Activist investor Starboard Value rattled Perrigo Co. on Mondaywith a scathing criticism of the drug company's management. A lookat Perrigo's financials reveals one way management has excelled:Making its results look good.

Quarter after quarter, the Dublin, Ireland-based maker ofgeneric drugs relied on one-time expenses and novel terms like“organic net sales” to highlight a string of profits on its ownadjusted terms. In its full-year 2015 report, Perrigo listed $1.09billion in adjusted profit. The word “loss” was used sparingly,despite a net loss of $33 million using non-adjusted accountingthat adheres to Generally Accepted Accounting Principles, known asGAAP.

It was the biggest percentage disparity last year betweenadjusted and GAAP figures among companies in the Standard &Poor's 500 index, according to data compiled by Bloomberg.

Many companies say adjusted figures, which are permitted by theU.S. Securities and Exchange Commission, strip outquarter-to-quarter noise and often give investors a truer pictureof a company's health. Even so, the divide between standard andnon-standard accounting measures has become a subject of scrutinyby the SEC, prompting companies to begin suppressing theirhand-picked numbers and toning down their characterizations ofperformance. Perrigo, for its part, began leading its reports withGAAP figures this year.

“I think what's upsetting the SEC is the emphasis on recordnon-GAAP results,” said Paul Chaney, an accounting professor atVanderbilt University, speaking generally about public companies.“Some companies put those numbers in a big font. But if you look atthe accounting numbers, it might show the exact opposite. Thecompany might have had a loss.”

Perrigo declined to provide comment on its use of adjustedfinancial results. Responding to Starboard's critiques, it said ina written statement that it's committed to transparency and “looksforward to a constructive and productive dialogue with Starboard.”Starboard didn't respond to a request for comment.

Starboard, an activist fund, disclosed a 4.6% stake in Perrigoin a letter Monday to the company's CEO, John Hendrickson.Starboard chastised management for its underperforming stock priceand said that “changes are needed to reverse the trajectory of pooroperating and financial performance.” The company's shares jumpedthe most since June 14 after the letter went public but are downabout 36% for the year.

Until recently, casual observers could be forgiven for thinkingthe company needed no such reversal. In 2014 and 2015, itsfinancial reports highlighted “record” high profits based onfigures adjusted for a range of temporary expenses, and its topexecutives received bonuses tied to those numbers. Its GAAPresults were often pushed to the bottom.

That changed last month, when the company shifted to a morematter-of-fact approach in releasing its second-quarter earnings.Dropping talk of records and emphasizing net income of $194million ahead of a higher adjusted figure, the Aug. 10 reportstated blandly: “Perrigo Company plc Reports Second Quarter 2016Financial Results.”

The change speaks to how publicly traded companies areresponding to the SEC's demands that they cut the hyperbole andswitch to a more standard, straightforward approach to thefinancial reports that analysts and investors rely on toassess the health of a company.

SEC Guidelines

In May, the agency released new reporting guidelines. Beyondurging companies to dramatically limit their use of adjustedfigures, the SEC cautioned management against giving such numbersmore prominence than conventional results that conform to GAAP.

Starboard didn't chastise Perrigo for the magnitude of itsadjustments. But it did take issue with its underlying financialresults and some of the activities the drugmaker strippedout of earnings to calculate its adjusted numbers. Thatincludes the cost of an “extremely expensive” defense against ahostile bid by Mylan NV and expenses related to the “severelymismanaged” integration of Omega Pharma NV.

Wall Street analysts generally haven't resisted theincreasing focus on adjusted numbers, which are often used bypharmaceutical companies. But one practice that has raised concernsamong regulators and some investors is when companies characterizerecurring expenses as one-offs — such as when a serial acquirerlike Perrigo consistently treats deal-related costs as one-timeexpenses.

Adjusted results are typically only one of several measures thatanalysts use to evaluate public companies, said David Buck, whocovers Perrigo for Northland Securities.

This spring, shortly before the SEC released its new guidelines,its chief accountant, James Schnurr, said in a speech that he was“particularly troubled by the extent and nature of the adjustments”companies were using to arrive at their own measures ofprofitability.

The agency's Division of Corporate Finance, in a letter-writingcampaign this year, has called out at least a few dozen companies,including NRG Energy Inc. and Chubb Ltd., asking them to clarifytheir use of non-GAAP accounting measures or ordering them outrightto make changes, public filings indicate. Perrigo hasn't been amongthose companies.

NRG and Chubb both responded to the SEC by saying they wouldchange their disclosures to comply with the agency's guidance. AChubb spokesman declined to comment for this article, and NRGdidn't respond to requests for comment.

One-Time Events

In general, executives have defended adjusted financials as away to help investors focus on the performance of their underlyingbusinesses by stripping away one-time events — like the oddacquisition or lawsuit — that are counted under GAAP. Regulatorshave shown some sympathy for that argument.

“The SEC is willing to concede that for some companies non-GAAPnumbers are a logical way to account for the business,” Chaney, theVanderbilt accounting professor, said. “But it wants them to startwith GAAP so at least there's some consistency.”

Accounting methods aside, Perrigo has attracted its share ofcontroversy. After being based in Michigan since 1887, itengineered a corporate inversion in 2013 to move its headquartersto tax-friendly Ireland. The company spurned a hostile takeover bythe EpiPen maker Mylan last year that offered shareholders twicethe company's current value. In April, after the deal died,longtime Chief Executive Officer Joseph Papa left the drugmaker forits embattled rival, Valeant Pharmaceuticals International Inc.

Perrigo's unparalleled 2015 earnings adjustment resulted from ahandful of large non-GAAP modifications of the sort that havebecome common among publicly listed companies. As Perrigo usedacquisitions to increase sales 28 percent to a record $5.3 billion,it also excluded acquisition-related amortization expenses from itscost of goods sold, thereby boosting its adjusted gross profit by$447 million.

Other adjustments cut operating expenses by nearly half abillion dollars more. Among those excluded were $100 million spentfighting off Mylan's hostile bid and $92 million inacquisition-related “selling” expenses. A separate adjustmentexcluded $265 million lost to a buyout-related currency hedge gonesour.

“It's real money going out door,” J. Edward Ketz, an accountingprofessor at Penn State, said about the acquisition-relatedexpenses Perrigo excluded from its adjusted results. “Shareholdersare going to feel the impact. As long as Perrigo's in the M&Abusiness, it can't argue that this is non-recurring.”

Bloomberg News

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.