Along with equal prominence, probably one of the most often non-GAAP comments we see issued by the U.S. Securities and Exchange Commission (SEC) Staff involves its objection to adjustments that it believes substitute individually tailored measurement methods for those of GAAP.  Often, the SEC Staff comments will cite to Question 100.04 of the Non-GAAP Financial Measures Compliance & Disclosure Interpretations, as follows:

Question 100.04

Question: A registrant presents a non-GAAP performance measure that is adjusted to accelerate revenue recognized ratably over time in accordance with GAAP as though it earned revenue when customers are billed. Can this measure be presented in documents filed or furnished with the Commission or provided elsewhere, such as on company websites?

Answer: No. Non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP could violate Rule 100(b) of Regulation G. Other measures that use individually tailored recognition and measurement methods for financial statement line items other than revenue may also violate Rule 100(b) of Regulation G.   [May 17, 2016] (emphasis added)

While Question 100.04 primarily flags adjustments to revenue as potentially violating Rule 100(b) of Regulation G, the last sentence of the answer also notes that “individually tailored recognition and measurement methods” may also relate to “financial statement line items other than revenue.”

In addition, Question 100.1 provides:

Question 100.01

Question: Can certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading?

Answer: Yes. Certain adjustments may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading. For example, presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading. [May 17, 2016]

With this background, we found particularly interesting this recent comment letter exchange (see here and here) where the SEC Staff took issue when a company, which had recently gone public, included an adjustment in its Adjusted EBITDA non-GAAP financial measure for “public company expenses” related to “additional headcount to build infrastructure and support the operations of a public company (i.e., public company directors & officers liability insurance, investor relation and public listing fees, additional legal and accounting fees, and additional independent board members).”  

The SEC Staff objected to this “public company expenses” adjustment because the Staff believed it related to “normal recurring transactions of a public company” and, therefore, “results in a tailored recognition and measurement method for a financial statement line item (general and administrative expenses).”

The comment letter exchange is repeated below for reference.

Initial Company Response:

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Non-GAAP Financial Measures, page 27

  1. We note your adjustment for public company expenses in the reconciliation of net loss to Adjusted EBITDA (loss) for the three and six months ended December 31, 2021 and 2020. Please clarify whether this adjustment covers transaction expenses related to your initial public offering.

If not, to the extent that public company expenses reflect “additional headcount to build infrastructure and support the operations of a public company (i.e., public company directors & officers liability insurance, investor relation and public listing fees, additional legal and accounting fees, and additional independent board members)” as described under the General and Administrative section, please remove the related adjustment. An adjustment for these expenses, which relate to normal recurring transactions of a public company, results in a tailored recognition and measurement method for a financial statement line item (general and administrative expenses). Refer to Q&A 100.04 of the C&DI on Non-GAAP Financial Measures.

Response:

The adjustment for public company expenses for the six months ended December 31, 2021 does not include transactional costs related to our IPO on July 1, 2021. The transactional IPO costs were treated as syndication costs and reduced our proceeds from the public offering.

The adjustment for public company expenses for the six months ended December 30, 2020 does not include transaction expenses related to our IPO on July 1, 2021, as we did not commence the IPO process at that time.

This number specified in adjustment for public company expense is accounted for fully and correctly in our GAAP financial statements. In the future, we will record this number pursuant to the referenced C&DI guidance, including in our upcoming Form 10-Q filing for the nine months ending March 31, 2022, which is to be filed by May 16, 2022.

Follow-Up Company Response:

Response:

As a clarification to the Company’s initial response to Item 4 in the letter dated March 29, 2022, commencing with the expected May 16, 2022 filing of our Q3 FY ‘22 financials and going forward, we will remove the adjustment for public company expenses in our reconciliation of net loss to Adjusted EBITDA (loss). We may address public company expenses in the MD&A/Operating Expenses section of our financial reports (and exclude from Non-GAAP Financial Measures)

Takeaway

This comment letter exchange serves as a good reminder of the Staff’s continued focus on adjustments to financial statement line items (e.g., general and administrative expenses in this example) and whether such adjustments could render the presentation of the non-GAAP financial measure potentially misleading under Rule 100(b) of Regulation G.

If you have any questions regarding any of the topics covered in this blog post, please feel free to contact a member of our Corporate & Securities practice group or, if applicable, contact your primary Bass, Berry & Sims relationship attorney.

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