All posts by George Wilson

An SEC Comment Challenge: Find the Non-GAAP Measure Issue – Post One

SEC Comment of the Week

As we approach third quarter-end 2020, many of us will be drafting and reviewing earnings releases.  A majority, perhaps most, of these earnings releases will include non-GAAP measures.  The SEC includes earnings releases in their review process and, as you likely already know, frequently comments on the use of non-GAAP measures included in these crucial communication documents.

More often than not the issues raised in these comments are areas that are dealt with in Regulation G, S-K Item 10(e), or the related Compliance and Disclosure Interpretations.  To help avoid non-GAAP problems in earnings releases and other documents, this series of posts focuses on earnings releases that resulted in SEC comments about the use of non-GAAP measures.

To make this a bit more of a challenge, you can first read the excerpt of the release behind the comment and try to spot the issue.  If you prefer, you can read straight through to the comment and explanation that follow.

This excerpt is from an 8-K filed by Dasan Zhone Solutions, Inc. on May 7, 2020.  Can you spot the non-GAAP issue?

Screen Shot 2020-09-24 at 9.41.22 AM

There is a bit of non-GAAP complexity behind the SEC comment on this release.  First, as an earnings release, it is essentially subject to Regulation G, the SEC’s non-GAAP guidance for measures not included in filed documents.

However, since an earnings release is required to be furnished (not filed) with the SEC on an Item 2.02 Form 8-K, it is subject to the Form 8-K instructions which include this “hook” to S-K Item 10(e), the SEC’s rules for non-GAAP measures used in a filed document.

Instructions:

The requirements of paragraph (e)(1)(i) of Item 10 of Regulation S-K (17 CFR 229.10(e)(1)(i)) shall apply to disclosures under this Item 2.02.

The part of S-K Item 10(e) that this instruction makes applicable to an earnings release is:

(e) Use of non-GAAP financial measures in Commission filings.

(1) Whenever one or more non-GAAP financial measures are included in a filing with the Commission:

(i) The registrant must include the following in the filing:

(A) A presentation, with equal or greater prominence, of the most directly comparable financial measure or measures calculated and presented in accordance with Generally Accepted Accounting Principles (GAAP); 

(B) A reconciliation (by schedule or other clearly understandable method), which shall be quantitative for historical non-GAAP measures presented, and quantitative, to the extent available without unreasonable efforts, for forward-looking information, of the differences between the non-GAAP financial measure disclosed or released with the most directly comparable financial measure or measures calculated and presented in accordance with GAAP identified in paragraph (e)(1)(i)(A) of this section;

(C) A statement disclosing the reasons why the registrant’s management believes that presentation of the non-GAAP financial measure provides useful information to investors regarding the registrant’s financial condition and results of operations; and

(D) To the extent material, a statement disclosing the additional purposes, if any, for which the registrant’s management uses the non-GAAP financial measure that are not disclosed pursuant to paragraph (e)(1)(i)(C) of this section;

This company included non-GAAP measures in the headline of their earnings release without presenting the related GAAP measure with equal or greater prominence.  This resulted in this comment:

Form 8-K furnished May 7, 2020 Exhibit 99.1, page 1

  1. We note your presentation of the non-GAAP measures, Adjusted EBITDA and Net Income (loss) attributable to DZS – Non-GAAP, on page 1 of your earnings release. Please revise to present the most directly comparable GAAP measure (i.e. net loss) with equal or greater prominence to avoid placing undue prominence on the non-GAAP measures. Refer to the guidance outlined in Question 102.10 in the Division of Corporation Finance’s Compliance and Disclosure Interpretations surrounding Non-GAAP Financial Measures.

The C&DI mentioned states:

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 is the Company’s response to the comment:

DZS acknowledges the Staff’s comment and will undertake to adjust, in future Forms 8-K related to financial results, the presentation of financial information to ensure that the most directly comparable GAAP measure is presented with equal or greater prominence relative to non-GAAP measures.

Specifically, the Company will include in the headline and table on page 1, with equal or greater prominence, GAAP Net Income (loss) attributable to DZS, as the most directly related GAAP measure to the non-GAAP measures Adjusted EBITDA and Net income (loss) attributable to DZS – Non-GAAP.

As always, your thoughts and comments are welcome!

A Big Day in SEC Rulemaking

SEC Hot Topic

On September 23, 2020, the SEC adopted two major Final Rules dealing with two very different issues, shareholder proposals and the whistleblower program.

Shareholder Proposals

The Commission approved changes in its rules for shareholder proposals in three areas.

First, the ownership thresholds for submission of shareholder proposals have been increased to:

  • $2,000 of the company’s securities for at least three years;
  • $15,000 of the company’s securities for at least two years; or
  • $25,000 of the company’s securities for at least one year.

Second, shareholders will no longer be permitted to aggregate holdings to meet the ownership thresholds.

Third, the voting thresholds for resubmission of a proposal have been increased from 3%, 6% and 10% for matters previously voted on once, twice or three or more times in the last five years to thresholds of 5%, 15% and 25% for those respective periods.

You can read more in this Press Release and the Final Rule.  The new shareholder proposal rules will be effective 60 days after publication in the Federal Register.

Whistleblower Program Changes

The commission made numerous changes in its whistleblower program rules affecting areas ranging from increasing efficiencies in how claims are processed to providing the Commission tools to provide rewards appropriate to the nature of a whistleblower’s efforts and contributions.  You can read more in this press release which contains a link to the Final Rule.

Along with the new rules, the Office of the Whistleblower has issued new guidance about how awards are determined which you can read here.

The new whistleblower rules will be effective 30 days after publication in the Federal Register.

As always, your thoughts and comments are welcome!

And the Beat Goes On – The Whistleblower Song

Uncategorized

As we have blogged on many occasions, the SEC’s Whistleblower Program has become an important part of the Enforcement Division’s activities.  On September 17, 2020, the SEC announced payments to joint whistleblowers who had raised concerns internally before blowing the whistle to the SEC.  And this September 14, 2020 Press Release announced a $10,000,000 (yes, million!) payment to a whistleblower “whose information and assistance were of crucial importance to a successful SEC enforcement action.”

To date the program has paid out approximately $521 million to 96 individuals.

If you want more background and detail, check out episode six of PLI’s inSecurities podcast, which features a review of how the whistleblower process works and a discussion of how the explosion of tips created by the program has affected the enforcement process.

As always, your thoughts and comments are welcome!

 

Training and Gearing Up for Third-Quarter and Year-End Reporting

About SECI

In the closing months of 2020, we are all facing new and unique SEC reporting challenges. You may be asking yourself: What will be the appropriate disclosures about the uncertainty and disruption created by COVID-19?  How should risk factors and MD&A be updated?  And how should companies grapple with the SEC’s new business, legal proceedings and risk factor guidance?

To help SEC reporting professionals prepare for these challenges and more, we have built new interactive modular Workshops and new on-demand content.  We are also offering our traditional Workshops and conferences via live Webcast.

New Interactive Modular Workshops

We are now offering three new half-day interactive, virtual Workshops to better fit hectic and sometimes disrupted schedules. Our half-day Workshops are designed in a modular format which allows you to pick and choose the content to meet your educational needs on a schedule that works for you.  Participants will be able to ask questions and speak directly to the discussion leaders through our interactive platform.  SECI is adding more dates and modules in 2021 so please be sure to visit our website to continue customizing your learning curriculum!

SEC Reporting Essentials 101 Workshop

Form 10-K SEC Reporting Essentials Workshop

SEC 10-K Disclosure Best Practices Workshop

 

On-Demand Content

Our on-demand content, including our new Ethical Challenges for SEC Reporting Professionals program, each offer one hour of CPE credit and can be taken anytime and anywhere!

Ethical Challenges for SEC Reporting Professionals

Using Non-GAAP Measures and Metrics to Explain the Impact of COVID-19 

Master the SEC Reporting and Research Process – Part One 

Master the SEC Reporting and Research Process – Part Two 

Master Form S-1 for an Initial Public Offering 

A Deep Dive Into COVID-19’s Impact on Quarter One Goodwill Impairment Testing

Impairment Testing Considerations for Quarter One in the 2020 Coronavirus Environment

SEC’s New Metric Guidance and a Non-GAAP Measure Update

Fifth Annual Dealing with MD&A Hot Topics 

Sixth Annual Form 10-K/Proxy Tune-Up 

 

Our Traditional Workshops via Live Webcast

Our time-tested, high quality Workshops have also been adapted for the Live Webcast format.  These one- or two-day Workshops are continuously updated for the latest SEC and FASB developments.

SEC Reporting Skills Workshop for Financial Professionals

SEC Reporting and Practice Skills Workshop for Lawyers

MD&A In-Depth Workshop

Form 20-F In-Depth Workshop

 

Our Traditional Conferences via Live Webcast

Our 16th Annual SEC Reporting & FASB Forum for Mid-sized & Smaller Companies and our 36th Annual SEC Reporting & FASB Forum will be offered via Live Webcast.  Our conferences will feature the same high-quality content and expert speakers as always, provide a focus on disclosures in the current COVID-19 environment, and include discussion of the latest developments from the SEC and FASB.  Our Webcast platform also provides an easy and convenient way to submit questions to our speakers.

16th Annual SEC Reporting & FASB Forum for Mid-sized & Smaller Companies

36th Annual SEC Reporting & FASB Forum (PDT)

36th Annual SEC Reporting & FASB Forum (EDT)

As always, your thoughts and comments are welcome!

PLI’s inSecurities Podcast

Uncategorized

If you are looking for a wonderfully informative and entertaining podcast to listen to while you work out at home, run or walk outside, or are just relaxing anywhere, check out PLI’s inSecurities podcast.

The hosts of the podcast, Chris Ekimoff, a forensic accountant, and Kurt Wolfe, a securities regulatory attorney, provide insightful practitioner perspectives in their  biweekly podcast.  Podcast episodes have addressed  topics such as insider trading, developments in the SEC’s whistleblower program, the perspectives the SEC Historical Society brings to securities regulation and business development challenges in the COVID-19 environment.  Chris and Kurt have interviewed prominent securities industry professionals including former SEC Commissioner Robert Jackson, NASAA General Counsel Vince Martinez and whistleblower attorney Matt Stock.

The most recent podcast episode focuses on current developments from the SEC, FASB and PCAOB, which were highlighted in the SEC Institute’s Quarterly Newsletter.  SEC Institute Director George Wilson joined Chris and Kurt for this timely discussion which you can listen to here.  You can also find PLI’s podcast at all the usual podcast sources, including Apple, Google and Spotify.

 

 

As always, your thoughts and comments are welcome!

Our New, Virtual, Interactive Form 10-K Disclosure Workshop

Reporting

Our new SEC 10-K Disclosure Best Practices Workshop is a perfect way to help you prepare for this year-end’s unique and complex reporting challenges.  Featured topics include COVID-19 related disclosures, the SEC’s modernization of business, risk factor and legal proceedings disclosures, rules and practice issues surrounding the use of non-GAAP measures and SEC “hot-button” comment areas in the current environment.  Best practice examples from different industries and companies are discussed in each section to illustrate effective disclosure practices.

Featuring open discussion in an interactive, Zoom-based format, this new Workshop will be presented over two afternoons (half days) on October 5_6, 2020, with a start time of 1 p.m. EDT on both days.

The Workshop includes online access to PLI’s SEC Reporting Handbook.

 As always, your thoughts and comments are welcome.

The SEC’s Updated RegFlex Agenda

Reporting

As we blogged about here, SEC Chairman Clayton has worked to make the SEC’s Regulatory Flexibility Act agenda a document that reflects the Commission’s short-term plans as opposed to a kind of regulatory “wish list.”  The latest update (known as the Spring version) was published at the end of June and provides a view of how the Commission intends to move forward with many significant initiatives despite the disruption of COVID-19.  Among the projects on the short-term agenda are:

  • Modernization and Simplification of Disclosures of Regulation S-K Items 101, 103, and 105
  • Modernization and Simplification of Disclosures Regarding MD&A, Selected Financial Data and Supplementary Financial Information
  • Universal Proxy
  • Amendments to Exemptions From the Proxy Rules for Proxy Voting Advice
  • Harmonization of Exempt Offerings
  • Update of Statistical Disclosures for Bank and Savings and Loan Registrants
  • Disclosure of Payments by Resource Extraction Issuers

You can review all the proposed rule and final rule stage projects on the short-term agenda here.  As you will see the above projects are only part of what the Commission intends to accomplish in the short term.

You can also view the long-term agenda here.

As always, your thoughts and comments are welcome!

A New Format and Approach for Inspection Reports

Reporting

In his speech “Seeing Through the Regulatory Looking Glass: PCAOB Inspection Reports” (which includes a delightful number of Alice in Wonderland references!), PCAOB Board Member J. Robert Brown Jr. explores historical decisions the Board made about the content and structure of inspection reports.  He then describes changes the current Board is making to these reports in their process of increasing transparency, including:

  • Use of plain English
  • Less jargon
  • Providing an executive summary
  • Including comparative charts and tables

In addition the Board is now grouping findings into three categories:

  • Findings that included an accounting violation
  • Audits with multiple deficiencies
  • Audits with a single deficiency

The Board has also added a new section to its inspection reports describing deficiencies that were not previously disclosed.  These deficiencies did not affect the sufficiency of audit evidence but were, nonetheless, areas where firms did not comply with audit standards.  An example would be failure to complete and “lock down” audit workpapers within the appropriate time frame.

Mr. Brown’s speech also discusses areas where the Board might consider additional changes to inspection reports.

The new inspection report format has been used for six reports as of July 27, 2020.  You can review these reports here.

As always, your thoughts and comments are welcome!

A Few Last Minute COVID-19 Disclosure Considerations

COVID-19

As we are now moving past the middle of July, many of us are reviewing draft Form 10-Qs and grappling with how to disclose the impact of COVID-19’s disruption and uncertainty.  Here are a few thoughts for your review process.

  1. Don’t forget to update and tailor your risk factors. Even if the impact of COVID-19 on your business has not been dramatic, consider your specific situation and think about whether risk factors should be updated.  As we know more about this situation now than we did at the end of the first quarter, risk factors may need to be adjusted for new information.  Here is an example from Home Depot, where the company added issues related to COVID-19:

Disruptions in our supply chain and other factors affecting the distribution of our merchandise could adversely impact our business.

A disruption within our logistics or supply chain network could adversely affect our ability to deliver inventory in a timely manner, which could impair our ability to meet customer demand for products and result in lost sales, increased supply chain costs, or damage to our reputation. Such disruptions may result from damage or destruction to our distribution centers; weather-related events; natural disasters; international trade disputes or trade policy changes or restrictions; tariffs or import-related taxes; third-party strikes, lock-outs, work stoppages or slowdowns; shortages of truck drivers; shipping capacity constraints; third-party contract disputes; supply or shipping interruptions or costs; military conflicts; acts of terrorism; public health issues, including pandemics or quarantines (such as the recent COVID-19 coronavirus outbreak); or other factors beyond our control. Any such disruption could negatively impact our financial performance or financial condition.

Also, don’t forget to update your 1995 Private Securities Litigation Reform Act safe harbor cautionary statements for uncertainties surrounding COVID-19.

  1. Don’t shy away from forward-looking information where it is required. This is the “known-trend” disclosure in MD&A.  If a company “reasonably expects” (a less than 50% probability threshold) that an uncertainty could have a material impact on future operations it should be disclosed in MD&A.  Here is an example SEC comment, related to a March 31, 2020 Form 10-Q, about this forward-looking information requirement.

We note that your revenue significantly declined by $65 million, or 92%, from $71 million for the three months ended March 31, 2019 to $5 million for the three months ended March 31, 2020. You indicate this was due to the decrease in the number of railcars delivered (11 versus 641 units) due to lower industry demand, which was partially offset by a higher average selling price for new railcars in 2020. We also note from your earnings call that the lower demand was due to the combination of timing and weakness in the backlog, line changeovers, and a loss of 8 production days at the end of the first quarter related to the Coronavirus. Revise your results of operations to provide qualitative reasons as to why demand was lower. To the extent possible, quantify how the differing factors impacted the overall change in your results of operations. Additionally, quantify how your expected deliveries are expected to ramp up through the year to the extent possible to provide further insight into known trends and uncertainties. We also note from your earnings call a withdrawal of the 2020 guidance for deliveries and capital expenditures, and although no order cancellations, you are not building any railcars that do not have a firm order behind them, and as the Mexico facility is expected to begin production during the third quarter but not without a firm customer order, please address how you expect deliveries to ramp up for the year. See Item 303 of Regulation S-K and SEC Release No. 33-8350.

  1. Don’t forget that in addition to MD&A disclosures ASC 275 requires disclosure in the financial statements of material uncertainties. Here is an example from MGM Resorts’ first-quarter Form 10-Q:

Financial Impact of COVID-19. The novel coronavirus (“COVID-19”) pandemic has caused, and is continuing to cause, significant disruption in the financial markets both globally and in the United States, and will continue to impact, possibly materially, our business, financial condition and results of operations. As of March 17, 2020, all of the Company’s domestic properties were temporarily closed to the public and have remained closed pursuant to state and local government requirements as a result of the unprecedented public health crisis from the COVID-19 pandemic. As a result, the Company’s domestic properties are effectively generating no revenue.  In Macau, pursuant to a request from the government of Macau, MGM China suspended all operations at MGM Macau and MGM Cotai for a 15-day period that commenced on February 5, 2020,  other than operations that were necessary to provide sufficient non-gaming facilities to serve any remaining hotel guests in that period. While the properties have since re-opened, several travel and entry restrictions in Macau, Hong Kong, and certain cities and regions in mainland China remain in place (including the temporary suspension of the visa scheme, the temporary suspension of ferry services and other modes of transportation, and bans on entry or enhanced quarantine requirements), significantly impacting visitation to the Company’s Macau properties, which continues to have a material impact on MGM China’s results of operations. The Company cannot predict the degree, or duration, to which its operations will be affected by the COVID-19 outbreak, and the effects could be material.

As always, your thoughts and comments are welcome!

COVID-19 Uncertainty in Earnings Releases

COVID-19

As we get closer to second quarter 2020 reporting, addressing the impact of COVID-19 in earnings releases is a top-of-mind issue.  The impact will, of course, differ from company to company.  Here is one example from Carnival Corporation.  Carnival’s fiscal year ends on November 30, so their fiscal second quarter ended on May 31, 2020.  Carnival released earnings on June 18, 2020, providing an early example of how COVID-19 can be reflected in earnings releases.

In their earnings release Carnival was very direct about how COVID-19 has affected their business:

SECOND QUARTER 2020 SUMMARY PRELIMINARY INFORMATION

  • S. GAAP net loss of $(4.4) billion, or $(6.07) diluted EPS, for the second quarter of 2020, which includes $2.0 billion of non-cash impairment charges.
  • Second quarter 2020 adjusted net loss of $(2.4) billion, or $(3.30) adjusted EPS.
  • Total revenues for the second quarter of 2020 were $0.7 billion, lower than $4.8 billion in the prior year.
  • The company’s guest cruise operations have been in a pause for a majority of the second quarter. In addition, the company is unable to definitively predict when it will return to normal operations. As a result, the company is currently unable to provide an earnings forecast. The pause in guest operations is continuing to have material negative impacts on all aspects of the company’s business. The longer the pause in guest operations continues the greater the impact on the company’s liquidity and financial position. The company expects a net loss on both a U.S. GAAP and adjusted basis for the second half of 2020.
  • Cash burn rate in the second quarter 2020 was generally in line with the previously disclosed expectation.
  • Second quarter 2020 ended with $7.6 billion of available liquidity, and the company expects to further enhance future liquidity, including through refinancing scheduled debt maturities. In addition, the company has $8.8 billion of committed export credit facilities that are available to fund ship deliveries originally planned through 2023.
  • Total customer deposits balance at May 31, 2020 was $2.9 billion, including $475 million related to cruises during the second half of 2020.

You can read the rest of the details in Carnival’s earnings release here.  As you can see, the company did not pull any punches.

As always, your thoughts and comments are welcome!