Crossposts: Two from Deep Quarry
Olga Usvyatsky has been on a tear, with two new posts, about long SEC comment reviews and what's in all those amended 10-Ks. I've got some additional comments for you on both.
Companies frequently file revised annual 10-K reports to make all kinds of changes and corrections. Every so often those amended reports deliver very bad news when, maybe, the company thinks no one is watching.
For example, I wrote about a whopper in The Dig.
One really interesting one Olga Usvyatsky mentions touches on a subject I have written a lot about: non-GAAP adjustments of revenue.
Notably, in December 2023, SEC’s Chief Accountant Paul Munter warned companies that the errors in the presentation of the cash flow statement could be material:
“In certain instances, the staff in OCA have been presented with analyses that conclude an error in the statement of cash flows is not material because it is an error in classification only. We have not found such analyses and their corresponding arguments persuasive since classification itself is the foundation of the statement of cash flows.”
In addition to cash flow inquiries, the SEC also raised concerns about how certain non-GAAP metrics are calculated. Specifically, the SEC noted that non-GAAP metrics that add back the change in deferred revenue liability create tailored accounting measures that are prohibited by Regulation G. The Company agreed to refrain from including the change in deferred revenue liability in calculating any non-GAAP financial measures in future filings.
At first glance I thought this one, referring to Equity Lifestyle Properties, Inc., might be about my favorite topic, ghost revenue.
But, instead, it is something more basic — a plain vanilla attempt to recognize all the revenue up front. But it’s a great example of how incorrigible companies can be and how the SEC will persist if they know they are right.
There is a lot more I can say about the SEC comments to Equity Lifestyle Properties, Inc., and how the company handled it, but, for starters:
1) The company presented cash flow errors as a reclassification, then changed it to “little r” restatement after the SEC commented, and then to a “Big R” restatement after the SEC continued to press them.
2) The company is trying to use “individually tailored” revenue metrics. That’s a big no-no. Note they insisted that they are going to present it until the end of the year and keep presenting one misleading metric despite SEC's ongoing objections.
3) The company had several off-the-record conversations with the SEC. How do we know that? Here’s the key phrase: "including the Staff’s dialogue with representatives of the Company on various occasions".
4) The EY audit partner and its law firm are copied on the company’;s correspondence. It is not a good sign when the company feels the need to point out to the audit partner that potentially their on-stop-shop “advice” is now being disputed by the SEC. (I will have to see what happens to EY’s “Audit-related” fees for this back and forth. They make money off you coming or going!)
5) The conversations are extremely long.
6) There are ongoing requests for extension of time to respond.
This correspondence between the SEC and Equity Lifestyle Properties Inc is not exactly a “long” comment letter process, as Olga described in her newsletter from a week ago. The company would not have been flagged because they resolved the SEC’s comments prior to filing their 10-K. What are “unresolved” comments and why are they important?
Instead, Olga is talking in her long SEC reviews newsletter about companies like Medical Properties Trust, a company that a lot of traders and short-sellers are interested in. Investors are likely to see less substantial comments that are resolved and released sooner, while information in longer (unresolved) conversations is unavailable until the review is complete.
MEDICAL PROPERTIES TRUST INC (Ticker: MPW) disclosed on February 29, 2024, that the SEC requested that the Company amend its annual 10-K report for the fiscal year ending December 31, 2022, to include audited financial statements of the Company’s investee Steward Health Care System LLC (“Steward”).
The SEC stated in a comment letter that the financial statements of Steward are required to understand the Company’s results of operations because the Company has “…significant assets concentration with Steward”. The Company agreed to file the requested audited financial statements but noted the difficulty in complying, citing the Company’s lack of control and liquidity issues at Steward.
Based on the Company’s 10-K filing, Medical Properties Trust has a 9.9% equity interest in Steward, accounted at cost less any impairments.
Operating and liquidity challenges at Steward prompted Medical Properties to record $700 million in charges - including reserving for all unpaid rent and receivables due from Steward - and move Steward to the cash basis of accounting for revenue effective December 31, 2023.
In addition to the request to file Steward’s audited financial statements, the SEC also asked questions about the presentation of non-GAAP Total Adjusted Gross Assets and AFFO metrics and requested clarity about loans to Steward. The conversation, which included ten back-and-forth letters issued over 241 days, was publicly released on EDGAR on March 28, 2024.
Olga mentioned the Medical Properties Trust situation in her amended 10-K newsletter, because it was having trouble getting the information from its equity investee, and the SEC told it to amend its 10-K as a result. It also had additional questions for the company.
Financial statements of an equity investee. In the March 31, 2024 quarter, 11 companies filed amended 10-K filings to add audited financial statements of significant investees pursuant to Rule 3-09 of Regulation S-X. An amended 10-K filed solely to provide the investee’s financial statement is generally not a red flag because sometimes the investee's financials are not available at the time of the investor’s 10-K filing. However, substantial delays in providing the investee’s financials could be a red flag if the delay is related to the investee's operational or liquidity issues (see an example of Medical Properties Trust’s investee Steward Health Care System LLC).
I highly recommend Olga’s newsletter Deep Quarry!
Enjoy!
© Francine McKenna, The Digging Company LLC, 2024