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Companies Are Winning the Battle Over Adjusted Earnings
More big firms convince the SEC that such figures aren’t
misleading investors
Coca-Cola has convinced the SEC its adjusted results aren’t
misleading. Above, bottles of lemonade at a Coca-Cola plant in
Utah. PHOTO: GEORGE FREY/GETTY IMAGES |
By
Tatyana Shumsky
May 22, 2017 8:00 a.m. ET
Companies are winning over
the Securities and Exchange Commission in their use of unofficial
accounting figures, a year after a crackdown on the practice.
Medtronic
PLC,
Coca-Cola Co. and
Boston Scientific Corp. are among
the 35 out of 51 companies that have successfully demonstrated to the
regulator that their adjusted earnings figures aren’t misleading
investors.
That outcome highlights how the complexities and nuances in
corporate accounting are complicating the SEC’s job in policing earnings. For
example, some companies are vulnerable to customer lawsuits that blur the line
between an occasional expense and a regular cost necessary to operate the
business.
Similarly, a restructuring plan announced in one year can bleed
across several years, clouding the distinction between a discrete cost and a
recurring expense.
An SEC spokeswoman declined to comment.
Large companies have the money and resources to lay out a
successful, detailed defense of disputed accounting practices. Chief financial
officers can tap a vast brain trust of internal finance teams, consultants and
legal counsel, as well as the board’s audit committee, to respond to SEC
concerns.
The agency last May issued new guidelines on the use of adjusted
earnings and other figures inconsistent with U.S. Generally Accepted Accounting
Principles. The move came amid concerns that these figures can misrepresent
company performance and often
furnish investors with a rosier picture of results
by excluding unusual charges or the impact of currency swings.
The regulator questioned dozens of companies on whether some of
these adjustments exclude regular business expenses and could be misleading,
according to an Audit Analytics analysis for The Wall Street Journal. In 69% of
cases the SEC backed down and concluded its conversations with the company
without forcing a significant change to its adjusted earnings presentation.
“What is reasonable to exclude and how do you decide what is
normal?” said Paula Hamric, national assurance partner at accounting firm BDO
USA LLP. “Even SEC staff haven’t been able to answer that, other than on a
case-by-case basis.”
Medtronic
in a Nov. 4 letter defended omitting
restructuring costs from adjusted earnings after the SEC asked whether it was
misleading because it excludes regular business expenses. “Restructuring charges
are not necessary to operate the business and are not necessary to generate
revenue,” said Karen Parkhill, CFO of the medical-technology company, in a
letter to the regulator.
The SEC scored many victories early in its push against the
proliferation of non-GAAP metrics. More than a quarter of S&P 500 companies
voluntarily changed their press releases to
report standard results first after the SEC updated its guidance last year.
Moreover, 29 out of 42 companies that were questioned about their
use of so-called tailored revenue metrics, another non-GAAP figure forbidden by
the new rules, changed their presentation of results to satisfy the SEC’s
concerns, according to Audit Analytics data.
Tesla
Inc., for example, said in an Oct. 2 release it would drop non-GAAP revenue and
other custom metrics. The decision came after the
SEC in an August letter questioned the company’s
use of “individually tailored” accounting figures.
The challenge for the SEC lies in drawing a distinction between
outliers and regular business expenses, when many fall into a gray area. Finance
chiefs and regulators must examine the company’s particular facts and
circumstances to decide whether adding back certain expenses is misleading
figure.
Coca-Cola
told the SEC that what may at first appear
to be recurring business expenses are in fact unique charges. The beverage maker
adjusted its 2016 results for costs from an overhaul and subsequent divestment
of its bottling plants in Germany. It also excluded nonroutine charges such as
severance pay, consulting fees and write-offs linked to a cost-cutting program
expected to end in 2019.
“We believe these restructuring charges and charges related to
our productivity and reinvestment program are not representative of the
company’s underlying operating performance and thus are appropriately excluded,”
said Larry Mark, controller, in a letter to the SEC in October.
A Coca-Cola spokeswoman declined to comment. A spokesman for
Medtronic said in an email that the company “responded directly and openly” to
the SEC.
SEC correspondence becomes public about 20 days after the
regulator judges the matter closed, although conversations can last for months
and cover multiple topics. It isn’t known how many matters are pending, as the
SEC doesn’t comment on cases.
Companies should establish a policy for how they calculate non-GAAP
figures to ensure the practice is consistent from one period to another, said
Beth Paul, partner at accounting firm PwC. Executives should work through the
nuance and judgment and be prepared to defend it to the audit committee.
“That makes responding to a comment letter easier because you’ve
talked through why it is you’ve made the adjustment,” Ms. Paul said.
Boston Scientific referenced its internal policy for which
charges and credits should be excluded from non-GAAP measures
in response to an SEC query in a Sept. 30 letter.
The Marlborough, Mass., company said the guidelines ensure that a materiality
threshold is applied to certain items, including litigation charges, to ensure
it is appropriate to exclude them from non-GAAP measures.
“We also provide disclosure regarding the nature of those
adjustments to further ensure that they are not misleading to investors,”
finance chief Daniel Brennan said in a letter to the SEC.
Boston Scientific declined to comment.
Some companies have been less successful in defending their
adjusted figures.
The SEC asked senior-housing provider
Five Star Senior Living Inc. to explain why
rent wasn’t a normal, recurring, cash operating expense necessary to run the
business. The Newton, Mass., company rented 88% of the units it operated as of
the end of 2016 and had furnished investors with adjusted earnings that omitted
rent costs.
Five Star
in January argued that the figure wasn’t
misleading because rent is analogous to the interest paid on the loans for
company-owned properties.
But
by the end of February, CFO Richard Doyle
told the SEC that Five Star would no longer use the adjusted figure in future
filings “in light of discussions with SEC staff.”
A spokeswoman for Five Star Senior Living declined to comment.
Write to
Tatyana Shumsky
at
tatyana.shumsky@wsj.com