Allergan set off alarm bells at the SEC in January, resulting in a scathing letter (PDF) from the agency about the company’s reporting of “non-GAAP” earnings per share. GAAP, which stands for generally accepted accounting principles, is the reporting standard that public companies are supposed to use, but as a new report from Credit Suisse reveals, Big Pharma companies are bending the rules—and reporting ever-widening spreads between GAAP and non-GAAP results.
Credit Suisse tallied up GAAP vs. non-GAAP results for eight large pharma companies following last year’s fourth-quarter reports and spotted an alarming trend: Reported non-GAAP income has been about 64% higher than GAAP income over the last three years. And of the eight companies examined, Allergan and Teva claimed the widest spreads between the two numbers.
In Allergan’s case, it reported a total of $13.2 billion in non-GAAP income over the past three years, but its GAAP income was actually a loss of $6.3 billion. The company’s non-GAAP income as a percentage of sales was a whopping 49.5%, vs. just 10.1% for all of the large-cap pharma companies Credit Suisse included in the report. Why the divergence? Allergan added back in high amortization expenses, M&A charges, collaboration fees, stock-based compensation and other drivers that would swing it into positive non-GAAP territory, according to Credit Suisse.
“Just because an adjustment isn’t explicitly prohibited by the SEC doesn’t mean it’s kosher,” wrote Credit Suisse analysts in the report, explaining that excluding normal operating expenses and stock-based compensation “could be misleading.” In fact, in the January letter, the SEC said it was reviewing pharma industry practices on non-GAAP reporting based on discussions with Allergan.
In a statement, Allergan says that as of its fourth-quarter report, it is reporting what it used to call non-GAAP earnings per share as “performance net income per share,” but that it’s not changing how it calculates the metric. “We believe this matter is considered closed with the SEC," the statement said.
Teva’s non-GAAP net income over the past three years was $14.4 billion, vs. GAAP income of $4.7 billion, according to Credit Suisse. The company also added back in amortization and M&A expenses, plus impairment of long-lived assets, goodwill and various expenses that it lumped into a category called “other.” That vaguely worded category included $900 million in goodwill from Teva’s acquisition of Rimsa and $225 million from its recent settlement over a pay-for-delay suit pertaining to the antibiotic Cipro.
Teva did not respond to a request for a comment.
The increasing spread between GAAP and non-GAAP results reported by pharma companies has continued despite the fact that the SEC updated its guidelines on non-GAAP reporting last May. The SEC told companies that as part of non-GAAP accounting they can’t report cash flow per share, for example, and they can’t try to deflect attention from GAAP results by putting non-GAAP results in bold or attention-getting fonts.
In the wake of the new rules, the vast majority of public companies continued to talk up non-GAAP results, according to a new analysis by MarketWatch. Between the first quarter of 2016 and the third quarter, the number of companies reporting non-GAAP earnings per share edged down from 359 to 350, but 72% of S&P 500 companies were still using at least one non-GAAP EPS metric in their reports, the report reveals.
The pharma company with the smallest spread between GAAP and non-GAAP income, as reported by Credit Suisse, was Johnson & Johnson. It recorded $48.3 billion in GAAP net income over the past three years and $54.5 billion in non-GAAP income. Amortization and legal expenses accounted for most of the add-backs, according to Credit Suisse. The biggest divergence in the two numbers came in the third quarter of 2014, when the company swallowed integration costs from its acquisition of Synthes.
Credit Suisse says it won’t make stock buy or sell calls based on the differences between GAAP and non-GAAP results. But its analysts will follow those spreads going forward “to see if any of our companies adjust their practices given the increased scrutiny.”