Valeant’s Come-to-GAAP Moment Followed Prodding by SEC

  • Regulator challenged pro-forma reporting in series of letters
  • Two accounting methods yield $10 billion difference in income

Valeant Pharmaceuticals International Inc., whose “adjusted” financial results once made it a market darling, just gave conventional financial measures a new prominence in its latest quarterly report. It wasn’t pretty.

Valeant’s decision to play up so-called Generally Accepted Accounting Principles in its quarterly earnings Tuesday -- showing a loss of more than $1 per share -- follows a six-month letter-writing campaign by U.S. officials. Beginning in December, the Securities and Exchange Commission challenged Valeant’s practice of playing down GAAP results in favor of its own adjusted pro-forma numbers, a method of reporting that critics say paints an unrealistically rosy picture of the drug-maker’s financial health.

Valeant, which regulators and lawmakers have criticized for its controversial strategy of buying drugs and raising their prices exorbitantly, is part of a broader swath of companies, including in the energy, food and manufacturing sectors, that have come under scrutiny in recent months for their use of non-traditional financial measures.

It’s legal to use non-standard accounting to report results -- and in some cases it’s the preferred way to exclude items like one-time restructuring costs -- as long as companies also report official GAAP numbers. But the securities regulator has recently warned several companies not to get too creative. The SEC and ConocoPhillips, for example, went head-to-head last year over reporting that gave the firm higher-than-GAAP profits using calculations based in part on older, higher oil prices. 

For a Bloomberg Gadfly analysis of Valeant, click here.

In December, SEC Chair Mary Jo White warned that the growing prominence of adjusted earnings “deserves close attention.”

“Your chief financial officer and investor relations team may be quite enamored of non-GAAP measures,” she said in a speech in Washington on Dec. 9. But she warned that company lawyers, audit committees and others should be asking questions, such as whether the figures are useful to investors, are calculated with appropriate controls and are given no greater prominence than GAAP results, as required.

As White made those remarks, Valeant’s shares were already being pummeled amid investor concerns that the company’s business was not as strong as it had appeared.

Increase or Decline?

“We are concerned with your overall format and presentation of the non-GAAP measures,” the agency wrote to the company on Dec. 4. Among the specific changes the SEC requested were giving GAAP numbers as much prominence as Valeant’s more bullish adjusted ones in future earnings releases. Its concerns included Valeant’s disclosure of a non-GAAP increase in earnings per share without noting that the GAAP figure declined 83 percent from the prior year.

Later that month, then-chief executive J. Michael Pearson and other executives walked investors through an outlook that focused on adjusted earnings. While Valeant’s SEC filings included GAAP measures, the 132-page investor presentation didn’t. A footnote at the end stated that Valeant believed the non-GAAP financials provided a “meaningful, consistent comparison” that excluded items it believed wouldn’t recur each quarter. 

The SEC pressed further in March -- pointing out that Valeant’s income figures were a full $10 billion higher over time than conventional reporting would dictate.

“We note that, over the past four years, you have reported approximately $9.8 billion of non-GAAP net income,” the SEC’s senior assistant chief accountant, Jim Rosenberg, wrote. “During the same period, you reported GAAP net loss of approximately $330 million for a total increase from GAAP loss to non-GAAP income of over $10 billion.” 

Rosenberg’s letter also expressed “significant concern” that the company was low-balling its tax liabilities. SEC officials, he wrote, “find this presentation to be potentially misleading.”

Valeant said in a written statement that it publishes adjusted financials because “The company believes these non-GAAP measures are useful to investors in their assessment of our operating performance and the valuation of our company. In addition, these non-GAAP measures address questions the company routinely receives from analysts and investors.”

Debt Threshold

The more favorable tally of Valeant’s financials are critical to the company for reasons that go beyond turning GAAP losses into adjusted profits. Bondholders use its Ebitda -- adjusted earnings before interest, taxes, depreciation and amortization -- as a key component in determining whether it remains in compliance with covenants on its $31 billion in debt, a threshold Valeant is now close to breaching.

The potential gulf between GAAP and adjusted figures was apparent Tuesday, as Valeant presented investors with two sets of first-quarter figures. Under the adjusted method Valeant favors, it earned $1.27 per share. Under GAAP, it lost $1.08.

In terms of its outlook, Valeant on Tuesday offered a single set of numbers -- adjusted non-GAAP ones. That prompted Wells Fargo analyst David Maris to ask on a conference call with Valeant managers on Tuesday whether “it’s easier to guide to non-GAAP adjusted earnings than GAAP earnings, or that’s what investors want -- which is that?”

Joseph Papa, Valeant’s new chief executive officer, fielded the question.

“We’ve guided to the adjusted numbers,” Papa said. “We did it in the past, and we’ll continue to do it for the future.”

Asked about Valeant’s non-GAAP forecast, SEC spokeswoman Judith Burns declined to comment.

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