We scrutinize the quality of earnings, the balance sheet, the conference call transcript and federal filings in an effort to assess whether a company may be vulnerable to future disappointment. We believe that Wolverine World Wide Inc.'s Q3 results exhibited several red flags.
Q3 revenue rose 12.9% year/year to $361.6 million versus the $358.1 million consensus. FX contributed $8.3M to the top-line. In spite of a $0.07 beat relative to Street expectations, Wolverine did not increase its guidance to reflect the earnings beat. The company’s FY11 guidance implies a range of $0.44-$0.50 for Q4/11 vs. the Street, which was at $0.54 for Q4. Furthermore, the +8% growth in backlog slowed from previous quarters (+13% in 2Q11, +30% in 1Q11, +38% in 4Q10). On the Conference Call, management commented that retailers are increasingly shifting to “at once” orders, which results in lower backlog, higher inventory, and higher gross margins. Share repurchases benefited the quarter by $0.02 per share, but the principal contributor was positive gross margin expansion, which contributed $0.06 per share. Following 95 bps of contraction in Q2,Wolverine delivered Q3 gross margin of 40.6%, up 44 bps over the prior year. The year-over-year gross margin expansion was largely driven by higher retail pricing (+300 bps) and favorable brand mix (+100 bps) partially offset by higher product costs (-200 bps), foreign exchange (-15 bps) and about 140 bps of unfavorable channel and business model mix. Year-to-date gross margins are flat with the prior year, and expected to be relatively flat to slightly up for the full fiscal year.
Inventory growth continues to outpace revenue growth. Following inventory growth of 46% Q1 (vs. -21% last year), 46% in the 2Q (vs. -7% last year), growth in Q3 slowed to +33.4% (vs. +13% in the prior year period). In the CC, management commented that:
Consolidated inventories at the end of the quarter were $278.2 million, an increase of 33.4% versus the prior year and a meaningful percentage reduction compared with our inventory position at the end of Q2. Of the approximate $70 million year-over-year increase about $12 million is specifically to support the new Merrell Barefoot and Merrell Origins collections; $9.9 million is due to the higher year-over-year product cost; and $4.7 million is due to the weaker US dollar. These items explain about 40% of the total increase.The remainder of the increase will enable us to better serve a burgeoning at-once order environment. Our at-once orders have been up over 20% in the last couple of months, the timing of which coincides with a pretty significant downward shift in the macroeconomic environment. We don't know how long this trend in order patterns will last, but our experience tells us that it benefits suppliers with strong balance sheets who can invest in core inventory which we have done. We believe the quality of our inventory is very high and we continue to project year-end inventory growth in line with our full-year revenue growth.
Wolverine management expressed optimism regarding its immediate future, but did make several cautious comments on the CC. For example, management commented,
Europe I think the macroeconomic environment is starting to weigh in certain countries a bit on retailers minds. Obviously I think this goes to the at-once order trend. They're just going to be very conservative this time around and people are just waiting to see if Europe is going to migrate from a common currency to a common fiscal policy and see if they can get their act together. But there is a challenge in Italy and a few countries obviously in the European region…the United States I'd have to tell you retailers are probably more concerned than the actual consumers…That being said, retailers are being more cautious, they're holding back their future orders a little bit, they're relying on companies to have inventory on hand so that they can freshen their shelves through at-once orders.
Our view is straightforward. Slowing backlog and high inventory levels, coupled with stable or improving gross margins, are usually an untenable combination as elevated inventory generally pressures gross margins as either production is slowed or finished goods need to be marked down in order to be cleared.
Wolverine has promised both reduced inventory and improved gross margins for Q4. In a difficult consumer environment, we believe that risk to Q4 and FY12 guidance exists.