Reporters and analysts covering first-quarter earnings from drug companies may have noticed a change in how they account for upfront payments made to finance research and development at companies in which they have acquired equity stakes.
Merck & Co.
Bristol-Myers Squibb Co.
and Eli Lilly & Co.
have all included boilerplate language in their releases to explain the change, which involves adjustments they were making for certain non-GAAP metrics, or those that do not conform with Generally Accepted Accounting Principles, the U.S. standard.
The change comes after the Securities and Exchange Commission sent a series of comment letters to Biogen Inc.
in 2021, which are available on the SEC website. The message seems to have reached other drug companies.
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“The pharmaceutical industry is quite clubby with lots of focus on regulatory issues by its trade associations and industry forums,” said Francine McKenna, an accounting expert and incoming faculty at the Wharton School of the University of Pennsylvania. (McKenna is a former MarketWatch reporter.)
“If one got a letter from the SEC, it wouldn’t take long for them all to find out about it and act without having to be told directly,” McKenna said.
In a letter dated March 25, 2021, the SEC questioned Biogen’s exclusion of upfront and premium payments paid for the acquisition of common stock in some of its collaboration partners to arrive at non-GAAP R&D expense and non-GAAP net income.
In a response dated April 7, 2021, Biogen said it excluded those costs “to better reflect our core operating performance,” arguing that those payments differ from regular recurring costs taken on in the course of business.
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The SEC disagreed in a letter from the following month, referring Biogen to guidance issued in May of 2016 regarding the use of non-GAAP metrics, that said creating performance measures that exclude normal expenses is misleading.
The SEC issued new guidelines for corporate reporting in 2016 in an effort to slow the proliferation of non-GAAP numbers and rein in the worst offenders. The SEC allows companies to use non-GAAP numbers to supplement their reporting, but they must give equal or greater prominence to GAAP numbers and explain how the two are reconciled.
The change is not insignificant.
In Eli Lilly’s case, for example, a regulatory filing from April 14 of this year said that the company expected to book charges for the quarter ended March 31 of about $165 million, equal to 15 cents in per-share earnings.
“The company is making these changes to its presentation of non-GAAP financial measures following guidance from the U.S. Securities and Exchange Commission (the “SEC”),” said the filing.
Merck said the accounting change led to an extra $1.7 billion of incremental R&D expense for 2021, shaving 65 cents off full-year EPS to $5.37.
Bristol Myers said the accounting change shaved 10 cents off first-quarter EPS. Pfizer got off more lightly, saying Tuesday the accounting change cost it just 5 cents of EPS in the first quarter.
On Friday, the SEC database had added comment letters sent to Eli Lilly and Bristol-Myers, showing it had raised the issue with both of those companies too.
The regulator usually posts those letters about 30 days after an issue has been resolved.