As noted in the May 13 edition of Corporate and Financial Weekly Digest, SEC Chair Mary Joe White, Deputy Chief Accountant Wesley R. Bricker and other high-ranking members of the staff of the SEC have expressed concerns regarding non-GAAP disclosure practices. Correspondingly, on May 17, the Securities and Exchange Commission’s Division of Corporation Finance issued 12 new and revised Compliance and Disclosure Interpretations (C&DIs) relating to the use of non-GAAP financial measures. The new and revised C&DIs included the following interpretive guidance:
- Misleading Non-GAAP Measures: The SEC clarified that certain adjustments may result in a non-GAAP measure that is misleading (whether or not the measure is expressly prohibited) and, therefore, prohibited by Regulation G (which set forth rules for presentation by registrants of non-GAAP financial information in all forums). For example, adjustments that are presented inconsistently between periods or exclude charges but do not exclude gains can be misleading. Similarly, presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading. The staff of the SEC (Staff) also indicated that non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP could be misleading. Accordingly, a registrant could not present a non-GAAP performance measure that is adjusted to accelerate revenue recognized ratably over time in accordance with GAAP as though it earned revenue when the customer is billed. Other measures that use individually tailored recognition and measurement methods for financial statement line items other than revenue may also be misleading.
- Per Share Presentation: The Staff clarified prior guidance that prohibited the per share presentation of non-GAAP liquidity measures in documents filed or furnished with the SEC. Specifically, the Staff stated that whether per share data is prohibited depends on whether the non-GAAP measure can be used as a liquidity measure (even if management presents it solely as a performance measure). To determine whether a non-GAAP measure can be used as a liquidity measure, the Staff will focus on the substance of the non-GAAP measure and not management’s characterization of the measure. Consistent with this guidance, the Staff expressly states that free cash flow, EBIT and EBITDA should not be presented on a per share basis.
- Prominence of non-GAAP Disclosure: Item 10(e)(1)(i)(A) of Regulation S-K requires that when a registrant presents a non-GAAP measure it must present the most directly comparable GAAP measure with equal or greater prominence. This requirement applies to non-GAAP measures presented in documents filed with the SEC and also earnings releases furnished under Item 2.02 of Form 8-K. The Staff provided several examples of disclosure of no-GAAP measures that the Staff views as “more prominent” than the comparable GAAP measure. The examples include (but are not limited to):
- omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures;
- using font styles (e.g., bold, italics, etc.) that emphasize the non-GAAP measure over the comparable GAAP measure;
- presenting a non-GAAP measure before the most directly comparable GAAP measure (including in a 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; 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.
- Taxes. The Staff clarified that a registrant should provide income tax effects on its non-GAAP measures depending on the nature of the measures. If a measure is a liquidity measure that includes income taxes, it might be acceptable to adjust GAAP taxes to show taxes paid in cash. If a measure is a performance measure, the registrant should include current and deferred income tax expense commensurate with the non-GAAP measure of profitability. In addition, adjustments to arrive at a non-GAAP measure should not be presented “net of tax.” Rather, income taxes should be shown as a separate adjustment and clearly explained.
The new and revised C&DIs is available here.