Reporting financial and other non-financial measures

There has been heightened focus on APMs in recent years and increased demand for transparency and explanation of APMs in order to provide reliable, comparable and comprehensive information. 

With the reporting of APMs receiving significant attention, we consider, below, the extant guidance surrounding APMs, some of the typical measures being used across the pharmaceutical sector and also some of the challenges and opportunities for improvement with respect to presenting APMs.

Guidance on APMs

Guidance on the reporting of APMs has been published by a number of different sources. This guidance includes the European Securities and Market Authority (ESMA) Guidelines on APMs, the International Organization of Securities Commissions (IOSCO) Statement on Non-GAAP Financial Measures, and several different publications from the Financial Reporting Council (FRC) and its Financial Reporting Lab.

In addition, the International Accounting Standards Board (IASB) is currently redeliberating proposals looking at the reporting of financial performance and the format of the income statement to remove some of the potential for inappropriate presentation of APMs.

Whilst the ESMA guidelines are not new, having first been published in 2016, the following seven detailed principles remain highly relevant:

• APMs should be labelled accurately.
• APMs should be clearly defined.
• Reconciliation of APMs to GAAP measures should be provided.
• The level of prominence given to APMs should be carefully considered.
• APM explanations should be informative.
• Comparatives should be provided.
• APMs and KPIs should be consistent period on period (and where restatements have been made, restated comparative or current-year figures should be provided).

Performance measures in the pharmaceutical sector

Entities operating in the pharmaceutical sector use a variety of performance measures, but some of the most common reported financial metrics are total revenue, adjusted EBITDA (or adjusted operating profit), EPS (reported and core), free cash flows and net debt.

Many entities believe that they can enhance the understanding of their performance by disclosing non-GAAP measures. These measures include “‘core” measures of performance which are intended to enable users to better compare business performance across years. Where measures such as “core results” are used, it is important that these are clearly reconciled to the GAAP measures and that assorted “one-off” and other exclusions are explained.

Whilst these headline metrics are important, often other metrics offer more insight for investors.  Innovation is critical to how companies improve health and create financial value. So items such as the R&D/revenue ratio, individual drugs sales patent or regulatory expiry dates and addressable markets, details of the number of products/assets in pipeline and pipeline approvals are as, or more, important than purely financial metrics. 

Ultimately, the success of major pharmaceutical companies is highly correlated to the discovery and development of new medicines.

In contrast to many other corporate activities, R&D isn’t something companies engage in to make an immediate profit. Because pharmaceutical companies must invest large amounts in R&D they must maintain adequate levels of liquidity and effectively manage debt levels. Hence, the focus on metrics such as net debt.

Many pharmaceutical companies’ growth strategies are based on selling a greater volume of drugs to patients, and therefore the ratio of spending on sales and marketing is important for some entities.

Additionally, attention is now switching to other key figures and measures, many of which represent neither financial performance nor the size or growth of the business franchise. These include climate-related disclosures, such as reduction in CO2 emissions, and reporting on the Sustainable Development Goals (SDGs) that represent the risks most salient to business activities. Embedding the SDGs is key for many organisations’ long-term strategies. 

Other sector KPIs include health and safety and quality measures. These, like the operational measures, will increasingly require the same rigour of monitoring and explanation of changes over time as financial measures currently receive.

Challenges and opportunities for improvement

In addition to publishing various reports considering performance metrics, the FRC has also issued a thematic review assessing the quality of APM reporting in the UK five years after the ESMA Guidelines were first introduced.

In the review, the FRC stated that it expects companies to:

• ensure that APMs are not presented in ways that give them greater prominence than amounts stemming from the financial statements
• provide specific, tailored explanations for the inclusion of individual APMs in company reports
• disclose the cash flow impact of material adjusting items and exceptional items and indicate the expected timing of future cash flow impacts
• explain terms such as “underlying profit” or “core operations”
• disclose relevant information for any significant multi-year restructuring programmes that are classified as adjusting items

Whilst compliance with the APM guidelines continues to improve, there are still areas which continue to warrant attention. Many have noted that “adjusted” profitability measures are typically higher than the equivalent GAAP measures, and care is needed to reassure users that the position presented is truly balanced and neutral. And attention is still needed with regard to identifying “unusual” or “one-off” items, as these items are often not isolated to one accounting period. Just because certain figures are volatile each year does not mean that they should be ignored by investors.

Because of the different strategic objectives of the financial statements and the different needs of their users it can be challenging for boards to provide the appropriate number of KPIs. Which measures are important is likely to be unique to each company and its strategy. 

With a risk of KPI overload, care should be taken not to have too many KPIs but nevertheless to cover the key strategic aims. And KPIs should not be changed too often, because comparability over time is particularly important when considering company performance.

Conclusion

APMs can help a company to tell its story and explain its performance to investors, and they are often key to the way management look at the business. In the pharmaceutical sector there are many important metrics, including R&D cost, cycle time, sales growth, health and safety and net debt. There is now a growing demand for sustainability-related metrics, including environmental and social measures, to supplement more typical industry measures.

Presenting lots of different metrics with the right amount of emphasis and detail can be challenging. So there is always likely to be room for improvement in the presentation of both APMs and KPIs. Companies should ensure the picture presented remains appropriate, balanced and transparent and closely tied to the entity’s strategy.