by Patrick Gallagher

July 19, 2016

Grappling with Non-GAAP Disclosure

As investor relations and corporate communications officers gear up for the summer round of quarterly reporting, the process promises to be more harried than usual as a result of heightened scrutiny by the Securities and Exchange Commission of non-GAAP reporting. Many companies will grapple with revisions to the wording and structure of their earnings releases. Others may need to significantly revise the template they have used for years.

Here are five Dos and Don’ts for making sure your reporting conforms with the new SEC Compliance and Disclosure Interpretations regarding the use of non-GAAP financial measures without distracting from a true financial picture.

1. Don’t Overreact

Non-GAAP metrics have gotten a bad name due to blatant abuse by a small number of registrants and casual disregard for GAAP numbers by others. But don’t overreact to the SEC crackdown by cutting back on information that you believe is essential to accurately reflect the company’s results of operations, financial position or how management runs the business. Non-GAAP financial information can be extremely useful (in truth, essential) for analysts and investors. However, it must be presented properly—and with more than a cursory rationale.

2. Do Give GAAP Its Due

Probably the most widespread shortcoming the SEC sees is companies giving greater prominence to their non-GAAP measures and downplaying the GAAP numbers. You don’t have to look far to find releases where the text barely mentions GAAP measures. The SEC is being crystal clear: If you present a non-GAAP measure you must give equal or greater prominence to the most directly comparable GAAP measure. What does “equal or greater prominence” mean? “Presenting a non-GAAP measure before the most directly comparable GAAP measure (including in an earnings release headline or caption)” would be considered inappropriate, the guidelines state.

3. Don’t Mislead in Touting Non-GAAP Results

According to the new interpretations, one may not “[Describe] a non-GAAP measure as, for example, ‘record performance’ or ‘exceptional’ without at least an equally prominent descriptive characterization of the comparable GAAP measure.”

4. Do Consider Other Communications

Most of the commentary on the new SEC interpretations has focused on earnings releases, but the stricter guidance applies to non-GAAP measures presented in all public disclosures—on the company’s website, in its investor deck, in its earnings conference call prepared remarks, and in the annual report letter to shareholders. A glance through a sample of recent annual reports suggests that a challenge awaits many letter writers next year. If the guidelines lead to torturous writing, the SEC will not have achieved its objective.

5. Do Watch How Analysts Respond

It will be interesting to see if the new SEC directives prompt sell-side analysts to give more prominence to GAAP measures in their own reports or to press companies for clearer disclosure. In most cases, analysts seem to be comfortable with the status quo.

For more commentary on this issue see:

BakerBotts: “A Brave New World for Non-GAAP Financial Measures

E&Y: “SEC Staff Updates Guidance on Non-GAAP Financial Measures