Under Armour, Inc.
Q3 2016 Earnings Call Transcript

Published: 25 Oct 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Under Armour Third Quarter Earnings Webcast and Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, today's conference is being recorded. I'd now like to introduce your host for today's conference, Ms. Carrie Gillard, Director of Investor Relations. Ma'am please go ahead.

[Carrie Gillard:]

Thanks, and good morning to everyone joining us on today's third quarter conference call. During the course of this call, we'll be making projections or other forward-looking statements regarding future events for the future financial performance of the company. We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially. These risks and uncertainties are described in our press release and in the risk factor section of our filings with the SEC. The company assumes no obligation to update forward-looking statements to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, as required by Regulation G, we need to make you aware that during the call we will reference certain non-GAAP financial information. We provide a reconciliation of non-GAAP financial information in our earnings release and in the electronic version of portions of the script from today's call, both of which are available our website at uabiz.com. Joining us on today's call will be Kevin Plank, Chairman and CEO; followed by Chip Molloy, our CFO, who will discuss the company's financial performance for the third quarter and provide an update for our 2016 and longer-term outlook. After the prepared remarks, Kevin and Chip, along with our Senior Vice President of Corporate Finance, Dave Bergman, will be available for a Q&A session that will end at approximately 9

[Kevin A. Plank:]

Thank you, Carrie, and good morning, everyone. We are a growth company. And with our 26th consecutive quarter of 20%-plus revenue growth, we continue to demonstrate our ability to drive a bigger and better company quarter-after-quarter. Our financial results are an incredible accomplishment for any brand and something that we believe separates us from others in our business. Today, I'd like to start by giving some perspective on our industry and articulate what that means for Under Armour in this moment in time. I believe we operate in a truly resilient industry. The athletic apparel and footwear business and in broader-context sports has been one of the most dynamic and strongest growing industries in our lifetime. As we continue to immerse ourselves in strategic and long-term growth, we ensure that we will continue to drive in an industry with barriers of entry today that are much higher than 1996 when I drove my old Ford Explorer door-to-door to teams selling T-shirts out of the bag. Our industry's collective ability to continue to evolve and make better products that improves an athlete's performance, bring the passion of the sports experience to consumers through our brand storytelling, and to do so with increasing profitability on a global basis is a reflection of what has been an ever-growing demand from consumers that our industry has met with outstanding financial results. Those measures of success are not as commonplace in other industries that are sometimes viewed as more stable or secure investments. Today, brands that five years ago were viewed as leaders in our field are in danger of being commoditized, disrupted, or worse, becoming extinct as technology and the way we live changes the way consumers need and value them. Our industry of sport is different. Our industry's growth opportunities are global with consumers around the world embracing athletic apparel and footwear at its historic levels. It's not about what people are conveniently referring to as athleisure is the simple truth that consumers all over the world are raising expectations about what to expect from their apparel and footwear and it's a shift that is not going to be reversed. The macro trends favorite not just us but all the premium brands in our business, which is part of the reason I believe our industry will continue to gain new and loyal consumers across the globe. In the sports industry, we represent something truly attainable, measurable and sought after by most consumers

[Chip Molloy:]

Thanks, Kevin. I would now like to spend some time on reviewing our third quarter 2016 financial results followed by our updated outlook for the remainder of the year as well as our long-term outlook and initial guidance for next year. Our revenues for the third quarter of 2016 increased 22% to $1.47 billion. On a currency-neutral basis, net revenues increased 23% compared with the prior-year's period. Our ability to deliver another quarter of consistent growth is a direct result of continued investments we have made in the business to meet consumer expectations through categories, channels, and geographies. As we continue to navigate through the changing dynamics of the North American retail landscape, we remain focused on solving problems for athletes all over the world and meeting the consumer with premium compelling product wherever they are interacting with our brand. During the third quarter, our wholesale revenues grew 19% to $1.01 billion. Our direct-to-consumer revenues grew 29% to $408 million, representing approximately 28% of total revenues for the quarter. During the quarter, licensing revenues grew 21% to $29 million and Connected Fitness revenues grew 40% to $20 million. On the product category front, apparel revenues increased 18% to $1.02 billion compared to $866 million in the prior year's quarter, led by consistent growth in our sport categories, including men's training, women's training, golf and team sports. Third quarter footwear revenues increased 42% to $279 million from $196 million in the prior year's quarter. Within running, we saw strong global demand for the brand, led by two of our new $100 price-point product offerings, the Bandit 2 and Slingride, showcasing our continued focus and investment in this key category of long-term growth. In basketball, the Curry signature line continues to drive strong growth for the Under Armour brand. Our accessories revenues during the third quarter increased 18% to $122 million from $104 million in the prior year's quarter, primarily driven by bags and headwear. On a regional basis, North American revenues in the third quarter increased 16% to $1.23 billion compared to $1.06 billion during the same period last year. Within our direct-to-consumer channel, our North American store count at the end of the quarter included 162 company-owned stores, comprised of 145 factory stores and 17 Brand House stores. With the opening of three new Brand Houses in the quarter, including Philadelphia, New York City World Trade Center and Madison, Wisconsin, we continue to invest in building and creating the best premium retail expression of our brand. International revenues increased 74% to $226 million in the third quarter to reach 15% of total revenues. On a currency-neutral basis, international revenues increased 80%. Within our international wholesale channel, the store count at the end of the quarter included 282 partner stores. Within our direct-to-consumer channel, our company-owned international store count at the end of the quarter included 63 stores, comprised of 32 Factory Houses and 31 Brand House stores. Looking at our international regions, starting with EMEA, we continue to post strong growth in the region as we expand our presence with key wholesale partners and distributors while building out our direct-to-consumer business. In the Asia-Pacific region, our premium performance brand strategy continues to resonate with the consumer driving strong growth in the quarter. As Kevin mentioned, we continue to see strong growth in basketball led by the Stephen Curry signature line and believe we are well positioned to capitalize and scale the business in our fastest-growing region. And in Latin America, we drove incredible brand awareness in the region and around the globe with the strong performances of our Olympic athletes. We remain focused on the long-term growth opportunity of this region as we continue to build and expand our distribution. Moving on to margins, third quarter gross margins decreased 130 basis points to 47.5% compared to 48.8% in the prior year's period. The following items contributed the majority of the margin contraction this quarter

[Operator:]

Our first question comes from the line of Michael Binetti with UBS. You line is now open.

[Michael Binetti:]

Hey, guys. Good morning.

[Kevin A. Plank:]

Hey, Michael.

[Michael Binetti:]

Kevin, let me – I'm going to start with a question for you Kevin. Can you just help us better understand within the context of the longer-term guidance, why you don't think you'll be able to hit the $800 million in operating profit income, and maybe what has changed that gives you confidence in hitting the $7.5 billion in revenues, wow, but not the $800 million in operating income?

[Kevin A. Plank:]

Yeah. Thank you, Michael, and this is obviously an area that I want to spend a little time on and go deep, so give me a few minutes to craft this for you.

[Michael Binetti:]

Sure.

[Kevin A. Plank:]

So, as Chip just said in his commentary, we talked about building a business as big as our brand. We've had our eye on $10 billion, that's the way that we see our company, I think it's the way that people view and judge us with $7.5 billion being our next milestone to be hit by 2018. And again, we want to reiterate that we're on track to hitting that goal. But there are a few factors that led to the decision to modify the operating income for us, since Investor Day September 2015. So what's happening and what's different? First of all, in North America, it's a place that provided incredible air cover for our brand for a very long time and I think like we're seeing in a lot of places that, that is modifying, it's changing. In the investments that we've made over the past 11 years as a public company, we've seen that our business, thankfully, has evolved from being strictly a North American wholesale apparel brand into a global sports brand that also has the ability to claim international and footwear as probably two of our largest and greatest opportunities for growth. And all the while, I want to be clear, with apparel remaining incredibly profitable and still growing at the tune of 18% in just the third quarter for us. So, there's not an end to the North American apparel story. That continues to march on for us as well. We just have other opportunities that are outpacing some of that growth. So some of those opportunities, like footwear and international, they are exceeding what we're putting up, in 24-plus percent topline growth as a company and that change in mix is modifying our gross margin story in the short-term. That means while we're doing better in footwear and international than we thought we were capable of doing, that we're fortunate to have these levers to pull and, frankly, attack as we maintain our industry-leading growth on the top line as well as continue to drive what we can in making the right investments in the right parts of our business. So it also changes our distribution. The fact that we've had three bankruptcies that have occurred in just the last 12 months in sporting goods that account for more than $4 billion in lost revenue for the sporting goods industry in North America, and compare that relatively speaking that going all the way back to 2008/2009 there was just $170 million of bankruptcies, of lost revenue in our industry. So we saw something pretty big happen that we'd thought about, but it definitely has been eye-opening for us, especially recently. We want to be clear, like our demand is still there, like this doesn't mean that the demand for the Under Armour brand has disappeared, but it certainly hasn't reappeared dollar-for-dollar in our immediate distribution. We believe that the opportunity is also still there. We just have to be more thoughtful about how to capture the consumers and their dollars including replacing with our own direct-to-consumer controlled retail as well as expanded distribution by doing things like Kohl's, which will carry the Under Armour product beginning in 2017. We also plan to make additional investments in the places where we know that we can win. So right now, that moment in time is a very important message I think for, obviously, our shareholders but, frankly, for our team and our consumer. Footwear and international are going to continue to be staples of our investment strategy, because we think the opportunity for us now is to strike and strike hard. And we take the momentum of things like Curry, with what is launching tonight, and I think you'll be pretty excited by what you see and, most importantly, the consumer is going to be pretty excited about what they see. We also have opportunities like lifestyle that, as we've talked about before on these calls, represents roughly a third of the revenues of our two largest competitors and today less than 5% of the business for Under Armour. Thirdly, Connected Fitness is continue going to be an area that we'll invest in, where we believe that redefining the expectation the consumer has of a sports brand with our data will give us perspective on our consumer that will be truly unmatched in our industry. Another factor that we've seen recently has been the escalation in the price and, frankly, the duration of sports marketing assets. The length of these deals has gone from standard 5-year deals arrangements to now 10 to 15-year deals. UCLA, one that we just wrapped up recently this past spring, was the largest collegiate deal in history, but it's a 15-year partnership. And at the same time, we also locked up Cal Berkeley and giving us a true position in California which, frankly, prior to that, we really didn't have. If we deem them strategic, the ability that what's happening in the sports marketing as these assets are being wrapped up, it's either act now, or lose them for frankly the mid to long-term. This, of course, does not mean every deal and I want to be clear, is that the shift in operating income for us is not about creating a bigger marketing budget so we can go buy more stuff. It is about truly investing in our brand, our systems, our infrastructure and especially our team. I'll give you another example of that in just a minute. So all those things are just some of the tactical but not to be ignored long-term strategic issues, new issues that we're facing since September of 2015. And when you grow a business 20-plus percent a quarter for 6.5 years, it builds a unique profile that we find ourselves today, which means adding $1 billion and growing a year in revenue and it requires significant resources and investment. But I want to be clear, is that the growth remains intact, it just costs more short-term investment dollars to achieve and the belief is that greater efficiency can come later and that the growth that we have over the short-term EPS is a priority for our long-term goal of becoming the number one sports brand in the world. And I want to reiterate that, like we are in this for the long haul and the opportunity that we see is to be the best in the world. And that does require investment and we know that people aren't going to like the way it sounds, but this is – I don't know if there's ever been another model like ours at 6.5 years with the growth that we've seen, particularly in consumer. And so the book isn't written anywhere and if it were, we'd have read it. But this is what we're telling you is that from our purview of 11 years public and what I've seen in our business, that now is the time for us to strike because I think the upside is so much greater on the other side. So on a relative basis, we believe the short-term dollars are better spent building our infrastructure, ensuring that we capture that 2018 goal of $7.5 billion, especially once we achieve the scale of a $10 billion growth company, which will be when we can truly begin to leverage our model to optimize expanding gross margins, our SG&A investment and ultimately shareholder value. So one of the issues that I just – I know people notice but I think it's worthy of us to say, that you face as a superior growth company, which Under Armour has always demonstrated its ability to be, is that operating growth of 15% for virtually any S&P or Fortune 500 business would be outstanding. But because our business is growing in the 20%s, a profile that only a very few rare companies in either the S&P or Fortune 500 and frankly not from our industry from either pharma or tech share and where we still expect to deliver more than $0.5 billion of operating income profit in 2017 alone. So we're not saying we're losing money. We are moving and marching forward or in growth terms that more than $0.5 billion is more than nearly two times the total revenue we delivered in our IPO year of 2005 proving that our investments in things like footwear, women's, and international have all paid off. But at the end of day, look, we believe that by making these investments, the ability for us is to mature into a business as big as our brand. And we want to drive best-in-class profitability as our business hits scale, our growth rates become more measured and we've got the people, distribution, systems and infrastructure to optimize. Today, we have pieces of it, but frankly it's just incomplete and that's why we must continue to invest. I want to give some perspective here for a second just on where we are. I mean, Under Armour's – we got dropped into the sporting brand pond about 20 years ago. And we jumped in and there were a lot of players, 20 players, 30 players or brands as many as you want. Today, we're the third-largest brand in the world. We're the second largest brand in North America. And our two largest competitors have more than 20,000 points of distribution each in North America alone compared to just our 11,000, which speaks to just some of the runway that we still have in front of us right here in our own backyard. They are also six times and four times our size respectively. So, let me give you a real-time example of what that means. It means in an area like women's footwear where we currently have just six teammates on our women's footwear team based in Portland, who are doing an amazing job for us and is building best-in-class product, our competitors who we get compared to on a one-to-one basis have dozens or even hundreds of people covering the same category. It's our responsibility for our long-term growth objective of being number one in youth, in men's, and of course, women's across all categories to continue to invest to meet that long-term goal. So, I want to be clear is that, you know, we have a saying around here, it's called, no loser talk. And it's the last thing we would ever do. And I want our shareholders to know how hard this company fights for every single dollar at the bottom line, but how we're looking honestly at this moment in time and saying it's time for us to invest. We have the best team and we've got the best brands and we expect to continue to grow.

[Michael Binetti:]

Thanks for all the detail, Kevin. I'll re-queue with my other questions. I appreciate it.

[Kevin A. Plank:]

Thank you.

[Operator:]

Our next question comes from the line of John Kernan with Cowen and Company. Your line is now open.

[John Kernan:]

Good morning, Kevin. Thanks for taking my question.

[Kevin A. Plank:]

Thank you.

[John Kernan:]

It seems like product flows into the retail channel and your wholesale channel are changing pretty dramatically, and we've heard from some of your competitors. And it just seems like there's a need for speed out of the supply chain and the sourcing from all the brands. Can you just talk about the change in product flows and how it's going to affect your business going forward?

[Kevin A. Plank:]

I mean, product flows for us, there's a lot of ways for us to think about it. So first of all, we're seeing a tough story that as we look or think about North America, you've heard a couple of people talk about it. And again, it's nothing's going away, but it's definitely been reflective in just some of the bankruptcies and the other things that we've seen recently. The people we're doing business with, I believe are doing very well. They're getting very smart about the way they're managing and running their business. But it's definitely, you know, you're not finding our accounts that are taking big inventory positions and betting on the cold weather. So, those are the things that are leading for us that's requiring us to run and to drive a better business. Today, I would define Under Armour as a great brand and as a great brand with a – but probably a good company. The opportunity we have is things like what we see with some of the speed to manufacturing. Things like recently when we announced our partnership at City Garage here in Baltimore and when we talk about a local-for-local strategy, which means bringing manufacturing back to the United States and again that's not a made in the USA initiative as much as it's an initiative for us about making great product anywhere. It's that the people of America want product made in America, the people of Europe want the same, the people of São Paulo want products from Brazil, so we're going to continue to answer that and look to drive on that answer. But there's a lot of investment on the front end. And the good news is that the sad thing about our industry is that a shirt and a shoe are still made the exact same way they were 100 years ago and we see a massive opportunity for that to improve. So some of the things I talked about in my script and my comments was how that we have the ability, I think, to accelerate the speed at which innovation can happen there. Right now to make a single shoe, for instance, it takes upwards of 300 pairs of hands to make a single shoe. So we think there's a lot of room for innovation, we're finding a lot about ourselves and I think that's continuing to move for us as well.

[John Kernan:]

Okay. And if I can just sneak one more in. I think longer term, what people see as they see one of your big competitors out in Portland with a mid-teens operating margin, they see one of your other competitors in Germany with a mid-single-digit operating margin, where does Under Armour fit in long-term? What's the true driver of margin expansion long-term? Is it really just following more through by better SG&A leverage, or gross margins and product margins can move higher? What pushes the operating margin longer-term when we think beyond just 2018?

[Chip Molloy:]

Hey, John. This is Chip. A couple of things.

[John Kernan:]

Hey. How are you?

[Chip Molloy:]

As we start to get to $10 billion, there's a couple things that will happen. One, the gross margins, we should start to get expansion on the gross margins and we'll start to get that because we won't be faced with as much of a mix shift that we're faced with today and the improvements we're seeing on the cost side of the house, we are seeing those today and they'll continue; but over time, as we start to gain more and more scale, we'll see that gross margin improvement. And on top of that as we get more into lifestyle, we'll see more gross margin as well. So, once we start to get towards $10 billion we'll see gross margin. At the same time, that's when we should really start to be able to leverage our expense structure. We're investing across the world. We're investing in offices, we're investing in IT systems, we're investing in distribution capacity. All of those things are happening today and will continue to happen over the next couple years, but we will start to see that leverage. So, it becomes sort of a perfect storm, once we get to $10 billion and we'll start to see operating income margin expansion. And I think we'll head towards more the premium level versus the other person or the other competitor that you're speaking with.

[John Kernan:]

Okay. Thanks. Best of luck.

[Chip Molloy:]

Yeah. Thanks, John.

[Operator:]

Our next question comes from the line of Erinn Murphy with Piper Jaffray. Your line is now open.

[Erinn E. Murphy:]

Great. Thanks. Good morning. I guess just on that last point Chip, for you, on the gross margin, the analyst that you talked about, 49% gross margin and now it sounds like you're saying that you need to get kind of bigger scale towards that $10 billion mark to really see that gross margin pick up. I mean, can you just help us think about at least over the next couple of years from a planning horizon perspective how should that gross margin line metric look?

[Chip Molloy:]

Yeah, Erinn. Well, first off, in any given quarter there will be noise around liquidations or FX. So that can happen in any given quarter, but over the course of the next couple years, we as a company will probably see flat gross margins. We're going to have mix as a headwind as we continue to grow our footwear at two times to 2.5 times our apparel and accessories business and the disparity between those gross margins creates a mix shift for us. At the same time, we're already seeing improvements in our footwear margins and we'll continue to see those improvements. And so net-net, we think we can overcome that mix shift through the improvements we're seeing on the costing side for the next couple of years; but net-net, it will be flat. Then as we start to approach $10 billion as I mentioned earlier, that's when we believe that we will have the scale and we will have a much more significant mix at that time of footwear that you'll start to see an expanding gross margin come $10 billion.

[Erinn E. Murphy:]

Okay. That helps.

[Kevin A. Plank:]

Erinn, we're also – I mean, I think it's just good to drive home the point about footwear and the opportunity we see there. So, Under Armour today, we're in the low to mid-30%s when it comes to our footwear gross margin that nets out compared to our competitors which are 10% or roughly 1,000 bps in front of us. And so, we've made great strides in the last couple of years actually taking hundreds of points of gross margin and calling that back and we see great opportunity as well. And so there's no secret sauce that someone else has that we don't. It's been time, it's been energy and experience and frankly having just gotten back from a trip from Asia about four weeks or five weeks ago and seeing the investment that our manufacturing partners are making us throughout China but also through Vietnam and the Philippines where you're seeing a lot of these new facilities going up, there is a great belief in a company and a brand like Under Armour that just a couple years ago, I think footwear is important to lay out. Last year, we made 30 million pairs of shoes. 2016, we'll make 40 million pairs of shoes. Obviously, you hear how bullish we are in footwear, so that number is increasing. And again, that's impressive, but it still compares to the hundreds of millions of pairs of shoes that are made by our competitors. So as we build scale, this will massively come on board as well it will help with people like Colin Browne, who is our new President of Sourcing, in some of the things that we'll do driving some of these initiatives. So, we see there's great opportunity in gross margin and this is nothing that we're laying back in – there's no excuse for what we're doing with operating income as it relates to – or the way that we're attacking gross margin across the board.

[Erinn E. Murphy:]

Okay. That's helpful. And then just on inventory up 12%, so fairly lean. I mean, do you feel like you have enough inventory if you go into the holiday season? And I think you're still planning for 20% growth in that Q4 and early part of 2017. How should we just think about that at the end of the quarter as well?

[Chip Molloy:]

Hey, Erinn. It's Chip. We feel like we're in really good shape from an inventory perspective. We did have very large growth rates over the course of late last year and then the early part of this year. So that growth rates come down, but the inventory is in great shape, and the inventory we have, we do have availability in the event that we all hope that it gets cold and it'll be nice and we do have the inventory to supply for that.

[Erinn E. Murphy:]

Okay. And then just last, Kevin, for you on women's. I didn't hear you talk much on this call on the women's opportunity. Can you just flush out where we're at now and kind of where you see that as you think about your 2018, $7.5 billion goal? Is that still unchanged in terms of the opportunity?

[Kevin A. Plank:]

Yeah, completely. So, I want to be clear is that women's remains one of our brightest opportunities for growth in our business. Women's is still growing in the quarter, up 17%, I think 18%. And again that the heart of this is category management. I spoke about it in my prepared remarks and we've done that with women's to specifically call it out and make sure that it gets the emphasis it needs. Pam Catlett is leading that. She's an industry vet and has been a complete pro in bringing the pieces together, but there's a lot of pieces to bring together. Probably the best thing I could say is, when you talk about our women's business, we have $1 billion women's brand. It's taken us one heck of a long time to get here, but we're incredibly proud of what that means. And but, you know what, I think probably looking at women's through the lens of – I gave the example about footwear in one of my earlier answers, and we have six people in our women's footwear team. We just built our first Women's Last, last year for the first time and those are the things from an operating income standpoint. I want to say is that when people say you don't have enough – people dress toe to head. It's the way they start with their shoe, but if the shoe isn't right, if the fit isn't right, if the color isn't right, if we don't have the right team, you know, the reason we didn't build the Women's Last before is because we were focused on the ability that we couldn't afford it. And so we're making a lot of those small decisions right now that we truly believe that looking at 2017, 2018, making the investment as unfortunately and fortunately because our growth rate is so great, it creates that drag. But making this right investment in footwear is important. So we go back with women is that one thing we think is incredibly important is that the football cleated opportunity and what we're doing being the number one cleat there isn't doing much for the women's category. But the confidence that we're demonstrating in running from our knit products, this is the – again, this will be the first year in the market that we'll have that Women's Last on people's feet, on women's feet and we also think that as we continue to drive a better product for driving both performance, style, strength and beauty, the focus is we'll have. And so I think we've got a terrific team in place. We are investing in our women's team as well. We think footwear will be one of the catalysts for it, but achieving $1 billion business in women's is a pretty big feat and it's something we're certainly not stopping or satisfied with.

[Erinn E. Murphy:]

Thank you. And best of luck.

[Carrie Gillard:]

All right. Operator, that's all the time we're going to have today for questions.

[Operator:]

Okay. I'd like to turn the call back to Ms. Gillard for closing remarks.

[Carrie Gillard:]

Thank you all for joining us today on our call. We look forward to reporting to you our fourth quarter and year end 2016 results, which tentatively have been scheduled for Tuesday, January 31, at 8

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day.