The Corp Fin staff has issued a group of revised and new compliance & disclosure interpretations on the use of non-GAAP financial measures. The CDIs are more detailed and expansive in describing disclosure that the staff considers to be misleading as well as presentations that the staff believes reflect excessive non-GAAP prominence over the comparable GAAP number under Reg S-K Item 10(e). Summaries are below.
Section 100. General
Question 100.01 (updated). Some adjustments to non-GAAP measures, even if not explicitly prohibited, may still be misleading in violation of Rule 100(b) of Reg G, depending on the company’s facts and circumstances. As the staff has previously indicated, presenting a non-GAAP performance measure that “excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business” is one example. What’s new and notable? In considering what is a normal operating expense, the staff looks at a broad expanse of factors, including “the nature and effect of the non-GAAP adjustment and how it relates to the company’s operations, revenue generating activities, business strategy, industry and regulatory environment.” How does the staff interpret “recurring”? It’s not just an operating expense that occurs repeatedly; it also refers to an operating expense that occurs “occasionally, including at irregular intervals.”
Question 100.04 (updated). Non-GAAP adjustments to a GAAP measure that have the effect of changing the recognition and measurement principles required under GAAP would be considered “individually tailored” and may cause the presentation of the non-GAAP measure to be misleading. Some examples from the staff (with the last two examples being new additions) of these potentially misleading non-GAAP measures include:
- “changing the pattern of recognition, such as including an adjustment in a non-GAAP performance measure to accelerate revenue recognized ratably over time in accordance with GAAP as though revenue was earned when customers were billed;
- presenting a non-GAAP measure of revenue that deducts transaction costs as if the company acted as an agent in the transaction, when gross presentation as a principal is required by GAAP, or the inverse, presenting a measure of revenue on a gross basis when net presentation is required by GAAP; and
- changing the basis of accounting for revenue or expenses in a non-GAAP performance measure from an accrual basis in accordance with GAAP to a cash basis.”
For the most part, these examples seem to illustrate instances where an important GAAP accounting principle is replaced with an alternate accounting model that does not conform to the company’s business.
Question 100.05 (new). A non-GAAP measure can be misleading simply by failing to appropriately label and clearly describe the adjustments made to the GAAP measure. That’s especially the case because the definitions of non-GAAP measures are not consistent among different companies, and the absence of an appropriate label and clear description could render the non-GAAP measure and/or any adjustment made misleading to investors. The staff provides the following examples that would violate Reg G:
- “Failure to identify and describe a measure as non-GAAP.
- Presenting a non-GAAP measure with a label that does not reflect the nature of the non-GAAP measure, such as:
- a contribution margin that is calculated as GAAP revenue less certain expenses, labeled ‘net revenue’;
- non-GAAP measure labeled the same as a GAAP line item or subtotal even though it is calculated differently than the similarly labeled GAAP measure, such as ‘Gross Profit’ or ‘Sales’; and
- a non-GAAP measure labeled ‘pro forma’ that is not calculated in a manner consistent with the pro forma requirements in Article 11 of Regulation S-X.”
Question 100.06 (new). The staff believes that, even if a non-GAAP measure were accompanied by “extensive, detailed disclosure about the nature and effect of each adjustment” made to the most directly comparable GAAP measure, the non-GAAP measure could still be materially misleading.
Section 102. Item 10(e) of Regulation S-K
Question 102.10(a) (revised). Item 10(e)(1)(i)(A) requires, both in SEC filings and furnished earnings releases that include non-GAAP financial measures, that the most directly comparable GAAP measure be presented with equal or greater prominence relative to the non-GAAP measure. The staff notes that this requirement applies to the presentation of, and any related discussion and analysis of, a non-GAAP measure. Whether a non-GAAP measure is more prominent than the comparable GAAP measure generally depends on the facts and circumstances, and this substantially revised CDI provides examples of the types of presentations where non-GAAP measures would be viewed by the staff to be more prominent than the comparable GAAP measures:
- “Presenting an income statement of non-GAAP measures. See Question 102.10(c). [Note that this bullet no longer refers to a “full” income statement.]
- Presenting a non-GAAP measure before the most directly comparable GAAP measure or omitting the comparable GAAP measure altogether, including in an earnings release headline or caption that includes a non-GAAP measure.
- Presenting a ratio where a non-GAAP financial measure is the numerator and/or denominator without also presenting the ratio calculated using the most directly comparable GAAP measure(s) with equal or greater prominence. [New]
- Presenting a non-GAAP measure using a style of presentation (e.g., bold, larger font, etc.) that emphasizes the non-GAAP measure over the comparable GAAP measure.
- 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.
- Presenting charts, tables or graphs of…non-GAAP financial measures without presenting charts, tables or graphs of the comparable GAAP measures with equal or greater prominence, or omitting the comparable GAAP measures altogether.
- 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.”
Question 102.10(b)(largely new). Some presentations of the non-GAAP reconciliation required by Item 10(e)(1)(i)(B) of Reg S-K could give undue prominence to a non-GAAP measure. The staff’s examples include:
- “Starting the reconciliation with a non-GAAP measure.
- Presenting a non-GAAP income statement when reconciling non-GAAP measures to the most directly comparable GAAP measures. See Question 102.10(c).
- When presenting a forward-looking non-GAAP measure, a registrant may exclude the quantitative reconciliation if it is relying on the exception provided by Item 10(e)(1)(i)(B) of Regulation S-K. A measure would be considered more prominent than the comparable GAAP measure if it is presented without disclosing reliance upon the exception, identifying the information that is unavailable, and its probable significance in a location of equal or greater prominence.”
Question 102.10(c) (new): In the staff’s view, “the presentation of a non-GAAP income statement, alone or as part of the required non-GAAP reconciliation, [gives] undue prominence to non-GAAP measures. The staff considers a non-GAAP income statement to be one that is comprised of non-GAAP measures and includes all or most of the line items and subtotals found in a GAAP income statement.”