02/16/2010

Corporate Finance Alert: SEC Staff Issues Updated Guidance on Non-GAAP Financial Measures

Regulation G and Item 10(e) of Regulation S-K govern the use of non-GAAP financial measures in public disclosures by reporting companies. A "non-GAAP financial measure" is a numerical measure of a company's historical or future financial performance, financial position or cash flows that (i) excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flows (or equivalent statements) of the company; or (ii) includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented. Both Regulation G and Item 10(e) require that when a company discloses material information containing a non-GAAP financial measure, it must accompany the measure with the most directly comparable GAAP measure and also must provide a reconciliation between the GAAP measure and the non-GAAP measure.

Prior guidance released by the staff of the Division created some uncertainty regarding the use of non-GAAP financial measures and, therefore, had the effect of limiting the use of non-GAAP financial measures by public companies in their SEC filings. The SEC staff has recently acknowledged in public statements that it is concerned about the growing disparity between the information contained in public companies' SEC filings and in their earnings releases and related earnings conference calls. The new C&DI's appear to be an attempt to encourage public companies to have a greater consistency across all of their communication channels with investors. Some of the more noteworthy revisions include the following:

Non-Recurring Adjustments – The new guidance makes clear that in general a company may use a non-GAAP financial measure that excludes any charge or gain that the company deems appropriate, so long as the measure otherwise complies with the applicable rule(s). The prior guidance had included language that made it difficult for a company to exclude recurring charges from a non-GAAP financial measure. A company, however, may not describe the charge or gain as non-recurring, infrequent or unusual unless it meets the specified criteria (i.e., a similar charge or gain was not incurred in the previous two years and is not reasonably likely to recur within the next two years). The C&DI's state that "[t]he 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." Additionally, the guidance no longer requires a company that is excluding a recurring item from a non-GAAP financial measure to bear the burden of establishing the usefulness of that measure.

Funds from Operations – The new guidance provides that a company may present funds from operations (FFO) measures that differ from the definition of FFO used by the National Association of Real Estate Investment Trusts if the adjusted FFO measure complies with Item 10(e). Additionally, if adjusted FFO is used as a performance measure, it may be presented on a per share basis. If adjusted FFO is presented as a liquidity measure, it may not be presented on a per share basis.

Constant Currency – Companies that have overseas operations will often present their results of operations on a "constant currency" basis in order to isolate the effect of foreign currency fluctuations. The new C&DI's clarify that a company can provide the required reconciliation by presenting both the historical results and the results on a constant currency basis together with a description of the process for calculating constant currency.

Non-GAAP Income Statements – It is generally not appropriate to present a full non-GAAP income statement for purposes of reconciling non-GAAP measures to the comparable GAAP measures, because the staff of the Division believes that doing so would attach undue prominence to the non-GAAP information.

Per Share Amounts – Non-GAAP per share performance measures may be included in documents filed with the SEC, provided that they are reconciled with GAAP earnings per share. Non-GAAP liquidity measures, such as those related to cash flow, may not be presented on a per share basis.

Management's Use of Measures – A non-GAAP financial measure may be provided to investors even though management does not use that measure in managing the business. In its SEC filings a company must, however, disclose the reasons why management believes the measure will be useful to investors. Under the prior guidance, it was unclear if a company could provide a non-GAAP financial measure that was not used by management.

Net of Tax Measures – A company may present an adjustment "net of tax" when reconciling a non-GAAP performance measure to its most comparable GAAP counterpart, provided that the company discloses (i) the tax effect of each reconciling item either parenthetically or in a footnote and (ii) how the tax effect was calculated.

Segment Information – Retained from the prior guidance is a statement that a measure of profit/loss or liquidity on a segment basis would be a non-GAAP financial measure unless the measure is presented in accordance with Accounting Standards Codification 280. The C&DI's state that "[s]egment 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 Accounting Standards Codification 280." The prior guidance required a company to prove that segment measures other than those reported to the chief operating decision maker (i.e., non-GAAP segment measures) would be useful to investors. The new guidance removes that burden from issuers.

Foreign Private Issuers – A foreign private issuer may include a non-GAAP financial measure that would otherwise be prohibited by Item 10(e) in its SEC filings if the measure is "expressly permitted" by the primary securities regulator in the foreign private issuer's home country. A measure is "expressly permitted" if the foreign regulator has demonstrated its acceptance of the measure through publication or direct communication to the foreign private issuer.

Potential Impact on SEC Comment Process – At recent securities law conferences, senior members of the staff of the Division have stated that they have requested the staff as part of the review of a public company's Exchange Act reports to also review the company's other public statements (for example, press releases, earnings conference calls, websites, etc.) to determine whether there is a consistent message being communicated to investors. If there is a disparity in the information included in a company's Exchange Act reports and its other public statements, the staff may issue a comment asking the company to explain why the additional information (if material) was not included and discussed in the Management's Discussion and Analysis section of the company's Exchange Act reports.

For more information on the SEC's updated guidance on non-GAAP financial measures, please contact Patrick Respeliers at 816.691.2411.