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Under Armour, Inc. (NYSE:UA)

Q3 2009 Earnings Call

October 27, 2009 8:30 am ET

Executives

Alex Pettit - Director, Investor Relations

Kevin A. Plank - Chief Executive Officer

David W. McCreight - President

Brad Dickerson - Chief Financial Officer

Analysts

Michelle Tan – Goldman Sachs

Robert Ohmes – Bank of America- Merrill Lynch

Sharon Zackfia – William Blair & Co.

Omar Saad – Credit Suisse

Jim Duffy – Thomas Weisel Partners

Michael Binetti – UBS

Dan Werer – Raymond James

Mitch Kummetz - Robert W. Baird & Co.

Kate Mcshane – Citi Investment Research

Chi Lee – Morgan Stanley

Christopher Svezia - Susquehanna Financial Group

Thomas Shaw – Stifel Nicolaus

Operator

Welcome to the Under Armour Inc. third quarter earnings results conference call. Today's call is being recorded. At this time, I would like to turn the call over to Alex Pettit, Director of Investor Relations.

Alex Pettit

Good morning to everyone participating in this morning's conference call. During the course of this conference call, we'll be making projections or other forward-looking statements regarding future events or the future financial performance of the company. The words estimate, intend, expect, plan, outlook, or similar expressions are intended to identify forward-looking statements.

We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially. Important factors relating to our business, including factors that could cause actual results to differ from our forward-looking statements, 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 date on which the statement is made or to reflect the occurrence of unanticipated events.

Before we continue, I'd like to direct you to our Web site, investor.underarmour.com. There you will find this morning's press release, and on our Web cast page, images of a number of the products and initiatives we will address on the call.

Joining us on today's call will be Kevin Plank, Chairman and CEO, followed by David McCreight, our President, and finally Brad Dickerson, our Chief Financial Officer who will discuss the company's financial performance for the third quarter and provide an updated outlook for 2009 and a preliminary outlook for 2010.

After the prepared remarks, Kevin, David, Brad and Wayne Marinox, our Chief Operating Officer will be available for a Q&A session that will end by 9:30. With that, I'll turn it over to Kevin Plank.

Kevin A. Plank

Good morning everyone. Under Armour is a growth company and we are on offense. This quarter's scoreboard is strong proof. Overall, revenues were up 16% with apparel growing 7% and footwear up 153%. And our year-to-date numbers are equally strong with total revenues up 16%, apparel up 8%, and footwear up 69%. These results are a great example of what Under Armour can accomplish as we build our multi-billion dollar global platform.

And while our eyes are fixed on the road ahead, we thought that looking back to the playbook we were working from when we became a public company might provide perspective on how we've grown.

In 2005 Under Armour revenues totaled $281.0 million. Our Women's business was just over $50.0 million, we had just set up our office in Europe, our retail store base consisted of just five outlet stores, our online presence was small, and we had not sold a single pair of athletic shoes.

So fast forward to our third quarter results and let's look at how we've delivered against the opportunities we identified at the time of our IPO. 45% of our incremental revenue growth in Q3 came from wholesale footwear. Another 41% of that incremental growth this quarter came from our direct consumer business. European revenues increased 53% in the quarter and the dollar growth in Women's was the strongest of the three pieces of our wholesale apparel business.

Overall we grew Q3 revenues 16% to $270.0 million, roughly the same revenue figure that we did four years ago in all of 2005. That is great evidence that the opportunities we identified four years ago are transforming from potential to being the large scalable businesses we believe they are. We are playing offense.

David and Brad will take you through more detail and specifics around revenue growth, but to me, the most important part of this quarter's story is how we accomplished this growth. We did it by growing every piece of our business: Men's, Women's, and Youth apparel, footwear, accessories, and licensing.

We continue to grow because just as we did when we started, by making a break-through piece of equipment for the team sport athlete, we are a company focused on innovation and product-thought leadership, and we continue to have a great dialogue with our consumer, who happens to love sports just as much as we do.

For Under Armour, innovation is taking many forms as we grow. We continue to innovate on the field. This quarter saw the introduction of the Armour bite and mouth wear, a revolutionary new technology that provides customized dental protection. The results have been proven to increase strength, endurance, and reaction time. At $500 it's not for everyone but we view it as a great example of what happens when we relentlessly seek to make athletes better.

We also saw great acceptance among athletes this quarter for our recharge suit that we told you about on the last call. It is built with strategic compression that stabilizes muscle tissue and controls post-workout swellings to let the body repair itself to a greater magnitude, getting the athlete back in the game faster.

This is the type of innovation that helps ensure our leadership position in performance apparel, but we are also aware that innovation needs to be scalable so we can bring that same level of innovation to more athletes and more categories.

Towards that end we are taking the performance benefits of Under Armour and expanding our reach with consumers beyond those who wear UA compression with our expanded line of fitted ColdGear. It provides a similar level of protection and warmth as our tighter-fitting compression product, but both the cut and sleeve construction allow for a fuller range of mobility. It's a great example of taking our core competency of making athletes better and bringing that level of innovation to a much broader audience than we did four years ago.

On the brand communication front, we are bringing the Under Armour story to that broader audience as well. The brand continues to show up strong on Friday nights and Saturday afternoons on high school and college football fields across the country, but the star of our [inaudible] campaign this winter will be Lindsey Vaughn, the world's best women's downhill skier and an Under Armour athlete.

In addition to our relationship with Lindsey and top U.S. snowboarder, Lindsey Jacobellis, we will be outfitting the U.S. style sled team and the U.S. freestyle skiing team at the Vancouver Winter Olympics in February.

We are protecting our house in football with our on-field presence in the Under Armour's football campaign airing now but we are also expanding our reach by using wider athletes in our brand messaging. We are much more than the company we were four years ago and you will see that with the athletes that we image going forward.

By scaling our brand equity we are able to tell the Under Armour technology story off the football field and help shape our consumer's view of UA as a brand for all athletes.

Under Armour is on offense and we are fixed on the road ahead. Apparel is the largest piece of our business and it is strong at retail and well positioned to accelerate in 2010.

Footwear contributed much of the growth this quarter and remains an area where we believe in the opportunity and will continue to invest. Our footwear business is young. We have made some great inroads on field with our number two market share position in both football and baseball cleats. Youth continues to be one of the largest opportunities and greatest successes in footwear for us. Our training platform is positioned to expand for us and running will be a major piece of our long-term growth in footwear.

Our path in footwear is clear. Our goal is to bring the same level of innovation and excitement that we bring to performance apparel to every category we are already in or plan to enter. To accomplish that, we are committed to investing both the financial and human capital to ensure that we reach our potential in footwear.

Our brand equity has never been stronger and more broad-based. We have grown in many ways the last four years. We are building large, scalable businesses as the foundation of our multi-billion dollar global platform continues to expand and we will continue to play offense.

Now I'm going to pass it over to David, who will discuss more specifics on our progress in managing the growth drivers to drive that long-term profitability.

David W. McCreight

I would like to talk today about some of the areas that are driving our revenue growth in the short term as well as those where we continue to invest for the long-term. As Kevin mentioned, we are focused on cohesively managing our multiple-growth platforms to allow us the flexibility to do what's right for our individual businesses. We have strategically added resources across our organization to ensure that we sustain our trajectory as a growth company.

The Under Armour brand was established, and continues to be validated, by athletes on field. Over the years, we have had tremendous success in driving growth through apparel, first through the locker rooms, independent dealers, and then sporting goods accounts. Next we are evolving from solely a compression brand by growing our offering beyond compression into loose-fit product and finally, by addition new apparel categories which began to address the needs of both youths and adults, male and female athletes.

As we detailed earlier this year, we continue to believe the landscape for growing Under Armour apparel is abundant. And while U.S. wholesale apparel is the core of our business today, the foresight to aggressively develop our direct-to-consumer and footwear businesses is paying off now.

We benefitted in 2009 as our strong revenue growth, in both direct-to-consumer and footwear, has helped offset the economic pressures of today's environment. Our improved ability to manage the total Under Armour brand growth will be an important competency for long-term success.

Our direct to consumer business is robust, with revenues up 47% for the first nine months of the year. As we indicated in previous calls, we made the strategic decision to focus our energy on investing in our factory house outlets and online businesses and to slow the expansion of our specialty stores. By focusing our resources, we were able to better drive and deliver on this high-growth pace.

Through the factory house outlets, we are able to reach athletes in new communities, build our multi-channel data base, and improve our ability to profitably manage excess inventory.

With the online business, we're able to better showcase the breadth of our product to hardcore Under Armour fans, build on our relationship with them in a brand-centric shopping environment, and drive profitable growth.

You have heard us talk about how we at Under Armour learn, adapt, correct, and move forward. Our experience to date in footwear has provided our team with some accomplishments and with some great lessons. As Kevin mentioned earlier, we play offense and our strategy around the long-term growth of our footwear business is no exception. We have meaningfully increased our expertise level in-house, we have a better aligned vision for footwear across the organization, and most importantly, we are singularly focused on making great athletic footwear for the athlete of this generation.

Footwear has been a key component to our growth in 2009 and continues to be a key part of our plan to establish Under Armour as a global athletic brand. As we have learned in apparel, success comes from compelling innovation, thoughtful design, and powerful communication aimed at your target customer.

Our experiences, learnings, and close consumer connection in sports are key to the re-acceleration we see for our football, baseball, and softball cleated businesses, as well as slides, in 2010.

In our newer, non-cleated footwear businesses, we are applying greater focus on our core athlete, identifying their future needs, whether they run to train or train to run, by developing a unique, innovative design language specific to Under Armour that speaks directly to our athletes, just as we do in apparel.

As our footwear team accomplishes this over the next several quarters and years, we will be working to position our run business for the improved product we see coming as soon as 2011. We are planning our running footwear business conservatively in 2010 and as such, our revenue plans for 2010 do not assume growth in our overall footwear business.

While our year-to-date revenue growth in 2009 highlights our ability to deliver today, we remain a company and a brand investing in a platform for a multi-billion dollar future. During 2009 we continued to prime the apparel product engine. We grew our team of designers, merchants, product developers, and sourcing teams.

We invested in consumer insights to better understand the needs of our growing base of customers, we expanded our product assortment and price points that, with the support of our partners, will help us take advantage of opportunities to gain floor space, and we embarked on a detailed analysis of U.S. distribution to better understand the opportunity in our current distribution and identify potential new distribution in the future.

What we learned reinforces our belief that the opportunity to grow through apparel and other categories for Under Armour remains vibrant. The investments and focus we have brought to the apparel product engine in 2009 will enable us to reaccelerate the apparel growth story in 2010 and allow us the flexibility to manage our footwear platform for growth in 2011.

We have always had a good sense of where we could grow the pieces of our business. What we are getting better at is the when and the how of growing these individual pieces of businesses and coordinating that growth so we can better plan and allocate resources.

We understand the challenges inherent in managing a brand with both the near and the long-term potential of Under Armour. The efforts entailed in building the necessary capabilities are not just what our consumers or athletes sees, it's an integration of brand building, product creation, merchandising, and distribution, as well as the coordinated alignment with the back end of the business to ensure that we are maximizing the opportunity and operational efficiency of the organization.

In summary, we are pleased with our ability to grow revenue 16% in today's environment, but we recognize the need for continued investment to fuel this expanding platform for the future. Investments will encompass many areas, including brand building and product development, innovation, systems, infrastructure, and most importantly, talent.

We continue to build our teams, bringing years of world-class industry experience to Under Armour. This ongoing infusion of talent, combined with numerous team members who have helped build this brand from scratch, instilled in us the confidence that the expansion of the Under Armour platform is an increasingly stronger position as we become the brand of this generation. We are building and we are playing offense.

With that, I will pass it over to our CFO, Brad Dickerson.

Brad Dickerson

With Kevin and David having taken you through some highlights and strategies for our business, I would now like spend some time on our third quarter financial results.

As an organization, we remain focused on driving sustainable, profitable growth by balancing financial discipline with a continued commitment to invest in the areas of our business, which we believe will generate the best long-term return for our shareholders. We believe our third quarter results are an example of this focus and commitment.

Our net revenues for the third quarter of 2009 increased 16% to $269.5 million. Year-to-date, net revenues are up 16% to $634.2 million. Apparel net revenues increased 7% during the quarter to $215.4 million, bringing our year-to-date growth rate in apparel to 8%. Footwear revenues were up 153% to $33.0 million in the quarter and were mainly driven by shipments of running footwear for the back-to-school season. Year-to-date, footwear is up 69%.

Direct-to-consumer contained its strong growth to 62% growth in the quarter and 47% growth year-to-date. During the quarter, direct-to-consumer represented approximately 15% of total net revenues.

Third quarter gross margins decreased 130 basis points to 49.7%. There were several puts and takes impacting gross margin. First, as we have talked about in the past, effective inventory management has been one of our key balance sheet initiatives. While still a small percentage of sales, one aspect of this has been the liquidation of excess inventory to third parties, which impacted our gross margin for the quarter.

These efforts continued to free up working capital and it's worth noting that without these liquidation sales, we still would have achieved a double-digit rate of growth in the quarter.

Second, during the quarter, we also increased inventory reserves on obsolete seasonal products. These items were partially offset by strong revenue growth in our higher margin, direct-to-consumer business, and decreases in our reserve for sales allowance within discount incentives for our wholesale customers.

SG&A expenses grew 21% year-over-year to $87.0 million in the third quarter. SG&A as a percentage of net revenues increased to 32.2% compared with 31% in the prior year's period. The year-on-year increase in SG&A was primarily driven by a continued expansion from our factory house outlet stores, as well as investments made in our team. Much of the increase in personnel costs went towards the build-out of our apparel and footwear design and production creation teams, as well as increased funding for our performance incentive plan relative to the prior year. Year-to-date SG&A increased 15%. The percentage of net revenues to SG&A decreased 37.9% compared with 38.5% in the prior-year's period.

Operating income during the third quarter increased to $47.1 million compared with $46.5 million in the prior year. Year-to-date operating income grew 8% year-over-year to $58.3 million.

Our effective income tax rate in the third quarter was 43.9% compared with 42.6% in the third quarter of 2008. We continue to anticipate our annual 2009 effective tax rate to be approximately 100 basis points improved from our 2008 effective tax rate of 45.3%.

Our resulting net income in the third quarter rose 2% to $26.2 million.

Third quarter diluted earnings per share increased to $0.52 compared with $0.51 in the prior-year's quarter. Year-to-date our EPS increased to $0.62 compared with $0.59 in the prior year.

As noted earlier, we continue to focus on strengthening our balance sheet and improving our working capital efficiency. These efforts have paid off with total cash and cash equivalents increasing over $53.0 million year-over-year to $93.4 million at quarter end.

Cash, net of debt, increased $72.5 million to $75.1 million at quarter end. We currently have no borrowings outstanding on our $200.0 million credit facility.

Net accounts receivable decreased 4% on a year-over-year basis, significantly below our net revenue growth for the quarter. In addition to the strong performance of our collections team, partly improvement in A/R came from the higher mix in direct-to-consumer sales.

Inventory at quarter end decreased 6.6% year-over-year to $152.8 million. In addition to improved inventory management processes, our inventory balance at quarter end benefitted from strong performance of our factory house outlet stores, an increased level of direct shipments related to footwear, and the third-party liquidation sales mentioned earlier.

We still anticipate inventory growth to be below revenue growth at the end of the year. Our inventory strategy remains intact as we continue to manage our inventory purchases, reduce our lead times, and sell excess inventory through our factory house outlets and other liquidation channels. We also will continue with our efforts to improve turns while supporting our growth platforms going forward.

Our investment in capital expenditures in the third quarter was $5.2 million, bringing our year-to-date capex investment to $18.4 million. We continue to anticipate 2009 capex to be in the range of $30.0 million to $35.0 million, below the $41.0 million invested in 2008.

Now, moving to our full-year 2009 outlook. We delivered strong results in the quarter but we maintain a cautious view on the consumer spending environment. However, given our performance year-to-date, we are raising our outlook for both the top and bottom lines. We now estimate full-year net revenues to be $830.0 million to $835.0 million, an increase of 14% to 15% year-over-year. This compares to our previous outlook of approximately $810.0 million.

Full year gross margins are still anticipated to be down year-over-year due to the increased sales mix of our lower margin footwear business. However, with the majority of our planned, third-party liquidation sales for 2009 having already occurred, and with the strength in our direct-to-consumer business expected to continue in the fourth quarter, we anticipate our fourth quarter gross margins to be up year-over-year.

Based on higher personnel costs during the second half of the year, including increased funding for our performance and incentive plan, we now anticipate SG&A for 2009 to grow in the mid-teens on a percentage basis, year-over-year.

For the full year we continue to expect to invest in marketing in the range of 12% to 13% of net revenues.

Based on our improved outlook for 2009 and our conservative approach in the beginning of the year, we now have the flexibility to invest in areas we believe are critical to our business.

Given current top-line projections, gross margin direction, and planned SG&A, diluted EPS for the full year of 2009 is currently expected to increase to a range of $0.85 to $0.87, versus our prior outlook of $0.80 to $0.82.

Before we wrap up, I would also like to provide you with a preliminary view into 2010. Based on our initial view, we currently anticipate 2010 net revenues and EPS to grow in the high single to low double digits. This growth is expected to be driven by a degree of acceleration in our wholesale apparel business, as well as continued strength in direct-to-consumer, and does not assume growth in our overall footwear business.

Obviously it is still early and we will provide additional detail on our 2010 outlook in the coming months.

Once again, in 2009, we have demonstrated that Under Armour is a growth company. Most importantly, we are a growth company balanced with profitability. Our growth this year is a result of the investments we have made for many years in the brand in our infrastructure and our team. We are committed to investing in our growth initiatives while driving effective cost management and continue to strengthen our balance sheet.

At this time, we would now like to open the call for your questions. We ask that you limit your questions to one or two per person so we can get to as many of you as possible.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michelle Tan – Goldman Sachs.

Michelle Tan – Goldman Sachs

I was wondering if you could give us a little more color on the drivers of the apparel re-acceleration next year, from a product perspective.

And then also talk about the demand you are seeing in the current quarter for colder weather apparel and whether your sales are inventory constrained at all here in the second half.

Kevin A. Plank

Let me just start with some of the things that we are seeing in apparel, and obviously we are real encouraged by some of the indicators that are out there and particularly in the performance in the quarter.

The first thing I think that's driving is more than anything is probably just our brand equity. I think we continue to see the brand move beyond being a sort of a narrow team sports brand into being much more open and accepted by athletes really of all backgrounds.

And we continue to build it with the consumer with great product delivered in a very authentic way. And so not compromising our message, not buying our way into categories, but really allowing the brand to be pulled into categories by athletes has really been driving.

And I think, as we mentioned, we really saw strength across the board, so apparel is obviously the highlight, but with Men's apparel, Women's apparel, and our Youth apparel all growing, as well as footwear, international, direct-to-consumer, accessories, and licensing, it's rare, or not often, I think, that you get every category up in a given quarter. So while apparel, of course, is the largest aspect of our business, we are really excited by all the different places we are seeing growth.

But the equity, I think, that we found, particularly where you find a lot of people talking about today's environment, we've always had our relationship with that core athlete, and that core athlete is someone that never really leaves our brand and in good times or bad, football will still be played in the fall, baseball in the spring, and volleyball and soccer and so on. So we haven't seen them necessarily go away.

But if we had any message around our business, and I think you will see us continue to innovate. I mentioned our fitted options that we will have to core compression business, and continue to expand the idea of base player, as we're not necessarily calling it compression anymore, but the next-to-skin product lines, as then us innovating with definitive products like we talked about Armour Bite as well, so we have those premium products that we'll have out.

So I think our remaining focus on innovation is driving us and I think we're doing a really good job in apparel right now. So that's been a real positive.

In terms of the quarter in inventory, obviously the cold weather helps and it always makes business, makes all of us a lot smarter, and so we are seeing some of the effects of that, but we will chase where we can and find the places where we see opportunities in the business, but for the most part we feel pretty good.

Brad Dickerson

Just to feed off what Kevin said, for the fourth quarter, we do have some ability to chase a little bit of product but based on our inventory management there will be a limit to how much upside we have in the fourth quarter. We will be able to chase a little bit, like Kevin said, but there will be some limit to that.

Operator

Your next question comes from Robert Ohmes – Bank of America- Merrill Lynch.

Robert Ohmes – Bank of America- Merrill Lynch

Just a couple of quick ones. The first one, I apologize if I missed it. If you could give us the number of outlet stores at the end of the third quarter and how many you expect at year end and then the growth in factory stores you expect for next year.

And the second question is just on the 2010 guidance. Can you help us think about footwear for 2010? You are saying footwear revenues—I guess growth in footwear isn't included in your initial 2010 take, but could footwear revenues actually be down? Or what's happening between running and cross training and new category launches, like basketball in 2010? Should we not expect that? If you could just give us a broad view on what footwear should like in 2010.

And also, the 2010 international assumption in that would be great, as well.

David W. McCreight

We ended the quarter with approximately 33 factory outlet stores and we are looking to add a few more for the beginning of Q4. We see continued opportunity to expand those. We will get into more details on the direct-to-consumer expansion but we're very satisfied with the direction we're taking with direct-to-consumer. We think it's a great way to connect with the hard-core Under Armour athlete and we are seeing it as a nice way to partner with our retail partners. So we're, as you've seen all year, we have seen steady March in progress and we will continue to see that in 2010.

As it relates to footwear and general guidance, we're not planning on growth in footwear. We have accomplished a great deal. We're seeing real progress in many categories. As I mentioned earlier we've launched and immediately became a leading force in cleated footwear in baseball, softball, and football. We are seeing great progress in the slide business, and we accomplished our goals with running this year, getting out, making a technically sound product, gaining acceptance from our retail partners, and gaining acceptance, more importantly, from our athletes. And we are going to continue with our new team to build that business and model but not planning growth in 2010.

Brad Dickerson

On the international question, we see international growing at a faster pace than our overall business in 2010, similar to 2009. But other parts of our business, we also see it doing that also, so I think as a percentage of revenues in general year-over-year, I think you will see international be relatively the same percentage of revenues year-over-year in 2010. But again, we will give you more detail on 2010 in the coming months.

Robert Ohmes – Bank of America- Merrill Lynch

So footwear, your 2011 could be the big break-out year for you.

Kevin A. Plank

We're giving you what we're seeing right now. We would really probably rather come back in another three months and tell you what 2010 looks like. We've got two new bodies in the chair in footwear that are doing a great job and continue to evaluate and see what our opportunities are there, but if there is a story right now about 2010, the good news is that we do have five levers to pull on and the good news is that our apparel business is accelerating, or re-accelerating, think about it the way you want to look at it, and gives us the opportunity to make the prudent decision long term that's in the best interest of the brand.

So I think there is opportunity there, but again, we don't feel any pressure to try to push something if the timing isn't right.

And in reaction to your question about categories, we like the categories we're in right now. We're going to become great and excellent in those categories and we're going to focus and refocus on the places where we're doing business today and the categories that we're in today.

We see those additional places, i.e. basketball, we're going to test, we're looking at them right now, we've eight division one programs who will be wearing our shoes this year. We've got 20 lead high schools. We've got Brandon Jennings from the NBA so we have presence and we, more importantly, have feedback from all levels of competition.

And we are evaluating and making those decisions to go at it, first and foremost when the product is ready and when we're ready to support if and tell a big story. Go heavy or go home.

Operator

Your next question comes from Sharon Zackfia – William Blair & Co.

Sharon Zackfia – William Blair & Co.

I guess just following up on the initial outlook for 2010, if higher margin apparels are growing faster than footwear, I am presuming you are taking this break in footwear to try to bring up those margins. Shouldn't we think about earnings growing at a much quicker pace than revenues? I guess I'm a little confused by why we're expecting them to grow in tandem in 2010 rather than the earnings outpacing the revenues.

Brad Dickerson

Yes, to your point, obviously with apparel growing, being more the growth in 2010 versus 2009 you would expect gross margins to have a benefit to that. But consistent with what we've seen here in 2009, we continue to invest in our business. We think it's important to continue to invest in our business to drive future performance in 2010, 2011 and beyond.

So in the SG&A area, similar to what we did in 2009, I think you're going to see similar investments in our team, product creation development teams, direct-to-consumer growing relatively above our overall company growth rates. We will continue to invest in direct-to-consumer.

So there's going to be continued investment in our SG&A that we feel is important to drive long-term growth.

Sharon Zackfia – William Blair & Co.

Are you anticipating any material improvement in footwear margins next year or are you leaving that open?

Brad Dickerson

Footwear margins right now, I think with the growth that David and Kevin walked you through, I think we would see gross margins in footwear would be relatively the same year-over-year, as you saw in 2009. I think we, obviously, long term see tremendous improvement ability in footwear margins, but we won't see as much of that in 2010.

Kevin A. Plank

Let me clear, too, we are not taking a break in footwear either. We are continuing to push and drive in footwear. And so again, you will hear a lot more color from us on the next call, as well.

Operator

Your next question comes from Omar Saad – Credit Suisse.

Omar Saad – Credit Suisse

I wanted to ask you about your seemingly cautious view on the fourth quarter on the top-line side. It seems like you are planning for a little bit of a deceleration, albeit it a good number, but a deceleration from where you were in the third quarter. The cold weather, this used to be—it used to focus so much on the cold weather for you in the last couple of years. Obviously the weather early has been cold in much of the country, kind of cold and wet and requiring some warm apparel. Can you help me reconcile what you're seeing at retail, given the weather and what the sell-through looks like and your outlook for the fourth quarter?

Brad Dickerson

A couple of things, just on timing between Q3 and Q4, which might help you answer your question. We did see some timing shifts from October orders into September, to your point. Weather helped us in September a little bit and sell-through was very, very strong in September. So a couple of our larger customers did want to get some product in early in September, to stock the shelves. So we did see some of October sales come in September.

Also, we talked on the last call about liquidation revenues, to third parties. You know, kind of being evenly spread out between Q3 and Q4. We actually saw more of those in the third quarter and as I called out, even with those increased third-party liquidation sales, we still had double-digit growth in the quarter. But more of those came in Q3 than we had anticipated earlier.

Also, on the cautiousness of the consumer environment, I think in addition to that, we also talked about it in the previous answer, our ability to chase product in the fourth quarter will be a little bit limited based on our inventory levels.

Omar Saad – Credit Suisse

Is the weather impacting the demand for Under Armour apparel?

David W. McCreight

We continue to make the leading product in our space and as Kevin mentioned, we are always smarter when the weather changes, but we continue to see our market share remain very strong, if not grow, and we're building platforms that will be weather-proof in the future.

Omar Saad – Credit Suisse

And also quickly, on SG&A, I like to hear the comments around SG&A and the willingness to invest. Philosophically, to the extent that you think about how to plan your spending, and to the extent that you see revenue upside over the next year or two, are you looking to kind of plow that back in the business: build the platform to the best of what your resources will allow you to do, marketing, advertising, the team, building up the team, systems, etc.? Or is it more kind of we have an opportunity to see some upside in terms of the bottom line to the extent that sales over the next couple of years kind of come in ahead of that high-single, low-double?

Kevin A. Plank

I think we are very bullish on the future and we are very bullish on our ability to continue to grow as a company. In order for us to do that there is certain investment that needs to be made and I think that we have prudently been able to balance the ability, a) to grow, b) with the ability the need to invest in key resources.

And I think, as Brad called out in his script, the key places we are investing first and foremost is around the product, primarily in continuing to put pressure around our apparel group and bring great talent in there, and as well as just filling out the boxes in footwear. I made the point on the last call, if you look at our business, look at the upside that we have in our business, where we've got, if you compare us to, or you can figure out where our margins are versus what some of our competitors, and there's more than 1,000 basis points of gross margin opportunity in our business, over time, for us to be able to invest back in.

Again, it's not some magic formula that our competitors have that we don't, it's just a matter of timing doing business. So as we enter these other categories and frankly, as we begin to get better at it, we're doing well as a company and hats off to our team on the quarter, but we have a long way to go and we have a heck of a lot of improvement, which speaks a lot to opportunity.

And the best way we think to be able to capitalize on that opportunity is some of the shorter-term investment that you are seeing us make in 2009, and frankly, in 2010 as well.

Operator

Your next question comes from Jim Duffy – Thomas Weisel Partners.

Jim Duffy – Thomas Weisel Partners

Could I ask you to speak to the split between apparel and footwear gross margins?

And then I want to talk a little bit about gross margin opportunities in 2010. You talked about footwear staying roughly consistent. As you look towards the new categories for apparel growth and your overall systems and productivity, is there more opportunity on the apparel gross margins in 2010?

Brad Dickerson

As far as the split between margins, we don't really break out the split between footwear and apparel margins in detail. But as we've talked about in the past, obviously footwear in general, now and in the future, will be below our apparel margins, although we do see long-term ability to improve those footwear margins. Right now they are below our apparel margins.

I think what you do see, though, in the third quarter and also we called out for the fourth quarter, is direct-to-consumer is a bigger part of our business in the back half of the year so you do see some benefit coming through with the direct-to-consumer business, which is mostly in the apparel side.

When you look at 2010, we have been calling out the continued work towards improving our apparel margins, longer term. We still see the ability to do that. We do see more long-term upside in footwear margins but we do still see the ability on the apparel side to improve margins, too, in the short and longer term.

You will also have to remember, direct-to-consumer continues to be growing above our overall company growth rate in 2009 and also we see that in 2010 and there should be a positive impact on margins from that, too.

Jim Duffy – Thomas Weisel Partners

And then a follow-up question. With regards to your decision to let's say regroup in 2010 on the footwear side, can you speak to some of the process improvements and things like that? What do you hope to accomplish by kind of tapping the brakes there and, as I characterized it, regroup?

David W. McCreight

As we discussed earlier, and we had mentioned, we've been out in footwear, first started with cleated, and learned a great deal and were accepted by lead athletes across many sports, and rapidly gained a strong market share.

And we're taking the same approach as we enter the larger and very competitive space in running footwear. We continue to sharpen the team. We've brought in just tremendous experience with Gavin Ivestor and Gene McArthy and others, in addition to the team we have in place. We are working on sharpening our product development cycles, working with key factories, our sourcing base, as well as our use of technology, to help us really define and develop a distinct point of view in bringing our technology and leading product to our non-cleated footwear categories.

So you go through a cycle of introducing a product, connecting with athletes, staying close to their needs, and you have learnings and you then you build it and ultimately deliver on the brand promise. So we are very confident we've learned a great deal and feel even more confident about our future going forward.

Operator

Your next question comes from Michael Binetti – UBS.

Michael Binetti – UBS

Just a quick housekeeping first. You used to typically provide the revenue and break down for your top three retailers with your quarterly release. I was wondering if we could get those percent of revenues for your top three.

Brad Dickerson

We will put that in the 10-Q. We don't really put that detail out right now but that will be in our 10-Q, which will come out in the next few weeks.

Michael Binetti – UBS

You commented I think at the top of the call that you were doing some assessment of where to take distribution next year. I'm assuming you're talking about away from your direct-to-consumer business. I was wondering if you could talk a bit about what some of your initial findings are telling you there? Perhaps a revised emphasis on the mix going through existing channels or some emerging opportunities in different channels that you might be seeing. Any kind of detail you could help us with there.

David W. McCreight

What we've learned is that there is great desire and acceptance of the Under Armour brand across America and we've found that in many locations that our partners are doing a terrific job. Our plans in the near term, in 2010, are to continue to grow our share within our existing partners. We are continuing to try to build floor space and rack space in each of the locations and we are seeing nice progress there.

Additionally, we are seeing a place to strategically position our direct-to-consumer business, both from our reach of the Web as well as to our own branded stores, and make sure that we are complimenting our existing partners as well. So we are seeing no material change in other partnerships for 2010 as an offing.

Michael Binetti – UBS

And if I could follow-up on the direct-to-consumer business. You said that that business grew by 62% in the quarter versus last year, versus your total revenues, which grew about 16%. At the same time it looks like direct only represented about 15% of the total in the quarter, which was just a little bit lower than the 16% of the total in the second quarter. I would guess that based on the growth rate there, that that would have led to a higher percent of revenues in this quarter. I'm just curious if there's any kind of change you're seeing in the that business, as well as any kind of change you can talk to us about in the buying habits of the consumer in your direct business, or the average ticket that you're seeing through your direct channels that you would care to call out.

David W. McCreight

We continue to make solid progress with our direct-to-consumer. We sort of measure both comp growth as well as we look at new athletes we're bringing, and we're continuing to do both. Very solid comp growth in both our direct-to-consumer areas, whether it's in our own stores as well as through the Web site. And we're also reaching additional traffic as well.

We've not seen any material shift in the purchase behavior and our average order of value, for the most part, is holding steady. It's one of increased traffic and conversion metrics.

Brad Dickerson

Direct-to-consumer was 15% of our business in Q3 of this year. Just directionally, last year it was 11% of our business. So we did see that increase grow year-over-year in direct-to-consumer.

Operator

Your next question comes from Dan Werer – Raymond James.

Dan Werer – Raymond James

Prior to the recession, you used to anticipate Under Armour growing 20% to 25% a year. Now, with this current environment perhaps being the new normal, is the 10% to 12% growth in 2010, do you anticipate more likely the growth rate for the company going forward, as the large numbers begin to catch up?

Kevin A. Plank

I think first and foremost, our growth platform is intact. That's one thing I want to let you know. We talked about five growth levers as far back as our IPO. We talked about Men's apparel, Women's apparel, footwear, international, and direct-to-consumer. And I think that Q3 is great evidence that all of them continue to grow, in light of any environment that's out there.

So how we measure ourselves and put a barometer, I think long-term growth targets intact is that we see ourselves building the next great athletic brand. And the opportunities that we have in the product categories, distribution, and regions, I think we've, again, demonstrated our ability to have the brand equity to deliver.

So more important than anything, is right now we're focused on our 2009 and 2010. We've always said that we're the kind of company that had 13 items, typically, in our top 10 list. Well, 2009 made us prioritize and so instead, we turned that list into our top five. And we really began to prioritize our investment. And more importantly, is our ability to not only prioritize our own investment, but to continue to grow while we do that.

So the thing that I think we're seeing from it and probably gives us the most upside, is as we look at the scope of who we are speaking to today, the athletes we're talking to, beyond just the team athletic fields, and particularly from the success we've seen in places like Women's, golf, footwear, running, and Europe. And I think that message of learning, adapting, and going is one that we will continue to push and drive going forward as well.

But from a growth standpoint, I'm very clear on the fact that we remain a growth company and we will continue to play off those through 2009 and 2010 and so the size of that growth is one of the things we want to put off until our next conference call. We'll see a little more, see how the holiday goes, and get a little more understanding. But right now we feel very comfortable with the outlook that Brad provided and we will continue to execute on that.

Dan Werer – Raymond James

As a follow-up, in the prior conference call you noted that you were wanting to rework the pricing, maybe the technology with your running shoes. I think a lot of us were anticipating these changes would be in place perhaps by the midpoint of 2010. I was curious as to why maybe it takes longer to reformulate the strategy, it sounds like, on the running shoes, before it begins to grow again.

David W. McCreight

Like we said, and Kevin mentioned, we get out, we call a play, we run the play, we learn, we adapt, and then we revise. And we have done that in cleated, we've done that successfully in other areas, as you're seeing now. In non-cleated we've had some terrific traction with our Youth footwear and we think we've got a very good price value as well as an innovation story.

Most importantly, we've had great acceptance and commitment and support from our footwear partners out there and we are continuing to look to build the business with them and find the spot for Under Armour.

As you look to dial in, you will see us really adjust price value, probably in the first half of 2010, and then the product development cycle, it's not a short development cycle. So that's what you will see most of that coming in the future.

But overall, we're very optimistic about taking a leading position in footwear, in the very near term.

Dan Werer – Raymond James

I think I wrote in my notes on the gross margin drivers in the quarter, did you say you reduced the incentives to wholesale customers?

Brad Dickerson

Yes, it was a combination of sales allowances and incentives to wholesale customers. It's more a reflection of last year's number being a little higher, more so than normal. I think this year's number is a little bit more normalized.

Dan Werer – Raymond James

So just with key retailers cutting back on inventories, they're earning fewer of these discounts than they had in the past?

Brad Dickerson

It could just be also that it is also a shift sometimes in how we spend those dollars, so sometimes it shows up in margins, sometimes it shows up in SG&A. So it's not really a significant change in the cost as much as it is where that cost shows up.

Operator

Your next question comes from Mitch Kummetz - Robert W. Baird & Co.

Mitch Kummetz - Robert W. Baird & Co.

Your sales guidance for next year, high single digits to low double digits. How should we be thinking of that in terms of first half and second half? Because you are going to be lapping a big footwear quarter in Q1, just based on the running shoe launch. I'm guessing that in terms of footwear being potentially flattish next year, you would probably expect it to be down in the first half and then maybe up in the second half. But tell me if I'm not thinking about it in the right way.

Brad Dickerson

I think we'll give a lot more detail on our 2010 outlook at the next earnings call, but to our point before and to what you're saying, with footwear growth not like it was in 2009, I think you can look at the timing of what footwear [inaudible] in 2009 compared to what you would see in 2010.

Also, similar to what we saw in 2009 on the direct-to-consumer side, again direct-to-consumer is a call out of ours that continues to grow above our overall company, and I think, as we pointed out, the back half of the year is usually a bigger growth area for our direct-to-consumer business.

Mitch Kummetz - Robert W. Baird & Co.

And any color you can give us on your spring orders, how are they coming in?

David W. McCreight

Early on we have worked with our partners for spring and we're getting a good response to the product offering.

Mitch Kummetz - Robert W. Baird & Co.

And lastly, I know you mentioned SG&A 12% to 13% of sales this year. Would you expect that percentage to hold comparable in 2010, because it sounds like you're sponsoring some Olympic athletes in some of the winter games so I'm just wondering if you would expect that percentage to come up at all. Our maybe you would be a little bit more lumpy in 2010 with a focus on the upcoming Winter Olympics.

Brad Dickerson

I think you meant marketing as a percent, on the 13%.

Mitch Kummetz - Robert W. Baird & Co.

Yes, I'm sorry.

Brad Dickerson

We will give you more outlook on the timing of marketing on the next earnings call, but we don't see any significant changes in the marketing as a percentage of revenues in 2010 versus 2009.

David W. McCreight

I just want to add on to Brad's comments, one of the things I think is so unique about Under Armour, and it's just terrific to join, has been Kevin's focus on driving the business forward. And you're hearing of a lot of companies that decreased SG&A this year and the strategic push has been invest, build the future, we're investing in large, scalable businesses that are going to lead us to a multi-billion dollar platform. And there is clearly some tension on do you want to leverage now. And we are very committed to building what we need to. And so you are going to see continued investment, just like in 2009, in 2010, in building that platform.

Operator

Your next question comes from Kate Mcshane – Citi Investment Research.

Kate Mcshane – Citi Investment Research

I wondered if you could give a little bit more detail on deflation and how much it contributed to any margin improvement in the third quarter and can we expect an acceleration in Q4 going into 2010?

David W. McCreight

Wayne and team are working on some tremendous sourcing initiatives. Those will, as Brad was saying earlier, we will start to see continued apparel gains, but through a shift in channel, as well as we're further along in building that supply chain and refining it. And then we expect to see further opportunities for footwear—actually, a tremendous opportunity for footwear—but that's more in the mid-to-longer future.

Operator

Your next question comes from Chi Lee – Morgan Stanley.

Chi Lee – Morgan Stanley

I have a follow-up question on the outlook for re-acceleration in the wholesale apparel side of the business. Can you just, maybe at a high level, talk about what the drivers you expect to be between distribution expansion, perhaps recalibration of inventory levels out there in the channel, and what you expect the economy to really do next year?

David W. McCreight

We are seeing the re-acceleration based on the strength of our apparels business within our existing partners. We are not planning on a tremendous expansion of doors with them, it has to do with the messages that Kevin related to earlier: exceptional brand, working on innovative product that resonates with our athletes. And we're seeing it in a broad-based manner. So it is less to do with back-filling of inventory and more has to do with the quality of the brand and the product we have coming in the future.

Chi Lee – Morgan Stanley

Just on the economic outlook, is your expectation that things will largely run sideways from where we are today, in that outlook?

David W. McCreight

Yes. We are not planning on any macroeconomic factors to improve or detract from the environment as it is today.

Chi Lee – Morgan Stanley

I believe last quarter you called out about a 60 basis point benefit coming from the apparel costing gains. Can you talk about what that was this quarter and what you expect it be heading into the fourth quarter?

Brad Dickerson

We did see some benefit from sourcing improvements, as David stated earlier. It was not quite the magnitude of Q2 but it was a positive. It was also offset by some mix, apparel margin mix, year-over-year in the third quarter. And also some distribution mix, also, which more than offset that apparel sourcing gain.

Chi Lee – Morgan Stanley

And with the benefit lower then in Q3 relative to Q2, should we expect that same trend to persist into the fourth quarter with perhaps no benefit coming from the pro costing?

Brad Dickerson

Again, with the mix issue, it's a little tough to give you direction on how apparel margins will go. What we'll say, as David stated, Wayne and his team are really working on improvements in sourcing going forward. We continue to see incremental sourcing improvements, quarter-over-quarter, but again, mix plays a big part, too, and that's a little tougher to give you direction on that.

Operator

Your next question comes from Christopher Svezia - Susquehanna Financial Group.

Christopher Svezia - Susquehanna Financial Group

I just want to talk about footwear for a second as you go into next year, and I guess more specifically, on the merchandise and product margin trend. I guess my thought is, how we should look at that. I know you're not really looking for too much of a benefit, but between less close-out product as you go into next year, kind of fine tuning the business model from a sourcing perspective, etc. And I know there are lead times that get factored into this, but why wouldn't we really anticipate at least some improvement in the merchandise or product trend as we go into next year, just given what you're up against and given maybe tweaks to how you're sourcing and how you're doing materials, etc. Are you still dealing with some inventory potential on the running side of the business because of seasonality? I'm just curious if you could flush that out a little more.

Kevin A. Plank

Number one is I just want to drive home the point, we couldn't have greater confidence in the upside of our long-term potential in footwear. So we believe in it and we are investing in and around it. And hopefully that message has clearly come through today.

As we do that, though, we are also realizing that you have got a long lead-time category of business here that typically runs 18 months or more when you figure in the design cycle and everything else that comes into it. So as much as we are working on enhancing, improving the supply chain or the cycle of product for us, more importantly, we are also working on trying to improve the product that we put in the market itself.

There's definitely a price to value balance there, where bringing in the expertise and the experience of people like Gene and Gavin to our team have really given us the ability to take what, in the past, something—and it's the ability for teams to work together longer and a shoe that would typically take us 20 pieces to build, we are finding ways and efficiencies to build it for 14 or 15 pieces.

So I think taking some of the performance, and just frankly, having the ability to build better shoes at a more cost-efficient pace, is something that we're building. So we have two wheels in motion. The first wheel is that long, 18-month cycle, which we've engaged the guys and which begins really in 2011. But also, we're not giving up on 2010. We do have some great product that we're going to have in the market in 2010 and again, we have mentioned momentum that we have with our number two market share with football and baseball cleats.

So those businesses will be growing in 2010 for us and we'll be taking more market share there. So I think we are very excited about what that means. I think the momentum we have seen around our Youth business, again, is another place that we believe we have great upside. But also we have the luxury, because of the growth model that we have with these five levers, I think to be more patient on areas where we want to ensure that we can put a great product in the market and ensure that we can deliver great value to the consumer at the same time, and not charge them more money just because we have an immature supply chain.

Christopher Svezia - Susquehanna Financial Group

And lastly, on Europe, give us your thoughts as you go into next year, about either how you might be investing in that business and kind of your thoughts about how you look at that business as you go into next year.

David W. McCreight

We see tremendous opportunity in Europe. We planted the flag year ago. And like we're seeing this year, we're planning on sizeable growth within Europe and we are continuing to build the team and develop the story and tell the brand story throughout the continent. So we will be investing additionally primarily in telling the story and reaching new markets within the continent.

Operator

Your final question comes from Thomas Shaw – Stifel Nicolaus.

Thomas Shaw – Stifel Nicolaus

Maybe a little clarity on some of the breakdown of the SG&A cost in the quarter, just from a modeling perspective. You have typically given out marketing costs as a percentage of revenues. Just any of that kind of data would help, from a modeling standpoint.

Brad Dickerson

For the quarter, I can give you some direction of some of the SG&A components. Marketing, year-over-year in the quarter, was down 40 basis points. We saw selling costs go up 60 basis points. Just remember that a big part of the selling cost is our direct-to-consumer cost, so obviously you would expect those to grow at a faster pace, cost-wise. And you also saw some increases year-over-year in product innovation supply chain, which we talked about, relative to building our teams.

Operator

This will conclude today's question and answer session. At this time I would like to turn the conference back to Mr. Kevin Plank for any additional or closing remarks.

Kevin A. Plank

Number one, I would like to start by just congratulating our team on what we thought was a very solid effort this quarter, and particularly to our customer base. But more importantly, I want to reiterate the fact that we certainly aren't declaring victory by any stretch. We have a long way to go, a lot of work, and hopefully you sense one thing from our team and our performance is that we have the resolve to do it and will continue to go to work every day.

So with that, I wish everybody a happy Halloween and take it from there. Thank you.

Operator

This concludes today’s conference call.

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Source: Under Armour, Inc. Q3 2009 Earnings Call Transcript
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