A couple of weeks ago we did a “Comment of the Week” blog posting about how the SEC has focused comments on the meaningfulness and reliability along with other issues in company developed metrics. You can find that post below; just scan down for the July 28 post.

Anyway, to help emphasize the importance of these metrics, and improving them as we go along, here is an example of how they need to be reviewed and improved. Twitter included this language as preliminary note in their 10-Q filed August 11, 2014. Check out the third and last paragraphs in particular.

NOTE REGARDING KEY METRICS

We review a number of metrics, including monthly active users, or MAUs, timeline views, timeline views per MAU and advertising revenue per timeline view, to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans and make strategic decisions. See the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Metrics” for a discussion of how we calculate MAUs, timeline views, timeline views per MAU and advertising revenue per timeline view.

The numbers of active users and timeline views presented in this Quarterly Report on Form 10-Q are based on internal company data. While these numbers are based on what we believe to be reasonable estimates for the applicable period of measurement, there are inherent challenges in measuring usage and user engagement across our large user base around the world. For example, there are a number of false or spam accounts in existence on our platform. We have performed an internal review of a sample of accounts and estimate that false or spam accounts represented less than 5% of our MAUs. In making this determination, we applied significant judgment, so our estimation of false or spam accounts may not accurately represent the actual number of such accounts, and the actual number of false or spam accounts could be higher than we have estimated. We are continually seeking to improve our ability to estimate the total number of spam accounts and eliminate them from the calculation of our active users. For example, we made an improvement in our spam detection capabilities in the second quarter of 2013 and suspended a large number of accounts. Spam accounts that we have identified are not included in the active user numbers presented in this Quarterly Report on Form 10-Q. We treat multiple accounts held by a single person or organization as multiple users for purposes of calculating our active users because we permit people and organizations to have more than one account. Additionally, some accounts used by organizations are used by many people within the organization. As such, the calculations of our active users may not accurately reflect the actual number of people or organizations using our platform.

Our metrics are also affected by third-party applications that automatically contact our servers for regular updates with no user action involved, and this activity can cause our system to count the users associated with such applications as active users on the day or days such contact occurs.  Historically we tracked and reported in this section all users who accessed Twitter through third-party applications. We have reviewed and refined our processes, however, to calculate a new metric that is comprised of only such active users who have used applications with the capability to automatically contact our servers for regular updates where there was no discernable user action involved.  In the three months ended June 30, 2014, approximately 11% of all active users solely used third-party applications to access Twitter.  However, only up to approximately 8.5% of all active users used third party applications that may have automatically contacted our servers for regular updates without any discernable additional user-initiated action.  The calculations of MAUs presented in this Quarterly Report on Form 10-Q may be affected as a result of automated activity.

In addition, our data regarding user geographic location for purposes of reporting the geographic location of our MAUs is based on the IP address associated with the account when a user initially registered the account on Twitter. The IP address may not always accurately reflect a user’s actual location at the time such user engaged with our platform.

We present and discuss timeline views in this Quarterly Report on Form 10-Q. We have estimated a small percentage of timeline views in the three months ended September 30, 2013 to account for certain timeline views that were logged incorrectly during the quarter as a result of a product update. We believe this estimate to be reasonable, but the actual numbers could differ from our estimate. Further, timeline views in 2012 exclude an immaterial number of timeline views for our mobile applications, certain of which were not fully tracked until June 2012. We present and discuss our total audience based on both internal metrics and data from Google Analytics, which measures unique visitors to our properties.

We regularly review and may adjust our processes for calculating our internal metrics to improve their accuracy. Our measures of user growth and user engagement may differ from estimates published by third parties or from similarly-titled metrics of our competitors due to differences in methodology.

As always, we would love to hear your comments!

Pick –up line for an accounting bar – So, what’s your favorite Item in Form 10-K?

A question that occasionally comes up, and can create confusion in the 10-K and 10-Q preparation process is what to do with item numbers that do not apply to your company.

For example, in Part One of the Form 10-K, Item 4 concerning mine safety disclosures frequently does not apply. So, what should you do with this Item number? Could you leave it out? Must you list it? Is it a style choice?

Well, as it turns out, the SEC has an Exchange Act Rule that answers this question: (And yes, we are into total SEC Geek territory here)

§240.12b-13   Preparation of statement or report.

The statement or report shall contain the numbers and captions of all items of the appropriate form, but the text of the items may be omitted provided the answers thereto are so prepared as to indicate to the reader the coverage of the items without the necessity of his referring to the text of the items or instructions thereto. However, where any item requires information to be given in tabular form, it shall be given in substantially the tabular form specified in the item. All instructions, whether appearing under the items of the form or elsewhere therein, are to be omitted. Unless expressly provided otherwise, if any item is inapplicable or the answer thereto is in the negative, an appropriate statement to that effect shall be made.

(Note that the bolding was added for this blog, and that this is also done below)

So, all Item numbers must be listed!

If you would like to look at the Exchange Act Rules, you can find them in our SEC handbook, or here on the web:

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

That said, every rule has an exception, and the exception to this rule is in the Form 10-Q, Part Two, which has an instruction that says:

PART II—OTHER INFORMATION

Instruction. The report shall contain the item numbers and captions of all applicable items of Part II, but the text of such items may be omitted provided the responses clearly indicate the coverage of the item. Any item which is inapplicable or to which the answer is negative may be omitted and no reference thereto need be made in the report. If substantially the same information has been previously reported by the registrant, an additional report of the information on this form need not be made. The term “previously reported” is defined in Rule 12b-2 (17 CFR 240. 12b-2). A separate response need not be presented in Part II where information called for is already disclosed in the financial information provided in Part I and is incorporated by reference into Part II of the report by means of a statement to that effect in Part II which specifically identifies the incorporated information.

(Note that the bolding was added for this blog)

So, save those references, and we all hope your reporting goes well.

As usual, we would love to hear your thoughts and comments.

So, how good is your goodwill?

The staff in the Division of Corporation Finance, as it has over the last several years, continues to ask questions about goodwill recoverability.  And, more importantly, the staff frequently asks for incremental disclosures about the risks surrounding goodwill recoverability in MD&A.

Forewarning disclosures, the complex known trend disclosure that got Sony into trouble when it had an unexpected goodwill write-off, are never easy. And, of course, they are very different from a risk factor. If you want a brief reminder, the Sony case is at:

http://www.sec.gov/litigation/admin/3440305.txt

Here is a very recent comment dealing with this issue:

1. We note that for 2013 you performed a quantitative assessment for Europe, India & Southeast Asia, and Middle East reporting units. Please tell us if you believe these reporting units are at risk of failing step one of the impairment test and your basis for this conclusion. Please also tell us, and in future filings disclose, the following related to the reporting units at risk of failing step one:

The percentage by which fair value exceeded carrying value as of the date of the most recent impairment test; and

•  The amount of goodwill allocated to these reporting units.

Alternatively, if in your view your reporting units are not at risk please disclose that fact. Refer to Item 303(a)(3)(ii) of Regulation S-K and Section V of Release 33-8350 for further guidance.

And, here is another similar comment, which even asks for disclosure regarding valuation approaches and assumptions:

We note that QiG continues to operate in a loss position and generates minimal revenues. We reference the disclosure that goodwill allocated to QiG is not at risk of failing step one of future impairment tests. Please revise future filings to disclose the specific valuation approach and underlying assumptions you used in determining the fair value of the QiG reporting unit to assess goodwill impairment. Please also clarify how you concluded that the fair value of the QiG reporting unit is substantially in excess of carrying value as of the date of your last impairment test.

So, if you are getting, or could get close on an impairment test, don’t forget known trend disclosure in MD&A!

As always, we welcome your comments and thoughts!

Generally SEC comment letter issues are about disclosure that the SEC believes investors need to make informed decisions. Sometimes they transmogrify into bigger, almost political issues, and that is happening with international operations, particularly in the tax area, right now.

We have been talking in our large conferences and workshops over the last few years about the issues involved in having significant amounts of cash held in overseas subsidiaries. The SEC’s focus on disclosure about this issue has historically centered on the related tax effect if this cash were repatriated.

This issue became important during the recession when many US companies found themselves in the situation where much of the cash on their balance sheet was actually held in overseas subsidiaries and in essence was not available to fund US operations without a significant tax impact.

Many companies received SEC comments like this one:

1. We note your disclosure on page 66 that the majority of your cash, cash equivalents and short-term investments are held by your foreign subsidiaries. We also note that a significant portion of your foreign earnings are deemed to be indefinitely reinvested in foreign jurisdictions. To assist investors understand the availability of funds in domestic operations such as payment of debt, dividends, acquisitions and capital expenditures, please provide enhanced disclosures. Please provide and confirm that in future Exchange Act filings you will disclose the following:

(a) the amount of cash and cash equivalents that are currently held by your foreign subsidiaries;

(b)  quantify the amount of cash and short-term investments held by foreign subsidiaries where the funds are not readily convertible into other foreign currencies, including U.S. dollars;

(c)  if foreign earnings are repatriated, disclose that these amounts would be subject to income tax liabilities both in the US and in the various foreign countries;

(d)  explain any other implications or restrictions upon your liquidity that is impacted by the majority of your cash, cash equivalents and short term investments held by foreign subsidiaries.

Refer to Item 303(a)(1) of Regulation S-K and Section IV of SEC Release 33-8350.

Now the flavor of this issue is changing to raise the question of how much tax has been paid on international earnings. A really hot topic in the press right now is the “corporate inversion”, a transaction in which a US company acquires a company outside the US and changes its tax domicile to the country outside the US to save taxes.

There is even an entry on the White House web page about inversions, which uses the phrase “economic patriotism”.

http://www.whitehouse.gov/blog/2014/07/24/what-are-inversions-and-why-should-you-care

We won’t put more links here, but if you Google “corporate inversion”, it is startling how much shows up!

While this is not a clear GAAP or investor risk issue right now, we think it is one to think about!

Welcome to our second “Comment of the Week” blog. We are always looking for evolving SEC focus areas, and the use of “metrics” is clearly becoming an important issue.

Check out any tech company’s earnings release and you will see various metrics. Here is an excerpt from Facebook’s second quarter release as an example:

Second Quarter 2014 Operational Highlights

Daily active users (DAUs) were 829 million on average for June 2014, an                         increase of 19% year-over-year.

Mobile DAUs were 654 million on average for June 2014, an increase of 39% year-over-year.

Monthly active users (MAUs) were 1.32 billion as of June 30, 2014, an increase of 14% year-over-year.

Mobile MAUs were 1.07 billion as of June 30, 2014, an increase of 31%                                     year-over-year.

You can read the whole release at:

http://investor.fb.com/releasedetail.cfm?ReleaseID=861599

The SEC Staff will frequently ask questions about whether such metrics really do correlate with financial performance. Here are three example comments.

3.  We note your disclosure on page 40 of Annualized Recurring Revenue and number of paid subscriptions for your Digital Media segment’s…and Document Services offerings. Please tell us how you considered disclosing the same metrics for your Digital Marketing segment’s subscription offerings…As part of your response, please tell us if there are any other key metrics used by management to evaluate the Digital Marketing segment’s subscription offerings and tell us what consideration you have given to disclosing any such metrics. See Section III.B.1 of SEC Release No. 33-8350.

4.  We note your disclosure that renewals for your…services were one of the primary reasons for the fiscal 2013 increase in deferred revenue. We also note your disclosure on page 60 of your 2012 10-K that you “expect renewal rates associated with…, and potentially other subscription offerings, will become key metrics used to measure their performance.” Please tell us the extent to which you consider renewal rates to be key metrics and whether you believe that these metrics contribute meaningfully to understanding and evaluating your company. Please tell us what consideration you gave to disclosing renewal rates for each of your subscription offerings…See Section III.B.1 of SEC Release No. 33-8350.

5.  We note your disclosures on pages 2, 85 and elsewhere regarding social media metrics concerning your…Network and G…Channels. To the extent management uses these metrics as key indicators of operating performance, please identify the specific metrics used and address them in your Results of Operations, as appropriate. Also provide an explanation of your calculations. For guidance, please refer to Part III.B.1 of Interpretive Release No. 33-8350 (December 19, 2003), available on the Commission’s website.

Interestingly, the staff in many cases refers companies back to FR 72’s discussion of key performance indicators (the reference to Release No. 33-8350). You can find FR 72 at:

http://www.sec.gov/rules/interp/33-8350.htm

The discussion referenced starts with these words:

1.  Focus on Key Indicators of Financial Condition and Operating Performance.  As discussed, one of the principal objectives of MD&A is to give readers a view of the company through the eyes of management by providing both a short and long-term analysis of the business.²⁵ To do this, companies should “identify and address those key variables and other qualitative and quantitative factors which are peculiar to and necessary for an understanding and evaluation of the individual company.”²⁶ 

Financial measures generally are the starting point in ascertaining these key variables and other factors. However, financial measures often tell only part of how a company manages its business. Therefore, when preparing MD&A, companies should consider whether disclosure of all key variables and other factors that management uses to manage the business would be material to investors, and therefore required.²⁷ These key variables and other factors may be non-financial, and companies should consider whether that non-financial information should be disclosed.

Many companies currently disclose non-financial business and operational data.²⁸ Academics, authors, and consultants also have researched the types of information, outside of financial statement measures, that would be helpful to investors and other users.²⁹ Such information may relate to external or macro-economic matters as well as those specific to a company or industry. For example, interest rates or economic growth rates and their anticipated trends can be important variables for many companies. Industry-specific measures can also be important for analysis, although common standards for the measures also are important. Some industries commonly use non-financial data, such as industry metrics and value drivers.³⁰ Where a company discloses such information, and there is no commonly accepted method of calculating a particular non-financial metric, it should provide an explanation of its calculation to promote comparability across companies within the industry. Finally, companies may use non-financial performance measures that are company-specific.

So, as you think about metrics, be sure they correlate to financial performance, and don’t forget about FR 72. As usual, we would love to hear your thoughts!

SAB 74 Disclosures are going to be important for the new Revenue From Contracts With Customers standards, so here is a starting point for your use.

First, a brief reminder of the requirements from SAB 74 (Topic 11-M in the SAB codification).  For recently issued accounting standards expected to have a material impact you should consider disclosing:

A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier.

A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined.

A discussion of the impact that adoption of the standard is expected to have on the financial statements of the registrant, unless not known or reasonably estimable. In that case, a statement to that effect may be made.

Disclosure of the potential impact of other significant matters that the registrant believes might result from the adoption of the standard (such as technical violations of debt covenant agreements, planned or intended changes in business practices, etc.) is encouraged.

The SAB also reminds registrants of the requirement to disclose in MD&A presently known material changes, trends, and uncertainties that the registrant reasonably expects to have a material impact on future sales, revenues or income from continuing operations. We will address the MD&A discussion in a future post.

You can read the entire SAB at: http://www.sec.gov/interps/account/sabcodet11.htm#M

Here is a draft of footnote disclosure for a registrant that currently does not know the impact the standard will have. Please consider this disclosure only as a starting point, to be edited with your facts and circumstances.

New Accounting Standards

On May 28, 2014 the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU establishes a new, contract-based model for recognizing revenue.  The new model replaces virtually all of the existing generally accepted accounting principles for revenue recognition that currently exist in US GAAP.  The new model is based on five steps, (1) identifying contracts with customers, (2) identifying performance obligations within each contract, (3) determining the transaction price, (4) allocating the transaction price to performance obligations and (5) recognizing revenue when or as a performance obligation is satisfied.  The new model significantly changes existing GAAP, requires substantial judgment in its application, and will generally require companies to make more disclosures about revenue.

Public business entities must implement the new Accounting Standards Update for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that year. Earlier application is not permitted.  Thus, we will implement the new standard for the quarter beginning on_________.

The new standard provides for two alternative implementation methods.  The first is to apply the new standard retrospectively to each prior reporting period presented.  This method does allow the use of certain practical expedients.

The second method is to apply the new standard retrospectively in the year of initial adoption and record a cumulative effect adjustment for the impact of adjusting contracts open at the date of adoption.  Under this transition method, we would apply this guidance retrospectively only to contracts that are not completed contracts at the date of initial application (which for us will be January 1, 2017).  We would then recognize the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings. This method also requires us to disclose comparative information for the year of adoption.

We have not yet determined which method we will use to implement the new standard.

We have not yet determined the impact the new standard is expected to have on our financial statements or on other matters or aspects of our business.

If you have attended one of our seminars or workshops, you know we always discuss the SEC’s Comment focus areas.  We do this so that potential problems and issues can be addressed before they become serious.

In our blog, we thought we would reinforce this with a semi-regular “Comment of the Week” entry.

And what would be a better topic to start with than reporting segments!  The SEC always mentions this area when they speak, and they continue to write comments about segments.  Here are two examples from letters issued this year:

1. We reference the disclosure on page 66 that you operate and account for your results in one reportable segment, the design, development, manufacture and market of high performance semiconductor products. Please tell us how you considered the guidance in FASB ASC 280-10-50-1 through 9. In this regard, we note that you have five major focused product groups, each of which has a Senior Vice President and General Manager that oversees its operations and may be considered a segment manager. Please clarify why these product groups do not represent segments or aggregated segments under FASB ASC 280.

7. You disclose your business is classified by management into three reporting segments. Further, we note your 2014 first quarter earnings transcript where you state, “[I]n terms of sales comparisons geographically, for the first quarter, the better performing regions in the U.S. were in the Southeast, Midwest, and Texas. Internationally, in local currencies, the better performing countries were Canada, Mexico, and Australia.” Please provide us with your analysis under ASC 280 that supported disclosing all operations as three reportable segments.

Please include the following information in your response:

• The operating segments you have identified in accordance with ASC 280- 10-50-1 through 50-9.
• If applicable, the basis for aggregating identified operating segments into three reportable segments given the aggregation criteria in ASC 280-10-50-11 and quantitative thresholds in ASC 280-10-50-12.
• How the aggregation of all of your operations into three reportable segments complies with the aggregation criteria.
• The process through which your chief operating decision maker reviews information to make decisions about resources to be allocated to your segments and assess their performance.

Why does the SEC consistently, year after year focus on this area?  As a reminder, check out the enforcement case against Sony, where their segments masked an issue in their movie business.

http://www.sec.gov/litigation/admin/3440305.txt

Or more recently, check out the enforcement case against Paccar, a Fortune 200 company that, among other issues, presented one reportable segment. As a result, the aggregation of two operating segments into one masked sizable losses in their largest segment.

http://www.sec.gov/litigation/litreleases/2013/lr22711.htm

The SEC broke its long silence about XBRL and raised some interesting questions for filers yesterday with an XBRL report from the Division of Economic and Risk Analysis titled “Staff Observations of Custom Tag Rates”.

The fairly brief report is available at:

http://www.sec.gov/dera/reportspubs/assessment-custom-tag-rates-xbrl.html#.U7wGKYm9K0d

Interestingly, the report notes that smaller filers use custom tags at a significantly higher rate than larger filers, and that this pattern can even be associated with which XBRL tools are used.  The report raises some very significant questions for filers in the smaller filer category.

One other XBRL discussion point for this blog – have you found an XBRL user focused analysis tool yet?  Check this one out from CalcBench, it is interesting!

http://www.calcbench.com

There are clearly many questions still to be addressed concerning XBRL.  We would love to hear your comments!