Tag Archives: SEC

Comment of the Week – Debt Versus Equity Issues on the Rise?

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The genesis of this post is actually a panel discussion from PLI’s 47th Annual Institute on Securities Regulation. This program is one of our major events in the CLE world. The roster of speakers is amazing, starting with a keynote address from Chair White and featuring so many SEC alums, current staffers and industry professionals that an SEC geek simply can’t resist the program.

Anyway, on the first day of the conference the first panel discussed capital market “health” in the current environment. One of the market developments they discussed was financing rounds companies complete shortly before an IPO. In the current environment more and more late round investors are demanding “price protection”. This “price protection” includes instruments like warrants with adjustable prices (ratchets or down-rounds) and preferred stock with adjustable conversions options.

(The staff does write comments about these kinds of instruments, and we have a few examples below.)

It turns out that sometimes the valuations used for these private placements shortly before an IPO don’t follow through to the valuations in the IPO. So the late round investors ask for price protection so they won’t seem to have overpaid shortly before an IPO. (This dovetails very nicely with the recent discussion in the financial press about how valuations for “unicorn” companies may be overstated in the current tech world.)

This is exactly the kind of price protection that has been common in emerging companies that have been far from the IPO process, and it is these kinds of instruments that have been the cause of so many restatements.

If you have ever attended any of our Midyear, Annual or Mid-Sized and Smaller Company SEC Reporting & FASB Forums you are familiar with the continuously updated list of restatement issues we discuss at those conferences. For the last seven years, the number one cause of restatements by public companies has been debt versus equity accounting. Instruments such as warrants with repricing provisions combined with the convoluted, complex accounting guidance in this area have caused more restatements than any other issue.

Being one of the few accountants in the Institute on Securities Regulation it was fascinating listening to the lawyers discuss these complex instruments. The discussion of disclosures that should surround these complex instruments and their unique features was deep and rich. No one however mentioned the accounting issues that they create, and the risk of restatement that goes along with this accounting complexity.

It was a great reminder that as accounting professionals we need to be on the watch for this issue and when we see it raise the accounting issues and assure they are dealt with effectively. This is one of the times when communication between finance, legal and accounting professionals is crucial.

If you would like to review an example of the accounting these instruments create, one of the participants on the panel was from BOX, a successful IPO which had this exact situation. In their first Form 10-K and their S-1 you can find a derivative liability on their balance sheet and a related fair value adjustment in their income statement related to redeemable preferred stock warrants they issued which were derivatives. You can find their Form 10-K at:

www.boxinvestorrelations.com/sec-filings

And, last, here are a couple of example comments. All of this really emphasizes the need to be aware of this issue and build the skills to recognize the issue and deal with it effectively.

It appears the exchangeable senior notes issued in August 2014 contain redemption features. Provide us your analysis that supports your conclusion that none of the redemption features are required to be bifurcated in accordance with ASC 815-15. Specifically address whether the debt involves a substantial discount in accordance with ASC 815-15-25-40 through [25-43].

We note your disclosure that the 1.25% Notes contain an embedded cash conversion option and that you have determined that this option is a derivative financial instrument that is required to be separated from the notes. Please provide us with the details of your analysis in determining that this conversion option should be accounted for separately as a derivative and refer to the specific accounting literature you relied on.

As always, your thoughts and comments are welcome!

P.S. And, just in case this is relevant to you, here is a link to our new workshop “Debt vs. Equity Accounting for Complex Financial Instruments”. This new case-driven workshop will be presented five times next year.

www.pli.edu/Content/Debt_vs_Equity_Accounting_for_Complex_Financial/_/N-1z11c8lZ4k?ID=262917

 

Evolution of the Audit Committee – Part Four

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In three previous posts about audit committee evolution we explored:

A bit of history about how audit committee responsibilities have changed over time,

Situations where independence issues have resulted in enforcement involving      auditors and companies, and

How some issues, such as auditor independence, are not just matters for the auditor to monitor, but also may require audit committee involvement.

 

As history demonstrates, audit committees play a crucial role in oversight of the financial reporting process. An effective audit committee is a crucial part of assuring the reliability and reasonableness of financial information. Unfortunately, history also shows us that audit committees don’t always successfully fulfill their responsibilities.

Chair White expanded on these issues in a June 2014 speech to the Stanford University Rock Center for Corporate Governance Twentieth Annual Stanford Directors’ College. In that speech, after reviewing two enforcement cases which involved audit committee members she said:

I mention these cases because audit committees, in particular, have an extraordinarily important role in creating a culture of compliance through their oversight of financial reporting. As you know, under the Sarbanes-Oxley Act, audit committees are required to establish procedures for handling complaints regarding accounting, internal controls, and auditing matters, as well as whistleblower tips concerning questionable accounting or auditing practices. Audit committees also play a critical role in the selection and oversight of the company’s auditors. These responsibilities are critical ones and we want to support you. Service as a director is not for the faint of heart, but nor should it be a role where you fear a game of “gotcha” is being played by the SEC.

Clearly Ms. White is emphasizing the responsibility audit committees have as gatekeepers in the financial reporting process.

(You can read the whole speech at: www.sec.gov/News/Speech/Detail/Speech/1370542148863 )

All of this leads us to the SEC’s July 1, 2015 Concept Release “POSSIBLE REVISIONS TO AUDIT COMMITTEE DISCLOSURES”. Attempting to perhaps incentivize audit committees to perform effectively, and even more importantly shed light on audit committee performance to help investors and other stakeholders understand whether audit committees are effectively fulfilling their oversight responsibilities are not simple issues, and this concept release begins a significant discussion.

What sorts of disclosures does the concept release propose to deal with these issues? The principle areas of focus are:

Audit Committee’s Oversight of the Auditor

Audit Committee’s Process for Appointing or Retaining the Auditor

Qualifications of the Audit Firm and Certain Members of the Engagement Team Selected By the Audit

In the summary of the concept release the commission makes their objective clear, stating:

Some have expressed a view that the Commission’s disclosure rules for this area may not result in disclosures about audit committees and their activities that are sufficient to help investors understand and evaluate audit committee performance, which may in turn inform those investors’ investment or voting decisions.

The reporting of additional information by the audit committee with respect to its oversight of the auditor may provide useful information to investors as they evaluate the audit committee’s performance in connection with, among other things, their vote for or against directors who are members of the audit committee, the ratification of the auditor, or their investment decisions.

Here is a quick outline of the areas addressed in the Concept Release:

  1. Auditor Committee’s Oversight of the Auditor
  2. Additional Information Regarding the Communications Between the Audit Committee and the Auditor
  3. The Frequency with which the Audit Committee Met with the Auditor
  4. Review of and Discussion About the Auditor’s Internal Quality Review and Most Recent PCAOB Inspection Report
  5. Whether and How the Audit Committee Assesses, Promotes and Reinforces the Auditor’s Objectivity and Professional Skepticism
  6. Audit Committee’s Process for Appointing or Retaining the Auditor
  7. How the Audit Committee Assessed the Auditor, Including the Auditor’s Independence, Objectivity and Audit Quality, and the Audit Committee’s Rationale for Selecting or Retaining the Auditor
  8. If the Audit Committee Sought Requests for Proposal for the Independent Audit, the Process the Committee Undertook to Seek Such Proposals and the Factors They Considered in Selecting the Auditor
  9. The Board of Directors’ Policy, if any, for an Annual Shareholder Vote on the Selection of the Auditor, and the Audit Committee’s Consideration of the Voting Results in its Evaluation and Selection of the Audit Firm
  10. Qualifications of the Audit Firm and Certain Members of the Engagement Team Selected By the Audit Committee
  11. Disclosures of Certain Individuals on the Engagement Team
  12. Audit Committee Input in Selecting the Engagement Partner
  13. The Number of Years the Auditor has Audited the Company
  14. Other Firms Involved in the Audit

As you can see, the areas the SEC is considering for disclosure are significant and would represent a major change in how much of the audit committee’s work is in the sunshine of disclosure. Along this evolutionary path it is important to remember that a Concept Release is essentially a discussion document. If the SEC does pursue rulemaking, the content of a proposed rule will be based on input received in response to the concept release. The SEC is always responsive to substantive comments, so if a rule is eventually proposed, it will differ from the proposed rule based on comments from constituents. This means we are early on in this process, and we can provide input to the process.

As a concluding thought, if you do want to comment on the Concept Release, here is where to do that:

www.sec.gov/cgi-bin/ruling-comments#

As always, your thoughts and comments are welcome!

 

SEC Comment of the Week – A Favorite Topic

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It is hard to believe we are already in mid-October, and the fourth quarter of the calendar year is well underway. Many companies will soon start planning for year-end reporting and being aware of “hot button issues” is a key part of this process. To help in this planning process we are going to highlight key planning issues through our blog posts. Here is the first of these issues we think all companies should be thinking about as year-end approaches.

As we have watched comments in recent weeks, one of the areas that continues to be emphasized is the quantification of analysis in MD&A. The roots of this issue are deep. Way back in 1989 one of the examples in FR 36 laid out the framework:

Revenue from sales of single-family homes for 1987 increased 6% from 1986. The increase resulted from a 14% increase in the average sales price per home, partially offset by a 6% decrease in the number of homes delivered. Revenues from sales of single-family homes for 1986 increased 2% from 1985. The average sales price per home in 1986 increased 6%, which was offset by a 4% decrease in the number of homes delivered.

The increase in the average sales prices in 1987 and 1986 is primarily the result of the Company’s increased emphasis on higher priced single-family homes. The decrease in homes delivered in 1987 and 1986 was attributable to a decline in sales in Texas. The significant decline in oil prices and its resulting effect on energy-related business has further impacted the already depressed Texas area housing market and is expected to do so for the foreseeable future. The Company curtailed housing operations during 1987 in certain areas in Texas in response to this change in the housing market. Although the number of homes sold is expected to continue to decline during the current year as a result of this action, this decline is expected to be offset by increases in average sales prices.

You can find the release at:

www.sec.gov/rules/interp/33-6835.htm

 

In 2003 FR 72 emphasized the importance of understanding the causal factors underlying changes:

  1. Focus on Analysis

MD&A requires not only a “discussion” but also an “analysis” of known material trends, events, demands, commitments and uncertainties. MD&A should not be merely a restatement of financial statement information in a narrative form. When a description of known material trends, events, demands, commitments and uncertainties is set forth, companies should consider including, and may be required to include, an analysis explaining the underlying reasons or implications, interrelationships between constituent elements, or the relative significance of those matters.

You can find the release at:

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

 

And, here are a few very recent comments where the staff focuses on these requirements in MD&A. (We have added emphasis to highlight key issues.)

As previously requested, please disclose more detail about the underlying material factors contributing to the increases in comparable store sales in both your year-end and interim results discussions, such as any changes in selling prices, volumes or the introduction or discontinuance of popular products that had a significant impact on your revenue. Refer to Item 303(a)(3)(iii) of Regulation S-K. In this regard, your current disclosures such as stating that comparable store sales increase primarily due to “strong deals in electronics, pets and clothing” do not provide enough insight into the underlying factors that drove the increase in comparable store sales that investors can access the likelihood that past results are indicative of future results. To the extent that multiple offsetting factors influenced your comparable store sales, you should discuss the impact of each significant factor. For example, if “strong deals” indicates that you lowered average prices through increased promotional activity, this would appear to decrease revenue; however, these lower prices may have been more than offset by higher volumes of products being sold. In this case, both the decrease in pricing and the increase in volume should be described.

Throughout your discussion of the results of operations, you refer to various factors that have impacted your results without quantifying the impact of each factor. Where a material change is attributed to two or more factors, including any offsetting factors, the contribution of each identified factor should be described in quantified terms. For example, you attribute the decrease in net sales and unit sales for the (Product A) in 2014 as a result of growth in the Greater China and Japan segments offset by declines in all other segments with no quantification. As another example, you attribute the growth in the Americas segment in 2014 as a result of increased net sales of (Products B, C and D), Software and Services offset by a decline in net sales of (Product E and A) and weakness in foreign currencies but you do not quantify the effects of these individual factors. Please explain to us how you considered quantifying the sources of material changes and offsetting factors throughout your discussion. Refer to Item 303(a)(3)(iii) of Regulation S-K and Section III.D of SEC Release No. 33-6835.

(Bloggers note: The release mentioned here is FR 36 quoted above)

We note you attribute the changes in headcount to explain certain changes in your results of operations but the headcount does not appear to be quantified. Please tell us your consideration of quantifying the headcount at the end of each period as a factor to explain the changes for the line items that are impacted. We refer you to Item 303(a)(3)(iii) of Regulation S-K and Section III.D of SEC Release No. 33-6835.

 

As always, your thoughts and comments are welcome!

Audit Committee Evolution – Part Two

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In our post last week we began a series focusing on audit committees. We briefly reviewed the history of audit committee requirements over the past 20 years or so hoping that understanding the past will help us understand what the future might hold. The current discussion about audit committee roles and responsibilities flows from this history. This discussion also has roots in several auditor/client events that have happened over the last several years.

This post discusses some of those recent events, primarily SEC Enforcement cases and related matters as they relate to auditor independence. Hopefully this will help provide context and yield more insight into what the future may hold.

One of the major themes in the SEC’s “Possible Revisions to Audit Committee Disclosures” Concept Release is audit committee oversight of independent auditors. Independence is clearly an important aspect of this oversight. Historically independence has been the auditor’s responsibility. When the SEC and the PCAOB have promulgated independence rules they have been directed primarily to the auditor, not the company or the audit committee.

It may be that it is time for this attitude to evolve and change.

Recent SEC enforcement cases provide several examples where the dividing line between the auditor’s and the company’s responsibility for auditor independence has been very fuzzy. (To be clear, in these cases it would not appear that there were many overt bad-actors who set out to break the rules. So, as you read the examples, ponder who should be in place to know the rules and assure compliance?)

A First Example

Sometimes independence problems are very simple. One of these foundational issues is that the auditor may not assist management in the preparation of financial statements. In fact, Regulation S-X Rule 2.01 states:

(4) Non-audit services. An accountant is not independent if, at any point during the audit and professional engagement period, the accountant provides the following non-audit services to an audit client:

(i) Bookkeeping or other services related to the accounting records or financial statements of the audit client. Any service, unless it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the audit client’s financial statements, including:

(A) Maintaining or preparing the audit client’s accounting records;

(B) Preparing the audit client’s financial statements that are filed with the Commission or that form the basis of financial statements filed with the Commission; or

(C) Preparing or originating source data underlying the audit client’s financial statements.

The idea here is that the auditor cannot really “audit” something they have prepared. This seems relatively straightforward, but when broker-dealers were first required to have their audits performed using the standards of the PCAOB and became subject to the SEC’s auditing requirements, this requirement was overlooked in a number of cases. Eight of these cases resulted in enforcement against auditors for helping their clients prepare financial statements.

You can read the details of the cases in this press release:

www.sec.gov/News/PressRelease/Detail/PressRelease/1370543608588

Now, as we described above, independence has usually been the bailiwick of the auditor. But, when there is an independence problem the company bears a harsh cost also, possibly even a new audit of the same period(s) by an auditor who is in fact independent. In a time of change such as using the PCAOB’s standards for the first time, would it be unreasonable to expect that the audit committee would be knowledgeable about these standards and as part of their oversight of auditing matters ask if there were any issues concerning compliance with the new standards? Is it possible that a strong audit committee could help avoid these problems?

Really, the deeper issue here is that a strong audit committee needs to monitor the financial reporting and auditing environment for changes and assure that management deals with these changes. Easy examples in today’s world include cybersecurity and oil prices.

As a postscript to this first example, the very first enforcement case brought by the PCAOB was over this very issue. It was “way back” in May of 2005. You can read the details at:

pcaobus.org/Enforcement/Decisions/Documents/05-24_Goldstein_and_Morris.pdf

 Second Example

The independence relationship can be very complex to track. Even firms with only a few professionals may not always be aware of all the business activities of all its professionals. For larger firms this can be a huge quality control and compliance challenge. In a recent enforcement a large firm was fined when its consulting affiliate maintained a business relationship with an individual who was a trustee and a board and audit committee member of three funds the firm audited.

Certainly there was a breakdown on the part of the firm in this case, but should the audit committees of the funds have been monitoring for such relationships? This is a complex issue, and the question should be addressed. As you will note in the press release linked below, the adequacy of the fund’s audit committee charter was called into question.

You can read the details of this case at:

www.sec.gov/news/pressrelease/2015-137.html

A Third Example

In this case an audit firm’s affiliate in Washington, DC provided lobbying services to companies that were also audit clients. Such advocacy services are always prohibited by the independence rules. And, again, the firm likely may have a quality control system issue to address tracking the myriad of business relationships in a large professional practice. But again the questions surrounding the client’s responsibility and the role of audit committees need to be addressed. It is not just the auditor who has a consequence in this situation. In a complex commercial world where business can happen so quickly, this issue is even more important.

You can read the details of this case at:

www.sec.gov/News/PressRelease/Detail/PressRelease/1370542298984

Concluding Thoughts

None of these cases are simple, and in each case the fact set behind the case makes it clear there were generally no overt bad-actors who were setting out to break rules. Which brings us back to the question, who is there to make sure that the rules are monitored and that companies comply? Is the audit committee part of that structure? We will see how the situation evolves!

As always, your thoughts and comments are appreciated!

 

 

 

Audit Committee Evolution

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Over the last 15 years the role of the audit committee has been discussed, regulated and disclosed in ever increasing and expanding ways.

(Yes, this was true even longer than 15 years ago, but we will focus on the last 15 years for now! Maybe more history later?)

As you have likely heard, in the last several months the SEC and the PCAOB have both been active in developing the next steps of audit committee evolution. All public companies need to deal with these possible changes, and to do that well it helps to have a perspective on how these changes fit into the longer-term change process.

It was way back in pre-SOX years, actually December 1999, that the SEC enacted rules to require the S-K Item 407 Audit Committee Report and related disclosures. Even in this pre-SOX period the importance of the audit committee was clear. The final rule mentions the “Blue Ribbon Committee” that had been formed to deal with this issue:

“We are adopting new rules and amendments to current rules to improve disclosure relating to the functioning of corporate audit committees and to enhance the reliability and credibility of financial statements of public companies. As more fully described in the Proposing Release, the new rules and amendments are based in large measure on recommendations made by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (the “Blue Ribbon Committee”)”

The Sarbanes – Oxley Act continued the evolution of the audit committee’s role. SOX’s provisions went well beyond disclosure, actually impacting audit committee member qualifications, structure and function. It enacted provisions dealing with:

  • Independence of audit committee members
  • The audit committee’s responsibility to select and oversee the issuer’s independent accountant
  • Procedures for handling complaints regarding the issuer’s accounting practices (whistleblower provisions)
  • The authority of the audit committee to engage advisors
  • Funding for the independent auditor and any outside advisors engaged by the audit committee

Because SOX’s changes go well beyond disclosures, the SOX requirements were implemented by requiring the exchanges to put the provisions in their listing rules.

The PCAOB has also been involved in this process and Audit Standard 16, Communications with Audit Committees, formalized the content and timing of the auditor’s communications with the audit committee. This requirement became effective for years beginning after December 15, 2012.

That is all history, prelude to the future.

As audit committees strive to hold themselves to best practices looking to the future is crucial.

So, what might the future hold?

PCAOB “Dialogue”

In May of 2015 the PCAOB also issued a document titled “Audit Committee Dialogue” to formalize issues it considered important for audit committee members to be aware of and deal with in the evolving focus on audit quality. You can find the “Dialogue” at the PCAOB’s under the “Information for Audit Committee Members”tab.:

http://pcaobus.org/Information/Pages/AuditCommitteeMembers.aspx

SEC Concept Release

The SEC issued a broad and potentially far-reaching Concept Release in July. It seeks comment on areas including audit committee oversight of the audit process, how the audit committee selects the auditor and the role of the audit committee in selecting and evaluating key audit team personnel. You can find the concept release at:

www.sec.gov/rules/concept/2015/33-9862.pdf

Auditor Independence

A kind of wild-card issue that is evolving with enforcement cases is how the audit committee deals with auditor independence issues. The days when this was an issuer for only the auditor are clearly over!

These are issues that need some deeper discussion! So, our next few posts will focus on the “Dialogue”, the concept release, independence and other issues.

If you have any topics you would like to see included, as always, your thoughts and comments are welcome!

SEC Pay Ratio Final Rule and What to Do?

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 As you doubtless have heard, the SEC, in a split vote, approved the Dodd/Frank mandated “Pay Ratio Rule” on August 5. And yes, there is a lot of politics and a lot of discussion going on about the rule.

Companies will, after the discussion is over, have to deal with all the challenges of actually implementing the rule! To help, we have already scheduled a program, “SEC’s Pay Ratio Rule:  What Companies Need to do to Prepare”, which will be webcast on October 15, 2015. You can get the details about the program at:

www.pli.edu/Content/Seminar/SECs_Pay_Ratio_Rule_What_Companies_Need_to/_/N-4kZ1z11asm?fromsearch=false&ID=263557

As always, your thoughts and comments, even the political ones, are welcome!

The Mystery of Public Float (or, Does Everything have to be Gray?)

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A question that frequently arises in our workshops is how to compute the “public float” number that is used to determine whether a company is a large accelerated, accelerated or non-accelerated filer. This is an important computation as it determines deadlines, SOX external audit requirements and Smaller Reporting Company status. The SEC also sometimes uses it when they phase in new rules. This number is disclosed on the cover page of Form 10-K, and is more formally called “common equity held by non-affiliates”.

While this might at first seem like a nice, simple, mechanical computation, like so many of the issues we deal with in the SEC world, it can get gray!

The whole process starts with this definition from Exchange Act Rule 12b-2:

Accelerated filer and large accelerated filer—

  • Accelerated filer. The term accelerated filer means an issuer after it first meets the following conditions as of the end of its fiscal year:

(i)The issuer had an aggregate worldwide market value of the voting and non-voting common equity held by its non-affiliates of $75 million or more, but less than $700 million, as of the last business day of the issuer’s most recently completed second fiscal quarter;

(ii) The issuer has been subject to the requirements of section 13(a) or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) for a period of at least twelve calendar months;

(iii) The issuer has filed at least one annual report pursuant to section 13(a) or 15(d) of the Act; and

(iv) The issuer is not eligible to use the requirements for smaller reporting companies in part 229 of this chapter for its annual and quarterly reports.

The definition of Large Accelerated filer is exactly the same except the dollar threshold is raised to $700 million. This rule also contains the definition of a smaller reporting company. You can find the complete exchange act rule at:

www.ecfr.gov/cgi-bin/text-idx?SID=8e0ed509ccc65e983f9eca72ceb26753&node=17:4.0.1.1.1&rgn=div5#se17.4.240_112b_62

The same information comes into play on the cover page of Form 10-K, in these familiar sections from the instructions to the form:

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

[] Large accelerated filer                                                                   [] Accelerated filer

[] Non-accelerated filer                                                                     [] Smaller reporting company
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.

So, what we commonly refer to as “public float” is, in the SEC’s guidance, defined as “aggregate market value of the voting and non-voting common equity held by non-affiliates”. To properly compute this number, there are two more definitions we need to deal with, both again from Exchange Act Rule 12b-2:

Affiliate. An “affiliate” of, or a person “affiliated” with, a specified person, is a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified.

Control. The term “control” (including the terms “controlling,” “controlled by” and “under common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.

Now, to the computation! First, we must compute the number of shares “held by non-affiliates”. The logical starting point is total number of shares outstanding. Treasury shares that have not been canceled are clearly held by an “affiliate”, that is the company itself, and are omitted from the calculation. Once the total shares outstanding is computed, the next step is to determine how many of these shares are held by “affiliates”.

Here is where the number can get a bit gray!

The definition of affiliate is clearly subjective. What does it mean, as in the definition above, to be a person who “directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified”?

When the definition of control above, that is control means “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise”, is factored into this determination, it is even more gray!

The categories of people who will fall into the affiliate category would clearly include all the company’s directors, as they “direct or cause the direction of management and policies” for the company. Additionally, executive officers, those officers with a policy or strategy setting role, are also clearly affiliates.

Major shareholders of the company may not fall as clearly into the definition of an affiliate. Generally, if a person owns enough shares, they have an ability to impact on the board and management. They may be able to “direct or cause the direction of management or policies”. In this day of activist shareholders, that is very clear. But there is no simple bright line for this determination. Judgment must be used. And, in very close cases, since this is in essence a legal determination, it may be appropriate to consult with counsel!

So, to get the shares held by non-affiliates, excluding shares held be directors and executive officers is fairly clear, shares held by major shareholders will require some judgment!

The next question is why do we use the price on the last business day of the most recently completed second fiscal quarter? We will leave that question our next post!

As always, your thoughts and comments are welcome!

Cybersecurity – Help Managing the Risk

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Cybersecurity risk continues to be in the news. The nature and severity of cybersecurity breaches seem to grow in severity and complexity. Both preventive and remedial cybersecurity related costs are continually increasing in our business environment. Fortunately, the tools available to manage cybersecurity risk also continue to evolve. The magnitude of this risk is so large that some companies view cybersecurity breaches all but inevitable!

In this changing world we are presenting a cybersecurity focused conference in September. The conference is titled “Cybersecurity 2015: Managing the Risk”. You can learn more about the program, which will be webcast, and review the agenda at:

www.pli.edu/Content/Seminar/Cybersecurity_2015_Managing_the_Risk/_/N-4kZ1z128nw?fromsearch=false&ID=225691

As always, your thoughts and comments are appreciated!

Hertz has some Hurts!

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A major restatement by Hertz has been in the news in recent weeks, and thanks to two of our community, Bill Story and Eric Braschwitz, for their timely heads up notice about this restatement. Hertz was late with their 2014 10-K, filing it in early July. And it is a major restatement.

The magnitude of the issues, the nature of the organizational issues involved, the impact that leadership had on financial reporting, and all the other issues that seem to be at the root of this restatement are old stories, and somehow seem to harken back to days before SOX. Much has been written about these issues and we won’t rehash them here.

But there is one issue we do want to bring out.

As a preliminary note, if you want to dig into the filings involved, you will find Hertz Global Holdings, which is the publically owned company, and another filer, Hertz, which is the operating company, and is wholly owned by Hertz Global Holdings. You will find the restatement issue in the Form 10-K for each of these businesses.

If you look back at Hertz Global Holdings’ 2013 Form 10-K, you will find this ICFR Report:

ITEM 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures

 (This section is omitted for this blog)

Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act, as amended. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2013. The assessment was based on criteria established in Internal Control—Integrated Framework 1992 issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2013. PricewaterhouseCoopers LLP, our independent registered public accounting firm, has issued an attestation report on our internal control over financial reporting. Their report is included in this Annual Report under the caption “Item 8—Financial Statements and Supplementary Data.”

So, everything looks like “situation normal” at Hertz. Then, for 2014, here is what happened.

From Hertz’ 2014 10-K, Item 9A is really long, so we will put our concluding comments here.

What?

And, note the focus on tone at the top!

As always, your thoughts and comments are welcome!

 

From Hertz’ 2014 Form 10-K

ITEM 9A. CONTROLS AND PROCEDURES

Restatement of Previously Issued Financial Statements

As described in additional detail in the Explanatory Note to this Annual Report on Form 10-K, in June 2014, we commenced an internal investigation of certain matters related to the accounting during prior periods. The investigation was undertaken by outside counsel, along with independent counsel for the Audit Committee. Counsel received assistance from outside consultants and new senior accounting and compliance personnel. The internal investigation is complete, although our outside counsel and the independent counsel to the Audit Committee continue to provide forensic and investigative support in connection with certain proceedings discussed in Item 3, “Legal Proceedings” and in Item 8, Note 14, “Contingencies and Off-Balance Sheet Commitments” to the consolidated financial statements in this Annual Report on Form 10-K involving our restatements and related accounting for prior periods.

Based on the internal investigation, our review of our financial records, and other work completed by our management, the Audit Committee has concluded that there were material misstatements in the 2011, 2012 and 2013 consolidated financial statements. Accordingly, our Board and management concluded that our consolidated financial statements for these periods should no longer be relied upon and required restatement. The restated consolidated financial statements for 2012 and 2013 are provided in this Annual Report on Form 10-K. The unaudited restated selected data for 2011 is included in Item 6, “Selected Financial Data” in this Annual Report on Form 10-K.

Evaluation of Disclosure Controls and Procedures

Our senior management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined under Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that as of December 31, 2014, due to the identification of material weaknesses in our internal control over financial reporting, as further described below, our disclosure controls and procedures were not effective to provide reasonable assurance that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.

Management’s Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f).

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management, including our new Chief Executive Officer and our Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework (2013). Based on this assessment, management has concluded that we did not maintain effective internal control over financial reporting as of December 31, 2014 due to the fact that there are material weaknesses in our internal control over financial reporting as discussed below.

Control Environment

The control environment, which is the responsibility of senior management, helps set the tone of the organization (including a commitment towards openness, honesty, integrity, and ethical behavior), influences the control consciousness of its officers and employees, and is an important component affecting how the organization performs financial analysis, accounting, and financial reporting. A proper organizational tone can be promoted through a variety of means, such as policies and codes of ethics, a commitment to hiring competent employees, the manner and content of oral and written communications, and structures that promote and reward openness, strong internal controls, effective governance, and ethical behavior.

As of December 31, 2014, we did not maintain an effective control environment primarily attributable to the following identified material weaknesses:

  • Our investigation found that an inconsistent and sometimes inappropriate tone at the top was present under the then existing senior management that did not in certain instances result in adherence to accounting principles generally accepted in the United States of America (“GAAP”) and Company accounting policies and procedures. In particular, our former Chief Executive Officer’s management style and temperament created a pressurized operating environment at the Company, where challenging targets were set and achieving those targets was a key performance expectation. There was in certain instances an inappropriate emphasis on meeting internal budgets, business plans, and current estimates. Our former Chief Executive Officer further encouraged employees to focus on potential business risks and opportunities, and on potential financial or operating performance gaps, as well as ways of ameliorating potential risks or gaps, including through accounting reviews. This resulted in an environment which in some instances may have led to inappropriate accounting decisions and the failure to disclose information critical to an effective review of transactions and accounting entries, such as certain changes in accounting methodologies, to the appropriate finance and accounting personnel or our Board, Audit Committee, or independent registered public accounting firm
  • We did not have a sufficient complement of personnel with an appropriate level of knowledge, experience, and training commensurate with our financial reporting requirements to ensure proper selection and application of GAAP in certain circumstances.
  • We did not establish clear reporting structures, reporting lines, and decisional authority responsibilities in the organization.We did not design effective controls over the non-fleet procurement process, which was exacerbated by the lack of training of field personnel as part of our Oracle ERP system implementation during 2013.

These material weaknesses in the control environment resulted in certain instances of inappropriate accounting decisions and inappropriate changes in accounting methodology and contributed to the following additional material weaknesses:

  • We did not design and maintain effective controls over certain accounting estimates. Specifically, we did not design and maintain controls over the effective review of the models, assumptions, and data used in developing estimates or changes made to assumptions and data, related to information technology expenditures; reserve estimates associated with allowances for uncollectible amounts receivable for renter obligations related to damaged vehicles; and accrued unbilled revenue.
  • We did not design and maintain effective controls over the review, approval, and documentation related to journal entries.
  • We did not design and maintain effective controls over changes to our policies and procedures over GAAP, as well as the review, approval, and documentation related to the application of GAAP.

Risk Assessment

We did not effectively design controls in response to the risks of material misstatement. This material weakness contributed to the following additional material weaknesses:

  • We did not design effective controls over certain business processes including our period-end financial reporting process. This includes the identification and execution of controls over the preparation, analysis, and review of significant account reconciliations and closing adjustments required to assess the appropriateness of certain account balances at period end.

Information and Communication

As of December 31, 2014, we did not maintain effective controls over information and communications. Specifically, we did not have an adequate process for internally communicating information between the accounting department and other operating departments necessary to support the proper functioning of internal controls. This material weakness led to misstatements in the capitalization and timing of depreciation of non-fleet capital.

Monitoring

We did not design and maintain effective monitoring controls related to the design and operational effectiveness of our internal controls. Specifically, we did not maintain personnel and systems within the internal audit function that were sufficient to ensure the adequate monitoring of control activities. This control deficiency resulted in some instances of the internal audit function’s failure to identify or sufficiently follow through on the analysis of certain inappropriate accounting decisions and changes in accounting methodology.

One or more of the foregoing control deficiencies contributed to the restatement of our financial statements for the years 2012 and 2013 and each of the quarters of 2013, including the misstatements of direct operating expenses, accounts payable, accrued liabilities, allowance for doubtful accounts, prepaid expenses and other assets, and non-fleet property and equipment and the related accumulated depreciation. Additionally, the foregoing control deficiencies could result in material misstatements of the consolidated financial statements that would not be prevented or detected. Accordingly, our management has determined that these control deficiencies constitute material weaknesses.

The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report, which appears in this Annual Report on Form 10-K.

Other Considerations Impacting our Historical Accounting

Our incorrect accounting was caused by the foregoing control deficiencies along with a complex mix of structural and environmental factors. One of those factors was the tone set and pressures imposed by our former Chief Executive Officer, which were inappropriate in certain instances, and may have been a factor influencing one or more employees to record an accounting entry now determined to be improper. Other factors affecting the overall historic accounting environment and employees included the distraction caused by the multiple, conflicting business initiatives; challenges related to managing complex, inefficient legacy systems; the lack of a sufficient complement of personnel with an appropriate level of knowledge, experience, and training with GAAP; unclear reporting structures, reporting lines, and decisional authority in the organization; and other matters. Taken together, these factors fostered a control environment and other control deficiencies that in some instances enabled inappropriate accounting.

Remediation Plan and Status

We have, and continue to, identify and implement actions to improve the effectiveness of our internal control over financial reporting and disclosure controls and procedures, including plans to enhance our resources and training with respect to financial reporting and disclosure responsibilities and to review such actions with the Audit Committee. Leading this process is our Senior Executive Vice President and Chief Financial Officer, who was hired in December 2013 and is being assisted by our new Chief Accounting Officer, who was hired in May 2014.

During 2014 and 2015, we have hired personnel with the appropriate experience, certification, education, and training for all of the key positions in the financial reporting and accounting function and in some cases have created new positions. Consequently, the employees involved in the accounting and financial reporting functions in which misstatements were identified are no longer involved in the accounting or financial reporting functions. In addition, we have taken, or will take, appropriate remedial actions with respect to certain employees, including termination, reassignments, reprimands, increased supervision, training, and imposition of financial penalties in the form of compensation adjustments.

In addition, we have taken, and continue to take, the actions described below to remediate the identified material weaknesses. As we continue to evaluate and work to improve our internal controls over financial reporting, our senior management may determine to take additional measures to address control deficiencies or determine to modify the remediation efforts described in this section. Until the remediation efforts discussed in this section, including any additional remediation efforts that our senior management identifies as necessary, are completed, the material weaknesses described above will continue to exist.

Control Environment

Our Board has directed senior management to ensure that a proper, consistent tone is communicated throughout the organization, which emphasizes the expectation that previously existing deficiencies will be rectified through implementation of processes and controls to ensure strict compliance with GAAP and regulatory requirements. We also have taken steps to effect a proper tone through changes in our personnel and policies.

On September 7, 2014 our former Chairman and Chief Executive Officer resigned his position. On November 20, 2014, a new President and Chief Executive Officer was named from outside the Company following a national search led by a special committee of the Board, with the assistance of an executive search consultant.

Our new President and Chief Executive Officer is one of four new members of our Board. The three other new directors joined our Board pursuant to the nomination and standstill agreement dated September 15, 2014 between the Company and the Icahn Group, which is included as Exhibit 99.1 to our Form 8-K filed on September 16, 2014.

In addition, since December 2013, we have hired the following additional key employees into the following positions who reflect our standards for integrity and ethical values:

  • Senior Executive Vice President and Chief Financial Officer
  • Senior Executive Vice President, Chief Administrative Officer and General Counsel
  • Senior Executive Vice President and Chief Revenue Officer
  • Executive Vice President and Chief Human Resource Officer
  • Executive Vice President and Chief Information Officer
  • Senior Vice President and Chief Accounting Officer
  • Senior Vice President and Chief Audit Executive
  • Senior Vice President, Procurement, Fleet and Project Management Office
  • Senior Vice President, Financial Planning and Analysis

In addition to the senior management changes detailed above, in order to ensure we have a sufficient complement of personnel with an appropriate level of knowledge, experience, and training commensurate with our financial reporting requirements, during 2014 and 2015 we have hired personnel for all key positions in the financial reporting and accounting function and in some cases have created new positions, including:

  • Senior Vice President and Controller (Corporate Finance)
  • Senior Vice President and Controller (U.S. Rental Car Operations
  • Vice President, SOX Compliance
  • Assistant Controller (Corporate Finance)
  • Vice President, Reporting, Research and PolicyVice President, Financial Systems
  • Vice President, Accounting and Assistant Controller Global Fleet
  • Vice President, Dublin Financial Shared Service Center
  • Senior Director, Oklahoma Financial Shared Service Center
  • Senior Director, Program Accounting
  • Senior Director, Financial Reporting
  • Director, U.S. Rental Operations Finance Consolidation and Analytics
  • Director, Financial Systems
  • Director, Technical Accounting
  • Director, Corporate Accounting
  • Director, Consolidations
  • Director, Policies and Procedures
  • Director, Global Procure to Pay
  • Director, SOX Compliance
  • Director, North America General Accounting

To assist in the restatement activities we augmented our personnel with qualified consulting resources and they will continue to be augmented by the consulting resources for the remainder of 2015.

Further, in 2014, we reinforced the importance of adherence to established internal controls and Company policies and procedures through formal communications, town hall meetings and employee trainings. To communicate a proper ethical tone and corporate culture, Hertz’s intranet website provides information on our philosophy and values. These philosophies and values, in addition to being addressed at personnel meetings, are periodically communicated to our employees via email notifications throughout the year.

In addition, we have established procedures for ensuring clear reporting structures, reporting lines, and decisional authority responsibilities in the organization and have enhanced communications with our operational departments, accounting, Board and Audit Committee.

To address the material weakness over the non-fleet procurement process, we have strengthened processes and controls for manual accruals and journal entries. In addition, we have enhanced an accrual methodology to ensure completeness over our non-fleet procurement liabilities.

To address the lack of training related to the implementation of our Oracle ERP system, in 2014 management engaged consulting resources to assist in the following:

Completed a library of training modules for the Oracle application;Completed a series of live trainings for Oracle users; andImplemented enhanced knowledge management tools and protocols.

Other activities completed in 2014 and 2015 related to the Oracle ERP system include:

  • Established a Financial Information Systems Steering Committee co-chaired by the Chief Accounting Officer and the Chief Information Officer to monitor activities and developments associated with our financial information systems;
  • Established a data governance team to monitor activities associated with the data integrity of our financial information systems;
  • Implemented changes within the Oracle application to enhance the quality of data and the timeliness of processing financial results; and
  • Implemented security rule changes to enhance the quality and timeliness of reported results.

To further enhance the financial close process and address the remediation of this material weakness, our management is currently completing activities associated with our chart of accounts and utilization of Oracle ERP features.

We have taken steps to improve our design and maintenance of effective controls for accounting estimates, including:

  • Where necessary, identified, implemented and documented controls over appropriate accounting methodologies for certain accounts;
  • Held trainings with accounting staff in the first quarter of 2015 to ensure there is a thorough understanding of the underlying methodologies implemented;
  • Established policies and procedures for the approval and implementation of new or modified accounting methodologies;
  • Hired accounting personnel with an appropriate level of knowledge and experience to execute the underlying accounting methodologies; and
  • Established policies and procedures for the review, approval and application of appropriate GAAP for transactions and accounting methodology changes.

In addition, to improve our controls over the processing of manual journal entries, we have reinforced procedures to ensure that manual journal entries recorded in our financial records are properly prepared, supported by adequate documentation, and independently reviewed and approved.

Risk Assessment

We are establishing mechanisms to identify, evaluate, and monitor risks to financial reporting throughout the organization to remediate our material weakness in the risk assessment process and monitoring, as described below.

We have designed and where appropriate enhanced controls over the preparation, analysis and review of transactions and, execution of balance sheet and significant account reconciliations. In addition, we have reinforced existing policies and procedures and enacted policy and procedures changes, where necessary, to better define requirements for effective and timely reconciliations of balance sheet and significant accounts, including independent review. We have also implemented a training program specific to the review and preparation of account reconciliations.

We are updating our global risk assessment. In addition, we have updated our internal audit plan to include internal audit monitoring activities responsive to the issues identified in our internal investigation and review of our financial records.

We have implemented new procedures and enhanced controls governing our internal management-led Disclosure Committee, sub-certification, and external reporting processes associated with the review and approval of the content of our SEC filings and other public disclosures.

Information and Communication

We have formalized procedures to ensure appropriate internal communication between the accounting department and other operating departments necessary to support the proper functioning of internal controls.

In addition, we are in the process of updating the corporate-wide accounting policies manual to ensure proper accounting for transactions in compliance with GAAP and consistently applied across all locations. Additional policies will also need to be developed and issued and corresponding training will need to be provided.

Monitoring

To address deficiencies in our internal audit function, we hired in 2015 a Senior Vice President and Chief Audit Executive, with global responsibilities. In addition, we have commenced recruiting for additional staff members and have recently hired a senior auditor. We are currently supplementing our personnel resources with a substantial number of internal audit consulting resources with financial accounting expertise.

We also have increased the number and quality of personnel assigned to management’s internal controls assessment process. In 2014, we hired a Vice President of SOX Compliance and a Director of SOX Compliance. During 2014 and 2015 we have supplemented our personnel resources with a substantial number of consulting resources experienced in controls and SOX compliance.

During 2014 and 2015, the internal audit and SOX compliance teams enhanced (i) our processes associated with the scoping and identification of processes and key controls, (ii) the documentation of these processes and (iii) our testing procedures to promote the consistency and accuracy of conclusions, deliverables and disclosures associated with SOX compliance. An automated tool is being implemented to monitor these activities.

Changes in Internal Control over Financial Reporting

Our remediation efforts are ongoing. During the quarter ended December 31, 2014, we completed account reconciliation and internal controls trainings for our accounting personnel, created and completed Oracle trainings, enhanced data governance and implemented changes within the Oracle application to enhance the quality of data and the timeliness of processing financial results. There were no other material changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2014 that materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

Known Trends in the News

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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!