In our recent package of stories, "The Numbers Game," we examined the ways companies guide investors to their preferred, more typically positive measure of earnings, dissuading us from diving deep into an income statement compiled according to generally accepted accounting principles, or GAAP.
But what if the company doesn't provide a traditional income statement at all? I'm talking about a set of numbers that takes you from revenue at the top, through the cost of goods sold and the expenses of selling, all the way to net income. Surely such an omission is not allowed?
And yet, it very well may be, if we take the disclosures of cheese company Saputo Inc. as our guide. The company, which is set to release earnings next week, likes to emphasize EBITDA, or earnings before interest, taxes, depreciation and amortization, as well as "Adjusted EBITDA," which cuts out even more expenses. That doesn't make Saputo unusual, as far as the S&P/TSX 60 goes: Our recent stories, based on a report from Veritas Investment Research, found that all but one of the companies in the 60 used some sort of metric that didn't conform with GAAP or International Financial Reporting Standards (IFRS).
What makes Saputo stand out is the difficulty in finding the details in the traditional income statement I described above. In its quarterly and annual reports, Saputo presents revenues, then lumps its sales costs into an item called "operating costs excluding depreciation, amortization, gain on disposal of a business, acquisition and restructuring costs." By doing this, it skips directly to a version of adjusted EBITDA, before proceeding down the income statement to "net earnings."
The company's earnings releases have less detail, skipping directly from revenues to EBITDA with nary a cost between in the results table on the first page.
The practical impact of this choice is that it's difficult again for investors to track trends in the company's biggest costs, as well calculate the company's gross profit margin. For evidence, I cite S&P Global Market Intelligence, a database used by many professional investors because the S&P staff is so good at digging the proper numbers out of securities filings. S&P had no gross margin information on the company this summer – until I told them what the company told me: Don't look at our statement of earnings, please look down in the footnotes for the details. S&P then added the margin data once I passed along the key to finding the answer. "Yes we are IFRS compliant," Saputo spokeswoman Sandy Vassiadis told me via e-mail.
And, it may surprise you, she seems to be correct. IFRS say "the following minimum line items must be presented in the profit or loss section" of the financial statements. The list includes revenue, and then six items of varying complexity, including "gains and losses from the derecognition of financial assets measured at amortised cost." The list doesn't include "cost of goods sold" or "selling, general and administrative expenses," items that appear in so many income statements, they may be taken for granted by analysts and investors.
There aren't wild fluctuations in Saputo's results, but the numbers, once divined with help from the S&P database, show that the company's gross profit margin had been on a consistent downward trend, from over 13 per cent in 2010 and 2011 to below 10 per cent by late 2014. It's been rebounding since, to more than 12 per cent in the most recent quarter – good news from S&P's database that's hard to find in Saputo's own disclosures. We should also note that the Saputo investing story has been more about growing earnings via acquisition, and investors have bought in, making it one of the S&P/TSX 60's best-performing stocks.
Saputo's rigid minimalism is its right, one supposes, but it strikes me as part of a larger pattern of underwhelming disclosure. Another example: When Saputo addresses its liquidity in its management discussion and analysis, it says "With regards to balance sheet items as at June 30, 2016, compared to those as at March 31, 2016, the variances are the result of normal operational fluctuations."
I've read a fair number of comment letters written by the staff of the U.S. Securities and Exchange Commission – which, of course, has no oversight of Saputo – and I think I can say they'd follow up with the company and ask for a little bit more discussion and analysis in that discussion and analysis. (The Ontario Securities Commission is believed to write such letters, too, but unlike the SEC, they are not made public.)
Says Saputo's Ms. Vassiadis, asked whether Canadian regulators had given any feedback on the adequacy of this disclosure: "Indeed, the variations are the result of normal operating fluctuations. It is important to specify that balance sheet fluctuations are explained by the cash flow analysis that covers current elements of our balance sheet, as well as long-term elements such as fixed assets, long term debts, etc." Okay, then.
Part of me is wary of even writing this column. In identifying what I think are weaknesses in both IFRS and Canadian regulation of companies' disclosure, I may be offering a road map for other companies to present their finances much less clearly, with key items buried in footnotes, not right up top where investors can find them.
My concern with that, however, is outweighed by a desire to hold Saputo up to the light and ask Canada's accounting standard-setters and regulators this question: Is this optimal, investor-friendly disclosure? Or can Saputo, and we, do better?
David Milstead