- Company says SEC focused on disclosures, not accounting
- Pull-forward sales a common technique, often used to meet projections
- Read This Next: Portfolio, BNA Pick, Additional Analysis on Revenue Recognition
The Securities and Exchange Commission has told Under Armour Inc.'s founder and chief financial officer that they will probably face enforcement action over the company’s practice of pulling sales from the next quarter into the current period—a type of earnings management that’s not uncommon and not necessarily illegal.
The company said in a regulatory filing that the SEC inquiry is focused on what the athletic apparel company disclosed to shareholders about the practice, not how it accounted for the revenue linked to those sales.
What are pull-forward sales?
A company convinces a customer to place an order sooner than they normally would. That lets it book the revenue sooner and still meet accounting standards for revenue recognition.
The practice can be a way to smooth out earnings and meet analysts’ projections for sales growth. Companies are supposed to disclose how they make material accounting estimates, including whether their policy is to recognize revenue by pulling forward sales.
“Because most companies have activity that spikes at the end of a reporting period, it can be difficult to identify when there are these types of manipulated transactions versus just the usual scramble at the end of a period,” said Lisa Braganca, a securities lawyer and former SEC branch chief.
What’s wrong with it?
Each instance takes sales away from one quarter to feed the previous one. Companies might repeat the practice hoping for a blowout quarter that would eventually make up the difference.
“At some point, the music is going to stop and you’re not going to have a chair,” said Mike Walworth, chief executive officer of GAAP Dynamics and a former auditor. “You don’t have any more sales to pump up into that quarter.”
The practice often comes with incentives to the customer in the form of discounts, rebates or buy-back guarantees, all of which impact revenue. Pulling forward can also disguise sham transactions known as channel stuffing, in which no product ever changes hands: The company books a sale to close the quarter so it can record the revenue, then the customer cancels the sales contract immediately after the quarter ends.
Why would Under Armour do this?
Investors in a lawsuit filed last year claimed that the sales shifting helped Under Armour maintain its oft-stated goal of increasing revenue growth 20% over the previous year every quarter.
“All of this really relates to revenue smoothing. At the end of the day that’s what they are trying to do. They are trying to provide consistent, recurring, smooth numbers that meet or beat analyst expectations instead of just reporting what really happened,” Walworth said.
Without proper disclosures, he said, “shareholders are getting an unrealistic expectation that these growth numbers are real when in fact what they are doing is they’re pulling from next quarter sales into this quarter.”
How long was this happening?
According to Under Armour, the SEC is focused on the third quarter of 2015 through the end of 2016.
In November 2019, the company disclosed that securities regulators had been digging into its accounting for more than two years. Under Armour first responded to requests for documents and other information related to its accounting practices and disclosures in July 2017.
What could SEC do as a result?
The SEC has issued a Wells Notice, which means that the staff attorneys think that there were violations of federal securities laws and that they will recommend a formal enforcement action. It doesn’t guarantee that the commission would bring any enforcement case against the company or its top executives, including administrative charges or a civil suit.
The SEC has multiple tools to hold companies accountable, including disgorgement, penalties, and officer or director bars for corporate leaders.
The company previously said that the Department of Justice was also investigating, which carries the threat of criminal charges.
—With assistance from Nicola M. White.
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