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

Good morning, everyone. I'm Bill Reuter. I'm the high yield, retail, apparel and footwear analyst here at Bank of America. Very pleased to have Anne Mehlman, the Chief Financial Officer of Crocs, a company that has great momentum and also one that I think is very cool. So Anne, thank you for joining us.

Thanks for having me.

So for you attendees that have logged in, please feel free to filter in your questions through me through the interface, I'll get those asked. In the meanwhile, I will hop in with some that I have. The first is that, to me, Crocs, I believe, is a company that has benefited by being hot. I'm wondering how you believe that you maintain this, how important collaborations are in light of this? And how you think about the risks of oversaturation in the market?

Yes, it's a great question. Definitely, we've seen some tremendous revenue growth over -- since 2018 and this year. On our last earnings call, we guided that we would be up 62% to 65% from a revenue perspective this year and over 20% next year. So certainly, that is because the brand has resonated with so many people. I think the way that we continue doing that is really through marketing innovation. And so we created this, I will say, growth streak because the brand is very recognizable. Everybody knows a Croc when they see it but they didn't think it was relevant for them. So we had to drive relevance, and we did that through marketing innovation. And that was collaborations, as you mentioned. And also we have a very democratic brand proposition. So we're a brand of the people, for the people. We've had 4 years of double-digit increases in brand relevance. We have a strong -- we've done that through strong collab pipelines, and we can collaborate all along the spectrum from niche streetwear brands to Post Malone to Luke Combs to Vera Bradley. So we sort of can speak to our very democratic consumer group. And we have a 360-degree integrated digital, global and local marketing campaign. So our campaigns are 100% digital. We made that switch in 2018, and that allows us to stay really close to our consumer and really understand what's happening in the marketplace. So I think those are all very important. I think the second thing is around product innovation. So really making sure that we're bringing product innovation. And that could be through collaborations, as you mentioned. It can also be through personalization, which is our Jibbitz that you put in the holes in the shoes and really allows the consumer to take our blank canvas of a clog and really personalize the shoe to what they want, and that's been huge. And that's really connected and tapped into that global personalization megatrend. And then we do a good job of bringing relevant colors and prints to the market to make sure that they're on trend with the consumer. So those are all very important for keeping the brand tight. I think also really focusing on our distribution and making sure we have an allocated distribution strategy in the U.S. where we really focus on what product goes to who and how much to make sure that we're controlling the brand. So I think it's all about staying close to the consumer and really driving that marketing innovation.

Yes. That makes sense, and I've seen all of that in the market. It seems like sandals is your greatest growth opportunity. It also seems like this is a bigger challenge because it's not so much using all of the equity that's been built up in your iconic clogs silhouette, but it's competing against a huge group of competitors in a very fragmented category. How do you expect that you will approach this? Like how quickly do you think you can achieve some of the growth targets that you've set out for yourself?

Yes. So I think from a sandals perspective, the reason why it makes sense for us is because it's something that we have permission from our consumer to sell. So we've had a pretty good sandals business for many years without really focusing on it. When we talk about sandals, it's slides, it's wedges, it's strappy flat sandals, it kind of runs the gamut. And so we know that this is a big opportunity because everybody sort of has the -- there's many brands that play in sandals, but there's very few brands that that's their core focus. So one of the things that we're really excited about that shows that we're gaining leverage in sandals is that our consideration for sandals is now equal to that of our clogs. Meaning that when we surveyed our U.S. consumers, they are actually considering buying a sandal from us equal to that of buying a clog from us. And obviously, you know how big our clog business is. So that's pretty exciting. And sandals is a much larger market. And also the sandal customer tends to return every year and by many pairs of sandals that she feels are on trend. So by leveraging our brand strength and our expertise in marketing as well as personalization, so we've expanded Jibbitz, which I just talked about, and that personalization to our sandal product. So you can see that in our slide in our two strap this year, and we'll continue to expand on that. We think that can really speak to the consumer as well as leveraging our brand DNA, molded, comfort and light. And so our C&O revenue right now is up 31% year-to-date. And we think that long term, by 2026, we grow 4x. It's about $300 million on a trailing 12 months when we talked about this. So that's a $1.2 billion sandal revenue for us by 2026. And we're really optimistic about the ability to serve multiple sandal consumers. And the way we're targeting kind of our sandals is icon, which is that two strap, really building on the clog, iconic, you -- it has Jibbitz. It looks kind of like a classic clog, but it's a sandal with the slide; style, which is our Brooklyn Wedge; light, incredibly comfortable, but definitely more stylish comfort, which could be a Crocband Flip. Or some of our product that's targeted a little bit more of our feel-good consumer and then adventure sandals. So a little bit more play on the outside -- on the outdoor, such as our Swiftwater sandals.

When you think about your competition, who do you view as the biggest competition to the brand? And I know that, that may be obviously different across the different products. But I guess how do you view that? And then do you -- does private label as a competitor, do you view that as a risk? There's obviously some knockoffs. You guys, I think, do your best to try and differentiate yourself in a lot of different ways, but if you could talk a little bit about that.

Yes. So we built a really strong brand that consumers seek, and our price point is pretty democratic. So -- and footwear is obviously a lot more branded than apparel. So I wouldn't say private label is a big threat. And then obviously, we have good protections around our Classic Clog product in the U.S. that allows us to defend our trademarks and our brand pretty rigorously. So I think people are willing to pay for our authentic product because our Classic Clog is $50, and I think the consumer sees the value in our brand. From a competition standpoint, I think we talk about it as we compete for wearing occasions. So whether that's a sandal might have a certain competitor versus a clog is more -- even though we don't have a direct competitor on the clog, it's more about we're competing for wearing occasions. We might be competing against other comfort. So casual comfort footwear brands are what we think about as our competition.

Pushing gears a little bit to talk about some of the challenges with regard to the supply chain. I'm not sure what you might disclose around this, but manufacturing in Vietnam has obviously been incredibly disrupted during July through September. I guess, has this improved? And with climbing cases, have you either heard any indications that there may be facility closures? Or do you worry about this going forward?

Yes, it's a great question and obviously, very top of mind for everyone. Definitely, the situation has improved from July, August, September, substantially, I think. As of today, most of our factories in Vietnam are operational. Although they are in various stages of opening and closing based on kind of, I'll call it, the COVID whack-a-mole game. But they are -- it's much more, I would say it's the zero-tolerance policy seems to have moved off a little bit. And so when there are COVID cases, the factories close and then reopen rather more quickly. And we are seeing vaccination rates tick up as well. So the situation is better. I will also say we have a competitive advantage. What we've seen is that our speed of ramping back up is pretty high. And what we've experienced from other COVID shutdowns is we have few components. We have simple production. We don't have a ton of labor, so we can ramp very quickly. So that is, I think, a competitive advantage for us as well as the actions we've taken to ship production to other countries, including China, Indonesia and Bosnia, where possible so that we can quickly ramp if things shut down in certain geographies.

Yes. I'm not sure what -- that's helpful. I'm not sure what you may be able to share in terms of your current sourcing in terms of geographic diversification and what percentage of different regions represent, but if you could share any metrics there. And then how the disruption we've seen this year caused you to alter your outlook for how you will diversify your manufacturing going forward?

Sure. So what we shared on our Q3 call is that Vietnam was meant to represent about 70% of our production this year. It actually ended up -- it's going to probably end up around 60% as we've shifted production, so 60-40 split. I will say we were in the process of diversifying anyways just to tap other markets. I mean we've been in China for a number of years. We've actually moved a lot of production from China to Vietnam, but China is still an important part of our manufacturing footprint. So we've also been diversifying to Indonesia. We'll have a second factory open in Indonesia by the end of this year. We're looking at diversifying to India, and we should -- I think we start building with our third party, obviously, doing -- building that out next year, so operation in the following year. So we were already looking at diversification. I think Vietnam, obviously, we've accelerated where we could and maybe move some production in other places. But Vietnam will still remain an important piece, but I think a diversified supply chain footprint makes a lot of sense.

I know that Vietnam made a big push in footwear and apparel over the last 5, 10 years. Is their production capability better? Is it cheaper? Why has so much of the industry moved to that country? And I guess the capabilities in the other countries you're moving towards, is it more or less an equal transition? Or actually, are there some challenges with that?

Yes. I think it depends on the country. So Vietnam tends to be -- so for footwear -- and our footwear, again, is relatively simple. It was easy for us to move production to Vietnam. I think China still has kind of a lot of the technical, highly technical manufacturing, technical from a footwear perspective. I think Vietnam is -- does tend to be cheaper. They also have some import and free trade agreements from a Europe perspective, which makes it very desirable. But I think there are other -- Indonesia also has good capabilities. I think India has good capabilities and then there's benefits to manufacturing in India from a local perspective. So I think, again, it depends on the geography and kind of labor rates and all those things in the geographies. But I think there are plenty of other compelling places to manufacture, but Vietnam is still important and will remain important in the long term.

You have contended with increased freight costs as well as any companies that I know pretty much during 2021. Would you -- you have talked about a relatively large headwind of $75 million in 2022 for airfreight. Will those costs largely go away in '23? How are you moving to try and put in place other permanent ocean freight, I guess, strategies that won't be as expensive?

Yes. I will say, I mean, we definitely have -- we normally don't use airfreight or certainly not at this level. I think this year, we're going to spend about $10 million in airfreight, and that's much higher than we normally spend. So $75 million, I don't expect that to be repeated. From an ocean freight standpoint, certainly, we've seen increases as well as just transit time increases or transit times have more than doubled to the U.S., and also expanded to Europe. So -- but I think we can handle those if we didn't have kind of the supply chain shutdown as well. So I think the kind of exacerbated and increased the need for airfreight. So I feel good about our ability to kind of manage through this year. The airfreight next year, we think, is important because financially, we are very strong. And so we think this will actually give us a competitive advantage. And it's really important for us to bring that product in, ahead of our spring summer season, but I don't see us using airfreight like this going forward.

We've talked about some of the drivers of the brand itself. In terms of growth of the footwear industry, I guess, do you worry that there was so much discretionary dollars being spent on footwear and apparel that we could see category declines in 2022? I guess I'm wondering how much -- some of that would have been driven by all of the stimulus as well as based upon some reopening excitement that may have enticed people to spend more on some of these categories.

Yes. I mean I do think stimulus certainly didn't hurt, but I'm not sure. Footwear is growing, it's a pretty good market and it's been a growing category for a number of years. So I don't see a big shock to the footwear category in general. I think what the pandemic done has accelerated some key trends that are important for us, which are casualization as well as continuing to accelerate the digital trends that had been a trend before. So both of those were already trends, but it just accelerated those things. And I think even as things hopefully start to normalize at some point, those trends are here to stay. And so that really helps us overall as a brand and over -- helps us continue our penetration in the market.

Shifting gears a little bit to some financial questions. Previously, you've targeted leverage around 2x. Is that still the appropriate level of leverage here? There's obviously a huge equity market cap at this point. So I guess, how do you come up with a 2x leverage target in light of the high equity valuation or strong...

Yes. I think 2x leverage target is probably where we would kind of max out from like an ongoing leverage. I mean, obviously, we can flex up and down this year. We're going to end up down around just over 1x around that. So not near 2x. We feel like we have flexibility to go up to 2x. Frankly, at this point, we don't have a use for capital that would get us up that high because we generate so much free cash. We are super opportunistic this year about accessing the high-yield bond markets, put some long-term debt at cheap interest rates, and I'm pleased with that. We were able to buy back some shares, which we thought made a lot of sense and was a great return on capital for our investors. So we'll continue to look at opportunities and see what makes sense. But I think 2x is kind of where we feel kind of operating the business on a long-term basis if we needed to, but that doesn't mean that we're going to necessarily go up to 2x or run that long term, if we don't have a need for the debt.

I guess you have a lot of organic growth opportunities, but there's obviously -- you mentioned you don't have a lot of uses for cash, but M&A is always an option. I guess, are there -- at this point, would you consider expanding through acquisition? And is there a vision that this could ultimately be a portfolio of brands over time?

Yes. I think it's -- when we laid out our long-range plan back in September and said, "to get to 2026, we're going to be a $5 billion brand." As you said, it's a lot of organic growth. And we think that represents a really great return to shareholders. So that's the focus. As we've always done, we continue to evaluate M&A opportunities as we become aware of them. But independent of M&A, we remain confident in our current long-term growth plan and don't see that we need to become a portfolio of brands to execute on that specific growth.

Okay. And then given that, I guess, should we assume that the majority of the company's free cash flow will be allocated towards shareholder-friendly activities whether that be either dividends or share repurchases?

Yes. So the way that I think the way that we talked about this back in September at our Investor Day is, obviously, our first priority is to invest in the business to support our growth. we said CapEx should be about 3% of revenue long term. And really, those investments are around operations and distribution center or distribution improvements just to their overall infrastructure to help us scale in an efficient manner as we grow. But obviously, we produce excess free cash flow. So yes, that would be -- second would be share repurchases where it makes sense. And then third would be M&A. It's how we prioritize. And this year, we're going to buy back about $1 billion worth of shares using those proceeds from our high-yield bonds.

Yes. You've obviously been very active over the second half of this year. In terms -- could you see the company approaching a position where they would want to be paying a dividend? Or do you just think there's so much organic growth opportunity that it doesn't make sense to transition there?

I don't think a dividend makes sense for us. I think we would -- we're a growth company and we want the flexibility. So share repurchases probably make more sense for us to return capital versus the dividend.

By the way, to anyone who is still -- for all the attendees that are still online, please feel free to ask questions. There's a good number of you on. And so in the event that you guys have questions, please feel free to filter them through me. Another question is labor inflation. Are you guys experiencing -- obviously, you outsourced your manufacturing. So you don't have that. Are you experiencing any meaningful labor inflation and other components of the business? I would imagine most of corporate costs would be relatively modest.

Yes. No, we are experiencing labor inflation. We talked about -- at the beginning of this year, we were really proactive in raising retail salaries and we came out and said we're going to take all of our retail employees -- our hourly retail employees to an average starting wage of $15 an hour. And so that is -- and that was in our SG&A for this year. That was an investment we made. Also, I think like everybody else, from a distribution center perspective, in the U.S., we're definitely seeing some wage inflation there. However, we took price early this year ahead of some of those inflationary impacts. So that would all be incorporated into our operating margins. But certainly, labor inflation, we're seeing kind of the same as everybody else is seeing, that it is definitely a factor right now.

Do you anticipate any changes in the company's advertising strategy in terms of how much you will be allocating towards it? You mentioned you're already doing all digital and made that transition a handful of years ago. But I guess, how you think about the return on increased investments?

Yes. I think the wonderful thing about digital marketing is, obviously, we can kind of pull back or push as we see things perform. And our marketing team does a great job of experiencing new mediums, experimenting on social. And there's different pieces around the world, like we launched Douyin, which is Chinese TikTok, and we do TikTok in the U.S. this year. So we've really started to play with different mediums and kind of play with different returns. We also have our collab strategy. We have a full calendar of collabs. We just announced our Salehe Bembury collab, which is very exciting and very cool and new silhouette for us, which is kind of different than what we normally do. So it's still our clog, but it looks a little different, they're a classic. And that will launch this year. So I think there's many different ways that we do advertising. And then obviously, there's our performance marketing, which is associated with digital, and those have great ROIs as far as bringing in new consumers to the brand. So right now, I think this year, we said we'd be right around 8% from a marketing standpoint, and we think that's a good level. And yes, I think I'm the only CFO that wants to give their marketing department more money because it's measurable, which is nice.

Yes. That's probably the case. In terms of the retail strategy, a while ago, you guys pulled back on some of your stores. Can you talk a little bit about where you view the opportunity now? I think it's largely going to be based upon outlets, but maybe just give us an update there.

Yes. Our store base has obviously been pretty stable as we've reduced a lot of stores. In the U.S., it's largely outlets, and that's a good format for us. We think that's a -- our footprint will remain mostly the same. We might open a few new outlets, but pretty stable. I think where there could be some store investment is in China. So we have -- we took back some outlets from one of our partners this year. And then also, we've built out some small footprint, but kind of experiential high-end stores in China to really help drive the brand there. And I think that we could open up some more select stores in geographies in China. So I would say, probably if there's any store growth, it will be mostly in Asia, smaller footprint stores. We also have a really good shop-in-shop business in Korea. So there are variable revenue stores. So you're in a department store and your rent is a percentage of revenue, and those are flexible. And so we have a relatively good-sized fleet there. So Asia is probably makes more sense. EMEA, we have very little. It's our most digital region, and it should stay that way. So overall, stable store footprint outside of Asia with some small growth there.

At your Investor Day, you guys highlighted the ESG initiatives in terms of also making much -- the components of the core products becoming more eco-friendly. I guess could you give us a little bit of a summary of what you did there and enable to continue to keep the functionality of the products, have them be unchanged from the consumer experience with regard to ESG?

Yes, I'm really excited about our ESG initiatives. I think educating our consumers that we already actually have a really low carbon footprint and then that we're going to be net zero by 2030 is a huge win for us. And I think the exciting part is, is that we're not asking our consumers to choose between the Classic Clog that they love or their classic shoes that they love, they can actually wear that shoe with confidence and just know that it's now even more sustainable. And so we're doing that by -- we developed a bio-based resin with Dow, in partnership with them, to basically -- so the shoe properties don't change at all. So it should be -- the consumer shouldn't notice the difference. But through that mix, it allows us -- it's a key part of us becoming net zero by 2030.

You touched upon price increases earlier. Can you talk about, in the event you were to see continued inflation in terms of raw materials, how frequently you're able to increase your prices with regard to your wholesale customers? And I guess, I know that most of your stores are outlet stores, so the pricing is going to be a little bit different than what we see in terms of retail pricing and full-price third-party retailers. But I guess, how you view pushing price up further in your own stores?

Yes. I think -- so the way that we think about it is direct-to-consumer, and outlet might not necessarily be different. You can have some relatively good full price selling in as well. I think what you can do is we took our price -- we've taken it up from -- I think in 2018, it was $35, we're now at $50. So we've moved it up quite a bit. This year, we took it from $45 to $50 on our key classic. And then the tertiary products around that have increased relatively with prints or buzz. We took that up in our own retail and e-com in the U.S. at the beginning of this year. And then we took it up in wholesale, so the wholesalers were able to sell through kind of at a higher price, and then we didn't increase pricing to them until the back half of this year. So we still have that flowing through in Q1 and Q2 of next year. I would say the bigger price opportunity after that is probably in our international markets. So we price market by market. And as markets heat up and we have pricing power at the consumer and permission, then that's usually where it will take price. And there's certainly opportunity in our international markets to align pricing a little bit better.

In your -- I guess, how are the margins across regions? Can you talk a little bit about some of those international regions and how you believe that the brand is perceived in the market and the ability to price there?

Yes. I think the margins across regions are a little bit different just based on two kind of things is one is how you go to market. So in EMEA and Asia, we have more distributors. So obviously, the gross margins are a little bit lower, but it flows through very strongly. And then scale, the ability to leverage SG&A is what we've seen in the Americas has allowed us to expand operating margins there. And we feel as we gain scale in these other international markets that should help from an operating margin standpoint. From a price standpoint, it's really market by market of how we're perceived. I think what we're seeing broad brush is EMEA is really starting to experience the hotness of the brand, as you said, that we've had in the U.S. and kind of that brand strength, and we're starting to see some of those things that we saw in the U.S. that are indicators that the brand is really starting to be very strong in EMEA. We are on a first cover of Vogue this year in EMEA. We've seen great things out of the U.K. So really exciting signs there. So I think that's a big opportunity. I think Asia is much different by the market. I think South Korea, we have great brand positioning there, a more premium position. And we've done a lot of great collaborations there to kind of support the brand. I think there's opportunity in China where I think we're just still relatively unknown for the size of the market. And Japan has been a difficult market overall just based on kind of the conservatism of the consumer. So there's opportunity for us to kind of rebuild the brand there. So I think it's market by market a little bit more in Asia. But definitely in EMEA, we're really starting to see that brand strength. So I think that is probably a closer in opportunity for us from an acceleration standpoint.

So I guess kind of wrapping this up, unless there's questions from the audience. When you look at the outlook for where Crocs is going to be in 3 years as a company relative to what it is today, is there something that you think will look tangibly different? How do you think that -- how do you think investors should view that kind of longer-term outlook?

I think the best thing about our strategy is it's not that we have to transform the company. I think it's doing what we do well already and just amplifying that. So taking our sandal business that we're already $300 million and expanding on that, continuing to drive the clog, building on international, becoming even more digital. So I don't think that the whole company is going to look different. I think we'll have more sandals in the market. And I think our international will probably be a bigger percentage. But other than that, I think that the company, we can take our core strategies, they still work and help us propel growth, which makes it such a great story.

Well, Anne, thank you very much for joining. All the attendees who have joined the presentation as well, thank you. I hope everyone has a happy holiday. The conference is almost over. But for those who still have meetings remaining, I hope that those go well. So thank you, everyone.

Thank you so much. Happy holidays.