Topic 9: Management's Discussion and Analysis of Financial Position and Results of Operations (MD&A)

The objectives of MD&A are:

1. To provide a narrative explanation of a company's financial statements that enables investors to see the company through the eyes of management;
2. To enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and
3. To provide information about the quality of, and potential variability of, a company's earnings and cash flow so that investors can ascertain the likelihood that past performance is indicative of future performance.

9110.2 MD&A should not consist of generic or boilerplate disclosure. Rather, it should reflect the facts and circumstances specific to each individual registrant. S-K 303 is a "principles-based" disclosure requirement. It is intended to provide management with flexibility to describe the financial matters impacting the registrant.

9210.2 Liquidity is the ability of the registrant to generate adequate amounts of cash to meet its needs for cash. Any known trends, or any known demands, commitments, events or uncertainties that will result in or are likely to result in the registrant's liquidity increasing or decreasing in a material way should be discussed. To the extent a material deficiency is identified, the registrant should disclose the steps taken to remedy the deficiency. The discussion should also evaluate the amounts and certainties of cash flows, as well as whether there has been material variability in historical cash flows.

9210.3 The requirements of the disclosures related to capital resources include a discussion of material commitments for capital expenditures, the general purpose of any commitments and how these commitments will be funded, and material trends in the registrant's capital resources, including expected changes in the mix (equity, debt and any off-balance sheet financing arrangements) and their relative cost.

9210.4 The liquidity and capital resources discussion should address:

1. Material cash requirements;
2. Sources and uses of cash, including cash provided by/used in operations, as well as cash provided by/used in investing and financing activities; and
3. Material trends and uncertainties related to a company's flexibility in determining when and how to use the available cash flows to satisfy obligations and make other capital expenditures.

9210.5 It may be necessary for the liquidity and capital resources discussion to address debt instruments, guarantees and related covenants. Disclosure is likely to be necessary if:

1. The registrant is, or is reasonably likely to be, in breach of debt covenants or
2. Debt covenants impact the registrant's ability to obtain additional debt or equity financing.

9210.6 Improving Liquidity and Capital Resources

1. One of the most common deficiencies is when registrants simply repeat items reported in the statement of cash flows. Registrants should focus on the primary drivers of and other material factors necessary to an understanding of the registrant's cash flows and the indicative value of historical cash flows.
2. Registrants should describe cash flows from operating, investing and financing activities associated with discontinued operations separately from continuing operations if that information is not apparent from the cash flow statement. Additionally, registrants should describe how the company's liquidity is likely to be affected by the absence of cash flows (or negative cash flows) associated with discontinued operations.

9220.2 The following disclosures are required by S-K 303(a)(3):

1. Any unusual or infrequent event or transaction or any significant economic change that materially affected the amount of reported income from continuing operations;
2. Significant components of revenues and expenses that are necessary in order to understand the results of operations (e.g., segmental information);
3. Any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations;
4. If events that are likely to cause a material change in the relationship between costs and revenues (increases in labor costs or raw materials for example), the change in the relationship should be disclosed; and
5. To the extent there is a material increase in net sales, discuss the price vs. volume mix (whether the overall increase is attributable to increases in prices or increases in the volume of goods and services being sold).

9220.3 In order to comply with the requirement to discuss significant components of revenue and expenses, registrants will often provide a discussion along segmental lines (as determined under ASC 280). Segment analysis is usually necessary to enable a reader to understand the consolidated amounts, but it should not result in repetitive disclosure that lengthens MD&A unnecessarily, or obscures salient information. The discussion and analysis of segments may be integrated with the discussion of the consolidated amounts to avoid unnecessary duplication. The discussion and analysis should be comprehensive. All components of the registrant's results of operations, including those that may not be allocated to the segments in determining the segmental profit or loss (such as certain corporate overhead items or income taxes for example) should be discussed.

9220.4 Registrants should consider discussing and analyzing the tax implications related to material transactions, trends and other important items impacting their business as disclosed elsewhere in MD&A. A discussion of the nature and impact of significant tax rate reconciling items should also be considered. For example, discuss the tax rate reconciling item resulting from a change in assumptions related to an unrecognized tax benefit or a different final resolution related to the unrecognized benefit. Similarly, when uncertain tax positions are a critical accounting policy, MD&A should address why the assumptions were changed or why the actual resolution differed from management’s assumption. (Last updated: 9/30/2010)

9220.5 Registrants should address the underlying reasons for changes in the price versus volume mix. For example, if sales declined because the volume of goods sold decreased by 20%, but this was offset by a 10% increase in price, the discussion in MD&A should not stop once it identifies the price and volume components. In this example, the underlying factors that contributed to the decline in volume as well as the increase in selling prices should also be discussed. In addition, discussions about changes in the price vs. volume mix should consider changes in foreign currency fluctuations.

9220.6 The results of operations may not always be prepared on a consistent basis. This will occur, for example, when there has been a change in basis in the underlying financial statements. This might occur in the following situations:

1. When there has been a material acquisition (either the acquisition of a target entity that is significant to the registrant or predecessor/successor step-up in basis) during the period;
2. When pushdown accounting has been applied; or
3. When the registrant has adopted fresh-start accounting upon its emergence from bankruptcy.

9220.7 When events such as those described in 9220.6 occur, registrants should consider whether the discussion of the results of operations and financial condition set forth in the audited financial statements included in the filing should be supplemented by a discussion based upon pro forma financial information. This supplemental discussion may be meaningful in the case of a material acquisition, but generally would not be appropriate in the case of fresh-start accounting. A determination as to whether a discussion of the audited financial statements should be supplemented by a discussion based on pro forma information should take into consideration all of the facts and circumstances surrounding the transaction, the nature of the pro forma adjustments to be made, and the overall meaningfulness of any such supplemental pro forma discussion.

9220.8 If it is determined that a supplemental discussion in MD&A based on pro forma financial information is appropriate, then the pro forma financial information may be presented in a format consistent with S-X Article 11. Other formats, such as the footnote pro forma information specified by ASC 805, may also be appropriate depending on the particular facts and circumstances. It would be inappropriate to merely combine information for the pre-and post-transaction periods without reflecting all relevant pro forma adjustments required by S-X Article 11. Pro forma financial information should only be prepared for the most recent fiscal year and interim period prior to the transaction occurring (although the staff will not object to the registrant providing a pro forma statement of comprehensive income for the corresponding prior interim period). If pro forma results are discussed in MD&A, they should not be discussed in isolation. Supplemental discussions based on S-X Article 11 pro forma financial information should not be presented with greater prominence than the discussion of the historical financial statements required by S-K 303. (Last updated: 9/30/2010)

For example, assume a material acquisition occurs on August 31, 2007, and the registrant is a calendar year-end company. In accordance with the Form 8-K requirements, pro forma financial information prepared in accordance with S-X Article 11 is prepared for the year ended December 31, 2006 and the interim period ended June 30, 2007 and filed on the Form 8-K. When preparing its MD&A for the Form 10-K for the year ended December 31, 2007, the registrant could elect to supplement the discussion of its historical results with a discussion based on S-X Article 11 pro forma information for the year ended December 31, 2007 that gives effect to the August 31, 2007 acquisition. The pro forma December 31, 2007 information would then be compared to the pro forma information for the year ended December 31, 2006 previously filed via a Form 8-K. This discussion would be in addition to a comparison of the audited financial statements, which would reflect the acquisition occurring in mid 2007. A supplemental discussion based on pro forma financial information in more detail than revenues and costs of revenues for the year ended December 31, 2005 would not be appropriate. The comparison of results of operations and financial condition for the year ended December 31, 2005 to December 31, 2006 would be on an as reported (and audited) basis and would not reflect any impact of the acquisition. In its Form 10-K for the year ended December 31, 2008, the registrant may carry forward the discussion of the pro forma results for the year ended December 31, 2006 and 2007 as a supplement to the discussion of the audited financial statements. No adjustments would be appropriate or necessary to the year ended December 31, 2008 as the acquisition would be reflected in the audited financial statements for the entire year.

9220.9 Disclosure should be provided to explain how the pro forma presentation was derived, why management believes the presentation to be useful, and any potential risks associated with using such a presentation (the potential that such results might not necessarily be indicative of future results for example, depending on how the information has been prepared, and the period that it covers). Typically, the presentation of complete pro forma financial information (reflecting the adjustments) in MD&A will be necessary in order to facilitate an understanding of the basis of the information being discussed. (In the circumstances described in the example in Section 9220.8, this presentation would include both 2006 and 2007.) However, there may be situations where the pro forma adjustments are limited in number and easily understood so that narrative disclosure of the adjustments alone will be sufficient.

9220.10 MD&A should fully explain the results of operations. For example, MD&A should not merely state that the increase in revenues and costs of revenues is due to a significant acquisition. Rather, the contribution of the recent acquisition to total revenues should be quantified to the extent possible, and any increase or decrease in the underlying revenues of the pre-existing business should then be addressed.

9220.11 There are two assessments that management must make where a trend, demand, commitment, event or uncertainty is known:

1. Is the known trend, demand, commitment event or uncertainty likely to come to fruition? If management determines that it is not reasonably likely to occur, no disclosure is required.
2. If management cannot make that determination, it must evaluate objectively the consequences of the known trend, demand, commitment, event or uncertainty, on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant's financial condition or results of operations is not reasonably likely to occur.

Note that "reasonably likely" is a lower threshold than "more likely than not" but a higher threshold than "remote". The concept of "reasonably likely" is used in the context of disclosure for MD&A purposes and is not intended to mirror the tests in ASC 450 established to determine when accrual is necessary, or when disclosure in the footnotes to the financial statements is required.

Note that equity-linked instruments (such as warrants, convertible debt or convertible preferred stock) where the criteria set forth in ASC 815 are met and therefore classification of either the warrant or the conversion option within stockholder's equity is appropriate (meaning that the instrument is eligible for the scope exception in ASC 815-10-15-74) meet the definition of an off-balance sheet arrangement as defined in (c) above, and should be assessed for materiality to determine whether disclosure is required. We would expect the assessment of materiality to include an analysis of the potential dilutive effect of such instruments, as well as an analysis of the likelihood that the scope exception will no longer be available with respect to the instrument (loss of the scope exception could occur as the result of modification to the terms of the instrument, or the issuance of new instruments that can be converted into an unlimited number of shares, thereby tainting other previously issued instruments), which would result in the instrument being treated as a derivative, brought on to the balance sheet at fair value, and marked to market at every period end. The disclosure requirements of this section are set forth in more detail below, but in this situation, the disclosure to be provided could include a discussion of why the registrant chose to issue that type of equity-linked instrument, the potential dilutive effect if the instrument were to be converted, and, depending on the likelihood of the registrant continuing to be able to meet the scope exception, the impact of a change in classification upon the registrant's financial statements.

With respect to (d) above, in this context a variable interest refers to an investment in an unconsolidated entity that would meet the ASC 810-10-15 definition of a variable interest because the investment absorbs expected losses and residual returns that occur in the unconsolidated entity. However, the entity in which the interest is held does not need to meet the ASC 810-10-15 definition of a variable interest entity in order to qualify as an off-balance sheet arrangement requiring disclosure.

9230.2 For the registrant's off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the registrant's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors, disclosure should be provided that addresses:

1. The nature and business purpose of the off-balance sheet arrangement;
2. The importance to the registrant of the off-balance sheet arrangement to their liquidity, capital resources, market risk support, credit risk support or other benefits;
3. The amounts of revenues, expenses and cash flows of the registrant arising from such arrangements; the nature and amounts of any retained interests, securities issued and other indebtedness incurred in connection with such arrangements; the nature and amounts of other obligations or liabilities of the registrant that are or are reasonably likely to become material and the triggering events that could cause them to arise;
4. Any known event, demand, commitment, trend or uncertainty that will result in or is reasonably likely to result in the termination or material reduction in availability to the registrant of the off-balance sheet arrangements that provide material benefits, and the course of action that they have taken or propose to take in such circumstances.

These requirements are intended to elicit disclosure about why the registrant engages in the off-balance sheet arrangement, the magnitude and importance of the arrangement and the circumstances that would cause the registrant to recognize material liabilities or losses related to the arrangement.

9230.3 In December 2007, the Division of Corporation Finance sent an illustrative letter to certain public companies identifying a number of disclosure issues they may wish to consider in preparing Management's Discussion and Analysis for their upcoming annual reports on Form 10-K or 20-F. The full letter is available at: http://www.sec.gov/divisions/corpfin/guidance/cfoffbalanceltr1207.htm.

9240.1 Overview

As an aid to understanding other liquidity and capital resources disclosures in MD&A, the contractual obligations tabular disclosure should be prepared with the goal of presenting a meaningful snapshot of cash requirements arising from contractual payment obligations. Registrants are encouraged to develop a presentation method that is clear, understandable and appropriately reflects the categories of obligations that are meaningful in light of its capital structure and business. Registrants should highlight any changes in presentation that are made, so that investors are able to use the information to make comparisons from period to period. (Last updated: 9/30/2010)

9240.2 Presentation

The table should be in substantially the format shown above. Disaggregating the specific categories shown above is appropriate, particularly if the categories used are specific to the underlying business. Therefore, the captions may be changed, and the number of line items expanded, as long as it is clear what is included within each line item. However, to the extent that the registrant has obligations that fall within the above categories, they should be reflected in the table.

9240.3 Purchase obligations

Purchase obligations are defined as agreements to purchase goods and services that are enforceable and legally binding, that specify all significant terms, including the quantities to be purchased, price provisions and the approximate timing of the transactions. Additional guidance has not been issued by the staff with respect to what should be included within this category. However, registrants should undertake reasonable effort and expense to assess and aggregate outstanding purchase obligations. Disclosure should accompany the table to clarify how the purchase obligations amount has been calculated.

9240.4 [Reserved]

9240.5 [Reserved]

9240.6 Other considerations

1. A registrant should evaluate whether or not it can reasonably estimate the amount and/or timing of payments it will be obligated to make under interest rate swap agreements to determine whether it can provide meaningful information in the table for these agreements. In some cases, market interest rates may have moved such that a registrant is in a position of receiving cash rather than paying cash under an interest rate swap; cash receipts under interest rate swaps should not be included in the table. If the swap is structured in such a way as to be a fixed rate loan, then the registrant should provide the information.
2. Bank certificates of deposits are contractual payment obligations on the part of the bank. Therefore, principal and interest payments should be included in the table.
3. The information disclosed in the table in respect of long-term debt obligations, capital (finance) leases and operating lease obligations should be consistent with the disclosures provided in the financial statements.

9240.7 Footnotes

The table of contractual obligations may be accompanied by footnotes to describe provisions that create, increase or accelerate obligations, or other pertinent data to the extent necessary for an understanding of the timing and amount of the registrant's specified contractual obligations. The footnote disclosure permits management to apply its judgment in determining what items should be included or excluded from the table. If management's judgment results in items being excluded from the table, accompanying footnotes should describe the nature of items excluded and why they are excluded. Management should also consider disclosing the prior year actual spending or budgeted amounts in cases where those purchase orders are not otherwise tracked by the registrant. Disclosure of the dollar amount up to which employees are authorized to make purchases could also be disclosed to help clarify the significance of amounts that may not be tracked by the registrant.

9240.8 Smaller reporting companies are NOT required to provide a tabular disclosure of contractual arrangements.

9250.2 [Reserved] (Last updated: 10/30/2020)

9250.3 There may also be circumstances where information was not material in the context of the annual results of operations but is material in the context of the interim results, and therefore that information should be discussed (e.g., seasonal aspects of the business).

9250.4 The tabular disclosure of contractual obligations is only required annually, and is not required on an interim basis. If there are material changes to information contained in the table, they may be discussed in the narrative during the interim period.

9270.1 SAB Topic 11M provides disclosure guidance for registrants regarding recently issued accounting standards that have not yet been adopted. The SAB highlights the types of disclosures that should be considered by registrants in MD&A and in the financial statements. It is generally not necessary to provide duplicative disclosure in the MD&A and financial statements, nor is it necessary to provide disclosure for accounting standards that will not apply to a registrant’s financial statements. Registrants should exercise judgment consistent with the SAB in determining the nature, extent, and location of the disclosure.

9270.2 EGCs should also follow Section 10230.3.

9410.2 The requirements of Item 5 of Form 20-F are as follows:

1. Operating results — Item 5.A.
2. Liquidity and capital resources — Item 5.B.
3. Research and development, patents and licenses, etc. — Item 5.C.
4. Trend information — Item 5.D.
5. Off-balance sheet arrangements — Item 5.E.
6. Tabular disclosure of contractual obligations — Item 5.F.
7. Safe harbor — Item 5.G.

9410.3 The discussion should focus on the primary financial statements in the document. References to the reconciliation to U.S. GAAP and a discussion of differences between home-country GAAP and U.S. GAAP should be provided to the extent they are necessary for an understanding of the financial statements as a whole. [Instruction 2 to Item 5 of Form 20-F]

9410.4 Issuers that file financial statements under IFRS as issued by the IASB without a reconciliation to U.S. GAAP are not required to address U.S. GAAP in their MD&A. Where Item 5 refers to a specific FASB pronouncement, the issuer should provide disclosure that satisfies the objective of the disclosure requirement. [Release No. 33-8879]

9410.5 The instructions to Item 5 of Form 20-F specifically refer to the SEC's 1989 interpretive release on MD&A disclosure. [Release No. 33-6835] The SEC’s 2003 interpretive release on MD&A [Release No. 33-8350] indicates that it applies to Form 20-F filers as well.

9410.6 The requirement under Item 5.C. of Form 20-F is the only one that does not have a direct correlation to the requirements in S-K 303. For research and development (R&D), disclosure should be provided in Form 20-F of the R&D policies over the last three years. (Last updated: 10/30/2020)

9510.2 Estimates related to goodwill impairment testing are commonly considered critical by registrants. As a result, the staff has developed guidance regarding these disclosures with the objective of ensuring that investors are provided with information that allows for an assessment of the probability of a future material impairment charge. Registrants should consider providing the disclosures outlined in Section 9510.3 in order to comply with the requirements of S-K 303(a)(3)(ii), which requires a description of a known uncertainty. Additional guidance appears in Section V of Release 33-8350, which states that under the existing MD&A disclosure requirements, a company should address material implications of uncertainties associated with the methods, assumptions and estimates underlying the company's critical accounting measurements.

9510.3 Registrants should consider providing the following disclosures for each reporting unit that is at risk of failing step one of the impairment test (defined in ASC 350):

1. The percentage by which fair value exceeded carrying value as of the date of the most recent test;
2. The amount of goodwill allocated to the reporting unit;
3. A description of the methods and key assumptions used and how the key assumptions were determined;
4. 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
5. A description of potential events and/or changes in circumstances that could reasonably be expected to negatively affect the key assumptions.

9510.4 A registrant need not provide these disclosures if the registrant asserts and discloses that material goodwill does not exist at reporting units that are at risk of failing step one or that no reporting units are at risk. Registrants should consider disclosing the supporting rationale if material goodwill is allocated to a reporting unit that is at risk, but disclosure is deemed unnecessary.

9520.1 Estimates used to determine share-based compensation are often considered critical by companies going public. In particular, estimating the fair value of the underlying shares can be highly complex and subjective because the shares are not publicly traded. The staff will consider if a company performing these estimates is providing the following critical accounting estimate disclosures in its IPO prospectus:

1. The methods that management used to determine the fair value of the company’s shares and the nature of the material assumptions involved. For example, companies using the income approach should disclose that this method involves estimating future cash flows and discounting those cash flows at an appropriate rate.
2. The extent to which the estimates are considered highly complex and subjective.
3. The estimates will not be necessary to determine the fair value of new awards once the underlying shares begin trading.

Companies may cross-reference to the extent that this, or other material information relevant to share-based compensation, is provided elsewhere in the prospectus.

9520.2 The staff may issue comments asking companies to explain the reasons for valuations that appear unusual (e.g., unusually steep increases in the fair value of the underlying shares leading up to the IPO). These comments are intended to elicit analyses that the staff can review to assist it in confirming the appropriate accounting for the share-based compensation, not for the purpose of requesting changes to disclosure in the MD&A or elsewhere in the prospectus.

9520.3 The staff will also consider other MD&A requirements related to share-based compensation, including known trends or uncertainties including, but not limited to, the expected impact on operating results and taxes.

9610.2 Disclosure of the following may be necessary, where related party transactions are material:

1. The business purpose of the arrangement;
2. Identification of the related parties transacting business with the registrant;
3. How transaction prices were determined by the parties;
4. If disclosures represent that transactions have been evaluated for fairness, a description of how the evaluation was made; and
5. Any ongoing contractual or other commitment as a result of the arrangement.

9610.3 Consideration should also be given to whether disclosure is necessary about parties that fall outside of the definition of "related parties" set forth in ASC-MG, but with whom the registrant has a relationship that enables the parties to negotiate terms of material transactions that may not be available for other, more clearly independent, parties on an arm's-length basis. An example of this type of entity might be a company established and operated by former management of the registrant.

Disclosure should be provided when an investor might not be able to understand the registrant's reported results of operations without a clear explanation of these arrangements and relationships.

9820.1 S-X 3-10 (a)permits the omission of separate financial statements of subsidiary issuers and guarantors of guaranteed debt or debt-like securities when certain conditions are met, including that the parent company provides supplemental financial and non-financial disclosures about the subsidiary issuers and/or guarantors and the guarantees (see Section 2500). There is no requirement for the results of operations as presented in these supplemental financial disclosures to be discussed. However, S-X 13-01 requires certain information about the issuers, guarantors, and guarantees to be disclosed. If, for example, there are factors that may affect payments to holders of the guaranteed security, such as contractual or statutory restrictions on dividends, or if the information presented in the supplemental financial disclosures indicates that trends for the issuers and guarantors are materially different than that of the consolidated entity, this should be discussed in the liquidity section of MD&A.

9820.2 If separate financial statements of an issuer or guarantor are filed because it does not qualify for relief under S-X 3-10, then MD&A is required.

9820.3 [Reserved].

9830.2 Similarly, registration and proxy statements that include annual financial statements that have been retroactively revised to reflect revised segment reporting, with the revision taking place after the year-end balance sheet date, should include a revised MD&A based on the revised segmental footnote disclosure. MD&A should address the change in segmental presentation, and explain why the chief operating decision maker has changed how they make decisions about the allocation of resources or the assessment of performance. The registrant should discuss the results of operations on a segmental basis and related trends based on the revised segmental disclosures included in the restated financial statements.

9830.3 Registration and proxy statements that include annual financial statements that have been retroactively revised to reflect the application of a different accounting principle in accordance with ASC 250 should also include a revised MD&A if the changes are material to the previously reported results of operations.