Chapter 4 — Other Registration Statement Reporting

4.5 Non-GAAP Financial Measures

While a company’s financial statements must be prepared in accordance with GAAP, many companies also elect to disclose non-GAAP financial measures1 — that is, numerical measures of a company’s financial performance, financial position, or cash flows for which the GAAP counterparts are adjusted in some fashion. Examples of common non-GAAP financial measures include EBITDA, adjusted EBITDA, adjusted earnings or adjusted EPS, and free cash flow.

When using non-GAAP financial measures, a registrant must be aware of certain SEC requirements, including the rules in Regulation G and Regulation S-K, Item 10(e). In addition, the SEC staff has published a number of C&DIs (which are updated periodically) to clarify its views on many non-GAAP presentation issues. SEC officials have indicated in public forums that the SEC is looking for full compliance with the C&DIs in IPO registration statements.

The key requirements for disclosure of non-GAAP information in SEC filings, including press releases, are related to the following:

Prominence — The most directly comparable GAAP measure should be presented with equal or greater prominence.
Not misleading — A non-GAAP measure should not be presented in a misleading manner.
Reconciliation — Registrants should present a quantitative reconciliation of the non-GAAP measure to the most directly comparable GAAP measure and should transparently describe all adjustments.
Clear labeling — Registrants should clearly label and describe non-GAAP measures and adjustments but should not, for example, use titles or descriptions that are confusingly similar to those used for GAAP financial measures.
Usefulness and purpose — Registrants should disclose why they believe the non-GAAP measure provides useful information to investors and, to the extent material, a statement disclosing how management uses the non-GAAP measure.

In addition, for additional background and guidance on the presentation and use of non-GAAP measures, see Deloitte’s Roadmap Non-GAAP Financial Measures and Metrics.

4.5.1 Presentation of Equal or Greater Prominence

The SEC has frequently cited its C&DI on prominence, Question 102.10, when commenting on non-GAAP measures. Accordingly, it may be helpful for a registrant to note the following:

If GAAP and non-GAAP measures are presented in a particular section of a document, the GAAP measures should be presented before the non-GAAP measures. For example, if a registrant wants to use certain non-GAAP measures in its discussion of results of operations, it should consider the order of presentation and discuss the GAAP results before the non-GAAP measures.
When a registrant reconciles a non-GAAP measure to the most comparable GAAP measure, it should start with the GAAP measure. See Section 3.2 of Deloitte’s Roadmap Non-GAAP Financial Measures and Metrics.
The registrant should not present a non-GAAP measure in more detail, or emphasize it more, than the comparable GAAP measure.
The disclosures related to non-GAAP purpose and use should not state or imply that the non-GAAP measures are superior to, provide better information about, or more accurately represent the results of operations than GAAP measures. See Section 3.4 of Deloitte’s Roadmap Non-GAAP Financial Measures and Metrics.
Certain presentations that give undue prominence to non-GAAP information, such as a full non-GAAP income statement, are prohibited.
If non-GAAP measures are presented in a chart or graphic, the chart or graphic should include the most directly comparable GAAP measures or they should be displayed in an equally prominent location.

Changing Lanes

In December 2022, the SEC updated Question 102.10 of the C&DIs on non-GAAP financial measures. This question provides guidance on when a non-GAAP measure is more prominent than the corresponding GAAP measure, to add additional interpretive guidance in three subsections:

C&DI Question 102.10(a), which highlights the scope of what is considered undue prominence and includes refreshed examples of situations in which non-GAAP measures would be disclosed more prominently than the comparable GAAP measures. Those include presenting (1) ratios when a non-GAAP measure is used in the numerator, denominator, or both without disclosing the equivalent GAAP ratio or (2) charts, tables, or graphs of non-GAAP measures without disclosing the comparable GAAP measures.

At the 2022 AICPA & CIMA Conference on Current SEC and PCAOB Developments, Division Chief Accountant Lindsay McCord noted that footnote 27 of the SEC’s original final rule on the conditions for the use of non-GAAP financial measures (issued in 2003) already extended the non-GAAP requirements to each non-GAAP measure used in the calculation of a ratio, but the guidance in the C&DI serves as an additional reminder for registrants that the GAAP counterpart should also be presented.
C&DI Question 102.10(b), which provides examples of situations in which non-GAAP reconciliations may give undue prominence to a non-GAAP measure. The SEC staff has stressed that non-GAAP reconciliations should always begin with the most directly comparable GAAP measure and go down to the non-GAAP measure.
C&DI Question 102.10(c), which specifies that a non-GAAP income statement would include all or most of the line items and subtotals contained in a comparable GAAP income statement. Before being updated, C&DI Question 102.10 indicated that disclosing a “full income statement of non-GAAP measures” would be an example of a non-GAAP measure that is presented with undue prominence. Ms. McCord noted that issuers often had questions about the meaning of the term “full” in that context, so the guidance was updated to delete the term “full.”

4.5.2 Potentially Misleading Non-GAAP Measures

An overriding theme of the SEC’s guidance on the use of or references to non-GAAP measures in public statements or disclosures is that they should not be misleading. Section 100 of the C&DIs also provides examples of potentially misleading non-GAAP measures, including those that:

Exclude normal, recurring cash operating expenses necessary for business operations.
Are presented inconsistently between periods, such as by adjusting an item in the current reporting period, but not a similar item in the prior period, without appropriate disclosure about the change and an explanation of the reasons for it.
Exclude certain nonrecurring charges but do not exclude nonrecurring gains (e.g., “cherry picking” non-GAAP adjustments to achieve the most positive measure).
Are based on individually tailored accounting principles, including certain adjusted revenue measures.
Are mislabeled or not clearly labeled as non-GAAP measures or otherwise include adjustments that are not clearly or accurately labeled or described.

In addition to the examples discussed in the C&DIs, various other presentations could be considered misleading depending on the facts and circumstances.

In interactions with the SEC staff regarding non-GAAP measures viewed as misleading, some registrants have proposed supporting continued presentation of such measures by adding transparent disclosures related to the calculation of the measures or about the measures’ purpose and use. However, Question 100.06 of the C&DIs indicates that even detailed disclosures about a misleading measure would not prevent it from being misleading.

At the 2022 AICPA & CIMA Conference on Current SEC and PCAOB Developments, the SEC staff indicated that once a non-GAAP measure or adjustment is concluded to be misleading or otherwise inconsistent with non-GAAP rules, the staff expects the registrant to correct the presentation in the next filing or publicly available SEC document by removing the measure or adjustment. If comparable periods are presented, the non-GAAP measure or adjustment should be removed from all periods presented.

Changing Lanes

In December 2022, the SEC staff released new and updated C&DIs on non-GAAP financial measures. The staff has observed that the volume of non-GAAP disclosure comments has remained high over the past several years and that it continues to receive questions on this topic. The new and updated C&DIs help increase the transparency of the SEC staff’s process for evaluating certain non-GAAP measures as well as its criteria for considering such measures misleading.

At the 2022 AICPA & CIMA Conference on Current SEC and PCAOB Developments, Ms. McCord emphasized that the intent of the new and updated C&DIs is to communicate interpretive feedback that the SEC staff has provided to registrants in various speeches and the comment letter process. In addition, she noted that the updates to the C&DIs are not intended to change the SEC staff’s position on non-GAAP adjustments that it has not objected to in the past (e.g., adjustments for restructuring costs and stock-based compensation). However, Ms. McCord further acknowledged that conclusions about the application of the C&DIs to non-GAAP measures and adjustments will depend on a registrant’s individual facts and circumstances.

The following changes related to misleading non-GAAP measures were made to the C&DIs:

C&DI Question 100.01 was updated to add interpretive guidance on what may be considered normal or recurring. The C&DI cautions issuers that a non-GAAP measure may be considered misleading if it excludes cash operating expenses that are normal and recurring in the operation of a registrant’s business. At the 2022 AICPA & CIMA Conference on Current SEC and PCAOB Developments, Ms. McCord explained that the SEC staff evaluates whether an expense is “normal” by considering the nature and effect of the non-GAAP adjustment and how the expense is related to the registrant’s operations, revenue-generating activities, business strategy, industry, and regulatory environment. She also noted that the SEC staff evaluates whether an operating expense is considered “recurring” when it occurs repeatedly or occasionally, including at irregular intervals of reoccurrence.
C&DI Question 100.04 was updated to clarify that adjustments that represent the application of individually tailored accounting principles extend beyond the original example of adjustments that accelerate revenue recognition. The C&DI specifies that non-GAAP adjustments that change the GAAP recognition and measurement principles would be considered individually tailored and may cause the presentation of the non-GAAP measure to be misleading. The C&DI includes new examples that illustrate the application of individually tailored accounting principles and thus may be misleading.
C&DI Question 100.05 was added to highlight the SEC’s guidance that non-GAAP measures should be labeled as such and that adjustments should be clearly labeled and described in the disclosures. The C&DI also gives examples of misleading labels and descriptions for non-GAAP measures.
C&DI Question 100.06 was added to emphasize that no amount of disclosure can make a measure compliant with the non-GAAP rules if it has been determined to be misleading.

During the IPO process, these concepts should be carefully considered in the determination of which non-GAAP measures to present in the IPO filing. Because non-GAAP measures are widely used in IPOs and are closely scrutinized by the SEC, non-GAAP measures are one of the most frequent topics on which the SEC comments during the IPO review process. See Deloitte’s Roadmap SEC Comment Letter Considerations, Including Industry Insights for the SEC staff’s recent comments on this topic.

In addition, for additional background and guidance on the presentation and use of non-GAAP measures, see Deloitte’s Roadmap Non-GAAP Financial Measures and Metrics.

Footnotes

Regulation S-K, Item 10(e)(2), defines a non-GAAP financial measure as “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 comprehensive 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.”