Experts Say Use Non-GAAP Measures Carefully

Normalized adjusted EBITDA less capex. Adjusted consolidated segment operating income. Adjusted EBITDA (as adjusted). Even enthusiasts of non-GAAP metrics have to admit that such measures often sound just a wee bit ridiculous.

Non-GAAP metrics, those not addressed in U.S. generally accepted accounting principles, are as controversial as ever. A small number of such measures, like EBITDA and free cash flow, have gained widespread acceptance in the investor community. But regulators often give companies flak for the way they use non-GAAP measures in public filings, press releases and other communications consumed by investors and analysts.

Groupon, the perpetrator of “adjusted consolidated segment operating income” (ASCOI), took heat from the Securities & Exchange Commission in 2012 because the metric excluded online marketing expenses, a critical part of the firm’s business model, from company performance. Groupon eventually dropped the metric from its initial public offering filing, but it absorbed further criticism for its post-IPO use of other non-GAAP measures.

Black Box, a telecommunications company, got some bad press in January 2013, when it included the metric “adjusted EBITDA (as adjusted)” in its quarterly earnings release. The metric subtracted from net income ordinary expenses such as a $2.7 million loss on a joint venture, creating EBITDA (as adjusted), then further excluded stock-based compensation expenses to create the final, rather silly-sounding redundancy. Black Box said the measure demonstrated its ability to service its debt. Others thought it made the company look like well, a black box.

A common opinion is simply that non-GAAP metrics are misleading to shareholders. “They may be perfectly understandable to accountants who know what that company is doing but confusing to others,” says Michele Amato, partner at accounting firm Friedman LLP. Indeed, the SEC has long subjected companies that use non-GAAP metrics to heightened scrutiny, and the chairman of the commission’s new accounting-fraud task force has vowed to keep up the pressure.

But companies that use these black-sheep metrics argue that they often depict financial performance more accurately than GAAP measures and afford investors a window to how management sees things.

Public companies are allowed to disclose non-GAAP metrics in their SEC filings, press releases and earnings calls, subject to certain rules. Under Regulation G, mandated by the Sarbanes-Oxley Act, use of a non-GAAP financial measure must be accompanied by the most directly comparable GAAP measure and a reconciliation of the two metrics.

Everything in Moderation

For her part, Amato says there’s a place for non-GAAP metrics:

 “A very significant variance between GAAP and non-GAAP metrics that management uses as a baseline for internal financial analysis might be of some use,” 

There is nothing wrong with using a non-GAAP metric to provide an additional perspective about something very germane to the company’s performance, like its valuation, credit standing or working-capital management, that can’t be communicated well through GAAP metrics alone, says Robert Rostan, CFO and principal at financial training firm Training the Street.

Original article by Marielle Segarra ad CFO.com

Is the Smartest MD&A the One With the Most Jargon?

“Plain English Works” in MD&A Statements

Those who prepare MDAs don’t have to prove how smart they are by using financial jargon, suggests the SEC’s ex-corporate finance director.

Excessive financial jargon in documents filed with the Securities and Exchange Commission often clouds intended messages, said speakers at an American Institute of Certified Public Accountants conference this week.

The sentiment particularly applies to the Management’s Discussion and Analysis (MD&A) section of quarterly and annual reports and other registration statements, where companies generally discuss their business, uncertainties, and market trends.

“Everyone likes to prove they’re the smartest person in the room because they understand the jargon,” said Brian Lane, partner in the Washington, D.C., office of Gibson Dunn & Crutcher and former SEC director of the division of corporate finance. “Plain English works.”

The best MD&As have “more tables and less jargon,” Lane opined. Tables, he noted, are easier to understand than mounds of text. In the text, companies often include too many comparisons going back several years, which is often unnecessary and even confusing, he said. It’s better to show simple comparisons between this year and last year in both the text and tables, and include information on other years just in tables.

Making sure MD&As are as readable and informative as possible may ward off or lessen the impact of SEC inquiries, Lane added. One key to doing that: in all areas of focus within the section, answer the question “why?” he said.

Actually, having more tables in financial reports is a widening theme. The Financial Accounting Standards Board made a push in that direction this past summer, requesting comments on a proposal calling for nonfinancial companies to disclose expected cash-flow obligations in a table segregated by time of expected maturity.

For one, Katherine Gill-Charest, controller and chief accounting officer at Viacom, should be prepared if the proposal is approved. She already is including more than the usual amount of detailed information in the company’s MD&A statements. To facilitate that, she holds “working meetings” with members of Viacom’s disclosure committee a couple of times a year, instead of having just one formal meeting at reporting time to head off any questions that might arise from the SEC. She also meets with the CFOs of Viacom’s divisions to be aware of pertinent issues in preparing MD&As.

For example, the SEC repeatedly has asked for information on how Viacom plans to fund its $10 billion share-repurchase program. Other questions come when an SEC official hears of a trend during an earnings call that is not included in the MD&A.

Lane supported that use of a firm’s disclosure committee. A good item to discuss with that committee, for example, is “cash runway,” a measure of how long a company’s cash on hand will last, he said. A hoard of $300 million in cash is not actually that much if the company is burning through it at $90 million a quarter.
Knowing what questions the SEC may have raised with competitors is important, too.

 “If I know a peer of mine has gotten reviewed, we will always take a look at the SEC’s comments,” said Gill-Charest, noting that she treats any correspondence between a competitor and the SEC as if it were her own document.

That made sense to Lane:

“You do need to see what competitors and peers are disclosing, because the SEC is going to look at you in that same lens,” he said.

One area where some companies could ease up is their heavy use of forward-looking disclosure statements.

“Projections are not required in [the] MD&A,” said Lane. “You [just] have to talk about known uncertainties and how they could impact the future.”

By Kathy Hoffelder  at CFO.com

FASB vs IASB: Split on Lease Accounting

The US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) failed to reach a consensus for new lease accounting guidance Wednesday but vowed to continue working together in pursuit of consistency.

During two days of meetings at FASB’s headquarters in Norwalk, Conn., the boards failed to reach common answers on key areas of lessee and lessor accounting. In particular, the IASB favored a single approach for lessees for recognition of all leases, while FASB voted for a dual-recognition approach for lessees, depending on the type of lease.

The boards issued a joint statement saying they had agreed on areas such as lease term and short-term leases. The boards also pledged to continue working together on the standard.

“While differences remain, most notably in their preferred approaches to expense recognition, the boards are committed to working together to minimize these differences and to creating greater transparency around lease transactions for the benefit of investors worldwide,” the boards said.

The boards are attempting to create a converged standard that would eliminate a hidden liability for lessees by bringing leases onto corporate balance sheets. But they have struggled to agree on how to do it.

No consensus for lessee accounting

IASB members this week expressed a preference for lessees to account for all leases as the purchase of a right-of-use asset on a financed basis. In this “Type A” approach, a lessee would recognize amortization of the right-of-use asset separately from the interest on the lease liability for all leases.

FASB members preferred a dual-recognition approach for lessees that would use a Type A interest-and-amortization method for leases classified as capital leases under existing guidance, and a “Type B” single, straight-line lease expense for operating leases.

But there may still be a chance for convergence on this issue. FASB Chairman Russell Golden asked the FASB staff to work with the IASB staff to conduct research that would help the boards understand the effects of a possible exception that would permit preparers not to apply the proposed standard’s requirements to leases of small, nonspecialized assets.

The IASB voted for the so-called small-ticket exception, while FASB voted against it. Golden asked for the staff research in hopes that a better understanding of the exception could lead to convergence, which could cause the boards to agree on a preferred method of expense recognition.

FASB member Tom Linsmeier said he would be more inclined to consider the Type A-only approach for lessees if the boards abandon the small-ticket exception.

Sticking point for lessor accounting

On lessor accounting, meanwhile, the boards agreed to keep standards similar to current guidance but couldn’t agree on one important detail. They agreed that lessors should classify their leases as Type A or Type B based on whether the lease is effectively a financing or a sale rather than an operating lease.

But the IASB preferred to make that determination by assessing whether the lessor transfers substantially all the risks and rewards incidental to ownership of the underlying asset.

FASB preferred to make the leases guidance consistent with the requirements for a sale in the soon-to-be-issued revenue recognition standard. FASB’s approach would preclude recognition of selling profit and revenue at lease commencement for any Type A lease that does not transfer control of the underlying asset to the lessee.

The core principle of the new revenue recognition standard will be that revenue should be recognized to depict a transfer of promised goods or services to the customer.

Despite the disagreement on lessor accounting, some IASB members said they could accept the FASB approach, with IASB Chairman Hans Hoogervorst holding a “swing vote” that Golden suggested could move the lessor accounting decision to a converged answer in the future.

Before the boards parted, Golden thanked IASB members and said the boards ought to work together on the definition of a lease, disclosures, and other aspects of the leases proposal.

“We will continue to work together to improve accounting in this area, to continue to meet our objective,” Golden said, “and I hope to continue to minimize any differences.”

The boards have been working since 2006 to come to agreement on a leases standard. Their second exposure draft on the topic, issued in 2013, caused many preparers and some investors to question the benefits of the information—and the costs—the proposal would have generated.

By Ken Tysiac at JofA

IFRS To Run Out of Money?

The International Financial Reporting Standards (IFRS) Foundation’s role in governing global accounting rules is under threat after European politicians said they were questioning whether the authority was “best suited” to the position.

The London-based authority, responsible for setting standards in 100 countries, has been severely criticised by MEPs for poor governance structures, a lack of transparency and its “close links to the accounting industry”.

Last week the European Parliament approved a new £50m five-year funding programme for the IFRS’s standard setting arm, the International Accounting Standards Board (IASB).

However, MEPs attached a series of conditions to the deal and warned if they are not met, the funding could be stopped in a year’s time.

Sharon Bowles, chairman of the influential European economic affairs committee and a Liberal Democrat MEP, said: “Questions have been raised by the European Parliament about the governance structures and lack of transparency of these bodies, as well as their close links to the accounting industry.

"The release of these EU funding streams will therefore only be forthcoming upon sufficient reform to prevent conflicts of interest, which will bring about much-needed trust and scrutiny on how these highly influential public bodies operate.”

Syed Kamall, a Tory MEP for London, who has raised concerns about the IFRS rules, said: “I am not convinced that it was right for the EU to outsource standard-setting to what is, in effect, a private sector body funded by public money.”

A spokesman for the IFRS Foundation said:

 “The foundation takes seriously any such concerns and has already begun planning its constitutionally-required five-year review of its structure and effectiveness, to be undertaken during 2014, and we welcome any proposals to improve aspects of our work.”

The MEPs’ concerns about the IFRS Foundation’s governance were raised after The Telegraph first highlighted errors in the authority’s filings at Companies House in February. However, the politicians are also concerned IFRS accounting standards are seriously flawed.

Last year a group of British investors wrote to Michel Barnier, the EU’s internal markets commissioner, warning him that the accounting rules were harming shareholders and destabilising the economy. They argued that the IFRS rules, introduced in the UK in 2005, had allowed companies, and banks in particular, to hide the build-up of risks on their balance sheets.

The European Commission has said it will launch a review of the IFRS rules.

By Louise Armitstead, the Telegraph

11 Issues to be Aware of for Your Next Shareholder Meeting

U.S. public companies are operating in an environment full of both risk and opportunity as they prepare for their annual shareholder meetings.

Cyberthreats, disaster planning, and political and economic unrest are among many factors that make the current climate hazardous for many companies.

Although high values in the stock market indicate an environment that has improved significantly—if slowly—since the lowest depths of the global financial crisis, recent dips in the market indicate that volatility still exists.

Shareholders are likely to be focused on both the risks and the opportunities in upcoming shareholder meetings, according to Wendy Hambleton, CPA, a partner in the corporate governance practice who also heads up the SEC practice at BDO.

“There is still that overriding sense of still coming out of that economic downturn, whatever you want to call the period from 2007 to 2009,” Hambleton said. “I think people are cautious, so they want companies to be cautious and prudent with their funds. I don’t think people are pushing as much for huge growth as they are for measured growth and maybe a little more secure growth.”

Against this backdrop of risks and a desire for secure growth, BDO has compiled a list of issues in a news release that corporate management and boards of directors should be prepared to discuss with shareholders in connection with annual meetings this spring:

- M&A opportunities and takeover defenses. Is management seeking M&A opportunities? Are potential targets properly vetted to prevent buyer’s remorse? And are boards poised to fend off unwanted takeovers and maximize shareholder value if a transaction is accepted?

“We are seeing more M&A activity,” Hambleton said. “A lot of companies have some cash on hand, but I think everyone wants to be cautious to make sure plenty of due diligence is done, that it’s the right transaction, that it makes sense, no one is rushing into deals”

- Spinoff advocacy. Management and the board need to be prepared to respond to well-funded, activist shareholders who have the potential to try to break up companies, according to BDO. This can be a costly exercise, Hambleton said.

“If you’ve got activist shareholders making suggestions and urging the company to take certain actions, that takes a lot of time and in some cases dollars that the company might have wanted to use in an alternative way,” she said.

- Global economic concerns. Investors are concerned about how the crisis in Ukraine and slowing growth in China, Brazil, Japan, and other markets will affect the global economic recovery, according to the news release. Shareholders may ask about how prepared the company is to deal with a serious economic collapse in a certain country or region.

The crisis in Ukraine demonstrates that problems can occur in unexpected places, Hambleton said. And emerging markets pose different political and economic concerns than more mature markets such as the United States, Canada, and Western Europe, according to Hambleton.

“That’s not a reason not to go into those markets,” she said. “It’s just a reason to go in from a measured perspective. And from a shareholder perspective, that’s what people want to see is a measured perspective, that people are thinking about the risks, thinking about the concerns, and then taking a measured response to that.”

- Cybersecurity. Headlines about numerous high-profile breaches are certain to have shareholders’ attention, and companies should be prepared to explain their approach and their defenses. Hambleton notes:

“Companies need to be able to explain to shareholders—without getting into the minutiae of the details and what they do—how they monitor, what kind of controls they have in place,”  

“Have they looked at refreshing their risk management approaches in this area? How often do they do certain types of monitoring activities?”

- Executive compensation. Performance-focused compensation models at public companies have gained favor in the wake of new avenues for shareholder feedback, according to the news release.

Since regulations do not require disclosure of the relationship between pay and company performance, it appears that an emerging consensus is that disclosures should report how the company’s total shareholder returns relate to the CEO’s realizable pay, BDO said. Shareholders will ask more questions when the executives are compensated handsomely while the company struggles, Hambleton said.

- Succession planning. An improving economy may create more opportunities for executives to change jobs. This could cause shareholders to ask whether the board has a succession plan and has identified candidates for CEO and other key positions. Surveys have shown that board members are interested in this issue, Hambleton said.

“If it’s something board members would want to spend time on, you’d think it’s something shareholders care about, too,” she said.

- Accessing public equity markets. In 2013, total U.S. initial public offerings and proceeds raised reached their highest levels since 2000, according to BDO. This may lead shareholders to wonder whether management is considering new securities offerings.

“Certainly, a good IPO market is an opportunity for companies that may be looking at spinning off either their noncore businesses or businesses that maybe would perform better in a separate company rather than as part of the overall conglomeration,” Hambleton said.

- Disaster planning. Events such as Hurricane Sandy in the United States and Typhoon Haiyan in the Philippines have caused tragic losses of human life and disrupted supply chains and operations. Shareholders may want to know if businesses have backup plans that will minimize the effects of such events.

For example, Hurricane Sandy showed that backup servers located far apart on the same coast may be vulnerable to the same storm.

“No one probably envisioned a storm that would start where it did and go all the way and cause so many blackouts that we need to have [servers] on opposite coasts or in the middle of the country or something like that,” Hambleton said.

- New COSO framework. Shareholders may want to know if a company has updated its system of internal control to reflect the guidance in the updated 2013 framework of the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

“I wouldn’t expect there to be significant changes to companies’ assessments,” Hambleton said. “But the new framework does have more particular guidance built into it, so I think some of the controls and the mapping will need to change. There will be some work to do. Hopefully, some enhancement of controls will come out of it.”

- Conflict minerals. New SEC rules require public companies to report to the SEC whether their products contain certain minerals produced in mines in the Democratic Republic of Congo. In some cases, those mines are run by warlords who oppress residents of the region. Although some companies may be behind in gathering information needed to report on these minerals by the May 31 deadline for the 2013 calendar year, Hambleton said shareholders will have a wider perspective.

“They’re going to want to know if [the company is] going to have to report that they use conflict minerals,” she said. “And that gets into the whole question of sustainability and corporate social responsibility with companies.”

- Auditor tenure. Mandatory audit firm rotation no longer is part of the PCAOB’s agenda afterlegislative pushback on the issue, but BDO said management and audit committees should be prepared for shareholders to ask about the length of their auditor’s tenure and their process for hiring their auditors.

“If you’re an audit committee member, you will have heard the discussion, and you need to be prepared to answer the question, what consideration did they give,” Hambleton said. “Not that they should be making a change, but what consideration did they give to it?”

By Ken Tysiac Journal of Accountancy.

 

SEC Comment Letter Watch -- Segment Reporting

Segment reporting is one of the SEC's most common areas of comment. The SEC often asks for specifics of documents that the Chief Operating Decision Maker (CODM) reviews on a regular basis. Companies need to be cautious when answering similar questions since the next request from the SEC might be "please provide us with all regular reports that the CODM review on a regular basis." If the SEC sees something different in those CODM reports from the answer provided previously, that spells trouble. Here is a sample from a letter to Charter Communications:

SEC's question:
We note your response to comment 4. Please provide us additional information about all of the “certain operating metrics”, such as “CPE” and plant maintenance, that management, in particular the CODM, relies on to assess performance and allocate resources.

Describe for us what these non-financial business and operational data represent, at what level of detail does the CODM review them (e.g.KMA or lower), and how the CODM uses them to assess performance and allocate resources.

Company's answer:
Our CEO, as CODM, receives and reviews information at the consolidated level, whether financial or non-financial in nature, and uses that information to assess performance and allocate resources on a consolidated basis. The CEO routinely receives consolidated operating metrics that include customers by product (video, Internet, and phone), sales and disconnects by product, customer net gains, penetration of estimated passings, bundled customer statistics, sales channel performance, call center and truck roll statistics and headcount. In addition, the CEO receives certain statistics related to the quality of physical transactions occurring at a local level, specifically truck roll data and ratios which use the number of customer connections, disconnections and average customers by service to calculate service level ratios. These statistics assist with the review of activity in the field at the local level, but are not the primary data used for resource allocation. Our CEO makes resource allocation decisions to specific operating strategies that impact the performance of the consolidated company. Furthermore, he assesses the performance of the Company on a consolidated level as a result of the implementation of the company-wide operating strategies. The execution of those strategies is carried out by levels below the CODM.

Resources allocated to our strategic initiatives of enhancing the customer experience and increasing customer growth are driven on a consolidated basis by our CODM. One such example would be CPE procurement, which is budgeted based on a certain number of connects and devices per connect, both estimated for the entire company. Consequently, CPE is purchased on a company-wide basis in order to maximize scalability during negotiations with our vendors and to meet estimated connects on a company-wide basis. Plant maintenance is another example. The allocation of corporate resources to plant maintenance is based on the strategy to improve the performance and reliability of the network. Levels below the CODM are then tasked with execution of the strategy and ensuring resources are provided where they are needed. A third example is our strategy of our all-digital network roll-out. Again, the amount of resources required for the all-digital roll-out is based upon an allocation of resources to implement the roll-out company-wide. In executing the all-digital roll-out, managers below the CODM carry out the initiative within our footprint based upon the potential immediate impact on our customers. Other overall resource allocation examples include, but are not limited to, implementation of a back office system to support customer growth or a decision to change the type of modem used, both of which would be on a company-wide basis.

Cleaning Up OCI

Accounting ‘Dumping Ground’ Headed For Clean Up

International accounting rulemakers may focus on cleaning up rules for “other comprehensive income,” a category in a company’s earnings statement that can obscure the true profit and loss picture, the chairman of the International Accounting Standards Board said this week.

The board may restart its efforts to improve financial statement presentation guidance in this area and bring more “discipline” to the way companies decide what is classified as profit and loss or other comprehensive income, IASB Chairman Hans Hoogervorst said in a speech in Tokyo.

More than 100 countries use International Financial Reporting Standards, which are set by the IASB. The U.S. does not use them for domestic companies, but allows foreign companies to file their results with U.S. regulators under these standards. U.S. multinational companies often have to use these standards for foreign subsidiaries.

Other comprehensive income, which includes items initially excluded from net income in a particular accounting period, has gotten a reputation as a sort of dumping ground where companies are allowed store information that would be too damaging to earnings.

For example, he said passing employee benefit expenses through other comprehensive income, rather than earnings, has dis-incentivized companies from dealing with large liabilities head-on.

“In the last decade, some big American car manufacturers and airline companies were brought to their knees by employee benefits that had been building up over the years,” Mr. Hoogervorst explained. Such liabilities may not have been taken as seriously because they were in other comprehensive income, he said.

The other comprehensive income figure is crucial because it can distort common valuation techniques used by investors, such as the price-to-earnings ratio. If the profit and loss statement and earnings are the primary indicators of a company’s performance, they need “to be robust and tinker-free,” Mr. Hoogervorst said.

Mr. Hoogervorst said he’d been approached by Japanese accounting stakeholders about improving and clarifying other rules, as well as differences of opinion from other countries, such as Canada.

In an interview with CFO Journal, Dr. Nigel Sleigh-Johnson, head of financial reporting for the Institute of Chartered Accountants of England and Wales said Thursday, “At the moment there is no clear and consistent basis for,” other comprehensive income.

Accounting rulemakers should try to make it easier for companies to decide what items need to be recognized in profit and what has to go into other comprehensive income, he said.

The U.S. Financial Accounting Standards Board has also been working to clarify rules for other comprehensive income in the past few years and make the rules more transparent to investors.  The board issued new guidance on how companies should present the figures in 2011 and updated accounting standards on items reclassified out of accumulated other comprehensive income last February.

 Article by Emily Chasan, at the Wall Street Journal