I’m the first to admit when I don’t get something. Happens all the time. But here’s something I REALLY don’t get…and it’s all about inventory issues at UA. And trust me, there are issues. The company won’t answer this question for me bc they’re miffed that I said the CEO should fire himself (c’mon…no harm no foul!). But if I had a meeting with PWC I’d go to town with them on this.
Why am I making this a big deal? Because it’s hard to know how much damage UA is doing to the brand with all the discounting, selling to off-price retailers, Kohl’s, Costco and Amazon. When will the brand be able to sell at full price again is the real question. That and only that is what matters if you own this as a growth (or even value) stock. Transparency in inventory is critical, and it ain’t there. In fact, it's opaque enough for me to call hard foul. These are the facts as they appear to me…
- We already know that in 2017K, UAA disclosed that the company was increasing its allowance for returns/markdowns by $100mm. #cookiejar. Nothing flat out wrong there…but not the transparent thing to do.
- For 2018, UAA adopted a rule booking reserves for returns, allowances, discounts and markdowns will be included as other current liabilities rather than accounts receivable, net. On the 1Q release, management reorganized the balance sheet, now listing a Customer Liability line item which serves as a catch all for those allowances, reserves for returns, discounts and markdowns.
- In 2Q the Customer Liability was down $50mm or 14% QoQ, implying that ~$50mm or 50% of the reserve allowance was used in 2Q alone. #AteALotofCookies
- But here’s the kicker…prepaid expenses were up $111mm yy this quarter. Now, this year’s newly adopted accounting rules included the change that the value of inventory associated with reserves for sales returns will be included within prepaid expenses.
- In other words, along with the reserve accounting change at y/e, it is reclassifying inventory that is reserved against into prepaid expenses. Just when the inventory returns are ballooning, is the company no longer classifying it as inventory?
- Under Armour is also taking a $20M charge against inventory in the future as part of the new restructuring charges. We’re not sure why inventory should be written off as part of the restructuring. That sounds like something a lesser quality company like HBI would do.
If a management team wanted to represent inventory levels as low as financially feasable per GAAP accounting, that’s the way to do it – cloud an inventory problem with return commitments stuffed into prepaids. Is that what happened here? I have no idea. But the facts simply are not lining up in a way that synchs with the intellectual and financial integrity one would expect from a company like UnderArmour.
I synch that with UA’s comments about inventory, and I paraphrase [inventory clearance today is 2017 leftovers, and that the current plan is to sell 2018 inventory through full line channels at (close to) full price.] But inventories are still outstripping sales by 3pts. Guided to inventories in line with sales by 4Q, but that banks on normalized sell through back to school. It’s a great sales environment out there – so might very well happen. But need to rely on very strong macro backdrop.
All in, the UA print was largely in line, but if I was long I wouldn’t be happy about it. The company beat on revenue and missed on margins. The bullish narrative is all about ‘slapping a normalized margin’ on the model to get to a $0.50-$0.75 EPS power – and it simply ain’t happening. The entire retail world is beating top line now, and UA can’t even flow it through? That’s despite the simply confounding inventory accounting changes noted earlier. I think there’s margin risk in the back half – which makes the current bull case even tougher to prove out.
UA still on my Best Idea Short list and staying there based on what I see today.
