When Under Armour (UA +3.27%)(NYSE: UA-C) released second-quarter 2016 results a little over a month ago, the athletic apparel and footwear specialist impressively marked its 25th consecutive quarter of achieving at least 20% top-line growth. But that was little consolation for our impatient market, which lamented the company's expectation for falling profits as it continues to invest in growing the business, and as it works to navigate the impact of Sports Authority's recent bankruptcy liquidation.
To that end, there is much more going on behind the scenes at Under Armour. And I think investors would be wise to look past the headline numbers to better understand exactly what's driving Under Armour's business today. Now that the dust has settled from earnings, one of the best ways to do so is by digging deeper into Under Armour's subsequent earnings conference calls. Here are five of the most important points Under Armour management discussed during the most recent call.
1. The purpose of Under Armour Sportswear
UAS is not just a category play or a distribution play; it's about bringing a new consumer into the Under Armour brand. UAS will bring a young, fresh, and modern voice to sportswear and reflects the insights we've gained as a performance brand now applied to the everyday wardrobe. This is not about being on trend or capturing the athleisure market. Consumers have the expectation that performance product is not just functional but is fully executed through fit and style. We don't believe that Under Armour technology should be exclusively for on field. We don't see it as an either/or thing. UAS is forged from the field and built for life.
-- Under Armour founder and CEO Kevin Plank
Recall that this past June, Under Armour revealed that it's targeting a fall 2016 launch for its new UAS (Under Armour Sportswear) brand. And later during the Q&A portion of this quarter's call, Plank noted that Under Armour's two primary competitors claim that sportswear represents between 20% and 30% their businesses, which collectively translates to around $50 billion in annual sportswear revenue. As such -- and keeping in mind that Under Armour has yet to formally enter the style-centric sportswear industry -- Plank believes that sportswear represents a roughly $15 billion incremental market opportunity for Under Armour.
2. An exciting new partnership
The next step in our strategy to reach new consumers is the partnership we're announcing today that will bring the Under Armour brand to Kohl's (KSS +1.33%) starting in 2017. One of the top retailers of activewear in the U.S., Kohl's has a large and loyal consumer base, the majority of which are women shoppers. This decision to reach new consumer through Kohl's is not a channel consideration but a consumer consideration. We want to reach our consumer where they expect to find Under Armour product, and we'll continue to partner with the retailers that provide us the opportunity to showcase the Under Armour brand.
-- Plank
The Kohl's deal will obviously help offset the bankruptcy of Sports Authority, which was responsible for an impairment charge of $23 million during Under Armour's second quarter. But perhaps more importantly is the fact that, as Plank points out, the majority of Kohl's customers are women. And Plank has repeatedly stated that one of Under Armour's top priorities is to grow its women's business as large as or larger than its core men's business. In any case, Under Armour is obviously happy to extend its reach to include one of the nation's largest clothing retailers.
3. The (less tangible) benefits of Connected Fitness
Mike Lee, the founder of MyFitnessPal, who joined us in early 2015, is now leading our strategic vision for the Connected Fitness business, and our team is becoming more knowledgeable every day about our consumer. [...] Some small but important wins for the brand have been our ability to, No. 1, quickly tailor our communications and content to our consumer based on their activities, giving us the opportunity to tweak our product mix and to get it more precise to the consumer showing up at our stores. Secondly, utilizing the data to create a heat map of run activity around a consumer's location, just a drop of what's to come in terms of personalization.
-- Plank
For perspective, Under Armour's Connected Fitness community -- that is, users of its various fitness and health-related apps -- had reached more than 175 million registered users as of last quarter's call, with over 100,000 more users signing up each day. It should come as no surprise, then, that Connected Fitness revenue climbed an impressive 73% year over year in Q2, to $23 million.
But Plank's comments bring up another point: that Under Armour is also working hard to benefit from Connected Fitness in much less tangible ways, including using its user base to more effectively tailor communications and content, and to personalize information to ensure that the Under Armour brand is that much more entrenched in consumers' lives.
4. On the drivers of Under Armour's shoe business
Sales of Curry footwear have been extremely strong, and with the Curry 3 coming this fall, we are anticipating our business will continue to post incredible growth. Many of these new UA consumers are finding the brand in Foot Locker doors, especially at Kids Foot Locker, not surprising given Stephen's growing popularity with the younger generation. So while the numbers he is putting up for Under Armour are record setting, we continue to be blown away by what Stephen has accomplished and incredibly excited for what is to come for both of us as a result.
-- Plank
As it stands, Under Armour's footwear revenue climbed 58% year over year last quarter, to $243 million. And that growth was largely driven by the Curry signature basketball line, but also through strong gains in running and cleated products. Nonetheless, with Curry on a campaign to raise awareness for the Under Armour brand in China last week, and with his Curry 3 line set to arrive before the end of the year, it would be shocking if Under Armour isn't able to at least sustain this torrid pace of footwear growth in the coming quarters.
5. On gross margin going forward
As we continue to outgrow our business in footwear and we continue to grow internationally at an accelerated pace, that is a headwind. On the flip side, it's our job to improve the cost side of the house and bring product to the table so that we can offset that headwind. So I think in the longer term, that's our job, and we're probably looking at a push. In the near term, as it relates to this year, we are looking at some meaningful impact in Q4. We have less of a mix challenge as the year progresses, and we will see notable improvements in the actual product margins in Q4 and anniversarying a negative number last year.
-- Under Armour CFO Chip Molloy
Finally, Molloy offered this clarification when an analyst asked him during the call about the implications of guidance on Under Armour's expected gross margin to close the year -- namely, that Under Armour's outlook indicates an inflection in gross margin (for the better) as it enters 2017. And to be fair, footwear tends to carry lower gross margin than Under Armour's lucrative core apparel segment. And it will take continued aggressive investments to sustain international growth -- revenue from which increased 68% year over year last quarter but still represented only 15% of total sales -- as Under Armour works to build new distribution partnerships, secure raw materials, and build new direct-to-consumer outlets overseas. But according to Molloy, we should see margins improve as 2016 comes to a close -- even if those improvements represent a temporary reprieve, given Under Armour's longer-term plans to grow its footwear segment and international expansion.
