Under Armour

Expectations send stock down 80 cents, despite improved 2nd-quarter results

Punishment from market

Housing slowdown, profit margins affect companies

July 27, 2006|By ANDREA K. WALKER | ANDREA K. WALKER,SUN REPORTER

The company thought it had given investors all they could ask for: a nice bump in profits, better-than-expected sales of a key new product and an improved financial outlook for the rest of the year.

But in the end, Under Armour's positives were overshadowed yesterday by investors' focus on slightly lower profit margins over the previous three-month period.

It was another illustration of a lesson the Baltimore athletic-apparel company has learned since going public last year: An entrepreneurial spirit doesn't always mesh with the critical eye of Wall Street.

Under Armour stock dropped nearly 6 percent early in the day before rebounding, though it still closed down 80 cents, or 1.9 percent, at $40.67. This was despite a 32.5 percent improvement in second-quarter net income to $2.4 million, or 5 cents a share, compared with $1.8 million, or 3 cents a share, in the corresponding period last year. Revenue rose 63.3 percent, to $80 million.

The company increased its outlook for the year. It now expects revenue of $400 million to $410 million, a 42 percent to 46 percent increase over last year. Net income is expected to come in at $34 million to $35 million, a 72 percent to 78 percent improvement from last year.

But throughout a conference call yesterday, analysts, while praising the earnings results, questioned the company about its gross profit margin, which was 47.8 percent compared with 51 percent during the quarter last year.

"Investors almost always dislike anything that lowers a company's margins," said Jeff Fischer, co-founder of online investment newsletter Complete Growth Investor. "The higher a profit margin, the more safety, or implied `protective moat' around a company's business. If margins are coming down, it may mean that competition is making things more difficult and that future earnings estimates may prove too high."

Launching of cleat

Part of the decline was expected because of the added costs of launching the company's football cleat, a small but important and somewhat risky leap into more direct competition against the likes of Nike.

While sales of the cleat came in beyond expectations - $15.6 million, as opposed to the expected $8 million to $10 million - Under Armour has acknowledged that cleats have lower margins than apparel because there is a limited audience. Football cleats, unlike apparel or other shoes, have no use off the field.

The company said that gross margins are better gauged over a longer period of time.

`Best view I can give'

"As far as the margins are concerned the best view I can give you for margins is not to look at it from a quarterly basis but from over a six-month period," said Wayne Marino, Under Armour's chief financial officer.

Marino said a number of factors in the latter part of the year should help increase margins. Improvement in its "sourcing" systems should start to have an impact, he said. The company also will have higher average selling prices in the second half of the year because more expensive merchandise will be in season. Last Christmas, a line of fleece did so well that the company plans to expand it later this year.

One analyst said the decline in profit margin might be normal as Under Armour expands internationally and introduces new products, which costs more money.

"This is something that is inevitable for this company to move to the next level," said Robbert Van Batenburg, head of research at Louis Capital Markets in New York, an independent global broker-dealer. "The margins are lower but the costs are higher as they move into new markets, introduce new products and market those products. It solidifies the success in the future."

New line for girls

Under Armour said it plans to introduce girls wear to its youth line in the fall and will begin selling baseball cleats later in the year.

The company also has implemented a computer system that better coordinates operations.

Analysts at Piper Jaffray increased their earnings per share estimates for this year and next after Under Armour's report yesterday.

In a research report, the analysts said Under Armour will capture more market share as it evolves from a company selling mostly form-fitting compression wear into more loose-fitting wear.

The report also said that a further expansion into footwear will help establish Under Armour as a top-tier company. The company will likely benefit from a "halo effect" where its fans will want to "fully accessorize under one brand name."

andrea.walker@baltsun.com

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