Friday, July 22, 2016

Mind the Non-GAAP

I think one of the cardinal rules of blogging is to never delve into the world of accounting or you risk losing like 97% of your readers but here goes...

We have a crisis in the financial world that is going under-reported.  The burgeoning industry of Non-GAAP earnings reports.  To begin with, let's define GAAP - Generally Accepted Accounting Principles - which dictates how companies and their CFOs recognize things like revenues, expenses, etc.  Without a common language and standards it is very hard to compare to companies.  These standards have been in place for roughly 75 years and while there is a move to adopt the more globally accepted International Financial Reporting Standards (IFRS), for the time being GAAP is still the standard for good corporate citizens.

Well, about 8 years ago a couple of trends started to emerge:

1) Tech startups with lumpy revenues and expenses started trying to smooth their income statements by reporting certain costs as "non-recurring" and reporting earnings as Non-GAAP. 

2) Large industrial players started charging off huge costs as one-time restructuring fees and also started reporting earnings as Non-GAAP.

The two poster children for these techniques are Solarcity in the tech world and Alcoa in the industrial world.  The problem with these definitions is that the companies and their investors have become addicted to the beautiful non-GAAP results that can be posted quarter after quarter. Consider that in the last 12 months Alcoa had a net loss according to GAAP of $500 million.  However, they reported $1 billion of "non-recurring, restructuring charges" and published a "non-GAAP" PROFIT of roughly $500 million. 

Now when it comes to issues like paying taxes or begging for another bailout from NY State, Alcoa will clearly point to their $500 million loss, but when they talk to investors they just say abracadabra and POOF! Hey, look at that we made $500 million last year!!

Now when it was just a weird solar panel company run by Lex Luther or a bit player in the aluminum market I let it slide but in the past few weeks here is a short list of the obscure companies that have reported Non-GAAP  nonsense -

Microsoft
Intel
Johnson & Johnson

These aren't startups or companies where liberal accounting should be the norm.  These principles are called GENERALLY ACCEPTED for a reason and the media and the investing public should demand more from public companies.

I believe that we could draw more attention to this issue if we started calling non-GAAP numbers by a new name which reflects that the numbers are in fact the opposite of Generally Accepted:

"Q1 EPS rose 12% according to Abnormal Accounting Principles"

"While GAAP revenue fell 2% it actually rose 6% according to the company's use of Questionable Accounting Principles"

To the SEC's credit they are starting to get more active in discouraging the use of non-GAAP reporting but until the media and analysts team up to ignore these faux reports, companies will keep up the non-GAAP games.

Okay - that's enough accounting talk for the next 6 months :)

Cheers!

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