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Company: Crocs (CROX)
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66%
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3 votes

  Lost targets and credibility

Before the market opened Tuesday, Crocs management issued a press release and hosted a conference call to update expectations for the recently completed first quarter. While the accountants are still dotting all the I’s and crossing all the T’s, it appears the first quarter is going to be significantly worse than previous expectations.

This came as a major surprise to investors as less than two months ago, management painted a very rosy picture of growing sales and strong margins. The only hint of trouble was that the company had a large inventory level. Management explained that the high inventory would enable it to meet strong demand coming into the first part of 2008.

Other tidbits from the Q1 conference call:

  • International Sales represented 53% of their sales with Japan representing the strongest region.
  • Regarding costs, CROX will be increasing advertising spend.
  • CROX expects Cap EX to be approx $85 million, down to previous expectations
  • Generally speaking, sell through rate was less than expected but still remains encouraging and “well positioned” for a strong 2009. CROX wants to beat industry growth in 2009 and beyond. Company will drill down on cutting costs going forward.
  • Crox believes inventory will be down 10-15% by the end of Q2; will continue to pull it down at the end of the next quarter.
  • They did guide for Y08 gross margins in the range of 54-56% for Y08 (Comment: this is nonsense, as management has guided high GMs like this before and failed to execute).

Something must have changed between that conference call on February 19th and Tuesday’s announcement. Now management explains that Q1 revenue will be around $195 to $200 million, with operating earnings of 8 to 13 cents per share. This is much lower than consensus numbers which were in the range of 40-50 cents. While the company tried to put a brave face on by explaining that sales are still higher than the same quarter last year, the result of the miss is that management has now lost all credibility with the street. Analysts find it very difficult to believe the environment deteriorated so quickly that management was unaware of the issues two months ago, but the environment is now so much worse than expected.

The bottom line is that there are two scenarios. 1) Management is incapable of projecting even short-term demand for their product, or 2) The economy is truly in a free-fall. Neither one of the scenarios brings much warmth to investors' hearts. Despite falling short of EPS estimates for the first time in its history, shares of CROX are ramping up the tune of 16%. CROX reaffirmed its second quarter and full year guidance, which are currently slightly above consensus estimates. However, CROX has not yet put a headlock on its inventory and margin issues, and on top of that, international sales are decelerating: that has everyone worried, especially because CROX management has pitched the international scene as their main avenue for growth going forward.

In the past, management has guided investors to expect 20-30% long-term revenue growth. When asked about this on the conference call Tuesday, management would not comment but expects to revisit this statistic during its official Q1 earnings release. This is another bad sign, as I would expect management to vigorously defend this number if it were still part of the expectations.

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60%
agree
5 votes

  Shutting down Canadian prduction plant

In response to the weakening demand, the company is shutting down its Canadian production plant which operated at a higher cost than many of its overseas production facilities. This will give the company less flexibility when ramping up orders for short-term demand (something management has struggled with in past quarters), but should cut out some fixed costs to allow margins to be a bit healthier.

Inventories continue to be high and management expects to keep these levels relatively unchanged in order to meet demand (despite the fact that demand is falling). There were some sales to discount channels over the last quarter, which drag down margins and raise additional concerns as to how effective the traditional sales channels are working.

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50%
agree
2 votes

  Shares at a premium

Despite falling short of EPS estimates for the first time in its history, shares of CROX are ramping up the tune of 16%. CROX reaffirmed its second quarter and full year guidance, which are currently slightly above consensus estimates. However, CROX has not yet put a headlock on its inventory and margin issues, and on top of that, international sales are decelerating: that has us worried, especially because CROX management has pitched the international scene as their main avenue for growth going forward.

The question we need to be asking ourselves right now is: has management pulled down numbers far enough? The international figures were not what we were looking for and we’d stay away from this stock altogether.

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