Columbia Sportswear Company (COLM) Q2 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the Columbia Sportswear second quarter 2015 financial results conference call. [Operator Instructions] I would now like to turn the conference over to your host, Mr. Ron Parham. Thank you, Ron. You may begin.

Thanks, Bob. Good afternoon, and thanks for joining us to discuss Columbia Sportswear Company's second quarter and first half financial results, and our upward revised 2015 financial outlook announced earlier this afternoon. Shortly after our earnings press release crossed the wire, we furnished an 8-K, containing a detailed CFO commentary covering the quarterly results and the assumptions behind our 2015 outlook. The CFO commentary is also available on our Investor Relations website, and we encourage investors to review it if you've not already done so. With me today on the call are Chairman of the Board, Gert Boyle; Chief Executive Officer, Tim Boyle; President and Chief Operating Officer, Bryan Timm; Executive Vice President and Chief Financial Officer, Tom Cusick; and Executive Vice President, Chief Administrative Officer and General Counsel, Peter Bragdon. I'll ask Gert to cover the Safe Harbor language.

Good afternoon. This conference call will contain forward-looking statements regarding Columbia's business opportunities and anticipated results of operations. Please bear in mind that forward-looking information is subject to many risks and uncertainties, and actual results may differ materially from what is projected. Many of these risks and uncertainties are described in Columbia's Annual Report on Form 10-K for the year ending December 31, 2014, and subsequent filings with the SEC. Forward-looking statements in this conference call are based on our current expectations and beliefs. And we do not undertake any duty to update any of the forward-looking statements after the date of this conference call to conform the forward-looking statements to actual results or to changes in our expectations.

Thank you, Gert. And I'll turn the call over to Tim.

Thanks, Ron. Welcome, everyone, and thanks for joining us this afternoon. Our exceptional first half results and upward-revised full year outlook illustrate the increasing earnings power of our expanded brand portfolio, seasonally diverse product offerings and distribution channels and enhanced operational platforms. Consolidated first half net sales increased 19% on a constant dollar basis, including prAna, and 11% on an organic constant dollar basis. Meanwhile, first half operating income increased 90% and first half net income grew 25%, aided by accretion from the prAna brand, which we acquired in May 2014. Keep in mind these outstanding consolidated results were achieved, despite the challenges facing our industry in Russia and Korea. The 11% organic constant dollar net sales growth in the first half was led by the Columbia brand, which grew 13% on strong performance in many key markets, including high-teen growth in North America, 30%-plus growth in Europe direct markets, low-double digit growth in China, high-single digit growth in Japan and mid-teen growth in sales to independent distributors in our Latin America/Asia-Pacific region. Our consolidated first half results benefited from approximately $58 million of incremental prAna net sales. In addition, prAna contributed $0.07 to first half earnings per share. We've just passed the one year anniversary of this exciting acquisition and are very pleased by the contribution the brand is making to our growth and profitability. Looking more closely at the Columbia brand's performance, very strong first half sell-through in North America was balanced across key product categories and our diverse wholesale channel, including specialty outdoor, sporting goods, hunt-fish-camp, department stores and specialty footwear stores as well as our own direct-to-consumer businesses. In our Europe direct markets, Columbia's constant dollar net sales growth was led by footwear, which has performed exceptionally well, while apparel also contributed strong double-digit constant dollar growth. Good sell-through and higher than expected at once demand from wholesale channels in North America and Europe during the second quarter has generated encouraging early momentum in wholesale advance orders for spring 2016. During 2015, we plan to open 12 new outlet stores in North America, two prAna branded stores in the U.S. and four outlets stores in Europe. Additionally, we recently opened a new PFG-themed Columbia branded store in Miami, Florida. Together with anticipated sales through our stores and ecommerce platforms in Japan, Korea and China, we expect global direct-to-consumer sales to continue to account for more than one-third of projected global sales for the full year. In the second half of 2015, despite ongoing challenges in Russia and Korea, we expect the Columbia brand to achieve low-double digit constant dollar growth, highlighted by high-teen constant dollar growth in North America, growth of more than 30% through our LAAP distributors and mid-teen constant dollar growth in Europe direct markets. Inventory levels are in line with our expectations, as we planned earlier receipt of fall production to enable us to meet the delivery timelines of our increased wholesale advance orders, as well as to support our growing brick-and-mortar and ecommerce businesses. We expect inventory growth to moderate over the third and fourth quarter to rate similar to our anticipated sales growth. We believe Columbia's wholesale and direct-to-consumer performance in the first half stands as further evidence that consumers are increasingly adopting Columbia as a year round brand that helps them enjoy their outdoor passions across all weather conditions. The Columbia brand's innovation platforms for fall 2015 feature TurboDown Wave, a unique outerwear construction method and a reengineered assortment of our high-end titanium branded products. We have more exciting innovations in the pipeline, including OutDry Extreme, a revolutionary extension of our OutDry brand into ultra-breathable waterproof rainwear. We believe innovations like this will keep the brand's momentum going into 2016 and beyond. Moving to the prAna brand, one of the things that attracted us to prAna was the differentiated consumer segments it addresses. Together with its balanced seasonality, strong management team, and the shared belief that we could help extend and accelerate prAna's growth around the world. PrAna contributed net sales of $63 million during the first half of 2015, representing pro forma growth of more than 30%. PrAna remains on pace to reach an estimated full year net sales of more than $120 million, demonstrating the seasonal balance of its business. We're very excited about the long-term potential of prAna, as it continues to gain awareness and build strong emotional connections with consumers. During the second quarter, we named prAna CEO, Scott Kerslake, as Interim President of Mountain Hardware, in conjunction with previously announced management changes. In addition to retaining his current role as CEO of prAna, Scott will be working alongside the Mountain Hardware team to accelerate their efforts to reinvigorate Mountain Hardware's heritage as a premium, high-end performance brand. We are fortunate to have someone of Scott's experience available to step in and guide these efforts, while we conduct a search for a permanent brand president. While there remains much work ahead, we believe Mountain Hardware has a great opportunity to leverage its authenticity and return to growth by bringing outstanding products and a distinct point of view to this segment of the market. Finally, let's talk about the Sorel brand. Earlier this year we took steps to create a more distinct, autonomous organization, led by brand President, Mark Nenow, our former head of all footwear brands, to focus resources behind Sorel's substantial global opportunities. Mark and his newly focused team are driving our long-term strategy to evolve Sorel into a diversified, multi-category, multi-season global brand, focused on fashion-forward female consumers, extending it well beyond its North American winter roots. The first phase of that strategy began two years ago, with the introduction of an expanded line of versatile fall styles that are fashionable and functional across a wide range of climates. Our North American wholesale customers have responded enthusiastically by ordering substantially more of these light-weight styles for fall, and we've already begun to see rapid sell-through of these products in select upscale stores and on our ecommerce site. In addition, we've translated Sorel's iconic design DNA into a targeted Sorel outerwear collection, which launches fall 2015, and we're introducing a limited collection of Sorel's spring and summer footwear styles for spring 2016. The outerwear collection will begin to appear in select wholesale customers and our own branded stores and ecommerce sites within the next 60 days. And we're in the process of collecting our first advance wholesale orders for the spring footwear line. Sorel's fashion-forward female customer continues to be excited about the Sorel brand, following last fall and winter, when demand outstripped supply. We're confident that they will embrace Sorel's expanded offerings. While Sorel's constant dollar sales grew 15% in its seasonally small first half, we're looking forward with great anticipation to the second half of 2015, where we expect constant dollar growth in excess of 30%, and to generate 90% of Sorel's full-year projected net sales of more than $200 million. In summary, the first half of 2015 has been very successful, and we're poised for continued growth and improved profitability during the second half. The Columbia, Sorel and prAna brands have strong momentum in North America. In Europe, the Columbia brand continues to make progress towards a position of strength, while also achieving renewed growth in Latin American distributor markets and continued constant dollar growth in Japan. Our upward-revised financial outlook for 2015 now anticipates mid-teen constant dollar net sales growth, translating into low-double digit growth, as reported in U.S. dollars, surpassing the $2.3 billion mark for the full year. We now expect full year operating margin of approximately 10.3%, and a record net income of between $160 million and $168 million or $2.25 to $2.35 per diluted share, which represents an increase of 17% to 22% over 2014. As we've indicated previously, we're committed to increasing our demand creation investments with particular focus on improving our in-store presentation and expanding our digital messaging. Since 2012, those investments have grown at a compounded rate of 18%, outpacing compounded net sales growth of 11% over the same period, while operating income has grown at a compounded rate of 21%. This year we're planning demand creation spend to expand 14%, increasing to 5.4% of net sales from 5.2% last year. Our strong balance sheet and expanding gross margins are enabling us to invest in each of our brands, and in the global operating platforms that support their growth and improving profitability. You can find out more detail on our Q2 and first half results and our 2015 outlook in Tom's CFO commentary available on our website. That concludes my prepared remarks. Operator, could you help us answer some questions?

[Operator Instructions] Our first question comes from the line of Bob Drbul with Nomura Securities International.

I just got a couple questions for you, Tim. The first question I have is, as you look to sort of the back half of the year here, has there been any sort of notable movement on your order book that you can talk about, has it strengthened, been any changes to it that have been material?

No, there's really been no specific changes that we would call out. I mean think based on the weather we had last year that extended so long, we've got a great appetite by our retail customers, our wholesale customers to receive the merchandise as early as possible. So as you know, we accelerated delivery of a bunch of inventory in a planned method to prepare ourselves for timely delivery. And that would be the only notable point I would want to mention.

And Tim, can you give us an update, just sort of any real-time, the last few weeks and months of what's happening in China, what you're seeing with your business? And I know, like I looked at the assumptions in your guidance on Korea and some of the tougher -- Korea specifically, Russia. Can you just talk a little bit about the inventory levels? You know you have some sort of excess inventory provision for Korea, but like how you were thinking about concerns in China or Russia, and how you're planning for that?

Certainly. We asked our team in China this specific question, and it's been interesting to note that the recent declines in the stock market really haven't impacted our business there in any specific way. It's important to remember that the Chinese stock market has been enormously successful, and even though it's come back a little bit over the last month or so, it's still a strong performer. But at the end of the day, our business in China remains on this path to hit our projected numbers for 2015. And there hasn't been much of an impact at all with the current stock market pullback. As it relates to Korea, we've installed a new manager there, as we discussed earlier. We have expectations that his financial acumen will allow us to get that business back on track. It's still profitable. And we have a significant inventory reserve to be able to help us liquidate that inventory without impacting our financial statements, and we're in the process of working through that inventory. So my expectations are that within the few months we'll have more information on Korea. But certainly our expectations are baked into today's projections for the full year 2015. As it relates to Russia, that's been an important market for the company and continues to be so. Our distributor is a well-capitalized retailer and franchise operator in that market. They run a great business. They have teams of people here constantly. In fact, our Russian distributor is here today, and we are working real-time to make sure that we've got the right products for them, realizing the impact of the currency change and the reduction in the robust nature of that market. But I feel comfortable with the projections that we've given you today, which include all those three international markets.

Maybe just a little more color on China. We're planning that business up low-single digit in constant dollars, and inventory actually down. We bought inventory pretty tightly for fall '15. So we're planning inventory down mid-to-high single-digits in that region this year.

Our next question comes from the line of Rafe Jadrosich with Bank of America.

Can you just talk about what's sort of driving the momentum in the direct markets in Europe? And then maybe can you give a little color, kind of broadly speaking, where those margins are tracking and then if you see any opportunity there?

Well, as you know, the company has had difficulty in our direct European markets, which basically include all the markets of the EU plus Switzerland. Over the last several years, it was and continues to be a very important part of our business, but it hasn't performed up to our expectations for several years. We changed the management team there about 18 months to 24 months ago, and added a seasoned executive in the apparel business, who has been very focused on key markets and key retailers within those markets. And that has really been frankly what's allowed us to turn the business around. We're still in the process of providing great products, which are specific to the European market. And that will be an ongoing process. But I would say, if I had to point to one thing, it's really the focus by Franco Fogliato, who is our European GM to manage that business and keep us focused. As it relates to margins, we've done a great job hedging our costing in the euro for 2015. And that's allowed us to have reasonably good margins in that market.

The direct Europe markets, are they EBITDA positive right now? I think the EBIT it's close to breakeven I think in 2014. Is there still a lot of opportunity there? Is there opportunity to get leverage as you improve the sales?

I would say, our European direct market is, when we combine the direct market with the distributor market that region is profitable. But on a standalone basis, the direct market is not profitable. So when you look at the upside opportunity from a consolidated operating margin standpoint, every dollar of revenue there is the biggest contributor to operating margin for the consolidated group.

And then just last question. Can you just talk about the trends in PFG? You obviously opened the store. Can you talk about maybe how large that business is now and then kind of what are the plans longer-term?

Well, it's been an interesting phenomenon, because we've really almost developed this business from scratch, the whole concept around performance and lifestyle apparel products, which are worn primarily in the sun are sort of at odds with what you would expect an outerwear company to be delivering. So the business there has grown. We've also had a significant amount of students and other young people in the south really embrace the products as lifestyle apparel. So we have sort of a double whammy going on there for the performance factor, as well as, just the style has become very popular. So the trends are strong. We have other competitors, obviously, but we're leading the market in that area. And the expectations for our stores, which we've established to highlight he PFG products are that they will again from a combined marketing/retail revenue standpoint will be really important to the continued growth of the business.

Our next question comes from the line of Lindsay Drucker Mann with Goldman Sachs.

I wanted to dig into the U.S. a little bit. And first of all, I just wanted to understand based on your guidance, in the CFO commentary, are you looking for low-20s organic revenue growth in the U.S. in the back half of the year?

Yes. That's certainly in the ballpark, yes.

So as I think about the composition of that growth, can you help me understand what component of that is pricing versus units? And I know that's a tough question, because you have multiple products you're selling. But is there pricing, is there any material price increase embedded in that? And then also given how favorable the inventories are after the cold winter last year, how much of that increase do you think is expected sell-through versus kind of a restock of retailer inventories?

So our business in the U.S., we've talked a lot about what we believe is an opportunity for the company to raise its AURs. But I would suggest that that is less of a factor in our business for fall 2015 than unit growth has been. So we've got just great acceptance really across all the channels that we work in. And so there is some AUR growth, but it's not the predominant reason that the business is bigger. And then as it relates to inventories, successful retailers want to end a winter season with zero inventory. Most of them actually get that way by just liquidating stuff. So the expectation is that from our retailers, what they're buying from us they're going to be selling with margin. So I think they've bought appropriately. I don't see the kinds of wild behavior in our retailers that we've seen in other times, but they certainly want their merchandise earlier. And it's because consumers are looking to make sure that they can have the stuff when they want it, which is earlier.

And as I think about the guidance, the outlook, a much stronger sales outlook, but not as much margin flow-through as I probably would have expected, what are the big margin offsets to think about in the back half of the year?

The single biggest offset would be international hedge rates. So currency is the biggest headwind. And then frankly, as we look at the back half, we had great winter weather in North America last year. So that certainly helped us. And then on the tailwind side of the equation, we took a fairly large Korean inventory provision in the fourth quarter. So that will be helpful in Q4.

And then just last question. As I think about the sort of long-term, I've heard you talk about this before, but your sort of long-term margin history and where we are today, obviously still well below some of your peak moments. As I think about maybe a three or five-year plan on margin improvement for Columbia, what are the biggest drivers? You talked about AUR? Is it leveraging fixed costs? Are you planning on focusing on higher margin in new categories? How do I think about the walk forward in margin expansion over the next few years?

Well, you're talking operating margin, right?

Yes.

Well, the goal is to increase the total revenues, right and lever the SG&A spend and to drive some additional marketing spend. So those are a larger operating margin, larger revenues, larger gross margins to a certain extent to give ourselves more marketing spend. So how we plan to do that is just continuing to improve our product range. We'd like to raise our AURs and in some cases I think we have an opening from consumers and from our retailers to do that. But we're mindful that we have a significant business that relies on scale and price points. So we've invested fairly heavily over the last 25-30 years in infrastructure to provide services at an efficient cost, as well as people to provide us with efficient competitive pricing on the merchandise that we're buying. So I would say, in terms of ranking them, it's probably going to be scale that helps us, as well as moving our AURs up where we can.

Our next question comes from the line of Susan Anderson with FBR.

I was wondering, if you could talk about the trail shoes that you had out this spring, I think in a bigger way. What was the consumer response? And then do you expect to get some more space gains in these for next spring? And then maybe just on Mountain Hardwear, the business there too, how do you feel about the fall product, and kind of when do you expect the sale to inflect?

Well, our biggest successes in trail footwear are really in Europe, and we had good penetration in the U.S. as well in sporting goods and specialty stores. But our big win for the spring season in '15 was in Europe. Sell-through was quite good. So our expectation is that we're building scale in that category of merchandise. And we expect that that will continue to be a big part of our future in footwear. It's really another testament to the fact that our brand can go beyond winter in footwear. So we're pleased about that.

And how was the response in the U.S., too? I was going to say, do you think that you'll kind of continue to gain some space there, too?

We do, yes. The response was quite good in the U.S. and we've converted several of our large retailers over to that one particular product, which sold so well for us in Europe. And it's sold well for them. So it's great to see the brand getting traction in that category, where it's really sort of a natural product category for the business and one that we've always thought that we should have done better than we did. So it's great to see the years of focus on that come into fruition. And then as it relates to Mountain Hardwear, Mountain Hardwear has been challenged in our business there, especially in North America. It's not been as good as we wanted. We believe that the brand still has very significant strength with the key consumers in that upper echelon market, we just have to be fulfilling their promise, the promise that the brand holds to provide high-quality product, differentiated through style and innovation, and at the right prices. So Scott will be focused on that, together with the team. And we believe that we've got really good things ahead of us for that brand.

Our next question comes from the line of Jay Sole with Morgan Stanley.

I just have a question about the Sorel brand. As we look into the holiday season, can you talk about how the assortment will kind of diversify from what you did last year, and maybe it will evolve and expand into perhaps different categories or more fashion or more weather or whatever the case may be?

Well, Sorel has a spectacular year last year. Most people think it was solely because of the weather we had in North America. But frankly, it was a combination of the focus on women's products that Mark and the team have put together, as well as certainly the winter weather was helpful. This year, we've already begun to deliver some fall product for Sorel, both what people would consider maybe winter as well as the product that we've been so focused on, which is I don't want to say anti-winter, but certainly fall-related product. And the sales to consumers, even this early in the season, have been really quite spectacular. So the expectation is that that business will continue to grow. We believe we have the right approach as it relates to the team running that business. We've put specific focus around the design and merchandising of the product. And we're testing some products in outerwear, as well as some spring product for 2016. I'm very excited about what that brand can be for the company, and especially as it relates to its focus on the female consumer.

And then maybe just to follow up on that, any new geographies that Sorel can start to get into, beyond U.S. and Canada and the main ones?

Well, we're distributing the product globally. I would say North America is where it has its broadest distribution. And I think you would naturally expect it to be heavily Northern Hemisphere and cold-weather influenced. And it certainly has been. But some of our biggest successes in early fall selling of 2015's collection have been in Alabama. So it's really a question of how well we do in assorting compelling footwear that works when there's not snow on the ground.

Our next question comes from the line of Christian Buss with Credit Suisse.

This is actually Sara Shuler on for Christian. Can you give us an update on the timeline for the ERP implementation in Canada, in Europe and some of the other regions? And maybe also remind us how long it took to roll it out in North America, and how soon afterwards you began to see kind of benefits materialize to gross margin.

So just to recap on the ERP, Canada was our first go-live. That was in April of 2012. The U.S. came online in April of 2014. Our international distributor business came online May of this year. So we've basically got roughly 70% of our business on the platform today. The next geography will be Japan. I would expect that to occur in the second half of next year. And then we'll have basically Korea, China and Europe to go. And the order of those implementations is yet to be determined. But if you look back at what's that meant to inventory turns, cash flow generation, and gross margin expansion over the last 10 quarters, I think it's been pretty meaningful, particularly in North America. So we're quite pleased thus far.

Our next question comes from the line of Kate McShane with Citigroup.

This is Nancy Hilliker on for Kate McShane. So we have a couple small questions. Just following-up on the SG&A trends this quarter, where was it in comparison to your expectations, and was there a pull for it at all in terms of spending since you had such great sales?

No. Actually SG&A came I think it was in under our plan by less than $2 million. We had a higher percentage spend for advertising in the quarter. So SG&A really came in basically on plan and with the revenue upside of roughly $30 million versus plan, it was actually a bit more in terms of leverage to the business in Q2.

And then just following-up on prAna, how would you think about the distribution this fall versus last fall? And then, also, just if you could talk about the outlet performance?

Well, as it relates to prAna, I believe I believe that we had really almost no new distribution for fall 2015. So the expectation is just a higher degree of penetration in those existing markets. And to date, we don't have any prAna outlet stores. So is your question around prAna outlets?

Sorry. Just generally, no outlet comps generally, sorry.

We don't report any of the typical retail metrics on our direct-to-consumer business, because we're really not a retailer. But our performance has been good. And we've been excited about it. And obviously, it shows in the increased investment in that type of retail environment through the balance of '15 and I'm sure there will be more through '16.

Thank you. There are no further questions at this time. I'd like to turn the floor back to management for closing comments. End of Q&A

Well, thank you all for listening in. It's been an exciting quarter for the company this year. We've got great things ahead of us. And we're really looking forward to reporting great things in Q3 and beyond. Thank you very much.