The Securities and Exchange Commission (SEC) has been particularly focused on the proper disclosure of non-GAAP financial measures by public companies in recent years. The two bodies of SEC regulation applicable to non-GAAP measures are Regulation G and Item 10(e) of Regulation S-K. The SEC staff provides guidance about how they interpret these rules through SEC comment letters and Compliance and Disclosure Interpretations (“C&DIs”).

Non-GAAP financial measures are used by companies to supplement or provide a better picture of the company’s actual financial performance. They exclude or include certain amounts that are present in the most directly comparable financial measure prepared in accordance with Generally Accepted Accounting Principles (GAAP). For example, adjustments may be made for company-specific items that are non-recurring in nature. Common non-GAAP measures disclosed by public companies include EBITDA, adjusted EBITDA, adjusted gross margin, adjusted net income, adjusted earnings per share, and free cash flow.

Regulation G applies to any public communication of a public company. For example, disclosures on a company’s website or in an analyst presentation are subject to Regulation G. In contrast, communications of a public company that are filed with the SEC are subject to both Regulation G and Item 10(e) of Regulation S-K. Similarly, earnings releases of public companies are subject to both sets of regulations.

Regulation G requires a public company to present a reconciliation to the most directly comparable GAAP measure whenever it discloses information about a non-GAAP financial measure. A reconciliation table will display the adjustments made to the GAAP measure in order to arrive at the non-GAAP measure. A key exception to Regulation G is when the public company discloses the non-GAAP orally or by telephone. In such a scenario, the company will be deemed in compliance with Regulation G if the company has posted the non-GAAP reconciliation table on its website at the time of the public disclosure.

Item 10(e) of Regulation S-K requires a public company to present the most directly comparable GAAP measure with equal or greater prominence than the non-GAAP measure. Item 10(e) also requires the company to provide management’s reasons for believing that the non-GAAP measure is useful to investors.

For non-recurring or unusual charges or gains that are reasonably likely to recur within two years, Item 10(e) prohibits companies from eliminating or smoothing such items. The SEC has also provided guidance in a C&DI that a non-GAAP financial measure can be misleading if it only makes adjustments to exclude non-recurring charges without also excluding non-recurring gains that occurred during the same time period. Misleading adjustments to non-GAAP measures could violate Regulation G. Also under Item 10(e), companies cannot exclude charges or liabilities that require cash settlement from their non-GAAP liquidity measures.

Non-GAAP financial measures are a frequent topic of SEC comment letters to public companies. These comment letters generally raise issues about the nature of non-GAAP adjustments and the undue prominence of a non-GAAP measure relative to its most directly comparable GAAP measure. For example, the SEC comment letter may raise an issue about whether a specific adjustment made to a non-GAAP measure was appropriate or in compliance with SEC rules.

Public companies should have robust processes in place for preparing non-GAAP measures. They should fully understand the SEC’s rules and interpretative guidance about non-GAAP measures, and stay aware of SEC comment letter trends with respect to the presentation of non-GAAP measures.