Tag Archives: Finance

A Fall Return to Our Comment of the Week (or So) Blog Posts

Now that summer vacation is over, and we’ve gotten through a very busy September with lots of SECI programs, we are ready to resume our comment of the week blog posts.

One topic in the news, thanks to all the political campaigning underway, is taxes. As the candidates discuss their plans to reform the tax code, we thought it would make sense to explore in a bit more depth Corp Fin’s comments about tax issues. As you likely know this has been a “frequent comment” hot topic for a while.

Here is a first comment, and a frequent theme in comments, international taxes. As you’ll see, the staff frequently asks for more detail about reconciling items. All of this of course to help readers understand the likelihood of such rates being sustainable.

2. We note from your disclosure in Note 9 that there is a significant reconciling item in the effective income tax reconciliation due to differences between foreign and United States statutory rates, which are primarily attributable to your Luxembourg holding company structure and tax rulings received from Luxembourg tax authorities. Please tell us the nature of the items included in the reconciling line item titled “differences between foreign and U.S. statutory rates.” Also, please provide us with the pre-tax income, statutory rate, and effective tax rate in Luxembourg for all periods presented. Additionally, please tell us the nature of the factors that are driving the changes in this line item from year to year, including the nature of any significant tax rulings.

This second comment in the tax arena is about tax benefits, and even mixes international issues along with the recoverability issue. You can almost hear the next comment asking about “positive and negative” evidence.

  1. Please tell us the facts and circumstances associated with the extraterritorial income tax benefit recognized in each of 2014 and 2013, including the basis for the amount recognized and changes therein. Also, tell us the nature of the reserve applied against such benefits and the amount of the reserve for each year.

Notice how this comment combines domestic versus foreign tax issues along with the theme of disaggregation:

  1. Please revise to disclose the components of income before income taxes as either domestic or foreign. See guidance in Rule 4-08(h) of Regulation S-X. Also, we note that in your reconciliation between the federal statutory rate and the effective income tax rate disclosed in Note L, foreign and state income taxes are combined in one line item. Please note that if either of these items (foreign income taxes or state income taxes) affect the statutory tax rate by more than 5% (either positively or negatively) they should be separately presented on the reconciliation.

And, in this last comment, the significant question of the repatriating the earnings of foreign operations is murky and the staff asks for clarification in disclosure.

  1. You disclose in note 15 that the income tax provision in fiscal 2014 includes $33.7 million of U.S. income and applicable foreign withholding taxes on dividends of $473.7 million due to repatriating foreign subsidiaries earnings to the U.S. parent entity to fund the share repurchase program. You also disclose you have not provided for U.S. and foreign withholding taxes on $471 million of accumulated undistributed earnings of foreign subsidiaries at February 1, 2015 because you intend to reinvest these earnings for the foreseeable future. It is not clear from your present disclosures how management overcame the presumption that all undistributed earnings of subsidiaries will be transferred to the parent and therefore require the accrual of an income tax payable as outlined in ASC 740-30-25-3. Please tell us how you have determined that you have both the ability and intent to indefinitely prevent accumulated undistributed foreign earnings from being repatriated without tax consequences. See ASC 740-30-25-17 and 25-18. In doing so, tell us the following:
    • Explain the specific evidence (e.g. experience of the entity, definite future plans and past remittances, etc.) to substantiate the parent’s assertion of the indefinite postponement of remittances from foreign subsidiaries;
    • Identify the entities and periods where the parent claims permanent reinvestment;
    • Tell us why you have not disclosed that the remittance of undistributed earnings is postponed indefinitely as opposed to the foreseeable future, which is the point used in ASC 740-30-25-19 to describe when it is apparent that a temporary difference reverses and a deferred tax liability is required to be recognized; and
    • Tell us how your decision to repatriate the $473.7 million of funds during 2014 in order to fund your share repurchase program was considered as part of your determination that the $471 million of accumulated undistributed earnings of foreign subsidiaries referenced above continue to be permanently reinvested as of February 1, 2015.

 

Taxes! Well, for now, we will forgo any jokes about how inevitable they are. We do know that tax comments asking for more clarity in disclosure will continue!

 

As always, your thoughts and comments are welcome!

Audit Committee Evolution

Over the last 15 years the role of the audit committee has been discussed, regulated and disclosed in ever increasing and expanding ways.

(Yes, this was true even longer than 15 years ago, but we will focus on the last 15 years for now! Maybe more history later?)

As you have likely heard, in the last several months the SEC and the PCAOB have both been active in developing the next steps of audit committee evolution. All public companies need to deal with these possible changes, and to do that well it helps to have a perspective on how these changes fit into the longer-term change process.

It was way back in pre-SOX years, actually December 1999, that the SEC enacted rules to require the S-K Item 407 Audit Committee Report and related disclosures. Even in this pre-SOX period the importance of the audit committee was clear. The final rule mentions the “Blue Ribbon Committee” that had been formed to deal with this issue:

“We are adopting new rules and amendments to current rules to improve disclosure relating to the functioning of corporate audit committees and to enhance the reliability and credibility of financial statements of public companies. As more fully described in the Proposing Release, the new rules and amendments are based in large measure on recommendations made by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (the “Blue Ribbon Committee”)”

The Sarbanes – Oxley Act continued the evolution of the audit committee’s role. SOX’s provisions went well beyond disclosure, actually impacting audit committee member qualifications, structure and function. It enacted provisions dealing with:

  • Independence of audit committee members
  • The audit committee’s responsibility to select and oversee the issuer’s independent accountant
  • Procedures for handling complaints regarding the issuer’s accounting practices (whistleblower provisions)
  • The authority of the audit committee to engage advisors
  • Funding for the independent auditor and any outside advisors engaged by the audit committee

Because SOX’s changes go well beyond disclosures, the SOX requirements were implemented by requiring the exchanges to put the provisions in their listing rules.

The PCAOB has also been involved in this process and Audit Standard 16, Communications with Audit Committees, formalized the content and timing of the auditor’s communications with the audit committee. This requirement became effective for years beginning after December 15, 2012.

That is all history, prelude to the future.

As audit committees strive to hold themselves to best practices looking to the future is crucial.

So, what might the future hold?

PCAOB “Dialogue”

In May of 2015 the PCAOB also issued a document titled “Audit Committee Dialogue” to formalize issues it considered important for audit committee members to be aware of and deal with in the evolving focus on audit quality. You can find the “Dialogue” at the PCAOB’s under the “Information for Audit Committee Members”tab.:

http://pcaobus.org/Information/Pages/AuditCommitteeMembers.aspx

SEC Concept Release

The SEC issued a broad and potentially far-reaching Concept Release in July. It seeks comment on areas including audit committee oversight of the audit process, how the audit committee selects the auditor and the role of the audit committee in selecting and evaluating key audit team personnel. You can find the concept release at:

www.sec.gov/rules/concept/2015/33-9862.pdf

Auditor Independence

A kind of wild-card issue that is evolving with enforcement cases is how the audit committee deals with auditor independence issues. The days when this was an issuer for only the auditor are clearly over!

These are issues that need some deeper discussion! So, our next few posts will focus on the “Dialogue”, the concept release, independence and other issues.

If you have any topics you would like to see included, as always, your thoughts and comments are welcome!

SEC Pay Ratio Final Rule and What to Do?

 As you doubtless have heard, the SEC, in a split vote, approved the Dodd/Frank mandated “Pay Ratio Rule” on August 5. And yes, there is a lot of politics and a lot of discussion going on about the rule.

Companies will, after the discussion is over, have to deal with all the challenges of actually implementing the rule! To help, we have already scheduled a program, “SEC’s Pay Ratio Rule:  What Companies Need to do to Prepare”, which will be webcast on October 15, 2015. You can get the details about the program at:

www.pli.edu/Content/Seminar/SECs_Pay_Ratio_Rule_What_Companies_Need_to/_/N-4kZ1z11asm?fromsearch=false&ID=263557

As always, your thoughts and comments, even the political ones, are welcome!

The Mystery of Public Float (or, Does Everything have to be Gray?)

A question that frequently arises in our workshops is how to compute the “public float” number that is used to determine whether a company is a large accelerated, accelerated or non-accelerated filer. This is an important computation as it determines deadlines, SOX external audit requirements and Smaller Reporting Company status. The SEC also sometimes uses it when they phase in new rules. This number is disclosed on the cover page of Form 10-K, and is more formally called “common equity held by non-affiliates”.

While this might at first seem like a nice, simple, mechanical computation, like so many of the issues we deal with in the SEC world, it can get gray!

The whole process starts with this definition from Exchange Act Rule 12b-2:

Accelerated filer and large accelerated filer—

  • Accelerated filer. The term accelerated filer means an issuer after it first meets the following conditions as of the end of its fiscal year:

(i)The issuer had an aggregate worldwide market value of the voting and non-voting common equity held by its non-affiliates of $75 million or more, but less than $700 million, as of the last business day of the issuer’s most recently completed second fiscal quarter;

(ii) The issuer has been subject to the requirements of section 13(a) or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) for a period of at least twelve calendar months;

(iii) The issuer has filed at least one annual report pursuant to section 13(a) or 15(d) of the Act; and

(iv) The issuer is not eligible to use the requirements for smaller reporting companies in part 229 of this chapter for its annual and quarterly reports.

The definition of Large Accelerated filer is exactly the same except the dollar threshold is raised to $700 million. This rule also contains the definition of a smaller reporting company. You can find the complete exchange act rule at:

www.ecfr.gov/cgi-bin/text-idx?SID=8e0ed509ccc65e983f9eca72ceb26753&node=17:4.0.1.1.1&rgn=div5#se17.4.240_112b_62

The same information comes into play on the cover page of Form 10-K, in these familiar sections from the instructions to the form:

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

[] Large accelerated filer                                                                   [] Accelerated filer

[] Non-accelerated filer                                                                     [] Smaller reporting company
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.

So, what we commonly refer to as “public float” is, in the SEC’s guidance, defined as “aggregate market value of the voting and non-voting common equity held by non-affiliates”. To properly compute this number, there are two more definitions we need to deal with, both again from Exchange Act Rule 12b-2:

Affiliate. An “affiliate” of, or a person “affiliated” with, a specified person, is a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified.

Control. The term “control” (including the terms “controlling,” “controlled by” and “under common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.

Now, to the computation! First, we must compute the number of shares “held by non-affiliates”. The logical starting point is total number of shares outstanding. Treasury shares that have not been canceled are clearly held by an “affiliate”, that is the company itself, and are omitted from the calculation. Once the total shares outstanding is computed, the next step is to determine how many of these shares are held by “affiliates”.

Here is where the number can get a bit gray!

The definition of affiliate is clearly subjective. What does it mean, as in the definition above, to be a person who “directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified”?

When the definition of control above, that is control means “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise”, is factored into this determination, it is even more gray!

The categories of people who will fall into the affiliate category would clearly include all the company’s directors, as they “direct or cause the direction of management and policies” for the company. Additionally, executive officers, those officers with a policy or strategy setting role, are also clearly affiliates.

Major shareholders of the company may not fall as clearly into the definition of an affiliate. Generally, if a person owns enough shares, they have an ability to impact on the board and management. They may be able to “direct or cause the direction of management or policies”. In this day of activist shareholders, that is very clear. But there is no simple bright line for this determination. Judgment must be used. And, in very close cases, since this is in essence a legal determination, it may be appropriate to consult with counsel!

So, to get the shares held by non-affiliates, excluding shares held be directors and executive officers is fairly clear, shares held by major shareholders will require some judgment!

The next question is why do we use the price on the last business day of the most recently completed second fiscal quarter? We will leave that question our next post!

As always, your thoughts and comments are welcome!

Cybersecurity – Help Managing the Risk

Cybersecurity risk continues to be in the news. The nature and severity of cybersecurity breaches seem to grow in severity and complexity. Both preventive and remedial cybersecurity related costs are continually increasing in our business environment. Fortunately, the tools available to manage cybersecurity risk also continue to evolve. The magnitude of this risk is so large that some companies view cybersecurity breaches all but inevitable!

In this changing world we are presenting a cybersecurity focused conference in September. The conference is titled “Cybersecurity 2015: Managing the Risk”. You can learn more about the program, which will be webcast, and review the agenda at:

www.pli.edu/Content/Seminar/Cybersecurity_2015_Managing_the_Risk/_/N-4kZ1z128nw?fromsearch=false&ID=225691

As always, your thoughts and comments are appreciated!

Hertz has some Hurts!

A major restatement by Hertz has been in the news in recent weeks, and thanks to two of our community, Bill Story and Eric Braschwitz, for their timely heads up notice about this restatement. Hertz was late with their 2014 10-K, filing it in early July. And it is a major restatement.

The magnitude of the issues, the nature of the organizational issues involved, the impact that leadership had on financial reporting, and all the other issues that seem to be at the root of this restatement are old stories, and somehow seem to harken back to days before SOX. Much has been written about these issues and we won’t rehash them here.

But there is one issue we do want to bring out.

As a preliminary note, if you want to dig into the filings involved, you will find Hertz Global Holdings, which is the publically owned company, and another filer, Hertz, which is the operating company, and is wholly owned by Hertz Global Holdings. You will find the restatement issue in the Form 10-K for each of these businesses.

If you look back at Hertz Global Holdings’ 2013 Form 10-K, you will find this ICFR Report:

ITEM 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures

 (This section is omitted for this blog)

Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act, as amended. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2013. The assessment was based on criteria established in Internal ControlIntegrated Framework 1992 issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2013. PricewaterhouseCoopers LLP, our independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting. Their report is included in this Annual Report under the caption “Item 8—Financial Statements and Supplementary Data.”

So, everything looks like “situation normal” at Hertz. Then, for 2014, here is what happened.

From Hertz’ 2014 10-K, Item 9A is really long, so we will put our concluding comments here.

What?

And, note the focus on tone at the top!

As always, your thoughts and comments are welcome!

 

From Hertz’ 2014 Form 10-K

ITEM 9A. CONTROLS AND PROCEDURES

Restatement of Previously Issued Financial Statements

As described in additional detail in the Explanatory Note to this Annual Report on Form 10-K, in June 2014, we commenced an internal investigation of certain matters related to the accounting during prior periods. The investigation was undertaken by outside counsel, along with independent counsel for the Audit Committee. Counsel received assistance from outside consultants and new senior accounting and compliance personnel. The internal investigation is complete, although our outside counsel and the independent counsel to the Audit Committee continue to provide forensic and investigative support in connection with certain proceedings discussed in Item 3, “Legal Proceedings” and in Item 8, Note 14, “Contingencies and Off-Balance Sheet Commitments” to the consolidated financial statements in this Annual Report on Form 10-K involving our restatements and related accounting for prior periods.

Based on the internal investigation, our review of our financial records, and other work completed by our management, the Audit Committee has concluded that there were material misstatements in the 2011, 2012 and 2013 consolidated financial statements. Accordingly, our Board and management concluded that our consolidated financial statements for these periods should no longer be relied upon and required restatement. The restated consolidated financial statements for 2012 and 2013 are provided in this Annual Report on Form 10-K. The unaudited restated selected data for 2011 is included in Item 6, “Selected Financial Data” in this Annual Report on Form 10-K.

Evaluation of Disclosure Controls and Procedures

Our senior management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined under Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2014, due to the identification of material weaknesses in our internal control over financial reporting, as further described below, our disclosure controls and procedures were not effective to provide reasonable assurance that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.

Management’s Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f).

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management, including our new Chief Executive Officer and our Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework (2013). Based on this assessment, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2014 due to the fact that there are material weaknesses in our internal control over financial reporting as discussed below.

Control Environment

The control environment, which is the responsibility of senior management, helps set the tone of the organization (including a commitment towards openness, honesty, integrity, and ethical behavior), influences the control consciousness of its officers and employees, and is an important component affecting how the organization performs financial analysis, accounting, and financial reporting. A proper organizational tone can be promoted through a variety of means, such as policies and codes of ethics, a commitment to hiring competent employees, the manner and content of oral and written communications, and structures that promote and reward openness, strong internal controls, effective governance, and ethical behavior.

As of December 31, 2014, we did not maintain an effective control environment primarily attributable to the following identified material weaknesses:

  • Our investigation found that an inconsistent and sometimes inappropriate tone at the top was present under the then existing senior management that did not in certain instances result in adherence to accounting principles generally accepted in the United States of America (“GAAP”) and Company accounting policies and procedures. In particular, our former Chief Executive Officer’s management style and temperament created a pressurized operating environment at the Company, where challenging targets were set and achieving those targets was a key performance expectation. There was in certain instances an inappropriate emphasis on meeting internal budgets, business plans, and current estimates. Our former Chief Executive Officer further encouraged employees to focus on potential business risks and opportunities, and on potential financial or operating performance gaps, as well as ways of ameliorating potential risks or gaps, including through accounting reviews. This resulted in an environment which in some instances may have led to inappropriate accounting decisions and the failure to disclose information critical to an effective review of transactions and accounting entries, such as certain changes in accounting methodologies, to the appropriate finance and accounting personnel or our Board, Audit Committee, or independent registered public accounting firm
  • We did not have a sufficient complement of personnel with an appropriate level of knowledge, experience, and training commensurate with our financial reporting requirements to ensure proper selection and application of GAAP in certain circumstances.
  • We did not establish clear reporting structures, reporting lines, and decisional authority responsibilities in the organization.We did not design effective controls over the non-fleet procurement process, which was exacerbated by the lack of training of field personnel as part of our Oracle ERP system implementation during 2013.

These material weaknesses in the control environment resulted in certain instances of inappropriate accounting decisions and inappropriate changes in accounting methodology and contributed to the following additional material weaknesses:

  • We did not design and maintain effective controls over certain accounting estimates. Specifically, we did not design and maintain controls over the effective review of the models, assumptions, and data used in developing estimates or changes made to assumptions and data, related to information technology expenditures; reserve estimates associated with allowances for uncollectible amounts receivable for renter obligations related to damaged vehicles; and accrued unbilled revenue.
  • We did not design and maintain effective controls over the review, approval, and documentation related to journal entries.
  • We did not design and maintain effective controls over changes to our policies and procedures over GAAP, as well as the review, approval, and documentation related to the application of GAAP.

Risk Assessment

We did not effectively design controls in response to the risks of material misstatement. This material weakness contributed to the following additional material weaknesses:

  • We did not design effective controls over certain business processes including our period-end financial reporting process. This includes the identification and execution of controls over the preparation, analysis, and review of significant account reconciliations and closing adjustments required to assess the appropriateness of certain account balances at period end.

Information and Communication

As of December 31, 2014, we did not maintain effective controls over information and communications. Specifically, we did not have an adequate process for internally communicating information between the accounting department and other operating departments necessary to support the proper functioning of internal controls. This material weakness led to misstatements in the capitalization and timing of depreciation of non-fleet capital.

Monitoring

We did not design and maintain effective monitoring controls related to the design and operational effectiveness of our internal controls. Specifically, we did not maintain personnel and systems within the internal audit function that were sufficient to ensure the adequate monitoring of control activities. This control deficiency resulted in some instances of the internal audit function’s failure to identify or sufficiently follow through on the analysis of certain inappropriate accounting decisions and changes in accounting methodology.

One or more of the foregoing control deficiencies contributed to the restatement of our financial statements for the years 2012 and 2013 and each of the quarters of 2013, including the misstatements of direct operating expenses, accounts payable, accrued liabilities, allowance for doubtful accounts, prepaid expenses and other assets, and non-fleet property and equipment and the related accumulated depreciation. Additionally, the foregoing control deficiencies could result in material misstatements of the consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that these control deficiencies constitute material weaknesses.

The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report, which appears in this Annual Report on Form 10-K.

Other Considerations Impacting our Historical Accounting

Our incorrect accounting was caused by the foregoing control deficiencies along with a complex mix of structural and environmental factors. One of those factors was the tone set and pressures imposed by our former Chief Executive Officer, which were inappropriate in certain instances, and may have been a factor influencing one or more employees to record an accounting entry now determined to be improper. Other factors affecting the overall historic accounting environment and employees included the distraction caused by the multiple, conflicting business initiatives; challenges related to managing complex, inefficient legacy systems; the lack of a sufficient complement of personnel with an appropriate level of knowledge, experience, and training with GAAP; unclear reporting structures, reporting lines, and decisional authority in the organization; and other matters. Taken together, these factors fostered a control environment and other control deficiencies that in some instances enabled inappropriate accounting.

Remediation Plan and Status

We have, and continue to, identify and implement actions to improve the effectiveness of our internal control over financial reporting and disclosure controls and procedures, including plans to enhance our resources and training with respect to financial reporting and disclosure responsibilities and to review such actions with the Audit Committee. Leading this process is our Senior Executive Vice President and Chief Financial Officer, who was hired in December 2013 and is being assisted by our new Chief Accounting Officer, who was hired in May 2014.

During 2014 and 2015, we have hired personnel with the appropriate experience, certification, education, and training for all of the key positions in the financial reporting and accounting function and in some cases have created new positions. Consequently, the employees involved in the accounting and financial reporting functions in which misstatements were identified are no longer involved in the accounting or financial reporting functions. In addition, we have taken, or will take, appropriate remedial actions with respect to certain employees, including termination, reassignments, reprimands, increased supervision, training, and imposition of financial penalties in the form of compensation adjustments.

In addition, we have taken, and continue to take, the actions described below to remediate the identified material weaknesses. As we continue to evaluate and work to improve our internal controls over financial reporting, our senior management may determine to take additional measures to address control deficiencies or determine to modify the remediation efforts described in this section. Until the remediation efforts discussed in this section, including any additional remediation efforts that our senior management identifies as necessary, are completed, the material weaknesses described above will continue to exist.

Control Environment

Our Board has directed senior management to ensure that a proper, consistent tone is communicated throughout the organization, which emphasizes the expectation that previously existing deficiencies will be rectified through implementation of processes and controls to ensure strict compliance with GAAP and regulatory requirements. We also have taken steps to effect a proper tone through changes in our personnel and policies.

On September 7, 2014 our former Chairman and Chief Executive Officer resigned his position. On November 20, 2014, a new President and Chief Executive Officer was named from outside the Company following a national search led by a special committee of the Board, with the assistance of an executive search consultant.

Our new President and Chief Executive Officer is one of four new members of our Board. The three other new directors joined our Board pursuant to the nomination and standstill agreement dated September 15, 2014 between the Company and the Icahn Group, which is included as Exhibit 99.1 to our Form 8-K filed on September 16, 2014.

In addition, since December 2013, we have hired the following additional key employees into the following positions who reflect our standards for integrity and ethical values:

  • Senior Executive Vice President and Chief Financial Officer
  • Senior Executive Vice President, Chief Administrative Officer and General Counsel
  • Senior Executive Vice President and Chief Revenue Officer
  • Executive Vice President and Chief Human Resource Officer
  • Executive Vice President and Chief Information Officer
  • Senior Vice President and Chief Accounting Officer
  • Senior Vice President and Chief Audit Executive
  • Senior Vice President, Procurement, Fleet and Project Management Office
  • Senior Vice President, Financial Planning and Analysis

In addition to the senior management changes detailed above, in order to ensure we have a sufficient complement of personnel with an appropriate level of knowledge, experience, and training commensurate with our financial reporting requirements, during 2014 and 2015 we have hired personnel for all key positions in the financial reporting and accounting function and in some cases have created new positions, including:

  • Senior Vice President and Controller (Corporate Finance)
  • Senior Vice President and Controller (U.S. Rental Car Operations
  • Vice President, SOX Compliance
  • Assistant Controller (Corporate Finance)
  • Vice President, Reporting, Research and PolicyVice President, Financial Systems
  • Vice President, Accounting and Assistant Controller Global Fleet
  • Vice President, Dublin Financial Shared Service Center
  • Senior Director, Oklahoma Financial Shared Service Center
  • Senior Director, Program Accounting
  • Senior Director, Financial Reporting
  • Director, U.S. Rental Operations Finance Consolidation and Analytics
  • Director, Financial Systems
  • Director, Technical Accounting
  • Director, Corporate Accounting
  • Director, Consolidations
  • Director, Policies and Procedures
  • Director, Global Procure to Pay
  • Director, SOX Compliance
  • Director, North America General Accounting

To assist in the restatement activities we augmented our personnel with qualified consulting resources and they will continue to be augmented by the consulting resources for the remainder of 2015.

Further, in 2014, we reinforced the importance of adherence to established internal controls and Company policies and procedures through formal communications, town hall meetings and employee trainings. To communicate a proper ethical tone and corporate culture, Hertz’s intranet website provides information on our philosophy and values. These philosophies and values, in addition to being addressed at personnel meetings, are periodically communicated to our employees via email notifications throughout the year.

In addition, we have established procedures for ensuring clear reporting structures, reporting lines, and decisional authority responsibilities in the organization and have enhanced communications with our operational departments, accounting, Board and Audit Committee.

To address the material weakness over the non-fleet procurement process, we have strengthened processes and controls for manual accruals and journal entries. In addition, we have enhanced an accrual methodology to ensure completeness over our non-fleet procurement liabilities.

To address the lack of training related to the implementation of our Oracle ERP system, in 2014 management engaged consulting resources to assist in the following:

Completed a library of training modules for the Oracle application;Completed a series of live trainings for Oracle users; andImplemented enhanced knowledge management tools and protocols.

Other activities completed in 2014 and 2015 related to the Oracle ERP system include:

  • Established a Financial Information Systems Steering Committee co-chaired by the Chief Accounting Officer and the Chief Information Officer to monitor activities and developments associated with our financial information systems;
  • Established a data governance team to monitor activities associated with the data integrity of our financial information systems;
  • Implemented changes within the Oracle application to enhance the quality of data and the timeliness of processing financial results; and
  • Implemented security rule changes to enhance the quality and timeliness of reported results.

To further enhance the financial close process and address the remediation of this material weakness, our management is currently completing activities associated with our chart of accounts and utilization of Oracle ERP features.

We have taken steps to improve our design and maintenance of effective controls for accounting estimates, including:

  • Where necessary, identified, implemented and documented controls over appropriate accounting methodologies for certain accounts;
  • Held trainings with accounting staff in the first quarter of 2015 to ensure there is a thorough understanding of the underlying methodologies implemented;
  • Established policies and procedures for the approval and implementation of new or modified accounting methodologies;
  • Hired accounting personnel with an appropriate level of knowledge and experience to execute the underlying accounting methodologies; and
  • Established policies and procedures for the review, approval and application of appropriate GAAP for transactions and accounting methodology changes.

In addition, to improve our controls over the processing of manual journal entries, we have reinforced procedures to ensure that manual journal entries recorded in our financial records are properly prepared, supported by adequate documentation, and independently reviewed and approved.

Risk Assessment

We are establishing mechanisms to identify, evaluate, and monitor risks to financial reporting throughout the organization to remediate our material weakness in the risk assessment process and monitoring, as described below.

We have designed and where appropriate enhanced controls over the preparation, analysis and review of transactions and, execution of balance sheet and significant account reconciliations. In addition, we have reinforced existing policies and procedures and enacted policy and procedures changes, where necessary, to better define requirements for effective and timely reconciliations of balance sheet and significant accounts, including independent review. We have also implemented a training program specific to the review and preparation of account reconciliations.

We are updating our global risk assessment. In addition, we have updated our internal audit plan to include internal audit monitoring activities responsive to the issues identified in our internal investigation and review of our financial records.

We have implemented new procedures and enhanced controls governing our internal management-led Disclosure Committee, sub-certification, and external reporting processes associated with the review and approval of the content of our SEC filings and other public disclosures.

Information and Communication

We have formalized procedures to ensure appropriate internal communication between the accounting department and other operating departments necessary to support the proper functioning of internal controls.

In addition, we are in the process of updating the corporate-wide accounting policies manual to ensure proper accounting for transactions in compliance with GAAP and consistently applied across all locations. Additional policies will also need to be developed and issued and corresponding training will need to be provided.

Monitoring

To address deficiencies in our internal audit function, we hired in 2015 a Senior Vice President and Chief Audit Executive, with global responsibilities. In addition, we have commenced recruiting for additional staff members and have recently hired a senior auditor. We are currently supplementing our personnel resources with a substantial number of internal audit consulting resources with financial accounting expertise.

We also have increased the number and quality of personnel assigned to management’s internal controls assessment process. In 2014, we hired a Vice President of SOX Compliance and a Director of SOX Compliance. During 2014 and 2015 we have supplemented our personnel resources with a substantial number of consulting resources experienced in controls and SOX compliance.

During 2014 and 2015, the internal audit and SOX compliance teams enhanced (i) our processes associated with the scoping and identification of processes and key controls, (ii) the documentation of these processes and (iii) our testing procedures to promote the consistency and accuracy of conclusions, deliverables and disclosures associated with SOX compliance. An automated tool is being implemented to monitor these activities.

Changes in Internal Control over Financial Reporting

Our remediation efforts are ongoing. During the quarter ended December 31, 2014, we completed account reconciliation and internal controls trainings for our accounting personnel, created and completed Oracle trainings, enhanced data governance and implemented changes within the Oracle application to enhance the quality of data and the timeliness of processing financial results. There were no other material changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2014 that materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

A Bit of Perspective about Clawbacks in the News

If you are involved in SEC reporting, you have likely been hearing about clawbacks of executive compensation. The SEC, as required by Dodd/Frank, has proposed a new rule about clawbacks. You can see the SEC’s press release about the proposed rule at:

www.sec.gov/news/pressrelease/2015-136.html

The press release also has a good summary of the proposal and a link to the text of the proposed rule. (The link is near the top of the press release on the right side of the page.)

This rule proposal has created a fair amount of commentary and discussion, as anyone would expect.

That said, courtesy of Section 304 of SOX, clawbacks have been in play before this proposed rule. And this SOX provision has some teeth. Diebold Corporation, in the wake of a settled accounting fraud enforcement action, was required to clawback compensation from its CEO. Here is an interesting quote from the press release announcing the various enforcements:

“The complaint does not allege that (the CEO) engaged in the fraud.”

You can read the release at:

www.sec.gov/litigation/litreleases/2010/lr21543.htm

So, what is the reason that Dodd/Frank requires more rule making about clawbacks? One of the principal differences concerning clawbacks between Dodd/Frank and SOX is that SOX requires clawbacks when a restatement arises from accounting fraud.

Dodd/Frank moves things to a higher level because it will require clawbacks for any material restatement, regardless of cause. So even an unintentional error will trigger a clawback requirement.

In a sense, this is a bit like the SOX whistleblower hotline compared to the Dodd/Frank whistleblower hotline. SOX requires an anonymous hotline to the audit committee, Dodd/Frank goes a step further and created the anonymous hotline directly to the SEC.

As always, your thoughts and reactions are welcome!

 

Non-GAAP Measures – The SAGA continues – Full non-GAAP Financial Statements?

In our last two posts we reviewed the two sources of SEC guidance for the use of non-GAAP measures:

Reg G for non-filed documents such as earnings releases, and

Reg S-K Item 10(e) for non-GAAP measures included in filed documents such as in the MD&A of Form 10-K.

We also explored issues in the definition of a non-GAAP measure, which can be complex for some operational measures such as revenue per employee and same store sales.

In our next few posts we will discuss areas where companies sometimes push the use of non-GAAP measures a bit too far. When this happens, as you would expect, the SEC frequently writes comments about these issues.

The first is something that has happened frequently when companies want to show what their F/S would look like without certain non-cash charges. A very common example is share based payment expense. Since share based payments can affect a number of lines in the F/S companies will sometimes present an entire F/S, for example an Income Statement, on a non-GAAP basis.

In the view of the SEC their non-GAAP measure guidance allows the presentation of individual measures, but it does not permit this kind of full financial statement presentation. In essence, the risk that this could cause investor confusion is too great.

This position is formally stated in a Compliance and Disclosure Interpretation (C&DI). Here is the text:

Question 102.10

Question: Is it appropriate to present a full non-GAAP income statement for purposes of reconciling non-GAAP measures to the most directly comparable GAAP measures?

Answer: Generally, no. Presenting a full non-GAAP income statement may attach undue prominence to the non-GAAP information. [Jan. 11, 2010]

You can find all the C&DI’s for non-GAAP measures at:

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

Given this position, when the staff sees this kind of presentation, they do write comments! Here is an example:

  1. We see on page 5 of your earnings release that you present non-GAAP financial measures and related reconciliations required by Item 10(e) of Regulation S-K in the form of non-GAAP income statements. Please tell us how your presentation considers the guidance set forth in Compliance and Disclosure Interpretation 102.10. Under the cited guidance, it is generally not appropriate to present a non-GAAP income statement for purposes of reconciling non-GAAP financial measures to the most directly comparable GAAP financial measures.

And, here is another that has a bit more complexity, but the same theme, and makes the point that gross sales is in fact a non-GAAP measure that should be reconciled to net sales.

  1. We note that you present gross sales less promotional and other allowance figures at the top of your full GAAP income statements on page 48. In addition, you present and discuss gross sales, a non-GAAP measure, prior to the presentation and discussion of net sales, the most comparable GAAP measure, in your selected financial data on page 40 and in your discussion on page 49. Furthermore, it appears that you reconcile gross sales, the non-GAAP measure, to net sales, the most directly comparable GAAP measure, by presenting this reconciliation in a full non-GAAP income statement which is generally not considered appropriate as it may attach undue prominence to the non-GAAP measure, gross sales. Please revise future filings to present and discuss the GAAP measure net sales, more prominently than the non-GAAP measure, gross sales. In addition, any reconciliation of the two measures should not be included on your full income statement as this may result in presentation of a full non-GAAP income statement. Refer to the guidance outlined in Item 10(e) of Regulation S-K and Question 102.10 of Staff’s Compliance & Disclosure Interpretation on Non-GAAP Financial Measures at http://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm

As always, your thoughts and comments are appreciated!

 

Non-GAAP Measures – Part Two – Some Definitional Issues

In our last post we discussed the use of non-GAAP measures and the two sources of guidance the SEC has issued concerning their use, Reg G and S-K Item 10(e). In our next few posts we will delve into some of the common problems companies encounter in the use of non-GAAP measures.

The first application issue would seem to be pretty straightforward, just what is a non-GAAP measure? Both Reg G and S-K Item 10(e) use the same definition:

“(2) For purposes of this paragraph (e), a non-GAAP financial measure is a numerical measure of a registrant’s historical or future financial performance, financial position or cash flows that:

(i) 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 (or equivalent statements) of the issuer; or

(ii) Includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented.

(3) For purposes of this paragraph (e), GAAP refers to generally accepted accounting principles in the United States, except that:

(4) For purposes of this paragraph (e), non-GAAP financial measures exclude:

(i) Operating and other statistical measures; and

(ii) Ratios or statistical measures calculated using exclusively one or both of:

(A) Financial measures calculated in accordance with GAAP; and

(B) Operating measures or other measures that are not non-GAAP financial measures.

(5) For purposes of this paragraph (e), non-GAAP financial measures exclude financial measures required to be disclosed by GAAP, Commission rules, or a system of regulation of a government or governmental authority or self-regulatory organization that is applicable to the registrant. However, the financial measure should be presented outside of the financial statements unless the financial measure is required or expressly permitted by the standard-setter that is responsible for establishing the GAAP used in such financial statements.”

There is a lot of technical detail included in this definition! Two common questions are:

  1. Is a measure such as “comparable store sales” a non-GAAP measure?

As is the case in many questions like this, the answer is “it depends”! Paragraph 4 above says that if a measure is computed with an operating measure that is not a non-GAAP measure (such as number of stores) and a GAAP financial measure, (such as sales), then it is not a non-GAAP measure.

However, if the sales number was somehow “adjusted”, for example to eliminate start-up period sales or to remove the impact of an unusual event, so that the sales number was a non-GAAP measure, then the comparable stores sales number would be a non-GAAP measure.

  1. My operating segment footnote includes measures that are non-GAAP measures (for example EBITDA) because we use them to evaluate operating segment performance. Do these disclosures fall into the non-GAAP disclosure requirements of S-K Item 10(e) or Reg G?

This one is pretty simple. As paragraph 5 above says disclosures of measures like EBITDA that are used to evaluate operating segments where the disclosure is required by GAAP are not non-GAAP measures, so reconciliations and other S-K Item 10(e) and Reg G disclosures are not required unless of course they are required by GAAP.

As always, your thoughts and comments are appreciated!

 

The CAQ – Why You Need to Know Who They Are!

Do you know where the SEC initially stated their position about transitioning to the 2013 Revised COSO framework? It was in September of 2013. Here is the path to that announcement.

One of the topics we discuss in our workshops is the importance of the “CAQ” in the financial reporting process. The CAQ is an important source of information about current positions and developments at the SEC. Surprisingly, we frequently discover that many people are not very familiar with this organization.

So, what is the CAQ? It is, in long form, The Center For Audit Quality.

Their web page is thecaq.org

At their home page you can learn about who they are:

“The Center is an autonomous, nonpartisan, nonprofit group based in Washington, D.C. It is governed by a Board that comprises leaders from the public company auditing firms, the American Institute of CPAs and three members from outside the public company auditing profession. The organization is affiliated with the American Institute of CPAs.”

And what they do:

“The Center for Audit Quality is dedicated to enhancing investor confidence and public trust in the global capital markets by:

  • Fostering high quality performance by public company auditors;
  • Convening and collaborating with other stakeholders to advance the discussion of critical issues requiring action and intervention;
  • Advocating policies and standards that promote public company auditors’ objectivity, effectiveness and responsiveness to dynamic market conditions.”

One really important part of this organization is The CAQ SEC Regulations Committee. This group meets periodically with the SEC staff, generally once each quarter for the first three quarters of the year, and discusses current accounting and disclosure issues. The home page for the committee is:

thecaq.org/resources/caq-committees/sec-regulations

The minutes of these meetings are published on the Committee’s webpage and frequently contain information that, while sometimes fairly narrow, is helpful in the financial reporting process.

For example, it was at a CAQ meeting that the SEC Staff early on stated their position about the transition to the 2013 COSO Framework. Here is a link to those minutes: (Check out page 6)

thecaq.org/docs/reports-and publications/2013septembe25jointmeetinghls.pdf?sfvrsn=0

The most recent highlights of the SEC Regulations Committee meeting with the Staff are at:

www.thecaq.org/docs/default-source/sec-regulation-committee-hightlights/sec-regulations-committee-highlights-march-31-2015.pdf?sfvrsn=0

This meeting addressed issues ranging from the reporting implications of the FASB’s new consolidation standard, ASU 2015-02, to the application of S-X Rule 3-14 to real estate acquisitions in prior years for a registration statement.

Yes, many of the issues are narrow and technical, but we suggest you check the CAQ minutes each quarter as you get ready to close!

As usual, your comments and thoughts are appreciated!