COLUMBIA SPORTSWEAR CO quarterly report, Q3 FY2014

Columbia Sportswear Company: Q3 2014 Form 10-Q Summary

Business context and reporting period

Columbia designs, sources, markets and distributes outdoor and active-lifestyle apparel, footwear, accessories and equipment under the Columbia, Mountain Hardwear, Sorel, prAna and Montrail brands. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods. Results are highly seasonal, with sales and profitability concentrated in the third and fourth quarters.

Significant developments included the January 2014 commencement of a 60%-owned China joint venture with Swire Resources and the May 30, 2014 acquisition of prAna Living LLC for $188.5 million net of acquired cash. The company also completed a two-for-one stock split on September 26, 2014.

Financial performance and key metrics

Metric	Q3 2014	Q3 2013	9M 2014	9M 2013
Net sales	$675.3 million	$523.1 million	$1,423.6 million	$1,151.9 million
Gross profit	$306.8 million	$232.3 million	$647.9 million	$505.9 million
Gross margin	45.4%	44.4%	45.5%	43.9%
Income from operations	$98.3 million	$76.9 million	$116.7 million	$79.6 million
Operating margin	14.6%	14.7%	8.2%	6.9%
Net income attributable to Columbia	$65.6 million	$54.6 million	$81.6 million	$57.6 million
Diluted EPS	$0.93	$0.79	$1.15	$0.83

• Q3 sales increased 29%; nine-month sales increased 24%. Foreign exchange reduced the consolidated comparisons by less than one percentage point.
• Q3 net income attributable to Columbia increased 20%; nine-month net income increased 42%. Nine-month results included a $5.6 million non-recurring tax benefit from the favorable resolution of uncertain tax positions.
• Q3 SG&A was $210.7 million, or 31.2% of sales, compared with $163.0 million, or 31.2%, in the prior year. Nine-month SG&A was $536.2 million, or 37.7% of sales, versus 38.0%.
• Q3 effective tax rate was 31.3%, compared with 29.5%; the nine-month rate was 27.5%, compared with 27.8%.
• Q3 dividends were $0.14 per share; nine-month dividends were $0.42 per share.

Revenue and operating drivers

• Q3 regional sales growth was 26% in the United States, 72% in Latin America and Asia Pacific, 1% in EMEA and 34% in Canada.
• Nine-month regional sales growth was 20% in the United States, 42% in LAAP, 11% in EMEA and 28% in Canada.
• Q3 product-category growth was 28% for apparel, accessories and equipment and 33% for footwear.
• Q3 brand sales increased 29% for Columbia, 23% for Sorel and included $28.2 million of prAna sales; Mountain Hardwear declined 24%.
• China joint-venture sales contributed $50.7 million in Q3 and $117.3 million for the nine months.
• Gross-margin expansion reflected a higher proportion of full-price wholesale and direct-to-consumer sales, lower international-distributor mix and the reclassification of certain China-related amounts from licensing income into gross profit. Unfavorable foreign-currency hedge rates partially offset these benefits.

Cash flow, balance sheet, debt and liquidity

• Cash and cash equivalents were $185.2 million at September 30, 2014, down from $437.5 million at December 31, 2013 and $274.2 million at September 30, 2013. Short-term investments were $0.5 million versus $91.8 million and $29.0 million, respectively.
• Operating cash flow was negative $108.5 million for the nine months, compared with positive $23.7 million in 2013. The principal working-capital uses were a $139.6 million increase in accounts receivable and a $163.9 million increase in inventory.
• Investing cash flow was negative $139.8 million, including the $188.5 million prAna acquisition and $42.8 million of capital expenditures, partly offset by net sales of short-term investments.
• Financing cash flow was positive $9.3 million, including $16.1 million from a related-party note, $16.3 million of net stock-plan proceeds and $29.4 million of dividends paid.
• Total assets were $1.762 billion and total equity was $1.327 billion at September 30, 2014. Inventory was $494.8 million, up from $410.1 million at September 30, 2013.
• The company had $2.2 million outstanding under international subsidiary credit lines. No balance was outstanding on its unsecured, committed $125.0 million domestic revolving credit facility, and the company reported compliance with its covenants.
• A related-party note payable to Swire was $15.9 million, maturing December 31, 2018 and bearing fixed interest of 7%.
• Approximately 76% of cash and short-term investments were held by foreign subsidiaries and were intended to remain indefinitely reinvested outside the United States.

Material changes versus the prior comparable period

• The prAna acquisition added $33.7 million of nine-month sales and $33.7 million of acquired intangible assets and goodwill-related balance-sheet value; prAna contributed a $0.4 million net loss, including acquired-asset amortization, from May 31 through September 30.
• The China joint venture materially increased LAAP sales and introduced non-controlling interest earnings. It also generated $7.1 million of related-party transition-service fees during the nine months.
• Cash declined substantially because of the prAna acquisition, seasonal working-capital investment and capital expenditures.
• Goodwill increased to $68.6 million from $14.4 million at year-end 2013, while net intangible assets increased to $146.2 million from $36.3 million, primarily due to prAna.
• Net licensing income fell to $5.1 million from $11.5 million for the nine months because certain China-related amounts were included in gross profit after the joint venture began operations.
• Accumulated other comprehensive income declined to $27.1 million from $35.4 million, primarily due to foreign-currency translation losses.

Guidance, outlook, risks and unusual items

Management did not provide a specific quantitative full-year sales or earnings forecast in the filing. It expected 2014 profitability to be affected by the China joint venture, prAna integration and purchase accounting, direct-to-consumer expansion, renewed wholesale growth, increased demand-creation spending, and ERP-related depreciation, training and post-implementation costs.

• Management emphasized continued concentration of profitability in the second half of the year and stated that results for interim periods are not necessarily indicative of full-year results.
• Key risks include unseasonable weather, discretionary consumer spending, order cancellations, excess inventory, foreign-currency volatility, international political and economic conditions, distributor liquidity, input and transportation costs, and competition.
• The multi-year global ERP implementation may cause business interruptions, data or control issues, implementation costs and delayed shipments. The U.S. ERP implementation went live in April 2014; the next planned phase was the global distributor business in 2015.
• Operating lease commitments were $341.7 million and inventory purchase obligations were $312.6 million at September 30, 2014.
• Management believed existing cash, operating cash flow and borrowing arrangements would cover liquidity requirements for at least the next 12 months.
• Routine litigation was not expected to have a material adverse effect. The company paid a $100,800 EPA fine in July 2014 related to labeling violations identified in an internal compliance audit.
• Foreign-currency hedges had total notional amounts of $165.8 million, and approximately $5.2 million of deferred net derivative gains were expected to be reclassified into income during the following 12 months, subject to exchange rates and underlying transactions.

Important facts for investors to verify

• Whether seasonal fourth-quarter demand and weather conditions support the elevated inventory and receivable balances.
• PrAna’s post-acquisition sales growth, profitability, integration costs and final purchase-price allocation.
• The sustainability of China joint-venture growth, profitability and related-party service arrangements.
• The conversion of negative nine-month operating cash flow into cash generation during the balance of the year.
• ERP implementation progress, costs, control changes and any operational or shipment disruptions.
• The effect of foreign exchange, hedging results and the concentration of cash held by foreign subsidiaries.
• Potential margin pressure from promotional activity, input costs, currency movements, distributor mix and Mountain Hardwear weakness.
• Lease, inventory-purchase and other contractual commitments, as well as the company’s available credit capacity and covenant compliance.