Earnings Call Transcript - GOOS Q2 2020

Operator, Operator

Good morning. My name is Mariama and I will be your conference operator today. At this time, I would like to welcome everyone to Canada Goose's Second Quarter 2020 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. I would now like to turn the call over to Patrick Bourke, Senior Director, Investor Relations. You may begin your conference.

Patrick Bourke, Senior Director, Investor Relations

Thank you and good morning, everyone. With me are Dani Reiss, President and CEO; and Jonathan Sinclair, EVP and CFO. After prepared remarks from Dani and Jonathan, we will take your questions. This call, including the Q&A portion, includes forward-looking statements. Each forward-looking statement, including discussion of our fiscal 2020 outlook, is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Certain material factors and assumptions were considered and applied in making these forward-looking statements. Additional information regarding these forward-looking statements, factors, and assumptions is available in the earnings press release issued this morning, as well as the Risk Factors section of the most recent annual report filed with the SEC and Canadian Securities Regulators. These documents are also available on the Investor Relations section of our website. Forward-looking statements made on this call speak only as of today, and we undertake no obligation to update or revise any of these statements. Our commentary today will include certain non-IFRS financial measures, which are reconciled in the table at the end of earnings press release issued this morning and available on the Investor Relations section of our website. With that, I will turn the call over to Dani.

Dani Reiss, President and CEO

Thanks Patrick and good morning, everyone. I am really pleased to tell you that the power of our brand and our business model pulled through despite a challenging external environment, and we delivered another strong set of results to finish the first half. Here are the highlights. In the second quarter relative to last year, revenue grew by 27.7% and adjusted EPS per diluted share increased 23.9%. Even with the unrest in Hong Kong, revenue in Asia nearly doubled to $48.9 million. Revenue in the US increased by 38.5% on a constant currency basis. Revenue in Canada grew by 29.9% against tough comparisons at our most developed market. This is a strong result. From a brand perspective, it is great to see customers at home embracing our lightweight down jacket and knitwear. From a channel perspective, wholesale led the way with the largest quarter, with revenue increasing by 22.9%. This was complemented by direct-to-consumer growth of 47.2%. Like in the first quarter, we continued to fulfill partner requests for earlier shipments on the back of increased operational flexibility. With that as a starting point, there are a couple of specific topics that I would like to address. Let me start with Hong Kong. As I'm sure you're aware, the situation has intensified since our last call. The impact on tourism and retail traffic has significantly affected the performance of our store in IFC. The same goes for a recently opened location at Ocean Center, which is one of our nine openings this year. With this addition, we are established in the two most important luxury retail districts in the city, complementing the mix of guests we've already reached through IFC. Although we wish that the situation was different today, we're developing markets and building stores for decades, not just for the next quarter. Fortunately, during our second quarter, strong top-line performances in other markets offset the impact in Hong Kong. We're watching the situation closely and evaluating actions to streamline our cost base on the ground, including negotiating accommodations from landlords. Moving on, wholesale timing is another important topic for understanding our business. The channel operates largely as a planned economy. Our fall/winter and spring order books are set down to the color and style well in advance, and this gives us great visibility through the year. The timing of when we ship these orders can and does shift from month to month in any given year. It comes down to a balance of what our partners want for delivery and when we can manufacture their orders most efficiently. This year, we've been well-positioned to fulfill customer needs earlier. The shape of every year has always been different, so movements of orders between quarters or months are not reliable indicators of annual performance. I am really pleased that we've shipped so much of our fall/winter order book earlier, which naturally means fewer shipments in the next quarter. It does not mean the underlying demand in the channel is changing. We continue to expect wholesale revenue to grow in the high single-digits in fiscal 2020. This shift has already impacted our numbers for Europe and the rest of the world, where revenue decreased by 3.4% in constant currency. For the same reason, this is not something that I am concerned about, and as it is our most wholesale-centric region, it grew by 79.7% in the first quarter. Moving on to inventory, which we discussed last quarter. We've continued to build an inventory buffer ahead of growth to maximize production efficiency and long-term commercial flexibility. Since our IPO, a key growth strategy has been increasing in-house production to control our own destiny, provide greater flexibility, and to increase margin. Over half of our downfill production is now in-house, and we're at a stage where we can actively reduce our contract manufacturers in the coming year. I continue to feel very good about the size and current composition of our inventory position. We continue to operate commercially with discipline and a selective allocation model both at wholesale and in our own direct-to-consumer channels and always at full price. Going into next year, once the rationalization and transition are complete, we intend to improve inventory efficiency relative to sales and expect that our inventory levels relative to revenue will trend lower over time. I'm also excited to share with you a few things that we're doing with innovation and experimentation in retail this season. I believe that our customers and our brand are defined by some of their experiences. Innovation and experimentation are important parts of that puzzle for us. With consumers looking to use outerwear to express their own personality more and more, the recent relaunch of BRANTA is a great example. A focused collection of six never-to-be-repeated styles is an elevated interpretation of Canada Goose's heritage, designed to inspire loyal brand fans and reach new audiences with pinnacle products. Through versatile 4-in-1 and 3-in-1 reversible styles, the feature includes artistic prints and luxury fabrics such as Loro Piana wool. BRANTA has been a high impact centerpiece on our floors, and the commercial response so far has been incredible. We've also introduced pilot programs to encourage self-expression, including the ability to add personal details on jackets, and to customize their jackets with new hood brim options, offering new reflective comfort and insulated brim choices. Consumers can tailor their jackets according to their personal style preferences. The customer response to these programs has been extremely positive, and we are learning a lot to inform the future direction of both product and retail engagement. Similar to our innovations with customization and personalization pilot programs, we continue to experiment and evolve with retail formats. In a fast-changing digital-first world, you cannot succeed by repeating the same store concept repeatedly; one box does not fit all. There are many interesting opportunities out there to micro-target specific locations, customers, influencers, and experiences. This year, we've activated a number of new direct-to-consumer formats to test and learn what works where, what customers want, and how we can deliver exceptional experiences in new ways. As we have done in the past, we're also utilizing pop-ups to activate markets and test locations for permanent openings. Later this week, we will be opening at Tyson's Galleria in Washington DC area, and we're excited to be bringing our amazing Canada Goose experience to life there. Having global brand strength, multiple avenues of growth, and the discipline and focus to execute well are so important in times like this. Winter has just kicked into high gear, and I'm encouraged by our strong performance despite continued external headwinds and ongoing uncertainties. We continue to see long lines in our stores across geographies, which demonstrate the power of great products and exceptional customer experiences.

Jonathan Sinclair, EVP and CFO

Good morning, Dani, and good morning, everyone. Thank you for joining us. We delivered strong second quarter results in line with our expectations. Brand power, geographic diversity, and high-quality distribution continued to be a winning combination. We were able to offset the impact of disruptions in Hong Kong with strong performances in other markets against external uncertainties. We're executing with discipline, and we're pleased to be in a position to reaffirm guidance for the year. Now, with that backdrop, I'll walk you through the numbers in detail. Please note that all figures are quoted in Canadian dollars. The second quarter compared to the same quarter last year saw revenue grow 27.7% to $294 million or 28.3% on a constant currency basis. Wholesale was a standout performer in the largest quarter with revenue growing 22.2% or 22.9% on a constant currency basis. This growth was primarily driven by existing partners complemented by earlier shipping timing relative to last year. Incremental revenue from Baffin in its peak sales quarter also had an impact. We continue to expect high single-digit wholesale growth for the year. This reflects our performance through the first half with a materially higher proportion of winter orders fulfilled relative to last year. We also anniversary the acquisition of Baffin which started in November. For these reasons, we expect wholesale revenues in Q3 to decrease in the mid-teens on a percentage basis year-over-year. This is purely a function of timing, with fewer remaining winter orders to work through, which drives the quarter. In Q4, we transition to the spring order book and late-season replenishment for winter. We're pleased to satisfy our obligations to our partners earlier, putting our 2000-plus points of distribution in a better position for the peak season. However, this does not change the commercial discipline with which we supply and operate this channel. DTC revenue increased by 47.2% or 47.4% on a constant currency basis. Due to the transition to a 445 fiscal calendar this year, we lost one day in the quarter relative to last year. Excluding the extra day in the prior period, growth would have been 49.3%. Our established store and e-commerce markets performed well, and our new store openings had good starts, with Shenyang and Edmonton being particularly noteworthy. Moving on to geography, we made great strides in key markets alongside continued growth at home. Starting with Asia, our top line nearly doubled to $48.9 million, and while growth in Japan was lower in Q1 due to shipping issues, it remained a positive contributor along with incremental revenue from DTC operations in Greater China. Unfortunately, and as we are all aware, the situation in Hong Kong has intensified as we enter the second half of the year, impacting the performance of our store there. We are being prudent with our local cost base and resource allocation, including accommodations with our landlords and service providers. Moving to the United States, revenue increased by 38.5% on a constant currency basis, driven by significant contributions from wholesale in its largest quarter complemented by strong DTC performance both online and in-store. In Canada, revenue increased by 29.9% against tough comparisons in the seasonally small quarter, and we were pleased with the performance of our highly productive DTC channel. Incremental Baffin revenue in its peak quarter was also particularly relevant to Canada. In Europe and the rest of the world, revenue decreased by 3.4% in constant currency. The decrease was driven by earlier timing of shipments relative to last year, as noted in Q1 growth was very elevated at 79.7%. Consolidated gross margin was 54.6%. At a channel level, wholesale gross margin came in at 47.5%, which represents normalcy relative to the first half of last year, which experienced elevated margins due to temporary timing factors. The mid to high 40s is where we aim to be over annual periods. DTC gross margin came in at a strong 75.6%, driven by positive impacts from pricing relative to costs. Wholesale operating income was $90.9 million, with an operating margin of 41.4%. DTC operating income was $30 million, representing an operating margin of 40.4%. Unallocated corporate expenses were $43.2 million compared to $34.2 million last year, primarily driven by increased growth investments in marketing, headcount, and infrastructure, including Greater China. In summary, we're pleased with our momentum during the first half of the fiscal year, and we're well-positioned as we enter our busiest commercial period. While external uncertainties are a reality, we remain confident in the power of the brand and our business model. Against this backdrop, we continue to deliver strong growth in revenue and earnings, and we are pleased to reiterate our outlook for the year.

Dani Reiss, President and CEO

Thanks, Jonathan. The first half of the year has truly been great. And with the peak season now in full swing, there are a number of exciting things on the horizon. We are opening our first store in Paris on Rue Saint-Honore shortly. This is a dream come true for me personally, and I can't wait to see it up and running. We're also launching our first concept store in Toronto, an experimental and experiential way to engage with our local customers. Last but not least, we will be introducing our first small format resort town location in Banff, which is one of Canada's most beautiful and popular international destinations. And with that, I'll now turn it over to the operator to begin the Q&A.

Operator, Operator

Your first question comes from the line of Kate Fitzsimons with RBC Capital Markets. Your line is open.

Kate Fitzsimons, Analyst

Yes. Hi. Good morning, guys. Congratulations on the momentum. I guess my first question is, the growth rates in your more established markets Canada and US were very impressive in the quarter. How do you think about what's driving the demand in the home market, particularly at the wholesale channel, as well as growth opportunities going forward in North America? And then secondly on Asia, obviously very impressive growth there despite the disruption in Hong Kong. Can you just dig into what you're seeing in other markets as an offset? And Dani, it's been about a year since you've been in China. What would you say have been the more interesting or surprising learnings there more recently, just despite the situation in Hong Kong? Thanks so much.

Dani Reiss, President and CEO

Thank you for your questions. I think that our brand has never been stronger and it continues to grow. Global awareness and affinity for our brand are in a great place, and you can see that in our results. We're significantly growing our business in all geographies, and we continue to achieve a very significant pace of growth from a much larger base today. I think some anecdotes are as it has gotten colder, the lines at our stores continue to grow as people try to get our collaborations and ensure they get one of our products. The demand for our products is truly stronger than ever across all geographies. Speaking of China, we’ve nearly doubled our business there, and we took the right approach by building and running China from within, investing in infrastructure and offices locally. The results are showing dividends, notwithstanding the issues in Hong Kong, which we hope will resolve positively.

Omar Saad, Analyst

Thanks. Good morning, nice quarter. I wanted to ask about a follow-up on a lot of your comments around the supply chain production and the inventory build. It looks like you're continuing to build that quarterly production. How much are you producing? You've said you're doing more in-house, I think over 50%. Could you talk about whether you expect production to still ramp, whether it's internal production or with your external suppliers over the next year or two from these levels, or do you expect production to level off at some point? Also on manufacturing, do you think you can get to a level much above 50% over time? And are you happy where it is? Help us think about some of your core items and how you've built the inventory longer-term, maybe frame it in terms of inventories per store or another metric.

Dani Reiss, President and CEO

Thanks for your questions. I'll talk a little bit about our manufacturing strategy. Going back to our IPO, one of our key growth strategies was to bring much of our manufacturing in-house by building or acquiring new facilities. We've built over four facilities now since then. We've been able to enhance our capacity in-house to the point where last year, it was close to 50% of our manufacturing. As for how high that can go; there's still room to grow. We don't have an absolute target, but it is crucial for a number of reasons. It's important to control our destiny and have a grip on our supply chain. Additionally, bringing manufacturing in-house allows for greater margins. We are excited to achieve this, though some of it has resulted in having a bit more inventory. We feel it's best to hold more inventory than not enough. Approximately two-thirds to 75% of our inventory is carry-over inventory, made to be sold at full price. I am not worried about our inventory and its risks.

Jonathan Sinclair, EVP and CFO

Building on that, we see that we build inventory in manufacturing ahead of the curve, particularly in core products, as Dani described. This allows us to align closely with sales trends. We do not expect this dynamic to change soon but anticipate improvement in inventory relative to revenue once rationalization takes effect. I’d also like to point out that we measure inventory in terms of turns, once we strip out raw materials and work in process, and our average turns are in line with others in similarly fast-moving, highly seasonal businesses.

Michael Binetti, Analyst

Hey, guys, good morning. Thanks for taking our questions here. So I guess you're reiterating the guidance for wholesales to be up high single digits for the year, but then you gave us some color that you think they'll be down mid-teens in third quarter. I think that leaves us with a pretty wide range of outcomes and wholesale for the fourth quarter ranging from positive double digits to even slightly negative. But Dani, you described that as a period when you'll start shipping for spring and replenishing for winter. Can you help us understand the upside versus downside in guidance and address what scenario could lead to the low end or negative in Q4? Also, is there a specific region you expect to be most impacted? Is that mostly the US given the second quarter growth rate you just saw? Thank you.

Jonathan Sinclair, EVP and CFO

Our wholesale business operates with a known order book for all seasons. We have a high single-digit assumption underpinning our guidance. If orders are fulfilled earlier, it inevitably means fewer orders later on. Our allocation model privileges our in-stores first, followed by e-commerce. However, that doesn't impede wholesale partners from making additional requests. Going forward, our focus is on how the wholesale channel is both strong and important to the brand's placement.

Dani Reiss, President and CEO

To add on, we feel confident in our wholesale business for the year. We're on track to end in line with previous expectations. There's no concern about downside. We have the inventory available for possible reorders should it become necessary.

Ike Boruchow, Analyst

Hey, Dani, Jonathan, Patrick. Good morning. Let me add my congrats. I just have two questions on wholesale. You have mentioned the pull-forward effects numerous times; could you quantify the pull-forward to assess what dollars may have shifted into Q2 from Q3? Additionally, Jonathan, there has been some normalization in the wholesale gross margin. Any color on how to think about the wholesale gross margins in the back half and specifically Q3? I'm trying to figure out if there's any more normalization dynamics to consider as we model that out.

Jonathan Sinclair, EVP and CFO

Regarding shipping timing, we ship according to customer demand. If the actual demand is exceeding inputs, it can influence projections. In terms of wholesale gross margin, our achievement of 47.5% in Q2 is what we want. Comparisons to last year distort readings due to fluctuations in margin. It should normalize through the remainder of the year.

Alex Walvis, Analyst

Good morning. Thanks for taking the questions. First question is on the operating margin guidance. You've reiterated full year guidance implying expansion in the back half. Could you talk us through the drivers between mix and operating leverage in each of the divisions? What are the key components of that? Second question is on the BRANTA product. You mentioned that this was intended to reach some new customers; could you elaborate a bit on that point? Are you planning to distribute it through new channels going forward, and how will that expand the relevance of the brand?

Jonathan Sinclair, EVP and CFO

We are guiding to at least 20% revenue growth and at least 25% earnings growth this year. Moving into the second half, we will continue investing heavily in marketing, particularly in the third quarter which is very important; this will allow us to leverage the direct-to-consumer channel, our most profitable channel. This increase in marketing weight is likely to enhance margin expansion towards the end of the third quarter and into the fourth quarter.

Dani Reiss, President and CEO

Regarding BRANTA, we are re-launching this product after having it in our line years ago. We're seeing tremendous demand which is great. These products are meant to be function-first while also redefining performance luxury everywhere. The intent is not to follow what's been done but to do it differently. This pinnacle product targets consumers at the top of the hierarchy, especially those who have been longtime fans of Canada Goose looking for something new and unique.

Mark Petrie, Analyst

Yes, I wanted to follow up on that line of questioning about BRANTA. You've been pushing prices up and introducing new parkas at higher price points. What have you seen in terms of response? You addressed BRANTA, but what about your core parka business? How does that affect your future portfolio positioning?

Dani Reiss, President and CEO

The luxury outerwear category is something that didn't exist 10 or 15 years ago, and we helped create it. It continues to grow. We're introducing new products at higher prices, and that's working well for us. Products priced higher have been performing exceptionally well, which bodes well for our future growth, and we are indeed very excited about it.

Jonathan Sinclair, EVP and CFO

Regarding wholesale gross margins, they are down slightly from two years ago, and we have leverage from greater in-house manufacturing. The most significant headwinds compared to two years ago include cost inflation in labor and materials, alongside reinvestments in new products and the development of offerings in both existing and new categories.

Ross Collins, Analyst

Good morning. I just wanted to follow up on the various retail formats including the pop-ups that you mentioned. Can you clarify the timing of those? Will they be for the holiday period or are they on a longer-term basis? I'd like to understand the implications for inventory and assortment as well as geography; will they only be within specific geographies or all of them?

Dani Reiss, President and CEO

Thank you for your questions. Pop-ups are important to us. I wouldn't classify them as a new strategy; we've utilized pop-ups for several years with both wholesale partners and our own operations. They serve as momentary brand experiences and learning opportunities for future permanent openings. Tyson's Galleria is a prime example; we will explore and test performance in that DC market area. In today's retail environment, executing a well-structured pop-up strategy is crucial, as retail is rapidly evolving.

Jonathan Sinclair, EVP and CFO

It's important to keep in mind that our pop-ups serve primarily as experimental learning experiences, contributing less significantly than retail and wholesale channels. Their sizes, durations, and geography will vary significantly, and all these factors are included in our guidance.

Operator, Operator

There are no further questions at this time. I will now turn the call back over to Dani Reiss for closing remarks.

Dani Reiss, President and CEO

Thank you and thank you all for taking the time to be here with us today. We appreciate your interest and support of Canada Goose. This is our last earnings call for the year and, in fact, for the decade. We wish you a great holiday season, an early Happy New Year, and I very much look forward to updating you on our progress when we report our third-quarter results next year. Thank you very much.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and you may now disconnect.