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

Welcome, everyone. We'll get started here. I'm Jon Komp, Baird senior analyst covering the active lifestyle sector. Really pleased to have Crocs with us today for this session here. I'm sure you all know the brand Crocs, but the company really is a leading casual footwear brand sold globally in more than 85 countries and has executed incredibly well the last few years and grown to well more than $2 billion for the core Crocs brand. On top of that, completed earlier this year, the company acquired HEYDUDE, which is another lifestyle brand that is expected to reach almost $900 million of revenue this year. So joining us, we have CEO, Andrew Rees, who took over as CEO in 2017, was at the company longer than that, has more than 25 years of experience in the industry; and CFO, Anne Mehlman, who rejoined in 2018 after an earlier stint with the company. So thank you both for joining. Happy to have you here. And Andrew, I'll turn it to you to start.

Thank you, Jon. I appreciate the introduction and appreciate everybody's interest today. As Jon mentioned in his introduction, we feel like the Crocs, Inc., the Crocs company is in a really great place. We have 2 fabulous brands, the core Crocs brand, which was 20 years old this year, has grown very significantly over the last several years and, we believe, has a very long and significant growth pathway in front of us. We also purchased HEYDUDE at back end of last year and culminated that transaction earlier this year. We're also really enthusiastic about the prospects for HEYDUDE. We see it as a brand that really plays into some of the same global macro trends that we're focused on. We're focused on providing consumers with affordable, lightweight, comfortable, easy-on-and-off shoes. We think those are kind of very significant global macro trends. HEYDUDE also appeals to those. So we're very excited about the integration of HEYDUDE into the Crocs company and our ability to grow both brands in parallel and see some leverage and synergies from operating them. So that being said, obviously, we acknowledge that the consumer environment potentially is going to be more difficult here in the next period of time but really believe that with the positioning of these brands, that also provides us an opportunity to gain share. So delighted to talk more about our prospects in the next few minutes.

Yes, that's great. I'll start the Q&A. And for those in the room, please feel free to e-mail me with the table tents, and we'll work it in. So it's interactive. But Andrew, maybe to start, if you could expand more, I know Crocs has had a multiyear effort to really increase consumer consideration and really to become a much better operated brand. So if you could start by expanding more on what's different and what -- everything you've accomplished.

Yes, I'd probably break that out to 2 big phases, Jonathan. One, the first phase was a turnaround phase. So I joined Crocs in 2014 when Blackstone made a major investment. We since bought them out of that investment, but they made a major investment, which was really a stimulus for a lot of change in the company. And the first couple of years, probably 3 years, we really focused on a turnaround strategy. That was about reducing SG&A. We took out over $80 million of SG&A. A lot of that was around store closings but also kind of making the company work more effectively. We also invested in systems and processes, around sourcing, around how we run the company and just around core competencies. As a young fast-growing company, the Crocs brand really hadn't put a lot of time and effort into making the company work well. So we made the company work well and reduced its cost structure. The second phase of that was really engaging our consumers. So we completely retooled the strategy. We retooled the product strategy, where we innovated the marketing strategy and the different -- a very different focus from a go-to-market perspective. So that was all about focusing back on the iconic clog, which is the icon that you're all familiar with, the Classic Clog. That's where the heart of the company is. That's what the consumer is looking for from us. And in the prior management strategy, they were diversifying away from the clog. So we focused back on the clog and drove relevance for the clog. We also identified a couple of key areas that we were going to invest in growth. That was sandals and then also personalization. We engaged an all-social, all-digital and collaboration-driven marketing strategy. And I think those things was what then started to drive the growth within the brand, right? And we saw a building and strengthening growth prepandemic. And then during the pandemic, we also pivoted to engage health care workers and do a variety, I think, of very effective marketing tactics that really brought the consumer to the brand. So we've reengaged the consumer from a -- with a much more focused product strategy, with an innovative marketing strategy and a very clear go-to-market that prioritizes digital, leverages wholesale and leverages some direct-to-consumer retail, but it's really digital- and wholesale-orientated. And that's what's driven the growth. And with that growth, we've gotten very significant improvements in profitability and operating leverage.

That all makes a lot of sense. Separately, I get asked all the time, Crocs now being 100-million-pair-a-year brand and with very high operating margins. How do you get comfortable that you're not going back to prior lower levels that this new level is sustainable and it's a base that you can grow off of?

Yes. There are a variety of things. That is a question we hear a lot, too. And I think that's almost not conceivable to us, but that's -- you probably expect us to say that. I think there's a few things. One is this is a very different company. As I referenced a couple of times in my -- the previous answer, the Crocs company, when it first grew up, was very immature and very entrepreneurial, and it really didn't have the brand leadership, the consumer-centric innovation that you'd expect a consumer brand to have. I would say today, we have established a core competency around designing, developing, building shoes, marketing shoes and really have an excellent team and a strong brand leadership. We have a very strong reputation. So leadership and the talent that we have is kind of one big area. Second big area is all around distribution. So we've gained a lot of distribution from a wholesale perspective. We've got very well-established digital capabilities. So we've built out our footprint and gained distribution. That's profitable distribution for us. It's very profitable distribution for our customers. So they're going to have to find a better alternative to want to displace us, and that's not easy to do in this environment. The third thing is we're very focused on innovation. We're very focused on bringing new ideas, new materials, new concepts, new colors, new graphics to the consumer. And when we bring them innovation, we see them react to it. So I think we're confident we can continue to engage the consumer. And I think the last thing, and maybe I should have mentioned this first, is around those kind of global megatrends. So we see, on a global basis, the consumer wants comfort. The consumer wants casual. The consumer wants to buy digitally. The consumer wants personalization. So we're leveraging those kind of global megatrends to underpin our brand and underpin our strategy. And I think if the consumer continues to go in that direction, even if they have a little bit less money to spend and they may go in that direction a little bit more slowly, but I think they're still going in that direction. So I think we're very much in sync with their trends. So we're very confident that we've built a very robust base. It's also a very profitable base, which allows us to do all the innovation and investment.

I think on the profitability side, just to talk about that a little bit because if you think about the P&L, right, revenue was one piece. But actually, the whole kind of base of the P&L changed. So when you think about from a margin structure, from a gross margin structure, the drivers of getting to low 50s to last year, we were 60%. The biggest piece was redoing the product line had really nothing to do with kind of the external pricing piece. It was really around redoing the product line, going to molded products, right, selling our icon, our core. This is not our core but almost our core. Selling our icon, our core and then adding Jibbitz to those, that really created kind of the biggest jump from gross margin. And then second, then obviously, we started taking price in 2018 and have kind of layered on price for the last couple of years. And then you have a smaller bucket about 100 basis points that was promotions related to last year. But if you think about that, almost 1,000-basis-point jump, there are a lot of that is structural. And then kind of same thing on the SG&A. When you think about SG&A back kind of pre this cycle, it was really tied up in retail and fixed SG&A, which we actually cut all that back. We took a lot of markets to distributor markets and created a much more flexible SG&A model. So we cut the retail base from like roughly 600 stores to 300 -- a little over 300, and we reinvested that back into flexible marketing. So the P&L, even though there may be still -- like it looks similar from a dollar amount, it's completely different in the way that it's structured, which gives it a lot more resiliency.

Yes. That's really helpful perspective. Maybe looking beyond the current period, you've shared 5-year targets that include pretty ambitious growth. And maybe just talk more about what gives you the confidence to project the growth that you have. And is your confidence in the U.S. today in this environment than it was last fall when you announced the...

Yes. Yes, really good. So kind of one way to think about those future growth. We've more than doubled the size of the Crocs brand over the last 4 years, right? And essentially, our plans drive to doubling it again, right? And the backbone of those -- of that growth trajectory and the strategies that we plan to pursue to get there are actually the same strategies that we've used for the last 4 years, but we just see a lot more potential in them. So we see growth in clogs. We see growth in sandals. We see growth in personalization. We see continued growth in digital. And then I think very importantly, if you look at where we've grown over the last 4 years, it's been heavily weighted towards the United States. That's really driven a lot of our dollar increases. And so in a nutshell, we see the future growth being more outside the United States. We think the U.S. will continue to grow. But the bolus of dollar growth will come from outside the United States, in important markets in Asia. We've talked quite a bit about China but also other major markets in Asia. And I remind everybody, these are big markets, right? The Chinese footwear market is the second biggest footwear market in the world, followed by Japan, so the sort of #2 and #3 footwear markets in the world are in Asia. But we also see growth in the Middle East. So in essence, I think we believe the playbook that we've developed and proven that works has more room to run, right? Yes, that could be harder in a different consumer environment because I think we've not got the flood of stimulus money, especially here in the United States that we had last year. We haven't had the -- but I think we also have things going on overseas. Like in Asia, I think the one of the things that's going on in Asia, with the exception of China, COVID, where they've had the lockdowns, a lot of the Asian markets are just now opening up. They didn't really open up last year like we did. So we see those markets opening up. So we continue to see potential for growth in those markets. And plus also, and maybe Anne can talk a little bit about this, we didn't plot on path for that growth trajectory. Anne, why don't you talk about some of the scenarios we...

Sure. Yes, I think in one data point just around Asia that for the first time since 2019, we saw our Southeast Asia distributors return to growth. So over that 2019, so 2020, '21, they've been a headwind, really, and we've done a lot to kind of hold back inventory and make sure they're in a good position to come out. So kind of an exciting sign this year to see them actually return to growth over '19. But from a scenario modeling standpoint, obviously, we know everything doesn't go perfectly, and it actually hasn't even for us over the last couple of years. It's been kind of bumpy with COVID. I think we plotted several different ways to get there. So when we looked at $5 billion and we looked at, okay, different scenarios of like what happens in the U.S. versus the rest of the world and how do we think about that, so -- because we knew that it wouldn't end up just in one way. So I think when we looked at a number of different scenarios and share that with our Board and our team, we felt comfortable that like we had several different ways and several different choices we could make in order to get to the same outcome.

So same playbook for Crocs. What's not the same is adding a new brand, HEYDUDE. So Andrew, maybe talk about kind of the size and how you view the opportunity enough to acquire a second brand?

Yes. We saw it and associate it as an incredible opportunity, right? I think as we've thought about growing the Crocs organization, number one, we'll focus on Crocs because we could see the potential there. And as we thought about sort of the investment potential of Crocs, and we thought about the long-term future of Crocs, we did recognize that we're a concentrated company, right? So we're a single brand, a single-branded public company that has a very high proportion of its sales in a single silhouette, right? So that represents a high-risk profile. And we definitely heard from investors that they would appreciate some diversification of that risk go forward, right? So when we looked at that, we had sort of in the back of our minds at some point in time, when time is right, if we were to pursue another brand, one, it would need to be a scale brand. So when we came across HEYDUDE, we've been watching them for some period of time. Really, from a product-inspiration perspective, we could see what they were doing. We thought they were making great product. And then when it became apparent to us late last year, that they were, a, for sale; b, the growth rate and the size of the company, the profitability of the company in essentially a constrained distribution environment, right? So when we saw that kind of performance, we saw a fantastic opportunity to acquire the company to provide our expertise and leadership to the organization, to build out the organization in a way which, we believe, will drive kind of sustainable growth and be able to use our distribution infrastructure, both here in the United States and internationally, to chart a growth pathway for the company that I think was very tangible in near term. So we see it as an incredible opportunity. We think the company will grow very rapidly. It will be extremely profitable. It's a great fit with Crocs, and we're excited.

Question from the audience related to HEYDUDE, are you seeing any challenges getting it shelf space in some of your accounts? And then maybe more broadly, how do you see distribution evolving '22 and '23 and beyond?

Yes. So no challenges getting shelf space, right? So it's exactly the opposite, where the major constraint for HEYDUDE dude is supply and being able to scale supply. So the company has grown historically prior to our ownership at over 200% compound annual growth rate. They've done actually a great job scaling supplier for a very small base, but that is the constraint right now. So as we talk to our wholesale partners in the North American landscape, they are absolutely -- even if they don't carry HEYDUDE today, which the majority of broad-based wholesale retailers do not, it's been more of a kind of mom-and-pop distribution with a couple of select national players. They're very much aware of the success of the brand, the consumer engagement, the getting requests for the brand and where we have isolated some product to do some testing, and some of those, it's been extremely successful. So there is tremendous demand from our wholesale partners to carry the brand on a broad basis. So -- and then I think your second question there was where, right? So today, I think the best way to think about HEYDUDE's distribution is kind of down the middle of the country. It's through the Midwest to Texas and into Florida. That's where you see the brand. That's where the brand has about 20% awareness. If you look on the coasts, both East and West Coast, the brand has a less than 5% awareness. So that gives you kind of an indication of where it's distributed and what people know about the brand. What we're primarily looking to do in the short term, in the short term being predominantly early next year, is broadened distribution with national retail chains. And I think that will be a very achievable task. And then beyond that, we'll then look at international growth, first, predominantly in Europe, and then we also look at Asia subsequently.

Yes, that's great. Maybe pivoting a little bit more towards the near-term environment. You shared a positive update on the first quarter. You raised the full year guidance at the time based primarily on the HEYDUDE brand. Can you just share more of what you're seeing in the business across some of the key markets and your assessment of the consumer environment that you see?

Yes. So I think the best way to think about this is it's very situational, right? So we see different things in different parts of the world. And as we kind of manage the company and think about that, I think it's important to be prudent where we need to be prudent. It's important to be -- continue to be assertive where there's a potential to be assertive, right? So maybe I'll kind of just talk about a few regions. The North American region, I think there's a lot going on with the consumer. I think we anticipated the lack of stimulus, and frankly, many of our wholesale customers anticipate a lack of stimulus, and I think we're quite realistic about what this year looks like. I think there's various high-profile announcements out there of companies that maybe weren't realistic about what this year is going to look like. But I think in the footwear industry, we feel like a lot of our partners were pretty realistic. They've forecast their business down. They've planned their business down, and we've planned accordingly. So I think that's kind of one dimension. But I think where the consumer goes, they're certainly feeling more cautious. They're certainly impacted by lack of stimulus. They're certainly impacted by inflation and worried about energy cost. But where they go, I think we'll all have to kind of remain a little bit agile and see how that goes. I think it's certainly not going to be -- it's not going to be like it was. It's going to be much more cautious. We see something a little similar in some parts of Europe. So if you look at kind of Northern Europe, we see something similar there, and they're certainly worried about inflation. They're certainly worried about the war, and they've become quite cautious. But that's -- in our view, that's not mirrored through all of Europe. If you look at Southern Europe, which is a very tourist- and vacation-orientated, they're pretty buoyant. They're looking forward to a great vacation season as Europe vacations. So we see some different patents there. Middle East and Africa, we see different patents. And then Asia is kind of a little bit the opposite. They're opening up. So there, the consumers are out there shopping again, and they see growth in the consumer economy. So we're a global company, so we're not just driven by what is happening here in the United States, and we have to kind of look at all different parts of the world. I think what is certainly true as we think about the future is there will be significant -- there is a lot of uncertainty in the world today. And as we think about kind of managing our company and as our brand, we want to remain really agile and nimble and read the consumer in the moments that they are and manage accordingly. And I actually think -- if we think about the COVID period over the last 2 years, we've demonstrated a tremendous amount of agility that has been very successful for the company and for shareholders.

Maybe a similar question but focused on inventory and then the promotional levels you're seeing in the industry you're expecting. Maybe if you could comment on those.

Maybe we can share that a little bit. So I'll let Anne talk a little bit about kind of inventory, and then I'll talk about promotions.

Yes. Perfect. So from an inventory perspective, again, it's very geographical. So I would say from the U.S. side, we definitely have elevated inventories, and we've seen that because -- and we expect to have them all year. We talked about that. Part of that is because in-transits, right? In-transit times are very long. And so we're having to carry more inventory. And part of that, we definitely saw a phenomenon where people from a wholesale side and some of our partners were overordering because they weren't sure what supply they were going to get. So we're making sure that we manage what's in channel because that's the most important, right? And our inventory were a little lucky because it's core. So -- and most of our inventory that came in the first half was core. So we can -- it doesn't have an expiration date, so we can control how much of that is in the market. From an EMEA perspective, they still remain lean. As you may remember, they were the most impacted by our Vietnam factory shutdowns. And that, especially showing up on the distributor side, where we had shifted a lot of inventory up channel, and so we're working hard to make sure that we can fulfill those and also move the -- we shut down our Russia business or paused our Russia business. So working through reallocating that inventory. And then Asia, I would say, is in really good shape. We've done -- we've really controlled the amount of inventory that's been sitting there. And even though Shanghai has been shut down and just come off a 68-day shutdown, we feel really good about the amount of inventory that we have in Asia, and kind of, I think, they have the right amount of inventory and the right amount of chase. So that's kind of the overall inventory picture for the globe.

Yes. And I think as we think about it, we kind of disconnect promotions from management of inventory because I think what's going to happen -- well, there's not -- I think it's already happening, right? In the footwear industry, I think we're returning to a more normalized cadence of promotional activity to incent consumer takeaway, right? So around key promotional events, whether it be Memorial Day, Fourth of July, Cyber Monday, et cetera, we're going to see promotions offered to consumers at key times to incent consumer takeaway. Our point of view is we're a democratic, broadly distributed brand. Our intent is to participate in those promotions. We'll participate to get our fair share of wallet and continue to drive the business forward. That is not a reaction to kind of inventory. That's a reaction that, I think, that's what the consumer environment is going to be and how we're going to participate in it. And I think Anne's team did some really great analysis just recently. We looked at the margin uplift that we see and the gross margin uplift we've seen since 2018. I think it was in 2018, which is 1,000 basis points, right? So an awful lot. The proportion of that, that was related to reduced promotions was 100 basis points. So 10% of the overall uplift was orientated towards reduced promotions. So I think we can expect to give some of that back. The majority of that uplift was pricing, was mix with Jibbitz, et cetera.

Great. Maybe a question from the audience, more near-term focused. The question is, do sandals pose a risk to the guidance that you've outlined? And then maybe the follow-on to that, can you just talk about some of the factors that you've embedded in the second half outlook and give you confidence in the guidance you've provided?

Let me talk really quickly about -- sorry, sandals and then turn it over to Anne to talk about guidance. So it's definitely been a slow sandal season, right? We've had not great weather here in the United States, and I'm talking really about the United States. So slow start to the sandal season. It has heated up a little bit in the last 10 days as the weather has improved, but it's not a great sandal season. So I think that is -- it's unlikely, I think, at this point, you catch up through the rest of the season, so -- but I don't think that has -- I don't think that factor presents any risk to our guidance.

Yes. We also anticipated lower sandals because of our lack of new -- like we had cut sandal -- sandals because of the -- we needed to focus on core because when Vietnam shut down, we wanted to maximize the amount of product that we would be able to make. And so a lot of that newness that we cut was in sandals. So we did actually anticipate that we would be slower in the first part of the year for sandals as well. We didn't anticipate the sandal season part, but we anticipated the amount of sandal product we would have available. So that is something to think through. And then for the full year, I mean, nothing has really changed there from how we've talked about it. As far as -- what we said is that we have visibility to an order book, both in the U.S. and internationally, obviously. Then we have our DTC trends, and then we can look at a lot of different external factors. So how in demand the brand is, we do brand awareness surveys, and we do brand surveys. And then we look at our own DTC channel. So we look at things like organic traffic or traffic overall, retail traffic. And so of course, there are things that you don't anticipate. I would say, we definitely didn't anticipate last November that there would be a war, that we would pause our Russia business. We didn't anticipate that China would be shut down but like -- so I'm pretty pleased that we were able to like incorporate those things into Q2. I think we also have currency kind of moving around and all those pieces that weren't anticipated back in November. But again, we do have clarity into order book. And the other thing is in the back half of the year is actually currency comps get a little bit easier at current levels, and we have a lot of newness coming in. So some of that newness that we've been impacted in the first half of the year because of the Vietnam shutdowns, that eases through the back half of the year.

Maybe a follow-up then on the cost environment. Just if you could share what you've seen in terms of the cost increases. And then I know you've been proactive on pricing over the last couple of years. But what are your current thoughts on pricing and ability to offset some of the cost inflation?

Yes, I think we've done an excellent job. We've offset all of the cost inflation up until this year. I think from this year perspective, we have $75 million of airfreight, right, which was related again to the Vietnam shutdown. That's not our normal practice. We don't use a lot of airfreight. So I would consider that kind of nonrecurring in nature. So if you think about the $75 million and kind of exclude that, we're still covering off. We more than covered off cost increases in Q1. And the biggest cost increases really have been coming in the forms of freight. So inbound freight, those levels have been elevated as you guys all know for the last year. So we didn't anticipate those getting better this year. There could be potential signs that it may start to ease a little bit. But as I said, we haven't anticipated that. That would be incorporated into what we talked about for the year from an operating margin standpoint. And then I would say the other piece is kind of on the input cost side. And there's not a perfect correlation for us between natural resources like oil and our resin prices because there's other things that go into that, like a strong U.S. dollar is actually helpful. There's other pieces. We kind of negotiate those every 6 months. So that would be -- we've obviously absorbed those headwinds. We did take some price in our Europe markets and Asia markets at the beginning of this year. We had already taken price in the U.S. last year, which is -- will flow through the first half of this year, and then we'll start anniversarying in the back half. So I feel like we've done pretty much all we can to offset those inflationary pressures at this point.

Great. And then we've got a minute left. So maybe Andrew, I'll -- if we could end it just, obviously, the message and the stock price are sort of 2 different factors these days. But just what are your thoughts on where you may not be getting recognition for everything we've talked about today?

Yes. I think -- well, clearly, I think given what we see as the financial performance of the company and the growth prospects we see for the company, even relative to our kind of guidance for this year, we're certainly not getting recognition in the stock price. I think the -- I think what we need to focus on is just continuing to execute. And that's kind of what we focus the teams sort of each and every day, keep executing. I think the biggest question in people's minds that we hear about is the sustainability of Crocs, right? And I think we believe Crocs has a growth pathway from here. To get to the current stock price, you have to have -- you actually have to believe that Crocs is going to shrink. So those are sort of diametrically opposed points of view. And I guess time will show.

Great way to end it. Well, if everyone could join me in thanking Anne and Andrew for joining us.

Thank you.