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How Under Armour's CFO Is Dealing With Messy Financials

By Brian Withers - Feb 24, 2018 at 10:01AM

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A streak of 26 consecutive quarters of 20%-plus revenue growth is great ... until it stops.

Under Armour (UA -2.81%) (UAA -1.61%) delivered amazing top-line growth between 2010 and 2016, but then it came to an abrupt stop and has yet to recover.

While the market seemed to like the performance-apparel company's most recent quarter, missed revenue targets have left a number of the company's financial metrics a mess. Here's what the CFO plans to do about it.

Top-line troubles

If you step back to Oct. 31, we took over $300 million out of our top-line plan for 2017.

-- CFO David Bergman

Up until the third quarter earnings call in October, the company had been projecting full-year revenue between $5.26 billion and $5.36 billion. While this doesn't seem considerably different from the actual tally of $4.98 billion, this late-in-the-year change means inventory had been purchased or was on the way. But this is only part of the company's woes.

As recently as five quarters ago -- third quarter 2016 -- the company indicated it was on track to achieve its $7.5 billion strategic revenue target for 2018 and was building considerable infrastructure to support it. The company backed off the commitment one quarter later and hasn't updated the plan, which is now much different from how things actually turned out.

This revenue miss for 2017 and the failure to live up to the company's strategic plans have left Under Armour with a financial mess that Bergman is in charge of cleaning up.

Cup of coffee and set of glasses sitting on top of a stock market graph in a newspaper.

Image Source: Getty images.

Taking stock of the situation

These missed revenue projections have contributed to lower gross margins; higher selling, general, and administrative (SG&A) costs; a bottom-line loss; and excess inventory.

SG&A costs were a staggering $2.1 billion for the year, representing 41.9% of the top line. While some of this spend was to support the infrastructure for fast-growing international and direct-to-consumer businesses, spending on a 3%-growth footwear business and efforts to create demand in the third quarter seem to be money wasted.

Gross margins came in at 43.2% for the quarter versus 44.8% from the previous year. Bergman explained that the difference was a result of a combination of selling more product in off-price channels, promotions, air freight, and a higher mix of lower-margin footwear than expected. These reasons are all symptoms of the problem: The right products were not selling as expected. This lower gross margin, combined with the significant level of SG&A spend, drove the bottom line to a full-year loss of $48 million.

Inventory was up 26%, which was a blend of "good" inventory supporting the high-growth international segment and "excess" inventory on the order of a "mid-teen percentage" growth in North America. With North American revenue down 4% in the quarter, this inventory growth can be directly attributed to the late revenue-forecast downgrade.

While the culmination of these impacts seem daunting, Bergman -- a 14-year Under Armour veteran -- has a plan to deal with it.

Restructuring and beyond

Part of the solution to these issues is a restructuring plan for 2018. Bergman announced that a significant portion of the $110 million to $130 million restructuring charges involve terminating long-term contracts or leases, yielding savings of $75 million in 2019. This is a smart move as the company determines what infrastructure is actually required to move its business forward. Bergman is also cutting $50 million out of capital expenditures for the current fiscal year from the 2017 levels.

While these moves will help push the SG&A costs in the right direction, the company recognizes it needs to do more. Bergman and the management team are working on a new strategic plan, which will be unveiled at an investor day later this fall. CEO Kevin Plank indicated the new plan will "ensure a more consistent, predictable path to deliver long-term value to our shareholders."

As for the gross margin and inventory issues, the company needs to move through the excess inventory first. Once this lower-margin product is gone, Bergman indicated that gross margins will improve in the second half of the year, bringing full-year gross margins to 45.5% for 2018. It's important to note that this improvement is dependent on new products being better aligned to what customers want and a decrease in the promotional activity in the retail channel.

Bergman certainly has his hands full executing a sound restructuring plan, building a new strategic one, moving excess channel inventory in a "brand-right way", and ensuring the new 2018 products are priced appropriately. While I've been impressed with Bergman, this is a daunting endeavor, and I'm afraid that cleaning up this mess will take longer than expected. Hopefully Bergman will prove me wrong.

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