Columbia Sportswear Company

Greetings and welcome to the Columbia Sportswear Company third quarter fiscal year 2019 financial results. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host. Mr. Andrew Burns, Director of Investor Relations and Competitive Intelligence for Columbia Sportswear. Thank you. You may begin.

Good afternoon, and thanks for joining us to discuss Columbia Sportswear Company's third quarter results in 2019 outlook. In addition to the earnings release, we furnished an 8K containing a detailed CFO commentary explaining our results and the assumptions behind our 2019 outlook. The CFO commentary is available on our Investor Relations website, investor.columbia.com. With me today on the call are President and Chief Executive Officer Tim Boyle, Executive Vice President and Chief Operating Officer Tom Cusick, Senior Vice President and Chief Financial Officer Jim Swanson, and Executive Vice President and Chief Administrative Officer Peter Bragdon. 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 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 with forward-looking statements to actual results or to changes in our expectations. I'd also like to point out that during the call we may reference certain non-GAAP financial measures, including non-GAAP results for 2018. For further information about Non-GAAP financial measures and results, including a reconciliation of GAAP to Non-GAAP measures and an explanation of management's rationale for referencing these Non-GAAP measures. Please refer to the supplemental financial information section and financial tables included in our third quarter 2019 earnings release. Following our prepared remarks, we will host a Q&A period during which we will limit each caller to two questions so we can get to everyone by the end of the hour. Now, I'll turn the call over to Tim.

Thanks, Andrew. Welcome, everyone, and thanks for joining us this afternoon. Record third quarter results exceeded our expectations with broad-based growth across our geographic segments, channels, and product categories. We were able to ship a greater portion of our fall 2019 order book in the third quarter this year compared to the fall 2018 season as retailers restocked depleted inventory positions after harsh winter weather and exceptional sell-through in North America last year. Our largest brands, both generated impressive double-digit growth, which was led by North America. We also generated 100 basis points of operating margin expansion compared to prior year non-GAAP results, driven by Project Connect margin benefits. Together, this fueled earnings per share growth in excess of 20% while continuing to make substantial investments in our strategic priorities. Based on strong year-to-date performance, We are raising the low end of our net sales outlook and raising our operating margin in earnings per share outlook for the full year. In the third quarter, net sales increased 14%, gross margin expanded 110 basis points, and diluted earnings per share increased 24% to a record $1.75 compared to non-GAAP third quarter 2018 diluted earnings per share of $1.41. On a year-to-date basis, net sales increased 11%. Gross margin expanded 130 basis points and diluted earnings per share increased 35% to a record $3.15 compared to non-GAAP year-to-date 2018 diluted earnings per share of $2.34. Regionally, U.S. net sales increased 17% in the quarter and 15% year-to-date. In the quarter, Growth was driven by low 20% growth in wholesale and mid single-digit percent growth in DTC, which included brick-and-mortar net sales growth and a high single-digit percent increase in e-commerce. Wholesale growth was driven by higher advance orders and earlier shipments of fall 2019 product. In DTC, both our brick-and-mortar and e-commerce businesses were up against exceptional sales performance last year. From our review of international markets and brand performance, I will reference constant currency growth rates, which we believe best reflect the underlying business trends. Net sales outside of the U.S. increased 11% in the third quarter and 8% year-to-date, with growth in all international regions. In Canada, net sales increased 22% in the third quarter and 15% year-to-date. Third quarter net sales growth was primarily driven by earlier shipment of fall 2019 wholesale product as well as increased fall 2019 advance orders. Our international distributor business net sales increased mid-teens percent in the third quarter and low double-digit percent year-to-date. In the third quarter, LIAP distributor net sales increased low 20% resulting from timing shifts in the shipment of fall 2019 product. EMEA distributor net sales grew high single digit percent driven by higher fall 2019 advance orders. Japan net sales grew mid single digit percent in the third quarter and high single digit percent year to date. We've experienced over 20 years of steady constant currency growth in this important market, which has continued in 2019. Europe Direct Net Sales increased high single-digit percent in the quarter and mid-single-digit percent year-to-date. In the quarter, growth was aided by earlier shipment of Fall 2019 product as well as higher closeout sales. We continue to experience a challenging retail environment in several European markets but remain optimistic about our long-term growth opportunities given our relatively low market share in that market today. Korea net sales increased high single digit percent in the third quarter and mid single digit percent year to date. Columbia remains one of the few successful outdoor brands managing to grow in 2019, despite a Korean outdoor market that continues to contract. In China, net sales decreased low single digit percent in the third quarter, but are up low single digit percent year to date. During the quarter, higher outlet store sales, and e-commerce growth help partially offset difficult wholesale performance. We are working to optimize distribution and remain focused on investing in our consumer experience to reinvigorate growth. Columbia's brand has strong market position in China, and we believe the decisions and investments we're making this year are building the foundation for long-term growth in this important market. Turning to gross margin performance, Third quarter gross margin was up 110 basis points to 49.3%, largely reflecting Project Connect benefits, including our design to value, assortment optimization, and manufacturing efficiency initiatives. These benefits more than offset modest headwinds due to channel and closeout product mix. Year-to-date gross margin is up 130 basis points to 49.7%, including greater than 100 basis points of benefit from Project Connect. It's important to note that 2019 gross margin performance is on top of full year 2018 non-GAAP gross margin expansion of 170 basis points. Regarding the current U.S.-China trade battles, we reiterate that we believe our diversified supplier base is a competitive strength. For 2019, We received the majority of our fall 2019 product prior to the September 1st tariff increase, resulting in minimal financial impact to 2019. When assessing the impact in 2020, it's important to remember that nearly 40% of our sales are outside the US and are not directly impacted by the US-China trade battle. Based on our projected 2020 production base, Product sourced in China for the US market is expected to represent a low double-digit percent of the total estimated imported value. As with tariffs around the world, we are actively working to mitigate the financial impact. Looking beyond the direct impact to Colombia, we believe escalating trade battles globally are disruptive for American businesses, bad for the global economy, and costly for consumers. In an industry that already suffers from punitive tariffs, some as high as 37.5%, adding additional taxes on our products places an undue burden on consumers and employers. Furthermore, raising tariffs in a capricious manner creates uncertainty for business, which discourages investment. History has shown the cost of these tariffs are borne by U.S. consumers. Turning to SG&A performance, SG&A expenses grew 14% compared to last year's non-GAAP SG&A expenses, resulting in SG&A as a percent of sales of 33%, which was flat when compared to non-GAAP SG&A as a percent of sales in the prior year. The biggest drivers of SG&A growth were planned investments to support our expanding global DTC operations, higher personnel and technology-related expenses, and increased demand creation spending. Moving to performance by brand, I'd like to remind you that I will be referencing constant currency growth rates. Looking at the Columbia brand globally, sales increased 15% in the third quarter and are up 12% year-to-date. In the third quarter, we were able to ship a greater portion of our fall 2019 order book compared to the fall 2018 season as retailers restocked depleted fall season inventory positions. Our team has done an excellent job of executing on fall 2019 deliveries and we believe retailers are positioned for success when winter weather arrives. In markets where winter weather has arrived, we've been pleased with our initial fall 2019 sell-through performance. In regions that are still awaiting the onset of cold weather, The benefits of our product diversification efforts are evident, as our popular PFG line has been a top performer. During the third quarter, Columbia's innovative product continued to receive media call-outs and awards. In apparel, Outside Magazine featured the Rogue Runner jacket and Flare Gun flannel in their annual Winter Buyer's Guide. Backpacker highlighted the Northern Comfort shirt in their article on the best women's hiking and backpacking apparel of 2019. In outerwear, Free Skiers Annual Buyer's Guide featured the Columbia Powder Kick Jacket and Snow Rival Pant as one of the best ski kits of the year. For fall 2019, the Columbia brand has several compelling product stories to highlight, including our newest collection of insulated product called Heat Seal, which utilizes several of our innovations, including OmniHeat and Advanced Baffling Construction so that heat stays in and cold stays out. The heat sale collection includes both casual and technical products and will be prominently featured in our marketing this season. We've also joined up with the team behind Disney's highly anticipated Frozen 2 movie to create a beautifully designed limited edition outerwear collection inspired by the iconic characters of the film. This product will be available on our website and at select retail locations starting November 15th. During the quarter, we launched our new Shift footwear platform at an exclusive media preview event in Brooklyn, New York and amplified the launch with comprehensive marketing campaign including influencers, digital, in-store, and out-of-home advertisements. Grammy award-winning artist Zedd helped to share the SHIFT story with consumers around the world. Since the launch, coverage has reached over 288 million impressions, including placement in major outlets and publications such as CNBC, Billboard, People, Gear Patrol, Hypebeast, and Men's Health, which awarded the SHIFT OutDrive Mid a 2019 Sneaker Award in their hiking category. We are pleased with the launch and believe this exciting new product is reaching younger urban consumers around the world. We follow this initial August launch of the low and mid product with the release of the Shift hiker and boot collections in October. We're excited about Shift's potential as well as several new footwear platforms that we'll be launching in the coming seasons. For OmniHeat, our most successful cold weather technology I'd like to note that since it was launched in 2010, cumulative sales have far exceeded $1 billion and we still see tremendous opportunity in the years ahead. For fall 2020, we will be celebrating OmniHeat's 10-year anniversary with our most innovative OmniHeat product to date. I look forward to sharing more details as we get closer to launch. Moving to marketing, in August, The Columbia-sponsored UTMB Trail Run event, or Ultra Trail de Mont Blanc, highlighted Columbia's relevance to the global trail running community and created a powerful brand experience for participants, spectators, and online viewers from around the world. Collectively, our UTMB sponsorship and content has generated over 200 million impressions since 2015. Several Columbia-sponsored athletes competed in the race, as well as our America's general manager, Franco Fogliato, who successfully finished the grueling race in a mere 41 hours. In the fourth quarter, we're executing two key city attack plans, one in Denver next month and one in the tri-state area, including New York City, where our market amplification has already begun. During most of October, thousands of consumers a day were able to view our window displays at the iconic Macy's Herald Square location. We continue to believe this focused marketing effort in targeted cities drives brand awareness and growth across our wholesale partners, DTC stores, and Columbia.com. For our Sorrel brand, 2019 has been a fantastic year that validates the brand strategy and positioning as a year-round function-first fashion footwear brand. Sorel Net Sales increased an impressive 29% in both the quarter and year-to-date. Growth in the quarter was led by U.S. wholesale, Canada, and U.S. DTC businesses. Sorel's success can be attributed to its evolution beyond its legacy winter utility business to become a year-round footwear brand. To put this in perspective, in 2016, winter product represented 70% of U.S. sales. In 2019, winter product is expected to be just 45% of the U.S. mix, and within that, the product mix has shifted significantly towards lighter, winter-style products. For fall 2019, Surreal has added several new bold products to its collection, including the Joan Next Winter Light Boot and the Joan Wedge Zip Boot. We are also excited to expand our successful Disney partnership beyond the core Columbia brand with the recently launched Sorel Frozen 2 collection for women and kids. Sorel's brand and product momentum are evident, and we are investing in demand creation to unlock its full potential. In October, Sorel hosted its biggest event yet, creating a mile-long runway through the streets and the High Line of New York City. 100 women walk in a full mile, walked a full mile in Sorrell's fall collection, transforming the event to a celebration of unstoppable women and demonstrating the meaning of function-first fashion footwear. In recent quarters, Piranha's sales performance has slowed, with net sales down 3% in the quarter and down 1% year-to-date. To reinvigorate the business, the Piranha team is focused on raising brand awareness, solidifying the brand's position at the intersection of style and outdoor, optimizing distribution, and refining the product offering. We believe the Prana brand continues to resonate with consumers, and we are taking the necessary steps to drive sustainable long-term growth. Mountain hardware sales declined 2% in the quarter and year to date. In the third quarter, Mountain Hardware launched a refreshed and re-energized fall 2019 product line, including a new Gore-Tex snow sport line, which fueled robust growth in our U.S. wholesale business. This was more than offset by a decrease in international sales, some of which was impacted by timing and lower DTC sales. We are excited about the new product direction at Mountain Hardware. and expect strong growth in the fourth quarter will drive full-year net sales growth. During the quarter, Mountain Hardware also created a unique product and brand story with their Everest expedition. A group of six employees embarked on a 10-day trek to Everest Base Camp, meeting up with a team of climbers, including brand president Joe Bernacchio, as they prepared for their chance to reach the highest summit on Earth. They field-tested products along the way, learned firsthand about the community that enables climbers in Nepal, connected with places that inspired the brand's existence, as well as connected with each other, bringing a stronger foundation back to Mountain Hardware's home base. I will now quickly review our balance sheet and cash flow. Total inventory exit in the quarter was up 16% to $717 million. primarily reflecting current and future season inventory, while aged inventory increased modestly. Inventory levels are slightly elevated, driven primarily by a more aggressive e-commerce businesses. X1 enables us to create mobile-first design sites more efficiently, which in turn will elevate the consumer experience as they shop our brands. We still expect the remainder of the X1 North America implementation to occur in 2020. As part of our headquarters expansion initiative, we recently purchased a property adjacent to our headquarters campus for $33 million in order to provide room for future expansion and employees that are currently offsite. We expect to begin occupying the property next year. We are also continuing to make strategic investments across our supply chain to enable growth, improve productivity, enhance service levels and add capacity throughout our distribution and fulfillment networks. I'd now like to provide some detail on our updated 2019 financial outlook and preliminary 2020 commentary. For 2019, we anticipate 7.5% to 8.5% full-year net sales growth. Gross margin is expected to improve by approximately 60 basis points with the largest driver of year-over-year improvement coming from Project Connect benefits, partially offset by difficult fourth quarter comparisons given last year's record performance. We expect operating margin to be between 13% and 13.2% compared to 2018 non-GAAP operating margin of 12.9%. Diluted earnings per share is expected to be between 470 to 480, up 17 to 20% from 2018 non-GAAP results. For the fourth quarter, it's important to remember we are lapping last year's record results that benefited from an extremely favorable retail environment as well as ideal winter weather. Additionally, fall 2019 shipments were more heavily weighted to the third quarter of this year compared to fall 2018 shipments. Including these factors, we anticipate low to mid single digit percent net sales growth and diluted earnings per share growth, excuse me, earnings per share of $1.55 to $1.65, which compares to 2018 non-GAAP fourth quarter diluted earnings per share of $1.68. Regarding our current planning efforts for 2020, based on advanced wholesale and distributor orders for spring 2020 season and plans for continued growth in our global direct-to-consumer business, we currently believe we can achieve mid-to-high single-digit percent net sales growth in the first half of 2020. We will provide our full-year 2020 net sales growth outlook when we report fourth quarter results next February and have better visibility to fall 2019 performance as well as fall 2020 advance orders. In 2020, we believe we'll be able to sustain meaningful gross margin benefits related to Project Connect that were achieved in 2019. Based on our visibility to spring and fall 2020 product costs, higher tariffs, and anticipated product mix, We expect gross margin to be relatively stable compared to 2019. Beginning in 2018, we initiated significant investments in the business to support our strategic priorities. These investments increased in 2019 and will continue into 2020. Based on the full year impact of initiative spending that commenced in 2019, as well as planned investments in 2020 to support our strategic plan, We expect modest SG&A deleverage as a percent of net sales. We will provide our full year 2020 financial outlook when we announce fourth quarter results in February. In summary, our record year-to-date performance is evidence that our brand-led, consumer-focused strategy is working. Our profitable growth trajectory and fortress balance sheet provide a foundation of strength and confidence from which we will continue investing in our strategic priorities to drive global brand awareness and sales growth through increased focused demand creation investments, enhance consumer experience and digital capabilities in all of our channels and geographies, expand and improve global direct to consumer operations with supporting processes and systems, and invest in our people and optimize our organization across our portfolio of brands. You can find more detail on our third quarter results in 2019 Financial Outlook in Jim's CFO commentary available on our website. That concludes my prepared remarks. We welcome your questions for the remainder of the hour. Operator, could you help us with that?