One of the recent areas of focus in the review by the US Securities and Exchange Commission ("SEC") of company disclosures has been the use of "non-GAAP" financial measures, which are financial measures that do not conform either to US generally accepted accounting principles ("GAAP") or international financial reporting standards ("IFRS"), as applicable. In May 2016, the SEC updated its compliance and disclosure interpretations ("C&DIs") regarding the use of non-GAAP financial measures.

In October 2016, we published a review of comment letters issued by the staff of the SEC's Division of Corporation Finance relating to the use of non-GAAP measures in company disclosures, which highlights the following topics in comment letters to SEC reporting companies:

  • Equal or Greater Prominence: The SEC has requested, as required by Regulation G and Item 10 of Regulation S-K, that a presentation of the most directly comparable GAAP or IFRS financial measure must be presented "with equal or greater prominence" whenever a non-GAAP measure is disclosed. Accordingly, headings, bullets and tables must first present the GAAP or IFRS and then the non-GAAP measures (in that order). Further, non-GAAP margins, ratios and per share metrics, such as adjusted EBITDA as a percentage of sales, need both reconciliation and a presentation of the comparable GAAP or IFRS measure in a location of equal or greater prominence; in this case, a presentation of net income as a percentage of sales. To the extent such measures appear in several places in a disclosure document, they should be presented in the same order wherever they appear.
  • Reasons for the Inclusion of Non-GAAP Measures: Boilerplate language that management believes the company's non-GAAP measures provide investors with helpful supplemental information may not be sufficient. In several comment letters, the SEC has asked companies to elaborate on the usefulness of each non-GAAP measure to the specific circumstances of the company, sometimes focusing on particular adjustments.
  • Accurate Labeling: Measures such as EBITDA or free cash flow must be labeled as "adjusted" if they include adjustments beyond those customarily made for measures with those names. Similarly, financial measures should only be described as "pro forma" if they have been prepared in accordance with the SEC's rules for pro forma financial statements in Regulation S-X.
  • Proper Adjustments and Reconciliation: In its updated non-GAAP C&DIs, the SEC has identified several adjustments as problematic, taking
  • the position that certain non-GAAP adjustments, while not expressly prohibited, are presumed to be misleading. Those adjustments include, among others: normal, recurring cash operating expenses; acquisition-related expenses; and purchase accounting adjustments. While companies can still provide explanations as to why such adjustments are relevant, they may increasingly face an uphill battle in defending those adjustments. For further details, please see our relevant client publication available at:
  • http://www.shearman.com/~/media/Files/NewsInsights/Publications/2016/10/Updated-NonGAAP-Guidance-The-First-150-Comment-Letters- CM-101920163.pdf

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.