Tuesday, January 26, 2021

Today Calcbench has a guest post from Olga Usvyatsky, doctoral student in accounting at Boston College and a long-time whiz at financial disclosures.

Last summer we had a post exploring how companies adjust their EBITDA metrics to account for COVID-19 costs. We identified a sample of more than 40 companies that chose to present pandemic-related costs as a separate line in the reconciling non-GAAP tables, and noted that in many cases, the adjustments were related to direct pandemic-related expenses such as protective equipment.

That was then. What’s been happening lately? Lots.

In December 2020, the SEC’s Division of Corporate Finance clarified that it wouldn’t object to the presentation of COVID-19 adjustments, so long as those costs were directly attributable to the pandemic and certain other conditions were met. Notably, SEC staff warned that adjusting for lost revenue would not be appropriate.

Meanwhile, companies continued to present non-GAAP COVID-19 expenses in third-quarter 2020, but the magnitude of those adjustments appeared to decline. For example, T-Mobile US ($TMUS), a wireless network operator that we looked at in our June blog, disclosed $117 million in Covid-19 costs in first-quarter 2020, and another $341 million for the second quarter. By Q3, however, T-Mobile said that “employee payroll, third-party commissions, and cleaning-related COVID-19 costs were not significant for Q3 2020.”

Non-GAAP metrics need to be presented consistently across periods (see Question 100.02 in the SEC’s Compliance & Disclosure Interpretations). Yet, changes in economic conditions or certain company-specific developments may prompt companies to modify the presentation and introduce new metrics or adjustments. So, what were the non-GAAP modifications introduced in 2020?

The first adjustment we looked at was related to the U.S. Treasury Department’s extended Payroll Support Program (PSP) established in early 2020 to provide payroll support to airline carriers. The relief provided by the program was material to many (if not all) of the airlines, whose business was severely disrupted by the pandemic. Notably, although most non-GAAP adjustments improve net income, PSP adjustments cause non-GAAP income to be lower than the number reported under GAAP. (Most times, non-GAAP income is higher than GAAP income, a trend Calcbench noted in a post last week.)

To illustrate, let's look at the non-GAAP section of Alaska Air Group ($ALK). In third-quarter 2020, Alaska Air recorded a "Payroll Support Program wage offset" adjustment that decreased non-GAAP income by $398 million (and by an aggregate $760 million through the first nine months of 2020). Based on Alaska’s latest quarterly report, the company “expects to record an additional $10 million in wage offset in the fourth quarter.”

To better understand how other airlines reported PSP adjustments in the non-GAAP section, we looked at American Airlines Group’s ($AAL) disclosure. The company didn’t provide the PSP relief as a separate reconciling line. Still, American did clarify in a footnote that in Q3 of 2020, $1.9 billion and $228 million of PSP assistance were included in mainline and regional operating special items non-GAAP adjustments.

We can’t provide an opinion about whether any of the metrics are compliant with Regulation G (the SEC rule governing non-GAAP reporting), and we are not implying that any of these disclosures are incorrect or non-compliant. Yet, as we approach the filing season, it’s worth remembering that Question 100.03 of the SEC’s CD&I states that if a company excludes charges in the calculation of a non-GAAP measurement, it should also exclude gains.

Non-GAAP and Taxes

The second type of adjustment we looked at was related to changes in tax legislation in 2020. One such change in legislation, the U.K. Finance Act of 2020, was signed into law effective April 2020. The law abandons plans to reduce the corporate tax rate from 19 percent to 17 percent — which results in an increased tax liability estimate for some companies (because their expected tax cut didn’t arrive).

For example, in third-quarter 2020, Hasbro ($HAS) modified its GAAP income by a discrete "tax reform" adjustment of more than $13 million and stated that the adjustment was caused by “revaluation of Hasbro's U.K. tax attributes in accordance with the Finance Act of 2020 enacted by the United Kingdom on July 22, 2020.”

In another example, L Brands (LB) adjusted its Q3 net income by $23 million and disclosed that the adjustment was related to “foreign investments and recent changes in tax legislation.” Notably, in Q2 of 2020, the company also recorded a discrete tax benefit of $21 million related to “changes in tax legislation included in the CARES Act.”

Some of the adjustments introduced in 2020 appear to be company-specific. A recent blog by Calcbench discussed an unusual "civil disruption cost" adjustment recorded by a grocery chain Albertson ($ACI). Calcbench was unable to identify any other retailer that adjusted GAAP results for a similar item.

Finally, the pandemic put economic pressure on whole sectors such as retailers, forcing companies to restructure operations and re-evaluate their expansion plans. Unsurprisingly, these restructuring costs may show up as a “new” adjustment in the non-GAAP section.

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