Oh Look, A Non-GAAP Warning
The SEC has long cast a skeptical eye toward the non-GAAP financial disclosures that companies like to report to investors. Now we have an example of the SEC warning a company that its non-GAAP numbers are too vague, in case any financial reporting enthusiasts out there want to heed that lesson as you compile your own line items.
The company in question is Premier Inc., a healthcare technology and purchasing business based in North Carolina that had about $1.7 billion in net revenue for 2021. Premier received a comment letter from the SEC several weeks ago about how it used a blandly named “Other expense, net” line item while reconciling adjusted EBITDA to traditional GAAP financial metrics the company had included in its Management Discussion & Analysis. (Credit to the research team at Calcbench.com for first noting this comment letter.)
Simply put: Premier used “Other expense, net” three times in those reconciliations, and gave that line item a different value each time. That enters a financial reporting no-fly zone; one shouldn’t use the same term for different amounts unless you clearly explain the different sub-totals that go into each one.
See Figure 1, below, for an example. In the top half, Premier is reconciling an adjusted EBITDA of $473.2 million to net income from continuing operations of $304.6 million, where “Other expense, net” is listed as $8.2 million. In the bottom half, however, where Premier is reconciling that same adjusted EBITA to income before income taxes, the “Other expense, net” adjustment is listed as $7.42 million.
Further down the MD&A, Premier reconciles its adjusted EBITDA to net income attributable to stockholders, and this time lists “Other expense, net” as $15.52 million.
The SEC staff reviewing Premier’s 2021 report quickly noted those discrepancies, and fired off a comment letter on May 11 asking Premier to explain what’s included in each line time and “why you have used the same name for an amount that apparently represents different items.”
The letter then tartly concluded with, “We remind you that the company and its management are responsible for the accuracy and adequacy of their disclosures.” This loosely translates from SEC-speak into, “Go clean up your room. We do have the Enforcement Division at the top of our speed dial, you know.”
The Bigger Picture of Non-GAAP
There is nothing inherently wrong with reporting non-GAAP financial metrics to investors; many times, those non-GAAP metrics provide nuanced views of corporate operations that traditional GAAP disclosures don’t capture. The issue is how a company presents its non-GAAP metrics, and how it explains to investors where those non-GAAP numbers came from.
Regulation G of federal securities rules governs how companies can use non-GAAP metrics. The three main points are these:
- A company can’t over-emphasize non-GAAP metrics in the headlines and other statements of an earnings release, to distract investors from a GAAP corresponding GAAP metric that might paint a less flattering picture of performance.
- A company must use the same non-GAAP metrics over time, and calculate those numbers in the same way; no juggling disclosures from one quarter to the next or changing how you do the math.
- All non-GAAP metrics must be reconciled back to the nearest corresponding GAAP metric, such as adjusted net income reconciled to net income.
Of those three criteria, Premier’s questionable use of “Other Expense, Net” comes closest to that third requirement to reconcile your non-GAAP metric back to its closest GAAP counterpart. You can’t easily do that when you use the same term for multiple line items without further explanation to investors.
To be clear, an SEC comment letter is not an SEC enforcement action. Indeed, we seldom see SEC enforcement action over sloppy non-GAAP reporting at all, although it does sometimes happen.
One of the first SEC enforcement actions for misleading non-GAAP reporting was against none other than Donald Trump, sanctioned in 2002 for shenanigans with his Trump Hotels & Casino Resorts business. (Cease-and-desist order only; no monetary penalty. Typical toothless punishment for The Former Guy.) More recently, the SEC filed non-GAAP enforcement actions against BGC Partners and Bausch Health Cos. in 2020. So the SEC does take action against non-GAAP abuses, even if rarely.
Filed under: Mind the Non-GAAP.
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