Earnings Call Transcript - UAA Q2 2021

Operator, Operator

Good day. Thank you for standing by and welcome to the Under Armour, Inc. Second Quarter Earnings Webcast and Conference Call. At this time all participants are in a listen-only mode. After the speaker’s presentation there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Lance Allega, SVP, Investor Relations and Corporate Development.

Lance Allega, SVP, Investor Relations and Corporate Development

Good morning and thank you to everyone joining us for Under Armour's second quarter fiscal 2021 earnings conference call. The information provided on today’s call will include forward-looking statements that reflect Under Armour’s view of its current business as of August 3, 2021. Statements made are subject to risks and uncertainties that are detailed in documents filed regularly with the SEC and the Safe Harbor Statement including this morning’s press release, both of which can be found on our website at about.underarmour.com. It is important to note that the ongoing uncertainty related to COVID-19 and its potential effects on the global retail environment could continue to impact our business results moving forward. We may reference non-GAAP financial measures and information on today's call including adjusted and currency neutral terms which are defined under SEC rules in this morning's press release. You may also hear us refer to amounts under U.S. GAAP. Reconciliations of GAAP to non-GAAP measures can also be found in our press release, which identify and quantify all excluded items and provides our view about why we believe this information is helpful to investors. Joining us on today's call will be Under Armour President and CEO, Patrik Frisk; and CFO, Dave Bergman. But before I hand it over to Patrik I would like to take a moment to recognize Carrie Gillard and the fact that this is her last earnings call with Under Armour. As an eight and a half-year veteran of this iconic brand and my partner in Investor Relations for the past four and a half years, it's been quite a journey to say the least. On behalf of the entire Executive Team, your determination, work ethic, and expertise have been truly appreciated and you will be missed. Can't wait to see all the great things you will accomplish in your next adventure. With that, I will turn the call over to Patrik.

Patrik Frisk, President and CEO

Thank you Lance and thank you Carrie. Good morning everyone and welcome to our second quarter conference call. At the halfway point of 2021, our better-than-expected results continue to validate that our multi-year transformation is working. With stronger top and bottom line performance relative to our previous outlook, perhaps more importantly, we're also driving high-quality growth, margin expansion, and greater profitability against our pre-pandemic 2019 results. In fact, diluted earnings per share through the first six months of 2021 are greater than the full year 2019, so overall, it’s been a great first half. Reflecting on the past 18 months amid a historically challenging environment due to the COVID-19 pandemic, I am incredibly proud of Under Armour’s global team and the way we have worked to hold ourselves accountable to our strategic playbook. By continuing to sharpen our focus on the operating model and financial discipline we have ingrained within our culture, we have a constant check and balance to deliver premium products and experiences to our consumers and customers. By driving higher quality revenue through our constant plans for operational excellence and applying what we've learned consistently refining and orienting towards brand-wide profitable growth means we are better positioned today to drive greater returns to our shareholders than we were before the pandemic started. With sustained uncertainty related to COVID which is trending unfavorably in key sourcing countries in Southeast Asia, the resiliency we've earned over the last year and a half will continue to serve as an asset while we navigate the second half of 2021. In this respect, we're focused on the things we can control, staying grounded in our four strategic pillars: strengthening the Under Armour brand, improving our operating model, amplifying a D-to-C focused approach, and increasing our capacity to return greater profitability across the company. Starting with strengthening our brand and the proactive decision we've made to reinvest some of this year's upside into additional marketing efforts, this flexibility is empowering us to amplify our middle to top of funnel activations geared at increasing awareness, attraction, and consideration for the Under Armour brand. As we work to connect with new athletes and inspire existing ones, we are centered on our brand attributes; resilience, hard work, heart, and edge. In the second half this will come to light more holistically as we illustrate the journey to compete through the process of training, setting goals, struggling, and ultimately realizing the results. Through a team sports lens supported by consistent messaging, our third quarter activations highlight the importance of mental strength, an often overlooked aspect of training and its relationship to unlocking an athlete's full potential. Certainly, coming out of a long stretch of COVID restrictions and as team sports hopefully open up more broadly this fall, we believe this is a timely effort to draw consumers into the psyche that is uniquely Under Armour as we work to make them better. Starting this month via social media, TV, and streaming be on the lookout for Chase Young, Trent Alexander Arnold, Ty Harris, and Nick Markakis among others helping to highlight mental training and the role it plays in achieving one's personal performance goals. As we say at Under Armour, if you train your mind, you train your game. So while there's still more work to be done to unlock our full marketing potential, I am pleased with the progress we're making in aligning our go-to market with focused performers and the evolving needs of our key retail partners around the world. The incremental marketing investments we're making in 2021 are aimed at setting us up more strongly in 2022 as awareness and consideration should lead to increased conversion as we strengthen our connectivity. In product, our strategy remains firmly rooted in an athlete's journey to sport, leading with insights and data to provide solutions they didn't know they needed and now can't imagine living without. With quite a few product highlights during the quarter I will start by recognizing the incredible milestone that our partners at Virgin Galactic achieved a few weeks ago with their commercial flight into space. We are excited to see what the future holds as new barriers get broken, inspiring all of us to strive for more. In apparel, second quarter highlights included strong sell-through of our ISO Chill running products featuring a UA innovation that keeps you cooler in hot conditions. We also saw strong sell-through in men's unstoppable bottoms and women's leggings, including Meridian and our no-slip waistband technology. We continued to build on the momentum with meaningful increases in our infinity and cross-back products. We also saw solid results in tops featuring our Rush technology. Lastly, Project Rock Apparel continued to build on its strong momentum as well with an excellent response to new products. In footwear, Flow Velocity performed well in all regions as did HOVR Phantom, along with significant growth against last year's already strong performance. Our Charge Pursuit II and certain nine footwear offerings also posted substantial numbers demonstrating continued success in our segmentation strategy to bring premium innovations across all price points. In Curry, we saw success on and off the court with our Curry flow eight signature shoe as well as retro styles that we pre-released in APAC, all good signs of momentum as we work towards the launch of the Curry Nine late this year. Finally, the Project Rock free shoe, which combines unidentified analyst HOVR and tri-based technologies for a highly comfortable and stable training platform, was also a standout. Switching gears to our next area of focus, which is continuous operating model improvement. Our second quarter results demonstrate once again that our ability to service increased demand with efficient, effective execution is getting better. Creating product at the right price and getting into the right place at the right time is at the core of how we win. To empower this, the adage holds 'success is doing the common things uncommonly well.' Simple perhaps, but precisely at the core of our strategic playbook and what we're obsessing over day to day. Turning to our regions, we believe it's most helpful to compare our results to 2019 since last year's second quarter was an incredibly unique period. Starting with North America, we're happy with our ability to drive higher quality revenue through sharper segmentation, tighter inventory management, and delivering consistent service to our customers. Versus 2019, North American revenue was up 11% in the second quarter and about 3% for the first half of the year. It's important to keep in mind that these comparable periods have key differences including a significant increase in our direct consumer business offset by considerably lower sales to the off-price channel, lower overall promotional and markdown activities, and supply constraints engineered to put us in a more advantageous position in the marketplace. All of this of course is geared towards continuing to lift the Under Armour brand to a more premium level in our largest market. To that point, as evidenced by our gross margin results, this strategy is working. From a channel perspective, we feel good about the pace we're earning back space with our key North American wholesale partners; driving fuller price revenue and showing up both digitally and physically in a more comprehensive way than ever before. Revenues from our owned and operated stores is up meaningfully in the quarter versus the same period in 2019 and includes improved quality and composition of sales. For the full year, we expect our North American business to be up at a low 20% rate compared to 2020.

David E. Bergman, CFO

Thanks, Patrik. At the halfway point of 2021, our second quarter results demonstrate that the strategies we've been executing against and the foundation we've worked hard to reset to increase Under Armour’s capacity to return sustainable, profitable growth to shareholders are working. Our operational execution has never wavered against an incredibly challenging and dynamic global market punctuated by COVID over the last year and a half. Our attention to Under Armour’s focused performers and delivering best-in-class innovations and premium experiences have never been sharper. All of this has come together to target full-year top line, bottom line, and working capital performance at better than pre-pandemic levels. In the second quarter, revenue was up 91% to $1.4 billion compared to the prior year. Versus our previous outlook, this overdrive was primarily due to higher demand across our wholesale and factory house businesses. Most of our Q2 wholesale overdrive was due to stronger sell-through and higher demand in North America. Our direct consumer business increased 52% led by 234% growth in our owned and operated retail stores, partially offset by an 18% decline in e-commerce, which faced a difficult comp as it was the primary business driver of last year's second quarter. Our licensing revenues were up 276% driven by increases in our North American partner business. By product type, apparel revenue was up 105%, driven by strength in our train, golf, and run categories. Footwear was up 85% driven by our run and team sports categories. Our accessories business was up 99% driven by hats, bags, and sports masks. From a regional and segment perspective, second quarter revenue in North America was up 101%. In wholesale, we continue to drive lower markdowns with tighter inventory enabling fuller priced sell-through. Within D-to-C, we saw strength in our owned and operated stores given the easier comparison to the prior year when most of our locations were closed for the quarter. This was partially offset by a decline in our e-commerce business, which conversely was up against a particularly tough comparison to last year. In EMEA, revenue was up 133% driven by growth in wholesale and D-to-C with significant strength across our wholesale and distributor partners. Revenue in Asia Pacific was up 56% with balanced growth across all channels. And in Latin America, revenue was up 317%, driven primarily by lapping the store closures in the prior year. As we move into the back half of the year, we expect the transition of certain countries to distributor models to negatively impact top line performance, particularly in the fourth quarter. Second quarter gross margin came in better than expected, improving 20 basis points to 49.5% driven by 570 basis points of pricing improvements due to lower promotional activity within our D-to-C channel, along with lower promotions and markdowns within our wholesale business. Overall, versus our previous outlook for second quarter gross margin, we experienced lower than planned promotions enabled through higher demand along with driving more favorable pricing. SG&A expenses were up 14% to 545 million primarily due to higher marketing costs and expenses tied to store operations. Relative to our 2020 restructuring plan, we recorded 3 million of charges in the second quarter, an amount less than we had anticipated due to timing of specific executions such as the realization of lease and contract terminations. Moving on, our second quarter operating income was 121 million, excluding restructuring and impairment charges; adjusted operating income was 124 million. After tax, we realized a net income of 59 million or $0.13 of diluted earnings per share during the quarter. Excluding restructuring charges, loss on extinguishment of 250 million in principal amount of senior convertible notes, and the non-cash amortization of debt discount on our senior convertible notes, our adjusted net income was 110 million or $0.24 of adjusted diluted earnings per share. In this respect, we are proud to report that in the first half of 2021 we have already surpassed our full year 2019 diluted earnings per share. So in a great position to finish out 2021 with strength against pre-pandemic levels. Inventory at the end of the second quarter was down 26% to 881 million, as we continued to drive improvements throughout our operating model, along with experiencing some inbound shipping delays due to COVID related supply chain pressures. Our cash and cash equivalents were 1.3 billion at the end of the quarter, and we had no borrowings under our 1.1 billion revolving credit facility. With respect to debt, during the second quarter, we entered into exchange agreements with certain convertible bond holders for 250 million in principal amount of our outstanding convertible notes and terminated certain related capped call transactions. We utilized 247 million in cash, issued 11 million shares of our Class C stock, and recorded a related loss of approximately 35 million which is captured in other income and expenses. Post this transaction, 250 million of our convertible bonds remain outstanding. Next, let's move on to our updated 2021 outlook, where based on better-than-expected performance in our second quarter, we flowed through the upside for a meaningful increase for our full year. That said, although recent consumer trends continued to track positively, we remain cautious with demand and the overall marketplace due to both the COVID-19 pandemic and developing manufacturing and logistics challenges in key sourcing countries in Southeast Asia. Accordingly, today's outlook is subject to our business continuing under the same general macros we've seen most recently with no significant shutdowns of manufacturing partners or retail or logistics disruptions, along with continuing improvements within the global retail landscape as we progress through the second half of 2021. That said, let's start at the top with revenue, which we now expect to be up at a low 20s percentage rate for the full year. This reflects the low 20s percentage increase in North America and a mid-30s percentage increase in our international business. For gross margin, on a GAAP basis, we expect a full year rate to be up to 50 to 70 basis points against our 2020 adjusted gross margin of 48.6% with benefits from pricing and changes in foreign currency being partially offset by the sale of MyFitnessPal, which carried a high gross margin rate along with higher expected freight expenses. The gross margin improvement relative to our previous outlook is due to improving benefits within pricing, partially offset by increased freight expense related to port congestion and logistics costs, which remains a rapidly evolving situation. Versus 2020, we expect a high single-digit rate increase in SG&A, a rate that is less than half that of our revenue growth. As laid out previously, it's important to remember that specific to 2021 we are taking advantage of our improved outlook and proactively making incremental investments, particularly in marketing to build even deeper connections with our consumers. Additionally, the other significant part of the overall increase in SG&A is higher incentive compensation, which is up against 2020 when we realized significant reductions against target levels. All in, of this expected high single-digit rate increase in SG&A in 2021, on an absolute dollar basis, about one-half of this is related to incremental marketing, one-third related to higher incentive compensation, and the balance related to our other underlying SG&A. On a two-year stack, the most significant drivers of SG&A dollar growth are the incremental marketing investments and higher incentive compensation we expect in 2021. As we look ahead, remaining disciplined around SG&A and striking the right balance between growth, productivity, and profitability is our top priority. With that, we now expect operating income to reach 215 million to 225 million this year, or 340 million to 350 million on an adjusted basis. Translated to rate, we expect to deliver an operating margin of approximately 4% or an adjusted operating margin just north of 6% in 2021. All of this takes us to an expected diluted earnings per share of $0.14 to $0.16 or excluding restructuring charges, the loss on early extinguishment of convertible senior notes, and non-cash amortization of debt discount on these convertible senior notes, we expect adjusted diluted earnings per share of $0.50 to $0.52 in 2021. In summary, our full year outlook reflects the combination of the overdrive we've realized in the first half of 2021 along with improvements across our business, positioning us to deliver growth and stronger profitability relative to 2019. Next, before giving more color on how we're thinking about the balance of the year, I'll highlight some headwinds that impact us more directly in the second half of 2021, including lower expected sales of our sports masks, supply and demand constraints, the absence of MyFitnessPal, lower expected sales to the off-price channel, changes to our Latin American operating model, and the exit of undifferentiated retail, which began in the third quarter. Looking at quarterly flow, we expect third quarter revenue to be up at a low single-digit rate and the fourth quarter to be relatively flat to finish out the year. Next, we expect third quarter gross margin to be up 130 to 150 basis points due to pricing benefits and channel mix as we anticipate lower promotional activity and lower sales to the off-price channel. These benefits will be partially offset by the absence of MyFitnessPal, higher expected freight costs, and changes in product mix driven by lower sales of sports masks. Bringing this to the bottom line, we expect third quarter adjusted operating income to be 95 million to 105 million or $0.13 to $0.15 of adjusted diluted earnings per share. Operational excellence, flexibility, a strong balance sheet, and consistent financial management when combined form a model that's allowed us to transcend pandemic challenges proficiently. Looking at the next six months, we believe Under Armour is well positioned to deliver on our next chapter of profitable growth.

Operator, Operator

And your first question comes from the line of Erinn Murphy from Piper Sandler.

Erinn Murphy, Analyst

Good morning. I guess my first question Patrik it's for you on North America. You talked about seeing that region get close to 2019 levels despite some of the structural and strategic changes that you've made. Can you just share a little bit more about what surprised you year-to-date to the positive on the underlying growth here in this region, and then as we exit 2021, how are you thinking about the long-term growth algorithm for North America?

Patrik Frisk, President and CEO

Hi, Erinn. Thanks for the question. We think in general, the ability that we've had to execute... So really at the essence of it is our strategy is working and we're able to execute against it. When we look a little bit forward into next year, I think the way to think about the current environment is there's a lot of uncertainty, right? And Dave highlighted this in terms of what we're seeing with the development on COVID-19 here in the back half.

Erinn Murphy, Analyst

Great. Thank you. And then if I can follow-up just on the supply chain. It's obviously been very challenging for everyone really. Can you share kind of what you're seeing real time, how much longer are the lead times coming out of Southeast Asia and I think going back to your Investor Day, Vietnam was maybe 23% exposure back then, what is that now and is there any workaround that you're needing to do to secure steady flow or as best of a steady flow of inventory as possible? Thanks.

Patrik Frisk, President and CEO

I think first of all, and I think it's a developing situation, I think that's something we're all dealing with across the industries, I should say. And you're right, we did talk about it in our Investor Day and at that point, it was a little bit lower than it is today. We're really happy with how we have planned our sourcing strategy and we talked about that actually at the Investor Day and we've continued down the path that we have talked about. Where we're not reliant necessarily in all categories is so much on APAC. We have a very balanced sourcing strategy across the world and today Vietnam for example, that you mentioned is about a third of what we do, but it's split right a little bit between apparel and footwear. It's important to note that we also have a good presence in Europe, Middle East, and as well as South America, Latin America in terms of our sourcing strategy. So we're well balanced.

Erinn Murphy, Analyst

Thank you so much and all the best.

Patrik Frisk, President and CEO

Thanks, Erinn.

Operator, Operator

And your next question comes from the line of John Kernan of Cowen.

John Kernan, Analyst

Excellent. Thanks for taking my question. Patrik, can you talk about the returns you're clearly earning on the top of the funnel in performance marketing, investments you made in the first half of this year, how we should think about them in the back half of the year, particularly within North America and how that fits into the revenue guidance for the back half of the year?

Patrik Frisk, President and CEO

I think you... So that means perhaps not so much driving more revenue this year, but really preparing ourselves for the future. So putting money into the top of the funnel to drive the brand, which will give us a payoff down the line.

John Kernan, Analyst

Understood. Dave, maybe one for you. The business generated at a 9% adjusted operating margin in the first half of this year. It's the highest the company has ever generated by far. Just curious, the path to a double-digit operating margin doesn't seem that far away.

David E. Bergman, CFO

Yeah, John... We are absolutely driving down that profitable growth journey now and we're excited about that, and we do believe that we will be able to get to a double-digit operating margin in the future. We're not ready to speak to what year that will be. There's a lot of different opportunities there that we will be excited to be able to speak more to in the future.

John Kernan, Analyst

Awesome, thank you.

David E. Bergman, CFO

You are welcome.

Operator, Operator

And your next question comes from the line of Jim Duffy from Stifel.

Jim Duffy, Analyst

Thank you. Good morning, guys. Couple of questions for me. A lot shifting stands in the environment, right. I'm trying to understand the impact of stimulus. Can you guys maybe speak to what you saw with retail door productivity cadence across 2Q and into July?

Patrik Frisk, President and CEO

Hi Jim, it's Patrik here. I think the way to think about stimulus is that it certainly had an effect on the consumer keeping the consumer in the market. We think that that's now also as we think about August, September, and especially Q3 here, turning into what could be a more normalized back-to-school perspective.

David E. Bergman, CFO

No, I think you covered it pretty well.

Jim Duffy, Analyst

Great. And then Patrik it's really encouraging to see the brands successfully engaging with consumers in the U.S. and selling more at full price. How does this leave you thinking about pricing power?

Patrik Frisk, President and CEO

I believe that as we progress through this year from Under Armour's perspective, we can clearly see that we are able to sell more full-price products with reduced discounts.

Jim Duffy, Analyst

Thank you.

Operator, Operator

And your next question comes from the line of Brian Nagel from Oppenheimer.

Brian Nagel, Analyst

Hi, good morning. Congratulations.

Patrik Frisk, President and CEO

Thanks Brian.

Brian Nagel, Analyst

So the question I want to ask and it's a bit of a follow-up to some of the other questions, but I mean there's a lot of cross currents in the consumer environment right now. And a lot of companies have been putting up good numbers. You're doing so here on the back of significant reposition investment you've made over last few years or so.

Patrik Frisk, President and CEO

Yes, hi, Brian. It's Patrik. That's a great question. What we're really proud of at Under Armour is the balance that you see coming through. Our growth is balanced and holistic. If you think about our ability to grow across all of our regions, grow across our categories, and to do that everywhere with a better gross to net, our ability to execute to get the right stuff, to the right place, at the right time and to be able to build franchises especially in footwear, something we never were able to do before.

Brian Nagel, Analyst

That’s very helpful. Appreciate it, Patrik.

Patrik Frisk, President and CEO

Thanks, Brian.

Operator, Operator

And your next question comes from the line of Matthew Boss from J.P. Morgan.

Matthew Boss, Analyst

Great. Thanks and congrats on a nice quarter as well.

Patrik Frisk, President and CEO

Thanks, Matt.

Matthew Boss, Analyst

So Patrik, maybe as we think about potential for the more normalized world that you laid out that hopefully we see in the back half and beyond, I guess maybe where do you see product execution, product opportunity across the apparel and footwear today versus how best to think about the evolution of your game plan on the product side as we think about 2022 and beyond?

Patrik Frisk, President and CEO

Matt, thank you for that question. It's one of my favorite questions because one of the things that's so exciting about Under Armour right now is our innovation pipeline. I think this increased laser focus that we have on consumer centricity is also helping us understand how to cadence things.

David E. Bergman, CFO

Matt, it's a great question. At this point, we've highlighted how outside of marketing and outside of incentive compensation this year we expect underlying SG&A to only grow 2% to 3%. So I think those are pointing towards where we've been able to drive that cost base towards.

Matthew Boss, Analyst

That's great color. Best of luck.

Patrik Frisk, President and CEO

Thanks, Matt.

Operator, Operator

And your next question comes from the line of Simeon Siguel from BMO Capital Markets.

Simeon Siguel, Analyst

Thanks. Hey, everyone. Good morning, congrats on the ongoing progress really, nicely done. Patrik, if I can go back just to contextualize the North America comment. So, having North America revenues almost hit 2019 is really fantastic.

Patrik Frisk, President and CEO

Yes, thank you. I would say that in general, gross margin tells the story here to a large extent. And your AUR are positive more or less across the board. We believe there's opportunity for us as we go forward.

David E. Bergman, CFO

Yes, I appreciate the interest in that. It was definitely a decent business for us.

Patrik Frisk, President and CEO

So, I think the way we're approaching it though is the fact that what I'm seeing from our teams here at Under Armour is an incredible resiliency and an ability to adapt and be agile in this pandemic situation.

Simeon Siguel, Analyst

Got it. Alright, thanks a lot guys. Congrats and best of luck for the rest of the year.

Patrik Frisk, President and CEO

Thanks, Simeon.

Operator, Operator

And your last question comes from the line of Paul Lejuez from Citi.

Unidentified Analyst, Analyst

Hi guys. This is Kelly on for Paul. Thanks for taking the questions. Looks like your revenue guidance in this year suggests North America sales will be down call it low to mid in the back half of the year versus 2019 it was up in the first half.

Patrik Frisk, President and CEO

Yeah. I mean, the outlook that we have for North America does contemplate a bigger impact in the back half of the year relative to the demand constraint work, but then also exiting the differentiated retail, we've been in that kind of 12,000 to 13,000 door range that we're going to be working down towards about 10,000 doors.

Unidentified Analyst, Analyst

Got it. Thanks. And then you mentioned some shelf space gains with key retailers in North America, which is great to see. Could you just elaborate on how exactly that's materializing?

Patrik Frisk, President and CEO

I would say it's broad and it's across categories and it's happening incrementally season over season, and a lot of it is with the new product that's coming out, right? That's driving the brand, the innovation. So it's good news.

Lance Allega, SVP, Investor Relations and Corporate Development

Thank you. That will conclude our second quarter earnings conference call. Thank you very much.

Operator, Operator

This does conclude today's conference call. Thank you for your participation. You may now disconnect.