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NON-GAAP FINANCIAL MEASURES: TOP 10 TAKEAWAYS
Tips from the Corporate Reporting Users’ Forum and the Financial Reporting Lab
1.
Annual reports:
The annual report should be clear and easy to use both on screen and if printed. Avoid excessive pictures that make it look like a brochure. Keep designs to single pages, since double page spreads do not translate well onto screen. Include all key information within the annual report, especially if it relates to indicators that drive remuneration. If possible, the annual report should be available (electronically) on the results day, enhancing transparency.
2.
The non-GAAP/GAAP “gap” is not the primary focus:
The audience asked the panel if regulators and standard setters are concerned with reducing the reporting gap between non-GAAP and GAAP. Panelists clarified that the gap itself is not the primary area of concern. Rather, they are focused on ensuring adjustments and presentation conform to applicable rules. The updated interpretations are intended to provide companies with more clarity on what is considered permissible.
3.
“Cash EPS” is misleading:
Long-standing rules prohibit liquidity measures such as “free cash flow,” “operating cash flow,” and “cash earnings” from being presented on a per share basis. Only performance measures – anchored in accrual accounting principles – may be presented on a per share basis. Panelists commented that named measures such as “Cash EPS” are, therefore, potentially misleading and not permitted.
4.
Stock-based compensation not under scrutiny:
Audience members questioned the panel on the merits of performance measures that omit stock-based compensation expense. Panelists commented that current SEC regulations do not prohibit such adjustments. Panelists also noted a “shift” in the market as more investors and preparers are now preferring to include stock-based compensation within performance measures.
5.
Recurring cash adjustments to receive more attention:
Audience participants questioned the permissibility of adjusting out recurring cash costs, such as restructuring, legal fees and M&A integration costs. Panelists highlighted that the updated SEC guidance prohibits excluding normal recurring cash costs. However, panelists noted that a long duration of adjustments, operating strategy and industry factors are important considerations in determining whether or a not an adjustment is normal and recurring.
6.
Inconsistent adjustments are problematic:
Panelists discussed instances where reporters adjust out nonrecurring expenses, but include nonrecurring gains. The updated guidance emphasizes that such inconsistencies are prohibited. Panelists also desired historical recast if definitions of non-GAAP measures have changed.
7.
No tailor-made accounting:
The new guidance emphasizes that companies are prohibited from tailoring their accounting away from the standards. For instance, panelists discussed companies that adjust their non-GAAP measures for changes in deferred revenue, thus accelerating and tailoring revenue recognition. Panelists also highlighted other areas of potential concern, such as pension accounting and non-GAAP share count methodologies.
8.
Non-GAAP only statements are prohibited:
The guidance also emphasizes that companies are prohibited from presenting a full non-GAAP income statement. A full non-GAAP statement is problematic because regulations require reconciliation, and a full statement may create prominence issues and may be considered potentially misleading.
9.
Cash tax rates don't belong in performance measures:
An audience member questioned when it is appropriate to use cash tax rates. Panelists observed that cash taxes are appropriate for cash-flow and liquidity measures, but not for performance measures. The updated guidance requires consistent application of deferred tax accounting in non-GAAP performance measures. A panellist provided an example of a company that is not profitable on a GAAP basis, generates large taxable losses, but is "profitable" on an adjusted earnings basis. It is inconsistent and potentially misleading to present such "profitability" along with the accumulation of tax losses (which drive the low cash tax rate).
10.
Standardization may be good and bad:
There was a colorful debate on the merits of standardizing and enforcing key performance and liquidity measures. Panelists opined that more standardization and regulation may help prevent perceived abuses. However, some investors in the audience argued that diversity of reporting may create investment opportunities and alpha, as differences between reporting and the underlying economics of the business cannot persist indefinitely.
What’s next: expect more comment letters – and potentially enforcement action. Panelists observed that SEC comments to companies are available to the public via the SEC Edgar system after review (link). The first “wave” of comment letters were issued after the SEC updated the non-GAAP guidance in May. Panelists noted that many companies ‘self-corrected’ potential reporting issues during the 2nd quarter earnings process. Panelists also noted that another “wave” of comment letters is expected to be released within the next few months. Further, Chair White has indicated that the Commission may pursue enforcement, if appropriate (link).
Event panelists:
- Mark Kronforst, Chief Accountant, Division of Corporation Finance, U.S. Securities and Exchange Commission
- Marc Siegel, Board Member, Financial Accounting Standards Board
- Douglas Oare, Managing Director, Head of US Investment Grade Research, BlackRock
- Simon Flannery, Managing Director, North America Telecommunications Analyst, Morgan Stanley
- Beth Paul, U.S. Strategic Thought Leader, Accounting Services Group, PwC (Moderator)
Please note, all panelists participated in an individual capacity and their views and remarks do not necessarily represent the views of their member organizations.
Contacts
Todd Castagno, U.S. CRUF Co-Chair
Zhen Deng, U.S. CRUF Co-Chair