Thursday, December 27, 2018

Here’s something you don’t see often: the Securities and Exchange Commission rapping a company on the financial knuckles for violations of non-GAAP reporting.

The agency hit ADT (yes, the home security people) with a $100,000 fine for poor disclosure relating to ADT’s financial statements for fourth-quarter and full-year 2017, plus first-quarter 2018. Specifically, ADT “did not afford equal or greater prominence to comparable GAAP financial measures” — which violates federal securities rules.

What exactly did ADT ($ADT) do? According to the SEC’s administrative order, ADT’s non-GAAP metrics it reported in 2017 included adjusted EBITDA, adjusted net income, and free cash flow before special items. None of those measures are improper unto themselves, if a company also reports the closest comparable GAAP measure with equal prominence. That equal prominence part is what ADT didn’t do.

For example, in the headline of ADT’s FY 2017 earnings release, the company proudly said that adjusted EBITDA was up 8 percent year-over-year (yay!) but omitted the detail that net income (the closest GAAP metric to adjusted EBITDA) was actually down for the same period. ADT did the same with the headline of its Q1 2018 earnings release.

ADT had a second non-GAAP indiscretion in its Q1 2018 earnings release, too. Aside from the headline issue, ADT then listed “FIRST QUARTER 2018 HIGHLIGHTS” on the first page of the earnings release, followed by nine bullet points. Three of those bullet points reported non-GAAP metrics: adjusted EBITDA, adjusted net income, and adjusted net income per share.

ADT did not, however, also include the closest comparable GAAP metrics right there in the bullet points (or, “the HIGHLIGHTS section,” as the SEC said in its settlement order). Only further down in the second and sixth full paragraphs did ADT report that its net loss grew from $141 million in Q4 2017 to $157 million in Q1 2018.

Earnings Releases and Calcbench

Calcbench does track earnings releases from SEC registrants. Subscribers can find earnings releases in our Interactive Disclosures database, by selecting the Earnings Release choice from our pull-down menu of disclosures on the left-hand side of the screen.

We pulled up ADT’s Q1 2018 earnings release to take a look. The offending headline and bullet points (also known as “HIGHLIGHTS”) are in Figure 1, below.

To the untrained and uncynical eye, those HIGHLIGHTS do look good. Only in the second paragraph, as the SEC noted, do we see the statement that net income was actually a net loss, and the net loss was getting larger.

Worry about the proliferation of non-GAAP was all the rage in 2016, and on this blog we’ve chronicled several non-GAAP enforcement actions by the SEC since then. Still, non-GAAP reporting is permissible under SEC rules, and is widespread among the S&P 500. The three crucial reporting principles are that a company: (a) explain why it believes its non-GAAP metric is worth including; (b) also reconcile that non-GAAP metric to the closest GAAP metric; and © give both GAAP and non-GAAP disclosures equal prominence in the earnings release.

For those of you who want to geek out on our prior non-GAAP discussions, feast on this:

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