US Federal officials have escalated an investigation into accounting practices at Under Armour Inc. at a time when the Baltimore-based sports apparel maker is struggling with worsening losses amid coronavirus-related store shutdowns.
Under Armour and two top executives, including founder Kevin A. Plank, have been alerted that the U.S. Securities and Exchange Commission could file a civil or administrative case alleging unlawful accounting methods, the company disclosed on July 27.
The warning came in the form of “Wells Notices” sent by the staff of the SEC to the company, as well as to Plank, executive chairman and brand chief, and David E. Bergman, chief financial officer, on July 22.
The notices recommend the SEC file an enforcement action against the company and each of the executives alleging violations of federal securities laws, according to Under Armour. Such notices are not formal charges of wrongdoing nor final determinations of any violations.
Under Armour reiterated that its accounting actions were “appropriate” and said it would respond to SEC staff as part of the Wells Notice process.
The company and its executives “expect to engage in a dialogue with the SEC Staff to work toward a resolution of this matter,” Under Armour said in its filing.
The company last November confirmed that its accounting methods are being investigated by both the SEC and the U.S. Department of Justice. Federal officials have reportedly been looking into whether the company manipulated its sales numbers to make them appear stronger.
Wells Notices, typically issued by the SEC’s enforcement division, can represent a significant step in an ongoing SEC investigation, said Eric Beste, a former prosecutor with the Department of Justice who worked with the SEC on accounting and securities fraud cases. The SEC could decide to file a civil lawsuit or an administrative case within the agency. If violations are found, companies or individuals could face financial penalties and individuals could be barred from serving as officers or directors of public companies.
“Not every Wells Notice leads to an enforcement action,” Beste said. “Having said that … , it’s a significant event and escalation in the process.”
The company’s position that it did not violate laws could mean there will be no quick settlement, said Beste, a San Diego-based partner in the business law firm Barnes & Thornburg.
“This one looks like they’re fighting it,” he said.
The investigation adds one more obstacle to an already struggling brand.
For years, Under Armour experienced explosive growth. But a nearly seven-year streak of quarterly sales gains in excess of 20% ended in the last three months of 2016.
The company was in the midst of a multiyear turnaround plan designed to stabilize business and reverse a slide in sales when COVID-19 struck the U.S. The sports apparel seller posted a wider-than- expected loss for the first three months of the year as it temporarily shut stores, laid off 6,700 employees temporarily and saw unprecedented drops in demand in the U.S. and internationally.
The turnaround strategy has focused on the brand’s athletic performance roots and on innovation in its products. But it also has been forced to discount merchandise to slash excess inventory.
The government regulators’ notices relate to the company’s disclosures of so-called pull forward sales of goods to its customers, such as retailers, that were counted as revenue from the third quarter of 2015 through Dec. 31, 2016, Under Armour said in an SEC filing. A pull forward sale typically includes a sale to a customer that occurs earlier than originally planned. The SEC is looking at the company’s disclosures of the use of pull forward sales to meet sales objectives.
Beste said such “pull forward” sales can be legitimate if a company’s revenue recognition policy allows for it.
Problems can arise if such methods are not properly disclosed.
“By not disclosing the fact that you are using pull forward, you could be creating a misleading impression to investors that … normal sales are getting bigger and bigger, when instead you are managing your sales pretty aggressively,” he said.
Such practices could mask that sales are actually declining or sales goals were not met, he said.
“The SEC Staff has not alleged any revenue recognition or other violations of generally accepted accounting principles relating to that or any other period,” Under Armour said in its SEC filing.
Under Armour Inc., in it’s Annual Report on form 10-K, has reported: “In 2015, our products were manufactured by 44 primary manufacturers, operating in 16 countries, with 10 manufacturers accounting for approximately 45% of our products. Approximately 63% of our products were manufactured in China, Jordan, Vietnam and Indonesia. As a result of our international manufacturing, we are subject to risks associated with doing business abroad.”
Regarding Sourcing, manufacturing and quality assurance, the report reads: "Many of the specialty fabrics and other raw materials used in our products are technically advanced products developed by third parties and may be available, in the short term, from a limited number of sources. The fabric and other raw materials used to manufacture our products are sourced by our manufacturers from a limited number of suppliers pre-approved by us. In 2015, approximately 54% of the fabric used in our products came from five suppliers. These fabric suppliers have primary locations in Taiwan, Malaysia and Mexico. The fabrics used by our suppliers and manufacturers are primarily synthetic fabrics and involve raw materials, including petroleum based products that may be subject to price fluctuations and shortages. We also use cotton in our products, as blended fabric and also in our CHARGED COTTON® line. Cotton is a commodity that is subject to price fluctuations and supply shortages. Additionally, our footwear uses raw materials that are sourced from a diverse base of third party suppliers. This includes chemicals and petroleum-based components such as rubber that are also subject to price fluctuations and supply shortages. Substantially all of our products are manufactured by unaffiliated manufacturers. In 2015, our products were manufactured by 44 primary manufacturers, operating in 16 countries, with approximately 63% of our products manufactured in China, Jordan, Vietnam and Indonesia. Of our 44 primary manufacturing partners, 10 produced approximately 45% of our products. All manufacturers are evaluated for quality systems, social compliance and financial strength by our quality assurance team prior to being selected and on an ongoing basis. Where appropriate, we strive to qualify multiple manufacturers for particular product types and fabrications. We also seek out vendors that can perform multiple manufacturing stages, such as procuring raw materials and providing finished products, which helps us to control our cost of goods sold. We enter into a variety of agreements with our manufacturers, including non-disclosure and confidentiality agreements, and we require that all of our manufacturers adhere to a code of conduct regarding quality of manufacturing and working conditions and other social concerns. We do not, however, have any long term agreements requiring us to utilize any manufacturer, and no manufacturer is required to produce our products in the long term. We have subsidiaries in Hong Kong, Panama, Vietnam, Indonesia and China to support our manufacturing, quality assurance and sourcing efforts for our products. We also manufacture a limited number of apparel products, primarily for high-profile athletes and teams, on-premises in our quick turn, Special Make-Up Shop located at one of our distribution facilities in Maryland.