December 30, 2002
Mr. Jonathan G. Katz
File No. S7-43-02
Dear Mr. Katz:
We appreciate the opportunity to comment on the Commission's proposed rule, Conditions for Use of Non-GAAP Financial Measures (the "Proposed Rule"). We agree that the quality of reporting will be greatly improved if the Commission adopts certain formal guidelines directed at the transparency and comparability of financial measures provided to investors that are not determined or defined in accordance with generally accepted accounting principles (GAAP).
KPMG acknowledges and appreciates the significant efforts of the Commission and the Commission staff to restore investor confidence in our capital markets through improved financial reporting and disclosure by public companies and regulation of market participants.
Congress, investors, analysts, the financial press and the Commission have rightfully criticized situations where companies have used "pro forma earnings" that could potentially mislead users of the information. Serious abuses occur when companies provide information that does not give the complete picture of their financial situation and future prospects. We believe that the abuses in the presentation of non-GAAP measures primarily relate to deficient disclosure and inadequate reconciliation to comparable measures included in the financial statements presented in accordance with GAAP. We agree with the Commission and Congress that alternative or non-GAAP measures of financial performance or liquidity should be grounded to a comparable measure based on information in the financial statements presented in accordance with GAAP. Accordingly, we believe that the final rule should focus primarily on enhancing the disclosures associated with the presentation of non-GAAP financial measures and providing a clear reconciliation to comparable GAAP measures.
During the final rulemaking process, we urge the Commission to be mindful of the need for flexibility and management's assessment of relevance in determining the appropriate disclosures to allow investors to see the company "through the eyes of management." We believe that certain aspects of the Proposed Rule may infringe on management's ability to meet that important objective. Finally, as further elaborated below, we are concerned about the dual system of disclosure created by the introduction of Regulation G and Item 10 of Regulations S-K and S-B, and the Commission's imposition of specific prohibitions on presentations of non-GAAP measures relative to Regulations S-K and S-B.
We offer the following specific comments and suggestions to enhance the Proposed Rule.
In the final rule, the Commission should clearly explain how earnings announcements or releases for completed annual and interim periods are affected by the Proposed Rule.
The Commission proposes that if a company makes a public announcement or release disclosing material non-public information about its results of operations or financial condition for a completed annual or quarterly fiscal period, that information must be filed as an exhibit to a Form 8-K within two business days. The proposing release indicates that the requirements of proposed Item 10(e) of Regulation S-K or Item 10(h) of Regulation S-B would apply to such a Form 8-K. While not explicitly stated, we understand that this requirement would effectively prohibit a company from making any public announcement or release for a completed annual or quarterly fiscal period of a non-GAAP financial measure that does not comply with the guidelines included in proposed Items 10(e) and 10(h) of Regulations S-K and S-B. If our understanding is correct, the Proposed Rule would have a significant impact on current business practices and we believe this impact should be clearly and openly explained in the final rule. As further discussed in additional comments below, we do not believe that management should be prohibited from providing information to investors, analysts and other users that they deem to be important in analyzing and understanding the manner in which they manage their companies (a stated goal of the Commission), as long as that information is reconciled to the GAAP financial information with appropriate disclosures.
The Proposed Rule may interfere with the goal of allowing investors to see a company's business "through the eyes of management."
Embedded within the Commission's own regulatory and interpretive framework is the notion that companies should provide information that allows investors to see a business "through the eyes of management." We believe that some of the prohibitions included in the Proposed Rule are contrary to this goal. When management analyzes its financial results, it does not confine itself to GAAP measures. Rather, management reviews a variety of ratios, data and schedules, which help to analyze past performance and identify trends in its business. From our experience, we believe that the non-GAAP financial information furnished by management is consistent with the information that they are using in evaluating their business, yet it may include non-GAAP financial measures that would be prohibited under the proposed amendment to Item 10 of Regulation S-K. By prohibiting certain non-GAAP information, this information will not be shared with investors, thereby eliminating a view of the business that is used by management.
In Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information," the Financial Accounting Standards Board recognized that management does not always use GAAP financial information in evaluating components of its business. In that standard, segment information is required to be presented using the measure used by management, even if the measure is not in accordance with GAAP. The standard requires reconciliation to the consolidated GAAP financial statements to link the information to the consolidated financial statements.
The disclosures required by proposed Item 10 of Regulation S-K are inconsistent with certain prohibitions provided in the same Item. For example, the disclosure requirements in proposed Item 10 of Regulation S-K include the following items:
However, the Proposed Rule then proceeds to prohibit certain non-GAAP financial measures, adjustments or presentations. We question what alternative this leaves management. If management uses a non-GAAP financial measure in managing its business, but such measure is prohibited by the proposed Item 10 of Regulation S-K, should management conform the presentation it uses to comply with Regulation S-K? If this course of action is selected, how does management meet the disclosure requirements otherwise included in Item 10 of Regulation S-K - the purpose and utility of such measures - when the Commission's prohibitions otherwise alter a measure actually used? We believe this inconsistency can only be resolved by eliminating certain of the Commission-imposed prohibitions (specifically, proposed Item 10(e)(1)(ii)(B) and (C) of Regulation S-K and Item 10(h)(1)(ii)(B) and (C) of Regulation S-B) on the use of non-GAAP financial measures, and instead focusing on the appropriate disclosures, including location of presentation, robust reconciliation to GAAP financial measures and the other disclosures required by Item 10 of Regulation S-K.
We believe that the Commission's final rule regarding the publication of non-GAAP information should correspond to the approach used in SFAS No. 131. Investors should receive the same information used by management, in whatever form it takes, with a proper reconciliation to the corresponding GAAP measure, without prohibitions. This approach allows investors to view a business "through the eyes of management" and management to otherwise meet its disclosure obligations relative to the purpose and utility of non-GAAP financial measures.
The prohibition on non-GAAP per-share measures should be modified.
We understand that confusion may have occurred for investors when registrants have presented non-GAAP per-share measures more prominently than, or in place of, GAAP earnings per share. We believe that the complete prohibition on non-GAAP per-share measures in proposed Item 10 of Regulation S-K should be modified to permit presentation of a non-GAAP per-share measure whenever the non-GAAP measure and related per-share measure are reconciled to the most comparable GAAP measure and related earnings per share (e.g., net income per share, income from continuing operations per share). In other words, if the most comparable GAAP measure is allowed to present a related per share amount, we believe that the non-GAAP measure also should be allowed to present a related per-share amount, with appropriate reconciliation and disclosure. We believe that, with proper presentation and reconciliation, the information may be useful to investors.
The scope of financial measures deemed to be non-GAAP financial measures should be narrowed.
The Proposed Rule is appropriately focused on financial measures that are derivations of operating or net income as well as derivations of total or operating cash flows; however, registrants frequently release non-GAAP financial measures that go beyond these areas. The Proposed Rule attempts to address this matter by exempting operating and other statistical measures, as well as ratios or measures, that are calculated using only financial measures calculated in accordance with GAAP and operating or other measures that are not non-GAAP financial measures. This exemption, however, leaves questions regarding the status of certain measures.
We believe the intent of the exclusion for ratios or measures that are calculated using only financial measures calculated in accordance with GAAP is to exclude from the scope of the rule common ratios and measures, such as return on assets or working capital, when the components of the calculation are GAAP measures. We question, however, whether the definition adequately differentiates between exempted measures and non-GAAP measures. For example, would presentation of a quick ratio be a non-GAAP measure since a component of the calculation is current assets excluding inventory or would it be exempt because the components of the calculation are all GAAP measures?
We believe there is a need for further refinement of the distinguishing characteristics of measures that are exempt from the final rule. Considering that perceived registrant abuses have generally been confined to derivations of operating income, net income, operating cash flows and total cash flows, the Commission should consider limiting the scope of the final rule to those measures. The Commission could provide accompanying general guidance requiring disclosure of the components of other measures used by companies to convey vital performance statistics. A narrower scope may also help prevent companies from limiting useful general or industry-specific operating ratios and measures currently made available to investors. Companies may limit the information provided due to uncertainty as to whether a measure may be deemed to be a non-GAAP financial measure or a desire to limit the volume of complicated reconciling information that may have to accompany each measure. Focusing on these areas would address the areas that have historically been abused and make compliance with the final rule less complicated.
Regulation G should require a discussion of the purposes for which the company's management uses non-GAAP financial measures and why management believes the presentation of the non-GAAP financial measure provides useful information to investors.
We do not believe there should be a different standard for filed and non-filed information as it pertains to disclosure of management's reasons for providing non-GAAP financial information and why the information is useful to investors. For filed information, the requirement can be satisfied by including the statements in the most recent annual report filed with the Commission and by updating those statements, as necessary. We believe that these disclosures should also address financial measures covered by Regulation G.
Companies should reconcile non-GAAP financial measures to the comparable GAAP measure.
We agree with the Commission's proposed requirement to reconcile non-GAAP financial measures to the most comparable financial measures determined and presented in accordance with GAAP. Reconciliation to specific GAAP financial measures would be difficult to prescribe in light of the myriad non-GAAP financial measures currently used by companies to present alternative ways to measure performance. Also, use of the most comparable GAAP measure will allow companies to eliminate extraneous reconciling items when such measure is a commonly known and understood component of a GAAP income statement, balance sheet, or statement of cash flows (e.g., income from continuing operations). Requiring all non-GAAP information to be reconciled to a specified amount such as operating income or operating cash flows may imply that only derivations of those measures are covered by the Proposed Rule.
Companies should not be required to disclose whether the reconciliation has been reviewed or audited by independent accountants.
To our knowledge, earnings releases have not been misconstrued by investors to have been reviewed or audited by independent accountants. We do not believe that the addition of the requirement to reconcile certain information in the release to comparable GAAP measures will change this understanding. In fact, many companies already provide such reconciliations with no apparent confusion on the part of investors as to the involvement of the independent accountants.
We do not believe that a statement as to whether the reconciliation has been reviewed or audited should be included in the release as it may lead the user to believe such a review or audit is appropriate. Currently, there are no generally accepted criteria (i.e., accounting or measurement principles) for such non-GAAP information presented in earnings releases and each company makes its own determination as to what is relevant and appropriate. Auditors are not able to perform an audit or review without generally accepted (suitable) criteria upon which to base their report. Furthermore, we do not believe it is appropriate to formalize the involvement of the independent accountants in the process by which management communicates preliminary earnings information (incomplete financial information) to the public.
Registrants should be required to present comparable measures for prior periods presented but should not be required to present comparable measures in future periods if the information is no longer relevant.
In order to ensure comparability, we believe that any disclosure of a non-GAAP financial measure should include the comparable prior fiscal period measure for all periods presented. We do not, however, believe that a non-GAAP financial measure presented for a particular period should necessarily be required in any future period, except to the extent required by the immediately preceding sentence. If this presentation is required in future periods, the inclusion of a non-GAAP financial measure will result in an endless cycle of providing the disclosure, even if changes in facts and circumstances warrant a change in the measure presented. We believe that registrants should be permitted to eliminate the disclosure if it ceases to be relevant. We believe that the market place will dictate the periods for which comparable measures are required.
The final rules for filed and non-filed information should be consistent.
We do not believe there should be different standards for financial measures that are filed versus those that are not filed. The Proposed Rule requires that public announcements regarding results for a completed annual or quarterly fiscal period be filed on Form 8-K. Therefore, for domestic filers, the only information that appears to be subject solely to Regulation G will be financial measures regarding incomplete periods. We find no rationale for having differing standards for complete versus incomplete periods. We believe that a lower standard for information regarding incomplete periods (the lack of specific prohibitions in Regulation G versus proposed Item 10 of Regulation S-K, as well as incremental disclosure in Regulation S-K) may result in companies reporting results shortly before period ends to avoid the more stringent rules. Also, preliminary information presented pursuant to Regulation G that is prohibited for filed information would not be allowed to be disclosed in a release after the period has completed. As referred to above in our comments in the "General" section, we believe that the final rule should eliminate certain of the Commission-imposed prohibitions on the use of non-GAAP financial measures. The elimination of such prohibitions will eliminate the most significant inconsistency between the dual systems, and provide investors with consistent, relevant non-GAAP financial measures used by management. When that consistency is achieved, the Commission can focus on the appropriate disclosures surrounding such measures, including location of presentation and robust reconciliation to the comparable GAAP measure.
Item 10 of Regulation S-K and Regulation S-B
We refer the Commission to our previous comments under "General" and "Regulation G," relative to our belief that certain of the Commission-imposed prohibitions on the use of non-GAAP financial measures should not be included in the final rule. If the Commission issues the final rule with the proposed content prohibitions, we have the following comments on particular sections of Item 10 of Regulations S-K and S-B.
Registrants should not be prohibited from presenting non-GAAP performance measures that eliminate items that are reasonably likely to recur if those items are also eliminated in measures used by management to assess performance.
The prohibition on adjustments to performance measures to eliminate or "smooth" items identified as non-recurring, infrequent or unusual could have a major effect on the information released by registrants. As a result, the intent and application of this provision must be clear.
We believe the "reasonably likely to recur" standard is too broad. From our experience, typical adjustments include gains and losses on the sales of assets, charges for impairments of assets, charges related to the discontinuance of a product, location or strategy, and costs incurred in connection with a merger or acquisition. While these types of events are "reasonably likely to recur," in certain situations management may factor these charges or gains out of the financial measures used to manage the business and assess any number of measures, including a concept of "core earnings" or comparably- styled measures. From our experience, management is in the best position to determine any non-GAAP measures used to manage its business, and investors should have access to this information with appropriate disclosure and a robust reconciliation to the comparable GAAP measure.
We believe that a literal reading of the Proposed Rule is appropriate. In other words, we believe that registrants should be prohibited from using the terms "non-recurring, infrequent or unusual" if the adjustments are likely to recur. However, this should not prejudice the ability to include or exclude an amount as long as the registrant states its purpose for the adjustment (and the purpose is not that the adjustment is non-recurring, infrequent or unusual) and why it believes the resulting non-GAAP financial measure after such an adjustment is useful to investors. For example, if a company believes that mark-to-market adjustments for derivative financial instruments is not relevant in interpreting its results because all derivatives are held to maturity, such an exclusion, under the literal reading of the Proposed Rule, should not be prohibited. Likewise, if a registrant believes that losses and gains on sales of non-operating assets are not a factor to be considered in evaluating its results because they are outside the core nature of its business (not because they are non-recurring, infrequent or unusual), then the adjustment should not be prohibited. The Commission could provide further interpretive guidance in the final rule that registrants should consider both credits and charges within the same category of adjustment. For example, if all losses on disposition of non-operating assets are eliminated in arriving at the non-GAAP financial measures, all gains should be eliminated as well.
Also, the Proposed Rule does not take into account the relative size of adjustments. If a registrant occasionally records insignificant gains on sales of assets but in one period records a substantial gain that is well in excess of past or expected future gains, the rule does not allow for an adjustment for events that have an abnormally large impact on earnings that, again, may not be indicative of core business performance.
In recent weeks, there have been articles in the financial press disparaging registrants for not making adjustments to their GAAP measures of performance to account for charges or gains that the registrants deemed to be in the normal course of business (in other words, investors, analysts and the press requested a non-GAAP measure of performance that the Proposed Rule would appear to prohibit). In these articles, analysts have accused registrants of possibly misleading investors because of a failure to make adjustments to GAAP earnings and not providing a non-GAAP measure of performance. In one example, a registrant recorded a substantial charge and did not exclude the charge in determining its earnings guidance, stating that the charge was a normal part of doing business. Analysts argued that the charge should be excluded, as not doing so will allow for favorable comparisons in the following year. In another example, a registrant did not adjust its GAAP results for a substantial gain on a sale of an asset. Commentators challenged the lack of an adjustment claiming that the registrant was possibly "inflating" its results for the current year.
As noted above, management is in the best position to determine any non-GAAP financial measure used to manage its business, and investors should have access to this information with appropriate disclosure and a robust reconciliation to the comparable GAAP measure. Evidenced by the press articles noted in the preceding paragraph, users of financial information, armed with specific and relevant information, will be in a position to assess financial performance or liquidity measures, whether presented on a GAAP or some form of non-GAAP basis (with appropriate disclosure and reconciliation).
Differing standards should not be used for liquidity and performance measures.
The proposed amendment to Item 10 of Regulation S-K includes differing prohibitions for liquidity and performance measures. We believe that these differences will result in confusion as certain measures could be deemed to be measures of both liquidity and performance. As a result, if a registrant wishes to present information that is prohibited for performance measures, it may present the information as a liquidity measure. For example, a registrant could contend that a non-GAAP measure of operating income is a liquidity measure if it corresponds to a measure used in debt covenants, thereby allowing it greater latitude in presenting the non-GAAP measure.
We believe that the differing prohibitions should be eliminated. If differing standards are maintained in the final rule, we believe that further guidance should be given regarding what constitutes a liquidity measure versus a performance measure.
The effective date of the final rule should be clarified.
The Proposed Rule is silent relative to a proposed effective date for the final rule. If the final rule includes proposed Item 10 of Regulations S-K and S-B unchanged for our recommendation to eliminate certain of the Commission-imposed prohibitions, we recommend that the Commission provide a transition period and delayed effectiveness. The prohibitions included in Item 10(e)(1)(ii) of Regulation S-K and Item 10(h)(1)(ii) of Regulation S-B could significantly change practice for earnings press releases for completed fiscal periods, which will now require a filing on Form 8-K and the need to comply with these new Items. Registrants and marketplace participants should be given a transition period to plan and adjust to the change in practices mandated by the Commission.
We agree that some registrants have used non-GAAP financial measures in a way that obscures true results and that measures should be taken to eliminate this practice. We believe, however, that certain measures included in the Proposed Rule go beyond what is necessary to cure the problem and will be detrimental to investors, as they will lose the ability to see a business "through the eyes of management." We believe that investors would be best served by receiving all information that management believes is useful in evaluating their business as long as the information is presented in a balanced manner and is accompanied by a robust reconciliation.
If you have any questions about our comments please contact Sam Ranzilla at (212) 909-5837 or Melanie Dolan at (202) 533-4934.