Did Alliance MMA Overstate Its Operating Margin? | Forbes
Dr. Paul Gift authors article about apparent financial reporting error.
Alliance MMA recently completed its first full year as a public company, a year with dueling story lines. On one hand, it became the first-ever U.S. mixed martial arts (MMA) promotion to go public through an IPO – ProElite and International Fight League went public through reverse mergers – raising roughly $8.9 million in net proceeds and since acquiring at least ten regional MMA promotions, a ticketing platform and a fighter management company.
On the other hand, as of this writing Alliance’s stock price is down 65% from last year’s IPO offering price, shareholders filed a class-action lawsuit in April following an apparent financial reporting error and the company executed another capital raise in August – just 11 months after going public – to ensure that “capital needs are met over the next twelve months,” according to its most recent 10Q filing.
As a nanocap stock trading on the NASDAQ, Alliance doesn’t appear to be covered by any analysts, who likely would’ve noticed something strange in the company’s Aug. 14 press release touting second quarter financial results. According to CFO John Price, the second quarter “resulted in a 43% operating margin, a 14% increase over the first quarter of this year. The positive trend of these key financial performance metrics…is highly encouraging as we proceed in executing our business plan in a methodical, expeditious manner.”
Yet simple calculations appear to show that Alliance’s operating margin for the quarter was a substantially lower -207%, while gross margin was in fact 43%.
When asked for comment, CEO Paul Danner had the following response, “There was no misstatement of our operating margin – the following table indicates the manner in which it was correctly calculated:
“It is management’s position that Gross Margin (which we labeled as ‘Operating Margin’ in the filing) is the most meaningful metric to track at this stage of our corporate development,” Danner continued, “because improvement in the margin indicates we are getting better at producing events at a lower cost as a percentage of revenue. As essentially a development stage operation, the corporate ‘overhead’ expenses underneath COGS represent an investment in infrastructure, and a fixed cost that will remain fairly static as revenues increase. As the Company is able to execute each production incrementally more profitable, we expect to eventually move to profitability as an enterprise.”
Follow-up questions went unanswered.
Yet how would someone reading the press release know that Alliance management simply decided to label gross margin as operating margin? The seemingly improper use of operating margin in Alliance’s press release might have been a typo not caught in the review process, but Danner’s response indicates there was “no misstatement” of operating margin which was “correctly calculated.”
When asked to explain the differences between gross and operating margin, John Paglia, a professor of finance at Pepperdine University’s Graziadio School of Business and Management who is unaffiliated with Alliance MMA said, “Gross margin and operating margin are well defined and accepted business metrics. Gross margin is defined as gross profit (revenues minus cost of goods sold) divided by revenues. Operating margin has additional (operating) expenses deducted and is defined as operating income divided by revenues. Given gross margins generally average 3-4x operating margins for publicly traded companies in the aggregate, their relative valuation metrics will also be significantly different. Misinterpreting or confusing these while performing a valuation analysis could have serious investing consequences.”
Information is an investor’s best tool, according to the SEC’s guide for microcap investors. This rings especially true for microcap and nanocap stock investments which are among the “most risky,” per the same guide. A concern in this situation is that current or potential Alliance investors might only read the press release and not scour the associated 10Q filing, which appears to contain accurate financial data.
During its brief existence since February 2015, Alliance has been a tough nut to crack. It’s a unique venture in MMA, essentially forming a conglomerate in the regional circuit in the hopes of securing national sponsorship deals and serving as a feeder league to larger, premier MMA promotions such as the UFC and Bellator – and raising questions along the way.
The perplexing announcement of Alliance’s second quarter operating margin would seem to raise more.
Disclosure: The author recently served as a judge at an Alliance MMA event in Los Angeles. While judges are assigned by the regulatory commission, they are paid by the event promoter. The author’s check from Alliance MMA was not cashed and will not be in the future.
Authored by Paul Gift