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CROX > SEC Filings for CROX > Form 10-Q on 30-Jul-2014All Recent SEC Filings

Show all filings for CROCS, INC.

Form 10-Q for CROCS, INC.


30-Jul-2014

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Business Overview

We are a designer, developer, manufacturer, worldwide marketer and distributor of casual lifestyle footwear, apparel and accessories for men, women and children. We strive to be the global leader in the sale of molded footwear featuring fun, comfort, color and functionality. Our products include footwear and accessories that utilize our proprietary closed cell-resin, called Croslite. The use of this unique material enables us to produce innovative, lightweight, non-marking, and odor-resistant footwear. We currently sell our products in more than 90 countries through domestic and international retailers and distributors and directly to end-user consumers through our company-operated retail stores, outlets, kiosks and webstores.

Since the initial introduction and popularity of the Beach and Crocs Classic designs, we have expanded our Croslite products to include a variety of new styles and products and have further extended our product reach through the acquisition of brand platforms. Going forward, we intend to focus our footwear product lines on our core molded footwear heritage, as well as develop innovative casual footwear platforms. We intend to streamline our product portfolio, eliminate non-core product development and explore strategic alternatives for non-core brands.

The broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including department stores and traditional footwear retailers as well as a variety of specialty and independent retail channels. We intend to drive cohesive global brand positioning from region-to-region and year-to-year to create a clearer and consistent product portfolio and message, resulting in a more powerful consumer connection to the brand. This strategy will be accomplished through developing powerful product stories supported with effective, consistent and clear marketing.

As a global company, we have significant revenues and costs denominated in currencies other than the U.S. Dollar. Sales in international markets in foreign currencies are expected to continue to represent a substantial portion of our revenues. Likewise, we expect that our subsidiaries with functional currencies other than the U.S. Dollar will continue to represent a substantial portion of our overall gross margin and related expenses. Accordingly, changes in foreign currency exchange rates could materially affect revenues and costs or the comparability of revenues and costs from period to period as a result of translating our financial statements into our reporting currency.

Use of Non-GAAP Financial Measures

In addition to financial measures presented on the basis of accounting principles generally accepted in the United States of America ("U.S. GAAP"), we present current period 'adjusted selling, general and administrative expenses', which is a non-GAAP financial measure, within this Management's Discussion and Analysis. Adjusted results exclude the impact of items that management believes affect the comparability or underlying business trends in our condensed consolidated financial statements in the periods presented.

We also present certain information related to our current period results of operations in this Item 2 through "constant currency", which is a non-GAAP financial measure and should be viewed as a supplement to our results of operations and presentation of reportable segments under U.S. GAAP. Constant currency represents current period results that have been restated using prior year average foreign exchange rates for the comparative period to enhance the visibility of the underlying business trends excluding the impact of foreign currency exchange rate fluctuations.

Management uses adjusted results to assist in comparing business trends from period to period on a consistent basis without regard to the impact of non-GAAP adjustments in communications with the board of directors, stockholders, analysts and investors concerning our financial performance. We believe that these non-GAAP measures are used by, and are useful to, investors and other users of our financial statements in evaluating operating performance by providing better comparability between reporting periods because they provide an additional tool to evaluate our performance without regard to non-GAAP adjustments that may not be indicative of overall business trends. They also provide a better baseline for analyzing trends in our operations. We do not suggest that investors should consider these non-GAAP measures in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP. Please refer to our 'Results of Operations' within this section for a reconciliation of adjusted selling, general and administrative expenses to GAAP selling, general and administrative expenses.

Recent Events

On May 13, 2014, the board of directors (the "Board") of the Company appointed Andrew Rees as President of the Company with principal responsibilities for the Crocs brand, effective June 9, 2014. In addition, the Board appointed Mr. Rees as principal executive officer to serve until such time as the Board appoints a Chief Executive Officer of the Company.


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On July 21, 2014, we announced strategic plans for long-term improvement and growth of the business. These plans comprise four key initiatives including:
(1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic markets, (3) creating a more efficient organizational structure including reducing duplicative and excess overhead which will also enhance the decision making process, and (4) closing or converting approximately 75 to 100 Crocs branded retail stores around the world.

Financial Highlights

During the three months ended June 30, 2014, we experienced revenue growth of 3.6%. We continued to experience strong revenue results in our Asia Pacific and Europe segments as market demand continues to grow through our wholesale and direct-to-consumer channels. Specifically, we experienced a 1.1% increase in comparable store sales in our Europe segment led by increased sales in Belgium, Russia and Spain. We experienced difficulty in our Americas segment as wholesale accounts remain lean on inventory and our retail channel remained flat despite an increase in retail locations primarily due to a 6.2% decrease in comparable store sales. On a constant-currency basis, our Japan segment experienced modest improvement; however, limited ability for growth in Japan due to macroeconomic turmoil continues to present challenges for the business as we saw the lingering decline of Japanese Yen decrease quarter-over-quarter revenues by almost $1.6 million and operating income by $0.5 million.

Globally, we are focused on expanding and improving current relationships with wholesale partners; however, as mentioned above, wholesale accounts remain lean on inventory levels and at-once ordering. We experienced a $4.9 million, or 3.7%, increase in retail channel revenues primarily through the addition of 49 global retail locations (net of store closures) since June 30, 2013 partially offset by a 5.1% decrease in comparable store sales compared to prior year. As we continue to diversify our product line with new footwear brands such as the Stretch Sole and Busy Day and carryover products such as the Huarache and A-Leigh wedge, we are experiencing a reduction in clog sales as a percentage of revenues.

The following are the more significant developments in our businesses during the three months ended June 30, 2014:

Revenues increased $13.1 million, or 3.6%, to $376.9 million compared to the same period in 2013. Revenue growth was predominately driven by a 0.6% increase in global average footwear selling price realized through new and classic product expansion as well as a 3.6% increase in global footwear unit sales.

Gross profit increased $1.7 million, or 0.8%, to $202.6 million and gross margin percentage decreased 150 basis points, or 2.7%, to 53.7% compared to the same period in 2013. The decline in gross margin percentage is primarily driven by the evolution of our product assortment and is consistent with our product strategy. As we expand our product lines, product mix shifts into styles that may utilize more expensive materials such as textile fabric and leather compared to the traditional clog.

Selling, general and administrative expenses increased $3.1 million, or 2.1%, to $153.4 million compared to the same period in 2013. Selling, general and administrative expenses increased due to the year-over-year global expansion of our retail channel and increased bad debt expense in our Asia Pacific segment as we are seeing slow payments from some of our wholesale accounts partially offset by cost savings in variable compensation. In addition, we experienced an increase of $0.3 million in expenses that we believe to be non-indicative of our underlying business trends including reorganizational charges as a result of transition activities, additional operating expenses related to our ERP implementation and charges related to litigation settlements.

We incurred $4.1 million in restructuring charges as a result of our strategic plans for long-term improvement and growth of the business. These charges included severance costs related to executive management as well as retail store closure costs.

We incurred $3.2 million in asset impairment charges related to certain underperforming retail locations in our Americas, Europe and Asia Pacific segments that were unlikely to generate sufficient cash flows to fully recover the carrying value of the stores' assets over their remaining economic life.

Net income attributable to common stockholders decreased $15.8 million, or 44.8%, to $19.5 million compared to the same period in 2013 driving our diluted earnings per share from $0.40 to $0.19. This decrease is primarily attributable to the increase in certain infrequent expenses such as restructuring and asset impairment charges as well as dividends declared on our Series A preferred stock and dividend equivalents as a result of our recent investment from Blackstone Capital Partners VI L.P. ("Blackstone"), which contributed a decrease of $3.8 million in net income attributable to common stockholders or $0.04 in diluted earnings per share.

We have halted our expansion of our retail channel locations and have begun to focus on the long-term profitability of current locations. We opened one global retail location in the second quarter 2014 (net of store closures) as compared to 28 global retail locations in the second quarter of 2013 (net of store closures). In addition, we closed an aggregate of eight locations in our Americas, Europe and Asia Pacific segments which were not scheduled to close until future periods and were selected for closure by management based on historical and projected profitability levels, relocation plans, and other factors.

We continue to fund the implementation of our customized and fully integrated operations, accounting, and finance ERP system. We recently launched the ERP in Australia and Japan with success and now expect the full implementation to launch globally in early 2015. We believe the introduction of the new ERP system to our current environment will allow for seamless and high-quality data across the Company. As of June 30, 2014, total costs to date related to the ERP


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implementation were $66.3 million, of which $54.4 million has been capitalized and $11.9 million has been expensed. As of June 30, 2014, we had $14.4 million in outstanding borrowings related to the ERP system under a Master Installment Payment Agreement ("Master IPA") with PNC Equipment Finance, LLC ("PNC Equipment").

We repurchased approximately 2.3 million shares at a weighted average price of $14.71 per share for an aggregate price of approximately $33.9 million excluding related commission charges under our publicly-announced repurchase plan. As of June 30, 2014, we had approximately $303.1 million available for repurchase under our repurchase authorization. Since June 30, 2014, we have repurchased approximately 0.6 million shares at a weighted average price of $14.72 per share for an aggregate price of approximately $8.2 million excluding related commission charges under our publicly-announced repurchase plan.

Remaining 2014 Outlook

As mentioned above, we recently announced strategic plans for long-term improvement and growth of the business. These plans comprise four key initiatives including: (1) streamlining the global product and marketing portfolio, (2) reducing direct investment in smaller geographic markets,
(3) creating a more efficient organizational structure including reducing duplicative and excess overhead which will also enhance the decision making process, and (4) closing or converting approximately 75 to 100 Crocs branded retail stores around the world.

First, we intend to focus on our core molded footwear heritage, as well as develop innovative casual footwear platforms. We intend to streamline the product portfolio, eliminate non-core product development and will explore strategic alternatives for the non-core products and brands. We expect more centralized product line control will also result in a reduction of the SKU proliferation that has occurred over the past few years, a more simplified and efficient supply chain and a reduction in overall product line costs and inventory levels.

Further, we intend to drive cohesive global brand positioning from region-to-region and year-to-year to create a clearer and consistent product portfolio and message, resulting in a more powerful consumer connection to the brand. This strategy will be accomplished through developing powerful product stories supported with effective consistent and clear marketing. Finally, we intend to increase working market spend, defined as funds that put marketing messages in front of consumers, by approximately 50%, funded primarily from a reduction of marketing overhead.

Second, we intend to refine our business model around the world, prioritizing direct investment in larger-scale geographies to focus our resources on the biggest opportunities and moving away from direct investment in the retail and wholesale businesses in smaller markets and transferring significant commercial responsibilities to distributors and third-party agents. These re-alignments are already underway in Brazil, Taiwan and other markets around the globe. Further, we intend to expand engagement with leading wholesale accounts in select markets to drive sales growth, optimize product placement and enhance brand reputation

Third, we have reorganized key business functions to improve efficiency and have eliminated 185 global positions of which the majority occurred on July 21, 2014, reducing structural complexity, size and cost. In addition, we plan to open a Global Commercial Center in the Boston area in late 2014, housing key merchandising, marketing and retail executives. The Boston location was selected in order to attract experienced senior footwear and business development management talent. The Global Commercial Center in Boston will join the Product Creation and Global Shared Services Center in Niwot, Colorado, the cornerstone of support for Crocs' global business. We intend to strengthen our Regional Commercial Centers in the Netherlands, Singapore and Japan with responsibility for managing Crocs' global business.

Fourth, we plan to rationalize under-performing business units, in order to re-align cost-structure and place greater focus on assets and operations with higher profit potential. This action will enable us to gain greater strategic and economic leverage from our direct-to-consumer assets, including owned retail and e-commerce stores. We intend to close or convert approximately 75 to 100 company-owned retail locations around the world, with 18 stores already closed or converted to partner stores in the second quarter of 2014. The impact of these closures and conversions is expected to reduce annual revenue by approximately $35.0 to $50.0 million and reduce selling, general and administrative expenses by approximately $17.5 to $27.5 million, with an insignificant impact on future operating income. We intend to consolidate global company-operated e-commerce sites from 21 to 11.

Overall, we undertook a comprehensive strategic review of the business and its operations globally, and identified four key areas of opportunity in the business: products, geographies, organization and channels. These plans prioritize earnings growth and our focus on becoming the leading brand in casual lifestyle footwear.


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At June 30, 2014, our backlog was up approximately $45.1 million to $206.2 million. The following table summarizes wholesale backlog by reportable operating segment as of June 30, 2014 and 2013:

                          June 30,
($ thousands)         2014        2013
Americas            $  68,693   $  58,628
Asia Pacific           67,299      53,430
Japan                  29,340      28,748
Europe                 40,836      20,230
Total backlog (1)   $ 206,168   $ 161,036



(1) We receive a significant portion of orders from our wholesale customers and distributors that remain unfilled as of any date and, at that point, represent orders scheduled to be shipped at a future date. We refer to these unfilled orders as backlog. While all orders in our backlog are subject to cancellation by customers, we expect that the majority of such orders will be filled within one year. Backlog as of a particular date is affected by a number of factors, including seasonality, manufacturing schedule and the timing of product shipments. Further, the mix of future and immediate delivery orders can vary significantly period over period. Backlog only relates to wholesale and distributor orders for the next season and current season fill-in orders and excludes potential sales in our retail and internet channels. Backlog also is affected by the timing of customers' orders and product availability. Due to these factors and since the unfulfilled orders can be canceled at any time prior to shipment by our customers, we believe that backlog may be an imprecise indicator of future revenues that may be achieved in a fiscal period and comparisons of backlog from period to period may be misleading. In addition, our historical cancellation experience may not be indicative of future cancellation rates.


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Results of Operations



Comparison of the Three Months Ended June 30, 2014 and 2013



                                                                                Three Months Ended June 30,                     Change
($ thousands, except per share data and average footwear selling price)          2014                2013                $                  %
Revenues                                                                    $       376,920     $       363,827     $     13,093               3.6 %
Cost of sales                                                                       174,349             162,960           11,389               7.0
Gross profit                                                                        202,571             200,867            1,704               0.8
Selling, general and administrative expenses                                        153,370             150,246            3,124               2.1
Restructuring charges                                                                 4,060                   -            4,060                 *
Asset impairment charges                                                              3,230                 202            3,028           1,499.0
Income from operations                                                               41,911              50,419           (8,508 )           (16.9 )
Foreign currency transaction losses, net                                                219                 814             (595 )           (73.1 )
Interest income                                                                        (403 )              (517 )            114             (22.1 )
Interest expense                                                                        128                 266             (138 )           (51.9 )
Other (income) expense, net                                                             (30 )               195             (225 )          (115.4 )
Income before income taxes                                                           41,997              49,661           (7,664 )           (15.4 )
Income tax expense                                                                   18,719              14,305            4,414              30.9
Net income                                                                           23,278              35,356          (12,078 )           (34.2 )
Dividends on Series A convertible preferred shares                                    3,033                   -            3,033                 *
Dividend equivalents on Series A convertible preferred shares related
to redemption value accretion and beneficial conversion feature                         721                   -              721                 *
Net income attributable to common stockholders                              $        19,524     $        35,356     $    (15,832 )           (44.8 )%

Net income per common share:
Basic                                                                       $          0.19     $          0.40     $      (0.21 )           (51.5 )%
Diluted                                                                     $          0.19     $          0.40     $      (0.21 )           (52.0 )%
Gross margin                                                                           53.7 %              55.2 %           (150 )bps         (2.7 )%
Operating margin                                                                       11.1 %              13.9 %           (280 )bps        (20.1 )%
Footwear unit sales                                                                  16,874              16,286              588               3.6 %
Average footwear selling price                                              $         21.77     $         21.65     $       0.12               0.6 %



* Percentage change is not relevant as prior years amounts were zero.


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Revenues. During the three months ended June 30, 2014, revenues increased $13.1 million, or 3.6%, compared to the same period in 2013, primarily due to an increase of 0.6 million, or 3.6%, in global footwear unit sales and an increase of $0.12 per unit, or 0.6%, in average footwear selling price primarily driven by new product introductions with higher average selling prices and a product mix shift from clogs to non-clog styles.

For the three months ended June 30, 2014, revenues from our wholesale channel increased $7.3 million, or 3.6%, compared to the same period in 2013, which was primarily driven by an increase in our Asia Pacific and Europe segments as a result of expansion of our wholesale doors and the continued support from existing customers partially offset by decreased wholesale channel revenues in our Americas and Japan segments. This decrease was mainly due to a soft wholesale market and slow sell-through of inventory as a result of macroeconomic declines leading to lower average footwear selling prices.

For the three months ended June 30, 2014, revenues from our retail channel increased $4.9 million, or 3.7%, compared to the same period in 2013, which was primarily driven by our global retail expansion as we opened 49 company-operated stores (net of store closures) since June 30, 2013 partially offset by a 5.1% decrease in comparable store sales. Although we expanded our global retail presence since 2013, we have begun to and plan on continuing to moderate the pace of our retail expansion in 2014 with a focus on consolidating and enhancing the profitability of existing locations.

For the three months ended June 30, 2014, revenues from our internet channel increased $0.9 million, or 2.9%, compared to the same period in 2013, which was primarily driven by increased internet sales in our Asia Pacific segment partially offset by a decrease in internet sales in our Americas segment. Our internet sales totaled approximately 8.2% and 8.3% of our consolidated net sales in the three months ended June 30, 2014 and 2013, respectively. We continue to benefit from our online presence through webstores worldwide enabling us to have increased access to our customers in a low cost, attractive manner and providing an opportunity to educate them about our products and brand. However, we intend to consolidate global company-operated e-commerce sites from 21 to 11 in order to focus our internet strategy in our principal geographical locations.

Impact on Revenues due to Foreign Exchange Rate Fluctuations. Changes in average foreign currency exchange rates used to translate revenues from our functional currencies to our reporting currency during the three months ended June 30, 2014 increased our revenues by $0.2 million compared to the same period in 2013. The majority of this increase was related to the increase in value of the Euro compared to the U.S. Dollar partially offset by a decrease in the Japanese Yen, Brazilian Real and Russian Ruble compared to the U.S. Dollar.


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The following table summarizes our total revenue by channel for the three months ended June 30, 2014 and 2013:

                             Three Months Ended June 30,               Change              Constant Currency Change(1)
($ thousands)                  2014               2013             $            %               $                %
Channel revenues:
Wholesale:
Americas                  $        65,715    $        69,089   $   (3,374 )      (4.9 )% $        (2,632 )          (3.8 )%
Asia Pacific                       71,748             67,383        4,365         6.5              4,731             7.0
Japan                              26,697             31,053       (4,356 )     (14.0 )           (3,275 )         (10.5 )
Europe                             44,576             33,742       10,834        32.1              9,254            27.4
Other businesses                      (86 )               98         (184 )    (187.8 )             (184 )        (187.8 )
Total Wholesale                   208,650            201,365        7,285         3.6              7,894             3.9
Consumer-direct:
Retail:
Americas                           60,622             61,041         (419 )      (0.7 )                2             0.0
Asia Pacific                       44,648             40,871        3,777         9.2              2,565             6.3
Japan                              12,328             12,327            1         0.0                432             3.5
. . .
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