Non-GAAP financial results have increasingly become a tool companies have used to bolster results. In 2015 88% percent of S&P 500 companies reported non-GAAP metrics, up from 71% in 2009 [1]. Additionally, GAAP and non-GAAP earnings are at their highest differential since 2008 [2]. Recently, the SEC released a revised non-GAAP set of Compliance and Disclosure Interpretations:

On May 17, 2016, the SEC’s Division of Corporation Finance escalated the SEC’s efforts to curb perceived misuse of non-GAAP financial measures with the issuance of a revised set of Compliance and Disclosure Interpretations (CDIs). This action follows a series of speeches by SEC Chair Mary Jo White and SEC senior staff members, and an uptick in comment letter activity, all focused on what a member of the SEC staff described in one speech as a “troubling increase over the past few years in the use of, and nature of adjustments within, non-GAAP measures by companies.”[3]

These new interpretations can be found here. As a result of these updated interpretations, we believe many companies will be forced to change how non-GAAP results (adjusted EBITDA and earnings, among others) are reported and may even be required to restate results.

Probes Reporter recently revealed that Tesla is under an unknown active SEC investigation through a SEC FOIA request. While there is speculation as to what this investigation is about, we believe it related to non-GAAP metrics and other companies could currently be under investigation as well.

The SEC FOIA website makes it very easy to submit a FOIA request or appeal. On July 21st, we submitted multiple FOIA requests to the SEC, inquiring if certain companies were under investigation related to non-GAAP results. Many companies, specifically tech companies, are consistently reporting adjusted EBITDA and earnings which have very little to do with the operational results of their businesses. We believe most investors do not realize how stark these differences have become and if companies are forced to change reporting methods, shares will sell off.

Hanesbrands (HBI) was highlighted in a July 1st article by Grants Interest Rate Observer and is one company for which we submitted an SEC FOIA request. HBI is almost twice as expensive on a P/E basis (22x) than some of its competitors, due to widespread adoption of its brands with American consumers and (non-GAAP) higher margins. Since 2013, HBI has spent $1.1BN on acquisitions, writing off / adding back $570.5MM in non-cash acquisition related expenses (over half of total purchase prices - these should be material in our opinion). LTM GAAP earnings were $1.12/share while adjusted earnings were $1.71/share. Grants at one point asks an analyst covering the company what HBI’s underlying earnings actually are, and the analyst responds, “I would love to understand that as well”.

Given analysts covering the name have literally no idea what actually makes up the delta between HBI’s GAAP earnings and adjusted earnings, or what metric they should be looking at as truly indicative of the health of the company, we wondered if the SEC was asking the company a similar set of questions.

Below is the response letter from the SEC Office of FOIA Services:


Based on the SEC’s response, it doesn’t appear that the SEC is formally investigating the company at this time in the context of the information we provided in our FOIA request. What we don’t know at this point, however, is how detailed a FOIA request must be with regards to a given subject in order to warrant a match within the SEC’s various systems of records (our request was rather general in nature, and we wonder if we may need to provide the SEC with additional information to prompt a different response). We have yet to hear back with regard to the other FOIA requests we submitted, and will update this article if we learn anything interesting. Regardless of whether or not these initial inquiries reveal any active SEC investigations, we believe this will prove an invaluable tool as we continue to search for companies where the emphasis on non-GAAP over GAAP metrics could prove materially significant for the company’s financials, and ultimately their valuation.

[1] https://blogs.cfainstitute.org/investor/2016/06/29/non-gaap-business-performance-measures-an-investor-perspective/

[2] http://www.investopedia.com/articles/financial-analysis/070216/why-gaap-and-nongaap-are-more-divergent-2009.asp

[3] https://corpgov.law.harvard.edu/2016/06/11/sec-guidance-and-non-gaap-measures/