In 2016 and early 2017, the SEC made a big push—through a series of staff oral admonitions and written guidance, as well as an enforcement action—to require issuers to be more transparent and more consistent in the use of non-GAAP financial measures and to avoid altogether non-GAAP measures that were misleading. In May 2016, the Corp Fin chief accountant, as reported in CFO.com, cautioned companies in neon lights that, with regard to non-GAAP financial measures, "[f]or lack of a better way to say it, we are going to crack down." (See, e.g., this PubCo post and this PubCo post.) By early 2017, the SEC staff were apparently sufficiently satisfied (see this PubCo post) with the responses to their campaign that the pendulum swung back, and the relentless finger-wagging by the staff about non-GAAP financial measures appeared to have tailed off. (See this PubCo post.) And, according to this analysis from Audit Analytics, in 2018, SEC staff comments regarding non-GAAP financial measures actually began to decline. But, MarketWatch has reported, with the onset of COVID-19, there seems to have been something of a resurgence in the use of non-GAAP measures. Will we see another crackdown?
SideBar
You might remember when EBITDAC—earnings before interest, tax, depreciation, amortization and coronavirus—became a thing. A few companies actually applied that new metric, even adding back profits they contend they would have earned but for the mandatory lockdowns resulting from COVID-19. As you can imagine, that didn't go over well. In March last year, the Corp Fin staff issued Disclosure Guidance Topic No. 9, which reminded companies that "we do not believe it is appropriate for a company to present non-GAAP financial measures or metrics for the sole purpose of presenting a more favorable view of the company." The staff then invoked earlier guidance cautioning that these metrics should not deviate materially from metrics used to manage operations or make strategic decisions." (See this PubCo post and this PubCo post.)
As MarketWatch reported, data provider Calcbench looked at the earnings releases for 2020 issued by companies in the S&P 500 that reported both GAAP and non-GAAP net income numbers. For the 60 companies that reported the largest positive difference between non-GAAP and GAAP, Calcbench then calculated the difference in net income. Calcbench also determined the total number of adjustments made to GAAP net income and classified them into 11 categories. For each category, Calcbench calculated the size of non-GAAP adjustments.
Calcbench found that, in the sample group, non-GAAP net income exceeded GAAP net income by $132.3 billion—more than double the total GAAP net income of $130.7 billion. By comparison, a 2019 op-ed co-authored by former SEC Commissioner Robert Jackson cited research showing that firms in the S&P 500 announced adjusted earnings that were, on average, 23% higher than GAAP earnings and pointed to 36 companies in the S&P 500 that, in 2015, announced non-GAAP earnings more than 100% higher than the GAAP equivalent, and 57 more companies that reported non-GAAP earnings that were 50% to 100% higher than GAAP. (See this PubCo post.) According to MarketWatch, non-GAAP earnings per share in 2015 were "higher than GAAP earnings per share by an average of 25%..., compared with a variance of just 6% in 2013."
The Calcbench sample group made more than 240 adjustments to GAAP net income, with amortization of intangibles accounting for the highest percentage (30%) of the total dollars in adjustments, followed by 22% of dollar adjustments that were categorized as "other." (The "other" category consisted primarily of "contingent considerations," mark-to-market losses on a defined-benefit plan and exploration costs.) Adjustments for in-process R&D made up about 16%, restructuring 10% and impairment about 14%.
SideBar
At a meeting of the SEC's Investor Advisory Committee in May 2020, the Committee voted to make recommendations to the SEC on several topics, including the use of non-GAAP financial measures and other metrics in investor communications, in circumstances where companies "manipulate or deceive investors with non-GAAP metrics, either relative to GAAP or by changing metrics over time." The Committee recommended continued monitoring by the SEC as well as a study of whether companies are using non-GAAP metrics prominently in communications to investors that are not part of formal SEC reports, "changing their non-GAAP metrics' definition or calculation, or otherwise using them in ways that may be materially deceptive to investors." In addition, the Committee recommended that the SEC "should also consider whether any of the commonly used non-GAAP metrics may be better presented within MD&A or other non-GAAP elements of formal reporting documents, where full SEC oversight and monitoring can be brought to bear." (See this PubCo post.)
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
