Are You Sure That Metric is a Non-GAAP Financial Measure? SEC’s Focus on Key Performance Indicators Continues

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Following the Securities and Exchange Commission’s (SEC) issuance of interpretive guidance regarding the disclosure of key performance indicators and metrics (KPIs) early last year, we’ve been tracking SEC comments in this area as the SEC fully incorporates the guidance into its disclosure review program. We’ve highlighted a few of the comment letters previously, but several recently issued comment letters caught our attention.

Spotting a KPI

Under the SEC’s KPI guidance, a KPI is one of the key variables through which management evaluates a company’s performance or status, disclosure of which would be material to investors. The SEC guidance states as follows:

“Some companies also disclose non-financial and financial metrics when describing the performance or the status of their business. Those metrics can vary significantly from company to company and industry to industry, depending on various facts and circumstances. For example, some of these metrics relate to external or macro-economic matters, some are company or industry specific, and some are a combination of external and internal information. Some companies voluntarily disclose specialized, company-specific sales metrics, such as same store sales or revenue per subscriber. Some companies also voluntarily disclose environmental metrics, including metrics regarding the observed effect of prior events on their operations.”

The guidance reminds companies that when including metrics in their disclosure companies should consider existing MD&A requirements as well as the extent to which an existing regulatory framework applies, such as GAAP or, for non-GAAP financial measures, Regulation G or Item 10 of Regulation S-K.  Although the SEC guidance instructs companies to consider whether other regulatory disclosure frameworks apply, in practice the lines between a KPI metric and a non-GAAP financial measure can be blurred in some cases.  And because of the SEC Staff’s laser focus on non-GAAP financial measure disclosures the past several years, it is easy to see how some companies may choose to err on the side of categorizing a metric as a non-GAAP financial measure when the metric falls in this blurred area.

A series of recent SEC comment letters contained an exchange in which the Staff, in connection with a 10-K and 10-Q review, delved into the determination of whether a KPI was a non-GAAP financial measure or an operational metric.  What we find particularly interesting is that the Staff in both instances concluded that the metrics at issue were actually not a non-GAAP financial measure.

Below is the first letter exchange, with hyperlinks to the letters here and here.

[Initial SEC Comment and Company Response]

  1. You disclose that gross sales represents sales to customers excluding the impact of sales adjustments, such as trade discounts and other allowances. We acknowledge your historical presentation of this measure as a non-GAAP measure of revenue and related reconciliation to net sales reported in accordance with GAAP. However, you also describe it as a metric in your disclosures. With regards to your disclosure of gross sales and in light of our existing non-GAAP guidance as well as our recent guidance in Release No. 33-10751 relating to metrics, we have the following comments:
    • Please clearly explain what “gross sales” represents. For example, does it represent full retail price of your products, such as MSRP?
    • Tell us if you view “gross sales” to be a non-GAAP measure of revenue or a metric based upon your assessment of Item 10(e) of Regulation S-K and the guidance in Release No. 33-10751 and why.
    • Considering that gross sales is widely disclosed throughout your documents, please tell us how you analyze trends in the level of trade discounts and other allowance provided to customers and if you have considered providing enhanced disclosures so that your investors can understand the relationship between “gross sales” and “net sales.”

Response: In response to the Staff’s comment, Mattel respectfully advises the staff that gross sales do not represent the retail price of product sold to Mattel’s customers. Gross sales represent the amount invoiced to Mattel’s customers and includes deductions from Mattel’s “list” price, where applicable. However, Mattel enters into additional arrangements which provide customers with further discounts from the amount invoiced. Specifically, sales adjustments represent arrangements with customers to provide additional sales incentives, support customer promotions, and provide allowances for returns and defective merchandise, which can be based upon fixed amounts or percentages, or also be discretionary in nature. Because sales adjustments are generally not associated with, or accounted for, by categories, brands or individual products, net sales are not presented on a categories or brand level, and in this regard net sales may be viewed as less meaningful to investors. Mattel believes that gross sales by category and brand is useful supplemental information for investors to assess the underlying performance and trends of Mattel’s categories and brands. As such, gross sales are described as sales to customers, excluding sales adjustments, and sales adjustments are explained in detail in Mattel’s disclosures regarding the application of critical accounting policies and estimates.

Mattel considers gross sales to be a non-GAAP financial measure based upon the definition set forth in Item 10(e)(2) of Regulation S-K and consistent with the guidance in Release No. 33-10751, which states that companies should “first consider the extent to which an existing regulatory disclosure framework applies, such as Generally Accepted Accounting Standards (“GAAP”) or, for ‘non-GAAP measures,’ Regulation G or Item 10 of Regulation S-K”. The Financial Reporting Manual defines non-GAAP financial measures as a “numerical measure of a registrant’s historical or future financial performance, financial position, or cash flow that:

a. excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flows of the issuer; or

b. includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable GAAP measure so calculated and presented.”

Gross sales is a numerical measure of Mattel’s historical performance that excludes the impacts of sales adjustments, which is presented in the most directly comparable GAAP measure (i.e. net sales), and as such, was determined to be a non-GAAP financial measure. Mattel has replaced the use of the word “metric” with “measure” in its disclosures starting in the second quarter of 2020 to clarify this point of view.

Sales adjustments are recorded during the year based upon Mattel’s expected level of annual spend and is adjusted in the fourth quarter based upon the actual expected amount of spend committed to customers. Mattel most commonly analyzes sales adjustments at a consolidated level, but also at a segment and regional level, and accordingly provides a reconciliation between total gross and net sales, such that investors can understand the varying level of sales adjustments provided to customers. Since the beginning of 2018, sales adjustments as a percent of gross sales on a quarterly and annual basis has consistently been between 11%-12% each period; given this consistency as percent of gross sales, Mattel does not view that sales adjustments have been a material driver of the change in net sales period over period. Nevertheless, in the future, Mattel will enhance its disclosure in periods where sales adjustments are a material driver of the change in net sales.

Mattel believes its current disclosures are adequate for the investor to understand the relationship between gross and net sales. Sales adjustments are one of Mattel’s critical accounting policies and estimates, and Mattel provides a description regarding the types of programs, its relationship to gross sales, and the timing of recognition. However, Mattel has enhanced its disclosure in its discussion of gross sales starting in the second quarter of 2020 to provide further clarity regarding the relationship between gross and net sales, as presented below, with changes underlined for ease of review:

Gross sales represent sales to customers at invoice, excluding the impact of sales adjustments. Net sales, as reported, include the impact of sales adjustments, such as trade discounts and other allowances. Mattel presents changes in gross sales as a metric measure for comparing its aggregate, categorical, brand, and geographic results to highlight significant trends in Mattel’s business . . .

Since sales adjustments are determined by customer rather than at the categories or brand level, Mattel believes that the disclosure of gross sales by categories and brand is useful supplemental information for investors to be able to assess the performance of its underlying categories and brands (e.g., Dolls, Barbie) and also enhances their ability to compare sales trends over time. Refer to Mattel’s critical accounting policies and estimates included in the 2019 Annual Report on Form 10-K for further detail regarding sales adjustments.

* * *

[Follow-Up SEC Comment and Company Response]

  1. We have carefully considered your response to prior comment 1 and your revised disclosures that “gross sales” represents sales to customers at invoice. Based upon this clarification, it appears that “gross sales” is more akin to a billings-type metric. Accordingly, please revise the title so as not to imply that it represents GAAP sales or revenue and comply with the metrics guidance set forth in SEC Release No. 33-10751. In your response, please include your proposed revisions, including your discussion of this metric in MD&A.

Response: In future filings, Mattel will replace the term “gross sales” with “gross billings,” to comply with the metrics guidance detailed in SEC Release No. 33-10751 and also include the following language regarding the use of the term “gross billings.”

Gross billings represent amounts invoiced to customers. It does not include the impact of sales adjustments, such as trade discounts and other allowances. Mattel presents changes in gross billings as a metric for comparing its aggregate, categorical, and brand results to highlight significant trends in Mattel’s business. Changes in gross billings are discussed because, while Mattel records the details of sales adjustments in its financial accounting systems at the time of sale, such sales adjustments are generally not associated with categories, brands, and individual products.

Here is a link to the other comment exchange where the SEC Staff tells the registrant that, based on the registrant’s description of “shipments,” it appears that the metric is “more akin to a financial metric, intended to convey the dollar value of shipments sent to [] customers each period, than a non-GAAP measure.”

KPI Trend Information

Another recent comment letter on KPIs that we found interesting was one related to KPI trend information. In summary, in the comment exchange the SEC asked the registrant to provide more disclosure regarding the KPIs on subscriber data to illustrate volume trends in revenue.

  1. In your Form 10-K, you provide various types of subscriber data such as paid circulation volume, average daily print readership, digitally activated subscribers. Revise to include relevant subscriber metrics for the periods presented to illustrate volume trends in your revenues. Please refer to the metrics guidance set forth in SEC Release No. 33-10751.

Response: We acknowledge the Staff’s comment and have considered the guidance in SEC Release No. 33-10751. We understand the importance of providing meaningful information that helps the users of our financial statements better understand key drivers for changes in our results of operations. We will revise future 10-Q and 10-K filings to include key performance indicators and metrics that management feels would be material to investors’ understanding of our results.

**Another unrelated but interesting aspect of this letter exchange is found in the second comment in the letter in which the Staff asks the registrant to revise its future filings to quantify the change and the reasons for the change if more than one factor is involved, in order for an investor to discern the relative contribution of each of the multiple components cited to the total change, and avoid using terms such as “primarily” or “partially offset” unless the other factors are not material.  Interestingly, the “partially offsetting” factor was the impact of COVID-19; however, the registrant generally responded that it was not possible to precisely isolate the impacts of the pandemic from those resulting from secular declines impacting the industry, so quantification of that particular driver was not possible.  This exchange is insightful because we anticipate many other registrants will have similar issues isolating and quantifying the impacts of COVID-19.

Takeaways for Public Companies

As reflected in these recent comment letters, the Staff is closely monitoring KPI disclosures. The determination as to whether a metric is also a non-GAAP financial measure is often not easy to determine, and these recent letters provide further clarification on the Staff’s thinking in this area.  Companies should closely review their disclosure package to ensure that KPIs are appropriately identified and presented.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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