On January 30, 2020, the SEC issued Commission Guidance on Management’s Discussion and Analysis of Financial Condition and Results of Operations.1 The guidance provides a framework for ensuring that disclosure of key performance indicators and metrics (“KPIs”)2 complies with existing disclosure requirements3.
Specifically, companies, with the oversight of their audit committees, should:
1. Determine if an existing regulatory disclosure framework applies to the KPI and if so apply that framework -- fully. For example, if the KPI is a GAAP financial measure, make sure it complies with GAAP. Similarly, if the KPI meets the definition of a “non-GAAP financial measure”, make sure it complies with Regulation G, and when applicable4, Item 10(e) of Regulation S-K.
2. Whether or not the KPI is subject to an existing regulatory disclosure framework, consider what information may be needed to provide adequate context for understanding the KPI. This will typically require the inclusion of:
- A clear definition of the KPI and how it is calculated
- A statement indicating the reasons why the KPI provides useful information to investors
- A statement indicating how management uses the KPI in managing or monitoring the company’s business
3. Consider whether there are estimates or assumptions underlying the KPI that should also be disclosed so that the KPI is not misleading.
4. Consider if a change has been made to how the KPI is calculated compared to prior periods. If a change has been made, the additional disclosure that may be required includes:
- An explanation of the change
- The reasons for the change
- The impact of the change on information currently being disclosed or previously reported
- An explanation of any other differences in methodology and results that would be relevant to understanding the company’s performance or prospects
- A recasting of the KPI for prior periods using the current methodology
The Commission Guidance also contains a reminder of the need to consider whether the company has effective controls and procedures in place around its KPIs.
The guidance will be effective upon publication in the Federal Register. While the guidance is generally consistent with prior statements from the Commission and staff, as a practical matter, some companies may be unable to fully consider the guidance with respect to their disclosures for the year or quarter ended December 31, 2019. For those companies, the guidance should be considered for future disclosure and reporting.
1 Also on January 30, the SEC proposed changes to several financial disclosure requirements in Regulation S-K, including significant changes to Item 303, the requirement to provide MD&A. Those proposals are beyond the scope of this alert.
2 Examples of KPIs include: operating margin; same store sales; sales per square foot; total customers/subscribers; average revenue per user; daily/monthly active users/usage; active customers; net customer additions; total impressions; number of memberships; traffic growth; comparable customer transactions increase; voluntary and/or involuntary employee turnover rate; percentage breakdown of workforce (e.g., active workforce covered under collective bargaining agreements); total energy consumed; and data security measures (e.g., number of data breaches or number of account holders affected by data breaches).
3 The existing disclosure requirements that must be complied with include Item 303 of Regulation S-K and Rule 12b-20, which requires the presentation of any additional information necessary so that disclosures provided are not misleading.
4 Item 10(e) of Regulation S-K applies to any information that is filed with the SEC, such as Form 10-Ks and proxy statements. The affirmative disclosure requirements contained in Item 10(e) also apply to Form 8-Ks that are furnished under Item 2.02, most typically materials relating to the quarterly announcement of earnings.