view Building confidence in non- GAAP measures and other KPIs A path forward

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May 2016
Building confidence in nonGAAP measures and other KPIs
A path forward
Multiple stakeholders play a role
• Non-GAAP measures and other key performance indicators (KPIs) can provide insight into a company’s business,
its past performance, and its potential prospects. Recently, non-GAAP measures and other KPIs have attracted
headlines noting their increased use, the growing difference between certain non-GAAP measures and their GAAP
counterparts, and the frequency with which analysts, advisors, and the press reference non-GAAP measures and
other KPIs without all the clarifying disclosures that companies provide.
• SEC regulations include an overarching principle that non-GAAP measures and other KPIs cannot be misleading,
and require certain disclosures when non-GAAP measures are presented. However, some critics question whether,
in some instances, management uses these alternative metrics to present their company’s performance in a more
positive light. To address these concerns head-on, management can act in a manner that builds confidence, in part
by avoiding inappropriate use or emphasis of non-GAAP measures and other KPIs. Companies that comply with
both the letter and spirit of the regulations can help create confidence in these metrics.
• Audit committees may want to consider their level of oversight with regard to disclosure of non-GAAP measures
and other KPIs. Acting as a bridge between management and stakeholders, the audit committee is well-positioned
to ask the right questions: Why has management chosen the non-GAAP measures and other KPIs presented? Will
stakeholders find these measures helpful? Are the measures presented in a fair and balanced manner? Where
applicable, are GAAP measures presented with equal or greater prominence? Is there consistency from period to
period, and should there be? Has management established effective disclosure controls around the non-GAAP
measures and other KPIs?
• Management and the audit committee are essential to building trust in non-GAAP measures and other KPIs, but
they cannot do it alone. Although their roles vary and are more indirect in nature, the SEC, auditors, analysts,
investors, advisors, and the financial press all participate in creating an environment in which non-GAAP
measures and other KPIs may be useful while not being confusing.
Providing context for non-GAAP
measures and other KPIs
Level-setting: Non-GAAP versus other KPIs
Non-GAAP measures have been in the headlines
recently—with significant focus on how common it is for
companies to include non-GAAP measures in their SEC
filings and public communications, and how those
measures may sometimes seem to tell a different story
than the GAAP measures. However, some of the
concerns raised about non-GAAP measures actually
relate to other KPIs: that is, metrics companies disclose
that are neither GAAP nor non-GAAP—they’re just
“other” metrics used to assess performance.
Non-GAAP measures adjust their GAAP counterparts in
some fashion. In contrast, KPIs are data points—like the
number of stores or customers—or metrics calculated
using GAAP amounts and a data point (e.g., sales per
square foot).
Non-GAAP
measures
•
•
•
•
•
EBITDA
Adjusted EBITDA
Adjusted EPS
Constant currency
Free cash flow
“Other” metrics
(KPIs)1
• Same store sales
• Average revenue
per customer
• Sales per square
foot
1
Assumes the sales/revenue numbers used are calculated using GAAP;
otherwise, the metric would be a non-GAAP measure.
The distinction between GAAP measures, non-GAAP
measures, and other KPIs is important because each
has a different level of inherent subjectivity, and each
has different regulations governing it. Knowing which is
which can help users better assess how they might
weigh the information in their decision-making.
Non-GAAP measures and other KPIs have their
purposes…and their limits
A company has flexibility to choose which non-GAAP
measures and other KPIs, if any, it reports, and how it
presents them, subject to certain requirements and
prohibitions. This inherent subjectivity means that what
one company reports could vary from what its peers
and companies in other industries report. This also
means that companies may calculate their non-GAAP
measures and other KPIs differently than other
companies, even when they are similarly titled. These
underlying differences could make the metrics
susceptible to misinterpretation without proper context
and explanation.
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By some indications…non-GAAP
measures are used extensively and, in
some instances, may be a source of
confusion.
Mary Jo White, SEC Chairman
December 9, 2015 speech
That said, stakeholders generally seem to value many
non-GAAP measures and other KPIs when presented in
the right context. The additional information may
facilitate a user’s understanding of a company’s
underlying financial performance, liquidity, or financial
position and its future cash flow prospects. It may also
convey changes to the business that are organic,
separate from those that may be considered unusual,
infrequent, or not representative of underlying trends.
Regulations differ depending on the measure
In addition to general prohibitions contained in the
anti-fraud provisions of the federal securities laws, nonGAAP measures have additional requirements and
prohibitions under SEC regulations.
A company’s public disclosure of a non-GAAP
measure—whether made orally, telephonically, via
webcast, media interview, or similar means—must also
be accompanied by the most directly comparable GAAP
measure and a reconciliation between the two. Some
situations (such as a broadcast interview) may not lend
themselves to the presentation of detailed financial
tables. In those cases, the SEC requires companies to
post the reconciliation simultaneously to its website and
announce the location. Because this supplemental
information may be important to fully understanding
the non-GAAP measure, users shouldn’t overlook this.
Another regulation requires companies that include
non-GAAP measures in (1) documents filed with the
SEC or (2) annual or quarterly press releases furnished
to the SEC to include the most directly comparable
GAAP financial measure with equal or greater
prominence, along with a reconciliation between the
GAAP and non-GAAP measures. Prominence can be
subjective. However, management might consider
placement (e.g., in headlines versus the body of the
text) and how much of the discussion relates to GAAP
versus non-GAAP information.
Companies must also disclose the reasons why the nonGAAP measure provides useful information to investors
and how, if at all, management uses the measure.
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Building confidence: The solution
starts at the source…
How can companies build trust in the nonGAAP measures and other KPIs they disclose?
Since companies and users both seem to believe that
non-GAAP measures and other KPIs provide useful
information, they should continue to be permitted.
However, companies can take steps to enhance
confidence in those measures so that they can be
assessed in the proper context, including:
Disclosure controls—Management can consider
whether their disclosure controls and procedures over
the calculation and presentation of non-GAAP measures
and other KPIs are as robust as their financial reporting
controls over GAAP financial statements.
Transparency—When companies present non-GAAP
measures, it is important to give equal or greater
prominence to the most comparable GAAP measures.
Companies should also title non-GAAP measures and
other KPIs in a manner that makes their nature clear. In
addition, they should consider providing transparent
disclosure of how the measure is calculated, including
the measure’s components and whether (and how)
those components reconcile to the GAAP numbers.
calculated, it should consider disclosure that explains
the changes and the rationale for them, and provide a
bridge between any previously provided metrics and the
metrics provided under the new methodology.
Comparability—Understanding which metrics are used
by peers may help management determine what
information to include in its communications. However,
if management is aware of differences in their
calculations compared to peers, they should consider
explaining the company’s disclosure and why the
measures may be different. Companies can also work
with industry groups to develop voluntary, industrywide metrics to enhance comparability.
Enhanced disclosure—Management should consider
whether enhanced disclosure of non-GAAP measures
and other KPIs makes sense: for example, what does the
metric demonstrate, what are its limitations, and what
is being adjusted and why? In addition, if management
intends to discuss a metric publicly or knows that such
information is often requested during earnings calls or
interviews, they may want to consider proactively
including the metric in their written disclosures to
facilitate understanding.
Management alone cannot build confidence
Users must have confidence in the financial information
they are using to make decisions. Management cannot
create that confidence alone—to varying degrees audit
committees, the SEC, auditors, and users may also have
a role to play.
Audit committees
Consistency—Disclosing policies on how non-GAAP
measures and other KPIs are calculated can help build
confidence and facilitate consistency from period to
period. Consistency—within the same year across
different investor communications, and from year to
year—is also critical when determining which nonGAAP measures and other KPIs to include. Measures
that are considered important to understanding the
business should be used consistently from year to
year and can provide useful information to users
regardless of whether they make the business’
performance look better or worse.
Audit committees can assess management’s reasons for
presenting the non-GAAP measures and other KPIs and
whether there is sufficient disclosure of why they are
helpful. They can evaluate whether the metrics present
a fair and balanced view of the company. They can also
assess how the metrics are publicized by analysts and
the financial press to the broader public.
The audit committee can provide a bridge between
management and stakeholders by asking: Are the
disclosures presented in accordance with SEC rules?
Has consistency from period to period been considered?
What judgments were involved in calculating the nonGAAP adjustments? Has the company designed
sufficient disclosure controls over the non-GAAP
measures and other KPIs, and are they operating
effectively?
When a company changes a previously reported nonGAAP measure or other KPI, or how such metrics are
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…but others also play a role
Regulator
The SEC’s mission is to protect investors, maintain fair,
orderly, and efficient markets, and facilitate capital
formation. As part of that mission, it can ensure that the
regulatory framework as it relates to non-GAAP
measures is clear, comprehensive, and achieves its
objectives. Additionally, the SEC staff’s review of
registrant filings and communications can focus on
non-GAAP measures and it can engage in a dialogue
with management aimed at helping companies comply
with the letter and spirit of the regulations.
Auditors
The external auditor’s opinions on the company’s
financial statements and, when required, the
effectiveness of the company’s internal controls do not
cover non-GAAP measures and other KPIs because they
are not included in the financial statements.
Professional standards indicate that auditors should
read the other information in certain documents
containing financial statements (such as annual and
quarterly reports) and consider whether the other
information or the manner of its presentation is
materially inconsistent with information appearing in
the financial statements. However, non-GAAP measures
and other KPIs are often included in press releases,
earnings calls, or other documents that are not covered
by the professional auditing literature, and therefore the
auditors are not associated with this information.
Though auditors do not report on non-GAAP measures
and other KPIs, audit committees and management
may consider using auditors as a sounding board when
evaluating whether regulations have been complied
with and balanced presentation has been achieved.
Investors, analysts, advisors, the press
Companies can make good judgments, follow all rules,
and disclose non-GAAP measures and other KPIs that
they believe are useful to investors. But those metrics
can still lead to confusion if stakeholders rely on them
as their only source of company information.
Contact Information
To have a deeper discussion about
our point of view on non-GAAP
measures and other KPIs, please
contact:
Beth Paul
US Strategic Thought Leader
Accounting Services Group
Phone: 973-236-7270
Email: [email protected]
John May
SEC Services Leader
Phone: 973-236-4793
Email: [email protected]
Analysts, advisors, and the financial press can be as
influential with investors as management’s direct
statements. For that reason, they should be careful to
convey non-GAAP measures and other KPIs in a way
that can be fairly digested, without imbalance or
omission of the GAAP measures.
Non-GAAP measures are intended to
supplement the information in the
financial statements and not supplant the
information in the financial statements.
However, when the financial news
networks report quarterly earnings, they
very frequently report the non-GAAP
measure of earnings with no mention of
the actual GAAP earnings, often not even
identifying it as having been adjusted.
James Schnurr, SEC Chief Accountant
March 22, 2016 speech
In summary
Appropriate determination and disclosure of non-GAAP
measures and other KPIs starts with management.
However, other stakeholders also have a role to play.
Audit committees have the ability to assess
management’s judgments about which non-GAAP
measures and other KPIs to disclose, and how they are
calculated, before those measures are ever
communicated publicly. Auditors read other
information included in annual and quarterly reports
and consider whether that other information is
materially inconsistent with the financial statements.
The SEC sets the rules and enforces them. Finally, users
should understand non-GAAP measures and other KPIs
and the context in which they should be considered
before making decisions. Doing so will facilitate
balanced assessment of these metrics. It will also
mitigate the risk of overreliance on non-GAAP
measures and other KPIs, which on their own may paint
an incomplete picture of a company.
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member firm, and may sometimes refer to the
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for further details. This content is for general
information purposes only, and should not be
used as a substitute for consultation with
professional advisors.