Crocs, Inc. Q2 FY2022 Earnings Call

Welcome to the Crocs Incorporated Second Quarter 2022 Earnings Call. All participants will be in listen-only mode. 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, Vice President of Corporate Finance. Please go ahead.

Good morning, everyone, and thank you for joining us today for the Crocs second quarter 2022 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 the acquisition of HEYDUDE and the benefits thereof, Crocs’ strategy, plans, objectives, expectations, financials 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, performance 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. A 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 will turn the call over to Andrew.

Thank you, Cori, and good morning, everyone. I’m pleased with our very strong second quarter results and the strength of our brands as we continue to navigate a dynamic consumer environment. Both of our brands are incredibly well positioned relative to the core consumer needs of comfort and value. We are very confident that we will continue to gain significant market share, resulting in industry-leading growth, profitability, and cash flow. I want to also thank all of our teams across the world for all of their hard work as they respond to the many opportunities in front of us. Looking at the second quarter of 2022, Anne will review our financial results in more detail shortly. But here are a few highlights. Consolidated revenues of $965 million, growing 56% on a constant currency basis. The Crocs Brand had another great quarter, growing 19% constant currency, negatively impacted by Russia and the China COVID lockdown, which offset approximately three percentage points of growth. HEYDUDE exceeded expectations, generating revenues of $232 million, an impressive growth almost doubling compared to last year. In July, we launched a new brand campaign for HEYDUDE that we think is compelling and introduced as an updated brand identity. Adjusted operating margin on a consolidated basis remains best in class at 30%, despite currency, inflation and supply headwinds. Adjusted diluted earnings per share increased $1.01 to $3.24. Finally, we are very proud that Crocs recently earned the number three spot on Forbes' list of America’s best employers for women. We are particularly pleased with our Q2 results in the context of the overall market. While market data is not as complete and timely as we would like, based on a variety of sources, we believe that the footwear market in the U.S. trended flat to down in the first half of 2022 and may have done a little better globally, but we believe it was best in class. In the context of a flat to down market during the first half, constant currency revenues for the Crocs Brand grew by 20%, and consolidated revenues grew by 52% driven by the acquisition of HEYDUDE. As you can see, both Crocs Inc and the Crocs Brand are gaining significant market share. There are many macroeconomic and external headwinds, including currency, inflation, rising interest rates, weakening consumer sentiment in the U.S. and Europe, the war in Ukraine, and China’s COVID strategy making this future very difficult to predict. That said, we believe great brands need to continue to invest in innovation and engage their consumers, and great companies must plan prudently and become more agile. In light of the current environment, we are very focused on managing the business prudently in order to maintain high levels of profitability and strong cash flow. During our call today, we will outline how Crocs Inc will continue to gain market share both as a result of the growth momentum of HEYDUDE and the growing consumer demand globally for the Crocs Brand. HEYDUDE is one of the hottest brands in the U.S. footwear market today, because of the consumer love of the brand and its products. We are investing rapidly in the capabilities that will allow us to sustain the growth potential of the brand; while we are not yet ready to outline the longer term potential, we believe it is significant and we will easily achieve a short-term goal of a billion dollars in sales. Our strategy utilizes the proven playbook of investing in great product and digital and social marketing combined with a disciplined go-to-market and distribution strategy. This will result in robust U.S. growth from expanding wholesale distribution, as well as strong digital growth. We are currently planning international growth beginning in 2023, and while small initially, we are confident in the growth potential given initial tests and the versatility of the Wally and Wendy styles. The integration of HEYDUDE is going well, including staffing many critical positions, as well as completing our brand work to help solidify the brand DNA and the consumer passion for the brand. We have recently unveiled an updated brand identity and positioning and will invest significantly in digital marketing through the back half of the year. The growth of the HEYDUDE brand will continue to be very profitable. Thanks to the simplicity of the product, the ability to drive supply chain efficiencies and the SG&A leverage we gain from shared services across both brands. Turning to the Crocs Brand, we will continue to gain market share because of our comfort positioning, molded DNA, strong marketing, and product innovation pipeline. We have developed deep connections with our consumers and they love our brand as evidenced by our own brand metrics, which continue to be very strong as well as leading industry studies. When we combine the brand awareness and relevance with our very competitive price point, we believe that the brand is very well positioned to thrive when the consumer is looking for comfort and value. In addition, Crocs has significant penetration opportunities in key international markets, hence I will focus on Asia. Our proven playbook is driving growth in South Korea, India, and Southeast Asia. We are very encouraged by the green shoots we are seeing in China. We will continue to create brand pull with our powerful social and digital marketing and a pipeline of new products. We had numerous successful collaborations and licenses, ranging from a second drop of Salehe Bembury to Cinnamon Toast Crunch cereal, to MCM in China and Lazy Oaf in Europe. One of our latest marketing innovations was our first-ever virtual store experience in the Metaverse, combining commerce and gamification with a Suki collaboration. From a product perspective, we expanded our sandal portfolio with a long-awaited Crush Sandal, debuted in the U.S. and top Asian markets. The Crush was recently featured in Vogue in an article entitled, 'These Ugly-Chic Sandals have gotten the most compliments this summer.' Innovations such as the Crush Sandal and dedicated marketing campaigns, such as Summer of Crocs, which featured five new sandal introductions, are just two examples of how we are driving growth in the $30 billion sandal market. We were disappointed with our year-to-date sandal revenue decline of 13% constant currency, as we over-edited the line to maximize throughput at the factories, and we had delays in newness which was also compounded by a poor sandal season in the U.S. Year-to-date, we do however see strong double-digit growth in our Icon Sandal franchise, and we expect sandals to improve in the back half with more newness and additional marketing. As a digital-first company, we also continue to engage our consumers in their preferred channel. In Q2, Crocs Brand digital sales grew by 21% constant currency with balanced growth from new and repeat customers. All of these factors give us confidence in our ability for the Crocs Brand to continue to gain market share. In terms of managing the company prudently, we must remain agile to be responsive in a shifting consumer landscape. Let me outline some of those key steps. With uncertainty around the future macroeconomic environment and consumer behavior, we are planning for lower growth in the Crocs Brand in the short-term. Our assumption is that consumer confidence in the U.S. and key European markets will continue to soften as the year progresses, as higher interest rates and high food and energy inflation slow consumption. For 2022, we expect Crocs Brand revenues to grow approximately 14% to 17% constant currency or 10% to 13%, including the negative impact of currency of approximately 400 basis points. This will allow us to prudently plan and manage our inventory and investments. Following strong HEYDUDE performance in H1, we now expect 2022 revenues of between $850 million and $890 million, which is nearly a billion dollars on a pro forma basis. We will continue to leverage SG&A and keep inventories lean. This will enable us to maintain strong marketing investment and constant consumer engagement and will position us to continue our track record of delivering industry leading profitability and cash flow generation. In summary, while we understand that the consumer environment is very uncertain right now, Crocs owns two incredible brands that are perfectly positioned for this time, and we are managing the company to take significant market share. We will now review our second quarter financial results in more detail.

Thank you, Andrew, and good morning, everyone. I will begin with a short recap of our second quarter 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 our press release. As you have already heard, both brands performed well during the second quarter. Amid many headwinds, we delivered strong revenue growth of 19.4% within the Crocs Brand, taking our first half revenue growth to 20.3%. HEYDUDE revenues continue to exceed our expectations and almost doubled from last year. Gross margins remain strong, particularly for the Crocs Brand, despite freight and FX headwinds. While consolidated SG&A leverage led to another quarter of industry-leading adjusted operating margins of 30.1% and strong adjusted EPS growth. Second-quarter consolidated revenues were $965 million representing 55.6% growth over last year. The Crocs Brand had a record-breaking quarter with revenues at an all-time high of $732 million, up 19.4% on top of 88.4% growth last year. The Crocs Brand growth rate was negatively impacted by currency of 510 basis points in the quarter. HEYDUDE revenues of $232 million, also a record, were up 96%. During the second quarter, the Crocs Brand sold 32.4 million pairs of shoes, an increase of 11.4% over Q2 2021. The Crocs Brand average selling price during Q2 was $22.39, a year-over-year increase of 2.5% driven primarily by higher pricing and product mix offset in part by channel mix and currency. Let’s review a few Crocs Brand highlights by region. In North America, second-quarter revenues increased 7.8% to $423 million on top of over 132.3% growth last year. This growth was driven by digital channels, including our own eCommerce, where we saw strong growth in traffic, evidencing strong consumer demand for the Crocs Brand in North America. For the first half, North America revenues grew 12.5%, amidst an approximately 3% decline in the U.S. wholesale footwear market according to NTD. The Crocs Brand in Asia generated second-quarter revenues of $149 million or 27.6% growth. Strength in the region was led by India and Southeast Asia distributors with revenues more than doubling versus last year. In Southeast Asia, distributor partners benefited from COVID reopening and the partial return of tourism to the region. This momentum was partially offset by softness in China due to COVID lockdowns. H1 results for Asia have been consistently strong for two years in a row, posting 25.5% growth this year on top of 24.3% growth last year. Crocs Brand revenues for EMEALA grew 48.4% to $160 million, growth was particularly strong in the UK, Germany and with our distributor partners. Similar to Asia, distributors are seeing strong demand and sell-through. Looking at the first half, EMEALA grew 38% on top of 60% for the first half of last year. Turning to HEYDUDE, revenues exceeded expectations contributing $232 million and growing 96% from pro forma 2021 revenues. We are excited to see the success of the brand during our first full quarter of ownership and expect the new branding and implementation of the Crocs playbook to fuel future growth. As a reminder, we will continue providing gross margin visibility by brand for the remainder of 2022. Beginning in 2023, gross margin will be reported on a consolidated basis only. Consolidated adjusted gross margins for the second quarter were down 660 basis points from last year to 55.2% due to increased air freight and logistics costs, the addition of HEYDUDE, channel mix and currency. Adjusted gross margin excludes a $34 million inventory write-up in connection with the HEYDUDE acquisition. At a brand level, adjusted gross margin for the Crocs Brand was 57.9% down 390 basis points, driven primarily by freight headwinds of 445 basis points, including a 340 basis point impact of incremental air freight and 105 basis points of currency, somewhat offset by increased prices and product mix. HEYDUDE's adjusted gross margin was 47.1%. HEYDUDE experienced higher inbound freight rates versus the prior year and we have moved quickly to leverage Crocs inbound rate contracts, which we expect to result in gross margin improvement in the back half of the year. During the second quarter of 2022, we were able to leverage consolidated adjusted SG&A 610 basis points, improving to 25.1% of revenues versus 31.2% last year. Non-recurring SG&A expenses for the second quarter were $8 million, including $6 million of HEYDUDE integration costs. The 610 basis points of leverage was achieved while investing an additional $42 million versus the prior year, primarily in marketing and talent. To support the long-term growth of both brands, we plan to continue leveraging SG&A while maintaining investment in the right areas to stay connected to our consumers. Our flexible SG&A base, coupled with our ability to leverage shared services of supply chain, IT, finance, HR and legal across the brands enables us to remain agile. Our second-quarter consolidated adjusted operating income of $291 million increased $94 million or 47.9% from last year, including $76 million attributable to HEYDUDE. Adjusted operating margin declined slightly to 30.1% from 30.7% last year, as gross margin headwinds were nearly offset by SG&A leverage. Adjusted operating margins would have been favorable to the prior year, excluding currency. Our second quarter non-GAAP diluted earnings per share increased 45.3% to $3.24. Our liquidity position remains strong, as we ended the second quarter with $187 million of cash and cash equivalents and $470 million of borrowing capacity on a revolving credit facility. Given strong cash flow generation in the second quarter, we repaid $110 million of debt during the quarter, reducing borrowing to $2.77 billion and net leverage to 2.6 times at the end of Q2. Our inventory balance at June 30, 2022, was $502 million, including $167 million for HEYDUDE. Similar to the industry, our in-transit levels remain elevated as a result of longer transit times. While inventories were up $125 million in the Crocs Brand, bear in mind that last year at this time, inventories were exceptionally lean. We also see elevated inventories in the U.S. due to the flow of our U.S. growth rate relative to what we anticipated. Having traditionally targeted over four times inventory turn, we are slightly below that today. However, excluding in-transit inventory turns exceeded six times for both brands. Turning to the future, I would like to share our current outlook for 2022 and the third quarter. All numbers will be on a reported basis unless otherwise stated. Since our prior guidance, we have seen a strengthening U.S. dollar, ongoing shutdowns in China, and we are also anticipating a continued weakening in consumer confidence. As such, we are planning our own DTC more cautiously and are helping to manage our inventory in our wholesale partners more tightly. Given those dynamics for 2022, we are lowering the Crocs Brand revenue guidance to be approximately $2.6 billion representing year-over-year growth of between 14% and 17% on a constant currency basis and 10% and 13% on a reported basis. We expect to grow in all regions with the strongest growth to occur in EMEALA and Asia, as the regions continue to experience high consumer demand and COVID reopening. With respect to HEYDUDE, we continue to gain visibility and confidence in our supply chain. Thus, we are raising our expectations for the full year and now expect HEYDUDE revenues to be between $850 million and $890 million on a reported basis, implying $940 million to $980 million on a pro forma basis. This translates to consolidated revenues growing 47% to 52% to approximately $3.4 billion to $3.5 billion. We continue to expect that we will have best-in-class adjusted operating margins of approximately 26% to 27% for the full year, implying adjusted operating income of approximately $880 million to $945 million. The net effect of the revenue revisions is that expected adjusted diluted earnings per share will be between approximately $9.50 to $10.30. For the third quarter of 2022, we expect consolidated revenues to be between $915 million and $955 million, representing 46% to 53% growth from the prior year. We expect Crocs Brand revenues to grow approximately 15% to 18% on a constant currency basis or 9% to 12%, including the negative impact of currency of 600 basis points. We expect HEYDUDE revenues to be approximately $235 million to $255 million. We expect adjusted operating margin to be between approximately 25% and 26%. As we manage through the shifting operating environment, our commitment to quickly pay down our debt remains unchanged, and we expect to be below two times gross leverage in the next 12 months, enabling us to repurchase shares should we choose to do so. In summary, as we navigate the mini-headwinds, we plan to actively take market share, drive highly profitable growth and reduce leverage. At this time, I will turn the call back over to Andrew for his final thoughts.

Thank you, Anne. Through the remainder of 2022, the strength of our brands continues to position us perfectly to take significant market share during these uncertain times. Our thoughtful management will drive strong profitability and cash flow and create tremendous shareholder value over the long term. Operator, please open the call for questions.

Thank you. Our first question comes from Tom Nikic from Wedbush Securities. Please go ahead.

Hey, good morning. Thanks for taking my question. I just wanted to drill down a little bit on the slowdown that you are expecting for Crocs Brand. It sounds like a pretty significant step down in Q4, kind of backing into something more like a mid-single-digit growth to high single-digit in constant FX. I just want to make sure I understand what is happening here. Is it a combination of DTC and wholesale? Where you are assuming more conservative assumptions? Is it something that you have been hearing from the wholesale partners? I just want to make sure I understand what exactly is happening in the North American market?

Yes. Let me give the sort of high-level, Tom, and then I will hand it over to Anne for more specifics. I think the backdrop, as we talked about in our prepared remarks, is we are just anticipating that the consumer continues to soften through the remainder of the year. As we look at the consumer over the past several months, we have definitely seen concrete signs of this in softening. I think we are very optimistic about back-to-school and feel good about that. But we anticipate as the drag of high interest rates, high inflation and uncertainty continues to impact the consumer, that we will soften as the year goes on. So we are trying to be more prudent, building that into our expectations so that we can manage our inventory and costs appropriately, orienting around our number one priority of maintaining very high levels of profitability and strong cash flow. And Anne can give you more details on that.

Yes. I think that is exactly right. When we were thinking about the full-year, we have obviously absorbed several headwinds, so about $100 million of currency pressure, which is about 440 basis points. The shutdowns in China and Russia for the full-year account for about 180 basis points. So we tried to incorporate all of that into our full-year from Crocs' perspective, as well as readjusting where we think the consumer could go for Q4. We wanted to make sure that we planned prudently so that we could also plan our inventory and cost structure around that.

Yes. And maybe I will come back on the flip side. We see very strong growth internationally. We don’t see some of those same pressures in some of our international markets. And so we are excited about continued growth internationally. And obviously, we have only owned HEYDUDE for a relatively short period of time now, but that continues to perform extremely well above our expectations. Looking forward, we are gaining more confidence in our supply delivery, and we think there is more upside there too.

If I could just do a quick follow-up, you made a couple of references to managing cost structure, and despite a more conservative top-line, you maintain the margin rate outlook for the year. Can you just talk about how you are able to maintain the margin rate for the year despite some of these mounting pressures?

Yes, I think we have a pretty flexible cost structure, and we have adjusted investments to be in line with where we think the top-line is growing, and we are obviously still growing our business strong double-digits. So, it is easy to pull back a little bit and still invest in marketing, which we are still planning on doing at the same rate as we were previously, which is for the Crocs Brand approximately 8% for the year. So that allows us to take advantage of that. Also, gross margins underlying for the Crocs Brand remain strong as well. We have air freight tapering off in the back half of the year. We do have some cost pressures coming in from a gross margin perspective, but we do lose the air freight headwind in the back half of the year, as we spent $75 million of that air freight investment program that is concluding in Q3 and we don’t have - I think we only have about $15 million left.

And just as a point of strategy, we believe that we maintain and create the most future shareholder value by maintaining profitability. So we are not anxious to sacrifice profitability to drive less profitable growth.

Understood. Thanks very much and best of luck for the remainder of the year.

The next question comes from Jonathan Komp from Baird. Please go ahead.

Yes, hi, thank you. Maybe just a follow-up, as we think about the Crocs progression throughout the year, could you maybe share a little more specifically on how you are planning, especially North America for the fourth quarter? As you think of the Crocs Brand holding onto the gains from the last couple of years, especially in the Americas, has your confidence in that outlook changed at all? I know you are still projecting a $5 billion long-term target. So I just want to hear how you are thinking about that any differently for the Crocs Brand.

Yes. Great question, John. So look, the Crocs Brand is absolutely holding onto the gains that it achieved over the last couple of years. In the first half of the year, the Crocs Brand grew about 20% globally. It grew in the U.S. marketplace, and the market was flat to down. So, we are gaining share, we are continuing to gain share. And I think the guidance that we are providing we anticipate will also show strong share gain for the Crocs Brand. So I think we are definitely holding onto the gains that we have been successful in acquiring for the last couple of years. As we look at the Crocs Brand, I would say all of the brand metrics remain extremely strong. Our own internal brand studies give us great confidence that the brand continues to strengthen over what it has been. You can see that in organic search. We also hear that from our wholesale partners as we discuss the brand, future strategies, and how we are going to continue to gain share shelf in our major wholesale partners, both here in the U.S. and in key international markets. DTC, if we look at DTC in the first half, particularly in Americas, grew 10% on a constant currency basis, significantly better than the market and growing over last year, which was an absolute record for the Crocs Brand. I would say we continue to see very strong demand for the core cloud that is driving a big part of our revenue growth and that is particularly here in the U.S. and also internationally. So everything that we are seeing really supports the long-term thesis, and even given what is a softer consumer environment today and what we anticipate over the near-term, we still have great confidence in our ability to hit the $5 billion Crocs Brand growth target that we projected by 2026.

If I could just add to the full-year, we did guide that all of the regions would grow. So all of our Crocs regions will grow for the full-year.

Okay. And just to clarify, that is full-year, not specifically to the fourth quarter which -.

Yes, we didn’t guide fourth quarter specifically.

Okay. Thank you. And then maybe, Andrew. One follow-up on HEYDUDE, you obviously, the message has changed pretty dramatically, even though you have only had it for one full quarter here with respect to the longer-term outlook. I want to maybe just ask more specifically what you are seeing early on for that brand to give you much more confidence in the potential and some of the early relationships you have engaged from wholesale partners, what are they seeing and what type of feedback are you getting?

Yes. I think maybe I will try and start at the top. As we did our consumer research in due diligence, and as we speak more and more to the consumer over the last several months since we have owned the brand, we see tremendous brand love from the consumers. The consumers absolutely love the brand. They are passionate about it. They talk to everybody about it. The viral component of the brand communication is extraordinary. We think that is due to what is a relatively unique product. It is lightweight, it is comfortable, it is easy on and off. It comes in hundreds, if not thousands of different materials and styles, so they can buy multiple pairs. There is a tremendous brand and consumer connectivity. That has not been created by brilliant marketing in the past. It is just the product and then finding and loving the product. As we look at our plans, I think we were cautious initially because we were taking over a founder-led very entrepreneurial company. It wasn’t really clear to us the degree we could get supply in the near-term. I would say that has gone a lot better than we thought. We have been able to shore up their supply, manage the supply, and really satisfy a lot of short-term demand. So, that was kind of our cautiousness in the short-term. Looking to the longer term and specifically receptivity from major wholesale partners, we are seeing exuberant enthusiasm from those partners that have taken on the brand. We have shipped a substantive amount of product to a number of key partners so that they could be in business for back to school. The comments that we are hearing are things along the line: this is the standout brand for back to school. It’s performing above almost any other brand we have in our portfolio. We are seeing very strong performance from that, which gives us confidence to plan, share a shelf in those partners and to plan our growth for the future. We are not yet ready to talk about what we think that looks like; it is very early days. But you can be confident that we will follow the playbook that we followed with Crocs. We will build a strong and thoughtful domestic business here in the U.S., and we think we will be pretty confident. The brand has a lot of likes internationally as well, so we are pretty excited.

Great. Thanks again.

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

Thank you for taking the question just on inventory. Can you talk about the composition of the inventory and then how we should think about the promotional cadence in the back half and how if that will have an impact on margin at all? And then are there any differences in product availability between Crocs and HEYDUDE? Thank you.

I will talk about the first part, and then I will let Andrew talk about product availability. So, inventories were up in the Crocs Brand, but bear in mind that last year at this time, our inventories were exceptionally lean, especially in the Americas where we see most of the increases today. So if you exclude the HEYDUDE inventory, Crocs inventory was up about $125 million, about 60%. About 30% of the increase is due to in-transit, and then we have about another 30% due to inflation sitting in inventory resulting from that is from thus far the higher freight costs, the FOB, and duties that are all sitting in that inventory. So while it is a little bit heavy, we believe that we will get back to four turns, and we are working really hard to do that, including in transit. If you exclude in-transit, now we are still turning above six times. The remainder of the inventory increase is really related to HEYDUDE and that turns very quickly and is very efficient, as that is mostly wholesale a lot of it is pick-up and related to our comp business for HEYDUDE.

Yes. So, Anne also embedded in question I think was sort of future promotional environment and availability differences between HEYDUDE and Crocs. So let me address those. So, look, we have already seen the retail environment, particularly here in the U.S., become more promotional, certainly more promotional than it was last year. I would still love to get back to sort of pre-pandemic levels. As we said on our last call, we think it is important as a democratic brand, and both of our brands reach a very broad base of consumers, and we need to participate in those events. You saw that at 4th of July, et cetera. As we look through the back half of the year, we will continue that strategy of participating in those key events. In terms of inventory availability, I think we have pretty strong availability on the Crocs side associated with our core products. As you look across wholesale, e-com, E-tail and our own source, which we are very much in stock and trading strongly on our core product. We are still lacking a little newness, particularly within sandals. So we have a strong pipeline of newness through the back half of this year as we catch up from the factory closures from the back end of last year. I would say that as we look to 2023, we have a record cadence of newness for the Crocs Brand in particular. We think that is particularly important. On the HEYDUDE side, the key issue for inventory availability is flow-through. We are getting strong shipments from our factories in Asia, and we are investing in our distribution capabilities to provide stronger flow-through to our customers here in the U.S. and abroad.

Thank you. It is super helpful.

Thank you.

The next question comes from Sam Poser from Williams Trading. Please go ahead.

Good morning. Thanks for taking my questions. I have a whole pile of them, so I will start with gross margin. Can you give some color on the gross margin for HEYDUDE in the quarter? And can you tell us sort of what the gross margin expectation is for the balance of the year? Are we looking down 600 basis points or somewhere in that world?

Yes. So let me start with the adjusted gross margins for the quarter were impacted by the addition of HEYDUDE, which accounted for about 250 basis points of decline for the quarter. HEYDUDE was impacted by two pieces: heavy wholesale demand in Q2 shifting the channel mix from DTC to wholesale, as well as very high freight rates. The inventory we were bringing in was the old shipping contracts for HEYDUDE, which was at very high spot rates. We have now shifted them to our Crocs freight rates, and that will significantly improve in the back half of the year and into next year as we start landing inventory at our freight rate. That is kind of the HEYDUDE piece. We do believe those were an anomaly and that build strength in the back half. The remainder from a Crocs standpoint was, if you exclude freight, actually up. So the freight and FX were the biggest pressures on the Croc side. If you exclude those pieces we were up, and again that includes the air freight associated with the air freight investment we made related to Vietnam. As you remember, that was $75 million, I think, we said is 15 to 18 less to spend in Q3. So that implies that back half margins will be higher than first half margins from a gross margin standpoint. And that would all be incorporated into our 26% to 27% operating margin guidance for the full year.

So could you give us a gross margin percent for the full year?

I think we are just not going to guide that piece because we are already giving operating margin percent and EPS guidance.

Okay. Alright, so secondly, Andrew, you hinted at the fact that you had newness issues. The question is did you have newness issues in clogs as well? Did the delay of the Crush clogs and those platform clogs when the bay went away affect you? Did you need more newness there? And how quickly is that being corrected, if that is an issue?

Yes. So Sam, good question. Yes, newness has definitely been an issue during the first half of this year. Having said that, we did achieve 20% growth in Crocs during the first half of this year. But the cadence of our brand is such that we need to bring more news to the table. I would say it was most poignant in sandals, particularly around the fashion sandals. We leaned heavily on our Icon sandals, classic slide, the classic flip which were easier to produce, and those have done really well. They are up strong, double digits over prior trading, but we missed the fashion sandals. We also lacked some newness in the clog arena. I would say the Crush, which you highlighted in your question, was tentatively introduced in the U.S. over the last couple of months, and we don’t have huge amounts of supply. You can see that this Crush family is already sold out on e-com, and we are currently introducing into the major Asian markets, and it is doing extremely well. That formula of height is working very well. Looking ahead to the clogs, we have new clogs coming in the back half of this year and have a number of significant new clog programs early next year.

Okay. And then does that mean in your guidance, given sort of the macro impact and the improvement of newness coming, is this more discretion is the better part of valor guidance? How much of this is the macro versus supply timing of product?

Look, we just think, Sam, I think we are very clear in our prepared remarks. I would say primarily it is the macro. We believe the consumer environment particularly in the U.S. will soften sequentially as we go through the year. I think there is lots of evidence and accomplished economists talking about that. We think it is prudent to plan for that. If we plan in that way, we can maintain our profitability and our cash flow, which is our primary requirement. We are very confident in the Crocs Brand where the Crocs Brand sits, and we will continue to gain share in that environment.

Thank you. And lastly, you mentioned you felt positive about back-to-school. Can you provide any color on what you are seeing for back-to-school to give you that confidence?

Yes. I’m not going to provide specific metrics, but I think what I would say is, as we look across all of our channels, we feel like the consumer is out shopping for back-to-school. We have also seen that in prior sessions. The consumer generally prioritizes their children strongly during a constrained environment. We feel like back-to-school is off to a good start.

Thanks very much and good luck.

Thank you.

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

Great, thank you so much. Andrew, I'm just wondering if you could elaborate a little bit further on your comments about HEYDUDE. Given the brand is turning toward a billion dollars, faster than probably the market expected. Any thought about the bigger picture, what this brand could achieve in terms of growth - revenue growth? At the same time if you could talk about the North America business a little bit, obviously there are a lot of new doors that seem like the brand has entered, whether it is famous footwear - a family channel type of doors, but how much more new door opportunity is there for HEYDUDE at this point in North America, relative to the number of doors you have now?

Yes. Let me take the second bit first. What I would say is we have tentatively shipped new doors. Yes, you can see HEYDUDE in places you haven’t seen it before, whether it be, as you said, famous footwear, rack room shoes, academy, and some sporting goods. We have shipped them what we have available and that is by no means what we consider to be a full assortment or by any means penetrating all of their doors. So, I would say, the door expansion opportunity is very substantive for HEYDUDE, not only the door expansion but the assortment in those doors and the ability to turn quickly. There is a lot of runway there. We are taking orders for spring 2023, and hopefully, we will be able to create much more compelling assortments for our major wholesale customers early in 2023. It is really a little bit hand to mouth today. But as I said earlier, where we are present, the results are very good. They are pleasing to us, and I think our wholesale customers are very pleased. In terms of the longer term, it’s just early days. As you said, we are achieving or very close to achieving kind of the billion-dollar number that we outlined. The reason we put that out there, we just wanted people to understand this is a scale business, not a niche. We wanted to ensure that understanding quickly because when we bought the business, we heard from the analyst and investment community, they didn’t understand what the brand was. We want to clarify that this is a scale brand. Clearly, we are just getting started, so I think the scale is much bigger than where it is today. But it will be well into next year before we are ready to talk about that in detail. We have got a lot of planning and work to do before.

Got it. And maybe I can ask one more just on the Crocs Brand. In retrospect now, given that you are lapping a quarter, you lapped a quarter in Q2 with fiscal stimulus, it probably drove a lot of growth in your DTC business. How did you see the effect of that on the business in 2021, and then what was the impact here in 2022 in Q2 in DTC and sort of how do you see the business trending in a normalized growth rate? What is the outlook for DTC growth for Crocs Brand North America?

Yes, I think we actually saw a lot of the stimulus more heavily weighted to Q1, into Q1 beginning of Q2. I would say from a stimulus perspective, we started to move through that pretty quickly, and I’m really happy with our over 10% direct-to-consumer performance in Q2 in North America. I will also say we had really good retention rates. Our retention rate was up on our U.S. e-com, so that also speaks to the strengths of North America and also that wasn’t just stimulus spending coming in from customers, because they came back. All of this leads to the fact that we have a really strong sustainable direct-to-consumer business in North America. I don’t think that is just stimulus-driven, as I said, I think we lapped most of that in Q1.

Yes. The only thing I would add, Jay, is one form of comping. We talked about comping up in the first half for our North American and DTC business by 10%. Record performance in 2021, driven by stimulus. We grew on that in 2022, so we didn’t shrink, we grew. One of the bigger impacts that we are seeing is actually the return of seasonality. By this, I mean I think in 2021, the constraints, the availability constraints were so high that consumers bought when available. We are seeing in 2022 and anticipating in the future, that we are going back to more kind of seasonal components. They will buy at key events, whether it be promotional events, holidays, or travel. We are seeing some shifts in the patterns of the business and planning for those to continue to revert to pre-pandemic patterns.

Got it. Okay, super helpful. Thank you so much.

The next question comes from Jim Chartier from Monness Crespi Hardt. Please go ahead.

Good morning, Andrew. You reiterated your expectation for your 2026 outlook for Crocs, and a big part of that is the sandals business. I wonder if you could talk about what reinforces your confidence in that large sandal opportunity, what are you seeing in performance today? And then you mentioned a lot of innovation for next year. What is the wholesale reception to that innovation for next year and are wholesalers investing behind the sandal category for you for next year?

Thank you, Jim. A couple of things. One is I would just start the question. Look, we were disappointed in sandal performance during the first half of the year. We have definitely studied it. We feel like we understand what happened. The lack of newness and supply hurt us. As we look at the back half of the year, we do see newness accelerating, and we have got very strong plans for the future. That gives us confidence around reversing that trend of decline that we saw in the first half. Looking forward longer-term and strategically, we are also starting to see what we anticipated in this category. When times get tough, other brands are retrenching. Some brands are pulling back on their sample programs pretty substantially. This represents the opportunity we forecasted. Sandals is a big category, it is an important category to some of the major players, and when times are tough they are going to de-emphasize it, and we feel like we are seeing that. So we feel there is a newness opportunity, and a competitive opportunity. Also, it wasn’t a strong sandal season in the U.S. this year. Spring was a little slow to come in, and we have seen some overall softness in the category. We still feel strongly about our opportunities within the sandal arena.

Great. Thank you.

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

Thanks for taking my question. It is on the Crocs Brand. I understand that you are taking guidance for back half growth just on macro. How does that impact your promotional marketing strategy in the back half given that you also have, I think, some product introductions you are excited about as well?

Yes, that is super important. We are taking our guidance down to reflect, I think the macroeconomic environment and our desire to position ourselves strongly. We are protecting all of our marketing activity. You will see Crocs Brand marketing activity accelerate in the back half. We have a record makeup in terms of collaboration schedule. We are protecting all of our dollars and cents that we plan to spend on marketing, both in the U.S. market, but also importantly in our major international markets, including China. We will continue to spend to support the introduction of all of those new products and to engage our consumers very proactively.

Got it. Thank you.

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

Hi, good morning. Andrew, thanks for mentioning the Crocs North America direct-to-consumer growth of 10%. Was that a second-quarter number or is that for the first half of the year?

First half.

I’m curious about the digital performance. Can you give us the North America direct-to-consumer number for the second quarter? The digital channel has been challenging for many in North America; if you could comment on the Crocs Brand digital performance in the second quarter as well, that would be helpful?

Yes. I don’t think we are going to be disclosing those specific numbers, Jim, but I can tell you it grew, and we are very happy with the performance.

Yes. Our overall digital growth for the second quarter for the Crocs Brand was up 21% in constant currency, with a DTC comp perspective up 7.5%. So that obviously, the biggest piece of that is the U.S. so you have to grow.

Okay. And then I’m curious, within the digital channel, what you are seeing between new and existing customers. Have you seen any fall off in recruitment of new customers or any fall off in contribution from existing customers? This question is mostly geared toward North America if you are willing to share.

Yes. From a North America standpoint, we saw actually retention up plus 30%, and we also saw acquisition up. So, it was double-digit. I wouldn't say that we have seen a fall-off either, and as mentioned in prepared remarks, we see really nice growth; our e-com growth is driven by both of those factors.

Next question, the board does a very nice job of aligning incentives with strategic objectives. We won’t get a view on this until the proxy but can you give us an idea of some of the key metrics for management compensation in 2022, where the board has you focus?

Yes. I would say look, you will see it later, Jim, but our program for incentives and management compensation is very consistent with what it has been in the past. So it is focused on profitability. It’s focused on growth. It is focused very strongly on cash flow, which I think is super important. It does call out kind of specific growth strategies, whether they be digital, whether they be sandals, whether they be Asia. But it is very consistent with what it is in the past. We think it works extremely well. It gets the whole team here at Crocs focused on the most important aspects to drive shareholder value.

Okay. And then last one for me, I just wanted to ask on HEYDUDE. Having been in his chair for a couple of quarters now, can you give us just an update on the vision for positioning of HEYDUDE, both from a branding standpoint and from a merchandising standpoint?

Yes. You have started to see a little bit of that. In July, we launched a new brand identity, which is starting to get out there. We think it has been extremely well received by the core consumer. I think it is more consistent with where we want to take the brand. We are also doing some brand advertising for the first time in the brand’s history, and that is early days, but it is also performing extremely well; we are very happy with that. Rick and his team, which we are building out rapidly, have started to develop product architecture that will probably be back half of 2023 before you start to see some significant evolution in product architecture. We will continue to develop consumer messaging and brand advertising that will start to play out early in 2023. We are really happy with how that is going, and I think it will be very, very strong.

Thank you.

The next question comes from Mitch Kummetz from Seaport. Please go ahead.

Thanks for taking my questions. I guess I just have a few hopefully quickly. I know a year ago with HEYDUDE there were a lot of retailers that relied on product. Do you sense how much of the year-over-year growth you are seeing is kind of filling that pipeline? Is there catching up with where they want to be? Do you have any metrics on kind of wholesale sell-through to support what is happening at retail with those partners?

Yes, I think the best way of getting at the core of your question is wholesale sell-through. We get that from our major partners; we don’t get it from all the smaller partners. But I think the retailers that do stock HEYDUDE would say sell-through is exceptional.

Okay. And then, Andrew you referenced Spring 2023 a couple of times. Do you have any sense of what the order book is looking like for the Crocs Brand in the U.S.? I’m wondering if it is going to be up or down.

Yes. It is early days on that yet, but we also don’t disclose order books ahead of time. We stopped doing that quite a long time ago. But we are selling in spring/summer 2023 both here in the U.S. and globally. We are pretty excited about a lot of the newness that we have to offer our customers.

Yes. And then, from an operating margins standpoint on each brand, remember, these are unadjusted for HEYDUDE. So that includes a $35 million inventory write-up in Q2 related to the acquisition. HEYDUDE operating margins were 17.9%, Crocs was 35.7%, and then our consolidated margin was lower.

Okay. Thank you.

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

Really appreciate everybody joining us today. Thank you for your continued interest in Crocs.

The conference has now concluded. Thank you for today’s presentation. You may now disconnect.