Two of the largest home health companies in the nation arguably are too liberal in how they calculate and report their adjusted earnings, which could be misleading investors, according to a new report from Mizuho Securities USA Inc. and a related Wall Street Journal article.
At issue are the adjusted financial results reported by Kindred Healthcare (NYSE: KND) and Amedisys Inc. (Nasdaq: AMED), as well as several other health care companies, according to Mizuho analysts Ann Hynes and Sheryl Skolnick. These companies report results based on U.S. Generally Accepted Accounting Principles (GAAP) as required by the U.S. Securities and Exchange Commission (SEC), but they also issue non-GAAP results.
One basic principle of reporting non-GAAP results is that it enables companies to mitigate the effects of events, such as severance paid out to departing executives, that are nonrecurring or otherwise skew the picture of how strong the company’s performance will be going forward. However, signs suggest that non-GAAP reporting has gotten out of hand; companies are testing the boundaries in their calculations and are emphasizing the non-GAAP results too much to investors, the SEC stated in Compliance & Disclosure Interpretations (C&DIs) issued in May.
The concern is that some companies may be overly aggressive in an attempt to present higher earnings.
“Frankly, it’s sometimes hard to tell the difference between those earnings that really are trying to give investors and analysts good insight into the core business and those that have other possible motivations,” wrote Hynes and Skolnick.
In light of these concerns, the analysts evaluated several companies that Mizuho covers, including Baton Rouge, Louisiana-based Amedisys and Louisville-based Kindred. Both companies make adjustments that are “rather significant,” the Mizuho analysis determined.
No Bright Line
Among the concerning practices at Amedisys, one is that the company “adds back” legal fees to its earnings-per-share and EBITDA numbers. But these legal fees appear to be recurring, as they relate to an ongoing Department of Justice (DOJ) investigation, the analysts stated.
Adding back legal fees is not unique to Amedisys, as it occurs across other health care companies as well, CFO Ronnie LaBorde told Home Health Care News. There is no “bright line” to denote when a non-permanent but recurring cost—such as the legal fees related to a DOJ investigation—should be added back, he said. Rather, it’s a matter of judgment, and it is up the company to make it clear to investors what any adjustment represents.
Something like a DOJ investigation does not have a definitive, finite timeline but it also is not permanent, and so the goal in presenting earnings is to reflect that, he explained.
Another concern flagged by Mizuho: Amedisys adds back restructuring charges related to an ongoing turnaround at the company, which has included leadership changes.
The rationale here is similar to the legal fees. These are costs that may be incurred over more than one reporting period, but they will come to an end as the restructuring period gives way to normalcy, LaBorde said.
“I would say we’re trying to highlight ‘chop’ that we knew was there and is largely self-imposed,” he said. “As your can see from our disclosures, [the charges] are in more than one reporting period, but they’re not permanent and forevermore.”
Overall, adjustments are not a substitute for GAAP reporting, and when done correctly should in fact bring more investor clarity rather than less, LaBorde said. However, they have to be considered in context.
“These types of items may well be part of the management discussion and analysis,” he said. “It’s pulling them out, isolating them, trying to give transparency.”
As for whether Amedisys will alter its reporting or adjustment practices in light of the SEC guidance and subsequent questions—which several other companies have done—LaBorde noted that second quarter 2016 earnings are scheduled to be released on Aug. 2.
“So, it’s not appropriate to foreshadow anything in the release, but I would say that as we have in the past, we desire to meet both the spirit and substance of what the SEC is looking for,” he said. “To make sure there’s an important prominence of GAAP and not overemphasize adjusted earnings, and disclose any adjustments in such a fashion as to not confuse the public but provide greater clarity.”
Kindred is not only the largest home health provider in the country but also has major market share in other parts of the post-acute continuum. Perhaps unsurprisingly for a company with many moving parts, its reporting practices are complex.
“KND is by far the most difficult company to model given a host of complex ‘adjusted’ concepts and addbacks,” the Mizuho analysts wrote.
These adjustments include adding back costs related to severance and retirement, research and development, and restructuring. Some of these costs appear to be integral to the ongoing operations of the business, Mizuho believes.
Furthermore, simply the profusion of adjustments also raises a red flag, Skolnick told WSJ reporter Tatyana Shumsky.
“We want the reported numbers and the numbers that we use to value companies to represent the truth about the intrinsic value and the earning power of the company,” Skolnick said.
Kindred had not responded to Home Health Care News as of press time. The company is scheduled to release its second quarter 2016 earnings on Friday.
Written by Tim Mullaney