Thursday, May 8, 2008

Crocs Earnings Report Deserves a Closer Look

Just a day before Niwot, Colorado based Crocs reported its 2008Q1 earnings (SEC filing) I wrote about its practice of capitalizing software development costs. Yesterday after Crocs (CROX 11.81, +1.85, +18.6%) reported a loss including one time charges for closing down operations in Canada, its shares jumped almost 20%. WSJ blog also predicted a high stock volatility.

For the quarterly earnings we do not have much insight into the components but some of the components do deserve a closer look before predicting a stock turnaround.

  1. The Cost of Sales grew faster than revenues, leading to a significant erosion in gross margin. This leads to questions, whether they increased sales by slashing prices and extending higher commissions. How far can they go to increase sales further?
  2. They use FIFO (First in First out) for inventories. The higher cost of sales is accounted for by the increasing raw material costs. The current cost of sales in the income statement represent the cost of materials when they acquired them, may be an year or two ago. Since then costs have been on the increase due to run up in oil prices. Their gross margin is bound to go down more.
  3. Cash position is weak as they generated no operating cash flow and ate into the cash reserves.
  4. Their SG&A is also on the rise indicating a higher fixed cost that is independent of sales.
  5. They indicate to us that the $12.1 million ($20 million total for the year) after tax charge on closing down Canadian operations is one time charge. In GAAP terms, this is still above the line but most companies tend to signal this to investors who also agree with this one time classification. But we need to find out whether the company is taking a big bath, adding many costs to the restructuring that are usually not one time charges. We do not have data to say either way.
  6. Capitalizing Software development costs. We need to see if some of these costs get written off as part of the one time charges.
Before rushing to buy the stocks at current levels, investors do need to ask these questions.

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