UAA

Under Armour, Inc. 10-Q Summary: Period Ended September 30, 2006

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2006, and the nine-month period ended on that date. Under Armour, Inc. is a developer, marketer, and distributor of branded performance apparel, footwear, and accessories. The company operates within a single reportable segment and sells primarily in the United States and Canada, with expanding international operations in Europe and Japan.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 47.5% for the quarter and 52.5% for the nine-month period compared to 2005. Growth was driven by volume increases in apparel, new footwear product introductions (football cleats), and a 61.5% increase in license revenues.
• Profitability: Net income surged 90.4% for the quarter and 113.2% for the nine-month period. Gross margins improved by 100 basis points (quarter) and 160 basis points (nine months) due to supplier discounts and higher-margin direct-to-consumer sales, partially offset by lower-margin footwear.
• Operating Expenses: Selling, general, and administrative (SG&A) expenses increased significantly ($14.2M quarter-over-quarter) due to marketing costs for the new NFL footwear agreement, international expansion, and ERP system implementation.
• Cash Flow: Operating cash flow turned negative ($15.9M used) for the nine months ended September 30, 2006, compared to $2.5M provided in the prior year. This was primarily due to a $17.5M increase in receivables and a $21.8M increase in inventory to support growth and new European operations.

Outlook, Risks, and Unusual Items

• Guidance & Outlook: Management expects the 2006 annual effective tax rate to approximate 33.6% due to a new state tax credit. Anticipated capital investments for the full year 2006 are estimated between $15.0 million and $16.0 million.
• Strategic Initiatives: The company launched footwear in Q2 2006 and plans to introduce baseball cleats in Q4 2006. International expansion continues with a new European headquarters in Amsterdam.
• Accounting Changes: The company adopted SFAS 123R (Share-Based Payment) effective January 1, 2006, resulting in the recognition of stock-based compensation expense ($0.5M for the quarter, $1.0M for nine months).
• Risks: Key risks include the ability to manage rapid growth, reliance on large sporting goods retailers (concentration of credit risk), seasonality of sales (heavily weighted to fall), and potential inventory obsolescence.
• Unusual Items: In August 2006, the company entered an NFL Promotional Rights Agreement, issuing warrants valued at $8.5 million as partial consideration, recorded as an intangible asset.

Investor Verification Checklist

• Inventory Levels: Verify the necessity of the $21.8M increase in inventory against actual sales velocity to assess obsolescence risk.
• Receivables Concentration: Review the concentration of accounts receivable among top customers (Customer A, B, and C represent significant portions of revenue and receivables).
• Footwear Margins: Monitor the gross margin impact of the new footwear line, which currently has lower margins than apparel.
• Operating Cash Flow: Assess the sustainability of negative operating cash flow given the heavy investment in working capital and capital expenditures.
• Debt Covenants: Confirm continued compliance with financial covenants on the $75M revolving credit facility, particularly regarding minimum borrowing availability.