SEC Updates Guidance on Non-GAAP Financial Measures

May 19, 2016

On May 17, 2016, the Division of Corporation Finance of the Securities and Exchange Commission (the "Staff") issued new Compliance and Disclosure Interpretations (C&DIs) regarding the use of non-GAAP financial measures and revised existing C&DIs on the same topic.  These interpretations come on the heels of numerous speeches by SEC Commissioners and the Staff indicating that the SEC is increasing its scrutiny of companies’ use of non-GAAP financial measures in light of the increasing use of such measures by companies, analysts and the press.  The Staff has also intensified its focus on non-GAAP financial measures in the review and comment process.  The C&DIs related to non-GAAP financial measures are available here, and a redline comparing the Staff’s non-GAAP C&DIs to its prior interpretations is availablehere

The new and revised interpretations will significantly impact companies’ use of non-GAAP financial measures and will require many companies to revise their current earnings release presentations.  Whereas the Staff in recent years was viewed as encouraging companies to include in their SEC filings any non-GAAP financial measures contained in analyst presentations, the new interpretations represent a dramatic swing of the pendulum in the Staff’s views on non-GAAP disclosures, and may lead companies to reconsider including such measures in earnings releases and filed documents.

The new guidance addresses two primary issues: the "equal or greater prominence" requirement for certain non-GAAP presentations and presentations of non-GAAP financial measures that the Staff views as improper.  These interpretations carry out the recent statement by the Chief Accountant of the Division of Corporation Finance that the Staff intended to "crack down" on a variety of non-GAAP disclosure practices. 

1.      Equal or Greater Prominence Requirement.  As stated in the C&DI, any document filed with the Commission and any earnings release furnished under Item 2.02 of Form 8-K that contains a non-GAAP financial measure must present the most directly comparable GAAP measure "with equal or greater prominence."  The Staff’s new interpretations read "equal" prominence to mean that the GAAP measure generally must precede any non-GAAP measure, and make clear that the Staff reads "prominence" to refer not simply to the location or ordering of GAAP and non-GAAP numbers, but also to apply to the manner in which GAAP and non-GAAP numbers are discussed and characterized. 

Specifically, while acknowledging that "prominence" generally depends on the facts and circumstances under which a disclosure is made, C&DI 102.10 states that the Staff would consider the following situations to be examples of impermissibly presenting a non-GAAP measure as more prominent: 

  • Presenting a non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline or caption), or omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures;
  • 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;
  • Presenting a non-GAAP measure using a style (e.g., bold, larger font) 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; 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.

In the context of providing forward-looking statements (such as guidance or outlook) using non-GAAP measures, the same C&DI interprets the "equal or greater prominence" requirement to create a new disclosure obligation.  Specifically, the non-GAAP disclosure rules require that any forward-looking non-GAAP financial measure be accompanied by a quantitative reconciliation to the most directly comparable GAAP measure, "to the extent available without unreasonable efforts."  C&DI 102.10 states that when a company relies on the "unreasonable efforts" exception, the equal or greater prominence rule requires the company to disclose "in a location of equal or greater prominence" the fact that the company is relying on the exception and to identify the information that is unavailable and its probable significance. 

Finally, the Staff reflected its long-standing disapproval of non-GAAP income statements through the equal or greater prominence rule, stating that a full income statement of non-GAAP measures presented alongside a GAAP income statement or presented when reconciling non-GAAP measures to the most directly comparable GAAP measures fails to satisfy the "equal or greater prominence" requirement. 

2.      Problematic Presentations of Non-GAAP Financial Measures.  Rule 100(b) of Regulation G prohibits the use of a non-GAAP financial measure that is misleading when viewed in context with the information accompanying that measure and any other accompanying discussion of that measure.  Four of the new interpretations address practices that, in the Staff’s view, can result in a non-GAAP financial measure that is misleading.  These are:

  • Presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading.
  • Varying non-GAAP financial measures from period to period by adjusting for a particular charge or gain in the current period when "other, similar charges or gains" were not also adjusted in prior periods, unless the change between periods is disclosed and the reasons for it explained.  The Staff noted that, in addition, it may be necessary to recast prior measures to conform to the current presentation.
  • For companies that present non-GAAP financial measures that are adjusted only for non-recurring charges, failing to adjust that non-GAAP financial measure for non-recurring gains that occurred during the same period.
  • Presenting a non-GAAP performance measure that is adjusted to accelerate revenue recognized over time under GAAP as though the company earned revenue when customers were billed or using other individually tailored revenue recognition and measurement methods.

Notably, the Staff guidance does not address whether accompanying disclosures that highlight the nature of non-GAAP adjustments would, in the Staff’s view, be sufficient to overcome the concern that a non-GAAP measure would be misleading.  Instead, these interpretations reflect practices that may draw SEC scrutiny regardless of the context.  For example, the Deputy Chief Accountant of the Division of Corporation Finance recently stated that, if a company presents an adjusted revenue measure, the company "will likely get a comment" from the Staff questioning the measure, and that companies should "expect the staff to look closely, and skeptically, at the explanation as to why the revenue adjustment is appropriate." See Remarks Wesley R. Bricker, Deputy Chief Accountant of the Division of Corporation Finance, before the 2016 Baruch College Financial Reporting Conference, available here.  

As well, other interpretations reflect a more proactive stance by the Staff in reviewing and questioning certain non-GAAP disclosures: 

  • Per Share Liquidity Measures.  The Staff’s interpretations, for example, reflect a more prescriptive position under which "non-GAAP liquidity measures that measure cash generated must not be presented on a per share basis."  As stated in interpretation 102.05, the Staff will apply the prohibition on the use of per share data to any non-GAAP financial measure that can be used as a liquidity measure, even if management characterizes it solely as a performance measure.  The Staff also revised existing C&DIs to make clear that free cash flow, EBIT and EBITDA may not be presented on a per share basis. 
  • Adjustments for Tax.  The Staff also has focused on how income tax assumptions related to adjustments are calculated and presented when presenting a non-GAAP financial measure.  The new interpretations touch upon this issue, stating that the nature of income tax effects reflected in non-GAAP financial measures depends on the nature of the measures.  If a measure is a liquidity measure that includes income taxes, the Staff states that it might be acceptable to adjust GAAP taxes to show taxes paid in cash.  If, however, a measure is a performance measure, companies should include current and deferred income tax expense "commensurate with the non-GAAP measure of profitability."  In addition, when setting forth reconciliations between GAAP and non-GAAP measures, adjustments to arrive at the non-GAAP measure should not be presented "net of tax," but instead income taxes should be shown as a separate adjustment and clearly explained. 

Based on speeches and comments by several SEC Commissioners and the Staff, these interpretations should be viewed as an early step, but not the last word, in the SEC’s re-examination of non-GAAP presentations.  Indeed, the Staff has indicated that they are more actively reviewing SEC filings, including earnings releases furnished under Item 2.02 of Form 8-K and investor materials presented on company websites, and commenting on non-GAAP financial measures.  In addition to the topics addressed in the Staff’s C&DIs, the Staff also has focused on the requirement that companies disclose the reasons why management believes that presentation of a non-GAAP financial measure provides useful information to investors, and has expressed concern that company disclosures in this area are often comprised of boilerplate explanations that do little to explain to investors the significance of non-GAAP financial measures. 

The new and revised non-GAAP C&DIs reflect a new stance by the SEC on the use of non-GAAP financial measures.  While many companies, analysts and investors find non-GAAP presentations helpful, the SEC is reacting to abuses it has seen in non-GAAP measures.  Companies should, in advance of their next earnings release, review their non-GAAP presentations, including descriptions of and language accompanying the non-GAAP financial measures, in light of the C&DIs, and consider whether their non-GAAP presentations should be modified, further elaborated on, or dropped entirely. 


Gibson Dunn’s lawyers are available to assist in addressing any questions you may have about these developments.  To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm’s Securities Regulation and Corporate Governance practice group, or any of the following practice leaders and members:

Brian J. Lane - Washington, D.C. (202-887-3646, blane@gibsondunn.com)
Ronald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)
James J. Moloney - Orange County, CA (949-451-4343, jmoloney@gibsondunn.com)
Michael J. Scanlon - Washington, D.C. (202-887-3668, mscanlon@gibsondunn.com)
Elizabeth Ising – Washington, D.C. (202-955-8287, eising@gibsondunn.com)
Lori Zyskowski – New York (212-351-2309, lzyskowski@gibsondunn.com)
Gillian McPhee – Washington, D.C. (202-955-8201, gmcphee@gibsondunn.com)
Michael A. Titera - Orange County, CA (949-451-4365, mtitera@gibsondunn.com)


© 2016 Gibson, Dunn & Crutcher LLP

Attorney Advertising:  The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.