When a company presents a non-GAAP measure investors generally should ask, “Is this non-GAAP measure presented to try and make things look better than the story the related GAAP measure tells?” For example, in this SEC enforcement against ADT, the company presented adjusted EBITDA in the headline of its earnings release, highlighting a 7% increase, but did not mention that the company’s GAAP loss had increased from $(141) to $(157) million until later in the release. Highlighting a positive change in a non-GAAP measure while the comparable GAAP measure deteriorates raises significant questions. In addition, ADT did not follow Regulation S-K Item 10(e), which clearly applies to a company’s earnings release, and requires that GAAP measures be presented with equal or greater (OK, really greater) prominence than the comparable non-GAAP measure.
In an interesting twist on this process, as discussed in a recent enforcement release, a company disclosed a non-GAAP measure that was not as positive as the related GAAP measure, but used a classic revenue manipulation strategy to make the non-GAAP measure look more positive.
In the headline for its third-quarter 2016 earnings release, Newell Brands said:
Newell Brands Announces Third Quarter Results
Net Sales Growth of 158.5%; Core Sales Growth of 3.0%
New Strategic Plan Transformation into Action
Raises 2016 Guidance to Top Half of Range
Provides 2017 Initial Outlook
At first glance, all appears reasonable with this headline. In particular, placing GAAP sales growth before the non-GAAP measure “core sales growth” follows the S-K Item 10(e) requirements discussed above, and avoids the frequent “equal or greater prominence” non-GAAP measure comment.
The large difference between the GAAP and non-GAAP sales growth rates raises a number of questions. The earnings release notes that the GAAP sales growth is primarily due to the impact of an acquisition. The question that naturally arises is, “what would have happened to sales without the acquisition?”
Below is the rationale for the company’s presentation of “core sales growth.” In its non-GAAP measure disclosures Newell Brands says:
“The company’s management believes that core sales provides a more complete understanding of underlying sales trends by providing sales on a consistent basis as it excludes the impacts of acquisitions (other than the Jarden acquisition, which is included in core sales on a pro forma basis starting in the second quarter of 2016), planned or completed divestitures, the deconsolidation of the company’s Venezuelan operations and changes in foreign currency from year-over-year comparisons.”
This presents a reasonable rationale for the presentation of the non-GAAP measure, and, in fact, the non-GAAP measure presents a reasonably positive picture.
This seemed true until September 29, 2023, when the SEC released an Accounting and Auditing Enforcement Release describing how Newell and its former CEO engaged in a classic revenue manipulation scheme – channel stuffing or “pull-forwards” – designed to inflate this non-GAAP measure. According to the AAER:
“During the last month of each quarter in the Relevant Period, Newell employees determined that its sales were inadequate to achieve management goals, including internal targets, guidance to investors, or analyst estimates. As part of an effort to achieve those goals, Polk (the former CEO) was made aware of and approved plans to pull forward sales scheduled for subsequent quarters. To do so, Newell employees identified orders scheduled for delivery early the following quarter and obtained customer permission to deliver those orders in the current quarter. Newell employees then informed Polk of the volume of orders that had been pulled forward.”
Many companies have used this strategy to try and maintain a sales growth rate. As we discussed in this post about Under Armour (where you can find links to a number of similar cases), this is not an unusual kind of fraud. In this case, however, it is interesting that the strategy was used specifically to manipulate the non-GAAP measure for “core sales growth.”
The company and the former CEO both entered into cease and desist orders and paid fines of $12,500,000 and $110,000, respectively.
As always, your thoughts and comments are welcome!