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Corporate Alert: SEC Issues C&DIs on the Use of Non-GAAP Financial Measures

May 24, 2016

The SEC’s Division of Corporation Finance issued several C&DIs on May 17, 2016 regarding the use of non-GAAP financial measures. These interpretations, some of which are new and some of which revise previous interpretations, appear to reflect concern about the use of non-GAAP financial measures recently expressed by SEC officials in public comments and suggest that issuers approach the use of such measures with increased caution. The C&DIs cover topics including non-GAAP financial measures that may be misleading, presentation of EBIT and EBITDA, and the requirement for equal or greater prominence of the most directly comparable GAAP measure. The new and revised C&DIs can be found here, and are summarized below:

  • Certain adjustments, although not expressly prohibited, can result in a non-GAAP measure that is misleading (in violation of Rule 100(b) of Regulation G). For example, presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading.
  • Item 10(e) prohibits characterizing a charge or gain used to derive a non-GAAP financial performance measure as nonrecurring, infrequent or unusual if the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years. However, the fact that a registrant cannot describe a charge or gain as nonrecurring, infrequent or unusual (because it does not meet the specified criteria) does not mean that the registrant cannot adjust for that charge or gain—the prohibition addresses the description of the charge or gain, not its nature. Registrants can make adjustments they believe are appropriate, subject to Regulation G and the other requirements of Item 10(e) (see preceding bullet).
  • A non-GAAP measure can be misleading if presented inconsistently between periods, unless the change is disclosed and explained (if the change is significant, it may be necessary to recast prior measures to conform to the current presentation).
  • A non-GAAP measure that is adjusted only for nonrecurring charges, but not nonrecurring gains in the same period, could be misleading.
  • Non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP (for example, by accelerating revenue recognition to when customers are billed) may not be presented in documents filed or furnished with the SEC or provided elsewhere, such as on company websites. Measures that use individually tailored recognition and measurement methods for financial statement line items other than revenue may also violate Rule 100(b) of Regulation G.
  • EBIT or EBITDA presented as a performance measure should be reconciled to net income as presented in the statement of operations under GAAP (not to operating income), and must not be presented on a per-share basis.
  • "Funds from operations" (FFO) in the SEC’s adopting release for Item 10(e) of Regulation S-K (Item 10(e)) refers to the measure originally defined by the National Association of Real Estate Investment Trusts (NAREIT) in 2000. The staff accepts NAREIT’s definition of FFO in effect as of May 17, 2016 as a performance measure, which may be presented on a per-share basis, subject to the requirements of Regulation G and Item 10(e). A registrant may present FFO on a basis other than as defined by NAREIT as of May 17, 2016, provided that any adjustments comply with Item 10(e) and Rule 100(b) of Regulation G, including Item 10(e) requirements for a performance measure or a liquidity measure, depending on the nature of the adjustments, some of which may trigger the prohibition on presenting this measure on a per-share basis (see first, third, fourth and fifth bullets and following bullet).
  • Non-GAAP earnings per-share numbers are not prohibited in documents filed with or furnished to the SEC. Non-GAAP per-share performance measures should be reconciled to GAAP earnings per share. However, non-GAAP liquidity measures may not be presented on a per-share basis in documents filed with or furnished to the SEC. Whether per-share data is prohibited depends on whether the non-GAAP measure can be used as a liquidity measure (focusing on the substance of the measure), even if management presents it as a performance measure.
  • A measure of "free cash flow" (typically calculated as cash flows from operating activities as presented in the statement of cash flows under GAAP, less capital expenditures), is not prohibited in documents filed with the SEC, provided that a clear description of how it is calculated, and the necessary reconciliation, accompanies the measure. Companies should not inappropriately imply that "free cash flow" represents the residual cash flow available for discretionary expenditures, since many companies have mandatory debt service requirements or other nondiscretionary expenditures that are not deducted from the measure. Free cash flow, as a liquidity measure, must not be presented on a per-share basis.
  • When a registrant presents a non-GAAP measure in documents filed with the SEC and earnings releases furnished under Item 2.02 of Form 8-K, it must present the most directly comparable GAAP measure with equal or greater prominence. Although “prominence” will depend on the facts and circumstances, the following would be considered to violate this requirement by giving non-GAAP measures greater prominence:
    • 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 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);
    • 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 with respect to 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.
  • With respect to the calculation and presentation of income tax effects, for a non-GAAP liquidity measure that includes income taxes, it might be acceptable to adjust GAAP taxes to show taxes paid in cash. For a non-GAAP performance measure, the registrant 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.” Income taxes should be shown as a separate adjustment and clearly explained.

Also of Interest


Joel I. Greenberg
Senior Corporate Partner
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Sara Adler
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