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SEC Issues New and Revised C&DIs on Non-GAAP Financial Measures
Practical Law Legal Update w-002-4520 (Approx. 5 pages)
SEC Issues New and Revised C&DIs on Non-GAAP Financial Measures
by Practical Law Corporate & Securities
| Published on 19 May 2016 • USA (National/Federal) |
The SEC's Division of Corporation Finance issued new and revised compliance and disclosure interpretations (C&DIs) on the use of non-GAAP financial measures.
On May 17, 2016, the SEC issued four new compliance and disclosure interpretations (C&DIs) and revised eight C&DIs on the use of non-GAAP financial measures. The new and revised C&DIs are summarized below:
- Rule 100(b). Questions 100.01-100.04 clarify whether certain practices may cause non-GAAP measures to be misleading within the meaning of Rule 100(b) of Regulation G, including:
- making certain adjustments (even if not explicitly prohibited), such as presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a company's business;
- presenting non-GAAP measures inconsistently between periods;
- excluding non-recurring charges from a non-GAAP measure but not excluding non-recurring gains that occurred during the same period; and
- replacing GAAP recognition and measurement methods with individually tailored methods (for revenue or other financial statement line items).
- Item 10(e) of Regulation S-K. Questions 102.01 and 102.05 clarify that the SEC:
- accepts the updated definition of "funds from operations" (FFO) as defined by National Association of Real Estate Investment Trust (NAREIT) as of May 17, 2016 for purposes of footnote 50 to Exchange Act Release No. 47226, Conditions for Use of Non-GAAP Financial Measures, which indicated that companies could use FFO as a non-GAAP measure;
- does not object to the presentation of FFO on a per share basis; and
- would accept a presentation of FFO on a basis other than as defined by NAREIT provided any adjustments comply with Item 10(e) of Regulation S-K (for a performance measure or a liquidity measure) and that the measure does not violate Rule 100(b) of Regulation G.
- Item 10(e)(1)(ii) of Regulation S-K. Question 102.05 confirms that not all non-GAAP earnings per share numbers are prohibited under Rule 10(e) because certain non-GAAP per share performance measures may be meaningful from an operating standpoint. Non-GAAP per share performance measures should be reconciled to GAAP earnings per share. However non-GAAP liquidity measures that measure cash generated cannot be presented on a per share basis in documents filed with or furnished to the SEC. Question 102.05 clarifies that whether per share data is prohibited is dependent on whether the non-GAAP measure can be used as a liquidity measure, even if management presents it solely as a performance measure. When analyzing use of a non-GAAP per share measure, the SEC staff will focus on the substance of the non-GAAP measure and not the management's characterization of the measure. In addition, Question 102.07 confirms that that free cash flow is a non-GAAP liquidity measure that must not be presented on a per share basis.
- Item 10(e)(1)(i)(A) of Regulation S-K. Question 102.10 provides the following examples of disclosures that are considered to give greater prominence to a non-GAAP measure than to the most directly comparable GAAP measure in violation of Item 10(e)(1)(i)(A) of Regulation S-K:
- 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 measures;
- omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures;
- presenting a non-GAAP measure in a style (such as in bold or a 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);
- 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 for 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.
The staff reiterated that its determination of whether a non-GAAP measure is given greater prominence generally depends on the facts and circumstances in which the disclosure is made. - Income Tax Effects. Question 102.11 was revised to state that, for certain measures, companies should provide income tax effects on those measures in its disclosures. The SEC staff provided the following examples of measures for which the company should consider describing income tax effects:
- a liquidity measure that includes income taxes may allow for adjustments to GAAP taxes to show taxes paid in cash; and
- a performance measure should include current and deferred income tax expense commensurate with the non-GAAP measure of profitability.
Adjustments to arrive at a non-GAAP measure should not be presented "net of tax," but rather as a separate adjustment that is clearly explained. - EBIT and EBITDA. Question 103.02 clarifies that if EBIT or EBITDA is presented as a performance measure, it should not be presented on a per share basis.
For more information on non-GAAP financial measures, see Practice Note, Using Non-GAAP Financial Information.