Tag Archives: auditor independence

Non-GAAP Measures – The Saga Continues

By: George M. Wilson & Carol A. Stacey

The sometimes fuzzy distinction between non-GAAP liquidity measures and non-GAAP performance measures is a major concern of the SEC’s Non-GAAP Compliance and Disclosure Interpretations (C&DI’s) and the comment letters the Staff issues focused on this topic. In the middle of this grey question are EBITDA and “adjusted EBITDA”. Whether these measures are liquidity measures or performance measures can be a very complex, subjective question. To take some of the grey away the SEC included this C&DI in their May 2016 changes:

Question 103.02

Question: If EBIT or EBITDA is presented as a performance measure, to which GAAP financial measure should it be reconciled?

Answer: If a company presents EBIT or EBITDA as a performance measure, such measures should be reconciled to net income as presented in the statement of operations under GAAP. Operating income would not be considered the most directly comparable GAAP financial measure because EBIT and EBITDA make adjustments for items that are not included in operating income. In addition, these measures must not be presented on a per share basis. See Question 102.05.  (emphasis added) [May 17, 2016]

 

The last sentence in this answer is all about the potential confusion between EBITDA and cash flow from operations. GAAP and the SEC guidance specifically prohibit presenting cash flow per share because of the potential confusion between earnings per share and cash flow per share. (This goes all the way back to ASR 142 and old SFAS 95!) EBITDA, even when intended by management as an operations measure, is so close to this line that it cannot be presented on a per share basis.

 

In an interesting sequence of comment letters and responses the SEC has pushed its concerns about these kinds of non-GAAP measures to a new level. After a number of back and forth letters with a registrant focusing on whether a “non-GAAP adjusted net income” was a performance or liquidity measure the staff included this language in a late round comment:

 

Finally, in light of our discussions about this matter, we will evaluate the industry practices you described to us and consider whether additional comprehensive non-GAAP staff guidance is appropriate.

 

It is extremely unusual, as was even reported in The Wall Street Journal on February 13, 2017, to see a statement like this in a comment letter.

 

Even more eyebrow-raising is this comment in the SEC’s closing letter:

 

Although we do not agree with your view, in light of the circumstances, we have completed our review of your filing. We remind you that the company and its management are responsible for the accuracy and adequacy of their disclosures, notwithstanding any review, comments, action or absence of action by the staff. (emphasis added)

 

If you are presenting an EBITDA or similar measure it would be smart to review these letters.

 

You can find the first of the comment letter series here. The company’s responses (CORRESP documents) and the follow-up comment letters (UPLOAD documents) appear in this EDGAR list.

 

As always, your thoughts and comments are welcome.

More Change – Final – Resource Extraction Payment Rule Repealed

By: George M Wilson & Carol A. Stacey

On February 14, 2017 President Trump signed the law eliminating the resource extraction payment disclosure provisions of the Dodd Frank Act.

From:

www.whitehouse.gov/the-press-office/2017/02/14/president-trump-cutting-red-tape-american-businesses

 

GETTING GOVERNMENT OUT OF THE WAY: Today, President Donald J. Trump signed legislation (House Joint Resolution 41) eliminating a costly regulation that threatened to put domestic extraction companies and their employees at an unfair disadvantage.

H.J. Res. 41 blocks a misguided regulation from burdening American extraction companies.

By halting this regulation, the President has removed a costly impediment to American extraction companies helping their workers succeed.

This legislation could save American businesses as much as $600 million annually in regulatory compliance costs and spare them 200,000 hours of paperwork.

The regulation created an unfair advantage for foreign-owned extraction companies.

 

 

As always your comments and thoughts are welcome.

 

Communicate Consistently – It Really Does Matter

By: George M. Wilson & Carol A. Stacey

 
As we discuss in our workshops, it is crucial that companies communicate consistently across all the channels they use. Here are a couple of SEC comments that illustrate this point.

This first comment refers to articles in the news. Yes, the SEC staff does read the paper! This means that companies need to monitor news stories to assure that publically disseminated information is consistent with other disclosures.

General

  1. Recent articles indicate that Yahoo’s November 2014 agreement with Mozilla contains a change-in-control provision that provides Mozilla with the right to receive $375 million annually through 2019 if Yahoo is sold and Mozilla does not deem the new partner acceptable. As this provision appears to take the agreement out of the ordinary course of business, please provide us with your analysis of the materiality of this agreement for purposes of Item 601(b)(10) of Regulation S-K.

 

Here is another frequent theme, how the staff monitors earnings calls and other presentations.

Results of Operations, page II-7

 

  1. We note in your September 8, 2015 earnings call, your chief executive officer made reference to verbal commitments from customers to escalate contract prices when oil prices improve. Given the importance of the price of oil on your results, please tell us and consider disclosing in more detail whether such verbal commitments represent a known event. Refer to Item 303(a)(3)(ii) of Regulation S-K and SEC Release No. 33- 8350.

 

As a parting thought, have all the members of your disclosure committee, and in particular the persons involved in drafting and reviewing MD&A, reviewed your earnings calls as part of their process? (And yes, the second comment is one of our favorite MD&A topics!)

 

As always, your thoughts and comments are welcome!

Non-GAAP Measures – Rise of the Enforcement Message!

By: George M. Wilson & Carol A. Stacey

On January 18, 2017, the SEC ended the speculation about whether or when we would see enforcement actions focused on non-GAAP measures.   MDC Partners, a New York marketing company, paid a fine and consented to an SEC cease-and-desist order without admitting or denying the findings. The case dealt with two issues, non-GAAP measures and failure to disclose certain perks properly. The non-GAAP measure issue related to amounts disclosed for “organic revenue growth” which the company did not calculate consistently from period to period. In addition the company did not present the comparable GAAP measure with equal or greater prominence, as Regulation S-K Item 10(e) requires in an earnings release.

 

Both issues are frequently discussed areas in the SEC’s May 2016 C&DI’s about non-GAAP measures.

 

You can read the related release here.

 

 

Third Annual Form 10-K Tune-Up

As you draft your annual Form 10-K it is always a challenge to be sure that you deal effectively with new and emerging issues and the ever-evolving focus areas of the SEC. Register for our January 23rd One Hour Briefing, Form 10-K Tune-Up. Review the key issues to address in this year’s Form 10-K, including the latest in SEC Staff comments about non-GAAP measures; new accounting standards, revenue recognition, leases and financial instruments.

http://www.pli.edu/Content/Seminar/Third_Annual_Form_10_K_Tune_Up_/_/N-4kZ1z10jog?Ns=sort_date%7c0&ID=301955

More About S-3 and the Transition to the New Revenue Recognition Standard

In a recent post we explored a very complex securities registration issue within retrospective application of the new revenue recognition standard. (The issue arises with any retrospective application, so it will also arise in the new leasing standard.) In a nutshell the registration issue comes up when you:

 

(1) Adopt the new revenue recognition standard as of January 1, 2018 (assume a December 31 year-end), then

(2) File your March 31, 2018 10-Q and then

(3) File an S-3 to register to sell securities.

 

The S-3 incorporates your 2017 Form 10-K by reference which includes 2015 financial statements. The 2015 financial statements would not normally be retrospectively adjusted for the new revenue recognition standard. In this case though that could be necessary. You can read all the technical details here.

 

This first post led to a really interesting question from a reader. What happens if you file the S-3 before you file your March 31, 2018 10-Q? We explored the issue in this post.

 

This then led to a really great comment from another reader. In our workshops we always emphasize building research skills and using all the relevant SEC resources, especially the CorpFin Financial Reporting Manual (FRM). This really astute reader found this section in Topic 13 of the FRM:

 

13110.2  In the case of a registration statement on Form S-3, Item 11(b)(ii) of that form would specifically require retrospective revision of the pre-event audited financial statements that were incorporated by reference to reflect a subsequent change in accounting principle (or consistent with staff practice, discontinued operations and changes in segment presentation) if the Form S-3 also incorporates by reference post-event interim financial statements. If post-event financial statements have not been filed, the registrant would not revise the pre- event financial statements in connection with the Form S-3, however, pro forma financial statements in accordance with Article 11 of Regulation S-X may, in certain circumstances, be required. In contrast, a prospectus supplement used to update a delayed or continuous offering registered on Form S-3 (e.g., a shelf takedown) is not subject to the Item 11(b)(ii) updating requirements. Rather, registrants must update the prospectus in accordance with S-K 512(a) with respect to any fundamental change. It is the responsibility of management to determine what constitutes a fundamental change.

 

 

Here there is at least some relief for the S-3 filed after year-end but before the Form 10-Q is filed! As a reminder S-X Article 11 contains this requirement:

 

  • 210.11-01   Presentation requirements.

(a) Pro forma financial information shall be furnished when any of the following conditions exist:

………………….

(Note: (1) to (7) omitted)

(8) Consummation of other events or transactions has occurred or is probable for which disclosure of pro forma financial information would be material to investors.

 

Some judgment will be required to make that decision! If the effect of the new revenue recognition standard is large enough, it could well be material to investors.

 

Similarly, for the S-3 shelf takedown S-K 512(a) includes this requirement (in bullet ii):

 

(ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement.

 

Again, some judgment will be required to make that decision!

 

Thanks to both the readers who contributed to this discussion, and as always your thoughts and comments are welcome!

 

A Really Good Question – Form S-3 and the New Revenue Recognition Standard

In a recent post we discussed a potential complication in the registration process and Form S-3 in particular if you retrospectively implement the new revenue recognition standard. You can review the post here. The issue arises if you file an S-3 in 2018 after you adopt the new revenue recognition standard but before your 10-K for 2018 is filed. The 2018 Form 10-K will have annual financial statements for 2018, 2017 and 2016 retrospectively applying the new standard. However, if you file an S-3, or have an S-3 shelf registration in place, before you file the 2018 Form 10-K, your S-3 would be required to have three fiscal years, now 2017, 2016 and 2015 that apply the new standard.

Thus, you could be required to report an extra year, 2015, on the new revenue recognition standard if you want to access the capital markets with an S-3, or an S-3 shelf registration, during 2018.

Whether or not the SEC can or will have any relief from this issue is not finalized. So stay tuned!

In our post we set up the example with an S-3 filed after the first-quarter 2018 form 10-Q is filed.

This all lead to a really great question from a reader:

 

In the hypothetical, if an issuer were to file an S-3 in the first quarter of 2018 (before its 3Q financials go stale and before the 2018 10-Q is filed), does Item 11 of Form S-3 require the company to file an 8-K with its recast 2015 financials reflecting the full retrospective adoption of the new standard before the issuer may take-down securities?

The answer to this question? Well, there is not a detailed rule anywhere that deals with the issue.

We researched the question and the closest guidance we could find was in the CorpFin Financial Reporting Manual Topic 11:

“Companies may transition to ASU No. 2014-09 and IFRS 15 (collectively, the “new revenue standard”) using one of two methods:

Retrospectively to each prior period presented, subject to the election of certain practical expedients (“full retrospective method”). A calendar year-end company that adopts the new revenue standard using this method must begin recording revenue using the new standard on January 1, 2018. In its 2018 annual report, the company would revise its 2016 and 2017 financial statements and record the cumulative effect of the change recognized in opening retained earnings as of January 1, 2016.

Retrospectively with the cumulative effect of initially applying the new revenue standard recognized at the date of adoption (“modified retrospective method”). A calendar year-end company that adopts the new revenue standard using this method must begin recording revenue using the new standard on January 1, 2018. At that time, the company must record the cumulative effect of the change recognized in opening retained earnings and financial statements for 2016 and 2017 would remain unchanged. The standard also sets forth additional disclosures required by companies that adopt the new standard using this method.

That language sure sounds like if you file after January 1, 2018, you need three years, 2015, 2016 and 2017 based on the new standard.

That said, stay tuned, we will all continue our research! And what is more fun than a really deep SEC research question?

As always, and especially with this one, your thoughts and comments are welcome!

Brexit and your Second Quarter 10-Q

In the massive press coverage about “Brexit” one of the most frequently used words is “uncertainty”. While the impact of Brexit will differ from company to company it is important, as we come to the end of the June 30, 2016 quarter (or whenever your next quarter end will be), to think about whether the vote and the resulting uncertainty should be dealt with in your SEC reporting.

 

The two most straightforward issues are likely risk factors and MD&A known trends.

 

The risk factor disclosure in Part II Item 1A of 10-Q refers back to S-K 503(c) and requires disclosure of what makes owning your company’s securities “speculative or risky”. Companies should consider whether the uncertainties and already known impacts of Brexit increase risk and deserve mention in risk factors.

 

When a risk factor becomes more probable of having a material impact the risk factor should transmogrify into an MD&A “known trend” disclosure. This disclosure is required when there are “known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” (S-K Item 303). There are similar known trend disclosures for liquidity and capital resources. If you could be affected by market uncertainty, reasonably possible changes in exchange rates or other impacts of Brexit this disclosure may be necessary in MD&A. Lots of judgment here.

 

It is always important to remember that the “reasonably expects” probabilistic test in FR 36 requires disclosure if you cannot say the trend is “not reasonably likely” to come to fruition. (Sorry for the double negative, but it is in the test!). So if there is a 50/50 chance of a material impact, disclosure should likely be made.

 

Lastly, beyond these two issues there are a wealth of other possible accounting and disclosure ramifications, ranging from issues such as possible elevated risk of impairment to tax consequences, depending on your circumstances.

 

As always, your thoughts and comments are welcome.

Form S-3 and the New Revenue Recognition Standard

The new revenue recognition standard allows for two transition methods. One is a kind of hybrid “retrospective with a cumulative effect” approach, where in the year of adoption a company records the cumulative effect and goes forward (with some significant “old GAAP” disclosures). The other is full retrospective implementation.

The full retrospective implementation comes with a lot of baggage beyond the amount of work it might require.

One question is what about the five-year summary? In Form 10-K is it necessary to retrospectively adjust the two earliest years in the five year summary along with the three years in S-X audited financial statements? The SEC staff has addressed this question and said this is not necessary. The CorpFin Financial Reporting Manual now states:

11100 REGISTRANT FINANCIAL INFORMATION

 

11100.1 Selected Financial Data

 

Question

A registrant elects to adopt the new revenue standard using the full retrospective approach. Must it apply the new revenue standard when reporting selected financial data (S-K Item 301)) for periods prior to those presented in its retroactively-adjusted financial statements?

 

Answer

No, but registrants must provide the information required by Instruction 2 to S-K Item 301 regarding comparability of the data presented.

This second question is a lot more intricate. What if a company does an S-3 after the first quarter of implementation? To set this issue up, here is a fact set:

Company year-end: December 31

Revenue Recognition Standard adoption date: January 1, 2018

Full retrospective method of adoption is used. In this method, for the 2018 Form 10-K the years 2016, 2017 and 2018 would be presented using the new revenue recognition standard.

Now assume that in 2018 (thus before the December 2018 Form 10-K is filed), the company reports for the first quarter of 2018 and files Form 10-Q on April 30, 2018. If the company then files an S-3 to raise capital on May 31, 2018, the previous Form 10-K for the year ended December 31, 2017, would be incorporated into the Form S-3. That Form 10-K would have financial statements for 2017, 2016 and 2015. The financial statements for 2015 are the key issue here, as they would not be required in the December 31, 2018 Form 10-K. But, since they are incorporated into the S-3 and the company has adopted the new revenue recognition standard, Item 11(b) in Form S-3 will apply (emphasis added):

 

Item 11. Material Changes.

 

(a) Describe any and all material changes in the registrant’s affairs which have occurred since the end of the latest fiscal year for which certified financial statements were included in the latest annual report to security holders and which have not been described in a report on Form 10-Q (§249.308a of this chapter) or Form 8-K (§249.308 of this chapter) filed under the Exchange Act.

 

(b) Include in the prospectus, if not incorporated by reference therein from the reports filed under the Exchange Act specified in Item 12(a), a proxy or information statement filed pursuant to Section 14 of the Exchange Act, a prospectus previously filed pursuant to Rule 424(b) or (c) under the Securities Act (§230.424(b) or (c) of this chapter) or, where no prospectus is required to be filed pursuant to Rule 424(b), the prospectus included in the registration statement at effectiveness, or a Form 8-K filed during either of the two preceding years:

 

(i) information required by Rule 3-05 and Article 11 of Regulation S-X (17 CFR Part 210);

 

(ii) restated financial statements prepared in accordance with Regulation S-X if there has been a change in accounting principles or a correction in an error where such change or correction requires a material retroactive restatement of financial statements;

 

(iii) restated financial statements prepared in accordance with Regulation S-X where one or more business combinations accounted for by the pooling of interest method of accounting have been consummated subsequent to the most recent fiscal year and the acquired businesses, considered in the aggregate, are significant pursuant to Rule 11-01(b), or

 

(iv) any financial information required because of a material disposition of assets outside the normal course of business.

 

This would seem to require that the new revenue recognition standard be applied to the year ended December 31, 2015.

Not a happy outcome!

This question has come up in earlier accounting standard transitions, and the SEC Staff is clearly aware of this issue. Wes Bricker, Deputy Chief Accountant, said this in a recent speech:

“I am also aware that registrants have expressed concern about the requirement to provide restated financial statements when a Form S-3 registration statement is filed after the registrant has filed its first Form 10-Q reflecting adoption of the revenue standard. This requirement to restate the financial statements means that companies that adopt the revenue standard under a full-retrospective transition approach would be required to restate an additional year in its Form S-3 to show the effect of the new revenue standard on that earlier period.

While this issue is not specific to the new revenue standard, the pervasive impact of the new revenue standard amplifies the issue.

To this, I would observe the transition provisions in the new revenue standard reference existing GAAP, which provides for an impracticability exception to retrospective application if, for example, a company is unable to apply the requirement after making every reasonable effort to do so. OCA is available for consultation if a registrant believes that, based on its facts and circumstances, a retrospective application of the new revenue recognition standard to all periods required to be presented in a Form S-3 is impracticable.”

The actual language he refers to in the excerpt above is from ASC 250:

250 – 10 – 45 – 5

An entity shall report a change in accounting principle through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so.

And:

Impracticability

250 – 10 – 45 – 9

It shall be deemed impracticable to apply the effects of a change in accounting principle retrospectively only if any of the following conditions exist:

  1. After making every reasonable effort to do so, the entity is unable to apply the requirement.
  2. Retrospective application requires assumptions about management’s intent in a prior period that cannot be independently substantiated.
  3. Retrospective application requires significant estimates of amounts, and it is impossible to distinguish objectively information about those estimates that both:
  4. Provides evidence of circumstances that existed on the date(s) at which those amounts would be recognized, measured, or disclosed under retrospective application
  5. Would have been available when the financial statements for that prior period were issued.

That’s where this issue is for now, and this could well be a problematic issue for any company raising capital in the year of adoption of the new revenue recognition standard!

As always, your thoughts and comments are welcome!

Cybersecurity’s “Evilution”

In our tech involved world the risk of cyber attack is constantly transmogrifying into ever more complex and evil modes. From phishing to ransomware to who knows what next, this risk is constantly changing.

 

To help you keep up-to-date with regulatory issues concerning this risk and to help make appropriate disclosures PLI is presenting a new One-Hour Briefing: Cybersecurity in the Age Of Regulators Gone Wild

 

You can read all about the briefing at:

 

http://www.pli.edu/Content/Seminar/Cybersecurity_in_the_Age_of_Regulators_Gone/_/N-4kZ1z10qbc?Ns=sort_date%7c0&ID=286898

 

 

As always, your thoughts and comments are welcome!