Twitter Puts Spotlight on How Firms Burnish Results

Twitter Puts Spotlight on How Firms Burnish Results

MICHAEL RAPOPORT

Nov. 9, 2013 7:06 p.m. ET

Twitter Inc. TWTR -7.24% lost money in the first nine months of the year. But when the company used a different set of measurements, it posted a profit. The strong interest in Twitter’s initial public offering brought back to the fore the accounting methods that companies can use to burnish otherwise lackluster results. Twitter has recorded a loss of more than $130 million this year using traditional accounting measures. But after stripping out several costs, Twitter posted a nine-month profit of almost $31 million.So which is it? Investors sent Twitter’s stock price up 73% in its first day of trading, suggesting they were willing to overlook the losses for now. Twitter declined to comment on its use of nonstandard measurements.

The risk is that investors lose sight of the true bottom line. The costs that some companies strip out are real, critics say, and if a company ultimately can’t post a genuine profit, investors could get a nasty surprise when that becomes apparent and the stock tumbles.

“You always worry, ‘Are they providing a misleading picture of their profitability,’ ” said David Larcker, a Stanford University accounting professor. “I think investors should be right to question and push back on those metrics.…I guess my view would be a little ‘buyer beware.’ ”

The San Francisco company hasn’t run afoul of any rules. Regulators allow companies to use nontraditional accounting measures as long as the companies also report results using the standard measures and make the proper disclosures.

Twitter was the latest in a long line of technology companies that have steered investors toward the companies’ preferred numbers. Many technology companies used exotic earnings measurements that stripped out all manner of expenses during the 1990s tech-stock boom—a practice derided by critics as “earnings before the bad stuff.”

After the 2000 crash and the accounting scandals of the next few years, the Securities and Exchange Commission stepped in and required companies to disclose more about their nonstandard measurements.

But use of such alternative measurements never went away. Today, it is common for tech companies to exclude large stock payments to employees from preferred measurements. Some also remove other costs, such as restructuring or acquisition expenses. Some companies even tout nonfinancial measurements, such as an increase in the user base. The SEC is watching that practice.

“Our staff’s concern has been the impact on investors of the sheer magnitude of some of these metrics,” SEC Chairman Mary Jo White said in a speech Wednesday. For investors “it can be hard not to think that these big numbers will inevitably translate into big profits for the company. But the connection may not necessarily be there.” She didn’t name any companies.

In a version of its IPO roadshow presentation posted online, Twitter executives talked about profitability using its preferred numbers, instead of the numbers based on generally accepted accounting principles.

Only a series of slides flashing by in the last minute of the presentation showed the loss under GAAP. The company’s prospectus said its nonstandard measurements “assist investors in seeing our operating results through the eyes of management.”

Twitter’s profit figure left out $79.2 million in stock payments made to employees. The company acknowledged in its prospectus that such payments are a “significant recurring expense.”

“Are you going to say the companies have managers who’ll work for nothing? That’s the implicit statement you make when you remove those costs,” said Jack Ciesielski of the Analyst’s Accounting Observer, an accounting-research newsletter.

Twitter isn’t the only technology company that has excluded stock payments from a preferred profit measure. Online-reviews service Yelp Inc. YELP +2.51% posted a loss of $8 million in the first nine months of this year, but its adjusted number was a $19 million profit. Yelp declined to comment.

Real-estate website Zillow Inc. Z +3.37% recorded a nine-month loss of $15.2 million, but its adjusted figure showed a profit of $14.5 million. A Zillow spokeswoman said the company believes “both GAAP and non-GAAP measures are useful to investors.”

Some companies, such as online coupon provider Groupon Inc., GRPN +6.43% have faced regulatory scrutiny for using nonstandard measurements. Before its 2011 IPO, Groupon scaled back its use of adjusted consolidated segment operating income, which excluded its marketing costs to land new subscribers, after the SEC raised questions. Groupon declined to comment.

Companies in other industries also sometimes use two sets of numbers. It is especially common among health-care companies, which sometimes strip out the costs of acquisitions, Mr. Ciesielski said.

But the practice is standard in the tech sector. A recent study by Mr. Ciesielski found that 56 of the 69 tech companies in the S&P 500 index used non-GAAP measurements in 2011 and 2012. The group’s 2012 non-GAAP earnings were $40.7 billion higher than its GAAP results, following a $25.6 billion difference in 2011.

Even critics concede that nonstandard measurements can be useful when companies have substantial nonrecurring costs that skew results, or costs that genuinely don’t represent the true health of the businesses.

“The concern is always how these numbers are derived,” said Sandra Peters, head of the financial-reporting policy group for the CFA Institute, which represents chartered financial analysts.