How companies use non-GAAP measures is one of the “hot topics” that we post about frequently. This is not just because we think it is interesting. (Although we do!). More to the point, it is a subject of frequent SEC comment, and in the last several weeks both SEC Chair Mary Jo White and Chief Accountant James Schnurr have expressed their concern about more aggressive use of non-GAAP measures. And a recent report from FACTSET (mentioned in more detail below) bears out this concern.
Carol and George, your blog authors, recently did a One-Hour Briefing about Non-GAAP measures.
You can find the archived One-Hour Briefing at:
In the Briefing we included this quote from Mr. Schnurr’s March 22, 2016 speech to the 12’th Annual Life Sciences Accounting and Reporting Congress in Philadelphia, PA:
Non-GAAP measures
Before I conclude today’s remarks, I’d like to provide my perspectives on non-GAAP measures, which is a topic that continues to receive attention from investors, those at the SEC, as well as the general news media.
The Commission adopted rules in 2003 addressing the disclosure of non-GAAP financial measures, both generally and with respect to inclusion in SEC filings. While the Commission’s rules allow companies to provide non-GAAP measures to investors as alternative measures that supplement information in the financial statements, the rules are clear that the non-GAAP measures must not be misleading. The SEC staff has observed a significant and, in some respects, troubling increase over the past few years in the use of, and nature of adjustments within, non-GAAP measures by companies as well prominence that the analysts and media have accorded such measures when reporting on the results of the companies they cover.
Non-GAAP measures are intended to supplement the information in the financial statements and not supplant the information in the financial statements. However, when the financial news networks report quarterly earnings, they very frequently report the non-GAAP measure of earnings with no reference to the actual GAAP earnings, often not even identifying it as having been adjusted. In addition, I am particularly troubled by the extent and nature of the adjustments to arrive at alternative financial measures of profitability, as compared to net income, and alternative measures of cash generation, as compared to the measures of liquidity or cash generation. In my view, preparers should carefully consider whether significant adjustments to profitability outside of customary measures such as EBITDA or non-recurring items or other charges to the business, such as the sale of portions of the business in order to provide the user with an understanding of how these events impact trends and future performance, are appropriate. As it relates to cash measures, I believe those measures should be reconciled to cash flow from operations.
Staff in the Division of Corporation Finance continues to monitor non-GAAP disclosures as part of its selective review process and regularly issues comments on this issue. The staff also provides guidance on the application of Commission rules through speeches and other mechanisms — and of course, staff comment letters are publicly available. You can expect that the staff will continue to be vigilant in their review of the use of these measures for compliance with the rules.
The proliferation of non-GAAP reporting measures among registrants, and reliance and reporting by analysts, should warrant increased focus by management and the audit committee. I believe the focus should go beyond determinations that the measures comply with the Commission’s rules and include probing questions on why, in contrast to the GAAP measure, the non-GAAP measure is an appropriate way to measure the company’s performance and is useful to investors. In addition, companies should ensure that the measure is prepared in a manner that includes appropriate controls and oversight procedures.
You can find the whole speech at:
www.sec.gov/news/speech/schnurr-remarks-12th-life-sciences-accounting-congress.html
Chair White’s Speech at an AICPA conference in December included these remarks:
- Another financial reporting topic of shared interest and current conversation is the use of non-GAAP measures. This area deserves close attention, both to make sure that our current rules are being followed and to ask whether they are sufficiently robust in light of current market practices. Non-GAAP measures are allowed in order to convey information to investors that the issuer believes is relevant and useful in understanding its performance. By some indications, such as analyst coverage and press commentary, non-GAAP measures are used extensively and, in some instances, may be a source of confusion.
- Like every other issue of financial reporting, good practices in the use of non-GAAP measures begin with preparers. While your chief financial officer and investor relations team may be quite enamored of non-GAAP measures as useful market communication devices, your finance and legal teams, along with your audit committees, should carefully attend to the use of these measures and consider questions such as:
- Why are you using the non-GAAP measure, and how does it provide investors with useful information?
- Are you giving non-GAAP measures no greater prominence than the GAAP measures, as required under the rules?
- Are your explanations of how you are using the non-GAAP measures – and why they are useful for your investors – accurate and complete, drafted without boilerplate?
- Are there appropriate controls over the calculation of non-GAAP measures?
So, the message has clearly been sent, be thoughtful about the use of non-GAAP measures and be careful to not be misleading.
How are companies responding to these messages?
For now, it does not look like they are listening. FACTSET has done a very detailed study that includes all the earnings releases for the Dow Jones Industrial Average companies for their most recent year-end. Their results are available at:
www.factset.com/insight/2016/03/earningsinsight_03.11.16#.Vw5yo2OPAQK
Their findings are very dramatic. For companies that released a non-GAAP earnings measure the difference between GAAP EPS and non-GAAP EPS from 2014 to 2015 widened from 11.8% to 30.7%. And that is just one of may statistics that highlight growing differences between GAAP and non-GAAP measures. Of course, the non-GAAP measures all seem to look better…
So, we suggest careful review by your audit committee and management of the use of non-GAAP measures. And, be sure to look back to the comments above and ask the questions Chair White asked:
- Why are you using the non-GAAP measure, and how does it provide investors with useful information?
- Are you giving non-GAAP measures no greater prominence than the GAAP measures, as required under the rules?
- Are your explanations of how you are using the non-GAAP measures – and why they are useful for your investors – accurate and complete, drafted without boilerplate?
- Are there appropriate controls over the calculation of non-GAAP measures?”
As always, your comments and thoughts are welcome!
Carol and George