In order to encourage registrants to provide more meaningful financial information to investors following the 2008-9 global economic crisis, the Division of Corporation Finance Staff has updated its Regulation G-related C&DIs (Compliance and Disclosure Interpretations). Chief financial officers, chief accounting officers, and other public company management should review these updates in connection with the preparation of their year-end earnings releases, SEC filed or furnished documents and other information provided to the public. Although not binding on the Securities and Exchange Commission, C&DIs contain the views of the staff of the SEC’s Division of Corporation Finance and, therefore, will be reflected in Staff comment letters. The revised Regulation G guidance reflects the agenda of the Division’s Director, Meredith Cross.
The updated C&DIs appear to reflect a shift in Staff attitude to Regulation G to permitting greater flexibility in reporting non-GAAP financial measures. For example, where a previous FAQ addressed whether a disclosure was “permitted”, the new C&DI discusses whether the same disclosure is “prohibited”, consistent with the Staff’s view that some of its prior guidance may have been too restrictive. In addition, a number of cash flow-related interpretations changed substantively, reflecting a Staff response to investors’ focus on public companies’ ability to operate from a cash flow perspective. In light of the FASB’s accounting codification effective September 15, 2009, the revisions reflect the relevant references to the FASB Accounting Standards Codification.
Regulation G. When a company publicly discloses material information with a non-GAAP financial measure, Regulation G requires that the disclosure be accompanied by a presentation of the most directly comparable GAAP measure and a reconciliation to that measure. If a company presents a non- GAAP financial measure orally, telephonically or by similar means, it may satisfy Regulation G by providing the required additional information by (i) posting that information on its website and (ii) disclosing the location and availability of the required information during the presentation. Item 10(e) of Regulation S-K sets forth requirements for non-GAAP measures where non-GAAP measures are included in filings with the SEC. Regulation G and Item 10(e) of Regulation S-K originated from a 2002 mandate under the Sarbanes-Oxley Act for the SEC to regulate non-GAAP financial information.
Revised Guidance. The Staff’s updates to its prior guidance in the C&DIs include a number of noteworthy substantive revisions and additions:
- Non-Recurring Adjustments. The Staff has indicated that a registrant may include in filings with the SEC non-GAAP measures that exclude a charge or gain that is a recurring item so long as the item is not described as “non-recurring, infrequent, or unusual.” A charge or gain is considered “recurring” if it is reasonably likely to recur within two years or there has been a similar charge or gain within the prior two years. The Staff’s guidance no longer requires that a registrant excluding a recurring item from a non-GAAP measure bear the burden of demonstrating the usefulness of the non-GAAP measure.
- REITs. The C&DIs clarify that registrants may present in materials filed with the SEC funds from operations (FFO) measures that differ from the National Association of Real Estate Investment Trusts’ definition of FFO. Separately, if an adjusted FFO measure is intended to be a measure of liquidity, it may not exclude charges or liabilities that required, or will require, cash settlement. If an adjusted FFO measure is intended to be a performance measure, it may be presented on a per-share basis; if it is intended to be a liquidity measure, it may not be presented on a per-share basis.
- Per Share Amounts. Per share non-GAAP amounts may be included in documents filed with the SEC if the measures are not cash flow-related or otherwise liquidity-related, subject to special guidance for REITs discussed above.
- Free Cash Flow Measures. Careful use of a free cash flow non-GAAP measure with an appropriate description is permitted in documents filed with the SEC, and the material limitations inherent in the measure no longer need to be disclosed.
- Use of Adjusted EBITDA in Filings. Registrants may discuss a credit agreement’s adjusted EBITDA financial covenant and its application in filed reports, assuming management believes that the credit agreement is a material agreement, the covenant is a material term and information about the covenant is material to an investor’s understanding of the registrant’s liquidity position. Registrants should consider (i) the material terms of the credit agreement, including the covenant, (ii) the amount or limit required for compliance with the covenant and (iii) the effects of compliance or non-compliance with the covenant on the registrant’s financial condition and liquidity.
- Non-GAAP Income Statements. Registrants should not present full non-GAAP income statements to reconcile their non-GAAP measures.
- Use of Measure in Managing Business. A non-GAAP measure may be used, even if the registrant’s management does not use that particular measure in managing the registrant’s business.
- Net of Tax Measures. Registrants are permitted to use a net of tax non-GAAP measure but need to provide the tax effect of each reconciling item either parenthetically or in a footnote and need to disclose how the tax effect was calculated.
- Foreign Private Issuers. A foreign private issuer may utilize a non-GAAP measure if its primary market regulator has indicated its acceptance in writing of the measure, by either publishing its acceptance or by direct communication to the issuer, such as a comment letter on an offering.
The Staff emphasized in its revised guidance that registrants should strive to provide non-GAAP measures that are understandable to investors, specific to a registrant and its business and presented fairly and in good faith.