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Relax, Investors; There is No ‘EBITDAC’ Pandemic

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

By Soyoung Ho

Is “EBITDAC”—short for earnings before interest, taxes, depreciation, amortization, and coronavirus—a thing that investors now have to worry about? Merchants are even selling coffee mugs that prominently say EBITDAC in the age of COVID-19.

Rest assured, experts say, because EBITDAC will not become a trend in the United States.

“There are more coffee mugs than there are such reconciliations,” David Gonzales, Vice President and Senior Accounting Analyst at Moody’s Investors Service, Inc., said during an interview on May 28, 2020. “This is the most attention that I got on something that I don’t ever expect to see in the United States,” adding that Moody’s has not found real life cases.

Ryan Wilkins, chair of corporate and securities law practice group at Stradling Yocca Carlson & Rauth, P.C., agreed.

“I am aware of a couple of companies in Europe that have used it. There have also been some criticisms I believe in Europe and Australia regarding this use of the metric,” Wilkins said. “It’s not become prominent, although I certainly understand why companies would be interested in using something like that.”

The EBITDAC phenomenon, or more accurately lack of, seems to have started with a German applied measuring technology company Schenck Process LLC when it reportedly added back 5.4 million euros to its earnings, the amount it would have made had there not been the pandemic.

In order to contain the spread of the novel coronavirus, countries around the world have imposed some sort of lockdowns, leading to abrupt disruptions to businesses. As a result, many companies have been and are expected to show financial losses in their books.

In general, companies say that non-GAAP measures provide a better representation of how they manage their business than some official U.S. GAAP figures do, and many investors also find that it is useful to get management’s perspective on the company’s operations. However, the use of adjusted earnings has been increasing in the past several years because non-GAAP financial metrics tend to show higher figures than comparable GAAP numbers that are audited. This would in turn boost the company’s stock prices.

Among non-GAAP metrics, companies have in particular touted EBITDA as true indicators during earnings calls, saying net income is meaningless for understanding their companies’ performance. But for a number of years, companies have been customizing EBITDA and have been including fewer costs in their unaudited income statements and making it difficult for analysts to do a fair comparison and understand the items taken out. And if a company uses EBITDAC to include speculative earnings, it will be taking the non-GAAP metric to the next level of sketchiness.

“The core reason for using Non-GAAP financial measure is to present the earnings of the company in a way that is adjusted for an unusual or non-occurring item. And so, if a company believes that they could quantify the impact of COVID, then you could see why they would want to show what it would have been,” Wilkins said. “I think the problem with using this metric is it’s very difficult to understand what the impact of COVID is on the business. It’s not like a typical non-GAAP adjustment… [that is] easily quantified. It’s very difficult to quantify the impact of COVID-19 because for many companies, COVID is impacting the business in a multiple way. So, it’s not a matter of just identifying one impact and trying to quantify it.”

For example, COVID-19 might have impacted lost sales because of reduced customer traffic. Companies may have also experienced disruptions on supply chain or have had more expenses to try to protect their workers.

“So, there are many different ways in which its impact on the business, and it’s hard to assess the overall impact and then make that adjustment,” Wilkins explained. “And the problem is if you can’t actually quantify the impact, then … EBITDAC is potentially misleading because now you have a number that is for an estimate or projection of what that impact may be.”

Analysts Criticize EBITDAC

Moreover, there will be a strong pushback if an American company tries to use EBITDAC.

“Nothing good can come of this,” said Jack Ciesielski, an investment manager who previously wrote The Analyst’s Accounting Observer, when he came upon a news report about EBITDAC. “Let’s hope EBITDAC is not contagious to other countries, like our own.”

Ciesielski, who has done extensive analysis of non-GAAP earnings, was already not a fan of adjusted measures.

“I weighed five pounds less before the coronavirus lockdown than I do now,” Ciesielski explained. “When I get my annual physical, should I report my weight to my doctor as five pounds less? He wouldn’t believe me; he’d put me on the scale and check it and take the weight down as reported.”

A member of the SEC’s Investor Advisory Committee was concerned, also perhaps seeing news reports out of Europe.

“The idea that companies are now using EBITDAC…, reporting earnings as if virus were not happening as a way to try to disclose normalized returns,” said advisory panel member John Coates, a professor at Harvard Law School, during a meeting of the committee on May 21. “I think that actually can be very helpful but obviously raises risks of confusion in the marketplace.”

Inherent Problems with Non-GAAP Metrics

In the meantime, Moody’s analyst Gonzales had a slightly different take about the issue because non-GAAP measures are by their nature highly customizable.

“It’s just tricky because what is it?” Gonzales said. “The problem of non-GAAP is that non-GAAP is not defined. And EBITDAC is whatever you think it is.”

In addition, if a company provides EBITDA reconciliation to U.S. GAAP, and the company removed an impairment charge because of the novel coronavirus, he asked whether is that EBITDAC or just an EBITDA reconciliation.

Gonzales said that Moody’s would not even consider looking at estimated lost revenue or estimated cost savings, for example, that are attributable to the coronavirus in the first place as it would never put any estimated number in an EBITDA reconciliation.

“But technically, all EBITDA reconciliations that are produced in the next five or six months, even longer, are going to be EBITDAC because they are going to remove some from coronavirus whether that’s just an impairment, or that’s an expense, or it’s specially related to coronavirus, or it could be tangentially related to coronavirus. But overall, from an investor and user perspective, there is no use in any metric that uses estimation to provide operation performance.”

Non-GAAP Measures Can Still Be Useful

Nonetheless, Gonzales believes that whether a company uses EBITDA or whichever non-GAAP metric, it is helpful because it adds another piece of information used in analyzing companies.

“A non-GAAP always highlights what is good and bad about financial reporting,” he said. “You could have companies removing core operating costs that are actually part of their business, but they are pretending that they are not. Or you can have companies removing one-time costs that are just one time and they are trying to provide a clear operational metric and so you can’t really generalize. We expect the same thing to happen during coronavirus. Some companies will remove more coronavirus related charges than other companies.”

Regulators Would Not Allow Dubious Adjustments Anyway

The SEC has regulations that govern the use of non-GAAP. And the staff in late March warned companies not to use adjusted metrics just to inflate their numbers during a pandemic.

Moreover, Matthew Jacques, chief accountant of the SEC’s Division of Enforcement, warned companies not to take advantage of COVID-19 and present misleading numbers.

“We expect companies will be using more non-GAAP metrics during this time to compensate for some of the weaknesses potentially how they are doing their financial reporting overall,” Jacques said during a May 12 forum. “GAAP is always the foundation; we much prefer if they reconcile back to that. But we are going to be on the lookout for people abusing those non-GAAP metrics representing in a way that is not transparent to investors.”

 

This article originally appeared in the June 03, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.

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