In this article, the WSJ reports on new data, prepared for the WSJ by Audit Analytics, showing how faithfully companies have conformed their disclosures to the recent guidance from the Corp Fin staff on non-GAAP financial measures. (See this PubCo post.) As more and more companies have prominently featured non-GAAP measures — and often more prominently than related GAAP measures — non-GAAP measures have come under increased scrutiny and a barrage of criticism from the staff amid concerns that they can be misleading. According to the WSJ, companies are listening.
As you may recall, the staff guidance emphasized, among other things, the need to present GAAP measures with equal or greater prominence relative to the non-GAAP measures. The guidance also advised companies to avoid cherry-picking of adjustments within a non-GAAP measure, the use of non-GAAP measures inconsistently between periods, adjustments to remove normal recurring cash operating expenses that are necessary to operate the business, replacement of important accounting principles with alternate accounting models that do not conform to the company’s business, and identifying excluded charges as non-recurring when the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years.
The analysis from Audit Analytics showed that over 25% of the companies in the S&P 500 index shifted their presentations to put GAAP at the top of their quarterly earnings releases and that, since the beginning of July, 81% have made GAAP numbers most prominent, compared with only 52% for the prior quarterly earnings releases. And, the article reports, in response to the staff guidance, some companies have dropped non-GAAP measures altogether.
However, transitions that involve more than placement on the page can be challenging, such as where investors and analysts have become accustomed to seeing certain metrics that the staff has now identified as misleading or otherwise unacceptable. In those instances, some companies may need time to consider the type of changes to make and how best to transition to them, attempting to balance “investors’ expectations with the concerns of the SEC staff.” And according to SEC staff members, that’s acceptable, but only temporarily. Recognizing that some companies have used the same, now problematic, non-GAAP revenue measures for many years and provided guidance to analysts and others on that basis, Corp Fin Chief Accountant Mark Kronforst (speaking for himself and not the SEC), has previously indicated that companies will be able to continue to present the same non-GAAP measures for one quarter, disclosing their intent to discontinue use of the measure in the future — essentially, “one and done.” Likewise, it would not be problematic, he said, for one quarter, to provide a roadmap to a new non-GAAP metric that does not transgress the guidance. Companies may also provide bridging disclosures to help analysts cope with change, for example, by presenting the GAAP numbers in a way that allows readers to “do the math.” (See this PubCo post.)
But beyond this “breathing room,” companies that fail to comply will risk SEC comments. The article reports that, in letters made public through August 5, according to Audit Analytics, the SEC issued non-GAAP-related comments this year to 166 companies, an increase of 13% from the prior year. Kronforst noted that, while the staff issued some “futures” comments on the first quarter disclosures (referring recipients to the new guidance), companies should expect to see more comments related to application of the new guidance in connection with second quarter press releases and 10-Qs. One commentator cited in the article characterized the process as “evolutionary…. The preparer community, the audit community, the legal community as well as the SEC will be learning over the next couple of months where the lines are.”
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