On January 24, 2019 Alteryx disclosed it was terminating PWC as its outside auditor. Because of the seriousness of an auditor termination, we are posting the company’s relevant disclosure here:
On January 17, 2019, following an internal review by PwC, PwC notified the Company that PwC had increased its use of, and communications and services related to, the Company’s software platform with its clients and prospective clients in 2018 and that this creates the possible appearance of a business relationship contrary to auditor independence standards. Based on its current assessment, PwC communicated to the Company that this concern did not extend to 2017 or any prior year.
As a result of the foregoing, the Company and PwC mutually agreed that it was appropriate for the Company to consider retaining a new independent registered public accounting firm and, accordingly, the Company dismissed PwC as the Company’s independent registered public accounting firm, effective January 24, 2019. The decision to dismiss PwC as the Company’s independent registered public accounting firm is not for any reason related to the Company’s financial reporting or accounting operations or policies. The decision to change independent registered public accounting firms was approved by the Audit Committee.
When a company fires its auditors, we get nervous and dig into the situation to learn more. We went back five years and could not find a single US public company with a market cap above $1 billion and a year end of December 31st that changed its auditor in the month of January. There were a handful of foreign registrants who changed their auditors in January but no US companies. The reasons is obvious. January is when most year end audit work is done. To change an auditor then likely means a non-timely filing and raises questions about disagreements.
In AYX’s case, we got more nervous when we realized the company has only been public for about 1.5 years and currently has a $4.2 bn market-cap (23x ttm revenue). We moved from nervous to concerned when we realized Alteryx terminated PwC just as it would have to file at the Alteryx’s very first 404(b) statement about the quality of the company’s internal controls. Our nervousness peaked when we learned of a prior adverse internal controls disclosure, remediated at the end of their first quarter 10q released May of 2018, with this disclosure:
In the course of preparing our financial statements as of and for the year ended December 31, 2016, we identified a material weakness in our internal control over financial reporting…our Chief Executive Officer and Chief Financial Officer, concluded that we have remediated the material weakness described above as of March 31, 2018.
This internal control weakness was identified by AYX as occurring during the first 3 quarters of 2016, but it took 15 months to be remediated.
Regarding PwC’s disclosure to AYX: such a disclosure is appropriate. However, PwC did not resign on its own accord after disclosing the issue. It was AYX who decided to terminate PwC. As a watchdog, we must consider whether Alteryx seized on the independence disclosure by PwC as an opportune moment to end the PwC relationship. If so, why?
An outside auditor is a watchdog who gets paid by management to act on behalf of investors. It would be rare, perhaps unheard of, to have a company abruptly end their audit agreement approximately 30 days before the company is expected to file its first full year of financial disclosures as a public company. Even in a case with possible independence issues, the company and auditor could have petitioned the SEC for an independence waiver, but they apparently did not.
We focus heavily on the timing of the PwC termination because of the legal requirement of Alteryx’s auditor being required to file a 404(b). Sarbanes Oxley was created, in part, to force companies and auditors to grade and disclose their internal controls. An auditor’s adverse 404(b) would be troubling particularly in areas of revenue recognition for which there are new and complex standards going into effect this year. At IPO, Alteryx was considered an “emerging growth” company and was given a waiver from the 404(b) requirement for an expected five years. However, because it was a hot growth stock, as soon as AYX’s market cap (public float) exceeded $700 million, a new clock started that qualified AYX as a large, accelerated filer. This category requires a 404(b) statement concurrent with AYX’s 2018 10K which must also be filed within 60 days of the close of its 2018 year (March 1, 2019).
Further regarding timing: It would be almost inconceivable that PwC was not already working on their first 404(b) assessment for Alteryx at the time PwC was fired. As part of their 404(b) assessment, PwC would review the CEO and CFO disclosure of Alteryx’s remedial conclusions about its own adverse internal control disclosures as noted in their May, 2018 disclosure. We note that the May, 2018 disclosure was management’s own assessment. It did not include any PwC opinion.
Another unusual issue caught our eye: When we read Alteryx’s statement announcing their decision to terminate PwC, we were struck by its concurrent announcement of Alteryx’s preliminary results. This disclosure appear to us to be an attempt by Alteryx’s management to release positive financial news to offset the troubling news of their termination of its outside auditor.
Preliminary results for the full year ended December 31, 2018 were as follows:
- Revenue is expected to be approximately $203 million, representing a year-over-year increase of approximately 54%.
- Billings is expected to increase approximately 55% year-over-year.
- As of December 31, 2018, the Company expects to have nearly 4,700 total customers, an increase of approximately 38% over December 31, 2017.
- The Company expects to report positive cash flows from operations.
These are certainly impressive results and we tip our hat to the management team. But as a watchdog, we are suggesting that investors should be asking hard questions to management about the nature and timing and issues not disclosed in the PwC termination announcement on January 24.
Lastly, we note some aggressive insider trading at AYX. Investors are likely happy with the dramatic and largely unpredictable upward share price movements since its IPO in April 2017. But this upward movement has come with aggressive insider sales activity. We note the CEO and Founder has grossed more than $50 million from share sales in the 16 months since share sale restrictions were lifted. More interestingly the CFO has grossed more than $7 million from insider sales in just the last 6 months. As a new CFO (start date April 2016), one would expect him to retain his converted options for future share price growth. Instead it appears he has sold shares almost as fast as they have been released from restrictions or converted from options. Insider sellers have the incentive during financial and internal control reporting to maintain share price levels for as long as possible. Are incentives such as this at work when considering the dismissal of PwC on such short notice? It is hard to avoid a high level of skepticism about what PwC’s dismissal really means when insiders are benefiting so substantially from insider sales. The mosaic surrounding this auditor change disclosure (8k, Jan. 24, 2019) gives one pause when trying to figure out what is going on.
What will happen next? The new auditor for AYX is Deloitte. First, we wonder whether Deloitte has clients using AYX? If so, then what? KPMG is already a “partner” on AYX’s site. Deloitte will now be starting its audit less than 45 days from the legally required large, accelerated filing date required for AYX. While we are sure Deloitte will deploy their best resources, we are almost certain investors can expect a notice of Non-Timely (NT) filings from Alteryx. Normally, an NT is seen in a negative light. An NT may negatively impact AYX’s stock price.
Moreover, Deloitte will also be responsible for the filing of AYX’s first 404(b) assessment. Here again, we anticipate timing and resource challenges for DT to hit the required filing date.
And what of PwC? It does not take a legal genius to anticipate PwC getting looped into any possible class action law suit brought against AYX if either the NT filing or an adverse 404(b) are disclosed in the coming months and the stock falls.
Alteryx is not in a great position here. It is a high-flying stock reporting massive revenue growth, moving into the SEC’s large, accelerated filer group which requires more stringent reporting. It has a history of adverse internal controls. It just terminated its outside auditing firm to engage a brand new firm, unfamiliar with its business or operations. The new auditor must both file AYX’s first full year financials AND its first 404(b) auditor’s assessment.