Securities Law Blog

Overview.  As SEC reporting companies prepare their earnings releases and SEC periodic reports for the most recently completed fiscal quarter or year, and for earnings presentations or calls regarding their financial results, it is important to determine in advance whether the company will disclose any “non-GAAP” measures of financial performance, financial condition or cash flow.  Such disclosure, whether written or oral, must comply with certain SEC rules and regulations, which compliance requires advance coordination and preparation by the company’s financial and legal teams.  In December 2015, SEC Chair White publicly stated that non-GAAP financial measures may be a source of confusion, and the SEC was paying close attention to their use as part of an effort to make sure that current rules are being followed and to ask whether such rules are sufficiently robust in light of current market practices.  As a result, companies should be particularly mindful of their use of non-GAAP financial measures in upcoming reporting cycles.

Non-GAAP Financial Measures.  Non-GAAP financial measures are financial metrics calculated by including or excluding items from financial measures used in a company’s financial statements calculated in accordance with GAAP.  Frequently used non-GAAP financial measures include EBITDA and adjusted earnings excluding certain non-recurring or unusual items (such as write-downs or restructuring charges).  Companies commonly use non-GAAP financial measures because they believe that the measures help investors (including analysts) better understand the company’s results or financial position.  Some non-GAAP financial measures have been developed as industry-specific metrics and become commonplace across the industry.

Disclosure Requirements.  The SEC rules and regulations applicable to the public disclosure of non-GAAP financial measures are Regulation G and Item 10(e) of Regulation S-K..

• Regulation G – Applies to any public disclosure of non-GAAP financial measures, whether written or oral, by a company with a class of security registered under Section 12 of the Exchange Act or that is required to file reports under Section 15(d) of the Exchange Act.  Regulation G requires that any such disclosure must also include the most directly comparable GAAP financial measure (e.g., EBITDA to net income) and a quantitative reconciliation of the difference between the non-GAAP and GAAP measures, showing how to calculate one from the other.  For oral presentations (including in an earnings call or webcast), the company can post this information on its website at the time of the presentation (recommended that the information remain on the website for at least 12 months) and the website address is publicized in the same presentation.
• Item 10(e) of Regulation S-K – Applies to the use of non-GAAP financial measures in SEC filings, including periodic reports under the Exchange Act and registration statements under the Securities Act.  Item 10(e) of Regulation S-K requires the same disclosures as Regulation G, except that the presentation of comparable GAAP information must be made “with equal or greater prominence.”  Additionally, the company must state why management believes that the non-GAAP financial measure provides useful information to investors and, to the extent material, how management uses the non-GAAP financial measure.  The disclosures beyond Regulation G’s requirements may be provided on an annual basis in a company’s Form 10-K so long as it remains accurate and up to date.  Additionally, Item 10(e) of Regulation S-K provides for certain restrictions on the non-GAAP financial measures that can be used and where they can be included.  These restrictions include (1) a prohibition on the use of a non-GAAP performance measure to eliminate charges or gains as non-recurring, infrequent or unusual items, when the charge or gain is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years and (2) a prohibition on the presentation of any non-GAAP financial measures within a company’s financial statements prepared in accordance with GAAP or the accompanying notes.  

Practical Tips.

• Advance communication between financial and legal teams is critical.  If the financial team of an SEC reporting company is contemplating using a new non-GAAP financial measure in oral or written investor communications, or doing so for the first time, they should alert and discuss the matter with the company’s legal team, including when such non-GAAP financial measure would be used, to determine whether Regulation G and/or Item 10(e) of Regulation S-K will apply.  Then the company can coordinate the preparation of the required financial information and narrative disclosure, and determine when and where it must be provided.
• A company’s legal team should review earnings releases, presentations and call scripts to confirm that non-GAAP financial information only is used in compliance with disclosure requirements.  Such review should take place sufficiently in advance of disclosure that the financial team can take action if the disclosure is not compliant.

• Seek to maintain consistency in the use and calculation of non-GAAP financial measures and the reconciled GAAP measure from period to period (and consider this goal when selecting non-GAAP financial measures for use in public disclosures) to help address the ever-present SEC concern that disclosures not be misleading to investors.

Helpful References
-Chair Mary Jo White, Keynote Address at the 2015 AICPA National Conference: “Maintaining High-Quality, Reliable Financial Reporting: A Shared and Weighty Responsibility” (Dec. 9, 2015) – https://www.sec.gov/news/speech/keynote-2015-aicpa-white.html
-SEC Compliance & Disclosure Interpretations: Non-GAAP Financial Measures – https://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm