Canada: CSA Proposes Non-GAAP Financial Measures Rule

The Canadian Securities Administrators (CSA) recently issued a request for comment on proposed National Instrument 52-112 Non-GAAP and Other Financial Measures Disclosure (Proposed Instrument), which would provide binding requirements for issuers disclosing non-GAAP and certain other financial measures and replace current CSA staff guidance.

This bulletin covers the following aspects of the proposed regime:

BACKGROUND

Currently, non-GAAP financial measures included in public disclosure by reporting issuers in Canada are subject to regulatory guidance contained in CSA Staff Notice 52-306 (Revised) Non-GAAP Financial Measures (SN 52-306). See our February 2016 Blakes Bulletin: CSA re: Non-GAAP, TSX NCIB FAQs and Other Acronyms.

As guidance, the commentary in SN 52-306 is non-binding, but is instead designed to assist issuers in providing disclosure of non-GAAP financial measures that is not misleading to investors. Although non-binding, the CSA has periodically undertaken reviews of continuous disclosure and prospectus disclosures of non-GAAP measures by issuers and issued reports and comment letters requesting that changes be made to provide clarity in issuers' use of such measures. For example, see our April 2018 Blakes Bulletin: Securities Regulators Find Gaps in Non-GAAP and Distribution Disclosures by REITs and REOCs.

"Many issuers, in all industries, disclose a range of financial measures that may lack standardized meanings under the financial reporting framework used in the preparation of the issuer's financial statements, lack context when disclosed outside of the issuer's financial statements, lack transparency as to their calculation or vary significantly by issuer and industry," the CSA states in the request for comment.

One of the stated key objectives of replacing SN 52-306 with the Proposed Instrument is to provide CSA staff with "a stronger tool to take appropriate regulatory action as needed". In many ways, the Proposed Instrument and accompanying draft companion policy (Proposed Companion Policy) are similar to, or seem to be informed by, U.S. securities law rules on this subject (Regulation G and S-K 10(e)) and related Securities and Exchange Commission guidance in its Compliance and Disclosure Interpretations.

PROPOSED REGIME

Scope

The Proposed Instrument has very broad scope. It would apply to all issuers (seemingly, not limited to reporting issuers) other than "SEC Foreign Issuers" (as defined in National Instrument 71-102 Continuous Disclosure and Other Exemptions Relating to Foreign Issuers). It concerns disclosure in all documents, including a written communication prepared and transmitted only in electronic form, that are intended to be, or reasonably likely to be, made available to the public in a CSA jurisdiction. This includes, but is not limited to, all documents filed with the CSA or any agency of a government under applicable securities or corporate law or with an exchange or quotation and trade reporting system under its bylaws, rules or regulations, as well as any other communication the content of which would reasonably be expected to affect the market price or value of a security of the issuer (which the CSA expects to include information presented on websites and social media by the issuer. The Proposed Instrument does not apply to oral statements, but the Proposed Companion Policy provides that if the issuer posts a written transcript of an oral statement, the issuer must provide the requisite disclosures, potentially as an attachment or appendix to the transcript.

Notwithstanding the broad application of the Proposed Instrument, some exceptions are provided. The Proposed Instrument would not apply to:

  1. Disclosure of a specific financial measure in accordance with a requirement of Canadian securities legislation or the laws of a jurisdiction of Canada (but not other countries) (e.g., earnings coverage ratios prescribed by securities legislation)
  2. Documents affecting the rights of securityholders referred to in paragraphs 12.1(1)(a) to (e) of National Instrument 51-102 Continuous Disclosure Obligations
  3. Material contracts per the definition in National Instrument 51-102 Continuous Disclosure Obligations or National Instrument 81-106 Investment Fund Continuous Disclosure
  4. The supporting documents referred to in any of clauses 3(1)(a)(iv)(A) to (C) of National Instrument 81-101 Mutual Fund Prospectus Disclosure.

"Primary Financial Statements" and Notes

The Proposed Instrument defines "primary financial statements" to be an issuer's statement of financial position, statement of profit or loss and other comprehensive income, statement of changes in equity and statement of cash flows, but not the notes thereto. The Proposed Companion Policy states that a financial measure is "presented" in financial statements if it is included in the primary financial statements, and is "disclosed" in financial statements if it is included in the notes thereto. The Proposed Companion Policy affirms that the definition of a non-GAAP financial measure (discussed below) excludes all measures presented or disclosed within the financial statements.

Non-GAAP Financial Measures

Currently, pursuant to SN 52-306, a non-GAAP financial measure is a numerical measure of an issuer's historical or future financial performance, financial position or cash flow that:

  1. Is not specified, defined or determined under the issuer's GAAP or generally accepted accounting principles (e.g., IFRS (International Financial Reporting Standards) for many Canadian reporting issuers)
  2. Is not presented in an issuer's financial statements
  3. Either (a) excludes an amount that is included in the most directly comparable measure calculated and presented in accordance with the issuer's GAAP or (b) includes an amount that is excluded from the most directly comparable measure calculated and presented in accordance with the issuer's GAAP.

Pursuant to the Proposed Instrument, this definition would be expanded to include certain disclosures that are specifically excluded under SN 52-306. For example, "sales per square foot" was listed in SN 52-306 among other performance measures "not considered to be non-GAAP financial measures", but would become a non-GAAP measure (unless the ratio is presented in the issuer's financial statements), even if the "sales" amount is the same amount as included as a line item in the issuer's primary financial statements.

The Proposed Instrument additionally specifies financial outlook (i.e., forward-looking financial information that is not presented in the format of a financial statement (e.g., earnings guidance)) for which no equivalent financial measure is presented in the issuer's financial statements as a non-GAAP measure. Financial measures that are a disaggregation, calculated in accordance with the accounting policies used to prepare the financial statements, of a line item presented in the issuer's financial statements (e.g., the provision of more granular information regarding revenues, by certain products or by division), would not be non-GAAP financial measures.

Similar to SN 52-306, the Proposed Instrument would require that:

  1. Non-GAAP financial measures be labelled appropriately given their composition and in a way that distinguishes them from totals, subtotals and line items presented in the issuer's primary financial statements
  2. Subject to certain exceptions for ratios, non-GAAP financial measures be presented with no more prominence in the document than the most directly comparable financial measure presented in the issuer's primary financial statements
  3. The first time each non-GAAP financial measure appears in each document, the document: (a) subject to certain exceptions for ratios, must identify the non-GAAP financial measure as such; (b) state that the non-GAAP financial measure does not have a standardized meaning under the financial reporting framework used to prepare the issuer's financial statements and may not be comparable to similar financial measures presented by other issuers; (c) explain how the non-GAAP financial measure provides useful information to a reasonable person and explains the additional purposes, if any, for which management uses the non-GAAP financial measure; and (d) subject to certain exceptions for ratios and financial outlook, provide a quantitative reconciliation, to the most directly comparable financial measure presented in the issuer's financial statements
  4. Explains the reason for a change, if any, in the label, composition or calculation of a non-GAAP financial measure.

In addition to the foregoing, the Proposed Instrument would further require issuers to present the same non-GAAP financial measure for the comparative period. Although the Proposed Instrument does not provide an exemption from the foregoing, unless one is granted by a CSA member upon application by an issuer, the Proposed Companion Policy appears to imply that compliance is not required where it would not be feasible, noting that this would be "only in rare circumstances, such as in the first period of operations where no comparative period exists". The Proposed Companion Policy also states that where comparative non-GAAP financial measures are presented for a previous period, a reconciliation to the corresponding most directly comparable measure should also be provided for that previous period.

Ratios

A non-GAAP financial ratio (e.g., working capital ratio or debt to equity) may be calculated using one or more measures that are presented or disclosed in the issuer's financial statements (e.g., revenue), non-GAAP financial measures (e.g., adjusted EBITDA or earnings before interest, tax, depreciation and amortization) and non-financial information (e.g., square feet).

Since many ratios do not have a directly comparable IFRS financial measure, the requirement in the Proposed Instrument for non-GAAP financial measures to be presented with no more prominence than the most directly comparable financial measure presented in the issuer's primary financial statements does not apply to a ratio that is presented with no more prominence in the document than similar financial measures presented in the issuer's primary financial statements. For example, the Proposed Companion Policy provides that an issuer may calculate a debt to equity ratio and use this in its discussion of liquidity however, this discussion should form part of an overall discussion that should include relevant measures from the issuer's financial statements.

The requirement in the Proposed Instrument to identify a non-GAAP financial measure as such does not apply to ratios for which all financial components are disclosed or presented in the financial statements (e.g., when gross margin percentage is calculated and disclosed as being total sales minus cost of goods sold, divided by total sales, where each of sales and cost of sales is a line item in the statement of profit and loss and other comprehensive income). It also does not apply to ratios for which all financial components are disaggregations, calculated in accordance with the accounting policies used to prepare the financial statements, of line items presented in the issuer's financial statements (e.g., same-store sales per square foot, calculated using a disaggregated same-store sales figure calculated in accordance with the issuer's accounting policies used in the preparation of the sales line item presented in the issuer's financial statements).

The requirement in the Proposed Instrument for providing a quantitative reconciliation of non-GAAP financial measures to the most directly comparable financial measure presented in the issuer's financial statements does not apply to ratios where the first time the ratio appears in the document, a discussion is included regarding how the ratio is calculated and either:

  • Identifies each non-GAAP financial measure used to calculate the ratio (e.g., same-store sales per square foot, where same-store sales (the numerator) is computed on a constant foreign exchange basis rather than under the requirements under IFRS) and provides the requisite disclosure for each such non-GAAP financial measure identified, or
  • Provides a quantitative reconciliation to the ratio as calculated using the most directly comparable financial measures presented in the issuer's financial statements.

Financial Outlook

If a non-GAAP financial measure is included in the document as financial outlook and the document discloses forward-looking financial disclosure in the form of a financial statement (FOFI), the Proposed Instrument would require that the issuer provide, for such non-GAAP financial measure, a quantitative reconciliation, to the most directly comparable financial measure presented in the FOFI.

If a non-GAAP financial measure is included in the document as financial outlook and the document does not include FOFI, the Proposed Instrument provides that the typical reconciliation is not required of the issuer if, the first time the financial outlook appears in the document, disclosure is included presenting the equivalent historical non-GAAP financial measure and describing: (i) each of the material differences (quantitatively where possible) between the financial outlook and the most directly comparable financial outlook for which an equivalent historical financial measure is presented in the issuer's financial statements; or (ii) each of the significant components of the financial outlook used in its calculation (which may include quantification of the components and/or a description of the process followed in preparing and reviewing the financial outlook). The Proposed Instrument does not include an exception to quantitative reconciliation where reconciling information would not be available "without unreasonable efforts", as is the case under U.S. rules.

If a non-GAAP financial measure is both financial outlook and a ratio, the Proposed Companion Policy provides that the issuer may choose to apply the alternate reconciliation requirements either for financial outlook or a ratio.

Segment Measures

For purposes of the Proposed Instrument, "segment measures" are financial measures of segment profit or loss, revenue, expenses, assets, or liabilities that are disclosed in the notes to the issuer's financial statements.

The Proposed Instrument provides that if an issuer discloses in a document other than its financial statements a total of segment measures that is not a total, subtotal or line item presented in the issuer's primary financial statements, the document must:

  1. The first time the total of segment measures appears in the document, provide a quantitative reconciliation of the total of segment measures to the most directly comparable financial measure presented in the issuer's primary financial statements
  2. Present the total of segment measures with no more prominence than the most directly comparable financial measure presented in the issuer's financial statements
  3. Include the presentation of the total of segment measures for the comparative period, if the total of segment measures has been previously disclosed.

Financial information about a segment that is presented or disclosed in an issuer's financial statements (including the primary financial statements and notes thereto) will not be "non-GAAP financial measures" under the Proposed Instrument. However, the Proposed Companion Policy notes that financial information about a segment will be "non-GAAP financial measures" under the Proposed Instrument if it: (i) is disclosed outside the issuer's financial statements (for example, in management discussion and analysis or an annual information form); (ii) is not also disclosed in the issuer's financial statements; and (iii) is not a disaggregation of a line item presented in accordance with the issuer's financial reporting framework. Such information would not be a segment measure, as it would not meet the element of the definition of having been disclosed in the notes to the issuer's financial statements.

Capital Management Measures

For purposes of the Proposed Instrument, "capital management measures" are financial measures that are disclosed in the notes to the issuer's financial statements to enable users of financial statements to evaluate the issuer's objectives, policies and processes for managing capital.

The Proposed Instrument outlines a regime governing capital management measures disclosed in a document other than the financial statements, that is similar to the proposed regime for non-GAAP financial measures, including requirements with respect to the prominence of such disclosures, a description of their calculation, a statement as to an absence of standardized accounting policies concerning the calculation of such measures, an explanation of the measure's usefulness to investors and management, a quantitative reconciliation, and presentation of the measure for a comparative period if there has been prior disclosure of the measurement.

Supplementary Financial Measures

For purposes of the Proposed Instrument, "supplementary financial measures" are financial measures that:

  • Are not disclosed or presented in the issuer's financial statements
  • Are a disaggregation, calculated in accordance with the accounting policies used to prepare the financial statements, of a line item presented in the issuer's primary financial statements
  • Are, or are intended to be, disclosed on a periodic basis to present an aspect of financial performance, financial position or cash flow of the issuer.

As an example, the Proposed Companion Policy provides that an entity that operates in the retail industry may consider same-store sales as a supplementary financial measure. Such an entity may disclose same-store sales (where same-store sales is a disaggregation calculated in accordance with the accounting policies used to prepare the sales line item presented in the primary financial statements) to periodically report sales performance from period to period.

The Proposed Instrument provides that if an issuer discloses a supplementary financial measure in a document, the document must include the presentation of the supplementary financial measure for the comparative period if the supplementary financial measure has been previously disclosed, and the first time the supplementary financial measure appears in the document, disclosure must be included describing how the supplementary financial measure is calculated and explaining the reason for a change, if any, in the label, composition or calculation of the supplementary financial measure if it has been previously disclosed.

For clarity, the Proposed Companion Policy provides that if an issuer discloses a financial measure that is a disaggregation of a financial statement line item in order to simply explain how the financial statement line item changed from period to period, such a measure would not meet the definition of a supplementary financial measure because the issuer is not presenting an aspect of its financial performance.

Other

Prominence: Determining whether a non-GAAP financial measure is presented with no more prominence is a matter of judgment, taking into account the overall disclosure and the facts and circumstances in which the disclosure is made. In the Proposed Companion Policy, the CSA has provided a non-exhaustive list of examples of what it views as causing a non-GAAP financial measure to be more prominent than the most directly comparable measure presented or disclosed in the financial statements. The list includes some not previously noted examples, such as omitting the most directly comparable measure from a press release headline or caption that includes a non-GAAP financial measure or describing a non-GAAP financial measure as, for example, "record performance" or "exceptional" without at least an equally prominent descriptive characterization of the most directly comparable measure. Additionally, the Proposed Companion Policy provides for a new safe harbour by noting "a location is not more prominent if it allows an investor who reads the document, or other material containing the non-GAAP financial measure, to be able to view the discussion and analysis of both the non-GAAP financial measure and the most directly comparable measure contemporaneously. For example, within the previous, same or next page of the document."

Reconciliation: In addition to the guidance carried over from SN 52-306 as new requirements, the Proposed Instrument would further require issuers to ensure that any requisite quantitative reconciliation to the most directly comparable financial measure presented in the issuer's primary financial statements be disaggregated and explained, each in such a way that it provides a reasonable person an understanding of the reconciling items. While the Proposed Instrument does not define the "most directly comparable financial measure", requiring that issuers apply judgment, the Proposed Companion Policy notes that, in applying such judgment, it is important for an issuer to consider the context of how the non-GAAP financial measure is used. For example, where the non-GAAP financial measure is discussed primarily as a performance measure used in determining cash generated by the issuer or its distribution-paying capacity, its most directly comparable GAAP measure will be from the statement of cash flows.

Comparative/Historical Period: The Proposed Companion Policy provides that determining the appropriate period for requisite comparative or historical disclosures is a matter of judgment, taking into account the time period covered by the financial outlook (if applicable), the nature of the issuer's industry and the extent to which the business of the issuer is cyclical or seasonal. If an issuer has a seasonal business, the comparative or historical disclosure could be for the same period from the prior year, whereas if the issuer's business is not seasonal, the comparative or historical disclosure could be for the most recently completed period of the same length.

Social Media: The Proposed Companion Policy notes that issuers should not disclose non-GAAP financial measures, segment measures, capital management measures or supplementary financial measures on social media, if character limits would preclude the disclosure of all the required information in accordance with the Proposed Instrument and that if an issuer uses social media to provide links to a publication, such publication would be within the scope of the Proposed Instrument.

Executive Compensation Disclosure: While item 2.1(4) of Form 51-102F6 Statement of Executive Compensation currently requires issuers that use performance goals or similar conditions in their compensation decision-making processes which are non-GAAP financial measures to only explain how the issuer calculates these performance goals or similar conditions from its financial statements, any such non-GAAP financial measures and ratios would not be exempted from additional compliance with the Proposed Instrument.

CONCLUSION

The Proposed Instrument is a complex and detailed regime and will represent a departure from current practice for many issuers. The CSA has requested that comments on the Proposed Instrument and Proposed Companion Policy be provided in writing on or before December 5, 2018.

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.

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