SolarWinds Corporation, a provider of IT infrastructure management software products, completed its IPO in the fall of 2018.  In its IPO registration statement and periodic reporting, the company disclosed lengthy cybersecurity risk factors.  For example, in its December 31, 2019 Form 10-K, the company included this risk factor:

If we sustain system failures, cyberattacks against our systems or against our products, or other data security incidents or breaches, we could suffer a loss of revenue and increased costs, exposure to significant liability, reputational harm and other serious negative consequences.

We are heavily dependent on our technology infrastructure to sell our products and operate our business, and our customers rely on our technology to help manage their own IT infrastructure. Our systems and those of our third-party service providers are vulnerable to damage or interruption from natural disasters, fire, power loss, telecommunication failures, traditional computer “hackers,” malicious code (such as viruses and worms), employee or contractor theft or misuse, and denial-of-service attacks, as well as sophisticated nation-state and nation-state-supported actors (including advanced persistent threat intrusions). The risk of a security breach or disruption, particularly through cyberattacks or cyber intrusion, including by computer hacks, foreign governments, and cyber terrorists, has generally increased the number, intensity and sophistication of attempted attacks, and intrusions from around the world have increased. In addition, sophisticated hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of our systems.

Because the techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not identified until they are launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. We may also experience security breaches that may remain undetected for an extended period and, therefore, have a greater impact on the products we offer, the proprietary data contained therein, and ultimately on our business.

The foregoing security problems could result in, among other consequences, damage to our own systems or our customers’ IT infrastructure or the loss or theft of our or our customers’ proprietary or other sensitive information.

(Note:  Balance of the risk factor is omitted.)

This risk factor provides a general discussion of cybersecurity risk.  It does not address the nature and extent of actual cybersecurity risks facing the company, any specific steps the company is taking to address cybersecurity risk, or the strengths and weaknesses of the company’s cybersecurity defenses.

After the company experienced a major cybersecurity breach, these issues were at the center of the SEC’s charges against the company and, interestingly, the company’s Chief Information Security Officer (“CISO”).  According to the SEC’s Press Release and the related Complaint, the company was aware that its defenses against cybersecurity attacks were weak and that the company was extremely vulnerable to cyberattack.

The Press Release states:

“SolarWinds’ public statements about its cybersecurity practices and risks were at odds with its internal assessments, including a 2018 presentation prepared by a company engineer and shared internally, including with Brown (The CISO), that SolarWinds’ remote access set-up was ‘not very secure’ and that someone exploiting the vulnerability ‘can basically do whatever without us detecting it until it’s too late,’ which could lead to ‘major reputation and financial loss’ for SolarWinds.”

Similarly, as described in the Press Release and Complaint, in 2018 and 2019 the CISO made presentations that stated the “current state of security leaves us in a very vulnerable state for our critical assets” and that “[a]ccess and privilege to critical systems/data is inappropriate.”

SolarWinds’ public statements about its cybersecurity practices and risks were very different from its internal discussions and documentation.  As companies implement the SEC’s new cybersecurity disclosures, there are clear lessons in this case.

The Press Release and Complaint provide more details and discussion.

As always, your thoughts and comments are welcome!

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!