The top five infamous Non-GAAP reporting measures
Reporting poor figures is tough. GAAP requirements are strict about how accounts are presented, leaving little room to present a more flattering story.
So, how do you make a loss-making business sound good on an investor call? What happens if your startup’s burning cash and you want to present the future as you see it?
You could come up with a creative reporting measure. It’s a process that’s probably as old as accounting itself. We took a look at some of the more infamous examples.
1. Community adjusted EBITDA
We want to start with the gem that led us to write this article. Community adjusted EBITDA is WeWork’s attempt to remove non-recurring costs from its profit numbers. A recent bond document shows a net loss of $933m in 2017, yet its community adjusted EBITDA is $233m.
Essentially, WeWork’s stripping out growth-related investment to give a representation of its ongoing profitability. What are those costs? Employee's cash compensation, advertising and expenses related to new locations.
If this account of operational expenses seems dubious, it’s worth looking at the model too. WeWork leases office space, divides it up and rents it, unlike its traditional competitors which buy buildings and rent the space. This is a precarious way to carve out a margin, even if you do offer craft beer.
Office rental company IWG, which was called Regus, reported a group EBITDA of £388m and listed £1.2bn of property assets on its balance sheet last year. Its market capitalisation is £2.82bn. In spite of the above issues, WeWork’s valuation was a jaw-dropping $20bn in its last funding round.
The market did not respond well to the bond offering.
2. Groupon plans for a future of sales without marketing
Coupon company Groupon included Adjusted Consolidated Segment Operating Income (CSOI) as one of its three key metrics in its 2011 Nasdaq listing, headlining the section “we don't measure ourselves in conventional ways”. It certainly was unusual.
“We believe Adjusted CSOI is an important measure of the performance of our business as it excludes expenses that are non-cash or otherwise not indicative of future operating expenses. In 2010 and the first quarter of 2011, we generated Adjusted CSOI of $60.6 million and $81.6 million,” the filing said.
Curiously, the company made a $420m loss in 2010. What were those pesky operating expenses that wouldn’t be relevant in the future? They include $36m in stock-based compensation, $203m acquisition-related costs and a whopping $242m in marketing spend.
3. Enron’s future gazing
Scandal-hit Enron has the dubious honour of featuring in presentations about company culture because it listed “integrity” as one of its core values.
Accounting issues included the way it used mark-to-market techniques. The company calculated the full value of sometimes decade-long energy deals using forecasted energy prices and the risk of default. The result was booked as a profit in the current year, rather than realising the income when the cash came into the business.
Its 2000 annual report explained the accounting practice but it’s impossible to unpick different divisions’ regular revenue from the mark-to-market calculations they were wrapped up with. The scandal erupted the next year and reduced the once-darling company to a penny stock before it was placed in one of the largest Chapter 11 bankruptcies on record.
4. The man who’s bond fell to earth
The Bowie Bond was perhaps the first instance of intellectual property rights securitisation. Okay, it’s neither an outrageous and ridiculous reporting method, but it is a fascinating financial product.
Bowie securitised the right to future royalties rather than selling the masters of the songs in the late 90s, according to a brilliant account by The Financial Times. This meant he was able to retain control of the music, while selling $55m of Bowie Bonds at 7.9% interest.
At the same time, his early 00s prophecy that IP would “take a bashing” and “music itself is going to become like running water or electricity” turned out to be relatively accurate. Illegal downloads and music streaming services devastated the industry over the next decade. Alas, the Bowie bonds were downgraded to junk status in mid-2003.
5. LinkedIn turned a $180m loss into a $1.4bn profit
LinkedIn reported a net loss of $180m in 2015 and 2016. However, its “adjusted EBITDA” wheeze allowed management to talk about a $1.4bn profit over that period, with a 26% margin in 2016.
LinkedIn’s adjusted EBITDA is net income plus provision for income taxes and other expenses, and net depreciation, amortization and stock-based compensation (see below).
“We include adjusted EBITDA because it is a key measure used by our management and board of directors to understand and evaluate our core operating performance,” explained its 2016 annual report. “Additionally, adjusted EBITDA is a key financial measure used by the compensation committee of our board of directors in connection with the payment of bonuses to our executive officers and employees.”
Non-GAAP reporting can be useful. Adjusted EBITDA, for example, is a routine way to eliminate one-off costs or standardise cashflows.
Problems happen when non-GAAP measures are misused or overused. It can obscure the financial health of a company, lead to over compensation of the executive team and make it difficult for like-for-like comparisons with other businesses.