Corporate Advisor

Corporate Advisor



Earnings Releases
What a difference a year makes.
Last December, the SEC issued new guidance regarding the reporting of pro forma financial information in earnings releases. Although the SEC called its December 2001 guidance “cautionary advice” and said that it was designed to “sound a warning” to public companies, the guidance was more tolerant of pro forma financial information than prior SEC positions and even acknowledged that pro forma information can serve useful purposes. On balance, while the December 2001 guidance did not give a green light to pro forma reporting, it did provide a yellow light. In response, many companies felt comfortable proceeding-with caution-in reporting pro forma financial information.
This January, as calendar year-end companies draft their earnings releases, they will need to take into account a new SEC rule proposal that, if adopted, will amount to a red light for certain common pro forma reporting practices, including the practice of reporting per share results on a non-GAAP basis.
This Corporate Advisor reviews the pending SEC rule proposal, which the Sarbanes-Oxley Act requires the SEC to act upon by January 26, 2003, offers practical suggestions for companies issuing earnings releases prior to the adoption of final rules and recommends other best practices for earnings releases. On January 8, 2003, the SEC announced that it will consider adopting final rules at its January 15 meeting.
SEC Proposal
The SEC has proposed a two-tier system to regulate the use of what it now refers to as “non-GAAP financial measures”:
  • Regulation G; and

  • amendments to Item 10 of Regulation S-K and to Form 20-F, the annual report form used by foreign private issuers.
Proposed Regulation G would apply whenever a public company discloses non-GAAP financial measures. The proposed changes to Regulation S-K would apply stricter requirements and prohibitions when non-GAAP financial measures are included in an SEC filing. In addition, the SEC has proposed to require that earnings releases and other similar announcements be filed with the SEC on Form 8-K. As a result, earnings releases that contain non-GAAP financial measures would be subject to the requirements and prohibitions contained in the proposed amendments to Regulation S-K.
The SEC proposal goes beyond the requirements of the Sarbanes-Oxley Act of 2002. The Act mandates the SEC to adopt rules by January 26, 2003 requiring that pro forma financial information included in any periodic or other report filed with the SEC pursuant to the securities laws, or in any public disclosure or press or other release, is presented in a manner that (1) does not contain an untrue statement of a material fact or omit to state a material fact necessary in order to make the pro forma financial information, in light of the circumstances under which it is presented, not misleading, and (2) reconciles it with the financial condition and results of the operations of the company under generally accepted accounting principles.
What is a Non-GAAP Financial Measure?
In order to minimize confusion resulting from the fact that GAAP requires “pro forma” financial statements in connection with certain business combinations, the SEC uses the term “non-GAAP financial measure” in the proposed rule. Simply stated, a non-GAAP financial measure is a numerical measure of a company’s historical or future financial performance, financial position or cash flows that either excludes items included by GAAP or includes items excluded by GAAP.1
Examples of non-GAAP financial measures include:
  • measures of operating income that exclude one or more expense or revenue items that are identified as "non-recurring;"

  • measures of operating margin where either the revenue component or the operating income component of the calculation, or both, were not calculated in accordance with GAAP; and

  • EBITDA (earnings before interest, taxes, depreciation and amortization).
Non-GAAP financial measures do not include operating and other financial measures and ratios or measures calculated using only:
  • GAAP financial measures; and

  • operating and other measures that are not non-GAAP financial measures.
Examples of ratios and measures that would not be non-GAAP financial measures include sales per square foot (assuming that the sales figure was calculated in accordance with GAAP), same store sales (assuming the sales figures for the stores were calculated in accordance with GAAP), unit sales, and numbers of employees, subscribers or advertisers.
Proposed Regulation G
If a company publicly discloses any material information that includes a non-GAAP financial measure, Regulation G would require the company to include the following information as part of the disclosure:
  • a presentation of the most comparable GAAP financial measure; and

  • a reconciliation of the non-GAAP financial measure to the most comparable GAAP financial measure. This reconciliation must be quantitative for historical measures, but may be qualitative for prospective measures, to the extent quantitative measures would not be available without unreasonable efforts.
A company may not present a non-GAAP financial measure that, taken together with the required accompanying information, misstates a material fact or omits to state a material fact necessary to make the presentation of the non-GAAP financial measure not misleading in light of the circumstances under which it is presented.
If a non-GAAP financial measure is released orally, telephonically, in a webcast or by broadcast, Regulation G would permit a company to provide the required accompanying information by posting it on the company's website and announcing the posting during its presentation.
A limited exemption from Regulation G is proposed for foreign private issuers.2
Documents Filed with the SEC
Proposed amendments to Regulation S-K3 would require companies using non-GAAP financial measures in filings with the SEC to provide:
  • a presentation, with equal or greater prominence, of the most directly comparable GAAP financial measures;

  • a quantitative reconciliation between the non-GAAP financial measures and the most directly comparable GAAP financial measures;

  • a statement disclosing the purposes for which the company's management uses the non-GAAP financial measures presented in the filing; and

  • an explanation of why the company’s management believes the non-GAAP financial measures provide useful information to investors.
The requirements described in the last two bullet points could be satisfied by disclosing such information in the company’s most recent annual report filed with the SEC (or a more recent filing) and by updating those statements, as necessary, no later than the time of the filing containing the non-GAAP financial measures.
In addition to these mandated disclosure requirements, the proposed amendments to Regulation S-K would prohibit:
  • presenting a non-GAAP financial measure in a manner that would give it greater authority or prominence than the comparable GAAP financial measure;

  • excluding cash charges or liabilities from non-GAAP liquidity measures;

  • adjusting a non-GAAP performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of the charge or gain is such that it is reasonably likely to recur;

  • presenting non-GAAP financial measures on the face of the company's GAAP financial statements or in the accompanying notes, or on the face of any GAAP-required pro forma financial information;

  • using titles or descriptions of non-GAAP financial measures that are the same as, or confusingly similar to, titles or descriptions used for GAAP financial measures; and

  • presenting any non-GAAP per share measures.
The Regulation G requirement that the presentation of non-GAAP financial measures may not be inaccurate or misleading in any material respect would also apply to disclosures in documents filed with the SEC.
The proposed Regulation S-K requirements regarding non-GAAP financial measures are more stringent than those set forth in Regulation G. In particular, in filings with the SEC, the presentation of the comparable GAAP financial measure would need to have equal, or greater, prominence than the non-GAAP financial measure, and there would not be an "unreasonable effort" exception to the requirement for a quantitative reconciliation of prospective non-GAAP financial measures.
Form 8-K Filing of Earnings Releases
The SEC has proposed a new Item 1.04 to Form 8-K that would require companies to file a Form 8-K within two business days of any public announcement or release disclosing material nonpublic information regarding results of operations or financial condition for a completed fiscal year or quarter. A copy of the announcement or release would need to be filed as an exhibit to the Form 8-K. As a result of this filing requirement, the proposed amendment to Item 10 of Regulation S-K discussed above, which regulates non-GAAP financial measures filed with the SEC, would apply to earnings releases that contain non-GAAP financial measures.
If material nonpublic information is disclosed orally, telephonically or by webcast, the company would not need to file a Form 8-K if:
  • the disclosure initially occurs within 48 hours of a related written release or announcement that is filed on Form 8-K;

  • the presentation is accessible to the public;

  • the information contained in the presentation is on the company's website, together with any information that would be required under Regulation G; and

  • the presentation was announced by a widely disseminated press release that included instructions as to when and how to access such information.
The proposed Form 8-K filing requirement would only be triggered by the disclosure of material nonpublic information regarding a completed fiscal year or quarter. Public disclosure of earnings estimates for current or future fiscal periods would not trigger the proposed Form 8-K filing requirement, unless those estimates are included as part of a public announcement regarding a completed annual or quarterly period. In those situations, specifically identified forward-looking information could be furnished under proposed Item 6.01 of Form 8-K (which corresponds to existing Item 9 of Form 8-K), rather than being filed under proposed Item 1.04 of Form 8-K. When information is "furnished," it is not incorporated by reference into registration statements, which reduces the company's liability exposure.
Suggestions for Handling Non-GAAP Financial Measures in Upcoming Earnings Releases
Many calendar year-end companies will issue their earnings releases prior to adoption of final rules relating to non-GAAP financial measures. In drafting earnings releases that will be issued prior to the adoption of final rules, we suggest that companies consider the following:
Reevaluate whether the company should report non-GAAP financial measures
In light of the renewed critical attention being paid to non-GAAP financial measures and the pending SEC rule proposal, companies should seriously reconsider whether it is still in their best interests to report non-GAAP financial measures. A number of technology companies, including 3Com, Yahoo and Xilink, have announced their intention to stop reporting non-GAAP financial measures. 3Com’s decision was made in response to criticism about its inclusion of a gain item in its pro forma calculation.
A company that stops reporting non-GAAP financial measures would continue to provide textual explanation and quantification of significant items affecting their GAAP reported results. Moreover, some companies are moving toward including fuller financial statements and a mini-MD&A as part of their earnings release. This approach has the added benefits of minimizing the risk:
  • of violating Regulation FD by disclosing material nonpublic information not included in the earnings release during any private meeting or conversation held following the earnings release4; and

  • that an insider who sells stock after the issuance of the earnings release, but prior to the filing of the 10-K or 10-Q, will be accused of insider trading based on more detailed information included in a subsequently filed 10-K or 10-Q but not included in the earnings release.
Under the SEC’s rule proposal, companies that do not include non-GAAP financial measures in their earnings release could discuss non-GAAP financial measures in a publicly-accessible conference call or webcast that follows the earnings release so long as (1) the company provides the information required by Regulation G on its website, (2) the notice of the conference call or webcast indicates the location on the company’s website where this information will be available and (3) the company satisfies the other conditions described above that are necessary to avoid triggering a Form 8-K filing requirement.
For companies that decide to continue providing non-GAAP financial measures, we recommend the following:
GAAP results should be presented first and more prominently
In addition to being mandated by the SEC’s proposed rule, the notion that GAAP financial measures should be presented first, and that non-GAAP financial measures should not be presented in a manner that attempts to make them more prominent than GAAP financial measures, has been endorsed by, among others, the National Investor Relations Institute5, and by the NYSE Committee on Corporate Accountability and Listing Standards in its June 2002 report proposing listing standards reforms.
In order to avoid making non-GAAP financial measures appear more prominent than the comparable GAAP financial measures, companies should not include non-GAAP financial measures as part of the headline of the earnings release. Further, companies should include an explicit statement in the earnings release cautioning investors that the pro forma financial information is not prepared in accordance with GAAP and that they should not construe the non-GAAP financial measures as being superior to GAAP.
Companies should never present non-GAAP financial measures without the corresponding GAAP financial measures.
Provide a tabular reconciliation between GAAP and non-GAAP financial measures
The earnings release should include a table that identifies and quantifies all of the differences between the GAAP and non-GAAP financial measures. Even companies whose only non-GAAP financial measure is EBITDA should include this reconciliation as a separate table. In addition, companies should include, as part of an earnings release, a narrative explanation of how they define non-GAAP financial measures.
As required by the SEC’s proposed rule, companies should not present non-GAAP financial measures on the face of the GAAP financial statements attached to the company’s earnings release.
Include a meaningful explanation of why pro forma information is included
While many companies have already adopted the practice of including a brief statement in their earnings release explaining that non-GAAP financial measures are included because they are used by, or useful to, management or analysts, the SEC has indicated that it will not be satisfied with such a boilerplate explanation of why non-GAAP financial measures are provided. Rather, the SEC wants companies to provide a substantive justification for their use of non-GAAP financial measures, including the purposes for which management uses such measures and a statement describing the reasons why management believes such measures provide useful information to investors. In addition, companies should consider explaining why, in management’s judgment, "unusual" items that have been excluded are not reasonably likely to recur.
When deciding to include non-GAAP financial measures in an earnings release, companies should keep in mind that the antifraud provisions of the federal securities laws apply and that non-GAAP financial measures must not be used to mislead investors. In addition, now more than ever, companies should keep in mind that overly aggressive non-GAAP financial adjustments run the risk of alienating investors and analysts and damaging management’s credibility.
If there are any differences in the pro forma adjustments between periods, highlight the differences and explain why they exist
Presentation of non-GAAP financial measures on a consistent basis from period to period is important in ensuring that the non-GAAP financial measures are not misleading. In a June 2002 enforcement action6, the SEC found that a company had misstated its pro forma results by changing the classification of expenses from one period to another and failing to disclose the change. Whenever there has been a change in the way non-GAAP financial measures are calculated, the company should provide a clear explanation of the change and why it was made.
Disclose significant one-time items that are included in the non-GAAP financial measures
The SEC’s view, as reflected in a January 2002 enforcement action7, is that by stating that a one-time charge is excluded from net income, a company implies that no other significant one-time items-whether they be gains or losses-are included in net income. Therefore, extra care must be taken when reporting non-GAAP financial measures to ensure that there is full disclosure of other significant non-recurring gains or losses that are part of the presented non-GAAP financial measures.
Consider avoiding the presentation of non-GAAP financial measures on a per share basis
The SEC’s rule proposal would ban the presentation of non-GAAP per share measures from documents that are filed with the SEC, including earnings releases. This position is rooted in an accounting series release dating back to 1973.8
The application of this aspect of the SEC’s proposal to earnings releases is one of the more controversial parts of the proposed rule and there is no way to know at this point whether this provision will be contained in the final rules. Nevertheless, we expect that some companies will voluntarily eliminate this practice even in advance of final SEC rule-making.
Other Best Practices for Earnings Releases
The proper use of non-GAAP financial measures is only one of many issues that arise when preparing earnings releases. The following recommended practices relate to some of the other significant areas that merit consideration.
Give forward-looking statements the extra attention they deserve
  • Before including any forward-looking information, consider whether the benefits to the company and its investors of making the statement outweigh the associated legal risks. For example, will the forward-looking statement result in a duty to update? If so, is the company prepared to make updates?

  • Consider whether the press release should contain any earnings guidance that the company plans to provide during its conference call or webcast. In most cases, inclusion of this information in the press release is not required by law. However, the company may wish to provide some or all of its guidance in the earnings release, either for investor relations reasons or to help ensure that the company’s message is fully and correctly disseminated. In addition, depending on the materiality of the guidance, NYSE-listed companies may have an obligation under NYSE rules to include it in a press release. With respect to NASDAQ-listed companies, on November 25, 2002, the SEC approved changes to NASDAQ’s rules that harmonize NASDAQ's disclosure requirements with Regulation FD. As a result, NASDAQ-listed companies may now use properly noticed and accessible webcasts and conference calls to disseminate material nonpublic information.

  • The company should have a reasonable basis for all forward-looking statements. This basis should be consistent with, and supported by, internal documentation. Consider creating a file containing the information used as support for forward-looking statements.

  • When discussing forward-looking events, the company should not make promises or guarantees. Projections should be presented as management’s current expectations or targets-not as fact. All forward-looking statements should be accompanied by appropriate qualifiers such as “plans to,” “expects to,” “anticipates” or “scheduled to.”

  • If the earnings release contains forward-looking information, include appropriate safe harbor language and a disclaimer of a duty to update. For example:
“Statements contained in this press release about [specifically identify forward-looking statements], and all other statements that are not purely historical, are forward-looking statements for purposes of the safe harbor provisions under The Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements. Factors that may cause or contribute to such differences include [specifically identify material factors] and the other factors discussed in [insert cross reference to appropriate SEC filing containing risk factors], which is on file with the SEC. In addition, any forward-looking statements represent our estimates only as of today and should not be relied upon as representing our estimates as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change.”
The safe harbor language should not be treated as boilerplate.The material factors specifically identified as part of the safe harbor language should be tailored so that they are specifically relevant to the forward-looking statements included in the particular release. In addition, the safe harbor language will look less like boilerplate if it is included in the body of the press release and in the same type size as the main text of the release.
  • When reporting historical results, statements should generally be worded in the past tense to avoid accidentally turning historical statements about performance in a recently completed period into guidance about the current or future periods. For example, changing "we are pleased with our 10% growth rate” to “we are pleased with the 10% growth rate we experienced in the fourth quarter” clarifies that the company is not making a statement about its growth in the current period or in any future period. Avoid characterizations such as “momentum,” that may be interpreted as transforming a historical statement into a prediction.

  • Consider segregating all forward-looking information into a separately captioned “Outlook” section. This will facilitate the identification of forward-looking statements, which is a requirement of the PSLRA safe harbor. In addition, if the SEC rule proposal is adopted, this practice will make it easier to identify the portions of the earnings release that are to be furnished under proposed Item 6.01 of Form 8-K, rather than filed under proposed Item 1.04 of Form 8-K.
Ensure that the earnings release is accurate and not misleading
  • Remember that the company can get into as much trouble for what it doesn’t say as for what it does say. The federal securities laws prohibit both the making of false or misleading statements and the omission of statements necessary to make information presented not misleading.

  • Superlatives and absolutes are usually inappropriate in an earnings release. Also, avoid hyperbole and buzzwords such as “dominant,” “unique” and “explosive.”

  • The company may be held responsible for what is said in its press releases, regardless of whether a statement is made directly by the company or by a third party. Apply the same standard of review to quotes from other parties as the company does to its own statements.

  • The headline and any subheading are also part of the press release, and care must be taken so that they are not misleading. For example, a headline that the company is reporting “record” revenues or growth may be misleading in the context of its overall financial results.

  • It is advisable to have earnings releases reviewed by either in-house or outside counsel.
Remember the perils of website links in press releases
  • The SEC’s view is that if a company includes a hyperlink in a press release, the company assumes responsibility for the hyperlinked information, and that information could subject the company to liability under the federal securities laws.

  • For a more comprehensive discussion of website liability issues, please see our October 2002 Corporate Advisor, “Spotlight Returns to Corporate Websites”.
Adequately disseminate the earnings release
  • The earnings release should be distributed through news services such as Dow Jones, Reuters, Bloomberg, Business Wire and PR Newswire. The company may also post the press release on its website and send it directly to analysts and stockholders, but this should not take place until after public dissemination through news services.

  • Comply with all applicable stock exchange rules concerning press releases. For example, NASDAQ requires that the NASDAQ MarketWatch® Department be notified prior to any public release of financial-related disclosures, such as an earnings release. In addition, under the new NASDAQ rules, if disclosure is being made through a conference call, press conference or webcast, NASDAQ must be given (1) a copy of the press release announcing the future conference call, press conference or webcast and (2) a descriptive summary of the material information to be announced during the conference call, press conference or webcast, to the extent that this information is not disclosed in a press release.

  • Publicly disseminate only the final version of the earnings release. This problem comes up most often when coordinating the version that is posted on the company’s website with the version released to news services. Also, if the company distributes electronic copies of the earnings release in Microsoft Word format, all metadata must be removed or else someone may be able to see “deleted” text.

  • If the company has an effective shelf registration statement, consider whether the earnings release should be filed with the SEC on a Form 8-K.
Obtain all required consents
  • Consider whether any consents are required in connection with the press release. For example, market data from analysts often cannot be reproduced without permission.

  • Even if it is not contractually required, the company may want to seek approval from its customers before mentioning them in the press release.
Patrick Rondeau
Jonathan Wolfman
[email protected]
1 For foreign private issuers whose primary financial statements are not prepared under U.S. GAAP, references to GAAP also include the principles under which those primary financial statements are prepared.
2 Regulation G would apply to public disclosure of a non-GAAP financial measure by a foreign private issuer unless (a) the securities of the company are listed or quoted on a securities exchange or inter-dealer quotation system outside the United States; (b) the non-GAAP financial measure and the most comparable GAAP financial measure are not calculated and presented in accordance with U.S. GAAP; and (c) the disclosure is made by or on behalf of the company outside the United States, or is included in a written communication that is released by or on behalf of the company only outside the United States, even if subsequently filed on Form 6-K.
3 With respect to foreign private issuers, a non-GAAP financial measure that would otherwise be prohibited would be permitted in Form 20-F if the measure was expressly permitted under the generally accepted accounting principles used in the company’s primary financial statements and was included in the company’s annual report used in its home country jurisdiction or market.
4 In November 2002, the SEC announced its first set of Regulation FD enforcement actions. For a discussion of important lessons learned from these enforcement actions, please see our December 2002 Corporate Advisor, “Lessons Learned from First Wave of Regulation FD Enforcement Actions”.
5 In April 2001, NIRI and Financial Executives International co-authored guidelines on the use of pro forma financial information that were endorsed by the SEC in its December 2001 cautionary advice. In April 2002, NIRI announced a new 10-point program designed to help restore investor confidence. One aspect of this program was a recommendation that companies should state their GAAP earnings first. In October 2002, NIRI issued new guidelines to improve earnings releases. The NIRI materials are available at
6 In the Matter of, et al. (June 10, 2002; Release No. 34-46052).
7 In the Matter of Trump Hotels & Casino Resorts, Inc. (January 16, 2002; Release No. 34-45287).
8 Accounting Series Release No. 142, “Reporting Cash Flow and Other Related Data” (March 15, 1973).
This Corporate Advisor provides general information and is not intended as legal advice. You should not act upon information contained in this Corporate Advisor without professional legal counseling.