By Thomas J. Ryan

It was trick and treat with Under Armour’s third-quarter earnings.

While the sporting goods giant logged a robust third quarter, including beating Wall Street’s expectations on sales and earnings, its stock (NYSE:UA) tumbled more than 13 percent to below $33 a share October 25 after officials warned that the company’s core apparel growth is slowing and that it would miss its three-year profit target due to investments to support growth in other areas.

On a conference call with analysts, Under Armour CFO Chip Molloy said the company still expects to achieve its top-line annual sales goal of $7.5 billion by 2018, with average yearly growth in the low 20-percent range. But the bottom-line goal for 2018, set last September at $800 million in operating income, will fall short as the company absorbs stepped-up investments in footwear, direct-to-consumer (DTC) and international and more aggressively enters sport fashion categories ­like UAS to make up for weakness in performance apparel offerings.

“North America apparel growth is slowing across the industry,” Molloy said. “While we expect to continue to significantly outpace the apparel industry, the growth rate going forward will be less than expected from our Investor Day in 2015.”

With international and footwear both less profitable than apparel, gross margins will be impacted going forward. “The growth is still there, and it requires significant investment,” Kevin Plank, Under Armour’s chairman and CEO, said on the call. “It is time for us to invest.”

Star On The Field
Not to be ignored, Under Armour turned in stellar numbers in the third quarter, far outpacing some of its peers that have been dragged by the shifting U.S. sporting goods retail market.

Earnings in the quarter ended September 30 rose 27.6 percent to $128.2 million, or 29 cents a share, exceeding Wall Street’s consensus estimate of 25 cents. Revenues rose 22.2 percent to $1.47 billion, also above the consensus target of $1.45 billion.

Within product categories, apparel revenues increased 18 percent to $1.02 billion, led by consistent growth in men’s training, women’s training, golf and team sports.

Footwear revenues in the quarter jumped 42.1 percent to $278.9 million, driven by strong growth in running and basketball. The brand found success with its new $100 price point product offerings, the Bandit 2 and Slingride, while Stephen Curry signature lines drove basketball. Accessories revenues climbed 17.6 percent to $121.8 million, driven primarily by growth in bags and headwear. Licensing revenues rose 21.3 percent to $29.5 million.

Wholesale net revenues grew 18.8 percent to $1.01 billion, while DTC revenues grew 29.1 percent year over year to $408 million. Three new Under Armour Brand House stores opened in the quarter at the new World Trade Center retail complex in Lower Manhattan, Walnut Street in Philadelphia and Madison, WI. The company ended the quarter with 145 factory stores and 17 Brand House stores in North America.

By region, North America sales grew 15.6 percent to $1.23 billion. Operating income in the North America segment inched up 0.6 percent to $182.8 million. Under Armour had flagged in July that third-quarter sales would slow, mainly because of the liquidation of Sports Authority.

International sales vaulted 73.7 percent in the quarter to $226.2 million, while operating income in the segment more than tripled to $25 million from $6.2 million. Currency-neutral revenues grew 80 percent internationally. Strong growth continued in the EMEA and Asia-Pacific regions, while brand awareness in Latin America was helped by the strong performance of its athletes at the Olympic Games.

In the Connected Fitness segment, sales climbed 39.8 percent to $20.2 million. The segment’s operating loss was reduced to $8.5 million from $16.6 million.

The bottom line was impacted by a reduction in gross margin by 130 basis points to 47.5 percent. Of the decline, officials said 80 basis points reflected liquidation efforts in the marketplace driven by Sports Authority, while lower product margins and currency-exchange headwinds made up the rest of the drop.

Molloy noted that while liquidations have weighed on margins for much of the year, “our inventory position is healthier and liquidation should not have the same negative impact moving forward.”

SG&A expenses grew 20 percent to $499.3 million, but were down as a percent of sales to 34.0 percent from 34.6 percent a year ago. Expenses were less than planned due to lower incentive compensation and the timing of marketing activations. Some marketing spend, including the launch of Curry 3, shifted to the fourth quarter. Operating income for the quarter increased 16.3 percent to $199.3 million.

Year-End Outlook … And Beyond
Under Armour reiterated its outlook for the year. The company continues to expect 2016 revenues of $4.93 billion, representing growth of 24 percent over 2015. Operating income for the year is expected between $440 million and $445 million, representing growth of 8 to 9 percent over 2015. Gross margins for the full year are expected to decline approximately 80 basis points. SG&A is now expected to grow approximately 26 percent, versus 28 percent previously.

For the fourth quarter, revenues are expected to grow approximately 20 percent, which was below Wall Street’s target of 22 percent. Gross margin is expected to be relatively flat versus the prior year. SG&A is expected to increase at a higher rate than the third quarter due to the timing of certain marketing activations along with continued investment in Connected Fitness, international and DTC. Operating income is expected to land in the range of $186 million to $191 million, representing growth of 5 to 8 percent over the prior year.

While in line with future growth plans, the prediction of growth in the low 20-percent range acknowledged that overall top-line growth is also slowing from its hectic pace. Prior to the third quarter, Under Armour had racked up 12 straight quarters of 25-percent-plus quarterly revenue growth.

But the bigger drag on Under Armour appeared to be its lower earnings forecast. Annual operating income growth is expected in the mid teens each of the next two years.

Shift In Priorities
Molloy said the earnings target miss amounts to a shift in priorities to place a greater focus on “investing to get big fast.”

The investments include “doubling down” in footwear innovation and “investing in a complete market strategy from merchandising to in-store marketing.” Other increased investments include in mobile, DTC — expanding awareness internationally, particularly in Asia — further optimizing its store network and investing in talent to support its newer sports lifestyle pushes.

Those investments will position Under Armour to hit its next goal beyond 2018 of reaching $10 billion in annual sales. Molloy said reaching $10 billion, “along with the investments we have made in people, infrastructure, will begin to pay off in the form of increasing operating margin rates.”

Asked directly about what’s changed since the company’s September 2015 guidance on its Investor Day, Plank remarked that Under Armour’s apparel remained “incredibly profitable and still growing” at about 18 percent in the third quarter. But the North America marketplace, the driver of its growth in its 20-year history, is “modifying and it’s changing.”

He pointed out that three bankruptcies that occurred in the last 12 months in sporting goods accounted for more than $4 billion in lost revenue for the sporting goods industry in North America. That’s leading Under Armour to replace those sales with its own DTC network and expand distribution to other places, including launching at Kohl’s in 2017.

“We want to be clear, our demand is still there,” said Plank. “This doesn’t mean that the demand for the Under Armour brand has disappeared. But it certainly hasn’t reappeared dollar for dollar in our immediate distribution. We believe that the opportunity is also still there. We just have to be more thoughtful about how to capture the consumers and their dollars.”

Heralding Under Armour’s untapped potential, Plank pointed out that Nike and Adidas have more than 20,000 points of distribution each in North America alone, compared to 11,000 for Under Armour, “which speaks to some of the runway that we still have in front of us right here in our own backyard.” Nike is also six times Under Armour’s size and Adidas is four times.

But part of the shift in investments “is to strike, and strike hard” on opportunities that are growing faster than planned, particularly footwear and international.

In other areas, lifestyle, which represents less than 5 percent of Under Armour’s business versus a third at Nike and Adidas, remains a largely untapped opportunity. Connected Fitness, represented by its MapMyFitness platform, promises to “give us perspective on our consumers that will be truly unmatched in our industry.”

Finally, Plank noted that escalating “prices and frankly, the duration” of many university deals will weigh on results. Many deals now run 10 to 15 years versus 5 years previously.

“I want to be clear that the growth remains intact, it just costs more short-term investment dollars to achieve,” said Plank. “And the belief is that greater efficiency can come later, and that the growth that we have over the short-term EPS is a priority for our long-term goal of becoming the No. 1 sports brand in the world.”

Photo courtesy Under Armour