Crocs: It's the Product, Not the Economy

| About: Crocs, Inc. (CROX)

After yesterday's earnings warning it looks like the Crocs Inc. (NASDAQ:CROX) story is headed to an end.  With revised 2008 expectations of revenue undperforming 2007 figures and EPS at breakeven, at $4-$5 per share, CROX is still grossly overvalued.  In addition, there's been very little action by management over the past few months to suggest that insiders have any belief that CROX shares represent a bargain.

What was laughable was the spin management tried to put on some questions on today's preliminary Q2 conference call.  For example, one analyst discussed potential customer attrition in terms of a possible reduction in retail doors.  Management suggested that CROX was looking to "create attrition" as though this was the Company's decision.  So the interest level in CROX shoes is slowing in the U.S. and retailers don't want these products, but CROX ending relationships with some of these retailers is the Company's own decision?  International growth also came in below the Company's expectations, indicating that demand for its product is waning overseas.  On top of that the CROX kiosks are experiencing declining comps.  Management was able to blame the economy, but the reality is the products have no competitive advantage and there's little doubt the Company's products were part of a short-term fashion trend (fad).

Rather than the high-growth, high-margin business that management presented to investors while aggressively dumping shares last year, investors are now realizing this is a negative growth, declining margin business and management is now "sizing our business to be profitable on lower projected sales volumes..."  Better said, it looks like CROX is following a "shrink to grow" strategy which is unlikely to work.  Based on today's conference call, management is still not utilizing total production capacity at existing factories through Q3 08 and doesn't expect full utilization to occur until spring production occurs.  This seems like a contradiction given that the business has to be reduced for lower sales volume, yet management is currently maintaining the existing facilities which will supposedly be at full capacity heading into the spring production season.

CROX had a terrific run from 2006 through the fall of 2007 but things have changed markedly since Q3 07.  Management has no credibility as it continuously misses its own estimates, and the Company's capital market handlers like Piper Jaffray have no credibility either.  Piper was lead underwriter on the Company's IPO and secondary offering where insiders sold off a considerable amount of their shares, so my skeptical side was not too surprised to see Jeff Klinefelter and other analysts consistently echo management's sentiments and voice strong support for the Company.  As recently as June 20, 2008, he reduced his rating on CROX to $17 from $20 but maintained a "Buy" rating on the stock.

It's perfectly acceptable to be a contrarian, but the risk with CROX was quantifying how much of its growth was due to a short-term hysteria surrounding the products and that eventually children, who accounted for a good portion of sales, would move on to the next trend.  With negative expected sales growth in 2008 CROX should now be valued at a much more severe discount, particularly when these sales are coming at the expense of profitability.  The Company is expecting a slight reduction compared to 2007 sales yet profits are down significantly, even when accounting for various one-time charges.  Table I presents my estimate of where 2008 revenues shake out and what the market could value CROX at based on the latest information provided by management.


Given the problems facing CROX, I stand by my seemingly laughable valuation range.  However, someone could doubt this and suggest CROX must be worth more than $1-$2 per share, after all, as of Q1 08 CROX had roughly $5.50 in book value.  The problem is that book value is inflated due to the valuation of inventory and various intangible assets on CROX's balance sheet.  Even on today's conference call, analysts appeared concerned with the Company's inventory levels despite these inventory levels being worked down.

Q2 08 book value will not be changed much from Q1 as at the mid-point of Q2 08 guidance, only $4MM of earnings will be added to the Company's book value.  So assuming CROX hits $0.05 in EPS for Q2, book value is roughly $5.54 per share.  Inventory will be around $230MM but will still be high on an absolute basis.  The true economic carrying value of these rubber shoes could be 50%-65% of that figure or $115MM-$150MM.  In addition, CROX carries about $57MM in goodwill and intangible assets.  These various patents and trademarks appear to have little value as there are a number of imitations sold globally.  When writing these phantom assets off and combining them with the midpoint of the inventory's  more realistic value, CROX's book value could be overstated by $155MM meaning the economic book value of the Company is really about $3.60 per share.

Also, that is based on the book value of CROX as of today.  For Q2 08 management is expecting a slight gain but by year-end 2008, the Company will be at breakeven, meaning no gains in book value will occur.  Management believes 2009 sales growth will be in the mid single digit range, but what kind of credibility do they have when they missed their revenue goals by over 10% for this quarter and EPS estimates by over 90%?  I suspect sales will probably decline in 2009 and margins will continue to suffer, which means that everyday CROX operates is a day that futher erodes the Company's value.  This is because retailers have leverage with CROX in terms of ASPs for the Company's shoes while production facilities are not being run at full capacity.  A glut of production facilities and those associated costs of under-utilization combined with potentially declining ASPs will mean subsequent quarters of operating losses which will eat away at CROX's value.  Also, this does not even factor in the transition steps management will be taking to right-size the business which will surely result in other additional charges.

While CEO Ron Snyder states that "we remain confident about the long-term prospects of this business" in the latest Company filing, he and other insiders have been reluctant to demonstrate any interest in the Company as an investment.  As Form 4 Oracle illustrates, management was all too happy to cash out, selling hundreds of millions in CROX stock when share prices were inflated and the Street was pumping the stock.  Now, at prices some couldn't imagine just 10 months ago, management has just one open market purchase to its credit, which in all fairness is one more than any investor should have at this point when it comes to CROX.

Disclosure: Author manages a hedge fund that owns puts on CROX