Earnings Call: Q2 2017

Aug 9, 2017

Please note that this conference is being recorded. I will now turn the call over to Marisa Jacobs. Ms. Jacobs, you may begin. Thank you. Good morning, everyone, thank you for joining us today for the Crocs' 2nd quarter 2017 earnings call. Earlier this morning, we announced our Q2 results, and a copy of the press release can be found on our website at crocs.com. We would like to remind everyone that some of the information provided on this call is forward looking and accordingly is subject to the Safe Harbor provisions of the federal securities law. These statements include, but are not limited to, statements regarding future revenues, gross margin or SG and A expenses and our product pipeline. Crocs is not obligated to update these forward looking statements to reflect the impact of future events. We caution you that all forward looking statements are subject to a number of risks and uncertainties described in the Risk Factors section of the company's annual report on Form 10 ks. Accordingly, actual results could differ materially from those described on this call. Those listening to the call are advised to refer to Crocs' Annual Report on Form 10 ks as well as other documents filed with the SEC for more information relating to these risk factors. The company may refer to certain non GAAP metrics on this call. An explanation of those metrics and a reconciliation to the most closely related GAAP metric can be found in our earnings release, which was filed earlier today, which has been posted on our investor website located at crocs.com. Joining us on the call today are Andrew Reese, President and Chief Executive Officer and Carrie Teffner, Executive Vice President and Chief Financial Officer. Following their prepared remarks, we will open the call for your questions. At this time, I'll turn the call over to Andrew. Thank you, Marissa, and good morning, everyone. I'll begin with some comments on our results and on the strategic progress we made during the Q2. Then I'll turn the call over to Carrie, who will go through the financial results for the quarter in greater detail and take you through our expectations for the Q3 and the full year. We will then take your questions. Overall, I'm very pleased with our 2nd quarter results. We met or exceeded the guidance we provided to you when we spoke in May. Equally important is that we continue to make progress against our strategic initiatives to strengthen the company and the brand. Revenues in the quarter were $313,200,000 and our gross margin rose by 180 basis points from Q2 last year to come in at 54.2 percent. SG and A at $140,400,000 was $8,700,000 lower than in last year's Q2 and included $1,800,000 of charges associated with our SG and A reduction plan. Our income from operations rose 42.9% over Q2 last year to $29,400,000 and our diluted EPS rose by 53.8%. I also want to note that our inventory at the end of the second quarter was down $14,000,000 or 8.3% compared to the same time last year. These results are tangible evidence that all of the hard work over the past few years to strengthen the company and position us for renewed profitable growth is taking hold. On our last call, Greg spoke about our ongoing initiatives to ensure that our product is fresh and relevant, our marketing builds engagement and drive sales, our wholesale, retail and e commerce sales channels are being optimized to drive profitable growth, and corporate investments are concentrated in our core markets. And we continue to strengthen our organization from both an operational and talent perspective. Since this is my first time speaking with you in my capacity as President and CEO, I want to reaffirm that we continue to be focused on these initiatives, each of which is essential to achieving our broader strategic objectives. Let me provide some color on each of our ongoing initiatives as it relates to our Q2 results. 1st product. As discussed with you on our last call, we are focusing heavily on clogs along with sandals, flips and slides as these silhouettes are most representative of Crocs DNA. Consequently, I'm pleased to report that with respect to these silhouettes, 2nd quarter growth exceeded our expectations. Classic clogs turned in particularly strong results as we continue to leverage our iconic clog with fresh colors and prints. Our Swiftwater collection exceeded expectations. The new Swiftwater deck clog is an example of a successful line extension developed to address an additional wearing occasion. New colors and prints are selling well, and it is especially gratifying to see wholesale accounts expand in the range of colors presented in their stores and on their e tail sites. Given our focus on sandals, it was great to see products such as a women's Capri and Sloan exceed expectations as well. We're striking the right balance of comfort and style and consumers are responding favorably. We are leveraging the momentum from springsummer 'seventeen to derisk our fall holiday business by focusing less on seasonal products such as boots and driving an expanded selling season for sandals, flips and slides and clogs, including line clogs. 2nd is marketing. Our Come As You Are campaign was in full swing during the Q2. We launched the campaign to boost brand relevancy and consideration and to elevate our digital marketing effectiveness and consumer engagement. It is succeeding on many levels. Our brand social engagement, social reach and PR coverage each roughly tripled compared to last year's Q2. We continue to introduce new content over the coming months. In addition, we are seeing the positive impact of our Come As You Are campaign on revenues. Wholesale accounts have enthusiastically embraced the campaign, utilizing our creative and window takeovers, end caps, on selling fixtures and on their own websites. In our DTC channel, our online and retail stores saw strong sell through of the products featured in the campaign. We are excited to announce we have entered into a product collaboration with 1 of our celebrity brand ambassadors, Drew Barrymore. Her designs will be introduced as part of our springsummer 2018 collection with fresh exciting new product reflecting her personality and infectious enthusiasm. We believe her designs will be a great addition to our lineup. The 3rd initiative relates to the optimization of our 3 business channels. At wholesale, accounts did well with our springsummer 2017 collection. Sell throughs continued to improve. Furthermore, full price selling improved, enabling our accounts to realize better product margin. In conjunction with our activation of the Come as You Are campaign, we were given expanded shelf space by some of our important key wholesale accounts, secure longer placement periods at some accounts and in others secured dedicated brand locations. All of those boosted the visibility of Crocs. Retail performed in line with expectations and while total retail sales declined, this was primarily due to a reduced store count as our retail comp was flat. We continue to make progress against our plans to rationalize our store fleet, closing or transferring 39 stores during the Q2, moving more quickly than we had originally estimated. With respect to e commerce, our comparable sales rose by 17.8%, driven primarily by Asia. These are strong results given that we are growing off a 20.6% comp in Q2 of last year. The 4th initiative is strengthening our organization. From an operational perspective, we are continuing to drive process improvements that are leading to greater efficiencies. During the Q2, SG and A declined by $8,700,000 or 5.8 percent, and we remain on target to hit our goal of eliminating between $75,000,000 $85,000,000 of SG and A expenses annually by 2019. As we noted previously, 70% of the SG and A reduction is tied to reducing company operated stores. We have accelerated the pace of our store reductions and we are now on track to have 19 net fewer stores by the end of this year. From a talent perspective, the transition between Greg and me has been seamless. Throughout the organization, the team remains focused on our key strategic objectives. In closing, we are right on track. The actions we have taken and additional actions to be taken through the balance of the year are transforming Crocs into a more nimble and stronger company capable of prospering in the face of a challenging retail environment. I am extremely grateful to the talented team we have in place across the globe and excited about the work we're doing to strengthen our business and drive shareholder value. At this time, let me turn the call over to Carrie. She will review our Q2 financial results and present our Q3 and full year 2017 guidance. Thank you, Andrew. As Andrew mentioned, we are pleased with our Q2 results, the hard work of the past few years, which involved transforming almost every aspect of our business, is translating into tangible benefits. 2nd quarter revenues were $313,200,000 down 10 point $6,000,000 or 3.3 percent from a year ago. These revenues came in at the high end of our guidance. Furthermore, this amount includes a negative impact of foreign currency translation, which decreased revenues by $2,000,000 compared to Q2 last year. The $10,600,000 or 3.3% decline from last year's Q2 primarily relates to the sale of our Taiwan business, store reductions and the additional actions taken to improve the quality of our revenues that we have discussed with you on previous calls. Adjusting for these items, Q2 revenues would have been up low single digits compared to Q2 last year. In terms of our channels, 2nd quarter wholesale revenues declined 7.3%. This is attributed to our intentional pullback on sales into discount channels and reduced shipments to select overstock distributors in Asia. We began those initiatives during the Q3 of 2016 and as a result, they will have less of an impact on our year over year comparisons in the back half of this year. Our global second quarter DTC comp was a positive 5.7%. While overall retail sales declined 4.4%, our retail comp was flat. We had 55 fewer stores compared to the end of last year's Q2, ending the quarter with 503 stores. Our e commerce business grew 14.5% compared to Q2 last year, while generating a 17.8% comp. I will discuss regional results in a moment. We sold 17,400,000 pairs of shoes in the quarter, a 1.8% decrease from the prior year. The average selling price of our footwear was $17.66 down 2.2%. As discussed on last quarter's call, this is due to our focus on core molded product, which carries a lower ASP, but also generates a higher gross margin, driving profitability gains. Turning to our regions. First, let me note that given the limited impact of currency in the quarter, the following revenue amounts are as reported. In the Americas, our revenue came in at $136,200,000 up 0.8%. The key takeaway is that we returned to growth in every channel in this region. Wholesale grew in absolute dollars and we simultaneously delivered both positive retail and e commerce comps. Wholesale revenues grew 4.9%. Key accounts saw better than expected sell throughs and in response increased at once orders and bought into a more diverse product range than last year. Marketing collaborations with key family footwear accounts contributed to an improved quarter as well. Our Americas 2nd quarter DTC comp increased by 1.1%. Our retail comp rose by 0.4%, while retail sales declined 3.8%, reflecting the fact that we were operating 11 fewer stores as compared to last year's Q2. E commerce sales rose 2.6%. Throughout the quarter, after a slow start, we saw comp sales accelerate with double digit comps in June as we adjusted our pricing and promotions in response to the highly competitive environment. In Asia, our terrific growth in e comm enabled us to partially mitigate the decline in wholesale revenues. Revenues in Asia were $124,600,000 down 4.7% versus prior year. Wholesale revenues declined 12.7%, the majority of which is associated with the sale of our Taiwan business in the Q4 of 2016 and reduced sales to select overstock distributors in the region. The impact of these items offset the growth we saw in our China wholesale business, where the work done over the past couple of years has enabled us to put our China wholesale business back on a healthy footing. Our Asia 2nd quarter DTC comp increased by 13.3%. The retail comp declined by 0.9%. Retail sales declined by 4.6%, reflecting the comp performance in 30 fewer stores as compared to last year's Q2. While our e commerce comp rose by 44.5%, reflecting the exclusion of our Taiwan e commerce results from last year. Most of this growth was due to outstanding results in China and Japan, Our Henry Lau event on China's Tmall and our LINE launch in Japan are examples of activities we used to support our e commerce business. Europe delivered a solid second quarter. While the wholesale channel is still reflecting the impact of the reduced discount channel sales, the retail channel delivered positive comps and e comm grew double digits. Revenues were $52,300,000 down 9.3 percent versus prior year. Wholesale revenues declined $5,200,000 or 14.5 percent due to the planned reduction in discount channel sales. Our European 2nd quarter DTC comp increased by 5.1%. Retail comps increased by 0.7%, while retail sales declined 6.3%, reflecting 14 fewer stores as compared to last year's Q2. E commerce sales grew 10.4%, driven by high conversion rates. Our gross margin was 54.2%, improving 180 basis points. The year over year improvement reflects continued focus on higher margin molded product and fewer discount channel sales. Our SG and A expenses were $140,400,000 down $8,700,000 from the prior year. Our SG and A includes $1,800,000 of charges related to our SG and A reduction program, which is below the $3,000,000 we guided to at the end of Q1. During the quarter, we benefited from approximately $1,000,000 related to a bad debt recovery, which had previously been reserved for in China, and we have a timing benefit of approximately $2,000,000 related to marketing expense. The remaining improvement over prior year reflects the benefit of our SG and A reduction efforts, which includes store closures, store transfers and business model changes combined with operational improvements. Our continued focus on controlling costs allowed us to deliver SG and A reductions in excess of what was included in our guidance. Our income from operations grew 42.9% over Q2 last year, increasing to $29,400,000 This reflects our improved gross margin offsetting lower revenues and the progress we have made in reducing SG and A. Net income attributable to common stockholders after preferred share dividends and equivalents of $3,900,000 was $18,100,000 Our earnings per diluted share at $0.20 rose 53.8 percent. The weighted average diluted common share count used to calculate EPS was 74,600,000 shares for Q2. Turning to the balance sheet. We ended the quarter with $157,000,000 in cash compared to $146,700,000 at the end of Q2 last year. We repurchased $10,000,000 of our common stock during the Q2, and at June 30, there were no borrowings outstanding on our credit facility. We ended the quarter with $155,700,000 in inventory, 8.3% below Q2 last year. Through Q2, we generated approximately $39,000,000 of cash from operating activities, almost double the approximately $20,000,000 of cash generated during the 1st 6 months of 2016. Let me now turn to guidance. Regarding currency, I want to note that our guidance is on an as reported basis. I also want to call out that our guidance does not reflect any meaningful changes to foreign currencies compared to today. With respect to the Q3 of 2017, we expect revenues to be between $230,000,000 $240,000,000 compared to $245,900,000 in last year's Q3. This guidance incorporates the impact of store closures and of store closures and transfers, reflecting the 39 net store reduction in Q2 and a planned reduction of 25 stores in Q3 and the sale of our Middle East business in the Q2 of 2017 and our Taiwan business in the Q4 of 2016. We expect Q3 gross margins to be essentially flat compared to last year. Keep in mind that last year's Q3 benefited from an inventory adjustment, which favorably impacted the gross margin rate by more than 200 basis points. Our SG and A for the quarter is expected to be down approximately $3,000,000 to last year. This guidance includes approximately $2,000,000 of charges to support our SG and A reduction plan. For the full year 2017, we continue to expect revenues to be down low single digits compared to the prior year. This guidance incorporates our updated store reduction plans, business model changes and the reduction in discount channel sales as we continue to improve the quality of our revenues. Our full year gross margin rate guidance of approximately 50% remains unchanged. And our SG and A for the full year 2017 is now expected to be between $490,000,000 $495,000,000 This is down from the range provided on our last call and $10,000,000 to $15,000,000 below our 2016 SG and A of $506,300,000 This change reflects continued progress against our plan to reduce SG and A by $75,000,000 to $85,000,000 and to deliver an incremental $30,000,000 to $35,000,000 in income from operations in 2019 and reflects the benefit of accelerating store closures. Please keep in mind that approximately $7,000,000 to $10,000,000 of charges associated with the implementation of our SG and A reduction plan are included in our full year SG and A guidance. I'm very pleased that our Q2 results were in line with or above the guidance we provided. We have made significant progress improving our business processes as well as the quality of our revenue, and this is resulting in our improved ability to predict the business. With the first half of the year behind us, we remain confident that our initiatives to drive higher quality revenues to rationalize our retail footprint and to reduce our SG and A will enable us to improve our bottom line profitability. Now, I'll turn the call back over to Andrew for his final thoughts. Thank you, Carrie. Throughout the quarter, we continued to advance our strategic objectives and strengthen our brand. Our springsummer 2017 product amplified by a successful Come As You Are marketing campaign generated higher quality revenues and improved gross margins. Our focus on expense management led to a significant SG and A expense reduction. In combination, these resulted in a meaningful profit improvement. In summary, Q2 was another solid quarter, and I want to reiterate our confidence in the business and its ability to generate enhanced shareholder value in the future. Before closing, let me once again express my sincere thanks to our incredible associates around the globe, whose dedication and hard work is so essential to the success of our company. Now, operator, I'll open the call up for questions. Thank you. We will now begin the question and answer And our first question comes from Erinn Murphy from Piper Jaffray. Your line is open. Great. Thanks. Good morning and nice to see some progress on some of the initiatives you guys have put together. I guess first, Andrew, for you, I was curious on your comment. You talked about June's promotional cadence. You made some adjustments there, drove some incremental improvement in the comp. I'd love to hear kind of what you learned about that and how that's shaping your strategy in North America as you get into the back half? Yes. Thanks, Aaron. So that was specifically relating to e commerce, right? So as we kind of look at our global e commerce business, we're pleased with where we are on a global basis. Obviously, our comps were up 17.8% on a global basis, really driven a lot by China and Japan. In Europe, we made a lot of progress putting in place key capabilities and adjusting our go to market strategy there. It's led to a double digit comp in Europe as well of a relatively poor performance in the back portion of last year. As we look at Americas, it started off slow. I mean, we started off slow in the quarter, and that was really driven by our overall strategy to drive higher quality revenues. We started off with a probably a less aggressive promotional cadence than we had been last year. So we tried to pull back. And as we looked at where we were placed relative to everything else going on in the marketplace, it wasn't driving the results that we expected and it wasn't competing effectively online where the consumer is obviously one click away from a different opportunity. So we didn't really we don't back to where we had been historically and where we think the marketplace was. We didn't go any further than that and that had the desired effect of really driving the revenues that we desired. Okay, that's helpful. And then I guess just on the wholesale side in North America, can you just talk about the retailer appetite for product when they're looking at taking kind of some of the fall winter product this year versus where it's been in the past? We've just heard from some of the other kind of broader global vendors that you're getting this calendar shift deeper into the season. Curious if that impacts your Q3 at all in terms of how you're thinking about the guidance there? Yes. I mean, I think one of the things well, firstly, I think we're focusing on what we're good at, right? So we're focusing on our clogs, sandals, flips and slides. And similar to last year, we are seeing that season go longer into the Q3. So you can certainly sell that product through July, through August and into September. And I think from your comment, that's what the impact that's having in the marketplace is those people who are trying to sell boots, it's constraining their season for boots and transitional products. And consistent with that observation, we talked about derisking of our back half business. We've really cut fairly significantly the proportion of our product that is boot or transitional and are really focusing on selling our clogs and line clogs in that period. So we actually think that's kind of working in our favor. Got it. And then just last question for me is on your store fleet optimization, that's been going a little bit faster than planned. Can you just talk about kind of the what the ideal footprint you see in the for the business over time? And then I guess, Carrie, for you, was the faster I guess, kind of further store closures, is that the biggest piece of the SG and A reduction for the full year in the guide? Thanks. Yeah. So I'll take both those, Erin. So as we talk about the store footprint, obviously, what we've guided to is approximately 400 stores by the end of 2018. And I really think having a perfect model right now is not possible. So our goal at this point is to continue to evaluate what the fleet should look like, what the footprint of mix of outlet and it will be primarily outlet is of that store base. But we'll kind of keep reassessing. But right now, our goal is to get to that 400 and then continue to evaluate from there. And then to your other question with respect to the SG and A for the quarter, certainly the accelerated store closures had an impact. But we also saw just with a much more higher focus on controlling costs in the business. So that played a part as well. But if I break down the kind of the $8 plus 1,000,000 that we are favorable year over year, we did have some timing benefit. So I do want to acknowledge that. We had about $2,000,000 of marketing expense that's moving from Q2 into Q3. We also had a reduction in our estimate charges associated with our SG and A reduction plans. We had originally thought it was going to be about 3, it came in a little bit under that at about 1.8. And then we also had essentially a onetime pickup that was essence, we had about $4,000,000 favorable, and that was, I think, fairly split between additional store closures and then just continued cost focus. Got it. Thank you for that detail. Thanks, Aaron. Our next question comes from Scott Criss from Buckingham Research. Your line is open. Thanks, guys. This is Matt Gollney on for Scott. A couple of questions. First off, I just wanted to know kind of what you guys had planned for bookings for the spring 2018 season? Yes. So I mean thanks, Matt. Some time ago, we stopped disclosing pre bookings or booking information. As we kind of disclosing pre bookings or booking information. As we kind of look at spring 'eighteen, it's really early in terms of the spring 'eighteen sell in. We started meeting key accounts relative to that line, and I think the feedback we're getting is very positive and supportive. So we feel good about where we are from a spring 'eighteen perspective. Okay. And what is I guess what is the hurdle rate to get reorders in season and are retailers interested in kind of optimizing sales with the products? I'm not quite sure what you're referring to around hurdle rate, but I think the way we plan our business is generally about 75% of our business is pre booked and about in the back half and about 25% is are at once or in season orders. And that's generally kind of how the business flows in the back half. Okay. And then lastly, do you mind just speaking to your strategy around pricing going forward for the rest of FY 'seventeen? Yes. It was I think, improvement in the quality of our revenues has really been coming from greater sell throughs and more full price sell through. So that has allowed us to firm up our net pricing, if you like. We haven't impacted our MSRP or our high level pricing, But we have seen some improvement in net pricing and margins from the more careful management of the business. As we look at the marketplace, we continue to evaluate opportunities for pricing. And as we introduce new products, we'll look at what is the competitive environment and the competitive products that we're comparing that to ensure that we're, 1, delivering exceptional value to the consumer, but also getting paid for the amount of innovation that we put into the product. Our next question comes from Benjamin Bray from Robert Baird. Your line is open. Hi, thanks for taking our question. I wanted to ask a little more about the accelerated pace of retail closures. What impact is that having on the full year revenue guidance? I would imagine there's some sort of negative And if so, is there a positive offset that is causing you to hold the guidance for the year? Yes, great question. So we are still guiding at the low single digits, which consistent with the guidance from last quarter despite the fact that we do have accelerated store closures. Part of the offset there is really around, there's been a favorable change in FX from the rates in place when we guided earlier after Q1. Q1. So really, it's kind of we're holding because we have the kind of a tailwind of FX against the headwind of accelerated store closures. Okay, thanks. And then looking out at Q3 and Q4, just wanted to know if you could provide some perspective on what's driving the decline in Q3 and then what gives you confidence that Q4 can return to growth? It looks like there's a little bit of implied growth for Q4 and what the current guidance is. So any perspective on your outlook for the back half and what's giving you confidence there would be helpful. Yes. So if I talk to Q3 first, so we are guiding at $230,000,000 to $240,000,000 The major differences versus prior year are essentially the business model changes and the store closings and transfers. If we take the midpoint of that range, that means we'd be essentially flat to last year. So that's kind of the assumptions we've made relative to Q3. And then as we get into Q4, we do have continued benefit of FX that we're based on the current rates today. And then we're lapping of kind of an easier Q4 last year because what we saw there is people pulling back on some of the at once business. We also had some challenging e com performance in the Q4 last year as well. So we think it's up against an easier compare. All right. Thanks very much. I am showing no further questions at this time. Okay. Well, just in closing, thank you everybody for your continued interest in the company, and we look forward to another strong quarter. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.