The SEC’s non-GAAP rules are set forth in Regulation G and in Item 10 of Regulation S-K, with the form of the disclosure driving which provision applies. Regulation G, the less restrictive of the two provisions, applies to all public disclosures (written or oral), whereas Item 10 applies only to documents “filed” with the SEC. In this context, “filed” generally excludes documents “furnished” to the SEC as contemplated by General Instruction B(2) to From 8-K and similar provisions. The critical exception to this generalization applies to any earnings release furnished under Item 2.02 of Form 8-K, to which Item 10 applies regardless of the fact that it is only “furnished.” The differences between Item 10 and Regulation G are small, but important, with the difference that comes into play most often being the requirement under Item 10(e) that a GAAP number be given “equal or greater prominence” compared to the comparable non-GAAP measure.
In the ten years since the non-GAAP rules were adopted, the SEC has put out a myriad of guidance in its C&DIs, Financial Reporting Manual, and comment letters. The 2002 proposing release and the 2003 adopting release also contain helpful guidance. It is noteworthy that the SEC’s position regarding the use of non-GAAP measures, especially in “filed” documents, has evolved to a stronger recognition now that, when done appropriately, non-GAAP measures can be beneficial to investors.
Despite the significant SEC guidance over the past ten years, the use of non-GAAP measures still generates frequent questions. Here are some observations with respect to the most common:
- Beware of using non-GAAP measures in headlines or captions. This practice is most common in earnings releases, which, as noted above, are subject to the equal prominence requirements of Item 10(e). There simply is no practicable way to match the “prominence” of this presentation without also including the comparable GAAP number within the headline or caption.
- You do not have to lead off with the GAAP measure, but it must follow in close proximity to the comparable non-GAAP measure. Alternating sentences certainly meets the requirement, and alternating paragraphs, assuming that they are relatively brief and not convoluted, should as well.
- When using bullet points or highlights, avoid using a non-GAAP measure in the first item. It simply provides an irresistible invitation to the SEC to scrutinize all of the non-GAAP measures.
- As one would expect, the likelihood of SEC comments with respect to non-GAAP measures appears to correlate to the number of non-GAAP measures used. Companies rarely get comments when they use non-GAAP measures sparingly, which argues in favor of judicious use generally.
- Similarly, the likelihood of SEC comments appears to correlate to the complexity of non-GAAP measures used. In this regard, companies should present the simplest and most straight-forward non-GAAP measures possible, at the same time being consistent with management’s use of similar data. Squeezing the last penny into an adjustment often is not worth the complexity it entails.
- Often a non-GAAP measure and the required tabular reconciliation can be avoided with the simple restructuring of a sentence. Compare “Operating income excluding amortization of goodwill was $X” to “Operating income was $Y. This amount included $Z of amortization of goodwill.”
- The rules do not specify how reconciliations are to be presented. Annexes at the end of the document appear increasingly to be the most common method, but in the simplest of situations, some non-GAAP measures are “self-reconciling” and we do not press clients for more detailed reconciliations.
- Reflecting the SEC’s changing views, companies that use non-GAAP measures in earnings presentations should be prepared to include them in their Form 10-K and Form 10-Qs. If it is important enough to present in the earnings context, it is difficult to explain why it should not also be included in the “filed” reports as well.
- Although we cannot suggest a strong connection, our experience also suggests that where non-GAAP measures are thoroughly explained in the reconciliation or elsewhere, comments are less likely.
While not often the target of Staff comments – the Staff does not have the resources to compare current filings to prior filings – we also encourage clients that use non-GAAP measures to report the same measures each period using the same adjustments. Independent of what the SEC ever might say, inconsistent adjustments to the line items excluded in deriving non-GAAP measures may be fertile grounds for a clever plaintiff to make a 10b-5 claim.
We are perfectly comfortable with non-GAAP measures, and where they help companies better convey their messages to investors, we think that companies should not hesitate using them. In some instances, they are designed to put a company’s best foot forward, or provide a bit of investor relations spin, and that is perfectly acceptable as well.
But, there is a well-established history of the Staff’s commenting on non-GAAP measures, and we think that most companies are well-advised to use them judiciously and only where they enhances investor understanding.
The original memo, available here, was published by Troutman Sanders on August 19, 2013.