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Edited Transcript of CROX earnings conference call or presentation 28-Feb-19 1:30pm GMT

Q4 2018 Crocs Inc Earnings Call

NIWOT Mar 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Crocs Inc earnings conference call or presentation Thursday, February 28, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew Rees

Crocs, Inc. - President, CEO & Director

* Anne Mehlman

Crocs, Inc. - Executive VP & CFO

* Marisa F. Jacobs

Crocs, Inc. - Senior Director of IR

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Conference Call Participants

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* Erinn Elisabeth Murphy

Piper Jaffray Companies, Research Division - MD and Senior Research Analyst

* James Vincent Duffy

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Jonathan Robert Komp

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Mitchel John Kummetz

Pivotal Research Group LLC - Senior Analyst of Footwear, Apparel Vendors and Retailers

* Samuel Marc Poser

Susquehanna Financial Group, LLLP, Research Division - Senior Analyst

* Steven Louis Marotta

CL King & Associates, Inc., Research Division - Senior VP of Equity Research & Senior Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is Jack, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Crocs, Inc. Fourth Quarter Earnings Call. (Operator Instructions).

I will now turn the call over to Marisa Jacobs, Senior Director, Investor Relations. Ms. Jacobs, you may begin.

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Marisa F. Jacobs, Crocs, Inc. - Senior Director of IR [2]

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Good morning, everyone, and thank you for joining us today for the Crocs Fourth Quarter 2018 Earnings Call.

Earlier this morning, we announced our fourth quarter results and a copy of the press release can 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 future revenues, gross margin, SG&A as a percent of revenues, operating margins, CapEx and our product pipeline. Crocs is not obligated to update these forward-looking statements to reflect the impact of future events. Adjusted SG&A, income or loss from operations, net income or loss attributable to common stockholders and earnings or loss per share are non-GAAP measures. A reconciliation of these amounts to their GAAP counterparts is contained in the press release issued early this morning.

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. 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.

Joining us on the call today are Andrew Rees, President and 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.

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Andrew Rees, Crocs, Inc. - President, CEO & Director [3]

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Thank you, Marisa, and good morning, everyone. Ahead of last month's ICR conference, we updated you on our fourth quarter performance so you'd know we had a very successful year.

The more detailed results reported this morning are for further evidence of our success. At ICR, we spoke about our expectations regarding 2019 revenue growth. Today, we are raising those expectations. We now anticipate revenue growth of approximately 5% to 7% in 2019 and excluding the impact of store closures, our 2019 revenue growth will be 7% to 9%.

During the balance of this call, Anne and I will cover a number of topics. We'll highlight our tremendous progress in 2018, the strength of our brand and our product and delve more deeply into our priorities and guidance for 2019. We had an outstanding 2018 as we returned the company to top line growth.

We grew revenues in each quarter and for the full year grew revenues 6% or 12% excluding the $60 million impact from store closures and business model changes. Both our Americas region and our e-commerce channels set new revenue records.

Our initiatives to improve the quality of our revenues materially improved our margins. In 2018, we expanded our gross margin by 100 basis points to 51.5%, our highest level since 2013.

Over the past 3 years, we have improved our gross margins more than 450 basis points. We've successfully completed our SG&A reduction plan by eliminating approximately $75 million of annualized expenses from our cost structure between 2017 and 2018.

In 2019, we'll realize approximately $10 million in additional cost reductions. We are reinvesting some of those savings into marketing and our e-commerce business to further strengthen our brand and drive incremental sales growth. With strong gross margin improvement and much of our work related to expense reductions behind us, our focus now and going forward is on accelerating sustainable, profitable top line growth, as we further strengthen our brand and continue to deliver compelling product.

We've reported before that the heat around our brand continues to build. Results from our 2017 and 2018 annual brand surveys showed dramatic increases in our brand desirability, relevance and consideration. The pace and scope of our collaborations further speak to our increasing brand heat.

We wrapped up 2018 with 2 Post Malone collaborations who sold out in minutes and generated significant consumer awareness and interest amongst its millions of followers.

Our 2019 collaborations are off to a great start. We've already rolled out 4 collaborations with edgy LA-based streetwear brands, PLEASURES, Left Hand L.A., Chinatown Market and PizzaSlime. Each drop featured a highly original take on the Classic Clog and brought us great visibility with the fans of those brands. All 4 sold out in minutes. We look forward to unveiling additional exciting collaborations throughout the year.

With the second quarter launch of our next generation of our Come As You Are campaign, we're featuring 5 exciting new brand ambassadors, selected for their relevance in our 5 key markets. We'll introduce impactful new marketing content designed to further raise our profile and drive sales.

Product of course, is at the heart of our recent success and is key to our future. Clog relevance, sandal awareness and visible comfort technology was central to 2018 and remain equally important in 2019 and beyond. New colors, graphics and embellishments have transformed clogs into a must-have year around silhouette. Our Jibbitz Charm allow our customers to personalize their clog selections to reflect their distinct personalities.

In Q4, we grew clog revenue 17% and full year growth was 13%. With a vibrant Spring/Summer 2019 collection and impactful marketing, clog sales will continue to grow as we drive demand across a diverse group of global consumers.

With respect to sandals. We are 2 years into a major initiative to grow sandal awareness. In 2018, we continued to take share in this large, highly fragmented category that is clearly in sync with our brand DNA. During Q4, sandal revenues grew 11% and generated 15% of our footwear revenues. Full year 2018 sandal revenues grew 19% and generated 23% of our footwear revenues compared to 20% in 2017. Consumer demand for our comfortable and attractively priced sandals is growing and wholesale accounts are responding in kind. We continue to see sandals as a key component of our future growth.

Last year, we brought new product to market to address the growing demand for visible comfort technology. Our LiteRide launch far exceeded our expectations. This was achieved through a globally integrated digital marketing campaign. We spent much of the year chasing product as LiteRide quickly became one of our top 5 collections. This year, we anticipate LiteRide sales will increase materially, and we've geared up to meet growing demand. We're also excited about the introduction of LiteRide for kids this fall.

With Spring/Summer 2019, we introduced another new product, Reviva, a sandal collection incorporating a strategically placed bubbles in the footbed that massage with every step. Reviva is just getting into market and the initial response from consumers has been enthusiastic. We will continue to introduce new products to keep our collections fresh and relevant.

Turning briefly to our distribution channels. I am pleased with the progress we've made in 2018. During Q4, wholesale revenues grew 10% as customers increased orders to keep pace with strong demand. Clogs were the standout and despite increasing the amount of line product available, demand exceeded supply. Within wholesale, growth was most robust amongst our e-tail accounts. Distributed the other leading opponent, the wholesale business, had a good quarter as well, as they continued to refine their assortments and marketing to enhance growth.

Our DTC comp which combines our retail and e-commerce results was up 16%. Our e-commerce channel grew 19%. This was our seventh consecutive quarter of double-digit e-commerce growth with our best fourth quarter e-commerce revenues ever.

We drive in each strong e-commerce results by continually improving the customer experience on our sites and enhancing the effectiveness of our global digital marketing activities.

At retail, we delivered our 6th consecutive quarter of positive comps, increasing 13% globally. We closed a net 175 locations over the past 2 years completing us to a closure plan. As a result, over half of our remaining stores are outlets, our most profitable format. On a full year basis, we delivered strong results in each channel. We grew our wholesale business 8%, our DTC comp was 14% and our retail comp was 11%.

Our e-commerce business grew 23% and made up 17% of our total sales, up from 15% in 2017. These results reflect the growing brand heat and consumer demand I discussed earlier.

I'm especially pleased with the growth of our digital commerce activities. This consists of our e-commerce business which has 2 parts: sales on our own e-commerce site, and sales we make on third-party marketplaces, plus the e-tail portion of our wholesale business. We embrace digital commerce early on, believing we would win by allowing consumers to shop wherever and however they wanted. And we've been investing to build our global team and technological capabilities in this area. E-commerce is the fastest growing portion of our business, and we expect that to remain the case going forward.

Marketplace is our newest e-commerce initiative. We are currently active on 8 sites, 5 of which came online late last year. This year, we expect to launch on approximately 5 more sites. We expect marketplaces to become increasingly important to us, since they provide another venue of direct access to our global consumers.

Before wrapping up, I want to tell you about another important project. We're investing in a new distribution center in Dayton, Ohio to support our long-term growth and provide better service to our customers. This new facility will replace our existing facility outside of Los Angeles. At 550,000 square feet, it's approximately 40% larger than our current facility and there's room to expand. Additionally, the new facility will incorporate automation, enabling us to increase our throughput by 50% and support our future growth plans. Another critical benefit associated with this move is greater speed to market, given Dayton's central location.

I'm very pleased about this move which will take place in phases and is expected to wrap up in the fourth quarter of this year. In 2020, when the new distribution center is fully operational, we expect the benefit to gross margin of approximately 100 basis points.

2019 will be an exceptionally busy year, as we focus on the opportunities we have identified to deliver further sustainable profitable revenue growth. From the product perspective, clogs, sandals and visible comfort technology will continue to be the key drivers of our growth.

From a channel perspective, we expect e-commerce to once again, be our fastest growing channel. At wholesale, our e-tailers and distributors present the greatest opportunity, while our retail business will keep benefiting from our prioritization of outlets. And from a regional perspective, we expect the strong momentum in Americas to continue, while we expect Asia to have the greatest long-term growth potential. Our global marketing organization will continue to drive the brand heat that helps fuel this growth. With content from our great new brand ambassadors and attention-grabbing collaborations, along with the increasingly effective digital marketing.

2019 is off to a strong start. We believe we are well positioned to deliver top line growth and profitability that in turn drives incremental shareholder value.

At this time, I'll turn the call over to Anne to review our fourth quarter results and guidance.

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [4]

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Thank you, Andrew and good morning, everyone. I'll begin with the short recap of our fourth quarter and full year 2018 results. For simplicity, I'm going to limit my remarks to our non-GAAP results. Please refer to our press release, which includes reconciliations of non-GAAP to GAAP results.

For 2018, our results far exceeded what we had guided to at the beginning of the year. We made important progress with respect to growing revenues and improving our operating margin. We strengthened our balance sheet and simplified our capital structure.

In terms of the fourth quarter, revenues were $216 million, up 8.5% from a year-ago, including a negative currency impact of approximately $6 million versus the fourth quarter last year. Store closure and business model changes reduced revenues by approximately $7 million in the quarter. Absent that $7 million impact, revenues would have grown almost 12%. This marks our fifth consecutive quarter of double-digit revenue growth, once you adjust for store closures and business model changes, demonstrating the strength of our underlying business. I do want to note that because fourth quarter sales significantly exceeded our expectations, inventory currently available for purchase is limited. This is reflected in our first quarter revenue guidance, which I'll turn to momentarily.

We sold 11.6 million pairs of shoes, an increase of 5.9% over last year's fourth quarter. Our average selling price for footwear during Q4 increased 2.2% to $17.93. ASP gains were achieved through less discounting and selective price increases. For 2018 in total, we sold 59.8 million pairs of shoes, 3.4% more than in 2017 at an average selling price of $17.71, up 2.3% from the prior year.

In the Americas, revenue grew by 15% to $121.6 million in the fourth quarter, including a negative currency impact of $2 million.

We saw exceptional strength across all channels, particularly in our North American direct-to-consumer business, which benefited from the growing demand for our Classic Clog. The strength we've been seeing in our DTC business for some time now is clearly migrating to our wholesale business.

Wholesale revenues increased 9.6%. In North America, in particular, we had a very good quarter as we work closely with wholesale customers to boost sell-through rates. Our Americas DTC comp was up 21.2%, following on the heels of a 21.6% increase in Q3.

Our retail comp was outstanding, coming in at 17.3% and representing our seventh quarter in a row of positive comp growth. Total retail revenues grew 13.4%, despite having 7 fewer stores than in last year's fourth quarter. E-commerce revenues increased 28.3% as site traffic surged. Active customers increased over last year and the number of new customers grew even more dramatically.

During 2019, our focus will be on maximizing clog growth and expanding our sandal penetration in the Americas among wholesale customers, while driving our DTC growth.

In Asia, revenues for the fourth quarter were $56 million, down $1.5 million or 2.5% from fourth quarter of 2017 with currency negatively impacting the quarter by $1.9 million. Strong wholesale results were more than offset by the impacted store closures and lower e-commerce sales in China. Wholesale revenues increased 5.1% on stronger sell-through's.

Our Asia DTC comp was 2.7%. Our retail comp was up 6.2%. Retail revenues declined 13.6% as we operated 33 fewer stores compared to the same time last year. E-commerce revenues decreased 4.8%, while we continued to see strong e-commerce growth across much of the region, in China, our 11/11 and 12/12 sales declined.

Participation in these festivals has continued to become more competitive and expensive. In response, we limited our participation to preserve margins, while focusing throughout the year on other festivals and events we find to be more profitable and impactful. During 2019, we will continue working to drive greater brand recognition across Asia and grow our owned markets, China, India, Japan, and South Korea, particularly through our e-commerce and marketplace activities. At the same time, our distributors will be pursuing top line growth and expansion across their respective territories.

In EMEA, revenues grew 5.1% to $37.4 million over last year's fourth quarter, with currency negatively impacting the quarter by $1.8 million. Strong wholesale and e-commerce results more than offset the decline in our retail sales. Additionally, Black Friday and Cyber Monday were more important in this region than in prior years. Wholesale revenues grew 13% as e-tailers and distributors also performed well in this region. Our EMEA DTC comp was 16.1%. Our retail comp was 4.7%, driven by higher conversions. We are very pleased with these results, coming on heels of an exceptionally strong Q3. We did operate 24 fewer retail stores, which accounted for the 28.7% reduction in retail revenues.

Our e-commerce business grew by 23.1%. Traffic through the site increased materially as our brand heat rose, and we delivered a better online customer experience. In EMEA, our 2019 focus is on delivering growth through digital commerce and on distributors scaling their businesses. The addition of new wholesale customers will also help drive growth in this region.

Moving to the other items on the P&L, our gross margin was 46.2%, coming in 80 basis points higher than in fourth quarter of 2017 and in line with our guidance. We continued to benefit from strong sales of high-margin clogs, the strength of our DTC business and lower promotions.

Our non-GAAP SG&A expense was $109.2 million. As a percent of revenues, non-GAAP SG&A was 50.6%, a 530 basis point improvement over our non-GAAP SG&A in the fourth quarter of 2017.

Our operating loss on a non-GAAP basis was $9.4 million. This was an improvement of approximately 55% compared to Q4 2017, and it reflects our success increasing revenues and gross margins, while limiting the expenses in our smallest quarter. It was also our best fourth quarter result in the last 5 years.

Our non-GAAP net loss per share was $0.10, compared to non-GAAP net loss per share of $0.27 in the fourth quarter of 2017. Our balance sheet continues to be very strong. Inventory at year-end was 4.5% lower than at the same time last year, reflecting our strong fourth quarter performance.

During the fourth quarter, we repurchased approximately 1.2 million shares of our common stock on the open market for $26.1 million at an average share price of $21.05. During 2018, in total, we repurchased approximately 3.6 million shares for $63.1 million at an average share price of $17.44. This leaves $156 million available under our plan for future share repurchases.

As a reminder, in connection with the transaction we entered into with Blackstone in December, we acquired half our preferred shares that represented 6.9 million shares of our common stock on an as converted basis. The remainder of the preferred shares were converted into approximately 6.9 million shares of our common stock.

We ended the year with $123.4 million in cash. We used approximately $195 million in connection with the Blackstone transaction and borrowed approximately $120 million against our credit facility for that transaction. At the end of 2017, we had $172.1 million of cash and no outstanding borrowings.

Earlier this month, we amended our credit facility to raise our borrowing capacity from $250 million to $300 million. During 2018, we generated $114.2 million of cash from operating activities, 16.2% more than in the same period last year. I am also really pleased to call a significant accomplishment in 2018. We grew our revenues and gross margins, while reducing expenses, bringing us much closer to achieving our double-digit EBIT margin target.

In 2017, our non-GAAP operating or EBIT margin was only 3.4%. In 2018, it was 7.7%, our best level since 2013. Our non-GAAP 2018 EPS increased 560% to $0.86 a share, compared to the $0.13 a share delivered in 2017.

As we turn to guidance, I want to remind you that our guidance is on an as-reported basis, based on current currency rates. For 2019, we now expect our revenues to grow 5% to 7%. This includes a negative currency impact of approximately $20 million. E-commerce and wholesale growth are expected to more than offset the lower retail revenues resulting from store closures. We continued to estimate that store closures will reduce our 2019 revenues by approximately $20 million compared to 2018, without, which, our revenues would grow by 7% to 9%.

We expect our 2019 gross margin to be approximately 49.5% of revenues compared to 51.5% in 2018. This decrease results from higher freight costs and declining purchasing power associated with the strengthening of the U.S. dollar. It also includes nonrecurring charges associated with our distribution center relocation project, which accounts for approximately 100 basis points of the reduction. SG&A for the full year is expected to be approximately 41% of revenues compared to 45.7% in 2018. This guidance anticipates expanding our marketing investment and modest incremental SG&A associated with growing revenues.

We expect to incur between $3 million and $5 million of nonrecurring charges in 2019 in connection with various cost reduction activities. We expect our operating income margin, or what we refer to as our EBIT margin, to be approximately 8.5%. This includes nonrecurring charges associated with our new distribution center and SG&A cost reduction initiatives. Excluding those nonrecurring charges, we expect to achieve our interim target of a low double-digit EBIT margin, which marks a significant milestone in our multiyear journey.

Our CapEx spend is going to increase substantially this year as we make investments to drive operational efficiencies, improve the customer experience and enable future growth. CapEx for 2019 is estimated at approximately $65 million, compared to $12 million in 2018. The distribution center project will account for approximately $35 million of the total. The balance relates to IT and infrastructure investments, some of which were deferred from last year, along with routine CapEx.

Depreciation and amortization is expected to be slightly below 2018's $29.3 million. In terms of income taxes, excluding unexpected impacts arising from the 2017 tax act, we expect a rate of approximately 25%.

Turning to the first quarter of 2019. We expect revenues between $280 million and $290 million compared to $283.1 million in last year's first quarter. Our guidance incorporates the loss of approximately $6 million of revenues associated with our reduced store count and approximately $10 million of negative currency impact. This guidance also reflects the Easter shift, which results in direct-to-consumer sales associated with the holiday shifting into Q2.

Finally, the impact of strong demand in last year's fourth quarter is constricting inventory available for certain at ones orders. Gross margin for the first quarter is expected to be approximately 45.5%., compared to 49.4% in last year's fourth -- first quarter. This decline is driven by four things. First, is higher freight costs, including the use of airfreight to replenish fast-selling items, following our stronger-than-anticipated fourth quarter. Second is the negative impact of the stronger U.S. dollar. Third is the Easter shift from Q1 to Q2, which results in higher margin, direct-to-consumer sales associated with the holidays shifting to Q2. And fourth, nonrecurring costs associated with the relocation of our distribution center will reduce our gross margin by approximately 50 basis points.

SG&A is expected to be between 37% and 38% of revenues compared to 40.2% in last year's first quarter. This includes approximately $1 million of nonrecurring charges relating to various cost reduction initiatives. We incurred $2.5 million of nonrecurring charges in the first quarter of 2018.

In summary, I'm very excited about our plans for 2019, as we continue to drive growth and achieve our interim target of a low double-digit adjusted EBIT margin, which marks a significant milestone in our multiyear journey.

At this time, I'll turn the call back over to Andrew for his final thoughts.

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Andrew Rees, Crocs, Inc. - President, CEO & Director [5]

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Thank you, Anne. In 2018, we demonstrated that the costs we embarked upon back in 2016 was the right one, to revitalize our business and strengthen our financial position.

We have significantly improved brand engagement, enhanced clog relevance and sandal awareness and improved the way we operate.

From a segment and channel perspective. These advances took incredible commitment and teamwork across the whole organization. I want to convey my sincere thanks to our whole team. 2019 is off to a great start and I'm confident in our ability to maintain the positive trajectory of our business. We will continue to build on our strong clog tradition and expand our sandal business with on-trend, comfortable and affordable sandals. We will upgrade our supply chain and maximize the growth potential across our 3 channels, while improving our top and bottom line.

Operator, please open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Steve Marotta with CL King & Associates.

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Steven Louis Marotta, CL King & Associates, Inc., Research Division - Senior VP of Equity Research & Senior Research Analyst [2]

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Couple of questions. The first is as it relates to the new DC being opened by the end of '19, can you quantify the duplicative cost associated with that, within '19? And also, Andrew, I believe that you mentioned that when the new distribution facility is completely operational, it'll be additive to about 100 basis points of gross margin. Is that for all of 2020? Or will there be some -- is it going to be by mid-2020 that will be the run rate? If you could just add a little bit of color on the ramp of the DC?

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Andrew Rees, Crocs, Inc. - President, CEO & Director [3]

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Yes. Thank you, Steve. We are happy to do that. So -- look, I think this is a really important investment for Crocs. It shifts our nexus of distribution from the West Coast to the center of the country, we're making a substantial investment. And I would say, a much more sophisticated DC operation than we've run in the past, which will run at a lower cost. And it will run at a lower cost for a couple of reasons. One is, obviously the land and the building is more economical in Dayton, Ohio than it is in the West Coast. Labor rates are generally less and probably more importantly, the automation means it will run the DC with substantially less labor. So the 100 basis points of improved gross margin, yes, that we will be in effect for the whole of 2020. And in terms of the sort of onetime costs or the cost that we're going to incur, I'll let Anne address that.

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [4]

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Yes. Hi, Steve, the 100 basis points of margin improvement as Andrew said, for next year is on an annual basis, and then we actually have 100 basis points of headwinds this year. So if you think through our full year gross margin guidance, our adjusted gross margin guidance is 50.5%, if you exclude the DC costs, which is about 100 basis points.

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Steven Louis Marotta, CL King & Associates, Inc., Research Division - Senior VP of Equity Research & Senior Research Analyst [5]

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All right, that's very helpful. One follow up and then I'll jump back in the queue. Was there any delta in the negative currency expectations for the current fiscal year from a revenue standpoint since ICR? I don't recall you talking about negative currency implications on fiscal '19 revenue at ICR?

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [6]

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Yes. We did talk about -- that our currency expectations at ICR did include a negative impact of currency. It really hasn't changed much. If you remember, currency is going to more strongly impact us in Q1 and Q2. The vast majority of the $20 million is going to be in Q1 and Q2, the way I would think about that is, approximately -- at current, currency rate is approximately $18 million out of $20 million is going to be the first couple of quarters of the year.

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Operator [7]

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Your next question comes from line of Jonathan Komp with Baird.

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Jonathan Robert Komp, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [8]

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I wanted to follow up. Just on the near-term guidance in the first quarter, I don't know if there's -- if you're willing to quantify the impact from being tight on some inventory or the Easter shift or maybe differently. If you could comment may be on roughly kind of the first half growth that you see, just to give us a sense of that first to second quarter shift that you're projecting?

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Andrew Rees, Crocs, Inc. - President, CEO & Director [9]

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Yes. Yes, I think so -- I think the first thing is, let's start with the year. So for the year, obviously we're raising our revenue guidance, we've previously talked about that being mid-single digits, we're now giving you kind of 5% to 7% growth for the year. And that's really due to -- what we see is continued strengthening of the brand. We continue to see very strong demand, an increasing demand, I would say, particularly in the U.S., but frankly also in our other regions. So we feel really great about that. From a Q1 perspective, there are a number of things. I would say the biggest damper on Q1 from a revenue growth is really the currency in the business model changes, right? So currency is about $10 million of headwind in Q1, business model changes is also the largest in Q1, we think that's about $6 million, so that's about $16 million in headwind just in Q1. And in addition to that, Easter shift and some constraints on our supply, particularly around our Classic Clog, so frankly I think constraints around supply is kind of a high-class problem. We're not overly concerned about that, and we are spending the money to accelerate supply and have done a number of critical things to improve that quickly. I don't think it's kind of productive to quantify that. But if we think about the first half, I would say our first half is very consistent with our full year guidance.

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Jonathan Robert Komp, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [10]

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Okay. And then maybe just a follow up on the DC and the capacity and throughput expansion, pretty significant expansion for both. And I'm wondering how we should view that in terms of your views on the U.S. growth potential and any thoughts on how far you expect that capacity to cover the growth that you see?

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Andrew Rees, Crocs, Inc. - President, CEO & Director [11]

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Yes. So -- yes, you're right, pretty substantial. So I think the overall square footage of the DC as we're building it out is 40% bigger than our prior facility, and we also have expansion room built into the footprint. So we can build bigger at relatively low cost when we need to. And the automation just gives us dramatically higher throughput with lower labor. So it's a big investment, obviously it's a significant CapEx. And obviously, we're making that investment -- as we believe we have significant growth runway here in the U.S. I think also being closer to our customers will dramatically improve our e-commerce customer service and being able to reach our customers far more quickly and far more efficiently. So we think it's a very important investment, and it will fuel our future growth.

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Jonathan Robert Komp, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [12]

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Okay. And last one if I could just squeeze in on the gross margin for '19. It does look like underlying, you're assuming some decline, and I know you called out a couple of factors. And I'm just curious, maybe the decision of not to take pricing to the level that you need to offset those pressures?

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [13]

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Right. So we have taken some pricing as you know on our Classic Clog, both in Europe and the U.S. And we'll continue to evaluate pricing as it makes sense. From the underlying gross margin factor, if you think through the adjusted gross margin of 50.5% for the year, excluding the 1x of 100 basis points from the DC. The other 100 basis points, we have about 40 basis points of FX for the year and about 60 basis points of freight, which includes higher freight costs and then the use of accelerated freight to help us replenish some of our core styles as Andrew just discussed in Q1. We still feel good, though, from a long-term perspective that low 50s is the right level for our gross margins and it's supported by the new DC investment in the U.S. where we get 100 basis points of favorability starting in 2020.

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Operator [14]

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Units with income from the line of Erinn Murphy with Piper Jaffray.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [15]

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I've got 2 questions and then a follow up. But first, just on the teen phenomenon for or the Gen Z phenomenon that you're seeing, are there pockets of the U.S. that you still haven't feel, you've seen that teen surge yet? And I'm just curious how you think about the sustainability of that trend broadly? And then my second question is really related to the DC again, you talked, Andrew, a bit about the speed-to-market opportunity. I'm curious how you're modeling what that could look like in 2020 and beyond, whether it's 2-day shipping or kind of just a closer connectivity to the consumer? So any kind of help there on what the true benefit will be to the everyday consumer?

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Andrew Rees, Crocs, Inc. - President, CEO & Director [16]

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Yes. So -- Okay, well let me take the classic trend and the traction that we're seeing with our younger consumer group first, and then -- and Anne can then talk a little bit about the DC. So in terms of traction with the younger consumer group, we've clearly, seen it stronger in the Midwest and the East, it's not as strong on the West. So -- and from our experience with these kind of things, they do spread across the country, so we think we've got incremental traction -- incremental opportunities for traction in the U.S. I would say it's the combination of the classic and the personalization. We are seeing that get traction in other parts particularly Europe, the parts of our global distribution. And frankly, we don't see this as a short-term trend. We see this as a real connection to a generation in the consumer group, we're offering them a product, which has incredible value. And I think the whole personalization aspects and the use of Jibbitz to make it really important for them has been really important. And we plan to continue to invest in the marketing activities and the stimulation activities that have driven this, whether that be collaborations, whether that be social media, whether that be digital connectivity with these customers. So I think we've seen with parallel brands, done the right way and executed the right way, this is not a one season, one year opportunity, this is a multiyear growth opportunity.

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [17]

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And then on our D.C., as Andrew discussed. As our e-commerce business continues to grow, we feel it's even more important for us to be centrally located and that allows us to reach our customers sooner. We're not discussing going to a 2-day ship promise. We have great e-tail partners that can offer you accelerated ship options. We feel we don't need to be that fast, but we will be more in line with industry standard, not from the use of upgrading our promise, but more that it's just faster because we're centrally located. So we gain speed to market by being centrally located, and we naturally speed up our shipping to our customers.

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Erinn Elisabeth Murphy, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [18]

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Okay. And then just my clarification on the inventory kind of being fairly tight exiting the fourth quarter, when do you expect inventory to be in a better position? And then Q1s growth margin obviously, the low watermark, how much of the pressure is airfreight? I know you said freight in total for the year is 60, but I'm imagining that bucket is a lot bigger in the first quarter, giving your air freighting right now?

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [19]

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Yes. So on inventory, we're really proud of the work we've done over the past few years to improve our working capital. We view lean inventories as key to ongoing brand strength. But we do obviously have a little bit of shortage in Q1, and we feel like that is encompassed in our full year guidance and we're confident in our outer quarters. It's mostly in the classic, and it's mostly in the U.S. that, that's impacting. And from an airfreight perspective, when you think through the margins in Q1, we didn't break it out, currency is about 80 basis points in Q1 and the rest -- and the remainder is mostly freight and then we have the some of the Easter shift, which does shift the higher-margin direct-to-consumers sales to Q2.

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Operator [20]

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Your next question comes from the line of Mitch Kummetz with Pivotal Research.

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Mitchel John Kummetz, Pivotal Research Group LLC - Senior Analyst of Footwear, Apparel Vendors and Retailers [21]

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I guess I just have a few housekeeping ones. So first one, so in this press release you guys are giving a non-GAAP reconciliation for the quarter and the year. And I'm curious on a go-forward basis, are you going to be doing that as well?

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [22]

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Yes. Good question. So we will. We felt like it was necessary especially because we have the large accounting charges associated with Blackstone, and we'll need to bridge that for the remainder of the year.

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Mitchel John Kummetz, Pivotal Research Group LLC - Senior Analyst of Footwear, Apparel Vendors and Retailers [23]

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Okay, will you provide some sort of reconciliation for the prior quarters to 2018, so that we have kind of a comparable basis to look at that?

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [24]

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What we've provided in our release, will be similar to what we'll provide all year. So when we do report on Q1, we will provide a similar walk for Q1 of 2018.

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Mitchel John Kummetz, Pivotal Research Group LLC - Senior Analyst of Footwear, Apparel Vendors and Retailers [25]

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Got it. And then Anne, on the 2019 EBIT margin guidance, I know you're saying low double digits on a non-GAAP basis, I guess when I'm doing my math, I'm not quite getting there. I think that's based on a gross margin like 50.5% and excluding the $3 million to $5 million SG&A charges, I'm coming up with something like 9.9% at the high-end. Am I missing something? Is there something else that gets you to low double digits?

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [26]

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I think within the revenue range, you're right around 9.9%, 10%.

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Mitchel John Kummetz, Pivotal Research Group LLC - Senior Analyst of Footwear, Apparel Vendors and Retailers [27]

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Okay. And then also on 2019. Can you may be talk to us about interest in the share count, kind of what's sort of baked into. I mean, I know that in the reconciliation today for 2018, it was like proforma interest is $5.6 million. Is that kind of the interest expense that we should expect for 2019? And obviously the share count changed and with the buyback and all that, I'm just kind of wondering what sort of average weighted diluted shares you're looking for in 2019?

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [28]

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Yes. The best way to think through the average diluted shares is we ended the year with approximately 73-ish million shares, on a fully diluted basis, we do have some dilution that will occur through the year. And we'll continue to evaluate our programs, but I think using an ending share count is the right way to think about it. And from a interest perspective, we haven't guided where our interest is going to be, but we do pay LIBOR plus 175 basis points on our line, which is a bit about 4.75% interest. Right now, we have $120 million at the end of Q4 financed on the line, and we'll continue to look at our cash and think through the best use of that cash.

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Mitchel John Kummetz, Pivotal Research Group LLC - Senior Analyst of Footwear, Apparel Vendors and Retailers [29]

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Maybe just one for Andrew. There was a comment on a competitors' conference call yesterday talking about an uptick in the flat business. I know that, that historically is a core competency for the company, I think that's been a category that's been a bit challenged last couple of years. I'm just curious, if you have any thoughts on that, is there an opportunity going forward, are you seeing an uptick in that side of your business as well?

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Andrew Rees, Crocs, Inc. - President, CEO & Director [30]

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That would be an opportunity. So we are not really seeing an uptick to date, I would say. I would say you are absolutely right. Historically, we've had a very good flat business, and I think our manufacturing technique, our technology and our aesthetic does lean itself towards flats. You are also absolutely light, that's been a silhouette that's been under severe pressure for probably the last 3 to 4 years to be quite honest. So if that silhouette does rebound, it would be an up opportunity for us. But to be clear, we're not releasing it today.

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Operator [31]

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Your next question comes from the line of Sam Poser with Susquehanna.

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Samuel Marc Poser, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [32]

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Let's -- just wanted to talk about the Easter shift and how many dollars you foresee there in that shift from Q1 to Q2? Because that's a lot in your DTC business, which is a higher margin, which would make -- I think it'd this also make up a lot of margin in the second quarter or because of that, the nature of that business.

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Andrew Rees, Crocs, Inc. - President, CEO & Director [33]

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Yes. I would say Sam, we're not breaking that out. But you're absolutely right, the impact is in the DTC business, it's particularly within the North American DTC business. It's not as exaggerated, obviously in Asia. It's a little bit in Europe, but it's very strongly in the North America DTC business. And yes, it is -- those are higher-margin dollars, right. So our retail and e-com, I know you've seen in Q4 and for a number of quarters now, our comps in North America, e-com and retail have been exceptionally strong. And so that does shift dollars and margin into Q2.

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Samuel Marc Poser, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [34]

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And then you've had some success with some of these collaborations of -- I mean there's a bunch. PLEASURES, Chinatown Market and Post Malone. Are you -- are we going to see any scaling of that? I mean, they did very well but it doesn't sound like there were hardly any pairs of any of it out there. So are you -- do you have any plans to scale that in any way to make it more meaningful or make the -- offer more of them? I mean, how are you thinking about that to continue -- to build the momentum of the brand?

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Andrew Rees, Crocs, Inc. - President, CEO & Director [35]

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Yes. No, that's a good question, Sam. So I would say, our approach is a portfolio of collaborations, so some of them will be niche and are really about exploring how you -- where you can take the Classic Clog, where you can have it appeal to different consumer groups, and some of them -- our nation are small but do drive significant resonance and PR and activity around the brand. Others will be bigger, and as we look into '19, we have a portfolio of kind of segmented collaborations that hit particularly consumer groups. We have broader collaborations with other brands that are bigger in scale. We have collaborations planned with particular retailers that could be more significant in scale. So it's a portfolio, and you'll see -- obviously we're not going to talk about that in advance. Part of the power of this is the surprise and delight nature of it and -- but you'll see that rollout through this year and frankly, we're already filling the pipeline for next year.

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Samuel Marc Poser, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [36]

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Let me just follow up on that. I mean, you had such -- on the -- I mean some of these shoes as you mentioned, I mean they sold out in like 5, 10 minutes. Are these other -- given that kind of response, it's telling you that there's a ton of demand off of, I would assume, you're regarding this Post Malone as a little more niche. But I mean, maybe that niche is bigger than what you think it is versus a partnership with a retailer that may be good, but you might not see that kind of rate. So I mean...

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Andrew Rees, Crocs, Inc. - President, CEO & Director [37]

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Yes. I think the -- Look, I think -- what I would say Sam is, Post Malone might've been a little bit less niche than you thought it was. We did sell a lot of pairs in a very small space of time. And it's a portfolio, right. It's a portfolio. So you'll see that evolve as we go through the year, and we're very confident, both in the level of interest we're getting from a very interesting group of brands, retailers, celebrities, personalities that we can put together a very compelling portfolio that will keep a very broad range of consumers focused and interested, and will also fuel our commercial appetite.

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Samuel Marc Poser, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [38]

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And then lastly, just to go back to the gross margin. If we think about the gross margin on the front half and back half, I mean how does that break out? I mean Q1 is going to be down, net around 340 basis points. How should we think about the gross margin, and how it runs on an annual basis? From the front after the back half?

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [39]

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Good question. So on gross margin, the best way to think about it, again, our gross margins for the year of 50.5% on an adjusted basis, which includes the 100 basis points of headwind from the DC 1x. Then the FX, just like the revenue is, the FX impact on margins is going to be much more front half weighted.

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Samuel Marc Poser, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [40]

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But then you're offset by the mix issue in the second quarter.

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [41]

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Correct. I don't...

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Samuel Marc Poser, Susquehanna Financial Group, LLLP, Research Division - Senior Analyst [42]

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Do you expect gross margin to be down in both parts of the year but more down in the front half of the year. Is that a fair statement?

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [43]

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I think we're really confident in guiding our full year gross margin, and I think the best way to think through it is the FX does pressure Q1 and Q2, like you said, you do have a little bit of a pickup in Q2 because of the DTC quarter, but it's all encompassed in our full year guidance.

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Operator [44]

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Your next question comes from the line of Jim Duffy with Stifel.

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James Vincent Duffy, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [45]

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Andrew, a few questions for you. The team has done very well to revitalize Clog demand that's proved a very a effective strategy. I guess I'm curious how you're thinking about that from here. Do you foresee clogs continuing to grow as a percent of the mix or do you see it strategic to try to push out growth from some of the other areas to build balance?

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Andrew Rees, Crocs, Inc. - President, CEO & Director [46]

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Yes. I think that's a really good question. Yes, I think we will continue to see growth in clog. I think the differential between clog growth and sandal growth will mitigate. So it won't gain as much share of a overall percent to total, as it has in this year. So I think, as we look next -- as we look into '19, we anticipate acceleration in our sandal business over '18.

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James Vincent Duffy, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [47]

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I also wanted to ask you to speak more about the engagement with marketplaces that you mentioned, I believe you said that started in the second half of the year. Who were those earlier relationships, was it just a change in the nature of the relationships with marketplaces? What's different about the engagement? Does that change the economics? Any help there would be great.

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Andrew Rees, Crocs, Inc. - President, CEO & Director [48]

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Yes. Yes. That's -- so the way to think about that, and I'll use an example probably to highlight it, right. So there are a number of marketplaces around the world where we participate on a 1P basis, so that means essentially we sell them wholesale, the marketplace takes ownership in the inventory and then resells the inventory. And there are an increasing number where we have augmented or paralleled that participation with the 3 key relationships, so that means we own the inventory, we manage the on-site presence for that portion of inventory and so yes, the economics are different. So we sell at retail and we incur all the cost to get the product to the customer, whether it be directly from our own DCs or using their fulfillment operations. So Andy, the 3P business will be included in our e-commerce business on a go-forward basis that shows up in our e-commerce segment, the 1P business shows up in our wholesale segment. And so -- as we're adding 3P marketplaces and a good example would be Rakuten in Japan where be opened up that in the late fourth quarter of last year. It was a marketplace, which we did not have a 1P relationship with, historically, so it's new territory for us. And our strategy there is really to take control of the brand in that environment, when we looked at that environment there were other people selling crocs on that environment. We felt like we needed to elevate how the brand showed up in that environment. And frankly, we could also take ownership of the economics, of selling product on that environment. So I would say, and as you look at the portfolio go forward, it's a combination of taking ownership of environments where we have not participated historically, directly. And also complementing environments where we have a effective 1P relationship, and we want to add a 3P environment. And really the reason in that case to do that would be potentially to showcase a product that might not historically have showed up in a wholesale type transaction. Does that make sense?

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James Vincent Duffy, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [49]

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It does. It makes good strategic sense. Are you indifferent from an economic standpoint, as to whether it's a 1P or a 3P sale? What would you...

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Andrew Rees, Crocs, Inc. - President, CEO & Director [50]

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We're (inaudible) productively indifferent.

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [51]

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Yes. We talked a lot about that, whether we sell to one of e-tailers, which as Andrew talked about would be 1P showing up in wholesale. Whether we sell directly on our own e-commerce website or whether we sell directly on a marketplace, which Andrew talked about as being 3P. We're happy to connect with the consumer wherever the consumer shows up.

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James Vincent Duffy, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [52]

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Very good. And the last one for you. Obviously fourth quarter demand came in much stronger than you'd expected but given the replenishment nature of the business, does that make you think any differently about your targeted inventory levels?

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Anne Mehlman, Crocs, Inc. - Executive VP & CFO [53]

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We're really proud of the work we've done with inventory. We're ahead of 4-turn business last year, and we think that's about right. We -- inventory supports the brand and supports the heat of the brand. Obviously we did have -- we were a little bit short on our classics, but the team is working to replenish, and we're looking at different capacity options to make that happen.

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Operator [54]

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The Q&A portion of the call has completed. I would now like to turn the call back over to Andrew Rees for closing remarks.

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Andrew Rees, Crocs, Inc. - President, CEO & Director [55]

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Thank you. I just like to closeout by thanking everybody for their continued interest in the company. We're very excited about this year and the future, so we look forward to talking to you again in the future.

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Operator [56]

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This concludes the Crocs, Inc. Fourth Quarter Earnings Call. We thank you for your participation. You may now disconnect.