On Wednesday, dELiA*s (NASDAQ:DLIA) showed a little pop of its own with a solid third-quarter earnings report. As a result, the stock ollied more than 10% in pre-market trading. If the teen retailer and skateboard purveyor continues this kind of performance, I wonder if investors might benefit from taking a closer look.
As for third-quarter details, there was strength in all areas with the exception of the company's Alloy brand. Revenues were up 12% over the third quarter of 2005 at $67.5 million, slightly lower than what analysts expected -- $68.2 million. The retail and direct segment contributed 26% and 4.5%, respectively, to total revenue growth. Earnings were up 83% to $0.11 per diluted share, $0.03 higher than the top range of analysts' estimates. The higher profits were driven by productivity gains in the direct business and increased operating leverage at the retail business.
Operating leverage benefited from a late surge in same-store sales for October, netting a 5% gain for the three months. Gross margins were also up 120 basis points to 41.7% from the third quarter of 2005, showing continued strength in its recent shift in product mix. However, in the conference call, CFO John Holowko Jr. noted that 70 basis points of gross margin improvement over third-quarter 2005 were due to a change in accounting, which should reverse itself in the fourth quarter.
Still, management believes that margins will benefit from several productivity initiatives that will take hold in fiscal 2007. Furthermore, the company continues to show commitment to profitability by closing underperforming stores. dELiA*s will also close its two outlet stores, which should bolster profit margins.
The "ifs" and "ands"
If management continues to expand margins and comes through with its plan of 25% annual square footage growth, this could be an interesting investment story. With only 71 stores, there's plenty of room to grow in the channel. And margins have the potential to expand when compared to the competition. Gross margins at dELiA*s retail segment, which were 32.4% for the quarter, are similar to Hot Topic's (NASDAQ:HOTT) and Pacific Sun's (NASDAQ:PSUN) and should expand toward Zumiez's (NASDAQ:ZUMZ) most recent 36.8%.
The "buts"
But I'm less positive about the short-term shareholder dilution from the outstanding warrants and stock option grants, which, with the recent run-up in share price, have many people now in the money. Lastly, the volatility alone in dELiA*s' stock price since its 2005 IPO would test an investor's constitution.
For this value investor, the "buts" win out for now, but if the stock price retreats and the story hasn't changed, I might sing a different tune.
For related retail Foolishness:
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Fool contributor Matthew Crews welcomes your feedback -- really! He has a financial position in American Eagle Outfitters but in none of the other companies mentioned in this article. The Motley Fool has an ironclad disclosure policy.
