The COVID-19 outbreak has brought out some creative accounting at companies, as executives attempt to gauge the impact of the pandemic on their businesses and how they would have performed if the crisis hadn’t all but shut the economy down.
Before companies began reporting first-quarter earnings, Twitter users joked that the outbreak would prompt new non-standard metrics that could be summarized as “earnings before COVID-19,” or EBITDAC, and they even created a series of coffee mugs that satirized the concept. Indeed, some companies chose to post earnings metrics that removed the pandemic’s impact.
“People will get creative telling their story and our message is to be cautious of the creativity,” said Sandy Peters, the head of global financial reporting policy at the CFA Institute in New York.
Uber Technologies Inc., for example, has always reported a range of non-GAAP measures, or those that do not comply with Generally Accepted Accounting Principles (GAAP), the U.S. accounting standard. Companies are allowed to supplement reporting with non-GAAP metrics, which they argue help provide insight into their underlying business, but they must lead with GAAP and offer a reconciliation of the two.
Uber’s non-standard metrics include adjusted net revenue, which the company says is needed because its drivers are its customers, and not ride-hailing passengers. When the company filed its initial IPO documents in late 2018, the SEC took issue with some of the non-GAAP metrics in a series of comment letters.
The company also reports adjusted Ebitda, or earnings before interest, taxes, depreciation and amortization, which is already an adjusted number. The SEC allows that metric to be used, but because it’s not standard, different companies adjust it in different ways, which can also confuse investors.
“People will get creative telling their story and our message is to be cautious of the creativity.”
— Sandy Peters, head, global financial reporting policy, CFA Institute
In the March quarter, Uber made further adjustments to both those metrics as the COVID-19 outbreak hammered its ride-hailing business. The company increased its adjusted net revenue by $19 million to add back “payments for financial assistance to drivers personally impacted by COVID-19.”
It increased adjusted Ebitda by $24 million to remove those relief payments to drivers along with the costs of personal protective equipment given to drivers.
Uber did not respond to a request for comment. In its earnings report, it said that the exclusion of these metrics from the adjusted numbers was “useful” because it lets investors “assess the impact of these response initiatives on our results of operations.”
There are questions, however, about the validity of adjusting away business activities related to a global health crisis when it’s unclear how long the pandemic will crimp Uber’s business.
Then there’s networking company Infinera Corp., which added back $2.88 million of coronavirus-related expenses in its adjusted numbers and provided a reconciliation that showed margin calculations.
“They’re probably one of the better ones because you can see it and it reconciles,” Peters said. But the company could have done a better job by discussing the impacts higher up in its release, rather than detailing them in a footnote to its tables, she argued.
Infinera did not respond to MarketWatch’s request for comment.
Overall, only a small fraction of companies tracked by law firm Bass, Berry & Sims adjusted their adjusted Ebitda numbers for COVID-19 impacts based on a review of 55 reports filed between April 1 and May 14. Other companies did not actually adjust their formal numbers but gave a description of the effects.
“That seems to me to be a better way to present this information than adjusting it away,” wrote John Jenkins on TheCorporateCounsel.net blog. Formal adjustments that back out the pandemic’s effects are like asking, “Other than that, Mrs. Lincoln, how did you enjoy the play?’” he said.
“Covid-19’s impact on key performance indicators is clearly relevant information, but including it in the Adjusted EBITDA metric itself implies that it should be regarded as a one-time event,” he said. “Unfortunately, it appears that the pandemic is more like the ‘new normal,’ and may impact operations in future periods even more significantly than it did during the first quarter.”
When AT&T Inc.posted first-quarter results in late April, it disclosed in the second line of its release that it saw adjusted earnings “of $0.84 ($0.89 without COVID-19 impact).” Later in its release, AT&T said it “did not adjust for COVID-19 costs of about $0.05 in the quarter” since the company expected the costs to be “short term.”
The company did not break down the drivers of that earnings impact in its release, but provided some more detail in a supplemental investor-briefing file. That file cited incremental bad debt expenses, March Madness production shutdown costs, and payments to front-line workers, as well as their impacts on reported Ebitda, amounting to about $430 million, or 5 cents a share.
AT&T’s investor-briefing file also provided an estimate of the pandemic’s effect on its revenues and corresponding Ebitda impacts from the loss of advertising, wireless service, and wireless equipment revenues.
“We did not adjust earnings for the COVID impact,” an AT&T spokeswoman said. “But in the interest of transparency, we wanted shareholders to understand the scale of the impact.”
Peters would have liked to see a more thorough breakdown of how the company got from its estimated COVID-19 revenue impacts to their associated effects on adjusted earnings, including by showing the impact on GAAP expenses.
Peer Verizon Communications Inc. took a different route, disclosing that the pandemic had a 4-cent negative impact on both reported and adjusted earnings per share, mainly related to an increase in the company’s bad debt reserve.
In another example, Boston Beer Co. was fine to discuss an estimated $10 million revenue reduction from COVID-19 in its April 22 report if the company could “truly isolate” the pandemic’s impact, Peters said. But once the company recomputed its margin to exclude those impacts, she wanted the company to show a formal breakdown of how it reached that adjusted number.
A Boston Beer spokeswoman said that “reconciliation could be recalculated” based on details provided in the release.
Aside from monitoring new adjusted metrics, investors should also look at whether companies are piling too many negative charges into the pandemic-affected quarters in order to make their reported results look even better once the crisis is over, said Gilles Hilary, an accounting professor at Georgetown’s McDonough School of Business.
“Firms will insist some of the costs will be non-recurring, and to some extent that’s true, but they’re probably going to dump all kinds of costs in this period that would have otherwise affected the firm in the future,” he told MarketWatch.
Hilary gave the example of a company that may have made a smart acquisition in the past and recorded goodwill. At some point though, that acquisition benefit will dissipate, and the company will have to write off the goodwill.
“Suppose that’s supposed to happen 10 years from now, but you could take that off right now, blame COVID, and no one’s paying that much attention because everyone’s suffering,” he said.
He recommends that investors look over the non-financial fundamentals that companies provide in order to better gauge whether businesses are massaging their accounting.
Accounting issues could further come into play when companies issue their executive-compensation requirements later this year, said Robert Pozen, a senior lecturer at MIT’s Sloan School of Management. Many businesses determine compensation based on metrics like total shareholder return, but companies will argue that the usual metrics aren’t optimal given that the pandemic was outside their control.
“I think there are going to be a lot of new measures,” he said. Businesses may try to get creative, focusing on measurements of a company’s ability to conserve cash, for instance, or how a company’s market value holds up relative to others.
Adjusted earnings typically are a big factor in compensation packages, but unlike earnings reports, compensation-committee reports don’t have to reconcile their numbers.
Revisions to companies’ compensation standards are “perfectly reasonable in theory but in practice depends on what the metrics are and how well they explain it,” Pozen said. “That’s why a reconciliation requirement would be really helpful for investors,” who vote on these proposals.
For many companies, COVID-19 only began to manifest in financial results during the March quarter, though the impact will continue for months to come, requiring that investors be conscious of the accounting behind COVID-related financial disclosures in corporate communications.
This article originally appeared on MarketWatch.
