^{MIZUHO SECURITIES USA INC.  |  US EQUITY RESEARCH}

Summary

The SEC is more focused on the excessive use of non-GAAP reporting measures given the recent C&DIs on the subject, and so are we. Based on our analysis, many company's adjustments are questionable and, as result, our models now reflect a "MSUSA adjusted EPS". We suspect that over time the SEC could be forced to issue regulations surrounding non-GAAP reporting if company's behavior does not change post the guidelines.

Key Points

SEC Is Focused On Non-GAAP. The SEC has made it increasingly clear in recent months that they think companies are being excessive when reporting using non-GAAP measures. With the additional guidelines, we think the SEC want to limit the company’s discretion on reporting non-GAAP measures going forward and wants to ensure that companies are not overly aggressive by applying adjustments that are normal operational in nature, recurring, cash operating expenses necessary to operate a company’s business as well as recurring non-cash items.

Sheryl Skolnick Analysis. Three of our companies guide to GAAP or near-GAAP EPS (HCA, UNH & HLS) and we make no adjustments to those high quality estimates. With the exception of KND, the rest of our companies do not yet add-back intangible amortization: we do not introduce this add-back to those companies either. KND is by far the most difficult company to model given a host of complex 'adjusted' concepts and add-backs, so we focus most on KND and make modest adjustments to those add-backs to EPS and would make more if we could have better detail.

Ann Hynes Analysis. Based on the guidelines, we think the only valid non-cash recurring adjustment is acquisition-related goodwill amortization. However, various companies in our coverage universe adjust other non-cash items (e.g. LIFO and stock comp). More concerning, many companies adjust out recurring cash expenses (e.g. recurring restructuring costs, expenses related to the implementation of cost-savings programs and acquisition-related expenses post a year after a deal close). Based on our analysis, we think ABC, TMH, MCK, DGX and WBA non-GAAP adjustments are “overly-adjusted”, while we view CVS and ACHC as the highest quality.

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