Columbia Sportswear Co Q1 FY2020 Earnings Call

Good afternoon. And thanks for joining us to discuss Columbia Sportswear Company's first quarter result. In addition to the earnings release, we furnished an 8-K containing a detailed CFO commentary explaining our results and updates relating to the COVID-19 pandemic. This CFO commentary is also available on our Investor Relations website, investor.columbia.com. With me today on the call are Chairman, 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; Executive Vice President and Chief Administrative Officer, Peter Bragdon. This conference call will contain forward-looking statements regarding Columbia's expectations, anticipations or beliefs about the future. These statements are expressed in this date and are believed to have a reasonable basis. However, each forward-looking statement 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 SEC filings. We caution that forward-looking statements are inherently less reliable than historical information. We do not undertake any duty to update any of these forward-looking statements after the date of this conference call to conform the forward-looking statements to actual results, or to changes in our expectations. I'd also like to point out that during the call, we may reference certain non-GAAP financial measures, including constant currency net sales. For further information about non-GAAP financial measures and results, including a reconciliation of GAAP to non-GAAP measures and the explanation of management's rationale for referencing these non-GAAP financial measures. Please refer to the supplemental financial information section and the financial tables included in our first quarter 2020 earnings release. Following the prepared remarks, we will host a Q&A period during which we will limit each caller to two questions so we can get to everyone by the end of the hour. Now I'll turn the call over to Tim.

Thanks, Andrew. Good afternoon, everyone. A lot has changed since our last earnings call on February 6. I hope that everyone is staying safe and healthy. In recent weeks, I've been frequently asked if this is the toughest environment Columbia Sportswear has ever had to navigate? I can safely say that we've faced bigger challenges when we were less prepared and we persevered. In 1970, following my father's sudden passing, Gert and I were thrust into managing a business we knew nothing about. I was a senior journalism student at the University of Oregon and Gert's previous business to the Columbia Sportswear office had been limited to dropping in to say hi. It goes without saying that the leadership team left room for improvement in those first few years. We faced insurmountable challenges across all aspects of the business, interest rates were over 20% and you couldn't buy gasoline at any price. That first year, we managed to take a company with $1 million in annual sales and turn it into a company with $500,000 in annual sales. We eventually found our path and built a global brand portfolio company you see today. Given the COVID-19 pandemic, this call will have a different format than usual. I'd like to provide an update on how the pandemic is impacting our business, the actions we've taken to mitigate the financial impact and our strategy for the balance of the year. We'll then quickly review the quarterly results and open the call for questions. As we dive into the details of this unprecedented global health and economic crisis, it's important to discuss our starting point. We entered into this crisis in a position of strength. Columbia Sportswear has been in business for over 80 years. And during our 20 years as a public company, we've achieved a 10% net sales and 12% compound annual growth in earnings. We have a unique brand portfolio that includes one of the largest global outdoor brands, Columbia, that consumers around the world recognize for its highly differentiated innovations and extraordinary value. We also entered this crisis in a position of financial strength. Exiting the fourth quarter, we had a fortress balance sheet of $688 million in cash and short-term investments and no long-term debt. Our 13% operating margin in 2019 was top quartile in our industry. While we are proud of our history and financial strength, we know that these are unprecedented times. Even well-built fortresses can be penetrated, and we're taking steps to strengthen liquidity, preserve capital and reduce costs as we prepare for a prolonged downturn of unknown duration. We are keenly focused on emerging from this crisis in a stronger competitive position. Before discussing the actions we're taking, I'd like to provide some details about the current operating environment and status of our stores. Prior to the outbreak, the first quarter was a continuation of trends we experienced in the fourth quarter; an unseasonably warm winter across most of the world was creating a challenging and promotional environment, particularly in outerwear and winter footwear. We have managed a weather-dependent seasonal business for decades, so we were prepared to handle this type of environment. By late January, we began feeling the impact of the COVID-19 outbreak in China. This quickly expanded throughout Asia with reduced store traffic and store closures prevalent across the region throughout most of February. In early March, we began to experience reduced store traffic across North America and Europe before closing all of our owned stores in these markets in mid-March. Most of our retailer partners and distributor stores across the world followed similar store closure timelines. As of the date of this call, the vast majority of Columbia stores in China and Korea have reopened, although many still operate with reduced store hours. In these markets, retail traffic trends have been improving but remain well below pre-pandemic levels. Japan had experienced a similar recovery trend to the rest of Asia until early April when a spike of new cases prompted an increase in-store closures. Across North America and most of Europe, our owned stores remained closed as well as the vast majority of our wholesale partner stores. We continue to evaluate a timeline for reopening stores in phases. In Europe, a small number of stores have already reopened and the first wave of U.S. store openings could begin in the coming weeks. This process will likely take time as each market is facing its own unique set of circumstances. It's uncertain how long it will take until foot traffic increases significantly. Turning to our e-commerce business, sales declined in March across North America as consumers focused on purchasing essential items. In April, we experienced a sharp recovery as consumers adapted to the new environment. Through the first several weeks of April, our U.S. e-commerce business was up over 60% year-over-year. We have also experienced healthy growth in our wholesale partners' online businesses. Footwear is performing very well across both brands with exceptional growth from SOREL. There have also been some surprise bestsellers, including the PFG Neck Gaiter, which is difficult to keep in stock as consumers look for face mask solutions. For reference, our own e-commerce business represented 11% of global net sales in 2019. In the U.S., including our own e-commerce site and wholesale partners' online business, we estimate that the Columbia brands' online penetration was over 20% in 2019. With the majority of stores closed, this is obviously a much higher number today, and we are leveraging every opportunity we have to connect with consumers online and deliver the innovative product they expect to their doorstep. The pandemic is also impacting supply chain and logistics operations. Starting in February, factory closures in China began to impact raw materials and finished goods production as well as logistics operations. As the outbreak expanded to a global pandemic, our factory partners in Bangladesh, India, and Sri Lanka, among others, have experienced closures and just began to reopen earlier this week. This remains a dynamic and rapidly evolving environment that will likely affect our ability to fulfill some Fall 2020 orders in a timely manner and could have longer-term implications for many production regions around the world. We have been working to strengthen the resiliency of our supply chain and believe our strong financial position, our scale, and diverse sourcing base remain a competitive strength. Now that I've provided an overview of the environment in which we are operating, I'd like to share what we are doing to minimize the financial, operational, and employee impacts. We quickly established a cross-functional crisis response team early in the outbreak to work through the evolving operational challenges that the pandemic represents. First and foremost, our top priority is to protect the health and safety of our employees, their families, our customers, and our communities. We initiated work-from-home measures around the world, which have been operating smoothly. For employees that are returning to the office environment, we are following best practices around social distancing and cleaning to promote a healthy environment. In our distribution centers, we have implemented social distancing policies, installed protective barriers, staggered shifts, and taken aggressive measures to clean the facilities. To do right by our employees, we have also implemented Catastrophic Paid Leave and furlough benefits, which vary by business unit and by region. We have also been helping frontline workers and the communities that they serve. Columbia has donated jackets and rain pants to emergency department personnel at several hospitals and health care systems. At Mountain Hardwear, the warranty team transitioned to a non-medical mask-making team while working from home. As previously announced, the detail in our CFO commentary, we have taken a number of actions to provide greater financial flexibility and liquidity. Taken all together, the company's total available committed and uncommitted credit lines provide $631 million of borrowing capacity, of which $525 million is committed. We are confident in our ability to access additional liquidity should the environment require such actions. We continue to evaluate our needs. We have also taken steps to reduce capital outflows. The company's Board of Directors approved the suspension of the company's quarterly dividend. We have suspended share repurchases and reduced planned capital expenditures by approximately $50 million. Collectively, these actions are expected to reduce 2020 capital outflows by approximately $130 million. In recent weeks, we have implemented several swift cost reduction actions, including minimizing discretionary expenditures, reducing demand creation spending, curtailing hiring, reductions of staff, and salary reductions. My salary has been reduced to $10,000, the minimum in order to retain health care benefits. Continuing independent Board members' compensation has been reduced by 50% through January 2021, and senior management and executive salaries will reduce between 5% and 15%. Taken together, these actions should lower 2020 operating expenses by more than $100 million before incremental extraordinary expenses relating to the pandemic. Given the uncertainty of the situation and the impact on our business, additional cost containment measures are under consideration and will continue to evolve. Overall, our near-term capital allocation priorities have shifted to focus on maintaining a strong balance sheet in order to provide maximum strategic flexibility and access to additional liquidity, if warranted. Within that context, our first priority is to build and preserve liquidity for business operations, while we continue to fund high-priority strategic initiatives. Our second priority is to limit the risk of financial distress given the pressure currently impacting the retail industry. We plan to revisit our capital allocation priorities when the business stabilizes and there is a more reliable and predictable flow of cash. Now that I walked you through the current environment and the actions we've taken to mitigate the impact of the pandemic, I'd now like to spend some time on our strategy for the balance of 2020. Our objective is to carefully navigate this environment with our historically disciplined operating approach and emerge from this crisis in a stronger competitive position. First, we will continue to leverage our strengths, starting with the power of our brands as consumers look to make every dollar they spend count during this downturn. We know that Columbia's reputation for exceptional value and differentiated innovation is as important as ever. I'm excited about the innovative product we'll be bringing to market in the coming seasons across footwear, apparel, and outerwear, including enhancements to our most popular innovation platform Omni-Heat. SOREL, which has been our fastest-growing brand in recent years, continues to outperform as consumers seek out their amazing products online. prAna and Mountain Hardwear have reinvigorated their product in strategic directions, and I'm confident that they'll be able to unlock growth opportunities when we emerge from this crisis. It's important to note that with all this uncertainty, our retail partners know that Columbia Sportswear will be around to continue selling them great products for seasons to come. We also remain committed to telling our brand's unique stories through demand creation investments. While we are adjusting our spending to align with the current environment, we are enhancing our digital strategy to efficiently emphasize our most powerful brand stories. We're focusing on key products across our unique brand portfolio that we know our retail partners can sell in high volume including iconic Columbia PFG styles and time-tested innovation platforms like Omni-Heat. Our Footwear initiative will remain an important area of focus for us across both the SOREL and Columbia brands. We will continue to support our footwear product engine and elevate key product launches with marketing support over the balance of the year. It's also clear that this pandemic has increased consumer adoption of online shopping and the ongoing e-commerce market share shift has accelerated. We know that our e-commerce businesses are powerful brand marketing engines in the marketplaces where we connect directly with consumers. We continue to invest in our Experience First initiative, or X1, and intend for the platform to go live for the Columbia, SOREL, and Mountain Hardwear brands in North America prior to the peak holiday sales period. Another key focus for us is optimizing our inventory utilization and matching anticipated demand. As door closures around the world started to mount, retailers quickly switched their focus to cash and liquidity concerns. We have been proactively working with our retail partners to build a comprehensive view of orders, inventory, and demand to take the holistic multi-season approach to optimizing inventory levels. Based on anticipated demand across both our wholesale and DTC businesses, we have significantly curtailed purchases of Fall 2020 inventory. For any remaining excess inventory, our outlet stores will be a vital part of our clearance strategy. Historically, we have used our balance sheet to drive production efficiencies and capitalize on sales opportunities. This strategy helped drive sales, but also led to slower inventory turns. In the current environment, we are acutely focused on managing inventory and improving turns. There's no doubt that this pandemic is creating financial pressures for many retailers around the world. We view our ability to manage credit risk as a competitive strength, and I'd like to highlight the low bad debt write-offs we had during the 2008, 2009 financial crisis and the period of elevated sporting goods bankruptcies in 2016 and '17. I'd now like to quickly cover our first quarter performance. Net sales decreased 13% primarily reflecting the impact of the pandemic, and to a lesser extent, lower demand resulting from warmer weather compared to strong sales performance in the first quarter of 2019. In the U.S., net sales decreased 9%, with the steepest decline in March. Retail traffic trends started to decline early in the month before we closed all our owned stores in mid-March. In our Latin America, Asia Pacific, or LAAP region, net sales decreased 22% in constant currency. China, the first market to experience pandemic weakness, was down high 40%. In our Europe, Middle East, Africa, or EMEA region, net sales decreased 20% in constant currency, reflecting lower consumer demand related to the pandemic and widespread store closures that started in mid-March. In Canada, net sales declined 13% in constant currency. First quarter gross margin declined 360 basis points to 47.8%, primarily reflecting COVID-related inventory obsolescence provisions and lower DTC product margins reflecting higher promotional activity. SG&A expenses grew 10% year-over-year in the first quarter, primarily driven by increased bad debt expense, higher personnel expense, and increased information technology spending. This was partially offset by lower incentive compensation and cost containment measures, including minimizing discretionary expenditures, reducing demand creation spending, and curtailing hiring. This resulted in a first quarter operating loss of $2 million and breakeven diluted earnings per share compared to operating profit of $88 million and earnings per share of $1.07 in the first quarter of 2019. Moving to performance by brand, Columbia brand net sales decreased 15% in the quarter. While lower demand related to the pandemic and weather impacted sales, Columbia's innovations continue to receive media attention and awards including GQ, Shape, and Men's Journal, covering our newest products for the season. Given our focus on footwear, it was great to see the Montrail F.K.T featured in Runner's World's coveted Spring 2020 Shoe Guide as one of the best shoes of 2020. On the marketing front, we launched our new Outdoor Guide collection of stories on our website and Instagram. This collection of custom how-to articles delivers down-to-earth advice for anyone who loves the outdoors and consumers can learn about our innovative technologies and products and prepare to be outdoors. As the pandemic unfolded, our marketing team quickly responded with our #effort together campaign, which provides the outdoor community with a platform to connect during this unprecedented time. Consumers can interact with our brand and each other to share their favorite outdoor adventures or tell us about their plans for the future. We're also working to help educate and inspire the outdoor community through our social channels, including live Instagram events, featuring some of our sponsored athletes and outdoor enthusiasts. Moving to SOREL, net sales were down 2% in the first quarter with the decline primarily coming from lower sales of winter utility styles in Europe. In the U.S., SOREL's brand momentum was clearly evident in the brand's robust e-commerce growth as consumers who were stuck at home sought out SOREL's products online. In April, SOREL had weeks where unit sales volumes across the brand's wholesale business and sorel.com were actually up year-over-year, setting sales records despite significant store closures. Through the first several weeks of April, sorel.com has generated nearly 300% year-over-year growth. prAna net sales declined 11% in the first quarter as lower wholesale sales more than offset e-commerce growth. We were encouraged that the robust e-commerce growth we discussed in the last conference call continued into early 2020, prior to when the pandemic took hold. We remain confident in prAna's focus, including its message of clothing for positive change and refreshed product line. Mountain Hardwear net sales declined 2% in the first quarter as a healthy start to the year gave way to lower demand due to the pandemic as the quarter progressed. As previously announced, given the ongoing business disruption and uncertainty surrounding the pandemic, we have withdrawn our 2020 financial outlook. We're modeling a number of downside scenarios and we believe that we have sufficient capital and access to liquidity to manage through the crisis. It's hard to say how this pandemic will permanently change consumer behavior, but in an era when everyone is working from home, trying to avoid crowds and looking for an escape, it certainly seems like getting outdoors and enjoying nature is the perfect solution. I'm convinced we're going to see outdoor participation grow as a result of this pandemic. Our mission is to connect active people with their passions, and we're ready to equip outdoor enthusiasts with innovative footwear and apparel. In summary, while 2020 will take a different path than we originally expected, we're confident in our strategy and ability to weather this storm. Our long-term commitment to driving sustainable and profitable growth has not changed. Our strategic priorities remain to drive global brand awareness and sales growth through increased focused demand creation investments, enhanced 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 the portfolio of brands. That concludes my prepared remarks. We welcome your questions for the remainder of the hour.

Our first question comes from Robert Drbul with Guggenheim Securities.

Tim, I just have a couple of questions. I think the first one is on your order book, your visibility. Can you just talk us through significant cancellations? How firm is your order book at this point? And when you think about your ability to sort of meet the demand? It ties into the second question, which is on the inventory that you have on the books today. How much of it are you going to carry old Fall inventory of '19 into '20? How much of the new '20 stuff had you gotten in before things locked down? You can start with maybe those two questions?

Sure. Well, as it relates to the first one, the current order book, we believe, is quite solid. We've spent really the last almost 60 days confirming with our retailers, where we believe we have issues as it relates to production and where we have solid deliveries available for the customers. We've done a lot of work on this, and we believe that we're in good shape on our order book and our visibility in that part is quite good. As I said, we want to maximize our inventories, and we're doing that through matching existing demand and also substitutions. As it relates to carryover inventory, as you know, the bulk of our sales are through fairly long historical products and we have good visibility on that merchandise, and we have some carryovers that we'll be selling over the next several years. We're going to be focusing on inventory turns and liquidity, an area where we really never had to manage with the kind of precision we're going to be working with in the future.

Got it. Okay. And then I guess my other question is, as you've focused on your digital capabilities, can you expand upon essentially how you're meeting the demand? Are you able to ship from some of your outlet stores? Or are you just shipping from your distribution centers? Can you just maybe elaborate a little bit in terms of how you've pivoted there?

Certainly. Well, I just want investors to understand that the single biggest investment we're making in 2020 is on improving and enhancing our digital capability, specifically as it relates to e-commerce. So our X1 project, which has been ongoing for several quarters now, is the largest capital expenditure we have. We cut others that we thought were less important. This one is critically important. So our digital business is a global digital business, and we're shipping from distribution centers almost exclusively around the globe. Certainly in the U.S. and in Canada, we're shipping merchandise only from our distribution centers. But it's important to remember that the company has a number of both pure play digital wholesale customers as well as the fact that many of our customers, our historical customers, have big digital businesses, and that would include DICK's Sporting Goods, Kohl's, REI, all of whom are having a significant business digitally on our products.

Our next question comes from the line of Jim Duffy with Stifel.

Thanks for all the thoughts on the business. Clearly, Tim, you've been very thoughtful about the approach to all the uncertainty. I guess my question relates to the extent that you might play offense. You have a fortress balance sheet, a lot of reasons to believe outdoor participation will increase and perhaps that becomes sticky. Can you talk about demand creation, budget management in areas where you may lean in and invest to capitalize and try to take share?

Certainly, Jim. Well, as you know, the company, as I said, to answer Bob's question, we're making a significant investment in our X1 platform. We believe that the use of digital marketing, whether it be specific to a particular initiative or program, as a complement to our digital platforms where we do commerce. So today, we have industry average conversion rates. That means that over 90% of the people visiting are leaving with a strong marketing message for the company. So I think for the foreseeable future, our emphasis will be on digital, whether it's included in our own commerce or in the typical Facebook, Instagram, and other platforms around the world. And obviously, the ones in China and Asia are different in terms of their format. But I'm sure that the bulk of our marketing efforts are going to be going to those very focused areas of marketing.

And then a question on the bad debt expense recognized in the quarter. Was that related to tangible risks? Or was that more proactive in anticipation of troubles that may come?

Yes, well, I know Jim is going to explain a little bit more on this, but that's an area that the company has a significant amount of experience we are very proud of the way our company extends credit. We've had incredibly successful years when others have had large write-offs. And I might just let Jim explain a little bit about the details there.

Yes, it's Jim. Appreciate the question. There's no kind of discrete customer looming risk that we're reserving against. It's more of just with regard to the general uncertainty in the marketplace, the liquidity and pressure that there is on retailers. And just a higher degree of risk associated with our business. And so as you look at the balance sheet, we've got $28 million in total bad debt reserve relative to $8 million last year. This is by far and away, the most significant that we've reserved from an allowance for doubtful accounts perspective. Historically speaking, as Tim touched on in the prepared remarks, if you go back over the course of the last decade plus where we've had some events along there from a crisis standpoint regarding the financial crisis and some of the sporting goods bankruptcies, even during those years, our write-offs of bad debt were in the mid single-digit millions of dollars.

Our next question comes from the line of Jonathan Komp with Baird.

Tim, I'd like to hear your thoughts on how consumers might respond to the current situation, considering your extensive experience and the diverse environments you've worked in. Are you observing any regional variations that could shape your perspective? Additionally, how do you think the discounting in the marketplace might affect brand positioning from a pricing perspective?

Certainly. I have been in the industry for a long time, which I consider to be a valuable experience. We are in unprecedented times, and the guidance from our Board regarding maintaining a strong balance sheet gives me peace of mind. We have looked at our businesses in Korea and China to gauge what might happen when physical stores reopen. As we come out of the crisis, it's encouraging to see a revival in in-person shopping alongside digital shopping. I believe people will be eager to spend more time outdoors. Additionally, our cautious approach to managing the business, whether through product line extensions or credit policies, positions us to emerge even stronger and take advantage of market share and shelf space opportunities that may arise, especially as others who haven't been as prudent may struggle. We are ready to capitalize on those opportunities.

Okay. And then maybe an add-on or a follow-up question. Just thinking about the back half of the year. Obviously, the third quarter, more of a sell-in period. So I'm assuming in all likelihood, you'll still see some pretty significant top-line pressures. And then the fourth quarter, shifting more to D2C. I'm just curious how you're planning inventory strategically for those quarters and even planning for D2C in light of the limited visibility that's out there today?

Certainly. Well, Q3, frankly, is an opportunity for our customers to fill their stores with the Fall and Winter merchandise. So our expectation is that the visibility that we have there, while it's limited, gives us the ability to feel comfortable with the third quarter. And I would expect that the orders that we have, and in fact, we're quite confident the orders we have for that period are going to be kept and shouldn't be a problem filling those stores. The fourth quarter, as those who follow the company know, is an important holiday period and is also impacted by weather. And so we're ready for both of those times, and we believe that our supply chain is well in hand and well organized to get us the merchandise that we need and that our customers need to be successful in that in the back half of the year.

Our next question comes from the line of Alex Perry with Bank of America.

I guess just first, just to follow-on the digital thread. You mentioned the first several weeks of April, e-commerce was up over 60%. I guess how sustainable do you think that is? And how much do you think was driven by some sort of fiscal stimulus or other one-time items? And then can you also just remind us in this environment of the profitability of that channel compared to your store and wholesale business?

Certainly. Well, we may not be able to sustain 60% growth, but I think the world is much more accepting of digital commerce today than they were pre-pandemic. So our expectations are that consumers are going to be much more willing to shop remotely through digital means, and that will continue to be a bigger part of our business. That's why it really is getting the single most significant investment in capital in the company in 2020. As it relates to profitability, we don't break that out by division, but it's a significant component of our future and is a significant business for us, whether it's our own digital business or through one of our customers, whether they be pure-play or a mix of online and offline stores. So we think taken in combination, it will be a significant growth vehicle for the company and quite profitable for us and for our dealers.

Perfect. That's really helpful. And then I guess just my second one. Can you talk through how resilient the Columbia brand has been through prior sessions and whether you expect potential market share opportunity here from some of your higher-priced competitors as the consumer searches for value?

Certainly. Well, the company has been able to grow through almost every prior economic challenge. And that would include economic challenges that we don't often think about happening outside the U.S., as an example, in Russia, where the company has got a tremendous market position and has grown through many crises. So the brand is quite resilient. So we expect that not only will we be taking market share from brands that price above us because of our value proposition, but also when we think about retailers and their allocation of inventory investment into private label, we believe that we can provide a better solution and we'll likely take market share from private label sources as well during this recovery.

Our next question comes from the line of Chris Svezia with Wedbush.

I'm glad you're all doing well. I guess the first question I have is just regarding the SG&A. Maybe if you can just talk about how we should think about the flow of the roughly $100 million decline year-over-year in SG&A expense. Just how we think about Q2, Q3, Q4? And I guess the bad debt expense, $21 million that's excluded from that. In other words, right now, we're looking all else equal about an $80 million reduction in that, if I'm thinking about it correctly. So any color about that would be helpful.

Yes, that's correct. The $100 million reduction in SG&A is before any exceptional charges like bad debt. Regarding the timing of that $100 million, we observed a small portion in the first quarter, and I expect it to gradually increase through the end of the year. It won't be evenly distributed across the three quarters but will build as we take certain actions and manage the P&L. Tim mentioned aspects related to demand creation, and given the current low level of consumer demand, we have significantly reduced our demand creation efforts during March, April, and May. We will reassess and redirect those investments in the second half of the year where we identify the best opportunities.

Okay. Got it. And just on the inventory and the wholesale orders. And just some of the comments that you made earlier about so far how you haven't seen cancellations, in particular for Fall/Winter product as of yet and you expect to, I guess, ship the majority of that product. Is it fair to say that at this point, you're potentially anticipating global wholesale to be up in the third quarter? Obviously, DTC could be impacted depending on how stores open, but how do I unpack that thought process for now? Or are you anticipating some cancellations to ensue or maybe that's potentially a risk depending on how long this goes on? Just maybe help me out with that a little bit.

Certainly. I didn’t mean to cause any confusion. We have experienced significant cancellations since the start of the pandemic. However, we believe that the residual order book we have now, after factoring in those cancellations, is quite solid. We expect our Q3 shipments to be largely in line with our plans, and we anticipate that our merchandise arriving from Asia will be on schedule. Therefore, we think our wholesale customers will be satisfied with their deliveries. I just wanted to clarify that we have had cancellations.

Yes, Chris, I’d like to add a comment for clarity. Regarding our inventory production for Fall 2020, we were actively managing our order book at the time when the pandemic pressures escalated. We had already placed many of our inventory orders, but in March, we significantly pulled back. Consequently, we have reduced a considerable amount of our inventory purchases to better align with the expected demand for the Fall 2020 season.

Got it. And lastly, just real quick on that. Just how do we think about where inventory? Any thoughts about that? And as we go through? Is Q2 sort of the peak inventory position potentially? And then it begins to slowly go down for Q3? Or how do we think about the inventory increases year-over-year?

I think it's all going to depend upon the flow of inventory. In terms of X factor and the timing of the manufacturing of the goods. I mean Fall '20 and the timing of those receipts and to what extent those fall into the latter part of the second quarter into the third. So to be able to kind of time that, I think it will be awfully difficult at this stage. We're keenly focused, as Tim touched on, on inventory management, improving our inventory turns and really getting through this year and exiting the year with as clean of an inventory position as we possibly can. And so on that note, to a degree, we do have excess inventory. Certainly, first and foremost, we're seeking to match inventory, the supply with the demand that we've got from our wholesale customers. A lot of our inventory that Tim touched on is a carryover based product that's valuable, and there's no sense in highly promoting that. And then our use of our outlet stores will certainly shift as we use those more for clearance purposes to really make sure that as we get to the end of this year, we're as in cleaner position as we can.

Our next question comes from the line of Mitch Kummetz with Pivotal Research.

Let's start with just a couple of follow-ups from Svezia. So Jim, I was surprised to hear you say that on the $100 million expense reduction that it would kind of build through the year. I would have guessed that you'd see the biggest year-over-year drop in Q2 just based on furloughed employees, particularly in your own retail stores. So I just wanted to clarify that.

There will be some benefits related to the furlough. We have implemented certain compensation programs. We had a Catastrophic Pay Program that allowed us to continue paying our retail and distribution center associates well into March. Since then, we have transitioned to a partial furlough program, where we are still compensating those individuals. The demand creation aspect is likely more pronounced in percentage terms in the second quarter, but it's challenging to determine exactly. We are not providing guidance today. However, we have a clear strategy in place to achieve the $100 million cost reduction, though identifying the pace throughout the year is somewhat difficult.

Okay. And then on the orders, Tim, I know you guys gave up the practice of talking about orders a long time ago, but I kind of feel like this is a unique circumstance that you just mentioned that you've seen a substantial reduction in fall orders. I guess I got a couple of questions here. Could you say what percent of Q3 wholesale is driven by the sell-in of your fall order book? And then can you maybe speak a little bit to that order book? I mean, is it down double digits? I mean I'm just looking at consensus. I think consensus sales on Q3 as you guys down 6% year-over-year. I don't know if that's kind of reflective of where you see the order book right now in the selling of those orders.

Yes, it was easier for us to be transparent with investors when our business was primarily wholesale. We stopped providing order book information because the retail segment grew significantly, leading to confusion for our investors regarding our guidance related to wholesale, which is now just a part of our overall business. We have experienced considerable cancellations and are currently in the process of reconciling orders with existing and new inventory, as well as potential substitutions to complete the wholesale order book. These mismatched inventory items will likely be allocated to our outlet store business since we have not yet acquired a significant amount of fall merchandise. Therefore, it's challenging for me to provide a specific figure for wholesale, as it now represents a smaller portion of our revenue compared to the past.

Okay. Fair enough. And maybe just one last quick one. On gross margin, how are you thinking about gross margin over the balance of the year? I guess, as it relates particularly to promotions? It doesn't sound like your inventory, there's tremendous risk to your inventory, but I imagine channel inventories are high. Other people are going to be promotional, you may have to react to that. I'm just wondering if kind of how much gross margin pressure you anticipate kind of at least over the next couple of quarters, in particular?

I know Jim will provide more information on this, but we've observed that some of the value channel players who have raised capital in the past 60 to 90 days are focused on their expectations of an excess supply of merchandise, or they are being selective in their choices. As a result, we plan to either avoid or postpone offering merchandise to that channel due to the effect it could have on gross margins. We believe we have a strong opportunity with our wholesale and direct-to-consumer businesses to manage inventory and gross margins effectively. I’m not sure if Jim has any additional comments on this.

Yes. And I'd just add, I think it's going to be a function of the overall environment from an overall standpoint. With as much inventory out in the channel and as promotional as it is, we're going to hold our own with the strength of the brands that we have, but there is going to be margin pressure that's there and trying to measure that at this stage, awfully difficult, but probably leave at that.

Our next question comes from the line of Camilo Lyon with BTIG.

Following up on the previous question regarding inventory clearance, Tim has mentioned multiple times that you are focused on managing inventory and liquidity, which is understandable. Can you discuss the promotional strategies you are engaging in with your wholesale partners? What are your preferences for clearing the excess inventory? Are you taking products back, allowing them to be stored, or do you have certain pricing discounts that you will not exceed in order to maintain product stability and margin, even if it prolongs the inventory clearance? Any information on this would be useful to evaluate your ability to clear some inventory within your desired timeframe.

Certainly. Based on our past practices, we expect to have similar discussions with retailers, focusing on ensuring they remain profitable with our brand. This approach will likely lead to a larger order book next year when they evaluate which brands offer the best returns. Our brand mainly consists of basic products that generate substantial revenue for our retailers, featuring well-known styles they have sold for many years. Therefore, we anticipate managing the liquidation of inventories at both their and our locations while also maximizing our gross profit margins. The negotiations with retailers will follow our usual process, and I don't foresee any significant changes to our standard practices.

Got it. As we consider how this process will unfold this year, particularly regarding the pack-away aspect in your discussions, is it up to the retailer to decide how much spring product they want to retain for the next season in 2021? Additionally, is it too early to discuss how this might look for your internal planning as you begin to strategize your production for spring 2021? Will there be a situation where you might need to adjust your business orders based on an excess of pack-away goods in the market, which could affect that ordering process?

We will begin accepting orders from our retailers in the upcoming weeks and will continue this process through July and possibly into August, allowing us to gain a clear understanding of what spring 2021 will look like. There is still ample time in fall 2021 for our wholesale partners to liquidate inventory at full price in their retail stores, so we will need to monitor that closely. I want to remind you that we receive sell-through data from about 85% of the total wholesale business in the U.S., providing us with good insight into the situation. We will keep an eye on it. Additionally, I want to emphasize that the inventory mainly consists of popular items that have been carried for many years and are not expected to become obsolete.

Could you provide an update on the outlet strategy? Specifically, has there been any change in the clearing strategy or the product composition? Additionally, can you clarify if there are any products specifically made for the outlet that you plan to hold onto as a way to manage excess inventory?

Yes, certainly. As I mentioned earlier, we have not acquired a significant portion of the outlet merchandise since we paused our purchasing in Asia. Thus, the outlet stores will primarily receive products from our unmatched order book once we finish that process. While the outlet stores will have items they typically wouldn't, these will not make up a large portion of their inventory. However, this allows us to better manage our overall inventory and gross margins, leading to improved profitability for the company.

Our final question comes from the line of Paul Lejuez with Citigroup.

It's Tracy Kogan filling in for Paul. I have two questions. The first is, I was hoping you guys could give us a sense of what your trends have been in China since the stores have reopened. I know you said it's still well below pre-pandemic levels, but has it improved? Or how has it improved by weeks? And then secondly, just a follow-up on your clearance strategy or the idea that you'll be clearing in the outlets. I wondered if that strategy might change if stores don't reopen as quickly as you expect? And might you shift the strategy and maybe clear more online?

Certainly. The trends in China and Asia overall have been gradually improving each week, although they are still not at the traffic and revenue levels we saw in 2019. Consumers are returning to stores and are maintaining social distancing effectively. Many stores, including ours, are bringing employees back in a controlled manner. We anticipate that these positive trends will continue. While we cannot predict exactly when we will return to 2019 levels, it is a possibility on our radar. Regarding clearance, it's important to recognize that our business is seasonal. Currently, we have spring and summer products in our stores, but when fall and winter arrive, those items won't sell as well, necessitating a shift to winter products. Retailers will have to decide whether to store leftover items or liquidate them through sales. At this moment, we do not plan to implement significant liquidations on our digital platforms, and I do not think our retailers, whether they are solely digital or have some online presence, intend to pursue high liquidation rates or major promotions either.

Ladies and gentlemen, we have reached the end of our question-and-answer session. And I would like to turn the floor back over to Mr. Tim Boyle for any closing remarks.

Thank you very much for listening. This is a challenging time, but we will get through it. The company has a highly experienced management team, and we have the capital and liquidity to enable a bright future for the business. Thank you.

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.