Nonplussed by Non-GAAP

CFOs are dismayed and discouraged by the SEC's approach to non-GAAP reporting.

Lawrence Hyatt knew when it was time to give up. “Maybe I’m a good enough poker player that I know when to hold ‘em and when to fold ‘em,” says the CFO of O’Charley’s Inc., which runs three well-known restaurant chains.

To be sure, his opponent — the Securities and Exchange Commission — had a natural advantage in this game. More than a year ago the regulator had sent Hyatt a letter about O’Charley’s 2007 annual report, asking him to justify why the company used certain financial measures in the management discussion and analysis that didn’t jibe with generally accepted accounting principles.

Under Regulation G and related SEC rules, companies are permitted to use non-GAAP numbers in SEC filings as long as they are not misleading, are reconciled to the most relevant GAAP numbers, and are meaningful to investors. The regulator objected to O’Charley’s non-GAAP on that final point. “We do not believe your disclosure clearly demonstrates the usefulness of the cited non-GAAP measures specific to you,” wrote SEC branch chief Lyn Shenk in a letter to the CFO. “Therefore, we believe you should discontinue use of such measures.”

Rather than prolong the dispute (the back-and-forth with the SEC lasted two months), Hyatt pledged to stop putting non-GAAP measures in future filings. But he isn’t happy about it. “The SEC has gone from what appeared to be the original intent of Reg G, which was to regulate how companies disclose information, to attempting to regulate what information is disclosed,” he says.

Hyatt’s reaction is echoed by other CFOs who have dealt with SEC queries regarding non-GAAP metrics. “If management believes a non-GAAP measure is meaningful to investors and users of the financial statements, they should be able to use it as long as they have adequate disclosures around why they find it meaningful and they reconcile it to GAAP,” contends Thomas Olinger, CFO of AMB Property Corp., a real estate investment trust. Other finance chiefs have found the SEC’s comments on their non-GAAP numbers to be discouraging and inconsistent.

The SEC has shown interest in companies' use of non-GAAP measures since adopting Regulation G.

The SEC has acknowledged such criticisms and says it is working to address them. For its part, the regulator is walking a fine line between allowing companies to provide numbers not fully blessed by GAAP and preventing the use of misleading calculations. After all, “non-GAAP measures can be less consistent, less transparent, and less comparable,” says Sandra Peters, head of the financial reporting policy group for the CFA Institute.

The Pros of Pro Forma

Companies cite a variety of reasons for using non-GAAP numbers (also called adjusted or pro-forma numbers). Probably the most common reason is to exclude the effect of unusual or one-time events during a reporting period. Doing so shows investors “how you are going to perform under a normal situation,” says Matthew Natalizio, CFO of Tix Corp., which provides ticketing services.


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