Are There Cockroaches Under Tesla’s Hood?
Tesla Motors Inc. shareholders have had much to fret about lately, from a nosebleed valuation and sagging stock price to periodic YouTube videos of exploding Tesla electric cars. Here’s another one for the list: Sometimes Tesla acts like it doesn’t know what it’s doing when it comes to financial reporting.
Consider Tesla’s news release last week disclosing its third-quarter financial results. The headline said Tesla had “Net income (non-GAAP) of $16 million.” Tesla spent parts of the first three pages discussing this and other nonstandard metrics that don’t comply with generally accepted accounting principles.
It wasn’t until the bottom of the third page that Tesla began citing its GAAP quarterly results. Tesla waited until page four to mention that it had a third-quarter net loss of $38 million under GAAP. It didn’t show a table reconciling its GAAP and non-GAAP numbers until several pages later.
That practice of accentuating the positive and downplaying the negative seems to fly in the face of Securities and Exchange Commission rules that say companies must give “equal or greater prominence” to GAAP numbers when they present their financial results. The SEC passed those rules a decade ago in response to widespread abuses of non-GAAP measurements. The regulations apply to companies’ regular SEC filings, as well as earnings releases that companies furnish to the SEC as exhibits.
“We comply fully with all legal obligations regarding each earnings release and 10Q,” Tesla spokeswoman Elizabeth Jarvis-Shean said in an e-mail. When I asked her to explain how the presentation in last week’s release complied with the SEC’s rules, she declined.
To make sure I wasn’t missing something, I asked Dan Mahoney, who heads the accounting-research firm CFRA in New York, to review Tesla’s release. He reached the same conclusion I did. “Page three is less prominent than page one,” as he put it. “The number-one thing is that the headlines have the non-GAAP numbers and not the GAAP numbers.”
Most companies that play the non-GAAP game goose their numbers by excluding expenses. Tesla does this, too. It backs out stock-based compensation, for example. But the biggest kick to its non-GAAP earnings comes from an increase in top-line revenue.
The company reported third-quarter non-GAAP revenue of $602.6 million, which was about 40 percent more than its GAAP revenue. It achieved such a boost by transforming $171.2 million of liabilities into sales.
Here’s how it worked. In April, Tesla started a new financing program under which customers have the option to sell their vehicles back to the company after three years for guaranteed minimum amounts. The accounting rules say Tesla can’t recognize all of the revenue immediately in those instances and must account for such transactions as leases. So after Tesla takes customers’ cash, it records liabilities for “deferred revenue” and “resale value guarantee” on its balance sheet.
Mahoney noted two main problems with including so much of those amounts in non-GAAP revenue. Some customers wouldn’t have chosen Tesla cars were it not for the financing program. So the non-GAAP revenue isn’t comparable to Tesla’s sales before the program began, and it may overstate the true growth and demand. Plus, by adding back the resale-value guarantee, the company “assumes that nobody is going to return the vehicle, for purposes of the non-GAAP revenue,” he said.
Lots of companies use gimmicky benchmarks in their earnings releases. What makes Tesla special is that it behaves as if it doesn’t know the proper way to present its non-GAAP numbers. In an ironic twist, two attorneys at Wilson Sonsini Goodrich & Rosati, which helped take Tesla public in 2010, penned a lengthy article in 2008 explaining the legal requirements and best practices for earnings releases; it’s still on the law firm’s website.
“GAAP comparison numbers in an earnings release must be set forth with equal or greater prominence to the non-GAAP numbers,” attorneys Steven Bochner and Richard Cameron Blake wrote. “For instance, if an issuer announces GAAP and non-GAAP earnings per share in its press release, it should report the GAAP earnings per share prior to the non-GAAP earnings per share.”
The bigger concern here should be what some investors call the “cockroach theory": Where there is one problem, there probably are more. Tesla has disclosed compliance failures before. In March, its management concluded that Tesla’s ‘‘internal control over financial reporting was ineffective as of Dec. 31, 2012.’’ Its auditor, PricewaterhouseCoopers LLP, concurred. In a related matter, Tesla had to restate its cash-flow numbers for much of 2011 and 2012. In its latest quarterly report, filed last week, Tesla said its controls still weren’t effective as of Sept. 30.
None of these flubs has been especially damaging. Yet taken together, they suggest a company that lacks basic skills in accounting and disclosure, which could be a serious problem for a young manufacturer with a $17 billion stock-market value that loses money and trades for 9.5 times its revenue for the past four quarters. The next time Tesla messes up because of poor controls, the consequences could be worse.
As Tesla said in its latest annual report: ‘‘If we are unable to assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal controls, we could lose investor confidence in the accuracy and completeness of our financial reports, which would have a material adverse effect on the price of our common stock.’’
At least they warned you.
(Jonathan Weil is a Bloomberg View columnist.)
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