On December 13, 2022, the Staff of the Division of Corporation Finance of the U.S. Securities and Exchange Commission updated its Non-GAAP Financial Measures Compliance & Disclosure Interpretations Questions (“C&DIs”).
Non-GAAP financial measures are numerical measures of a registrant’s historical or future financial performance, financial position or cash flows that exclude amounts included in, or include amounts excluded from, the most directly comparable measure calculated under the generally accepted accounting principles (“GAAP”) used in preparing the registrant’s financial statements. Non-GAAP financial measures exclude operating and other statistical measures.
Pursuant to Regulation G, a registrant that publicly discloses a non-GAAP financial measure must present the non-GAAP financial measure with the most directly comparable GAAP measure, as well as a quantitative reconciliation (or, in the case of a forward-looking non-GAAP financial measure, a qualitative reconciliation to the extent presenting a quantitative one would involve unreasonable efforts) of the differences between the non-GAAP financial measure and the comparable GAAP measure. Pursuant to Item 10(e) of Regulation S-K, when the non-GAAP financial measure is included in a registration statement, periodic report or current report filed, or earnings release furnished, with the SEC, the non-GAAP financial measure must not be presented with greater prominence than the comparable GAAP measure. In annual reports, registrants must provide a statement disclosing the reasons why management believes that presentation of the non-GAAP financial measure provides useful information to investors and any additional purposes for which management uses the non-GAAP financial measure. Additionally, any publicly disclosed non-GAAP financial measure, in light of the circumstances under which it is presented, must not be misleading.
Although the updated and new C&DIs are generally consistent with prior Staff guidance, the updates reflect the SEC’s continued focus on the use of non-GAAP financial measures. The timing of the release of the updated and new C&DIs—shortly before most public companies report annual earnings—and prior experience with similar updates lead us to expect additional SEC scrutiny and comment on annual earnings materials. Public companies that present non-GAAP financial measures in their public disclosures or SEC filings should consider whether revisions to their non-GAAP disclosures are needed in light of the new guidance. In particular, registrants should confirm that:
- non-GAAP performance measures do not exclude normal, recurring, cash operating expenses that are necessary to operate a registrant’s business.
- non-GAAP financial measures do not contain individually tailored accounting principles.
- non-GAAP measures and adjustments are specifically identified as “non-GAAP” and are not labeled with potentially misleading titles.
- public disclosures do not contain misleading non-GAAP disclosures, even if accompanied by extensive, detailed disclosure about the nature and effect of the adjustments.
- GAAP measures always precede non-GAAP measures, whether they are in the form of dollar amounts, ratios or percentages.
The updated C&DIs are shown below:
Question 100.01 (revised)
Question: Can certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading?
Answer: Yes. Certain adjustments may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading. Whether or not an adjustment results in a misleading non-GAAP measure depends on a company’s individual facts and circumstances.
Presenting a non-GAAP performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business is one example of a measure that could be misleading.
When evaluating what is a normal, operating expense, the staff considers 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.
The staff would view an operating expense that occurs repeatedly or occasionally, including at irregular intervals, as recurring.
Question 100.04 (revised)
Question: Can a non-GAAP measure violate Rule 100(b) of Regulation G if the recognition and measurement principles used to calculate the measure are inconsistent with GAAP?
Answer: Yes. By definition, a non-GAAP measure excludes or includes amounts from the most directly comparable GAAP measure. However, non-GAAP adjustments that have the effect of changing the recognition and measurement principles required to be applied in accordance with GAAP would be considered individually tailored and may cause the presentation of a non-GAAP measure to be misleading. Examples the staff may consider to be misleading include, but are not limited to:
- 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.
Question 100.05 (new)
Question: Can a non-GAAP measure be misleading if it, and/or any adjustment made to the GAAP measure, is not appropriately labeled and clearly described?
Answer: Yes. Non-GAAP measures are not always consistent across, or comparable with, non-GAAP measures disclosed by other companies. Without an appropriate label and clear description, a non-GAAP measure and/or any adjustment made to arrive at that measure could be misleading to investors. The following examples would violate Rule 100(b) of Regulation 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)
Question: Can a non-GAAP measure be misleading, and violate Rule 100(b) of Regulation G, even if it is accompanied by disclosure about the nature and effect of each adjustment made to the most directly comparable GAAP measure?
Answer: Yes. It is the staff’s view that a non-GAAP measure could mislead investors to such a degree that even extensive, detailed disclosure about the nature and effect of each adjustment would not prevent the non-GAAP measure from being materially misleading.
Question 102.10(a) (revised)
Question: Item 10(e)(1)(i)(A) of Regulation S-K requires that when a registrant presents a non-GAAP measure it must present the most directly comparable GAAP measure with equal or greater prominence. This requirement applies to non-GAAP measures presented in documents filed with the Commission and also earnings releases furnished under Item 2.02 of Form 8-K. Are there examples of disclosures that would cause a non-GAAP measure to be more prominent?
Answer: Yes. 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 in which the disclosure is made. The staff would consider the following to be examples of non-GAAP measures that are more prominent than the comparable GAAP measures:
- Presenting an income statement of non-GAAP measures. See Question 102.10(c).
- 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.
- 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 a 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) (revised)
Question: Are there examples of disclosures that would cause the non-GAAP reconciliation required by Item 10(e)(1)(i)(B) of Regulation S-K to give undue prominence to a non-GAAP measure?
Answer: Yes. The staff would consider the following examples of disclosure of non-GAAP measures as more prominent than the comparable GAAP measures:
- 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) (revised)
Question: The staff considers the presentation of a non-GAAP income statement, alone or as part of the required non-GAAP reconciliation, as giving undue prominence to non-GAAP measures. What is considered to be a non-GAAP income statement?
Answer: 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.
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