Thesis: Crocs, Inc

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Crocs Inc.

Current Context

Crocs Inc. is a manufacturer and marketer of footwear. Their core product utilizes a patented resin that molds well to the foot, making the product more comfortable than most shoes. Crocs became a defining fashion trend of the 2000s. The company, which launched in 2002, went public in 2006. The IPO raised $208 million in a 9.9 million share offering at $21 per share. The day of the IPO, the price went over $31 (Denver Business Journal, 2006). The share price had originally been slated for the $13-15 range prior to the IPO (Reeves, 2006) but this was changed at the last minute. The stock price shot up as high as $75 before collapsing to the $1-4 range it has now occupied for several months.

As a young company, Crocs does not have any legacy issues. This makes them an excellent case for study of financial policy, as they have a simple set of contrasting forces. That there are no legacy issues means that the current management team is entirely responsible for the company's current financial policy. Contrasting this is the fact that the company has grown rapidly, which can add an element of chaos to financial planning. Such companies can find themselves with a given financial structure before they have time to formulate a coherent policy. This paper will examine the case of Crocs, and investigate the financial policies that the firm has exhibited in its young history.

The analysis will be conducted in the context of the firm's rapid growth and competitive operating environment. The firm's has suffered a downfall in revenues, not unlike many firms in the apparel industry. However, the newness and faddishness of Crocs means that the downturn in revenue may be entirely unrelated to the current economic context. Certainly, there has been limited competitive response to Crocs, which operate largely in their own sub-category with very little direct competition. The footwear market overall, of course, is highly competitive. Whether the niche that Crocs has carved out for itself is sustainable depends on the whims of fashion at this point, rather than the actions of competitors or the influence of the economy.

Analysis of Financial Policy I: Description

An organization's financial policies can be described using by analyzing seven elements. These are the mix of capital; maturity structure; basis of coupon and dividend payments; currency issues; preference for financial innovation; external control and distribution of value.

The first element is the mix of capital. Analysis of this element seeks to ascertain the degree to which the firm relies on different classes of capital. At Crocs, the current debt-to-equity ratio is 58.7%. In 2007 this was 41.2% and in 2006 it was 43.7%. The company has little long-term debt. The bulk of its liabilities are current liabilities, and these are spread out among different classes, the largest being accounts payable and "other." The company had a nominal amount of long-term debt prior to their IPO but has since eliminated that from the balance sheet. Since the IPO the long-term liabilities at Crocs have consisted mainly of "other."

The majority of the firm's equity derives from the IPO. In 2007 Crocs had a higher debt-to-equity ratio than in 2008, the result of having higher retained earnings. The company's earnings have been very volatile during the past few years. When earnings were high, they went into retained earnings. Last year, when the company recorded a substantial loss, retained earnings were similarly reduced. The company did not take on debt in order to cover the losses. An analysis of the Statement of Cash Flows reveals that capital expenditures were financed by cash flow from operations in 2008, the latter being positive despite the accounting loss.

The firm's lack of reliance on debt is reasonable at this point in their life cycle and for the business in which they are engaged. Crocs is barely two years removed from its initial public offering, meaning that there is equity financing available to fund operations and expansion. An analysis of the firm's environment reveals that Crocs faces a difficult operating environment, even without considering the impact of the global economic crisis. The Crocs product has characteristics of a fad, albeit one with some legitimate traction in the marketplace. The company faces intense competition from a wide range of suppliers. Perhaps the most significant environmental threat is with respect to intellectual property rights. Crocs depends on right with respect to both the resin used in production and with respect to their sandals designs, in addition to the usual rights with respect to branding. Protection of these rights is essential because Crocs charges relatively premium prices for their shoes ($30-$60), given the production costs. Protection of these margins is essential, but cannot happen if knockoffs are allowed to enter the market. Defending the Crocs technology and design against myriad threats is going to be a difficult, expensive proposition (Reeves, 2006), complicated by Crocs' management's decision to offshore some production to China, a move that virtually guarantees the production of knockoffs.

Given these risks, Crocs is wise to limit their use of leverage. Leverage will increase volatility at a firm whose operations are already highly volatile. The current economic downturn has significantly suppressed revenues and earnings. If Crocs had been leveraged going into 2008, their situation would be dire, whereas it is merely bad at present. This conservatism has given the company a chance to pull through the crisis.

The second element is the maturity structure of the firm's capital.

A risk-neutral position with regards to maturity is where the life of the firm's assets equals the life of the firm's liabilities. For Crocs, the liabilities are almost entirely current. The current portion of long-term liabilities on the balance sheet has been used more extensively in 2008, a function of lower than expected revenues. This consists of a revolving credit facility, priced in relation to either the Fed Funds rate or LIBOR, at the company's option. The agreement was amended several times throughout 2008 and by the end the rate was 12.25% and did not allow for new borrowings. There are also rental commitments through 2013 and beyond.

The life of the financing is weighed against the life of the firm's assets. Property/plant/equipment is the largest non-current component of total assets. A significant proportion of capital equipment was leased in previous years, but the firm has reduced that to $9,000. Another class is intangible assets. These are considered to have finite lives ranging from 5 years to 10 years, with most falling in the 7-year category. The 10-year category consists of the patents, perhaps the most important intangible asset category.

The interpretation of maturity structure is that the firm must choose between a preference for refinancing risk or reinvestment risk. The maturities and assets are not matched at Crocs. Indeed, the company appears to strongly prefer reinvestment risk, since they appear to be plowing back their funds into capital investments. This is especially evident in the way that the company has eliminated its long-term debt. Crocs managers, therefore, are placing their bets that continued growth through expansion of products and markets is better for the long-term success of the company. Refinancing is seen as riskier, possibly because the increased risk will undermine the company's ability to continue to grow as it sees fit.

The third element is the basis for the firm's coupon and dividend payments. Crocs does not pay dividends (MSN Moneycentral, 2009). This is consistent with behavior typical of young, growing firms. In part, this is because of the emphasis such firms place on growth. In part, this is due to the volatile nature of earnings in young firms, for whom dividend payments would be a risky obligation.

In late 2007, Crocs entered into their revolving credit facility. This facility is based on a floating rate (Fed Funds, LIBOR or prevailing bank rate). This indicates that Crocs had taken a view that interest rates were going down, which they did. The company being new, management would have had little indication of how Crocs would respond to changes in the macroeconomic environment. It was reasonable to assume that their strong growth trajectory would continue, however that has not been the case. Therefore, by accepting a floating rate, the company saw its interest payments decline as rates dropped at the beginning of 2008. This corresponded with a drop in revenues as the financial crisis worsened. Thus, the floating rate was matched with the firm's revenue streams. Management of course did not known that their revenues would drop as the result of macroeconomic weakness. Indeed, their slow response with respect to cost-cutting resulted in steep losses and inventory writedowns in 2008. Thus, it can be inferred that the company's floating rate choice was matched with its revenue streams only by chance. The decision to utilize a floating rate was more likely driven by an accurate assessment of the future direction of interest rates, which was predictable in light of the fact that the… [END OF PREVIEW]

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