difficult environment for footwear and apparel we continue to grow. We continue to grow on fairly large numbers at this point. Our US business is expected to grow in Q2 about 4%, and where we grew about 13% in Q1 and our international business is expected to grow between 20% and 30% for the remainder of the year.

Jeff Klinefelter - Piper Jaffray

In Q1 how much of that business was Mammoth product? Do you have a sense within that 13% growth Mammoth versus core versus new styles?

Ronald R. Snyder

I don’t really have it at the top of my head, Jeff. Of course the Mammoth was a big contributor to Q4, but not so big a contributor to Q1.

Operator

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

Jim Duffy - Thomas Weisel Partners

On the guidance, it seems you forecast improvement in the second half of the year versus the first half of the year, which is contrary to what your seasonality has historically been. Can you speak to that please?

Ronald R. Snyder

Part of it is the third quarter is always been a very strong quarter for us and our strongest quarter of the year. We see the sell-through start through, say that middle of Q2 and we ride the momentum through really to end of the warm season in each market around the world.

So we do expect a fairly large Q3 and that coupled with we had a lot of success with our warm products, our Mammoth and some other products that we had in Q4 of last year. This year, we’ll begin shipping that product in Q3 and have sell-through in Q4 or at once business in Q4 for that product. So I think we’re pretty confident on the sale side.

On the cost side, with inventory now in-house and we’re planning our production and our shipments very effectively now, we’re going to be cutting down airfreight. So by Q3 airfreight becomes a very small portion of our product expense, which takes out of a chunk of expense, which obviously helps our margin in Q3 and Q4.

Jim Duffy - Thomas Weisel Partners

Say the sales do fall short of your plan. What are some of the additional leverage that you might have to employ to streamline the expense structure?

Ronald R. Snyder

We don’t expect that, we think we put in a pretty good plan now for the remainder of the year. We, of course, still have some variable costs in SG&A. We’ve got some level of variable cost still in manufacturing but we don’t anticipate any further moves for the remainder of the year.

Jim Duffy - Thomas Weisel Partners

Can you speak to what you’re seeing from inventories in the channel? Are you comfortable with where inventory levels are there? And then follow-up to that, where would you see inventory levels at the end of the year, do you think that you can make improvements from where the balance was at the end of ‘07? Second part of it relates to your anticipation where the inventory levels would be at the end of ’08. Would you be able to see improvement from inventory levels at the end of ‘07?

Ronald R. Snyder

Well, with channel inventory, we feel pretty comfortable with the inventory in the channel. It was certainly a little bit higher than it was in 2007, so we didn’t get the uptick in business that we got in March ‘07 in ’08. We’re now starting to see some of that improvement in April, as the weather starts to warm and the at once business starts to grow.

The second part of the question, we expect that at the end of ‘08 the inventory, Jim, I have to cache this with depending on what our sales forecast and what the demand curve looks like as we go into spring of ‘09. We’re going to properly position our inventory to meet that.

We will not be building excess, since we now have the capacity and we now are confident that we can make product more closely to the demand for the products and for the sell through of the product, we won’t be adding product a quarter early as we did this last year.

Jim Duffy - Thomas Weisel Partners

And then really as your Canadian facility didn’t have a tremendous amount of capacity, but does that change your ability to chase business in North America with the elimination of that facility?

Ronald R. Snyder

No, we still have a very flexible manufacturing factory in Mexico. We’ve been bringing that facility up for the last, really 2.5 or so years, bringing in more capabilities. And it just makes sense to consolidate all of our manufacturing in North America in a lower cost factory, in a factory that had more capabilities to do sewn product, [inaudible] product, and molded product. We compounded on material down there, so that’s a very vertically integrated factory where the Canadian facility didn’t have all those capabilities.

Jim Duffy - Thomas Weisel Partners

Can you speak to the number of doors you are seeing both domestically and internationally at the end of the quarter?

Ronald R. Snyder

We’ll have an update on that at the call, but it’s risen slightly. It’s slight flat in the US and risen slightly internationally.

Operator

And we’ll take our next question from Mitch Kummetz - Robert W. Baird.

Mitch Kummetz - Robert W. Baird

I don’t know if you want to talk about it now or wait till the call as well, but in terms of your outlook for door count by the end of the year, 2008.

Ronald R. Snyder

We’re going to have a little or have more clarity on that at the earnings call. It’s becoming a little bit modeled in some new doors that we add. We don’t offer all of our product line. We’ve added golf doors for our golf product lines, which don’t really get reported in the 13,000 doors that we talked about in the last call.

So what I’m going to do this next time we’ve got, for example, we have doors now for our Ocean Minded brand. We sell to [Paxon] and Journeys and some other that aren’t counted in the 13,000 but we’re going to start to break those out because we have quite a few more doors than the 13,000 now if you count all of our brands.

Internationally, we are going to still aggressively add doors through 2008 as we continue to build the brand and in many of the markets that we’re still early in the penetration phase. So we expect to be adding doors in countries throughout Europe, where we’re newer, and certainly some of the Asian and the emerging countries where we have a lot of activity these days.

Mitch Kummetz - Robert W. Baird

Can you just speak a little bit to your overall visibility for the year, in terms of your forecast? What gives you that level of comfort in terms of your new guidance, and maybe talk a little bit about pre-book orders that you have, and I think you mentioned 48 styles that are pre-booked to a certain level. What does your overall backlog look like and how much of your business over the balance of this year is going to be driven by backlog?

Ronald R. Snyder

We had a really tough backlog here. I would say that our pre-books currently are in the 40% range of what we expect to ship for Q2. And that’s about as expected, a little bit higher than it was last year at this point.

We are confident in the floor space were being given at retail, the sell-through that we’re seeing from some of our key retail partners where we get that data is still quite good even in a very, very difficult retail environment.

You have to remember that we’re still a bit of impulse buy. Much of our product line is an impulse buy and we need the traffic in order for our sales to really pick up. But that said, even without the traffic we continue to sell at higher rate than last year and last year was a pretty good year.

Mitch Kummetz - Robert W. Baird

Can you give us some additional color on Q1 product performance, core versus non-core or any of the new styles that either got good traction or maybe you fell a little short of your expectations?

Ronald R. Snyder

In our pre-book right now our core models are about 55% of pre-books and that’s about as we expect because remember the core is all the replenishment business. So as even comes along we’ll be able to replenish much more core than we will with the new product. The new product will take a little bit longer. We’re seeing very good trends for our new styles.

And as I said, we now have 48 styles and if you count all of our styles from all of our brands we have about 250 counting Ocean Minded all the different styles that we have of our license produce, we have about 250 styles. We now have booked a 50 of them that have sold over 50,000 pairs so far this year, which is quite encouraging.

We obviously aren’t a one-shoe company anymore and we’re hearing that some of the winners for the spring already and it’s still quite too early to tell, but some of the products coming from last year are Cleo, and Capri and the Crete, some of our Ocean store models are selling very well. Early on we are also seeing a nice sell through on the Malindi and the Adara, which are about equal and successful for in early season.

And then in our new men style called the Yukon are really getting some nice traction and that’s really helping our male business.

And of course, we are doing extremely well in the entertainment licensed products with all of the different entertainment shoes that we have now. We’ve got a quite a number of those.

Mitch Kummetz - Robert W. Baird

I’m still little confused on the Q1 margin why it was as low as it was. Because as I calculated even with the sales having coming about $25, $30 million below expectations, it still looks like your cost to sales and your SG&A were actually up above plan on an absolute dollars basis. So I was hoping for a little bit more color there, did you just spend more than you were expecting initially in the quarter or were your gross margin forecast originally too aggressive?

Ronald R. Snyder

No, so we did really two things, part of the mix is related to volume, a little bit of mix but more volume for about half of the mix. The other half was we were gearing up and continue to gear up for a larger Q2 and Q3, the numbers that we had given before were quite a bit larger than what we’ve now given as guidance.

So we had under utilization at our company-owned and third-party factories, which certainly impacted the result, as well as our distribution centers where we were gearing up for much larger numbers in Q2 and Q3. We now size that appropriately and as we said we feel confident with the numbers that we’ve given going forward for the rest of the year.

Operator

We’ll take our next question from Jeff Mintz - Wedbush Morgan.

Jeff Mintz - Wedbush Morgan

Can you talk a little bit about the inventory strategy as we roll into 2009? Is the plan to continue to hold the significant amount of inventory going into seasons and then use manufacturing capacity to meet at once demand?

Ronald R. Snyder

No, not really. What we’re doing now is as I said; we were bringing-up capacities and capabilities in our various manufacturing sites around the world in Mexico, to some extend in Europe, certainly in China and Vietnam. We now have adequate capabilities to build all the various type of product that we have. So we don’t have to pre-build now.

A few months before the season, we can stay closer to the season and hit the products that are selling well in season within a month or two of the shipment. So we won’t have to go into ‘09 with as to having an inventory level we did in ‘08.

Jeff Mintz - Wedbush Morgan

So we should see inventory dropped in each quarter starting with Q2 or Q3 for the rest of the year.

Ronald R. Snyder

Yes.

Jeff Mintz - Wedbush Morgan

On your last call you had talked about a long-term growth rates. I believe it was 25% to 30%. Do you have any further update on that or do you still assume that that number is achievable over the next three to five years?

Ronald R. Snyder

We’re going to take a look at that over the next few weeks and have more clarity for you on the earnings call.

Jeff Mintz - Wedbush Morgan

And then have you started to see the need to pay mark down dollars in terms especially some of the department store accounts and if so what kind of an impact does that have on gross margins?

Ronald R. Snyder

We really haven’t had mark down dollar issues at this point. Certainly, as we would bring on more seasonal product or fashion related product we would expect that could be an eventuality, but at this point we don’t pay mark down dollars.

Jeff Mintz - Wedbush Morgan

On the international business, I’m a little bit surprised to see that you expected to slow from Q1 to Q2. Q1 still seems like significant growth and dropping to 20% to 30% in Q2, that’s still decent growth, but it’s a very rapid deceleration. Can you talk about kind of what you’re seeing there and why the rapid deceleration in growth?

Ronald R. Snyder

Well, it looks like a rapid deceleration. We’ve really grew significantly in Q2 over Q1 in ‘07. So, we’re talking about bigger numbers obviously. So, the growth rate has come down.

We could still continue to grow internationally very well. We’ve become a little cautious with the potential of the slowdown in the UK. Still too early to tell because we’re just getting into the season, but we’re cautious as we go into Q2 and Q3 with UK all over that get offset by the rest of Europe, which remains fairly robust.

Also, we’ve seen a slower start in Asia than we had expected. We feel and hope that its weather related because they also had quite a bad March in weather in Japan and Korea. And we did see some nice numbers in our stores for this last weekend which the weather must be breaking there, but that’s why we’ve been appropriately conservative in those markets with limited data that we have.

Operator

We’ll take our next question from Robert Samuels with JP Morgan.

Analyst for Robert Samuels – JP Morgan

It’s Alice Richards for Rob Samuels. Could you talk about where cash balance was at the end of the quarter and given the working capital drain how you plan on financing the buyback?

Ronald R. Snyder

I don’t have a cash number for you. We haven’t closed our books around the world, so we will have that at the earnings call. We’re going to be generating quite a bit of cash in Q2. We’ll be financing some through cash, and we will probably use some data as well.

As I mentioned at the close of the scripted remarks, we do remain quite optimistic about the business. We’re disappointed in the results for Q1. Obviously it was somewhat related to market trends and weather patterns that we didn’t have control over.

However, we do feel very confident going into the now busy season, the spring and summer season for our products. We have some great new products that, as I said are already beginning to sell quite well, and we’re confident in that.

Thank you very much, and if any of you want to call, Russ and I’ll be available the rest of the day. Thank you.

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