Crocs - Q2 2023

Transcript

Operator (participant)

Good morning, welcome to the Crocs Q2 2023 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Corinne Lin. Please go ahead.

Corinne Lin (VP of Corporate Finance and Investor Contact)

Good morning, everyone. Thank you for joining us today for the Crocs Inc. Q2 2023 earnings call. Earlier this morning, we announced our latest quarterly results, and a copy of the press release may be found on our website at crocs.com. We would like to remind you 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 laws.

These statements include, but are not limited to, statements regarding our supply chain challenges, cost inflation, the acquisition of HEYDUDE and the benefits thereof, Crocs' strategy, plans, objectives, expectations, financial or otherwise, and intentions, future financial results and growth potential, anticipated product portfolio, our ability to create and deliver shareholder value, and statements regarding potential impacts to our business related to the COVID-19 pandemic.

These statements involve known and unknown risks, uncertainties, and other factors which may cause our actual results, performance, or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Crocs is not obligated to update these forward-looking statements to reflect the impact of future events, except as required by applicable law.

We caution you that all forward-looking statements are subject to risks and uncertainties described in the Risk Factors section of our annual report on Form 10-K and our subsequent filings with the SEC. Accordingly, actual results could differ materially from those described on this call. Please refer to Crocs annual report on Form 10-K as well as other documents filed with the SEC for more information relating to these risk factors.

Certain financial metrics that we refer to as adjusted or non-GAAP are non-GAAP measures. The reconciliation of these amounts to their GAAP counterparts is contained in the press release we issued earlier this morning. Joining us on the call today are Andrew Rees, Chief Executive Officer, and Anne Mehlman, 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.

Andrew Rees (CEO and Director)

Thank you, Corrine, good morning, everyone. I'm incredibly pleased with our Q2 results. We delivered record quarterly revenues of over $1 billion. The Crocs and HEYDUDE brands continue to perform extremely strongly, as evidenced by 26% direct-to-consumer revenue growth. We gained appreciable market share and once again delivered industry-leading profitability with 30% operating margins.

Ann will review our financial results in more detail shortly, but here are a few highlights from the Q2. Revenues of over $1 billion grew 12% on a constant currency basis. Crocs brand revenues grew 15% constant currency, fueled by Asian revenues increasing 39% and global DTC comparable sales rising 20%. The Crocs brand continues to gain market share in North America, with revenues up 13%, driven by sandals and new product introductions.

HEYDUDE brand revenues were $239 million, with exceptional DTC growth of 30% and digital growth of 37% constant currency. Adjusted diluted earnings per share increased 11% to $3.59 per share. Gross leverage ended at 1.8x, and net leverage was 1.7x at quarter end, allowing us to repurchase $50 million of shares in July.

Finally, Crocs, Inc. was named to the TIME100 Most Influential Companies for 2023. In summary, we had an excellent quarter and our teams globally remain focused on driving brand health, market share gains, and profitable growth in the back half of the year. I would now like to provide updates for each of our brands.

The Crocs brand has delivered strong revenue growth since 2018 as we built both clog and brand relevance across the globe. This past quarter, our product and marketing efforts continued to deliver newness and excitement to the current brand, while simultaneously reaching new consumers who may not have considered our brand in the past.

With respect to product innovation, we are diversifying our clog offering and growing sandals. We've seen significant success with a number of height-orientated new clog introductions, including the Crush, Mega Crush, and more recently, the Siren. In addition, our recent launch of Dylan, a more elevated and fashion-forward clog, is very encouraging. The Echo continues to outperform our initial expectations, and personalization continues to drive global relevance for the Classic. Turning to sandals.

As we have shared, this category is an important growth initiative for Crocs, allowing us to expand into the adjacent $30 billion global sandal category, where we believe our molded technologies, accessible price points, strong go-to-market, will allow us to compete effectively in a relatively fragmented market. We're excited by our incredible sandal performance, where revenues grew 34% compared to Q2 last year and 40% growth on a trailing twelve-month basis.

Growth was robust in all regions, driven by our diversified sandal offerings, new product introductions, and robust marketing calendar. The Classic and Brooklyn continue to be our leading sandal franchises. In addition, the more recent Mellow and Crush introductions have been extremely successful and are also top-selling styles. We will continue to drive sandal awareness and customer acquisition with activations such as the new Pollex slide with Salehe Bembury.

Overall, we're pleased with the sandal trajectory. I'm very confident that sandal revenues will grow to in excess of $400 million this year. From a collaboration perspective, we announced plans for a two-year partnership with Salehe Bembury, who will serve as creative director of the Crocs times Pollex Pod to introduce innovative new styles.

This quarter, we introduced the Pollex slide, which sold out instantly and provided a halo for our sandal offerings globally. More recently, we partnered with rapper Lil Nas X to showcase our height collection, such as Siren and Crush. During Paris Fashion Week, we took over the same Merci pop-up space. Other marketing highlights from the quarter include our Mellow Slide with Taco Bell, a clog collaboration with Parisian running brand Satisfy, and a slide and clog partnership with Korean food brand Ottogi.

Finally, this month, our Barbie collection, featuring clogs, sandals and Jibbitz, quickly sold out ahead of the blockbuster movie launch last weekend. Asia is another important long-term growth driver for the Crocs brand, as the brand is currently under-penetrated relative to here in the U.S. In Q2, Asia revenues grew by 39% constant currency. Growth was again broad-based, with strong brand momentum throughout the region, including China, Australia, South Korea, and Southeast Asia.

We're particularly encouraged by another exceptional quarter of growth in China, where Q2 revenues increased over 100% ahead of our expectations and one more sign of the potential within this market. The leadership team and I had the opportunity to visit China in June for the first time in three years. It was wonderful to see how much the brand had grown. We met with our partners, suppliers, and visited many stores.

We've been deploying the same playbook we have used globally, including influences, collaborations, and personalization. We partnered with local celebrities, including Bai Jingting and Zhou Yutong, to style collaborations and products in their own authentic way. Crocs creations by four emerging Chinese designers from fashion incubator Labelhood were featured at Shanghai Fashion Week.

Jibbitz, our vehicle to self-expression, continues to surprise and delight consumers and create great excitement in our stores. Crocs rising popularity in China has created a passionate following with a hashtag known as Dongman or clogs followers. On Red, a leading Chinese social app, topics related to Crocs have accumulated over 310 million views. During the popular mid-season festival in June, Crocs sales ranked second on Tmall within casual footwear brands. In Douyin, Chinese TikTok, we ranked first in sales during mid-season festival.

In summary, we're incredibly excited by the Crocs brand momentum in China. We're even more confident about the potential for the Crocs brand in the second-largest footwear market in the world. To HEYDUDE. We're incredibly pleased with the exceptional DTC growth of 30% and constant currency digital growth of 37%. Our product and marketing innovation is driving new customer acquisition and is growing awareness on the coasts. Our e-commerce data demonstrates that Q2 revenues on both the East and West Coast increased 45% compared to last year.

New product introductions, which range from new colors to new silhouettes, are driving excitement. Our Americana styles were top sellers ahead of Memorial Day and Fourth of July holidays amongst men, women, and kids. As a demonstration of our test and learn approach, this year, our Americana collection featured over 20 patterns and colors, building on the early success we saw last year.

The new Wally and Wendy Funk and washed canvas styles have performed strongly in both DTC and wholesale. Our efforts to expand the brand beyond the iconic Wally and Wendy within sneakers are off to a great start. The Karina for women and the newly introduced Rocco sold out quickly, and we're in the process of getting them back in stock.

On the marketing front, we focused on enhancing brand awareness. We launched our first-ever HEYDUDE collaboration this quarter with outdoor lifestyle brand Mossy Oak, and we saw a great sell-through. We've also started to seed our back-to-campus collection on social channels and look forward to launching our collection featuring colleges from the Southeastern Conference, or SEC, in September. Finally, with respect to wholesale revenues, as we discussed in June, a large part of last year's revenue related to pipeline fill for some of our new strategic alliance partners.

We estimate pipeline fill was $70 million for the Q2 of last year and $220 million for fiscal 2022. This pipeline fill was a very conscious decision on our part to secure shelf space, knowing there will be competition in the marketplace. Aggregate consumer takeaways for the brand across all channels, we estimate to be up approximately 27% during Q2 of 2023, based on over 80% increase in our strategic alliance accounts, shrinkage in our non-strategic wholesale accounts, and 30% DTC growth.

Retail track and service data from Circana, formerly NPD, indicates that HEYDUDE rose from the number 15 in fashion footwear brand in Q2 of last year to number eight in Q2 of this year, based on US sales. As we look towards the remainder of the year for HEYDUDE, we are lowering our outlook for revenues. Wholesale growth is expected to be low. As we outlined in June, there is $220 million of non-comparable sales last year due to the rapid expansion to major US strategic customers and the discontinuation of relationships with some smaller customers.

Since then, while our wholesale partners are very pleased with the performance of HEYDUDE, and a number have called this out in their recent earnings, many are cautious in terms of future bookings based on their overall market outlook and lack of historical data on HEYDUDE's performance.

Finally, as we previously shared, we anticipate constrained distribution capabilities, particularly related to at-once in the back half of the year, due to ERP and warehouse transitions. Even with this lowered near-term revenue outlook, the HEYDUDE brand is acquiring new customers and is gaining penetration in strategic accounts and on the coasts. We remain incredibly optimistic about the long-term potential of the brand on a global basis.

Finally, turning to digital for both brands, we saw exceptional 21% constant currency growth, driven by new product introductions that are resonating well with consumers globally. For the Crocs brand, the app is rapidly scaling and gaining consumer traction, reaching penetration over 20% in South Korea. In the U.S., we continue to be excited by our launch of customization, and on our site now offering an online configurator for organizations to design custom clogs and Jibbitz.

Our global CRM database is also accelerating in key markets with the expansion of programs like SMS and the app. As we mentioned last quarter, to gain better control of our brand and realize higher ASP, we anticipate transitioning some of our Crocs e-tail business that sits in our wholesale segment to a direct digital sale, both on crocs.com as well as marketplaces, where we'll sell directly to the consumer. This will result in lower wholesale sales and higher DTC sales.

For HEYDUDE, we're investing in digital capabilities such as enhanced site experience, payment offerings to improve the customer journey. We're also scaling our digital marketing investments to acquire and retain new customers. These efforts, coupled with new product introductions, have led to strong growth rates across all our digital channels, including being a top-performing brand during Amazon's recent Prime Day.

Overall, our digital-first approach is working and is driving strong growth globally. In summary, we have tremendous confidence in, and clear evidence as to the underlying strength and growth potential of both the Crocs and HEYDUDE brands. Sell-through from both of our brands continues to be robust, and we believe we're benefiting from our democratic price points and gaining share in a difficult market. I will now turn the call over to Anne for a review of Q2 financial results in more detail.

Anne Mehlman (EVP, CFO and Brand President)

Thank you, Andrew. Good morning, everyone. I will begin with a short recap of our Q2 results. All revenue growth rates will be cited on a constant currency basis, unless otherwise stated. For a reconciliation of the non-GAAP amounts mentioned to their equivalent GAAP amounts, please refer to this morning's press release. We had an excellent Q2, with over $1 billion in consolidated revenues, representing 12% year-on-year growth.

We delivered another quarter of industry-leading profitability, with adjusted gross margin at 58.1%, adjusted operating margin of 30.3%, and adjusted diluted EPS growth of 10.8%. Our portfolio is diversified from a brand, channel, and geography perspective. On a trailing 12 month basis, ending Q2, HEYDUDE brand revenues were 26% of total revenues.

Channel mix was well balanced, with wholesale revenues representing 54% of trailing twelve-month revenues and DTC at 46%. Approximately 31% of total TTM revenues and 40% of Crocs brand TTM revenues were from international markets. During the Q2, Crocs brand revenues were $833 million, growing 14.9% to prior year and driven by strong DTC growth of 26.8%. The brand sold 33 million pairs of shoes, an increase of 1.8%.

The Crocs brand's average selling price during Q2 was $25, which was up 12.8% on a constant currency basis, driven by price increases and fewer DTC promotions internationally. Within the Crocs brand, clogs grew double digits and continued to generate demand with newer products such as Echo, Crush, and Dylan.

Sandals, an important growth pillar for the future, increased 34% in Q2, with growth in all regions to represent 16% of Crocs brand sales. Finally, Jibbitz continues to create excitement and engagement with consumers around the world, growing 13% from last year, with strong growth internationally.

Now, let's discuss a few Crocs brand highlights by region. In North America, Q2 revenues increased 12.5% to $475 million, and first half revenues increased 11.5%. We gained significant market share in a declining U.S. footwear market. The North America DTC channel for the Crocs brand, an indicator of underlying consumer demand, was a key growth driver, with DTC comparable sales of 12.9%.

Wholesale revenues were also robust, increasing 5.5% despite a more challenging wholesale environment. Asia Pacific delivered significant growth as we execute on our long-term growth plan to ignite the brand in the region. Crocs brand Q2 revenues in Asia grew 39% to $198 million. Growth was broad-based across countries and channels.

China and Australia led the growth, with revenues increasing over triple digits, while South Korea and Southeast Asia also had strong double-digit growth. Crocs brand revenues for EMEALA were $160 million, a decline of 1.4% from the Q2 of 2022. As a reminder, Q2 last year benefited from a $40 million revenue shift out of Q1 following the Vietnam shutdowns. This quarter, strong growth in direct markets, including the UK and France, as well as outstanding DTC comp growth of 38.6%, was offset by a decline in distributors.

In connection with the newly implemented marketplace management program, in the quarter, we terminated a relationship with a significant distributor servicing Africa. This was not anticipated going into the quarter, and we terminated the relationship after finding evidence of product diversion to the gray market outside of their approved territories.

This impacted revenue by $8 million in Q2, and will impact second half revenues by $21 million. We expect EMEALA revenue growth to reaccelerate in the back half of this year. Turning to HEYDUDE, Q2 revenues were $239.4 million, an increase of 2.9% from last year. During Q2, the brand sold 8.3 million pairs of shoes, an increase of 3.6% over last year.

HEYDUDE average selling price during Q2 was $28.88, or 0.6% lower than prior year, due to price pressure from gray market selling on Amazon. The DTC channel, which is predominantly e-commerce, led the growth, with revenues increasing 29.7% from last year. Digital sales increased 36.6%, and digital penetration increased 1,000 basis points to 41.8%. As Andrew explained earlier, underlying consumer demand for the HEYDUDE brand is incredibly healthy.

Consolidated adjusted gross margins for the Q2 were 58.1%, increasing 290 basis points from last year, driven by favorability in ocean freight rates and the absence of air freight that was partially offset by higher overhead and fulfillment costs associated with our HEYDUDE distribution network inefficiency.

Currency negatively impacted consolidated gross margins by approximately 50 basis points. Turning to the brands. Adjusted gross margin for the Crocs brand was 62%, or 410 basis points higher than prior year. Reduced air freight of approximately 380 basis points, combined with lower inbound freight rates, higher prices internationally, and channel mix, were partially offset by product mix. Currency negatively impacted margins by 80 basis points.

HEYDUDE adjusted gross margins were 47.1%, flat with prior year. We continue to see a reduction in inbound freight rates. However, this has been offset by additional inventory storage and network costs related to the transition of our subscale distribution network, combined with gray market pressures on ASP in our digital channel.

During the Q2, consolidated adjusted SG&A represented 27.8% of revenues, which is 270 basis points higher than last year, as we invested more in marketing and talent for both brands to support our growth trajectory and annualized additional investments for HEYDUDE.

Our Q2 consolidated adjusted operating income was $325 million, and increased to prior year by 11.7%, and consolidated adjusted operating margins remained best in class and increased 20 basis points to 30.3%. Our Q2 non-GAAP diluted earnings per share increased 10.8% to $3.59. Our continued strong free cash flow generation enabled us to repay approximately $300 million of debt in the first half, reducing borrowings to $2 billion.

At the end of Q2, adjusted gross leverage was 1.8x, achieving our mid-year leverage goal, and net leverage was approximately 1.7x, as we ended the Q2 with $166 million of cash and cash equivalents. Our exceptional free cash flow generation has enabled us to quickly deleverage and resume our share repurchase program.

In July, we completed $50 million of share buyback. We're purchasing 425,000 shares at an average price of $117.72. We currently have $1 billion remaining on our share repurchase authorization, and we will continue to methodically balance debt repayment and share repurchase as we approach our long-term net leverage target of 1x to 1.5x.

Our inventory balance at 30 June 2023, was $436 million, a decline of 13% to Q2 last year. Crocs brand inventory was $307 million, down 8.4% to prior year, and HEYDUDE inventory was $130 million, a decrease of 22.3% to prior year. Inventory turns continue to improve, and we are very pleased with the health of our inventory.

As we look forward, I would like to share our current outlook for the Q3 and the balance of 2023. All numbers will be on a reported basis unless otherwise stated. Having completed an exceptional first half, and with improved visibility and confidence around the second half, particularly for the Crocs brand, we are raising our full year 2023 outlook for revenue and profitability.

We now expect revenue growth of 12.5% to 14.5% on a reported basis compared to 2022, up from prior guidance of 11% to 14% growth, and resulting in full-year revenues of approximately $4 billion. On a consolidated basis, as always, we are focused on best-in-class profitability and are raising our adjusted operating margin to be approximately 27.5% for the full year.

We are confident in our ability to deliver higher operating margins as gross margins have outperformed, and we have been able to closely manage SG&A while investing for future growth. We are also raising our adjusted diluted earnings per share outlook to be between approximately $11.83 to 12.22, up from the prior guidance of $11.17 to 11.73.

From a brand perspective, we are raising our expectations for the Crocs brand and now expect to grow 12% to 13% on a reported basis, up from 7% to 9% previously, with Asia expected to deliver the highest growth and DTC outperformance expected to continue.

For HEYDUDE, as Andrew mentioned, we are lowering our full year growth outlook to be between 14% and 18% revenue growth on a reported basis. This translates to approximately 3.5% to 7.5% growth on a 2022 pro forma revenues of $986 million. While we continue to anticipate strong growth in wholesale sell out for the HEYDUDE brand, our wholesale partners are planning to manage their inventory very closely for the remainder of the year, and we have a constrained warehouse that limits our at-once capabilities.

On a two-year basis, HEYDUDE growth is very healthy at approximately 80%, and we remain excited about the long-term growth potential of this young brand. For Q3, we expect consolidated revenue to grow approximately 3% to 5% as we've got significant pipeline sales for HEYDUDE. We expect Q3 adjusted operating margin to be approximately 27% and adjusted diluted earnings per share of $3.07 to $3.15. In summary, we are incredibly pleased that we are able to raise expectations for revenue, operating margin, and EPS. At this time, I'll turn the call back over to Andrew for his final thoughts.

Andrew Rees (CEO and Director)

Thank you, Anne. As we look forward, we're incredibly confident in the strength of the Crocs and HEYDUDE brands and our ability to drive market share gains and sustainable, profitable growth. Our focus remains squarely on sustaining brand health and creating long-term shareholder value. Operator, please open the call for questions.

Operator (participant)

Thank you. We'll now begin the question-and-answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we'll pause momentarily to assemble our roster. Our first question comes from Jonathan Komp from Baird. Please go ahead.

Jonathan Komp (Senior Research Analyst)

Hi, good morning. Thanks, everyone. I want to start just by asking a little more detail about your outlook for HEYDUDE. Could you give a little more color what you're expecting for the Q3, embedding in your total revenue guidance and just how to think about the channel expectations in Q3 for HEYDUDE? Maybe a bigger picture question. I know when you bought the brand, you pointed to at least $1 billion in revenue by 2024. You're delivering that this year, but how should we think about the growth drivers as we get beyond 2023?

Andrew Rees (CEO and Director)

Great. Thank you, Jonathan. Yeah, maybe I'll do the last part of your question first and kind of set the stage for HEYDUDE, then we can come back to Q3. As we look at the period since we've owned HEYDUDE, look, we've been rapidly expanded distribution to what I would say is essentially the same or very similar distribution to Crocs.

A large part of that expansion was last year, and I'll come back to that. At the same time, we've introduced new innovative silhouettes that we think are doing well, or we know are doing well, and we see we dramatically strengthened the team. As we look at Q2 sellout for the brand, up 27% as we look across all channels, and consumer satisfaction is incredibly high. NPS for the brand is 71%, which is about 50% higher than, frankly, most brands in the casual footwear space.

As we look at the back half of the year, we are reducing our expectations for the brand, principally related to wholesale. There's a few things going on there. Number one, as I talked about in prepared remarks, we got $220 million of sell-in that we did last year, that is pretty hard to come. Second, we are seeing our wholesale partners be pretty cautious in the back half of the year. I think they're being cautious for kind of three reasons. One is, they're just cautious about overall traffic trends and the trajectory of the consumer.

They've got some overstock in some other brands, principally some of the big athletic brands that they've got to work through, and they don't have good history on HEYDUDE in the back half of the year. We're seeing very cautious bookings. When we combine that with some constraints that we have around our at-once business, you know, we're transitioning towards the end of the year, our warehouse and our ERP system, so we're being realistic about our at-once capabilities.

Then lastly, I think, you know, we've seen some gray market from on the Amazon platform, which we think is principally coming from the distributors that we closed last year. We are seeing a slight mitigation of that, but we're also working hard to clean up the Amazon presentation.

I think hopefully that gives you a strong picture of what's happening with HEYDUDE. We're incredibly confident with the brand, incredibly confident of the long-term growth trajectory. We're not ready to guide next year's growth i think that was embedded in your question, but we feel well positioned for the long-term growth of the HEYDUDE brand, both here in the U.S. and internationally. I'll let Anne add some commentary around Q3.

Anne Mehlman (EVP, CFO and Brand President)

Thanks, Andrew. Hi, Jon. I think the biggest thing for Q3 is just to remember we're still dealing with, as Andrew mentioned, the non-comp business of HEYDUDE or the pipeline sale. For Q3, we do expect HEYDUDE to be down, and that's primarily, that's really related to the wholesale part of the business, as Andrew just mentioned. You can see from our presentation, we had about $60 million of pipeline sale last year. Then we expect direct to consumer to be up and then Crocs, obviously, to continue to grow, and that provides the cover around the overall Q3 guidance for revenue growth.

Jonathan Komp (Senior Research Analyst)

Okay, that's very helpful. If I could just ask separately about Crocs. Given some of the sales that looks like you're gonna miss in the second half, maybe close to $30 million from the distributor you mentioned, you're still raising guidance for the year. Could you just highlight maybe where you're seeing upside for Crocs, and maybe tie in with that any updated thoughts on the gross margin for the year for Crocs, since it looks like it was quite strong in the quarter? Thank you.

Andrew Rees (CEO and Director)

Yeah, thanks, Jon. look, Crocs business is very strong, and we're seeing the brand perform strongly, in, in frankly, many regions. I'd probably call out a couple. DTC is very strong, particularly here within North America, but also in Asia. Our U.S. wholesale business is probably a little bit stronger than we thought it was gonna be, so we feel really good about that.

China, I think we gave you a lot of color around China in our in our prepared remarks, is performing very well, and broader Asia is also performing well. I think what we're seeing is, you know, continued strength in, in Crocs, really driven by the same things that we've kind of talked about a few times, but it's really product innovation, it's marketing innovation. We see it across clogs as well as sandals, as well as Jibbitz. I would feel very confident in the overall Crocs trajectory. I want Anne to pick up on your gross margin point.

Anne Mehlman (EVP, CFO and Brand President)

I would also just add that EMEALA DTC is actually incredibly strong as well. Even though the distributor part is impacting that, we saw very strong growth in EMEALA DTC of, I think, around 40%. But overall, from a gross margin perspective, Crocs gross margins are also flowing through stronger. Some of that is just stronger channel as DTC outperforms.

The second piece is we've taken quite a bit of price in our international markets, which are really supporting margins. Then we've seen promotional levels kind of level out in North America. Then obviously, we've been able to recoup the freight, air freight last year, as well as just lower freight rates.

I would say overall, we expect margins to be higher than the kind of original guide we thought they were gonna be, like, a little bit higher than 58%, now we're thinking they're probably gonna be north of that. Overall, our gross margin expectations for the year are higher than the kind of 55.5% we talked about last time, and that supports the operating margin raise.

Jonathan Komp (Senior Research Analyst)

All right. Thank you very much.

Anne Mehlman (EVP, CFO and Brand President)

Thank you.

Operator (participant)

The next question comes from Abbie Zvejnieks, Zvejnieks from Piper Sandler. Please go ahead.

Abigail Zvejnieks (Senior Research Analyst)

Hi, yeah, thanks for taking my question. Just first, can you just comment on any differences, I guess, that you're seeing, from your, you know, wholesale partner behavior between Crocs and HEYDUDE in the U.S. specifically? Is there, you know, is there any difference between sell-out between the brands, or is this really that non-comp dynamic and then just not having that historical, you know, just historical data on what happened in the second half for HEYDUDE?

Andrew Rees (CEO and Director)

Yeah, I think that is obviously a question that we've definitely been kind of asking ourselves and looking closely at Abby. I would say a lot of it is really the newness of the brand we sell. Crocs is clearly performing well. I would say Crocs at U.S. Wholesale, it's the newness, it's both clogs, it's both sandals, and it's performing well.

I would say the HEYDUDE sellout is also very strong. I think we gave you some visibility to that in the strategic partners. It's up dramatically, I think, close to 80%. Sell out in aggregate across all channels, and our estimate is up 27%. Consumer takeaway is strong. It's definitely performing at wholesale. We think the principal issue is they, you know, they have years and years in history on Crocs and how it performs in the back half of the year.

The history is very light and to some of the wholesale partners, non-existent for the back half of the year. We're seeing, you know, cautious bookings. As I highlighted in my earlier answer, you know, it's hard for us to react to that without one, given our kind of warehouse situation. That's really our, our, our diagnosis.

Abigail Zvejnieks (Senior Research Analyst)

Got it. That makes sense just on the, you know, inventory management was really strong during the quarter. You talked about, you know, HEYDUDE gross margin was flat year-over-year, but, you know, some pressure from those storage costs. As you cleared through inventory, when do you think you could start to see maybe some benefit to the HEYDUDE gross margin? Thanks.

Anne Mehlman (EVP, CFO and Brand President)

Yeah, we're very pleased with our overall inventory, obviously, down for both brands and really coming in line with, you know, our longer-term target for turn targets for both brands being about four times. I think from a gross margin perspective, overall, there's kind of two pieces pressuring HEYDUDE gross margins. One piece, as you mentioned, is the additional kind of storage and subpar logistics situation for that brand, which we expect to obviously cure next year with the opening up of our new Las Vegas distribution center.

The second piece is we are seeing quite a lot of gray market activity on Amazon pressure our HEYDUDE AFPs, and that's really related to some of the terminations that we did when we went through and terminated some of the legacy international distributors and also some of the legacy U.S. partners. We expect to work through that, and that to improve throughout the year. I expect next year, our gross margins should be back in line, kind of with where we, you know, originally thought, which is, you know, more on the lines of around 50% in the shorter term.

Abigail Zvejnieks (Senior Research Analyst)

Got it. Thank you.

Operator (participant)

The next question comes from Tom Nikic from Wedbush Securities. Please go ahead.

Tom Nikic (Senior Equity Research Analyst)

Hey, yeah, thanks for taking my question. I guess when we think about HEYDUDE, obviously, yeah, I believe you said down in Q3, that would imply that, you know, there's a pretty significant step up in the Q4. There's and, you know, based on the slide deck, there's also a, you know, pretty significant amount of new door contribution last year. I'm not sure if that's, you know, channel fill or self-fill. -or channel fill that had happened earlier in the year or whatever. I guess, how do we get comfortable with kind of the reacceleration that's embedded in HEYDUDE for the Q4?

Andrew Rees (CEO and Director)

Yeah, I think, there's a few things. One is, in, in the Q4, we anticipate that the DTC balance of the business is bigger, right? It typically is with the, with the holiday period. We think DTC is the bigger, and as you can see, we've gotten, you know, nice trajectory on our DTC business. We also, you know, looked at our wholesale business, and yes, there is still a component of sort of pipeline fill that's harder to comp in the Q4. I think the balance of the business, you know, we will see a rebound in Q4.

Tom Nikic (Senior Equity Research Analyst)

All right. I just wanted to follow up on inventories. I think inventory was down 13% year-over-year if I'm not mistaken. Should we think about inventories being down year-over-year in the back half as well?

Anne Mehlman (EVP, CFO and Brand President)

Yeah, we don't typically guide inventory. I would say that we expect by the end of the year to look at, you know, to be closer to our four-term target. I think, you know, it depends a lot on, obviously, from a revenue perspective, and we will both for both brands, you know, tend to bring in inventories ahead of a very high selling season for wholesale in Q1. Some of that depends on our Q1 order bump, obviously. We think that our inventories will be back in line probably around four terms by Q4.

Tom Nikic (Senior Equity Research Analyst)

Understood. Thanks, Anne. Thanks, Andrew. Best of luck in the back half.

Anne Mehlman (EVP, CFO and Brand President)

Thanks, Tom.

Operator (participant)

The next question comes from Jay Sole from UBS. Please go ahead.

Jay Sole (Managing Director and Equity Research Analyst)

Great. Thank you so much. You know, in the slide deck, you gave us that nice data point that sandals continue to expect to be $400 million for the Crocs brand. You also mentioned some new styles from HEYDUDE. I think you pointed out in the slide deck, the Funk, the Sirocco. What percentage of HEYDUDE revenue is, is the Wally and Wendy right now, and where maybe where was it a year ago, and where do you see it going from here? Thank you.

Andrew Rees (CEO and Director)

Yeah, that. We don't, we've not been providing that data, Jay, but I can qualitatively tell you that a very large portion of the HEYDUDE business is Wally and Wendy. That's the iconic silhouette. While we're highlighting new styles, which we think is important to continue to diversify and build out the brand and take the brand into kind of other silhouettes and other wearing occasions, a ton of our effort from a product innovation and newness perspective is going into the Wally and Wendy. I think we were highlighted, you know, a great example is the Patriotic Pack, right?

Last year, essentially, when we bought the brand, they had a stars and stripes shoe that did really well going into Memorial Day and Fourth of July. You know, we saw, you know, great traction with that we expanded that to, I think we said 20+ style colors across men's, women's, and kids, and that did amazing.

Yeah, a good, a large portion, a very large portion of the business is Wally and Wendy, and our innovation is going into Wally and Wendy, plus also the additional silhouettes. I would call out, you know, Sirocco in particular, which is kind of a running-orientated silhouette, casual running, is performing very well in our DTC business and in our key wholesale accounts.

Jay Sole (Managing Director and Equity Research Analyst)

Okay, got it. Anne, if I can maybe ask one more. Can you give us an update on the cash use plans for Q3 and Q4? Obviously, paid down a lot of debt in the quarter, bought back some stock i mean, do you expect those trends to continue at a similar rate or different rate? That would be helpful. Thank you.

Anne Mehlman (EVP, CFO and Brand President)

Thanks, Jay. We are, we're incredibly pleased with our historical debt paydown and what we anticipate to pay down we've obviously done a lot of work on de-risking the balance sheet and paid down $850 million of debt since we purchased HEYDUDE. We do expect to continue to generate incredible free cash flow.

That free cash flow, given these dynamics, after we will, you know, funding our business, obviously, we'll continue to deploy capital. We'll prioritize paying down debt to get to a target net leverage, longer-term ratio, 1 to 1.5, as we've stated, and we will look to opportunistically also buy back shares. We will balance both in the back half of the year.

Jay Sole (Managing Director and Equity Research Analyst)

Is that included in the EPS guidance?

Anne Mehlman (EVP, CFO and Brand President)

No, the EPS guidance includes debt paydown and excludes any opportunistic share buybacks.

Jay Sole (Managing Director and Equity Research Analyst)

Got it. Okay. Thank you so much.

Anne Mehlman (EVP, CFO and Brand President)

Thank you.

Andrew Rees (CEO and Director)

Thank you.

Operator (participant)

Our next question comes from Samuel Marc Poser from Williams Trading. Please go ahead.

Samuel Poser (Senior Equity Research Analyst)

Good morning, everybody. Thanks for taking my questions. All right. At the FANY Show, we were told that when showing a lot of new product that, you know, to help balance you run a MAP program, but you have MAP holidays. My question to you is:

What are you doing with core product in both Crocs and HEYDUDE to create more relative scarcity so you don't need the MAP holidays, so you can drive a better, you know, more of a full price business? Because I think everybody out there is seeing a good amount of promotion. Then I want to follow up on how you're controlling MAP, Amazon and how long that's gonna take to get that all cleaned up?

Andrew Rees (CEO and Director)

Okay. All right, I think, let me do the first part first, Sam. What I'd say is, for Crocs and HEYDUDE, we you know, we operate MAP as you well know. We try and make sure our, you know, key styles are mapped, and so they are not promoted on an ongoing basis. Then we give the retailers, I think five holidays a year, throughout the year, which is frankly pretty typical. I would say most brands follow that cadence, give them an opportunity to drive some promotion. Those are all at key promotional periods when the consumer is expecting, promotion.

You know, we think that is a very sensible strategy to maintain majority full price sell-through, plus also give our wholesale partners an opportunity to drive a little extra business at key times and compete with other brands. I would highlight, you know, particularly for Crocs, where that's been in place for some period of time, that is driving a very high overall achieved gross margin rate and a great deal of profitability for the brand. You wanna ask your question associated with Amazon cleanup?

Samuel Poser (Senior Equity Research Analyst)

Yeah, but I mean, I, I understand, but, you know, if you have a brand that appears as strong as both your brands are, and you have a strong MAP policy, wouldn't the consumer start waiting for the sale periods over time versus, you know, just control it? You know, I understand promoting stuff you need to clear, but if you have core colors that you're gonna promote, I mean, you know, it just…

Andrew Rees (CEO and Director)

Yeah.

Samuel Poser (Senior Equity Research Analyst)

I don't really understand it.

Andrew Rees (CEO and Director)

I would say, Sam, there's not a lot of evidence for that, right? We see our core products, core colors, core products sell week in, week out, right? There's really not a lot of evidence that they're waiting for the MAP periods. I would say the MAP breaks on the cores are pretty light. I would say, you know, look, we're doing a ton of other things with scarcity, right? We do, you know, multiple collabs a week to drive scarcity and drive consumer interest in the brand and a reason to buy. We have huge amounts of kind of seasonal product that's in and out.

You know, if you think about the core Classic Clog, you know, a whole range of seasonal colors that don't get replenished, and so the consumer knows if they don't buy them, they're not available later. I think, you know, the balance of collabs, marketing activity, consumer activation, is kind of working really well, to be honest, in terms of driving the overall trajectory of the brand, as well as the sales and gross margin achievement.

Samuel Poser (Senior Equity Research Analyst)

Apply that to HEYDUDE, including the Amazon question?

Andrew Rees (CEO and Director)

Yeah, you know, we're transitioning to a similar strategy for HEYDUDE, right? We've rapidly expanded the distribution of the brand essentially to the same partners that have Crocs. We're following kind of a similar pricing approach. I would say we are seeing quite a lot of pressure in terms of Amazon gray market, and we're working really hard to close that down. I think we've highlighted that we think a lot of that product is coming from the distributors that we closed internationally.

The amount of product that they have available is finite and will run out, and we believe is running out. You know, it's a disruption, temporary disruption to the business. I think we're very clear about what it is and how we deal with it.

Samuel Poser (Senior Equity Research Analyst)

Thank you very much.

Andrew Rees (CEO and Director)

Okay. Thanks, Sam.

Operator (participant)

The next question comes from Jeffrey Lick from B. Riley. Please go ahead.

Jeffrey Lick (Senior Research Analyst)

Morning, guys. Congrats on a great Q2. Andrew or Anne, I was wondering, you know, your Q2 presentation that you put out on June seventh, you know, the implication is, you know, you take the HEYDUDE guidance from, you know, mid-20s down to the 14 to 18. You know, the implication is things were probably on track at that point, you know, given how you go about your IR efforts and your communications.

I'm just wondering if you could walk us through some color as to, you know, what happened, you know, from June seventh on to today, in terms of, you know, how did you get the feedback? You know, any, any color on how things deteriorated a little bit and changed?

Andrew Rees (CEO and Director)

Yeah, look, I think the biggest thing, Jeff, is what I highlighted to an earlier question, right? Which was, as we look at our. You know, there's really two big pieces. One is wholesale, the other is sort of, you know, our efforts to clean up the gray market. The biggest probably is the wholesale. You know, as we look at our bookings for the Q4, they were more conservative than we thought they were gonna be. That's really the biggest change.

You know, the reasons we think the reasons that we've been told and the reasons that we understand for that is, number one, you know, the wholesale channel, majority of the wholesale channel has been pretty cautious about the back half of this year.

They have some inventory overhang. From some other brands that they need to work through, so their open-to-buy dollars are a little bit more constrained than they'd like to be. You could argue that, you know, they should invest in the performing brands and then deal with the, the overstock brands separately we've certainly made that argument, and we'll continue to make that argument.

They don't have strong history on HEYDUDE, right? You know, unlike Crocs, where they have years and years of history and can see exactly how it performs in the back half of the year, they don't have the same history and confidence in HEYDUDE. They're pushing a bit of the responsibility back on us in terms of at-once, but we don't have the ability to deal with that to the degree they'd like us to.

You know, we just felt at this point it was prudent to lower expectations for the back half of the year. That's really what changed. As we look beyond the back half of this year, you know, we see lots of growth opportunities for the brand, both from a territory perspective, from a customer perspective, and also from a silhouette and new product introduction perspective.

Jeffrey Lick (Senior Research Analyst)

Just a quick follow-up on the direct-to-consumer HEYDUDE, at 29.7%. I'm curious, is that relative to the 40.6% in Q1 on a two-year, are those comparable? It seems like that probably decelerated a little bit. I was wondering, as you guys measure the gray market impact, how much of an impact in terms of percentage points might that have on that DTC revenue %?

Anne Mehlman (EVP, CFO and Brand President)

Jeff, 40% was just the only that was just March. If you remember, that was direct-to-consumer call for March, because we didn't own the business before that. The 29.7% is total growth for direct-to-consumer, which is e-com, we have a small amount of retail type of clearance stores. That's the 29.7% growth you're comparing kind of three months to one month when we kind of own the business i'm not sure it's a totally fair comparison, we feel pretty good about a 30% direct-to-consumer growth.

I'm not sure if we can actually or we're ready to kind of talk about how much the gray market has hurt from a growth perspective, I would say actually on both brands, it's not insignificant. It's actually, you know, pressured ASPs and also, you know, obviously we lose, you know, with the buy-backs and being able to, you know, sell directly to the consumer.

We've been very aggressive in attacking that we talked about we've launched a market cleanup kind of program, you know, obviously canceled a pretty significant distributor. You know, we will continue to be very focused on making sure that our product ends up where it should be.

Jeffrey Lick (Senior Research Analyst)

Great. Thanks very much.

Anne Mehlman (EVP, CFO and Brand President)

Thank you, Jeff.

Operator (participant)

The next question comes from Jim Duffy from Stifel. Please go ahead.

James Duffy (Managing Director and Senior Equity Research Analyst)

Thank you. Good morning. First, Andrew, I'm hoping you can speak to the development of the China marketplace and opportunity throughout the build maybe to start, just can you size the baseline, a lot of moving parts with COVID? Give us a sense for the size of that business now, and then maybe speak to the current channel mix. With that background, if you could speak to the different avenues for growth will digital be the principal channel, or do you plan to open more stores in China as well?

Andrew Rees (CEO and Director)

Yeah. Let me talk about the strategy about what we're going to do in China. I'll have Anne come in at the end and talk to you about the size of the base and, give you-

James Duffy (Managing Director and Senior Equity Research Analyst)

Great.

Andrew Rees (CEO and Director)

Give you some perspective there, right? From a strategy perspective, the way to think about it, and we've talked about this, you know, historically through the cleanup. The way to think about it, in China today, we have a large digital business. We've definitely invested very heavily in digital. It's probably our, you know, probably our most important channel within China.

Then secondly, we have a small footprint of company-owned stores. Those company-owned stores are in the major cities and in the best malls, which are sort of quite expensive for your distributors or your distribution partners in country to invest in. They're super important because they showcase all of our latest products. They drive authenticity with the consumer.

Then we have outlet stores that we also own directly ourselves. Important because they are highly profitable, and also they allow you to keep your inventories clean. The third component of the strategy is the franchise, or partner-owned mono-branded stores.

As we look at growth, we think growth will principally come from two things: We think our digital business will continue to grow, and that's diversified across the platform. That's Tmall, that's [inaudible], but also increasingly China's TikTok, where we do a lot of social selling in China. The growth will come from digital and will also come from partner-operated stores. As we look at the partner portfolio, they will continue to grow their store footprint, you know, probably quite aggressively.

The stores that they're operating for Crocs are performing extremely well. They're making a lot of money from those, and they're, you know, they're really commercial animals. If they're making money and they can see an opportunity to open more stores, they will, and obviously we'll encourage that. Really, the partner-operated stores and the digital will drive the business in the future.

Anne Mehlman (EVP, CFO and Brand President)

Yeah. I think historically, from a size perspective, we said China was about 5% of the Crocs revenue base. Obviously, you know, our longer-term growth for that is we expect it to grow up to be about 10%, which would be a $500 million kind of base. Roughly, if you do the math, historically, when we said it would have been more like a $60 million business. We obviously, you know, are growing it very quickly, so it's outgrowing, so it is taking share and really on track with those kind of that long-term trajectory. We're pretty pleased overall with how China's growing and that it's on track.

James Duffy (Managing Director and Senior Equity Research Analyst)

Anne, is that a margin-accretive business?

Anne Mehlman (EVP, CFO and Brand President)

We're investing quite heavily in it right now, right? We're investing outsized marketing into that business. Long term, obviously, you leverage that, and the gross margins in that business are incredibly strong.

James Duffy (Managing Director and Senior Equity Research Analyst)

Great. Last question for me, it's just on the HEYDUDE SG&A. I'm curious if you've at all adjusted it for the tempered revenue view.

Anne Mehlman (EVP, CFO and Brand President)

I'm sorry, can you say that again? What was the last part of your question?

James Duffy (Managing Director and Senior Equity Research Analyst)

It's, the HEYDUDE SG&A. I'm curious if you've adjusted your planned, SG&A investment in the HEYDUDE brand for the tempered revenue view.

Anne Mehlman (EVP, CFO and Brand President)

Understand. No, actually, we continue to accelerate investments into HEYDUDE in line with our original plan because again, this is not a consumer takeaway issue. We feel very strongly that we need to invest in our brands, and luckily, we can still, you know, generate 27.5% operating margins. It's the benefit of having a portfolio and also the benefit of, you know, having one brand spin off so much profitability we will continue to invest in HEYDUDE SG&A throughout the year at the same pace.

James Duffy (Managing Director and Senior Equity Research Analyst)

Excellent. Thank you.

Anne Mehlman (EVP, CFO and Brand President)

Thank you.

Operator (participant)

The next question comes from Laura Champine from Loop. Please go ahead.

Laura Champine (Director of Research and Senior Consumer Analyst)

Thanks for taking my question. I hear that the shift from expecting HEYDUDE to grow in the mid-20s to more like high teens this year is because of wholesale customer orders coming in conservatively. Does that impact your own internal thoughts about the growth rate for HEYDUDE for next year and beyond?

Andrew Rees (CEO and Director)

No, Laura. I think, you know, connected to, and answer to Jim's question, immediately prior. No, we see HEYDUDE on essentially the same trajectory as we saw it on when we bought the company and since we've owned it. We still have very high expectations for the long-term growth of the brand, and we continue to make, I would say, the SG&A investments, the talent investments, and the marketing investments, that we had anticipated making even before taking down this adjusted, you know, this adjustment to our growth rate.

We will continue to do that we're very confident in the long-term potential of the brand, and, you know, we're managing this brand for its, you know, ultimate potential, not its kind of one year of sort of one quarter or one half year performance.

Laura Champine (Director of Research and Senior Consumer Analyst)

Understood. Then just a follow-up on, on this sort of Wild Wild West environment on, on Amazon and the gray goods sold there. Has there been a change in your own policy for wholesale customers for HEYDUDE to resell on Amazon? If so, how much is that impacting, that guide for this year?

Andrew Rees (CEO and Director)

Yeah, there has been a change. We will make further changes. What we did last year, and that doesn't impact our guide for this year, just to be clear. What we did last year is we did terminate some customers, that were operating, I would say, one or two stores, but buying goods principally to sell on Amazon. We, we terminated several customers that were doing that. That was done last year that's not this year. We also have been very clear in our terms of sale to all of our partners that they are not allowed to sell on Amazon. That doesn't mean that some don't some do, 'cause they do, but that is our policy.

We will further, as we go through the back end of this year, constrict our wholesale customers' rights to sell on their own dot-coms as well, right? This is essentially moving HEYDUDE to the same policy we have for Crocs, which is our large wholesale customers think, you know, Famous Footwear or, you know, or, you know, Foot Locker. They absolutely have the rights to sell on their own dot-com, but the mom-and-pop retailers will not have the rights to sell on any web presence that they have. We're in the process of the sort of continued reining in of digital selling.

Laura Champine (Director of Research and Senior Consumer Analyst)

Got it. Thank you.

Andrew Rees (CEO and Director)

Just to emphasize, we're getting it to the same place that Crocs is. We're not restricting further than that.

Laura Champine (Director of Research and Senior Consumer Analyst)

Makes sense. Can you be specific on how much that has impacted the guide for 2023?

Andrew Rees (CEO and Director)

Look, it's probably had some impact. We can't break that out and be specific about that, but it probably is a factor.

Laura Champine (Director of Research and Senior Consumer Analyst)

Understood. Thank you.

Operator (participant)

The next question comes from Rick Patel from Raymond James. Please go ahead.

Rick Patel (Managing Director and Equity Research Analyst)

Good morning, everyone. Thank you for taking the question. Can you talk about the drivers of the Crocs brand in North America going forward? I'm just curious how we should think about the contribution of pricing versus volume in the back half. If there's anything to call out in terms of the wholesale business in light of the trends that you're seeing at HEYDUDE.

Andrew Rees (CEO and Director)

I mean, the drivers of Crocs, I think your question is kind of a multi-period question. We see new product introductions, we see strong marketing support, we see collaborations continuing to drive very high interest in the Crocs brand, and in fact, growing interest in the Crocs brand. We will capture that interest through continuing to diversify clogs and continuing to grow our clog business, as well as the rapid acceleration of sandal and penetration of sandal categories, and also continued innovation within.

We really see those core businesses towards the back end of this year, we'll also continue to experiment with, I would say, kind of new and innovative silhouettes that we think the Crocs brand can be particularly relevant. You'll continue to see us push the envelope in terms of experimentation. I think that's super important. You know, I'm pretty confident, you know, we'll, you know, as evidenced by our DTC growth and our strong wholesale performance, that will continue to drive kind of multi-year trajectory for the Crocs brand in North America.

Rick Patel (Managing Director and Equity Research Analyst)

Can you also update us on where you are with addressing HEYDUDE's ERP and capacity constraint issues? I believe you touched on working through that next year, but I'm just curious if it's going to be a first half versus second half event, and when that does happen, what kind of change we can expect from HEYDUDE, from a go-to-market strategy perspective, in terms of potential to add new wholesale partners or accelerate international efforts?

Andrew Rees (CEO and Director)

Yeah, we plan to transition to our new ERP and our warehouse, essentially at the end of the year. That will be the transition period. That will release a couple of important constraints. One is we're incurring a lot of extra costs to move goods around, double handle goods, and have goods stored in subscale places that will reduce. That'll alleviate some expense and also some flexibility and ability to react to the business. It will also give us the opportunity to have a much larger at-once business in the following year.

It will also allow us a little bit more flexibility with some of our major wholesale partners, with whom today we're really trying to do a lot of direct shipments, which can be efficient and cost-effective, but are also not very flexible. It'll give us a lot more flexibility. It'll give us lower costs, flexibility, and the opportunity for a larger at-once business.

Rick Patel (Managing Director and Equity Research Analyst)

Thanks very much.

Operator (participant)

This concludes our question-and-answer session. I would like to turn the conference back over to Andrew Rees for any closing remarks.

Andrew Rees (CEO and Director)

Just to close, I think I'd like to just thank everybody for their continued interest in the business. Obviously, we had a phenomenal Q2, and I think what you're also seeing is the real cash-generating power of our portfolio, and the ability to pay down debt very rapidly and give us a lot of balance sheet flexibility. Thank you for your interest, and we'll talk to you again next quarter.

Operator (participant)

Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.