2.4 Debt
2.4.1 Restrictions
Examples of SEC Comments
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We note your disclosure . . . that your [company’s] ability to repay debt and pay dividends “depends on the continued transfer to it of dividends and other income and funds from its subsidiaries” and that the ability of your [company’s] “subsidiaries to pay dividends and make loans and other transfers to it is generally subject to various regulatory, legal and economic limitations.” Please explain to us your consideration of the applicability of Rules 4-08(e), 5-04(c) Schedule I and 12-04 of Regulation S-X to your filing.
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[Y]ou disclose that you are largely dependent on the receipt of distributions and dividends or other payments from your subsidiaries and joint ventures for cash to fund all your operations and expenses. Please address if there are any restrictions on your ability to declare dividends and discuss the potential impact on your liquidity, financial condition and results of operations, including the disclosures required by Rule 4-08(e) of Regulation S-X. Please also tell us what consideration you gave to the need for parent only financial statements under Rules 5-04 and 12-04 of Regulation S-X.
The SEC staff may comment on restrictions that limit a registrant’s ability to pay
dividends or transfer funds within a consolidated group. When the transfer of assets (cash or other
funds) to the parent company/registrant from its subsidiary (or subsidiaries) or equity method investee
is materially restricted, limited, or in need of a third party’s approval, Regulation S-X, Rules 4-08(e), 5-04,
and 12-04, may require:
- Footnote disclosure of the restriction or limitation (Rule 4-08(e)).
- Presentation of condensed parent-company financial data in a financial statement schedule (i.e., Schedule I).
- Both footnote and Schedule I disclosures.
Rule 4-08(e) disclosures are intended to inform investors of restrictions on a registrant’s ability to pay
dividends or transfer funds within a consolidated group. Such restrictions may result from a contractual
agreement (e.g., a debt agreement) or a regulatory body. Without appropriate disclosure of such
restrictions, an investor may presume that the registrant (at the parent or subsidiary level) has more
discretion to transfer funds or pay cash dividends than is actually the case.
If Rule 4-08(e) applies, registrants must disclose in the notes to the financial
statements a description of “the most significant restrictions on the payment of
dividends by the registrant, indicating their sources, their pertinent
provisions, and the amount of retained earnings or net income restricted or free
of restrictions.”
Disclosure is also required under Rule 4-08(e)(3) if such disclosure would be considered material.
Disclosures required under Rule 4-08(e)(3) consist of the following:
- The “nature of any restrictions on the ability of consolidated subsidiaries and unconsolidated subsidiaries to transfer funds to the registrant in the form of cash dividends, loans or advances.”
- Separate disclosure of “the amounts of such restricted net assets for unconsolidated subsidiaries and consolidated subsidiaries as of the end of the most recently completed fiscal year.”
In addition, to give investors separate information about the parent company, registrants are required
under Rule 5-04 to file Schedule I “when the restricted net assets [of the registrant’s] consolidated
subsidiaries exceed 25 percent of consolidated net assets as of the end of the most recently completed
fiscal year.”
The calculations under Rule 4-08(e) may be different from those under Rule 5-04,
which governs Schedule I; consequently,
registrants must consider both rules to determine
what is required. Given the materiality-based
threshold for footnote disclosures under Rule
4-08(e), if Schedule I is required, footnote
disclosures under Rule 4-08(e) may also be
required. However, if Rule 4-08(e) disclosures are
required, Schedule I may not be required. In
addition, a registrant’s filing of Schedule I does
not necessarily mean that the registrant has
satisfied the disclosure requirements of Rule
4-08(e), which are separate and distinct.
2.4.2 Financial Covenant Disclosures
Examples of SEC Comments
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We note that . . . you disclose that you were in compliance with, or had waivers for, all covenants under your debt facilities as of [the end of your fiscal quarter]. We further note your disclosures . . . in which you obtained waivers related to covenants contained in your debt agreements. In future filings, please expand your disclosures of liquidity and capital resources to address the following:
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Disclose the terms of waivers received, including how long the terms of the covenants were specifically waived.
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Discuss the potential impact on your liquidity and capital resources if you do not comply with any remaining covenants and/or are unable to obtain a waiver of compliance in the future. Specifically, you should state whether noncompliance with any covenants could lead to the acceleration of payments due under any of your debt arrangements.
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Disclose your actual performance relative to the covenants.
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We note that [Company A] was in compliance with the terms of their financial covenants in the Credit Agreement and Purchase Agreement as of December 31, [fiscal year 1] and June 30, [fiscal year 2]. You disclose that due to the low commodity price environment, it is possible that the total leverage ratio financial covenant may not be met at some point during [fiscal year 2] without further action. Please revise your disclosure to explain the reasonably likely impact of any breach on your financial condition or operating performance and identify any alternate sources of funding.
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We note your credit facilities include certain affirmative and negative covenants that impose restrictions on your financial and business operations. For each class of debt, please tell us whether you were in compliance with the covenants as of the reporting date.
It is important for a registrant to consider providing disclosures about covenant compliance in MD&A to
illustrate its financial condition and liquidity. These disclosures may include a discussion of (1) the terms
of the most severe covenants and how the registrant has complied with those covenants, (2) waivers
obtained from lenders and the likelihood of failing a covenant or obtaining a waiver in the future, and
(3) the impact of noncompliance on the registrant’s financial condition and liquidity. In addition, a
registrant may present a table that compares its most material actual debt covenant ratios as of the
latest balance sheet date with the minimum and maximum amounts permitted under debt agreements.
Such transparent disclosures will enable investors to better understand the risk of future covenant
noncompliance by the registrant.
For additional discussion of liquidity, see Section
3.1.3.
2.4.3 Classification as Debt or Equity
Examples of SEC Comments
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We understand from your disclosures . . . that you have classified warrants . . . as liabilities because the warrant agreement provisions may either require net-cash settlement if an event occurs that is not within your control, or provide the counterparty with an option to choose net-cash settlement. . . .Please expand your disclosures to describe the particular warrant provisions that have resulted in your liability classification; and to clarify how a “fundamental transaction” is defined and relevant to the classification and valuation of your warrants.You may refer to FASB ASC 505-10-50-3 if you require further guidance on the associated disclosure requirements.Tell us the specific language within the exhibits referenced above that correlates with your assessments, or if there are incremental contractual arrangements that govern the manner of settlement provide those documents for our review.Please submit the analysis that you performed of the contractual provisions and specific accounting guidance in formulating your view on the classification.
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You report the Series A and B convertible preferred stocks as permanent equity. Please respond to the following comments:
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Provide us with your analysis of the applicable guidance to support your conclusion that these convertible preferred stocks should not be classified as temporary equity following ASC 480-10-S99-3A. . . .
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Revise to expand your disclosures to include all key terms for these convertible preferred stocks, including any redemption features, as well as any adjusting mechanism for their conversion price.
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Revise to disclose in the equity section of the statement of financial position the aggregate amount of liquidation preference of these convertible preferred stocks if considerably in excess of the par or stated value of the shares. Refer to ASC 505-10-50-4.
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- Please provide us with a detailed analysis explaining how you determined that the preferred interests issued in [year 1] and [year 2] should not be classified as debt in accordance with ASC 480.
- Please elaborate on why you believe the decision by your Board of Directors to either exchange the common units and Class B shares for Class A shares or to redeem them for cash is within your control. In doing so, tell us how you considered the guidance in paragraph 7 of ASC 480-10-S99-3A.
Under ASC 480, certain financial instruments that embody an obligation of the
issuer should be accounted for as liabilities even
if their legal form is that of equity or they
involve obligations to repurchase or issue the
entity’s equity shares. In addition, the guidance
in ASC 480-10-S99-3A(2) states, in part, that “ASR
268 requires preferred securities that are
redeemable for cash or other assets to be
classified outside of permanent equity if they are
redeemable (1) at a fixed or determinable price on
a fixed or determinable date, (2) at the option of
the holder, or (3) upon the occurrence of an event
that is not solely within the control of the
issuer.” ASC 480-10-S99-3A also notes the SEC
staff’s belief that ASR 268 can be applied
analogously to other redeemable equity
instruments.
Consequently, the SEC staff frequently asks registrants with redeemable securities — including
registrants undergoing IPO transactions — to support the basis for their classification of such securities
as debt, temporary (mezzanine) equity, or permanent equity. In addition, the staff often asks registrants
about the accounting for conversion features in convertible instruments, including convertible preferred
securities.
See Section 2.16
for more information about redeemable
noncontrolling interests. See Section
2.8.1 for considerations related to
embedded conversion features.
Other
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