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Called to Account: Brown-Forman changes accounting after SEC tells it to stop using metrics first highlighted by MarketWatch

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Brown-Forman Corp. said Thursday it would no longer use certain non-standard metrics in its financial reporting, including ones that had been criticized by the Securities and Exchange Commission and highlighted by MarketWatch in past reporting.

In its fiscal third-quarter earnings, the maker of Jack Daniel’s whiskey said it would stop using the word “underlying” to describe non-GAAP metrics, or those that do not conform with Generally Accepted Accounting Principles, the U.S. standard.

“We will no longer report ‘underlying changes’ in certain measures of the statements of operations; instead, we will now report ‘organic change’ in certain measures,” Chief Executive Lawson Whiting said in the earnings release.

That new description “includes all of the non-GAAP adjustments that we have historically made in adjusting GAAP to ‘underlying change’ results, except that ‘organic change’ does not include an adjustment for ‘estimated net change in distributor inventories,’” he said.

Brown-Forman
BF.B,
+6.70%

has for decades used the term “underlying” for its non-GAAP reporting and told MarketWatch in 2016 that it was “terminology commonly understood in our industry and (we) provide disclosure that explains what those terms mean.”

See now: Brown-Forman ‘underlying’ numbers more spirited than actuals

A typical earnings release would have more than 70 mentions of the word, including for underlying net sales, underlying operating income, underlying gross profit, underlying SG&A (sales, general and administrative expenses) and underlying operating expenses, among others.

The company does announce its GAAP numbers first, as required under SEC rules, but after that its releases focused solely on non-GAAP numbers, which the rules do not allow. Companies are allowed to use non-GAAP numbers to supplement the GAAP ones but they must give GAAP ones equal prominence and offer a reconciliation of the two.

See also: Jack Daniel’s maker Brown-Forman’s latest earnings are more of the same

The SEC sent the company a comment letter last year relating to its 10-K for fiscal 2021, ended April 30.

“Please expand your disclosure to include discussion and analysis, with equal or greater prominence, of the most directly comparable GAAP financial measure to underlying measures,” the regulator wrote. “We note that your results of operations discussions primarily focus on the year-over-year changes in the underlying measures as opposed to movements in the GAAP measures. ” In other words, the company had not been offering the required reconciliation between its GAAP and non-standard numbers.

The SEC also took issue with how the company was making an adjustment for inventory that is not allowed under its rules.

Read: SEC tells BlackBerry to stop using non-GAAP revenue metric first highlighted by MarketWatch

“We note that you present non-GAAP measures adjusted for the ‘estimated net change in distributor inventories.’ Please clarify for us what this adjustment represents and explain in sufficient detail how you calculate the amounts,” said the letter.

The SEC referred the company to Question 100.04 of the Compliance and Disclosure Interpretations on Non-GAAP Financial Measures.

That stipulates that “Non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP” could violate SEC rules. That’s because Individually tailored methods substitute a company’s own interpretation of accounting standards for GAAP.

See also: U.S. companies went right back to heavy use of nonstandard accounting metrics during the pandemic

Also: Cigna’s use of adjusted revenue in quarterly earnings does not conform with SEC rules, experts say

Brown-Forman responded by saying that it used “estimated net change in distributor inventories” to reflect its distributors’ downstream sales, as it believes those “more closely reflect actual consumer demand than do our shipments to distributors.” But it can only recognize revenue when its products are shipped to distributors or delivered to customers.

“Our shipments increase distributors’ inventories, while distributors’ depletions (as described above) reduce their inventories. Therefore, it is possible that our shipments do not coincide with distributors’ downstream depletions and merely reflect changes in distributors’ inventories. Because changes in distributors’ inventories could affect our trends, we believe it is useful for investors to understand those changes in the context of our operating results,” the company wrote.

The SEC disagreed and described the adjustment as an attempt to create “individually tailored revenue recognition” which is not allowed. Companies cannot create their own rules to accelerate revenue reporting.

“Please remove this adjustment from future filings or explain why you do not believe it represents a tailored accounting measure,” it wrote back. Brown-Forman agreed to remove that metric too.

The SEC did not highlight one issue that is a MarketWatch bugbear; Brown-Forman “flips” its table, meaning it reports last year’s number before this year’s, breaking with the accounting convention that tables are read from left to right. That can mislead investors who are not expecting it.

See also: Square is dropping an accounting metric after the SEC said it’s not allowed

The company posted net income of $259 million, or 54 cents a share, for the quarter through Jan. 31, up from $219 million, or 45 cents a share, in the year-earlier period. Sales rose 14% to $1.037 billion from $911 million a year ago. The FactSet consensus was for EPS of 52 cents and sales of $1.036 billion.

Whiting said the quarter was hit by supply chain constraints, notably in glass supply. The company expects margins to be hurt in the full fiscal year by continued supply chain issues and inflationary pressure.

Shares rose 6.5% Thursday, but are down 1% in the last 12 months, while the S&P 500
SPX,
+0.04%

has gained 15%.

See also: SEC may be set to crack down on companies that adjust revenue

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