Category Archives: SEC Hot Topic

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

Reporting, SEC Hot Topic

In this series of posts we are focusing on non-GAAP measure problems and related SEC comments.  As the first, second and third posts in this series did, this post gives you an opportunity to see if you can spot the issue, and then provides the background and SEC guidance behind the issue.

As a brief reminder, the SEC’s guidance about the use of non-GAAP measures is primarily in three places:

  1. Regulation G for non-GAAP measures used anywhere,
  2. S-K Item 10(e), for non-GAAP measures in filed documents, and
  3. Compliance and Disclosure Interpretations.

Just like the first, second and third posts in this series, you can 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.

These excerpts are from Papa John’s International, Inc’s Form 10-K for the fiscal year ended December 29, 2019.  You may recognize this Company as we highlighted their 10-K in our third post in this series.  Can you spot the non-GAAP issue?  As you review this information, focus your thoughts on the “special charges,” and within the detailed list of “special charges” look at the “Royalty relief” line item.

To begin, here is one of the non-GAAP measures presented by Papa John’s:

PapaJohn One

Papa John’s also provided this detail about the special charges:

PapaJohn Two

As you review the list of non-GAAP adjustments, letter (a) about royalty relief to franchisees seems like a typical kind of adjustment.  But the issue here is more complex, as royalty income is a significant source of revenue for Papa John’s.

This is the comment the SEC issued about this non-GAAP adjustment:

Form 10-K for the Fiscal Year Ended December 29, 2019

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Items Impacting Comparability; Non-GAAP Measures, page 40

  1. Please tell us the consideration you gave to Question 100.04 of the Non-GAAP Financial Measures Compliance and Disclosure Interpretations in adjusting your non-GAAP measures to add revenues you did not receive due to royalty relief.

The C&DI referenced, Question 100.04 makes a very important point:

Question 100.04

Question: A registrant presents a non-GAAP performance measure that is adjusted to accelerate revenue recognized ratably over time in accordance with GAAP as though it earned revenue when customers are billed. Can this measure be presented in documents filed or furnished with the Commission or provided elsewhere, such as on company websites.

Answer: No. Non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP could violate Rule 100(b) of Regulation G. Other measures that use individually tailored recognition and measurement methods for financial statement line items other than revenue may also violate Rule 100(b) of Regulation G.   [May 17, 2016]

This is Papa John’s first of two responses to this comment:

We did consider the guidance in Question 100.04 in connection with our inclusion in “Special charges” of royalty reductions that are above and beyond the level of franchise support the Company would incur in the ordinary course of its business. We also evaluated Rule 100(b) of Regulation G, which states that a registrant may not make public a non-GAAP financial measure that, taken together with the information accompanying the measure, is misleading.   We believe the adjustment reflects the add-back of contractually due and waived franchise royalties in our financial statements rather than the tailoring of the recognition or measurement principles under GAAP.

 Papa John’s franchisees are contractually required to pay a 5% royalty on sales. As part of its voluntary program to provide temporary financial assistance for traditional North America franchisees in response to declining North America sales discussed above, the Company extended financial assistance to its traditional North America franchisees in the form of a reduction in the contractually due royalties beginning in the third quarter of 2018, for a limited time period. The decline in sales was due to the negative publicity and consumer sentiment surrounding the Company’s brand as noted in Comment 1 (Note:  See the third post in this series for this information) above. Sales remained negative into 2019, which led the Company to formalize a temporary relief package, publicly announced in July 2019, to provide its franchisees with certainty regarding the availability and schedule of the relief which will continue through the third quarter of 2020. The total royalty relief included in “Special charges” was $19.1 million and $15.4 million for the years ended December 29, 2019 and December 30, 2018, respectively. The scheduled royalty reductions presented in “Special charges” represent the difference between the usual 5.0% contractual royalty rate applicable to North America franchise sales and the reduced royalty rate under our franchisee assistance program ranging from 0.5% to 2.0% of franchise restaurant sales varying by quarter. Additionally, North America franchisees that met certain defined service measures also received a 0.25% reduction in the royalty rate in the third and fourth quarters of 2019.

We believe that presenting these royalty reductions as “Special charges” is consistent with the objectives of our non-GAAP presentation, which is to show the financial performance of our ongoing operations excluding the temporary impact of the Company’s initiative of providing short-term support and financial assistance to the North America franchise system in response to the severe decline in North America sales. The Company did not receive the revenue foregone from its royalty relief program, as it is waiving a contractual right to recognize the revenue earned. We excluded the temporary waiver of this contractual right together with the marketing investments discussed in our response to Comment 1 for internal comparison purposes when evaluating the Company’s underlying operating performance and when analyzing trends. When presented next to the most directly comparable GAAP measure, we believe we are presenting a supplemental measure that shows the impact of our discretionary, non-contractual franchise support and relief program to our operating results. Accordingly, the Company respectfully advises the staff that we have considered the prescribed guidance and we believe that the presentation of royalty relief from our non-GAAP financial results, taken together with the information accompanying the measure, does not cause those results to be misleading.

To help further clarify the nature of the royalty reductions, beginning in our Form 10-Q for the quarter ended March 29, 2020, we will revise the footnoted description of the royalty relief in our “Special charges” table as follows: “Represents financial assistance provided to the North America system in the form of temporary royalty reductions that are above and beyond the level of franchise support the Company would incur in the ordinary course of its business. This temporary financial assistance provides our North America franchisees with certainty regarding the availability and schedule of the temporary relief through the third quarter of 2020. Under the formal relief program, the franchisees pay royalties below the 5.0% contractual rate on franchise restaurant sales with varying rates by quarter as specified under the terms of the program.”

After this first response the SEC and Papa John’s had further phone discussions about this issue.  Interestingly, the SEC did not issue a second comment letter.  While we cannot know the content of these discussions, they were clearly substantive.  They resulted in this final answer by Papa John’s:

Response: As discussed during the phone conversation between the Staff and the Company on April 24, 2020, beginning with the Company’s earnings release for the first quarter of fiscal 2020, the Company will no longer present adjusted (non-GAAP) financial results adjusted to add revenues we did not receive due to royalty relief.

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!

$376 Million! – Whistleblower News and Big Dollars!

SEC Hot Topic

The SEC’s whistleblower program has reached a new milestone, now having paid out $376 million to 61 individuals since it made its first award payment in 2012.  On March 26, 2019 the program announced payments to two individualstotaling $50 million. This program is clearly having a significant impact in how the enforcement process finds wrong-doing. You can read more about the program here.

As always, your thoughts and comments are welcome!

An SEC MD&A Comment Example

SEC Hot Topic

By: George M. Wilson, SEC Institute

Many of us are finalizing disclosures in our Form 10-K (or perhaps a 10-Q) for December 31, 2017. Here is a reminder and issue to consider as you review your MD&A.

In our workshops when we discuss the SEC review process for MD&A we always mention the Staff’s focus on deeper analysis of causal factors and drivers in MD&A. Here is an SEC comment that highlights both issues. It presents a nicely balanced approach based on the nature of the company’s business to the issues raised by the Staff.

The Staff’s Comment:

 

  1. We note that your discussion of results of operations identifies certain events and trends affecting revenues and expenses. However, your current discussion lacks sufficient analysis and quantification of the underlying reasons for changes in your results of operations. For example, you state that for the year ended February 2, 2014, revenue increased $54.9 million from the net addition of 53 stores and Blue Tomato sales during fiscal 2013 that were not comparable to the prior year, partially offset by the effect of the 53rd week included in fiscal 2012 results and comparable store sale decrease of 0.3% for fiscal 2013. Please provide expanded discussion of the underlying reasons of your revenue growth, including quantified information with respect to key drivers such as price, volume and other key variables that management uses to manage the business. Also, please expand the discussion of results of operations for all periods discussed to quantify the effect of the events disclosed and to describe their underlying causes. For additional guidance, please refer to SEC Release 33-8350, available on the SEC website at www.sec.gov./rules/interp/33-8350.htm. Please provide a draft of your proposed disclosure.

 

The Company’s Response

We believe that our discussion of the results of operations identifies and discloses the key performance indicators used to manage our business and that we believe are material to our investors. In particular, as a retailer that offers a diversity of merchandise, including men’s and women’s apparel, footwear, accessories and hardgoods, the sales results of any one product category are not material to understanding our results of operations. Rather, we believe that due to our diversification model, comparable sales is a key performance indicator. Accordingly, in response to the Staff’s comment, we will provide additional disclosures on the quantification of our net sales results by comparable sales, geographic region, new stores and other relevant categories (such as the presence of an additional week during a fiscal period) in future filings. As an example, please refer below for our expanded quantification of the reasons for our revenue growth related to fiscal 2013 compared with fiscal 2012 (emphasis on modifications added):

Fiscal 2013 had 52 weeks versus 53 weeks in fiscal 2012. Net sales numbers for fiscal 2012 include an additional week and fiscal 2013 comparable sales are compared to the comparable sales for the 52 weeks ended February 2, 2013. Net sales were $724.3 million for fiscal 2013 compared to $669.4 million for fiscal 2012, an increase of $54.9 million or 8.2%. The increase reflected a $65.9 million increase due to the net addition of 53 stores (made up of 53 new stores in North America and six new stores in Europe offset by six store closures in North America) and Blue Tomato sales during fiscal 2013 that were not comparable to the prior year, partially offset by a $9.3 million decrease due to the impact of the 53rd week included in fiscal 2012 results and a $1.7 million decrease due to comparable sales for fiscal 2013. By region, North American sales increased $35.2 million and European sales increased $19.7 million during fiscal 2013 compared to fiscal 2012.

The 0.3% decrease in comparable sales was a result of a 1.0% decrease for our comparable in-store sales, partially offset by a 5.4% increase for our comparable ecommerce sales. Total ecommerce sales represented 12.3% of sales for fiscal 2013, compared to 11.2% of sales for fiscal 2012, increasing due to Blue Tomato ecommerce sales that were not comparable to the prior year and the growth in comparable ecommerce sales mentioned above. The decrease in comparable sales was primarily driven by a decline in comparable transactions, partially offset by an increase in dollars per transaction. Dollars per transaction increased due to an increase in units per transaction, partially offset by a decrease in average unit retail due to changes in sales product mix. Comparable sales decreases in men’s apparel, footwear and boy’s apparel were partially offset by comparable sales increases in junior’s apparel, hardgoods and accessories. For information as to how we define comparable sales, see “General” above.

Furthermore, we will continue to review our discussion on results of operations and enhance the disclosure to provide analysis and quantification, as appropriate, in accordance with SEC Release 33-8350.

 

 

As always, your thoughts and comments are welcome!

 

Regulation S-X 3.13 – You Can Ask for a Break!

SEC Hot Topic

By: George M. Wilson, SEC Institute

Many of us have likely been in the position of reviewing an SEC disclosure requirement and thinking that the exact form of the requirement may not fit our particular circumstances. Sometimes we may believe such situations could create incremental work and cost while not providing particularly meaningful information to investors.

 

Is there any way to seek a discussion and discover a potentially better way to provide useful information to investors? It turns out, yes!

 

At the SEC’s conference in Washington, D.C. in early December, both Chair Jay Clayton and CorpFin Director William Hinman emphasized that the SEC is encouraging companies to consider using an historically little mentioned rule to avoid potentially complex costly disclosures that don’t provide material information to investors.

 

Regulation S-X Rule 3.13

210.3-13   Filing of other financial statements in certain cases.

The Commission may, upon the informal written request of the registrant, and where consistent with the protection of investors, permit the omission of one or more of the financial statements herein required or the filing in substitution therefor of appropriate statements of comparable character. The Commission may also by informal written notice require the filing of other financial statements in addition to, or in substitution for, the statements herein required in any case where such statements are necessary or appropriate for an adequate presentation of the financial condition of any person whose financial statements are required, or whose statements are otherwise necessary for the protection of investors.

 

Such requests will certainly require judgment, and both Chair Clayton and CorpFin Director Hinman emphasized that requests will be granted only when they are consistent with the goals of investor protection. That said, if an alternative to a formal rule will provide the information investors need Rule 3.13 can help avoid delay and unnecessary costs.

 

Director Hinman and CorpFin Chief Accountant Mark Kronforst (who you have likely heard will be leaving the SEC soon) discussed these process related issues:

 

First, all fact patterns are different, and it is important to not make any assumptions about how the process will work.

 

If you have a simple question you could begin by using the contact information in the CorpFin Financial Reporting Manual to get an initial plan in place.

 

The staff prefers that a formal request begin with email.

 

In your communication with the staff it is very important to explain all facts concisely and completely.

 

You should support you position with a clear explanation of why is it consistent with investor protection.

 

Early involvement of auditors also makes these requests proceed more smoothly.

 

The staff is working to respond promptly to each request and you should hear back in about 10 days unless the request is made during one of the periods when CorpFin is very busy.

 

Examples of areas where requests may arise include:

 

Significance tests – if one of the three parts of this test seems out of the norm then there may be other, more appropriate, considerations in making a determination whether separate financial statements are useful.

 

Pre-and post-acquisition periods for rule 3.05 – when appropriate it may be best to use an analysis that is less mechanical and focuses on trend issues that are meaningful and helps assess how the acquisition may impact on post-acquisition results.

 

Predecessor/Successor issues – relevance of stub periods may not be as relevant or reliable carve out F/S may not be possible to build. For example, it may be that abbreviated financial statement may provide the information that investors need.

 

IFRS financial statements may be acceptable for some acquisitions and equity method investees – if company could be a foreign private issuer the staff may accept IFRS financial statements.

 

Mechanical compliance with a rule sometimes is not the best way to provide investors with the information they need. It is a good thing to know that there are alternatives. So, when you think you are in this situation, go talk to the staff!

 

 

As always, your thoughts and comments are welcome!

 

Are There Consequences for Reporting ICFR Problems? – The Chief Accountant Speaks!

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By: George M. Wilson & Carol A. Stacey

In a recent speech SEC Chief Accountant Wesley Bricker, towards the end of his remarks, made some interesting overall comments about the evaluation of ICFR. These comments are an interesting step in the ongoing conversation about whether the SOX 404 evaluation of ICFR makes any difference in investor behavior. There has been a lot of anecdotal evidence and much discussion about this question. Mr. Bricker’s comments are not based on supposition, inference or piecemeal observation. His comments have their roots in articles from various academic journals, including the Accounting Review and The Journal of Accounting Research. Research in these peer-reviewed journals is based on statistical analysis of quantitative data. (If you have never heard of these journals, they are very prestigious academic journals, so if you decide to read any of the articles grab a cup of coffee and a calculator!)

Here are some excerpts from his remarks. The footnote numbers are references to the academic papers which support his points. We left them in so you could follow-up if you would like to review the quantitative research underlying his comments.

 

Recent experience with disclosures 

Another point related to ICFR is consideration of disclosures.  Investors tend to incorporate disclosure of ICFR deficiencies in the price they are willing to pay for a stock.  For example, companies disclosing material weaknesses are more likely to experience increased cost of capital, and to face more frequent auditor resignations and restatements.[11]

 

Recent academic research suggests:

 

Companies disclosing internal control deficiencies have credit spreads on loans about 28 basis points higher than that for companies without internal control deficiencies; [12] and

 

After disclosing an internal control deficiency for the first time, companies experience a significant increase in cost of equity, averaging about 93 basis points. [13]

 

Remediation of ineffective ICFR tends to be followed by improved financial reporting quality, reduced cost of capital, and improved operating performance.[14]   For example,

 

Companies that have remediated their prior disclosed internal control deficiencies exhibit an average decrease in market-adjusted cost of equity of 151 basis points; [15]  and

 

Remediating companies also experience increases in investment efficiency and in operating performance, suggesting that accounting information generated by effective ICFR is more useful for managerial decision-making. [16]

 

A disclosure of material weaknesses, combined with demonstrating progress toward remediation, can provide investors with information about the company’s ability to function as a public company.  Some companies, for example, voluntarily disclose material weaknesses in their registration statements along with their plans for remediating those weaknesses. [17]

 

You can find citations in to the relevant articles in the text of the speech.

As always, your thoughts and comments are welcome!

ICFR Changes and the New Revenue Recognition, Leases, and Financial Instrument Impairment Transitions

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By: George M. Wilson & Carol A. Stacey

 

In his recent, much publicized speech, Chief Accountant Wesley Bricker discussed the transition to the new revenue recognition standard. A bit later in the speech he addressed a not so frequently discussed issue, the requirement to disclose material changes in ICFR as it relates to implementation of the new revenue recognition, leases, credit losses and other standards. Here is an excerpt:

 

Over the next several years, updating and maintaining internal controls will be particularly important as companies work through the implementation of the significant new accounting standards. Companies’ implementation activities will require careful planning and execution, as well as sound judgment from management, as I have mentioned earlier in illustrating areas of judgment in the new GAAP standards.

 

In his remarks, well worth the read, he also comments on two crucial ICFR concerns in these new standards:

Having the requisite skills in the accounting and financial reporting area to make the many new, complex judgements required by these standards, and

Setting an appropriate tone at the top to assure these judgments are made in a reasonable, consistent and appropriate manner.

 

We did a post about reporting changes in ICFR in November 2016. To refresh your memory, or if you are not familiar with this area, here is a summary of the disclosures required for material changes in ICFR. This applies to material changes made to implement new accounting standards as well as any other material changes.

 

These requirements begin with Item 9A in Form 10-K and Part I Item 4 in Form 10-Q. They both refer to S-K Item 308(c):

 

(c) Changes in internal control over financial reporting. Disclose any change in the registrant’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of §240.13a-15 or 240.15d-15 of this chapter that occurred during the registrant’s last fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

 

With changes to ICFR for revenue recognition for information about contracts and estimates, like stand-alone selling price and when control transfers, and changes to ICFR for capitalization of all leases, these new standards could require material changes to ICFR. Are these the types of changes included in the S-K 308(c) disclosure requirement?

 

This is an excerpt from the ICFR C&DI’s, number 7, about SOX reporting which you can find here:

 

After the registrant’s first management report on internal control over financial reporting, pursuant to Item 308 of Regulations S-K or S-B, the registrant is required to identify and disclose any material changes in the registrant’s internal control over financial reporting in each quarterly and annual report. This would encompass disclosing a change (including an improvement) to internal control over financial reporting that was not necessarily in response to an identified material weakness (i.e. the implementation of a new information system) if it materially affected the registrant’s internal control over financial reporting. Materiality, as with all materiality judgments in this area, would be determined upon the basis of the impact on internal control over financial reporting and the materiality standard articulated in TSC Industries, Inc. v. Northway, Inc. 426 U.S. 438 (1976) and Basic Inc. v. Levinson, 485 U.S. 224 (1988). This would also include disclosing a change to internal control over financial reporting related to a business combination for which the acquired entity that has been or will be excluded from an annual management report on internal control over financial reporting as contemplated in Question 3 above. As an alternative to ongoing disclosure for such changes in internal control over financial reporting, a registrant may choose to disclose all such changes to internal control over financial reporting in the annual report in which its assessment that encompasses the acquired business is included.

 

 

The SEC Regulations Committee of the CAQ has also discussed a particularly intricate issue in this transition. What if you change your ICFR this year, but the change is for future reporting when you begin to report under the new standard next year? This issue is still in play, as this excerpt from the minutes discusses:

 

Changes in ICFR in preparation for the adoption of a new accounting standard

Item 308(c) of Regulation S-K requires disclosure of changes in internal control over financial reporting (“ICFR”) during the most recent quarter that have materially affected or are reasonably likely to materially affect the registrant’s ICFR. The Committee and the staff discussed how this requirement applies to changes in ICFR that are made in preparation for the adoption of a new accounting standard when those changes are in periods that precede the date of adoption and do not impact the preparation of the financial statements until the new standard is adopted.

 

The staff indicated that they are evaluating whether additional guidance is necessary for applying the requirements of Item 308(c) in connection with the transition to the new revenue standard.

 

So, as you begin implementing systems and processes for these new standards, don’t forget this part of the reporting!

 

As always, your thoughts and comments are welcome!

Master SEC Reporting and Prepare to Tackle New Challenges

SEC Hot Topic, , , , , , , , , , , , , , , , , , ,

 

The complicated world of SEC reporting has now gotten even more challenging! Be sure you are prepared to comply with the recently enacted changes and have a plan in place to deal with the SEC staff “hot buttons”.  Attend SECI’s live workshop SEC Reporting Skills Workshop 2017 being held April 24-25 in Chicago, May 8-9 in McLean, Va., May 16-17 in Dallas and May 24-25 in San Francisco with additional dates and locations listed on the SECI website.

http://www.pli.edu/Content/SEC_Reporting_Skills_Workshop_2017/_/N-1z10od0Z4k?ID=290559

A Bit of SEC News and a Hopefully Enjoyable Video

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By: George M. Wilson & Carol A. Stacey

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

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

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

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

https://youtu.be/59iJmRDdeqY

 

As always, your thoughts and comments are welcome!