Small Public Company Forum

The SEC’s recent guidance on the use of non-GAAP financial measures offers public companies the opportunity to expand their use of these measures, as long as certain guidelines are satisfied. Many companies have not yet taken advantage of these opportunities.

Adopted in the wake of the Enron scandal, the SEC’s restrictions on non-GAAP financial measures are contained in two separate rules – Regulation G, governing public disclosures outside of SEC filings (including earnings releases), and Item 10(e) of Regulation S-K, governing disclosures within SEC filings. The SEC has also released Compliance & Disclosure Interpretations (C&DIs) interpreting the rules.

In new C&DIs released earlier this year, the SEC loosened some of its previous restrictions on the use of non-GAAP measures. However, the SEC now appears to be asking companies for more consistency in their use of non-GAAP measures in SEC filings and non-GAAP measures in other public disclosures outside of SEC filings.

SUMMARY OF CHANGES IN GUIDANCE

Below is a summary of the more important changes in guidance that are likely to be of interest to smaller reporting companies:

• In its SEC filings, a company may now present non-GAAP financial measures that exclude the impact of recurring items (so long as the excluded items are not labeled as “non-recurring”)—a significant departure from the Staff’s prior guidance under Item 10(e).  To do this, a company should clearly disclose and explain the reasons for eliminating the recurring items in the non-GAAP financial measure.  See C&DI 102.03.
• In its SEC filings, a company may now present non-GAAP financial measures that are not used by management in evaluating the business.  Instead, the new guidance directs companies to disclose the additional purposes, if any, for which management uses the measure, to the extent material.  However, the use of any non-GAAP financial measure must still be accompanied by disclosure of the reasons why management believes the measure is useful to investors.  See C&DI 102.04. 
• When complying with the Regulation G requirement that any non-GAAP performance measure be reconciled to GAAP, a company may present adjustments net of tax provided that the tax effect of each reconciling item, and the manner in which the tax effect was calculated, is disclosed.  Disclosure is typically made through a footnote or in a parenthetical.  See C&DI 102.11.

The other noteworthy development is that, according to at least one national law firm, the SEC Staff has begun advising companies to present non-GAAP financial measures in a consistent manner, whether those measures are disclosed in SEC filings or other forms of public disclosure.  Apparently, this is meant to eliminate the practice of using two different presentations of performance and liquidity—one set of presentations in press releases and a different set of presentations in official SEC filings. 

SUMMARY OF SIGNIFICANT REQUIREMENTS FOR THE USE OF NON-GAAP FINANCIAL MEASURES

For ease of reference and to place the above changes in guidance in context, below is a summary of the most significant current requirements for, and prohibitions on, the use of non-GAAP financial measures in SEC filings and other public disclosures.