Tuesday, July 24, 2012
Under Armour's Special Effectsby Michael Markowski, Director of Research @ Stockdiagnostics
Via the press release that Under Armour (NYSE:UA) issued which covered its earnings for its second quarter ended June 30, 2012, the company has done a good job of using special effects to paint a picture of financial health. Its release stated that Net Income for the second quarter of 2012 was "$7 million compared with $6 million in the prior year's period." Net Income for the quarter actually increased by $427,000, from $6,241,000 to $6,668,000. Under Armour rounded its numbers for its previous quarter down and rounded them up for its current quarter to create the special effect that it had increased its earnings by $1 million. It likely would have been very embarrassing for it to disclose in its press release that it had not even increased Net Income by at least $1 million on a revenue increase of $78 million as compared to its year earlier prior quarter.
Under Armour's Balance Sheet Highlights in its press release emphasized:
"The Company had no borrowings outstanding under its $300 million revolving credit facility at June 30, 2012 ... and that Long-term debt increased to $74 million at June 30, 2012 from $37 million at June 30, 2011, primarily driven by the acquisition of the Company's corporate headquarters in July 2011."
The "Balance Sheet Highlights" in Under Armour's press release are another use of special effects by Under Armour's management. UA's mentioning that "Long-term debt had increased to $74 million at June 30, 2012, in their press release does not add up. According to the 6/30/12 Balance Sheet that they made available on their web site on the morning of the press release the company's "Long term debt, net of current maturities" was $31,499,000. According to the same Balance Sheet on their web site the "$37 million" number that they gave for 2011 also does not add up. The actual long term debt that they disclosed at June 30, 2011 was $31,290,000.
Upon a further examination of Under Armour's Balance Sheets I believe was able to determine how they actually calculated the misleading amounts. What I think they did is that they added $42,387,000 of the "Current maturities of long term debt" which is listed in the Current Liabilities section of their Balance Sheet to their actual long term debt of $31,499,000. The total came out to be $73,886,000. It was rounded to $74 million to come up with the special effects for its press release. I believe they did the same for the year earlier number. By adding $5,567,000 of the current maturities of long term debt to their actual long term debt of $31,290 they came up with $36,857,000 and they rounded it to $37,000,000.
For its press release highlights I believe Under Armour purposely inflated its long term debt by 135%. The question is why would any company go to such trouble to fabricate or inflate the actual amount of long term debt that it had so that it could highlight the number in a press release? The only reason why any company would want to do that is to create the illusion that its Balance Sheet was stronger than it actually was. Any analyst would agree that the moving of more than $42 million from the Long Term debt to the Current Liabilities section of a Balance is a negative. By putting well crafted spin into its press release it was hoping that investors would overlook the fact that a significant portion of its long term debt had become due and payable in its quarter ended March 31, 2012 and was now a current liability.
I suspect that Under Armour created the special effects for its Balance Sheet highlights because it did not want "unsophisticated" investors and shareholders to focus on the fact that its Balance Sheet at 6/30/12 had weakened considerably as compared to prior periods. I believe it did not want investors focusing on the fact that the current portion of its long term debt that was due and payable at June 30, 2012 had skyrocketed to $42 million or by approximately 657% as compared to $5.6 million at June 30, 2011. Additionally, its Current liabilities compared to its year earlier period increased by 46%. Its ratio of current to total liabilities increased from 65% at the end of its most recent calendar year to a current 80%. The following are the key changes in liabilities and stockholder's equity for Under Armour's recently ended second quarter versus its first quarter ended March 31, 2012:
- Accounts Payable increased by $50 million
- Accrued expenses increased by $19 million
- Total liabilities (all current) increased by $69 million
- Stockholders Equity increased by only $15 million
Why does Under Armour want to obscure the obvious? Its either going to have to tap its unused credit line or raise capital via the sale of equity or the issuance of long term debt. I believe that management is nervous about utilizing its credit line for two reasons. The first I believe is that they believe that the tapping of the credit line would be politically incorrect. Doing so would show or indicate weakness or put a dent in their armor. With Under Armour's shares at their all time highs they can ill afford for that to happen. This is especially because of the second reason which is the company's inability to generate consistent operating cash flow.
The key issue which Under Armour's management has had to face since its inception is that the Cash Flow that the company has been able to generate from its Operations has been inconsistent. The Company's Cash Flow From Operations (CFFO) for its Fiscal years ended December 2009, 2010 and 2011 steadily declined from $119 million to $50 million and $15 million respectively.
The 5 Year charts below which were provided by stockdiagnostics.com illustrate the differences in Operating cash flow growth rates for Under Armour and Lululemon Athletica (NASDAQ:LULU). Under Armour's 5 Year chart depicts that its CFFO had increased for the first two of its past five years and has been in steady decline for the past three years. Lulu's 5 Year chart below depicts that its CFFO has grown steadily for each of the five years.
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UA 5 year OC chart by StockDiagnostics.com
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LULU 5 year OC chart provided by StockDiagnostics.com
The 20 quarter charts below illustrate both the inconsistency of Under Armour's CFFO and the consistency of Nike's CFFO. Under Armour's CFFO is very inconsistent. The CFFO or OC bars for a majority of its 20 quarters are negative or red. It only has one quarter, its 4th, depicted by the gold circles in the chart, which has been consistently positive.
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UA 20 quarter chart provided by StockDiagnostics.com
As shown below Nike's 20 quarter chart is altogether different than Under Armour's. Nike's CFFO or light green bars remain positive for the entire 20 quarter period which is covered.
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NKE 20 quarter chart provided by StockDiagnostics.com
Given Under Armour's CFFO inconsistencies its not likely that it will tap its credit lines to pay its current liabilities. The biggest risk to its share price is that it does a secondary offering to raise the capital to pay off its long-term debt, which only recently became due and payable.
While Under Armour's CFFO has been inconsistent its never the less an American icon and its brand is very valuable. Due to its inconsistent CFFO and it current share price to its CFFO multiple of 207 its shares are currently overvalued when compared to Nike's Price to CFFO per share multiple of 24 and Lululemon's multiple of 43. Few would disagree that its an immature company compared to Lululemon or Nike. To become recognized as a peer of both it needs to fine tune its business model so that it can generate consistent positive cash flow on a quarterly basis. If it can do that it will join the ranks of the world's most formidable companies. If it can't its shareholders will suffer from constant dilution.
*Click here to see historical Stockdiagnostics Charts of Under Armour