Remarks at New York University Forum on Non-GAAP Metrics
Here are my remarks from the panel discussion I participated in on November 7, 2016 at NYU Stern.
Nice mention afterward from Matt Levine at BloombergView:
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My remarks are from the perspective of a journalist who is also an accountant with a particular interest and aptitude in auditing.
First, we have been reporting at MarketWatch on this subject and, in particular, the challenges for journalists or anyone tries to get quick read from earnings press releases now that non-GAAP metrics are out of control.
My New York colleagues Ciara Linnane, editor of MarketWatch’s Companies section and her lieutenant Tomi Kilgore are here. They try every day to decipher the less and less intelligible earnings release info put out by companies. It used to be that before the market opens you could quickly and easily pick out the key numbers and comparisons with prior periods from that day’s earnings releases.
Revenue, Gross Profit, Net Income, and EPS. Non-GAAP metrics like EBITDA and free cash flow are now generally accepted.
But the proliferation of non-GAAP metrics and the thousands of versions of each has made their life a nightmare. It’s like standing behind the person in the Starbucks line who orders their coffee with seven different variations. They don’t want milk or even 2%. They want soy or maybe now coconut milk. They want half caf/half decaf. They want extra espresso shots but skinny syrup. Maybe they want wet or extra dry foam, whatever the heck that means. And the final ridiculousness is some people actually dictate the temperature of the drink!
I’ve often said Starbucks should make a rule, no more than two variations! Otherwise the barista inevitably can’t juggle all those adjustment, you can never count on the person to order the same formula the next time because it’s dictated by the weather, their mood, maybe even the moon phases and, worst of all, the line slows to a crawl. No one is going to be happy.
If journalists, and analysts we’ve heard from, who do this ten times a day across the thousands of public companies can’t quickly find or figure out which number is the primary GAAP number for the key financial data and which non-GAAP number is intended to the one most directly equivalent, imagine what the average investor is thinking? Many have given up. They feel bamboozled. They feel misled.
That’s what the lack of discipline and enforcement of the non-GAAP rules is like. We see everything during earnings season at MarketWatch.For example, the number of different non-GAAP EPS variations can skew P/E ratios reported by other news outlets and aggregators. You never know whether they have picked up the GAAP number, the most directly-related non-GAAP number or some other preliminary or unofficial version.
Could the chicanery have a more sinister motive? The shares move on the non-GAAP EPS, compared to “consensus estimates” and guidance, lately also appearing as non-GAAP metrics. Is someone taking advantage of the pop on numbers that can have nothing to do with the financial reality of the company? When does reality catch up?
When I came to MarketWatch I was confused, as an accountant, by all the emphasis on the earnings release. We never go back to the Q. Unless there’s something really unusual going on, the numbers announced in earnings release and on the conf call are the only ones that get reported. What if the filings are inconsistent with the earnings release or the call or both? What if the company guides on a non-GAAP number that they change or make an error in calculating?
Journalists have been doing a lot of good work on the growing differences between GAAP and non-GAAP numbers. My colleague at the Wall Street Journal, Michael Rapoport, has been sounding the alarm for a while.
At MarketWatch we have been calling out specific companies for what could be considered broken windows infractions – the errors in prominence, or form or insanely format. Why do we see, at least once or twice a week, some company flipping the table? I am referring to putting prior year numbers before current year numbers in the reconciliation and calculating the % comparisons in reverse. Who gave these people their accounting degrees? They should be drummed out of the beancounter business.
I’ve written that a lot of people are going to get comment letters as a result of a dedicated task force in Corp Fin begun after the May guidance came out that is focusing on the most frequent and egregious offenders in each industry group. I’ve heard at least half of the companies reviewed are getting letters.
Michael reported last week that enforcement is also looking at a few cases for bigger penalties. We’ve already seen two cases of criminal fraud enforcement related to non-GAAP, the Credit Suisse case and the American Realty Capital Partners case. I am personally waiting for charges to be brought against the Brixmor REIT CEO, CFO and Chief Accounting Officer who were fired over a supposedly “non-material” case of manipulation of metrics. That’s because I wrote that it was all about their bonus metrics.
In my opinion the next frontier for enforcement should be, one, the use of non-GAAP metrics for exec compensation purposes, which I think no one is seriously scrutinizing. The Mylan story is a great example. There, Theo Francis of the WSJ reported that the $465 million penalty the company paid for overcharging Medicaid is not included in the metric used to calculate executive bonuses, a non-GAAP “adjusted diluted” earnings figure.
That’s just nuts.
I also think it’s time someone started comparing the use of non-GAAP metrics on the conference call with the what is defined and reconciled in earnings release and what shows up in the later Q. I think a passing reference and link is not enough. And it’s certainly not right if all kinds of new and non-defined metrics are showing up, either never to be used again or inevitably redefined the next time something needs to be explained away.
And finally, as I always do, I ask, where is the auditor in all this. Nowhere, it seems. As we heard in the report from the PCAOB Investor Advisory Group, The auditor is not responsible for what’s in the earnings releases, in investor presentations, or in any other communications with analysts or the public like the conference call.
The IAG actually made the recommendation, with SEC Chair Mary Jo White in the room, that non-GAAP metrics should be audited. We know why the auditors will never agree to that, at least not as part of the standard audit report. They won’t get paid extra for it and they will incur additional liability. Even non-accountants know that doesn’t add up.
The IAG recommended two possible solutions:
Require disclosure and presentation of NGFM in financial statements, which puts them under the auditors responsibility. That would ensure they are consistently calculated and audited. Unfortunately there are significant concerns about who would force this and whether this could ever be achieved.
Or, the PCAOB/SEC could mandate inclusion of non-GAAP metrics in supplementary information and make them subject to AS 17, Auditing Supplementary Information Accompanying Audited Financial Statements.
I’ll leave those discussions for another time.