The “Big News” first. We just calendared a webcast – “Non-GAAP Disclosures: Corp Fin Speaks“ – featuring Corp Fin’s Chief Accountant Mark Kronforst & Dave Lynn. They will discuss what companies are doing – and should be doing – in the wake of the first year’s worth of Corp Fin comment letters since last year’s CDIs.
Anyway, some may be inclined to grumble about how Corp Fin is scrutinizing the way companies use undefined non-GAAP terms, but I think most people would prefer that scrutiny to the NY US Attorney’s approach – sending a CFO to jail for using an undefined non-GAAP term in an allegedly fraudulent way.
Adjusted funds from operations – “AFFO” – is a widely used non-GAAP metric among REITs, but the Staff hasn’t provided any guidance on how it should be calculated. Last month, the former CFO of American Realty Capital Partners was convicted of fraud for the way in which his company used this metric – an outcome that this Forbes article says amounted to “rule-making for the SEC on materiality by criminal indictment and conviction.” Here’s an excerpt:
The SEC has not issued a specific rule or guidance as to how an issuer should calculate the AFFO metric. And, there is no regulatory guidance as to how Mr. Block should have made the reconciliation. There has been a lot of demand for the SEC to do more rule-making in this space. Possibly, this verdict will result in a louder cry for rule-making. Meanwhile, the verdict is a warning shot across the bow for corporate officers publishing and discussing non-GAAP metrics.
Regardless of the merits of this criticism, the case is a reminder that non-GAAP disclosures are subject to close scrutiny – and not just by the SEC. In the current environment, companies & officers should not expect to be cut a lot of slack by the SEC – or federal prosecutors – for “creativity” in how undefined non-GAAP metrics are used.
Non-GAAP: Corp Fin on “Free Cash Flow” Use
This recent MarketWatch article says that Corp Fin is scrutinizing companies’ use of “free cash flow” as a non-GAAP measure – and “has warned more than 20 companies in the last six months about their potential misuse use of the non-standard metric “free cash flow.”
Actually, this kind of warning from Corp Fin goes back far beyond the May 2016 CDIs, as that language dates back to June 2003 FAQs. We believe that the Staff has been issuing comments about how FCF is calculated for nearly 15 years with no change. The Staff did add a single – and obvious – sentence to that 2003 guidance, but it was not for a widespread problem. Corp Fin added: “Also, free cash flow is a liquidity measure that must not be presented on a per share basis.”
While free cash flow refers generally to operating cash flow less “cap ex,” it doesn’t have a standard definition. Despite that, it’s a metric that investors really like. As this Fredrikson & Byron blog points out, that combination of factors may be the reason for the Staff’s close watch on the way companies use it.
Non-GAAP: Corp Fin (Once) Said “Tone it Down”
In other non-GAAP news, in this article, the WSJ reported that Corp Fin told one major airline to tone down the praise of a non-GAAP measure. Here’s the Staff’s comment letter – which notes that the comment also applies to the company’s earnings releases. Here’s an excerpt from the WSJ article:
American Airlines Group removed certain “descriptive language” from its financials at the behest of the Securities and Exchange Commission, according to recently released correspondence. The regulator directed the airline to stop telling investors that numbers inconsistent with standard accounting were “more indicative” of company performance and “more comparable” to metrics reported by other major airlines. American Airlines, in an April 3 letter to the SEC, said it would drop the references from its future filings and replace them with language that describes adjusted measures as useful to investors.
Note that this clearly is not a trend – it would not surprise us at all if that was the only comment of its kind. The Staff did indeed say “tone it down” – but I’m not sure how much that matters if they did it once – or even a handful of times. We’re not hearing much in the way of a broad warning about this kind of thing when the Staff is out speaking.
Don’t forget to tune into our September 13th webcast – “Non-GAAP Disclosures: Corp Fin Speaks” – featuring Corp Fin’s Chief Accountant Mark Kronforst & Dave Lynn. They will discuss what companies are doing – and should be doing – in the wake of the first year’s worth of Corp Fin comment letters since last year’s CDIs.
– John Jenkins