Reference no: EM132966595

Question - The CFO, King Bernard, of Blackswan Petfood, a large publicly traded manufacturer of organic gourmet dog and cat food, is getting ready for the quarterly conference call with major investors and financial analysts in two days. The King has been reviewing a draft of the quarterly conference call with major investors and financial analysts in two day. The King has been reviewing a draft of the quarterly financial statements for the fourth quarter ending September 30, 2018, and working with his financial team on how best to present the numbers in the conference call. During the current quarter, the company had two material transactions which to him appear to unfairly distort the financial condition of the company in the GAAP numbers provided by Debbie Doberman, the Senior Manager in charge of financial reporting. The first relates to a loss of $2 million due to a massive tsunami which wiped out their manufacturing facilities in Chihuahua, Mexico. This amount was included in Additional Income/ Expense items. The second item relates to a loss of $1 million from the disposal of their Red Rooster product line of gourmet chicken feed that was discontinued.

The income statements currently reads as follows:

Blackswan Pet Food Income Statement September 30, 2018 (in 000's)

Sales $458,543

Cost of Goods Sold $(257,678)

Gross Profit $200,865

Selling and Administrative $(123,738)

Depreciation and Amortization $(25,324)

Non-Recurring Items $(25,000)

Other Operating income $(13,435)

Operating Income $13,368

Additional Income/ Expense Items $(2,456)

Earnings before Interest and Tax $10,912

Interest Expense $(3,478)

Earnings before Tax $7,434

Income Tax $1,918

Net Income tax before Discontinued Operations $5,516

Discontinued Operations (net of tax) $(7,500)

Net Income (loss) $(1,984)

Earnings (loss) per share (0.20)

Loyal Doge, the newest member of the CFO's financial team (and recent college graduate), suggests that they provide the analysts with a number of GAAP and Non-GAAP metrics. He double majored in accounting and marketing to obtain the required 150 credits to sit for the CPA exam. He said he learned in his strategic marketing class that a lot of companies aren ow using non-GAAP metrics to "better" explain their financial results and provide more useful information to users of the financial reports. He also noted that the recent change to GAAP which eliminated the concept of Extraordinary Items was just bad accounting and he believed that alone was reason enough to create some metrics of their own. King Bernard thought his idea made a lot of sense as he, too, was wondering why the costs related to the tsunami should be included in operating income.

The group discussed providing the analysts with the following measures.

Earnings before Interest, Tax, Depreciation and A amortization (EBITDA)

Earnings before Discontinued Operations

Earnings before Extraordinary Items.

Recurring Earnings which would exclude both the discontinued operation and extraordinary item.

Whichever number(s) were to be presented would be net of tax, and an EPS number would be calculated as well. In addition, they discussed highlighting these new measures in the financials presented on their website. The group had a very animated discussion, and excitement continued to build as they realized that, through the use of these new metrics, they could paint a much better picture of the operating results of the company.

"Dilly, Dilly" , Loyal Doge said expressively. He was excitedly talking about using multiple colors, large fonts, and the bolding of non-GAAP numbers in the quarterly financials when Debbie Doberman decided to speak up. Since it as 5 pm, the group decided to stop for the day and meet at 8 am the following morning at which time they would address Debbie's concerns.

Assume you are in Debbie's place. You are a CPA, MBA, CFE. You have purposefully been silent up until now to first gather all the facts hear everyone's opinions and then provide guidance on what is and is not acceptable with respect to non-GAAP disclosures. Consider the following in developing a game plan for what to say when you address the group tomorrow.

Required -

1. What are the main arguments, that you will need to counter? That is, what are the reasons and rationalizations you will need to address?

2. What is at stake should you not convince King Bernard to follow the SEC guidelines on the use of non-GAAP metrics? Include both short and long-term potential consequences in your answer.

3. What levers do you have available? Include in your answer a discussion of the specific rules and guidelines for the use of non-GAAP metrics.

4. If you cannot convince the King to follow the guidelines for using non-GAAP metrics, what is your next step?

5. If the earnings call goes forward and the non-GAAP measures are prominently highlighted as Loyal Doge suggests, what are you opinions then?