Crocs, Inc. (CROX) Earnings Call Transcript & Summary

Good morning, and welcome to our fireside chat with Crocs. My name is Farid Foroughi, and I head up Morgan Stanley's Disruptive Commerce and Technology practice. Before we begin, I will read a short disclaimer. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, it's my great honor and privilege to be hosting a fireside chat today with Crocs. Joining us virtually are CEO, Andrew Rees; and Executive Vice President and CFO, Anne Mehlman. In terms of the format for today's session, I will allow Andrew to make some opening remarks, and then we will spend the bulk of the session in a Q&A format. If you have any questions throughout the session, please log them via the portal, and we will try to get to them. Without any further ado, Andrew, would you like to kick off with any opening remarks?

Farid, thank you. I appreciate you inviting us to attend this conference and appreciate the opportunity to talk to a very wide audience about our company. So the Crocs brand has got exceptional momentum. I think everybody is aware of that. We've been growing strongly since 2018. And as we look at the current year, when we guided our -- the remainder of the year on our Q3 call, we highlighted that we'd grow between 60% and 65% for full year '21 and have industry-leading profitability at around 28% operating profit. So clearly, a company that is on trend and doing well with consumers. During that time, we've really focused on improving our brand relevance and connecting with our consumer base to drive revenue growth. Back in September, we held an investor conference, where we really talked about the long-term potential for the brand. We highlighted that we believe the brand can grow to in excess of $5 billion by 2026. That would be an implied 17% compound annual growth rate over that period. That growth will be driven largely by the strategies that we already have in place. We're not reaching to a new strategic platform to drive our future growth. We see the strategies we have in place continuing to propel growth. That's around expanding from the Classic Clog into the sandal arena. That's around continuing to invest in product and marketing innovation. It's around digital penetration, where we see a digital penetration in excess of 50% by the end of that period, and it's around growth in Asia. You've seen recently very strong growth in the Americas, and we see that growth extending both into our EMEA region and ultimately into our Asia region. So we feel really good about where we are from a growth perspective. So I think that kind of sets the stage, hopefully, for a lot of good discussion that we could have today, and I'll be delighted to take your questions.

Yes. I mean, it's been a phenomenal story, Andrew. I mean, Crocs has been not only one of the best performing names in consumer retail from a share price performance but, frankly, the overall market. I think I noticed shares are up 165% plus year-to-date. As you noted, you recently held an Investor Day and spoke about your ambitions to grow the company to a sales base north of $5 billion by 2026. You started to speak a little bit about how you will do this, but can you just give us a little bit more color as to the next wave of growth for Crocs?

Yes. I think I mentioned in my opening remarks, but I think the important thing about the next wave of growth, it's not a new set of strategies. It's not a new approach for the company. It's really a continuation of what we're doing today, which I think should give investors tremendous confidence because we can see the impact of those strategies. And so if we kind of break them apart, number one, sandals. As you look at the product arena, we're really proud of our product and marketing innovation. Those have been the cornerstone of our growth in the most -- in the last several years. And I think what will be important in the future is adding sandals to our clog business. Our clog business is very substantial. It's very profitable, and it's what we're known for. It's the icon that the company is built around. But as we've grown into the sandal arena, there a couple of things that are important. One is a very large addressable market. So it's a much bigger addressable market on a global basis. We think it's in excess of $30 billion. The consumer buys sandals every single year, so it's a replaceable portion of the business. And we think we have great traction and heritage in that arena. Then we think about digital, right? And then we can see that in the current shopping environment. The consumer has clearly, through COVID, shifted even more to digital. Some people talk about kind of 10 years of digital penetration in the last 2 years. And I think we feel like we've seen that. We're investing behind digital. We anticipate our digital distribution. And when we say digital distribution, we mean both our dot-com, which is a business that we own, but also major e-tail partners like an Amazon or a Zappos or a Zalando because the consumer is transacting digitally. It's meeting all of their digital requirements. It's just not us. So we think about those 2 things together. We see that in excess of 50% of the business. And what's great about the digital arena is we have direct contact through most of those channels with the consumer. We know who the consumer is. We can continue an ongoing dialogue and relationship with the consumers. Then Asia, right? We've seen very strong growth in the United States. If you look at our numbers over the last several years, you see the growth in the United States has been outsized. We can see that spreading very, very strongly to our EMEA region. But ultimately, Asia is the big price and, in particular, China, right? The significant populations that we see in China and India and Southeast Asia, we think our product is incredibly applicable to those populations. It's very democratic in terms of its price point. It's very approachable, easy on and off, lightweight, comfort, all of the things that, that consumer is looking for. So we think that has a tremendous long-term potential. So we feel really good about that approach. And we think that's a formula that drives high levels of growth but frankly, also high levels of profitability.

Makes sense. And Anne, we're obviously in an important selling season today in the midst of Cyber Week. Could you talk a little bit about how you were positioned heading into the Black Friday and Cyber Week and any early highlights?

Yes. I think we were -- I think we had pretty good inventory levels in our channels, which is great. And we're really pleased with what we saw on Black Friday, Cyber Monday. I think it was in line with our expectations for the quarter. As Andrew mentioned, when we guided back on our Q3 call, we implied 26% to 36% revenue growth for Q4, so we think we are in line with our overall guidance. And we continue to see the trends that we've seen recently for our brand, which is strong traffic, more full-priced selling and I think strong conversion. So I think all of those things we saw over the holiday weekend, obviously, this is the beginning of the holiday period, but yes, we are really pleased with the results.

That's great to hear. Another thing that's probably on investors' minds is Omicron and some of the more recent developments around variants. Andrew, maybe one for you. Could you talk a little bit about any early reactions to the news? And in particular, maybe just a little bit further around some of the global supply discussion that you had with investors during your Q3 earnings release and how the company is faring today?

Yes. Well, clearly, COVID-19 has had many twists and turns over the last 2 years. And as a company, we've really kind of had to and learned to really be nimble in that environment and manage as best we can, given everything that's going on. I think the largest impact we're seeing as a company today is really not at the selling and consumer receptivity. It's been most recently at the supply chain end with the factory closures that we talked about in detail on our Q3 earnings that affected Vietnam. I would say what we've seen since that time frame is the majority of our factories are now open, but there is some erraticness in the level of that production. I would say it's meeting our expectations. It's meeting the plans that we put in place. But clearly, this is not over from a sort of COVID impacting the supply chain perspective. Then also the transportation of goods is taking a lot longer. There's been a lot in the press about that. People have talked a lot about that. That is still there. But obviously, once you sort of fill the pipe, that is less of an impact on an ongoing basis. So we feel like it's been difficult to manage. Our plans that we put in place are working. The factories are opening. They're meeting our production expectations. As I mentioned, we felt good about the product that we had on the shelves, both in our DTC channels and with our wholesale partners. In the holiday period, I think they're all in a pretty good place from a Crocs' selling perspective. And as we look to the future, obviously, we're going to have to move past this. We've done the things that we talked about in Q3. We've moved production to other regions, whether it be Indonesia or China and also some of our Western Hemisphere facilities. And we will use kind of substantial airfreight in the first portion of next year to bridge that gap to allow us to bring in the goods at an accelerated fashion that we're able to produce post the closing. So I think we've got the plans in place to create the -- to maintain the momentum of the brand and maintain the trajectory. Obviously, it's going to cost us a little bit more money in the first part of next year, but we feel pretty good about where we are.

Yes. It's great to hear. And Anne, I guess from a financial perspective, anything you would add around what investors should be expecting in terms of the investments you are making, whether it's airfreight or otherwise, to meet the demand for this selling season and into '22?

Yes. I think Andrew touched on airfreight ahead of the selling season, which is one of the most meaningful investments we're making. We said we're going to-- on our last call -- or last earnings call, we said we're investing $75 million in 2022, and that would include us -- allows us to maintain flexibility. We're securing capacity through airfreight through a variety of different means, and I think that's really important for us because it allows us to be aggressive and also keep our share and hopefully take some share. Even with that, we anticipate delivering best-in-class profitability, as we discussed on the call, of 28%. So excluding that airfreight, we would have margins largely in line with this year of 28%. I think switching down to the other side of the P&L, as Andrew talked about in his opening remarks of how we're going to achieve our long-term goals, from an SG&A investment side, we'll certainly look to invest behind our key initiatives. So -- and that's focused on growth in China. So China investment, marketing and product innovation and really digital are kind of the key investment areas we're looking at for next year.

All makes sense. Andrew, I wanted to shift gears a little bit and talk about digital. Obviously, you have larger ambitions. You already are conducting a lot of your business on a direct basis online, but just elaborate a little bit on that for us. Where are you investing globally? What does that get you? Any impacts to the P&L, et cetera?

Yes. So it is a very important focus for us, as it is many companies, right? So I think the consumer has been really clear. On a global basis, they -- the convenience of transacting digitally and the ability to communicate with them, frankly, largely on their phone and their mobile devices today is critically important. So from a global basis, I would say we're investing in digital everywhere, right? So we're investing in digital here in the U.S. Our EMEA region is actually our most highly penetrated from a digital perspective. But also in Asia, where we see -- and I would say, particularly in China, some really significant evolutions of the digital ecosystem. Particularly with TikTok and Douyin, we're seeing a lot of social commerce emerging very, very quickly in that region. So we use the global footprint and the experience that we have from that global footprint to help and form our capabilities on a global basis. So I would say it's largely -- it's everywhere around the world. In terms of some of the things that we are looking at, we recently launched an app here in the U.S., and that will be extended to our major markets around the world during 2022. We think that's particularly important in terms of maintaining an ongoing dialogue with our consumers, having a direct dialogue with our consumers. But we'll also use that app to do some exciting things around limited releases and around some of our collaborations that will be accessible through that app. So I think that's going to be an exciting innovation for us. We're also looking at B2B customization. We've been doing a lot of work behind how we can improve our immediacy and speed around customization. And we think there's significant applications for that, whether it be with businesses or sports teams looking for a customized product. And I think our product is very customizable. So we think that's kind of an interesting extension. But beyond that, I would say some of the investments are also just going into scaling the business. The business is growing very quickly. So we need to add people. We need to add technology, and we need to add supply chain capability to be able to service all of those consumers. So those are some of the key components, and I think that's going to be a very strong focus for several years to come.

No, makes a ton of sense. And Anne, I guess, from a financial perspective and just what you're seeing on the ground, digital critically important, but obviously, the wholesale channel equally important. Curious what kind of demand you are seeing on the wholesale side from partners and how do you balance product distribution in this environment where there are supply chain constraints between the wholesale channel and your direct channels?

Yes. We obviously allocate inventory very carefully. I think all of our channels are very profitable, whether it's our own direct-to-consumer or wholesale. From a wholesale standpoint, we partner with kind of our top 20 global brick-and-mortar accounts to really make sure that they have the product that's right for their consumer. But we're also very focused, especially as Andrew mentioned, on digital, keeping our own digital in-stock because we don't want to disappoint our consumer. So we protect our in-stocks from a digital perspective and make sure that we have the right product for a consumer coming to our website as well as we have an allocation model for our wholesale partners. So we carefully think through with them how much product they should sell and especially in our key and core styles such as our Classic Clog.

Makes sense. Andrew, I wanted to double-click on one of the comments you made earlier around your global growth. Obviously, Crocs is a fast-growing global business. You're accelerating your brand relevance in markets like Asia. Could you just give us a little bit more detail around some of the key markets of focus? And any initiatives that you're focused on in the near term?

Yes. I mean, maybe kind of I'll take that kind of a little bit kind of region by region. So starting with EMEA. So EMEA is our sort of Europe, Middle East and Africa region. We're seeing really great traction from the brand in countries like the U.K. and kind of Western Europe where we're seeing really nice growth. But we're also seeing, frankly, much stronger demand than we're able to fulfill with some of our distributors. And we use distributors in Southern Europe, in sort of Spain, Italy, Greece and Eastern Europe and then also in Middle East and Africa. And just naturally in a supply constrained environment, we've unfortunately had to go through some prioritization and allocation that you just kind of talked to Anne about and the sort of low man on the totem pole, unfortunately, as those distributors. It's not that we don't want to support those distributors in the long term, but it's just the -- it's a logical conclusion of what you have to do. But we're really seeing strong demand for them as well. So we see a lot of very clear trajectory in EMEA. If we shift to Asia, that I think is the bigger prize in the long term given the size of some of those markets. The Chinese market is the second biggest footwear market in the world. And obviously, with their population and the growth in the GDP, that's a very big prize. We've been on a multiyear kind of reset approach in China. We think we talked about that kind of fairly extensively. I would say that continues to go well, like we're tracking to all of our key components. We opened 6 kind of key flagship stores in China this year. We're very pleased with how those are performing and the impact they're having on the consumer. We're very pleased with our digital business in China and also the traction that we have from a digital marketing perspective. And we also feel like we're on track with our distribution partner reset. We use partners to operate mono-branded stores into key provinces. We've been through a reset there, and we think that is close to complete. China will grow double digits this year, but off a small base, and we have much bigger ambitions. Around the rest of Asia, our business in India and South Korea continues to perform extremely well. And I think the one piece that has been a drag this year that we had hoped would come back online towards the end of this year is the Southeast Asia distributors. We operate through distributors in Southeast Asia, whether that be Indonesia, the Philippines, Vietnam, et cetera. Those have quite a large potential. Thailand as well, they have large potential. We thought tourists might start returning to those arenas -- those countries, sorry, during the back end of this year. And frankly, it just has not happened, right? So with COVID, it kind of went the other way, to be honest. So our approach with that has been we don't want those distributors sitting on inventory they can't sell. So we've really pulled back on selling into them. We're hopeful that, that market will reemerge in '22 as tourists start to visit those countries again. So look, yes, Asia is the big prize. China is very important, but there are a lot of other growth opportunities in H2.

Yes, that makes a ton of sense. And Anne, we have one question in the queue that kind of relates to this around Asia growth, which is, could you just speak maybe at a high level around some of the relative margin differences between the APAC geography businesses and what you're experiencing domestically? And any levers that you have to help continue to increase those margins in the Asia Pacific region to the extent it would be appropriate to comment?

Sure. I think there's a couple of things. So from an Asia perspective, from a gross margin perspective, Asia does have more distributors than our Americas market. So that is lower gross margin but very profitable from an operating margin. But certainly, I think as markets heat up, as we saw in the U.S., we have pricing power, and we will be able to increase prices and pull back on promotions and discounts, which has really driven a lot of the margin expansion in the U.S. So we think there's opportunity there. The second piece is as we scale these smaller subscale markets, we can also drive SG&A leverage, and that's probably a really big lever of opportunity for us. Again, similar to how we saw in the Americas, as we drive top line revenue growth, we're able to leverage that very efficiently. And so certainly, as, again, we see those markets heat up and we drive growth in Asia, we should see their margins come back in line. There's nothing structurally from an Asia perspective that excludes them from having higher operating margins.

Makes a ton of sense. Andrew, I wanted to come back to some of your comments around sandals and the earlier learnings there. Would love to just double-click there and understand what learnings from sandals do you kind of take with you as you think about other adjacent product categories. Does this give you confidence to move into other areas? And what do you think about other areas?

Yes. I think -- so sandals, I think, we identified sandals as an opportunity because of the large addressable market and the applicability of the Crocs brand, the DNA that we -- that our brand has and the relationship we have with our consumers. I think that was very, very clear, and actually, some historic success. As we've expanded in the category, we've really seen personalizable or Jibbitable sandals do extremely well this year. In particular, we introduced a 2-strap Classic, and we'd also have introduced a year before in the height of COVID a slide that are both Jibbitable. Those have done extremely well. But we also have some style-centric sandals and some outdoor-centric sandals that have gotten good traction. So I think we've gotten some good reads from the strategies we put in place, which has really given us confidence for our desire to 4x the sandal business over the next 4 years. And I think as we looked at -- through the end of Q3, we talked about sandals having grown kind of 31% this year. Now I think -- so I think we've learned a lot about how to really understand the market, focus on the market and execute well. So -- but I do think as we go further, we need to be kind of very sequenced and purposeful, right? So we don't need, as a brand, to hit our growth aspirations, be all things to everybody. We need to be really focused and sequenced around what we're going to focus on in terms of the next silhouette or the next consumer group. As we look at the history of the company, of our brand and, frankly, other brands as well, when they go on a kind of mass diversification, it can often lead to fragmentation and a lack of focus. And we're really determined that we maintain strong focus. So I think we've learned a lot. We recently introduced Socks, which I think is doing quite nicely. It doesn't have the same kind of potential as sandals, but obviously, it's a natural adjacent purchase as you think of Crocs and Socks.

That makes sense. Anne, one question for you around marketing as well as collaboration. This was actually a question that came in, in the queue. I guess the first part is just help us understand how you kind of prioritize and benchmark your return on investment of your marketing dollars and where you're putting those today. And then the question on collaborations, I think, in the queue is really how you think about collaborations for 2022. Can you give us a sense for the magnitude of the number of collaborations or where you're focused?

Yes. So good question on marketing. We plan to invest in marketing, which for us is 100% digital, and that's both top of the funnel and what you would consider more performance marketing based on an e-commerce perspective and, obviously, on the e-commerce side. And because it's digital, we can manage our ROIs very closely and pull back and kind of push as we need. So I think I will say our marketing team is best-in-class. They're very good at experiencing and experimenting on different mediums as well as our very successful collaboration engine, which I would consider more kind of top-of-funnel marketing. The beauty of collaborations is obviously it's kind of self-funded marketing as they have profit associated with them. But they're not large volume drivers. They're definitely more around expanding our consumer set and relevance and really getting us talked about a lot. So -- and then next year, obviously, marketing doesn't let me actually talk about what we have planned, but we have a very robust 2022 map that I'm very excited about. So you'll have to stay tuned and download our app to see all of this.

We look forward to it. Anne, why don't we stick with you? I was hoping that you could just further comment on your profitability more generally. Obviously, you're at a level right now, which is already best-in-class. But longer-term expectations, what are some of the puts and takes for how you guided at Investor Day?

Yes. We're very excited about being able to guide best-in-class profitability. And what we said is we'll be approximately 28% this year on our last earnings call. We also said next year, excluding airfreight, we'll also be at about that 28% level. And then longer term, we said we'd be more north of 26%. And obviously, every year, it's hard to guide that long for -- it won't be the same every year. We think there's opportunity where it could be higher, but there are some really puts in a little bit from a margin perspective. So very excited about our ESG initiatives that we're announcing, where we're using bio-based resin in our clogs, but that does have some cost headwinds associated with it. Just general inflation also associated with input costs that we're seeing impacting gross margin. And then sandals, as we expand into that arena a little bit more does carry a slightly lower gross margin than some of our clog product, even though it's molded. So that 26% gives us room to really make sure that we can invest behind all of our strategic initiatives in a way that makes sense but still deliver best-in-class operating margins.

That makes sense. And Andrew, Anne -- and Anne noted ESG, which has obviously been a tremendous theme in the consumer retail sector more broadly. You all have been at the forefront of innovation and leadership in this respect. Could you just speak about your commitments and the timing of some of these bio-based products that you're planning on introducing?

Yes, yes. So I think -- look, I think there's 2 kind of important drivers here. What is clearly the consumer, especially the younger consumer, is looking for the brands that they're interested in and committed to, to do the right thing relative to sustainability and the environment. And also, as a company, we want to do that, too, right? So we announced that we would be net 0 by 2030, which is obviously not far away. And a key component of allowing us to do that were, number one, the already low carbon footprint of our product, right? If we look at the Classic Clog, it has a 3.94 kilogram equivalent of carbon, which is one of the lowest carbon footprint of any footwear product on the market today. So even buying our kind of current traditional product is still doing the right thing relative to the environment from a sustainability perspective. The second thing we announced is that we would then blend in bio-based resin in terms of how we make that. We've actually started that process already. So we're producing our product today that has bio-based resin, which is then further lowering the carbon footprint of those products. Over time, we'll increase the proportion of bio-based resin that we include. And I would also highlight that we talked about green comes in every color because we're not asking the consumer to choose. We're not asking them to buy a sustainable product at a higher price than a non-sustainable product next to it. We're actually putting those benefits into every single product that we're manufacturing that uses Croslite. So what we will see over time is the proportion of bio-based resin will increase and the footprint of each of those products will decline. And then we'll also have a variety of other initiatives associated with the operations of our company and making sure that we can be sustainable in that regard as well. So -- and then we'll bridge the last component of our kind of net 0 promise and obligation with some offsets. So I think we feel really good about the plan. And the consumer will start to see the impact and the benefits of the plan we have in place starting early next year.

Makes sense. We did get some further questioning in and around some of the bio-based Croslite material, and maybe it's appropriate for you to comment. I know you addressed it already at a certain level, but I think the question is really around how does the cost of some of this material compared to your existing materials, and are there any differences in the performance characteristics of the material?

Sure. So the exciting thing is that there's no difference. To the consumer, it's completely -- it doesn't matter. They won't be able to tell the difference. And I think it's a little early to kind of call out some of the cost differences just because we're blending it in to our existing. So it'll obviously increase over time. So for next year, it's not a big driver of cost. And we're also hoping that as we scale and as these resources become more widely available, then we can get a little bit more cost leverage. So I would say that's included right now in how we're thinking overall about our 26% operating margins long term, and we'll certainly provide more insight into that as we get a little bit closer to having it become a bigger mix of our shoe. I am excited that it's launching them next year, and I think consumers are going to be excited to not have to make a choice between buying something sustainable and buying something that they've always loved, right, which is our traditional Classic.

Makes a ton of sense. The last series of questions, Anne, that we saw in the queue kind of related to return of capital. And I was wondering if you could just spend a moment on your balance sheet and how investors should be thinking about capital allocation going forward. And in particular, there was one question in the queue around the cadence of some of the share repurchases that you're expecting in the near term.

Sure. So we obviously generate a lot of free cash flow and are very pleased with our very strong balance sheet. I think our priorities are, first, investing in the business. But obviously, we have excess cash left over after that. Second, as we talked about during our Investor Day, share buybacks have been an important part of our capital allocation strategy. And we expect to repurchase $1 billion worth of shares this year at the -- again, at our investor conference, we announced a significant accelerated share repurchase that would finish by the end of this year. So that would get us to the to the $1 billion of share repurchases this year. And we -- we're very opportunistic. So we took the opportunity this year to issue debt, fixed rate debt, long term, low interest rate and really use that to buy back shares as we're very confident in the long-term trajectory of our business. And then I think finally, there's -- M&A is third, and that's really -- we continue to -- again, we're opportunistic. So we'll continue to evaluate M&A opportunities as they become aware. But excluding M&A, we're very confident in the long-term trajectory of our business.

And Anne, maybe one final question on that topic from the queue. How should investors be thinking about the composition of CapEx going forward? I think you guided to something like 3% of sales for the longer term.

Yes. Our CapEx is pretty straightforward. It's really based on the growth of the business and supporting the operations. As Andrew talked about and touched on briefly with digital, being able to continue to grow operations and our operations footprint and our distribution, to be able to support that digital business is kind of the biggest chunk of capital so that sits in distribution centers both in the U.S. and abroad. I would say that's the largest part. There'll be other pieces as we continue to support growth. But the biggest part of our capital spend will sit in our operations functions.

Makes a ton of sense. I am not seeing any further questions in the queue. Andrew and Anne, I might just ask, are there any other topics that we didn't discuss that you think should be on folks' mind?

No. I thought -- I think that was very comprehensive, Farid. We really appreciate you organizing all the questions. I think we've given -- hopefully given investors the opportunity to get a really good update and thorough overview. Sorry, my lights have gone out. That's our sustainability initiative. Lights are on a motion sensor. So I think we've given investors hopefully a really good overview of what's going on within Crocs and our confidence in our growth trajectory and industry-leading profitability for the future.

Yes, we would agree. Thank you so much for joining us, Andrew and Anne, and best of luck for the rest of 2021 and into 2022. Happy holidays.

Happy holidays to you.

Thank you. You, too.