Under Armour Inc (UA) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter Under Armour, Inc.

second quarter earnings webcast and conference call.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session, and instructions will follow at that time.

(Operator Instructions).

As a reminder, this call may be recorded.

I would now like to introduce your host for today's conference, Tom Shaw.

Sir, you may begin.

Thanks, and good morning to everyone joining us on today's second quarter conference call.

During the course of this call, we will be making projections or other forward-looking statements regarding future events or the future financial performance of the Company.

We wish to caution that such statements are subject to risks and uncertainties that could cause actual events or results to differ materially.

These risks and uncertainties 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.

Joining us on today's call will be Kevin Plank, Chairman, CEO, and President; followed by Brad Dickerson, our Chief Financial Officer, who will discuss the Company's financial performance for the second quarter, followed by an update to our 2012 outlook.

After the prepared remarks, Kevin and Brad will be available for a Q&A session that will end at approximately 9.30 AM.

Finally, a replay of this teleconference will be available on our website at approximately 11.00 AM Eastern time today.

And with that, I'll turn it over to Kevin Plank.

Thanks, Tom, and good morning, everyone.

The US athletic business is in a very strong up cycle, and our second quarter results speak to Under Armour's contribution to that growth.

With revenues up 27% in the quarter, it's clear that our growing capacity to innovate and add value to the athlete is working.

Equally important, our results to date in 2012 are strong evidence that when we add that value for the athlete, we do not see consumer resistance to price.

Our innovation agenda, combined with our improved ability to sequence products, is enabling us to broaden both our distribution and our share of closet, while maintaining our premium brand position.

We are growing on multiple fronts.

We're growing our core categories, like base layer in women's.

We're seeing strong results in kids, golf, and outdoor.

We're expanding our distribution in categories, like underwear, where we believe we're just scratching the surface of this major growth opportunity for the brand.

And we're getting meaningful traction in footwear, as we launch UA Spine this last month.

While it's always easier to look for one single piece of compelling news on these conference calls, for Under Armour, the reality is that the whole is greater than the sum of its parts, and that has been a hallmark of our 20%-plus top line growth over the past nine quarters.

We don't talk about it as maturing, because we know we are still in the early stages of where our brand can go.

But we have built a product engine that is starting to take full advantage of the strong equity we have built over the years in the Under Armour Brand.

But I do want to talk a bit this morning about some of the parts that are working particularly well.

I'll start, as I did last quarter, by talking about the strength in our women's business.

The momentum from the strong first quarter launch of our Armour Bra and Studio product continued in Q2, and we also saw great growth in women's running apparel.

While we've always had a loyal consumer who understood the performance benefits of our women's products, our team's commitment and focus has enabled us to deliver a more Under Armour-specific design language that is clearly connecting with our consumer across multiple categories.

In men, core categories like training and base layer remain absolute strengths, while we continue to see solid growth in golf.

But we are speaking to a different demographic than our core younger athlete.

In short, we are growing on the field and off.

Our core team sport athlete remains a loyal Under Armour fan, while we add both revenues and dimension to our brand in categories like golf, outdoor, and underwear.

But as I said earlier, the whole is greater than the parts.

One of the drivers of our growth has been our ability to create a steady cadence around our innovation and product sequence.

While we're bringing new technology like coldblack to market this year, we are expanding our year two assortments and distribution for key products, such as Charged Cotton and Storm.

This cadence lets us broaden the end use of our apparel while continuing to drive an innovation agenda that addresses the highest performance needs of athletes.

This focus comes from our taking a much more strategic approach to product development and assortments and better utilization of our wholesale distribution.

We're now able to take initiatives like Charged Cotton and Storm Cotton and build platforms with hundreds of millions of dollars in revenues today, where just a few years ago, that revenue channel did not exist for the brand.

Our growth in footwear is also a function of better understanding the need for that proper cadence.

We're starting to have a lot to talk about in footwear, whether it's the strong performance at retail of our football and baseball cleats, or our new $100 UA Spine footwear that is just now hitting store shelves.

As I said in our Q1 call, we've been very patient internally on our footwear business, and some of you know how hard a word that is for me to use.

But our 44% growth in Q2 and the excitement that is building around Spine are great examples of creating the proper cadence within our footwear business.

First, our cleats business is performing exceptionally well.

We are gaining market share, driving higher ASPs, and just as importantly, leading onfield innovation with products like the $130 Highlight football cleats.

With the most unique silhouette on the football field, the Highlight cleat that NFL Rookie of the Year Cam Newton wore exclusively last season, is both highly technical and iconic.

It's driving our strong sell-through at retail, as athletes in football hotbeds like Florida, California, and Texas are embracing this next generation of cleats.

And much like we are doing now in football, we saw strong market share gains in baseball cleats as well.

Not only does our product continue to drive the loyal UA consumer back into the store, but we are benefiting from our great presence in Major League Baseball, with stars like Buster Posey and Bryce Harper.

Some of you may remember, we talked about Bryce at our investor day a couple years ago, in part, to illustrate how our brand is focused on the next generation of athletes.

So while we were very proud to have 12 players wearing UA cleats in the Major League All-Star Game, you should know that in the future's minor league game, where the next Bryce Harper and Buster Posey were on display, we had 24 of the 50 players there wearing Under Armour cleats.

For us, that is great evidence that we're not only getting our footwear on the next generation of best athletes, but that they are embracing our product and outperforming their competition as well.

In addition to football and baseball, we launched the UA brand firmly onto the soccer pitch earlier this month with the introduction of our kit for Tottenham Hotspur of the English Premier League.

The new uniform will be on display in the US tonight for the first time, when the Spurs start their US tour against the L.A. Galaxy of Major League Soccer.

The tour then brings them to Baltimore Saturday against Liverpool and New York next Tuesday against the Red Bulls.

They will also be on the Premier League's season opener on ESPN next month when they play Newcastle.

We are building our business outside the US much as we did here.

We have always taken a grassroots approach to building our brand, and we are intently focused on being authentic to the sport and relevant to the local consumer in every market.

With our Tottenham relationship, we are introducing ourselves to a much wider audience, bringing the Under Armour performance story to soccer fans not only in the UK, but also in markets all over the world, where the premiership dominates the sports landscape.

So in summary, there are many parts of our business that are doing well.

As our portfolio continues to widen, we are getting better at establishing the proper cadence in each of our categories, bringing new initiatives to market while ensuring that in year two, we are capitalizing on the broader opportunity through expanded assortments and distribution.

Most importantly, our innovation agenda enables us to continue to deliver against the most demanding expectations of the world's top athletes, like Michael Phelps, Tom Brady, Cam Newton, and Tottenham Football Club.

These and the other athletes and teams with which we have built relationships will always be our most discerning consumer, and our ability to meet and exceed their needs ensures we will bring that same level of performance to all our consumers.

I'm proud of the 27% growth we put on the board this quarter, but we need to constantly evolve, and there are always areas where we can get better.

Our operational execution and our ability to plan around our business continue to improve.

We are building out our supply chain team, while remaining intently focused on improving how we present the brand to our consumer at retail.

With inventory growth below revenue growth for the first time in eight quarters and our consumer base continuing to expand, we are well positioned for the balance of 2012 and building a sound foundation for growth well beyond that.

And with that, I'll turn it over to our CFO, Brad Dickerson.

Brad?

Thanks, Kevin.

I would now like to spend some time discussing our second quarter financial results, followed by our updated 2012 outlook.

Our net revenues for the second quarter of 2012 increased 27% to $369 million.

Apparel grew 23% to $253 million during the quarter, and we experienced relatively balanced growth across our men's, women's, and youth categories.

Training and base layer continued to drive our men's business, but we also saw strength in golf and underwear, with underwear introduced to 250 Macy's stores earlier this spring.

In women's, we are seeing strong traction in our Studio line, and the successful Armour Bra launch is helping drive our overall sports bra category.

Our direct-to-consumer net revenues increased 35% for the quarter, representing approximately 29% of net revenues, compared to 27% in the prior year period.

In our retail business, we opened eight new factory house stores during the second quarter, increasing our factory house store base to 92, up 28% from 72 locations at the end of the second quarter in 2011.

While we are still experiencing solid growth on the e-commerce side, we are working through some conversion challenges to our new platform that we launched last November.

I'll provide additional color in our guidance.

Second quarter footwear net revenues increased 44% to $67 million from $47 million in the prior year, representing nearly 18% of net revenues.

Growth during the period was driven by new introductions in performance running footwear, including the initial sell-in of our new UA Spine platform, as well as strong performance with our football cleats, led by the $130 Highlight cleats.

Our accessories net revenue during the second quarter increased 21% to $39 million from $32 million the prior year period, led by strong performance across our bags business.

International net revenues increased 48% to $21 million in the second quarter and represented approximately 6% of total net revenues.

International growth includes a strong rebound with our licensing partner in Japan, following the impact of last year's tsunami.

Now looking at margins.

Second quarter gross margins contracted 40 basis points to 45.9%, compared with 46.3% in the prior year's quarter.

Three factors primarily drove the disperformance during the quarter.

As expected, higher input costs for North American apparel and accessories products negatively impacted gross margins by approximately 70 basis points.

Our sales mix negatively impacted gross margins by approximately 50 basis points, primarily driven by growth in footwear.

Partially offsetting these factors, lower year-over-year apparel sales discounts and sales allowances positively impacted gross margins by approximately 50 basis points as we continue to improve our processes around planning and supply chain.

Selling, general, and administrative expenses as a percentage of net revenues deleveraged 30 basis points to 42.7% in the second quarter of 2012 from 42.4% in the prior year's period.

Details around our four SG&A buckets are as follows.

First, marketing costs increased to 12.6% of net revenues for the quarter from 11.7% in the prior year period.

Expense deleveraged during the period with the function of the previously announced strategic decision to move certain media costs into the second and third quarters.

Second, selling costs held steady at 10.5% of net revenue.

Third, product innovation and supply chain costs also held steady at 10.7% of net revenues, as increased investments in our distribution facilities were offset by overall expense leverage in other areas, given our top line growth.

And finally, corporate services decreased to 8.9% of net revenues for the quarter from 9.5% in the prior year period, driven by decreased corporate facilities costs.

Notably, the three non-marketing SG&A buckets each showed a sequential deceleration in growth rates, which is in line with our prior guidance.

Operating income during the second quarter grew 3% to $12 million, compared to $11 million in the prior year period.

Operating margin contracted 70 basis points during the quarter to 3.2%.

Our second quarter tax rate of 38.9% was favorable to the 41.7% rate in last year's period, primarily due to a state tax credit received in the first quarter, which benefits the full year effective tax rate.

Our resulting net income in the second quarter increased 7% to $7 million, compared with $6 million in the prior year period.

Second quarter diluted earnings per share held steady with the prior year at $0.06.

EPS calculations for both periods reflected two-for-one split, which was effective on July 10.

Now switching over to the balance sheet, total cash and cash equivalents at quarter end increased 19% to $143 million, compared with $120 million at June 30, 2011.

We had no borrowings outstanding on our $300 million revolving credit facility at quarter end.

Long-term debt increased to $74 million at quarter end from $37 million at June 30, 2011, reflecting the acquisition of our corporate headquarters.

Inventory at quarter end increased 22% year-over-year to $381 million, compared to $311 million at June 30, 2011.

Inventory growth came in below our net revenues growth of 27%, due to less creation of excess inventory and successful liquidations, primarily through our factory house channel.

Our investment in capital expenditures was approximately $15 million for the second quarter.

We continue to plan for 2012 operating capital expenditures in the range of $60 million to $65 million.

Now moving on to our updated outlook for 2012.

Our prior outlook called for 2012 net revenues of $1.78 billion to $1.8 billion, representing growth of 21% to 22%, and operating income of $203 million to $205 million, representing growth of 25% to 26%.

Based on our current visibility, we are raising our net revenues outlook to a range of $1.8 billion to $1.82 billion, representing growth of 22% to 24%.

Elements of our increased net revenues guidance include continued strength in our North American wholesale apparel and factory house businesses, higher growth expectations in footwear, given additional orders in running and training, partially offset by lower growth expectations in e-commerce, given challenges with conversions.

In addition to net revenues, we are raising our operating income outlook to a range of $205 million to $207 million, representing growth of 26% to 27%.

With this updated outlook, I would like to provide some additional color on several items for the year.

First, on gross margins, we now expect full-year gross margins flat to down slightly from last year's 48.4% level.

This compares to our prior full-year outlook of relatively flat year-over-year levels.

Relative to the back half of the year, here's what has not changed from our prior guidance.

We see improvements to gross margin through easing product costs and early stage supply chain efficiencies.

These benefits are being somewhat offset by our strategy to more aggressively utilize our outlet channel to work through excess inventory, resulting in lower gross margins within this channel.

We see more of this impact in the fourth quarter, when our factory house business typically represents a significant percentage of our total net revenues.

What has changed in the back half of the year from our prior guidance is the incremental near-term pressure from our expected sales mix, which includes higher footwear and lower e-commerce net revenue expectations.

We anticipate the impact of this sales mix change to be magnified in the fourth quarter.

I would like to add a little more color on e-commerce.

We continue to grow the business at a healthy pace, but we have had some challenges converting traffic to sales since our new site launched last November.

Our team continues to work through some of the technical issues with the site, including speed and ease of shopping experience.

As we work through these issues, we believe it's prudent to take a more conservative view of e-commerce's contribution to our business for the duration of the year.

Shifting to SG&A, our story remains relatively consistent, as we see the opportunity for moderate full-year leverage, balanced by sustained investments to support our future growth.

In marketing, we continue to expect full-year spending rate of approximately 11.4% of net revenues, similar to the spending rate last year.

From a timing perspective, we now see approximately 150 basis points of deleverage during the third quarter, compared to our prior guidance of approximately 200 basis points of deleverage.

While we will continue to focus on telling our big brand stories like UA Spine and women's, during the third quarter, we are reallocating some dollars to the fourth quarter to better support our holiday efforts.

Looking at our other S&A buckets in aggregate, which combine selling, product innovation, and supply chains, and corporate services, we expect the second half of the year will show considerably more leverage than the first half of the year, though the vast majority of this improvement will be experienced in the fourth quarter.

This late-year leverage largely reflects the lapping of incremental investments incurred during 2011 in areas such as e-commerce, sourcing, and planning.

Shifting to components below our operating results, our current outlook includes higher year-over-year interest expense, given the full year of the additional long-term debt for our headquarters acquisition, a full-year effective tax rate at the lower end of our previous guidance range of 37.5% to 38%, and fully diluted weighted shares outstanding in the range of 106 million to 107 million.

Finally, on the balance sheet, we are proud to reach our target inventory growth below sales growth one quarter earlier than planned and see no change to our previous guidance of the inventory growth rate coming in below the net revenues growth rate in the back half of the year.

We will continue to balance these inventory management efforts with our ability to service our customers and drive improved fill rates.

We would now like to open the call to your questions.

We ask that you limit your questions to two per person so we can get to as many of you as possible.

Operator?

Thank you.

(Operator Instructions).

Our first question comes from Eric Tracy of Janney Capital.

Your line is now opened.

Thanks, guys.

Good morning.

I guess we could start with the footwear.

Obviously, came in sort of ahead of plan.

I think it was really supposed to kick in in FY '13.

So maybe talk about, obviously, the contributions from Charge RC, Highlight, and obviously the launch of Spine.

Did that give you greater comfort to accelerate that business a little bit faster and the opportunities to sort of capitalize on that, relative to clearly a little bit of dilution on the margin side?

And maybe, Brad, for you, how we should relate that relative to what's going on in e-commerce?

And then on the positive side, the supply chain, just thinking about the margin dynamics with those businesses.

Yes, I'll take the first part then.

Innovation is the name of the game.

And that's what's really coming through, and that's when we're looking to see we're going to win.

You'll hear a theme coming from me that basically says when we innovate, we win.

I think that's what's happening in footwear right now and what we're beginning to see.

So first off, around Spine, we're not -- we're very excited about the launch that we had.

We had a great event up in New York, and the product's hitting retail shelves right now.

I wouldn't say it's as much of a launch as much as it's rolling in.

And so, we're tempering expectations as we're looking at that.

But more importantly, I think demonstrating some of the maturity that the brand has reached with recognizing that the definition of success is not going to come in the first day or weeks or even months.

But what you'll see from us is a much more comfortable brand with the ability to show the consistency and the continuity of our belief in this product.

And so this is a 3, 6, 12, really 24 months that we believe getting behind this technology, not only putting great product in the market, but great marketing and storytelling, to tell the consumer about it.

So we're pretty pleased, I think, with how we're positioned there, and especially how many of our partners are supporting that program as well, not saying is this something, is it in, and how do we see success?

At the same time, some of the early reads from anecdotal things, great feedback on the product, a lot of big excitement around it, and we'll let ourselves define and see how that goes.

As far as just holistically about Under Armour footwear, we feel very good about where we are, and you think about just the timing.

I recently did a talk up at -- for Footwear News at one of their conferences, and the title of the speech that I gave was called Seven Years.

And you think about it is that we've been in footwear for seven years, and you look how long that has taken.

There's lots of signs that have demonstrated that the market is ready for a new player.

And I think we really exploited that this year with football cleats.

I think a lot of times we get sort of brushed off of big deals, small category, what you're doing.

But effectively what we've done this past year with the Highlight cleat, it demonstrates, number one, there is room for a new player, and probably even more significant is the fact that that new player can win.

You know, if it bleeds, we can kill it.

I say that with the easiest way that I can.

But after seven years, we said our first few years, several years to acclimate, our factories, our team, product, and establishing our point of view.

And just take football cleats, and again, a small category, but I think it's indicative of what's happened with our brand.

Years four, five, and six, we spent really becoming as good as anybody else on the market, and creating a product out there with a consumer expectation that no one was sacrificing anything by putting their shoes on our feet, as our team continued to build and evolve.

And in Year Seven, where we've broken out with frankly brand-defining innovation in the Highlight cleat, it's $130 football cleat that looks unlike anything else, delivering innovation to the consumer, with not having to tape, greater support, a terrific aesthetic.

But beyond that, it's a product that flat-out works, and of course, having probably the most exciting player in football right now in Cam Newton wearing that product is something that's really going to help us.

So, as we sit and we look at Year Six in baseball, Year Five in training, Year Four in running, Year Three in basketball, I don't think we have to declare that we're going to need to wait seven years for each one of those categories as our learning curve has really accelerated.

But our innovation pipeline is full, and we anticipate being important in each one of these categories.

Our confidence in building brand-defining product lets us believe that footwear can be a global platform for our Company, and I think you've just seen us scratch the surface.

But what I promise you is there's much more coming.

And so, we did say 2013 was going to be important, so we're pleased with the results.

But I want to be clear, we're not declaring victory by any stretch.

We've got very good competitors out there that are very good at what they are doing and they are keen on, but we're pretty keen on it, too.

And so, as we said, we think there's plenty of room, and you are going to see a lot more exciting things from us, whether it's on the football field, the baseball field, the pitch, or what we're putting on -- in some of our key specialty doors and running and other categories like that.

Brad?

Eric, on the economics between footwear and e-commerce, if you take a look at our baseline gross margin last year, about 48.4%, and use that as a baseline, footwear's gross margins are probably about the same distance below that as e-commerce margins are above that, relative to the economic model.

However, when you look at gross margins and then all the way down to operating margin, the model changes a little bit, where our footwear SG&A costs are relatively fixed.

So, additional revenues in footwear the back half of the year, although they will impact gross margins, there's not a lot more SG&A that goes into delivering those additional footwear revenues.

E-commerce side, however, though, the SG&A model is a lot more variable, especially around the demand drivers that point us to sales on the e-commerce side.

So, even though gross margins are much higher, the SG&A model in e-commerce is much higher also because of that.

So, when you look at the back half of the year from a gross margin perspective and the obvious impact of gross margins, with footwear increasing and e-commerce decreasing relative to our expectations.

But we were able to call up the operating margin for the year -- operating profit for the year, because of the way those economic models work between the fixed part of our footwear and SG&A, and the variable part of e-commerce and SG&A.

Okay, great.

Thank you.

That's really helpful.

And then, Kevin, for you, kind of a little bit bigger picture question.

Obviously, you have been very tactical about the investments made around the London Olympics.

But as we think forward to the '14 World Cup and '16 Olympics in Brazil, maybe talk about sort of how you feel like you guys are positioned.

Is there an opportunity to sort of more fully capitalize and make some investments around those big platforms?

And obviously, now making investment in Tottenham from a soccer perspective as you look to penetrate Latin America, and specifically Brazil, how you think about that business over the next few years?

I think one of the worst things we can do is get caught up with a game of keeping up with the Joneses.

And so we're very clear, I think, on the brand of, A, who we are, and probably just as importantly, where we are in time.

And so, with 27% growth in the quarter, I think we're doing the things that we need to do to protect our Business, and more importantly, to really innovate and grow our Business.

And so we feel good about where we are right now.

That being said, there's opportunity for us.

As we continue to look and build out the global stage, and I've said many times that our expectation is to be a global brand, and we define that where more than half of our revenues will come from outside of our home country.

And so, sitting here with roughly 90% of our revenues coming from the US, and obviously, it plays well in times like now, with the growing US market and predicting the exposure of overseas.

But we've been investing there for a while.

We think we're going to have the ability to really start picking up some of the investments that we've made in places like Asia and places like Europe, and it's going to be a matter of time.

And so, I think all these things are cyclical with any of these other markets.

They're great support markets, and they're great opportunities for us.

And I can tell you, we've got a team of committed people outside of the United States that are working like crazy to make Under Armour important and relevant to those consumers outside of the US.

That being said, we, we've got great assets with the Olympics, and we've got Michael Phelps, and we've got many members of the US Women's Soccer Team, and Lauren Cheney and Heather Mitts and Becky Sauerbrunn.

And you'll see us continue to add to that roster of Olympic athletes and, frankly, not just US Olympic athletes either.

We expect to play, and we're not going to wait all the way until '15 either to Brazil, but you'll see us in Sochi, you'll see us around World Cups, and you'll see us start picking up these other assets as it makes sense to us.

But I've got to tell you, we have a pretty good disciplined approach with how we're going to spend money.

I think we've been very disciplined, around 11% to 12%.

Brad won't let me spend any more money, and so we have that arm wrestling competition.

He still beats me, and I think it's the right thing that he does.

So, we'll be prudent and thoughtful, I think, about the investments that we make, but I tell you, we're having a lot of fun, and hopefully that comes across with the group of -- with the way our team's working right now.

And I think a lot of the opportunity that we see and the ability for us to become global and build something a little bigger.

Okay, thanks.

Best of luck, guys.

Thank you.

Our next question comes from Sharon Zackfia of William Blair.

Your line is now opened.

Hi, good morning.

I was hoping you could provide some additional information on e-commerce.

I don't recall you taking about some challenges with the new launch previously.

I might have just forgotten.

So, if you could help us understand where the conversion is now on the traffic you're getting to the website and where it maybe was pre-launch, and the challenges, and kind of fixing what seems to be a speed issue on the website.

Sharon, this is Brad.

Just to start that conversation, really we were working through this as we went through the holiday season last year into the first quarter.

So, not really understanding how long it would take to work through these issues, it really didn't become apparent to us until the last few months as we started getting into the back half of the year that this continues to be a little bit of an issue.

And obviously, the difference in volume of e-commerce in the back half of the year versus the front half of the year is vastly different.

Really, the issue has been conversion.

We have not seen as much of an issue in traffic, at all, really.

So the people are coming to the site.

The growth in traffic is healthy.

It really has been around conversion, and a lot of that, we thought, and are looking at relative to issues we had with speed and just the ease or shoppability of the site.

So, we made some changes relative to speed recently in the last three weeks or so.

We've seen some positive improvements so far based on that, but again, I think it's too early to tell, until we see a little bit more of a trend in the next few weeks, whether we think that's going to point in the right direction for us relative to conversion going forward.

Also, we made some minor changes around ease of shopping of the site too, just to make it easier to get through the site.

So, I think in general, we've made pretty good changes during the course of Q2.

We've seen some positive impact to those in the short-term, but we need to see a few more weeks of that to really make it look like a trend going forward that we can expect from -- have some higher expectations in the back half of the year.

And let me just underscore for that, too, it's -- this is not a brand issue either.

We're getting plenty of traffic, increased traffic and, frankly, exceeding what we thought we would be seeing.

We've been struggling a little bit on the conversion side, and that's where -- just getting a little better on the functionality.

So Brad brought up many of the things that our team is doing.

We've got people working really very hard.

And this is not the hard stuff, either.

It's easier said than done, but it's just a matter of applying the right technical.

And so, we've got a great number of people internally, externally on it, and we expect to see the great growth that we've seen from our DTC channel very quickly.

And go to the web and buy something.

And just to be really clear, because the fourth quarter, obviously, is so important for e-commerce, are you modeling in that you see an improvement in that conversion by the holiday season?

Or are you modeling in somewhere between historical conversion and where you are running now?

Just help us understand where the risk or opportunity might lie for the fourth quarter on that.

Sharon, what we have done is we've modeled in basically what we saw in Q1 and Q2 in the back half of the year.

We have not anticipated any improvements in conversion.

Again, although we made some changes recently and saw some slight improvements, we did not build that into our outlook going forward, because I think we need to see five or six weeks of that versus a couple weeks of that.

So, the back half of the year right now, our expectation is similar to what we saw on the front half of the year.

Perfect.

Thank you.

Thank you.

Our next question comes from Omar Saad of ISI Group.

Your line is now open.

Yes.

Good morning, guys.

This is Sam Lee in for Omar Saad.

Congratulations on a good quarter.

Hi, Sam.

Hi.

Our first question was just on the apparel strength.

It seems like -- obviously, footwear is very strong, but the apparel's still going strong, as well, and seems to be coming in as you're reducing the SKUs.

And I guess our question is, what does this mean for the supply chain leverage and the margin outlook for the rest of the year?

And is there an opportunity to reduce SKUs further?

Yes, Sam, on the supply chain leverage and SKU productivity, we talked about this on last quarter's call too, and the numbers have stayed relatively the same.

We see about a 20% reduction in SKUs by the end of this year compared to the beginning of 2011.

And that's right in line with what we've been talking about over the last few quarters.

A lot of that benefit, if you happen to think about it, especially on the apparel side, the fact we can move and liquidate apparel through our outlet channel very profitably, the impact to gross margin, although there is a little bit of a benefit there, isn't as big of an impact as what you're seeing relative just to inventory management.

So, I would look at SKU productivity.

We kind of call it reducing noise in the supply chain, bringing productive SKUs to the supply chain versus non-productive SKUs.

And it just helps our focus around productivity.

It also helps our focus around inventory management and creating less excess inventory, more so than it has a positive impact to gross margin.

So, kind of look at SKU productivity as a benefit to inventory management, more so than margins.

A lot of the other factors we're working on will help gross margins.

And then also, I think you're seeing a double-down on technology, as well.

And we've built a pretty good portfolio of big products and big SKU runs and things like our HeatGear t-shirts and ColdGear mocks.

And what we've been doing to add to that is things like game-changing pricing with our Armour Bra up in the nearly $60.

Coldblack is a new technology we just launched.

I mentioned in my script about what we've done with the whole cotton line.

Again, cotton didn't exist, Charged Cotton, Storm Cotton didn't exist with this Company just two and a half years ago.

And so, adding categories like that with hundreds of millions of dollars that we can bring into our existing distribution, and really things that make sense for our brand without taking us to a different place from a perception standpoint, I think that's what makes us pretty excited.

And then we're talking about apparel, but looking at the upside that we see, the opportunity in things like footwear and accessories, is we just become frankly more experienced and a little better at it.

Just sometimes these things take time, and I think that's what you're starting to see from our Company, is that -- I'm not saying we have all the answers, but we're starting to figure some things out.

Great.

And speaking of the Armour Bra, it looks like the women's growth in second quarter was driven by Armour Bra and Studio line.

Are you seeing an inflection in that business?

And can you share with us some of your learnings and sort of where you see the opportunities in the back half of the year and then, as well as going into 2013?

We went public in 2005.

Women's was less than 20% of our total business, and today it's nearly 30%.

And at the same time, we've also added close to $1.5 billion in revenues.

And so, hats off, I think, to our team that's been working there and just committed over and over.

And we've had everybody -- we've had lots of people tell us what we can and what we can't be.

And it's good to see it just come through.

Again, I think in any of these categories, and I want to be clear, we're a long way from declaring victory.

We're doing better, I think you're seeing, in items.

But there's a lot of work for us to do in terms of tightening up our presentation, how we're telling the stories at retail, how we're really selling the product.

And you're seeing a full force effort, first and foremost in our existing retail partners.

And so, places like Dick's and Sports Authority and Finish Line and End Foot, where they've got a real heavy apparel focus for us, and they are really giving us the ability to tell our women's story.

I don't think that we're showing up great yet.

I think we have a lot of work to do there.

But we're also -- we're going to places where, frankly, women do -- have shopped traditionally in places like -- into some of the department stores where we've been, of trying to really soften our brand and put product in a place that's prudent and appropriate for the consumer who is shopping there.

And so, a lot of times I think we're driving traffic to some of our existing partners.

In other places we're helping to fill out, I think, the perception of the women's brand by showing up in partners like Bloomingdale's and showing up in partners like Nordstrom and many other key mall partners that we have, as well.

Great.

Thanks, guys.

Thank you.

Thank you.

Our next question comes from Jim Duffy of Stifel Nicolaus.

Your line is now opened.

Thanks.

Good morning.

Good morning, Jim.

So Kevin, as you move beyond the spring sales meetings, what are some of the key stories you expect to be drivers for the apparel business as you look out to '13?

Yes, I think a lot of what we've -- a lot of what we've talked about.

So, as I mentioned, our innovation pipeline is full.

But we've got enough -- you can get caught up with newness, newness, newness, but we've got some pretty great stories in some of our heritage product that we have.

As I mentioned, some of the reinvention you'll see coming into -- through fall and especially as we're looking at '13, some of the reinvention you'll see around many of our base layer categories.

We just spent a little time talking on the women's side about Armour Bra, but what Studio will mean for us is, we started this product line off when we launched Studio, for instance, and I think we've learned a thing or two where we made the first product prototypes and they looked good and we tested them and we tested them again, and then we put our first plans together.

And the last thing we did is we cut our plans in half, and we said, let's make sure we get it right.

Let's deal in scarcity.

And you've seen us build on that, because frankly, the good news about our platform, and not unlike, I think, the general theme of my script, was that we are much -- the whole is much greater than the sum of its parts right now.

And that we're able to put that together, I think especially on women's, where we don't have to take one swing for the fences shot at anything, but we can build ourselves up the right way.

Coldblack is a very cool technology that we just got the thing going, and I think we're just beginning to tell that story.

But it's a t-shirt that can keep you -- or a finish on a t-shirt for running or golf or you name the category that keep you effectively 10 degrees cooler than the person you're playing next to.

So, any of those kind of innovations.

And then, a lot of the simple stuff, too.

Our ColdGear mocks, Tech Tee, that we just had a reinvention of our Tech Tee.

And these are million, million unit programs where we took the price up from $20 to $22 on that product and we're giving the consumer a better product that, frankly, works better.

So, I think you'll see this constant reinvention, and the good news or the best thing for us is that we still have 30 or 40 key styles that are driving, I would guess on the math, I would probably say 30% or 40% of our Business, too.

So, by staying pretty focused on not as many of having to look across the entire spectrum, but staying focused on key big programs, I think that we can touch and affect the consumer.

At the same time, we do see the ability to let us dream a little bit and go into a little more specialty product.

And that's where, as I was talking about sort of the expansion of the brand from being sort of a one-trick pony with, okay, I get it, you're the compression shirt and compression short company, I think you're seeing and we're demonstrating we're a lot more than that.

And so new categories, as we go to outdoor and we look at what hunt and fish and, frankly, we look at what underwear could mean to us, but in things like golf, that there's a ton of opportunity for us to grow.

And we need to be -- stay within ourselves and frankly keep doing a lot of what we demonstrated this quarter.

Okay.

That's helpful.

Thanks.

And then, Brad, nice progress on the inventory.

With respect to the gross margin in the factory stores, where are you on the mix of clearance versus made-for product, and how do you see that progressing?

We'll be more heavy in the back half of the year than we were in the front half of the year.

We think we'll probably be somewhere in the 55% to 60% of units will be made-for in the back half of the year.

That compares to a number that was probably above 70% last year.

Again, that's what we've been calling out.

That's going to be a big part of liquidation of excess inventory here in the back half of the year as part of the Factory House.

On the inventory side, I think we are -- we're really proud of where we got so far this year.

Really, the drivers of that for the most part have been creation of less excess than we had last year.

We actually created about 50% less units of excess than we did last year in the front half of the year.

And we've sold about 30% more units of excess in the front half of the year than we did last year.

So, that's a big driver of where we're at with inventory right now.

But we've always said there's a balance there of making sure that as we improve inventory and we focus on inventory management, we also have to focus on the flip side with fill rates and customer service, too.

So, we'll constantly be balancing that out going forward.

Proud of where we're at.

We still have some work to do, but we're proud, again, of where we're at here at Q2.

Very good.

Thank you.

Thanks, Jim.

Thank you.

Our next question comes from Sam Poser of Sterne Agee.

Your line is now opened.

Good morning.

Thank you for taking my question.

A couple things.

Number one, on the gross margin, you gave some guidance by quarter on the SG&A.

Can you give us some idea of how you see the gross margin playing out by quarter?

Brad?

Yes, you look at the guidance we gave, you can see that most of the back half of the year pressure will be in the fourth quarter.

And there's a couple reasons for that.

One, the fact that we are lowering our expectation around e-commerce.

That business is very heavily weighted towards the fourth quarter.

So from the change in guidance there, you would see that impact the fourth quarter more than anything.

In addition, just year-over-year comps, it's a little tougher comp in Q4 than it is in Q3 last year, versus last year.

So, that's part of the driver, too.

And then obviously, again, Factory House is a big equation there.

If we're going to lean heavily on Factory House in moving excess inventory in the back half of the year, again, if you look at Q3 versus Q4, their Q4 business is larger than their Q3 business.

So, when you look at the back half of the year, anticipate more pressure on Q4 than Q3.

You would expect gross margin likely to be down in the fourth quarter and up, up significantly in Q3, just based on the comparison?

Directionally, yes.

Directionally, probably pretty close there, yes.

Okay.

Thank you.

And then, you talk about the rolling out of lots -- these many different -- the different programs and so on, especially with the innovations that you're speaking of.

Can you talk about the change -- you talk about the Tech Tee and innovation and raising it $2 and updating the product.

Do you have other things of that nature in the hopper right now, looking ahead into next year, which I assume will -- which could both potentially help gross margins and give you an extra push on revenue without getting pushback from the customer because you're improving the product?

Well, I think it's doubling down on the categories that we've already demonstrated that we can lead.

So, the entire cotton platform is a huge one for us, where we launched cotton because for us, it was a whole new manufacturing base.

It was a whole new, lead time, supply chain, it was a new everything for us.

And so, as we're sitting here in year two and working on year --seasons three and four, we can be a lot more aggressive with how we can open those silhouettes up.

And cotton has been -- the consumer has really voted for it.

And so you'll see, in addition from having a $25 t-shirt and a $60 hooded fleece to saying, okay, now we can have a $35 and a $40 version.

You'll see, no, the v-necks.

This is not like huge innovation either.

If we were a crew neck T-shirt at $25, and we had a v-neck at $30 and the thing blows out.

So, the consumer is looking for us to push and innovate a bit more.

And our product team is highly focused on that, as we continue to introduce more and more style as the consumer is looking to take Under off the field and really, I think, showcase our brand a little more.

At the same time, we're not going to show up at Fashion Week next year.

It doesn't mean -- style and design, it's absolutely, it's an aspiration.

You'll see it come through from our Company more and more.

But we're very relevant -- very, I'm sorry, very aware of where we are, and so we're very aware, I think, of the cadence, as to where and how fast we will go.

And this is a long road that we have in front of us, and the consumer's going to take us to some great places, and I think it's the places that are appropriate for us.

But I think the cotton story and the same thing on the high end, on the Storm Cotton side, where not only what you're seeing us do on the fleece, but as we push and look at things like outerwear, we think there's an enormous opportunity for us there, too.

So, we pressure tested a lot of these categories that we're looking to enter.

And again, as I mentioned before, I don't think we have to take a lot of huge chances.

And so, based on the learnings that we've had over the last few years and based on some really low-hanging fruit and whether it's Charged Cotton, Armour Bra, doubling down on women's and some of these other places, we can really stay within ourselves.

And we can continue to find meaningful growth, again, that I think is demonstrated in what we put up in Q2.

Thank you.

And just one follow-up.

You talked about looking for the places to go.

You've been good in sporting goods.

I think you're working on athletic specialty.

One of the concerns that some people have cited to me personally is that they are concerned about how sustainable is the apparel growth in the US, given your current distribution and so on?

Can you talk a little bit about new doors versus additional assortments in existing and how you foresee the growth over time in that regard?

I think our apparel growth is up 20%-plus for the past seven or eight-plus quarters.

And that's on us.

When we think about new distribution and these other things that we've contemplated as well or that we're executing on, the idea here isn't relegating anything to our sporting goods customers.

First and foremost, what's happening within our existing consumer base, we are very proud, I think, of the close, if not consistent, double-digit comp growth that we're driving and delivering for these.

And that's how we measure ourselves.

And so, we're not looking to cannibalize or take anything away from that.

And so, they are almost strategies that are mutually exclusive of one another, where we feel an obligation to deliver that type of double-digit growth for our existing account base first and foremost.

And as we can complement that, where the consumer isn't having the ability of finding the Under Armour brand, that's where you'll see us open up new distribution, where frankly they are not shopping in sporting goods.

And it's another way for us to get our brand to them.

So, we'll be very careful with that, too.

Thank you.

Continued success.

Thanks very much, Sam.

Thank you.

We have time for one more question, from Camilo Lyon of Canaccord Genuity.

Your line is now open.

Hey, guys, thanks for taking my question, and congratulations on the good quarter.

Kevin, I was hoping you could give us some early indications on how your experience has been with the department store channel.

What's worked for you, what's not working, what changes can we expect to see in the back half?

I mean, they have been great.

I think the partnerships are -- they are very new, and so we don't know a lot yet.

But at the same time, we've had things like opening up our underwear program at 250 Macy's stores.

The early reads that we have on that frankly are, it's where you think it would be.

We've got a brand called Under Armour who basically -- who is housed in base layer and understanding compression and what that means, and we should be the number one player there.

And that's the expectation.

We've had a modest Underwear business that's been successful, I think, at sporting goods, where typically underwear has not been purchased.

And I'm speaking on the men's side.

And then we introduced it on the women's side, as well, and not typically the place where women like to go buy intimates either.

So, as we expand ourselves and look at getting to more appropriate distribution, number one, we want to drive within our existing account base, first and foremost.

But we see a huge opportunity to take over things like Herald Square in New York.

We should be the number one -- we should be the number one underwear brand, period.

And so, that's how we're thinking about it.

And again, the number one player today is hundreds of millions of dollars, and I can tell you our underwear business is not there yet.

But based on some of the signs that we're seeing, as we become more sophisticated, as we continue to expand our breadth, as we get into the right and appropriate doors, we believe with every bit of confidence that we can be that number one player.

Again, I think the story that we have goes beyond underwear, but it's giving us a great ability to really find and test and say, how is this distribution channel appropriate for the Under Armour Brand?

Does the consumer get it?

And so again, I want to reiterate is that the partners we've been dealing with at the underwear level, from the highest executives at Macy's across the board, is everyone has been very open, very welcoming, and really doing things and been a great partner to us.

So I think we're excited about what that means.

And then some of the other department stores, Nordstrom's, they have been -- consistently we've had our women's assortment in there, and I think you'll see us open up with some men's golf and some other things that make sense to our consumer.

But again, underscoring all of this is about coming back and making sure -- I wouldn't say protecting, but continuing to drive our existing account base.

So, we're not looking to give in anywhere or concede anything.

We think we can win in a lot of different places, but it means, I think, doing it the right way and doing it a prudent way and doing it with the right patience and cadence.

Great.

And can you tell us about how the receptivity of some of the apparel in the Macy's stores has been?

I know that the underwear has been pretty successful, as you said.

But how has the receptivity of the apparel done in those stores?

I'm not sure we have much -- we have some women's product in there, a little bit.

But there's no -- it -- frankly, it's not really hitting our radar yet.

And I think that there's a plan, but I think we want to find the right assortments and other right things like that.

But there's no massive plans for us to expand on the apparel side.

In saying that, I want to hedge that with, you will see an apparel presence, but it's not really making our radar that we're bringing up and saying this is a huge growth opportunity for us today.

We're not prepared to talk about that.

But I think that again, what you are seeing is we're finding success with where we're going.

And before we try to unload and say we need to put X amount of product in X number of doors, we're going to learn.

And I think we like where we are.

Got it.

And then just my final question, Brad, could you just remind us how you're positioning the back half sales guidance relative to weather and where outside can come from if weather remotely normalizes?

Sure.

Consistent with what we talked about before, we're looking at the back half of the year, weather relatively consistent to last year.

So, that was built into our original guidance.

We took a conservative view to winter 2012 based on winter 2011.

We haven't changed that outlook at all.

So the increase in our guidance is not being driven by any expectation around weather whatsoever.

Where the upside could be, obviously, is in our armour punishment product, where we have safety stock.

So if the weather does get cold, we have safety stock levels on the end use product for cold weather products, and we would be able to see some upside there.

We would have the inventory for that.

Great.

Thank you so much.

And good luck for the balance of the year.

Thanks.

Operator, we can take one more question.

Certainly.

Our next question comes from Robbie Ohmes of Bank of America Merrill Lynch.

Your line is now opened.

Oh, thanks.

Just two really quick ones.

The marketing shift to the fourth quarter for, I guess you guys said increased holiday efforts, can you give us any insight, what you're specifically thinking there that drove that shift?

And the other quick question was international ex-Japan.

So, it sounds like Japan really supported international this quarter.

Can you remind us how you're thinking about international for the next two quarters and what could be driving it or not driving it the next six months?

Thanks.

Yes, Robbie, the marketing shift was pretty straightforward.

We weren't happy with the amount of funds we had last year in the fourth quarter on holiday to support our business.

So it was, again, more around making sure we had some funds there, especially around key selling time frames, around Black Friday and so forth, that we had some funds to make sure that we got our brand message out there for Q4.

That's all it was.

And Robbie, on the international front, yes, our partners in Japan are just terrific.

And we got that right now as we're sitting here in year 12 or 13 of that relationship.

It just goes to show you, it takes time.

I think there's a much broader message here that you see a lot of brands, particularly in the consumer space, that come and go.

And those that demonstrate they have the ability to run for the longer haul typically win, just because we've been doing it and you have the ability to gain experience and knowing a little bit more about what you're doing and where you're heading.

So, we're still in the early learning phases of many of the markets that we're entering on a global basis.

But obviously, I think when you look at the five growth drivers and the same message we've been telling since we went public, grow men's apparel, someday make women's apparel larger than men's apparel.

Footwear, make footwear someday larger than our apparel businesses combined, and then taking those product stories country by country around the globe, and where we don't find the appropriate distribution, augmenting that with our own direct-to-consumer channel.

International probably is one, as we'll look at we're doing business in 61 countries today, and I'm not sure we're doing as much business as we could.

And so we're very excited about the addition of Charlie Maurath, who will join us in September of this year to head up our international efforts.

And Charlie's a pro.

He comes with 20-plus years of industry experience and having done it, of build big businesses in our space and in our sector, from a few hundred million dollars to several billion dollars.

And so, that's what we're looking at.

When we look at different markets between, Asia, Europe, and the Americas, we want to be patient.

And so, what you are seeing from us is the continual execution of the teams that we've had in place.

But we're expecting that we're going to keep bringing on expertise.

This isn't a one-person hire.

We're constantly building the teams that we have working in our Amsterdam office and the teams that we have in our office in Shanghai that was recently opened, and the several stores that we now have open in some of the new stores that we're building in China.

We've got our first prototype we put up a little more than a year ago, and it's a store that's getting us very excited on a dollars per square foot basis.

Without giving all the math away, we've seen -- we're leading there.

We're convincing consumers to walk by four or five of what they have known as the global brands, seven or eight local brands, and walk into an Under Armour store and say, what is this Company, I get it.

And so, that's the first and most difficult message that we're going to have, is convincing consumers as to why they need to walk by these other brands they have known for years and to explain the story as to why Under Armour is relevant to them.

And I think you're seeing us do that on a country-by-country basis, and more importantly, to show and demonstrate the ability that we are here for the long haul.

We're not here -- we are going to be here and we're going to be working and we're going to be fighting and we're going to be scratching and clawing and doing anything we can, because we believe in this brand.

And I think we believe in our opportunity.

So, global will be a big part and a big player for us, and we're excited about bringing somebody like Charlie on in addition to augment the existing team that's working their tails off as we speak.

Great.

Thanks so much.

And thanks for squeezing me in there in the Q&A.

Thanks, Robbie.

All right.

Thanks, everyone, for joining us on the call today.

We look forward to reporting to you our third quarter 2012 results, which tentatively have been scheduled for Thursday, October 25, at 8.30 AM Eastern time.

Thanks again, and good-bye.

Ladies and gentlemen, thank you for participating in today's conference.

This concludes today's program.

You may all disconnect.

Everyone have a great day.