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07 April 2020

First Quarter 2020 Amid COVID-19: Non-GAAP Measures

Posted In: Financial Reporting

Investor Considerations Regarding Non-GAAP Measures

SEC Allows Reconciliation of Non-GAAP Measures to “Estimates of GAAP Measures”

Alongside the 25 March 2020 Securities and Exchange Commission (SEC) order allowing conditional deferral of first-quarter Form 10-Q filings, the SEC’s Division of Corporation Finance (the Division) published a document, CF Disclosure Guidance Topic 9 (the Guidance).   The Guidance provides reminders and advice to issuer companies with respect to 1) assessing and disclosing the evolving impact of COVID-19 – including a reminder to use their ability to rely on the safe harbor provisions afforded to forward-looking information and 2) the need to refrain from trading prior to the release of material non-public information.  Also included in the release is some unique guidance on the use of non-GAAP measures in reporting earnings and financial results.  Specifically, the Guidance allows companies to reconcile their non-GAAP measure to “estimates of GAAP measures.” What exactly does that mean?  We explain below – along with questions and considerations investors should be mindful of as they come across such measures.  The COVID-19 crisis is also likely to result in new non-GAAP measures and metrics and we include considerations for investors as they evaluate such measures.


The guidance from the Division is detailed, nuanced and inclusive of useful insights. It takes more than one reading to gather all the takeaways.  As such, it is best read directly.  For that reason, we have excerpted it below. We have bolded key messages and bolded an underlined the areas we consider more fully in the following section.

Reporting Earnings and Financial Results

Although not required to do so, companies often release earnings estimates and other financial results in advance of finalizing the required financial reporting for the relevant period.  We understand that companies may be considering how to report the evolving impact of COVID-19 in light of unexpected nonrecurring charges and expenses.  We also recognize that the impact of COVID-19 on businesses may present a number of novel or complex accounting issues that, depending on the particular facts and circumstances, may take time to resolve.

The ongoing and evolving COVID-19 impact will likely make it more difficult for companies and their auditors to complete the work required to maintain timely filings and we encourage companies to proactively address financial reporting matters earlier than usual.  For example, to the extent a company or its auditors will need to consult with experts to determine how the evolving COVID-19 situation may impact its assets, including impairment of goodwill or other assets, it should consider engaging with those experts promptly so that its reporting remains as timely as possible, as well as complete and accurate.

We also remind companies of their obligations under Item 10 of Regulation S-K and Regulation G with respect to the presentation of non-GAAP financial measures, as well as the Commission’s recent guidance with respect to performance metrics disclosure.  To the extent a company presents a non-GAAP financial measure or performance metric to adjust for or explain the impact of COVID-19, it would be appropriate to highlight why management finds the measure or metric useful and how it helps investors assess the impact of COVID-19 on the company’s financial position and results of operations.  We understand that there may be instances where a GAAP financial measure is not available at the time of the earnings release because the measure may be impacted by COVID-19-related adjustments that may require additional information and analysis to complete.  In these situations, the Division would not object to companies reconciling a non-GAAP financial measure to preliminary GAAP results that either include provisional amount(s) based on a reasonable estimate, or a range of reasonably estimable GAAP results.  For example, under this position, if a company intends to disclose on an earnings call its earnings before interest, taxes, depreciation and amortization (EBITDA), it could reconcile that measure to either its GAAP earnings, a reasonable estimate of its GAAP earnings that includes a provisional amount, or its reasonable estimate of a range of GAAP earnings.  The provisional amount or range should reflect a reasonable estimate of COVID-19 related charges not yet finalized, such as impairment charges.  A non-GAAP financial measure should not be disclosed more prominently than the most directly comparable GAAP financial measure or range of GAAP measuresIn addition, in filings where GAAP financial statements are required, such as filings on Form 10-K or 10-Q, companies should reconcile to GAAP results and not include provisional amounts or a range of estimated results.

In addition, if a company presents non-GAAP financial measures that are reconciled to provisional amount(s) or an estimated range of GAAP financial measures in reliance on the above position, it should limit the measures in its presentation to those non-GAAP financial measures it is using to report financial results to the Board of Directors.  We remind companies that we do not believe it is appropriate for a company to present non-GAAP financial measures or metrics for the sole purpose of presenting a more favorable view of the company.  Rather we believe companies should use non-GAAP financial measures and performance metrics for the purpose of sharing with investors how management and the Board are analyzing the current and potential impact of COVID-19 on the company’s financial condition and operating results.  If a company presents non-GAAP financial measures that are reconciled to provisional amount(s) or an estimated range of GAAP financial measures, it should explain, to the extent practicable, why the line item(s) or accounting is incomplete, and what additional information or analysis may be needed to complete the accounting.

We similarly understand that companies may consider presenting metrics related to COVID-19, or changing the method by which it calculates a metric as a result of COVID-19.  In these cases, we remind companies of the principles explained in recent Commission guidance related to metrics.


Non-GAAP Adjustments to GAAP Measures to Remove Uncertainty – As highlighted in the Guidance excerpt above:   

the Division would not object to companies reconciling a non-GAAP financial measure to preliminary GAAP results that either includes the provisional amount(s) based on a reasonable estimate or a range of reasonably estimable GAAP results.

Questions for Investor Consideration –This is unique, as the GAAP measure is traditionally the anchor to the non-GAAP measure. In this situation, the implication is that the GAAP measure is more uncertain than the non-GAAP measure. If investors see such measures, it is important for them to consider the following:

  • Is the preliminary GAAP measure only preliminary because of the items being adjusted to arrive at the non-GAAP measure?
  • What is the nature of the item excluded from the non-GAAP measure that results in the non-GAAP measure being more certain than the GAAP measure? 
  • Has the company made disclosure of the individual GAAP to non-GAAP adjustment(s) in a manner that allows an investor to understand the uncertainty in the GAAP measure?  
  • Specifically, does the disclosure include a description of a) the nature of each adjustment; b) why the adjustment is necessary and why it creates uncertainty in the GAAP measure; c) a range around the adjustment that is accounted for in the GAAP measures range of uncertainty; d) what is necessary to resolve the uncertainty; and e) what line item (not simply the total or subtotal) is impacted by this adjustment?  
  • Will there be a subsequent reconciliation of the non-GAAP measure to the final GAAP measure?
  • Will these measures persist in future periods until all uncertainty is resolved?  

Our Thoughts – The Division Guidance highlights that impairment charges may be an example of just such an adjustment as impairment assessments may be challenging to complete by the date of the earnings release.  While it is true that many companies exclude impairments from non-GAAP measures such as EBITDA, as the Division Guidance highlights, we believe the following should be considered in the evaluation of such measures by investors (i.e. and possibly in the preparation of such measures by issuers):     

  • The Non-GAAP Measure May Be More Certain, But Likely Not the Most Relevant for Investors  While accountants regularly highlight that impairments are removed from GAAP results to arrive at these non-GAAP measures such as EBITDA, this removal isn’t a signal that the item excluded (impairment) doesn’t include value relevant information.  Rather, the exclusion is simply a mechanical process to arrive at a quick and dirty proxy for normalized earnings and cash flows (e.g. EBITDA).

While companies may avail themselves, in the first quarter of 2020, of the ability to use preliminary GAAP earnings and exclude uncertain items such as impairments to arrive at a more certain or normalized non-GAAP measure of performance such EBITDA, the resulting non-GAAP measure is not likely to be useful, or of greatest interest, to investors for several reasons as follows:

The first quarter will include two months, or slightly more, of “business as usual” results with only the month of March being unusual.  As such, normalized measures such as EBITDA for the first quarter are not particularly useful in the predictive efforts of analysts and investors. 

Investors will be focused on the highly uncertain elements of future results, not the more certain historical results represented by these non-GAAP measures that remove uncertain adjustments.

Income statements for the first quarter will likely not be the focus of investors. Rather, investors will, or should, focus on balance sheets and cash flows. At this moment communication to investors should be focused on future viability rather than historic profitability.   

  • Focus on the Adjustments and the Uncertain Measures – Investors recognize that asset impairments and the assumptions and estimates inherent in their determination include value relevant information. In the case of COVID-19 and the first-quarter results, it is these forward-looking estimates that should be more value relevant and interesting to investors.

We believe it is essential that companies, as the Division Guidance highlights, provide a comprehensive description of the adjustments. It is these adjustments which should be of significant interest to investors as such adjustments have information content.

Investors need to know the uncertainty in each adjustment.  They also need to know that the range around preliminary GAAP measures does not include uncertainties related to items not adjusted out in arriving at the non-GAAP measure. Investors need a range around the adjustments used at arriving at the non-GAAP measure from the preliminary GAAP measure.  These ranges around the adjustment should be the same as the ranges around the preliminary GAAP figures from which they have been deducted.  If there are multiple adjustments there should be a range for each adjustment. 

  • Uncertainty Won’t Be Fully Resolved with Release of GAAP Financials – Investors should also be interested in how the adjustments are resolved and the outcome of the uncertainty.  Understanding the uncertainty around the adjustments and how it is resolved is likely to give an indication of the assumptions inherent in the estimation of future cash flows of the organization. While the Guidance notes that when issuers file their Form 10Q they should not include provisional amounts. The Guidance does not appear to explicitly state that a final reconciliation must be provided in the filing. If a Form 10Q does not include the non-GAAP measure – it is only provided in the earnings release – then reconciliation will likely not be provided.  Investors should request details of a final reconciliation. 

While the GAAP financials will ultimately be issued, this doesn’t mean the uncertainty in the GAAP measures will be fully resolved.  It simply means the uncertainty has been estimated to the degree reasonably possible for US GAAP.  Depending upon the course and duration of the pandemic, the uncertainty will change and further updates to the measurements will be needed. In 2017 with the passage of the Tax Cuts and Jobs Act in late December, the SEC issued guidance that allowed for a year to incorporate the impacts of the new legislation on financial statement measurements and estimates.  Similar guidance has not been issued with respect to COVID-19 uncertainties.  As such, companies will need to make reasonable estimates and adjust in future periods.  Whether second-quarter earnings releases will include such estimates of GAAP measures is something only time will tell. 

Overall, to some, the adjustments might imply that non-GAAP measures are more credible that GAAP measures when in fact the adjustments communicate estimates of the future performance of the business that a historical EBITDA measure may not.  For that reason, we believe investors should focus on the traditional GAAP measures and understand the inherent uncertainties in the business that make such adjustments uncertain. 

In some cases, it may be better for companies – amidst the COVID-19 uncertainty –  to illuminate elements of GAAP financial results that are more credible and have a bearing on future company performance than historical measures of EBITDA that don’t reflect drivers of performance in the immediate future. The quarterly earnings release call really should focus investors more on balance sheets, cash flows, and basic business drivers than emphasize future sustainability of business operations rather than historic profitability.  

Changes to Existing Non-GAAP Measures & New Non-GAAP Measures – The last paragraph of the Division Guidance makes two very important points that investors must be alert to:   

We similarly understand that companies may consider presenting metrics related to COVID-19 or changing the method by which it calculates a metric as a result of COVID-19.  In these cases, we remind companies of the principles explained in recent Commission guidance related to metrics

The first point in this last paragraph of the Division Guidance is an important one.  Companies may alter or change their method of computing the traditional non-GAAP measures they have provided in previous periods.  During the last financial crisis, we saw changes to the non-GAAP metrics companies traditionally provided to ones that more favorably depicted results.  We remind investors to carefully evaluate these revised measures, what they depict, their comparability and their prominence.  Investors should carefully examine what measures have changed and why and discuss them with management. 

The second reminder in the last paragraph of the Division Guidance is that there may be new measures or metrics.  This too is very important. Those metrics or alternative performance measures that facilitate understanding of key business revenue or expense drivers are useful to investors if they assist in understanding the company’s future business prospects.  That said, investors should cautiously evaluate new non-GAAP measures of performance or cash flows that may have as an objective to display a more favorable picture of financial performance.

A Reminder on Key Issues with Non-GAAP Measures

The Division’s Guidance that emphasizes disclosure of metrics given to the Board is very important and something investors should focus on and query.  The SEC also rightly reminds companies to consider the SEC’s guidance on non-GAAP measures.

We remind investors to consider the challenges we have previously communicated with respect to non-GAAP measures in our previous publications (Investor Uses, Expectations and Concerns on Non-GAAP Financial Measures and Bridging the GAAP:  Ensuring Effective Non-GAAP and Performance Reporting)

Investors should always consider potential abuses of non-GAAP measures, pandemic or not.  These crises, however, put more pressure on such measures and investors must exercise a healthy degree of skepticism with respect to changes in existing measures or the creation of new metrics. 

Look Across Companies and Industries

While much of the evaluation of non-GAAP measures is company-specific, we also encourage investors to step back and consider the communication of non-GAAP measures across companies and industries as they may see trends related to COVID-19 that are helpful at the company level. 

Image Credit: © Getty Images/William_Potter

About the Author(s)
Sandy Peters, CPA, CFA

Sandy Peters, CFA, is head of financial reporting policy and serves as spokesperson for CFA Institute to key financial reporting standard setters including the IASB, FASB, and the US Securities and Exchange Commission. She holds the Certified Public Accountant (CPA) designation.

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