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UA’s Q3 EPS of $0.88 came in above printed expectations of $0.83E, but the quality of the beat was low due to a $0.04 tax benefit. A real number was closer to $0.84. We were at $0.83, and true market expectations were for a number starting with a 9. This has been one of our top short ideas as the market is underestimating the margin risk for UA to right-size it's growth profile long-term. There's nothing in this release that makes us change that view.

Here are our key takeaways ahead of the 8:30 call:

What We Liked:

  • Incremental footwear revenues were the key driver of +42% top-line growth above our expectation of 37% with the difference in footwear alone accounting for an additional 5% growth. This supports improved trends that we’ve highlighted with recent share gains in the athletic channel with UA finally piercing the 1% market share mark.
  • Other SG&A spend (product innovation etc.) was up +36% consistent with last quarter and slightly higher than we expected. We would have liked to see marketing spend higher as well (see below), but at the end of the day UA needs cutting edge product to sell and this line drives that engine.

What We Didn’t Like:

  • Inventories are still high up +63% yy on +42% revenue growth compared to +73% last quarter. The increase last quarter was attributed to the need to better service demand, an earlier build of ColdGear apparel for the fall/winter season, and the transition of hat’s and bag business in-house. Inventory levels up over 60% for the third quarter in a row has us increasingly concerned in the in the obvious -- which is the direction of Gross Margins. 
  • The absence of an initial 2012 outlook. The company provided its initial view on 2011 in its Q3 release last year and the year before management spoke to it in their opening remarks. If they don’t offer a view in their prepared remarks, you can rest assured they’ll be asked in the Q&A.
  • Marketing spend ratio of 10.4% was the lowest in 5-years. Sure, it’s due in part to higher sales, but we know that endorsement spending is up, which means that media and consumer facing marketing is down – not what we want to see as a 2012 revenue driver.
  • Apparel came in softer than we expected. This doesn’t give us any reason to think that our concern re Q4 apparel revs is unwarranted.  
  • We highlighted the growth in footwear, but timing is playing a role here. Yes, the latest running product is starting to gain traction – a definite positive after several years of disappointment, however the mention of “earlier y/y shipments of basketball product” indicates a shift at play here compared to a much higher level of sustainable demand.
  • The $0.04 tax benefit in the quarter – it boosts the headline number, but is meaningless to true underlying performance.

We’ll be back with more as warranted after the call.

UA: Low Quality Beat - UA S 10 11


Casey Flavin