Alert

The Division of Corporation Finance posted an update to the Non-GAAP Financial Measures Compliance & Disclosure Interpretations (C&DIs).

The C&DIs comprise the division’s interpretations of the rules and regulations on the use of non-GAAP financial measures. The SEC staff updated C&DI Questions 100.01, 100.04–100.06, and 102.10(a)(b)(c) on December 13, 2022, with the intent to provide additional transparency and an understanding as to how the SEC staff considers non-GAAP measures when reviewing documents.

The updated C&DIs are a result of an increase in SEC comments and questions received by the SEC staff related to non-GAAP measures. The updates focus on a company’s use of misleading non-GAAP measures, including the determination of what’s a normal and recurring operating expense and the undue prominence placed on the presentation of non-GAAP measures.

Normal and Recurring Operating Expenses

Question 100.01 addresses how certain adjustments may result in a non-GAAP measure that’s misleading. It was updated to provide transparency around how the SEC staff views normal, recurring operating expenses.

Whether an adjustment results in a misleading non-GAAP measure depends on a company’s individual facts and circumstances. When evaluating what’s a normal, operating expense, a registrant should consider the nature and effect of the non-GAAP adjustment and how it relates to the company’s:

• Operations
• Revenue generating activities
• Business strategy
• Industry
• Regulatory environment

The presentation of a non-GAAP performance measure that excludes normal, recurring operating expenses necessary to operate a registrant’s business is one example of a measure that could be misleading.

The SEC staff would view operating expenses that occur repeatedly or occasionally, including at irregular intervals, as recurring.

During the 2022 AICPA & CIMA Conference on Current SEC and PCAOB Developments, the SEC staff discussed an example relating to the opening and closing of retail stores and restaurants.

While it will ultimately depend on a company’s individual facts and circumstances, the SEC staff would generally believe expenses related to the opening and closing of a retail store or restaurant to be normal and recurring operating expenses.

Tailored Accounting Principles

Question 100.04 addresses the recognition and measurement principles used to calculate the non-GAAP measure. It was updated to clarify it relates to any tailored accounting, not just the acceleration of revenue.

A non-GAAP measure excludes or includes amounts from the most directly comparable GAAP measure. However, non-GAAP adjustments may cause the presentation of a non-GAAP measure to be misleading when the adjustment changes the recognition and measurement principles required to be applied in accordance with GAAP.

Example non-GAAP adjustments the SEC staff may consider tailored and misleading include, but aren’t 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 on a net basis as if the company acted as an agent in the transaction, when gross presentation as a principal is required by GAAP—or inversely, presenting a measure of revenue on a gross basis when net presentation is required by GAAP
• 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

Labeling of Non-GAAP Measures

Question 100.05 was added to address how the incorrect labeling of a non-GAAP measure can be misleading. The new C&DI question memorializes what the SEC staff has said publicly for the last several years and that have been issued in comments.

Without an appropriate label and clear description, a non-GAAP measure could be misleading to investors as non-GAAP measures aren’t always consistent or comparable between companies. This means all non-GAAP measures are required to be labeled as non-GAAP.

The following presentation examples would be considered materially misleading non-GAAP financial measures in accordance with Regulation G:

Identification Failure

The failure to identify and describe a measure as non-GAAP.

Presenting a Non-GAAP Measure with an Incorrect Label

Using a label that doesn’t reflect the nature of the non-GAAP measure—including:

• A contribution margin calculated as GAAP revenue less certain expenses, labeled net revenue
• A non-GAAP measure labeled the same as a GAAP line item even though it’s calculated differently
• A non-GAAP measure labeled pro forma that isn’t calculated consistently with the pro forma requirements in Article 11 of Regulation S-X

Disclosure of Non-GAAP Measures

Question 100.06 was added to address how a non-GAAP measure may be misleading, even if accompanied by disclosure about the nature and effect of each adjustment made to the most directly comparable GAAP measure.

Non-GAAP measures could mislead investors to such a degree that even extensive, detailed disclosure about the nature and effect of each adjustment wouldn’t prevent the non-GAAP measure from being materially misleading. The SEC staff’s view is that there’s no amount of disclosure that can cure a misleading measure.

Further, when the SEC staff determines a non-GAAP measure is misleading or isn’t consistent with the rules, regulations, and guidance, the expectation is that the measure should be removed in the next filing, whether it’s an earnings release, an annual report, or another public SEC document that the measure would be presented in. There isn’t a transition period for misleading non-GAAP measures.

Prominence of Non-GAAP Measures

Question 102.10(a)(b)(c) addresses how a non-GAAP measure should be presented to avoid giving undue prominence to the non-GAAP measure. It was updated to provide clarity and new information the SEC staff has provided to the public in previous conferences. It was also separated into three different C&DIs for readability.

Scope

The updated C&DI clarifies the scope of the undue prominence guidance. A registrant that presents a non-GAAP measure is required to present the most directly comparable GAAP measure with equal or greater prominence. This includes any related discussion and analysis of non-GAAP measures, such as the presentation of tables, charts and graphs that include non-GAAP measures and ratios that contain a non-GAAP measure in the numerator or denominator.

In accordance with Regulation S-K, this requirement applies to non-GAAP measures presented in documents filed with the SEC and earnings releases furnished under Item 2.02 of Form 8-K.

The SEC staff considers the following to be examples of non-GAAP measures more prominent than the comparable GAAP measures:

• Presenting an income statement of non-GAAP measures
• 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 or denominator without also presenting the ratio calculated using the most directly comparable GAAP measure with equal or greater prominence
• Presenting a non-GAAP measure using a style of presentation—such as bold or larger font—that emphasizes the non-GAAP measure over the comparable GAAP measure
• Describing a non-GAAP measure as 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
• 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

Reconciliations

The updated C&DI clarifies that reconciliations required by Regulation G and Item 10(E) of Regulation S-K should always begin with the GAAP measure.

The SEC staff would consider the following to be examples of reconciliations that give undue prominence to the non-GAAP measure:

• 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

Another example offered by the SEC staff is when a registrant excludes the quantitative reconciliation when presenting a forward-looking non-GAAP measure, the measure would be considered more prominent than the comparable GAAP measure if it’s presented without disclosing the registrant’s reliance upon the exception provided by Item 10(e)(1)(i)(B) of Regulation S-K, identifying the information that’s unavailable, and its probable significance in a location of equal or greater prominence.

Non-GAAP Income Statement

The SEC staff has historically considered the presentation of a non-GAAP income statement, alone or as part of the required non-GAAP reconciliation, gives undue prominence to non-GAAP measures.

However, the C&DI was updated to clarify that the SEC staff would consider a non-GAAP income statement to be an income statement comprised of non-GAAP measures that includes all or most of the line items and subtotals found in a GAAP income statement.

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