NON-GAAP/ALTERNATIVE PERFORMANCE MEASURES: WHAT IS THE BIG DEAL?

Transcription

1 NON-GAAP/ALTERNATIVE PERFORMANCE MEASURES: WHAT IS THE BIG DEAL? Vincent Papa June 7, 2017

2 NGFM Context Company Communication of NGFM Investors Use of NGFM Key Investor Concerns Bridging the Gap 2

3 CONTEXT: EVOLVING CORPORATE REPORTING LANDSCAPE EVOLVING AUDIT AND ASSURANCE SERVICES Perceived Shortcomings of Traditional financial statement information (Country specific GAAP/ IFRS) Increased demand for Other information (Non-GAAP, ESG, Risk Reporting, Intellectual capital) Corporate Information for Capital Markets TECHNOLOGY TRANSFORMING THE NATURE, DELIVERY & ASSURANCE OF COMPANY INFORMATION (XBRL delivery, implications of adoption of blockchain technologies, leveraging big data) 3

4 EXAMPLES OF NON-GAAP MEASURES NGFM/APM Adjusted revenue Adjusted net income EBITDA Adjusted EBITDA EBITDAR EBIT Adjusted EPS Free cash flow Funds from operation Net debt Unbilled deferred revenue Other metrics KPIs Same store sales Average revenue per customer Sales per square foot 4

5 DRIVERS OF NGFM REPORTING SUPPLY FACTORS Companies desire to convey relevant entity-specific information Measures help to manage perception of performance Variation by country 43% of SIX versus in 2013 >80% of US (S&P500) and UK (FTSE100) in 2015 Prevalent in particular industries (Healthcare, technology) Regulatory environment can determine quality of alternative performance reporting DEMAND FACTORS Investor demand for supplemental information on earnings components Institutional practices (e.g. consensus earnings) A by-product of GAAP complexity and perceived irrelevance 5

6 ILLUSTRATION: NOVARTIS Novartis USD Millions IFRS Income before taxes 7,817 8,134 11,921 10,496 10,925 Amortization of intangible assets 4,097 4,132 3,073 3,159 3,045 Impairments , Acquisition or divestment related items (33) 182 (647) Other exceptional items 648 1,275 (1,096) Adjusted income before taxes 13,315 14,092 14,826 14,337 14,777 EPS Adjusted EPS and 2015 only reflects continuing operations 6

7 ILLUSTRATION: ROCHE ROCHE GROUP CHF 'Millions IFRS net income 9,733 9,056 9,535 11,373 9,660 Global restructuring ,037 Intangibles amortisation Intangibles impairment 1, , Alliances &business combinations (222) (37) Legal & environmental Major debt restructuring Pension plan settlements (11) (4) (12) Normalisation of ECP tax benefit (22) (26) Adjusted net income 12,688 11,837 12,533 12,526 11,765 7

8 TYPICAL EARNING ADJUSTMENTS-SIX Figure 4: Occurrence of Adjustments for 13 (12) SIX companies in 2013 (2012) Occurence of Adjustments Impairment Depreciation and amortisation Restructuring IAS 39 related items Disposal of investments Disposal of fixed assets Source: 2014 Deloitte IAS Financial Reporting by listed companies- Spotlight on Swiss Trends 8

9 ADJUSTMENTS- S&P 500 COMPANIES Restructuring* 52.5% 45.9% 42.1% 49.0% 51.5% 48.0% Investment gains/losses* 17.6% 20.1% 19.0% 19.7% 21.0% 27.6% Acquisition* 26.1% 34.4% 31.7% 36.1% 35.2% 36.0% Stock compensation 17.6% 17.0% 17.6% 16.5% 17.0% 15.0% Amortization* 22.3% 20.5% 23.1% 22.3% 22.8% 24.0% Impairment* 29.0% 24.3% 25.5% 30.6% 27.5% 27.6% Legal 21.8% 19.7% 23.8% 22.3% 25.9% 28.2% Pension (MTM)* 1.3% 1.9% 3.1% 3.5% 0.3% 4.2% Pension (OPEB)* 2.1% 2.7% 5.2% 9.4% 7.7% 10.2% Currency 1.3% 3.1% 1.4% 1.3% 4.3% 5.4% Tax resolution/change 30.7% 40.2% 37.2% 31.3% 34.6% 35.1% Tax adjustments (NGFM) 36.1% 33.2% 35.2% 36.8% 36.7% 37.5% Debt extinguishment 10.5% 19.7% 13.4% 16.1% 14.5% 18.6% Interest revenues/costs 6.7% 6.6% 6.6% 5.2% 5.2% 4.5% 9

10 INVESTORS USE OF NGFMS 10

11 WIDESPREAD USE 40.0% 35.0% 33.5% 38.0% 37.1% 35.2% Use of NGFM; N= % 26.5% 25.0% 20.0% 23.1% 21.0% 18.8% 15.0% 14.3% 13.8% 13.3% 12.1% 10.0% 5.0% 0.0% 4.9% 4.0% 4.3% Always Often Sometimes Rarely Never Portfolio managers+buy-side analysts=376 Other+Sell-side analysts=182 All=558 11

12 GAAP/IFRS STILL IMPORTANT Use of GAAP/IFRS; N= % 40.0% 35.0% 30.0% 25.0% 33.5% 32.3% 32.7% 40.8% 34.6% 38.8% 20.0% 15.0% 10.0% 5.0% 16.5% 17.0% 16.7% 11.0% 8.3% 9.2% 3.8% 2.1% 2.7% 0.0% Always Often Sometimes Rarely Never Portfolio managers+buy-side analysts=375 Other+Sell-side analysts=182 All=557 12

13 SOPHISTICATED INVESTOR USE Further adjust NGFM; N= % 60.0% 50.0% 40.0% 30.0% 61.8% 49.0% 57.5% 40.0% 34.9% 32.4% 20.0% 10.0% 5.8% 11.0% 7.5% 0.0% Yes No Not applicable Portfolio managers+buy-side analysts=293 Other+Sell-side analysts=145 All=438 13

14 INVESTORS: COMMONLY USED NGFMS "Top-Half" Use of NGFM; N= % 80.0% 70.0% 78.4% 74.7% 67.4% 72.2% 68.6% 69.8% 68.8% 64.5% 65.9% 60.0% 50.0% 40.0% 57.1% 55.6% 56.6% 50.2% 52.1% 50.8% 49.1% 45.9% 39.6% 47.9% 42.7% 40.1% 30.0% 20.0% 10.0% 0.0% Free cash flow EBITDA Adjusted EBITDA Net debt Adjusted EPS EBIT Adjusted earnings Portfolio managers+buy-side analysts=287 Other+Sell-side analysts=144 All=431 14

15 INVESTORS: COMMONLY USED NGFMS "Bottom-half"- Use of NGFM; N= % 45.0% 40.0% 35.0% 30.0% 25.0% 46.5% 41.3% 39.0% 38.3% 38.7% 36.8% 35.9% 42.4% 38.1% 20.0% 17.4% 18.1% 17.6% 15.0% 10.0% 13.2% 12.1% 9.7% 8.0% 6.9% 7.7% 5.0% 0.0% Adjusted EBIT Adjusted operating profit Funds from operations Adjusted revenue Unbilled deferred revenue Other Portfolio managers+buy-side analysts=287 Other+Sell-side analysts=144 All=431 15

16 REASONS FOR USE Top 5 reasons for Use of NGFMs; N= % 60.0% 50.0% 40.0% 63.4% 63.2% 61.5% 57.6% 56.9% 58.3% 57.4% 56.5% 53.1% 50.0% 48.4% 45.1% 38.6% 47.9% 41.7% 30.0% 20.0% 10.0% 0.0% To assess earnings quality To facilitate period to period trend analysis To facilitate forecasting of future earnings Disagree with particular GAAP treatment Understand performance through eyes of management Portfolio managers+buy-side analysts=290 Other+Sell-side analysts=144 All=434 16

17 REASONS FOR USE- CONTINUED Other reasons for use of NGFM; N= % 42.4% 40.0% 35.0% 30.0% 25.0% 32.4% 31.3% 31.7% 29.2% 35.3% 28.3% 36.1% 30.9% 24.8% 31.3% 27.0% 20.0% 15.0% 10.0% 10.3% 9.2% 6.9% 5.0% 0.0% Identify management misreporting incentives and choices Suitable for my valuation model To make forecasts that are comparable to other analysts To conform to consensus earnings Other Portfolio managers+buy-side analysts=290 Other+Sell-side analysts=144 All=434 17

18 DARK SIDE OF NON_GAAP MEASURES: INVESTOR CONCERNS 18

19 MANAGING PERCEPTION OF PERFORMANCE For 380 S&P 500 firms reporting on a non-gaap net income basis in 2015 and included in the S&P 500 from 2009 onward. and R.G. Associates, Inc. 19

20 PRIMARY CONCERNS Lack of comparability across companies & across reporting periods Questionable exclusions that can mislead investors on entity s performance Excluding recurring restructuring costs Excluding stock option expenses- (i.e. real expenses) Lumping recurring expenses into other Inappropriate application during executive compensation determination Inadequacies of reconciliation and disclosure of NGFM adjustments Instances of inadequate disaggregation to specific line items Instances where reconciliation is not prominently located Boiler plate and inadequate explanations Lack of assurance on NGFM Risks Associated with Greater Prominence of NGFM relative GAAP/IFRS measures Mispricing of equities Misleading ROE, ROIC 20

21 UNDUE PROMINENCE: RISK OF COMPARING APPLES TO ORANGES Facebook Performance Operating Margin Non-GAAP 60% 56% Operating Margin GAAP 45% 35% Investors Business Daily- 15th February Top Rated Stocks with 50 % Plus Profit Margins Annual pre-tax Margin Facebook 60.0% United Therapeutics 59.3% Phillips-66 Partners 55.7% BOFI Holdings 53.4% Alibaba 52.9% Mobileye 51.8% 21

22 UNDUE PROMINENCE CAN CONTRIBUTE TO MISPRICING OF EQUITY BY SOME INVESTORS Price to Earnings Ratio (April 2015) Reported GAAP- Reported NGFM- Modified NGFM- Based EPS Based EPS Based EPS Facebook Oracle Intuit Merck Regeron Pharmaceuticals

23 DISCLOSURES FAIL TO ADEQUATELY EXPLAIN ADJUSTMENTS Novartis USD Millions IFRS Income before taxes 7,817 8,134 11,921 10,496 10,925 Amortization of intangible assets 4,097 4,132 3,073 3,159 3,045 Impairments , Acquisition or divestment related items (33) 182 (647) Other exceptional items 648 1,275 (1,096) Adjusted income before taxes 13,315 14,092 14,826 14,337 14,777 EPS Adjusted EPS and 2015 only reflects continuing operations 23

24 DISCLOSURES FAIL TO ADEQUATELY EXPLAIN ADJUSTMENTS NOVARTIS ANNUAL REPORT 1 Amor%za%on of intangible assets: Cost of goods sold includes recurring amor%za%on of acquired rights to in-market products and other produc%on-related intangible assets; Research & Development includes the recurring amor%za%on of acquired rights for technology plaborms; Income from associated companies includes USD 296 million for the Novar%s share of the es%mated Roche core items. 2 Impairments: Cost of goods sold and Research & Development include impairment charges related to intangible assets; Other income includes impairment reversals of property, plant and equipment; Other expense includes impairment charges related to property, plant and equipment, and financial assets. 3 Acquisition or divestment related items, including restructuring and integration charges: Other income and Other expense include transitional service-fee income and expenses, and other items related to the portfolio transformation; Other income also includes a gain from the revaluation of a previously held financial investment in a newly acquired company. 24

25 DISCLOSURES FAIL TO ADEQUATELY EXPLAIN ADJUSTMENTS NOVARTIS ANNUAL REPORT 4 Other items: Other revenues include an early release of deferred income associated with a collaboration agreement; Cost of goods sold, Other income and Other expense include net restructuring and other charges related to the Group-wide rationalization of manufacturing sites; Research & Development, Marketing & Sales, Other income and Other expense include other restructuring income and charges; Cost of goods sold and Research & Development include adjustments of contingent considerations; General & Administration, Other income and Other expense include items related to setup costs for Novartis Business Services; Other income and Other expense also include legal settlements and changes in provisions; Other income also includes gains from product divestments, other income related to the portfolio transformation and a gain related to the sale of real estate; Other expense also includes a charge as a result of a pension plan amendment, a charge for an indirect tax settlement and other costs; Income from associated companies includes USD 135 million for the Novartis share of the estimated GSK Consumer Healthcare Holdings Ltd. core items; Other financial income and expense relates mainly to devaluation losses in Venezuela 25

26 INVESTOR PROTECTION- WHAT IS REQUIRED? 26

27 BRIDGING THE GAP: CREATING A DEPENDABLE PERFORMANCE REPORTING FRAMEWORK 27

28 THANKS FOR LISTENING! 28