Columbia Sportswear Co

NASDAQ:COLM

Earnings Call Transcript 2018-Q2

[Operator]

Greetings and welcome to Columbia Sportswear Company's Second Quarter Fiscal 2018 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. It is now my pleasure to introduce your host, Andrew Burns, Director of Investor Relations. Please go ahead, sir.

[Andrew S. Burns, Columbia Sportswear Co.]

Good afternoon and thanks for joining us to discuss Columbia Sportswear Company's second quarter results and updated 2018 outlook. In addition to the earnings release, we furnished an 8-K containing a detailed CFO commentary explaining our results and the assumptions behind our full year 2018 outlook. The CFO commentary is also available on our Investor Relations website, investor.columbia.com. With me today on the call are Chairman of the Board, Gert Boyle; 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. Gert will start us off by covering the safe harbor reminder.

[Gertrude Boyle, Columbia Sportswear Co.]

Good afternoon. This conference call will contain forward-looking statements regarding Columbia Sportswear's business opportunities and anticipated results of operations. Please bear in mind that the 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 expectation and beliefs. 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 change in our expectations (02:27).

[Andrew S. Burns, Columbia Sportswear Co.]

Thanks, Gert. I'd also like to point out that during the call, we may reference certain non-GAAP financial measures including non-GAAP results which exclude the effects of new accounting requirements associated with ASC 606, program expenses and discrete costs associated with Project CONNECT and income tax charges associated with the Tax Cuts and Jobs Act as well as constant currency net sales growth. You'll find a reconciliation of these non-GAAP financial measures to comparable measures reported under U.S. GAAP in the supplemental and financial tables that accompany our earnings release along with an explanation of management's rationale for referencing these non-GAAP financial measures.

Following our prepared remarks, we will host a Q&A period during which we will limit each caller to two questions so that we can get to everyone by the end of the hour. Now, I will turn the call over to Tim.

[Timothy P. Boyle, Columbia Sportswear Co.]

Thanks, Andrew. Welcome, everyone, and thanks for joining us this afternoon. We're delighted to report better than expected second quarter results with revenue, gross margin and earnings per share all at record levels. With strong first half results and momentum in our business, we are raising our full year outlook as well.

Non-GAAP net sales increased 17% on a constant currency basis for the quarter adjusting for the favorable impact of new revenue accounting standards. Non-GAAP net income increased to $11.3 million or $0.16 per diluted share compared to an earnings loss of $0.13 per share in the comparable quarter last year. This represents the first quarterly profit in the second quarter, our lowest volume quarter, since 2007.

First half non-GAAP net sales increased 11% on a constant currency basis with the first half revenue eclipsing $1 billion for the first time in our company's history. Non-GAAP earnings per share of $0.93 was up 133% compared to the first half of 2017.

Because the second quarter is our lowest volume quarter, I'm going to focus my remarks largely on our first half non-GAAP results as they more accurately reflect underlying business trends. Regionally, the United States business grew 13% in the first half, benefiting from continued strong DTC performance as well as improved performance of our wholesale business which was up high single digits percent. In our DTC business, both the brick-and-mortar and e-comm businesses exceeded our expectations in the first half with improved brick-and-mortar store productivity and low 20% growth in our e-commerce sales.

International markets grew 9% on a constant currency basis in the first half after adjusting for new revenue accounting standards. This growth was driven by our Europe-direct international distributor, Japan and China businesses partially offset by Korea which was down mid-single digits on a constant currency basis.

Europe-direct was up low teens percent on a constant currency basis in the first half led by strong wholesale performance continuing the trend of healthy growth we've seen in recent years. Our first half international distributor business benefited from early shipments of fall 2018 product falling into Q2 as well as growth in our fall order book.

We're particularly pleased with the growth we're seeing with our Russian-based distributor. And Japan remains a steady growth engine for the company and is on track to add to its long record of consecutive years of local currency growth which spans two decades.

China was up mid-single digit on a constant currency basis in the first half. As we discussed in our Q1 conference call, we remain on track to conclude the purchase of the remaining 40% interest of our China joint venture in early 2019. The China market represents one of Columbia's largest regional growth opportunities. And as such, we remain committed to investing in that business to ensure long-term success.

We intend to maintain the existing team and organizational structure following the buyout. Please note that the current general manager of Columbia Sportswear China, Jason Zhu, has decided to depart in September. A search for his replacement is underway. And Doug Morse, Senior Vice President of Emerging Brands and APAC, will assume direct management responsibility for the China region until Jason's replacement has been hired.

Turning to our margin performance. First half consolidated non-GAAP gross margin was up 110 basis points to 47.7% as a result of our clean inventory positions, driving full price sales mix and foreign currency hedge rates. With the recent escalation of trade battles between the United States and other countries creating concerns among investors, I wanted to provide some background about how that's going to affect our business particularly with respect to China.

First, in 2017, 38% of our sales occurred outside the U.S. and are not directly impacted by U.S.-China trade barriers. We rely on a diversified sourcing base mostly across Asia and have considered our diverse and flexible supply chain to be one of our strengths. In 2017, China represented less than 20% of our total imported value into the United States. To date, newly announced tariffs in the U.S. have not targeted our primary product categories. In addition, because a high percentage of our fall 2018 products will have been shipped in the coming weeks; if tariffs are raised on our primary categories, the impact would likely be felt mostly in future years.

We do face cost increases related to some accessories. And we are anticipating immaterial cost increases for some construction and fixturing as a result of steel and aluminum tariffs. That said, the escalating global trade battles have the potential to be very disruptive to our business as well as our vendors, our customers and to many of the countries where we do business including the United States.

Apparel and footwear products already carry some of the nation's highest tariffs averaging in the double digits. To add to those high tariffs with additional punitive measures would not only have a detrimental impact on our business, it would represent a significant tax on American consumers.

China continues to be an important market for us both for manufacturing and sales. We have a long history of sourcing in China and remain committed to maintaining these important partnerships as the local manufacturing base is critical to our success. We also have several hundred employees in our China joint venture focused on helping Chinese consumers to stay outdoors longer with our market-leading products. We will continue to monitor trade debates closely and engage with policymakers to seek constructive solutions.

On the SG&A front, we remain focused on driving sustainable profitable growth through investment in our strategic initiatives while maintaining cost discipline. In the first half, excluding the Project CONNECT program and discrete costs, we improved our non-GAAP SG&A rate by 260 basis points helping drive non-GAAP operating margin up to 7.6% from 3.8% in the first half of 2017.

The majority of Project CONNECT initiatives are being implemented throughout the business and are a part of our sustained go-forward operational strategy. And we are realizing some of the financial benefits for Project CONNECT this year and continue to expect a more meaningful financial value capture in 2019 and beyond. We remain confident that the expected financial results from Project CONNECT will enable continued incremental investment while delivering consolidated profit improvement.

As we move into the second half of 2018, our SG&A growth rate will increase, reflecting higher demand creation expenses, continued investment in our DTC business, capability development and informational technology spending to support our strategic initiatives. These investments are factored into our guidance and are expected to result in a contraction in operating margin in the second half. Our full-year revised guidance calls for up to 40 basis points in non-GAAP operating margin expansion.

I will now review our performance by brand on a reported basis. Looking at the Columbia brand globally, our brand-led consumer-centric approach generated 14% constant currency growth in the first half. This growth was achieved via strong DTC performance, including our brick-and-mortar stores and e-commerce businesses as well as improved wholesale performance.

From a category perspective, our spring 2018 product line experienced healthy sell-through across apparel and footwear. PFG footwear was a particular standout for the spring 2018 season, with sales more than doubling, in part driven by the Houston marketing campaign which I will discuss in more detail in a moment. Columbia's innovative product were recognized by several industry publications, including Outside magazine's coveted Summer Buyer's Guide, which featured the Columbia Montrail Rogue F.K.T. II which was called out as the most lightweight and technical of all the trail shoes that Outside tested. The exceptionally versatile Columbia Blue Magic trunks were also featured.

Our newest cooling technology, Omni-Shade's sun deflector won Elevation Outdoors' Summer 2018 Peak Gear Award and was highlighted in Field & Stream magazine's Best New Fishing Apparel for 2019. Sun deflector has performed well in its initial season at retail and will be incorporated into more styles and categories for spring 2019.

For fall 2018, we're launching our latest innovation of the popular Omni-Heat platform, Omni-Heat 3D, which combines improved heat retention, durable warmth and next-to-skin comfort to create our most advanced Omni-Heat product to-date. This exciting launch will be supported globally with several unique marketing stories throughout the upcoming winter season.

We're also launching our third Star Wars collaboration in our global DTC channel in December. This collection is particularly relevant to the Columbia brand, given that it's true performance outerwear. Our first two Star Wars collections performed extremely well, with last season's product selling out within minutes online.

As part of our commitment to demand creation, we remain focused on increasing our engagement with consumers with an always-on digital-first marketing strategy. This year, that commitment includes: 2018 new artist of the year, Columbia PFG loyalist and country music star, Luke Combs; and 2018 Grammy nominee, Kesha; as well as organic partnerships with She Explores and other outdoor influencers, all amplified on social media and other digital channels. We're also engaging with influence around the world, such as (14:40) with the UK national parks.

Most recently, our Best Bad Idea marketing campaign, which launched in June, features former Director of Toughness, Lauren Steele, and friend, Paddy O'Connell, testing our cooling technologies in extreme summer heat, hiking 80 miles of Utah's infamous White Rim Trail. That campaign has already garnered nearly 2.4 million video views and 23 million impressions.

On our last call, we highlighted our marketing and sales intensification efforts for PFG footwear in the Houston market. This successful initiative generated over 150 million impressions and fueled a surge in Columbia brand sales across Texas and the Southeast. PFG footwear sell-through for participating sporting goods retailers exceeded expectations, more than doubling compared to last seasons. Including all styles, Columbia footwear sales were up over 70% year-over-year in Houston. We're pleased with these results and we'll execute a similar marketing initiative in the Greater Chicago market later this year as temperatures drop.

SOREL had a very strong first half with revenue growing 23% constant currency, driven by healthy sell-through of spring, summer styles such as the Joanie and Ella collections as well as strong demand for winter product earlier in the year. The new Kinetic line of casual sneakers embodied SOREL's brand positioning as a function-first fashion footwear brand and quickly sold out at retail. We'll look to build on this success with more Kinetic products in the seasons ahead. Overall, the spring 2018 growth validates the SOREL brand's ability to extend beyond the core winter business and become a year-round presence at retail.

At prAna, sales grew 9% in constant currency in the first half, largely driven by DTC e-commerce growth as well as U.S. wholesale. For spring 2018, the men's lifestyle category performed well and we continue to build out our swim and active lines in the women's business, both of which remain meaningful growth opportunities for the brand.

At Mountain Hardwear, we're encouraged by the brand's U.S. fall 2018 order book, which reflects a return to growth including new products such as StretchDown outerwear and Gore-Tex technical climbing outerwear and gloves. First half gross margin materially improved, reflecting a clean inventory position compared to elevated clearance activity in 2017. First half sales were down 10% on a constant currency basis, reflecting our decision to exit the Korean market. Under Joe Vernachio's leadership, the Mountain Hardwear team is well along in developing compelling products and marketing strategies to deliver sustainable growth in the future.

I'll now quickly review our balance sheet and cash flow. Our inventories are clean, with total inventory up 2% to $571 million or 4% excluding the impact of balance sheet reclassifications related to the new revenue accounting standard. Our balance sheet remains extremely strong, with cash balances of $775 million exiting the second quarter. We continue to have no long-term debt. During the first half of 2018, the company repurchased approximately 500,000 shares of common stock for $40 million and paid $31 million in dividends. We have approximately $98 million remaining under the current stock repurchase authorization.

In summary, we're pleased with our solid first half performance and how we've positioned our brands and regions for sustained growth in 2018 and beyond. It's from this position of strength and confidence that we are investing in our strategic priorities. In June, we went live with the global ERP in our Europe-direct business and are currently optimizing processes ahead of the important fall and holiday season. This substantially completes our global ERP rollout which has been a fundamental component in the improved operating performance we see today. I'd like to congratulate and thank our global teams for the hard work and dedication over the last several years to make this project a success.

Our Consumer-First or C1 strategic initiative will enable us to deliver a more personalized, seamless experience for consumers across our global retail operations and includes a new retail ERP platform, CRM, loyalty, order management and point of sales systems. We have completed the design phase and moved into the build phase and continue to expect to begin implementation in the first half of 2019 with our North American business.

Our newest initiative, Experience First or X1, will create a mobile-first architecture designed to enhance the mobile consumer experience. This encompasses an upgrade of our e-commerce platforms to offer best-in-class search, browsing, checkout, loyalty and customer care experiences for global shoppers. We are currently in the design phase and expect to begin implementation in the first half of 2019 in the North American business.

Finally, I want to provide a little more color about our updated expectations for 2018. Our 2018 non-GAAP outlook now anticipates 7.5% to 9% revenue growth, up from our prior guidance for 6.5% to 8.5%. We now expect up to 40 basis points of operating margin expansion to approximately 11.7% of sales on a non-GAAP basis. Together, we now expect 14% to 17% non-GAAP net income growth. In summary, we believe that a combination of our global multi-brand multichannel business, our sound strategic plan and our team that's around the world form a solid foundation that will continue to drive growth, expand our profitability and increase our total return to shareholders in the years ahead.

To accelerate our performance, we will continue to invest in our four strategic priorities which are 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 Q2 results and our 2018 financial outlook in Jim's CFO commentary available on our website. That concludes my prepared remarks. We welcome your questions. Operator, could you help us with that?

[Operator]

Certainly, we'll now be conducting a question-and-answer session. Our first question today is coming from Bob Drbul from Guggenheim Securities. Your line is now live.

[Robert Drbul, Guggenheim Securities LLC]

Good afternoon.

[Timothy P. Boyle, Columbia Sportswear Co.]

Hey, Bob.

[Robert Drbul, Guggenheim Securities LLC]

Tim, I guess the first question that I have for you is when you look at your – sort of the top line results but I think equally impressive is the gross margin results. When you look at the full price sales, are you attributing a lot of this – is it all the product improvement that you've made? Can you just give us some insight in terms of – I know it's a small second quarter. But if you look at it from outside and you look at the record gross margins and a very strong top line, is that what's driving it here? And I guess when you look at the next several seasons, right – fall is already locked and loaded. But like when you look at spring of next year and you guys have some pretty long lead times, how do you feel about sort of what's driving the business right now and how sustainable are these type of results?

[Timothy P. Boyle, Columbia Sportswear Co.]

Well, listen, we're thrilled with the results obviously. And there's a number of factors at play here, including our ability to manage the inventory levels properly so we don't have a bunch of markdowns. And additionally, the help from our direct-to-consumer business and our innovations which frankly give us pricing power in some of these categories where we haven't in the past had them. And lastly, maybe specifically in the U.S., just the power of our PFG business where we don't compete heavily with a lot of different brands in that particular kind of category. So there's a number of things at play here. But I think the opportunity for us to maintain these kinds of gross margin rates and possibly even expand are certainly in the foreseeable future.

[Jim A. Swanson, Columbia Sportswear Co.]

And, Bob, this is Jim. I'd add a couple of other points to that as well. I think operationally we've been disciplined. If you look at the CFO commentary, our excess inventory's down 8% at this point in time this year relative to last year. So as Tim commented, we're really clean on inventory. And then on a go-forward basis, if we look out to next year – you'll recall the Project CONNECT work that we've been doing. And certainly, our expectation would be that Project CONNECT delivers some solid gross margin pickup as we get into 2019 and beyond.

[Robert Drbul, Guggenheim Securities LLC]

Okay. And thanks, Jim. And I guess just, Tim, you sounded pretty optimistic on the Mountain Hardwear progress. Can you elaborate a little bit more on Mountain Hardwear?

[Timothy P. Boyle, Columbia Sportswear Co.]

Certainly, yeah. That brand is a very special brand. We've owned it for a long time. And we allowed, to our detriment, the product team to be suboptimal. So having Joe Vernachio there with a keen focus on product, that's going to build the base for us to allow us to really improve that business and really harvest the opportunity that we have. I think he's a spectacular merchant. We've got lots of opportunity ahead of us. And what we've seen so far in terms of his first blush at products for fall of 2018 are going to be quite well accepted and get us well along on our way.

[Robert Drbul, Guggenheim Securities LLC]

Great. And I know you said two questions, but can I sneak in a third?

[Timothy P. Boyle, Columbia Sportswear Co.]

Yeah, sure.

[Robert Drbul, Guggenheim Securities LLC]

So the cash balance is pretty high. And I guess when you look at the balance sheet and you look at what you're projecting for the year, can you just give us some updated thoughts on uses of cash at this point and sort of how you're thinking about that?

[Timothy P. Boyle, Columbia Sportswear Co.]

Well, yeah, as you know, we have the three primary cash usages which are dividends, share repurchase and, yeah, inventory levels to make the business right. And frankly, at this time, with what we're seeing happening in Washington, D.C., and the nuttiness around this trade activities; having a strong fortress balance sheet allows us really to, with confidence, invest in the future of the business where others who have more tenuous financing might not be able to do so.

[Robert Drbul, Guggenheim Securities LLC]

Okay, great. Thanks very much.

[Timothy P. Boyle, Columbia Sportswear Co.]

Thanks.

[Operator]

Thank you. Our next question is coming from Jonathan Komp from Robert W. Baird. Your line is now live.

[Jonathan R. Komp, Robert W. Baird & Co., Inc.]

Yeah, hi. Thank you. Just a broader question on the guidance. When I look at the first half performance, I know you previously had put out a range for operating income performance in the first half and you exceeded that by a pretty nice margin. And I think you're flowing through less to the full year in terms of the operating profit upside. So I wanted to maybe just understand that dynamic and what you're assuming there.

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah. Jon, well, I'll summarize. So I think if you look back – it's part of our April call that you're referring to – our non-GAAP operating income, we'd projected to be up $25 million to $30 million through the first half of the year. And obviously, we're incredibly pleased with performance in terms of what we achieved in the second quarter and exceeded that to the tune of, call it, I think $15 million, $16 million from operating income's standpoint. And when we break down that beat, a good chunk of that related to better top line performance. We certainly saw that with our U.S. business. Our U.S. wholesale business performed exceptionally well, saw strong replenishment. As Tim noted, our direct-to-consumer business both from a brick-and-mortar and from an e-commerce standpoint, both drove productivity as well. And so that benefit and growth that we've seen in the business, we've effectively tapped that long as a part of the full year take-up. What we haven't in there is there were some timing shifts that relates to our distributor business and a little bit less so in other parts of our wholesale business worldwide. And then we had some timing shifts on some discrete project-based costs out of the first half and the second half and that's effectively the delta. But really pleased on our performance on the first half and have passed those benefits along to the year.

[Jonathan R. Komp, Robert W. Baird & Co., Inc.]

Understood. And a bit of a follow-up to some of that. But I wanted to ask a broader question really most on the Columbia brand for the second half. I know the consolidated revenue, you pointed to mid-single digit growth in the second half. And just wanted to better understand the thinking there, especially I know at different seasons. But given some of the momentum you're seeing from a brand-wise perspective kind of what you're expecting to slow down in terms of the momentum and how the overlaps versus last year play into that?

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah. Let me answer it as this. So our back half – we planned the back half up a mid-single digit level. That's relatively in line with what we've seen in our fall 2018 order book. There are some timing shifts as I had indicated with regard to our distributor business in which we shift a higher proportion of our fall 2018 orders in the second quarter so that has a little bit of an impact. Certainly planning for nice growth still within our direct-to-consumer business. I think the other delta certainly that you're going to have when you look at first half relative to second half is foreign currency was a nice tailwind to the first half of the year contributing, I think, nearly 2.5 points of positive benefit to the top line. As we get into the back half of the year, that'll actually go slightly the other way. So I think when you kind of normalize for the effect of timing and what's going on off from a currency standpoint and you look at the guidance that we provided the second half of the year; on an adjusted basis, it'd come up more in line with our full year outlook.

[Jonathan R. Komp, Robert W. Baird & Co., Inc.]

Okay. And just as a follow-up, I know the e-commerce business in the U.S. has been very strong and up more than 20%. Is there anything unique in the last couple of quarters or could you see some of that continue?

[Timothy P. Boyle, Columbia Sportswear Co.]

Yeah. This is one of the areas where we've seen some of the first fruits of our Project CONNECT business and the taxonomy and other technical aspects of the business were impacted positively to give us the kinds of conversion rate improvement and business improvements. And we expect that those will increase over time. And certainly we expect to have those kinds of positive things happen in the second half.

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah. I'd also note the site traffic that we've seen has been quite positive and the conversion. We've been able to convert that traffic on the site and the performance we've seen both from a desktop and mobile perspective has been quite fruitful through the second quarter.

[Jonathan R. Komp, Robert W. Baird & Co., Inc.]

Great. Thanks for the color.

[Operator]

Thank you. Our next question is coming from Kate McShane from Citigroup. Your line is now live.

[Kate McShane, Citigroup Global Markets, Inc.]

Hi, good afternoon. Thanks for taking my question. Tim, you mentioned that you're getting pricing power thanks to your innovation. I just wondered, is ASP growth accelerating and contributing more to the sales growth and even a year ago? And how should we think about higher prices as we get to the second half for fall and winter?

[Timothy P. Boyle, Columbia Sportswear Co.]

Yeah. We've had some ability to increase prices although that hasn't been the primary – the bulk of our pricing power has been these new areas that we've invested in. The sun deflector category, which we're able to price at a premium, has been very helpful as well. The back half of the year I don't think is going to be as impacted from that area where we have more competition. In the springtime, we tend to have less competition on some of those more technical products.

[Kate McShane, Citigroup Global Markets, Inc.]

Okay, thank you. And then my second question is just your view, Tim. I'd appreciate hearing just how you're viewing the consumer going into the back half of the year as we start to lap what seem to be better numbers and better spend from the U.S. consumer. As we get to the back half of the year, how are you guys feeling about the state of the consumer?

[Timothy P. Boyle, Columbia Sportswear Co.]

Well, I think even though the traffic in total has been challenging for many businesses and I think we monitor a lot of our retailers' progress and traffic has been an ongoing issue, I think the consumer is generally spending more. Now whether or not that's a result of the tax cuts or whether the consumer's feeling more confident, I don't know. But we just have to be mindful of these tariff issues and whether or not they're going to be impactful on the second half more than we think.

Some of the additional tariffs on aluminum and steel will impact consumers, certainly ones that are involved in businesses manufacturing products out of either steel or aluminum. So I think in general the consumer is fairly confident. But the results of the whole year, we'll have to wait and see. This is again a reason to have a very, very strong balance sheet so we can weather these storms, should they arise.

[Kate McShane, Citigroup Global Markets, Inc.]

And this is a quick follow-up to that. For any products that do have aluminum or steel in it, are you seeing any kind of different ordering pattern from retailers? Are they trying to order products before the October deadline, any change there?

[Timothy P. Boyle, Columbia Sportswear Co.]

No, we don't manufacture products with either of those components. However, our consumers do, so that's what we're concerned about. And again, if you remember; for our business, orders for our products for fall have been in place almost since November of last year.

[Jim A. Swanson, Columbia Sportswear Co.]

I think, Kate, in Tim's prepared remarks, there was a comment in there. It pertained more to the fixturing that we've put into both our own stores and our wholesale account. So there would be some impact to that over time.

[Kate McShane, Citigroup Global Markets, Inc.]

Okay. Thank you.

[Operator]

Thank you. Our next question is coming from Jim Duffy from Stifel. Your line is now live.

[James Vincent Duffy, Stifel, Nicolaus & Co., Inc.]

Thanks. Good afternoon, everyone.

[Timothy P. Boyle, Columbia Sportswear Co.]

Hey, Jim.

[James Vincent Duffy, Stifel, Nicolaus & Co., Inc.]

I have a question on Project CONNECT. You guys alluded to meaningful financial benefits and clearly, digital's already seeing some benefits. As you guys progress further into this initiative, can you highlight some of the Project CONNECT-specific financial benefits maybe that you're most excited about and the timing of when you expect those to show in the model?

[Timothy P. Boyle, Columbia Sportswear Co.]

Certainly. Well, as we pointed out, the beginnings where we can immediately impact the business, are in our e-comm business. But we would expect SG&A savings from products that we manufacture. Those will be likely in the future. And then the whole focus on streamlining our product offering globally, which has been an area we've undertaken with some significant amount of activity and not without its challenges. But we're making meaningful progress to simplify the products that we offer. And so I would expect over time that the simplification is going to be impactful. And those are just some of the areas. Jim might be able to point out more.

[Jim A. Swanson, Columbia Sportswear Co.]

I think to maybe just touch on a couple of pieces there, Jim. And I'll point particularly to what's really driving our performance in 2018. Some of it relates to indirect procurement spend from an SG&A standpoint that Tim had touched on, just everything from packaging to travel-based costs to certain things that we're doing from a freight standpoint as well.

And then, I think as we get into the latter part of this year and in particular to our retail business, I think the combination of changes that we've made as we've done some A/B testing on our e-comm site and have seen meaningful returns from a conversion standpoint with consumers that's shopping there. And then even within our brick-and-mortar stores, as we've done some testing and began to implement some changes with regard to pricing markdown and optimization that's driving a combination of top-line and margin performance. And I think as we get into the back half of this year, hopefully we see a bit more of that benefit flow through.

[James Vincent Duffy, Stifel, Nicolaus & Co., Inc.]

Great. And then I have a follow-up question on the digital business. You're a number of years into your investments here and I recognize this is somewhat of an ongoing journey. But is there a way to characterize where you stand in this journey? Do you expect that you get to the point in coming years where you're seeing leverage on these investments and we get more flow-through on them? Or is there so much to do and is it progressing at such a rate that it's kind of a continued area of investment?

[Timothy P. Boyle, Columbia Sportswear Co.]

No, we're seeing returns now on these investments. So I would expect the investments will continue. I would like to think that at some point, there will be a punctuation. But we're very conservative in terms of how we approach these digital investments and really try to do it with some cadence where we can have a visibility of the returns quickly. And so far, we've been rewarded with those kinds of returns. But it does seem like a never-ending journey really.

[James Vincent Duffy, Stifel, Nicolaus & Co., Inc.]

Fair enough. Thanks for those thoughts.

[Timothy P. Boyle, Columbia Sportswear Co.]

Yeah. Thank you.

[Operator]

Thank you. Our next question today is coming from Camilo Lyon from Canaccord Genuity. Your line is now live.

[Pallav Saini, Canaccord Genuity, Inc.]

Thanks. This is Pallav Saini on for Camilo. Thanks for taking our questions. First of all, you noted improving performance in the wholesale channel in the U.S. Can you give us your thoughts on the channel inventory? Has there been any change in how the retailers are planning their business for the fall versus when you last spoke with us in April?

[Timothy P. Boyle, Columbia Sportswear Co.]

No. Again, the kinds of products that we're selling today at retail, whether it's in our own DTC business or wholesale, it would be spring-related merchandize, lightweight rainwear, shorts, lightweight tops, fishing apparel. And that's quite different from the products that our retailers will be selling, call it, from September beyond into the fall, which are heavyweight items, fleece items, so a different collection of products. The products that the retailers would be selling again in September and beyond through the back half of the year were purchased from us beginning in November of last year. So we haven't seen any change in their activities. And our expectation is that we're going to have a good second half.

[Pallav Saini, Canaccord Genuity, Inc.]

Thanks for that. And can you quantify the sales shift from Q3 to Q2? And excluding these shifts, which brands or channels drove the outperformance versus your plan in Q2?

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah. So as it relates to the shift from Q3 into Q2, that's predominantly our distributor-based business. It's a load – well, I'll call it a $10 million range shift out of Q3 into Q2. And in terms of the outperformance on the quarter with the results, I would describe the lion's share of that's with the Columbia brand. Yeah, that's probably it.

[Pallav Saini, Canaccord Genuity, Inc.]

Great, thanks.

[Operator]

Thank you. Our next question today is coming from Laurent Vasilescu from Macquarie Group. Your line is now live.

[Laurent Vasilescu, Macquarie Capital (NYSE:USA), Inc.]

Good afternoon. Thanks for taking my question. I wanted to follow up on the third quarter guidance of revenues. I think you just mentioned that there was a $10 million shift from 3Q into 2Q. Is there a shift 3Q into 4Q? And then overall for the third quarter, how should we think about DTC and wholesale growth?

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah. So (42:21) between the third quarter and fourth quarter. And we spent some time talking about this in years past in terms of shifts that we see and particularly in our wholesale order book. As it relates to our fall 2018 order book, we don't see a material shift in the timing of our orders between the third quarter and fourth quarter relative to our experience last year, so should be relatively consistent aside from the distributor comment that we made a few minutes ago and earlier timing into the second quarter. So from an overall standpoint, I think the wholesale fall 2018 order book is up kind of in the mid-single digit range. As it relates to our DTC business, continuing to plan the productivity improvements and gains both at the store and the e-comm level consistent generally with the way we've planned it coming into the year albeit I think that we've obviously had exceptional performance in the second quarter. And to the degree we perform at those levels, there could be opportunity as we get into the back half of the year.

[Laurent Vasilescu, Macquarie Capital (NYSE:USA), Inc.]

Okay, very helpful. And then drilling down into the U.S., how should we think about DTC and wholesale growth for the third quarter? Should these third quarter metrics be similar to the U.S. annual guide of low teen growth for DTC and the wholesale up mid-single digits?

[Jim A. Swanson, Columbia Sportswear Co.]

Laurent, could you repeat that, please?

[Laurent Vasilescu, Macquarie Capital (NYSE:USA), Inc.]

Yeah, sure. And with regards to the U.S., just specifically on the U.S., how should we think about the third quarter for DTC and wholesale growth? Any color on that would be great.

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah. Unfortunately, we haven't provided that level of granularity and I don't have that immediately in front of me.

[Laurent Vasilescu, Macquarie Capital (NYSE:USA), Inc.]

Okay, fair enough. And then maybe just as a follow-up question. I think in the prepared remarks, you've called out that demand creation expenses might go up this year. I think last year overall advertising expenses were like 5% of sales. Where do you think it goes this year?

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah. So I think our total demand creation spend in 2017 was, call it, just over $120 million, a shade under 5%. We are looking to take that up. As we indicated in our call last quarter, we made some decisions from an incremental investment standpoint of up to $10 million in incremental SG&A at back half of the year. A good chunk of that is going towards demand creation. So we'd anticipate the demand creation as a percentage of sales of north of 5%. Potentially up as much as, call it, 25 basis points on the year is probably the right way to think about that. And we'll continue to evaluate that as we go through the balance of the year.

[Laurent Vasilescu, Macquarie Capital (NYSE:USA), Inc.]

Okay. Thank you very much and best of luck.

[Operator]

Thank you. Our next question is coming John Kernan from Cowen & Company. Your line is now live.

[John Kernan, Cowen & Co. LLC]

Good afternoon, everyone. Thanks for taking my questions. I was just wondering how you're thinking about gross margin in the back half of the year. It sounds like you've got a lot of momentum in terms of full price sell-through, ASPs and inventory. And the balance sheet's obviously in a good position. So just wondering how you're approaching gross margin. The guidance obviously implies kind of a deceleration in the current trend in terms of year-over-year increase. So can you help us think about that? Thanks.

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah, I'll just touch on some of the contributing factors. So our first half, up about 110 basis points; the second half, planned up about 25 basis points. The contributing drivers of gross margin through the first half, which included the clean inventory position that we've had, the stronger full price sales, the currency benefits; certainly, those carry forward into the back half as does the channel sales mix shift as we've seen in the DTC business growing at a slightly faster rate than the balance of the business. I think the delta in part as we get into the back of the year is in part just more difficult comps. I think if you look at the back half of last year, the relative gains that we saw from a gross margin expansion standpoint, comping against more difficult margin levels in comparison to our experience through the first half. And then we've had some ever so slight shifts from a product and sales mix perspective that's impacting the back part of the year, Q4 in particular.

[John Kernan, Cowen & Co. LLC]

Okay, that's helpful. Thanks. And then my final question is EMEA. It's obviously a smaller portion of the overall business. But its growth has been some of the best in the portfolio at this point, particularly in the direct business which you've calling out, I think, both in this quarter and in the first quarter. So can you talk about what's changing in Europe? Obviously, some of it's product-driven. But are there other things changing in terms of the marketing or the brand awareness? But what do you think is driving this inflection right now in Europe particularly in the direct side of the business? Thanks.

[Timothy P. Boyle, Columbia Sportswear Co.]

Yeah, I would say it's a combination of many, many factors. But if I was to list the most important ones, it'd be focus. So we had a rather scattered approach to how we looked at our direct business in Europe. And under the direction of Franco Fogliato who was our prior European GM – we've since moved him to North America. He's become much more focused and drove the team there to really emphasize our relationships with our largest customers in our largest markets. And that's been very rewarding. The successor to Franco is a guy who follows the same theorems. And so the combination of an improving product line that's focused for Europe and that focus on large retailers and a focused product offering has really borne great fruit. We're now starting to reinvest there from a demand creation perspective. And so our expectation is that that market will continue to grow and perhaps lead the growth in all geographies.

[John Kernan, Cowen & Co. LLC]

Helpful. Thanks, guys. Best of luck.

[Timothy P. Boyle, Columbia Sportswear Co.]

Thanks.

[Operator]

Thank you. Our next question today is coming from Chris Svezia from Wedbush Securities. Your line is now live.

[Christopher Svezia, Wedbush Securities, Inc.]

Thank you and thanks for taking my questions. Congrats. I guess first question. Just I'm curious with regard to the shifts and you called out the distributorship business. Roughly $10 million seems to be the movement here. You still did about 16% revenue growth, give or take, for the second quarter. And the guidance is sort of mid-single as we go into the back half of the year. How much of this is just – a lot of it was driven by seasonal product like performance fishing gear which is not as critical in the back half of the year. How much of it is just being conservative? And how much of it is just Q4 is a highly sensitive DTC quarter, which obviously we don't know 100% how that's going to play out? So I'm just trying to understand those mechanics. You can maybe talk about that.

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah, Chris. I think it's a combination of things. If you look at the first half alone, the replenishment that we saw with the sell-through that we achieved through the second quarter was quite strong. I think if we even go back as far as the first quarter, we had some favorable weather that obviously drove some positive gains through the January and February timeframe that we spent some time talking about. Certainly, the currency has played a benefit through the first half of the year. And then as it relates to the balance of the year, we're looking at a combination of our order book and applying more of a normalized view of what we would expect from a cancel, reorder and replenishment based perspective and as planned likewise from a retail standpoint. And as I'd mentioned, certainly to the degree we see the outperformance that we saw in the second quarter, there's potential there for our retail business in the back half of the year. That said, our comps within retail, we performed exceptionally well through parts of the back half of last year as well.

[Christopher Svezia, Wedbush Securities, Inc.]

Okay. And, Jim, you mentioned – with regards to retail, you mentioned I think fourth quarter just as it pertains to gross margin; there's some sales, there's some mix impact on sales that I think is a negative to gross margin. Maybe just elaborate, if you could, on what that is.

[Jim A. Swanson, Columbia Sportswear Co.]

It's really broad-based, Chris. There's no kind of specific if not – I think from an overall apparel footwear standpoint, the relative rates of growth that we're anticipating from our apparel business are relatively consistent with footwear. So it's intermixed within the categories. I wouldn't over-dwell on it from a size perspective. I think the bigger driver in there is just going to get more difficult comps with the rate of gross margin expansion that we achieved through the fourth quarter and back half of last year.

[Christopher Svezia, Wedbush Securities, Inc.]

Okay. And last just two things quickly. Your e-commerce business, I think in the past you might have mentioned that it's as profitable if not more profitable than the core business. Can you just confirm where that stands? And lastly, I guess, Jim, now that you've become profitable in the second quarter; does this mean you're going to be profitable all the time in the second quarter? That's a joke, but just curious.

[Jim A. Swanson, Columbia Sportswear Co.]

I hear you. Hopefully, that's the case. But, yeah, as it relates to channel-based profitability; certainly the e-commerce business, as we look at that on a direct contribution margin basis, it's as healthy of a margin-based business as we have. Certainly, our wholesale business would be up there as well. And the brick-and-mortar business obviously with the additional fixed costs you have with operating in that channel are going to be on the lower end of the range within the channels that we do business with. So even with that, we're continuing to make investments in the expansion of those stores and seeing nice contribution to our overall profitability.

[Christopher Svezia, Wedbush Securities, Inc.]

Okay. Thanks very much and all the best.

[Jim A. Swanson, Columbia Sportswear Co.]

You bet.

[Operator]

Thank you. Our next question is coming from Omar Saad from Evercore ISI. Your line is now live.

[Westcott Rochette, Evercore Group LLC]

Hey, guys. This is Westcott on for Omar. I'd love to hear your thoughts, thinking three to five years out, how you're viewing the channel shift between, say, domestic wholesale, your e-commerce, digital wholesale players; where you expect kind of the growth to come from and how you're expecting that to kind of play out.

[Timothy P. Boyle, Columbia Sportswear Co.]

Certainly. Well, it's well known – there have been a number of bankruptcies over the last several years of weak retailers that the company had done significant business with. As I see the landscape of our current domestic retail partners, I find them to be much stronger and much more likely to be in business for the next several years. And our expectation is that – as we've said many times, being a wholesale business primarily; our expectation is that our business with wholesale partners will continue to increase. That will be exceptionally true if we can make the kinds of progress we think is available for us in the footwear category, which for us and in our business will be almost exclusively a wholesale business.

[Westcott Rochette, Evercore Group LLC]

Right. And just a follow-up. If you think about your e-commerce and your store, roughly what percent of the product that's available on e-commerce and new introductions are also available on your wholesale? Is there any exclusive or are you introducing new things on your e-commerce that you then introduce to your wholesale and how are you kind of managing that relationship as well?

[Timothy P. Boyle, Columbia Sportswear Co.]

We don't use that channel for new launches. Frankly, the only time we would have an exclusive launch would be something along the lines of our Disney activity with Star Wars. But in general, we consider ourselves to be a wholesale company and focus on our wholesale partners to help us launch products and to continue to grow the business.

[Westcott Rochette, Evercore Group LLC]

Okay. Thank you very much. Appreciate it.

[Timothy P. Boyle, Columbia Sportswear Co.]

Thanks.

[Operator]

Thank you. Our next question is coming from Rick Patel from Needham & Company. Your line is now live.

[Rick B. Patel, Needham & Co. LLC]

All right. Good afternoon, everyone. Thanks for taking the question. My question's on SOREL. So you had very strong growth on top of what was a pretty tough comparison last year. As we think about the success of spring products, anything to highlight in terms of where you're seeing that strength, whether it's by geography or channels? And what's your level of confidence that this brand will continue to outperform as we think about fall products in the back half?

[Timothy P. Boyle, Columbia Sportswear Co.]

Well, frankly, today in the spring product category, SOREL's primarily a USA business. It's great to see this kind of success here, frankly, because we want that business to become more year-round, less weather-dependent. It will help us internationally where our partners on the Columbia and Mountain Hardwear and prAna brands tell us that for SOREL to be a truly significant business, it has to be year-round.

So the expectation is that with the great successes we've had in the U.S., we'll have continued momentum globally on those spring styles. It's important to remember that there have been very heavy investments in the company, not only in spring product but also fall product for SOREL, so less weather-dependent. So the goal really is to get that brand to year-round activity so we can encourage wholesale partners to invest in that brand and to help us strengthen the sales there globally.

[Rick B. Patel, Needham & Co. LLC]

And I know it won't happen until early next year, but I'm hoping you can give us a sneak preview of the outlook of China after the JV is taken in-house. Just from a very high level, what do you see as the most compelling drivers of growth as we think about distribution, brands and categories there?

[Timothy P. Boyle, Columbia Sportswear Co.]

Certainly. Well, as I said earlier, we feel that China is the largest geographic opportunity for the company. And if you remember, by far, the bulk of our business is in monobrand stores featuring the Columbia product. Some of those stores, we currently operate. And the bulk of them are operated by franchisees.

So as our Project CONNECT work continues and we're able to strengthen the product offering globally to be more focused, we think that the opportunity to have a much more robust business in China is quite significant. It's an important part of our future. And we've invested in that business with people and processes to get us to the next level. About 10% of the stores that we operate in China are our own stores. We've added personnel to bring our stores up to a higher quality level. And I honestly believe that that's going to be a real shining star in our future growth.

[Rick B. Patel, Needham & Co. LLC]

Thank you. Good luck in the back half.

[Timothy P. Boyle, Columbia Sportswear Co.]

Thank you.

[Operator]

Thank you. Our next question today is coming from Rafe Jadrosich from Bank of America Merrill Lynch. Your line is now live.

[Rafe Jason Jadrosich, Bank of America Merrill Lynch]

Hi. Thanks for taking my question. Can you talk about how PFG performed in the second quarter? And then, I think a few years ago, you told us that it was around $100 million. Can you just update us on the size it is now?

[Timothy P. Boyle, Columbia Sportswear Co.]

Yeah. Let me tell you it's significantly improved and primarily because we've added footwear in a significant measure to the business. The focus on our marketing efforts in Houston and certainly for a halo effect in the Southeast, was really significant. We've had triple-digit weeks of growth over prior periods and primarily in the footwear. But it's also helped us on the apparel as well. I don't know that we've actually quoted the exact growth percentages and where we are now. But it's significantly grown over last year and again because of the addition of the footwear category.

[Rafe Jason Jadrosich, Bank of America Merrill Lynch]

And then, can you update us on where you are in your shop-in-shop initiative and maybe some of the lift that you're seeing at wholesale from it?

[Timothy P. Boyle, Columbia Sportswear Co.]

Certainly. And that's where I don't know that we've specifically called out the number of shop-in-shops that we've got installed. But we're continuing to install them and with a focus on PFG, frankly, in the southern part of the United States where we have a competitive advantage and an opportunity to continue to grow that business where we don't compete heavily with other brands.

How we appear at retail is bundled into our demand creation efforts. And so in addition to increasing the demand creation through digital and print media and TV, we're also increasing our investment in shop-in-shops and other in-store point-of-purchase fixtures and facilities.

[Rafe Jason Jadrosich, Bank of America Merrill Lynch]

Okay. That's really helpful. And then, my last question is just can you compare or give us some color on the operating margins by channel between wholesale, your own stores and then e-commerce?

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah, nothing more than what I described earlier. And this all just be on a relative basis. I think certainly our higher margin businesses are going to be the combination of our wholesale and e-commerce channels. And they're relatively similar and I'm speaking probably more specific to our U.S. business. We look at it within the geography. But the wholesale business being the more profitable, e-commerce being amenable (01:01:13). And then the direct-to-consumer business within the brick-and-mortar side is going to be a bit lower than that, just given the fixed cost nature of the stores. And then, I'd also mention the distributor-based business and the distributor-based business not having much of an SG&A cost structure associated with that. So that's pretty commensurate with what we see within our wholesale and e-commerce channels.

[Rafe Jason Jadrosich, Bank of America Merrill Lynch]

Okay. Thanks for all the color.

[Operator]

Thank you. Our next question is coming from Susan Anderson from B. Riley FBR. Your line is now live.

[Luke Hatton, B. Riley FBR, Inc.]

Good afternoon. This is Luke Hatton on for Susan. Thanks for squeezing us in here. I'll just do one quick one. So looking at DTC from the brick-and-mortar side, how are you thinking about your current store fleet and new openings for the rest of the year maybe just by branded versus outlet and then domestically versus internationally?

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah. To touch on that, I think in total across the combination of U.S. and Canada from a North America standpoint in 2018; we had, I believe, eight stores planned for the year. One of which was a branded store. And we've essentially opened all but one or two of those. So we're on track. The balance will be opened pre-holidays. And then from an international standpoint, our European business; I think we've got six stores planned in that market. And then the composition from our Asia business is predominantly shop-in-shop based, so not a lot of capital obviously involved from that standpoint. But continuing to open stores both in the Japan and China markets.

[Luke Hatton, B. Riley FBR, Inc.]

Great, thank you. Good luck next quarter.

[Timothy P. Boyle, Columbia Sportswear Co.]

Thanks.

[Operator]

Thank you. Our next question is coming from Michael Kawamoto from D.A. Davidson & Company. Your line is now live.

[Michael Kawamoto, D.A. Davidson & Co.]

Yeah. Hey, guys. Thanks for taking my question. Also just a quick one. On the Experience First initiative, if I could get some more color there. Is that something that you're going to be doing all in-house or will there be a third-party kind of software development team to be called in to help with that? And then did you quantify the investment around that as well?

[Timothy P. Boyle, Columbia Sportswear Co.]

Yeah. So as is true with many of the enhancements to our e-commerce business, there are multiple vendors involved. And this would be the same. It's important to note that something like half of our business today is conducted on mobile, on the e-comm business with actually into the 80% range in our China e-comm business. So these are going to be really important investments over time. I don't know that we would be able to quantify the exact investment. But suffice it to say that it's a coordinated effort among our own teams and vendors.

[Jim A. Swanson, Columbia Sportswear Co.]

Yeah, that's right. In terms of the investment, we have quoted what that is. It's built into our outlook both from a P&L standpoint as well as the capital. And certainly some of these Project CONNECT benefits that we've begun to generate, that's certainly helping us in terms of being able to make these strategic investments back into parts of the business. X1 being one of those areas.

[Michael Kawamoto, D.A. Davidson & Co.]

Got it. Thanks, guys, and good luck for the rest of the year.

[Timothy P. Boyle, Columbia Sportswear Co.]

Thank you.

[Operator]

Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further closing comments.

[Timothy P. Boyle, Columbia Sportswear Co.]

Thank you. Well, I think it's important to note that coincidentally this is the company's 80th year in business and this is our 80th conference call. And just speaking personally, it's been a tremendous pleasure to talk to each one of you over the last several years as we've been a public company. And we always appreciate your questions and they help us greatly to manage the business. So thank you very much and look forward to talking to you in a few months.

[Operator]

Thank you. That does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.