When Non-GAAP Reporting Meets FCPA

Maxwell Technologies reported its second-quarter earnings yesterday with this nugget: the company reported non-GAAP net income 46 percent higher than its GAAP-approved net income—and listed FCPA investigation costs as one of the adjustments it made to get that higher number.

The adjustment, all of $62,000, didn’t help much. Maxwell reported a net loss of $10.1 million for the quarter, and its various adjustments still left the company with a non-GAAP loss of $5.48 million. That’s 46 percent better $10.1 million, but still a loss. Listing residual costs of its FCPA probe, as well as costs related to a separate SEC probe after a financial statement, do little more than catch the eye of compliance industry analysts like me.




First, the history of Maxwell’s FCPA trouble. The company makes batteries and other energy storage equipment. In 2011 it agreed to pay $8 million to the Justice Department and $6.3 million to the SEC, to settle charges that a Swiss subsidiary bribed government officials in China to win equipment contracts. Maxwell executives knew about the offending activity as early as 2002, which lasted until 2009. The company also had a three-year deferred-prosecution agreement.

Then there’s the financial restatement. Maxwell had to restate results for 2011 and 2012, cutting recognized revenue by $19.2 million (although $2.5 million of that was money mis-classified, so the “real” revenue loss was only $16.7. million). The company didn’t complete that restatement until 2013.

Give credit to the company for consistency: Maxwell has disclosed its FCPA and restatement costs quarter after quarter, and then counted them as one of its multiple adjustments to arrive at non-GAAP net income—which, as one would expect, always looks better than “traditional” GAAP net income.

Can Companies Do That?

Yes. Adjusting net income is nothing new; companies do it all the time, and litigation costs are one of several primary reasons to adjust.

Calcbench did a study of more than 800 firms last year that reported non-GAAP net income. Those firms made a total of 4,630 adjustments, and “legal” accounted for roughly 7.5 percent of that number. In dollar terms, that category accounted for 1.6 percent of the $164.1 billion in total adjustments. (Merck, for example, made a $680 million adjustment last year to exclude the costs of Vioxx litigation from its net income.)

Still, for compliance officers, seeing a non-GAAP adjustment that specifically cites the FCPA is like one of those crossover nights between episodes of Chicago Fire and Chicago PD. They happen, but you don’t see them often. So I went back to Calcbench (disclosure: I do some paid writing and research for the company) to see how often companies do cite the FCPA as an adjustment to net income or operations.  

Thirteen companies cited the FCPA in their earnings releases for fiscal 2016. Sometimes that made sense. For example, Och-Ziff reported “non-GAAP economic income” that excluded the $412 million it paid to settle FCPA charges last September: a big, one-time charge that Och-Ziff won’t be paying again, even if residual costs linger for some time. You need to hunt for that line item, which is deep in Och-Ziff’s reconciliation of non-GAAP net income back to GAAP income; but it’s there, and it’s appropriate.

A different example is Avon. The company settled FCPA charges for $135 million in fines and penalties in late 2014. It made a one-time payment of $67 million to the SEC in early 2015. So Avon had to note in its 2016 report that the absence of that payment boosted cash from operations last year—but it only did so in a written footnote, rather than the line-by-line, tabular presentation that Maxwell has been making.

PTC splits the difference. The company took an adjustment of $3.2 million for “legal accrual” in its 2016 report—one of 10 adjustments PTC made, to turn a GAAP loss of $54.5 million into a non-GAAP profit of $137.8 million. Only in its written footnotes did PTC disclose that those “legal accrual” costs stem from its FCPA settlement ($28 million, announced February 2016). We don’t know whether those FCPA costs accounted for the entire $3.2 million accrual.

Rules for Non-GAAP Adjustments

You might remember that fretting about non-GAAP adjustments was all the rage in 2016. The SEC and the PCAOB convened task forces to examine the issue, and the SEC published a refresher on non-GAAP reporting rules in May 2016. (A better treatment of the subject is a speech that SEC chief accountant Wes Bricker gave on the subject that same month.)

non-gaapWe even had a wave of concern that the SEC would begin enforcing Regulation G, which governs non-GAAP reporting. Mostly that “enforcement” has been SEC comment letters about non-GAAP metrics, and if the company can defend its logic behind those non-GAAP adjustments, life goes on.

That brings us to the spirit of what non-GAAP adjustments are all about, and when adjusting for FCPA probes makes sense.

The SEC’s paramount concern is that non-GAAP adjustments make sense and give investors a true sense of the company’s financial operations. So if you do have an FCPA-related cost that is a material amount of money and isn’t likely to recur (see Och-Ziff, above; or even PTC, despite its language switcheroo), that’s a good case.

That said, another SEC concern is that companies not change up their adjustments willy nilly, to bamboozle investors too inattentive to notice a less-pleasant GAAP net income number elsewhere in the earnings release. If you’re going to make an adjustment to net income, generally you need to stick with that category of adjustment quarter after quarter; investors need constancy even with non-GAAP net income. (Or when you do change your calculation of non-GAAP net income, you need to explain that change clearly.)

That might be what drives Maxwell’s continued use of FCPA costs as an adjustment to net income. The amounts don’t seem to be material now, but they may have been in the past.

And this situation does raise questions about why Maxwell still has residual FCPA and restatement costs, years after the restatement and years after its DPA ended. (I didn’t listen to Maxwell’s earnings call yesterday to see if the subject came up.) Companies aren’t wrong to complain that FCPA enforcement can lead to costs that linger in the legal or compliance department budgets like zombies, never completely dying off.

That, however, is a post for a different day.

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