Last week, the Securities and Exchange Commission (SEC) released several new and revised Compliance and Disclosure Interpretations (C&DIs) related to the use of non-GAAP financial measures under Regulation G and Item 10(e) of Regulation S-K. The new guidance addresses the SEC staff's concern with the use of non-GAAP financial measures in a manner that could be viewed as misleading to investors. The new and revised C&DIs focus on providing consistent, clear presentations of non-GAAP financial measures that show a complete financial picture. Companies should use the new guidance as an opportunity to review their use of non-GAAP financial measures. A link to the C&DIs can be found here. For a copy of the new and revised C&DIs marked against the previous C&DIs, click here.

This WSGR Alert highlights certain key C&DIs. Companies should review the entire list of new and revised C&DIs to assess the applicability to their businesses.

Misleading Presentation of Non-GAAP Financial Measures

Several of the new C&DIs address presentations of non-GAAP financial measures that the SEC staff believes could be misleading. These include:

Adjustments. Certain adjustments, while not explicitly prohibited, may be problematic if they result in misleading non-GAAP financial measures. For example, the presentation of a performance measure that excludes normal, recurring cash operating expenses necessary to operate a company's business may violate Regulation G.

Period-Over-Period Inconsistency. Changes in non-GAAP financial measures between periods, and the reasons for such changes, should be explained to avoid a violation of Regulation G. The SEC staff has also clarified that if period-over-period changes in non-GAAP financial measures are significant, it may be necessary to recast prior measures to conform to current presentations and contextualize the disclosure. For example, the adjustment of a particular charge or gain in a period without a comparable adjustment of a particular charge or gain in the prior period may require explanation or recasting.

Offsetting. Companies should be consistent with items that are included and excluded in non-GAAP presentations in a single period, particularly charges and gains. For example, a non-GAAP financial measure that excludes non-recurring charges without excluding non-recurring gains in the same period could violate Regulation G.

Non-GAAP Revenue Presentations

The new C&DIs suggest that non-GAAP financial measures that present revenue in a manner that is inconsistent with GAAP could violate Regulation G or Regulation S-K. The SEC staff extended this guidance beyond earnings releases furnished on a Current Report on Form 8-K and other reports publicly filed with the SEC, and noted that non-GAAP adjusted revenue presentations would cause concern when presented in any public disclosure. The new guidance reflects the SEC staff's recent focus on non-GAAP financial measures that calculate non-GAAP revenue in a manner perceived to be inconsistent with a company's business. According to the SEC staff, this may apply to financial statement line items other than revenue.

Labeling metrics as "adjusted revenue" or otherwise describing these metrics as a substitute for GAAP revenue will likely draw significant SEC scrutiny. Performance metrics that are not non-GAAP financial measures—such as billings—are not prohibited under the new guidance.

Equal or Greater GAAP Prominence

Regulation G requires non-GAAP presentations to be accompanied by comparable GAAP measures and to be presented with equal or greater prominence. Although the determination of prominence is a facts and circumstances test, one C&DI provided a description of certain practices and presentations that should be avoided:

• Presentation of a full income statement of non-GAAP measures, including when reconciling non-GAAP measures to the most directly comparable GAAP measures
• Omission of comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures
• Presentation of a non-GAAP measure using a style of presentation (e.g., bold, larger font) that emphasizes the non-GAAP measure over the comparable GAAP measure
• Presentation of a non-GAAP measure before the most directly comparable GAAP measure (including in an earnings release headline or caption)
• Description of a non-GAAP measure as, for example, "record performance" or "exceptional" without at least an equally prominent descriptive characterization of the comparable GAAP measure
• Provision of tabular disclosure of non-GAAP financial measures without preceding it with an equally prominent tabular disclosure of the comparable GAAP measures, or including the comparable GAAP measures in the same table
• Exclusion of a quantitative reconciliation with respect to a forward-looking non-GAAP measure in reliance on the "unreasonable efforts" exception in Item 10(e)(1)(i)(B) of Regulation S-K without disclosing that fact and identifying the information that is unavailable and its probable significance in a location of equal or greater prominence
• Discussion and analysis of a non-GAAP measure without a similar discussion and analysis of the comparable GAAP measure in a location with equal or greater prominence

Other Presentations

The SEC also addressed a number of additional considerations with respect to certain non-GAAP presentations. Some of the key considerations include:

Free Cash Flow. As there is no specific calculation methodology for free cash flow, it is important for companies to indicate how their free cash flow measure is calculated and to provide the necessary reconciliation. Additionally, misleading free cash flow uses should be avoided. For example, free cash flow should not be characterized as representing the residual cash flow available for discretionary expenditures.

Per Share Non-GAAP Measures. The C&DIs clarify that non-GAAP liquidity measures that reflect cash generated must not be presented on a per share basis in documents furnished or filed with the SEC. Even if management presents per share data as a performance measure instead of a liquidity measure, the SEC will conduct its own independent analysis focused on the substance of the non-GAAP measure to determine the appropriateness of the company's disclosure instead of relying on management's categorization of such measure.

Wilson Sonsini Goodrich & Rosati will continue to monitor the applicability of the new and revised guidance related to non-GAAP financial measures. For more information, please contact any member of the firm's corporate governance practice.