Under Armour Inc. Stock Down 10% After Earnings: Here's Why

What happened

Shares of Under Armour Inc. (NYSE: UA) (NYSE: UAA) fell 10.7% and 8.8% respectively on Aug. 1, following the release of the company's second-quarter financial results. That leaves Under Armour shares down 41% so far this year, and down by 65% from the all-time high.

So what

Mr. Market is beating up on the apparel and footwear maker for a variety of reasons. To start, its financial and operating results were underwhelming. Under Armour reported revenue of $1.1 billion, up 9%, with strong 20% growth in direct-to-consumer sales, while wholesale revenue was up 3%. Under Armour also reported a $12 million net loss in the quarter, for a loss of $0.03 per share, and a $5 million operating loss, as gross margin contracted 190 basis points to 45.8%.

The gross-margin contraction was due to a number of things, including an increasingly competitive environment in North America, and the big impact of several major retailer bankruptcies over the past couple of years cutting into the company's distribution footprint. Case in point: Under Armour's footwear business, which had been its fastest-growing segment for several years, reported a 2% revenue decline in the second quarter.

International sales continue to be a bright spot. While revenue was flat in North America, sales increased 57% in EMEA (Europe, Middle East, and Africa), 89% in Asia-Pacific, and 10% in Latin America. From a profitability perspective, Asia was the lone bright spot, reporting $15 million in operating income, up 54% year over year, and the only segment with positive operating income in the quarter and first half of the year.

Now what

Under Armour's founder and CEO Kevin Plank and his management team have acknowledged that it's time to make some changes. While the company had grown sales and operating income at incredibly high rates for years -- at one point the company reported over a decade of 10%-plus consecutive quarterly sales growth -- the competitive landscape has changed. The company's operating expenses are simply too high, which is a limiting factor on its ability to adapt and invest in the best growth opportunities. Furthermore, it's led to poor returns on the company's growth investments.

For this reason, the company is going to implement a restructuring plan to "more closely align its financial resources to support ... efforts to better serve the evolving needs of the changing consumer and customer landscape." In other words, management plans to be far more disciplined with capital, which should be a positive long-term development. The bad news: This will cost up to $130 million in restructuring expenses and charges ($70 million of which is cash), and cost some 280 Under Armour employees their jobs.

The company is also taking a more segmented approach to managing its categories, expecting that more focus on the basketball, men's training, women's, running, and lifestyle product categories will drive better growth and lead to stronger long-term profitability.

Looking ahead

In part because of the restructuring plan, but mostly due to heightened competitive pressure in North America, management said it expects revenue to grow at a slower pace than previously expected, lowering full-year guidance to revenue growth of 9% to 11%, down from prior guidance for 11% to 12%. Gross margin is also expected to decline, falling 160 basis points by year-end, due to restructuring costs, inventory management, foreign-currency impact, and competitive pressures. Operating income is expected to be $160 million to $180 million on a GAAP basis, and $280 million to $300 million when adjusting for restructuring costs.

The big question that investors must ask today: Is the restructuring a serious plan to realign costs to better support strategic growth and deliver better returns, or is it just a cost-cutting exercise? With Plank maintaining firm control of the company, it's almost certainly the former.

If that does prove to be the case, the odds are probably in Plank's favor that Under Armour, which still commands powerful brand equity and is growing in very important international markets, will be in far better shape, and selling a lot more goods, in years to come.

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