As recently as last month I wrote about the SEC’s heightened focus on non-GAAP financial measure disclosures, evidenced by recent pronouncements from SEC Chair Mary Jo White, PCAOB Chair James R. Doty, SEC Commissioner Kara M. Stein and SEC Chief Accountant James Schnurr. (See this Doug’s Note.) Others have made similar comments since then. As a result, additional SEC guidance regarding appropriate use of non-GAAP financial measures had been expected.
Sure enough, last week the Division of Corporation Finance issued 12 new or updated Compliance and Disclosure Interpretations dealing with the use of non-GAAP financial measures. It is fair to say that the new guidance does not significantly change what we thought we already knew on the topic, though it does confirm and clarify several gray areas. For example, new C&DI’s offer the following guidance:
- Presenting a performance measure that excludes normal, recurring, cash operating expenses could be misleading (Q&A No. 100.01);
- A non-GAAP measure presented inconsistently between periods could be misleading unless the change between periods is disclosed and the reasons for the change are explained (Q&A No. 100.02);
- A non-GAAP measure could be misleading if it excludes charges but does not exclude gains (Q&A No. 100.03);
- Non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP or that use other tailored recognition and measurement methods other than revenue could violate Regulation G (Q&A No. 100.04);
- Free cash flow is a permissible non-GAAP measure, but may not be presented on a per share basis (Q&A No. 102.07); and
- EBIT or EBITDA used as a performance measure may not be presented on a per share basis (Q&A No. 103.02).
The C&DI that most caught my eye, however, addresses the requirement to present the most directly comparable GAAP measure with “equal or greater prominence” to the related non-GAAP measure. In my experience, this is the non-GAAP issue that crops up most frequently in company disclosures. It requires delicate balancing of legal and investor relations interests, often leaving neither department particularly happy with the result.
In Q&A No. 102.10, the staff says that the following are examples (which I quote verbatim) of inappropriately prominent non-GAAP measure disclosures:
- Presenting a full income statement of non-GAAP measures or presenting a full non-GAAP income statement when reconciling non-GAAP measures to the most directly comparable GAAP measure;
- Omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures;
- Presenting a non-GAAP measure using a style of presentation (e.g., bold larger font) that emphasizes the non-GAAP measure over the comparable GAAP measure;
- A non-GAAP measure that precedes the most directly comparable GAAP measure (including an earnings release headline or caption);
- Describing a non-GAAP measure as, for example, “record performance” or “exceptional” without at least an equally prominent descriptive characterization of the comparable GAAP measure;
- Providing tabular disclosure of non-GAAP financial measures without preceding it with an equally prominent tabular disclosure of the comparable GAAP measures or including the comparable GAAP measures in the same table;
- Excluding a quantitative reconciliation with respect to a forward-looking non-GAAP measure in reliance on the “unreasonable efforts” exception in Item 10(e)(1)(i)(B) without disclosing that fact and identifying the information that is unavailable and its probable significance in a location of equal or greater prominence; and
- Providing discussion and analysis of a non-GAAP measure without a similar discussion and analysis of the comparable GAAP measure in a location with equal or greater prominence.
I’d bet that a lot of well-intentioned companies have violated one or more of these guidelines at some point. Because it is clear that upcoming SEC reviews will focus on these issues, it would be wise to revisit your company’s non-GAAP reporting practices well in advance of its next SEC filing and be prepared to make any necessary adjustments.