As you may have heard, Virgin Galactic, Richard Branson’s space tourism company, began trading on the NYSE on October 28, 2019.  There was not a lot of press leading up to this listing as the company did not purse a traditional IPO.  The company achieved its NYSE listing by merging with a special purpose acquisition company or “SPAC”.  A SPAC is a company that raises capital through an IPO and lists on an exchange with the intention of finding another company to acquire.  Virgin Galactic merged with a SPAC named Social Capital Hedosophia Holdings Corp.  This interesting transaction is very similar to a reverse merger.  In the combination of Virgin Galactic with Social Capital Hedosophia Holdings Corp. the accounting acquirer is Virgin Galactic and the legal acquirer is Social Capital Hedosophia Holdings Corp.  This in essence results in a NYSE traded company with the historical financial statements of Virgin Galactic, but with the equity section replaced by that of Social Capital Hedosophia Holdings Corp.  If you would like to read more check out this definitive proxy statement.

As always, your thoughts and comments are welcome!

The SEC has made some technical corrections to its March 2019 Final Rule for Disclosure Modernization and Simplification.  These corrections were made in an August 6, 2019 Final Rule to make technical corrections to the March 20, 2019 original Final Rule.

First, in several registration statement forms (S-1, S-3, S-4, F-1, F-3, and F-4) the Item 3 section header should now read as:

            Item 3. Summary Information and Risk Factors

As of September 5, 2019, versions of these forms on the SEC’s web page still had the now obsolete heading of:

            Item 3. Summary Information, Risk Factors and Ratio of Earnings to Fixed Charges.

Second, to address some confusion caused by the original Modernization and Simplification Rule, the August 6 Final Rule made a technical correction to the Electronic Code of Federal Regulations (or “e-CFR”) on-line version of the Exhibit Table in S-K Item 601(a).  The e-CFR version of the Exhibit Table was updated to make it clear that the new Exhibit 4 “Description of Registrants Securities” is required in Form 10-K.  (This is the information in S-K Item 202.) There was a similar update for Exhibit 104 “Cover Page Interactive Data” to clarify that it is required for Forms 10-K and 10-Q as well as Form 8-K.

You can review a few other detailed changes, primarily to the “N” forms, in the Final Rule.

As always, your thoughts and comments are welcome!

It is always a good to remember that auditor independence is not just an issue for auditors but also for audit committees and management.  With the recent auditor independence enforcement actions against RSM and PwC as reminders, all companies, and in particular multinational companies, should review their own processes to assure no company personnel act in a way which could impact on auditor independence.  Particularly, offices outside the United States, where financial and other personnel may not be aware of the more restrictive SEC independence requirements, should be trained about the restrictions in non-audit services and related issues.

As an additional resource in this process, earlier this year the Office of the Chief Accountant updated its auditor independence FAQs, which could be a helpful resource in policy development and training.

As always, your thoughts and comments are welcome!

In our last post we explored the relationship between metrics and nonGAAP measures, and how a metric that is computed with GAAP numbers is not a non-GAAP measure.  In this post we explore other important aspect of metrics, including explaining to investors how they relate to financial performance and also relating them to performance.

When companies present metrics, such as “average monthly users,” these measures can look impressive, but in many business models the relationship between the metric and financial performance measures, such as revenue growth or profitability, may not be clear.  This leads the CorpFin staff to write comments such as this:

1. Refer to your response to comments 9 and 11. Please clarify on page 76 that there is currently no material difference in revenue per active rider for ridesharing and shared bikes and scooters. Also disclose the substance of your response relating to the reasons this metric is useful to investors. Similarly, disclose on page 77 the substance of your response relating to the reasons why the number of Rides taken by each cohort for each year is useful to investors.

Another important aspect of disclosing metrics, particularly in MD&A, is to discuss the linkage between the metric and financial performance, as these  three comments illustrate:

11. Please quantify the number of riders comprising each cohort for each year presented and the retention by cohort by year. Also, discuss the extent to which the available cohort data evidences any material known trends or uncertainties. For example, it appears that for the 2015 cohort, retention grew at a lower percentage from 2016 to 2017 compared to 2015 to 2016. Finally, tell us how your calculation involving number of rides, as opposed number of riders, is a measure of “retention”

11. Please ensure that you provide an indication of the magnitude of each of the factors you identify that caused material changes in revenue. Address the following:

Clarify how the increase in average MAUs, which you attribute primarily to international user growth that monetizes at a relatively low rate, contributed to the increase in revenue. Revise to include the change in international revenues in order to provide context to this statement; and

Revise to quantify the increase in the number of advertisements delivered, as well as the increase in the number of advertisers and the increase in demand from existing advertisers that each contributed to such increase. In this regard, we note that the number of ad impressions and the number of advertisers are among the variables that impact your growth in monetization affecting your performance, based on your discussion on page 61.

Refer to Item 303(a)(3) and Instruction 4 to Item 303(a) of Regulation S-K and Section III.D of SEC Release No. 33-6835.

Results of Operations, page 71

2. We note your response to prior comment 6. Your discussion and analysis should provide insight into the extent to which historical financial information is indicative of future results. In order to provide further context to the nature of your historical growth in light of the early stage of your monetization efforts, please quantify how both the number of advertisements placed by new advertisers and the increased number of advertisements from existing advertisers have impacted the change in revenue. Refer to Item 303(a)(3)(iii) of Regulation S-K and Sections III.A and III.D of SEC Release No. 33- 6835.

Lastly, if you do use metrics extensively, it is important to remember that MD&A is written through the eyes of management.  So it’s important to consider whether to disclose those metrics that are important to management.  The SEC made this point in this comment:

Key Metrics, page 57

3. You state in the risk factors section on page 28 that you regularly review metrics to “evaluate growth trends and the depth and quality of engagement of Pinners” in addition to the number of active users. Please disclose the key metrics that management uses to manage the business for each period presented. You state that in the past, you relied on metrics such as “saving a Pin” and “clicking and other activities.” As part of your response, clarify whether you still measure these activities. Refer to Section III.B of SEC Release No. 33-8350.

As always, your thoughts and comments are welcome!

One frequently misunderstood aspect of the SEC’s non-GAAP measure guidance is whether or not certain “operational metrics” such as same-store sales are non-GAAP measures.  Here is an example SEC comment that raises this question:

Item 6. Selected Financial Data, page 52 

Are measures such as “average cost per dry metric ton of bauxite” non-GAAP measures?  The comment above leaves this question open.  The starting point in researching whether such measures are non-GAAP measures is the definition of a non-GAAP measure in Reg G and S-K Item 10(e).  This is the definition from Reg G:

(a)(1) Non-GAAP financial measure. 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.

(2) A non-GAAP financial measure does not include operating and other financial measures and ratios or statistical measures calculated using exclusively one or both of:

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

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

(3) A non-GAAP financial measure does not include 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.

(Note:  The definitions in Reg G and S-K Item 10(e) are not exactly the same wording, but are substantially identical.  You can review the differences with the links above)

For measures such as same-store sales and those in the comment above this definition may not be simple to apply.  In particular a measure such as “average cost per dry metric ton of bauxite” does not fit easily into this thought process.  This is an example of a situation where it will be important to look past the S-K guidance and dig a bit deeper.

A good first place to start digging is in the Compliance and Disclosure Interpretations or C&DI’s, published by CorpFin.  While they are not “authoritative” they are frequently go-to guidance.  As you may know, the SEC has provided guidance about the use of non-GAAP measures in several C&DI’s.  These C&DI’s include all the May 2016 and subsequent guidance from the staff that created such discussion and change in the registrant community.  However, these C&DI’s don’t address issues in the definition of a non-GAAP measure.

So, what is the next research step?  This is a great example of how sometimes questions go beyond the actual rules and the related C&DI’s.  To resolve some issues, it is necessary to go all the way back to the SEC Release that adopted the related rules.  Here is a quote from the adopting release for the SEC’s non-GAAP measure guidance, which implemented the non-GAAP provisions of SOX:

1. Discussion of the definition

We do not intend the definition of “non-GAAP financial measures” to capture measures of operating performance or statistical measures that fall outside the scope of the definition set forth above. As such, non-GAAP financial measures do not include:

• operating and other statistical measures (such as unit sales, numbers of employees, numbers of subscribers, or numbers of advertisers); and
• ratios or statistical measures that are calculated using exclusively one or both of:
• financial measures calculated in accordance with GAAP; and
• operating measures or other measures that are not non-GAAP financial measures.

Non-GAAP financial measures do not include financial information that does not have the effect of providing numerical measures that are different from the comparable GAAP measure. Examples of measures to which Regulation G does not apply include the following:

• disclosure of amounts of expected indebtedness, including contracted and anticipated amounts;
• disclosure of amounts of repayments that have been planned or decided upon but not yet made;
• disclosure of estimated revenues or expenses of a new product line, so long as such amounts were estimated in the same manner as would be computed under GAAP; and
• measures of profit or loss and total assets for each segment required to be disclosed in accordance with GAAP.

The release also provides these examples:

Examples of ratios and measures that would not be non-GAAP financial measures would include sales per square foot (assuming that the sales figure was calculated in accordance with GAAP) or same store sales (again assuming the sales figures for the stores were calculated in accordance with GAAP).

For the measures in the comment letter above, as long as the financial components of the measures are computed in accordance with GAAP, they are not non-GAAP measures.  And, as you can see in this  response letter, the company told the SEC they would expand their disclosures and that the disclosures would be based on GAAP numbers.  Because of this approach, the non-GAAP measure guidance would not apply.

This is the first step in presenting metrics to investors.  There is more, and our next post will address the issue of explaining why the metric provides relevant information to investors.

As always, your thoughts and comments are welcome!

As we move towards the end of the third-quarter and begin preparations for year-end reporting we are presenting a series of posts focused on common questions and problems in quarterly and annual reports.

One of the interim reporting issues we emphasize in our Workshops deals with the timing of the auditor’s review of the financial statements in Form 10-Q.  Regulation S-X Article 10-01(d) states:

(d) Interim review by independent public accountant. Prior to filing, interim financial statements included in quarterly reports on Form 10-Q (17 CFR 249.308(a)) must be reviewed by an independent public accountant using applicable professional standards and procedures for conducting such reviews, as may be modified or supplemented by the Commission. If, in any filing, the company states that interim financial statements have been reviewed by an independent public accountant, a report of the accountant on the review must be filed with the interim financial statements.

While this requirement may seem fairly innocuous, and it is simple to confirm that the auditors have completed their review, in September 2018 the SEC actually enforced against five companies for not having their reviews performed prior to filing Form 10-Q’s.   You can read the details here.  All five of the companies paid substantial fines.  It is clear that the SEC believes the protections that investors get from interim reviews are very important.

As you read the cases you might begin to wonder “how did the SEC find out that Forms 10-Q had been filed without review?”  In the release the SEC says:

These actions are the Commission’s first enforcement proceedings against an issuer for violating the Regulation S-X interim review requirement and resulted from a review of filings, staff comment letters and other metrics that indicated potential violations.

It would be interesting to know what the “other metrics” are!

As always your thoughts and comments are welcome!

On September 26, 2019 the Division of Corporation Finance announced that they have reorganized into a new streamlined structure with seven industry offices.  In addition, the new structure will support focusing on developing risks and evolving disclosures and include a new office to evaluate the effectiveness of the review program.  You can read the details and find instructions to learn which group your company is in here.

In addition, CorpFin’s Filing Review Process document has been revised and is actually much shorter!

As always, your thoughts and comments are welcome!

Last week we reminded folks that our IPO program will be held on October 25, 2019.  In a timely IPO related development, on September 26, 2019 the SEC finalized a rule to allow all issuers, not just EGC’s, to “test the waters” in the IPO process.  We explored this proposal in this post from last June and discussed the implications of extending this JOB’s Act provisions to all companies.  You can read the details of the final rule in this press release and accompanying Fact Sheet and learn all about its implications in our IPO program.

The IPO market has been in the news the last several months with deals including Uber, Lyft and now WeWork in the headlines.  Interestingly, along with all these high-profile deals there have been several successful deals that have not attracted headlines.  If you are on the offering path now or may be in the future you can learn this process “from start to finish” at our Public Offering program on October 25, 2019.  The program will be presented live in New York and also via webcast.  Details include:

• Focus on drafting key securities offering documentation
• Learn to work effectively with the SEC – including registration, disclosure and publicity restrictions
• Earn up to 2 hours Ethics CLE credit learning the importance of ethics in due diligence in the offering process – comfort letters, 10b-5 statements and in-house counsel considerations

You can get more information and register here.

As always, your thoughts and comments are welcome!

As the debate surrounding the impact of quarterly reporting on company management and investor behavior continues, CFA Institutehas completed a survey of its global membership in a report titled “The Case for Quarterly and Environmental, Social, and Governance Reporting,”  which provides valuable data and insights for this discussion.CFA Institute has more than 164,000 members worldwide and is the not-for-profit organization that awards the Chartered Financial Analyst® (CFA) credential (as well as several others).

The report’s executive summary provides an overview of the survey results:

“Respondents, however, indicate that quarterly reports remain more important to investors than earnings releases. These quarterly reports provide a structured information set that follows accounting standards and regulatory guidelines and include incremental financial statement disclosures and management discussion and analysis. In addition, quarterly reports offer greater investor protections as they are certified by the officers of the company, subject companies to greater legal liability, and are reviewed by company auditors.”

The report also provides a discussion of CFA’s position about long-term versus short-term thinking:

“CFA Institute has long contended that when companies focus on long-term strategy, they are looking at a time horizon of three to five years or longer, not six months. Accordingly, extending the reporting period from three to six months would have little impact. We believe that a better approach to deterring short-termism would be to focus on companies’ incentive structures. Companies interested in encouraging a long-term view should consider adopting five-year performance periods in their incentive plans. In addition to incentives, general corporate leadership, tone at the top, and company culture are important contributors to long- vs. short-termism.”

And, as an interesting final note, the survey respondents also weighed in on ESG reporting issues with this overall summary of the results:

“…survey respondents and roundtable participants say that they incorporate governance factors into their investment analysis to a greater extent than they incorporate environmental and social factors. Investors, however, note that ESG means different things to different people. Hence, clear definitions of the terms and related metrics are needed. They also believe that specific ESG and sustainability disclosures should be a regulatory requirement for public companies and that securities regulators should either develop ESG disclosure standards or support an independent standards setter (i.e., a single, global standards setter in this field) to develop such standards.

You can read all the details here, and out thanks to CFA Institute for providing this valuable report and permission to pass it on to you in this post.

As always, your thoughts and comments are welcome!