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MILSTEAD: Workers using stock options helped Crocs boost liquidity

By David Milstead, Rocky Mountain News (Contact)

Published January 9, 2008 at 12:05 a.m.

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The market didn't take kindly to the news that Crocs told many of its workers to take a hike for the last couple of weeks in the year. While the company said the personnel matter was routine and customary, sellers worried that the highflying Niwot shoemaker might have sales slowness or even a bit of a cash crunch.

It seems like crazy talk for a debt-free company that doubled sales and tripled profits for the first nine months of 2007. But the news of the furlough, appearing Saturday in a story by my colleague James Paton, draws focus back to Crocs' significant inventory buildup in the third quarter. At a time when the company spent plenty of money making all that product, which it then didn't sell, the company's main source of financing was beginning to dry up.

I'm not talking about sales of shoes or even the international credit markets. Incredibly, Crocs financed itself in 2007 primarily through the exercise of employee stock options.

How do we know? The cash flow statement, as opposed to the earnings figures a company announces, tracks the actual dollars in and out of a company, whether they're recognized as sales or expense during the period.

A company that builds up its inventory without actually selling it will see a large impact on cash. And indeed, that's what happened to Crocs.

Net income of $56.5 million exceeded the second quarter's profits by a few million dollars. But operating cash flow, which includes money spent on unsold inventory, dropped from $34 million in the second quarter to negative $739,000.

Free cash flow, which subtracts the amount a company spends on the property, plant and equipment used to run the business, went from $20 million in the second quarter to negative $17.7 million in the third.

Crocs has almost no debt, using a small line of bank credit primarily for vendor letters of credit. Instead, it has another source of liquidity: stock options.

When employees use options, the company is selling them shares for the exercise price. The company pockets that cash.

Another benefit to the company is the tax deduction it gets when an employee exercises the option. The full difference between exercise and market price can be used to offset income on the corporate tax form.

Crocs' cash flow statement shows just how big an impact the options are making. For the first nine months of the year, the company received nearly $14 million in proceeds from the exercises, plus $38.6 million in taxes it didn't have to pay because of the option deductions.

Add the two together, and it's nearly $53 million, which explains how Crocs can post operating cash flow of $22.2 million, then spend $41.6 million on capital expenditures without the aid of a bank. (That's negative free cash flow of $19.4 million.)

There's a problem, however. Option proceeds declined in the third quarter, compared to the second. They probably weren't higher in the fourth quarter, given the stock's decline. And the first quarter of 2008 isn't looking so hot.

As Crocs stock declines, and fewer options are used, less cash will flow in.

How big a deal is this? Crocs' disclosure says "seasonal variations in product demand . . . may directly affect our cash flows from operating activities" and one quarter's number is "not necessarily indicative . . . for any other quarter."

While commentary after the third-quarter report focused on foreign warehousing problems, Crocs said its inventory increase was intentional, "in order to meet anticipated demand for the nine months ending June 30, 2008," plus freeing up production capacity for new product lines.

Many of these points were reiterated to me in an e-mail composed in part by Crocs CEO Ron Snyder. He added, "Using the proceeds and tax benefits from exercised employee stock options is an appropriate source of financing for investment in the growth of our business, and is less costly than borrowing."

And he said the year-end furlough is not tied to the company's sales. "We simply said that, like many companies, the holidays are a slower and less productive period for our corporate office employees," Snyder wrote. "We right-sized our office staff for this period and allowed employees that were not working to use vacation time."

The company's boosters say pish-posh to the inventory problem: All that product is necessary for the blow-out-the-barn-doors performance that's sure to come next spring.

They should hope so. Without a sharp rebound in the stock price, Crocs will need a new form of financing - or Crocs' staff might be taking a forced summer vacation, too.

David Milstead and James Paton take turns writing Up and Down 17th Street. Contact Milstead at 303-954-2648 or milstead@RockyMountainNews.com.

Comments

  • January 9, 2008

    10:16 a.m.

    Suggest removal

    jcrash writes:

    Yes, I'm sure they will have a hard time securing financing on a $175 million dollar accounts receivable.

    Get a clue.

  • January 9, 2008

    7 p.m.

    Suggest removal

    chickenlittle writes:

    Nice Pseudo Journalism... Hey Henny Penny the sky is falling

  • January 9, 2008

    7:32 p.m.

    Suggest removal

    bernandoo writes:

    So how much money did the hedge fund pay you this time?

  • January 10, 2008

    12:34 a.m.

    Suggest removal

    aspenextreme writes:

    One has to wonder about the hidden agenda behind these two authors that put out two consecutive smear articles on Crocs within the span of two days, as the stock is in a precarious position. Also, their content has little real substance but they spin it as if it's some sort of big negative. Meanwhile, professional analysts report that the company itself is performing amazingly well as they expand and scale the operation worldwide. While this author get's an email snippet from them, JP Morgan's analysts has a long discussion with management:

    Here's an excerpt form the JP Morgan January 7th 2008 report:

    "• We had a long discussion with CEO Ron Snyder this morning and
    walked away with renewed confidence about the current business
    and the company's prospects for 2008.
    • One of our key takeaways is that in addition to sales of the
    Mammoth exceeding all expectations during the holidays, core
    products also performed well even despite the seasonal nature of
    the Beach and Cayman styles. This supports our own channel
    checks throughout the quarter. We note that investors have been
    concerned that sales of core products have slowed.
    • With regards to CROX's international business, even though this
    was the first season that most European and Asian stores carried
    Crocs during the winter months, sales remained healthy.
    • Pre-books for Q1 have started out on a very positive note in
    Europe and are actually running higher than what they were in the
    U.S. during the same period last year. The Asian business has
    become much more at-once and also remains strong. The
    company plans to have almost 1,000 doors open in China by the
    spring.
    • We remain comfortable with previous guidance of 35-40% EPS
    growth for 2008 and believe that the upcoming ICR conference
    will provide a long-awaited positive catalyst for the name. At
    under 11x our ’08 estimate of $2.70 we think risk/reward is very
    compelling. "

  • January 10, 2008

    12:35 a.m.

    Suggest removal

    aspenextreme writes:

    (continued from my prior post)

    The CEO and JP Morgan would not go out on a limb like that unless it were true, lest they risk huge liability. So, as much as these authors try to spin their web of half-truths and negative innuendo about Crocs, I'm going to go ahead and trust the professional analysts, who know much more about what they're doing when it comes to looking at a large global business than these local yokels from the Rocky Mountain pennysaver.

    With the sales strong and growing like they are, Crocs doesn't need the stock option income the author talks about to finance their business. If they need funding beyond what they get from operations, numerous banks would line up to lend it to them, or they could issue bonds or stock if it came down to it. This guy implies the business is going to be damaged somehow of they can't use the rather paltry option income, which borders on ridiculous.

    The local media should be proud of Crocs' amazing success and the jobs they created and the way they made a great business in Colorado. It seems so transparent to me that these two authors are trying to spin trivialities into a firestorm of poo raining down on Crocs and their supporters. One has to wonder what their motive is. One thing we do know, it's not unbiased journalism. CNBC's Karen Finnerman outed these guys on national TV earlier tonight. SEC investigations may follow unless we see a retraction.

  • January 10, 2008

    7:31 a.m.

    Suggest removal

    Oh_Wise_One writes:

    What are some of you other commentators? Employees. This was a good article compared to some others here online at the RMN.
    Bottom line. If Crocs doesn't sell their fad shoes this spring, kiss your job and your stock options goodbye.
    Someday, at a garage sale, selling for $1, I might try on a pair of those neon clogs and then pass on buying it.

  • January 10, 2008

    9:09 a.m.

    Suggest removal

    Cowboy_Joe writes:

    We all know CEOs are the most reliable source of truthful, objective information.

    This article is just pointing out the obvious from information supplied by Crocs. These comments slamming the author seem a little rabid if they're from anyone without something to gain, whether pride or money. Get a grip!

  • January 11, 2008

    1:55 a.m.

    Suggest removal

    Milsteads_Mama writes:

    Davey, you've been a bad, bad boy.