Non-GAAP Net Income $164.1 Billion Higher Than The Traditional Numbers by Calcbench & Radical Compliance

Introduction

The U.S. Securities & Exchange Commission and other influential voices in the financial reporting community have raised repeated concerns this earnings season about the use of “non-GAAP” —financial metrics that companies tout to investors, but are not calculated according to Generally Accepted Accounting Principles.

Federal securities law does allow a company to report non-GAAP metrics that it believes are useful to investors, so long as the company can explain why the non-GAAP metric is useful and reconciles that metric to the closest matching GAAP metric. (For example, reconciling non-GAAP net income to “traditional” net income.) Where companies have relied on non-GAAP metrics too much or devised metrics that seemed more cosmetic than useful, the SEC has disallowed their use.

Non-GAAP Net Income In several speeches this year, SEC officials have said the use of non-GAAP metrics has become too common—so Calcbench and Radical Compliance set out to investigate exactly what non-GAAP metrics corporate filers are reporting, and how much those metrics diverge from traditional accounting. We reviewed the non-GAAP disclosures that 816 firms included in their earnings releases for fiscal 2015, and examined:

  • Which adjustments are used most often, and which ones cause the largest differences between GAAP and non-GAAP net income;
  • The differences among business sectors in how they reconcile GAAP and non-GAAP net income, and the size of differences within those sectors
  • The specific non-GAAP reporting of 13 large filers, to give examples of the size and nature of non-GAAP financial metrics today.

This paper focused on metrics for net income only; companies also file numerous non-GAAP metrics for revenue, cash flow, and other financial items. A complete discussion of our methodology can be found at the end of this paper.

Findings

[drizzle]The 816 firms in our sample group made a total of 4,632 adjustments to their GAAP net income numbers. Those adjustments led to non-GAAP net income $164.1 billion higher than the traditional net income numbers those firms also reported under GAAP.

Non-GAAP Net Income

While the specific reasons cited for adjustments were diverse, they could be grouped into five major categories: acquisition costs; debt; legal costs; restructuring charges; and equity compensation costs. As one can see from the following charts, restructuring, equity compensation, and acquisition-related items make up the lion’s share of non- GAAP adjustments, both in dollars adjusted and in number of adjustments made.

Non-GAAP Net Income

The patterns diverge more when examining non-GAAP net income by industry. In dollar terms, the financial services sector reported the largest difference between GAAP and non-GAAP net income: $40.8 billion. Next were the IT sector ($34.3 billion in total adjustments) and energy ($26.7 billion). Each sector, however, had different drivers behind those numbers. For example, most of the non-GAAP difference in the financial sector stemmed from acquisition costs, while IT’s adjustments were driven by equity compensation adjustments, and the energy sector’s by restructuring costs.

The table below shows the breakdown of non-GAAP adjustments across nine major industries in our sample group.

Non-GAAP Net Income

When one looks at non-GAAP adjustments by number of adjustments made, however, different patterns emerge. For example, the IT sector had more adjustments for acquisition costs than the financial sector (396 compared to 117), even though the dollar value of those 396 adjustments was far smaller than the dollar value for the financial sector’s 117 adjustments. In other words, the financial sector made fewer acquisition-related adjustments that were far larger in size. Likewise, the energy sector had 111 adjustments related to restructuring costs, while consumer discretionary had 364—but those 111 energy sector adjustments totaled $26.3 billion, while the 364 in consumer discretionary added up to only $7.6 billion.

Non-GAAP Net Income

Broadly speaking, those dollar amounts make sense given the conventional wisdom about each of these sectors. The energy sector, for example, suffered severely in 2015 from plummeting oil prices, so it is no surprise that restructuring costs there would be higher. The IT sector routinely offers stock options or restricted stock units as compensation to employees, so one would expect that sector to report high adjustments related to those costs.

Non-GAAP Net Income

Company Examples

The PowerPoint presentation that accompanies this paper includes 13 examples of specific companies’ reconciliation between non-GAAP and GAAP net income. We will present three of those companies here—Facebook, HP, and Merck—that demonstrate particularly significant examples of non-GAAP reporting.


Facebook reported GAAP net income of $3.688 billion in 2015 and non-GAAP net income of $6.518 billion—an increase of $2.830 billion, or 76.7 percent. Almost all of that increase is due to an adjustment for equity compensation expenditures.

Non-GAAP Net Income

GAAP requires companies to include equity compensation costs as part of operating expenses before calculating net income. Facebook argues that its non-GAAP net income, which excludes equity compensation costs, is a better metric because the accounting standard to determine those costs (ASC 718, Stock Compensation) allows so many valuation methodologies and subjective assumptions that comparisons across companies are too difficult. As the company says in its earnings release:

[W]e believe that excluding this expense provides investors and management with greater visibility to the underlying performance of our business operations, facilitates comparison of our results with other periods, and may also facilitate comparison with the results of other companies in our industry…

HP Inc. (the successor company to Hewlett-Packard Co.) reported GAAP net income of $4.554 billion and non-GAAP net income of $6.592 billion—a difference of $2.038 billion, or an upward adjustment of 44.7 percent. The upward adjustments were largely due to restructuring charges and separation costs.

HP announced in 2015 that it would separate into two publicly traded companies, and the company attributes its $1.259 billion separation charge and its $927 tax adjustment to that separation. In its earnings release, HP argues that since the separation will occur only once, adjusting net income for those one-time charges helps investors to better understand its long-term financial operations.

Non-GAAP Net Income

The $1.017 billion restructuring charge is a different matter. HP has reported $8.6 billion in restructuring charges since 2008, and has reported a restructuring charge every year since 2009. What’s more, HP’s restructuring plans change over time. In 2012, for example, the company announced a three-year plan to trim 29,000 jobs at an estimated cost of $3.7 billion. By the time that plan was completed in 2015, however, it had eliminated 55,800 jobs and cost $5.5 billion. And when HP announced the completion of that restructuring plan in 2015, it also announced a new restructuring plan that would run from 2015 through 2018.

Merck & Co. reported GAAP net income of $4.442 billion and non-GAAP net income of $10.195 billion—a difference of $5.753 billion, or an upward adjustment of 129.5 percent. The upward adjustments were largely due to acquisition costs, plus restructuring costs, litigation settlements, and foreign exchange losses due

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