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Jan 4, 2022
Disclosure of Non-GAAP Financial Measures: A Practical Guide to National Instrument 52-112
Public companies in Canada continue to utilize non-GAAP financial measures in their public disclosure documents as part of their financial communications strategy. Securities regulators have again expressed concern that many issuers disclose non-GAAP financial measures that lack standardized meanings under the financial reporting framework used in the preparation of the issuer’s financial statements. The calculation of non-GAAP measures can vary significantly by issuer and industry, which has increased concerns regarding transparency and challenges in assessing an issuer’s results and comparing results to those of other issuers in the same industry. In response to these concerns, securities regulators around the world, including the International Organization of Securities Commissions, the European Securities Markets Authority and the U.S. Securities and Exchange Commission, have strengthened their efforts to regulate the use of non-GAAP financial measures.
Following rule proposals, drafting and consultations stemming back to 2018, National Instrument 52-112 Non-GAAP and Other Financial Measures Disclosure (“NI 52-112” or the “Instrument”) came into force on August 25, 2021. The Instrument is designed to address the lack of standardization in non-GAAP financial measures and sets out mandatory disclosure requirements for issuers concerning non-GAAP and other financial measures.
NI 52-112 replaces CSA Staff Notice 52-306 (Revised) Non-GAAP Financial Measures (“SN 52-306”) and provides Canadian securities regulators with stronger enforcement mechanisms if an issuer’s use of non-GAAP financial measures is misleading.
The Instrument applies to disclosure by reporting issuers for financial years ending on or after October 15, 2021. Therefore, reporting issuers with a December 31, 2021 year-end should be cognizant of the Instrument and ensure that the disclosure in their upcoming annual filings is compliant with NI 52-112.
Application of NI 52-112
The disclosure requirements in NI 52-112 apply to documents and materials intended to be, or reasonably likely to be, made available to the public. In this respect, the Instrument applies to disclosure by issuers beyond documents that are required to be filed on SEDAR, including on the issuer’s website and social media platforms. In such cases, the “first instance” disclosure requirement may be satisfied by providing a website hyperlink to a page where the necessary disclosure can be found with, according to the Instrument’s Companion Policy, “minimal or no scrolling or navigating.”
There are certain issuers that are exempt from the application of the Instrument, including:
- investment funds (as defined under Canadian securities law);
- designated foreign issuers; and
- certain issuers that have disclosure required under the Standards of Disclosure for Mineral Projects, section 5.4 of Form 51-102F2 Annual Information Form, and Standards of Disclosure for Oil and Gas Activities.
Additionally, the disclosure requirements in NI 52-112 do not generally apply to pro forma financial statements required to be filed under Canadian securities legislation and any report prepared by an analyst or reporting issuer other than the issuer or entity that is the subject of the specified financial measure or a transcript of an oral statement.
What is a non-GAAP Financial Measure?
A non-GAAP financial measure is defined in NI 52-112 as a financial measure disclosed by an issuer that:
- depicts the historical or expected future financial performance, financial position or cash flow of an entity;
- with respect to its composition, excludes an amount that is included in, or includes an amount that is excluded from, the composition of the most directly comparable financial measure disclosed in the primary financial statements of the entity;
- is not disclosed in the financial statements of the entity; and
- is not a ratio, fraction, percentage or similar representation.
Financial measures such as “EBITDA,” “adjusted earnings,” “adjusted EBITDA,” “adjusted funds from operations,” “free cash flow,” “pro forma earnings,” “distributable cash,” “cash earnings,” “earnings before non-recurring items” and measures presented on a constant-currency basis are all considered non-GAAP financial measures for the purposes of NI 52-112. Issuers in certain industries commonly rely on non-GAAP measures in their disclosure documents, such as the use of “FFO” (funds from operations) and “AFFO” (adjusted funds from operations) in the real estate industry and “AISC” (all-in sustaining cost per gold ounce sold) and “average realized gold price per ounce” in the mining industry.
The Companion Policy to NI 52-112 notes that the following are not captured by the definition of non-GAAP financial measures:
- amounts that do not depict historical or future “financial performance,” “financial position” or “cash flow,” which relate to elements of the financial statements, such as share price, market capitalization or credit rating;
- financial information that does not have the effect of providing a financial measure that is different from a financial measure presented in the financial statements, such as the addition or subtraction of an identical line item, subtotal or total originating from multiple periods of primary financial statements; or
- non-financial information, such as number of units, number of subscribers, volumetric information and number of employees, environmental measures, information on major shareholding, acquisition or disposal of the issuer’s own shares and the total number of voting rights.
Disclosure Requirements for Non-GAAP Financial Measures Under NI 52-112
Under NI 52-112, an issuer cannot disclose historical non-GAAP financial measures unless the following requirements are met:
- the non-GAAP financial measure is labelled using a term that, given the measure’s composition, describes the measure and distinguishes it from totals, subtotals and line items disclosed in the primary financial statements of the entity to which the measure relates;
- the non-GAAP financial measure is identified as a non-GAAP financial measure;
- the document discloses the most comparable financial measure disclosed in the primary financial statements of the entity to which the non-GAAP financial measure relates;
- the non-GAAP financial measure is given no more prominence than that of the most directly comparable financial measure referred to in the primary financial statements;
- in proximity to the first instance of the non-GAAP financial measure, the document:
- explains that the measure is not a standardized financial measure under the financial reporting framework used to prepare the financial statements;
- discloses, directly or by incorporating by reference,
- an explanation as to the composition of the non-GAAP financial measure,
- an explanation on how the non-GAAP measure provides useful information to an investor and explains the additional purposes,
- a quantitative reconciliation to the most comparable financial measure in a permitted format, and
- if the label or composition of the measure has changed from what was previously disclosed, an explanation of the reason for the change;
- if the non-GAAP financial measure is disclosed in the issuer’s management’s discussion and analysis (“MD&A”) or in an earnings release of the issuer, the document discloses the non-GAAP financial measure for the relevant comparative period, unless impractical to do so.
Where non-GAAP financial measures disclose forward-looking information, a document must:
- disclose an equivalent historical non-GAAP financial measure;
- label the non-GAAP financial measure using the same label used for the historical non-GAAP financial measure;
- present the non-GAAP financial measure that is forward-looking with no more prominence in the document than that of the equivalent historical non-GAAP financial measures; and
- describe in proximity to the first instance of the non-GAAP financial measure that is forward-looking any significant difference between the historical and forward-looking non-GAAP financial measure.
Other Financial Measures
In addition to requiring identification and disclosure of non-GAAP financial measures, NI 52-112 differs from SN 52-306 in that it also specifically requires identification and disclosure of:
- non-GAAP ratios, such as “adjusted EBITDA per share” or “funds flow per barrel of oil equivalent,” which use a non-GAAP measure as one or more of its components and which are not disclosed in the financial statements;
- total of segment measures, which is a subtotal of two or more reportable segments of the issuer, which is not disclosed in the financial statements;
- capital management measures, which are financial measures intended to enable the investor to evaluate an issuer’s objectives, policies and processes for managing its capital, such as “annualized adjusted EBITDA” and are not disclosed in the primary financial statements of the issuer; and
- supplementary financial measures, which are disclosed on a periodic basis to depict historical or expected future financial performance, financial position or cash flow, and which are not disclosed in the financial statements of the issuer.
Incorporating by Reference
NI 52-112 permits an issuer to incorporate certain disclosure from its MD&A regarding non-GAAP financial measures by reference, so long as:
- the issuer indicates that the information is incorporated by reference;
- the issuer specifies the location of the information in the MD&A; and
- the MD&A is available on the issuer’s SEDAR profile.
However, an issuer cannot incorporate the required non-GAAP financial measure disclosure by reference into its MD&A if the document that contains the necessary disclosure being referenced is another MD&A filed by the issuer. An issuer cannot, for example, incorporate the required non-GAAP financial measure disclosure in its interim MD&A by reference to its annual MD&A. Full disclosure of the non-GAAP financial measures, including reconciliations, are required in both interim and annual MD&A.
While the Instrument generally allows an issuer to incorporate by reference the required disclosure in a news release, an issuer is still required to disclose certain items, such as the quantitative reconciliation of non-GAAP financial measures, directly in the news release if the news release is an earnings release.
Practical Tips for Applying NI 52-112
There are a number of practical ways that an issuer can ensure that they comply with NI 52-112:
- Keep the Investor in Mind
The Instrument is crafted to protect investors from misleading, though commonly accepted, financial information, concepts and terms. An issuer should consider how an investor is likely to read a non-GAAP financial measure and ensure investors can identify such measures and reconcile them with measures included in the issuer’s financial statements.
- Effectively Incorporate by Reference
Knowing how to successfully incorporate by reference can prevent duplicative disclosure. When incorporating required information by reference, an issuer must clearly identify where the required information is located within the referenced document. A reference to a MD&A, for example, should include the date of the MD&A, its reporting period and the specific section or page reference within the MD&A.
There are complex rules that dictate how to properly incorporate by reference in an issuer’s disclosure. Effectively and compliantly incorporating by reference can help keep costs down, may expose investors to other materials prepared by the issuer and can streamline an issuer’s disclosure. An issuer should consider consulting legal and accounting professionals when incorporating by reference.
- Recognize the Themes in NI 52-112
To comply with the Instrument, issuers may need to change reporting practices that have become commonplace. There are a number of themes in the Instrument that tease out several “rules-of-thumb” that an issuer can apply when preparing its disclosure documents and material:
- Identify – Clearly identify any non-GAAP financial measure as a non-GAAP financial measure in a location that is proximate in the disclosure document to the use of the non-GAAP financial measure.
- Label Appropriately – Label the non-GAAP financial measures, non-GAAP ratios and supplementary financial measures to differentiate those terms from items in the issuer’s financial statements. Labels that are easily confused with those used under the financial reporting framework should be avoided. For example, a measure labelled “cash flows from operations” and calculated as cash flows from operating activities before changes in non-cash working capital items is confusingly similar to the term “cash flows from operating activities” specified in IAS 7 Statement of Cash Flows. Labels should not be overly optimistic by purporting something in a title but then exclude items of a similar nature (e.g., a label such as “results from operating activities” excluding inventory write-downs, restructuring costs, impairment of assets used for operations and stock-based compensation).
- Disclose the Comparable Financial Measure – Disclose the most comparable financial measure to the non-GAAP financial measure available in the financial statements. The presentation of a non-GAAP financial measure against its most directly comparable financial measure should not confuse or obscure the presentation of the comparable financial measure. An issuer must also include a quantitative reconciliation between the non-GAAP financial measure and the most directly comparable financial measure in a “permitted format” such as a table. An issuer may begin with the non-GAAP financial measure or the most directly comparable financial measure, provided the reconciliation is presented in an understandable and consistent manner. The Instrument does not define “most directly comparable financial measure,” and therefore, the issuer needs to apply judgment in determining the appropriate comparison.
- Proximity to First Instance – To limit duplicative disclosure, an issuer may include the information required by the Instrument in one section of a document. When doing so, an issuer should include a reference to this section when the specified financial measure first appears in the document, either through a footnote or in another manner. There may be types of documents where it is not clear when the specified financial measure first occurs, such as on websites and social media. In these situations, the “first instance” disclosure requirements may be satisfied by providing a website hyperlink to where the disclosures are found on another section of the website with minimal to no scrolling or navigation. Hyperlinking may only be provided within a website or a document.
- Explain – In the context of historical information, it is vital to explain (a) the composition of the non-GAAP measure, (b) its usefulness to an investor, (c) any additional purposes and (d) any changes from label or composition that was previously disclosed. The Instrument does not define the term “useful.” However, the Companion Policy states that the term “useful” is intended to reflect how management believes that the presentation of the non-GAAP financial measure provides incremental information to investors regarding the issuer’s financial position, financial performance or cash flows. Further, the composition explanation should include a clear description of how the specified financial measure is calculated. For example, an issuer is expected to describe the type of adjustments made, such as those for “non-cash” items or the basis being used to determine the type of adjustments. It is important to consider whether any new adjustment made in the calculation of a specified financial measure might constitute a change in composition or whether the adjustment is consistent with the stated usefulness of the measure.
- Watch Prominence – Non-GAAP financial measures should be presented with “no more prominence in the document than that of the most directly comparable financial measure.” Issuers should take particular caution if including a non-GAAP financial measure in the title or subtitle of a document.
- Ensure you have accounting and legal professionals assisting the production of your materials
It is vital that an issuer and its management team employ the services of reputable and experienced legal and accounting professionals in the preparation of their disclosure documents, particularly in light of the Instrument. Experienced professionals can help to ensure that an issuer is in the best position to understand and comply with the Instrument.
Aird & Berlis LLP’s Capital Markets Group is ready to assist with any matter or question relating to NI 52-112, disclosure documents or securities legislation more generally. If you require assistance with the foregoing, please contact us.