Now that we are past the July 4^thholiday (hope you had fun!)  and far enough past quarter-end close to be getting ready for reporting, here are a few things to be thinking about as we work on 10-Q’s or 10-K’s.

It was, in the SEC reporting world, a long time ago (but not in a galaxy far, far away), that the SEC issued its “revised” guidance about the use of non-GAAP measures.  (The updated May 2016 C&DI’s are here.) Even with the passage of time, there are still some pretty basic and some more complex problem areas that the SEC discovers in the comment process.  Here are a few example comments to use as reminders to make sure you are following the guidance in Reg Gand S-K Item 10(e), the two primary sources of SEC guidance in this area.

For this first comment, here is a part of S-K Item 10(e):

 (ii) A registrant must not:

……………

 (B) Adjust a non-GAAP performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years;

 Now, this requirement from S-K Item 10(e) applies to non-GAAP measures in filed documents, but it is augmented and expanded by this C&DI:

 Question 102.03

 Question: Item 10(e) of Regulation S-K prohibits adjusting a non-GAAP financial performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual when the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years. Is this prohibition based on the description of the charge or gain, or is it based on the nature of the charge or gain?

Answer: The prohibition is based on the description of the charge or gain that is being adjusted. It would not be appropriate to state that a charge or gain is non-recurring, infrequent or unusual unless it meets the specified criteria. The 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. Registrants can make adjustments they believe are appropriate, subject to Regulation G and the other requirements of Item 10(e) of Regulation S-K. See Question 100.01. [May 17, 2016]

The C&DI mentioned at the end of 103.03 is:

Question 100.01

Question: Can certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading?

Answer: Yes. Certain adjustments may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading. For example, presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading. [May 17, 2016]

These pieces of guidance build a framework that in any non-GAAP measure, if you say it is unusual or infrequent, it has to meet a logical definition of those terms.

These requirements are behind the following comment:

Non-GAAP Financial Measures

4. We note your disclosure under this section, describing certain adjustments to your non- GAAP measures, stating “these non-recurring items are excluded because, by their nature, they are not indicative of our business or economic trends.” However, it appears that several of these items have occurred in sequential years. Please refrain from referring to charges as non-recurring when such charges have occurred within the prior two years or are reasonably likely to recur within two years. You may refer to our Non- GAAP Financial Measures Compliance and Disclosure Interpretation (C&DI) 102.03 if you require further clarification or guidance.

 

This second example is based on the following C&DI:

 Question 102.11

 Question: How should income tax effects related to adjustments to arrive at a non-GAAP measure be calculated and presented?

 Answer: A registrant should provide income tax effects on its non-GAAP measures depending on the nature of the measures. If a measure is a liquidity measure that includes income taxes, it might be acceptable to adjust GAAP taxes to show taxes paid in cash. If a measure is a performance measure, the registrant should include current and deferred income tax expense commensurate with the non-GAAP measure of profitability. In addition, adjustments to arrive at a non-GAAP measure should not be presented “net of tax.” Rather, income taxes should be shown as a separate adjustment and clearly explained. [May 17, 2016]

 

Attention to this kind of detail is important.  This is a comment from a March 2018 comment letter:

5. Within the reconciliations of GAAP net income to non-GAAP adjusted net income attributable to XXXXXX and of related GAAP diluted earnings per share (EPS) to non- GAAP adjusted diluted EPS, you present a number of reconciling items net of income taxes. Please present such adjustments before tax and show the related income tax as a separate adjustment to comply with Non-GAAP Financial Measures C&DI 102.11.

 

last, here is an interesting comment about the intersection between the use of non-GAAP measures and operating segment disclosures.  The non-GAAP disclosure requirement involved is from S-K Item 10(e):

(i) The registrant must include the following in the filing:

………………

(C) A statement disclosing the reasons why the registrant’s management believes that presentation of the non-GAAP financial measure provides useful information to investors regarding the registrant’s financial condition and results of operations; and

That said, if a non-GAAP measure is used in evaluating segment performance then its disclosure is essentially required by GAAP and reconciliation is not required.  This company went one step beyond the segment disclosure requirements:

1. We note your presentation of Total Segment Adjusted EBITDA included as part of your tables which outline your sales and Segment Adjusted EBITDA for each of your reporting segments. You state on page 29 that Segment Adjusted EBITDA is a meaningful measure as it is used to assess business and operating performance of the segments, and for operational planning and decision-making purposes. However, it is unclear from your disclosures why management believes the presentation of Segment Adjusted EBITDA on a consolidated basisis useful to investors regarding your financial condition and results of operations. Please revise to disclose and to the extent material, include the additional purposes, if any, for which you use the non-GAAP measure in accordance with Item 10(e)(1)(i)(C)-(D) of Regulation S-K. Refer to the guidance outlined Question 104.04 of the C&DIs on the use of non-GAAP financial measures which can be found on the SEC’s website.

We hope these reminders help as you work towards quarter or year-end, and as always, your thoughts and comments are welcome!