Under Armour, Inc. reported earnings and sales came in better than expected in the fourth quarter due to strong growth internationally and fewer promotions. But sales in North America dropped six percent and a return to growth isn’t expected in the region until at least the second quarter.
On a conference call with analysts, Under Armour officials reiterated their outlook for the year provided at last December’s Investor Day that includes a call for relatively flat results for North America in 2019.
But officials indicated that the recovery won’t be coming in the first quarter as sales in the period are expected to be flat to slightly-down overall as continued double-digit growth overseas isn’t able to offset a mid-single decline in North America.
On the call, Dave Bergman, CFO, said the North America region is still lapping higher sales to the off-price channel in Q118 due to extensive efforts to reduce inventories in the marketplace to improve its premium positioning. Under Armour ended 2018 with a 12 percent decrease in inventory following a 26 percent jump in 2017.
Second, Bergman said Under Armour had some service level challenges in late ’17 and early ’18 that impacted buys from wholesale partners in Q119. Bergman added, “We’ve been improving a lot there as we move forward beyond that.”
Relatedly, Under Armour is facing “a little bit of continued contraction” at wholesale in North America that will continue in Q119 although to a “lesser degree” than Q118.
Finally, direct-to-consumer (DTC) is expected to decline in North America in the first quarter due to the closure of some Brand Houses as well as focus on maintaining normalized promotional levels.
Still, Patrik Frisk, president and COO, said that although management is confident that its healthy innovation pipeline will drive accelerated growth in the balance of the year after the first quarter, Under Armour has to win back shelf space.
Said Frisk, “When you’ve lost space on the shelf you got to earn it back and it takes a little bit of time and that’s really what you’re seeing.”
He added, “Trust is kind of earned, so you got to earn it back. You got to fight your way back onto the shelf.”
In the quarter ended December 31, net income came to $4.2 million, or 1 cent a share, against a loss of $87.9 million, a year ago. Restructuring and impairment charges were $48 million against $36.0 million a year ago.
Adjusted net income was $42 million, or 9 cents per share, exceeding Wall Street’s estimate of 4 cents. In the year-ago period, the loss came to $1 million, or break-even cents per share, on an adjusted basis. The year-ago loss excluded the impact of the restructuring plan as well as a one-time charge related to the U.S. tax reform.
The improved earnings in the quarter reflect an improvement in gross margins by 160 basis points to 45.0 percent. Excluding restructuring efforts in both periods, adjusted gross margin rose 160 basis points to 45.1 percent. Benefits in the quarter included approximately 80 basis points of the channel and regional mix, 60 basis points of improvements in product costs and lower promotions and 50 basis points of benefits due to lower air freight. These benefits were partially offset by about 30 basis points of foreign currency headwinds.
SG&A expenses decreased 1.2 percent to $587 million, or 42.3 percent of revenue, from 43.4 percent a year ago.
The operating loss came to $10 million against a loss of $37.1 million a year ago. Adjusted operating income was $40 million against break-even results on an adjusted basis a year ago.
Revenue in the quarter was up 1.5 percent to $1.4 billion and added three percent on a currency-neutral basis. Sales were just ahead of Wall Street’s average expectation of $1.38 billion.
Wholesale revenue inched up 1 percent to $737 million, driven by growth internationally. DTC revenue was flat at $577 million, representing 41 percent of total revenue.
Said Bergman, “For context, it’s important to keep in mind that promotional activity in North America was down by about one-third compared to 2017, which created a more difficult comp in the second half of the year. However, we believe this is the right strategy to drive our premium positioning.”
In-line with expectations, licensing increased 39 percent to $46 million primarily driven by royalties received from socks and the Japanese businesses.
By product type, apparel revenue increased 2.0 percent to $970.4 million with growth in the train category. Footwear revenue decreased 4.5 percent to $235.2 million primarily driven by lower sales to the off-price channel. Accessories revenue decreased 2.2 percent to $108.2 million due to softer demand and continued actions to optimize inventory and distribution.
By region, North America revenue decreased 5.8 percent to $965 million, in-line with expectations. The drop was driven by a contraction in its wholesale business coupled with lower sales to the off-price channel. On a profitability basis, North America showed an operating loss of $7.08 million against a loss of $43.9 million a year ago.
The overall international business increased 24 percent to $395 million (up 28 percent currency neutral), representing 28 percent of total revenue.
In the EMEA region, sales were $178.2 million, representing a gain of 31.7 percent on a reported basis and 35 percent currency neutral. The gain was driven primarily by growth in its wholesale business and continued strength in DTC. The region posted a loss of $11.1 million versus earnings of $3.99 million the prior year.
In the Asia-Pacific region, revenues climbed 35.2 percent to $167.5 million and were up 39 percent currency neutral. The growth was helped by strength in wholesale and DTC. Under Armour said it now has over 660 locations in the region across owned and partner doors with the majority in China. Said Bergman, “As we continue to expand in this key region, our focus on performance and our commitment to maintaining our premium positioning will remain central to our execution.”
Asia Pacific’s profits gained 64.6 percent in the quarter to $21.4 million year-over-year.
The Latin America region’s revenues were down 15.1 percent to $49.2 million and declined 11 percent currency neutral. The decline was driven primarily by the business model change in Brazil, which transitioned from an owned subsidiary to a licensing and distributor model which carries lower yet more profitable revenue. The business model change is expected to negatively impact the year-over-year revenue comparison through the majority of 2019. The region slightly increased its operating loss to $11.0 million from $10.9 million a year ago.
In the Connected Fitness segment, sales improved 9.1 percent to $30.3 million, driven by continued strength in subscription revenue. The segment showed an operating loss of $2.6 million versus earnings of $792,000 the prior year.
For the year:
- Revenues were up four percent to $5.2 billion;
- Gross margin was 45.1 percent, in line with the prior year including a $21 million impact related to restructuring efforts. Excluding restructuring efforts in both periods, adjusted gross margin increased 30 basis points to 45.5 percent;
- SG&A expenses increased four percent to $2.2 billion, or 42.0 percent of revenue;
- Restructuring and impairment charges were $183 million;
- Operating loss was $25 million. Adjusted operating income was $179 million;
- Net loss was $46 million or 10 cents loss per share. Adjusted net income was $122 million, or 27 cents share.
Wholesale revenue in the year increased 3 percent to $3.1 billion and direct-to-consumer revenue was up 4 percent to $1.8 billion, representing 35 percent of total revenue.
North America revenue decreased two percent to $3.7 billion and international business increased 23 percent to $1.3 billion (up 22 percent currency neutral), representing 26 percent of total revenue. Within the international business, revenue was up 25 percent in EMEA (up 23 percent currency neutral), up 29 percent in Asia-Pacific (up 27 percent currency neutral), and up five percent in Latin America (up eight percent currency neutral).
Apparel revenue increased five percent to $3.5 billion with growth primarily driven by the train category. Footwear revenue increased 2 percent to $1.1 billion largely driven by growth in the run category. Accessories revenue was down five percent to $422 million due to softer demand and continued actions to optimize inventory and distribution.
On the conference call, chairman and CEO, Kevin Plank, elaborated on the progress his company made during 2018, which marked the second year of the three-year Protect This House restructuring program.
Said Plank, “With two years in the books of what we believe will prove to be the most transformative phase in Under Armour’s history. The offensive and defensive strategies we’ve employed are empowering us to make better decisions and deliver consistent results.”
Frisk said that Under Armour stabilized the business in 2018 with the aid of “dramatically rightsizing” its inventory and “look forward to the numerous opportunities we have with our retailer partners to ensure positioning and growth that is mutually beneficial around the world.”
On the product side, according to Frisk, the company “delivered newness, innovation and in some cases scarcity more realistically and methodically than ever before all within the improvements of our go-to-market framework allowing us to tell sharper stories and engage with our consumers.”
Among key areas, a third cushioning platform, Under Armour HOVR, was launched in 2018 with a tighter distribution strategy that helped drive strong results for the brand in run. Said Frisk, “As we look ahead into 2019, we expect HOVR to continue to fuel this important category growth driver with new performance styles including Infinite, Mega and Guardian as well as generation two versions of Sonic and Phantom establishing franchisees from which to deliver on.”
In train, its largest category, success was seen last year with the Reactor and Threadworm as well as exclusive collections, including Project Rock and Unstoppable, and the brand’s women’s collections. Said Frisk, “And this is a really important point as we continue into 2019, we believe that our assortments, product flow, and cleaner inventory positions will create greater opportunities for clear differentiation and therefore improved segmentation amongst our retail partners.”
Within sports style footwear, limited releases of product like the Forge 96 that mix style with performance are paying off, added Frisk.
Within core sports, the Curry franchise “continues to drive elevated brand relevance and authenticity in basketball and our team sports businesses continue to deliver the best product for athletes on the field, in training, and on the sidelines.”
Frisk cited four priories for 2019.
- Global structure alignment: Frisk said, “As we continue to expand globally we will be heavily focused on empowering our regional businesses with a stronger, more consistent structure and operating model including dedicated and localized support functions. This will help to drive greater uniformity and enter global alignment from a strategic, operational, and financial perspective to ensure that we properly leverage our scale while driving optimal business results that focus on protecting the brand.”
- Category evolution: Said Frisk, “We are working to further unlock the strategic benefits of our category structure while ensuring which they appropriately leverage at the crossroads of our accelerated innovation pipeline, consumer insights, speed to market and rates of return. With each subsequent season, you will see better holistic synergy particularly as we enter into 2020, where the first full season will come to market that has been designed, architected and executed under a shorter 17-month calendar.”
- Marketing transformation: Frisk said, “With a clearly defined understanding of our target consumer and where and how we plan to compete, we are moving toward better strategic and tactical executions using insights and data analytics to inform clear, return based and brand right decisions. Continued investment in social, personalization and agile testing along with shifting to an always-on mentality is the top priority in this effort which over time will yield more prescriptive and high return opportunities to drive greater engagement, preference, and considerations.”
- Process redesign: Said Frisk, “With the synchronization of the consistent go-to-market along with our sales and operations planning processes that final steps are locking into place to ensure that our goal of improved consistency, predictability, and repeatable processes are driving results. This effort has already produced a meaningful reduction in tactical steps, approvals and the previous case that were counterproductive to our efficiency.
Frisk said the four priorities will help Under Armour drive growth in its four largest long-term growth opportunities: DTC, footwear, women’s and international.
From a regional perspective, the focus will be on balanced growth.
Said Frisk, “For North America, that means we are at a point of stabilization. Inventory is cleaner and tighter to demand. Our pricing and promotional activities are normalized at lower levels than just two years ago, and our product segmentation strategy continues to get sharper.
“In our international business, which is now more than a quarter of our total revenue we will continue to make prudent investments to protect and drive brand right profitable growth. In this respect, many of the lessons we learned and the discipline we instituted in our North American business in 2018 will be applied internationally in 2019 including distribution optimization and strategic inventory management actions to ensure that we protect our premium brand positioning.”
He added that there is still “work to do to get our international regions into better stability and consistency from an operation and strategic perspective and we believe the actions we will take in 2019 will allow us to exit our Protect This House chapter with all of our regions operating more efficiently, consistently and profitably.
Plank concluded his formal comments, “In closing our operating model is working, we’re confident and committed to our long term strategic plan. We’re in control and command of our business and actively applying the lessons we’ve learned. We’re also acutely aware of just how special the Under Armour brand is and most importantly the hard work, choices, and effort it has taken and will take from this team to keep it in reverence for the years to come.”
Under Armour reiterated its outlook for the year initially provided on its December 12, 2018, Investor Day:
- Revenue is expected to increase approximately three to four percent reflecting relatively flat results for North America and a low double-digit percentage rate increase in the international business.
- Gross margin is expected to improve approximately 60 to 80 basis points compared to 2018 adjusted gross margin due to channel mix benefits from lower planned sales to the off-price channel and a higher percentage of direct-to-consumer sales along with more favorable product costs due to ongoing supply chain initiatives.
- Operating income is expected to reach $210 million to $230 million.
- Interest and other expense net are planned at approximately $40 million.
- The effective tax rate is expected to be in the 19 percent to 22 percent range.
- Earnings per share are expected to be in the range of $0.31 to $0.33.
- Capital expenditures are planned at approximately $210 million.
Image courtesy Under Armour