Revised SEC Interpretations Regarding Non-GAAP Financial Measures // Cooley // Global Law Firm

By Cydney Posner

In January, the SEC posted a number of new and revised interps regarding non-GAAP financial measures (NGFMs). In a number of cases, the interps represent a retrenchment from some of the staff's more aggressive positions including some positions that seemed to exceed the language of the rule itself). But what's really interesting here is the "back story": some SEC staff have suggested at conferences that the reason that the interps take a more permissive position in some cases is to permit companies to include more NGFMs in their SEC filings. Apparently, the staff is bit dismayed by the disconnect between the presentation of results in press releases and other public communications as compared with SEC filings. The staff may be reviewing more rigorously companies' public statements and encouraging companies to eliminate disparities by including the NGFM is the filing or, in effect, by deterring companies from using the NGFM at all. For some of the key changes, look for the asterisks below.

Business Combination Transactions

The exemption from Reg G and Item 10(e) of Reg S-K for NGFMs disclosed in communications relating to a business combination transaction does not extend to the same NGFMs in registration statements, proxy statements and tender offer materials. There is an exemption from Reg G and Item 10(e) for NGFMs disclosed in communications subject to Rule 425 and Rules 14a-12, 14d-2(b)(2) and 14d-9(a)(2). However, this exemption does not extend beyond those communications. Consequently, if the same NGFM were also disclosed in a registration statement, proxy statement or tender offer statement, no exemption from Reg G and Item 10(e) would be available for that NGFM. However, the exemption from Reg G and Item 10(e) for NGFMs disclosed pursuant to Item 1015 (reports, opinions, appraisals and negotiations) of Reg M-A applies even if the NGFMs were included in registration statements, proxy statements and tender offer statements.
If reconciliation of an NGFM is required and the most directly comparable measure is a "pro forma" measure prepared and presented in accordance with Article 11 of Reg S-X, companies may use that measure for reconciliation purposes, in lieu of a GAAP financial measure.

Item 10(e) of Regulation S-K

The reference to "funds from operations" in footnote 50 to Exchange Act Release No. 47226, Conditions for Use of Non-GAAP Financial Measures (which indicates that companies may use "funds from operations per share" in earnings releases and materials that are filed or furnished to the SEC, subject to the requirements of Reg G and Item 10(e)) refers to the measure as defined and clarified, as of January 1, 2000, by the National Association of Real Estate Investment Trusts. The staff accepts this definition of FFO as a performance measure and, as a performance measure, it may be presented on a per share basis.
A registrant may present "funds from operations" on a basis other than as defined and clarified, as of January 1, 2000, by the National Association of Real Estate Investment Trusts, provided that any adjustments made to "funds from operations," as defined in footnote 50 of Exchange Act Release No. 47226, comply with Item 10(e) of Reg S-K for a performance measure or a liquidity measure, depending on how it is presented. If the adjusted measure is a performance measure, it may be presented on a per share basis; if it is a liquidity measure, it may not be.
***Item 10(e) of Reg S-K prohibits adjusting an NGFM to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years. This prohibition is based on the description of the charge or gain that is being adjusted, not on the nature of the charge or gain. It would not be appropriate to state that a charge or gain is non-recurring, infrequent or unusual unless it meets the specified criteria. The fact that a registrant cannot describe a charge or gain as non-recurring, infrequent or unusual, however, does not mean that the registrant cannot adjust for that charge or gain. Registrants can make adjustments they believe are appropriate, subject to Reg G and the other requirements of Item 10(e) of Reg S-K.
*** It is not a prerequisite to disclosure of an NGFM that the registrant use the NGFM in managing its business or for other purposes.. Item 10(e)(1)(i)(D) states only that, "[t]o the extent material," there should be a statement disclosing the additional purposes, "if any," for which the registrant's management uses the NGFM. There is no prohibition against disclosing an NGFM that is not used by management in managing its business.
***While Item 10(e)(1)(ii) of Reg S-K does not prohibit the use of per share NGFMs, the adopting release for Item 10(e), Exchange Act Release No. 47226, states that "per share measures that are prohibited specifically under GAAP or Commission rules continue to be prohibited in materials filed with or furnished to the Commission." However, not all non-GAAP earnings per share numbers are prohibited in documents filed or furnished with the SEC. Item 10(e) recognizes that certain non-GAAP per share performance measures may be meaningful from an operating standpoint. Non-GAAP per share performance measures should be reconciled to GAAP earnings per share. On the other hand, non-GAAP liquidity measures, such as cash flow, should not be presented on a per share basis in documents filed or furnished with the SEC, consistent with Accounting Series Release No. 142, Reporting Cash Flow and Other Related Data, and Accounting Standards Codification 230.
Item 10(e)(1)(i) of Reg S-K, which requires the prominent presentation of, and reconciliation to, the most directly comparable GAAP financial measure or measures, is not intended to change the staff's practice of requiring the prominent presentation of amounts for the three major categories of the statement of cash flows when a non-GAAP liquidity measure is presented.. The requirements in Item 10(e)(1)(i) are consistent with the staff's practice. The three major categories of the statement of cash flows should be presented when a non-GAAP liquidity measure is presented.
Item 10(e)(1)(ii) does not prohibit the use in SEC filings of a measure of "free cash flow," which is typically calculated as cash flows from operating activities as presented in the statement of cash flows under GAAP, less capital expenditures. However, this measure does not have a uniform definition and its title does not describe how it is calculated. Accordingly, a clear description of how this measure is calculated, as well as the necessary reconciliation, should accompany the measure where it is used. Companies should also avoid inappropriate or potentially misleading inferences about its usefulness. For example, "free cash flow" should not be used in a manner that inappropriately implies that the measure represents the residual cash flow available for discretionary expenditures, since many companies have mandatory debt service requirements or other non-discretionary expenditures that are not deducted from the measure.
Item 10(e) does not apply to a filed free writing prospectus unless the free writing prospectus is included in or incorporated by reference into the issuer's registration statement or included in an Exchange Act filing. Reg S-K applies to registration statements filed under the Securities Act, as well as registration statements, periodic and current reports and other documents filed under the Exchange Act. A free writing prospectus is not filed as part of the issuer's registration statement, unless the issuer files it on Form 8-K or otherwise includes it or incorporates it by reference into the registration statement.
***Item 10(e)(1)(ii)(A) prohibits "excluding charges or liabilities that required, or will require, cash settlement, or would have required cash settlement absent an ability to settle in another manner, from non-GAAP liquidity measures, other than the measures earnings before interest and taxes (EBIT) and earnings before interest, taxes, depreciation and amortization (EBITDA)." Where a company's credit agreement contains a material covenant regarding the NGFM "Adjusted EBITDA," the company may disclose this NGFM in a filing even though it would violate Item 10(e), as it excludes charges that are required to be cash settled. The prohibition in Item 10(e) notwithstanding, because MD&A requires disclosure of material items affecting liquidity, if management believes that the credit agreement is a material agreement, that the covenant is a material term of the credit agreement and that information about the covenant is material to an investor's understanding of the company's financial condition and/or liquidity, then the company may be required to disclose the measure as calculated by the debt covenant as part of its MD&A. In disclosing the NGFM in this situation, a company should consider also disclosing the following: I. the material terms of the credit agreement including the covenant; II. the amount or limit required for compliance with the covenant; and III. the actual or reasonably likely effects of compliance or non-compliance with the covenant on the company's financial condition and liquidity.
***It is generally not appropriate to present a full non-GAAP income statement for purposes of reconciling non-GAAP measures to the most directly comparable GAAP measures.. Presenting a full non-GAAP income statement may attach undue prominence to the non-GAAP information.
A registrant may present an adjustment "net of tax" when reconciling a non-GAAP performance measure to the most directly comparable GAAP measure, provided that the tax effect of each reconciling item is disclosed parenthetically or in a footnote to the reconciliation. Alternatively, the company can present the tax effect in one line in the reconciliation. Regardless of the format of the presentation, registrants should disclose how the tax effect was calculated.
Where a registrant discloses a financial measure or information that is not in accordance with GAAP (or calculated exclusively from GAAP amounts), but that was prepared in accordance with, but not required by, guidance published by a government, governmental authority or SRO applicable to the registrant, this information is considered to be an NGFM for purposes of Reg G and Item 10. Unless this information is required to be disclosed by a system of regulation that is applicable to the registrant, it is considered to be an NGFM. Registrants that disclose this information must provide the disclosures required by Reg G or Item 10, if applicable, including the quantitative reconciliation from the NGFM to the most comparable measure calculated in accordance with GAAP. This reconciliation should be in sufficient detail to allow a reader to understand the nature of the reconciling items.

EBIT and EBITDA

Exchange Act Release No. 47226 describes EBIT as "earnings before interest and taxes" and EBITDA as "earnings before interest, taxes, depreciation and amortization." The GAAP measure intended by the term "earnings" is net income as presented in the statement of operations under GAAP. Measures that are calculated differently than those described as EBIT and EBITDA in that release should not be characterized as "EBIT" or "EBITDA," and their titles should be distinguished from "EBIT" or "EBITDA" (e.g., by using "Adjusted EBITDA"). These measures are not exempt from the prohibition in Item 10(e)(1)(ii)(A) of Reg S-K, with the exception of measures addressed above where the measure is in contained in a covenant in an agreement and disclosure is material to an investors' understanding.
If EBIT or EBITDA is presented as a performance measure, it should be reconciled to net income as presented in the statement of operations under GAAP. Operating income would not be considered the most directly comparable GAAP financial measure because EBIT and EBITDA make adjustments for items that are not included in operating income.

Segment Information

Segment information that is presented in conformity with ASC 280 (which provides that a company may determine segment profitability on a basis that differs from the amounts in the GAAP financial statements) is not considered an NGFM under Reg G and Item 10(e). NGFMs do not include financial measures that are required to be disclosed by GAAP. Exchange Act Release No. 47226 lists "measures of profit or loss and total assets for each segment required to be disclosed in accordance with GAAP" as examples of these measures. The measure of segment profit or loss and segment total assets under ASC 280 is the measure reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segment and assessing its performance. The list of examples in that release is not exclusive. As an additional example, because ASC 280 requires or expressly permits the footnotes to the company's financial statements to include specific additional financial information for each segment, that information also would be excluded from the definition of NGFM.
Item 10(e)(1)(ii) of Reg S-K does not prohibit the discussion in MD&A of segment information determined in conformity with ASC 280. Where a company includes in its MD&A a discussion of segment profitability determined consistently with ASC 280 (which also requires that a footnote to the company's financial statements provide a reconciliation), the company should also include in the segment discussion in the MD&A a complete discussion of the reconciling items that apply to the particular segment being discussed. In this regard, see Financial Reporting Codification Section 501.06.a, footnote 28.
A measure of segment profit/loss or liquidity that is not in conformity with ASC is an NGFM under Reg G and Item 10(e). Segment measures that are adjusted to include amounts excluded from, or to exclude amounts included in, the measure reported to the chief operating decision maker for purposes of making decisions about allocating resources to the segment and assessing its performance do not comply with ASC 280 and are, therefore, NGFMs subject to all of the provisions of Reg G and Item 10(e).
In the footnote that reconciles the segment measures to the financial statements, a company may total the profit or loss for the individual segments as part of the reconciliation required by ASC 280. However, the presentation of the total segment profit or loss measure in any context other than the ASC 280-required reconciliation in the footnote would be an NGFM because it has no authoritative meaning outside of the reconciliation required in the footnotes by ASC 280.
***A table illustrating a breakdown of revenues by certain products is not an NGFM, even if it is not totaled to the revenue amount presented in the financial statements, so long as the product revenue amounts are calculated in accordance with GAAP. The presentation would be considered an NGFM, however, if the revenue amounts were adjusted in any manner.
***A company describes in MD&A that the reason for changes in various financial statement line items is attributable to changes in foreign exchange rates between periods used for translation from local currency into the reporting currency. To isolate the effect of exchange rate differences, the company wants to present the financial information in a constant currency (e.g., assume a constant exchange rate between periods for translation); that presentation would be an NGFM. The company may comply with the reconciliation requirements of Reg G and Item 10(e) by presenting the historical amounts and the amounts in constant currency and also describing the process for calculating the constant currency amounts and the basis of presentation.

Item 2.02 of Form 8-K

Item 2.02 of Form 8-K contains a conditional exemption from its requirement to furnish a Form 8-K where earnings information is presented orally, telephonically, by webcast, by broadcast or by similar means. Among other conditions, the company must post on its website any financial and other statistical information contained in the presentation, together with any information that would be required by Reg G. An audio file of the initial webcast would satisfy this condition to the exemption, provided that (1) the audio file contains all material financial and other statistical information included in the presentation that was not previously disclosed, and (2) investors can access it and replay it through the company's website. Alternatively, slides or a similar presentation posted on the website at the time of the presentation containing the required, previously undisclosed, material financial and other statistical information would satisfy the condition. In each case, the company must provide all previously undisclosed material financial and other statistical information, including information provided in connection with any questions and answers. Reg FD also may impose disclosure requirements in these circumstances.
To satisfy the Item 2.02 of Form 8-K conditional exemption from its requirement to furnish a Form 8-K where earnings information is presented orally, telephonically, by webcast, by broadcast or by similar means, the company must provide on its website any material financial and other statistical information not previously disclosed and contained in the presentation, together with any information that would be required by Reg G at the time the oral presentation is made. In the case of information that is not provided in a presentation itself but, rather, is disclosed unexpectedly in connection with the question and answer session that was part of that oral presentation, the information must be posted on the company's website promptly after it is disclosed. Any requirements of Reg FD must also be satisfied. A webcast of the oral presentation would be sufficient to meet this requirement.
A company's failure to furnish the Item 2.02 Form 8-K in a timely manner would not affect the company's eligibility to use Form S-3 because an Item 2.02 Form 8-K is furnished, not filed. The Form S-3 requirement applies to reports required to be "filed." While not affecting a company's Form S-3 eligibility, failure to comply with Item 2.02 of Form 8-K would, of course, be a violation of Section 13(a) of the Exchange Act.
A company's filing of its quarterly earnings release as an exhibit to its Form 10-Q, rather than in an Item 2.02 Form 8-K, prior to holding its earnings conference call, would not preclude its reliance on the exemption for the conference call, assuming that all of the other conditions of Item 2.02(b) were met. <br>• If a company issued a press release announcing its results of operations for a just-completed fiscal quarter, including its expected adjusted earnings (an NGFM) for the fiscal period, this press release would be subject to Item 2.02 of Form 8-K because it contains material, non-public information regarding its results of operations for a completed fiscal period. The adjusted earnings range presented would be subject to the requirements of Item 2.02 applicable to NGFMs.
Where a company does not furnish its earnings release on a Form 8-K before its conference call, the company cannot rely on the exemption from the requirement to furnish the information in the conference call on a Form 8-K. As a result, the company must furnish the material, previously non-public financial and other statistical information required to be furnished on Item 2.02 of Form 8-K as an exhibit to a Form 8-K and satisfy the other requirements of Item 2.02 of Form 8-K. A transcript of the portion of the conference call or slides or a similar presentation including that information will satisfy this requirement. In each case, all material, previously undisclosed, financial and other statistical information, including that provided in connection with any questions and answers, must be provided.

Foreign Private Issuers

The Note to Item 10(e) of Reg S-K permits a foreign private issuer to include in its filings an NGFM that otherwise would be prohibited by Item 10(e)(1)(ii) if, among other things, the NGFM is required or expressly permitted by the standard setter that is responsible for establishing the GAAP used in the company's primary financial statements included in its SEC filings. A measure is "expressly permitted" if the particular measure is clearly and specifically identified as an acceptable measure by the standard setter that is responsible for establishing the GAAP used in the company's primary financial statements included in its SEC filings. The concept of "expressly permitted" can be also be demonstrated with explicit acceptance of a presentation by the primary securities regulator in the foreign private issuer's home country jurisdiction or market. Explicit acceptance by the regulator would include (1) published views of the regulator or members of the regulator's staff or (2) a letter from the regulator or its staff to the foreign private issuer indicating the acceptance of the presentation — which would be provided to the SEC staff upon request.
A foreign private issuer that has furnished a press release on Form 6-K that includes NGFMs may incorporate by reference into a Securities Act registration statement only those portions of the furnished press release that do not include the NGFMs. Reports on Form 6-K are not incorporated by reference automatically into Securities Act registration statements. To incorporate a Form 6-K into a Securities Act registration statement, a foreign private issuer must specifically provide for its incorporation by reference in the registration statement and in any subsequently submitted Form 6-K. See Item 6(c) of Form F-3. Where a foreign private issuer wishes to incorporate by reference a portion of the press release provided on a Form 6-K, it should either: (1) specify in the Form 6-K those portions of the press release to be incorporated by reference, or (2) furnish two Form 6-K reports, one that contains the full press release and another that contains the portions that would be incorporated by reference (and specifies that the second Form 6-K is so incorporated). Using a separate report on Form 6-K containing the portions that would be incorporated by reference may provide more clarity for investors in most circumstances. A company must also consider whether its disclosure is rendered misleading if it incorporates only a portion (or portions) of a press release.
A foreign private issuer publishes an NGFM that does not comply with Reg G, in reliance on Rule 100(c), and then furnishes the information in a report on Form 6-K. The foreign private issuer must comply with Item 10(e) of Reg S-K with respect to that information if the company chooses to incorporate that Form 6-K report into a filed Securities Act registration statement (other than an MJDS registration statement).
If a Canadian company includes an NGFM in an annual report on Form 40-F, the company does not need to comply with Reg G or Item 10(e) with respect to that information if the company files a non-MJDS Securities Act registration statement that incorporates by reference the Form 40-F. Information included in a Form 40-F is not subject to Reg G or Item 10(e) of Reg S-K.

Voluntary Filers

Section 15(d) of the Exchange Act automatically suspends its application where, if other conditions are met, on the first day of the company's fiscal year, it has fewer than 300 holders of record of the class of securities that created the Section 15(d) obligation. This suspension is automatic and does not require any filing with the SEC. Rule 15d-6 requires the filing of a Form 15 as a notice of the suspension of a company's reporting obligation under Section 15(d), but that filing is not a condition to the suspension. A number of companies whose Section 15(d) reporting obligation is suspended automatically by the statute choose not to file the notice required by Rule 15d-6 and to continue to file Exchange Act reports as though they continue to be required. A company whose reporting obligation is suspended automatically by Section 15(d) but continues to file periodic reports as though they were required must comply with Reg G and the requirements of Item 10(e) of Reg S-K. Reg S-K relates to filings with the SEC and, accordingly, a company that is making filings as described must comply with Reg S-K or Form 20-F, as applicable, in its filings.

As to other public communications, any company that has a class of securities registered under Section 12 of the Exchange Act or is required to file reports under Section 15(d) of the Exchange Act must comply with Reg G. The application of this standard to those companies that are no longer "required" to report under Section 15(d) but choose to continue to report presents a difficult dilemma, as those companies technically are not subject to Reg G, but their continued filing is intended to and does give the appearance that they are public companies whose disclosure is subject to SEC regulations. It is reasonable that this appearance would cause shareholders and other market participants to expect and rely on a company's required compliance with the requirements of the federal securities laws applicable to companies reporting under Section 15(d). Accordingly, while Reg G technically does not apply to a company in this circumstance, the failure of the company to comply with all requirements (including Reg G) applicable to a reporting company can raise significant issues regarding that company's compliance with the anti-fraud provisions of the federal securities laws.

Revised SEC Interpretations Regarding Non-GAAP Financial Measures

Related insights

Public Companies Update – February 2025 One-Minute Reads

Public Companies Update – December One-Minute Reads

Public Companies Update – November One-Minute Reads

Others have viewed