Greetings, welcome to the Columbia Sportswear third quarter 2016 financial results. At this time, all participants are in 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, Ron Parham, Senior Director of Investor Relations and Corporate Communications for Columbia Sportswear. Thank you, Ron. You may begin.
All right. Thanks, Bob, good afternoon, everyone. Thanks for joining us to discuss Columbia Sportswear Company's third quarter financial results and our updated 2016 financial outlook. In addition to the earnings release, we furnished an 8-K containing a detailed CFO commentary analyzing our third quarter results and explaining the assumptions behind our updated 2016 financial outlook. The CFO commentary is available on our investor relations website. With me today on the call are Chairman of the Board, Gert Boyle; Chief Executive Officer, Tim Boyle; Executive Vice President of Finance and Chief Financial Officer, Tom Cusick; and Executive Vice President and Chief Administrative Officer, Peter Bragdon. President and Chief Operating Officer, Bryan Timm, who also usually participates on our call, is down at our Mountain Hardwear headquarters today for the kickoff of that brand's fall 2017 sales meeting.
Gert's going to start us off by covering the safe harbor reminder.
Good afternoon. This conference call will contain forward-looking statements regarding Columbia's business opportunities and anticipated results of operations. Please bear in mind that forward-looking information is subject to many risks and uncertainties, 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, we do not undertake any duty to update any of the forward-looking statements after the date of this conference call to confirm the forward-looking statements to actual results or to change in our expectations.
Thank you, Gert. I'd also like to point out that during the call, we will reference constant currency net sales growth, which is a non-GAAP financial measure, and you'll find a reconciliation of constant currency net sales to net sales as reported under US GAAP in the supplemental financial tables that accompany our earnings release, along with an explanation of management's rationale for including this non-GAAP measure. Now I'll turn the call over to Tim.
Thanks, Ron. Welcome, everyone, and thank you for joining us this afternoon. I want to start by looking back to Q3 2015, when North American wholesale customers were aggressively restocking their fall inventory following a very favorable winter, driving U.S. sales up 26% and Canada's up 39% on constant currency basis and contributing to a 39% increase in net income. Our slightly better than expected third quarter earnings of $83.6 million, or $1.18 per diluted share, were achieved against those very difficult comparisons, despite a North American marketplace that looks and feels very different than it did one year ago, including weak consumer traffic across brick and mortar retail landscape, lingering effects of wholesale customer bankruptcies, a glut of competitor brands in liquidation channels.
I'd like to take this opportunity to remind listeners that we chose, in contrast, to rely primarily on our own outlet stores to clear last year's excess inventory. This year's lingering warm weather across key portions of the Northern Hemisphere, a conservative inventory posture among our North American wholesale customers, and North American wholesale customers shifting delivery of a larger portion of their cold weather products into the fourth quarter. During the third quarter, these headwinds in our U.S. wholesale business were partially offset by mid-teen growth in our U.S. direct-to-consumer business as consumers increasingly seek to engage directly with brands. In our Europe direct markets, the Columbia brand drove high 20% growth, making the seventh consecutive quarter of 15% or greater constant currency growth and producing mid 20% growth through the first nine months of 2016.
Momentum in our Europe direct markets is broad-based, consisting of growth across each of the markets where we operate, growth within each channel of distribution, and growth from each of our brands, led by the Columbia brand. Our Tested Tough marketing campaign, our global partnership with Manchester United, and our successful sponsorship of the Ultra-Trail du Mont-Blanc are succeeding in engaging European consumers with the Columbia brand's authenticity and unique personality. On the operational front, we will open four outlets and two partner stores in Europe this year and plan to add a similar number next year. We're also making investments to migrate our Columbia and SOREL brand e-commerce business in-house in 10 European countries during the first quarter of 2017. We expect that transition to drive incremental revenue growth, enhance the consumer experience, and improve our online marketing capabilities and effectiveness while leveraging our existing European infrastructure.
Our updated full year outlook anticipates our Europe direct business generating constant currency growth of approximately 20%. Our team in Europe has been extremely focused on improving profitability. We expect our Europe direct business to be EBITDA neutral in 2016, despite significant currency headwinds. We're confident that Europe holds great potential for additional growth and profitability in the years ahead. The Columbia brand also drove mid-teen constant currency growth in China, including strong wholesale and e-commerce sales. Our team in China is focused on improving the productivity of our distribution channels to position the joint venture for a strong finish to the year and for continued growth in 2017. In Korea, we're encouraged that consumers rank the Columbia brand in the top 5 among the more than 50 outdoor brands that compete in that market.
As we've discussed in previous quarters, the Korean marketplace continues to struggle to absorb a large industry-wide inventory overhang caused by a shift in consumer preference away from the outdoor sector in that country. We remain firmly committed to using our strong balance sheet to strengthen our market position through this market reset. Columbia brand inventory levels in Korea are gradually declining. We're currently expecting the industry-wide glut to continue and make it very unlikely for us to return to growth through at least 2017. In Russia, we're confident that our business is poised to return to moderate growth in the first half of 2017. Annual sales to our longtime distributor have declined significantly over the last 18 months as they have adapted their business to Russia's economic and currency challenges. Our third quarter sales to this distributor declined as expected.
Stepping back and looking at our business from a global brand perspective, third quarter Columbia brand global sales contracted 4%, popping against 14% constant currency growth in last year's third quarter. The mission of our Columbia brand is to help people enjoy the outdoors longer by keeping them warm, dry, cool, and protected in any climate and any weather year-round. For the fall season, our primary emphasis in the northern tier markets is on keeping people warm and dry. Columbia's patent-pending OutDry Extreme technology, first introduced in rain shells this past spring, is the latest example of our significant investments to create superior proprietary technologies that define and differentiate the Columbia brand. OutDry Extreme has redefined the waterproof, breathable apparel category by moving the waterproof membrane to the exterior of the garment, where it works best to keep people dry while enhancing the jacket's breathability.
In contrast to traditional products that sandwich the membrane between two layers of fabric where both waterproofness and breathability are significantly compromised. For fall 2016, we have extended OutDry Extreme into Columbia insulated jackets, gloves, and an expanded assortment of rain shells. In spring 2017, we'll extend it to further into soft shells and trail footwear. In addition, Columbia's OutDry Extreme ECO rain shell swept the Best of Show awards in multiple categories at the Outdoor Retailer Summer Market in August and has since been heralded globally by journalists and ecologists as the most functional performance rain gear with the least impact on the environment. To date, OutDry Extreme ECO has generated nearly 150 million media impressions. It hasn't even hit the market yet. We're very excited about our December 1 launch of Columbia's award-winning OutDry Extreme ECO rain shell.
During the entire month of December, OutDry Extreme ECO will be available exclusively at more than 100 REI retail stores and online at rei.com, with availability extending into other outdoor specialty wholesale customers and to columbia.com in early 2017. While I'm on the topic of our ongoing efforts to reduce the environmental impact of our products, I'm very proud to draw your attention to the recent publication of the Columbia brand's 2016 Corporate Responsibility Report. While we have a long history of sustainability and corporate responsibility programs, this is our most comprehensive summary of our ongoing efforts and related metrics from around the globe. I won't take time to go into detail on this call, but I would encourage you to visit our corporate website to read the online version.
During the third quarter, we launched the second year of Columbia's award-winning Tested Tough advertising campaign, featuring our own tough mother, Gert Boyle, and began recruiting across the U.S., Canada, and the U.K. for candidates to apply to become Directors of Toughness for Columbia for 2017. This year's Director of Toughness recruiting efforts attracted 4,500 applicants and has already generated over 200 million media impressions, representing a five-fold increase in media attention compared to our very successful first Directors of Toughness campaign last year. From those 4,500 applicants, we'll select two to travel the world for nine months, putting Columbia gear to the test in some of the planet's most extreme conditions while chronicling their journey and generating even more consumer engagement with the Columbia brand.
Social media campaigns and traditional advertising help drive consumers into retail stores in search of Columbia products, we also want to make sure they have a memorable brand-enhancing in-store experience when they shop. During the third quarter, we began deploying new in-store shop-in-shop brand environments designed to drive productivity for our wholesale partners by inspiring consumers and conveying Columbia's unique connection to the outdoors. In 2016, consumers will be able to see these experiences in eight locations in the U.S., three in Moscow, two locations in Beijing, as well as stores in Toronto, Nuremberg, Shanghai, Singapore, Dubai, and Seoul. Our current plans anticipate rolling out several hundred of these environments around the world by the end of 2017 and many more beyond.
This provides a great example of how our balance sheet and global operations enable us to invest in our brands to support our wholesale customers and distributors around the world. Before moving on from the Columbia brand, I want to emphasize its broad assortment of lightweight layering styles, rainwear, fleece, and sportswear, including our market-leading Performance Fishing Gear, or PFG, that keep people warm, dry, cool, and protected in all climates and in all seasons year-round. We believe the brand is extremely well-positioned to address changing consumer preferences towards versatile protection in the face of unpredictable seasonal weather. Our updated outlook anticipates approximately 4% global growth from the Columbia brand in 2016. Turning now to the SOREL brand. Third-quarter sales of SOREL increased 1% in constant currency, comping against last year's 59% constant currency increase, and reflecting cautious advanced wholesale orders in response to last year's warm winter.
Coupled with supply chain issues, which have been substantially resolved, that pushed some sales into the fourth quarter and a slight impact from the U.S. wholesale bankruptcies. SOREL's product team continues to make steady progress de-winterizing the brand. SOREL's new lightweight fall styles, led by the Lea Wedge, Addington, and Out'N About collections, accounted for 85% of the increase in SOREL's fall 2016 advance orders. SOREL's expanded spring line, launched successfully in 2016 in partnership with Nordstrom, paved the way to opening a significant amount of new accounts across North America for spring 2017. We continue to have confidence that SOREL represents a large, long-term global opportunity as we establish it a year-round brand and gradually expand it into more markets around the world. Our updated outlook anticipates approximately 6% global growth from the SOREL brand in 2016.
The prAna brand grew 11% in the third quarter, on top of 22% growth in last year's third quarter. prAna's men's and women's shorts, pants, and short-sleeved tops were their best performers, illustrating once again how balanced that brand's business is between the spring and summer and fall-winter seasons. prAna sales are heavily concentrated in the U.S., where it's fighting through headwinds from U.S. bankruptcies, a warm early fall, and cautious advance orders from wholesale customers. Our prAna team is working to increase e-commerce traffic and conversion through catalog mailings and site enhancements while also planning to expand their wholesale business in 2017. Our updated outlook anticipates approximately 14% global growth from prAna in 2016. Finally, our Mountain Hardwear team remains focused on implementing the turnaround strategy we formulated over the last six months.
President and COO Bryan Timm is working closely with our team in Richmond, California, to implement our brand reset strategy, accentuating Mountain Hardwear's high-performance Alpinist DNA across all of its target market categories and consumer segments, aiming towards a return to sustainable, profitable growth by 2018. This fall, Mountain Hardwear's target consumers and wholesale customers have begun to see the brand's new imaging and messaging platform across social media and in a new print campaign currently running in leading publications, including Alpinist, Rock & Ice, Climbing, Outside, and Men's Journal, along with many others. Mountain Hardwear's key product initiatives are focused on providing lightweight warmth through their ultralight Ghost Whisperer collection, as well as their innovative Stretchdown products that deliver superior warmth and comfort. Third quarter Mountain Hardwear sales declined 13% in constant currency against last year's 17% constant currency growth.
Our revised outlook anticipates global Mountain Hardwear sales contracting by approximately 10% in 2016, primarily in the U.S. wholesale channel and the very challenging Korean market. Overall, we're pleased with the consolidated results of our third quarter, despite the sluggish U.S. consumer environment. Consolidated gross margins were equal to last year's third quarter, overcoming approximately 100 basis points of foreign exchange headwinds with a greater proportion of direct-to-consumer sales, a lower proportion of sales to international distributors, and selective price increases, and a favorable sourcing environment. Inventory levels improved, ending the quarter up 8% from last year, comparable to the fourth quarter sales growth rate implied in our updated full-year outlook. On the expense front, our management team again demonstrated solid spending discipline that resulted in a 1% decline in spending compared to last year's Q3. Looking ahead, the global retail stage is set for the fourth quarter.
Historically, our third quarter sales and profit are predominantly a function of shipping advanced wholesale orders, while fourth quarter sales and profit are more a function of the performance of our direct-to-consumer business. Based on record early warm weather during the first four weeks of October and poor consumer traffic patterns, we felt it was prudent at this time to trim our full year EPS outlook by $0.05. Our revised full-year outlook now anticipates sales and operating income growth of approximately 4%, maintaining a 10.7% operating margin. We expect full year 2016 net income to increase approximately 8% to between $180 million and $187.5 million, or $2.55 to $2.65 per share, including an unfavorable impact of approximately $0.26 per share due to changes in currency exchange rates.
We remain focused on the things we can control, including strengthening our brands, bringing innovative products to market, and driving consumer demand through compelling marketing and in-store and online experiences. Our strong balance sheet provides us with the flexibility to invest behind our strategic initiatives to improve our operating platforms and drive profitability, while our strong cash flow enables us to steadily enhance returns to shareholders, demonstrated by the 6% dividend increase we announced today, marking our ninth increase since we began paying a dividend in 2006. You can find more details on our Q3 and year-to-date results and our updated 2016 financial outlook in Tom'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 out with that?
Thank you. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment while we pull for questions. Our first question comes from the line of Bob Drbul with Guggenheim Securities. Please proceed with your question.
Hi. Good afternoon.
Hey, Bob.
Hi, Tim. I guess just a couple of questions for you. The first one is, when you look at the marketplace and where your inventories are versus what you're seeing in off-price competitively, what are your assumptions over the next couple of weeks and months as it relates to demand overall for the cold weather merchandise or for the outerwear category?
Well, Bob, as you know, we've been in this business a long time. Frankly, we've spent a lot of time looking at not only this market, but other markets globally. That amalgamation of all those kinds of variables basically gives us confidence to give you the outlook for the balance of the year that we've given you.
Got it. Okay.
Bob, this is Tom. Maybe to add a little more color to that. If you look at where we're sold in from a wholesale perspective for fall for the Columbia and SOREL brands, the cold weather brands in the U.S. wholesale market, we'll be about 80+% exiting October. That's a pretty typical pattern for us.
Okay. As you think about the bankruptcies that have gone on and some of the mergers that are taking place and the consolidation, especially in the U.S. here, when you look at next year, is there sort of a base case on how you consider your positioning and door count on a wholesale basis as you think through the next 12 months?
Yeah, we do a lot of analysis, and in fact, we're just about to start selling our fall 2017 product in the next few days. We've concluded our sales meeting here at Columbia, and the SOREL and Mountain Hardwear meetings are in place now. We have a fairly good idea about where we think the product will be placed and where we think the business is going to end up. Of course, there's a bit of a weather variable involved in all this stuff. Frankly, we're behind some of our competitors, and we think there's an opportunity for us to gain market share based on the current performance of the product at retail against our competitors. We're not looking to add a bunch of doors.
We're not looking to add additional distribution, we think there's an opportunity for us to continue to gain share in those key retailers across the U.S. and obviously in Europe, where we've been doing very well against competitors there in terms of gaining share.
Great. I guess, Tim, when you look at the fourth quarter and you look at your inventory levels and the inventory levels at retail, when you think about how we are positioned, especially year-over-year, do you think there's a lot of risk in what's happening with the inventory levels out there in the outerwear categories?
Not really. If you remember last year, the enormous warm weather was in November and December of last year. I think we've looked at the comparable sales expectations across not only our stores but our customer stores, and the expectation is that we've got the right amount of inventory. This is a time when a strong balance sheet really trumps I hate to use that word, but the strong balance sheet makes us less vulnerable than others, perhaps.
Great. Thank you very much, Tim. Good luck.
Yeah, thanks.
Thank you. Our next question comes from the line of Andrew Burns with D.A. Davidson. Please proceed with your question.
Good afternoon.
Andrew.
It seems like every season we hear more and more about the buy now, wear now trend in retailers pushing inventory risk back onto the brands. What you saw this quarter, is this just a reflection of the cautionary environment we're in? Is there any sort of reflection of a more structural change occurring? If it's structural, is there any ways as you look at your business that you think it needs to evolve?
Well, we've gotten pretty good over the years at managing seasonal businesses, especially, as it relates to cold weather businesses. You might remember that 2014 was a terribly cold year, retailers ran out of cold weather product, we had a high demand at the beginning of 2015, consumers actually went into stores and bought that merchandise earlier than in a year when there's been warm weather. We're pretty good at managing these things. Again, I focus on the balance sheet in terms of making sure that the company can do the right things as it relates to growing the business and maintaining relationships without having to react to save the company. Inventory risk will continue to be an issue, especially in the environment where we have consolidation and fewer wholesale customers. It'll be a constant discussion point, I'm sure.
Over the next several years, will be more important and a bigger part of our discussions. Structurally, we're committed to being a supplier of merchandise to wholesale to retail customers, and we're going to be focused on those retail customers that we believe will be here for the long term. We have great relationships lasting 40 years plus with some of these great retailers, and we expect that we'll be able to take advantage of working together to get through these particularly tough times.
Okay, thank you. If you could spend just a little more time as to what the lingering wholesale bankruptcy issues that you brought up are. As you look at 4Q, are we fully past this? How should we think of that as a headwind in terms of the timing here?
Well, I think Tom had the number earlier, but it's in the neighborhood of like 1% of our sales were to these folks who went bankrupt. They were great customers that, unfortunately, they didn't survive. The expectation is that as obviously the business climate improves a bit for retailers, that the remaining retailers are gonna be able to pick up that business. It's tough to lose that part.
Maybe just to add a little more color to that, Andrew. In the core of the bankruptcies that we've alluded to, Sports Authority, Sport Chalet, et cetera, impacted Q3 in the U.S. region by about 4%. We expect to have about a 2% impact on the U.S. region for the full year and about a 1% impact on the consolidated revenue for the full year.
Okay, thanks for the color. Good luck.
Thanks.
Thank you. Our next question comes from the line of Laurent Vasilescu with Macquarie Group. Please proceed with your question.
Good afternoon. Thank you very much for taking my question. I want to ask about the U.S. revenue guide. It's predicated on a high teen % growth in direct-to-consumer for the full year. Is that U.S. guide dependent on further acceleration in direct-to-consumer during the fourth quarter? I think in the prepared remarks, it says that the third quarter had mid-teen growth in direct-to-consumer.
Yeah, we're planning. Don't want to get too far into the specifics with regard to specific direct-to-consumer guidance in the fourth quarter. I guess to just provide some amount of color there, obviously, we're comping much easier against Q4 a year ago, assuming normal winter weather this year. I would say, our outlook is fairly consistent in Q4 with where that business has trended through September of this year.
Okay. Very helpful. Maybe just asked a little bit differently. I think the direct-to-consumer number for percentage for global sales last year was about 35% of global sales. Is it fair to assume that the percentage is around 45% for the fourth quarter?
I would say for the full year, we estimate DTC to be about 38% of the business this year, and we would expect Q4 to be less than half the business.
Okay. Very helpful. Lastly, I noticed you raised your free cash flow forecast for the year. Can you talk about the drivers for this raise?
Yeah, I would say predominantly it's a function of CapEx spending for the year. We've taken that down $10 million-$15 million and just the puts and takes within our working capital assumption set. We think we'll be $150 million ± for the full year.
Okay. Oh, yeah. Thank you. Lastly, if I could squeeze one more in. I think there was some call-out in the prepared remarks that traffic is challenging across the space. Could you provide any color on how your U.S. stores are doing quarter-to-date?
Yeah, we really don't consider ourselves a retailer, so don't publish traffic numbers or other typical retail metrics. I can tell you that we're not immune to the reduction in traffic, which has been seen across all channels. I might leave it at that.
Okay. Thank you very much, and best of luck.
Thank you. Our next question comes from the line of Jessica Schmidt with KeyBanc Capital Markets. Please proceed with your question.
Hi. Thanks for taking my question.
Can you kind of bridge the gap between what you're seeing in wholesale and, I guess, direct-to-consumer? How are kind of your sell-throughs at retail?
Yeah, our sell-throughs at retail, I would say, would be comparable to prior periods. We're about where we want to be globally in terms of how the business is progressing at retail. In our own DTC business, obviously, we don't talk about the metrics there, but those would be comparable.
Okay. Then in terms of pricing, where have you seen these increases? Has this been difficult, just given how promotional the environment still is? Are you still expecting promotions overall to be up for the holiday?
I would say the bulk of our increases in prices have probably been spread across our global business. As it relates to promotion, really, you can take a look at the temperatures and determine if there's going to be greater or lesser promotions this year. I would just caution you as it relates to Columbia, to remember that we're a global company and we have sales outside of the northeastern part of the United States.
Okay, great. Thank you.
Thank you. Our next question comes from the line of Jonathan Komp with Robert W. Baird. Please proceed with your question.
Hi, thanks. Maybe first, just to clarify the U.S. implied outlook in the fourth quarter. I know DTC is strong. It's a higher portion of the mix. Any way to clarify the shift of the wholesale shipments, the later timing, how much of a swing that'll have on the growth when you look quarter-to-quarter?
That's a good question, Jon. When we spoke in July, we had assumed that if we step back, we had about a $40 million shift a year ago into Q3 from Q4 in terms of just the normal historical order book and how it shifts between Q3 and Q4 for our U.S. wholesale business. $40 million shift a year ago. Coming into the quarter, we had planned a $30 million shift back from Q3 into Q4. We actually ended up at roughly a $20 million shift is what we'd planned, and we ended up with a $30 million shift into Q4. Like I'd mentioned earlier in addressing Bob's question, in terms of percentage of the book shipped through the month of October for the Columbia and SOREL brands will be 80-plus% exiting October.
We're basically right on track relative to historical norms in terms of how we deliver fall wholesale orders.
Okay, that's fair.
Maybe just one more point there. If you look at our Q4 consolidated sales growth rate, roughly half of that is coming from this timing shift of U.S. wholesale.
Got it. Great. Maybe just following up on the fourth quarter, just a little bit of, at least on the top-end diminished outlook, given some of the headwinds you see in the environment, could you just kind of explicitly outline what changes you made or at least brought the top end down for the fourth quarter in terms of the guidance?
Yeah, I would say it's really a combination of the US business and Korea. Korea continues to trend downward. We haven't found the bottom there yet.
Okay, great. Maybe a bigger picture question for Tim. I know you outlined before, the North American environment looks and feels a lot different than it did this time last year, but yet you've had a couple of periods now recently where, depending on the weather in the prior year, you've had pretty big swings in the business. When you look forward to 2017, if you have a normal winter for the next two months here or a few months, do you think 2017 again could look more like 2015, the last time you came off of a normal winter? Do you think there's structural changes that would make the environment look different in 2017?
Well, we talked about the consolidation at retail, that will be an overhang. I think frankly, retailers bought cautiously for 2016. If we have a normal winter that extends through the January and early February portion, I think that those shelves will be rather empty and we'll be closer maybe to '15. Some of it has to do with the share shift, where we would expect to be the recipient of some of the good news there.
Okay. The last one, just if I could, broader on the marketing efforts. The Directors of Toughness campaign seems to be driving a pretty big increase in the impressions. Any change in the thinking bigger picture, longer term about just given some of the social interaction and engagement you're seeing going forward, if that changes your plans at all for marketing the brand?
Is that a veiled application for a Directors of Toughness position? No. We've obviously been mindful of the change in how consumers get information about brands and products specifically. We've emphasized that part of the business in our marketing efforts to be larger on the social and digital front, frankly, than we've been in the past. It's reaping terrific rewards, especially when we have really interesting technical stories to talk about the product, as well as interesting personal stories about the Directors of Toughness and what they do globally.
I'm just wondering, previously, you've talked about wanting to maybe increase the marketing spend, at least as a % of sales. Does the success you're seeing on more of a grassroots basis change that for you at all?
No, we still need to be spending more than we have been as a %. We believe that we'll grow our marketing spend in 2016 against 2015, but we need to do more. At the same time, spending more can be multiplied by spending it more efficiently. We hope to be doing both.
Okay, great. Thanks a lot.
Thank you. Our next question comes from the line of Susan Anderson with FBR & Co.. Please proceed with your question.
Hi. Thanks for taking my question. I was wondering if you'd talk about just the shelf space in the stores this fall. How are you stacking up versus your peers? I think you made a comment just saying that hopefully you would be a potential winner of any shelf space that's given up. Then also in footwear, are you getting more product fill on the shelves for this fall?
Yes, certainly. Let me answer the first one. In these independent studies that a few of these firms provide, it shows that we're gaining share against most of our competitors, which is a positive, especially in the outdoor space. We would expect that will continue through the balance of the year and into next year as well. In terms of footwear, I've said for years that it should be our biggest product category. Obviously, it's not. We have a new team there in place that their expectations, frankly, is going to be to grow the Columbia branded footwear team. Of course, even though the SOREL has been impacted by the winter of 2015, our expectations for that brand are really for it to become a year-round global brand, as Mark Nenow says, "Toe to head," and where we'll be leading in that space.
So far, the results have been astounding, absent the lack of winter. Our expectation is that footwear, in total, that we'll be a much bigger company between the Columbia brand and the SOREL brand over time.
Okay, great. That's helpful. Just to clarify or follow up on the third quarter revenue. Was the lower revenue just primarily the issues within the U.S. wholesale business and then maybe the bankruptcies a little bit worse, I guess, split between the two of them, or was there something else? On the U.S. wholesale business, are you seeing those lower orders across all channels?
Yeah. Maybe to start with the timing shift and the bankruptcy impact. Between the two of them, they impacted the third quarter by about 9%, with the bankruptcies being 4%. Slightly bigger impact from the timing shift of roughly $30 million. Maybe you could repeat your second question?
Oh, I was just wondering, the weakness at wholesale in the U.S., because I know you're selling in Kohl's too and sporting goods, is it really what you're seeing across all the channels?
It's really a traffic issue, I believe, and weather. We have a lot of information that would show that where there's weather, there's fairly significant delta in sell-through against non-weather locations. Yes.
Got it. Okay. Last one, just on the inventory carryover. I guess, how much is left in your inventory now, and where are you guys expecting to end fourth quarter?
We're generally comfortable with our inventory level. Virtually all the growth is in the U.S. and our Europe direct region, where we're planning for growth in Q4 and beyond. We've got the outlet channel to clear excesses in both of those regions. Obviously, inventory turns at 2.4, 2.5 times aren't where we want them to be. We'd like them to be ultimately north of three times. We've got work to do there. We expect inventory exiting the year, and some of this will be dependent on timing of spring receipts, we expect the inventory to be up in the mid to perhaps high single digits, depending on receipt of timing and how weather plays out here over the next couple of months.
Got it. That's helpful. Thanks a lot. Good luck next quarter, guys.
Thank you. Our next question comes from the line of Lindsay Drucker Mann with Goldman Sachs. Please proceed with your question.
Thanks. Good afternoon, guys.
Hey, Lindsay.
I wanted to ask about the shop in shops that you talked about in your prepared remarks. Could you specify maybe what retail partners you're looking to roll these out at, whether they involve greater square footage in existing doors? Maybe the cost to do it and how you think it might impact productivity in those doors or any other details you have.
Certainly. In the U.S., we're talking about DICK'S and Academy are two of the recipients of the installations. In Canada, it's with Forzani Group. There's one INTERSPORT store in Europe. We've actually opened a partner store in Korea with this installation. The stores in China are partner stores of ours, as well as one store that we directly operate. The expectation, frankly, is for call it in the 4%-5% lift on comparable space, and we've been seeing both comparable space as well as increased space in certain installations. One of the things we talk about, as well as the fact that we've been spending less than we should be on marketing, is the fact that our merchandise doesn't look as good, we believe, in store as it should.
It doesn't look as good as our competitors, and frankly, it's something that we have to work on diligently to get that comparable appearance. This shop-in-shop focus is going to get us there. We showed it to our group of independent distributors last week when they were here in Portland for the sales meeting, universal acclaim. The expectation is that this is going to be helping us to improve our sell-throughs sort of globally.
Can you, I think you said hundreds. How many of these do you expect to have?
I'm sorry. I thought you were just talking about the ones in this year, 2016. We're going to put several hundred in place across the bulk of our key accounts in the U.S. and in Canada, as well as installations in our direct businesses in China, Korea, Europe direct, as well as Japan. We'll have installations throughout Russia, et cetera. We're putting several hundred in next year, and the plan is to put several hundred per year in key stores where we can get a lift.
Who pays for the fixturing or for the installation?
It really depends. The primary investment is on the company, is on Columbia. There are times some of our distributors actually will make the investment themselves. The bulk of the investments in our direct businesses will be our own.
Got it. I wanted to go back to part of your prepared remarks, where you talked about you didn't participate as much or you declined to participate in off-price for a lot of the excess product you had exiting last year. Could you talk, maybe just clarify on how you transacted with off-price this year and, if you're not in that channel, how the heavy inventory levels that you referenced is impacting you?
Well, since we get almost zero return on our cash, we find it a better use of cash if we have excess inventory to hang on to the bulk of especially the valuable outerwear component. That's not to say that we don't have good customers in the off-price channel, we do. When the market is stuffed, it's more challenging to make the decision to sell off-price, sell in that channel. Our expectations are that we end the year with the inventory levels that Tom indicated. We think that there's likely to be some impact by sales of competitors' products in the off-price channel, and we've taken that into account when we've given you our guidance.
Okay, one last thing. You talked about for next year, this year, and I guess maybe next year, the impact of consolidation on your U.S. wholesale business. Could you put any numbers behind how you think, whether it's stores or accounts or even dollars, what you think the impact that could be on your business in 2017?
Well, we haven't talked much about 2017 at all, I wouldn't expect that the entire revenue that we had with Sports Authority, as an example, would be picked up by existing retailers. I'm assuming some of that revenue is going to be gone, and some of it'll be picked up by our existing wholesale customers. Some of it, frankly, will be picked up by ourselves in our DTC business, but that should be the smaller portion. As retailers continue to consolidate, it'll become a more competitive environment at wholesale, which we're prepared for. It's hard to know exactly what's going to happen. The vagaries of the weather obviously have to be taken into account as well.
I guess what I'm asking is, are your comments really specific to the carryover impact of the Sports Authority or any other consolidation we're seeing among retailers? Is that something that you're also thinking about?
Well, the company is adept at extending credit, we get a chance to see the financial health of many of our customers. I'm talking about the consolidation, which would include the Sports Authority, Sports Chalet, Bob's, EMS, the combination of Cabela's and Bass Pro Shops and other bankruptcies which are likely to occur in the future, depending on the state of the retail business.
Okay. Thanks very much.
Yep.
Thank you. Our next question comes from the line of Eddie Ryan with Morgan Stanley. Please proceed with your question.
Thanks for taking my question. I was wondering, how are you thinking about the potential opportunity with online pure-play retailers? Is that something you're considering, or are there too many challenges in that business?
Yeah. We currently sell through many of those online pure-play retailers, they've been solid vehicles for the company to distribute its products.
Are there any sort of margin differentials between that and your typical wholesale arrangement?
No, not in sales from us.
Okay. Got it. I had one question on 4Q. You mentioned how you had the mix shift to D2C in 3Q, benefiting your gross margin. Do you expect that to reverse in 4Q? How much of that shift to wholesale in 4Q is going to really be impacting that gross margin?
Yeah. The implied gross margin lift in Q4 of this year versus the projection versus last year is about, what, 25 basis points plus or minus. That's really going to be a function of channel mix shift. Full price, off price, again, assuming normal winter weather conditions, offset by some FX impact. The FX impact won't be as dramatic in Q4 as it is in Q3, where a higher percentage of international wholesale shipments are delivered.
Okay. That's helpful. Thank you.
Thank you. Ladies and gentlemen, as a reminder, if you would like to ask a question, please press *1 on your telephone keypad. Our next question comes from the line of John Kernan with Cowen and Company. Please proceed with your question.
Hi, this is David Buckley on for John Kernan. Thanks for taking our question. Could you guys please provide an update on the timing of European distributor improvement and how that channel performed in the quarter ex the Russian business?
Yeah. I want to make sure I answer your question properly because our EMEA distributor business, frankly, a very high percentage of that business is through our Russian distributor. As we said, they've been challenged from the, basically, economy in Russia as well as the currency levels in Russia. We have a strong relationship with that firm. Our business is solid there. They've been impacted along with other retailers. I want to make sure I answer your question. Can you maybe clarify?
No, that's helpful. You guys are expecting Russia to return to moderate growth in the first half of 2017. Is that correct?
Well, I would say growth. We really haven't quantified it, but it will be growing in the first half of 2017, yes.
Okay. Excellent. Can you just discuss the SOREL and prAna brands for a second? What are the remaining growth opportunities for both of those brands, and how should we think about the growth rates as we look into 2017 and beyond?
Well, let me take SOREL first, which is, obviously, we've added a spring component to the business, and that's going to be a significant portion of growth for that brand. Once we get the DNA properly situated on the spring product, frankly, it'll allow us to be much more impactful internationally. We've had a number of our international distributors very interested in that product range, but if they're going to make an investment in a store or a portion of their store, it's going to have to be a year-round business, and we've got to get ourselves calibrated there so that the spring merchandise is successful. So far, the early indications from leading retailers across North America are that we have a really solid chance of that business growing nicely and becoming a real foundation for an international expansion on SOREL.
As we de-winterize SOREL, frankly, the fall portion and spring portions of the business have enormous opportunity. prAna has been growing nicely. As you can see, it's led the growth in the business this year. We expect that business, as they expand their wholesale base and their e-commerce business as well, that'll provide a solid base for us to, again, find the holy grail as it relates to getting that merchandise distributed globally. We've struggled a bit on that. We thought we'd be further along at this time. We think there's a large opportunity internationally with prAna that we have to capture.
Great. Thank you. Then just one last question. How sustainable is your CapEx rate at current levels, especially as you guys go more direct domestically and in Europe looking out into next year? Thank you.
I would say the CapEx in the $60 million range, plus or minus, is fairly sustainable for the foreseeable future.
Okay, great. Thank you very much.
Thanks.
Thank you. Our next question comes from the line of Rafe Jadrosich with Bank of America Merrill Lynch. Please proceed with your question.
Hi, guys. It's Rafe. Thanks for taking my question.
Hey, Rafe.
You called out kind of faster sell-through than competitors and you're picking up some market share. Is there any specific channel that you can kind of call out where that's happening, and what do you think is sort of driving the share gains?
I want to specifically, in our sportswear PFG business, we have a very dominant position in the marketplace there. It's unique, and that's an area specifically where we've been picking up share in the outdoor business, especially in the southern part of the U.S., where winter is relatively absent year-round. That gives us a significant lift, and the business there has been quite good. I would point to that as one of the specifics around our growth in market share.
Thank you. In terms of just thinking about the margins longer term and your opportunity to drive SG&A leverage, can you give us some color on what level of sales growth you think you need to hit where you can continue to invest in marketing but still achieve leverage overall?
This is Tom, Rafe. I would say, we've said that historically, we generally need, all things considered equal, high single digit to low double digit top line growth to leverage the operating margin. We're not seeing that this year, but we're holding serve on the operating margin. That's a function of diligent cost management and some improvement in gross margin. There's lots of components here. Generally speaking, high single digit top line growth will drive operating margin leverage.
Is there a target for where you want to take marketing over time? Can you just remind us where it is right now as a % of sales?
Sure. We're just north of 5%. Our key competitors would range from 12% of sales to high single digits. That's sort of where we need to be, and we're focused on getting there.
Yeah. One final question, just based on where you are hedged right now, I know FX is a big headwind to 2016. Do you have any visibility on, if rates stay where they are right now, what the impact of FX will be to 2017?
Yeah. I would say, we're fairly well hedged in many currencies, but not all. As we sit here today, I would say that currency will be a tailwind to gross margin next year, absent any major weakness in the China RMB.
Great. Thank you. That's really helpful.
Thank you. Our next question comes from the line of Camilo Lyon with Canaccord Genuity. Please proceed with your question.
Thanks. Good afternoon, guys. I just wanted to ask a couple follow-ups here. It's starting to get a little colder here on the East Coast. Has that tempered any of the skittishness that the wholesale partners are speaking to you with? Is there some sort of pent up demand that's starting to release that they're seeing that maybe they're considering they're under-inventoried, or is the cautiousness still kind of consistent with what it has been leading up to the start of the season?
Yeah. We're thrilled when it starts to get cold, I know we had some snowflakes in Massachusetts today, we've had some snow already in Canada and many places. We're excited about that kind of weather appearing, we take into account all the expectations and our knowledge of the marketplace, it takes a long time to put these plans in place, as you've seen today. That's where we believe the business will end up.
Okay. It sounds like you're a little bit more sanguine than what your wholesale partners are reflecting.
Again, harping on the balance sheet, it gives us a lot of confidence and comfort that we can establish strategic plans and stay with them despite the daily weather impacts.
Okay. Is that to assume that there hasn't been any adjustments to your inventory receipts because of some of these timing shifts that may or may not impact reorders?
No. I'd have to rely on what Tom might tell you about the cadence of our inventory deliveries, but we've been fully stocked for winter for quite some time now.
Yeah. We're on a pretty normal delivery trajectory through October at this point in time. I think a polar vortex like we saw in 2014 and early November would be good for everybody.
From your lips, absolutely. The other question I had was, you mentioned in your prepared remarks, that you expect Europe to be EBITDA neutral this year. Is that to suggest that with your last comment around FX being a tailwind to gross margin, that you expect a return to profitability next year?
Europe returning to profitability next year? From an EBITDA perspective, yes, that would be our expectation.
Is there any sense of magnitude?
Maybe just some color there, that our European direct business has been hit by a double-digit millions of dollars gross margin impact from currency. When you look at the $0.26 from currency, they're taking their fair share of that hit this year.
It's not like we'd hedged the euro in the mid 130s a year ago, and it's 110 ± today. We're not going to see a snap back there in 2017 for the euro, but it's better than it was. We expect it to be better in 2017 than it was this year in 2016, based on where we've placed our hedges.
Okay, great. Just finally, from where you sit today, what you can tell to the balance of the year, is there any incremental risk that you see from a deferral of distributor shipments flowing out of Q4 into Q1?
That one's always a tough call because these distributor shipments for spring really straddle the 2-3 weeks before year-end and after. They're factory direct shipments, they come out of the factory and go straight to our distributor. We don't have tremendous control in that process. It's really more a function of the manufacturing process. We've used all the intelligence we have to forecast that, which is considered in our outlook here.
Is there a way to think about what that magnitude could be if there were a shift? What % of the shipments are distributor based in the fourth quarter?
They go both ways, really.
They do go both ways, and I think we've talked historically about $10 million to $20 million, $30 million shifts one way or the other. It's kind of that order of magnitude.
Okay.
It's not like we don't have plenty of factory capacity right now in Asia, though. Keep that in mind as it relates to timely delivery of product.
Got it. Thanks very much, and good luck in the holiday season, guys.
Thank you.
Thank you. Our next question comes from the line of Jared Feinstein with Buckingham Research Group. Please proceed with your question.
Yes, thanks for taking my question. I was wondering if you could talk a little bit more about the potential puts and takes with regards to input costs in the fourth quarter, and then maybe some high-level thoughts on 2017 to give us a way to conceptualize any potential opportunity you have.
I want to make sure. You're talking about input, you're talking about costs in Asia as it relates to 2016?
Correct. Next year, if you could.
Yeah. We've made purchases obviously for 2017 spring, and we're on the cusp of making 2017 fall purchases. We find that, as Tom mentioned earlier, there's plenty of capacity. The dampened demand in the U.S. has had a similar impact in Asia, and there's factory capacity which is available, and that tends to be one of the key components of the costs that are input in our business, as well as the commodity costs, which in many cases are based on the price of oil. I would say the same thing would be true of 2016 as it relates to 2015 and early 2016, when we were buying that product. There's capacity in Asia for production, and there's obviously low commodity prices right now in oil. Our expectation is that there shouldn't be too much impact negatively on our pricing for 2017.
Okay, great. Thanks for taking my question.
You're welcome.
Thank you. There are no further questions at this time. I'd like to turn the floor back to management for closing comments.
Well, thank you very much for listening to us, and we're looking forward to talking to you next quarter.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.