One frequently misunderstood aspect of the SEC’s non-GAAP measure guidance is whether or not certain “operational metrics” such as same-store sales are non-GAAP measures. Here is an example SEC comment that raises this question:
Item 6. Selected Financial Data, page 52
|In your selected financial data and your results of operations discussion for your segments, you present certain amounts, such as “average realized price per metric ton of primary aluminum”, “average cost per dry metric ton of bauxite”, “average cost per metric ton of alumina” and “average cost per metric ton of primary aluminum”. Please disclose the numerators and denominators used to compute each amount and reconcile the numerators to amounts presented in your financial statements.|
Are measures such as “average cost per dry metric ton of bauxite” non-GAAP measures? The comment above leaves this question open. The starting point in researching whether such measures are non-GAAP measures is the definition of a non-GAAP measure in Reg G and S-K Item 10(e). This is the definition from Reg G:
(a)(1) Non-GAAP financial measure. A non-GAAP financial measure is a numerical measure of a registrant’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 issuer; 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.
(2) A non-GAAP financial measure does not include operating and other financial 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.
(3) A non-GAAP financial measure does not include financial measures required to be disclosed by GAAP, Commission rules, or a system of regulation of a government or governmental authority or self-regulatory organization that is applicable to the registrant.
For measures such as same-store sales and those in the comment above this definition may not be simple to apply. In particular a measure such as “average cost per dry metric ton of bauxite” does not fit easily into this thought process. This is an example of a situation where it will be important to look past the S-K guidance and dig a bit deeper.
A good first place to start digging is in the Compliance and Disclosure Interpretations or C&DI’s, published by CorpFin. While they are not “authoritative” they are frequently go-to guidance. As you may know, the SEC has provided guidance about the use of non-GAAP measures in several C&DI’s. These C&DI’s include all the May 2016 and subsequent guidance from the staff that created such discussion and change in the registrant community. However, these C&DI’s don’t address issues in the definition of a non-GAAP measure.
So, what is the next research step? This is a great example of how sometimes questions go beyond the actual rules and the related C&DI’s. To resolve some issues, it is necessary to go all the way back to the SEC Release that adopted the related rules. Here is a quote from the adopting release for the SEC’s non-GAAP measure guidance, which implemented the non-GAAP provisions of SOX:
- Discussion of the definition
We do not intend the definition of “non-GAAP financial measures” to capture measures of operating performance or statistical measures that fall outside the scope of the definition set forth above. As such, non-GAAP financial measures do not include:
- operating and other statistical measures (such as unit sales, numbers of employees, numbers of subscribers, or numbers of advertisers); and
- ratios or statistical measures that are calculated using exclusively one or both of:
- financial measures calculated in accordance with GAAP; and
- operating measures or other measures that are not non-GAAP financial measures.
Non-GAAP financial measures do not include financial information that does not have the effect of providing numerical measures that are different from the comparable GAAP measure. Examples of measures to which Regulation G does not apply include the following:
- disclosure of amounts of expected indebtedness, including contracted and anticipated amounts;
- disclosure of amounts of repayments that have been planned or decided upon but not yet made;
- disclosure of estimated revenues or expenses of a new product line, so long as such amounts were estimated in the same manner as would be computed under GAAP; and
- measures of profit or loss and total assets for each segment required to be disclosed in accordance with GAAP.
The release also provides these examples:
Examples of ratios and measures that would not be non-GAAP financial measures would include sales per square foot (assuming that the sales figure was calculated in accordance with GAAP) or same store sales (again assuming the sales figures for the stores were calculated in accordance with GAAP).
For the measures in the comment letter above, as long as the financial components of the measures are computed in accordance with GAAP, they are not non-GAAP measures. And, as you can see in this response letter, the company told the SEC they would expand their disclosures and that the disclosures would be based on GAAP numbers. Because of this approach, the non-GAAP measure guidance would not apply.
This is the first step in presenting metrics to investors. There is more, and our next post will address the issue of explaining why the metric provides relevant information to investors.
As always, your thoughts and comments are welcome!