From the moment I entered the building I knew that I was in another world.  The building was the Burbank headquarters of Warner Brothers Studios.  My host, Joe Smith, was President of Warner Brothers Records and our meeting had been arranged by a mutual friend from Boston.  Joe was a major figure in the music business and was eager to show me some movie lots before we had lunch at the studio commissary.  We were an odd couple as we walked the studio grounds!  I was wearing a Brooks Brothers suit, button down shirt, and striped tie.  I felt awkward in my East Coast costume.  Joe had on a long pointed collar shirt which was open at the neck.  No jacket, just jeans.  Instead of a necktie he wore a visible heavy gold chain.  He was strictly West Coast.  It was 1974 and I was the one who was inappropriately dressed … especially for where I was.

As we walked, Joe would say, “This set was for the series …” and mention a TV show from the 60s or early 70s.  I would stop, look at a set and think to myself, “I can’t believe people have bought into this. The buildings are so phony.  There’s just a front to the building there.  It’s totally artificial!  There’s nothing behind the wall.”  And yet upon reflection, I realized that I too had bought into the TV image. This world of make-believe would appear on Wall Street 26 years later, but thanks to Joe I was prepared.

In the investment business, this make-believe world is known as Non-GAAP accounting.  GAAP is an acronym for Generally Accepted Accounting Principles.  Non-GAAP is not Generally Accepted Accounting Principles.   All companies must report earnings on a GAAP basis but Non-GAAP can be included as well.  It’s a slight-of-hand way to demonstrate a company’s theoretical growth rate.  I say theoretical because companies using this method exclude the total cost of employee compensation.  A company will charge an employee’s $10,000 a month paycheck against its income statement as a cost but exclude a $500,000 stock compensation package as a charge. Thus, the total cost of an employee’s compensation is not expensed through the company’s income statement.  Yet, share-based compensation is a real corporate cost. It dilutes the value of existing stock holders.  Not including such compensation makes employees seem to work for less money than they do.  A corporation thus appears more profitable than it really is.  If a company buys the issued employee stock in the open market then there is no dilution to shareholders, but it is still spending stock holders’ money to maintain this profitability illusion.  Highly competitive businesses such as technology are often aggressive users of Non-GAAP accounting.   After all, who wouldn’t want to appear more profitable?  It’s what drives a stock higher.

In screen writing there is a term called a plot hole.  Usually, when we watch a movie or television show and the script has a plot hole we blissfully go right by it.  We miss it because we are not expecting it.  Example:   In the first episode of SEASON TWO, Tony Soprano, tells his sister that he has just put their mother’s house up for sale.  But the house had already been sold in SEASON ONE.  It’s not until you get on a movie set and look behind a “building” that you can fully understand what is reality or an illusion.

Francis Patrick Boland