Tag Archives: Comment Letters

Frequent Comment Update: Part Two – Cash Flows

By: George M. Wilson & Carol A. Stacey

 

In our blog post “Time Again for a Frequent Comment Update”, we listed the frequent comment areas that CorpFin Staff members have been discussing at our Midyear Forums. In that post, we also highlighted a number of recent comments about non-GAAP measures. In this post, we turn our attention to comments about the statement of cash flows.

 

In the last several years there have been a number of restatements related to the statement of cash flows, some undoubtedly related to comment letters. Additionally, the FASB and EITF have issued two ASU’s to address various issues in the statement of cash flows.

 

ASU 2016-15 in August 2016

Provides guidance on 8 specific cash flow issues

 

ASU 2016-18 in November 2016

Provides guidance on classification and presentation of restricted cash

 

 

There is much discussion about root causes for cash flow statement problems. Theories range from the idea that the statement is prepared late in the reporting process and perhaps tends to be a more mechanical, “do it the way we did it last year” process, to the fact that there are some areas that are ambiguous in the cash flow statement guidance. Whatever the causes, there is clearly a need for care and review in preparing the statement of cash flows.

 

This first comment is about being sure you are familiar with the statement of cash flow requirements and also addresses a frequent problem area of ASC 230, discontinued operations:

 

We note your presentation of the decrease in cash and cash equivalents from discontinued operations in one line item. Please note that ASC 230-10-45-10 requires that a statement of cash flows shall classify cash receipts and cash payments as resulting from investing, financing, or operating activities. Please revise your current presentation to classify the cash flows from discontinued operations within each of the operating, investing and financing categories.

 

Whether to show cash flows from financing activities on a gross or net basis is not a mechanical decision. It requires judgment about the substance of the financing as this comment demonstrates:

 

We note from your financing activities section in your statement of cash flows that you present net proceeds (repayments) of short-term borrowings rather than on a gross basis. Please explain to us your basis for this presentation. Refer to ASC 230-10-45-7 through 9.

 

Another interesting aspect of cash flow statement preparation is how to treat hybrid items that have an element of two different types of cash flows. This comment demonstrates this is not always a mechanical process:

 

We note your presentation of payments for the costs of solar energy systems, leased and to be leased. Given that approximately 61% of your revenues for the year ended December 31, 2015 and 64% of your revenues for the period ended June 30, 2016 represented solar energy systems and product sales, please tell us how you reflect the costs of solar energy systems sold on your statements of cash flows pursuant to ASC 230.

 

These last two comments are not strictly speaking financial statement comments. They are common MD&A comments, and definitely needs to be part of the statement of cash flows conversation. Frequently MD&A tries to explain operating cash flows with confusing or mechanical language relating to items in the indirect method reconciliation from net income to operating cash flows.

 

Note the mention of drivers in this comment:

 

We note that your discussion of cash flows from operating activities is essentially a recitation of the reconciling items identified on the face of the statement of cash flows. This does not appear to contribute substantively to an understanding of your cash flows. Rather, it repeats items that are readily determinable from the financial statements. When preparing the discussion and analysis of operating cash flows, you should address material changes in the underlying drivers that affect these cash flows. These disclosures should also include a discussion of the underlying reasons for changes in working capital items that affect operating cash flows. Please tell us how you considered the guidance in Section IV.B.1 of SEC Release 33-8350.

 

Lastly, note the focus on underlying reasons for change in this comment:

 

You say that in the statement of cash flows, you provide reconciliation from net loss to cash flows used in operating activities where you have provided quantitatively the sources of your operating cash flows. However, as you use the indirect method to prepare your cash flows from operating activities, merely reciting changes in line items reported in the statement of cash flows is not a sufficient basis for an investor to analyze the impact on cash. Therefore, please expand your disclosure of cash flows from operating activities to quantify factors to which material changes in cash flows are attributed and explain the underlying reasons for such changes. Refer to Section IV.B.1 of “Interpretation: Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations” available on our website at http://www.sec.gov/rules/interp/33-8350.htm for guidance. Provide us a copy of your intended revised disclosure.

 

 

As always, your thoughts and comments are welcome!

Time Again for a Frequent Comment Update

By: George M. Wilson & Carol A. Stacey

Every six months, when we do our Midyear Forums in May and June and again when we do our Annual Forums in November and December, we discuss the SEC Division of Corporation Finance’s presentation of frequent comment areas. At our recent Midyear in Dallas the staff discussed the topics below, which are not in any particular order:

 

  • Non-GAAP Measures
  • Statement of Cash Flows
  • Segments
  • Income Taxes
  • Business Combinations
  • Fair Value
  • Goodwill
  • Revenue Recognition
  • Disclosure of Recently Issued Standards
  • Compensation
  • Internal Control over Financial Reporting

 

As usual the list contains many familiar topics and themes. In the next several weeks we will post about each of these topics.

 

For this first post, we’ve chosen non-GAAP measures which shouldn’t be a surprise. We are all likely familiar with the SEC’s focus on this area and the C&DI’s they issued in May 2016. For our review here we thought we would explore three of the more problematic C&DI’s and recent staff comments for each of them:

 

Question 100.01, which is about whether or not presentation of certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading,

 

Question 100.04, which is about attempts to build tailored accounting principles that are not in accordance with GAAP, and

 

Question 102.10, which discusses “equal or great prominence”.

 

 

When is an Adjustment Misleading, Even if it is Not Specifically Prohibited?

 

The full text of this C&DI is:

 

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]

 

 

The idea of “normal, recurring, cash operating expenses” can be subjective. Here is an example where that C&DI is translated into a comment:

 

We note that you exclude pre-opening expenses as part of your calculation of Adjusted EBITDA. Please explain to us why these are not normal, recurring, cash operating expenses necessary to operate your business. In this regard, we note pre-opening expenses for all periods presented, along with your discussion throughout the Form S-1 that your growth strategy is to expand the number of your stores from 71 to 400 within the next 15 years. Please refer to Question 100.01 of the updated Non-GAAP Compliance and Disclosure Interpretations issued on May 17, 2016.

 

Here is another similar example:

 

Management’s Discussion and Analysis Earnings Before Interest, Taxes, Depreciation and Amortization (Non-GAAP measure)

 

Please tell us how you concluded that the amounts in the acquisition-related adjustments reconciling item were appropriately excluded from your non-GAAP measures (e.g., adjusted EBITDA, adjusted gross margin and adjusted SG&A) presented here and in your Item 2.02 Forms 8-K filed October 25, 2016 and December 8, 2016. It appears that in each period presented you may be reversing a portion of your GAAP rental expense and removing recurring cash operating expenses, like sponsor fees and other costs. Refer to Non-GAAP Financial Measures Compliance and Disclosure Interpretation, Questions 100.01 and 100.04, which can be found at:

 

http://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm.

 

What is a Tailored Accounting Principle?

 

The full text of the C&DI is:

 

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]

 

Here are two comments to illustrate that a company should not try to tinker with GAAP to create their own accounting principles. This first comment is an attempt to adjust revenue recognition so that a non-GAAP measure would include revenue that is deferred under GAAP:

 

  1. We note your response to prior comment 4. The adjustment “change in deferred amusement revenue and ticket liability” in arriving at your non-GAAP measure “adjusted EBITDA” appears to accelerate the recognition of revenue associated with the deferred amusement and ticket liability that otherwise would not be recognized in any of the periods for which adjusted EBITDA is presented. Accordingly, adjusted EBITDA substitutes a tailored revenue recognition method for that prescribed by GAAP and does not comply with Question 100.04 of the staff’s Compliance & Discussion Interpretations on Non-GAAP Financial Measures. Please remove this adjustment from your computation.

 

This second comment shows an attempt to undo business combination accounting:

 

Refer to the line items, ‘purchase accounting adjustments,’ and ‘purchase accounting amortization’ within the reconciliation of net income to adjusted income before income taxes. Please explain to us the basis behind these adjustments as they appear to portray tailored accounting principle under GAAP for business combination. Refer to the guidance under Questions 100.01 and 100.04 of C&DI on Non-GAAP Financial Measures.

 

What Does Equal or Greater Prominence Mean?

 

The text of this much-discussed C&DI is:

 

Question 102.10

 

Question: Item 10(e)(1)(i)(A) of Regulation S-K requires that when a registrant presents a non-GAAP measure it must present the most directly comparable GAAP measure with equal or greater prominence. This requirement applies to non-GAAP measures presented in documents filed with the Commission and also earnings releases furnished under Item 2.02 of Form 8-K.  Are there examples of disclosures that would cause a non-GAAP measure to be more prominent?

 

Answer: Yes. Although whether a non-GAAP measure is more prominent than the comparable GAAP measure generally depends on the facts and circumstances in which the disclosure is made, the staff would consider the following examples of disclosure of non-GAAP measures as more prominent:

 

Presenting a full income statement of non-GAAP measures or presenting a full non-GAAP income statement when reconciling non-GAAP measures to the most directly comparable GAAP measures;

 

Omitting comparable GAAP measures from an earnings release headline or caption that includes non-GAAP measures;

 

Presenting a non-GAAP measure using a style of presentation (e.g., bold, larger font) that emphasizes the non-GAAP measure over the comparable GAAP measure;

 

A non-GAAP measure that precedes the most directly comparable GAAP measure (including in an earnings release headline or caption);

 

Describing a non-GAAP measure as, for example, “record performance” or “exceptional” without at least an equally prominent descriptive characterization of the comparable GAAP measure;

 

Providing tabular disclosure of non-GAAP financial measures without preceding it with an equally prominent tabular disclosure of the comparable GAAP measures or including the comparable GAAP measures in the same table;

 

Excluding a quantitative reconciliation with respect to a forward-looking non-GAAP measure in reliance on the “unreasonable efforts” exception in Item 10(e)(1)(i)(B) without disclosing that fact and identifying the information that is unavailable and its probable significance in a location of equal or greater prominence; and

 

Providing discussion and analysis of a non-GAAP measure without a similar discussion and analysis of the comparable GAAP measure in a location with equal or greater prominence. [May 17, 2016]

 

This C&DI created perhaps the most confusion, or maybe consternation, raising issues of what is bolded and which measure is presented first. This first example comment is about a recent earnings release:

 

Your headline references “Record Q1 Non-GAAP Revenues and EPS, Growing 29% and 44% Respectively Year-over-Year” but does not provide an equally prominent descriptive characterization of the comparable GAAP measure. We also note several instances where you present a non-GAAP measure without presenting the comparable GAAP measure. This is inconsistent with Question 102.10 of the updated Compliance and Disclosure Interpretations issued on May 17, 2016 (“the updated C&DI’s”). Please review this guidance when preparing your next earnings release.

 

This second example is from a recent MD&A:

 

Management’s Discussion and Analysis Non-GAAP Measures

 

Return on Invested Capital, page 47

 

Please present the comparable GAAP measure with equal or greater prominence and label the non-GAAP calculation as “adjusted” or similar. Refer to Item10(e)(1)(i)(A) and Question 102.10 of staff’s Compliance and Discussion Interpretation on Non-GAAP Financial Measures for guidance.

 

And this last comment is from a 2016 earnings release:

 

  1. We have the following observations regarding the non-GAAP disclosures in your fourth quarter 2016 earnings release:

 

  • Your statement of “net sales growth across all segments” in the earnings release headline is inconsistent with the segment results table on page 3 and appears to be based on pro forma adjusted results excluding foreign currency translation impact. In this regard, we note that both the Consumer and Other segments had a decrease in the reported net sales in 2016.

 

  •  It appears that you provide earnings results discussion and analysis of only non- GAAP measures in the body of the release without providing a similar discussion and analysis of the comparable GAAP measures.

 

  •  The measure you refer to as “free cash flow” is adjusted for items in addition to what is commonly referred to as free cash flow.

 

Please revise future filings to use titles or descriptions for non-GAAP financial measures that accurately reflect the amounts presented or calculated, and are not the same as, or confusingly similar to, GAAP measures. Also, to the extent you continue to discuss your results based on non-GAAP measures, you should also provide the comparative measures determined according to GAAP with equal or greater prominence. Refer to Question 102.10 of the updated Compliance and Disclosure Interpretations issued on May 17, 2016.

 

Stay tuned for our next topic, the statement of cash flows next week, and as always, your thoughts and comments are welcome!

A Bit of SEC News and a Hopefully Enjoyable Video

By: George M. Wilson & Carol A. Stacey

In the first few weeks of the new Administration there was news from the SEC including reconsideration of the Conflict Minerals and Pay Ratio disclosures as well as the legislative repeal of the Resource Extraction Payment disclosure.

While there have not been as many highly publicized developments in recent weeks, the Commission is continuing its normal business. A final rule for Hyperlinks to Exhibits, a proposal to for Inline XBRL, approving an XBRL Taxonomy for IFRS, and a Request for Comment to consider changes to Bank Holding Company Disclosures in Guide 3 are a few of the normal course of business things going on at the SEC. The Enforcement Division continues its normal process with cases ranging from an auditor trading on inside information to a Ponzi scheme involving resale of Hamilton tickets. And, of course, CorpFin continues its review program, and after reviewing over 50% of all companies last year it will be interesting to see the numbers this year.

In a way, especially with so many of our SEC reporting community working on year-end and quarter-end reports, it is nice to have a normal flow of work from the SEC instead of big stories!

So, enjoy the lull! And, to have a bit of fun in this lull, here is a hopefully entertaining diversion. The SEC’s Office of Investor Education and Advocacy has, via its investor.gov website, produced a number of educational videos for investors. This one, titled “Don’t let someone else live the life you’ve been saving for”, is particularly entertaining! Enjoy!

https://youtu.be/59iJmRDdeqY

 

As always, your thoughts and comments are welcome!