Crocs, Inc. Q4 FY2022 Earnings Call

Good day, and welcome to the Crocs, Inc. Fourth Quarter and Full Year 2022 Earnings Conference 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 Cori Lin, Vice President, Corporate Finance. Please go ahead.

Good morning, everyone, and thank you for joining us today for the Crocs Fourth Quarter and Full Year 2022 Earnings Call. Earlier this morning, we announced our latest quarterly and annual 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, 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 the Crocs Annual Report on Form 10-K as well as other documents filed with the SEC for more information relating to these risk factors. Adjusted gross profit, adjusted gross margin, adjusted selling, general and administrative expenses, adjusted income from operations and operating margin, adjusted income tax benefit and effective tax rate, adjusted basic and diluted earnings per common share 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'll turn the call over to Andrew.

Thank you, Cori, and good morning, everyone. As you saw in our press release issued this morning, we delivered extraordinary 2022 results, including record $3.5 billion in sales and industry-leading adjusted operating margins of 27.7%. These results underscore the high consumer demand globally for the Crocs brand, the growing momentum of the HEYDUDE brand and our ability to consistently deliver strong profitability while investing for the future. Looking forward to 2023, we expect another year of robust revenue growth, top-tier margins and significant cash flow generation. Now let me share a few highlights from the full year of 2022. Total revenues grew 54% as we added a second fast-growing brand, HEYDUDE. Crocs brand revenues were $2.7 billion, increasing 19% on a constant currency basis. Crocs brand International growth was exceptional at 47% constant currency for 2022 and accelerating to 75% constant currency growth for Q4 in both Asia and EMEALA. HEYDUDE brand revenues exceeded initial expectations and reached nearly $1 billion on a pro forma basis and delivered over $275 million in adjusted operating income. Consolidated digital revenues grew 58% to represent 37.8% of 2022 revenues. Exceptional adjusted gross margins of 54% even with significant freight and inflationary pressures. Adjusted income from operations increased 42% to nearly $1 billion and adjusted operating margins of nearly 28%. Adjusted diluted earnings per share increased 31% to $10.92 and strong cash flow allowed us to reduce gross leverage from 3.1 times upon the acquisition of HEYDUDE to 2.25 times at year end. As we transition to 2023, I want to give you additional insights into three of our long-term growth drivers for the Crocs brand, sandals, international and innovation in both product and marketing as well as provide an update on HEYDUDE. Sandals, an important growth initiative for Crocs, allowing us to extend 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. The category also provides an additional entry point to the Crocs brand for consumers who may not choose to engage with the clog. We know our sandals resonate with consumers since sandal consideration is now on par with that of clogs. And we already have a sizable $310 million sandal business. Within sandals, we refined our focus on four subcategories; Everyday, Style, Street/Sport and Adventure. The Everyday category offers broad-reaching classics for everyone and includes our personalizable slides, two straps and flips. Our Style category is female-centric, trend-driven and includes styles such as the Brooklyn, Crush and Mega Crush. Our Street/Sport category is rooted in street style with a focus on him, but inclusive of her and includes our new Echo and Mellow franchises. Finally, our Adventure category has functional design for the whole family and includes our All Terrain and Swiftwater franchises. 2022 for the Crocs brand sandals was a year of two halves. In the first half, sandal revenues declined due to the lack of newness following the Vietnam factory shutdowns in 2021. In the second half of 2022, Sandals grew by 31% as we introduced a strong cadence of newness such as the Crush, Mellow and Echo supported by effective sandal-specific marketing. We're incredibly confident in sandal growth in 2023, given planned newness and a significant increase in marketing allocated to sandals and the strong Crocs brand trajectory in important sandal markets such as India and Southeast Asia. With respect to newness in our Style category, we're planning additional height and new uppers in our popular Brooklyn franchise. In our Street/Sport category, we continue to use innovative technology in our Mellow franchise, and we'll launch a new flip during the year. With the new product introductions, marketing investments and regional brand momentum, we expect sandals to be our fastest-growing product category in 2023, reaching approximately $400 million in sales. Moving to another important growth driver for the Crocs brand, our international markets, we have now seen eight consecutive quarters of strong double-digit growth outside of North America. We anticipate even greater growth as a Crocs brand has approximately one-third of penetration internationally than it has here in the US. The drivers of this growth are, in essence, the same drivers of growth that we saw in the US. First, focusing on our iconic clog and driving relevance with innovation and collaborations; second, leveraging Jibbitz for personalization and consumer engagement; third, expanding our addressable market with sandals; and finally, always on social and digital marketing to continuously engage our existing and new consumers. Our unique playbook for Crocs has been successful in the US and across all of our key focus markets. In EMEALA, Western Europe grew revenues by 38% constant currency with the United Kingdom up 105% constant currency. In Asia, South Korea grew over 30% constant currency despite having an already high level of penetration. India grew 91% constant currency. Additionally, we see our global brand building activities having a halo in many of our distributor markets, resulting in triple-digit revenue growth in Latin America, the Middle East and Southeast Asia. China has been a unique case. As you know, we completed the repositioning of our China business in 2021. Since then, China has been constrained by COVID lockdowns, yet we still invested in our team and in marketing to build brand relevance. We have seen green shoots in the second half of 2022. Revenues grew 35% constant currency. As China reopens and the consumer returns to more normalized shopping, we're excited about the prospect of building significant Crocs brand presence in 2023 and beyond. While still a smaller base than we would like, we expect China to grow approximately 30% in 2023. Products and marketing innovations are another important driver of the Crocs brand. Our marketing calendar is extremely robust. As we look to put more Crocs in more consumers' hands, in 2023, we expect to have record new product introductions, some of which I mentioned when discussing sandals. Product newness will be critical to our always-on brand drumbeat as well as a strong pipeline of more than 60 global brand partnerships across a healthy mix of celebrities, mega brands and licenses of which 25% will be regionally led. We will invest a record amount of marketing dollars over $200 million to drive the Crocs brand relevance amplifying our products and engaging new and existing consumers. This will be achieved by maintaining our digitally led and social-first approach to engage consumers through digital-first drops, social innovation and brand ambassadors. Turning now to HEYDUDE. Today represents our first full year of ownership, and we've accomplished a lot. The integration is on track, although there is still much work to be done. We've developed a clear plan for the brand and the future is bright. With respect to recent accomplishments, there are many. We have updated the brand identity and clarified its purpose and meaning. We've expanded the line with several new icons to be trialed in 2023, staffed the entire leadership team and hired over 150 roles, stabilized and expanded the manufacturing footprint, developed a business systems roadmap, expanded distribution capabilities to handle the immediate throughput needs, turned over many international distributors and spent nearly $60 million on marketing in the second half alone, which on an annualized basis was almost 4x the amount spent in 2021. We've also seen great initial results exceeding our expectations. Brand revenues in 2022 grew 70% on a pro forma basis, driven by wholesale partner expansion in the United States. DTC revenues were approximately 36% of sales. Gross margins have been lower than anticipated due to channel mix, unfavorable pre-acquisition freight contracts and higher inventory handling costs as we work to expand the HEYDUDE distribution center to support the $1 billion and growing brand. Even with this, HEYDUDE generated over $275 million in adjusted operating income, a $0.31 adjusted operating margin. While we have more to do, we are incredibly excited about our results thus far, the potential for the HEYDUDE brand and the value this acquisition will generate for shareholders. The addition of HEYDUDE has brought other benefits as well. It enables us to access a larger addressable market, which is now approximately $160 billion on a global basis versus $40 billion prior to the acquisition. We are now far more diversified from a product perspective with casual HEYDUDE silhouettes representing 27% of 2022 revenues on a pro forma basis, COGS representing 57% of consolidated revenues. Finally, we substantially leveraged our shared services across the two brands, further supporting our industry-leading operating margins. Before I turn the call over to Anne, I'm incredibly proud that our five-year annualized TSR of 54% would have placed Crocs, Inc. as the number two best-performing company in the S&P 500. This exceptional performance is a testament to our strategy, our execution and our talented team. I want to express my gratitude to the entire Crocs, Inc. organization for their hard work and commitment to delivering best-in-class growth and profitability. 2022 was a transformational year as we integrated HEYDUDE, but the Crocs and HEYDUDE brands enter 2023 with incredible strength and momentum. I'm confident in our brands, our team and our demonstrated ability to deliver sustainable growth, profitability and shareholder value. With that, Anne will now review our financial results in more detail.

Thank you, Andrew, and good morning, everyone. I'll begin with the recap of our fourth 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. Our fourth quarter results were outstanding with $945 million in consolidated revenues, a 64.8% increase to prior year, aided by the addition of HEYDUDE. We continue to deliver top-tier profitability with adjusted gross margin of 53.3%, adjusted operating margin of 26% and adjusted earnings per share of $2.65, up 23% to the fourth quarter of last year. Strong profitability and tight working capital management enabled us to repay $300 million on our term loan B facility in the quarter. I will now detail our revenue highlights by brand, beginning with the Crocs brand. During the quarter, we sold 27 million pairs of shoes, an increase of 20.8% over last year. Our average selling price in Q4 was $23.95, a 6.8% decline on a reported basis and a 3.6% decline on a constant currency basis. As a slight decline in North America associated with higher DTC promotions offset constant currency ASP increases internationally. Importantly, while the North American markets became more promotional in the second half of the year and helped right-size channel inventories to a healthy level, the Crocs brand was still less promotional in the fourth quarter and for the full year than pre-pandemic. From a product perspective, for the fourth quarter, results continue to be driven by our key product pillars: Clogs, Sandals and Jibbitz. Sales of clogs increased 9% to become 79% of Crocs brand revenues, with growth of our profitable classic clog franchise outpacing that of other clogs. Sandals grew 53% in the quarter to represent 10% of brand revenues. Jibbitz continued to drive consumer engagement and grew 13% to become 8% of brand revenues. For the full year, clogs were 77% of brand revenues, sandals were 12% and Jibbitz grew 27% to become 8% of brand revenues. Now let's review Crocs brand highlights by region for the quarter. North America revenues of $457 million were relatively flat from 2021 as strong DTC growth of 18%, an indicator of underlying consumer demand was largely offset by a 25% decline in wholesale. DTC comparable sales for North America increased 13%, on top of 53% DTC comparable sales growth in the fourth quarter of 2021. Digital led the growth driven by brand strength and newness. Wholesale declined as we continue to proactively manage market health with our partners in the fourth quarter. Brick-and-mortar channel inventory in North America is very healthy with on-hand inventory levels down double digits versus prior year. Similar to the third quarter, Crocs brand growth was led by international with both Asia and EMEALA revenues up 75% in the quarter. Asia Q4 revenues were $91 million, up 74.8% from last year. As Andrew mentioned, we saw broad-based growth across all channels in all of our key focus markets. South Korea and India continued to outperform and grew strong double digits during the quarter and the year. China faced periodic COVID lockdowns; however, it grew 38% for the quarter, following 34% growth in Q3. EMEALA revenues increased an exceptional 75.6% over Q4 2021 despite our exit of direct Russia operations. Momentum has been building over the last two years and resulted in broad-based growth in our direct and distributor markets. Overall, we are extremely pleased with the underlying strength of the Crocs brand internationally. Turning to HEYDUDE. Revenues were $279 million, growing 36.6% from Q4 of 2021. Digital sales were particularly strong during the holiday and constituted 51.6% of brand sales in the quarter. We remain confident in the potential of the brand and look forward to sharing our growth strategies and plans in the future. From a channel perspective, digital remains our top priority for both brands as it enables us to meet our consumers in their preferred channel. During Q4 2022, our consolidated digital business, which combines e-commerce and e-tail, grew 80% on top of 41% growth in Q4 of 2021. Digital penetration for the quarter was 45.1%, up from 40.3% last year and 34.2% in 2019. Our digital growth benefited from product newness, refined user experience and additional marketing activities that drove strong traffic. Consolidated adjusted gross margin for the quarter was 53.3%, down approximately 1,000 basis points from last year. About half of the compression to consolidated adjusted gross margin is related to the addition of the HEYDUDE brand. Crocs brand adjusted gross margin was 56.1% or 760 basis points lower than prior year, which was in a typical year as we took price ahead of inflation and had an overall lack of promotions in the industry. The decline in adjusted gross margin is attributable to approximately 340 basis points of promotions, 180 basis points of inflationary costs and 180 basis points of higher freight and inventory handling costs. Currency negatively impacted gross margins by 70 basis points. HEYDUDE brand gross margin for the quarter was 46.4%, as positive channel mix was offset by the continued effect of legacy freight contract costs. Higher inventory storage costs as we work to expand distribution center capabilities to support the larger business and holiday promotional activity. Our Q4 adjusted SG&A at 27.3% of revenues improved by 780 basis points compared to prior year. This excludes $18 million of costs in Q4, primarily related to the shutdown of our Russia direct operations and the HEYDUDE acquisition and integration. For full year 2022, adjusted SG&A leveraged 490 basis points to 26.7%. The significant decrease in adjusted SG&A rate for the quarter and the full year is due to the leverage of shared services across both brands given as we invested over $215 million this year in additional marketing, talent and infrastructure to support future growth. Our fourth quarter adjusted operating margin declined 260 basis points to 26% compared to 28.6% for the same period last year as gross margin pressures offset SG&A leverage. Fourth quarter adjusted diluted earnings per share increased 23.3% to $2.65. For the full year 2022, let me recap a few highlights. Total revenues grew 54% to $3.55 billion with Crocs brand revenues increasing 19% on a constant currency basis on top of 65% growth in 2021 and HEYDUDE brand revenues reaching nearly $1 billion on a pro forma basis. Crocs Brand International growth was exceptional at 47% constant currency. Adjusted income from operations increased 42% to $986 million and adjusted operating margin of 27.7% remains industry-leading. Full year adjusted diluted earnings per share increased 31% to $10.92. We concluded 2022 with a strong liquidity position comprised of $192 million of cash and cash equivalents and $749 million of borrowing capacity on our revolver. Through strong cash flow generation and tight working capital management, we pre-paid $300 million on the Term Loan B during Q4, reducing total borrowings to $2.3 billion and gross leverage of 2.25x and net leverage to approximately 2.1x. We remain focused on deleveraging to under 2x gross leverage by the middle of 2023. Our inventory balance at December 31, 2022, was $472 million inclusive of $169 million of HEYDUDE inventory. The Crocs brand inventory balance was $303 million, a 42% increase over the prior year and continues to decline sequentially, down 7% versus the third quarter. Our higher inventory reflects revenue growth, higher costs of inventory and a very low level of inventory last year due to limited availability with the factory closures. While HEYDUDE inventory is slightly elevated from pre-acquisition purchases, Crocs brand inventory is very healthy. Our entire team is extremely focused on inventory health, especially as we grow. In 2022, capital expenditures were $104 million. A little over half of this investment was in our distribution centers as we expand and automate our facilities. The balance of the investment was in our information technology, retail fleet and corporate offices, all of these investments support future growth. And as I mentioned, we will continue to invest in the business to fuel and sustain growth. Now turning to the future. I would like to share our current outlook for Q1 and then full year 2023. For Q1, we expect consolidated revenues to grow approximately 27% to 30% at current currency rates, with the Crocs brand growing double digits. We expect adjusted operating margin to be between 24% and 25% and adjusted diluted earnings per share of $2.06 to $2.19. For the full year 2023, our guidance contemplates some conservatism as we are cautious about the impact of macroeconomic events, particularly on the US and European consumer as the year progresses. Even with this, we continue to expect revenue growth of 10% to 13%, assuming current currency rates. For Crocs brand revenues, we expect to grow 6% to 8% and 9% to 11% in constant currency with growth in all regions and all channels. For HEYDUDE brand revenues, we expect growth to be in the mid-20s on a reported basis. We expect consolidated adjusted operating profit margins of approximately 26%. This includes an anticipated benefit to Crocs brand gross margin associated with lower inbound freight rates and the clawback of air freight, slightly offset by channel mix and the growth in sandals. For the full year 2023, we expect our underlying non-GAAP tax rate, which approximates cash tax paid to be approximately 20%. Our GAAP tax rate will be approximately 24%. We anticipate non-GAAP earnings per share to be approximately $11 to $11.31 in 2023, which does not assume any impact from potential future share repurchases. It also incorporates increased interest expense on our floating rate debt associated with the current rate environment. To support growth for both brands, we expect to invest approximately $165 million to $180 million in capital expenditures. Investments include the expansion of our distribution capabilities, including our new HEYDUDE DC in Las Vegas, implementation of new technology systems for HEYDUDE and expansion of our corporate facilities to support our growth. In 2023, we estimate approximately $30 million of one-time charges primarily related to the aforementioned capital investments and are fairly balanced across COGS and SG&A. We expect the combined brands to generate significant cash flow, allowing us to achieve two times or less gross leverage by the middle of this year. Our capital allocation priorities are first to invest in the business and second, to balance deleveraging with the ultimate goal of reaching one to 1.5 times net leverage and resuming our historically successful share repurchase program. In summary, throughout 2022, we delivered strong revenue growth, profitability and cash flow. With the underlying strength of the core Crocs business and the addition of HEYDUDE, we are confident we have positioned ourselves for sustained profitable growth, strong cash flow generation and significant value creation for our shareholders. At this time, I'll turn the call back over to Andrew for his final thoughts.

Thank you, Anne. Crocs, Inc. had an exceptional year in 2022. The Crocs brand is resonating strongly with consumers throughout the world, and we're confident in continued growth led by sandals and international. The HEYDUDE acquisition is exceeding expectations. Integration is going well, and we have a clear plan for growth. I could not be more excited for the future and the tremendous value creation opportunity for shareholders. Operator, please open the call for questions.

Thank you. And we will now begin the question-and-answer session. And our first question today will come from Jonathan Komp of Baird. Please go ahead.

Yeah. Hi. Thank you. Good morning. Anne, can I ask a follow-up on the first quarter guidance? I believe you said, the Crocs brand should grow double-digits. Could you give a little more color on how that might look geographically? And then a bigger picture question for 2023 for the Crocs brand, are you expecting North America to grow for the full year? And could you comment on some of the drivers across some of the product initiatives and the channel performance you're expecting?

Sure. Jonathan, good morning. So let me start with full year and then I'll talk about Q1. So for full year, as shared, we expect the Crocs brand to grow 6% to 8%, which is about 9% to 11% given constant currency and growth is really going to be powered by international, but the US will grow. I think we're currently cautious about the consumer in the US, especially in the back half, but we're still anticipating growth over last year driven, and that growth is really going to be driven by sandals and newness. And we do expect North America to have good growth in Q1 as well. And then from just an overall channel perspective, we still expect DTC to lead the growth in our North America region for this year as we continue to focus, especially on our e-comm side.

Yes. And just about maybe a tad or color to that, Jonathan. I think one of the reasons that DTC is leading the growth. That's where we have the newness, the fastest, right? We were able to bring a lot of new sandals and new styles to our DTC environments in Q4, and they are showing up faster as you'd expect in our DTC environments, both e-comm and in store in Q1. We're extremely pleased at this point with the performance we're seeing, and we're excited as those new products are supported by our social digital marketing flows to wholesale.

That's great. And then one follow-up just on the outlook for the Crocs brand gross margin. It looks like you quantified a little over 400 basis points from airfreight investment and then higher freight and inventory handling in 2022. So as we think about some of those costs coming back into the business as a benefit, would you expect Crocs brand gross margin to be back to the 58% level, or could you maybe just give some color on the puts and takes you see there? Thank you.

Yes, that’s a great question. Let me take a minute to recap. In 2022, we reached a high point from 2021, with our Crocs brand adjusted gross margin finishing at 56.7%, which reflects a decline of about 500 basis points compared to 2021. We experienced approximately 220 basis points related to air freight that will come back, along with roughly 190 basis points from higher freight and inventory handling costs that we have previously discussed. The remainder of the decrease was mainly due to inflationary costs, promotions accounting for about 90 basis points, and currency effects. For 2023, we believe that the Crocs brand will largely align with our long-term expectation of around 58% gross margin. The HEYDUDE brand is anticipated to show year-over-year growth, but the increase will be gradual throughout the year as we continue to address the subscale distribution and logistics network. For our overall consolidated adjusted gross margins this year, we project it to be around 55% to 55.5%, which includes the impact of HEYDUDE. Additionally, we will keep providing gross margin insights by brand for the rest of the year.

That’s all really helpful. Thank you.

Thank you.

Thank you.

Our next question today will come from Tom Nikic of Wedbush Securities. Please go ahead.

Hey, Andrew, hey, Anne. Thanks for taking my question. I want to ask about North America wholesale, which I believe you mentioned was down 25% in Q4. On the Q3 call, you provided information on the wholesale sell-through, which gives a better insight into the demand for the brand in the wholesale channel. How did the sell-throughs perform in North America wholesale for Q4?

Yeah. I would say, Tom, we were very happy with the performance of North American wholesale in Q4. We ended the year with inventories in-channel down double digits, and that was one of our primary goals, to ensure that we took advantage of the promotional quarter to clear out end-of-season goods while enabling our wholesale partners to effectively compete. So we're very happy with the performance of the wholesale business. It was important to keep our inventories in line. And as we look at our in-channel inventories, we think we're very well positioned for 2023.

I wanted to ask about the inventory growth for the core Crocs brand. I understand it's decreasing sequentially, but it still seems like a significant number, particularly in the low-40s. How should we view this reduction throughout 2023, and do you see any risk of being over-inventoried with the core Crocs brand?

Yeah. I would say, Tom, there's a couple of ways to think about this. One is, yes, it's a 40% growth over the same period last year. But remember that same period last year was an exceptional low, right? So on a normalized basis, we actually think the Crocs inventory is very well positioned relative to our future growth plans. So on a normalized basis, it puts us at approximately four turns, which is where we'd like to be from an inventory to sales ratio. We think that's one of the best in the industry and allows us to have healthy core inventories, while also bringing in new products as demand allows, without having excess inventories.

Understood. Thanks, Andrew. And if I could just sneak one more in for you. The $30 million of one-time charges that you're expecting for 2023. Can you give us a little bit more color as to what that comes from? I guess, the description in the press release was kind of investments for growth which normally are included in the adjusted numbers, but I'm just kind of curious like what those one-time targets.

Sure. There's kind of three buckets. The majority of those are things that were just consistent in how we talk about it. It's distribution center overlap where we might be transitioning distribution centers, so it's overlap on bringing up the HEYDUDE distribution center causing duplicate rent and other costs. Also, we're making some changes, as we talked about, with some investments in corporate headquarters to expand, which also leads to duplicate rent. So those are the majority of the charges. The other one is we're implementing a new ERP system for HEYDUDE. And those costs, we typically call out as one-time costs.

That’s helpful. Thanks Andrew. Thanks Anne. And best of luck in 2023.

Thank you.

Thank you very much.

Our next question today will come from Abbie Zvejnieks from Piper Sandler. Please go ahead.

Hi, guys and thanks very much for taking my question. So how should we think about the cadence of gross margin in terms of tailwinds from lopping air freight versus the promotions and the greater mix of HEYDUDE revenue? And then just on the HEYDUDE inventory composition, I think you said it's a bit elevated. Can you just talk about the reasons for this? Is this due to changes in wholesale partner behavior or more so on logistics? Just any color there would be helpful. Thanks.

Yes. Thank you, Abbie. Let me start with gross margin then I'll let Andrew talk about the HEYDUDE inventory. So from a gross margin perspective, from a Crocs brand, I expect it to be a pretty normal cadence throughout the year, so a return to seasonal patterns. Q1 tends to be low just given the wholesale channel mix in the quarter. So I would just model that out as kind of normal seasonal patterns given the guidance. I think from a HEYDUDE perspective, we do expect, as I mentioned earlier, to be lower in the first half as we're still rolling through some of those higher freight and storage costs. And then as we get into rolling off those costs as well as into a better-sized distribution center, we expect that to increase into the back half of the year. And that plays into our overall gross margin that we talked about from 55% to 55.5%.

Yes. Regarding your question about HEYDUDE inventories, we believe they are currently heavier than we would prefer moving forward. This situation is primarily due to several factors. Firstly, there were inbound shipments ordered before our acquisition that did not align with our desired composition, resulting in an excess of items that haven't sold quickly. We will need to manage this inventory. Additionally, we are working on improving our planning functions to better match demand and supply, which we have historically done well. While we haven't achieved the same success with HEYDUDE as we have with the Crocs brand over the past year, we are optimistic about getting there. We see numerous opportunities to sell this inventory over the next year and are not overly concerned, even though it is somewhat heavier than we would like at this stage.

Perfect.

I think it's on our owned inventory, just if I can voice over. One, just a quick note is, as our owned inventory, we're actually very satisfied with the inventory that we have in channel from the HEYDUDE perspective.

Yes.

Got it. And then another on promotions, should we think about this as like more of a normalized level, especially as you guys are bringing in more newness and more fashion risk, or how are you thinking about the go-forward promotional environment?

Yes. So from a promotional standpoint, I mean, I think Q4 played out exactly as we anticipated from promotions on the Crocs side, especially. I think for this year, we expect it to be normalized promotion environment. Again, I don't think it has to do with more of our product mix. I think it has more of a return to the norm of a promotional environment against a very low promotional environment in 2021. As we said in our prepared remarks, we're still actually less promotional than we were pre-pandemic. So I do expect promotions to maintain and pretty much be in line from this point going forward.

Got it. Thank you so much.

Thank you.

Thank you.

Our next question today will come from Laura Champine of Loop. Please go ahead.

Thanks for taking my question and congratulations on the international growth in Q4. If growth continues to be mixed towards international, how is that likely to impact gross margins if the mix continues to shift in that direction in 2023?

Yes, hello. It does depend a little bit on where that growth occurs. So if it occurs in our direct-to-consumer channels like anywhere else in the world, then that's obviously helpful from a gross margin standpoint. Obviously, we've had really strong distributor growth, which is a headwind to gross margin but carries no SG&A. So the higher the distributor growth have outperformed, it will impact gross margins a little bit, but again, be accretive overall because there's no SG&A associated with it. And that would be embedded, obviously, we've embedded good international growth into our guidance. So that would be embedded in our current margin guidance from a Crocs perspective.

And are you incorporating a stable mix of distributor versus DTC, or do you think the outsized growth in distributors continues through this year?

No, it's a pretty stable mix. Actually, I think last year, we had really strong distributor growth as we saw tourism return to a lot of markets, and we saw some restock. I think this year it's actually a much more balanced mix between DTC and distributor.

Got it. Thank you.

Yes.

Our next question is from Sam Poser of Williams Trading. Please go ahead.

Thank you for taking my question. I have a small handful. Number one, you mentioned that you're going to increase the marketing, I would assume for both brands pretty aggressively. What kind of ROI are you assuming on those increased investments?

So yes, I think I would say we're going to increase our dollar spend, Sam, but we're investing at about the same rate that we have invested historically. So if you remember, we've run the Crocs brand at between kind of 7% and 8% of sales in terms of marketing. That includes both our brand marketing and a lot of our digital marketing and our social marketing and we're maintaining that rate. But obviously, as the brand has grown over the last several years, that dollar amount is a lot more significant. And that's one of the important factors around scale in this business. If you have scale and you invest as a percentage of sales, you can reach a lot more consumers. From a HEYDUDE perspective, it will be an increase over last year because we underinvested in the first half of the year as we were digesting the brand. We did invest at a similar rate in the back half of the year for the HEYDUDE brand. So it will be an increase in the first half and then similar in the back half. But of course, we're also getting growth there as well. So the dollar amount will be larger.

Let me follow up on that. When you entered 2022 and stated your investment plans, was the return on your investment greater than you expected?

The return on investment was consistent with our expectations.

Thank you. What is the expectation for first quarter North American wholesale? Will it resemble the fourth quarter, and will direct-to-consumer be similar as well? Should we consider it this way in North America, especially given retailers' hesitance to increase their activity at the moment?

Sure. I can address that. We don’t provide guidance by channel or region, and we never have. However, I think the key point you're trying to make is about the health of the wholesale channel and whether we expect sell-in to align with sell-through. As we consider the first half of 2023, we are quite confident that sell-in will normalize, and sell-through will occur since we have reduced our in-channel inventories significantly by year-end. We believe we are in a strong position regarding channel inventories. The main challenges we might face are from some partners who still have excess inventory with other brands and are trying to manage limited distribution centers and budget constraints, which adds a layer of uncertainty. We are in the process of introducing significant new products to our North American wholesale, and we feel confident about this, although there is still some unpredictability involved. Nonetheless, in the first half of 2023, we definitely expect to see a normalization in North American wholesale sell-in and sell-out.

And then Anne, can you tell me what is your assumed net gross interest expense you're expecting for the full year?

Yeah. So from an interest rate perspective, so our guidance obviously assumes higher interest rate expense than last year driven by the full year of debt related to HEYDUDE in the rate environment. So as a reminder, we locked in $700 million of fixed rate debt at an average rate of 4.2%. And then the balance of our debt is the $1.7 billion Term Loan B that's floating rate, which is silver plus 350. So on average, it's like 7.7% if you want to model the interest rate. And then obviously, we paid down $550 million of debt in 2022, and we anticipate really strong cash flow this year and significant down against this year, which will offset some, but interest will be higher this year than it was last year.

All right. Thanks very much. Continued success.

Thanks, Sam.

And our next question is from Jim Duffy of Stifel. Please go ahead.

Sorry about that. Yeah. I was on mute.

Good morning, Jim.

Good morning, Anne, good morning, Andrew. I have a couple of questions around margins for the brands and the regions. First, on HEYDUDE, you've had some unforeseen challenges. The HEYDUDE margins, however, still running at 31%, which is above your original objective of 26%, 27%. I guess I'm curious, does that make you rethink the margin opportunity for the HEYDUDE brand?

Yeah. Hey, Jim, thank you so much. I do believe that the HEYDUDE margins we're very pleased with, overall, the operating margins. One thing when we originally guided, HEYDUDE to operating margins, we hadn't pulled out the shared service cost from both brands. So now we've pulled that out. And so both brands are running higher operating margins. And then we have obviously pulled out the shared service cost to get to our overall operating margin guide of 26%. So obviously, last year, we ran higher. We delivered 27.7%, but our long-term guide is around 26% as we continue to invest in both brands to support the growth.

Thank you for your assistance. Anne and I understand that you may not want to provide specific regional margin guidance. However, regarding the Crocs brand, can you discuss the varying trends in regional profit pools? Are you expecting a significant shift towards international markets, or will the planned investments and growth for international markets maintain a consistent margin mix across the regions?

Yes. So, a couple of things there. Obviously, from an operating margin perspective, all of our regions are very profitable. As we continue to scale international markets, we will continue to see that profitability expand. In Asia, we've been investing significantly in China to support that growth. And so, as those Asian markets scale, then obviously, it drives leverage and continues to expand our profit margins. So, I don't expect a significant operating margin change based on our international mix.

Okay. Thank you very much.

Thank you.

Our next question is from Mitch Kummetz of Seaport Research. Please go ahead.

Yes. Thanks for taking my questions. First question on HEYDUDE. So you gave the guide in reported. I think by my math, the pro forma works out to be kind of mid-teens growth year-over-year. I'm curious to know, if you expect that to be kind of a straight line cadence over the quarters? I know that the growth has been moderating a little bit, I think, as you're lapping larger numbers. And I would think that as you go through the year, you continue to kind of lap larger numbers. So I'm wondering if we should be thinking of that sort of mid-teens on a straight-line basis pro forma or do you expect that to kind of moderate as the year goes by?

Yes. Good morning, Mitch. I think obviously, Q1 is highest growth just as we didn't own them for a full year. So as you mentioned. On a reported basis, we haven't guided by quarter, I think we see good growth throughout the year. As Andrew also mentioned, we're cautious in the back half of the year, just given cautious on the Crocs brand but also just cautious overall on the consumer. So we've incorporated that into our guidance for the back half of the year.

Okay. And then on the Crocs business, maybe just a couple of questions. You mentioned Clogs growth in the quarter, and I think it was said that the classic kind of outperformed the clog category overall. I'm curious to know how lined clogs performed in the quarter. I believe that was a pretty healthy business for you guys last year in Q4. And I'm curious how that lapped this year? And then, I guess, secondly, on sandals, Andrew, you referenced kind of four big sandal segments there. I'm kind of curious if how that kind of performed by segment in the back half and then sort of the outlook for 2023? I assume that the kind of the everyday piece is the biggest of those segments. And I'm wondering if you're seeing kind of outsized growth there versus the others, and if that would be expected to continue in 2023?

Mitch, there were a lot of questions. Classic performed exceptionally well in Q4 and throughout the entire year. As we mentioned in our prepared remarks, it's crucial for us to establish a strong presence in various international markets, and we've been doing a fantastic job with Classic, which has driven robust growth. Online Classic is also performing very well in the US. On the other hand, the Lined business in the US peaked last year, representing the highest level of consumer interest, which has since moderated a bit this year. We anticipate that this will continue to balance out, and we plan to adjust the Lined business to a slightly lower level. It's still a vital part of our performance in Q4, and we have promising innovations to introduce in that segment. Internationally, however, Lined presents a different situation, with significant growth opportunities in markets that require winter-related products, such as Northern Europe and certain parts of Asia. Regarding sandals, we expect over 30% growth in the second half, and in Q4, the growth rate exceeded 50%. This impressive growth was largely fueled by new styles we've launched and strong distribution sales, particularly in regions like Southeast Asia, where sandal sales are high.

Okay. That’s helpful. Thanks and good luck.

Thank you.

Yes.

Our next question is from Jay Sole of UBS. Please go ahead.

Hi, good morning. This is Mauricio Serna representing Jay Sole. Thank you for taking our questions and congratulations on the results. I would like to inquire further about the performance of the European business and your expectations for this year, particularly from both wholesale and direct-to-consumer perspectives. Additionally, regarding the gross margin outlook for 2023, when do you anticipate returning to more normalized promotional levels? Lastly, concerning the health of the balance sheet, it appears you are on track to achieve your target leverage ratio. Should we expect the company to resume buyback activities in the second half of 2023, and will it be at a similar rate to what you were doing before the HEYDUDE acquisition? Thank you.

So Mauricio, I’ll provide some insights on the EU, and then Anne will discuss gross margin and the balance sheet. The EMEALA business, which includes Europe, the Middle East, Africa, and Latin America, performed exceptionally well in the fourth quarter, achieving 75% growth which is remarkable. If we focus specifically on Europe, the Crocs brand is experiencing a strong upward trend in the European market. As we mentioned in our prepared remarks, there was a 105% growth in the UK, a significant market in Europe. The strong momentum for the brand is evident in both our direct-to-consumer business, which is mostly digital in Europe, and our wholesale business. Looking ahead to 2023, we might not reach 75% growth again, but we still anticipate robust trends in our European business, which gives us a lot of confidence. This reflects the brand's growth; it’s gaining traction. Consumers are not pulling back from our brand. While this may not apply to other product categories, they continue to purchase Crocs.

I think your second question pertains to our gross margin outlook. As I mentioned, Q4 unfolded as we expected regarding margins and the promotional environment. Our seasonal promotions and inventory liquidation were very successful and continue to be so. In January, we typically go through a liquidation phase before returning to more normalized conditions in the following quarters. In terms of the promotional environment, we're currently less promotional than before the pandemic, and we believe we're at a normalized level this year. I don’t see anything unusual happening. Regarding your second question on capital allocation, we paid down $550 million of debt in 2022, which we are very pleased with. Our priority for 2023 is to continue reducing debt to reach a 2x gross leverage ratio and then go beyond that. At current interest rates, our focus will be on paying down debt, aiming for a net leverage ratio of 1x to 1.5x, and we will also consider resuming share repurchases at that stage.

Okay. Thank you so much.

Thank you.

At this time, we will conclude our question-and-answer session. I'd like to turn the conference back over to Andrew Rees for any closing remarks.

Thank you very much, everybody. Appreciate everybody's interest and great questions this morning. As you can tell from our prepared remarks and also the answers to our questions, we're incredibly confident in terms of how our brand is positioned or brands are positioned for another exciting year in 2023. Thank you.

The conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.