Thursday, August 11, 2022

SEC comment letters often make for interesting reading in the world of financial analysis, and one recent letter to Marathon Oil ($MRO) offers numerous interesting nuggets about non-GAAP reporting.

The SEC sent the comment letter to Marathon on April 21, but the letter only became public via the EDGAR database this week. (That’s standard practice for SEC comment letters.)

And why is this letter so interesting? Because the SEC calls out numerous instances of non-GAAP metrics that Marathon included in an earnings report on Feb. 16 of this year, where Marathon either (1) did not include a reconciliation back to the closest comparable GAAP metric; or (2) calculated its non-GAAP metric beyond what investors typically see from other companies reporting that same non-GAAP metric.

So if you’re an in-house executive preparing your own earnings release and want some hints on how the SEC looks at non-GAAP disclosures, or if you're an analyst trying to understand how a company might report non-GAAP metrics that don’t give a complete picture — this comment letter to Marathon is instructive.

For example, the SEC questioned Marathon’s reporting of free cash flow, which is a non-GAAP metric. In the earnings release, Marathon touted free cash flow in a series of bullet points under a heading the company happily called “Highlights.”

Except, Marathon did not include a comparable GAAP metric. That’s a financial reporting no-no; when reporting a non-GAAP metric, you must also include the closest comparable GAAP metric. In this case, that would typically be net cash provided by operating activities; then you get your non-GAAP free cash flow with adjustments for capital expenditures.

Anyway, Marathon didn’t do that, which prompted this terse request in the SEC comment letter: “Please revise your disclosure to ensure the presentation of the most comparable GAAP measures with equal or greater prominence to your non-GAAP measures. For example, free cash flow is disclosed without the most comparable GAAP measure in the Highlight section bullet points listed at the beginning of your press release.”

The SEC also wanted more clarity from Marathon about its definition of free cash flow. Deep in the fine print of the earnings release, Marathon defined it as follows:

Free cash flow before dividend (“free cash flow”) is defined as net cash provided by operating activities adjusted for working capital, exploration costs (other than well costs), capital expenditures, and EG LNG return of capital and other.

That’s not consistent with SEC guidance, per Question 102.07 of the Compliance and Disclosure Interpretations on Non-GAAP Financial Measures. So, again, another terse request from the SEC: “We note that your calculation of free cash flow includes adjustments beyond the typical calculation of cash flows from operating activities less capital expenditures…  Please revise to relabel this measure or revise its computation to more accurately reflect its definition.”

Then we have a flock of other concerns about non-GAAP, too:

  • Total capital expenditures as a non-GAAP measure that appears to use a title “confusingly similar” to its comparable GAAP measure;
  • The company reports adjusted net income (loss) on a per share basis without reconciling to GAAP earnings per share;
  • More tut-tutting about how Marathon reports expected free cash flow and related reinvestment rates, which are forward-looking non-GAAP disclosures and therefore require even more specific reconciliation and presentation.

So all in all, the SEC had plenty of questions about how Marathon reported its non-GAAP metrics. That is not the same as the SEC rebuking a company for improper use of non-GAAP metrics; a comment letter is not an enforcement action, and nobody has accused Marathon of deceiving investors.

Still, the letter’s contents are food for thought for others who report non-GAAP or read non-GAAP disclosures, and want to understand how those numbers might trigger early-warning radar at the SEC.

As always, you can read SEC comment letters on the Calcbench Comment Letter database. Don’t forget to set alerts for companies you follow, too, so you get notified of new comment letters promptly.

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