From the nearly ~650 filings our Robo-Analyst analyzed last week, we’re highlighting unusual items in the filings of Exxon Mobil (XOM) and several other companies during the second week of The Real Earnings Season.

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Exxon’s Hidden Non-Operating Items Significantly Impact Earnings

In its 2020 10-K, analyst Jacob McDonough found that Exxon Mobil recorded multiple write-downs that were hidden in “Depreciation and depletion” and “Exploration expenses, including dry holes.” Detailed below, these hidden and reported unusual gains/losses amount to $22.5 billion and materially distort (by 100%) Exxon’s GAAP earnings:

  • $24 billion charge in Upstream to reduce carrying value of the dry gas portfolio to fair value – Page 80 2020 10-K
  • $1.2 billion non-service pension and postretirement benefit expense reported on the income statement
  • $900 million impairment charge in the Upstream unit – Page 80 2020 10-K
  • $611 million pre-tax goodwill impairment charges in the Upstream, Downstream, and Chemical units – Page 75 2020 10-K
  • $600 million impairment related to U.S. upstream equity investments – Page 78 2020 10-K
  • $500 million impairment charge in the Downstream unit – Page 80 2020 10-K
  • $450 million pre-tax charges related to employee separation costs – Page 107 2020 10-K
  • $100 million impairment charge in the Chemical unit – Page 80 2020 10-K
  • $73 million amortization of prior service costs – Page 96 2020 10-K

In addition, we made a $5.4 billion adjustment for income tax distortion to normalize reported income taxes by removing the impact of unusual items.

In total, Exxon has -$22.5 billion in Earnings Distortion that reduces earnings by -$5.26/share, or 100% of GAAP EPS. After removing Earnings Distortion, Exxon’s 2020 Core Earnings of $0.01/share are much greater than GAAP EPS of -$5.25.

How We Treat Non-Operating Items: Non-operating items, such as asset write-downs, restructuring, or litigation costs, are one of many reasons why GAAP net income doesn’t tell the whole story of a company’s profitability.

We remove all unusual gains/losses, including write-downs, to calculate Exxon’s true recurring profits, i.e. Core Earnings. We also add-back the after-tax value of asset write-downs to our measure of invested capital to ensure management can’t erase equity from the balance sheet.

Without careful footnotes research, investors would never know that these non-recurring expenses distort GAAP numbers to the point where traditional, unscrubbed earnings for U.S. stocks are off by an average of ~20%.

Other Material Earnings Distortions & Red Flags We Found

Since February 19, 2021, we have parsed 1,395 10-Q and 10-K filings, which means Exxon’s hidden non-operating items aren’t the only unusual items our analysts have found. Below are a few other highly material Earnings Distortions that we discovered while rigorously analyzing the footnotes and MD&A:

Chegg, Inc. (CHGG) – Abnormal reported tax rate

  • While analyzing Chegg’s 2020 10-K, analyst Alex Sword found a notable tax situation. On page 82 of its 2020 10-K, the firm discloses a 2,900% tax expense for stock-based compensation and a 5,900% tax benefit from convertible senior notes. Ultimately, despite reporting a GAAP pre-tax loss of $861,000, Chegg reported over $5 million in taxes during 2020. However, we made a $5 million adjustment for income tax distortion to normalize reported income taxes by removing the impact of unusual items. After removing all Earnings Distortion (177% of GAAP EPS in 2020), Chegg’s 2020 Core Earnings of $0.04/share are much greater than GAAP EPS of -$0.05.

S&T Bancorp, Inc. (STBA) – Non-operating loss due to fraud

  • Analyst Devyn DeLange noticed on page 111 of S&T Bancorp’s 2020 10-K that the firm recognized a $59 million pre-tax loss due to fraud resulting from a check kiting scheme. We remove this non-operating charge from our measure of net operating profit after tax (NOPAT) and Core Earnings to calculate the true recurring profits of the business. After removing all Earnings Distortion (275% of GAAP EPS in 2020), S&T Bancorp’s 2020 Core Earnings of $2.01/share are greater than GAAP EPS of $0.54.

Orthofix Medical, Inc. (OFIX) – Related party transaction with possible conflict of interest

  • Analyst Sam Moorhead found the disclosure of a related party transaction that could create a conflict of interest on page F-43 of Orthofix Medical’s 2020 10-K. Per the disclosure, Orthofix entered into a technology assignment and royalty agreement with a medical device technology company partially owned and controlled by the wife of Orthofix’s President and Chief Executive Officer for consideration up to $10 million. While the firm noted the CEO was excluded from the negotiation and evaluation of the transaction, such a finding is a good reminder that potential conflicts of interest may only be disclosed deep within annual filings. Diligence matters.

The Power of the Robo-Analyst

We analyzed 644 10-K and 10-Q filings last week, from which our Robo-Analyst[1] technology collected 74,709 data points. Our analyst team made 11,867 forensic accounting adjustments with a dollar value of $4.2 trillion. The adjustments were applied as follows:

  • 4,408 income statement adjustments with a total value of $340 billion
  • 4,891 balance sheet adjustments with a total value of $1.7 trillion
  • 2,568 valuation adjustments with a total value of $2.1 trillion.

Figure 1: Filing Season Diligence for the Week of March 1 – March 5

Sources: New Constructs, LLC and company filings.

Every year in this six-week stretch from mid-February through the end of March, we parse and analyze roughly 2,000 10-Ks to update our models for companies with 12/31 and 1/31 fiscal year ends. This effort is made possible by the combination of expertly trained human analysts with our “Robo-Analyst.” Featured by Harvard Business School in “Disrupting Fundamental Analysis with Robo-Analysts”, our Robo-Analyst research automation technology uses machine learning and natural language processing to automate and improve financial modeling.

Only our “novel dataset”, which leverages our Robo-Analyst technology, enables investors to overcome flaws with legacy fundamental datasets to apply reliable fundamental data in their research. Core Earnings: New Data & Evidence, forthcoming in The Journal of Financial Economics, reveals the problems with fundamental data provided by legacy firms like Bloomberg, Refinitiv, FactSet (FDS) and S&P Global (SPGI). 

This article originally published on March 9, 2021.

Disclosure: David Trainer, Jacob McDonough, Alex Sword, Devyn DeLange, Sam Moorhead, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, sector, style, or theme.

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[1] Harvard Business School features the powerful impact of our research automation technology in the case New Constructs: Disrupting Fundamental Analysis with Robo-Analysts.

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