Under Armour, Inc. (UA) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Under Armour Inc. Third Quarter Earnings Webcast and Conference Call. [Operator Instructions] As a reminder, today's conference call is being recorded. I'd now like to turn the conference over to your host, Mr. Tom Shaw, Director of Investor Relations. Please go ahead.

Thanks, and good morning to everyone joining us 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 or 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 uncertanties are described in our press release and in the Risk Factors 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 an unanticipated event. Joining us on today's call will be Kevin Plank, Chairman, CEO and President; followed by Brad Dickerson, our Chief Financial Officer, who will discuss the company's financial performance for the third quarter, provide an update to our 2012 outlook and introduce our preliminary 2013 outlook. After the prepared remarks, Kevin and Brad will be available for a Q&A session that will end at approximately 9:30 a.m. Finally, a replay of the teleconference will be available on our website at approximately 11:00 a.m. Eastern Time today. And with that, I'll turn it over to Kevin Plank.

Thank you, Tom, and good morning, everyone. 10 consecutive quarters of 20-plus percent top line growth. 12 consecutive quarters of 20-plus percent growth in Apparel. Third quarter revenues up 24% and EPS up 23%. Inventory is down 2% year-over-year. These numbers speak to the level of consistent execution that you'll come to expect from an industry leader like Under Armour. We are a growth company. One that in 7 years in the public markets has proven our ability to patiently unlock the power of the next great global athletic brand. So I will start with some commentary on how we achieved our strong third quarter results. I believe the most compelling piece of our growth story is our patience in developing our brand and the opportunity that provides us to continue to grow at this accelerated pace into 2013 and beyond. But first, the scoreboards. The external financial scoreboard is full of Ws, with balanced contributions on the revenue side from our 3 key Apparel drivers of Men's, Women's and Kids. When we spoke after our first quarter results earlier this year, we talked about 2 key themes that were critical to our success in 2012 and beyond. First, when we innovate and add value for the athlete, we win. And second, our success in balancing the need to improve operationally in critical areas like supply chain, planning and design while executing to deliver that 20-plus percent growth. So looking at our innovation and operational scoreboards, the results were equally strong. First on innovation. The strong acceptance we saw this past quarter for our Spine footwear technology and the fact that Cam Newton Highlight cleat was the single most compelling on-field product at retail in 2012 is great evidence that our thought leadership has raised consumers' expectations for Under Armour…

Thanks, Kevin. I would now like to spend some time discussing our third quarter financial results, followed by our updated 2012 outlook. I will conclude with some initial thoughts on 2013. Our net revenues for the third quarter of 2012 increased 24% to $575 million. Apparel grew 22% to $445 million during the quarter, representing the 12th straight quarter of at least 20% growth for our largest product category. We continue to see strong results across our Men's, Women's and Youth categories. Men's was led by training, hunting and underwear, with underwear driven by the category's introduction into over 500 department stores year-to-date. On the Women's side, we are experiencing strong results in our Studio line and Sports Bras to continue to deliver a better balance of performance and design. In Youth, we more than doubled our graphic business year-over-year while also expanding into more than 250 department stores. Our Direct-to-Consumer net revenues increased 31% for the quarter, representing approximately 24% of net revenues compared to 22% in the prior-year period. In our retail business, we opened 4 new Factory House stores during the third quarter, increasing our Factory House store base to 96, up 26% from 76 locations at the end of the third quarter in 2011. We plan to open 5 additional Factory House stores in the fourth quarter, bringing our total Factory House store count by year end to 101. In e-commerce, we have seen improvements in site fee and functionality in the last quarter and the conversion GAAP year-over-year has narrowed. Third quarter footwear net revenues increased 21% to $63 million from $52 million in the prior year, representing approximately 11% of net revenues. As you will recall, we shipped nearly 5 million in introductory footwear product to our Japanese licensee, Dome, in last year's third…

[Operator Instructions] Our first question comes from Omar Saad of the ISI Group.

Kevin, you mentioned -- 2 questions. You mentioned on some of your prepared remarks the importance of the authenticity of the sporting goods channel and how critical that has been for the brand and will continue to be for the brand. Can you talk about the channel distribution options for you guys as you think about some of the new areas where you want to grow, International, Women's. Is that still the right channel especially International? Are there sporting goods, authentic sporting goods retailers, available that you guys can partner with? And also how does that make you feel about owning retail? Are you thinking about to the extent there isn't a great sporting goods channel in some of these opportunities? Are you guys revisiting the idea maybe doing a little bit more own retail outside of the factory channel?

Yes, well I think it definitely forces our hands as we look outside the United States. Beginning here, I don't think we can reiterate enough the strong partners that we have, the relationship and partnership we have with Dick's Sporting Goods is really, is clearly our largest customer and has been a real advocate for our brand from the beginning. And so you'll continue to see large investments in their doors and what we're doing on a partnership level at that level. And it's not limited to just Dick's though either, throughout sporting goods as a channel for us. So we're very proud of our relationship there. And I think we're demonstrating with things like the 20-plus percent Apparel growth that we'll still continue to grow there too. More productive floor space, more compelling shops and better stories and then we'll continue to come back. And I think be a driver for those doors as well is demonstrating with innovation and winning. And then we're also leveraging again our core basics with the sporting goods guys with helping us with footwear in getting our market out there. And so what we, really, we reset in 2010 with the idea of selling product above $100, that's typically not where sporting goods is selling footwear either. So it's been challenged. But we found success beginning with our roots and things like the Highlight cleat at $130 this past football season with something that was great and that's leading over to the new Cam Highlight trainer that we have coming out in a few weeks. So we'll continue to set the mark of what we're doing at sporting goods. At the same time, you're watching the brand evolve. And again, I'm speaking domestically. But many of the players I'm talking about can help…

Our next question comes from Kate McShane of Citi Research.

I was wondering if we could have a little bit more detail on inventories. Can you break out any areas in terms of what categories where inventories are maybe higher than the corporate average? What product are you finding you have to airfreight and how inventories are at your retail accounts?

Sure, Kate. And I think the first and foremost, the things -- the message to get across is obviously demand for our brand is very strong. Obviously, 20% growth in apparel kind of proves that out. With that growth, supply chain is always going to be challenging. Last few years, this year, even into next year, we know there's going to be challenges to support that strong demand for our brand. Our job is to execute and manage through these challenges and then our teams obviously have done that. The back half of this year though, we do have a little bit of some challenges on the apparel side of the business, really relative to the on-boarding of a couple of new factories and it persisted in Q3. It'll persist a little bit in Q4. And again, our team did a great job managing our way through some of those challenges to deliver the demand. One thing I think to notice though is in prior years, we've had similar challenges to support the growth of our brand that we're having this year. However, the change probably being is in prior years we've had a lot more inventory kind of as a backstop to offset some of those challenges. And obviously, we talked a lot about our inventory management initiatives over the last 12 to 18 months and we've seen a lot of success in those initiatives. And the one thing we've talked about is kind of the analogy of the pendulum and that we know that when we manage inventory that the pendulum will continue to swing. It's an imperfect science. Our job is to make sure that pendulum swings in a very, very narrow of range. Right now, when we look at our current inventory balance being down 2%…

Our next question comes from Michael Binetti of UBS.

Brad, can you just help me really quickly walk through the math on how the supply chain challenges you point out in the third quarter resulted in higher airfreight, but that you did see favorable impact from allowances and discounts year-over-year?

Yes, really liking it Michael. So if you look at last year, if you remember what we're talking about last year, again, we've had supply chain challenges pretty much every year to support our growth. It's our team's job to manage through that. If you remember our conversation last year was some of those conversations where we were trying to sell some stuff to customers and get some customers to take some product, sometimes it was a little bit late. Sometimes it was exchange type product to deliver to them to keep the shelves full because of the demand for our brand. And that costs us sometimes a little bit on the discount side. Mostly around the areas where we weren't getting stuff maybe on time last year and we had to give them something else in exchange for that. So we called out those sales discounts and allowances last year again to meet demand. This year, the change being a little bit is that we don't have that backstop of a lot of excess inventory, so it's really important that we're delivering exactly what we plan to sell on the retail floor. So the need for sales and discounts is reduced this year because we're not selling, we're basically selling exactly what they wanted. The challenge for us though obviously without that backstop of inventory is to get that product there on time. Therefore, you're seeing more of an airfreight pressure this year to get that product from manufacturing on time. And that's really the difference year-over-year if you look at sales discounts and allowances versus airfreight.

Michael, too, I would just want to give I think a callout to our team as well is that good companies even in tough quarters, they do what they said they're going to do. And this is I think a really good case of really the way our team came together is that when we do see challenges is that we make things happen. And more importantly, we do it the right way. And we're very, very proud of that. And it always begins with leadership. I mean, this quarter, what Jim Hardy has done and meant to our supply chain and coming in now here and just a under a shade -- under 6 months, has really jumped in. First and foremost, bought into the Under Armour culture in a way that is unique and then more importantly, leading the team. So we saw that. That was evident this quarter in the things that our team did to ensure that we got the product to our customers they're looking for. And the good news is that they're still hungry for a lot more. So we'll make that happen. The things we've done as well just building out our supply chain from a systems standpoint. We continue to sophisticate there with a great partner like SAP and building that out in some of the systems we're adding to our ERP system, and our planning system as well. Physically, we've added a new warehouse in Rialto, California that's just come online, it'll be nearly more than 1 million square feet that will give us more capability and servicing and getting our product from the Far East into the U.S. as well as we just continue to become more sophisticated there. Our factory base, building new relationships. 2012, we found ourselves really…

Kevin, can I ask you quick follow up? Just on the 2013 initial guidance, you pointed to the retailers ordering now and will have a better look at how that year will go next year as you get through your bookings for next year. But we've seen all year these guys went through a rough winter last year than the spring was warmer than expected early on. We've seen the retailers ordering pretty close to what they were actually seeing on the floor at this time. Obviously, the weather is off to a slow start this fall. I mean, what's your sense as to how the early orders that you've seen, how your strategic partners are feeling about the year ahead? Do you feel that they're still ordering, looking at it right now and follow off to the slow start or how much conservatism do you feel like there is out there in the early orders that you are seeing at this point?

So I think that begins with us being prudent the way that we approach the year in the same approach we took is we basically we weren't looking for any upside from a year ago. So I walked outside this morning. It's 65 degrees and you just watch people walking down the street in Bermuda shorts and you're going, "What's going on? It's late October." So the good news is we've had a couple of cold pops. And we when we see that, traditionally, we've seen over the last 17 years in business, business screams when we get it's 30 or 40 degrees outside and kids are running through their local sporting goods store and buying their ColdGear Mocks. But frankly, we've evolved as a company where we're not dependent on that anymore. So the way that we're approaching 2013 in general, it's again I think when we started to see this last year, we made a decision actually -- fortunate for us, a couple of years ago, we decided we no longer wanted to be weather-dependent as a company, but we wanted to become innovation dependent where we can control, we could be, we could define our space and not waiting for mother nature to get cold or anything else. So innovation for us is going to continue to be a focus and I'll take a second to tell you about 2013. We're going to continue to grow in the core categories like Men's, Women's, Youth apparel and then our direct consumer channel will continue to be a force for us as well. You're also going to see a continued expansion of key platforms that we have. Things like Charge Cottons and Storm Cotton giving the consumer reason to buy is that whether it's a long sleeve shirt or…

Our next question comes from Camilo Lyon of Canaccord Genuity.

So just going back to the inventory question. Do you feel that you guys have enough -- what's your ability to meet the auto-replenishment demand in the fourth quarter if weather does get colder? Given that your inventories are now down 2% and you had some supply chain challenges?

Yes, Camilo. Obviously, again, we're going to see a little bit of those challenges into Q4 also and that's why again we're going to lean a little bit on airfreight to make sure we can meet that demand. So, especially around seasonal product, I think that is where the need will be to get that seasonal product in on time. Specifically, around some of the product that Kevin was talking about outside of maybe our ColdGear mock product. When you look at auto replenishment, we tend to lean a little bit heavier in Q4 on auto-replenishment. And some of those areas that you do lean on are some of those areas that maybe are a little more weather-dependent. And coming out of last year's warm winter, I think the retailers obviously had some stock of that very cold weather-dependent product and we do, too. So I see less risk in the auto-replenishment sides. I think we're well positioned from the inventory perspective to satisfy that demand, that need if the weather behaves for us.

So that outlook on the source of upside from that part of the business doesn't sound like it changed? Is that correct?

Yes. From an outside perspective, I think you looked at the same thing that we talked about last quarter in Q4 and that, one, is weather; and two, is our e-commerce business. And we talked about taking a more moderate approach to our e-commerce business last quarter. We've seen some positive trends in the third quarter. But such a large volume of our e-commerce business is done the last 2 months of the year and we want to be careful how much we guide and anticipate the benefit to be much during the last 2 months. So we're still taking kind of a moderate view towards our e-commerce the last 2 months.

Our next question comes from Joseph Parkhill of Morgan Stanley.

I was wondering if you could talk about given the lower levels of excess inventories, how you're thinking about your outlet business next year. Will that impact sales at all? Are you planning to supplement that with more made-for-product and then maybe how that impacts your margins within this retail segment?

Yes, good questions, Joseph. And obviously, the level of excess we have as a company, outlet's going to be a big part of the relief valve for that excess. So we talked this year a lot about leaning on our outlet business this year and that having obviously a negative impact to our gross margins. Because we're going to lean on them from an excess inventory perspective, especially in the back of the year, which we're doing right now. Obviously, creating a lot less excess units this year even more so than we had planned to create less. That does impact the business a little bit now with next year. So we've had to look at next year's business and know that we're going to lean a little bit more on the made-for side to fill in the gaps on outlet. There's good and bad to that. The good being obviously that gives us a good ability to control the products in the space and outlet. The challenge to that obviously is we have to make more products versus having the products here in the warehouse. So our teams are working on that right now. To your point, the result of that should be trying to get the right balance of made-for versus excess as we move throughout the year. The percentage of made-for should be higher next year versus this year and there should be a positive impact to gross margin next year on that also.

Just a big picture around footwear over the next several years. Do you think that footwear will outpace apparel growth in the next several years? And is there kind of a market share that you look for targeting or think that's achievable within the subcategories that you compete?

As Brad said the first one was a good question, that was a great question. So let me take a minute actually get into footwear for a second. Coming of the Spine, I think there's a lot of speculation of how do we feel about how we feel about our Spine launch. We made a big deal about its launch in New York City with Tom Brady and Lindsey Vonn, Kemba Walker. So we had I think a lot of excitement going into it. But we learned a lot too. This is really exciting for us because it's true, it's our first really commercial midsole technology that gives us a platform to build on. And so we want to be clear that where we're starting with Spine is not exactly where we're going to end up. And this isn't a -- we threw it against the wall and try it. But we're going to come back and we're going to commit and we're going to market and we're going to tell the story of what Spine is. And most importantly, you're going to watch the product evolve. You're going to watch the product evolve and continue to get sleeker, continue to do improved aesthetic, continue to become more conducive to what the athlete is looking for and we're starting to see that. So Spine 1 was a great learning experience for us. And what we have hitting retail so far is the update to that, which is actually Spine Storm playing into that Storm technology, of that water resistant capability frankly that makes any product Under Armour and that begins to hit retailers in December. It's something that's going to be really exciting for us. But you look at where we've come from going back to the 2009, 2010, when…

Our next question comes from John Zolidis of Buckingham Research.

I was wondering if I can ask a little bit more about the department store launches. Can you talk about what products you put in the department stores, how it's gone so far? And in particular, if you think there's been any impact on either the DTC business or the traditional distribution channels with the sporting goods partners, and then kind of how do you see that evolving over time?

Yes, we've entered a little more than 500 new points of distribution year-to-date so throughout 2012. And so we've been pretty thoughtful and strategic as I mentioned about 300 Macy's, about 150 Dillard's. And beyond that, there's a few other key partners that we've had in there. But really, the story that we've led with a majority of these has been our underwear story on the Men's side, you've had a limited or maybe a little more than a limited display on our Women's product because again, just finding out the appropriate distribution for where women shop is part of what our goal is there. But we're still in the introductory phase. Take Macy's for instance. We've learned that prints and colors perform better than basics in things like underwear for us there. We're testing a few things like our tech fleece in November and a few of our basics. But golf I think is something that at least stylizes. It's something that gives an opportunity there, but Youth is something where again we're constantly struggling for Youth distribution and so the department stores give us good access there. And on the Men's side, we are pretty limited I think with the display that we have in Men's. For Dillard's as well it's led by underwear and boy's, much smaller assortment than girls, Women's and Men's. So we're really I think we're biding our time. We're making sure that we have success and that we have wins. We're making sure that it's appropriate and that it works and that the brand is relevant there. To the answer to the tune of how it affects any of our own stores or our known DTC, we haven't seen any cannibalization there. Our DTC today from a bricks-and-mortar standpoint is defined as 96 outlet stores today so there's not a lot of crossover with that. And we haven't seen any cannibalization of our -- more importantly, our core distribution. So we feel very, very good about it and I think, what you'll notice, with 38% growth in 2011, with 24% growth this quarter and where we're trailing for the year, we feel like we've got the 5 growth engines we were talking about since our roadshow, Men's apparel, Women's apparel, footwear, International, Direct-Consumer, we're very fortunate to have the ability to lean on any one of those when we need to. But to generate or drive more growth, we're not desperate for distribution and it gives us the ability to be selective with not only the partners that we choose, but then the assortments that we actually put in those partners as well. So we want to protect our current partners first and foremost.

Our next question comes from Mitch Kummetz of Robert W. Baird. Mitchel J. Kummetz - Robert W. Baird & Co. Incorporated, Research Division: Brad, you talked about earlier, you talked about how ColdGear replenishment is heavier in the fourth quarter or replenishments in general that's heavier in the fourth quarter. Can you give us some sense as to what type of percentages in terms of your overall apparel business in Q4 like cold year replenishment?

Just to give you some context to that, overall for the year, it's probably in the 25% to 30% range on replenishment. When you get into the fourth quarter, you're probably more in the 35% range for replenishment. So in general, it's definitely higher, but it's not significantly higher. Mitchel J. Kummetz - Robert W. Baird & Co. Incorporated, Research Division: And can you remind us how that business performed last year in Q4? I assume it was not very strong?

Yes, again there's a balance there in auto-replenishment, so it's not all cold weather-dependent product. Obviously, our cold weather-dependent product is going to be heavy in Q4 and also early Q1. But there's also some more versatile product in auto-replenishment also that wouldn't be cold weather-dependent. So there's a little bit of a balance in those numbers. So obviously when you look at last year's numbers in a warm weather environment our versatile product, our fleece product did very, very. While obviously, our cold weather-dependent product did not perform as well. So again in this environment, this year kind of the same balance. We're kind of forecasting and planning our business in the same weather environment as last year, so we would expect our versatile product, our less weather-dependent product to perform well and our cold weather-product would not perform well if the weather was warm. Mitchel J. Kummetz - Robert W. Baird & Co. Incorporated, Research Division: Quickly, one last question. In terms of carryover inventory at retail, I mean you alluded to it in your comments you've talked about it before. Can you tell us what impact that's having in terms of how you're deliveries are flowing in the back half of the year did that put a little pressure on Q3 that maybe helps you a little bit in Q4? Or how should we be thinking about that?

Yes, I think it's a good way to look at it. Obviously, when you see that cold weather kind of replenishment cycle start, that'll usually start in September. So from that perspective, if you carry inventory into this year from last year, you would expect the start of that cycle would be really servicing demand from that cycle would be from product you already have in stock. So to your point it definitely impacts the beginning of the cold weather auto-replenishment cycle, which that would be September, October time frame. For the most part, it's I think where you would see the most impact from the last year's weather and the inventory stock.

We have time for one more question.

And our final question comes from John Kernan of Cowen.

Just wanted to -- wondering what you're planning in terms of international growth into 2013. What's embedded in your assumptions? And what you're learning about that soccer and European consumer following the launch of the Hotspur partnership last in the summer?

Yes, on the international front, Charlie's just getting here and what he's doing is, of course, doing a deep dive on what Under Armour is and what it looks like. With 90-plus percent of our business coming from North America today, first and foremost, we're going to protect that. We're going to drive it against that as well. But we see the opportunity abroad is extraordinary. It's led by the example of our business in Japan. First and foremost, those guys are going to do close to $200 million this year and we're looking at a business that'll grow of north of 30% to 40% as well looking at 2013. So we've got great upside and belief there. I talk about leadership because what we have in Japan is a guy named Shinji Kushiro [ph] who runs Dome Corporation, our partner there and he runs that company. There's 300 people or 400 people that they have at Dome today. They work for Shu [ph], they work for Under Armour and they believe in their mission. So we know how critical it is to get that right in the other regions that we have around the world. So finishing off Asia from what Shu's [ph] doing in Japan to appointing leadership in China as well will be the next thing is we're building out our office in Shanghai and really getting things going. So you'll see a little bit of shift in taking some people that understand the DNA and the way that things work at Under Armour here in Baltimore and how they can use that to their advantage of not feeling just an office in another city and halfway across the world. We've done frankly the same things in Europe. Charlie just got back and spent the last couple…

Sounds great. And if you don't mind me squeezing one more question. The cash flow, performance this year is going to be up big given the improvements in working capital. Brad, how are you thinking about capital allocation next year CapEx and maybe additional uses of that cash?

We're still rolling some ideas up around that right now, so we'll give you some more guidance on that as we get to our January earnings call. But obviously, cash flow for us is tied to inventory and the management of inventory. So when you see us be successful in managing inventory the benefits of that flow to the free cash flow metric. When you see challenges in inventory you see vice versa for us so cash for us right now is all about inventory. Our job is to put ourselves in the position to have cash on the balance sheet. It's important for us. It's important for us from a competitive perspective to position ourselves to have that strength in our balance sheet. So we want to manage inventory efficiently the best we can without the pendulum swinging too far. That will benefit our cash. And we think at this point in time, it's important for us to keep that cash in the balance sheet and or use it for appropriate investments to continue to drive growth in our long-term brand.

Thanks for joining us on the call today. We look forward to reporting you our fourth quarter fiscal results, which tentatively has been scheduled for Thursday, January 31 at 8:30 a.m. Eastern Time. Thanks again, and goodbye.

Ladies and gentlemen, this does conclude today's conference. You may now disconnect, and have a wonderful day.