In this period of earnings releases we always watch for interesting disclosure examples. Microsoft has provided us with a great example of the “forward looking” disclosures about “known trends and uncertainties” that we discuss in our workshops.
As a reminder, this S-K Item 303 MD&A disclosure requirement says:
(3) Results of operations. (i) ………..
(ii) Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed.
In their most recent earnings release Microsoft reported a $7.5 billion goodwill impairment related to its acquisition of Nokia’s “Devices and Services” business, which they refer to as NDS. At issue here of course is that such an impairment rarely would ever come out of the blue in an unexpected way during the current quarter. In fact, the risk of impairment would almost always be known well before actually recording the impairment. And, if the company “reasonably expects” there will be an impairment in a future quarter, the company must disclosure this risk in MD&A.
On April 29, 2014 Microsoft completed the acquisition of substantially all of Nokia Corporation’s (“Nokia”) Devices and Services Business (“NDS”), which they reported in a new Phone Hardware segment.
Microsoft, which has a June 30 fiscal year end, said this in their Critical Accounting Estimates disclosure in their June 30, 2014 Form 10-K, which was of course shortly after the acquisition.
Goodwill
We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit.
(some text omitted)
The valuation of acquired assets and liabilities, including goodwill, resulting from the acquisition of NDS, is reflective of the enterprise value based on the long-term financial forecast for the business. In this highly competitive and volatile market, it is possible that we may not realize our forecasts. Given the value assigned to goodwill in the purchase price allocation, we will closely monitor the performance of the business versus the long-term forecast to determine if any impairments arise.
They also had a robust risk factor disclosure which you can find in the 10-K.
This disclosure was essentially repeated in their first quarter Form 10-Q for the quarter ended September 30, 2014.
For the second quarter ended December 31, 2015, the disclosure was adjusted a bit to focus on the Phone Hardware segment:
The valuation of acquired assets and liabilities, including goodwill, resulting from the acquisition of NDS, is reflective of the enterprise value based on the long-term financial forecast for the business. In this highly competitive and volatile market, it is possible that we may not realize our forecasts. Given the value assigned to goodwill in the purchase price allocation, we will closely monitor the performance of the business versus the long-term forecast to determine if any impairments arise in our Phone Hardware reporting unit. Except as clarified above, we determined that none of our reporting units were at risk of impairment as of our most recent annual goodwill impairment testing date.
And, in their Form 10-Q for the third quarter ended March 31, 2015, this “known trend or uncertainty” became a bigger risk and was addressed directly:
“Goodwill
(Some text omitted)
We determined that none of our reporting units were at risk of impairment as of our most recent annual goodwill impairment testing date. The valuation of acquired assets and liabilities, including goodwill, resulting from the acquisition of NDS, is reflective of the enterprise value based on the long-term financial forecast for the Phone Hardware business. In this highly competitive and volatile market, it is possible that we may not realize our forecast. Considering the magnitude of the goodwill and intangible assets in the Phone Hardware reporting unit (see Note 8 – Business Combinations of the Notes to Financial Statements), we closely monitor the performance of the business versus the long-term forecast to determine if any impairments exist in our Phone Hardware reporting unit. In the third quarter of fiscal year 2015, Phone Hardware did not meet its sales volume and revenue goals, and the mix of units sold had lower margins than planned. We are currently beginning our annual budgeting and planning process. We use the targets, resource allocations, and strategic decisions made in this process as the inputs for the associated cash flows and valuations in our annual impairment test. Given its recent performance, the Phone Hardware reporting unit is at an elevated risk of impairment. Declines in expected future cash flows, reduction in future unit volume growth rates, or an increase in the risk-adjusted discount rate used to estimate the fair value of the Phone Hardware reporting unit may result in a determination that an impairment adjustment is required, resulting in a potentially material charge to earnings.”
(Emphasis added)
Blunt words to forewarn investors of the risk of impairment!
As always, your thoughts and comments are welcome!