By Tatyana Shumsky
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
(END) Dow Jones Newswires
May 23, 2017 02:47 ET (06:47 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
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