Varsity's Paperback Profits
Tuesday November 22, 11:05 am ET
By Rich Smith
Sorry I'm late, Teach. My dog ate my homework.
Not buying it? Well, while I think up a better excuse, here's a brief rundown of the earnings report for school-textbook retailer Varsity Group (Nasdaq: VSTY - News), which reported its third-quarter 2005 numbers a good week ago, but which I've only now gotten around to reviewing. Darn dog.
From a generally accepted accounting principles (GAAP) perspective, Varsity had a bang-up Q3. The company reported 34% year-over-year sales growth, helped in large part by its recent acquisition of school-uniforms business Campus Outfitters. Between CO's better-than-books margins, and whatever organic growth Varsity proper managed to scrape together, the company managed to beat analysts' depressed estimates of $0.35 by $0.03. (I call these estimates "depressed" because, as you may recall, just three months ago, analysts were expecting Varsity to post $0.43 in Q3.)
Unfortunately for its shareholders, beating those depressed estimates earned Varsity little respect on the Street. Why? Because there are profits, and then there are profits. Cash profits, or free cash flow, are like a hardcover book -- solid. Substantial. Great for whacking a tardy student upside the head with. Varsity's profits, however, fall under the category of GAAP, or "accounting profits," the softcover version of cash profits -- they hold up all right at first glance, but the more you page through them, the less substantial they appear.
For example, under GAAP, Varsity nearly doubled its year-ago profit of $7.3 million, earning $14.2 million in Q3 (historically, its strongest quarter by far). But upon closer examination, you'll notice that $7.3 million of Q3's profit came in the form of a tax benefit -- something that also boosted last year's Q3 results, if by the smaller amount of $1.9 million. Back those benefits out, and Varsity's earnings performance reads less like a 94% year-over-year increase and more like 25%. Still good, but considerably less good than the apparent near-double.
Then there's the matter of cash flow. For reasons that I fear are all too clear, Varsity didn't bother to give its investors a look at its cash flow statement in its earnings release. To find it, investors had to rummage through the company's filings with the Securities and Exchange Commission. There you'll find that, to date, Varsity has generated net free cash outflows of $3 million in 2005 (excluding acquisitions) -- a significant deterioration from the $1.8 million it burned through in the first nine months of 2004. This came about in large part because of a quadrupling of Varsity's inventories and a near sextupling of its accounts receivable. With so much of its cash tied up in inventories and uncollected bills, it's little wonder why Varsity is bleeding cash.
So forget why I'm late in getting around to doing this book report. What you should really be asking for is Varsity's excuse.
Fool contributor Rich Smith owns shares of Varsity Group. The Motley Fool has a disclosure policy.
biz.yahoo.com |
