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Training Material
2000 Edition (3.31.00)
Division of Corporation Finance
an Overview
Accounting Disclosure Rules and Practices
Topic Eight: Non-GAAP Measures of Financial
Performance,
Liquidity and Net Worth
Table of Contents
I. Disclosure of Non-GAAP Measures Such as Earnings Before
Interest, Taxes, Depreciation and Amortization (''EBITDA'')
A. Common Problems and General Guidelines
While it may be required under FAS 131 for some registrants to disclose
in a note to the financial statements and discuss in MD&A a non-GAAP measure
related to its operating segments (see Section B below), some registrants choose
to present a non-GAAP financial measure such as EBITDA or FFO (funds from
operations) in their disclosure documents. Although such measures can be useful
in some circumstances, an unbalanced presentation can be confusing and lead to
undue reliance on the measure by investors. Problems associated with
presentations of non-GAAP measures were highlighted by the Commission in
Accounting Series Release No. 142. Some comments cited frequently by the staff
include the following:
1. Undue authority or prominence A non-GAAP measure should be presented in a manner
that does not give it greater authority or prominence than
conventionally computed earnings or cash flows as reported in the GAAP
financial statements. For example, the staff recommends that EBITDA and
similar measures be located within an ''other data'' section in selected
financial data. Discussions in MD&A of results as measured in the GAAP
financial statements should be no less complete than discussions of
performance or liquidity as depicted by non-GAAP measures.
2. Measures not comparable Wherever the non-GAAP measure is used, a footnote or
other reference to a complete explanation of its calculation and
components should be provided. Since all companies and analysts do not calculate
these non-GAAP measures in the same fashion, the staff recommends that the
footnote or other disclosure alert investors to the fact that the measure
presented may not be comparable to similarly titled measures reported by other
companies.
3. How measures are used by management and investors Management should consider how any non-GAAP measure is expected to be used by
investors, identify significant factors that should be considered, and discuss
significant trends or requirements not captured by the measure to ensure balance
and avoid undue reliance on the measure. Notwithstanding disclosures by
competitors or requests from financial analysts, the staff believes that most
non-GAAP measures generally should be avoided unless management itself believes
that the measure provides relevant and useful information.
4. Balanced presentation Non-GAAP measures that measure cash or ''funds'' generated by operations
(liquidity) should be balanced with equally prominent disclosure of amounts from
the statement of cash flows (cash flows from operating, investing and financing
activities) and, in some cases, the ratio or deficiency of earnings to fixed
charges. Explanation may be necessary to the extent that funds depicted by the
measure are not available for managements discretionary use (due to legal or
functional requirements to conserve funds for capital replacement and expansion,
debt service and balloon maturities, deferred interest and dividend payments,
and other commitments and uncertainties).
5. Measure of operating performance vs. measure of liquidity A frequent disclosure issue is the use of a non-GAAP measure in a discussion
of operating performance when the measure is primarily a measure of liquidity,
capital resources, or debt service capacity. For example, calculations that
depict an adjusted or normalized measure of working capital or funds generated
by operations and available to meet capital and debt requirements often are
presented inappropriately as if they should be used as alternative measures of
earnings, return on investment or similar performance or efficiency factors. In
that case, the staff will request the measures presentation in an appropriate
context with clarification of its expected use.
6.
Pro forma measure
of performance
If management is presenting
the non-GAAP calculation as an alternative or pro forma
measure of performance, the staff discourages adjustments to
eliminate or smooth items
characterized as
nonrecurring, infrequent or unusual.
Different unusual items are
likely to occur every period, and
companies and investors may
differ as to what types of
events warrant adjustment.
Trends may be distorted and
disclosure unbalanced if
only certain items are adjusted while
the effects of other
infrequent events or transactions (whether
favorable or unfavorable)
are not considered or highlighted.
Of course, all such special
items should be highlighted in the
registrants disclosures to
permit analysis by investors.
Where management intends the
measure to be indicative of
liquidity and communicates
that use through the context of
its presentation, the staff
ordinarily will not object to
adjustment for non-cash
charges relating to special items if it
is meaningful to investors
in the circumstances.
7. Per share
presentation Per share data other than
that relating to net income is not appropriate.
8. Location of presentation Presentation and discussion of non-GAAP measures
should be limited to selected and summary financial data, MD&A and
notes to pro forma information. Presentation of non-GAAP measures is not
appropriate on the face of the audited financial statements or on the face of SX Article 11 pro forma information.
B. Segment Analysis and Non-GAAP Measures
Where consistent with a registrants internal management reports, FAS 131
permits measures of segment profitability that differ from consolidated
operating profit as defined by GAAP, or that exclude items included in the
determination of the registrants net income. Under FAS 131, a registrant also
must reconcile key segment amounts to the corresponding items reported in the
consolidated financial statements in a note to the financial statements.
Similarly, the staff expects that the discussion of a segment whose
profitability is determined on a basis that differs from consolidated operating
profit as defined by GAAP or that excludes the effects of items attributable to
the segment also will address the applicable reconciling items in MD&A.
Likewise, the staff expects that the effects of managements use of non-GAAP
measures, either on a consolidated or segment basis, will be explained in a
balanced and informative manner, and the disclosure will include a discussion of
how that segments performance has affected the registrants GAAP financial
statements.
II. Ratio of Earnings to Fixed Charges
[SK 503]
A. Required disclosure If debt securities are being
registered, a ratio of earnings to fixed charges shall be presented. If
preference equity securities are being registered, a ratio of earnings to
combined fixed charges and preference security dividend requirements shall be
presented. The ratios shall be presented for each of the last five fiscal years
and the latest interim period for which financial statements are presented.
B. Definition of fixed charges For purposes of the ratios, fixed
charges are defined as the sum of interest, whether expensed or capitalized, amortization
of premiums, discounts and capitalized expenses related to indebtedness, amounts
accrued with respect to guarantees of other parties obligations, and the
estimated interest component of rental expense.
C. Dividend requirements Preference security dividend
requirements for purposes of the ratio are intended to represent the amount of
pre-tax earnings that would be required to pay the dividends on outstanding
preference securities of the registrant and other fully or proportionally
consolidated entities. The amount shall be computed as the dividend requirement
divided by (1 - income tax rate).
D. Definition of earnings For purposes of the ratio,
earnings are defined as the registrants income from continuing operations
before taxes as determined in accordance with GAAP, except that only
distributed earnings of less than 50%-owned equity investees are
included, plus fixed charges reduced by the amounts of capitalized interest,
plus income allocable to minority interests in consolidated entities that have
incurred fixed charges.
E. Equity in investees losses Losses from investees
that are not fully or proportionally consolidated by the
registrant may not be added back to earnings for purposes of the
ratio, unless the registrant is obligated directly or
indirectly to service the debt, dividend requirements, or rental
obligations of the investee. If the registrant is so obligated,
its equity in the investees loss shall be included in earnings, and
fixed charges shall include the investees fixed charges
that are related to the obligation.
F. Inadequate earnings to
cover fixed charges
If a ratio indicates
less than one-to-one coverage, the registrant shall state
that earnings are inadequate to cover fixed charges and disclose
the dollar amount of the coverage deficiency.
G. Pro forma effect of refinancing If proceeds from the sale of the
debt or preferred stock being registered will be used to extinguish a portion or
all of one or more specific issues of outstanding debt or preferred stock, a pro
forma ratio depicting the effect of the refinancing shall be presented if the
change in the ratio would be ten percent or greater. The adjustments to derive
the pro forma ratio shall be limited to the net change in interest or dividends
resulting from the refinancing. If only a portion of the proceeds will be used
to retire debt or preferred stock, only a related portion of the interest or
preferred dividend should be used in the pro forma adjustment. The pro forma
ratio shall be presented for the latest year and interim period only.
H. Foreign private issuer If the registrant is a foreign
private issuer, the ratio shall be computed on the basis of the primary
financial statements and, if materially different, on a U.S. GAAP basis
I. Exhibit 12 Calculations demonstrating the
determination of the ratios shall be furnished as an exhibit to the registration
statement
III. Tangible Book Value per Share
There are no rules or authoritative guidelines that define
tangible book value. Tangible book value per share is used generally as a
conservative measure of net worth, approximating liquidation value. The staff
believes generally that tangible assets should exclude any intangible asset
(such as deferred costs or goodwill) that cannot be sold separately from all
other assets of the business, and should exclude any other intangible asset for
which recovery of book value is subject to significant uncertainty or
illiquidity.
In some cases, the staff accepts dual calculations of tangible book value.
For example, some intangible assets (such as patents) may be sold separately,
but the ability to recover their carrying value may be indeterminable. Also,
some material deferred costs are accounted for as adjustments to the yield on
specific assets or liabilities (debt costs or policy acquisition costs). The
staff has accepted tangible book value per share calculations made with and
without those assets, with appropriate explanation.
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