At first glance, Tuesday's news out of Rule Breakers pick Under Armour (NYSE: UA ) looked underwhelming. Despite growing its sales an amazing 46% year over year, the best the company could come up with on the earnings front was a modest (given the context) 25% rise in earnings per share, leading yours Fool-y to ask: "What's the frequency, Kevin (Plank)?" Where'd all the profits go?
Uncle Sam ate 'em
Ordinarily, when you see profits lag revenue growth so badly, a Fool's first instinct is to look for massive stock options dilution. But the thing is, there was none, or practically none, at Under Armour. In fact, over the course of the last year, shares outstanding grew a bare 1%. No, another culprit was needed here.
Looking further, therefore, I spied out of the corner of my eye a tall, lean, grey-bearded man running round the corner, a bag dripping dollar bills slung over his shoulder. That's right, Fools. This was a case of: "The tax man runneth." Thanks to $2.3 million in tax benefits recorded in last year's Q3, Under Armour's per-share profits were inflated by $0.05 last year. This time around, no credit was found. As a result, year-over-year, Under Armour's tax bill more than doubled in size, to a whopping $14.4 million.
But for the taxes, I believe we would have seen Under Armour's profits not only pace sales growth, but surpass it. Compared to Q3 of last year, the company expanded its operating margin by a good 100 basis points to 18.4%. In so doing, it lengthened its lead over sportswear also-rans Nike (NYSE: NKE ) and K-Swiss (Nasdaq: KSWS ) , plus Skechers (NYSE: SKX ) , Timberland (NYSE: TBL ) , and Wolverine (NYSE: WWW ) .
In other news
In 2006, it was the accounts receivable. Then, accounts receivable again. But by the end of 2006, the story had shifted toward inventories, and there it remains. The single most noticeable chink in Under Armour these days runs directly through the company's management of working capital -- namely, its production of way more goods than even this stellar seller seems able to sell. Q3 sales were up 46%, versus slower A/R growth of just 43%. Meanwhile, the firm let its pile of inventories soar to teeter-tottering heights -- up 102% year over year.
Now, I don't know for sure that this ruined the firm's free cash flow production for the quarter. Under Armour once again conveniently forgot to include the cash flow statement -- which would have answered this question for us -- in its earnings release. But if I were a betting man, then yes, I'd say spending money to manufacture goods, but failing to sell all those goods, probably ate up a good deal of the firm's cash profits this quarter.