Pwc 2015 Technology Sector Sec Comment Letter Trends

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Technology institute November 2015

Highlights of SEC comment letters and financial reporting trends in the technology sector

Stay informed 2015 SEC comment letter and disclosure trends Technology

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to any person or entity.

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sustained by any person or entity who relies on this publication.

The content of this publication is based on information available as of June 30, 2015. Accordingly, certain aspects of this publication may be superseded as new guidance or interpretations

emerge. Financial statement preparers and other users of this publication are therefore cautioned to stay abreast of and carefully evaluate subsequent authoritative and interpretive guidance that

is issued.

Stay informed | 2015 SEC comment letter trends Technology 3


Contents

Message from Kevin Healy 5

SEC developments 7

What’s new 9

Internal controls and procedures 11

Revenue recognition 13

Management’s discussion and analysis 16

Compensation 25

Impairments 26

Income tax 28

Loss contingencies 29

Segments 30

Business combinations, variable interest entities, and divestitures 32

Other notable trends 34

Disclosure effectiveness 36

SEC comment letter process 37

About PwC's Technology Institute 39





Message from Kevin Healy

To our clients and friends:

Once again, companies are beginning to prepare for another annual financial reporting period. Keeping the focus on high-quality financial reporting now, while readying for future changes in the landscape, continues to be a challenging task. We are pleased to introduce our third annual publication, which focuses on trends in SEC staff comment letters specific to companies in the technology sector. We have analyzed over 1,200 comments issued from July 1, 2014 to June 30, 2015 to companies in the Computers & Networking, Semiconductors, and Software & Internet subsectors. While some comments are applicable to all companies in the technology space, others are subsector specific. In addition to providing you with insights from SEC staff comment letters, this year we have also analyzed the annual filings of 90 registrants across the subsectors over the last twelve months. Specifically, we have benchmarked selected disclosures, including those related to non-GAAP measures, segment reporting, and internal control over financial reporting.

We hope our benchmarking study, along with our analysis of SEC staff comment letters, provides useful and thought-provoking insights that can aid you in the preparation of your upcoming filings. Please don’t hesitate to reach out to your engagement teams, the PwC contacts listed at the end of the publication, or me to discuss this information in more detail. We look forward to working with you in 2016.

Best regards,

Kevin Healy US Technology Assurance Leader




SEC developments

Accounting and financial reporting are at the heart of the SEC’s core mission. Accurate, reliable, and transparent financial information provides investors the tools they need to make informed decisions and build the trust and confidence that promote capital formation. So it comes as no surprise that 2015 was another year of heavy interest for the SEC in the accounting and financial reporting arena.

One area the SEC staff was keenly focused on in 2015 was the implementation of the new revenue accounting standards. Whether by facilitating the identification and resolution of broad-based practice issues or encouraging companies to take a fresh look at their revenue-related internal controls, the SEC staff is working to promote a successful implementation and consistent application in the US and around the world. Revenue is one of the most important financial measures used by investors across industries and geographies, and the SEC wants to make sure the transition to the new standards is a smooth one. Once the new revenue standards have been implemented, the accounting in that area will be largely converged. Still, there was much discussion throughout 2015 about whether International Financial Reporting Standards should play a broader role for US public filings of domestic registrants. The SEC staff heard from a wide array of stakeholders in 2015. Through those discussions, they heard that there is continued support for the objective of a single set of high-quality, global accounting standards. However, they also heard that there is little or no support for the SEC to require all companies to prepare their financial statements using IFRS or even to provide US companies an option to do so (although there is ongoing consideration of whether US companies should have the option of providing supplemental IFRS information). So what does all of this mean? It's not clear what the next steps are, but Jim Schnurr, the SEC's Chief Accountant, recently remarked that for now, it appears that the most likely path for advancing the objective of high-quality, global accounting standards is for the FASB and the IASB to continue to work together to converge their standards. During 2015, we also saw a continuation of the SEC’s agency-wide emphasis on internal controls as the SEC staff continued to ask questions when a filing disclosed immaterial accounting errors—especially when there have been multiple errors. The staff is probing beyond what happened at the transaction level and is seeking to

understand the root cause of the deficiency—looking beyond the individual control activities and asking whether there are broader issues involved. For instance, if a particular error related to a new line of business, revenue stream, or geography, they may ask how the company evaluated whether the deficiency relates to its risk assessment, monitoring, or control environment. The SEC staff is also looking closely at how the company evaluated the severity of the deficiency—focusing both on the magnitude of the actual error and on the volume of activity that reasonably could have been exposed to the deficiency. The SEC recognizes that a company’s internal controls form the foundation of accurate financial reporting, and this is undoubtedly an area of long-term interest.

But the SEC’s interest in financial reporting and internal controls is not limited to the Commission’s accountants. The Enforcement Division has expressed great interest in these areas as well. Enforcement actions and investigations in the financial reporting area have increased substantially over prior years. “Corporate disclosure and financials” is at or near the top of the list of most frequent whistleblower allegations, and internal controls have figured prominently in several recent enforcement cases, including some where there were no underlying fraud charges. Additionally, following on from its “accounting quality model,” the Division of Economic and Risk Analysis devoted substantial effort over the past year to buildout its data-driven Corporate Issuer Risk Assessment tool (known as CIRA), which provides staff across the agency (including the Enforcement Division’s Financial Reporting and Audit Task Force) with more than 100 custom metrics designed to identify situations or activities that warrant further inquiry. 2015 was a busy year at the SEC, and with the pending confirmation of 2 new Commissioners, the implementation of securities-based crowdfunding and further progress on the disclosure effectiveness, clawback and pay versus performance initiatives on the horizon, 2016 promises more of the same, but the continued focus on accounting, financial reporting and internal control are sure to remain high on the priority list. We hope you find the analysis that follows helpful as you navigate this year's financial reporting season.

John A. May SEC Services Leader



What’s new

SEC staff comments received by technology companies continued to decline in 2015.

The number of comments received in 2015 decreased 20 percent compared to 2014, even after a 26 percent decrease from 2013 to 2014 (see Figure 1).

Each subsector experienced a decrease in the number of comments received from 2014 to 2015, with the semiconductor subsector decreasing at the highest rate of 27 percent (see Figure 2).

Our analysis shows that while there is an overall decrease in the number of comments received, this trend continues to be driven by a decrease in the number of technology companies receiving comment letters, while the average number of comments per registrant was flat (see Figures 3 and 4). We noted that the number of technology companies reviewed declined by nearly 17 percent from 2014 to 2015, compared to a 4 percent decline from 2013 to 2014. This decline was most significant in the semiconductor industry where the number of companies reviewed declined by 29 percent from 2014 to 2015.

Despite the decline in the overall volume of comments received from 2014 to 2015, we saw an increase in the number of comments received in the revenue recognition, internal control over financial reporting, and disclosure controls and procedures areas. We also saw increases in comments related to compliance and the business section. We explore all of these areas in greater detail in this publication.

2,079 1,538 1,226

2013 2014 2015

Figure 1. Overall volume of comments

744

258

224

905

325

308

1,230

484

365

Software & Internet

Computers & Networking

Semiconductors

Figure 2. Volume of comments by subsector

2013 2014 2015

98

687

45 66

5 6 6

Software &Internet

Computers &Networking

Semiconductor Overall

Figure 3. Average number of comments by subsectors

2013 2014 2015

130

64 60

254

125

57 62

244

115

44 44

203

Software &Internet

Computers &Networking

Semiconductor Total

Figure 4. Number of companies reviewed

2013 2014 2015


What’s new

In addition to SEC comment letter trends, throughout this publication, we share our insights from the financial reporting trends study we performed. We analyzed disclosures in the annual filings of 90 registrants in the technology industry related to internal control, segments, critical accounting policies and estimates, and non-GAAP measures.

We also looked at the number of days from a company’s year-end to the filing of its earnings release and its annual report on Form 10-K, respectively. On average, the companies in our study took 38 days to file their earnings release and 57 days to file their 10-K. 10 companies filed their earnings release within a day of filing their 10-K. A shorter gap between the two may prevent preliminary information from being included in the earnings release. Preliminary information may change materially, which could challenge the effectiveness of a registrant’s DC&P and ICFR.

We note your filing of Form 8-K on February 6, 20X5 wherein you adjusted your fourth quarter and full year 20X4 financial results from those previously reported in the Form 8-K you filed on January 21, 20X5… Please tell us more about the nature of the adjustment, why it occurred and whether you concluded the revision was material. If you concluded the revision was not material, please explain to us in reasonable detail whether and how your controls would have caught this error prior to publishing your financial information in your earnings release if the error had been material. Additionally, we note you concluded that both your DCP and ICFR were effective as of December 31, 20X4. Please tell us in detail how you considered the aforementioned revision of income tax benefits in your assessment and ultimate conclusions of the effectiveness of your DCP and ICFR as of December 31, 20X4. In your response, please describe to us the internal controls you had in place that were relevant to the adjustment…

Methodology

This study of comment letter trends was based on an analysis of comments posted on the SEC’s EDGAR website from July 1, 2014 to June 30, 2015 (referred to as “2015”) related to technology companies (domestic and foreign registrants reporting under US GAAP) specific to their periodic filings on Forms 10-K, 10-Q, 20-F, 8-K and 6-K. The comparative periods, referred to as 2014 and 2013, represent our analysis of comments posted on the SEC’s EDGAR website from July 1, 2013 to June 30, 2014 and July 1, 2012 to June 30, 2013, respectively.

The financial reporting trends study was based on an analysis of registrant filings on Form 10-K posted to the SEC’s EDGAR website from July 1, 2014 to June 30, 2015 by 90 technology companies reporting under US GAAP. We analyzed disclosures included in annual filings on Form 10-K and some limited information from current reports on Form 8-K filed during the same period. The study included an even distribution of companies within each of the subsectors listed below, with an equal representation of companies with revenues below $500 million, between $500 million - $1.0 billion, and greater than $1.0 billion.

Each subsector includes registrants categorized under the following SIC codes:

Software & internet—7370, 7371, 7372, 7373, 7374, 7389

Computers & networking—3570, 3571, 3572, 3576, 3577, 3578, 3661, 3663, 3669, 3812, 3825, 3861, 4899, 5045, 5065

Semiconductors—3670, 3672, 3674, 3679

Certain registrants’ business may span multiple technology subsectors. For consistency of evaluation, our analysis was based solely on the SIC code for each registrant, as indicated on the SEC’s EDGAR website.

0 200 400 600

Management's discussion and analysis

Business combinations, divestitures, andvariable interest entities

Revenue recognition

Income taxes

Internal controls

Compensation

Goodwill, intangible assets, and long-lived assets

Segment reporting

Loss contingencies

Other notable trends

Figure 5. Comments by topic

2013 2014 2015

34

52

18

48

68

20

38

70

32

Press Release Form 10-K Difference

Figure 6. Average days to file from period end date

Large Accelerated Accelerated

Non-accelerated and SRC


Internal controls and procedures

Internal control over financial reporting continues to be a focus area of the SEC.

The SEC staff continues to focus on internal control over financial reporting (ICFR), and we have seen an increase in the volume of comments in this area since 2014. Registrants should continue to carefully consider the ICFR and disclosure controls and procedures (DC&P) implications of their responses to the SEC staff, even when the SEC staff has not raised any questions regarding internal control. Registrants should also continue to assess the sufficiency, accuracy, and completeness of their disclosures and certifications.

Recent SEC staff comments reflect their concern that not all material weaknesses are being properly identified, evaluated, and disclosed. Specifically, they continue to question why a restatement did not result in the reporting of a material weakness. Over the past year, several SEC staff members have emphasized the fact that there is a low number of material weaknesses reported in the absence of a restatement or other known material error, implying that it is possible the “could factor” or the potential exposure is not being correctly evaluated. 1. Based on the reasons for the previously identified errors and

your internal review of the contract, tell us if you have re-evaluated the effectiveness of your internal controls over financial reporting and what your conclusions are.

The SEC staff has also questioned registrants when there is no explicit conclusion about the effectiveness of DC&P or when management has concluded that ICFR is ineffective while DC&P is effective. Although separately assessed, it is important to remember there is substantial overlap between the processes included in the definition of DC&P and those considered part of ICFR. Nearly all of ICFR falls within the scope of DC&P, whereas there are aspects of DC&P that extend beyond what is considered part of ICFR. As such, it is rare that a material weakness in ICFR would not also result in DC&P being considered ineffective. 2. Please tell us how you considered the correcting adjustments

discussed in your filing in concluding that your disclosure controls and procedures were effective at June 29, 20X4. Further, we note that the material weaknesses you identified in your internal control over financial reporting include the fact that the company did not have sufficient qualified financial reporting and accounting personnel equipped with appropriate U.S. GAAP and SEC reporting and disclosure knowledge or

experience. Given the definition of disclosure controls and procedures outlined in Rule 13a-15(e), please explain in detail how your management was able to conclude that DC&P were effective at December 31, 20X3.

In the sample of technology companies studied, eight registrants, or nine percent, reported ineffective internal control over financial reporting as of the end of their most recent fiscal year. Material weaknesses were identified in the areas of income taxes, revenue recognition and associated estimates, inventory valuation, stock-based compensation, and journal entries. Of the eight registrants reporting material weaknesses, six also reported corresponding revisions or restatements to correct errors in the financial statements. Item 308 of Regulation S-K requires registrants to disclose any change in the company’s ICFR that has materially affected, or is reasonably likely to materially affect, the registrant’s ICFR each quarter. Changes requiring disclosure include changes in internal control made in the process of remediating previously identified material weaknesses, as a result of the integration of significant acquisitions, or due to the implementation of new information technology systems. The SEC staff often looks to information contained in companies’ current reports, on their websites, and in other sources to identify potential changes in ICFR. SEC staff comments in this area have focused on the timeliness and completeness of the disclosures in periodic filings. 3. Please disclose whether there was any change in your

internal control over financial reporting during your fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, your internal control over financial reporting. In this regard, we note that your Form 10-Q for the period ended September 30, 20X3 disclosed that you identified a material weakness in your internal control over financial reporting as of September 30, 20X3. If the disclosure in this Form 10-K was intended to indicate that your internal control over financial reporting was effective as of December 31, 20X3, you must have had material changes to your internal control financial reporting in the quarter ended December 31, 2013 to remediate that material weakness. Refer to Item 308(c) of Regulation S-K.


Internal controls and procedures

Mergers and acquisition activity continues to be significant as companies are looking for growth opportunities and/or efficiencies from consolidation. Of the technology companies studied, 51 percent completed one or more acquisitions during their most recent fiscal year. If a registrant completes a business combination during the year, the SEC does not object if management (and the auditor) excludes the acquired business from their report on internal control over financial reporting. This “grace period” cannot exceed 12 months from the date of the acquisition. Management must identify the acquired business excluded and indicate the significance of that business to the registrant’s consolidated financial statements. Even when registrants take advantage of this accommodation, they must disclose any material changes to their internal controls due to the acquisition and any known material weaknesses in the acquired business’s controls. Approximately 20 percent of the registrants studied that completed acquisitions during the year took advantage of the permitted exclusion. These acquisitions were completed anywhere from the first month of the year all the way to the last month of the fiscal year. The significance of the excluded acquired businesses varied significantly, ranging from 1 to 19 percent of total assets and from 1 to 13 percent of total revenue.

In addition to comments related to ICFR and DC&P, the SEC staff also issued a number of comments related to the certifications provided pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act. These comments focused on certifications that referred to the wrong filing or did not follow the prescribed wording specified in Item 601 of Regulation S-K. A registrant that files incorrect certifications has to file an amendment of the entire periodic report as specified in Compliance and Disclosure Interpretation 161.08.

4. We note this certification refers to the report for the quarter

ended September 29, 20X3. Please file a full amendment to your March 30, 20X4 Form 10-Q, including updated certifications, to include a Section 906 certification from your President and Chief Executive Officer that refers to the current quarterly report on Form 10-Q of the company for the quarter ended March 30, 20X4.

5. We note that you did not include the reference to internal

control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) in the introductory language in paragraph 4 of the certifications in exhibits 31.1 and 31.2. Please confirm that your certifications in future filings will include the introductory language of paragraph 4 in exact form as specified in Item 601(b)(31)(i) of Regulation S-K. Please note that similar concerns apply to your Form 10-Q for the quarterly period ended March 31, 20X4.

14%

29%

36%

21%

Figure 7. % of excluded acquisitions completed in each quarter

Q1 Q2 Q3 Q4


Revenue recognition Comments on revenue recognition increased in 2015, representing 12 percent of the comments received by technology companies, up from 9 percent for the 2014 year.

Multiple-element arrangements

Multiple-element arrangements continue to be a focus area of the SEC staff’s comments on revenue recognition. While the technical guidance has not changed, application of the existing guidance remains challenging. For arrangements with multiple deliverables, Accounting Standards Codification (ASC) 605, Revenue Recognition, requires that companies allocate arrangement consideration among deliverables using their best estimate of selling price (BESP) when vendor-specific objective evidence (VSOE) or third-party evidence (TPE) of the selling price is not available. Registrants’ critical accounting estimates and judgments related to multiple-element arrangements continue to be among the most common revenue-related comments in the technology sector. They include questions about determining the appropriate units of accounting and the valuation techniques and assumptions used to arrive at their respective values, as well as the periods over which revenue should be recognized.

1. We note that for multiple element arrangements you recognize revenue for each delivered item or items as a separate earnings process when they have value to the customer on a standalone basis. Please tell us how you allocate the consideration received in the arrangement to all deliverables and describe the significant factors, inputs, assumptions and methods used to determine the allocation. Please also tell us what consideration was given to disclosing this information. Refer to ASC 605-25-30-2 and ASC 605-25-50-2(e).

2. You disclose that TPE is generally not available because your service offerings are highly differentiated and you are unable to obtain reliable information on the pricing practices of your competitors. In light of your highly differentiated service offerings, please describe for us how you determine that each element in your multiple element arrangements has stand-alone value. Refer to ASC 605-25-25-5.

Vendor-Specific Objective Evidence: For arrangements accounted for under the software revenue recognition guidance, registrants must use VSOE to allocate the consideration among the multiple elements in an arrangement. The SEC staff frequently challenges companies about how they are able to determine VSOE and has requested enhanced disclosure to that effect in the financial

statements. In addition to enhanced disclosure, the SEC staff has, at times, requested that registrants provide their VSOE analysis.

3. We note that you have multiple element arrangements that can include implementation services and post contract customer support in addition to software and subscription services. Please tell us how you establish VSOE for the post contract customer support included in your software arrangements.

4. We note that you have established vendor-specific objective evidence (VSOE) of selling price for the combined maintenance component when you sell your solution bundled with the software. Please describe, in detail, your methodology for establishing VSOE for combined maintenance services. If VSOE is based on stated renewal rates established by management, then please tell us how you determined the renewal rates are substantive. In this regard, please provide the range of renewal rates and tell us what percentage of your customers actually renew at such rates or whether there have been any changes to these rates upon renewal. Alternatively, if VSOE is based on stand-alone sales, then provide the volume and range of stand-alone sales used to establish VSOE.

5. We see that you determine vendor specific evidence (VSOE) of fair value based on a bell-shaped curve approach. Please describe to us the nature of the bell-shaped curve approach and its application in your policy. Please discuss the methodology for determining the bell-shaped curve utilized in your model and describe how the curve varies amongst transactions or when specific elements are sold separately.

Software revenue recognition

Software licensing arrangements and related questions regarding revenue recognition continue to present challenges to the preparers of financial statements. The primary accounting guidance is included in ASC 985-605, Software-Revenue Recognition. The SEC staff’s comments have been focused on the following areas.

More-than-incidental considerations: Determining whether a software element is more than incidental to the overall arrangement is a matter of judgment. The staff’s comments in this area have asked for an explanation of how the software and hardware components function together and for more transparent disclosure of the company’s accounting policy.


Revenue recognition

6. We note your disclosure that in multiple element arrangements where software is essential to the functionality of the products, revenue is allocated to the non-software deliverables and software deliverables as a group using the relative selling price. Please clarify why you allocate revenue to the non-software deliverables and the software deliverables when the software is essential to the functionality of the product. In this regard, if the software is essential to the product, the combined deliverable would be scoped out of ASC 985-605. Refer to ASC 985-605-15-4(e).

Services revenue: The SEC staff continue to focus on revenue recognition for companies that deliver services. Whether the services revenue relates to software-as-a-service arrangements, set-up fees, training, licenses, or customer support, the staff has raised questions about the timing of revenue recognition and whether the service has stand-alone value in a multiple-element arrangement. In addition, comments focused on the appropriate period over which to recognize services revenue: the term of the contract or the estimated term of the customer relationship more broadly.

7. We note your disclosure that implementation services that are delivered prior to the customer being able to use the platform do not have stand-alone value and are recognized over the longer of the life of the subscription or the expected life of the customer relationship. Please explain your basis for concluding that these services do not have standalone value and tell us how you considered ASC 605-25-25-5(a). In this regard, we note that you disclose that these services can be provided by the Company, third-party service providers or distributors.

8. We note you disclose that for cloud offerings in multiple element arrangements, where units of accounting include more than one deliverable but are treated as a single unit of accounting, you recognize revenue generally over the estimated customer relationship period. Please tell us what deliverables are typically included in these types of arrangements and considered one unit of accounting. Further, tell us why you believe it is appropriate to recognize these arrangements over the customer relationship period, citing the accounting guidance followed, as it appears you are otherwise recognizing revenue from your cloud offerings over the related contract term. Lastly, tell us how much revenue these arrangements generated in the periods presented.

Other trends related to revenue recognition

Gross vs. net: Registrants in the technology sector may act as intermediaries between other companies and end customers. For example, they could be fulfilling obligations to deliver IT equipment and parts, selling internet media services on behalf of another company, or hosting game software on their

platform. In these cases, registrants need to determine whether to present revenue on the gross or net basis, which requires analysis of the arrangement using criteria specified in ASC 605-45. The analysis is aimed at determining whether the company acts as a principal or an agent in the arrangement with the end customer. SEC staff comments frequently asked for registrants’ detailed analysis of the factors listed in the authoritative guidance and, while the ultimate conclusion is an area of significant management judgment, greater emphasis is placed on who is the primary obligor, who has the ability to set prices, and who bears inventory risk.

9. We note that the majority of your revenues related to third-party products and services are recognized on a gross basis as you are generally acting as the principal under the arrangements. Please clarify whether your arrangements with third party device manufacturers that integrate your models into their products are recognized on a gross basis. Describe the significant terms of your revenue arrangements with third party device manufacturers. In addition, provide an analysis that supports your presentation taking into consideration all of the factors outlined in ASC 605-45-45.

10. Please tell us in detail the nature of your advertising revenues from sponsored access, promotional programs, and online display advertising on your managed and operated networks and your partner networks. Please tell us if such advertising revenues are part of multiple element arrangements and if so, provide us with an analysis of your revenue recognition policy for such arrangements. In addition, tell us how you considered whether your advertising revenues should be recognized on a gross or net basis pursuant to ASC 605-45-45.

11. We note from your disclosure that you offer some of your services through third party vendors. Please tell us more about these relationships and how your account for revenue from these arrangements. Please refer to the authoritative guidance you relied upon when determining your accounting.

Income statement presentation: Regulation S-X 5-03(1) requires separate presentation in the income statement for product, service, and other revenue, to the extent that the amounts related to any of these categories exceed 10 percent of total revenues. In addition to separate presentation of revenue, the guidance also requires cost and expenses related to each revenue category to be reflected separately in the income statement. The SEC staff may question registrants’ aggregate presentation of revenue and expense line items in the income statement, as more disaggregated information provides investors with additional insight into a company’s business.


Revenue recognition

12. We note the discussion in your filing about revenue generated from professional services. Revenue and related costs from service arrangements that account for more than 10% of net sales should be separately presented on the face of the statements of operations. Please tell us how your presentation complies with Rule 5-03(b)(1) and Rule 5-03(b)(2) of Regulations S-X or revise future filings as necessary to separately present revenues and related costs from tangible goods and services in your statements of operations.

13. We note that you separately present revenues as "advertising and other" and “subscription." Tell us what consideration you gave to presenting costs of revenues in the same manner. Refer to Rule 5-03(b) of Regulation S-X.

14. We note that you aggregate software, maintenance and services in your revenues and the related cost of revenues line items in your Consolidated Statements of Income. Please tell us how you considered providing separate disclosure of software products and service revenues and the related cost of revenues pursuant to Rule 5-03(b)(1) and (2) of Regulation S-X.

15. We note that you classify revenue from subscription services within the “product licenses and subscription services” line item. Please explain your basis for including subscription services with product revenues. In this regard, we note that these are services, and you refer to them as “service contracts.” See Rule 5-03(b)(1) and (2) of Regulation S-X.


Management’s discussion and analysis

Management’s discussion and analysis of financial condition and results of operations (MD&A) is a critical component of registrants’ communications with investors.

The key objectives of MD&A are to provide a narrative explanation of the financial statements that enables investors to see the company through the eyes of management, to offer context to the financial statements, and to provide information that allows investors to assess the likelihood that past performance is indicative of future performance. We have found that the majority of SEC staff comments in this area are not aimed at meeting specific technical requirements, but rather at enhancing the quality of disclosures to meet these objectives.

The requirements themselves are set forth in Item 303 of Regulation S-K, which identifies five categories of disclosure in MD&A: liquidity, capital resources, results of operations, off-balance-sheet arrangements, and contractual obligations. Additional guidance is also contained in Financial Reporting Release (FRR) 36 and FRR 72. More recently, the SEC has renewed its commitment to coordinate with the FASB on their joint disclosure effectiveness project to develop recommendations focused on improving and streamlining disclosure requirements.

Ultimately, this project is expected to result in updates to Regulations S-K and S-X that may reduce the costs and burdens on companies and eliminate duplicative disclosures in MD&A, but may also identify opportunities to increase the transparency of information, which may lead to new requirements. In the meantime, absent formal rule changes, SEC comments in the past year related to MD&A reflect this initiative to streamline disclosures by asking registrants to tailor boilerplate language in areas such as risk factors and legal proceedings, avoid duplication (e.g., between critical accounting policy and summary of significant accounting policy disclosures), and eliminate outdated information.

In doing so, the comment letter process has reinforced the well-established MD&A objectives that disclosures should be 1) transparent in providing relevant information, 2) tailored to the company’s facts and circumstances, 3) consistent with the financial statements and other public communications, and 4) comprehensive in addressing the many business risks that exist in today’s economic environment. Results of operations and liquidity and capital resources have received the most attention in SEC comment letters relative to these objectives (see Figure 8).

Results of operations

SEC staff comments continue to focus on the requirements of S-K Item 303(a)(3), reminding registrants that the results of operations section should provide readers with a clear understanding of the significant components of revenues and expenses, as well as events, transactions, and economic trends that have resulted in or are likely to cause a material change in the relationship between costs and revenues.

The SEC staff has frequently issued comments specifying that MD&A should not simply repeat information provided elsewhere in the filing; rather, it should explain the underlying drivers behind changes in the financial position, results of operations, and cash flows of registrants. Increasingly, registrants are being challenged to quantify the impacts that such factors have had, especially when an account has been impacted by multiple factors. General observations on the population of SEC staff comments include the following:

Disclosing known trends: The SEC staff has asked registrants to disclose known trends affecting the business, in particular, disclosure of events that have occurred and how those events were a positive or negative indicator of future performance. Examples include loss of a significant customer, development

50%

26%

17%

3% 4%

61%

21%

14%

3%1%

53%

20%

13%

9%5%

Results ofoperations

Liquidityand capitalresources

Non-GAAPmeasures

Criticalaccounting

policies

Other

Figure 8. Breakdown of MD&A comments by area

2013 2014 2015



of new products that might increase future revenues or reduce costs, entering a new market, or an acquisition that is expected to impact operating results significantly. In addition, they encourage the discussion of key operating metrics used by management, coupled with an analysis of the relationship between such metrics and GAAP results.

1. In future filings, please expand you explanation of material drivers of changes in your financial results to address not only the causes of the changes but the reasons behind why the causes occurred. For example, you disclose that your financial results were negatively impacted beginning in August 20X4 by “significant reductions in carrier capital spending…” Such a discussion should also address why customers’ capital spending dropped and whether management believes this to be a seasonal event going forward.

2. We note your net increase in net subscriber equipment sales was due to the introduction of the X product line for the three and nine month periods ended September 30, 20X4. However, we also note a trend in declining satellite handset sales in 20X3 that has continued in 20X4. Please disclose in future filings, in greater detail, the impact of the trends in terms of equipment sales volume and product mix of your different product lines on your business and results of operations. We note your disclosure that you anticipate subscriber equipment revenue for the full year 20X4 to exceed full year 20X3.

Drivers behind fluctuations: Many comments relate to improving registrants’ disclosures of significant fluctuations between periods, including pricing, volume, the impact of acquisitions, and currency movements. The SEC staff has asked for more detailed descriptions related to the specific factors driving such fluctuations and for registrants to quantify each factor separately, even when they net to an insignificant change overall.

3. We note that your explanation of the 33% increase in revenues in fiscal 20X4 does not specify in quantitative terms the contributions from what you disclose as the volume-driven increases from new customers, upgrades and additional subscriptions from existing customers and a decline in attrition rates. In addition, you disclose that the acquisition of X in July 20X3 resulted in a majority of the increased demand for services in 20X4. Please tell us why you have not disclosed more quantitative analysis of revenues resulting from the contributing factors you disclosed as well as from the acquisition of X. Refer to Item 303(a)(3) of Regulation S-K and Section III.B.3 of SEC Release 33-8350.

4. We note that revenue increases in your various service lines are attributed to the addition of new clients and/or rate increases for existing clients. Please tell us what consideration was given to disclosing the extent to which revenue increases were attributed to increases in prices or to increases in the volume or amount of services being sold. Refer to Item 303(a)(3)(ii) of Regulation S-K. Also, wherever multiple factors are cited as the

underlying drivers for changes in revenues or expenses, tell us what consideration was given to quantifying each factor. Refer to Section III.D of SEC Release 33-6835.

Consistency of information: The SEC staff has been known to review public information for consistency with the information included in a registrant’s periodic filings. When management discusses events or trends on earnings calls, social media channels, investor materials, or the company’s website, the SEC staff may question why such events are not also addressed in MD&A.

5. Your corporate blog recently identified certain challenges related to your business and revenue growth. For example, a recent blog post provided the following updates on your business: "We have been experiencing a great deal of interference in this endeavor, resulting from macro factors affecting patents generally and standard essential patents in particular"; “Notwithstanding our lack of traction thus far in our enforcement efforts ..."; and “[T]he sticking issue has been -- and remains divergent opinions of royalty values." Please tell us what consideration you are giving to expanding your MD&A overview in future filings to provide insight into challenges and risks such as those described above. Refer to Section III.A of SEC Release 33-8350.

Segment discussion: SEC staff comments have also encouraged the use of a segment analysis if such analysis would provide readers with a more in-depth understanding of the consolidated results. The segment analysis may be integrated with the discussion of the consolidated results to avoid unnecessary duplication.

6. We note that you assess performance of your segments using income (loss) from operations, among other things. We also note that you present income (loss) from operations and operating margins for each of your reportable segments. It appears that segment income (loss) from operations and operating margins have varied significantly for each of your segments, however, your discussion of segment results does not address these variances. Please tell us what consideration was given to discussing income (loss from operations) and operating margins by segment, or tell us why such information is not necessary in obtaining an understanding of your business.

Liquidity and capital resources

A key objective of the liquidity and capital resources discussion is to provide a clear picture of the registrant’s ability to generate cash and to meet existing known or reasonably likely future cash requirements. In accordance with items 303(a)(1) and (2) of Regulation S-K, the SEC staff expects the liquidity and capital resource discussion to address material cash requirements, sources and uses of cash, and material trends and uncertainties related to a registrant's ability to use its capital resources to satisfy its obligations. General observations on the


population of SEC staff comments include the following:

Disclosure of events impacting liquidity: The SEC staff has asked registrants to discuss known trends, events, or uncertainties that are reasonably likely to impact future liquidity. Such events could include entry into material commitments, loss of customers or contracts, loss contingencies, treasury stock repurchase programs, or plans for significant capital expenditures.

7. Please consider expanding your overview in future

filings to include a more detailed assessment of whether the trends and uncertainties of transitioning

from your legacy product suite to your new product

offerings will have, or are reasonably likely to have, a

material impact on the company’s liquidity, capital

resources or results of operations. See Item 303 of

Regulation S-K. For additional guidance, consider Section III of SEC Release No. 33-8350.

8. In future filings, please consider expanding your management’s discussion and analysis to provide a

balanced and meaningful discussion of known

material trends and uncertainties that will, or are reasonably likely to, have a material impact on your

revenues or income or result in your liquidity

decreasing or increasing in any material way. For example, consider discussing the deceleration of your

revenue growth and any trends related to your

negative cash flows to the extent any are known trends or uncertainties that you expect may continue to

impact your results in future periods. Further, please

discuss in reasonable detail any economic or industry-wide factors relevant to your company and any

material opportunities, challenges and risks you may

face in the short and long term and the actions you are taking to address them. For guidance, please consider

Sections III.A and III.B of SEC Release No. 33-8350.



Debt agreements and related covenants: Comments from the SEC staff have requested expanded disclosure of the material terms of debt agreements, including an indication of compliance with financial covenants. In situations where there has been or is projected to be a violation with regard to covenant compliance, registrants should provide a detailed description of the covenants, the target and actual covenant measures for the most recent reporting period, and an indication of the sensitivity of those measurements, if applicable. Other items potentially impacting the availability of credit should also be made clear, including limitations on the ability to draw on existing lines of credit, or other borrowing limitations.

9. Tell us what consideration you gave to describing the material covenants related to your outstanding debt, including the amount or limit required for compliance with the covenants and the actual or reasonably likely effects of compliance or non-compliance with the covenants on your financial condition and liquidity. In this regard, we note that you were in breach of one of the financial covenants under your short-term bank borrowings. Refer to Section IV.C of SEC Release 33-8350, Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations. Provide us with any proposed revisions to your disclosure in future filings.

Stranded cash: For companies with foreign operations, the SEC staff has focused on the registrant’s ability to repatriate cash to the United States in order to meet significant upcoming obligations, such as debt repayments or mandatory pension contributions. Comments have focused on the relationship between liquidity needs and the income tax assertion about management’s intent to permanently reinvest foreign earnings. The SEC staff has also asked companies to quantify the amount of cash held overseas and the amount of incremental deferred tax, if any, that would be recorded if cash were to be repatriated. This is also a common topic in SEC staff comments related to income taxes.

10. We see that your U.S. operations have historically

generated net losses and that you intend to indefinitely reinvest undistributed earnings of your foreign

subsidiaries. Please quantify for us the amount of cash,

cash equivalents, and investments held by foreign subsidiaries that would be subject to a potential tax

impact associated with the repatriation of

undistributed earnings on foreign subsidiaries. Please also tell us your consideration of providing enhanced

liquidity disclosures to describe these amounts that

would be subject to potential repatriation of undistributed earnings taxes to illustrate that some

cash and investments are not presently available to fund domestic operations such as corporate expenditures or

acquisitions without paying a significant amount of

taxes upon their repatriation. We refer you to Item 303(a)(1) of Regulation S-K and Section IV of SEC

Release 33-8350.

Of the companies studied in our analysis, 89 percent disclosed a permanent reinvestment assertion with respect to all or part of undistributed foreign earnings. Of those, 23 percent quantified the potential deferred tax liability upon repatriation, 46 percent stated it was impracticable to do so, with the remainder being silent. While companies are required under GAAP to either disclose the potential deferred tax liability upon repatriation or state it is impracticable to do so, those not disclosing may have considered the materiality of such potential amounts in determining that no disclosure is necessary.

A significant majority of the companies studied (80 percent) that asserted permanent reinvestment disclosed their cash balances held overseas.

23%

20%

20%

27%

46%

60%

24%

53%

33%

20%

56%

23%

Total

Software & Internet


Semiconductors

Figure 9. Of registrants asserting indefinite reinvestment, % disclosing tax impact

Quantified Not practicable Not disclosed

80%

80%

88%

73%

20%

20%

12%

27%

Total

Software & Internet


Semiconductors

Figure 10. Of registrants asserting indefinite reinvestment, % disclosing the amount of cash held domestically vs. internationally

Yes No



Critical accounting policies

Registrants are required to discuss their most critical accounting policies and estimates, preparer judgments, and risks and uncertainties within MD&A. Financial Reporting Release No. 60 further clarifies the need for more robust and transparent discussion of critical accounting policies and the likelihood of materially different reported results if different assumptions or conditions were to occur. This differs from the requirement for disclosure of accounting policies within the notes to the financial statements, which is broader and covers all relevant accounting policies. SEC staff comments in this area have highlighted the need for a full evaluation of the most critical accounting policies and estimates in determining which disclosures should be included in this section of the Form 10-K.

11. Please note that the accounting policy notes in the financial statements should generally describe the method you use to apply an accounting principle; whereas the discussion in Management’s Discussion and Analysis of Financial Condition and Results of Operations should present your analysis of the uncertainties involved in applying a principle at a given time or the variability that is reasonably likely to result from its application over time. In future filings please include an analysis, to the extent material, of factors such as how you arrived at critical estimates, how accurate the estimate/assumption has been in the past, how much the estimate/assumption has changed in the past, and whether the estimate/assumption is reasonably likely to change in the future. In addition, your disclosure should address sensitivity of the estimate/assumption to change based on other outcomes that are reasonably likely to occur and would have a material effect. Please refer to the Commission Guidance Regarding Management's Discussion and Analysis of Financial Condition and Results of Operations, Release No 34-48960. In your response, please show us what your revised disclosures will look like

12. Please tell us your consideration for including your policy of assessing impairment of goodwill in your critical accounting policy and estimates discussion as it appears to contain significant judgments and assumptions that are uncertain given the trends in your results from operations and the potential impact an impairment could have on your net loss.

Given the aforementioned requirements, registrants often have fewer critical accounting policies disclosed in the MD&A than in the notes to the financial statements. The table below shows that the number of critical accounting policies and estimates disclosed by the technology companies studied ranged from 3 to 16, with an average of 6.

The top five critical accounting policies disclosed by registrants in our study were:

• Revenue recognition—including discussion of multiple-element arrangements, distributor sales, and deferred revenue;

• Income taxes—mainly focused on deferred tax asset valuation allowances and uncertain tax positions;

• Goodwill and intangible assets—primarily covering the impairment testing methodology and the key assumptions used;

• Stock-based compensation—mostly discussing the judgments involved in determining the key inputs into the stock-option valuation model; and

• Inventory—exclusively centered on the valuation of inventory and the process for estimating excess and obsolete inventory. As expected, the only significant variance noted among subsectors was the absence of inventory from the software & internet subsector.

3

15

10

29

13

96

1 2 1 1

0

5

10

15

20

25

30

3 4 5 6 7 8 9 10 11 13 16

Nu

mb

er o

f re

gis

tra

nts

Number of critical accounting policies disclosed

Figure 11. Number of critical accounting policies disclosed

25

27

36

39

40

47

55

63

82

84

0 20 40 60 80

Business combinations

Fair value and fin. instruments

Long-lived assets

AR and allowances

Contingencies and warranties

Inventory

Stock-based compensation

Goodwill and intangible assets

Income taxes

Revenue and deferred revenue

Number of registrants

Figure 12. Top 10 critical accounting policies disclosed



Non-GAAP measures

Companies often supplement their GAAP financial reporting with non-GAAP information that is intended to provide additional insight into the financial performance of the business. A non-GAAP financial measure is a numerical measure that adjusts the most directly comparable measure determined in accordance with GAAP. Such measures provide supplemental information regarding a company’s historical or future financial position, performance, cash flows, or liquidity. They generally convey changes to the business that are organic and separate from those that may be considered unusual, infrequent, or not representative of underlying trends. Common non-GAAP financial measures in the technology industry include earnings before interest, taxes, depreciation and amortization (EBITDA), adjusted EBITDA, free cash flow, adjusted earnings, and adjusted earnings per share.

A company has flexibility as to which non-GAAP financial measures it chooses to report, if any, and how it calculates such metrics, subject to certain prohibitions. Therefore, a limitation inherent in non-GAAP financial measures is that they are subjective and may not be comparable to similarly titled non-GAAP financial measures used by other companies, including peers. With the adoption of the new discontinued operations accounting standard, fewer disposals are expected to meet the criteria for discontinued operations. Registrants may seek to utilize non-GAAP measures to present adjusted results excluding the disposed business.

When non-GAAP financial information is presented in periodic reports filed with the SEC, registrants are required to include:

• the reasons why management believes that the non- GAAP measure is relevant to investors;

• the additional purposes, if any, for which management uses the non-GAAP measure;

• the most directly comparable GAAP financial measure with equal or greater prominence to facilitate comparability among other registrants; and

• a reconciliation to the comparable GAAP measure.

In addition, Item 10(e) of Regulation S-K prohibits adjusting a non-GAAP financial performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of such charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the preceding two years.

Below are some of the circumstances that generated comment letters reviewed in our analysis:

• use of terminology that implies a non-GAAP measure is a standard measure, e.g., a measure that includes adjustments to the standard definition of EBITDA should not be labeled "EBITDA";

• omission of required non-GAAP disclosures due to inappropriate conclusion that a financial measure is not a non-GAAP measure;

• excluding charges or liabilities that require cash settlement from non-GAAP liquidity measures; and

• giving greater prominence to non-GAAP results over GAAP results.

13. We refer to your discussion and presentation of segment operating profit throughout your MD&A. In this regard, please revise your disclosure to provide a reconciliation of this measure to the most directly comparable GAAP financial measure of operating performance. Refer to Item 10(e)(1)(i) of Regulation S-K. In addition, since this measure is not the measure of profit disclosed in the segment note, it does not appear appropriate to label this measure as segment operating profit.

14. We note the non-GAAP adjustment for "income tax effect of non-GAAP adjustments." Please tell us what consideration was given to disclosing how this adjustment was calculated. Refer to Compliance and Disclosure Interpretation Question 102.11 for guidance.

15. Reference is made to your disclosure of expected Non-GAAP Net Income and Non- GAAP Earnings per Share for fiscal 2015. In future filings please provide a quantitative reconciliation, to the extent available without unreasonable efforts, of the differences between the non-GAAP financial measures with the most directly comparable financial measures calculated in accordance with GAAP. Please refer to Item 10(e)(1)(i)(B) of Regulation S-K.

16. In your adjusted EBITDA, adjusted cash earnings and adjusted cash earnings per share measures you add back merger and acquisition expenses and label them as non-recurring. It appears the nature of merger and acquisition expenses are not non-recurring as you have completed other acquisitions within the past two years. Please confirm to us that you will not refer to these items as non-recurring in future filings or explain to us why such a description is appropriate. We refer you to Item 10(e)(1)(ii)(B) of Regulation S-K and Question 102.03, in the Non-GAAP Financial Measures section of our Compliance and Disclosure Interpretations.




For the technology companies studied, our study indicated that 89 percent of companies disclosed non-GAAP measures in their earnings releases, while 46 percent of those companies also disclosed non-GAAP measures in their Form 10-K filings. An analysis of non-GAAP measures by subsector revealed that Software & Internet companies have a higher propensity to report non-GAAP measures in their Form 10-K filings with 63 percent, compared to 40 percent of Computers & Networking companies and just 33 percent of Semiconductor companies.

The results of our study also found that, even when registrants disclose non-GAAP measures in their Form 10-K filings, they typically include more non-GAAP measures in their earnings releases (average of approximately four as compared to one).

The most commonly reported non-GAAP measures include non-GAAP earnings per share, net income, operating income, and gross profit, adjusted EBITDA, and free cash flow. This was consistent across all subsectors included in the study.

100% 93%73%

89%

7%27%

11%

Software & Internet Computers &Networking

Semiconductors Total

Figure 13. % of registrants disclosing non-GAAP measures in earnings release

Yes No

63%40% 33% 46%

37%60% 67% 54%



Figure 14. % of registrants disclosing non-GAAP measures in Form 10-K

Yes No

4.33.7

3.23.7

1.9

0.9 0.81.2



Figure 15. Average number of non-GAAP measures

Earnings release Form 10-K

28 25 22

715 12 10

3 4

2523

14

8

11

5 8

4 4

19

18

13

15

4

7 5

2 1

Nu

mb

er o

f re

gis

tra

nts

Figure 16. Most common types of non-GAAP measures disclosed

Software & Internet Computers & Networking Semiconductors



When developing non-GAAP measures, the technology companies in our study most frequently excluded the following items from their GAAP operating results: share-based compensation expense, amortization of acquired intangible assets, restructuring charges, and acquisition, integration, and divestiture related costs.

27

23

12

16

15

9

5

7

19

19

12

9

11

7

6

7

16

14

14

12

4

5

8

5

0 10 20 30 40 50 60

Share-based compensation expense

Amortization of acquired intangible assets

Restructuring charges

Acquisition, integration and divestiture-related costs

Capital expenditures

Acquisition-related adjustments (fair value ofinventory, deferred revenue, contingent consideration)

Goodwill, intangible and other impairment losses

Legal expenses, settlement gains/losses

Number of registrants

Figure 17. Top non-GAAP adjustments

Software & Internet Computers & Networking Semiconductors


Compensation

Accounting and disclosures for compensation arrangements require significant judgment related to key inputs and assumptions.

The accounting guidance for stock-based compensation requires detailed disclosures of the methodologies used to determine the assumptions underlying option pricing models used to estimate the fair value of share-based compensation awards, which in turn drives significant expense charges in the income statement. While the guidance on stock-based compensation disclosures has not changed, it remains a challenging area for registrants.

The accounting guidance provides for certain accommodations in those circumstances where a company does not have sufficient reliable historical data of its own. As an example, to estimate the expected term for “plain vanilla” options, management can use a simplified approach, which takes the mid-point between the vesting date and contractual expiration date in lieu of the actual experience of the company with its own employees exercising stock options. Also, a newly-public company typically does not have sufficient company-specific historical data about the volatility of its own stock price. In that case, management is allowed to use the volatility of a peer group instead. These accommodations are expected to be used for a limited time. After accumulating sufficient historical experience, a company should not rely solely on peer information for the volatility assumption or use the simplified method for the expected term assumption. While there is no bright line as to what constitutes sufficient company-specific historical experience, based on comments issued by the SEC staff to registrants, that period should generally not exceed three years.

1. Please tell us your consideration of disclosing the methods used to determine the dividend yield; risk-free interest rate; expected option life; expected volatility and suboptimal exercise multiple for each period presented. We refer you to ASC 718-10-50-2(f).

2. We note your disclosure that you use the simplified method to estimate the expected term of your stock options. Considering the extent of the exercise activity since your initial public offering, please explain why you continue to believe that it is appropriate to use the simplified method rather than using historical information. Also, tell us when management expects that sufficient historical information will be available. Refer to Question 6 of SAB Topic 14.D.

Item 402 of Regulation S-K requires extensive disclosures related to executive compensation in proxy statements, Form 10-K filings, and registration statements, the objective of which is to provide users of financial statements with robust and transparent information. Comment letters issued by the SEC staff in the past year have focused on how registrants determine amounts awarded to executive officers. While some registrants disclose the data points used, such as peer group or salary survey data, the SEC staff has criticized registrants for generic disclosures in this area. In many cases, comment letters have requested that registrants explain how specific awards to each executive officer were determined.

3. Although you discuss what you generally considered in determining the amount of equity incentives, you have not discussed the specific considerations that led to the actual amounts awarded. For example, you do not appear to explain why Messrs. X and Y received more equity incentives than Mr. Z. Please address this in future filings, to the extent applicable. See Item 402(b) of Regulation S-K.

Comment letters issued by the SEC staff have also required that registrants disclose the specific performance targets and thresholds that employees need to achieve in order to earn their compensation awards. Some registrants have claimed “competitive harm” if such disclosures are made; however, the SEC staff remains skeptical, especially when such information is based on actual company results and the performance target is disclosed after the fiscal year has ended.

4. We note your disclosure that you elected not to disclose your performance targets because such information involves confidential financial information, the disclosure of which would result in competitive harm to you. Please provide us with a detailed explanation supporting this conclusion. See, for guidance, Instruction 4 to Item 402(b) of Regulation S-K, and Question 118.04 of the Regulation S-K Compliance and Disclosure Interpretations. In addition, in future filings, to the extent that it is appropriate to omit specific goals and metrics, please provide appropriate disclosure pursuant to Instruction 4 to Item 402(b) of Regulation S-K. In discussing how difficult or likely it will be to achieve the levels, you should provide as much detail as necessary without disclosing information that poses a reasonable risk of competitive harm.


Impairments

The SEC staff continues to issue comments on registrants’ disclosures of critical accounting estimates related to goodwill, indefinite-lived intangible assets, and long- lived asset impairments.

Goodwill and indefinite-lived intangible assets

SEC staff comments during 2015 have requested details surrounding a company’s quantitative impairment tests and the related assumptions. For reporting units whose fair values are not substantially in excess of their carrying amounts (“at risk” reporting units), the SEC staff has asked registrants to disclose additional quantitative and qualitative information consistent with the guidance outlined in the Division of Corporate Finance Financial Reporting Manual Section 9510.3.

Some registrants also received comments from the SEC staff when no impairment charge was recorded during the annual assessment, but other publicly available data indicated the presence of a negative trend that could impact the impairment assessment.

1. Please provide us with a more thorough description of the assumptions used in your DCF valuation for the X and Y reporting units. Include the carrying values of the reporting units, the source of assumptions specific to each unit, and whether the assumptions and methodology used for valuing goodwill in the current period have changed from the testing performed in 20X3. Identify the impact of any changes and describe the reasons for such changes. For example, specifically tell us the long-term growth rates and risk-adjusted discount rates used for each of these reporting units and how you derived those rates for your testing in 20X4 and 20X3. Explain the reasons for any changes between the dates. Tell us about the projected cash flows used in your valuations and how these cash flows compare to other internal forecasts and budgets of the company, historical cash flows for the reporting units, and actual cash flows since that time.

2. We note your disclosure that there have been no significant events or circumstances that may have impacted the valuation of goodwill subsequent to the assessment performed on October 1, 20X3. Please tell us how you considered the following when making this determination: There has been a significant decline in your market capitalization as a result of the decline in the fair value of your common stock. In this regard, we note that your stock price was $X on October 1, 20X3 compared to $Y as of June 30, 20X4.

The decline in license and maintenance revenue as well as the fact that you operated at a loss in the three and six-months ended June 30, 2014. In this regard, we note that we do not believe that 10% is substantially in excess.


Impairments

Long-lived assets

The themes of the SEC staff comments related to long-lived assets were consistent with those for goodwill and other indefinite-lived intangible assets. Additional information about the level of uncertainty and sensitivity of key assumptions related to “at risk” assets or asset groups has been a point of focus by the SEC staff. In some instances, the SEC staff requested details of the impairment analysis and challenged registrants’ conclusions relative to how registrants considered economic challenges, operating losses at a specific segment, or the impairment of similar assets as a potential trigger event.

3. We note that you recognized an impairment in 20X3. Please respond to the following: For each category of fixed asset impaired, tell us the carrying amount prior to recognition of the impairment loss and the impairment amount. Tell us how you applied FASB ASC 360-10-35 in determining the amount of the impairment loss. If the assets were fully impaired, please tell us why.

4. Please tell us and disclose the facts and circumstances leading to the abandonment of certain products and the method used for determining fair value of the impaired assets. In addition, please tell us and disclose the segment(s) in which the remaining impairment charges are reported. Please refer to ASC 360-10-50-2.


Income tax While valuation allowance conclusions and indefinite reinvestment disclosures remain a focus, the effective tax rate is emerging as an area of emphasis of SEC staff comments.

Income tax related disclosures and analysis continue to be an area of focus for the SEC staff. In particular, comments have requested that registrants expand their discussion of significant fluctuations and transactions and provide additional insight into material factors affecting trends. The SEC staff has also focused on enhancing registrants’ disclosures relating to the effective tax rate reconciliation and management’s conclusion over the need for a valuation allowance.

Effective tax rate reconciliation: Recent comments from the SEC staff have inquired about the nature of certain line items in the effective tax rate reconciliation and their consistency with information disclosed elsewhere in the registrant’s filing. When there was a substantial difference between the effective tax rate and statutory rate, the SEC staff has asked registrants to enhance their disclosures and discussion of the trends and variability of material components within the reconciliation.

1. We see that the effect of foreign operations taxed at various rates significantly impacted the reconciliation between the statutory U.S. federal income tax rates to the actual effective income tax rate for fiscal 20X3. As required by FASB ASC 740-10-50-14, please revise future filings to disclose the nature and effect of significant matters affecting comparability of information for all periods presented. In this regard, please disclose the identities of specific jurisdictions that materially affect the effective tax rate, their tax rates, and information about the effects on such foreign jurisdictions on the effective tax rate.

2. Please provide us with a breakdown of the components included in the line items: tax credits, tax reserve for uncertain tax positions, and the change in earnings mix included in your effective tax rate reconciliation for the fiscal year ended December 31, 20X3. As part of your response, tell us what consideration you gave to providing further quantitative breakdown of these line-items. We refer you to Rule 4-08(h) (2) of Regulation S-X. In this regard, tell us whether any other items are included in these line items.

Valuation allowances: The SEC staff continued to scrutinize registrants’ assessments of the recoverability of deferred tax assets, the assessment of which involves significant judgment. In comment letters, the SEC staff asked registrants to explain the nature and weight of the positive and negative evidence considered in their assessment. The SEC staff has further requested that registrants discuss whether the assumptions and future trends considered in this assessment are consistent with the assumptions used in other assessments, such as those prepared to evaluate goodwill or intangible or tangible asset impairments.

3. We note that as of December 28, 20X3, you concluded that "it was more-likely-than-not that the amount of deferred tax assets recorded on the balance sheet would be realized." We further note that over the last three fiscal years, you have incurred a cumulative loss before income tax (benefit) provision. In light of such cumulative loss, please provide us with your basis for your conclusion that a valuation allowance is not needed. Refer to ASC 740-10-30-23.

4. We note that you have a history of losses and have not recognized a valuation allowance for deferred tax assets, and in particular, deferred tax assets related to capital and net operating losses. Please tell us the evidence, both positive and negative, you considered to determine whether, based on the weight of the evidence, a valuation allowance for deferred tax assets is needed. Please include a discussion of the possible sources of taxable income that may be available to realize the tax benefits for the deductible temporary differences and carryforwards, including reversal of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences, and tax planning strategies. Please be sure to explain how you support a conclusion that a valuation allowance is not needed given the cumulative loss in recent years. Please refer to ASC 740-10-30-16 through 25.

Indefinite reinvestment assertion: If a registrant determines that its investment in a foreign subsidiary is essentially permanent in nature (i.e., asserts its earnings will be indefinitely reinvested outside of the US), it does not have to record a deferred income tax liability for any related basis differences. In addition to disclosure in the MD&A regarding the impact of indefinite reinvestment assertions on liquidity, the SEC staff reminded registrants that when an indefinite reinvestment assertion is made, ASC 740-30-50 requires disclosure of the amount of the unrecognized deferred tax liability on undistributed earnings of foreign subsidiaries or a statement that such determination is not practicable.

5. You indicate that you intend to permanently reinvest the undistributed earnings from other foreign subsidiaries. Tell us what consideration was given to disclosing the accumulated amount of undistributed foreign earnings of these subsidiaries. Refer to ASC 740-30-50-2(b). Provide us with any proposed revisions to your disclosure in future filings.

Sample comments regarding MD&A disclosure of the impact of indefinite reinvestment assertions can be found on Page 19.


Loss contingencies

To keep investors apprised of material developments associated with the nature, timing, and amount of a loss contingency, such details should generally not be disclosed for the first time in the period in which a liability is recorded.

The disclosure requirements of ASC 450, Contingencies continue to be a challenging area for registrants and a focus of the SEC staff. Under the guidance, companies should record an accrual for a loss contingency when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. In instances where the criteria for accrual have not been met, disclosure may be required if the loss is reasonably possible. For loss contingencies that meet the criteria for disclosure, registrants should include a description of the nature of the contingency and an estimate of the possible loss or range of loss (or a statement that such an estimate cannot be made). To alleviate registrants’ concerns that disclosure of such information may impact the outcome of litigation, the SEC staff has accepted disclosure of estimated exposure on an aggregated basis, rather than requiring separate disclosure for each individual matter. In certain situations, when a registrant discloses that an estimate of the possible loss or range of loss cannot be made, the SEC staff has questioned the procedures undertaken to develop the estimate or range and the factors leading to the inability to develop such estimates. Disclosure of the nature, timing, and amount of a loss contingency should generally not be disclosed for the first time in the period in which the loss is recorded. The SEC staff has frequently evaluated the disclosures in periods prior to the period in which a loss is recorded and commented on a lack of adequate “early-warning” or foreshadowing disclosures. Such comments often request additional information to understand the triggering event for recording the loss and whether such losses should have been recorded in an earlier period. The SEC staff expects that loss contingency disclosures will be updated regularly, both qualitatively and quantitatively, for developments in the related matters and as more information becomes available.

1. Please tell us how you have complied with the disclosure

requirement in ASC 450-20-50-4 to either disclose an estimate of the possible loss or range of loss in excess of amounts accrued, or provide a statement that such an estimate cannot be made.

2. We note the discussions relating to the lawsuits filed in January 20X5 but note that you did not provide all the

disclosures required by FASB ASC 450-20-50, including management's conclusion or inability to conclude on the probability of loss and any related accrual. Please confirm that you will comply fully with the guidance in future filings. Please provide us with your proposed revised disclosure.

3. You disclose that in management's opinion claims not disclosed involve amounts that would not have a material adverse effect on your consolidated financial position if unfavorably resolved. Please also disclose in future filings the expected impact on your cash flows and results of operations.

4. For a number of your legal proceedings disclosed in Item 3, you disclose the claims are without merit and/or you plan to vigorously defend them. If there is at least a reasonable possibility that a loss exceeding amounts already recognized may have been incurred, in your next periodic filing, please either disclose an estimate (or, if true, state that the estimate is immaterial in lieu of providing quantified amounts) of the additional loss or range of loss, or state that such an estimate cannot be made. Please refer to ASC 450-20-50.

If you conclude that you cannot estimate the reasonably possible additional loss or range of loss, please tell us: (1) explain to us the procedures you undertake on a quarterly basis to attempt to develop a range of reasonably possible loss for disclosure and (2) for each material matter, what specific factors are causing the inability to estimate and when you expect those factors to be alleviated. We recognize that there are a number of uncertainties and potential outcomes associated with loss contingencies. Nonetheless, an effort should be made to develop estimates for purposes of disclosure, including determining which of the potential outcomes are reasonably possible and what the reasonably possible range of losses would be for those reasonably possible outcomes.

You may provide your disclosures on an aggregated basis. Please include your proposed disclosures in your response.


Segments The purpose of segment disclosures is to provide investors the ability to see the company through the eyes of management.

Recent remarks by the SEC staff highlight the continued importance of accurate segment disclosures in public filings. Historically an area of focus for the SEC staff, segment reporting gained further prominence as a result of observations made by an SEC staff member at the 2014 AICPA National Conference on Current SEC and PCAOB Developments. Specifically, the staff announced its plans to refresh its approach to reviewing segment disclosures. In addition to the areas of focus indicated in last year’s comment letters, registrants should be prepared for the possibility of new trends emerging in the near future based on the staff’s reconsideration of segment disclosures. Future comment letters might challenge:

The identification of the Chief Operating Decision Maker (“CODM”) or

Relying too heavily on the CODM reporting package to identify operating segments (i.e., registrants should also consider the basis on which budgets and forecasts are prepared, the basis on which executive compensation is determined, and the overall organizational/management structure).

1. We note 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.

Currently, the most frequent SEC staff comments on segments relate to the proper identification of operating segments and the aggregation of operating segments into reportable segments. The SEC staff routinely requests documentation supporting the registrant’s identification of operating segments. Registrants are often asked to provide copies of the CODM reporting package to allow the SEC staff to consider whether the information is consistent with the registrant’s identification of its segments. This is particularly important for companies asserting that they operate as a single segment. However, as noted above, the staff has recently indicated that the CODM package should not be the only information considered when

identifying operating segments. Registrants should understand that the staff continues to review publicly available information, such as earnings calls, press releases, investor presentations, and registrant websites, to ensure a company’s description and organization is aligned across all public information.

2. We note your disclosure that the company operates as three segments which are sufficiently similar and aggregated. We further note that you identified two operating segments in your Form 10-K for the fiscal year ended December 31, 20X3. Please tell us what your operating segments are and provide us with your analysis of how you concluded that aggregation is appropriate under ASC 280-10-50-11, including an analysis such as gross margins and sales trends, supporting the conclusion that the operating segments are expected to have similar long-term economic characteristics.

3. We note that you have not presented segment information for your vertical-based business units as you do not have discrete financial information. However, we note that in your earnings call transcript for Q4 20X3 results your CEO indicates that the new structure empowers verticals, making them responsible for their respective P&Ls. Please explain why you do not have discrete financial information for your vertical-based business units considering that you appear to have business unit P&Ls. See ASC 280-10-50-1 and ASC 280-10-50-10.

Depending on how the CODM assesses operating performance and allocates resources, the basis of segmentation used by registrants may vary, for example, based on geography, line of business, product or service type, or a combination thereof. In our benchmarking study, we noted than 57 percent of registrants disclosed operating as a single segment. Of those registrants reporting more than one segment, over half (59 percent) determined their segments based on different product or service types, 18 percent based them on lines of business, and another 18 percent on geography. There were no meaningful differences in this distribution by subsector with the exception of semiconductors, where segmentation was even more heavily weighted towards product type at 79 percent.

Products & Services

59%

Line of Business

18%

Geography18%

Combination 5%

Figure 18. Basis of segmentation


Segments

The SEC staff routinely issues comments related to a registrant’s conclusion that its operating segments satisfy the “economic similarities” criterion for purposes of aggregation. Information such as analyst presentations and public filings are often used by the staff when considering the appropriateness of aggregation. Comment letters frequently request additional information from registrants, such as historical and projected gross and operating margins, to support the assertion that aggregated operating segments exhibit similar long-term financial performance. In addition, demonstrating similar long-term performance is not in and of itself sufficient to support the appropriateness of aggregation. All of the qualitative criteria outlined in ASC 280 should be considered, including (1) the nature of a registrant’s products and services and (2) the type or class of customer for those services. Registrants are reminded that the aggregation criteria are meant to set a high hurdle to overcome.

4. We note your disclosure of revenue by type of product or service in accordance with ASC 280-10-50-40. It appears that your display advertising, click and call advertising, and lead generation advertising revenue streams have distinct natures and risks; as such, it does not appear that these services are similar enough to be aggregated into a single group. Please further disaggregate your online revenue category, and show us how this disclosure would have appeared in this Form 10-K.

5. Please address the following:

• Please provide us with a clear description of the nature of the products for each of your major product lines. In this regard, please also describe any major similarities and differences among the product lines.

• You state that many of the products are based on the same underlying technology, and that serves as part of your basis for concluding they are similar products. Please explain to us in the nature of customization or enhancements that is done to the base underlying technology in order to create the product lines that you reference.

• We note that you serve four diverse target markets. Please explain to us how each of your product lines serves each target market. Given the diversity of your end markets, please explain to us why you believe the products serving those end markets are substantially similar.

• To the extent available, please provide us with revenue and gross profit by product line for your last two fiscal years. Within your analysis, please address any significant differences between revenue growth rates and gross margin percentages for each of your product lines.

Based on comments made at the 2014 AICPA Conference, the SEC staff believes entity-wide disclosures are often overlooked in company filings. These disclosures are required even for registrants organized in a single reportable segment. As the staff continues to highlight the importance of these disclosures, registrants may receive comments if they have omitted the disclosure of revenue by product or service, by groups of similar products or services, or by geography. These questions are usually based on the way management describes the registrant’s business or discusses the results of operations in MD&A. The SEC staff frequently challenges registrants who assert that providing such disclosures is impracticable, especially in filings in which the description of the company’s business outside of the financial statements (e.g., within MD&A) includes quantification and discussion of different revenue categories. It is worth noting that the entity-wide disclosure of revenue by product may differ from how revenue is presented in segments organized by product.

6. We note you derive a significant portion of your revenue from your international business and disclose plans to expand your operations in Europe, Asia, Latin America, and other geographic regions. Please tell us how you considered ASC 280-10-50-41 in determining no individual foreign country represents a material source of revenue.

While there is a requirement to disclose revenue by geography, there is no prescribed basis in GAAP for the geographical attribution of such revenues from external customers to individual countries. Our study found that 74 percent of companies attributed revenues based on customer location. Some companies were more specific about defining the customer’s location as a “bill to” location or a “ship to” location. In addition, 8 percent of companies attributed revenue by sales origin, which is sometimes referred to as the “bill from” location.

Customer location

28%

Ship to location

19%

Bill to location

27%

Sales location

8%

Other or not

disclosed 18%

Figure 19. Basis for geographical attribution of revenues


Business combinations, variable interest entities, and divestitures

As technology companies continue to seek growth and transformation opportunities through acquisitions and divestitures, the SEC staff continues to comment on key accounting and disclosure items in this area.

Mergers and acquisitions deal activity has escalated over the years and, as a result, the SEC staff continues to comment on various aspects of acquisition accounting and disclosure. Acquisition-related accounting and disclosure requirements can be complex and will likely vary based on the structure of the transaction and the nature of the assets acquired and liabilities assumed. ASC 805, Business Combinations, requires extensive disclosures to enable users to evaluate the nature and financial effects of a business combination. Companies should carefully consider the applicable disclosure requirements, both in the period of the acquisition and in subsequent periods.

Business combinations: For companies in the Technology industry, the SEC staff comments have focused on:

purchase price allocations, including questions about

how fair value was determined and the key

assumptions used;

the reasons for significant adjustments to the initial

purchase price allocation and why such information

was not available at an earlier date;

additional information about the qualitative factors

that resulted in significant goodwill;

how goodwill was allocated to reporting units and the

interplay with the company’s operating segments

disclosures; and

how the company evaluated whether the transaction

was the purchase of assets or a business.

The SEC staff has also questioned the omission of the proforma financial information required by ASC 805-10-50-2, as well as the omission of disclosures of actual revenue and earnings since the acquisition date, as required by ASC 805-10-50-2.

1. You disclose that you did not disclose the amounts of revenue and earnings of the Microphone Product Line from the acquisition date included in the consolidated statements of operations because the impact was not material. Given the impact of the acquisition, as reflected in your pro forma information, please tell us the amounts of revenue and earnings of the X Product Line from the acquisition date to March 30, 20X4 and discuss your conclusions that the amounts are not material. Refer to FASB ASC 805-10-50-2(h).

2. Please explain in further detail how you concluded that the patents acquired, including the licenses to access patents, and technology do not qualify for recognition as separate assets pursuant to the guidance in ASC 805. In particular, provide us with your analysis to explain how you considered the contractual/legal and separability criterion, including the guidance in ASC 805-20-55-2(c).

3. Please tell us if you anticipate future research and development that may utilize any of the acquired patented technology. If so, explain to us the consideration you gave to this possibility when estimating the useful life of the acquired patents.

4. Please tell us how you determined the useful lives of the existing airport and customer contracts and relationships for the X and Y acquisitions, respectively.


Business combinations, variable interest entities, and divestitures

Variable Interest Entities (VIEs): Accounting guidance requires that a reporting entity consolidate any entity in which it has a controlling financial interest. A variable interest is an investment or another interest that will absorb portions of a VIE’s expected losses or receive portions of the entity’s expected residual returns. The identification of variable interests represents one of the more challenging aspects of the VIE model. A VIE is required to be consolidated by the primary beneficiary, which is the party that has the power to direct the entity’s most significant economic activities and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the entity. This party could be an equity investor, some other capital provider, or a party with certain rights pursuant to a contractual arrangement. In the Technology industry, there continues to be significant focus on VIE structures in China and, specifically, the enforceability of the contractual terms in light of existing local government regulations, management actions that demonstrate that the contractual terms are being adhered to, country laws that can affect the operations, and related parties in the structure.

The VIE model requires that both the primary beneficiary of a VIE and a reporting entity with a variable interest in a VIE disclose certain information about their involvement with a variable interest entity. These extensive disclosures are intended to enable users to evaluate the nature and financial effects of VIEs. Accordingly, it is important that companies develop, monitor, and maintain systems, processes, and internal controls to ensure compliance with these requirements in a timely and complete manner.

The SEC staff comments have requested registrants to:

• enhance disclosure of the types of structures in which the company participates and the accounting policy and determination of which entities are consolidated and which ones are not;

• describe the methodology used in evaluating whether the company is the primary beneficiary of a VIE, including a description of the significant judgments and assumptions made;

• describe the qualitative factors considered and also provide the quantitative analysis used, if any, to determine whether the rights to receive benefits could potentially be significant; and

• disclose the primary factors that cause a change in the conclusion about consolidating a VIE and the effect on the financial statements.

5. We note your disclosures here and throughout the filing that you account for the 51% investment in X and Y under the equity method of accounting. We further note your disclosures of the substantive participating rights that the no controlling shareholder holds. Please tell us more about these rights as well as the rights that you hold by virtue of your effective 51% investment. Explain in greater detail why you determined that it should not be consolidated based upon the guidance in FASB ASC Topic 810.

Divestitures: With new accounting guidance in place with respect to the definition of, and disclosure requirements for, discontinued operations, companies are required to evaluate accounting for disposals under a new model. Discontinued operations are now limited to disposals of components that represent a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. In addition to evaluating the accounting and disclosure requirements for a disposal, companies should also consider the requirement to file an Item 2.01 Form 8-K to disclose that a significant disposition has occurred and the related proforma effects of the disposal, based on the significance tests set forth in Regulation S-X 1-02(w).

Prior to the new guidance going into effect for interim and annual periods beginning January 1, 2015, in instances where registrants had accounted for disposals under the existing guidance, the SEC challenged registrants about their conclusions that a divestiture met the criteria for discontinued operations presentation, and also the significance conclusions for the Form 8-K reporting requirements. As they adopt the new guidance, registrants should be mindful of the need to perform and document a thorough analysis of the disposal and expect that the SEC may inquire about the factors considered in concluding whether a disposal represented a strategic shift of the business.

6. We note your determination that the divestiture of the X business did not qualify for discontinued operation due to the significant continuing involvement of the Company in the X business operations. Please tell us the nature of your continuing involvement and why you deem it significant. Refer to ASC 205-20-55-15.

7. We note from your press release that you sold your X operation to Y, a business process outsourcing service provider. Please tell us what consideration you gave to ASC 205-20 and ASC 360-10-45-9 in determining whether this business should be reflected as assets held for sale and correspondingly discontinued operations. In addition, please tell us why you were not required to file an Item 2.01 Form 8-K for the disposition of these assets.



In addition to the areas highlighted so far, there were several other notable trends in SEC comment letters.

Compliance

The SEC staff continues to raise numerous compliance- related questions, including requests to file copies of material agreements, inquiries about the determination of a registrant’s filing status and eligibility to use certain Securities Act forms, and inquiries about the content of the auditors’ reports on financial statements.

Business section and risk factors

The SEC staff has increasingly requested that registrants include specific information about their business in both the Business and Risk Factors sections of filings. The SEC staff has been critical of registrants who include general discussions of the business and risk factors applicable to the industry without specifically focusing on the unique operations and business of the registrant.

Further, the SEC staff has also asked questions of registrants in instances where there is a lack of consistency among any significant business matters or potential risk factors disclosed, and other sections of its periodic filings or other publicly available information.

More specifically, in the Business section, the SEC staff has posed questions to registrants regarding backlog disclosures and has challenged registrants in instances where backlog has not been disclosed.

1. Although we understand that the backlog amount does not include overage fees as these amounts are not firm, the disclosure of backlog and the amount of backlog not reasonably expected to be filled within the current fiscal year is a requirement per Item 101(C)(1)(viii) of Regulation S-K. Please confirm that in future filings you will provide this required disclosure.

2. We note that because you invoice your customers in a variety of installments, your deferred revenue does not represent the total contract value of your non-cancellable subscription agreements. Please tell us what consideration you gave to disclosing backlog as required by Item 101(c)(1)(viii) of Regulation S-K.

Disclosure of operations in locations identified as state sponsors of terrorism

There has continued to be a decline in SEC staff comments regarding registrants’ business conducted with state sponsors of terrorism (Syria, Cuba, Iran, and Sudan). Nonetheless, the SEC staff continues to ask registrants to disclose quantitative and qualitative information about interactions with these countries factors that a reasonable investor would regard as important in making an investment decision. These include the nature and extent of contact (directly or indirectly), including the amount of revenues derived and assets associated with each country (without any materiality threshold), and a description of equipment and technology that the company has provided to these countries. The comments are often triggered by a review of the company’s website, which may contain references to one of the countries designated as state sponsors of terrorism.

3. You state that customer X represented 63% of your total revenue for 2013. X’s website provides contact information for service and support centers for Sudan and Syria. Additionally, we are aware of an article stating that X’s products are popular in Cuba. Cuba, Sudan, and Syria are designated by the Department of State as state sponsors of terrorism, and are subject to U.S. economic sanctions and export controls. Please describe to us the nature and extent of your past, current, and anticipated contacts with Cuba, Sudan and Syria, if any, whether through subsidiaries, distributors, customers or other direct or indirect arrangements. You should describe any services, products, information, or technology you have provided to Cuba, Sudan, or Syria, directly or indirectly, and any agreements, commercial arrangements, or other contacts you have had with the governments of those countries or entities they control.

38%

6%7%

18%

4%

10%

18%

17%

3%

7% 12%

8%

6%

46%

21%

12%

4%11% 5% 5%

42%

Figure 20. Breakdown of other notable trends by topic

2013 2014 2015



Investments and fair value measurements

Investments and fair value measurements comments included requests to disclose the methods and key assumptions used to determine fair values, transparent disclosures with respect to credit quality of investments, management’s consideration of temporary versus other- than-temporary investment losses, and detailed disclosures about unobservable fair value measurements (Level 3), such as the reconciliation of beginning and ending values for the period and the sensitivity of fair values to changes in assumptions.

4. Your fair value disclosures indicate that you estimate the fair values of other short-term receivables and payables as well as prepayments and other assets, long-term deferred revenues, and other long-term liabilities using Level 3 valuation techniques. Please explain why the amounts determined using Level 3 valuation techniques are not presented within the fair value table. In this regard, please consider revising future filings to include the amounts determined using Level 3 measurements techniques within the table. In addition, consider providing a discussion of changes to your fair value measurement techniques as well as the movement of amounts from one Level to another, including the reasons for such changes or movements. Please refer to and tell us how you addressed the disclosure guidance in ASC 820-10-50.

Of the companies studied, approximately 47 percent disclosed one or more Level 3 valuations for either recurring or non-recurring fair value measurements. The most common type of recurring Level 3 fair value measurements was for contingent consideration liabilities, with 25 percent of companies disclosing a Level 3 fair value measurement for those types of instruments. Level 3 fair value measurements for auction rate securities and derivatives were also common, with 10 percent of companies reporting Level 3 fair value measurements for each of these types. For non-recurring fair value measurements, the most common type disclosed were Level 3 fair value measurements for asset impairments and assets held for sale, with 15 percent of companies reporting such a measurement.

Other

Materiality: The SEC’s guidance on evaluating materiality is included in SAB Topics 1.M and 1.N. Materiality should be evaluated considering both quantitative and qualitative factors. The quantitative analysis should include the effects of the errors on each of the company’s

financial statements impacted (both annual and interim) and related disclosures using both the iron curtain and roll-over methods. However, registrants should not assume that an error is not material simply because it falls below a certain dollar or percentage threshold. A qualitative analysis should also be performed to address considerations such as whether the error impacts management’s compensation, whether it was intentional or the result of a fraudulent act and, if the error impacts reported trends or analysts’ expectations. The materiality analysis should be robust and balanced (reflecting both positive and negative factors), and should be contemporaneously documented, as the SEC staff often asks registrants to provide their materiality analysis.

5. We see that you recorded out-of-period correcting adjustments to write off certain manufacturing and subcontractor costs that were capitalized within other current assets in previous periods. We reference your statement that the corrections resulted in an increase to the Company's net loss of $X for the six months ended June 29, 20X4. Given the company’s net income for the six months ended June 29, 20X4 of $Y, please tell us how you concluded that the amounts were not material, either individually or in the aggregate, to any prior period and to the 20X4 interim or expected full year financial statements. Please provide us with your SAB No. 99 analysis in assessing the materiality of the error.

6. We note that during the second quarter of 20X3, you identified an error related to prior year periods for Brazilian indirect tax incentives and you determined that the error is not material to each year presented. Please provide us with a reasonably detailed SAB 99 analysis encompassing each period affected by the error, including quarterly periods, and tell us how you considered each of the qualitative factors.

7. We note you reclassified certain costs that were previously included in general and administrative expenses to cost of revenue based on personnel or activities that were directly related to supporting your customers. Please describe in detail the nature of the activities performed by these personnel and describe any other costs that were reclassified to cost of sales that supports the classification of these expenses as cost of revenue. As part of your response, please tell us how you determined that this was a reclassification rather than an error and refer to the authoritative guidance you relied upon.


Disclosure Effectiveness

The SEC staff is in the midst of a broad, ongoing project to evaluate the requirements of Regulation S-K and certain provisions of Regulation S-X for all registrants. This effort evolved out of a JOBS Act requirement for the SEC staff to evaluate ways to modernize and simplify the registration process and reduce the costs and other burdens associated with Regulation S-K requirements for issuers that are emerging growth companies.

SEC Chair Mary Jo White has emphasized that disclosure effectiveness continues to be an area of focus for the SEC staff. Additionally, SEC Commissioner Daniel M. Gallagher stated in a March 2015 speech, “I hope and expect that the Division of Corporation Finance will come out with an aggressive agenda for disclosure simplification.”

While the SEC staff has been clear that current disclosure requirements are not broken, there appears to be widespread support for identifying targeted recommendations to minimize duplicative and overlapping requirements, eliminating disclosures that are not useful, and reducing the costs and burdens of financial reporting to preparers.

Through this initiative, the SEC is looking for ways to update and modernize its disclosure system while continuing to provide material information. The SEC staff has been clear that reducing disclosure is not the objective of this important project, but they have indicated that they believe the initiative can reduce costs and burdens on companies. While the disclosure effectiveness project may identify and eliminate duplication or overlaps in disclosure requirements, it may also identify gaps in information that investors would find useful, in which case, it may lead to additional disclosure requirements.

On September 25, 2015, the SEC published its first request for comment from the disclosure effectiveness initiative. The request for comment focuses on the portions of Regulation S-X that address financial information of entities other than the registrant (e.g., acquired businesses, equity method investees, guarantors). The application of these rules can be complex, and many consider it to be disproportionately burdensome to smaller registrants since they are more likely to trigger the quantitative thresholds in these rules. The project may serve as an opportunity to further scale disclosure requirements for the various classes of registrants. The SEC is soliciting input on how this financial information is used by investors and what changes would facilitate the disclosure of the most useful information.

In advance of formal rule making, registrants can still take action to make disclosures more effective and streamlined by:

Reducing repetition – Registrants should think before repeating something. For example, MD&A should not simply repeat information, such as critical accounting policies, provided elsewhere. Greater use of hyperlinks and cross referencing where applicable and appropriate can also decrease unnecessary duplication.

Eliminating outdated information – Disclosures should evolve over time. Companies should regularly evaluate their disclosure to determine whether they are material to investors.

Avoiding boilerplate language – Disclosures should be tailored for the entity. For example, risk factors should be less generic and explain how these items would affect the company if they came to pass.


SEC comment letter process

The SEC’s Division of Corporation Finance (CorpFin) has a long history of reviewing selected filings made under the Securities Act of 1933 and the Securities Exchange Act of 1934. The intent of the review is to monitor and enhance compliance with applicable disclosure and accounting requirements.

Until Sarbanes-Oxley, these reviews were periodic and not subject to specific intervals. Section 408 of the Sarbanes-Oxley Act requires the SEC to review those who issue Exchange Act reports no less frequently than once every three years. A significant number of companies are selected more frequently. CorpFin does not publicly disclose the criteria it uses to select companies and filings for review, but Section 408 asks the SEC to consider the following selection criteria:

• Issuers with material restatements of financial results

• Issuers that experience significant volatility in their stock price as compared to other issuers

• Issuers with the largest market capitalization

• Emerging companies with disparities in price to earnings ratios

• Issuers whose operations significantly affect any material sector of the economy

• Any other factors that the SEC may consider relevant

Once a company or filing is selected, the extent of the review may be (1) a full cover-to-cover review, (2) a review of the financial statements and related disclosures (e.g., MD&A), or (3) a targeted review of one or more specific items of disclosure. The identified reviewer concentrates on critical disclosures that appear to conflict with SEC rules or the applicable accounting standards and on disclosure that appears to be materially deficient in explanation or clarity. They evaluate the disclosure from an investor’s perspective and ask questions that an investor might ask when reading the document.

CorpFin performs its reviews through 11 Assistant Director (AD) offices organized based on specialized industry, accounting, and disclosure expertise. Technology company filings are typically reviewed by AD offices No. 3 (Information Technologies and Services) and No. 10 (Electronics and Machinery). An issuer’s AD assignment is shown in EDGAR following the basic company information that precedes the company’s filing history. This organizational structure can sometimes explain why multiple companies in the same industry receive very similar comments around the same time.

Responding to SEC Comment Letters

The SEC staff’s comments are based primarily on a company’s disclosure and other public information, such as information on the company’s website, in press releases, discussed on analysts calls, etc. (nonpublic information, such as whistleblower tips and PCAOB inspection findings, can also be a source of comments). SEC staff comments reflect their understanding of the applicable facts and circumstances. In comments, the SEC staff may request that a company provide supplemental information so the staff can better understand the company’s disclosure, or may ask that the company provide additional or different disclosure in a future filing or change the accounting and the disclosure by filing an amendment.

When responding to the SEC staff, keep these best practices in mind:

• Own the process—Companies should leverage the knowledge and experience of their auditors and SEC counsel, but it’s important to maintain ownership. As with any project, there should be a clear owner and project manager coordinating the input from various sources and developing a response.

• Don’t rush—Companies should evaluate how long they believe it will take to respond. Although the letter from the SEC staff will request a response in 10 business days, it is acceptable for management (usually through a call by counsel to the SEC staff) to request more time if 10 days is not sufficient. A thoughtful and complete response is better than a quick reply.

• Think about future filings—Companies should discuss letters received shortly before it is planning to file a registration statement with its auditors and counsel to determine if there are any implications to the content and timing of the registration statement. Questions about timing can also be discussed with the SEC staff as well as the possibility of an expedited review of the company’s response.

• Ask the SEC staff—Companies can call the SEC staff if they do not understand the comment. The objective should not be for the company to explain their position, but to gain clarification when a comment or aspects of the comment is unclear.

• Remember that comments become public— Comments become part of the public domain once submitted and resolved. Comments and


SEC comment letter process

the related responses are posted to the SEC’s website no earlier than 20 days after the review is completed or the registration statement is declared effective. Even those comment letters related to Emerging Growth Companies that have submitted confidentially are eventually made public. CorpFin will redact any information subject to a Rule 83 confidential treatment request without evaluating the substance of that request.

• Don’t rely solely on precedent—Previous comments and responses of other companies may provide useful information but should not be the primary basis of the response. Each comment is based on specific facts and circumstances and may involve different levels of materiality. Accordingly, the reason the staff accepted a response for one company may not be applicable in another situation. Make sure the response is appropriate based on the company’s specific facts and applicable accounting literature.

• Address the intent of the question—Consider, if possible, the objective of the SEC staff comment. Sometimes providing a complete answer that addresses the intent of the question can stave off future comments.

• Provide planned disclosures—Many comments request additional disclosure in future filings. To ensure there is a meeting of the minds, provide the SEC staff with a draft of the applicable disclosure, even if the data used is from a prior period. This can allow the SEC staff to assess whether the narrative sufficiently addresses their comment and may prevent future comments on the same disclosure.

The company or its representatives should feel free to involve the SEC’s Office of the Chief Accountant (OCA) (distinct from CorpFin’s Office of Chief Accountant) at any stage in this process. Generally, OCA addresses questions concerning the application of GAAP while CorpFin resolves matters concerning the age, form, and content of financial statements required to be included in a filing.

Closing a Filing Review

When a company has resolved all SEC staff comments on an Exchange Act registration statement, a periodic or current report, or a preliminary proxy statement, CorpFin provides the company with a letter to confirm that its review of the filing is complete.

When a company has resolved all SEC staff comments on a Securities Act registration statement, the company may request that the SEC declare the registration statement effective so that it can proceed with the transaction.

A more detailed discussion of the filing review process used by the Division of Corporate Finance can be found on the SEC’s website at:

http://www.sec.gov/divisions/corpfin/cffilingreview.htm




About PwC’s Technology Institute

The Technology Institute is PwC’s global research network that studies the business of technology and the technology of business with the purpose of creating thought leadership that offers both fact-based analysis and experience-based perspectives. Technology Institute insights and viewpoints originate from active collaboration between our professionals across the globe and their first-hand experiences working in and with the Technology industry.

Let’s talk Please reach out to any of our technology leaders to discuss this or other challenges. We’re here to help.

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Acknowledgments

The following PwC professionals contributed their experience and knowledge to produce this paper.

Mila Petrova Partner National Professional Services Group SEC Services 973 236 5601 [email protected] Jeff Womer Partner National Professional Services Group SEC Services 973 236 5360 [email protected] Courtney Blum Senior Manager National Professional Services Group SEC Services 973 236 7726 [email protected] Marti Bruketta Managing Director National Professional Services Group SEC Services 408 817 4428 [email protected]

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