Summary of CROCS, INC. - Yahoo! Finance

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that contain such statements. Forward-looking statements include statements as to industry trends and our future expectations and other matters that do not relate strictly to historical facts and are based on certain assumptions of our management. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to us. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. This Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, among others, the risks described in the section entitled "Risk Factors" under Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2008 and subsequent filings. These factors include without limitation:

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º macroeconomic issues, including, but not limited to, the current global financial crisis;

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º our ability to obtain adequate financing;

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º our ability to effectively manage our future growth or declines in revenue;

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º changing fashion trends;

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º our defense and the ultimate outcome of a pending class action lawsuit;

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º our ability to accurately anticipate and respond to seasonal or quarterly fluctuations in demand for our products;

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º our management and information systems infrastructure;

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º our ability to obtain and protect intellectual property rights;

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º our reliance on third party manufacturing and logistics providers for the production and distribution of products;

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º our reliance on a single source supply for certain raw materials;

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º inherent risks associated with the manufacture, distribution and sale of our products overseas;

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º our ability to develop and sell new products;

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º our limited operating history;

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º our ability to accurately forecast consumer demand for our products;

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º our ability to maintain effective internal controls;

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º our ability to attract, assimilate and retain management talent;

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º our ability to respond to further adverse changes in the retail environment;

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º our ability to effectively market and maintain a positive brand image;

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º the effect of competition in our industry; and

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º the effect of potential adverse currency exchange rate fluctuations.

We caution the reader to carefully consider such factors. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

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Overview

We are a designer, manufacturer, distributor, worldwide marketer and brand manager of footwear for men, women, and children. We aspire to be the global leader in molded footwear design and development. Crocs shoes combine fun colors and innovative design and we manufacture a product offering that provides new and exciting molded footwear products that feature fun, comfort and functionality. We design and sell a broad offering of footwear, apparel, gear and accessories that utilize our proprietary closed cell-resin, called Croslite. Croslite is a unique material that enables us to produce an innovative, soft, lightweight, non-marking, slip and odor-resistant shoe. Shoes made with Croslite have been certified by US Ergonomics to reduce peak pressure on the foot, reduce muscular fatigue while standing and walking and to relieve the musculoskeletal system.

Since the initial introduction and popularity of our Beach and Cayman models, we have expanded our Croslite products to include a variety of new styles and products and have extended our product reach through the acquisitions of new brand platforms such as Jibbitz, LLC ("Jibbitz") and Ocean Minded, LLC ("Ocean Minded"). We intend to continue branching out into other types of footwear, bringing a unique and original perspective to the consumer in styles that may be unexpected from Crocs. All of our products are designed to allow the product to be defined by comfort, fun, and function. In part, we believe this will help us to continue to build a stable year-round business as we look to offer more winter-oriented styles.

Our marketing approach is also becoming significantly more focused on a defined target consumer. All marketing efforts are integrated around specific product launches and the majority of our marketing efforts moving forward will be focused on our retail partners, ensuring that our presentation and story are first class and drive purchasing at point of sale.

We currently sell our Crocs-branded products throughout the U.S. and in 128 countries. We sell our products through domestic and international retailers and distributors and directly to end-user consumers through our webstores, Company-operated retail stores, outlets and kiosks. The broad appeal of our footwear has allowed us to market our products to a wide range of distribution channels, including department stores and traditional footwear retailers as well as a variety of specialty channels.

General

Revenues are recorded when products are shipped and the customer takes title and assumes risk of loss, collection of related receivables are probable, persuasive evidence of an arrangement exists, and the sales price is fixed or determinable. Title passes on shipment or on receipt by the customer depending on the country of the sale and the agreement with the customer. Allowances for estimated returns and discounts are recognized when related revenue is recorded. Because we use both internal manufacturing and contract with third parties to manufacture our products, our cost of sales represents our costs to manufacture products in our Company-operated facilities, including raw materials costs and all overhead expenses related to production, as well as the cost to purchase finished products from our third-party manufacturers. Cost of sales also includes the cost to transport these products to our facilities and all warehouse and outbound freight expenses. Our selling, general and administrative expense consists primarily of selling, marketing, wages and related payroll and employee benefit costs for selling, marketing and administrative employees, travel and insurance expenses, depreciation, amortization, unrealized gains or losses on foreign currency exchange, all related retail expenses, including rent and depreciation, professional fees, facility expenses, bank charges and non-cash charges for share-based compensation.

Recent Events

From our inception through the year ended December 31, 2007, we experienced rapid revenue growth and had difficulty meeting demand for our footwear products. During this period, we significantly increased our production capacity, warehouse space and inventory in an effort to meet

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demand. This pattern changed in 2008. Our revenue growth moderated and then began to decline during 2008 when compared to 2007. Accordingly, we evaluated our production capacity and operations structure and, in 2008, we discontinued our Canadian manufacturing operations and consolidated our Canadian distribution activities with other existing North American distribution operations, we abandoned certain equipment and molds that represent excess capacity, we discontinued manufacturing operations at our Brazilian manufacturing facility, we decreased our fixed costs by consolidating our global distribution centers and reducing our warehouse space and we reduced our global headcount by approximately 2,000 people over 2008 and into the first quarter of 2009. We believe these actions were necessary in order to align our production and distribution capacities with our revised demand projections. Furthermore, we have taken actions to reduce our selling, general and administrative costs, including reductions in personnel, reducing our space costs by consolidating certain offices and reducing other discretionary spending. We may continue to experience declines in revenue during 2009, particularly given the current economic downturn, and accordingly, we may take further actions to align our cost structure with general demand for our products.

During the three months ended March 31, 2009, we experienced a decline in revenue of 32% when compared with the same period in the previous year, due to declines in consumer demand for our products as a result of the economic downturn, the maturity of our products within certain markets, increased competition and challenges we have experienced merchandising our expanded product lines in existing wholesale channels. Likewise, as our revenue has declined, our gross and operating margins have compressed as we begin to lose our ability to leverage our fixed costs. Our margins were also affected by changes in product mix in the quarter towards products with lower profit margins. Net loss for the first quarter of 2009 was $22.4 million, or ($0.27) per diluted share, compared to a loss of $4.5 million, or ($0.05) per diluted share, in the same period of 2008.

Results of Operations

Three Months Ended March 31, 2009 Compared to Three Months Ended March 31, 2008

Revenues. Revenues decreased 32%, or $63.6 million, to $134.9 million in the three months ended March 31, 2009, from $198.5 million in the three months ended March 31, 2008. The decline is primarily attributable to a decrease in our Americas and European markets, specifically driven by a decrease in unit sales of our footwear and Jibbitz products. Unit sales of footwear products decreased 20.0% or 2.1 million pairs, to 8.4 million pairs in the three months ended March 31, 2009, from 10.5 million pairs in the three months ended March 31, 2008. Sales of our Jibbitz products decreased 53.6% to $5.1 million in the three months ended March 31, 2009, from $11.0 million in the three months ended March 31, 2008.

Our wholesale channel revenues decreased 45.0%, or $77.9 million, to $95.3 million, in the three months ended March 31, 2009, from $173.2 million for the three months ended March 31, 2008. We believe that this decrease is due to the global economic downturn, which has lessened consumer demand and caused some retailers to choose to operate at leaner inventory levels. We believe unit sales of our footwear also declined due to the challenges we face in merchandising our expanded product lines in existing wholesale channels as well as lessening consumer demand for our products as such products reach a more mature stage in their product life. Additionally, we believe competitors entering the market with imitation products that are sold at substantially lower prices has also contributed to the revenue decline.

We operated retail locations, including retail stores, kiosks and outlets, which increased to 290 locations at March 31, 2009, which is up from 213 at March 31, 2008. Total revenue from Company-operated retail locations increased 60.3%, or $10.5 million, to $27.9 million in the three months ended March 31, 2009, from $17.4 million for the three months ended March 31, 2008. We expect revenues from our Company-operated retail stores to increase in the future as we continue to increase the number of our retail locations and focus on expanding our visual and fixture merchandising platforms.

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Our plans for expanding retail locations in future periods may be adjusted, or suspended should economic conditions worsen or demand for our products further decline.

Revenues from our internet channel increased $3.7 million, or 46.3%, to $11.7 million in the three months ended March 31, 2009 from $8.0 million in the three months ended March 31, 2008. The increase in revenues during the first quarter of 2009 is due primarily to increased web-based and other marketing efforts aimed at driving consumer awareness of our webstores. We intend to expand our webstores and web-based and other marketing initiatives into other markets depending on business and economic conditions.

The majority of our revenues during the three months ended March 31, 2009 were attributable to our non-classic footwear models. Sales of our classic models, Beach and Cayman, represented 19.0% of total revenues for the quarter ended March 31, 2009, compared to 28.5% for the three months ended March 31, 2008. Sales of new 2009 footwear product lines represented 14.7% of our overall revenues for the three months ended March 31, 2009. We intend to continue to diversify our product offerings in order to expand our brand and expect that sales of our classic models will represent a smaller portion of our overall revenues in the future. We also intend to segment our product offerings into our various sales channels and to enhance our visual and fixture merchandising platforms in Company-operated and wholesale customers' stores to more effectively display our expanded product portfolio.

Changes in foreign currency exchange rates in the three months ended March 31, 2009 compared to the three months ended March 31, 2008 contributed to a reduction of $10.5 million in revenues. We expect that sales in international markets in foreign currencies will continue to represent a substantial portion of our overall revenues. Accordingly, changes in foreign currency exchange rates could materially affect our overall revenues or the comparability of those revenues from period to period as a result of translating our financial statements into our reporting currency, the U.S. dollar.

Americas Market. Our revenues from the Americas decreased 36.8%, or $39.3 million, to $67.6 million in the three months ended March 31, 2009 compared to $106.9 million for the three months ended March 31, 2008. We believe the decline is reflective of economic conditions in the United States coupled with the challenges we face in merchandising our expanded product lines as well as the maturity of our core products in the consumer market and lessening demand for such products, as discussed in "Recent Events" above.

The number of Company-operated retail locations in the Americas, including retail stores, kiosks and outlets, increased to 160 locations at March 31, 2009 from 149 locations at March 31, 2008. Revenue from Company-operated retail locations increased 58.9%, or $6.3 million, to $17.0 million in the three months ended March 31, 2009, from $10.7 million for the three months ended March 31, 2008. Our Company-operated retail locations allow us to showcase our entire product offering, which we believe results in better sales of new product offerings and increased brand awareness.

Asian Market. Our revenues in Asia increased 6.6%, or $2.4 million, to $39.0 million in the three months ended March 31, 2009 from $36.6 million for the three months ended March 31, 2008. The increase is attributable to higher unit sales quarter over quarter as we increased our direct sales in China and expanded our product offerings as well as our increase in door openings in 2009. Although we continued to experience revenue growth in the Asian market in the first quarter of 2009, as we expand into new countries, we believe the global economic downturn and the maturity of our core products in the region could affect our ability to grow revenues in this region and we could experience declines in revenues similar to those that we have recently experienced in the Americas and European markets.

We increased the number of Company-operated retail venues in Asia to 116 locations at March 31, 2009, from 59 locations at March 31, 2008. Revenue from Company-operated retail locations increased 54.1%, or $3.3 million, to $9.4 million in the three months ended March 31, 2009, from $6.1 million for the three months ended March 31, 2008.

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European Market. Our revenues in Europe decreased 48.6%, or $26.7 million, to $28.3 million in the three months ended March 31, 2009 from $55.0 million for the same period in 2008. We have noted a decline in revenues in certain European countries, particularly in those which represent a more mature market for our products. We believe this decline is due to an increased number of imitation products that we believe infringe on our intellectual property as well as the maturity of our core products in the consumer market and lessening demand for such product. We expect to continue defending our intellectual property rights in the European and other markets to mitigate such impacts, as we deem necessary.

As of March 31, 2009, we operated 14 retail locations in Europe versus 5 in the same period of 2008. Revenue from Company-operated retail locations was $1.4 million in the three months ended March 31, 2009 versus $0.6 million for the three months ended March 31, 2008.

Gross profit. Gross profit decreased 41.7% to $49.7 million in the three months ended March 31, 2009. Gross margin declined to 36.9% in the three months ended March 31, 2009, compared to 42.9% for the three months ended March 31, 2008. The decrease in gross profit can be largely attributed to changes in our sales mix towards products with lower profit margins in the quarter ended March 31, 2009 when compared to the quarter ended March 31, 2008. We now manufacture a wide range of products which require additional materials, such as canvas, cloth lining and suede, and additional processes, such as stitching, to manufacture. As we continue to expand our portfolio and non-classic models become a larger portion of our business, we expect this trend to continue. Likewise, as our revenue has declined, our ability to leverage our fixed costs has lessened, thereby compressing our gross margins.

Changes in foreign currency exchange rates in the three months ended March 31, 2009 compared to the three months ended March 31, 2008 reduced our gross margin by $7.0 million. We expect that sales at subsidiary companies with functional currencies other than the U.S. dollar will continue to generate a substantial portion of our overall gross profit. Accordingly, changes in foreign currency exchange rates could materially affect our overall gross profit or the comparability of our gross profit from period to period as a result of translating our financial statements into our reporting currency, the U.S. dollar.

Selling, general and administrative expenses. Selling, general and administrative expense decreased 6.2% to $72.2 million in the three months ended March 31, 2009, from $77.0 million for the three months ended March 31, 2008. As a percentage of net revenues, selling, general and administrative expenses increased to 53.5% in the three months ended March 31, 2009 from 38.8% for the three months ended March 31, 2008. This decrease was primarily attributable to decreases in marketing expenses of $9.0 million, of which $2.9 million is related to corporate sponsorships and $6.1 million is related to advertising expenses, and decreases in salaries and wages of $4.0 million, offset by increases in depreciation of $1.8 million and increases in building expenses of $3.3 million related to additional retail and office space. In addition, total share-based compensation expense was $4.2 million for the three months ended March 31, 2009, compared to $5.4 million for the three months ended March 31, 2008. Also included in selling, general and administrative expenses for the three months ended March 31, 2009 is a net loss on changes in currency exchange rates for transactions denominated, and settled or to be settled, in a currency other than the functional currency of the consolidated entity of $3.4 million compared to a net gain on changes in currency exchange rates of $9.2 million for the three months ended March 31, 2008.

Changes in foreign currency exchange rates in the three months ended March 31, 2009 compared to the three months ended March 31, 2008 reduced our selling, general and administrative expenses by $3.7 million. We expect operations at consolidated companies with functional currencies other than the U.S. dollar will continue to represent a substantial portion of our overall business. Accordingly, changes in foreign currency exchange rates could materially affect our overall selling, general and administrative

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expenses, or the comparability of our selling, general and administrative expenses from period to period as a result of translating our financial statements into our reporting currency, the U.S. dollar.

During the 2008 fiscal year, we took certain actions to reduce our selling, general and administrative expenses. Those actions included workforce reductions, office space reductions, and reductions in certain discretionary spending, including discontinuation of certain sponsorship and consulting arrangements. We are continuing to evaluate our operating expenses, including selling, general and administrative expenses. Should economic conditions further deteriorate or demand for our products decline further, we may experience further declines in revenues and we may take additional actions to reduce our selling, general and administrative expenses further.

Restructuring charges. We recorded $3.8 million in restructuring charges in the three months ended March 31, 2008. These charges relate to our announcement in April 2008 of our decision to cease Canadian manufacturing activities and consolidate Canadian manufacturing and distribution into existing North American operations. Accordingly, as of March 31, 2008, we established reserves covering future known obligations of closed manufacturing and distribution operations in our Canada location. These reserves consisted entirely of termination benefits and were accounted for in accordance with SFAS 112, Employers' Accounting for Post Employment Benefits-an amendment of FASB Statements 5 and 43. We recognized an immaterial amount of restructuring charges during the three months ended March 31, 2009.

Impairment charges. We recorded impairment charges of $10.8 million during the three months ended March 31, 2008. The $10.8 million charge in 2008 consisted of the following:

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º $9.8 million related to the write-down of equipment and shoe molds. We evaluated our production capacity at our facilities compared with demand projections and capacity requirements and decided to abandon certain manufacturing equipment that clearly represented excess capacity. The impairment charge on shoe mods related to shoe styles that we either no longer intend to manufacture or styles for which we have more molds on hand than necessary to meet projected demand.

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º $1.0 million related to the write-off of goodwill for our Fury business, which was closed during the quarter.

We recognized an immaterial amount of impairment charges during the three months ended March 31, 2009.

Interest expense. Interest expense increased $0.3 million to $0.7 million in the three months ended March 31, 2009. The increase in interest expense is the result of increased interest rates on our Revolving Credit Facility as the facility was renegotiated through 2008 and the first quarter of 2009.

Other income/expense, net. Other income increased $0.6 million, to $1.0 million in the three months ended March 31, 2009. The increase resulted primarily from the sale of certain equipment in our Europe segment to a third party.

Income tax expense. During the three months ended March 31, 2009, we recognized income tax expense of $0.2 million on a pre-tax loss of $22.2 million, compared to income tax benefit of $1.9 million on pre-tax income of $6.4 million for the three months ended March 31, 2008. The effective income tax rate was a 1.0% tax expense rate during the three months ended March 31, 2009 compared to a 29.4% tax benefit rate during the three months ended March 31, 2008. The change in the effective tax rate is primarily the result of a full valuation allowance recorded against the tax benefits of operating losses sustained in jurisdictions where management believes that it is not more likely than not that those tax benefits will be realized.

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Liquidity and Capital Resources

The accompanying condensed consolidated financial statements for the three months ended March 31, 2009 were prepared under the assumption that we will continue to operate as a going concern, which contemplates the realization of assets and the liquidation of liabilities in the normal course of business. At March 31, 2009, we had $50.9 million in cash and cash equivalents. We had $19.8 million in borrowings outstanding under our Revolving Credit Facility which has no further available borrowings. Our Revolving Credit Facility, as amended, matures on September 30, 2009 and bears interest at rates based on a premium over the Bank's reference rate tied to the then-outstanding principal balance.

We are currently in discussions to obtain a new borrowing arrangement to replace the existing Revolving Credit Facility and are exploring alternatives for other sources of capital for ongoing cash needs. There can be no assurance that we will be able to secure additional debt or equity financing or receive an extension of the current Revolving Credit Facility by or before the date of maturity of the Revolving Credit Facility and, accordingly, our liquidity and ability to timely pay our obligations when due could be adversely affected.

We experienced rapid growth in our revenues and earnings from our inception through December 31, 2007 and had difficulty meeting customer demand for our footwear products. During this period, we significantly increased production capacity, warehouse space and inventory in an effort to meet demand. This pattern changed in 2008. Our revenue growth moderated and then began to decline during 2008 when compared to prior year. For the three months ended March, 31, 2009, this trend continued as our total revenues declined 32% and units of footwear sold declined 20.0% compared to the same period in 2008, attributable in large part to deteriorating global economic conditions, lessened demand for our products and difficulty marketing our expanded product line. We may incur additional losses through the remainder of 2009. Due to the decline in revenues and unit sales, we took certain actions to right-size our production and distribution capacity in 2008 and may take additional steps to right-size our business in 2009.

We incurred a net loss of $22.4 million in the three months ended March 31, 2009 and experienced a decline in revenues from $198.5 million for the three months ended March 31, 2008 to $134.9 million for the three months ended March 31, 2009. Throughout 2008, we took certain actions to reduce our operating cost structure in response to declining revenues and unit sales, including closing our Canadian and Brazilian manufacturing operations, personnel . . .