Regulator Ups Scrutiny of Pharmaceuticals’ Adjusted Figures

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By Denise Lugo

The SEC’s plan to review the pharmaceutical sector’s use of non-GAAP or “adjusted financial measures” could curb earnings distortions, but could also stifle a company’s attempt to present a more comprehensive performance picture of itself, practitioners told Bloomberg BNA.

The Securities and Exchange Commission’s views some “non-GAAP,” or non-generally accepted accounting principles, filings as questionable and potentially misleading to investors.

The SEC in May updated the guiding principles of non-GAAP rules with specific examples that spell out what measures the commission would consider misleading and thus in violation of SEC regulations.

SEC Mulling Issue

The SEC’s potential review of the pharmaceutical sector’s use of alternative measures to GAAP emerged in a Jan. 11 letter the agency sent to Botox maker Allergan Plc.

The letter admonished Allergan over the way it calculated adjusted earnings per share (EPS) and exclusions that were made that caused numbers to deviate too much from standard EPS. The agency warned broader scrutiny of the sector would follow. SEC also said it would consider whether additional comprehensive non-GAAP staff guidance is appropriate.

Allergan is the second pharmaceutical company to be chastened by the SEC over the past year about errant use of non-GAAP metrics. Valeant Pharmaceuticals International, Inc. a maker of Wellbutrin XL for treatment of depression, was also admonished in 2016 over the overall format and presentation of its non-GAAP measures. The company was told to revise its future earnings releases and investor materials.

Used Often in MD&A

Companies provide non-GAAP measures in press releases and in management discussion and analysis (MD&A) to provide more insights about their operations, including past performance, cash flows and future prospects.

Non-GAAP, in addition to being referred to as adjusted financial measures, can also be referred to as alternative performance measures. Non-GAAP measures have not been audited, where GAAP measures have gone through auditing scrutiny.

Can Add Value

But used correctly, alternative performance measures can add value, practitioners told Bloomberg BNA.

Inherent in adjusted financial measures is “that you want to share with investors what you think about your company’s performance and operations,” Neri Bukspan, a partner in Ernst & Young LLP’s financial accounting advisory services practice told Bloomberg BNA.

“And if you articulate too much consistency across them, what you’re essentially creating is GAAP for non-GAAP; you’re creating a blue print for the next non-GAAP, which might or might not be good,” said Bukspan, who is also EY’s Americas disclosure leader.

Potential to Hinder Full Story

Practitioners said it’s always helpful to have some consistency for reporting across a sector because it helps investors compare the same information.

However, they caution that forcing additional industry disciplines for non-GAAP could prove to be counterproductive if it is too stringently done.

Non-GAAP numbers are “about a company trying to tell their story in the way they want to tell their story,” Mark LaMonte, Moody’s Investor Service’s managing director of credit strategy and standards, told Bloomberg BNA.

“They’re trying to help investors and financial statement users understand their performance better or the value of their company better,” he said.

From an investor perspective however, said LaMonte, the non-GAAP metric itself is less useful than the explanation of the difference between the GAAP and the non-GAAP number.

” he said.

General Rules to Follow

Non-GAAP measures, debated for years, are a recurring topic by SEC senior staff at financial reporting conferences.

SEC found glaring differences between non-GAAP and GAAP numbers in cases where the differences aren’t justified, they said. Moreover, companies aren’t providing the correct headlines for certain items.

There is currently no sector-by-sector non-GAAP guidelines, but there are general requirements across industries that companies should follow. Non-GAAP numbers are to be reconciled to the corresponding GAAP measure. Furthermore, they can’t be reported in a way that makes the non-GAAP metric more prominent than the GAAP measure.

There are also guardrails around what isn’t an appropriate non-GAAP measure.

“The SEC doesn’t want people doing per-share cash flow measures,” said LaMonte. “They’ve written a number of comment letters to companies when they see it.” he said.

To contact the reporter on this story: Denise Lugo in New York at dlugo@bna.comTo contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bna.com

For More Information

The SEC's May 2016 updated Non- GAAP compliance disclosure rules are at https://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm

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