On Thursday, in addition to voting to issue a new rule proposal regarding changes to MD&A and other financial disclosure requirements (see this PubCo post), the SEC also issued new companion guidance on the disclosure of key performance indicators and other metrics in MD&A. There has been an increase in investor interest in disclosure of KPIs and similar metrics, as part of MD&A and especially outside of MD&A, for example, in connection with sustainability reporting. (See this PubCo post.) Although the SEC's guidance applies specifically in the context of MD&A, companies may want to take the guidance into account in other contexts as well.
What is a KPI? In general, a KPI is a quantitative measure used to demonstrate performance of a business or operational objective. To the extent that these factors are material to an understanding of MD&A, the SEC believes that they should be disclosed:
"Item 303(a) of Regulation S-K requires disclosure of information not specifically referenced in the item that the company believes is necessary to an understanding of its financial condition, changes in financial condition and results of operations. The item also requires discussion and analysis of other statistical data that in the company's judgment enhances a reader's understanding of MD&A.... The [SEC has] previously stated that companies should identify and address those key variables and other qualitative and quantitative factors that are peculiar to and necessary for an understanding and evaluation of the individual company. Such information could constitute key performance indicators and other metrics."
These metrics may be financial or non-financial, "relate to external or macro-economic matters," be company specific or industry specific, or combine external and internal information. Some examples of KPIs identified in the guidance include:
- operating margin;
- same store sales;
- sales per square foot;
- total customers/subscribers;
- average revenue per user;
- daily/monthly active users/usage;
- active customers;
- net customer additions;
- total impressions;
- number of memberships;
- traffic growth;
- comparable customer transactions increase;
- voluntary and/or involuntary employee turnover rate;
- percentage breakdown of workforce (e.g., active workforce covered under collective bargaining agreements);
- total energy consumed; and
- data security measures (e.g., number of data breaches or number of account holders affected by data breaches).
In the guidance, the SEC cautioned that, because prior guidance instructs a company to "provide a narrative that enables investors to see a company 'through the eyes of management,' so these metrics should not deviate materially from metrics used to manage operations or make strategic decisions." [Emphasis added.]
In a Q&A at a December 2018 meeting of the SEC's Investor Advisory Committee, SEC Chair Jay Clayton indicated that what he would like to see with regard to KPIs and NGFMs is a clear tie-back to GAAP and period-to-period consistency for each company. In addition, he indicated, these types of measures should track how management looks at its business, not just how management wants to present its business. (See this PubCo post.)
What is the difference between a non-GAAP financial measure, which is subject to Reg G and Item 10 of Reg S-K, and a KPI ? What about a GAAP measure? While there might be some overlap, the guidance notes that, as stated in Item 10(e)(4), "non-GAAP financial measures exclude operating and other statistical measures; and ratios or statistical measures calculated using exclusively one or both of (i) financial measures calculated in accordance with GAAP, and (ii) operating measures or other measures that are not non-GAAP financial measures." In addition, the SEC has stated that "operating and other statistical measures such as unit sales, numbers of employees, numbers of subscribers, or numbers of advertisers are not non-GAAP financial measures." The guidance also noted that subsets of line items in the financials and ratios or statistical measures calculated using exclusively GAAP measures calculated or disclosed under GAAP are GAAP measures.
What should be disclosed about KPIs? The guidance recommends that, when including KPIs in their disclosure, companies will need to look to the "MD&A requirements and the need to include such further material information, if any, as may be necessary in order to make the presentation of the metric, in light of the circumstances under which it is presented, not misleading." To that end, companies will need to first examine whether any existing regulation or guidance, such as GAAP or Reg G or Item 10 of Reg S-K may apply. Beyond that, the guidance advises that the company "should consider what additional information may be necessary to provide adequate context for an investor to understand the metric presented." More specifically, depending on the facts and circumstances, the SEC expects to see:
- "A clear definition of the metric and how it is calculated;
- A statement indicating the reasons why the metric provides useful information to investors; and
- A statement indicating how management uses the metric in managing or monitoring the performance of the business.
The company should also consider whether there are estimates or assumptions underlying the metric or its calculation, and whether disclosure of such items is necessary for the metric not to be materially misleading."
What if we change the method of calculation of the KPI? If a company changes the method of calculation or presentation, the guidance advises that the company
"should consider the need to disclose, to the extent material:
(1) the differences in the way the metric is calculated or presented compared to prior periods,
(2) the reasons for such changes,
(3) the effects of any such change on the amounts or other information being disclosed and on amounts or other information previously reported, and
(4) such other differences in methodology and results that would reasonably be expected to be relevant to an understanding of the company's performance or prospects."
The guidance also recommends that companies consider the need to "recast prior metrics to conform to the current presentation and place the current disclosure in an appropriate context," depending on the significance of the change.
How are KPIs used outside of MD&A? While the guidance is specifically applicable to MD&A, in the guidance, the SEC observes that companies also use KPIs to describe the performance of their operations and businesses. In those cases, the metrics may be specific to certain industries, such as the use of "same-store sales," or vary among companies and industries. Some companies have also used KPIs in describing environmental or other sustainability factors, such as human capital.
In a recent study of human capital disclosures, the EY Center for Board Matters suggested that some of the disclosures could have been improved by identifying or quantifying KPIs. For example, with regard to culture initiatives, some of the KPIs mentioned related to diversity hires, employee engagement, turnover and issues escalation resolution. However, with "limited exceptions, the companies did not provide quantitative results for their disclosed KPIs." Similarly, with regard to health and safety, "KPIs included recordable injury rates and the number of employees participating in certain health and wellness programs, but less than half of those addressing this topic disclosed KPIs and very few provided data." The same goes for the few companies that discussed workforce stability: some discussed certain turnover rates (e.g., turnover rate for high‑performing personnel) as KPIs; few provided quantified results for their KPIs. (See this PubCo post.)
What about controls? The guidance reminds us of the importance of maintaining effective disclosure controls and procedures in connection with the "material key performance indicators or metrics that are derived from the company's own information. When key performance indicators and metrics are material to an investment or voting decision, the company should consider whether it has effective controls and procedures in place to process information related to the disclosure of such items to ensure consistency as well as accuracy."
The SEC added the new guidance as new Section 501.16 of the "Codification of Financial Reporting Policies."
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