Stay Informed 2013 Technology Sec Comment Letter Trends

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www.pwc.com Stay informed 2013 technology SEC comment letter trends Technology institute December 2013 Highlights of SEC comment letters issued to companies in the technology sector This publication has been prepared for general information on matters of interest only, and does not constitute professional advice on facts and circumstances specific to any person or entity. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication. The information contained in this material was not intended or written to be used, and cannot be used, for purposes of avoiding penalties or sanctions imposed by any government or other regulatory body. PricewaterhouseCoopers LLP, its members, employees, and agents shall not be responsible for any loss 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, 2013. Accordingly, certain aspects of this publication may be superseded as new guidance or interpretations emerge.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. Contents Message from Cory Starr 5 Overview 7 1. Revenue recognition 10 2. Management’s discussion and analysis 14 3. Executive compensation disclosures 19 4. Goodwill and intangible assets 20 5. Income taxes 22 6. Commitments and contingencies 24 7. Segments 26 8. Business combinations 27 9. Other notable trends 28 Acknowledgements 33 About PwC’s Technology Institute 33 Stay informed  | 2013 technology SEC comment letter trends 3 4 PwC Message from Cory Starr To our clients and friends: Year-end is just around the corner and most of you are now preparing for the 2013 reporting season. The economic recovery in the United States and overseas continued at a slow pace over the past year. Changes in the regulatory environment, including recent developments at the SEC, continue to bring about uncertainties and put additional pressures on registrants. High-quality financial reporting, as well as transparency in communicating with investors and other stakeholders, is increasingly important. We are pleased to introduce this publication, which focuses on trends in SEC staff comment letters specific to companies in the technology sector. We have analyzed over 2,000 comments issued from July 1, 2012 to June 30, 2013 to companies in the following subsectors: computers and networking, semiconductors, and software and internet. While some comments are subsector specific, others are applicable to all companies in the technology space. We hope that a better understanding of these trends, along with specific examples of comments, will provide you with helpful insights and aid in your production of high-quality annual reports for investors and other stakeholders. Please don’t hesitate to reach out to your engagement teams and the PwC contacts listed here to discuss this information in more detail. We look forward to working with you in 2014. Best regards, Cory Starr US Technology Assurance Leader Stay informed  | 2013 technology SEC comment letter trends 5 6 PwC Overview Social media, mobile computing, the cloud, the use of Big Data, and other emerging technologies continue to change the way many companies do business. More than ever, companies are connecting with their customers through social media by tapping into their likes and dislikes, creating intimate experiences, rapidly evolving their products and fine-tuning their marketing efforts. And now, social media outlets such as Facebook and Twitter have become new communication platforms for the Securities and Exchange Commission (SEC) to monitor. In April 2013, the SEC announced that companies may use social media to disseminate material information so long as investors are alerted, know where to turn to for the latest news on the company, and are not restricted from accessing such information. This reminds us of nearly half a decade ago, when the SEC concluded that posting important information for investors on company websites was permitted. We may start to see more companies using social media to engage with their investors in the same way they have been using social media to connect with their customers. There is no denying it: The volume of information that is readily available is exploding. Analyzing Big Data is extremely important for companies to remain competitive and, for technology companies, this means using Big Data to benefit from the ability to quickly analyze sales and customer reactions and to identify patterns and trends to successfully deliver on customer needs. Big Data is the combination of inputs from unstructured social media and input from structured sources of information, such as a company’s sales results, that together provide a comprehensive flow of information from which entities derive value.1 Analyzing Big Data is not only important to companies; recently, the SEC noted that they are leveraging technology to identify fraudulent activities, such as insider trading or other unusual securities transactions. The SEC staff have also embraced the Big Data phenomenon by introducing the Accounting Quality Model (AQM), a new software tool that is currently in development and is based on econometric regression. Using AQM, the SEC staff will be able to identify inconsistencies and anomalies, and otherwise filter the enormous amount of information, and many years of past enforcement data, which would allow them to target accounting practices and disclosures that have a higher risk of noncompliance. We also see business leaders recognizing the powerful use of the cloud to lower IT costs and reduce infrastructure complexities within the organization to drive overall business growth and flexibility. Cloud computing has evolved from experimental to mainstream. Adoption of the cloud is expected to skyrocket during this decade: Forrester Research forecasts that the global market for cloud computing services will soar from $40.7 billion in 2011 to more than $241 billion in 2020. We have seen tremendous growth in the software-as-a-service (SaaS) business model in the technology industry, and that has attracted its share of revenue recognition comments from the staff. Virtually all companies are at risk of cyberattacks. With the widespread use of social media, collection and use of data, and storing information in the cloud, threats to data security and privacy are more significant than ever and need to be managed responsibly. Many big-name companies have made headlines after experiencing potentially severe breaches, and hackers have moved the stock markets by billions of dollars in just minutes, putting companies at risk for both financial and reputational damage. Investors must be informed of the relevant risk factors and whether companies have the proper infrastructure in place to tackle these business risks. 1.  PwC, Technology Institute, “The new digital ecosystem reality: nine trends rewriting the rules of business,” September 2013. Stay informed  | 2013 technology SEC comment letter trends 7 Figure 2. Volume of comments by subsector Lastly, the conflict minerals rule, mandated by the DoddFrank Act, is something that companies should be preparing for now. Most registrants will need to file their first Form SD by May 31, 2014, less than six months from now. Given the potentially extensive reporting requirements, most companies will need a considerable amount of time to gather the necessary data to fully comply with the rule. Some may view the rule as a compliance exercise, while others may view it as an opportunity to strengthen their supply chains and brands.2 Figure 1. Overall volume of comments 1,639 2012 2,079 2013 Our review of the most recent comment letter trends for technology companies, as presented in this publication, indicates a continued focus in the areas of revenue recognition (multiple element arrangements and software continue to dominate this area, but online gaming has become a frequent topic), income taxes, impairment of goodwill, and commitments and contingencies. The SEC staff continue to give considerable attention to executive compensation disclosures and recently issued a proposal on CEO pay-ratio disclosures. We also continue to see inquiries from the staff into companies that maintain a one-segment reporting structure, and those that aggregate operating segments into reportable segments. For management’s discussion and analysis, the usual suspects include providing the “whys” behind the results of operations, more transparent and robust liquidity disclosures that move away from simply repeating the activities from the cash flow statement, and giving greater prominence to the equivalent GAAP measures when using non-GAAP measures. Computers and networking Semiconductors 2012 2013 484 251 365 1,159 1,230 Software and internet While the absolute number of comments grew considerably, this increase seems to be driven mainly by the number of companies reviewed (see Figure 4). When analyzing the average number of comments by registrant, we observed an overall decrease, which was consistent among all subsectors other than computers and networking (see Figure 3). Figure 3. Average number of comments by subsector 2012 2013 8 5 Computers and networking 10 9 9 9 6 Semiconductors Software and internet 8 Overall Figure 4. Number of companies reviewed 111 Software and internet 2012 44 Computers and networking 183 28 Semiconductors 2013 saw a 27% increase in SEC comments received by technology companies (see Figure 1). Each subsector experienced an increase in the absolute number of comments received, with computers and networking showing the largest increase (see Figure 2). 229 130 Software and internet 2013 64 Computers and networking 254 60 Semiconductors 2.  PwC, “10Minutes on conflict minerals,” May 2013. 8 PwC As shown in Figure 5 below, the main areas of focus by the staff did not change significantly from 2012 to 2013. On the following pages, we dive deeper into each of the key trends. Figure 5. Comments by topic Management’s discussion and analysis 2012 2013 Revenue recognition Executive compensation disclosures Methodology This comment letter trends study was based on an analysis of comments posted on the SEC’s EDGAR website from July 1, 2012 to June 30, 2013 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. For comparative purposes, we have also analyzed comments posted on the SEC’s EDGAR website from July 1, 2011 to June 30, 2012. Each subsector includes the following SIC codes: • Software and internet—7370, 7371, 7372, 7373, 7374, and 7389 Goodwill and intangible assets • Computers and networking—3570, 3571, 3572, 3576, 3577, 3578, 3661, 3663, 3669, 3812, 3825, 3861, 4899, 5045, and 5065 Income taxes • Semiconductors—3670, 3672, 3674, and 3679 Commitments and contingencies Certain registrants may be involved in multiple technology subsectors. For consistency of evaluation, the analysis was based solely on the SIC codes indicated on the SEC’s EDGAR website for each registrant and the aforementioned allocations. Segments Business combinations Other notable trends 0 200 400 600 Stay informed  | 2013 technology SEC comment letter trends 9 1. Revenue recognition Revenue recognition in the technology sector can be quite complex. During the past year, revenue recognitionrelated comments accounted for 9% of all comments received. We have summarized the main trends below. Multiple-element arrangements Technology companies often provide multiple products or services to their customers as part of a single arrangement. These deliverables may include software, hardware and services; can be delivered upfront or over a period of time; and may be labeled “free.” It can sometimes be challenging to determine the most appropriate technical guidance to apply, given the complexities of the arrangements. New guidance for arrangements with multiple deliverables became effective for arrangements entered into or modified in fiscal years beginning on or after June 15, 2010. Under this guidance, a company is required to allocate arrangement consideration among deliverables using its best estimate of selling price (BESP) when vendor-specific objective evidence (VSOE) or third-party evidence (TPE) of the selling price is not available. Allocating arrangement consideration using the residual method is no longer permitted. 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. We note that you offer a vast array of products and business services to your clients. Tell us your consideration of disclosing whether the significant deliverables in your arrangements qualify as separate units of accounting, and the reasons that they do not qualify as separate units of accounting, if applicable. In addition, your disclosures should discuss the significant factors, inputs, 1 10 PwC assumptions and methods used to determine the selling price (whether vendor-specific objective evidence, third-party evidence, or estimated selling price) of the significant deliverables. We refer you to the guidance in ASC 605-25-50-2. Please describe how you account for optional services when these services are included in a multiple element arrangement. In this regard, tell us whether these services are separable from the other elements of your arrangement and if so, describe how you considered ASC 605-25-30-2. Also, please tell us what consideration you gave to revising your disclosure in future filings to describe your accounting for arrangements that include optional services. 2 Your disclosure regarding multiple-element arrangements addresses determination of selling price for maintenance and support, but it does not clearly address determination of selling price for product sales or other services such as installation and training. Please tell us what consideration was given to providing a discussion of the significant factors, inputs, assumptions, and methods used to determine selling price (whether vendor-specific objective evidence, third-party evidence, or estimated selling price) for all significant deliverables. Please refer to ASC 605-25-50-2. 3 Your disclosure indicates that you recognize the entire consideration associated with your multiple element arrangements ratably over the term of the related agreement or the customer life. Please provide additional details regarding the types of arrangements that result in recognition over the customer life rather than the term of the agreement and how you estimate customer life. 4 We note that you determine vendor-specific objective evidence (VSOE) of fair value of your professional services based upon average standalone selling price for those services. Please provide additional details regarding your analysis including how average standalone selling price impacts your analysis, the volume and range of standalone sales used to establish VSOE and how you account for standalone sales that are outside of your range. 5 We further note that you determine VSOE of fair value of your core services based upon the overage rate. Please tell us how you concluded that the overage rates were substantive. In this regard, describe the volume and range of standalone sales used to establish VSOE, whether your customers consistently purchase one unit of service based on the contractual overage rates and whether the overage rates are consistent with the rates used to establish the monthly, quarterly or annual commitments in the contracts. We note that you have vendor-specific objective evidence (VSOE) of fair value of your core services based upon the overage rate. However, we further note that the unit price charged for your core services on a standalone basis, presumably your overage rate, can fluctuate significantly due to volume and geography. Given your statement that consistent pricing of standalone transactions cannot be used to determine fair value, please tell us how you concluded that your overage rates were substantive. 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 Accounting Standards Codification (ASC) 985-605, Software-Revenue Recognition. The FASB’s updated guidance in Accounting Standards Update (ASU) 2009-14 impacted how companies account for arrangements that include software elements. 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. Please tell us more about your arrangements that include hardware including the nature of the hardware sold and how your software functions with the hardware. In this regard, please tell us whether these arrangements include software that is more-than-incidental to the hardware. See Accounting Standards Update No. 2009-14. To the extent you have such arrangements, please tell us how you account for these arrangements and how your current disclosures address these arrangements. 6 VSOE: For arrangements determined to fall under software revenue recognition guidance, registrants must use VSOE to allocate the consideration among the multiple elements in an arrangement. The staff frequently challenge companies about how they are able to determine VSOE and will request enhanced disclosure to that effect in the financial statements. With respect to your multi-element software arrangements, please tell us whether you have established vendor-specific objective evidence (VSOE) of fair value for each element. To the extent applicable, please describe, in detail, your methodology for establishing VSOE of maintenance and professional services. If VSOE of maintenance is based on stated renewal rates, 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 renews at such rates. Alternatively, if VSOE is based on stand-alone sales, provide the volume and range of standalone sales used to establish VSOE. We further note that you offer two levels of support. Please tell us how the pricing of any premium support affects the allocation of revenue in your multiple-element arrangements. 7 Stay informed  | 2013 technology SEC comment letter trends 11 (SaaS): Software-as-a-service arrangements, where the company hosts software for customers instead of selling term licenses, are becoming increasingly popular in the software space. The distinguishing characteristic of SaaS arrangements is the customer’s inability to take possession of the software. The staff have raised questions about whether revenue should be recognized upfront or over a period of time. In the latter case, comments focus on the appropriate period: the term of the contract or the estimated term of the customer relationship more broadly. We note your disclosure describes your hosting services. Please describe your accounting policy and provide additional details regarding your hosting arrangements including whether your customers have the right to take possession of the software. Refer to ASC 985-605-55-119 through 125. We further note that your multiple element arrangements may include hosting services as well as professional services, which may include implementation services. Please also describe your accounting policy for arrangements that include both hosting services and implementation services. 8 Revenue recognition in a virtual environment Online gaming has been a rapidly growing segment of the technology industry. In the past, game developers mostly sold term licenses to game software. That trend is changing, as more and more games are being played online in a hosted software environment. The revenue recognition models registrants are using are changing as well. One of the key challenges in this area is accounting for virtual goods and virtual currency, which was highlighted by the SEC staff during the 2012 AICPA National Conference on Current SEC and PCAOB Developments. The staff emphasized that they expect companies to provide clear and transparent disclosure about their accounting policies for recognizing revenue from the sale of virtual goods, including critical assumptions used. Companies should be clear about whether they recognize revenue from the sale of virtual goods (for example, premium features) and currency over the life of the virtual goods, the average life of the gamer, or the term of the game itself, and how the chosen term best reflects the consumption of the virtual benefit. Additionally, the staff have asked registrants to more clearly disclose the nature of premium features and how these features are being consumed by the gamers. Another area of frequent comment is the accounting for unused prepaid cards and online points, especially in situations where the registrant is a platform provider and no longer has the game license. 12 PwC Your disclosures indicate that you recognize revenue from the sale of virtual currency and other virtual items ratably over the estimated average playing period of paying users. Please clarify the significant assumptions and judgments that you consider in determining the estimated average playing period. Tell us the average playing period of paying players for each period presented. Explain whether there have been any changes made to the estimated average playing period. In addition, describe the estimates and assumptions that you consider in differentiating between revenues attributable to durable and consumable virtual goods. 9 10 Please describe the nature of the premium features referenced in this note. In this regard, tell us and disclose in future filings whether these features are virtual services, “consumable” virtual items and the “permanent” virtual items discussed in your critical accounting policy. For virtual services and consumable virtual items, please tell us if the consumed items provide any ongoing effects, or provide users with any ongoing benefits, after being consumed, and how you considered these factors in determining the timing of revenue recognition for these items; tell us the amount of online game revenue generated from: 1) virtual services, 2) consumable virtual items, and 3) permanent virtual items for each period presented, and what consideration you have given to disclosing these amounts; and tell us the weighted average life of for your permanent virtual items, and what consideration you have given to disclosing this life, including any changes in the estimated life and the impact on revenue for all periods presented. 11 We note from your current disclosures that revenue from prepaid game cards and prepaid online points applicable to your online game services are recognized over the estimated life of the premium features or as the premium features are consumed. Please tell us how you account for un-activated game cards or unused online points. As applicable, describe the methodologies and assumptions used to determine breakage and when you recognize such revenues. Also, tell us the amount of breakage recognized from your online game services for each of the periods presented and if material, tell us your consideration to disclose your accounting for such revenues. Other trends related to revenue recognition Reseller arrangements: In addition to selling directly to end customers, registrants also sell their products through resellers, distributors, and channel partners. Such arrangements are typical for semiconductor companies that sell their products not only to original equipment manufacturers (OEMs) but also to electronic contract manufacturers (ECMs) and distributors. Revenue may be recognized either upon the initial sale (“sell-in” model) or it may be deferred until the distributor resells the product to the end customer (“sell-through” model). The decision to use the “sell-in” model or the “sell-through” model depends on whether the selling price is fixed or determinable at the time of sale and whether collectability is reasonably assured. “Sell-in” arrangements typically include no or very limited price adjustments and price protection. Under “sellthrough” arrangements, on the other hand, companies allow for significant return rights, price protection, and adjustments subsequent to the initial product shipment. As semiconductor companies face rapid product obsolescence and declining prices over the product life cycle, returns and pricing adjustment uncertainties increase, making it more challenging for companies to produce reliable estimates. In their comments, the staff have requested registrants to disclose material arrangements with resellers, including the nature and extent of return rights and price protection privileges, and how these arrangements impact companies’ revenue recognition policies. 12 Please help us understand the timing of revenue recognition and the related incentives for sales to and by your third-party affiliates and independent dealers. In that regard, please provide us the following information: the timing of recording equipment revenue from the sale of devices to third-party affiliates; a summary of any incentives, such as point-of-sale discounts and dealer commissions, you provide the affiliate associated with the device or related service contract and whether the incentive is related to the sale of the device or service contract; the impact of each incentive on revenue recognition timing; the basis for determining when an incentive is offered; the timing of recognizing the cost of each incentive associated with the devices and the service contracts; whether the company is able to reasonably estimate the cost of the incentive at the time of the company’s sale to the affiliate; and the basis in U.S. GAAP underlying your policy. To the extent equipment revenue and the related incentives are not recorded in the same period, please provide your basis in U.S. GAAP for your policy. Gross vs. net: Companies 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, companies should determine whether to present revenue on the gross or net basis, which requires analysis of the arrangement using criteria listed 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. Staff comments frequently request 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. 13 We note your disclosure that revenues from sale of IT equipment to end users are recorded on net basis because the Company is not a primary obligor, does not take inventory risk and does not have latitude to establish pricing or supplier selection with respect to IT equipment and software delivered to end users pursuant to the guidance in ASC 605-45. We also note your disclosure that the cost of revenues for system integration consists of third-party hardware and software purchased for your clients. Based on this disclosure, it appears that you are recording third-party hardware and software sales for system integration on a gross basis. Clarify whether you recognize revenue for sales of third-party hardware and software under your system integration arrangements on a gross or net basis and provide the reasons for your conclusions. In your response, tell us how you considered each of the factors presented in paragraphs 3-18 in ASC 605-45 in determining your revenue recognition policy for these arrangements. 14 You disclose that revenue for digital marketing media sales is recorded based on the gross amount billed to the client as revenue when key indicators suggest the company acts as a principal. Please update us as to the amount of revenue recognized on a gross basis for digital marketing media sales for each period presented, if any. To the extent revenue recognized on a gross basis is material, please explain how you considered each of the factors presented in ASC 605-45 and determined that gross accounting was appropriate. Stay informed  | 2013 technology SEC comment letter trends 13 2. Management’s discussion and analysis Management’s discussion and analysis (MD&A) of financial condition and results of operations is a critical component of registrants’ communications with investors. Its primary objectives are to enable investors to see the company “through the eyes of management,” to provide context in which financial information should be analyzed, and to provide information about the quality and variability of a company’s earnings and cash flows. Required disclosures are set forth in Item 303 of Regulation S-K and include a discussion of the registrant’s results of operations, liquidity, capital resources, off-balance sheet arrangements and contractual obligations. The SEC states in its interpretive guidance that it is seeking to “elicit MD&A that not only meets the technical disclosure requirements but generally is informative and transparent,” adding that “[the analysis] should not consist of generic or boilerplate disclosure, but rather should reflect facts and circumstances specific to each individual registrant.” Therefore, staff comments on MD&A are often not a matter of compliance or non-compliance with the rules, but rather suggestions to improve the clarity and transparency of disclosures. Among all topics addressed in comment letters, MD&A continues to be the most common, representing 24% of all comments made by the staff to technology companies during the past year. MD&A comments break down into the areas shown in Figure 6. Results of operations One of the general themes in MD&A comments is to not simply repeat information contained in the financial statements or elsewhere in the filing, but to provide an analysis of the financial results for the period and the “whys” behind the fluctuations. Discussing known trends and key metrics: The staff has consistently asked registrants to disclose known trends affecting the business. Examples include loss of a customer, 14 PwC Figure 6. Breakdown of MD&A comments by area, % 2012 Results of operations 46 Liquidity and capital resources 28 Non-GAAP measures 11 Critical accounting policies 11 Other 4 2013 50 26 17 3 3 development of new software which might increase future revenues or reduce costs, entering a new market, or an acquisition that is expected to impact operating results. 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. We note your disclosure of your long term strategic plan. To the extent this plan represents a known trend, please provide us with additional details about its expected impact on your results. For example, we note from your earnings call that you plan to decrease your focus on traditional subsidy markets, including rooftop applications and that you intend to focus on utility-scale solar plants. Please also confirm that in future filings, you will include such disclosure. 1 We note your disclosures where you indicate that due to consolidations in the advertising industry, the bigger agencies may demand larger sales rebates in the future, which could reduce the Company’s revenue growth. Considering the significance of the rebates to total advertising revenue, tell us 2 how you considered including a discussion in your Operating Results disclosures with regards to these pricing adjustments and the effects they have had on your revenues for each period presented. In this regard, it appears that your current disclosures do not provide investors much insight into the trends and uncertainties of these rebates and their impact on your revenues. We refer you to SEC Release 33-8350. Please describe further the key metrics that impact your business. In this regard, tell us your consideration to disclose, for example, the average number of users, the number of paying players, the average revenue per player, and/or the average period that a player typically plays the game and include a discussion that correlates these metrics to changes in your results of operations. It appears that this would be important information to the users of your financial statements since users are a critical component of your business. In addition, please clarify whether there are any other operational statistics and usage patterns monitored by the company which affect your results of operations. We refer you to Section III.B of SEC Release 33-8350 for guidance. 3 Fluctuation drivers: Many comments seek to improve companies’ description of fluctuations, including quantifying the impact of changes due to price, volume, acquisitions and exchange rates, among others. The staff has asked companies to describe the specific factors driving such changes, and to quantify each factor separately, even if they net down to an insignificant change overall. provide investors with a quantified analysis and sufficient insight into the reasons for changes in your results, as discussed in section III.B.4 of SEC Interpretive Release No. 33-8350. Please revise future filings to provide a clear and quantified discussion of the underlying material factors that impacted your results of operations for the periods presented in this Form 10-K. Provide us with a sample of your proposed revised disclosure. Refer to Item 303(A)(3) of Regulation S-K. Consistency of information: The SEC often reviews other 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 or the company’s website, the staff have raised questions about why such events are not also addressed in the MD&A. For example, if in an earnings release management talked about their efforts to create a best-selling web game or plans to explore growth opportunities in the mobile game sector, these events and their impact on future results are expected to be disclosed in the MD&A. The transcript of your earnings conference call for the third quarter of 2012 mentions that “there are often quarterly fluctuations in geographic performance.” With a view to material disclosure in your next Form 10-K filing, please tell us whether your business is seasonal and if it is, what consideration you gave to providing the disclosure required by Item 101(c)(1)(v) of Regulation S-K. 5 Further to the above, we note throughout your management’s discussion and analysis that you attribute changes in your revenue to (i) the acquisition of ABC Corporation, (ii) volume changes and (iii) pricing changes. These explanations appear to be overly general and do not 4 Stay informed  | 2013 technology SEC comment letter trends 15 Liquidity and capital resources In the current environment of economic uncertainty in the United States and worldwide, it is not surprising that the SEC staff frequently focus their review and comments on liquidity disclosures. The staff expect registrants to provide transparent and robust discussion of liquidity and capital resources to enable investors to understand the company’s ability to generate cash and to meet its obligations as they come due. Disclosure of events impacting liquidity: The staff have 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, treasury stock repurchase programs, or plans for significant capital expenditures. You state that you expect to spend approximately $60.3 million for new and existing facility expansion, new hardware and software. We note from your fourth quarter earnings call that your board has approved $150 million capital outlay over three years, which will be used for a residential training facility. Tell us whether you considered discussing this capital outlay in your liquidity and capital resources discussion. Also, consider providing quantitative data regarding this capital outlay. 6 Debt agreements and related covenants: Comments from the 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 “close call” with regard to covenant compliance, registrants should provide a detailed description of the covenants, actual values for the most recent reporting period, and some level of sensitivity of the key financial components. We note that your credit facility and the Notes Purchase Agreement contain financial covenants. Please revise future filings to present, for your most significant and restrictive covenants, actual ratios and other actual amounts versus the minimum/maximum ratios/amounts permitted as of each reporting date. Such a presentation may allow investors to more easily understand your current status and future ability to meet your covenants. See Sections I.D and IV.C of the SEC Interpretive Release No. 33-8350. 7 Stranded cash: For companies with foreign operations, the staff have focused on the registrant’s ability to repatriate cash back to the United States in order to meet significant upcoming obligations, such as debt repayments or mandatory pension contributions. Comments focus on the relationship between liquidity needs and the permanent 16 PwC reinvestment assertion that registrants may have made, which results in no deferred income tax liability provided on foreign earnings. The staff have also asked companies to quantify the amount of cash held overseas and the amount of incremental deferred tax, if any, if cash were to be repatriated. If it is not practicable to determine the amount of deferred tax liability, disclosure of the reasons for such conclusion is required. We note that a significant amount of your revenues and pre-tax income are from subsidiaries outside of the U.S. Please tell us what consideration you have given to disclosing the amount of cash and cash equivalents that are currently held outside of the U.S. and the impact of repatriating the undistributed earnings of foreign subsidiaries. In this regard, we note that this disclosure would illustrate that some cash is not presently available to fund domestic operations and obligations without paying taxes upon their repatriation. Please refer to Item 303(a)(1) of Regulation S-K and Section IV of SEC Release 33-8350. 8 Cash flow analysis: One of the common deficiencies in the liquidity analysis is to simply repeat the information presented on the face of the statement of cash flows. Instead, registrants need to disclose the underlying factors driving the changes in operating, investing and financing cash flows of the company. Please refer to your disclosure regarding the net cash provided by operating activities for the last three fiscal years. We note that your analysis of these cash flows primarily consists of quantification of net income, quantification of certain non-cash expenses, and quantification of the net change in operating assets and liabilities for each of the respective years. However, you have not provided any further analysis of the factors contributing to and/or reasons for the material changes in the reported net cash provided by operating activities. In this regard, we believe that you should expand your disclosure to cite, quantify, and analyze the specific items and/or factors that have contributed thereto. Please note that references to (A) your results of operations recorded on an accrual basis and (B) the changes in specific working capital line items presented on your balance sheets may not provide a sufficient basis for a reader to analyze the change in the amount of cash provided by or used in operating activities. Therefore, please consider whether it would be appropriate to accompany any such references that may be included in your expanded disclosure with additional narrative disclosure that explains the reasons therefor. For example, for purposes of your comparative analysis of cash provided by operating activities for the last two fiscal years, we believe that it would be appropriate for you to discuss (a) the timing and nature of cash receipts that resulted in the 9 recognition of a significant deferred revenue balance at the earlier year-end, (b) the subsequent recognition of the deferred amounts as revenue, (c) the reasons why a significantly smaller deferred revenue balance was reported at the following year-end, and (d) the underlying reasons for any material differences between the timing of cash receipts and subsequent recognition for the comparable periods. For further guidance, please refer to Section IV.B.1 of “Interpretation: Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which is available on our website at http://www.sec.gov/rules/interp/33-8350.htm. Please provide your proposed expanded disclosure as part of your response. Non-GAAP measures Registrants often present certain quantitative measures of past performance, financial position, or cash flows that make various adjustments (inclusions or exclusions) to GAAP measures reported in the financial statements. Some of the non-GAAP measures frequently used by technology companies in their earnings releases or periodic filings with the SEC include EBITDA; adjusted EBITDA (commonly reflecting the elimination of stockbased compensation expense, which is typically high for companies in this sector); adjusted revenue (eliminating acquisition accounting adjustments related to deferred revenue); or free cash flow (often defined as operating cash flow less capital expenditures). It is important to keep in mind that these non-GAAP measures are not standard or prescribed by US GAAP and may differ considerably from one company to the next. Such non-GAAP financial measures are permitted to be included in press releases, periodic filings, and registration statements, as long as they meet the requirements set out in Regulation G and Item 10(e) of Regulation S-K. While the comments have decreased over the years, we continue to see them in the following areas: Identification and reconciliation: The staff have commented when non-GAAP financial measures have not been clearly labeled as such or have not been clearly reconciled to the most directly comparable GAAP measure. Registrants should disclose why the non-GAAP measure is useful to investors and detail the adjustments made to the comparable GAAP measure. They should not label adjustments as non-recurring, infrequent, or unusual when similar events and transactions have occurred in the past or are reasonably likely to occur in the future. Similarly, the staff question when issuers call adjustments “non-cash” if the underlying obligations may have to be settled in cash in the future, or when they remove cash items from liquidityrelated non-GAAP measures. 10 We note the disclosure at the top of the first page of your press release of net income and diluted earnings per share excluding impairment and other one-time charges. Please be advised these are non-GAAP measures and must comply with Item 10(e) of Regulation S-K. If you wish to present these measures in future filings, please identify these measures as non-GAAP measures, provide a reconciliation to the most comparable GAAP measure, disclose the reasons why you believe these non-GAAP measures provide useful information to investors and, if applicable, disclose how management uses these non-GAAP measures. Furthermore, please be advised that any per share non-GAAP performance measures should be reconciled to GAAP earnings per share. 9 11 We note that you refer to the non-GAAP adjustments for lease termination and contingent consideration as “non-recurring.” Tell us how you considered the guidance in Item 10(e)(1)(ii)(B) of Regulation S-K when referring to these charges as non-recurring. In this regard, to the extent it is reasonably likely you may incur similar charges in the next two years, referring to such charges as non-recurring, infrequent or unusual may not be appropriate. Please tell us how your current disclosure complies with this guidance or tell us how you intend to revise your disclosures in future filings. In addition, it is unclear how your current proposed Stay informed  | 2013 technology SEC comment letter trends 17 disclosures describe that management uses this non-GAAP information for internal budgeting and forecasting purposes. Please revise to include this information in future filings pursuant to Item 10(e)(1)(i)(D) of Regulation S-K. Undue prominence: The staff have commented consistently when non-GAAP measures are presented more prominently than the directly comparable GAAP measures in MD&A or in earnings releases. They also object to the inclusion of a full non-GAAP statement of operations. 12 We believe that your earnings release gives undue prominence to the presentation and discussion of non-GAAP measures. For instance, we note your references to Modified EBITDA in the introduction of the earnings release without references to the corresponding comparable GAAP measures. In addition, we note that you give undue prominence to the presentation and discussion of the nonGAAP measure throughout the earnings release. Accordingly, we believe that you should revise future earnings releases to comply with the reporting requirements of Item 10(e) of Regulation S-K. Refer to Instruction 2 to Item 2-02 of Form 8-K in this regard. 13 It appears that you are presenting the non-GAAP information and the related reconciliation required by S-K Item 10(e) in the form of an “adjusted” income statement. Please tell us how your presentation considers the guidance set forth in Compliance and Disclosure Interpretation 102.10. Under the cited guidance, it is generally not appropriate to present a non-GAAP income statement for purposes of reconciling non-GAAP measures to the most directly comparable GAAP measures. Other MD&A comment trends: Critical accounting estimates: Technology companies use many estimates in the areas of revenue recognition (particularly when a company enters into multiple-element arrangements and allocates the arrangement consideration using the best estimate of selling price); estimated useful lives of tangible and intangible assets; fair values; and asset impairments. Those estimates that are subject to a higher degree of uncertainty and have the potential to impact materially the registrant’s financial position and results of operations must be disclosed and discussed by management in MD&A. The staff often request that companies provide more transparency with respect to how such estimates are determined, including key assumptions and their volatility and what impact changes to the estimates will have on the financial statements. Comments often remind registrants to avoid merely repeating accounting policy disclosures that are included in the notes to the financial statements. 18 PwC 14 We note that network plant and equipment are depreciated over various lives from 3 to 50 years, with a weighted average life of approximately 11 years. Given the significance of your network plant and equipment, please consider expanding your disclosure to show the carrying amount of each significant category or type of network plant and equipment and the estimated useful life. Also describe the method you used to estimate the useful life and the uncertainties associated with the assumptions, or levels of judgment utilized in the estimate. Please clarify why you believe it is appropriate to use a life of more than 20 years for some of these assets. 15 You include discussion of allowance for system removal within the significant accounting policy section of your footnotes, but you state that no allowance has been established as of year-end, despite your growing number of installed units. Please explain why you have not established an allowance. Include discussion of any contractual obligations with regard to removal of your systems. Contractual obligations: Registrants must disclose their known future contractual obligations as of the end of the year. The disclosure is tabular and is meant to provide a snapshot of the registrant’s committed future cash requirements. When uncertainty exists as to the timing of payments resulting from an obligation, companies should disclose that information in the footnotes to the table. The staff are primarily focused on ensuring the completeness of the disclosure. Items most often omitted include future interest payments, payments relating to unrecognized tax benefits, and contingent purchase consideration. 16 Please tell us what consideration was given to including contingent consideration obligations and unrecognized tax benefits within your contractual obligations table or in an accompanying note. Please refer to Section IV.A of SEC Release 33-8350 and footnote 46 thereto. For additional guidance, please see Section C of SEC Release 33-9144. 3. Executive compensation disclosures Item 402 of Regulation S-K requires extensive disclosures on executive compensation for 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 staff have required registrants to disclose the specific performance targets and thresholds that employees must achieve in order to earn their compensation awards. Many registrants have claimed “competitive harm” if such disclosures are made; however, the staff remain skeptical, especially when such information is based on actual company results and the performance target is disclosed after the fiscal year has ended. In your letter you committed to disclose the relevant performance targets and threshold levels applicable to your incentive program, so long as doing so would not cause competitive harm. Please explain why you chose not to disclose the performance targets and threshold levels applicable to the awards granted during the fiscal year. If you omitted this information because you believe disclosure would cause competitive harm, provide in your response letter a detailed analysis to support that conclusion for each material performance measure. Please note that we generally do not agree with the argument that disclosing a performance target for the last fiscal year would cause a registrant competitive harm when disclosure of the performance target will occur after the fiscal year has ended and the target is a measurement based on actual company results that have been disclosed. In the alternative, confirm that you will disclose your material performance targets and thresholds going forward, indicating which material performance targets you intend to disclose for executive compensation. For guidance, please refer to Question 118.04 of the Division of Corporation Finance’s Compliance and Disclosure Interpretations of Regulation S-K, available on our website at http://www.sec.gov/divisions/ corpfin/cfguidance.shtml. 1 When registrants benchmark their executive compensation against other companies, the SEC staff regularly ask them to disclose the specific peer companies used for benchmarking purposes, specify how the peer group was established, how the pay for named executive officers compared with the established benchmarks and provide an explanation if actual compensation differs from the targeted percentiles. You state the size of the peer group varied for each of your executive officer positions. In order to provide readers with a clearer understanding of the role the comparative companies played in the executive compensation decisionmaking process, in your response letter identify the specific peer group companies used in setting the compensation of each of the named executive officers. To the extent you use different peer groups for different named executive officers, it appears that in future filings you should identify the constituents of each group together with the officer(s) whose compensation was evaluated with respect to the particular group. In addition, you should consider informing readers of the factors considered in deciding which companies to include in the peer group for each executive officer position. 2 Stay informed  | 2013 technology SEC comment letter trends 19 4. Goodwill and intangible assets It has been more than a year since GAAP was revised to allow entities to evaluate qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill test. Registrants are not required to calculate fair value of a reporting unit unless, based on the qualitative assessment, it is more likely than not that its fair value is less than its carrying value. Financial reporting of goodwill impairment already involves considerable judgment, given the amount of estimation and assumptions necessary to determine whether a reporting unit has been impaired. The qualitative assessment may require registrants to apply even more judgment and the SEC staff have issued a number of comment letters specifically asking registrants to expand their disclosures of the qualitative factors considered in assessing impairment. The same also goes for indefinite-lived intangible assets. When registrants are using the qualitative assessment option in the new standard for testing indefinite-lived intangible assets for impairment, the staff have requested information about the factors considered in arriving at the conclusion that it is not more likely than not that the asset is impaired. For reporting units that are “at risk” of failing step one of the goodwill impairment test, the staff have requested registrants to include significant expanded disclosures: the percentage by which fair value exceeds carrying value as of the date of the most recent test, the amount of goodwill allocated to the reporting unit, and a qualitative discussion of assumptions used to determine fair value, including the inherent uncertainties and potential events and circumstances that could have a negative effect on the reporting unit’s fair value. If a reporting unit is at risk of failing step one of the impairment test and a material impairment charge could occur, please disclose the following: The percentage by which fair value exceeded carrying value as of the date of the most recent test; The amount of goodwill allocated to the reporting 1 20 PwC unit; A description of the methods and key assumptions used and how the key assumptions were determined; A discussion of the degree of uncertainty associated with the key assumptions. The discussion regarding uncertainty should provide specifics to the extent possible (e.g., the valuation model assumes recovery from a business downturn within a defined period of time); and A description of potential events and/or changes in circumstances that could reasonably be expected to negatively affect the key assumptions. The staff frequently challenge the timing of impairment charges related to goodwill and indefinite-lived intangible assets, particularly when they result from the annual impairment test but factors and conditions may have existed at an earlier time. A depressed stock price for an extended period of time, a sustained decline in revenues and operating income are just a few examples of situations where the staff have challenged registrants on why they did not conclude there were triggering events requiring an interim impairment assessment. We note that you adopted the guidance in ASC 2011-08 for your annual goodwill impairment test. Please confirm that the company determined it was not more likely than not that the fair values were less than the carrying values for each reporting unit and tell us your consideration to include this disclosure in future filings. Also, please consider expanding your disclosures in future filings to include a more comprehensive discussion regarding the qualitative factors considered in assessing your goodwill for impairment. 2 It appears that you did not perform a two-step impairment test for the period ended September 30. While we note that the company generated positive net income and completed a joint venture during this period, we also note that the decline in your market capitalization was not short-term and has continued subsequent to September 30. As there are several indicators listed in ASC 350-20-35-3C that appear to be applicable to the company and considering the decline in your market capitalization appears to be other-than-temporary, please further explain how you concluded from your qualitative assessment that it was not more likely than not that the fair value of your three reporting units was less than their carrying amount as of September 30. 3 We note that during the second quarter you performed an interim goodwill impairment test as a result of your continued depressed stock price and your market capitalization relative to net book value. Please tell us whether your reporting unit had an estimated fair value that was not substantially in excess of the carrying value and was at potential risk of failing step-one of your goodwill impairment analysis and provide the percentage by which fair value exceeded carrying value. We further note that your annual goodwill impairment test completed in October appeared to rely solely on a qualitative analysis. If you concluded that the fair value of the reporting unit was not substantially in excess of the carrying value and was at potential risk of failing step-one please tell us how you concluded that it was appropriate to only perform a qualitative analysis in October. 4 Registrants need to support their initial conclusions regarding the estimated useful lives of intangible assets using relevant factors, such as the expected use of the asset by the entity; legal, regulatory or contractual provisions; obsolescence, competition and other economic indicators, among others. Companies need to re-evaluate such estimates on an ongoing basis. We have seen a number of comments from the staff questioning management’s estimates of useful lives, particularly in the case of indefinite-lived assets, as well as registrants’ processes for periodically updating these estimates. We note that your balance of indefinite-lived intangible assets consists of trademarks and domain names. We have the following comments: Please provide us a detailed listing of your indefinite-lived intangible assets as of the year-end balance sheet period. Please tell us why you believe these assets are indefinite-lived. Refer to ASC 350-30-35-4 through 35-5 and 350-30-55. For each indefinite-lived intangible asset, please describe to us in detail your process for evaluating the remaining useful life in each reporting period after the acquisitions to determine whether events and circumstances continue to support an indefinite useful life. Refer to ASC 350-30-35-16. 5 We note that you have an amortization period of 2-15 years for customer relationships and a 15-25 year amortization period for long-term service contracts. Please tell how you determined these useful lives and why you believe they are appropriate. In doing so, please provide your analysis of the factors in ASC 350-30-35-3. 6 Stay informed  | 2013 technology SEC comment letter trends 21 5. Income taxes As technology companies increase their global footprint, questions related to international taxation, such as permanent reinvestment of foreign earnings, the impact of different tax rates, and tax holidays become more relevant. Additionally, the prolonged global economic recession continues to raise questions about realization of net operating losses and other tax credits. The most notable comment letter trends in the area of income taxes are: Permanent reinvestment: If the company determines that its foreign earnings will be permanently reinvested outside of the United States, it does not have to record a deferred income tax liability related to repatriating these earnings. The staff has regularly asked registrants to provide support and disclose in MD&A their considerations related to the permanent reinvestment assertion, to quantify the amount of undistributed earnings for which no tax liability has been recorded, and to quantify the amount of the unrecognized tax liability or disclose why it is not practicable. You disclose that you have not provided deferred taxes on future distributions of tax-exempt earnings as you have not determined to pay any dividends in the future and those earnings are considered to be permanently reinvested. Please tell us the amount of such earnings and what consideration was given to providing this quantitative disclosure in your filing. Also, tell us your consideration to disclose the amount of the unrecognized deferred tax liability related to such earnings, if practicable, or a statement that determination is not practicable. We refer you to ASC 740-30-50-2(b) and (c). Please also revise your MD&A, as necessary, to discuss any implications of your plans to permanently reinvest international earnings on your liquidity. For example, to the extent that you have material amounts of cash and cash equivalents in foreign locations with lower tax rates and repatriation of that cash would result in a significant tax liability, you should revise your disclosures accordingly. 1 22 PwC Impact of different tax rates on earnings: Comments frequently ask registrants to disclose how foreign effective tax rates differ from the domestic rate and analyze how the results of operations are impacted by having proportionally higher or lower earnings in jurisdictions with different effective tax rates. Please tell us your consideration of providing additional disclosures regarding the domestic and foreign components of pre-tax income, your domestic effective tax rate as compared to your foreign effective tax rate, and the significant impact on your overall effective income tax rates and results of operations of having proportionally higher earnings in countries where you have lower statutory tax rates. It appears as though this information is very pertinent to understanding your results of operations for each year and may also warrant discussion under the Overview subheading. Further, such disclosures seem more relevant in light of your disclosure that the United States and Ireland are your two major tax jurisdictions and considering recent fiscal problems in Ireland which could impact the country’s tax policy. As such, please tell us your consideration of disclosing possible outcomes or implications on your operations as the Irish and other various tax jurisdictions, as applicable, address these conditions and other events. Please refer to Item 303(a)(3)(i) of Regulation S-K and Section III.B of SEC Release 34-48960. 2 Deferred tax assets: The assessment of recoverability of deferred tax assets involves significant management judgment. In their comment letters, the SEC staff have asked companies to explain and disclose in their filings their considerations related to the recoverability of deferred tax assets, including analysis of both positive and negative evidence, especially when a prolonged history of losses exists. Additionally, any time a company records or reverses a valuation allowance against its deferred tax assets, they should be prepared to respond to a challenge from the SEC staff as it relates to the timing of the charge or reversal (i.e., why now or why not last quarter or year). You disclose that during the fourth quarter, based on positive evidence regarding past earnings and projected future taxable income from operating activities, you determined that it was more likely than not that you would 3 realize a portion of deferred tax assets outside the U.S. and you recorded a tax benefit of $154 million associated with the release of a valuation allowance on those deferred tax assets. Please tell us the negative and positive evidence that you considered in making this assessment. In particular, discuss how in reaching your conclusion that it was more likely than not that you would realize a portion of these deferred tax assets you considered the fact that you had recorded a loss from continuing operations before income taxes outside the U.S. for two of the past three years. Please refer to ASC 740-10-30-16 through 30-25. Other comments include providing (a) a more detailed breakdown of the effective tax rate reconciling items (i.e., showing all individual items greater than 5% of the statutory tax rate); (b) more transparent disclosure of unrecognized tax benefits; (c) quantitative disclosure of aggregate and per share effect of tax holidays; and (d) details of how registrants estimate the effective tax rate in interim periods. You indicate that you have realized tax advantages from conducting activities in certain foreign low tax jurisdictions. To the extent that the low foreign tax rates are the result of relief from income taxes only for a specified period, tell us what consideration you gave to disclosing the aggregate dollar and per share effects of the tax holiday and briefly describing the factual circumstances, including the date on which the special tax status will terminate. Also tell us what consideration you gave to disclosing and quantifying any reasonably expected material impact on your liquidity, capital resources and/or results of operations from the currently known trends, events and uncertainties related to any such tax holidays. Refer to SAB Topic 11C and Section III.B.3 of SEC Release 33-8350. 6 Please describe the nature of the discrete items that are impacting the estimated annual effective tax rate for the interim reporting periods. Explain why these items are discrete to an interim period. In addition, please explain why you calculated your effective tax rate based on year-to-date results as opposed to estimating your annual effective tax rate. 7 Please tell us the nature of each significant reconciling item in your reconciliation of income taxes computed at the Federal statutory tax rate to the effective tax rate. We note that the `Other, net’ line item of ($839) million in the reconciliation has an impact of approximately 7% on your effective tax rate which may consist of multiple significant reconciling items. Please refer to ASC 740-10-50-12 for required disclosure. 4 Please tell us what consideration you gave to separately disclosing decreases in the unrecognized tax benefits relating to settlements with taxing authorities and reductions as a result of a lapse of the applicable statute of limitations in your reconciliation of unrecognized tax benefits disclosure. Refer for ASC 740-10-50-15A. 5 Stay informed  | 2013 technology SEC comment letter trends 23 6. Commitments and contingencies Financial reporting of commitments and contingencies remains a top focus area of the SEC staff. While the quality of disclosures has improved over the past several years, some registrants continue to resist providing the required disclosures for fear that they may divulge information that could adversely affect the outcome of litigation. To that end, the staff will accept disclosure of estimated exposures on an aggregate basis rather than requiring it separately for individual matters. GAAP requires companies to record an accrual for a contingency when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Even if the criteria for accrual have not been met, disclosure may still be required if the loss is reasonably possible. The disclosure should provide the nature of the contingency and an estimate of the possible loss or range of loss. It has been fairly common for the staff to request the registrant to explain its estimation process or the specific factors precluding a reasonable estimate at the current reporting date. Additionally, the staff commonly ask whether there was a reasonable possibility that a loss exceeding amounts already recorded may have been incurred and request that amounts materially greater than the amounts accrued be disclosed. When a loss is assessed as being probable, but no one number within the estimated range of exposure is considered a better estimate than any other number in the range, the accounting guidance requires companies to record the low end of the range. In the spirit of keeping the investors apprised of significant forward-looking information, the nature and amount of a loss should generally not be disclosed for the first time in the period in which it is recorded, but rather earlywarning disclosures should be provided as soon as they are appropriate. As with goodwill impairments, the staff will 24 PwC challenge registrants about whether such losses should have been recorded in an earlier period and what the triggering event was for such recognition (i.e., why now). In instances when a loss has been settled, the staff is likely to review prior filing disclosures and inquire as to whether those disclosures were appropriate in light of the final outcome and whether loss contingencies should have been recorded or disclosed in earlier periods. The staff expect that loss contingency disclosures are updated regularly, both qualitatively and quantitatively, for developments in the related matters. 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 FASB ASC 450-20-50. If you conclude that you cannot estimate the reasonably possible additional loss or range of loss, please supplementally: (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. 1 You state that you believe that you have “provided sufficient chronology in Note 7 for the reader to understand that this is a December quarter-end event.” However, we note that this disclosure only provides information commencing with the receipt of the show cause letter in November. It appears that the concerns from the third party arose earlier than that time though, as you state that you “did not sell to the third party in the prior fiscal year and in the current year.” Considering that the Company knew that it was not selling to the third party in the prior fiscal year and in the current year, please tell us why you concluded disclosure was not necessary in the June 30 Form 10-K or September 30 Form 10-Q. Refer to Item 303 of Regulation S-K. In this regard, please tell us when you were notified that the third party would no longer take deliveries of new units. 3 We note that on June 7 you entered into a preliminary settlement agreement with respect to a state wage and hour lawsuit that had been filed against the company earlier in the year. Please tell us what consideration was given to the disclosure requirements of ASC 450-20-50-4 for each period during which this lawsuit was unresolved including periods prior to the preliminary settlement. Additionally, please tell us the following: the date the lawsuit was filed; the timing of the settlement discussions; the estimated dollar amount of the loss; and the status of the settlement. 4 We note that you entered into an agreement which released you from and avoided certain potential litigation but provided no other future benefits. We further note that you recorded a loss related to this litigation. Please provide us with a detailed timeline of the significant events pertaining to this agreement including the dates any complaints were filed, if any, as well as when you began entering into discussions regarding this agreement. Please also tell us what consideration was given to the disclosure requirements of ASC 450-20-50-4 for each period during which this matter was unresolved. 2 Stay informed  | 2013 technology SEC comment letter trends 25 7. Segments The purpose of segment disclosures is to provide investors the ability to see the company through the eyes of management. In particular, they allow investors to obtain information about a company at a disaggregated level that is used by the company’s chief operating decision maker (CODM) to evaluate performance and make resource allocation decisions. Often, the SEC staff have asked issuers to provide the information given to the CODM and will independently evaluate the appropriateness of the registrant’s identification of its segments (particularly when a company reports only one segment). This frequently leads to questions about the aggregation of operating segments into reportable segments. GAAP allows registrants to aggregate operating segments into reportable segments only if the segments have similar economic characteristics (for example, long-term gross margins) and are similar in a number of other areas. We note that you have identified three operating segments that you aggregate into one reportable segment. We further note your disclosures whereby you describe how you believe you meet the criteria to aggregate your three operating segments into one reportable segment. Please provide us with additional details regarding your analysis of whether the operating segments exhibit similar economic characteristics. In this regard, based on your response that the historical and long-term forecasted average gross margin for each segment is within a range of plus or minus ten percent of 62.4%, it appears that the gross margin estimates for the segments range from 56.2% to 68.6%. Therefore, the gross margin of the highest performing segment is approximately 22% higher than that of the lowest performing segment. Explain to us in greater detail why you believe this reflects “similar economic characteristics.” In order to assist our evaluation, please provide us with a copy of the CODM package corresponding to the 10-K. 1 We note that your Chief Operating Decision Maker evaluates performance and makes decisions regarding allocation of resources based on total company results and therefore you have concluded that you operate in one 2 26 PwC segment. However, we further note that remarks made in your Results Earnings Call indicate that you have multiple segments including A, B and C. Please tell us whether you considered determining operating segments based on the three segments described in your presentation. Refer to ASC 280-10-50-1 through 50-9. The staff have sometimes challenged registrants’ determination of both their operating segments and their reporting units used for purposes of goodwill impairment testing. The incorrect identification of operating segments could potentially result in a company avoiding a goodwill impairment charge. Please tell us whether you have aggregated operating segments as defined in ASC 280-10-50, into reporting units for purposes of conducting goodwill impairment testing. We refer you to ASC 350-20-20 which defines a reporting unit as an operating segment or one level below an operating segment, thus precluding aggregation of operating segments for purposes of determining reporting units. If you have not aggregated operating segments into reporting units, please clarify your disclosures accordingly. For example, your disclosure seems to indicate you have identified three operating segments, based on regions, which have been aggregated into a reportable segment. Also, your disclosures seem to indicate that goodwill is tested for impairment at the level of the reportable segment, which appears to represent an aggregation of operating segments. 3 The staff have also requested that registrants disclose the amount of revenues for each product or service or each group of similar products or services. The staff have been skeptical when registrants have asserted that providing such disclosures is impracticable, particularly when the description of the company’s business elsewhere in the filing includes discussion or quantification of different revenue categories. Please provide us with your consideration to disclose the revenues from external customers for each service or group of similar services, unless it is impracticable to do so pursuant to ASC 280-10-50-40. If providing the information is impracticable, that fact shall be disclosed. In this regard, based upon review of your revenue recognition policy, it appears you may have four types of services. 4 8. Business combinations The disclosure requirements for business combinations are extensive. They include details about the acquiree, the purchase consideration and the fair value of assets acquired and liabilities assumed, among others. The disclosures are designed to inform the reader about the nature of the acquisition as well as its effects on the financial statements of the acquirer. The relevant disclosures outlined in ASC 805-10-50-2 through 50-7 should be provided for each material business combination that occurs during the periods presented. Revise to include these disclosures for the acquisition. 1 Companies sometimes fail to provide the required pro forma information in accordance with ASC 805 for acquisitions that are material individually or in the aggregate. Please tell us why you have not presented pro forma information for the acquisition. Given the significance of the acquisition, we believe the pro forma disclosures required by ASC 805-10-50-2.h should be provided in the notes to your financial statements. Please revise or advise as appropriate. 2 It is also important for registrants not to overlook the requirements of Item 9.01 of Form 8-K and Rule 3-05 of Regulation S-X for the filing of historical financial statements of an acquiree and pro forma information in accordance with Article 11 of Regulation S-X, when the acquiree exceeds certain materiality thresholds. Failing to file such financial statements within the specified period following the completion of the acquisition may impact a registrant’s eligibility to use certain Securities Act forms. In the event that the company was required to file a report on Form 8-K in connection with the acquisition, but failed to do so, the report would not be considered to be filed on a timely basis. As a result, please discuss and pre-clear with the Office of Chief Counsel in the Division of Corporation Finance any questions on the company’s eligibility to use Securities Act Forms that are predicated on the current and timely filing of the company’s current and periodic reports. 3 Stay informed  | 2013 technology SEC comment letter trends 27 9. Other notable trends In addition to the areas highlighted so far, there were several other notable trends in SEC comment letters. Figure 7. Breakdown of other notable trends by topic, % 2012 Compliance 26 State sponsors of terrorism 6 Variable interest entities (VIEs) 13 Investments and fair value measurements 6 Controls and procedures 12 Risk factors 8 Other 30 2013 30 15 13 8 7 5 22 Compliance The SEC staff continue to raise compliance-related questions. Among them are questions regarding compliance with the various requirements of Regulation S-X: guarantor financial information (S-X 3-10), separate product and service revenue disclosure in the statement of operations (S-X 5-03), and financial statement schedules (S-X 5-04). The staff have asked registrants to file copies of material agreements, inquired about the determination of a registrant’s filing status, requested corrections to the officer certifciations and raised questions about impact of certain compliance issues on a registrant’s eligibility to use certain Securities Act forms. 28 PwC Guarantor disclosures: Over the last couple of years, many technology companies accessed the debt markets, which have provided an attractive cost of financing in this environment of sustained, historically low interest rates. A registered offering of guaranteed securities requires full financial statements for the issuer of the securities and each guarantor, unless one of the exemptions in Rule 3-10 of Regulation S-X applies. If eligible for the exemption, the company may provide significantly reduced disclosures, generally in the form of consolidating financial information. We have seen an increased level of comments from the staff relating to the application of Rule 3-10. One category of comments is directed at identifying whether the specific structure is eligible for relief. To be eligible, among other criteria, the guarantors must be 100% owned by the parent and the guarantee must be full and unconditional, subject only to certain customary releases. The staff have asked for details related to any provisions for releases in order to evaluate whether they meet the limited exceptions permitted under the rules. Another subset of comments has been targeted at potential errors in the preparation of the consolidating financial information; for example, the staff have asked about the proper presentation of intercompany balances on the balance sheet (grossing up receivables and payables, presenting balances as current and long-term) and the cash flow statement (depending on the nature of the payments as loans, operating balances or dividends). We note that you appear to be relying on the exception to the general rule to file separate financial statements of each guarantor subsidiary under Rule 3-10(f) of Regulation S-X. Please confirm, and also disclose in future filings, that each subsidiary guarantor is 100% owned and the guarantees are joint and several. Refer to Rule 3-10(i)(8) of Regulation S-X. 1 We note that the Notes are fully and unconditionally guaranteed except for certain customary release provisions. Please describe the release provisions and tell us what consideration you gave to disclosing these provisions. 2 Disclosure of operations in locations identified as state sponsors of terrorism As technology companies expand their operations internationally, some find themselves doing business, directly or indirectly, with countries that have been listed by the US government as state sponsors of terrorism: Syria, Cuba, Iran, and Sudan. The SEC staff have asked registrants to disclose quantitative and qualitative factors that a reasonable investor would regard as important in making an investment decision. These include the nature and extent of contacts with the aforementioned countries (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 issuer’s website, which may contain references to one of the countries designated as state sponsors of terrorism. In addition, the Iran Threat Reduction and Syria Human Rights Act of 2012 was signed into law last year, and as of February 2013, issuers are required to provide disclosure in their periodic reports if, during the reporting period, they or any of their affiliates have knowingly engaged in certain specified activities involving contacts with or support for Iran. If such activity is reported in a periodic report, the issuer is also required to file a separate form on Edgar (IRANNOTICE). Variable interest entities Accounting related to variable interest entities (VIEs) is judgmental and complex. The SEC staff often request that the variable interests and the specific terms of the agreements are discussed more clearly in the filings. Registrants may also be asked to disclose the assets and liabilities of a consolidated VIE as well as the impact the VIE has on the registrant’s operations. There is a fair amount of focus on China VIE structures and whether such structures allow registrants to establish control over the VIE, in light of the existing government regulation in that country. Investments and fair value measurements Investments and fair value measurements comments include requests to disclose methods and key assumptions used to determine fair values , transparent disclosures with respect to credit quality of investments, management’s consideration of temporary versus otherthan-temporary investment losses and detailed disclosures about unobservable fair value measurements (Level 3), such as reconciliation of beginning and ending values for the period and sensitivity of fair values to changes in assumptions. Controls and procedures Another area of common questions relates to internal control over financial reporting (ICFR). The SEC staff sometimes challenge registrants’ conclusions about the effectiveness of ICFR, especially when material errors in the financial statements have been identified. Management must timely disclose material changes to a company’s internal control environment in periodic filings, which includes remediation of previously identified material weaknesses during the period. The SEC staff often look to information contained in current reports, companies’ websites and other sources when raising questions about changes in ICFR. There are also comments with respect to disclosure controls and procedures (DC&P), including lack of an explicit conclusion about the effectiveness of DC&P and conclusion that DC&P is effective when ICFR is ineffective. Stay informed  | 2013 technology SEC comment letter trends 29 Risk factors When it comes to risk factors, the SEC staff insist on risk factors being specific to the registrant as opposed to generally applicable to the industry. Cybersecurity has become an area of more frequent comments by the staff in recent years given the rapidly growing volume of sensitive information which is stored on computers that are connected to the internet. Cybersecurity: Cybersecurity has become a real threat to companies in many industries and with that development comes increased scrutiny on whether registrants are adequately disclosing the cybersecurity risk related to their business. Where registrants have included a generic risk factor related to cybersecurity, the staff have prompted registrants to tailor such disclosures, particularly when there have been actual cyber-incidents or attacks experienced by the company. The staff have also been skeptical when registrants do not include any cybersecurity discussion in their risk factor disclosures, given that there is such immense dependence on digital technologies in business today. Expected disclosures are consistent with the guidance provided by the Division of Corporation Finance in CF Disclosure Guidance: Topic No. 2 and include, but are not limited to, the cost of remediation related to actual security breaches as well as the related loss of revenue, the cost of building a cybersecurity program, the potential impact on litigation costs, and reputational damages. We note your disclosure that computer hacking or other breaches of network or IT security that affects your wireline and wireless networks could have a material adverse effect on your operations. We also have read several reports of various cyber attacks directed at the company. If, in fact, you have experienced cyber attacks, security breaches or other similar events in the past, beginning with your next Form 10-Q, please state that fact in order to provide the proper context for your risk factor disclosure. Please refer to the Division of Corporation Finance’s Disclosure Guidance Topic No. 2 at http://www.sec.gov/divisions/corpfin/guidance/ cfguidance-topic2.htm for additional information. 3 You disclose that your databases “may be” subject to unauthorized access and if you experience a security breach, the integrity of your databases “could be” affected. You disclose that you have experienced a cyber incident where a subset of a client’s customer data was exposed by an unauthorized entry into your email system. In order to provide the proper context in your risk factor disclosure, please confirm that beginning with your next Form 10-Q, you will expand your risk factor to clearly state that you have experienced a cyber breach. 4 30 PwC We note that none of your risk factors, or other sections of your Form 10-K, specifically address any risks you may face from cyber attacks, such as attempts by third parties to gain access to your systems for purposes of acquiring your confidential information or intellectual property, including personally identifiable information that may be in your possession, or to interrupt your systems or otherwise try to cause harm to your business and operations. Given that other companies in your industry have actually encountered such risks and have disclosed that such risks may be material to their business and operations, please tell us what consideration you gave to including disclosure related to cybersecurity risks or cyber incidents in your Form 10-K. 5 You state that certain countries in which you operate are, or in the future may be, subject to international sanctions, including those imposed by the United States. We are aware of news reports indicating that you may provide services to ETECSA in Cuba; that you may provide international voice roaming services in Sudan and in Syria; and that your Armenian subsidiary may operate one or more channels from Armenia to Iran. Cuba, Iran, Sudan, and Syria are designated as state sponsors of terrorism by the U.S. Department of State, and are subject to U.S. economic sanctions and export controls. Your Form 20-F does not include disclosure about operations in those countries. Please describe to us the nature and extent of any past, current, and anticipated contacts with Cuba, Iran, Sudan, and/ or Syria, whether through direct or indirect arrangements, during the last three fiscal years and the subsequent interim period. Your response should describe any products, equipment, software, technology, information, support, and services you have provided into Cuba, Iran, Sudan, and/or Syria, directly or indirectly, and any agreements, arrangements, or other contacts you have had with the governments of those countries or entities they control. 6 Other Cash flows: Cash flow-related comments typically center around (1) the classification of certain items in the statement of cash flows as operating, investing, or financing, and (2) the presentation of cash activity on a net basis rather than gross. While the classification of certain transactions is explicitly prescribed in the authoritative accounting guidance, in many other cases, transactions have to be analyzed in accordance with the general principles in the standard. Cash flows are required to be presented gross because that information is generally more relevant to financial statement users, unless the turnover is very quick (three months or less), in which case net information would be sufficient. We note from your disclosure that certain amounts reported as “due to related parties” as well as a portion of the change in this balance between reporting periods related to advances from management for working capital. As those advances do not appear to have been reflected in the “Investing Activities” or “Financing Activities” sections of your statement of cash flows, it appears that certain, if not all, of these advances may have been reported within the “Operating Activities” section of your statement of cash flows. If so, explain to us why you believe that operating activities, rather than financing, is the appropriate classification within the statement of cash flows—particularly, as such advances would appear to be equivalent to loans. 7 You present the cash receipts attributable to the collection of outstanding notes receivables as “cash flows from operating activities.” However, the notes receivables collected appear to have arisen in connection with investing activities (e.g., the dispotition of assets and the funding of a third party’s capital expenditures), rather than the operations of your business. As such, it appears appropriate to report cash received from the collection of such receivables as “cash flows from investing activities” in your statements of cash flows. Based upon the observations noted above, please tell us why you believe that your current classification of the collections on notes receivables is appropriate. Alternatively, reclassify such amounts to the investing activities section of your cash flow statement. Please refer to both FASB ASC 230-10-45-12 and the definition of “Investing Activities,” as provided in the glossary to the Accounting Standards Codification, for further guidance. 8 Materiality: The SEC’s guidance on evaluating materiality is included in SAB Topics 1.M and 1.N (previously SAB 99 and SAB 108). Materiality must 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 must also be performed to address important considerations such as whether the error impacts management’s compensation, whether it was intentional or the result of a fraudulent act and, last but not least, 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 staff often ask registrants to provide their materiality analysis. You indicated in your prior response that revenues from certain resale project contracts were incorrectly recognized on a gross basis. Tell us what prior period(s) the fourth quarter adjustment relates to and tell us the impact on your GAAP financial statements for each period in which revenues were overstated. Also, tell us whether similar adjustments were recorded in any other periods and tell us how you determined that correcting this error in the fourth quarter was appropriate. In addition, please confirm that you intend to disclose the nature of the fourth quarter adjustment in future filings. 9 The staff also challenge registrants as to whether certain adjustments, which may have been characterized as reclassifications, are in fact errors. Similarly, when errors are deemed by management to be immaterial and are recorded in the period in which they were identified as out-of-period adjustments, the staff have challenged that conclusion and asked registrants to restate or revise their previously issued financial statements. Disclosure of any errors and related corrections is considered best practice, as it provides transparent information to the users of the financial statements. 10 Explain further the circumstances that result in the over-accruals of project costs. Tell us to which arrangements these cost adjustments relate. Tell us how often you have recorded such adjustments during each of the last three fiscal years and provide the amount of such adjustments. Provide similar information as it relates to the prior fiscal year. In addition, tell us if you consider these adjustments to be a correction of an error and if not, why not. 11 Please clarify whether the discrete items noted in your prior response was due to a change in judgment or correction of an error. We refer you to ASC 740-10-25-15 and 35-2. In this regard, explain in greater detail the cause of the inconsistencies in the positions taken in the tax reconciliation and the tax return filed. 12 We have reviewed your response to prior comment, which explained the items recognized during the three and nine months ended September were attributed to a correction of an error and not a change in judgment as defined by ASC 740-1025-15. Please explain what consideration you gave to disclosing the items as immaterial errors under ASC 250-10. Tell us how you evaluated the error based on estimated annual results for the full fiscal year when the error was discovered. Further, describe your materiality assessment of the errors [for the annual period] in preparation for filing your Form 10-K. Stay informed  | 2013 technology SEC comment letter trends 31 PwC can help If you would like to discuss how these SEC comment letter trends might impact your company, please contact one of our practice leaders: Cory Starr US Technology Assurance Leader 408 817 1215 [email protected] Mila Petrova Partner, SEC Services 973 236 5601 [email protected] Let’s talk Please reach out to any of our technology leaders to discuss this or other topics. We’re here to help. Tom Archer US Technology Industry Leader 408 817 3836 [email protected] Kayvan Shahabi US Technology Advisory Leader 408 817 5724 [email protected] Cory Starr US Technology Assurance Leader 408 817 1215 [email protected] Diane Baylor US Technology Tax Leader 408 817 5005 [email protected] 32 PwC Acknowledgments The following PwC professionals contributed their experience and knowledge to produce this paper. Alyona Teeter Senior Manager / SEC Services 973 236 7045 [email protected] Jennifer Y Chen Senior Manager / SEC Services 973 236 4735 [email protected] Anil Persad Senior Manager / SEC Services 973 236 5009 [email protected] Special thanks Special thanks to all the other resources in the National Professional Services Group, Technology Sector, Marketing and US Studio who contributed substantially to the final editing, production and overall quality of this technical publication. 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 factbased analysis and experiencebased 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. For more information please contact Tom Archer, US Technology Industry Leader. Stay informed  | 2013 technology SEC comment letter trends 33 www.pwc.com © 2013 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the US member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. 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