By Thomas J. Ryan
Under Armour’s second-quarter results were basically in line with expectations, and officials indicated that the company’s strategic transformation program is progressing on plan. Shares of Under Armour, however, fell 12.2 percent on Tuesday as sales targets for North America for the year were reduced and Q3 results were guided below Wall Street expectations.
The company maintained its guidance for EPS and revenues for the year. The third-quarter shortfall was attributed to expectations that the direct-to-consumer (DTC) business in North America would remain challenging as well as due to the timing of international shipments. A robust fourth quarter, including a return to double-digit growth, is expected to make up the third-quarter softening for the year.
Shares fell $3.36 to $24.08 on the day. The stock could have been set for some profit-taking since shares had gained more than 50 percent since the beginning of the year before Tuesday’s sell-off.
On a conference call with analysts Kevin Plank, CEO and chairman, stressed that the company in the third year of its strategic transformation remains committed to instilling disciplines to become a “stronger, faster and smarter” company that’s able to “deliver consistent profitable results for years to come.”
He added, “Halfway through 2019, I am very pleased with the progress we continue to make against our near and long-term objectives.”
In the quarter ended June 30, sales improved 1.4 percent to $1.191 billion, in line with Wall Street’s consensus expectation of $1.197 billion.
Wholesale revenue decreased 1 percent to $707 million, driven primarily by planned lower sales to the off-price channel. Excluding reduced sales to the off-price channel, wholesale revenue would have been up slightly.
DTC revenue was up 2 percent to $423 million, representing 35 percent of total revenue. DTC came in lower than expected due to traffic and conversion challenges primarily in North America; however, Dave Bergman, CFO, said the company has “remained disciplined in our shift toward full-price selling” in the DTC channel.
Licensing was up 20 percent to $25 million, driven primarily by a settlement with one of its North American partners.
DTC Weakness Offsets Wholesale Momentum in North America
In the North America region, revenues decreased 3.2 percent to $816 million reflecting declines in both wholesale and DTC.
Patrik Frisk, president and COO, said Under Armour’s strategy to reduce off-price sales across wholesale on a year-over-year basis is on track which he described as “a positive brand right move, to be sure, but still a negative impact to this region’s revenue growth for the quarter.” Overall, wholesale “is trending slightly healthier than we had originally anticipated” based on orders in-hand and helped by improving service levels.
DTC is experiencing softer than anticipated demand as the store business, which is 90 percent focused on factory outlet selling in North America, is being reset to emphasize full-price selling. The stores are seeing higher conversion and slightly higher AURs (average unit retails) but that’s not offsetting the “slower” traffic patterns since Q1.
Online in North America, traffic and AURs are improving, but conversion is down. Frisk added, “All in for North America, direct-to-consumer is a bit of a mixed bag with challenges to work through and pockets of strength to build on.”
Operating earnings in North America in the quarter improved 5.0 percent to $139.2 million. Frisk noted that cleaner inventory positions, better service levels and SG&A efficiencies are “helping to provide top and bottom-line mitigation.”
Looking ahead, sales in North America are now expected to see a “slight decline” in 2019, rather than “relatively flat” previously forecasted as the stronger wholesale expectations are offset by softer DTC demand.
Frisk described the adjusted outlook as “modest” and predicted improving trends in the second half. He saw the improving wholesale sell-throughs as a sign that Under Armour is “finally starting to show up like we would like to show up” with more elevated products and more consistent and better messaging across channels.
He said, “I think we’re kind of bullish on the North American consumer in terms of that being a stable picture for the back half of the year.”
Asia Paces Healthy International Growth
International revenues increased 12 percent to $339 million or 17 percent on a currency-neutral basis. International represented 28 percent of total revenue.
Asia-Pacific saw the fastest growth, jumping 22.6 percent to $154.1 million, or 29.2 percent currency-neutral. The region saw continued expansion with key wholesale partners and sustained DTC momentum. Said Frisk, “The story here remains fairly balanced among product and channel. So, overall, we are very pleased with this region’s progress.”
Asia-Pacific is now expected to show growth in the low-20s for the full-year, up from the previous high-teen expectation.
Frisk did note that the Japanese business, which is serviced through a licensee, has been underperforming and is expected to show a loss for the balance of the year. The company has a minority interest in the business.
In the EMEA region, sales were up 6.1 percent to $145.3 million or 10.7 percent currency-neutral. Continued growth was seen in wholesale and DTC channels.
Latin America sales were down 2.5 percent to $39.7 million while growing 1.5 percent currency-neutral. The small gain was directly related to the change in the company’s Brazilian business model. Excluding the Brazilian impact, Latin America revenue was up in the quarter and also helped by continued growth in both wholesale and direct-to-consumer.
Among categories, apparel sales reached $739.7 million, down 1.1 percent. Footwear rose 4.7 percent to $284.1 million. Accessories inched up 0.3 percent to $106.3 million. Connected Fitness’ revenues were $31.9 million, up 9.7 percent.
Under Armour reduced its loss in the quarter to $17.3 million, or 4 cents a share, just besting Wall Street’s expectation for a loss of 5 cents. The year-ago net loss of $95.5 million, or 21 cents, included $78.8 million in pre-tax restructuring and impairment charges.
Gross margin increased 170 basis points to 46.5 percent. Of the improvement, 110 basis points came from continued supply chain initiatives related to favorable product cost and lower airfreight, 50 basis points related to prior year impacts from restructuring efforts and 30 basis points of regional mix primarily due to the higher gross margin Asia-Pacific business outpacing the growth of other regions. Foreign currency caused approximately 30 basis points of headwinds.
SG&A expenses increased 2 percent to $566 million, or 47.5 percent of revenue. The rate was better than expected due to continued cost management efforts, as well as a shift in marketing spend out of the quarter coupled with lower than planned depreciation from capital expenditures and timing of store openings.
The operating loss came to $11 million.
At the quarter’s end, inventory was down 26 percent to $966 million, as planned, to support premium selling. Cash and cash equivalents were up 131 percent to $456 million. Total debt was down 24 percent to $591 million and capital expenditures were down 23 percent.
The updated guidance for the year includes:
- Revenue is expected to be up approximately 3 to 4 percent reflecting a slight decline in North America and a low- to a mid-teen percentage rate increase in international business. Under Armour had previously expected relatively flat results for North America and a low double-digit percentage rate increase internationally.
- Gross margin is still expected to increase approximately 110 to 130 basis points. Excluding restructuring charges from the comparable prior period. Margins are also still expected to increase 70 to 90 basis points due to ongoing supply chain initiatives and channel mix benefits.
- Operating income is now expected to reach approximately $230 million to $235 million versus the previously expected range of $220 million to $230 million. The change was traced to productivity gains from transformation efforts.
- Interest and other expense, the net is now expected to be approximately $30 million versus the previous expectation of approximately $35 million.
- The effective tax rate is now expected to be approximately 22 percent versus the previous expectation at the high-end of a 19 percent to 22 percent range.
- EPS is still expected to be in the 33 to 34 cents range including a negative impact from the company’s minority interest in its Japanese licensee.
- Capital expenditures are still expected to be approximately $210 million.
Providing some guidance for the balance of the year, Under Armour expects revenue in the third quarter to be down 2 percent to 3 percent, putting sales in the range of $1.40 billion to $1.41 billion. Wall Street’s consensus estimate had been $1.51 billion.
The sales drop is expected to be driven by lower sales to the off-price channel, tempered DTC expectations and the timing of distributor sales in international regions shifting more to the fourth quarter.
Third-quarter gross margin is expected to be up approximately 120 to 140 basis points on an adjusted basis and 130 to 150 basis points on a GAAP basis. The increase is primarily due to channel mix benefits with lower off-price sales compared to the prior year and supply chain initiatives including lower air freight and product cost improvements.
Operating income in the third quarter is projected to reach $115 million to $120 million and EPS to range between 17 cents to 18 cents. Wall Street’s consensus estimate had been 27 cents.
With the EPS and sales outlook not changing for the year, strong improvement is then expected for the fourth quarter.
For the fourth quarter, revenue is expected to be up at a low to a mid-teen percentage rate. In North America, cleaner inventory positions and service levels are expected to enable the company to more efficiently meet wholesale demand earlier than last year.
In the international business, expanded distribution including new store openings along with improved service levels is expected to “meaningfully benefit” growth in the fourth quarter. The Latin America region will anniversary the Brazilian business model change and should accelerate growth in Q4.
Under Armour officials spent much less time than typical calls discussing product.
Frisk talked enthusiastically about the potential in footwear with the successful expansion of the Hover platform and the lessons the brand has learned around footwear launches from the model’s success. Frisk said, “We are very encouraged by that and what’s exciting for us is, we have new innovations in footwear coming in the back-half of the year and new styles. We also have a strong line-up going into the future.”
Plank also briefly talked about the Hover and Rush apparel range and assured analysts the “innovation pipeline that we see is strong.”
But, he stressed Under Armour would remain disciplined in its go-to-market approach by focusing on tighter, better-segmented assortments bolstered by improving return-focused and product-specific marketing.
“We are editing, and that’s the beauty that we are in the position of right now as we have innovations coming from a number of different places and it’s more of the biggest issue we have is picking and choosing of what is actually going to get center stage and top billing,” said Plank.
Plank said that efforts to become leaner, better manage inventory and improve profit margins are helping Under Armour reach its stated goal of becoming “a quiet company and a loud brand” rather than the other way around.
“This is a great stabilization quarter for us,” Plank said. “Again, nobody is declaring victory, but we like the way that we look and the way we are set up for the future. So, this company is hungry, and we are ready to run”
Photos courtesy Under Armour