A Look at Top SEC Comment Letter Issues in 2017

2017 marked the eighth consecutive year of decline in the number of SEC comment letters. During the first six months of 2017, 2,315 letters1 were filed (905 CORRESPs and 1,410 UPLOADs) – a decrease of 246 letters (9.6%) from the first six months of 2016.

In this annual analysis, we looked at the most common issues raised in SEC comment letters over the past three years.

The 2017 topics were fairly similar to what we have seen in 2015 and 2016, with non-GAAP, MD&A, fair value, segments, and revenue recognition comments at the top of the list. Before we move into a more detailed overview of each of the categories, it’s worth noting a couple of recent Big 4 publications that provide in-depth analysis of the trends in SEC comment letters including Deloitte’s SEC Comment Letters Series and Ernst & Young’s SEC Comments and Trends.

Now, let’s look at each of the major comment letters categories.

Non-GAAP Measures

Non-GAAP comments were the most common area of concern in 2017, with almost one-third of the companies receiving at least one non-GAAP comment. This is not unexpected considering recent SEC reviews and speeches. A number of sources ipredict that the number of non-GAAP comments will gradually decline and shift towards the pre-review level in the future.

Some of the most common types of questions included undue prominence in the non-GAAP presentation, including lack of comparable GAAP metrics or presentation of the non-GAAP metric ahead of the comparable GAAP number. For example:

1. In the heading of the press release included as an exhibit to your Form 8-K, you disclose the Non-GAAP “adjusted EBITDA” for the fourth quarter of fiscal 2017 and for the full fiscal year 2017 as compared to the comparable periods of the prior year. Please revise to present the most comparable GAAP measure, net income, for each of these periods prior to the presentation of this non-GAAP measure. Refer to the guidance outlined in Question 102.10 of the Compliance and Disclosure Interpretations Regarding Non-GAAP Measures as updated on May 17, 2016.

Response: The Company acknowledges the Staff’s comment and confirms that its future earnings releases will comply with the Staff’s comment. In addition, please find attached as Exhibit A, a highlighted revised heading to the earnings release for the year ended March 4, 2017, which illustrates our intended revised disclosure in the heading of the press release to include GAAP net loss prior to the presentation of adjusted EBITDA, in accordance with the Staff’s comment.

Other common questions related to non-GAAP focused on the presentation of non-GAAP measures that exclude normal and recurring adjustments, presentation of metrics that use tailored recognition and measurement methods, and the presentation of free cash flow metrics that do not conform to industry practices.

For the most part, companies promised to address the issues raised by using clarifying language in future filings. However, in some cases, companies had to substantially modify the non-GAAP presentation by either completely removing a specific adjustment or the entire non-GAAP metric. In other cases (see example below), presenting the information needed and avoiding resemblance to the income statements requires breaking up the presentation into a sub-section.

3. On page 14, you present what appears to be a non-GAAP income statement to reconcile your non-GAAP measures operating margin and EBIT. Please revise your presentation to reconcile your non-GAAP measures without providing what appears to be a full income statement. See Question 102.10 of the updated Non-GAAP Compliance and Disclosure Interpretations issued on May 17, 2016.

Response: The consolidated results table on page 14 was meant to show reconciliations of two different non-GAAP measures: (a) a reconciliation of operating margin to operating income and (b) a reconciliation of EBIT to net income. Since both reconciliations involved essentially all items included in the income statement, from operating revenue to net income, the presentation became inadvertently similar to a full income statement. Also, the format of these reconciliations presented non-GAAP measures first followed by the most directly comparable GAAP measures as we reconciled from non-GAAP measures to GAAP measures. In future filings, we will revise the reconciliation to (a) separately show the two reconciliations, (b) include only relevant items from the income statement in the reconciliations, and (c) present the most directly comparable GAAP measures first in the reconciliations. The following is an example of these proposed revisions.

Fair Value Measurement

Comments relating to fair value measurement were similar to what we have seen last year. Some of the main areas of focus included fair value input used in valuation of goodwill and/or assets, fair value inputs used to measure contingent consideration during M&A transaction, and valuation of Level 3 assets.

2. Please revise to include fair value measurement disclosures related to assets and liabilities measured at fair value on a non-recurring basis, such as the indefinite lived intangible assets that were impaired during 2016. See requirements in ASC 820-10-50-2.

Response: The Company acknowledges the Staff’s comment and we have reviewed the disclosure requirements of ASC 820-10-50-2 in light of the comment. Upon our review, we respectfully believe that the Company’s consolidated financial statements include the significant disclosure requirements related to assets measured at fair value on a non-recurring basis in the footnotes, albeit outside of the referenced Note 5 – Fair Value Measurements. For example, our disclosures of the indefinite lived intangible assets impairment on page F-26, in Note 7 – Goodwill and Intangible Assets, Net, includes the required measurement date disclosure and reason for the measurement and impairment. In addition, on page F-13, Note 2 – Significant Accounting Policies, our disclosure includes the valuation techniques for such assets. However, we acknowledge that the disclosure requirements relating to the level within the hierarchy of the fair value measurements (Level 3) and the fair value measurement at the measurement date ($76 million) were not included and that aggregating the information into one location would be helpful to the reader of the financial statements. In future filings, as applicable, we will revise our fair value measurement footnote disclosures to include the aggregate of any such non-recurring fair value measurements into the Fair Value Measurements footnote, and ensure completeness of the required disclosures, as requested by the Staff.

Segment disclosure

Aggregation of segments also remained as one of the top segment related topics with comments such as:

3. You disclose that Global Health Care aggregates the Commercial and Government operating segments due to their similar economic characteristics, products and regulatory environment. Please compare and contrast your Commercial and Government operating segments relative to their economic characteristics and to each of the areas listed in ASC 280-10-50-11a to 11e. Regarding any differences among your operating segments, tell us why you determined that disaggregation was not warranted.


Results of Operations

For the most part, the 2015 and 2016 trends continued into 2017, with Results of Operations still being one of the top areas of concern. Some of the most common comments included requests to clarify year-over-year changes in the operating results.

1. In your analysis of results of operations, you attribute period-to-period changes to a combination of several different factors, such as in your discussion of revenue for your Healthcare segment. When you list multiple factors that contributed to changes, please quantify, if possible, the impact of each factor that you discuss to provide better insight into the underlying reasons behind the changes in your results. Refer to Item 303(a)(3) of Regulation S-K and SEC Release No. 33-8350.

Others focused on MD&A disclosures, requesting a more detailed disclosure on a segment basis.

4. We note from your disclosure in Note 19 to the financial statements, that you have identified two operating segments, Passive Safety and Electronics. We further note that although your MD&A discussion in your Quarterly Reports on Form 10-Q includes a discussion of your operating results by segment, your MD&A section in your Form 10-K does not. In this regard, please revise your MD&A in your Form 10-K to discuss and analyze your results of operations for each of these operating segments.


Revenue recognition

Revenue recognition questions ranged from general requests to provide more clarity to the revenue recognition policy to more industry-specific comments such as revenue recognition practices related to milestone payments and collaboration agreements.

6. We note that under the terms of the Elanco agreement you will receive additional payments upon achievement of certain development, regulatory and sales milestones in the aggregate amount of up to $61.0 million. Please revise your disclosure to describe each substantive milestone and the related contingent consideration. Refer to ASC 605-28-50-2b.

Response: The Company respectfully acknowledges the Staff’s Comment and has revised the disclosure on page F-74 of the S-4/A to describe each substantive milestone and the related contingent consideration under the Elanco agreement.

Although most trends in 2017 have been consistent with those in the past, one new area of focus that emerged this year is related to the implementation of the new revenue recognition standard, ASC 606.

In 2017, at least 17 companies received comments that explicitly referenced implementation of the new revenue recognition standard. Interestingly, so far, only a handful of companies early adopted ASC 606 and three of them (Workday Inc., First Solar, Inc., and Cboe Global Markets, Inc.) have already received ASC 606 comment letters.

Yet, in some cases, ASC 606 comments might be a little more subtle, and may not even reference ASC 606 explicitly. For example,

1. Considering that you have consolidated revenues in excess of $13B for the year ended December 31, 2016 and that; based on the information disclosed throughout your filing, you have revenues from multiple lines of business, please tell us why you do not provide disaggregated information of your revenues for each line of business.

Response: The Company is currently amidst adoption efforts relative to the new revenue recognition guidance that is effective on January 1, 2018, including providing disaggregated information on its revenue. Under the existing guidance, the Company has historically taken the position that all revenue is from real estate services and provided some information on line of business performance within its MD&A discussion. Given the comment above, the Company will add disaggregated information on its revenue to its consolidated and segment MD&A tabular disclosures, beginning with its Form 10-Q for the quarter ended June 30, 2017.

In the past, the SEC emphasized (on more than one occasion) the importance of SAB 74 disclosure and indicated that the staff is closely monitoring the progress made by companies toward the implementation. According to the WSJ, however, the SEC indicated in a recent speech that “they will hold off on issuing comment letters scrutinizing company compliance with the new revenue accounting standard in the early stages of implementation.”

Tax issues

Many of the tax comments were related to income generated overseas. This is an extremely hot topic, especially considering the discussion surrounding the upcoming tax reform.

3. We note that no deferred income taxes have been recognized on cumulative undistributed earnings of foreign subsidiaries of $866.2 million as these earnings are considered indefinitely reinvested. However, we note that you have repatriated a portion of your foreign earnings in fiscal 2015 and 2014 and also incurred domestic net loss before income taxes in fiscal 2016. Please tell us how you were able to conclude that all of your undistributed earnings of foreign subsidiaries should be considered to be indefinitely reinvested pursuant to ASC 740-30-25-17. Please address your specific plans for reinvestment for these undistributed earnings that demonstrate remittance of the earnings would be postponed indefinitely.

Lastly, we would like to point to an interesting type of comment that we noted in 2017. A number of retailers, as well as companies in some other industries, received comments related to the presentation of gross profit as a revenue less cost of sales excluding depreciation. In these comment letters, staff indicated that gross profit excluding depreciation is, in fact, a non-GAAP metric and the companies should either label the metric as non-GAAP or allocate the depreciation costs to the cost of sales.

1. We read your response to comment 1. Please tell us how your proposed presentation complies with the guidance in ASC 225-10-S99-8 and Rule 5-03 of Regulation S-X as your gross profit measure presents a figure for income before depreciation. Otherwise, please revise to either: (a) include an appropriate allocation of depreciation to costs applicable to revenue or (b) remove the gross profit subtotal and relabel the costs applicable to revenue line item throughout the filing to indicate that it excludes depreciation.

For more information or to request the full list of top issues in comment letters, please contact us at info@auditanalytics.com or call (508) 476-7007.

1. Comment letters reviewed through 10-K, 10-Q, and 8-K as of November 15, 2017. One important thing to remember is that comment letters are normally released only 20 days after the resolution of all the comments, so the numbers of letters and number of registrants may change for the mentioned periods. Based on historical experience, for about 10% of the comments dissemination days is more than 90 days after the filing date of the letter. ↩