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Kevin Plank, CEO of Under Armour, makes his presentation at the shareholders meeting.
Kevin Plank, CEO of Under Armour, makes his presentation at the shareholders meeting. (Barbara Haddock Taylor, Baltimore Sun)

Under Armour confirmed this week that its accounting practices are the subject of a federal investigation.

The Baltimore-based athletic brand said it has been cooperating with the investigation since mid-2017.

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“We firmly believe that our accounting practices and disclosures were appropriate,” Under Armour’s chief financial officer, David Bergman, said Monday.

Here are five things to know about the investigation:

What is known about the investigation?

The U.S. Securities and Exchange Commission and the Justice Department are looking into whether the athletic footwear and apparel company manipulated its sales numbers to make them appear stronger, reported the Wall Street Journal, which broke the story Sunday. The investigation is both civil and criminal.

While Under Armour confirmed the investigation, the SEC declined to comment and a spokeswoman for the U.S. Attorney’s Office in Baltimore said prosecutors could neither confirm nor deny the existence of an investigation.

What might the feds be looking at?

One of the most common areas of enforcement action for the SEC is determining whether revenue was improperly recognized, said Ken Joseph, a former SEC official who is now managing director and fellow at Duff & Phelps Institute, a corporate citizenship think tank.

Public companies must follow strict rules regarding the way revenue is recognized, including proper timing, said Timothy Spence, a San Francisco-based financial consultant who advises companies on SEC matters.

“Some industries, like fashion, are highly seasonable, with sales varying widely from quarter to quarter,” Spence said. “There appear to be two questions here. The first is, was this a ‘smoothing’ of revenue to make quarterly revenue recognition more consistent?"

Another question would be whether the company recognized revenue in advance and expected to make it up in the next quarter, he said.

“Both practices are highly questionable accounting, if not outright fraud," said Spence, who added he has no specific information about practices at Under Armour.

What might the outcome of the investigation be?

Most SEC investigations tend to take two to three years. The Under Armour probe could be in a later phase, where investigators compile testimony, said Joseph, who previously worked as a supervisor in SEC’s division of enforcement.

Once testimony is taken, the SEC would decide whether to bring charges against a company or individuals. Any action, which would be filed publicly, could include a settlement or go to litigation, he said.

About half the time, investigations result in no action, Joseph added.

What was the reaction to news of the investigation?

Wall Street pummeled Under Armour’s stock Monday. Shares plunged nearly 19 percent to close at $17.14 each.

Analysts attributed the decline to the investigation as well as Under Armour’s guidance during its earnings announcement Monday that its sales would be lower than what it suggested earlier this year.

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At least one analyst questioned why Under Armour hadn’t disclose the investigation much earlier.

“Failure of management, on the earnings call, to address why the investigation was not disclosed prior to last night is disconcerting,” said Sam Poser, an analyst with Susquehanna Financial Group, in a report Monday.

Does this affect Under Armour’s turnaround effort?

Since 2016, when Under Armour’s rapid sales growth ground to a halt, the company has struggled to boost declining sales — particularly in the United States, its largest market — and lift its profits and moribund stock price. The company has been reorganizing, refocusing and cutting costs and excess inventory, but the effort is in its third year.

On Monday, Under Armour reported that its global sales slipped 1% to $1.43 billion in the three months ended Sept. 30, while North American sales fell 4% to $1 billion. However, its profitability improved as the company earned 23 cents per share, a nickel more than Wall Street expected.

Company officials touted the turnaround Monday, saying Under Armour has reduced excess inventory and its reliance on sales through off-price or discount stores, while reviving sales at full-price stores.

However, the company also said Monday that its sales growth this year likely will be about 2% rather than the 3% to 4% it earlier told analysts to expect.

Analysts’ reactions to the results were mixed.

“Prospects in a near-term turnaround in North America ... are dimming, we think due to growing competition from Nike, Lululemon and Columbia Sportswear, whose innovation pipelines are in the fast lane,” said Camilla Yanushevsky, an analyst with CFRA.

Stifel analyst Jim Duffy applauded the company’s better-than-expected revenue and gross profit margin improvement.

“We maintain our bullish view on potential for revenue and margin improvement,” Duffy said in a research report Monday.

But most agreed the federal investigation would be a distraction and likely a drag on the stock price.

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