Under Armour, Inc. (UA) Q2 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Under Armour Incorporated Second Quarter Earnings Webcast and Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn [ph] today's conference call to Mr. Tom Shaw. You may begin, sir.

Thanks, and good morning to everyone joining us for the -- on today's second 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 uncertainties 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 day on which the statement is made or to reflect the occurrence of unanticipated events. Joining us for today's call will be Kevin Plank, Chairman and CEO; followed by Brad Dickerson, our Chief Financial Officer, who will discuss the company's financial performance for the second quarter, followed by an update to our 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 this teleconference will be available at our website at approximately 11 a.m. Eastern Time today. And with that, I'll turn it over to Kevin Plank.

Thanks, Tom, and good morning, everyone. Q2 marked the 15th consecutive quarter where Under Armour Apparel grew at least 20% and the 13th straight where total revenues grew at 20%-plus. We look at these results and 3 key themes jump out at us. First, our long-term strategy for growth is clearly working. At our Investor Day here in Baltimore last month, we laid out our plan to once again double the size of our company, targeting $4 billion in revenues by 2016. Today's results reinforce how our brand continues to resonate with both our core and new consumers in both established and new channels of distribution in North America. Second, these continued strong top line results are great evidence that there is still significant runway for our brand in North America, not just in the areas where we see accelerated growth opportunities like Women's and Youth Apparel, but in our core Men's Apparel business as well. And third, the significant opportunities to grow our Apparel business in North America provide a great foundation for the investments we are undertaking to make Under Armour a truly international athletic brand with Apparel and Footwear platforms being built to reach a global consumer. These investments in our Footwear and global infrastructure will cost money, but we are confident that the return on them will enable us to continue leveraging our brand equity as we expand into new categories and geographies. So let's start with our U.S. Apparel business and the multiple ways we continue to resonate with our customers here in the States. We continue to take share in multiple categories and genders through a combination of increased floor space and greater productivity from our existing retail partners, expanding our presence within our relatively new department store distribution and that ultimate driver of…

Thanks, Kevin. I'd now like to spend some time discussing our second quarter financial results followed by our updated outlook for 2013. Our net revenues for the second quarter of 2013 increased 23% to $455 million. Apparel grew 23% to $310 million during the quarter from $253 million in the prior year, representing the 15th straight quarter of at least 20% growth for our largest product category. Increased newness remains a key factor in our Apparel strength here to-date, highlighted in the second quarter by our new HeatGear Sonic Baselayer line as well as our expanded Storm and Charged Cotton platforms. Additional success in Women's was driven by our expanded sports bras assortment, new designs in tanks, heightened color in capris. We are also seeing tremendous traction in Youth, both Boys' and Girls', where we are seeing strong growth in both new and existing distribution led by graphic tees. Our Direct-to-consumer net revenues increased 29% for the quarter, representing approximately 30% of net revenues compared to approximately 29% in the prior year period. In our retail business, we opened 3 new Factory House stores during the second quarter, increasing our domestic Factory House store base to 105, up 14% from 92 locations at the end of last year's second quarter. As we provided at last month's Investor Day, we expect to open approximately 13 total Factory House stores during 2013, closing the year with 114 domestic locations. On the specialty store side, we continue to test and learn at our first UA Brand House store in Baltimore and remain on track to open our second location at Tysons Corner this November. In e-commerce, we achieved another quarter of strong growth highlighted by ongoing positive trends in average order value, which benefited from an improvement in our inventory positioning across the…

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

You talked a lot about international in your prepared remarks. I wanted to get your thoughts in terms of how those channels are developing. And if you see kind of the partners out there, at least on the wholesale side, that you can work with in some of these new markets? Or is DTC going to be a key factor there? And then also in the tax rate, does that play into the International piece? It came in a little bit higher, kind of you raised the tax rate guidance as well.

Yes, well, I'll let Brad jump on the tax rate. But let me start with International. As you can hear, we're really excited about it. We think there's -- as I said, it's going to be our largest growth category next year, which will be somewhere north of 40% as we see it as a company. And again, it's off of a small base right now. It's only been 6%, 7% of our total revenues to-date, but it's something where we continue to get -- be involved in and gain confidence in the fact of what International can be. The way we evaluate the opportunities as a whole begins with the opportunities. So we're currently doing business in 61 markets today. When I say doing business really well, it means that a lot of times, we just have a rack of clothes and maybe a distributor. And so, we're really trying to professionalize that and really grab markets that we can make an impact in. So beginning, a, with the opportunity of where should we go based off GDP, things like that. Then we're looking at the return because we're not looking to make 15-year investments, although we have the ability to do that and we are, in some cases, but we understand that we also want to invest in markets that can return to us quickly. And then we're also looking at the market expertise. And that basically comes down to do we have the leader. It's the thing that took us to Japan back in 1999 or '98, and it's what is leading us and getting us so excited about markets like Brazil that I mentioned where we have nearly 50 years of experience. So what we're finding when we go to these markets, as we mentioned in…

Yes, Omar, on the tax side, obviously the U.S. has one of the highest corporate tax rates in the developed world, which is unfortunate in general but especially for us, where approximately 90% of our revenues are generated at this point. The opportunity for us to have a lower tax rate is really to increase our global footprint. And the good news here is we've invested a lot of time and money over the last 5-or-so years implementing a really sound international tax structure. The good news is the structure is in place, it's ready to go. That's behind us. So there's really 2 ways for Under Armour to generate profits overseas going forward, which inherently would be taxed at a lower rate than in the U.S. One is the sourcing structure we have. And we have physical presence overseas and substance overseas that provides a lot of crucial product development and supply chain support to deliver our products to our customers. We do have some of the structure in place, and we have already seen some of the benefits of that structure in our current tax rates. But the bigger piece probably is just profitable International business from top to bottom overseas. Again, roughly 90% U.S. based, we really don't have this yet. And this is really the longer-term opportunity is for us. A larger proportion of not only revenues but a larger proportion of profits overseas will be the ability for us to see a more favorable tax rate. Since we're clearly in investment mode right now in the International front, the profitable piece of this business is longer term, and that's why you're seeing a tax rate benefit also to be longer term for us relative to that. So basically, if you look at the tax rate for us, as our profits overseas increase, our tax rate should benefit, being taxed in lower-rate jurisdictions. And on the flip side, if our overseas profits decline, this would hurt our tax rate as a higher proportion of our income would be taxed in the U.S. This is kind of evident this year when we talked about in prepared remarks of the recent acceleration of investments in Latin America and our FX exposure to our Japanese licensing business, both reducing near-term profits overseas, was the reason why we saw our tax rate kind of uptick this year. But longer term, again, as we expand our International business and become more profitable longer term, that should have an obvious benefit to our tax rate.

Our next question comes from Mitch Kummetz with Robert Baird. Mitchel J. Kummetz - Robert W. Baird & Co. Incorporated, Research Division: A couple of questions, first for Brad. I don't recall you talking about discounts and allowances for a while in your gross margin discussion. Could you just remind us where fill rates have been trending through the first half of the year maybe compared to last year and sort of what your expectation is there as we go forward into the back half?

Yes, Mitch, on the fill rate side, the trends have been pretty positive. Still not where we want to see them be, but they're trending very positively compared to last year. So we had fill rates in the back half of last year, especially by customer request date as low as in the 60s, in the low 60s at some point in the back half of last year. And even by cancellation date, that improved maybe into those low 80s as a percentage for fill rates for kind of our seasonal product. Our AR items last year were probably bolstered to a 90% fill rate, especially in the back half of the year. What we've seen with the trending so far in the front half of this year is much better fill rates. Still again not where we want them to be, but right now, as we look at the second quarter of '13, our fill rates on -- by cancellation are kind of more closer to 80%. So up from the low 60s last year to closer to 80% this year. And then, by cancellation date, we're in the 90s on seasonal product, which, again, we were in the low 80s last year. And on the AR side of our business, a lot of the replenishment side of our business, we're into the mid-90s now. So definitely seen the positive trends from last year to this year. Still have a little bit of work to do there to get where we want to get, which the goal is to kind of have the overall both those metrics kind of in that 90% to 95% range by customer request date. And so we've got some work to go. As far as discounts and allowances go, we've talked a little bit about that in the past. And then obviously, we're seeing less of an impact on that right now with fill rates trending in the positive direction. We're not really seeing any negative impact to discounts and allowances. And positive impact, for the most part, is in our numbers and in our guidance and it's relatively small at this point in time. Mitchel J. Kummetz - Robert W. Baird & Co. Incorporated, Research Division: Okay. And second question, can you just -- as far as your guidance for the back half of the year, your sales guidance, is there a sort of underlying weather assumption that, that is based on? I mean, are you expecting sort of similar weather to a year ago or better weather or normal winter? And then kind of with that as a backdrop, how are you thinking about reorders and maybe your -- the comp on your own stores in terms of kind of what's embedded in your back half outlook?

Back half outlook, for the most part, if you look at kind of our Q3 and Q4, not really seeing a lot of changes in our Q3 outlook in revenue relative to our previous guidance. What we have seen is a little bit of more favorability to our bookings on the wholesale side in the back half of the year, especially as we get into Q4. And some of that also -- that Q4 strength is being driven by the fact that we are making some additional investments in shop-in-shops at especially Dick's Sporting Goods, which will have -- most of those will be in place by the fourth quarter and therefore have some impact to the fourth quarter. And this higher outlet store count we talked about will really come into play in the fourth quarter and not the third quarter also. So some of what you're seeing is kind of the nuances of the Q3, Q4. Q3 story is pretty much the same as our previous guidance. Q4 is a little bit higher because of some of the visibility we have around our bookings and also some of the things we've done in the investment side in, in-store shops-in-shops and outlets -- and the outlet side. As far as the weather goes, we really kind of take a point to look at last year's weather and use that as a predictor for this year's weather. So for the most part in our businesses, I believe, whether it's wholesale, retail, e-commerce, we are reflecting in our guidance a similar weather pattern in the end of Q3, Q4 this year that we saw last year.

Our next question comes from Robbie Ohmes with Bank of America Merrill Lynch.

Actually just one question. I was hoping that maybe, Kevin, you could talk a little bit more about the 4 business. So the Spine is -- has done well, Speed is being well received. How should we think about the timing of a more significant ramp-up in Under Armour's sneaker business? And what are the puts and takes on that happening faster or slower? And then remind us how you're seeing gross margins in the 4 business being impacted by the growth of sneakers and whether that's coming through as expected or better than expected.

Yes. I think if we take a second on Footwear. I want to be clear, we're certainly not declaring victory by any stretch. But we certainly have a lot of things that are moving in the right direction, which give us an incredible amount of confidence that we can be as important in Footwear as we are in Apparel. And so it begins -- you mentioned Spine. I agree. It was a $100 platform we began with and we've worked that price point now to where -- somewhere between $90 to $110 depending on the style and where we are with the product. But it's been very well received. More importantly, we're beginning to build some legacy, where the consumer knows what to expect. They can start asking and having an anticipation of what the Spine product is going to be. And these are things that just take time, so we're very fortunate to start figuring it out. And I think all this groundwork is very laid as we look at our 7-year heritage that we have in the cleated business. So the reason that we point -- we make such a big deal about Highlight and the success that we're seeing there, our partners at Eastbay through Foot Locker and between Ken and Dick and the leadership they have there and taking the best that they have on us in cleated footwear as well as the way that, that's translated in some of the running products that we have through their doors, I think we're really encouraged by the signs that we're seeing. I think we've been thoughtful about the size of the allotments that we're giving and the allocation that we're giving to consumers, and I think we're rightsizing it as well. There's 3 big stories that we…

And Robbie, on the gross margin side, I guess Footwear for us kind of globally right now, our Footwear margins are at -- say, they're in the low 30s. And obviously, our ability to get to where we think we should be, probably closer to 40, maybe low 40s in the longer term, is really going to be driven by a couple of things: one being the mix of our Footwear between cleated and not cleated; and two, our ability to continue to innovate, like Kevin has spoken of, and also to produce footwear efficiently. If you look at our mix, first on the mix side, our mix today still is heavily weighted towards cleated versus non-cleated relative to a lot of other players out there. Obviously, that cleated side of our business is really, really important to our overall Footwear business from an authenticity perspective and credibility perspective, but it does come at the lowest of low margins in Footwear. So with our mix being more weighted towards cleated, that obviously impacts our overall Footwear gross margins. Over time, though, as we are able to grow our non-cleated Footwear business, specifically things like running, which we've been recently doing, we have the ability -- those are -- those commit better margins, and that should help our mix going forward, gross margins in Footwear as we sell more non-cleated footwear. And every indication is things like the Spine platform that we have and also SpeedForm that Kevin spoke of are all things that are heading in the right direction for us relative to margins that could impact mix. And obviously, just how we produce efficiently, too, the ability for us to keep gaining competencies and capabilities in the sourcing side, the product development side will internally help us do things better and produce things in a much better fashion and have an impact towards margins, too. So again, low 30s right now. We do see ourselves over the long term working our way towards more of that 40-ish to low 40s gross margin in Footwear. That will take up the ability to -- first to scale well in the non-cleated side to do that, produce things more efficiently internally. Also, I want to make sure we keep going back to the fact that even though gross margins in Footwear in the 40% to low 40s will still be below our Apparel, that when you look at the whole business model of Footwear longer term, even though you have lower gross margins with those higher price points, Footwear does give you the ability to scale and leverage in SG&A in a better fashion and that operating margin business model in the longer term should look pretty similar on the Footwear and Apparel side.

Our next question comes from Michael Binetti with UBS.

So I just want to understand the gross margin comment, Brad, a little bit in the back half. It sounds like the guidance is pointing to about 40 basis points of compression and I'd like to make sure and directionally thinking about it correctly and then understand what's changed in your thinking a little bit here. And maybe to start with, can you talk -- maybe you can just talk a little bit about second quarter gross margins, and what are all the input costs, the product cost leverage came from the quarter. If I look back to last year, it was a slight headwind in the second quarter. But certainly, the 140 basis point upside you pointed is well ahead of what we're expecting. So maybe a little bit on the components there?

Yes, mix didn't really play a part there. So we had some positive and some negative mix. So that really wasn't a play as much as far as channel mix goes that is. When you look at the 2 components that really drove Q2, it's pretty split between what I'd say is some better-than-expected supply chain efficiencies relative to freight, and that's both freight in from a -- the ability for us to reduce our exposure to air freight in Q2 and also freight out to customers on some early wins we've had there. So I'd say about half of what I would say is the upside benefit we saw in Q2 versus expectation was just from those types of things in the supply chain side. And the other half, I would say, is more on the product cost side in general. A couple things there. One is there was a -- the need from the customers to -- on the bag side of our business, which we were -- I've been talking about relaunching this year for back-to-school. A lot of our customers really wanted to get those bags on the floor early because it was a relaunch as we get into Q3, and those come at much better margins year-over-year. So there was a little bit of an earlier shipment on the bag side a little bit that had a good positive impact on margins. And also, just on the costing side, truthfully costing is an area that kind of worked against us from a product mix perspective, not necessarily a channel mix. But from a product mix, it has tended to be a little unfavorable for us over the course of the last 4 to 6 quarters. So we've been pretty careful in how we forecast that…

And just directionally, as the -- you said airfreight will be a positive. Is it -- will airfreight, to the magnitude that it -- you thought it will be, will it still be about the same tailwind for you in the back half of the year as -- is what you're planning when we talked to you last time, Brad?

Yes, it is. So I think we pretty much anticipated the airfreight and the supply chain initiatives to start kicking in, in the back half of the year. The reality is they kicked in about a quarter early on us. So it was a Q2 upside, but we had anticipated some of these initiatives have been benefiting the back half of the year already, so that's not a change really.

But if we add it all up, it doesn't seem like some of the supply chain efficiencies that you talked about in the second quarter are flowing through into the back half. Is that -- or am I missing something on that?

They're definitely flowing through. So again, the impact in the back half of the year for especially airfreight is where most of these supply chain issues show up. It is very similar benefit as we talked about earlier in the last earnings call. It's that resourcing piece, I think, you got to look at and say, the resourcing of cleats, which is a very big product line for us in the back half of the year, obviously, resourcing that's going to have a negative impact.

Our next question comes from Pamela Quintiliano with SunTrust.

Kevin, just want to follow up on International. Understandably, you're tremendously excited about it. If you could just talk us through the brand awareness within some of the larger regions and where you think there is the most opportunity with what Under Armour represents to the local customer versus what you think the product can be for them and then where you potentially have the biggest hurdles?

I think we're still establishing ourselves. The one thing about International and probably lessons learned over the last 17 or 18 years was that any of these things just take time. And I think a longer view is the way that we need to approach any of these markets. I use the story of Japan a lot in sort of articulating how long it takes to -- 8 years from 0 to $35 million, and then it was year 9 that they went from $35 million to $72 million and I think the tipping point really occurred. So I don't know if that model -- even with larger scale, larger size, more resources, things that we have today going for us, it still comes back to an investment, and it's a prudent model. So I don't see where we just want to pour money in and really looking for losses. We can't really afford to do that either. So either drive with brand messaging, but we need to do it at a local and a grassroots level where -- letting people find about us. Opening Brazil, for instance, is probably a -- it's a great example where we're walking into a market that's got a tremendous amount of hype and excitement around it -- what we're looking at is the World Cup. And we played with the idea of how big do we need in China to keep up with the Joneses, but that's not what you're going to find from us. And our approach to Brazil has been -- let's attack World Cup in '14 and we need to be ready for Olympics in '16. And of course, we've got a great team over there on the ground literally with a pro running the office in Marcelo and the…

And just a quick follow-up. The Shanghai store, is that something, if it works out well, you would anticipate doing in other regions? Does it...

Yes, completely. Now it's expensive, and so there's definitely -- I'm getting eyes over here. But it's going to be the first experience that we have. So again, it's 80% experience and the last 20% is a very focused assortment of this is the world's greatest shoe and you'll have the SpeedForm product. This is the world's greatest t-shirt, you'll see, one of our Tech Tees or Charged Cottons. So we want to be very focused because a lot of people come in and they can get overwhelmed by a brand. So I think the key to any great brand is having a point of view. So we're going to sell with a point of view that when someone walks in and says, well [ph], I really understand, a, what it's like to be an athlete; and b, Under Armour's interpretation of what being an athlete is like and that these are the products that they endorse, this is the world's greatest t-shirt, this is the world's greatest shoe. So we're going to keep it very simplistic and very easy for the consumer to understand. And then we're going to be driving people to our e-commerce website in China as well, as well as back to our other full-line retail stores that we have in the market. So we're going to learn a lot. Look, I think -- the most important thing to International is that we're going to test a lot of different things, of having good, smart, thoughtful people on the ground, which we have in China, which we have in Brazil, which we have in Australia, which we have in Europe, which we have across the globe. And so we're fortunate -- which we have in Mexico. So we're very fortunate to have those. We're going to focus on those key markets, that, again, with having the right leader in the chair. And then we're going to invest behind them, and we think we can generate some heat and a lot of energy. So a lot of exciting things to come from us on a global front for sure.

Our next question comes from Kate McShane with Citigroup.

My questions are for Brad this morning. Brad, with your SG&A comments today around 2016, I just wanted to make sure that, that wasn't different than what you had said at the Investor Day. Or was it just further clarification that you're going to be using upside to revenues to put towards SG&A?

Yes, Kate, further clarification really. So I think in Investor Day, we were pretty articulate around the pace of operating margin improvement between last year and 2016 basically, and why that pace and the importance of us to invest to support the growth that we talked about at Investor Day. So I think part of it, yes, was just reiterating what we said at Investor Day was the fact that we're going to look and be opportunistic with any upside we see in our business to either accelerate or support all those growth initiatives we talked about at Investor Day. And this is, I think, another example of what we're doing here in the back half of this year, the ability to enter the markets in Brazil and Chile and Latin America, a little bit of a quicker pace than we originally planned, the ability for us to do that because we're seeing some upside in revenue in the back half of this year. So we're going to do that.

Okay, great. And then my second question, just to follow up on the revenue growth question from earlier, with the improved visibility with the wholesale ordering, is that coming from incremental distribution or the new incremental distribution to the department stores and how much they contribute to the revenue growth?

No, we're seeing it across-the-board, really. It's not really a distribution strength as much as it is just in general across the board. Bookings are coming in a little better than we anticipated. Again, I don't want to also downplay some of the things that we've done and we've controlled here by investing some -- into extra [ph] shop-in-shop, also with Dick's Sporting Goods and also higher [indiscernible] store counts. So those are investment decisions we made that are also impacting the back half and their revenues, too.

All right, thanks, everyone, for joining us on our call today. We look forward to reporting to you our third quarter 2013 results, which tentatively have been scheduled for Thursday, October 24, at 8:30 a.m. Eastern Time. Thanks again and goodbye.

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