Performance measures: non-GAAP measures and the SEC

Almost every listed company tells its story with numbers that are not defined in the accounting standards: adjusted earnings, adjusted EBITDA, organic growth, free cash flow, same-store sales. Management argues that these measures strip out items that do not reflect underlying performance and show the business as management runs it. Investors use them heavily, and many executive pay plans are built on them. Regulators accept that they can be useful but worry that they are often used to present a rosier picture, by excluding costs that are in fact normal and recurring. This lesson looks at how each framework and regulator handles these measures, and at the judgments a reporting team makes when it chooses and reconciles them.

What the SEC rules require

Regulation G applies whenever an SEC registrant publicly discloses a non-GAAP financial measure, in an earnings release, on a call, on a website or anywhere else, and requires presentation of the most directly comparable GAAP measure and a quantitative reconciliation. Item 10(e) of Regulation S-K adds requirements for filed documents such as Forms 10-K and 10-Q: the GAAP measure must be presented with equal or greater prominence, the company must state why management believes the measure is useful to investors and, if material, how management uses it, and certain adjustments are prohibited, such as excluding charges that require cash settlement from liquidity measures other than EBIT and EBITDA, or labeling an item non-recurring, infrequent or unusual when a similar item occurred in the prior two years or is reasonably likely to recur within two years. The SEC staff's Compliance and Disclosure Interpretations (C&DIs), last substantively updated in December 2022, explain how the staff applies these rules.

The C&DIs that cause the most comment letters deal with misleading adjustments. Excluding normal, recurring, cash operating expenses necessary to operate the business, such as ordinary marketing or slotting fees for a food company, can make a measure misleading even if the adjustment is disclosed. Individually tailored accounting principles, such as accelerating revenue that GAAP recognizes over time, can make a measure misleading. Presenting a full non-GAAP income statement, or leading an earnings release with adjusted figures before GAAP figures, violates equal prominence. Adjusting only for charges and not for similar gains is also a concern. The staff reviews earnings releases, investor presentations and websites as well as filings, and non-GAAP measures have for years been among the most frequent topics in SEC comment letters.

Tamarind Bay's adjusted measures

Tamarind Bay has reported two adjusted measures for years: adjusted operating profit, which adds back restructuring, impairment and acquisition-related costs, and adjusted EBITDA, which also adds back depreciation and amortization. Its credit agreement defines a covenant EBITDA that happens to equal adjusted EBITDA. In 2026 the business development team proposes a new adjustment: excluding 14.0 million of slotting fees paid to a national grocery chain to win shelf space for a new snack line, on the grounds that the fees are a one-off investment.

# Non-GAAP reconciliation for Tamarind Bay Foods, 2026, millions (invented).
# Adjusted EBITDA is reconciled from net income, the most directly comparable GAAP measure.
ni, tax, int_exp, int_inc, da = 80.7, 37.2, 36.6, 3.1, 71.7
adj = [("Goodwill impairment, Frozen reporting unit", 31.0), ("Restructuring", 18.6),
       ("Acquisition-related costs", 2.9), ("Share of earnings of equity method investee", -6.4),
       ("Dividend income", -0.8)]
ebitda = ni + tax + int_exp - int_inc + da
print(f"{'Net income':<46}{ni:>8.1f}")
for n, v in [("Income tax expense", tax), ("Interest expense", int_exp), ("Interest income", -int_inc),
             ("Depreciation and amortization", da)]:
    print(f"{n:<46}{v:>8.1f}")
print(f"{'EBITDA':<46}{ebitda:>8.1f}")
tot = ebitda
for n, v in adj:
    tot += v; print(f"{n:<46}{v:>8.1f}")
print(f"{'Adjusted EBITDA':<46}{tot:>8.1f}")
# Adjusted EPS: after-tax effect of each adjustment, attributable to Tamarind shareholders
ni_attr, shares, rate = 79.5, 120.0, 0.25
aftertax = 31.0 + 18.6 * (1 - rate) + 2.9 - 2.9 * 0.4 * rate - 1.5 * (1 - rate) * 0.20
print(f"\nGAAP basic EPS: {ni_attr / shares:.2f}")
print(f"Adjusted EPS: ({ni_attr} + {aftertax:.2f}) / {shares:.0f} = {(ni_attr + aftertax) / shares:.2f}")
print("Rejected: excluding 14.0 of slotting fees - a normal, recurring cash operating expense")

Net income                                        80.7
Income tax expense                                37.2
Interest expense                                  36.6
Interest income                                   -3.1
Depreciation and amortization                     71.7
EBITDA                                           223.1
Goodwill impairment, Frozen reporting unit        31.0
Restructuring                                     18.6
Acquisition-related costs                          2.9
Share of earnings of equity method investee       -6.4
Dividend income                                   -0.8
Adjusted EBITDA                                  268.4

GAAP basic EPS: 0.66
Adjusted EPS: (79.5 + 47.34) / 120 = 1.06
Rejected: excluding 14.0 of slotting fees - a normal, recurring cash operating expense

The reconciliation starts from net income, the most directly comparable GAAP measure for adjusted EBITDA as a performance measure, and works up to adjusted EBITDA of 268.4 million, which happens to equal the covenant definition in the credit agreement. Adjusted EPS starts from GAAP net income attributable to Tamarind Bay and adds the after-tax effect of each adjustment, net of the non-controlling interest's share; the goodwill impairment is added in full because it is not deductible. The release must present GAAP EPS of 0.66 with at least equal prominence to adjusted EPS of 1.06, and explain why each measure is useful.

The slotting fee proposal fails. Slotting fees are a normal, recurring cost of selling packaged food: Tamarind Bay pays them every time it launches a product or enters a retailer, and lesson 4 shows that they reduce revenue. Excluding them would overstate the profitability of the new line and make the measure misleading. Calling them a one-off investment does not change their nature; every launch is a one-off in isolation. The audit committee rejects the adjustment, and the minutes record why.

Recurring restructuring and other hard cases

Restructuring raises a harder question. Tamarind Bay has reported restructuring charges in each of the last four years: plant consolidation in 2023, a sales reorganization in 2024, warehouse automation in 2025 and the Frozen network review in 2026. Each program is different, but a reader could fairly ask whether restructuring is part of how this company normally operates. The regulators' position is not that recurring charges cannot be excluded, but that they cannot be described as non-recurring, unusual or infrequent, and that the explanation must be honest about the pattern. Tamarind Bay's 2026 disclosure therefore lists the charges for the last four years and explains why management still finds a measure before restructuring useful for comparing the operating performance of the continuing business.

Share-based compensation is a recurring debate. Many technology companies exclude it, arguing that it is non-cash and that its fair value depends on volatile share prices. Critics, including several large investors, reply that paying employees in shares is as much a cost as paying them in cash and that excluding it overstates profitability. Tamarind Bay does not exclude it, which makes its adjusted measures more conservative than some peers'. Whatever a company does, consistency matters: changing the definition of an adjusted measure from year to year to improve the trend is one of the patterns regulators look for, and IFRS 18 requires an explanation of any change in an MPM's calculation, with restated comparatives.

Key performance indicators and other measures

Not every measure is a non-GAAP financial measure. Operating and statistical measures, such as metric tons produced or number of retail doors, are outside Regulation G, though the SEC's 2020 interpretive release on key performance indicators in MD&A expects them to be clearly defined, consistently calculated and accompanied by an explanation of any change. Organic revenue growth and free cash flow are non-GAAP measures, and free cash flow must not be presented in a way that implies it represents residual cash available for discretionary expenditure if mandatory debt payments are not deducted. Segment measures reported under ASC 280 are not non-GAAP measures in the segment note, but they become non-GAAP measures if presented on a consolidated basis outside the note.

Using adjusted measures in pay and covenants

Adjusted measures matter beyond investor communication. Most of Tamarind Bay's annual bonus depends on adjusted operating profit, and its long-term incentive plan uses adjusted EPS. That creates a direct incentive for management to classify costs as adjustments. The compensation committee therefore approves the definition at the start of the year, specifies which kinds of items can be adjusted, and reviews every adjustment at year end, with internal audit testing the calculation. Lenders do the same in a different way: the credit agreement defines covenant EBITDA precisely, caps the add-backs for restructuring at a percentage of EBITDA, and requires a compliance certificate signed by the chief financial officer. When the definitions in pay plans, covenants and public reporting differ, the company must keep three sets of calculations, and analysts must be told which one they are reading.