To better tell the story of their financial performance, many public companies use non-GAAP financial measures in press releases and other investor materials and communications.
Non-GAAP financial measures are numerical measures of a registrant’s historical or future financial performance, financial position or cash flows that either:
- excludes amounts, or are subject to adjustments that have the effect of excluding amounts that are included in the most directly comparable measure calculated and presented in accordance with GAAP; or
- includes amounts, or are subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable GAAP measure.
While these measures can certainly be helpful to investors in understanding a company’s performance, they are also, if not presented properly, subject to abuse. Therefore, about 15 years ago the SEC was directed by The Sarbanes-Oxley Act of 2002 to adopt rules on governing non-GAAP financial measures. The rules adopted by the SEC on non-GAAP financial measures are set forth in Regulation G and Item 10(e) of Regulation S-K and are pretty simple.
Under Reg G, an SEC reporting company that publicly discloses material information that includes a non-GAAP financial measure must accompany that non-GAAP financial measure with: (i) a presentation of the most directly comparable GAAP financial measure, and (ii) a reconciliation of the differences between the non-GAAP financial measure and the GAAP measure. Of course, neither companies, nor persons acting on their behalf, can make public a non-GAAP financial measure that, taken together with the information and discussion about that measure, contains an untrue statement of a material fact, or omits to state a material fact necessary in order to make the use of the non-GAAP financial measure, in light of the circumstances under which it is used, not misleading.
In addition to conditions above, Item 10(e) of Reg S-K adds certain requirements when a company includes a non-GAAP financial measure in an SEC filing by requiring companies to include (i) a statement disclosing the reasons why management believes that use of the non-GAAP financial measure provides useful information to investors, and (ii) to the extent material, a statement disclosing the additional purposes, if any, for which management uses the non-GAAP financial measure. In addition, Item 10(e) requires that the presentation of the most directly comparable GAAP financial measure be made with “with equal or greater prominence.”
In May 2016, the SEC staff provided CD&I guidance warning that whether a non-GAAP measure is more prominent than the comparable GAAP measure generally depends on the facts and circumstances. The staff cautioned that the following disclosures of non-GAAP financial measures could be viewed as more prominent:
- 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 in an earnings release headline or caption).
- 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.
- 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.
The staff also cautioned that certain adjustments, although not explicitly prohibited, could result in a non-GAAP financial measure being misleading, such as presenting (i) a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business, (ii) a non-GAAP financial measure inconsistently between periods unless the change between periods is disclosed and the reasons for it explained, and (iii) a non-GAAP measure that is adjusted only for non-recurring charges when there were non-recurring gains that also occurred during the same period.
Regarding the presentation with equal to or greater prominence of the GAAP measure, in light of the staff’s guidance about the order in which a company presents information, presenting the GAAP measure first (although not technically required by the rules) should serve to demonstrate compliance with Reg G and Item 10(e) of Reg S-K. Finally, if a company touts a non-GAAP financial measure (non-GAAP earnings, adjusted earnings or some other number) as being a “record,” the company should also make similar commentary about the comparable GAAP measure.