Under Armour, Inc. (UA) Q3 2013 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, this conference call is being recorded. I would now like to turn the conference over to Tom Shaw, Director of Investor Relations. You may begin.

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 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 event 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 third quarter, provide an update to our 2013 outlook and introduce a preliminary 2014 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. From our very first day of existence, Under Armour has been about making athletes better. Executing against that promise in 1996 had its own set of challenges, but they're dwarfed by the complexity of running a global brand with over $2 billion of revenues. Our consumers' expectations shift constantly higher and they count on their favorite brands to consistently take them some place new. The company that we are building to deliver on that promise is in constant evolution. We are a different company every 6 months. Our consumer moves quickly and fortunately, so does Under Armour. Today, I want to discuss that evolution. How it's manifesting itself in product innovations like SpeedForm and ColdGear Infrared with emerging athletes like Stephen Curry and Jordan Spieth, and new retail experiences in Shanghai and New York City. All key elements of our growth story, yet all of them have already become important Under Armour stories in the past few months. So while this evolution is taking place throughout our organization, I want to talk today about 4 areas of our business where our focus is helping generate growth in 2013 and beyond. First, I will cover how we will be more integrated than ever when it comes to telling our brand stories. We will have our product communications and retail presentation aligned unlike anything we've done in the past, aggressively bringing our consumers into retail at key points during the year. The second area is around innovation and how will we innovate, not only do we win with consumers, but we drive an industry-leading pricing model. Because wherever we show up in regional sporting goods, urban department stores or our new retail experience in Shanghai, we are a premium brand. That premium status comes from our…

Thanks, Kevin. I now like to spend some time discussing our third quarter financial results followed by our updated outlooks for 2013 and preliminary thoughts on 2014. Our net revenues for the third quarter of 2013 increased 26% to $723 million. Apparel grew 26% to $561 million during the quarter from $445 million the prior year, representing our 16th straight quarter of at least 20% growth for our largest product category. In Apparel, we continue to perform best when we deliver newness and innovation to the consumer, a powerful dynamic that helped drive average selling prices of approximately 5% higher during the quarter. Apparel results benefited from new innovations like the recently introduced ColdGear Infrared technology, expanded platforms in areas such as Storm and Charged Cotton and enhanced design across both legacy and new offerings. From a product category standpoint, while training remains our largest category and drove majority of the dollar growth, we experienced strong growth rates in our running, hunting and mountain categories across genders. We also continue to see momentum in our Women's Studio line, as well as significant growth across our Youth business. Our Direct-to-Consumer net revenues increased 34% for the quarter, representing approximately 25% of net revenues compared to approximately 24% in the prior year period. In our retail business, we opened 6 new Factory House stores during the third quarter, increasing our North American Factory House store base to 112, up 17% from 96 locations at the end of last year's third quarter. We currently expect to open 4 additional Factory House stores during the remainder of the year, bringing our total door count to 116. We're also on track to expand 9 existing locations in 2013 as part of our efforts to better service demand with our broader assortment in areas such as…

[Operator Instructions] The first question is from Matt McClintock of Barclays.

So, Kevin, I was just wondering if you could drill down more into the Women's business. The improvements of the product that you've made in the fall, what you're seeing there specifically? And then if we could actually extrapolate that into what you're doing with the Studio shop-in-shop, and how you think about using that to potentially transform what -- traditionally hasn't been a place for women to shop, the sporting goods channel to actually draw women to that channel?

Great. So I want to say this remains a tremendous opportunity we think for the brand. And as we stated all along, we believe that Women's has the potential to be larger than Men's. In fact it will be larger than Men's some day in the future. Women's today is nearly 30% of our Apparel business versus less than 16% when we were a public company that we'll celebrate here in just another week or 2, more than 8 years ago. So in addition, we've also added more than $2 billion in revenues during that time, and so we're very pleased I think with the trajectory that Women's have is outpacing our overall growth of the company. Our Women's business, as we stated in Investor Day as well, it's something we anticipate to be nearly $1 billion business for us by 2016 and we're highlighting that with the emphasis around opening our New York office some time the end of this year, early part of next year, led by Leanne Fremar who joined us from Theory within the past year. And we're seeing the team that Leanne is building out, and again, in addition to the other brand experts that we already had here. From a momentum we have and the ownership we believe we have in that female athletes, I'm frankly making more beautiful product for her. Taking her from beyond just on the athletic field and taking her to places that I don't think they'd expect the Under Armour consumer to be in the past. We're also I think putting our money where our mouth is around Women's. You mentioned the shop-in-shop, so you'll see a big emphasis on that. One thing that we've done differently in 2013, we think they paid a very good dividend for us…

And next question is from Eric Tracy of Janney Capital.

Really want to dig in on the Footwear piece here a bit. Maybe if you could just talk about some of the evolution of Spine as we go into spring next year. The introduction of SpeedForm, sort of the cadence and how we should think about the distribution strategy there. It seems to be again we're in an inflection point and an acceleration but I just want to sort of gauge your thoughts a bit on Footwear?

Yes, I think -- keep level setting I think with the expectation we laid out back in June at Investor Day. But a lot of the things we talked about was being a top 3 Footwear brand in sporting goods. And we look at where we're successful and where we're winning. And obviously the Apparel floorspace in any given sporting goods stores, Under Armour has a significant impression. And unfortunately, we haven't represented that way on the Footwear side. And so we've got a couple of things. When Kip first took over the Footwear business several years ago, one of the initiatives we had was building shoes that cost $100. And I think we saw a success for things like Charge RC, seeing success with the first price point introduced spine with. RC was that $120, Spine was at $100 and I think we came to realize is that just picking some number isn't necessarily the right place for us to be, particularly in sporting goods where you're really winning there is at $70, $80, $90. And so we've changed that mindset a bit that we're very pleased I think with the premium product that we have and things like Charge RC and things like Spine and products that we have like SpeedForm and I'll get to that in a second. But we also have some products we're really excited about heading into the year with some real house price points like the $80 product that we have called engage coming out. So we really want to emphasize and focus on winning where we're already being successful in the Apparel side, which is in sporting goods. We also believe that there's tremendous opportunity in the mall. Our key partners in Finish Line, Foot Locker that have been incredible partners for…

And, Eric, I just want to tie in to Kevin's comments and clarify my prepared remarks around that Q4 growth rate in Footwear. And again, just emphasize this is the timing issue. The fourth quarter actually is our lowest volume quarter for Footwear. And this is really more around the timing of our baseball cleat shipment and again it's our lowest volume quarter, so our year-to-date 2013 growth rate in Footwear is around 25% and again, we called out the fact that Footwear is going to be above the company growth rate in 2014. So the Q4 growth is just the timing issue.

That's fair. And then I guess, Brad, to follow on that, the Footwear acceleration next year understand that dynamic in terms of laying on gross margin. But the early sort of color on gross margin next year of modest gains, given supply chain enhancements, given -- now pricing seems to be again, whether it's within Footwear or even Apparel, a nice tailwind. Some of these onetime sort of upfront costs should go away. Can you just maybe walk through again the gross margin dynamic next year, where the potential is for upside or is it purely just the mix on the Footwear that should be the drag?

Sure. And to be honest with you right now on the gross margin side, looking at the data we have and the data that we don't have yet, we have pretty clear visibility into spring, summer '14 and don't have all the data points in fall and winter '14 yet, so we're kind of using spring, summer '14 as a proxy for our guidance for the full year '14. And if you did kind of look at the front half of the year and the things that you have. You have a couple of things working in your favor, a lot of the things you mentioned some supply chain enhancements that we've been making along the way we would continue to expect to see some benefits from those going into next year and for the full year. From the things working against us is the mix piece, so obviously we're calling out things like Footwear and International, those are 2 parts of our business that from a gross margin perspective, although both improving year-over-year within themselves, they're still a drag on gross margins overall for the company, so that would be a big part of offsetting some of those supply chain enhancements that we'd make during the front half of the year. So again, positives, supply chain side, again, positive there working for us. The negatives on the gross margin side would be the businesses that are growing above the company growth rate for Footwear and International.

And the next question is from Evren Kopelman of Wells Fargo.

Okay. I wanted to ask on the inventory, maybe thinking both the inventory on your growth and also thinking about the channel. Excluding the Fleece and timing compare issue you mentioned, how do you feel about it, about the content of it? And thinking that the second have interrelated question is how the sell-through performance in the channel, in the quarters maybe, was there difference in sporting goods versus department stores versus other in the wholesale channels?

Our inventory in general and then sell through -- from an inventory perspective, like I said, there are a couple of big issues that are really driving that and the year-over-year growth rate. We are absolutely comping a challenging service level of last year, that we talked about last year especially in the Fleece business, so more normalization of our inventory levels on the Fleece side. If you remember our inventory growth last year in the Q3 with a minus 2%. Just kind of going back to some of the challenges we're having last year at this time. In addition to that, we kind of are in this kind of middle of a period here towards improvement relative to the some supply chains, thanks, specifically on the inventory side. We talked a lot in our Investor Day upon our 3-year planning process and the benefits that's going to have specifically in the supply chain longer term. Those really probably the benefits of getting better visibility out there further from a capacity perspective, probably it won't start really coming in to play for us until I think until we hit 2015 maybe the end of '14 into 2015. So in the meantime, we've talked about kind of resourcing some of our products to our existing suppliers and in putting more capacity to our existing suppliers. So part of the byproduct of that was making sure with them, really working with them and managing their capacity and their level loading of inventory, and manufacturing the ability to smooth that out and take some inventory at earlier too. So the impact of that has been a little bit more than we anticipated coming into the back half of this year on top of, again, the comp issue that we're absolutely having the back…

And the next question is from Camilo Lyon of Canaccord Genuity.

Kevin, I wanted to just touch on Youth and in particularly Alter Ego, since like that's been a runaway success for you. I'm just curious to hearing your thoughts on how you plan to expand the distribution? I know that you started going into your wholesale partners with the product this quarter. How do you see that broadening unfold? Do you think about shop-in-shop's dedicated to the Youth category?

So first of all, Alter Ego for us has been a really great success in 2013. It's a business that in June of 2012 didn't exist. We ideated it, tested it, built a product and had it in store this year. We primarily were in market with just a couple of our key partners, only may be 2 or 3 for partners, so we're just starting to get in front of the production side where we can get the product out there. So within our existing distribution, there's a lot of runway, I think for Alter Ego. At the same time, as good a partner as Marvel and D.C. Comics have been for us with this process. We'll also go after this cautiously optimistic about how many Batman and how many Superman t-shirts. First of all, there's a whole slate of characters that they have and so we're already sure we spread that, and we don't want to get caught holding the bag as trends move up and trends go down. However, we believe in it, we think there's a plenty of runway there. What we discovered I think as a company though is that not as much about just any one particular. Character, as it is about the want, the desire, the need for newness and for novelty. And so we believe that we've invented this new category of novelty. And so whether it is Batman, Superman, Ironman or whoever else to use or whether it's a slogan, we know the consumers are not looking for a basic white T-shirt in Under Armour logo, a black Under Armour logo on the left chest, that we need to provide a little bit more and that frankly across the board what we've seen with our -- all of our styles is…

Great. And then, Brad, just quickly, you talked about assuming a similar weather pattern as last year. How do you view your ability to meet at once orders should weather become more favorable? And have you think of that as a source of upside? And then just finally on gross margin, have you begun to realize the mix benefits in your Direct-to-Consumer business as you skew more towards made-for versus excess?

Yes, first on the weather side. Yes, absolutely if weather is in our favor, there'll be upside for us but again, the part of AR business and the part of our business that's extremely weather dependent is much less than maybe was 5 or 6 years ago. So a lot of our Q4 product is going to be in the Fleece side, which is more versatile and maybe less dependent on weather then may be with how we look 5 or 6 years ago. So would there be an upside for us if weather was cold? Yes, but let's just make sure we're prudent on how much upside there would be relative to that. From an AR perspective, absolutely, our AR fill rates are much better year-over-year. We're in the high 80s last year in AR fill rates and now we're in the mid-90s where we probably should be. So again, if the weather gets cold and somebody has looking for that product is an AR style, we should be able to service that demand in the fourth quarter. Our relative to the gross margin and then the realization of benefit per mix. Yes, we're still seeing some of that benefit on the made for mix. It was definitely there in the third quarter also. It was being offset by some other mix issues specifically with the growth in Footwear for us in the third quarter also. So yes, we're seeing consistent benefit in the made-for mix in the margin upside of that. It's just a little bit muted in the third quarter because there's some other things going on in mix.

And next question is from Michael Binetti of UBS.

So, Brad, since you mentioned it earlier on, on the International investment in the quarter, that was a big point of the conversation at the Analyst Day you guys had at the headquarters this summer. Maybe you guys could talk a little bit about the plan for International as you look just into 2014 in the context of what you guys talked about at the Analyst Day in the headquarter, what some of the investments may look like, that was -- it was obviously a material components of how you guys guided operating margins as well as well. So maybe just a little bit more about how the near term looks on that?

Yes, Michael, let me take this to sort of a big overall, spend a minute on International for us. So first of all, I think we laid it out very well. And it was great to have the ability to introduce Charlie to I think the investment community and get you to see the type of leadership that we have there. So would have a couple basic rules here at Under Armour and one of them is that great ideas get funded, but only great ideas with great leaders get funded. And So we're putting our money where our mouth is on that side as well in addition to that Women's. And what we see is that International has great dividend for us but we know it's going to an investment, it's going to take time. And part of our restructuring was really built around that. The movement that we did with Kip and with Henry was really to put some of our better leaders on our cash generators. And the philosophy that we're driving I think our corporate strategy these days is the principle that I have in my script. Our North American growth and castration are going to be the engine that feeds our global ambition. Because we have the success in North America, it allows us to make just longer-term investments. And so we're going to be investing appropriately internationally. But we're going -- we believe we've got some really good ideas, we believe they have some really good leadership. So let me work my way around the world and start with Latin America, which Charlie has been working on prior to coming to Under Armour's, particularly for the last 8 years but not exclusively, of course. Mexico, we're in the process of bringing back in our…

And, Mike, just on the magnitude of the investment both will be growing SG&A in Europe to Kevin's point. I think most of the additional investment we're looking at from '13 to '14 and even starting in '13 is just building up the foundation of the international business globally so making sure that we have the right people, process and systems from an information technology perspective. Supply chain and leadership as Kevin mentioned is part of the additional investment this year and into next year and probably the other big piece of the additional investment is going to be the Latin American region as we bring Mexico in as a fully-owned subsidiary and we opened up fully-owned subsidiaries in Brazil and Chile. So when you're looking at kind of year-over-year incremental investments, it's that International corporate group and it's Latin America that really is driving the investment in International for the most part.

And next question is from Kimberly Greenberger of Morgan Stanley.

I'm wondering if you can just help us with the preliminary 2014 outlook. I know that on your fourth quarter call, you'll have a lot more detail. But if what is that you're seeing happening in the environment that would suggest that the lower end of your targets are the right place to be for next year? And if there's any additional color you could offer on that, that would be fantastic.

Sure. I think if you just kind of look where we're guiding this year compared to our guidance next year relative to revenue growth rate. Two things that we did call out. International and Footwear being accelerated growth next year, so you would look at those 2 things seeing positives from our growth rate perspective. But the one thing I think that clearly we look at year-over-year, where we are this year versus next year, that the largest piece of our Direct-to-Consumer business is our outlet business. And we have talked about slower growth indoors, new doors on the outlet side although we're focusing on growing and expanding some existing doors. Our outlet business will grow at a slower pace than this year as we start the transition also into putting more effort into the Brand House side of our business on top of the outlet business. So that DTC business is obviously a much bigger business than International and Footwear combined. And again outlet is the biggest part of that DTC business, so you have 2 businesses growing at a faster pace that are off a smaller base than the outlet business, which will grow a little bit slower pace.

Okay, that's really helpful. And then in terms of your wholesale. Should we assume that wholesale who also be nearing the lower end of that range as well?

Yes, usually since wholesale is the biggest part of our business you would expect it to be pretty much close to the range we're guiding to for the most part.

Okay, and then the last question is from Sam Poser of Sterne Agee. Sam Poser - Sterne Agee & Leach Inc., Research Division: Brad, I was just wondering, can you give us some detail on how you're thinking about the SG&A next year? Will it be this constant reinvestments or do you expect that to open up a little bit towards the back of the year? If sales come in above where you're going?

Sure, Sam. A couple of things just to call out on SG&A next year. We do see some items like marketing as an instance, it probably would have been, if I was look at it directionally for marketing right now, I'd say, probably going to be a little bit of a de-leverage for us next year. Based on where we're going to end up this year. Again, we haven't really figured out the exact timing of that yet, so we'll give more information on timing in the next earnings call. And something we're calling this year will also be a little bit of an investment overall for the company next year and that's in incentive compensation next year, which is kind of across all 4 of our SG&A buckets that will be a de-leverage item next year. Consistent stories relative to again some of the investment needs -- both is innovation is an area, that directionally, we would look to be increase our investments. So on the product side, specifically innovation, supply chain is an area again an investment for us as we are looking to expand our capabilities globally and obviously, a continued expansion of our global business itself as we just talked about specifically in the Latin America will be investment areas for us. Relative to your question about how the investments play out versus our top line and performance. And I think the one thing that we're going to constantly balance is we are focused on driving operating income dollars and operating income dollar growth just like we talked about in our Investor Day over the long term. We will always look for opportunities to help ensure successful business in a subsequent year or do things in the current year that could benefit the current year also from an SG&A or investment perspective. So if numbers would come in better than we are planning for 2014 and the timing of that would happen differently, we would definitely look to where we can reinvest those dollars and be opportunistic to benefit '14 or probably more specifically as they get towards the end of '14, what could we do to accelerate or ensure our success for 2015? Sam Poser - Sterne Agee & Leach Inc., Research Division: Okay. And then you've talked about the mix -- in the fourth quarter you talked about gross margin being down, but the mix of retail's going up and the mix of Footwear is going down in the fourth quarter, so why would that drive lower gross margins?

Probably the only -- the couple of things that are going to be happen in Q4 that maybe were a little bit more impactful than Q3. First and foremost, if you remember the Canadian duty issue we called out in the last call, we talked about some uncertainty around the impact of margins for that in the back half of the year. That's still an ongoing issue. We have not resolved that issue, it's still kind of in the audit mode right now. So we didn't really have an impact in the third quarter relative to that issue. We do fully anticipate that, that issue is going to be resolved in the very, very near term here, so there will be a fourth quarter impact to that issue as we finish up this year. So that would be a little bit of a difference from Q3 to Q4 and also on the FX side, our business in Japan where this really impacts us the change in the yen rate year-over-year will be a little more elevated in the fourth quarter versus the third quarter also. So those are 2 things -- 2 unique things, I think, that are going to be more elevated in the fourth quarter versus the third quarter specifically. Sam Poser - Sterne Agee & Leach Inc., Research Division: And just any word on tax rate for next year and that's it.

Tax rate for next year come again, that's something we have to really kind of roll together, the all the numbers in especially the back half the year. But I would anticipate the 2 big drivers of tax rate for us right now is our ability to have comparable tax credits year-over-year. Would be one thing, we're able to get tax credits next year that we would have this year would be one way to look at the direction of our tax rate and the second thing would be obviously pointing to incremental international investments and we need international profits to drive the lower tax rate and when we are in an investment mode that will work against us from a tax rate perspective. So my part would be our tax rate last -- next year will probably be a little bit higher than this year, but as we get more information we'll guide to that obviously in January.

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

Ladies and gentlemen, this concludes today's program. You may now disconnect. Good day.