Handling Earnings Announcements
It’s almost earnings reporting season again. To help companies get ready, this article reviews practices for handling earnings announcements in light of new SEC rules that took effect on March 28, 2003 and recent guidance provided by the staff of the SEC’s Division of Corporation Finance in the form of an FAQ issued on June 13, 2003.
Overview of New Rules
Even though many of the new SEC rules are focused on reining in the practice of reporting “non-GAAP financial measures,” it is important to keep in mind that the new rules also affect companies that only report GAAP numbers.
In particular, new Item 12 of Form 8-K requires companies to furnish to the SEC on Form 8-K any public announcement or release disclosing material nonpublic information about a completed annual or quarterly fiscal period, whether or not that announcement or release contains non-GAAP financial measures.
To the extent the earnings announcement includes any non-GAAP financial measures—which essentially means 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—then the company must also comply with both:
- new Regulation G; and
- some, but not all, of the stricter requirements of new Item 10(e) of Regulation S-K, which applies whenever non-GAAP financial measures are included in an SEC filing.
Under Regulation G, whenever a public company publicly discloses material information that includes a non-GAAP financial measure, that non-GAAP financial measure must be accompanied by:
- a presentation of the most directly comparable GAAP financial measure;
- a reconciliation, by schedule or other clearly understandable method, of the non-GAAP financial measure to the most directly comparable GAAP financial measure (this reconciliation must be quantitative for historic measures, but may be qualitative for forward-looking information if a quantitative reconciliation would not be available without an unreasonable effort); and
- such other information as is necessary to prevent the non-GAAP financial measure from being untrue or misleading.
New Item 10(e)(1)(i) of Regulation S-K requires companies using non-GAAP financial measures in filings with the SEC or in any disclosure that is furnished to the SEC under Item 12 of Form 8-K to provide:
- a presentation, with equal or greater prominence, of the most directly comparable GAAP financial measure;
- the same reconciliation required by Regulation G;
- an explanation of why the company’s management believes the non-GAAP financial measure provides useful information to investors regarding the company’s financial condition and results of operations; and
- to the extent material, a statement disclosing the additional purposes, if any, for which the company's management uses the non-GAAP financial measures.
Procedures for Complying with the New Rules
To ensure that its next earnings release and related earnings call comply with the new rules, a company must:
- Furnish its earnings release on Form 8-K (this requirement applies whether or not the earnings release contains non-GAAP financial measures).
- Comply with Regulation G with respect to both the earnings release and the earnings call (this requirement only applies to the extent the earnings release and/or earnings call include non-GAAP financial measures).
- Determine whether the company will seek to take advantage of an exemption under the new rules that allows a company to conduct an earnings call without triggering an obligation to furnish to the SEC on an Item 12 Form 8-K material nonpublic information about the completed financial period that is disclosed on the call. This exemption, which is discussed further as part of Approach #1 below, is available if:
- the earnings call is complementary to, and initially occurs within 48 hours after, a related, written announcement or release that has been furnished on Form 8-K pursuant to Item 12 prior to the earnings call;
- the earnings call is broadly accessible to the public by dial-in conference call, by webcast, by broadcast or by similar means;
- the financial and other statistical information contained in the earnings call is provided on the company's website, together with any information required under Regulation G; and
- the earnings call was announced by a widely disseminated press release that included instructions as to when and how to access it and the location on the company’s website where the information referred to above would be available.
- the earnings call is complementary to, and initially occurs within 48 hours after, a related, written announcement or release that has been furnished on Form 8-K pursuant to Item 12 prior to the earnings call;
Companies must, of course, also continue to be mindful of the various requirements and other considerations impacting earnings releases that existed prior to the new rules, including Regulation FD, safe harbor language under the Private Securities Litigation Reform Act, general antifraud rules and good investor relations and stockholder communications practices.
Three approaches to compliance are discussed below. In most cases, we expect companies to attempt to follow Approach #1, which takes advantage of the exemption that allows a company to conduct an earnings call without triggering an obligation to furnish to the SEC on an Item 12 Form 8-K material nonpublic information about the completed financial period that is disclosed on the call. Companies that cannot meet all of the conditions needed to take advantage of this exemption would typically follow the second approach described below. Finally, in those few situations where the company discloses all material nonpublic information about the completed period in its earnings release, a third approach is available. To better highlight the differences between the three approaches, the descriptions of Approaches #2 and #3 simply focus on the ways they differ from Approach #1.
Approach #1 – The Earnings Call Exemption
Companies that provide a live webcast and audio replay of their earnings call can follow the steps outlined below in order to comply with the new rules. The principal benefit of Approach #1 is that it avoids the need to furnish a transcript of portions of the earnings call under Item 12 of Form 8-K. The principal drawback of Approach #1 is that it requires the earnings release to be furnished to the SEC on Form 8-K prior to the start of the earnings call.
Step 1. Give notice of the earnings call
Notice must be given a reasonable period of time before the earnings call. For regularly scheduled earnings calls, we generally recommend that notice be given via a press release issued approximately one week before the earnings call. Longer notice is generally fine, and notice given as few as two business days in advance of the call should be acceptable under Regulation FD.
The press release giving notice of the call should include the following information:
- the date and time of the earnings call;
- instructions as to when and how to access the earnings call;
- the location on the company’s website where the earnings call and other required information (i.e., the material described in Step 4 below that is to be posted on the company's website) will be available;
- the subject matter of the earnings call (for example, to discuss results for the period ended June 30 and management’s outlook); and
- the period of time during which a replay of the call will be available and how to access the replay.
Step 2. Draft the earnings release to comply with the new non-GAAP rules
To the extent the earnings release includes any non-GAAP financial measures, it should include for each non-GAAP financial measure:
- A presentation, with equal or greater prominence, of the most directly comparable GAAP financial measure
- The required reconciliation of the non-GAAP and GAAP financial measures
- Statements (1) disclosing the reasons why the company's management believes that presentation of the non-GAAP financial measure provides useful information to investors and (2) any additional purposes for which the company's management uses the non-GAAP financial measures
- Such other information as is necessary to prevent the non-GAAP financial measure from being untrue or misleading
Instead of including in the earnings release the statements about why the non-GAAP financial measures are useful to investors and how they are used by management, these statements can be included (1) in the Item 12 Form 8-K containing the earnings release that is required to be furnished to the SEC or (2) in the company’s most recent Form 10-K (or a more recent filing), provided the statements in such filing are updated, if necessary, no later than the time the Item 12 Form 8-K is furnished to the SEC. However, even if one of these approaches is used, because the company could still be subject to an antifraud claim based on its use of non-GAAP financial measures, we generally recommend that the press release contain some explanation about why the company uses the non-GAAP financial measures presented, in addition to a cross reference to the more extensive explanation provided elsewhere.
The SEC has stated that the statements about why the non-GAAP financial measures are useful to investors and how they are used by management should not be boilerplate. Rather, the statements should be substantive and specific to the non-GAAP financial measure used, the company, the nature of the company's business and industry, and the manner in which management assesses the non-GAAP financial measure and applies it to management decisions. The fact that the non-GAAP financial measure is used by or useful to analysts cannot be the sole support for presenting the non-GAAP financial measure.
In addition to the disclosure requirements under Item 10(e)(1)(i) that are described above, new Item 10(e) of Regulation S-K contains another part, Item 10(e)(1)(ii), that prohibits certain practices relating to non-GAAP financial measures in any SEC filing. The practices prohibited by Item 10(e)(1)(ii) of Regulation S-K are as follows:
- excluding charges or liabilities that required, or will require, cash settlement, or would have required cash settlement absent an ability to settle in another manner, from non-GAAP liquidity measures, other than the measures EBIT and EBITDA;
- adjusting a non-GAAP performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when (1) the nature of the charge or gain is such that it is reasonably likely to recur within two years, or (2) there was a similar charge or gain within the prior two years;
- 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; and
- 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.
Although the practices listed above are not prohibited in earnings releases that are furnished to the SEC under Item 12 of Form 8-K, they should, nevertheless, be considered when drafting an earnings release that contains non-GAAP financial measures. In particular, if the earnings release includes any non-GAAP financial measures that would be prohibited by Item 10(e)(1)(ii), or any other adjustments that might appear to be an attempt to smooth reported earnings, extra attention should be paid to the company’s statements about why the non-GAAP financial measures are useful to investors and how they are used by management. In its FAQ, the SEC staff said that: “[W]hile there is no per se prohibition against removing a recurring item, companies must meet the burden of demonstrating the usefulness of any measure that excludes recurring items, especially if the non-GAAP financial measure is used to evaluate performance.” The SEC staff went on to indicate that use of a non-GAAP financial measure that excludes a recurring item may be misleading absent the following disclosure:
- the manner in which management uses the non-GAAP measure to conduct or evaluate its business;
- the economic substance behind management’s decision to use such a measure;
- the material limitations associated with use of the non-GAAP financial measure as compared to the use of the most directly comparable GAAP financial measure;
- the manner in which management compensates for these limitations when using the non-GAAP financial measure; and
- the substantive reasons why management believes the non-GAAP financial measure provides useful information to investors.
Step 3. Disseminate the earnings press release by wire services
Prior to issuing its earnings release, the company should give the advance notification required by the rules of the stock market on which its securities are listed. For example, NASDAQ requires that the NASDAQ MarketWatch® Department be notified at least 10 minutes prior to any public release of financial-related disclosures, such as an earnings release. In addition, under the NASDAQ rules, if disclosure will be made through a conference call, press conference or webcast, NASDAQ must be given prior notice, including (1) a copy of the press release announcing the 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 the press release.
Step 4. Post required items on the company’s website
Prior to the start of the earnings call, the company must post the following on its website:
- if the earnings call will include non-GAAP financial measures, a presentation of the most directly comparable GAAP financial measure and a reconciliation to the most comparable GAAP financial measure (for many companies, this will be accomplished by posting a copy of the company’s earnings release after it has been disseminated by the wire services); and
- the financial and other statistical information to be contained in the earnings call.
The SEC staff’s recent FAQ confirms that these requirements can be met by having a live broadcast of the entire call available on the company’s website and then posting an audio replay of the conference call on the company’s website. The audio replay must contain all material financial and other statistical information included in the presentation that was not previously disclosed, including any information provided during the Q&A portion of the earnings call. These requirements could also be met by posting on the company’s website slides containing the required information prior to the start of the earnings call.
The FAQ also confirms that the SEC staff is willing to show some flexibility where a company provides additional information on the earnings call that it was not originally intending to provide. In that case, the SEC staff has indicated that the company should post the additional required information on its website promptly after it is disclosed (which happens automatically when an audio replay of the entire earnings call is posted on the company’s website).
These materials should not be posted on the website until after the press release has been publicly disseminated.
Step 5. Prior to the earnings call, furnish to the SEC via EDGAR an Item 12 Form 8-K that includes the text of the earnings release as an exhibit
Following Approach #1 requires that the Item 12 Form 8-K containing the earnings release be furnished to the SEC much earlier than it otherwise would be due. The actual deadline for filing the Item 12 Form 8-K is five business days after the earnings release is issued (although this deadline is likely to be shortened if the SEC proceeds with its proposed amendments shortening all Form 8-K filing deadlines). However, in order to take advantage of the exemption for furnishing a transcript of the earnings call, the Item 12 Form 8-K must be furnished prior to the start of the earnings call.
Because the necessary programming to add Item 12 of Form 8-K to the SEC’s EDGAR system is not yet complete, the SEC has indicated that (1) companies should furnish the information required by Item 12 under Item 9 of Form 8-K and (2) the caption in the Form 8-K that provides information required under Item 12 should indicate that information is being provided under Item 12, or under Items 9 and 12, as the case may be, until the SEC announces that the necessary programming of the EDGAR system is complete.
Companies that now issue their earnings release after the 4:00 p.m. close of regular trading and hold the earnings call at 4:30 or 5:00 p.m. may wish to (1) hold their call later in the afternoon in order to allow more time to prepare and submit via EDGAR the Item 12 Form 8-K containing the earnings release or (2) consider shifting to a morning schedule in order to have more time in which to accomplish the administrative tasks needed to disseminate the earnings release and submit the Form 8-K (for example, issue the earnings release at 7:00 a.m.; submit the Form 8-K at 8:00 a.m. when EDGAR opens; and hold the earnings call at 8:30 a.m.).
Step 6. Hold the earnings call
When: The earnings call must be held after the Form 8-K has been accepted by EDGAR and within 48 hours after the earnings release was issued.
How: The earnings call must be broadly accessible to the public by dial-in conference call, by webcast, by broadcast or by similar means. Approach #1 assumes that the earnings call is webcast.
Use of Non-GAAP Measures: To the extent the company presents any non-GAAP financial measures on the earnings call, it must do so in compliance with Regulation G. The company has two choices for complying with Regulation G’s requirements to present the most directly comparable GAAP measure and a reconciliation. The company can either:
- post the most directly comparable GAAP measure and a reconciliation on its website prior to the call (as contemplated in Step 4) and announce the location of the website as part of the earnings call; or
- orally present the most directly comparable GAAP measure and a reconciliation as part of the earnings call.
Disclaimers at Beginning of the Earnings Call: At the beginning of the earnings call provide (1) a safe harbor statement under the Private Securities Litigation Reform Act relating to forward-looking statements, (2) a disclaimer of the duty to update and (3) a statement about the use of non-GAAP financial measures and the location of the website where the company has posted the information required by Regulation G.
- Sample PSLRA safe harbor warning:
“Various remarks that we may make about the company’s future expectations, plans and prospects constitute 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 as a result of various important factors, including those discussed in [reference appropriate SEC filing containing risk factors], which is on file with the SEC.”
- Sample disclaimer of duty to update:
“In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views 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 and, therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.”
- Sample statement about non-GAAP financial measures:
“During this call we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in the investor relations section of our website, www.name.com, under the heading “Non-GAAP Financial Measures.”
Step 7. Keep a replay of the earnings call available
The SEC has “encouraged” companies to provide “ongoing” website access to the information identified in Step 4. Ongoing access can be provided by posting an audio replay of the earnings call. The SEC suggests, at a minimum, that access be provided for at least 12 months. This is significantly longer than the one- or two-week period for which many companies have previously kept their calls posted. It is not clear at this point how practice will evolve. One possibility is that companies will continue to leave the full replay available for only a short period of time, but will post the material financial and statistical information discussed on the call at the point when the full replay is removed.
Regardless of whether a replay of the earnings call or the financial and statistical information is placed on the company’s website, the company should be sure that there is a safe harbor statement under the PSLRA for any forward-looking statements. Moreover, since the SEC may consider the availability of an audio replay to be equivalent to a written statement, the safe-harbor language should satisfy the more stringent requirements applicable to written statements. A safe harbor statement for writings must cite risk factors, rather than just cross reference the SEC filing in which disclosure of risk factors is available.
If the replay or other information is left posted for an extended period, it should be placed in a clearly marked “archive” section and a clear disclaimer of the duty to update should be provided.
Approach #2 – The Non-Exempt Earnings Call
Companies that do not furnish the earnings release on Form 8-K prior to the earnings call will not be able to comply with the new rules by following Approach #1. There may also be other reasons that companies cannot meet the conditions to having an exempt earnings call. Companies that cannot meet all of the conditions of the exemption can comply with the new rules by following the steps outlined in Approach #2, which is a modification of the steps in Approach #1. The principal drawbacks of Approach #2 are (1) the need to furnish a transcript of portions of the earnings call to the SEC under Item 12 of Form 8-K within five business days after the call and (2) the need to comply with the additional disclosure requirements of Item 10(e)(1)(i) of Regulation S-K in connection with the earnings call.
A. Required steps prior to earnings call (in lieu of Steps 4 and 5 of Approach #1)
At the same time the earnings release is sent over the wires, or immediately thereafter (and in any event prior to the earnings call), to the extent the company plans to present any non-GAAP financial measures on the earnings call, post on the company’s website a presentation of the most directly comparable GAAP financial measures and a reconciliation to the most comparable GAAP financial measures. As mentioned above, many companies will be able to satisfy this requirement simply by posting the earnings release on their website prior to the earnings call.
B. Hold earnings call (in addition to items described in Step 6 of Approach #1)
Additional Requirement Applicable to Use of Non-GAAP Measures: Because a transcript of portions of the earnings call will be furnished under Approach #2, the company needs to comply with the additional disclosure requirements under Item 10(e)(1)(i) of Regulation S-K with respect to non-GAAP financial measures disclosed in the earnings call, including any made in response to questions.
C. Furnish Form 8-K after the call (in addition to steps described in Approach #1)
Within five business days after the date of the earnings release, furnish to the SEC via EDGAR an Item 12 Form 8-K that briefly identifies the earnings release and the earnings call and includes as exhibits the text of the earnings release and a transcript of the portions of the earnings call that reference material nonpublic financial and other statistical information about a completed financial period. In lieu of furnishing a transcript, the SEC staff has indicated that a company could file slides or a similar presentation materials that include the required information.
Approach #3 – The Earnings Call without Material Nonpublic Information
The steps outlined in Approaches #1 and #2 assume that the company will disclose additional material nonpublic information about the completed financial period during the earnings call. If the company is certain that all material nonpublic information about the completed financial period is contained in the earnings release (and, therefore, is certain that no material nonpublic information about the completed financial period is going to be provided during the earnings call, including in response to questions), then the company may prefer to follow Approach #3.
Under Approach #3, the company would follow the steps shown above for Approach #2, except that when the company furnishes its Item 12 Form 8-K, it would only include a copy of the earnings release. In this case, the company would not need to file a transcript of the earnings call because the earnings call would not have included any material nonpublic information about the completed financial period and would not need to satisfy the additional disclosure requirements imposed by Item 10(e)(1)(i) of Regulation S-K with respect to non-GAAP financial measures discussed on the earnings call.
As a practical matter, Approach #3 is not going to be available to many companies, since it is unlikely that a company will be able to ensure that no material nonpublic information about the completed financial period is provided during the earnings call, particularly during the question and answer period.
Others Issues to Consider
The following questions and answers address other issues that arise in connection with the announcement of earnings under the new rules.
Question: We are considering including only GAAP financial measures in our earnings release, but using the earnings call to discuss non-GAAP financial measures. Are there benefits to this approach?
Answer: Under the final rules adopted by the SEC, this approach no longer offers the same benefits as it would have under the proposed rules, and its benefits are probably outweighed by other considerations.
Under the proposed SEC rules, the earnings release would have been “filed” on Form 8-K, which would have increased the company’s liability exposure. In addition, under the proposed rules, because the earnings release would have been treated as a filed document, the earnings release would have become subject to the various prohibitions contained in Item 10(e) of Regulation S-K (which under the proposed rules included a ban on the use of per share non-GAAP financial measures). Changes in the final SEC rules eliminated both of these concerns and, therefore, have removed the key drivers underlying the approach described in this question. Under the final rules, Item 12 of Form 8-K permits companies to “furnish” earnings releases on Form 8-K. The fact that the Form 8-K is “furnished,” rather than “filed” as the SEC originally proposed, means:
- the information furnished is not subject to Section 18 of the Exchange Act, a liability provision that has not often been used by private litigants;
- the information furnished will not automatically be incorporated by reference into registration statements, and therefore will not be subject to the stricter liability standard that applies to registration statements; and
- the list of practices relating to non-GAAP financial measures that are identified by new Item 10(e)(1)(ii) of Regulation S-K will not be prohibited, since Item 10(e)(1)(ii) does not apply to furnished documents.
If non-GAAP financial measures are presented on the earnings call, they are subject to Regulation G, just as they would be if contained in an earnings release. Therefore, the approach described in this question does not alter the need to comply with Regulation G.
If (1) non-GAAP financial measures are presented only in the earnings call and (2) the earnings call is conducted in a manner (such as Approach #1) that does not require a transcript of portions of the call to be furnished on an Item 12 Form 8-K, then the approach described in this question would avoid application of the additional affirmative disclosure obligations of Item 10(e). However, since these additional disclosure obligations (primarily the statements about why the non-GAAP financial measures are useful to investors and how they are used by management) should not be particularly burdensome to address in the earnings release, there does not seem to be a significant benefit from this approach. Indeed, in the current environment, companies that find it difficult to articulate the reasons why the non-GAAP financial measures are useful to investors should carefully reassess their decision to use non-GAAP financial measures.
From the perspective of investor relations and effective communications, there are advantages to presenting the non-GAAP financial measures in the earnings release, where it is easier to ensure that they are presented in a fair and balanced manner.
Finally, the SEC has stated that the Form 8-K exception for nonpublic information that is disclosed orally, telephonically, by webcast, by broadcast or by similar means is not intended to foster “changes in practice whereby disclosure is shifted from the written release or announcement to the complementary presentation.”
Question: What should we do if we get a question during our earnings call, the answer to which would involve providing a material non-GAAP financial measure that we did not originally plan on providing?
Answer: As discussed below, you will need to consider your ability to comply with Regulation G, Item 10(e) of Regulation S-K and Regulation FD.
In order to answer the question, the company will need to provide not only the requested non-GAAP financial measure, but also the most directly comparable GAAP measure and a reconciliation between the two. Regulation G requires that these two items be furnished whenever a company publicly discloses material information that includes a non-GAAP financial measure. As a practical matter, it may be difficult to effectively do this on the fly in response to a question.
In addition, as required by Regulation G, in answering the question, the company would need to provide any other information needed to make the non-GAAP measure not misleading.
If the company is relying on Approach #2 described above, which requires a transcript of portions of the earnings call to be furnished on an Item 12 Form 8-K, the company’s response (or the Form 8-K containing the portions of the earnings call) would also need to satisfy the additional disclosure requirements of Item 10(e)(1)(i) of Regulation S-K.
Answering the question should not raise any issues under Regulation FD so long as proper notice of the call had been given and the call otherwise constituted a broad, non-exclusionary dissemination of information.
Question: Historically, we have provided guidance on a non-GAAP basis (for example, pro forma net income). Can we still do this?
Answer: Yes, but as discussed below you will also need to provide additional disclosure.
Both Regulation G and Item 10(e) of Regulation S-K require a reconciliation, by schedule or other clearly understandable method, to the most directly comparable GAAP measure. In the case of forward-looking information, this reconciliation does not have to be quantitative, to the extent a quantitative reconciliation would not be available without unreasonable efforts. Therefore, if the forward-looking measure is reasonably accessible on a GAAP basis, you would also need to provide that GAAP measure and the required reconciliation.
To the extent a quantitative reconciliation is not available without unreasonable efforts, the company must disclose that fact and provide reconciling information that is available without an unreasonable effort. Furthermore, the company must identify information that is unavailable and disclose its probable significance.
In its release adopting the new non-GAAP rules, the SEC described input it received from three companies that present forward-looking non-GAAP financial measures in earnings releases and indicated what it thought the companies disclosure obligations would be: “Those companies indicated that they do not have the most directly comparable GAAP financial measure available at the time they prepare their non-GAAP measure because they are unable to quantify certain amounts that would be required to be included in the GAAP measure. (For example, one company that uses a non-GAAP financial measure derived from net income told us that it excludes realized capital gains and losses, gains and/or losses on dispositions of operations, and accounting changes in preparing its non-GAAP financial measure, because it is unable to forecast with any degree of comfort the amounts that would be recorded under GAAP for these items.) However, those companies would be able to explain, at the date the forward-looking non-GAAP financial measure is released, the types of gains, losses, revenues or expenses that would need to be added to or subtracted from the non-GAAP financial measure to arrive at the most directly comparable GAAP measure, even though they cannot quantify all of those items.”
This article is for general information only and is not intended as legal advice with respect to any particular situation. Readers should not act upon information contained in this article without professional legal counseling.