Columbia Sportswear Company (COLM) Q1 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the Columbia Sportswear First Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ron Parham, who is the Senior Director of Investor Relations and Corporate Communications for Columbia Sportswear. Thank you. Mr. Parham, you may begin.

All right, thanks Bob. Good afternoon, and thanks for joining us today. Earlier this afternoon, we announced first quarter financial results and our revised outlook for 2013. In keeping with our standard practice, we also furnished an 8-K containing a detailed CFO commentary on the results and posted that commentary on our Investor Relations website for listeners to review prior to this conference call. With me today are President and CEO, Tim Boyle; Senior Vice President and Chief Financial Officer, Tom Cusick; Executive Vice President and Chief Operating Officer, Bryan Timm; and Senior Vice President and General Counsel, Peter Bragdon. I'll ask our Chairman, Gert Boyle, to cover the Safe Harbor language.

Good afternoon. This conference call will contain forward-looking statement 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, 2012, and subsequent filing with the SEC. Forward-looking statement 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 better-than-expected first quarter results, including a 5% decrease in net sales, operating margin expansion of 210 basis points and 159% increase in net income to $10.1 million from $3.9 million in last year's first quarter may appear, on the surface, contradictory to the slight downward revision to our full year outlook we announced today. In fact, these results are consistent in illustrating the weather-driven volatility of our current businesses. While the recent cold weather clearly benefited our first quarter results, our full year outlook reflects the caution exhibited by our North American wholesale partners as they place fall 2013 advanced orders, following 2 consecutively warm fourth quarters. We expect the wholesale portion of our North American and European direct business to contract in 2013, partially offset by continued growth in our North American direct-to-consumer business and our EMEA direct -- excuse me, EMEA distributor business, led by Russia. We expect declines in the Latin America, Asia Pacific region following 2 years of rapid growth, driven by a decline in Japan resulting primarily from a significantly weaker yen, the effects of transitioning to a joint venture in China and the transition to a new distributor in Australia. From a brand perspective, we expect full year 2013 Columbia and Mountain Hardware sales to be comparable to 2012 while Sorel, our most weather-sensitive brand, is expected to decline modestly. We're proud of the brand positions we have established and have every intention of utilizing those brands to remain a global leader in cold weather apparel, footwear and accessories. However, at the same time, our vision is to become better recognized as a provider of market-leading products that help consumers manage all of the climactic elements they encounter whenever and wherever they go outside any time of the year. We made an important step towards that vision earlier this month at the April 5 global launch of Omni-Freeze ZERO and Cool.Q ZERO, our innovative sweat-activated cooling technology deployed in the Columbia and Mountain Hardware brands and supported by the largest spring marketing campaign in our history. We're encouraged by the responses we're seeing from consumers who have experienced Omni-Freeze ZERO, particularly in the Southern U.S. where our Omni-Freeze tour trucks have provided live demonstrations of its cooling properties. And additionally, thousand of our retail partners around the world have been supplied with a total of nearly 2 million Omni-Freeze ZERO demonstrations sleeves, allowing dealers to perform the same demonstration at the point of sale. We've seen the best early selling -- excuse me, early sell-throughs in specialty outdoor channels that cater to our loyalty PFG, which is Performance Fishing Gear consumers, especially in golf markets where the weather has been warm. Although it's still very early, we expect demand for Omni-Freeze and Cool.Q ZERO to increase as summer spreads to more parts of the Northern Hemisphere. Over the next several years, our goal is to establish ZERO as a new franchise to add to our existing portfolio of franchise collections like Omni-Heat, PFG and OutDry. We'll continue to focus our seasonal marketing efforts around these differentiating, innovative technologies. During our fourth quarter conference call in February, I spoke about the renewed efforts to drive demand for our innovations by designing our products at more accessible price points where the Columbia brand excels while maintaining distribution discipline and channel segmentation. While we don't expect to see significant benefits until spring '14 and further in fall '14, we are encouraged by the steady progress we're making on this initiative. We've also remain focused on improving our inventory planning and purchasing processes in order to reduce the level of promotional activity necessary to liquidate end-of-season goods. We're forecasting inventory levels to remain below last year's level throughout 2013 as evidenced by the 11% decline at the end of the first quarter. In Europe, we have taken several steps during the first quarter to address our persistent underperformance in Europe direct markets. First, we move Doug Morse, longtime Columbia employee and most recently General Manager of our Canadian region to serve as Interim General Manager of our Europe direct operations. We also took the difficult but necessary step of downsizing the European staff, and we recently closed our branded retail store in Munich, Germany. These actions were the primary components of the $2.4 million restructuring charge we recorded in the first quarter and an additional $1.7 million that we will recognize in the second quarter. While some of our underperformance in Europe is a function of the difficult macroeconomic environment, there are many areas within our control that we are determined to improve. I'm confident in Doug's ability to work closely with me and the rest of the European leadership team to continue making those improvements and to continue evaluating the cost structure of the business while we strive to improve our results. I'll conclude my prepared remarks with a few comments about our plans to transition to a 60-40 joint venture in China with Swire Resources beginning January 1, 2014. When we announced these plans in August 2012, we noted that Swire has done a spectacular job establishing Columbia as a leading outdoor brand during the 10 years that they've been our exclusive distributor in China. Since then, they've concluded another successful year growing sales at a rate of more than 20% to more than $150 million in 2012 and generating double-digit EBITDA. We're looking forward to partnering with the Swire team and adding this new growth engine to our business beginning in 2014. As we've begun transitioning to the joint venture, we have started to defer income and incur certain costs. The CFO commentary that we published before today's call contains an explanation of how we expect preoperating costs and the deferral of income to affect our 2013 financial results. If you have not already done so, I strongly encourage you to read the entire commentary, paying special attention to China joint venture section beginning on Page 4. You'll find the commentary on our Investor Relations website at columbia.com/investor. That concludes my prepared remarks. Operator, could you please help us with Q&A?

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

I guess the first question is, I'm not sure if I saw it, but can you give us an idea how much of the -- there was this shift from Q2 into Q1 and on the revenue side?

Tom?

In terms of the distributor shift, Bob, it was in the mid- to high single-digit millions of dollars from Q4 to Q1.

Got it, okay. And overall, when you look -- Tim, when you look at your -- the outlook from where it was 3 months ago to where we are today, did you receive more cancellations from the time that you gave us the last update? And can you just talk a little bit about the overall outerwear market and sort of where you see the market number shaking out this year in terms of like the declines, market positioning for Columbia right now?

Sure. Well, we have not received cancellations from our -- in any amount -- any subsequent amount in the last, call it, 4 months. We've seen -- we're talking about for fall '13 now, right?

Yes.

The outlook that we gave you today really predicated on the conservative future view our customers have as it relates to weather. I think there's no question that our customers, for the most part, are suggesting that they are going to be declining their outerwear open-to-buys and weather-sensitive product open-to-buys by 10% to 15% for fall '13 with the expectation that they'll be able to chase the business if the weather arrives. So that's what we're looking at from a North America standpoint. In terms of market share, I think even though our bookings would show that we have a higher percentage of more moderate temperature apparel, meaning outerwear that's designed for more moderate temperatures rather than extreme temperatures, the percentage there has declined in the extreme weather-sensitive apparel, but it's never been more than about 20% historically. So it's declined from that percentage. As it relates to market share, I think we've been close to holding market share, but it is possible that we've lost some to other makers of lighter weight apparel. Does that answer your question, Bob?

And Bob, this is Tom. Just one correction. I think I said mid-single digit. I meant mid-teen millions of dollars shift from Q4 to Q1.

Okay. And Tim, could you talk a little bit about -- I mean, a lot of the changes going on at J.C. Penney and any discussions that you've had with J.C. Penney and the Columbia brand? And any different outlook from that perspective from Columbia business?

Well, we try to avoid any specific conversations that we have about particular customers. But I can tell you, in general, our expectations are that our business with that customer will be more challenging for the foreseeable future.

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

This is Darla Shay on for Christian. You've talked about a strong early reception to the Omni-Freeze ZERO. I'm just wondering how many doors is it now, and how should we think about the product rollout going forward?

Look, Darla, I don't have for you the number of doors globally. But it would be -- it should be approaching 10,000 in that range or maybe even slightly larger. The rollout has been as planned. We have activations planned in many of the doors, all the important ones really where we actually have consumers experiencing through these Omni-Freeze ZERO sleeves the cooling effects of the product and it's demonstrated by a human being. So we've got the most intelligence about the U.S.A. market where we have started earlier than the rest of the world on the demonstration and the rollout. And we've seen successes in the Gulf states, primarily where our PFG or Performance Fishing Gear penetration is the highest. The expectations are quite high and we have plans for a broader, more democratically priced version of this innovation for spring '14. So we're excited about the potential.

All right, great. That's helpful. And then I understand sort of the revenue side of your guidance coming down slightly. But then new guidance assumes a flat gross margin from your preliminary outlook for slightly up. Could you just walk us through the changes in that assumption and maybe through -- is it product costs or potentially markdowns?

No, it's really a function of the full price wholesale business coming down slightly relative to the prior guidance, predominantly related to the North American and European wholesale business. And to some degree, further weakening in the Japanese yen. I would say that, in and of itself, is really the biggest driver of the year-over-year change in the guidance, is the further weakening of the yen.

Our next question comes from the line of Lizabeth Dunn with Macquarie.

I guess the first question is just to follow up to an earlier question. So there's no shift per se impacting the second quarter. And then as we look out to the third and fourth quarter, it seems like fourth quarter might be a little bit lower because of the loss of China or how the China revenues are flowing, is that the right way to think about it? Or could you just help us with quarterly flow of revenue?

Yes. As it relates to Q4, you're correct with regard to that China deferral negatively impacting the top line there. And then there is a shift between Q2 and Q3 with more of our EMEA distributor business shifting from the second to the third quarter. So I would say that's the biggest driver in the decline in year-over-year Q2 revenue.

Okay. And how much is that? What ...

I would say that's in the low $20 million range.

Okay, great. In terms of the business, the health of the footwear business. Can you just sort of provide an update on how you're feeling? I mean, obviously weather has been a major impact, but how are you feeling about where the business is positioned, putting weather aside?

Well, Lizabeth, based on my high expectations for this category of merchandise which are quite high, we think we're moving along the right path as it relates to merchandise, which is less weather sensitive. However, the combination of the Sorel business which is almost exclusively weather dependent and the heavy dependence and success in the Columbia brand on winter footwear, it's depressing those otherwise improving results. So I think we're on the right track and we've got the right team there. And the expectations for me are high, but we're not able to circumvent this weather issue.

All right. And then just one more, if I may. In terms of the expense control, you sort of touched on it in your prepared comments, but can you just give us a more robust explanation of sort of where things stand? How much more expense reduction is there to be had, if any? And sort of what are some areas for future opportunity, if any?

Yes, Liz, this is Tom. I would say SG&A is an area that with all forms discretionary spend we've managed diligently on an ongoing basis. There's always room for improvement there. We feel like we've done a pretty good job over the last year, particularly last year. And we felt it was important this year to reinstate our compensation and benefit programs after not having increases last year. And I would say the biggest driver of what's driving the expense growth excluding that preoperating costs for China and the restructuring charges are the increase in the direct-to-consumer business. So that's the biggest component of the increase.

But the increase is relatively minimal. So are there other things that are down year-over-year, I would imagine?

Well, obviously, we're getting some benefit from translation of currency, so I would say that's the biggest offset in addition to the cost reductions that we've put in place last year that we realized and you could see in the year-over-year comps in Q1.

Liz, just one further comment. I think we've all realized that the business is operating and frankly not performing as well as it needs to on the top line. So we focus -- now that we've concluded this -- the SG&A reductions that we felt were appropriate, the focus for the management team here has been on growing the business from the top line. We don't have much to show for it now, but that's where we're focusing our time and effort. And at the end of the day, that's going to reflect much better on the business than further cost-cutting.

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

I just -- just to kind of go back to Bob's original question. When we look at the delta in your revenue guidance now versus last quarter, you had always been expecting a cautious order pattern from your wholesale partners, and kind of the text in the CFO comments really didn't change much. So if you could rank order what the big drivers of your slightly lower view on revenues versus when you initially gave guidance between U.S. wholesaler patterns. You mentioned Europe and LAAP as drivers in his text and you hadn't last time around and I guess maybe currency. What's the biggest delta versus what you had thought last quarter?

Yes, I would say number one would be Europe. Number two, we're in the midst of transitioning our Australian distributor business that wasn't fully contemplated 90 days ago. And then also, as well, is the further weakening of the yen. So those are really the main drivers.

Okay. And as you think about really your wholesale partners being cautious, that really hasn't changed versus where we were a quarter ago?

No.

I mean, are they incrementally more cautious or they're still as cautious as you thought?

I think we expected caution from them and we got it.

Okay. And then on the European business, can you -- do you have sort of a preliminary plan on the past recovery in that market? I know you talked about some other restructuring initiatives. But how do we see ultimate improvement off of the depressed revenue and margin levels we're at?

Well, I would say at a very high level, we need to get the merchandise -- we need to get an improved offering of merchandise there that could be more relevant to that marketplace. And that's the primary goal. We continue to monitor the situation as it relates to our investment there, both from fixed assets and variable asset -- variable costs. And our expectation is that we'll be able to put together a compelling product offering, which will get us back to growth again. Again, our focus has been on getting the business to the size we believe it's appropriate from a cost standpoint and then focus heavily on improving the top line. And so that'll be a combination of the product offering modifications, which are well underway and people improvements. As we said, we sent one of our best managers, a longtime employee, there to help us get that business turned around and our expectations that we'll be able to do that.

Okay. And then lastly, can you give us if we were to pull spot rates forward, what or whatever is embedded in your guidance what the FX drag is on revenue and profit?

In terms of rates or the overall impact? So the year-over-year impact of currency is about $0.12 of which $0.08 would be the back half, $0.04 would be the front half.

Okay. And then in terms of -- on revenue, the rate of the percentage...

It's about 1.5%, call it, $25 million.

[Operator Instructions] Our next question comes from the line of Kate McShane with Citigroup.

I just had 2 questions with regards to the winter business and the warmer -- the cold-weather apparel business. I think, Tim, if I heard you correctly, you had highlighted that maybe you had lost some share, maybe lost some share. Is that because you don't -- you didn't have as much lighter weight outerwear product? And if that's the case, how are you addressing that for this upcoming winter?

No, I think we had the right -- the appropriate amount of light weight product. The fleece business, which for all intents and purposes is light weight outerwear, is probably the company's largest category from a unit standpoint by far and away. I think what we saw was just a reduction in purchases of heavyweight apparel where the company's had, call it, 20% of its business historically. And I think market shares in this business is so hard to calculate just based on the data that's available. It could be that we had some market share loss. But at the end of the day, we think we had the appropriate merchandise offering where customers pick the appropriate kinds of inventory from our collections. But they just picked a lot less of it because their open-to-buys for these weather-sensitive categories, including cold-weather apparel and the specialty cold-weather boots, really depressed the results for us for this year in '13. Are we going to improve for '14? I think absolutely. But the weather impact is still significant.

Okay. And then one question on Europe. I know the focus of the turnaround is on your direct business, but can you update us at all about what you're thinking with your distributors in Europe? It sounds like they might be outperforming the direct business. And what do you think is the main difference is between the 2 businesses?

Well, our biggest business in Europe on a distributor basis is in Russia and our Russian distributor has a significant component of their own retail business, as well as a Columbia franchise business where they can direct the offering much more a focused way. And the Russian weather was, frankly, spectacular for our kinds of business last year. So those 2 things really in combination made the business better in Russia than we otherwise would have had.

So will there be any change to the product offering that the distributors are selling currently like you will do in the direct business?

No, what we -- the process is we prepare our global line. We have an offering that's filtered by numerous merchants that work the lines here. And our Russian distributor is able to pick from that selection of product. But they've been much more focused on sort of the moderate price points as opposed to where we've been operating globally when we've been directing our salespeople at a higher level.

Our next question comes from the line of Corbin Weyer with Robert W. Baird. Corbin N. Weyer - Robert W. Baird & Co. Incorporated, Research Division: Just a quick one here. Just wanted to dig a little bit more into the second quarter revenue guidance and seeing that you guys are talking about U.S. wholesale down. With that in mind, what's kind of Incorporated into that guidance in terms of an at-once order perspective? I mean, is there opportunity there? I guess, given the late start to spring that we've seen here, I'd imagine that there's probably some pent-up demand out there for some product.

Yes, we've had -- as we talked about the weather sort of greatly this quarter, it's been colder. It's been helping our winter product business, not necessarily from an expanded margin standpoint for our retailers, but they've certainly been able to liquidate more inventory there. We think that we're in the right positions as it relates to our spring product for the balance of the year. And our customers, typically, for us, spring is like a net 0 reorder business. So the expectation for us, regardless of this particular spring's temperatures is for the U.S. business to provide just about a 0 reorder basis.

Yes, the biggest crater of volatility in Q2 is the timing of our distributor shipments that really straddle Q2 and Q3, so they can shift into either quarters in a given year and that's what's really driving a downward comp in year-over-year Q2 sales this year. And again, that's that EMEA distributor shift in the low $20 million range that I alluded to earlier.

[Operator Instructions] Our next question comes from the line of Andrew Burns with D.A. Davidson. Andrew Burns - D.A. Davidson & Co., Research Division: I wanted to follow up on a comment, which I think I heard earlier about retailers wanting to take prebook down. I think there was a 10% to 15% number. I think that was maybe an industry or something like that, but wanting to chase business if the cold weather arrives. I'm sure your average outdoor retailer would love outerwear to be more of an at-once business. Obviously, that's tough to do from your standpoint. So given the 2 consecutive winters, is the business changing at all more towards at-once? Is there any potential competitive advantage to take a little bit of inventory risk to try to catch your sales upside in this cold weather years?

Certainly. Well, Andrew, I've been around this business for a long time. I hate to even think about how long, but -- with these kinds of weather abnormalities, I remember back when the dinosaurs were still here. But these kinds of weather abnormalities, if they happen a couple of years in a row tend to become backed in retailers' minds. So it's not unusual for them to take sort of a broad view of categories and merchandise and reduce the open-to-buys for those. So that's what we've seen, is that the retailers have basically said, okay, we're not going to invest this heavily in cold-weather footwear and in outerwear as we have in the past and we'll chase that. Because the outerwear and cold-weather footwear businesses require long lead times from our Asian sourcing, we have to take a position and that's what we've got. So we've reflected on where we believe the business will go this year and what the open-to-buys will be for the balance of this year and we've taken what we think is the appropriate position on inventories. Yes, retailers would love to have an at-once business as it relates to outerwear, but it's just one those kinds of categories that's -- it's not available. So if we have a spectacular weather year for the company, which would be cold weather early, we won't have a significant increase in the top line, but we will have an improvement in our gross margins. So that's how we have run the business historically and that's how we might expect this year will play out depending on the weather. Andrew Burns - D.A. Davidson & Co., Research Division: Great. And during the call, you mentioned some shifting of management around and focus on some improvements there. Are there any plans to increase hiring of additional senior executives? Perhaps I've missed it, but since Mick's departure, there was talk of maybe a couple of new positions being created and I just didn't see that occur. Just looking for an update there.

Certainly. Well, yes, as we said, when Mick departed, we weren't going to replace his position directly. So we're going to be adding people over time to help us improve the business and we're taking some time to make sure that we have the right candidates identified, and there'll be more news on that happening as we make additions.

[Operator Instructions] Our next question comes from the line of Mark Duvall [ph] with the Lemon [ph] Company.

Wondering if you could talk about your longer-term capital allocations decisions. You have a strong balance sheet, you're generating cash. I'm just curious how open you are to share repurchase or maybe bumping up the dividend yield over time?

Yes, Mark, this is Tom. March 31 is typically -- the March-April time frame is typically the peak of our annual operating cash as we collect our wholesale receivables from the winter months. So we would expect cash to decline seasonally like it has historically from March forward. With that being said, we intend to generate roughly $85 million in free cash flow this year and we'll begin to fund our China JV beginning this quarter through the first quarter of next year with that funding comprising about $50 million and most of that will come from cash domiciled offshore. With that being said, at any given time, 30% or 40% of our cash is held offshore. So if we were to repatriate that, it would cost us significantly from a tax perspective. We've got the buyback. We've got $58 million available under that. We've got the dividend program. And we've got M&A opportunity.

Our next question comes from the line of Robbie Ohmes with Bank of America.

Could you remind us, once you get -- once you take over the China JV, just what the multiyear ramp-up could look like in 2014 and beyond? How many full-line stores could you be doing? Are you going to be doing a lot of outlet stores in China? If you could just walk us through what sort of the 3-year plan, 2014 through 2016, looks like?

Yes, we -- Robbie, we really haven't talked at all about '14. We've walked through what the plan is as it relates to '13 for China. And the expectation is that we will continue to grow on the same cadence. It won't change the nature of the operations there. In other words, we don't have very many outlet stores. It's almost all full-priced stores. And so the expectations are for continued expansion of that market even though there's some slowing. But maybe I might just ask Tom to...

Yes, Robbie, that business did just over $150 million last year. It grew over 20%, generated double -- low double-digit EBITDA margin. We expect healthy growth in 2013. It's about 75% wholesale, 25% retail. Currently, we don't anticipate that changing dramatically. There are roughly 80 company-owned stores and several hundred -- 500-plus dealer-operated rooftops in that marketplace today.

There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.

Well, we thank you all for listening in. And we appreciate your attention. We'll be back to you in about 3 months. Thank you.

This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.