The Registrant has requested confidential treatment of this draft registration statement and associated correspondence
pursuant to Rule 83 of the Securities and Exchange Commission.
New York Washington DC | Paris Madrid Tokyo Beijing Hong Kong | |||||
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| Alan F. Denenberg | ||||||
Davis Polk & Wardwell LLP 1600 El Camino Real | 650 752 2004 tel 650 752 3604 fax alan.denenberg@davispolk.com | |||||
January 10, 2020
U.S. Securities and Exchange Commission
Division of Corporation Finance
100 F Street, N.E.
Washington, D.C. 20549
| Attention: | Ms. Brittany Ebbertt |
Mr. Craig Wilson
Mr. Matthew Crispino
Ms. Jan Woo
| Re: | PF2 SpinCo LLC Submitted December 17, 2019 CIK No. 0001790930 |
Ladies and Gentlemen:
On behalf of PF2 SpinCo, Inc. (formerly PF2 SpinCo LLC)1 (the “Company”), we are submitting this letter in response to comments from the Staff (the “Staff”) of the Securities and Exchange Commission (the “Commission”) received by letter dated December 31, 2019 (the “Comment Letter”) relating to the above-referenced draft registration statement on FormS-4 and FormS-1 of the Company, confidentially submitted December 17, 2019 (the “Draft Registration Statement”). The Company is concurrently confidentially submitting a revised draft registration statement on FormS-4 and FormS-1 (the “Revised Draft Registration Statement”), including changes in response to the Staff’s comments.
We are responding to comments from the Staff received in the Comment Letter. For ease of review, we have set forth below in italics each of comments number 1 through 3 in the Comment Letter, together with the Company’s responses thereto. All page references in the Company’s responses are to the prospectus—offer to exchange included in the Revised Draft Registration Statement. All capitalized terms used and not otherwise defined herein shall have the meanings set forth in the Revised Draft Registration Statement.
1 The Revised Draft Registration Statement reflects the Company’s conversion from a Delaware limited liability company to a Delaware corporation on December 27, 2019.
The Registrant has requested confidential treatment of this draft registration statement and associated correspondence
pursuant to Rule 83 of the Securities and Exchange Commission.
| 2 | January 10, 2020 |
In addition, as discussed orally with the Staff, the Company hereby supplementally confirms that Change Healthcare LLC intends to reflect changes responsive to comments number 7 and 8 in the Staff’s letter dated November 27, 2019 in its financial statements for all future periods, beginning with the unaudited interim consolidated financial statements for the nine months ended December 31, 2019, which will be included in a futurepre-effective amendment to the registration statement.
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The Registrant has requested confidential treatment of this draft registration statement and associated correspondence
pursuant to Rule 83 of the Securities and Exchange Commission.
| 3 | January 10, 2020 |
The Transactions
Background of the Transactions, page 290
| 1. | We note your response to prior comment 3. Please revise your disclosure to state that the parties did not have substantive discussions regarding alternatives to the Reverse Morris Trust structure for a Qualified McKesson Exit. |
Response: The Company has revised the disclosure on page 291 of the prospectus—offer to exchange to state that the parties did not have substantive discussions regarding alternatives to the Reverse Morris Trust structure for a Qualified McKesson Exit.
Ownership of Change Healthcare Inc. Common Stock, page 347
| 2. | Please update the table in this section to disclose the beneficial ownership of Change Healthcare Inc. common stock as of the latest practicable date. |
Response: The Company has revised the disclosure on page 345 of the prospectus—offer to exchange to disclose the beneficial ownership of Change Healthcare Inc. common stock as of January 7, 2020.
Change Healthcare LLC
Notes to Condensed Consolidated Financial Statements
3. Revenue Recognition, pageF-135
| 3. | We note your response to prior comment 9. Please revise your disclosure to clarify the fact that you only use the directly observable historical prices approach to determine substantially all of your standalone selling prices pursuant to ASC606-10-50-20(c). |
Response: The Company acknowledges the Staff’s comment and advises the Staff that it is providing supplementally herewith a version of footnote 3 to the unaudited interim consolidated financial statements of Change Healthcare LLC for the six months ended September 30, 2019 (attached asAppendix A hereto) that has been revised to clarify that Change Healthcare LLC uses the directly observable historical prices approach to determine substantially all of its standalone selling prices. The version of footnote 3 attached as Appendix A hereto also reflects the changes responsive to comments number 7 and 8 in the Staff’s letter dated November 27, 2019. The Company respectfully advises the Staff that since Change Healthcare LLC has already issued unaudited interim consolidated financial statements of Change Healthcare LLC for the three months ended June 30, 2019 and the three and six months ended September 30, 2019 in quarterly reports on Form10-Q filed on August 14, 2019 and November 14, 2019, respectively, the Company hereby supplementally confirms that Change Healthcare LLC intends to reflect these responsive changes in its financial statements for all future periods, beginning with the unaudited interim consolidated financial statements for the nine months ended December 31, 2019, which will be included in a futurepre-effective amendment to the registration statement.
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The Registrant has requested confidential treatment of this draft registration statement and associated correspondence
pursuant to Rule 83 of the Securities and Exchange Commission.
| 4 | January 10, 2020 |
We appreciate your assistance with this matter. Please do not hesitate to contact me at (650)752-2004 or alan.denenberg@davispolk.com or Jason Bassetti at (650)752-2071 or jason.bassetti@davispolk.com with any questions or comments regarding this correspondence.
| Very truly yours, |
| /s/ Alan F. Denenberg |
| Alan F. Denenberg |
Enclosure:
Revised footnote 3 to the unaudited interim consolidated financial statements of Change Healthcare LLC for the six months ended September 30, 2019
| cc: | Paul A. Smith, President and Secretary, PF2 SpinCo, Inc. |
Via EDGAR and overnight delivery.
The Registrant has requested confidential treatment of this draft registration statement and associated correspondence
pursuant to Rule 83 of the Securities and Exchange Commission.
| 5 | January 10, 2020 |
Appendix A
Revised footnote 3 to the unaudited interim consolidated financial statements of
Change Healthcare LLC for the six months ended September 30, 2019
3. Revenue Recognition
The Joint Venture generates most of its solutions revenue by using technology solutions (generally Software as a Service (“SaaS”)) to provide services to its customers that automate and simplify business and administrative functions for payers, providers, pharmacies, and channel partners and through the licensing of software, software systems (consisting of software, hardware and maintenance support) and content.
The Joint Venture recognizes revenue when the customer obtains control of the good or service through the Joint Venture satisfying a performance obligation by transferring the promised good or service to the customer.
Principal Revenue Generating Products and Services
Content license subscriptions and time-based software—The Joint Venture’s content license subscriptions and time-based software arrangements provide a license to use a software for a specified period of time. At the end of the contractual period, the customer either renews the license for an additional term or ceases to use the software. Software licenses are typically delivered to the customer with functionality that the customer can benefit from the software on its own or together with readily available resources. As contracts for these solutions generally do not price individual components separately, the Joint Venture allocates the transaction price to the license and ongoing support performance obligations based on standalone selling price (“SSP”), primarily determined by historical value relationships between licenses and ongoing support and updates. Revenue allocated to content license subscriptions and time-based software license agreements is generally recognized at thepoint-in-time of delivery of the license or the content update upon transfer of control of the underlying license to the customer. Generally, software implementation fees are recognized over the implementation period through an input measure of progress method. Revenue allocated to maintenance and support is recognized ratably over the period covered by the agreements, as passage of time represents a faithful depiction of the transfer of these services. In some cases, software arrangements provide licenses to several software applications that are highly integrated with the implementation services and software updates and cannot function separately. The bundle is a single performance obligation since the individually promised goods and services are not distinct in the context of the contract because the related implementation services significantly modify and customize the software and the updates provided to the integrated software solution are critical to the software’s utility. The related revenue is recognized on a straight-line basis, ratably over the contractual term due to the frequency and criticality of the updates throughout the license period. Revenue for content license subscriptions and time-based software, which is included in solutions revenue, is generated by the Software & Analytics segment.
Contingent fee services—The Joint Venture provides services to customers in which the transaction price is contingent on future occurrences, such as savings generated or amounts collected on behalf of its customers through the delivery of its services. In some cases, the Joint Venture performs services in advance of invoicing the customer, thereby creating a contract asset. Revenue in these arrangements is estimated and constrained until the Joint Venture determines that it is probable a significant revenue reversal will not occur, and variable consideration is allocated to the performance obligation for which the Joint Venture earns a contingent fee. The Joint Venture uses the expected value method when estimating variable consideration, as the Joint Venture has a large number of contracts with similar characteristics and considers a portfolio of data from other similar contracts to form its estimate of expected value. Revenue for contingent fee services, which is included in solutions revenue, is generated by the Software & Analytics and Technology-enabled Services segments.
Perpetual software licenses—The Joint Venture’s perpetual software arrangements provide a license for a customer to use software in perpetuity. Software licenses are typically delivered to the customer with functionality from which the customer can benefit from the license on its own or together with readily available resources. Perpetual software arrangements are recognized at the time of delivery or through an input measure of progress method over the installation period if the arrangements require significant production or modification or customization of the software. Contracts accounted for through an input measure of progress method are generally measured based on the ratio of labor hours incurred to date to total estimated labor hours to be incurred. Software implementation fees are recognized as the work is performed or under the input method for perpetual software. Hardware revenues are generally recognized upon delivery. Maintenance is recognized ratably over the term of the agreement as passage of time represents a faithful depiction of the transfer of these
The Registrant has requested confidential treatment of this draft registration statement and associated correspondence
pursuant to Rule 83 of the Securities and Exchange Commission.
| 6 | January 10, 2020 |
services. License, implementation, hardware and maintenance revenue for these arrangements, which is included in solutions revenue, is generated by the Software & Analytics segment.
Professional services—The Joint Venture provides training and consulting services to its customers, and the services may be fixed fee or time and materials based. Consulting services that fall outside of the standard implementation services vary depending on the scope and complexity of the service requested by the customer. Consulting services are deemed to be capable of being distinct from other products and services, and the services are satisfied either at a point of time or over time based on delivery and are recognized as solutions revenue in the Software & Analytics and Technology-enabled Services segments. Training services are usually provided as an optional service to enhance the customer’s experience with a software product or provides additional education surrounding the general topic of the solution. Training services are capable of being distinct from other products and services. The Joint Venture treats training services as a distinct performance obligation, and they are satisfied at a point of time and recognized as solutions revenue in the Software & Analytics and Technology-enabled Services segments.
Transaction processing services—The Joint Venture provides transaction processing (such as claims processing) services to hospitals, pharmacies and health systems via a cloud-based (SaaS) platform. The promised service is to stand ready to process transactions for our customers over the contractual period on an as needed basis. The revenue related to these services is recognized over time as the transactions are processed, and the revenue is recognized over the individual days in which the services are performed. Revenue for these services is recognized as solutions revenue in the Software & Analytics, Network Solutions, and Technology-enabled Services segments, with the exception of revenue related to postage that is generated through the delivery of certain of these services. Postage revenue is further discussed below and is separately presented on the statement of operations. Any fixed annual fees and implementation fees are recognized ratably over the contract period.
Hosted solutions and software as a service (“SaaS”)—The Joint Venture enters into arrangements whereby the Joint Venture provides the customer access to a Joint Venture-owned software solution, which are generally marketed under annual and multi-year arrangements. The customer is only provided “access” (not a license) to the software application. In these arrangements, the customer does not purchase equipment nor does the customer take physical possession of the software. The related revenue is recognized ratably over the contracted term. For fixed fee arrangements, revenue recognition begins afterset-up and implementation are complete. Forper-transaction fee arrangements, revenue is recognized as transactions are processed beginning on the service start date. Revenue for hosted solutions and SaaS, which is included in solutions revenue, is generated by the Software & Analytics, Network Solutions, and Technology-enabled Services segments.
Contract Balances
The Joint Venture’s payment terms vary by customer and product type. For certain products or services, the Joint Venture requires upfront payments before control of the product or service has transferred to the customer. For other products and services, the Joint Venture invoices the customer in arrears after providing the products or services. In addition, for certain contingent fee services, customers are billed in arrears, typically based upon a percentage of collections the Joint Venture makes on the customer’s behalf.
Under the new revenue standard, the Joint Venture generally recognizes a contract asset when revenue is recognized in advance of invoicing on a customer contract, unless the right to payment for that revenue is unconditional (i.e. requiring no further performance and only the passage of time). If a right to payment is determined to meet the criteria to be considered ‘unconditional’, then the Joint Venture will recognize a receivable.
There were no impairment losses recognized on accounts receivable or contract assets during the three and six months ended September 30, 2019.
The Joint Venture records deferred revenues when billings or payments are received from customers in advance of its performance. Deferred revenue is generally recognized when transfer of control to customers occurs. The deferred revenue balance is driven by multiple factors, including the frequency of renewals, invoice timing, and invoice duration. As of September 30, 2019, the Joint Venture expects 94% of the deferred revenue balance to be recognized in one year or less, and approximately $328,000 of the beginning period balance was recognized during the first six months of fiscal 2020.
Costs to Obtain or Fulfill a Contract
The Registrant has requested confidential treatment of this draft registration statement and associated correspondence
pursuant to Rule 83 of the Securities and Exchange Commission.
| 7 | January 10, 2020 |
Sales commissions and certain other incentive payments (e.g., bonuses that are contingent solely on obtaining a contract or a pool of contracts) earned by the Joint Venture’s sales organization are capitalized as incremental costs to obtain a contract. The Joint Venture typically does not offer commissions on contract renewals. Decremented commissions upon renewal (i.e., non-commensurate with initial commissions) are offered to the Joint Venture’s sales associates for certain customers and are not material. Under ASC 606, all commissions and other qualifying incentive payments capitalized are amortized over an expected period of benefit defined as the initial contract term plus anticipated renewals. In contrast, under ASC 605 these capitalized costs were amortized over the specific revenue contract terms, which are typically 12 to 60 months. In making the significant judgment in determining the appropriate period of benefit, the Joint Venture evaluated both qualitative and quantitative factors such as the expected customer relationship period and technology obsolescence. In addition, prior to solution go-live, the Joint Venture incurs certain contract fulfillment costs primarily related to SaaS setup for our clients. These costs are capitalized to the extent they are directly related to a contract, are recoverable, and create a resource used to deliver the Joint Venture’s SaaS services. Capitalized costs to fulfill a contract are amortized over the expected period of benefit.
At September 30, 2019, the Joint Venture had capitalized costs to obtain a contract of $12,407 in prepaid and other current assets and $67,426 in other noncurrent assets. During the three and six months ended September 30, 2019, the Joint Venture recognized $5,098 and $9,207 of amortization expense related to such capitalized costs, respectively, which is included in the total operating expenses. At September 30, 2019, the Joint Venture had capitalized costs to fulfill a contract of $1,383 in prepaid and other current assets and $8,571 in other noncurrent assets. During the three and six months ended September 30, 2019, the Joint Venture recognized $313 and $609 of amortization expense, respectively, related to such capitalized costs, which is included in cost of operations.
Postage Revenues
Postage revenues are the result of providing delivery services to customers in the Joint Venture’s payment and communication solutions. Postage revenues are generally billed as a pass-through cost to the Joint Venture’s customers. The service is part of a combined performance obligation with the printing and handling services provided to the customer because the postage services are not distinct within the context of the contract. The Joint Venture presents Postage Revenue separately from Solutions Revenue on the consolidated statements of operation as it makes the financial statements more informative for the users. The revenue related to the combined performance obligation of the postage, printing, and handling service is recognized as the transactions are processed, and the revenue is recognized over the individual days in which the services are performed.
Arrangements with Multiple Performance Obligations
The Joint Venture engages in customer arrangements which may include multiple performance obligations, such as any combination of software, hardware, implementation, SaaS-based offerings, consulting services, or maintenance services. For such arrangements, the Joint Venture allocates revenues to each performance obligation on a relative standalone selling price basis.For substantially all such arrangements, aAperformance obligation’s standalone selling price is determined based on the directly observable prices charged to customers., when available or estimated using other methodsWhen directly observable prices charged to customers are not available, other methods are usedsuch as the adjusted market assessment approach, the expected cost plus a margin approach, or other approaches in cases where distinct performance obligations are not sold separately but instead sold at a bundled price. For performance obligations with historical pricing that is highly variable, the residual approach is used. Such instances primarily relate to the Joint Venture’s perpetual software arrangements in which the Joint Venture sells the same products to different customers for a broad range of amounts.
Remaining Performance Obligations
The aggregate amount of transaction price allocated to performance obligations that are unsatisfied (or partially unsatisfied) for executed contracts includes deferred revenue and other revenue yet to be recognized from non-cancellable contracts. As of September 30, 2019, the Joint Venture’s total remaining performance obligations approximated $1,347,000, of which approximately 52% is expected to be recognized over the next twelve months, and the remaining 48% thereafter.
In this balance, the Joint Venture does not include the value of unsatisfied performance obligations related to those contracts for which it recognizes revenue at the amount for which it has the right to invoice for services performed. Additionally, this balance does not include revenue related to performance obligations that are part of a contract with an original expected duration of one year or less. Lastly, this balance does not include
The Registrant has requested confidential treatment of this draft registration statement and associated correspondence
pursuant to Rule 83 of the Securities and Exchange Commission.
| 8 | January 10, 2020 |
variable consideration allocated to the individual goods or services in a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. Examples includes variable fees associated with transaction processing and contingent fee services.
Disaggregated Revenue
The Joint Venture disaggregates the revenue from contracts with customers by operating segment as it believes doing so best depicts how the nature, amount, timing and uncertainty of the Joint Venture’s revenue are affected by economic factors. See Note 9,Segment Reportingfor the total revenue disaggregated by operating segment for the three and six months ended September 30, 2019 and 2018.
The Joint Venture’s total revenue by disaggregated revenue source was generally consistent for each reportable segment for the three and six months ended September 30, 2019 and 2018.
In addition to disaggregating revenue by operating segment, the Joint Venture disaggregates revenue between revenue that is recognized over time and revenue that is recognized at a point in time. Approximately 97.0% of revenue was recognized over time and approximately 3.0% of revenue was recognized at a point in time for the three months ended September 30, 2019. For the six months ended September 30, 2019, 95.0% of revenue was recognized over time and 5.0% was recognized at a point in time.
Customer Incentives
Certain customers, which include the Joint Venture’s channel partners, may receive cash-based incentives or rebates based on actual sales and achievement of a cumulative level of sales, which are accounted for as variable consideration. The Joint Venture considers these amounts to be consideration payable to the customer, and therefore, the Joint Venture estimates these amounts based on the expected amount to be provided to customers and reduces the transaction price accordingly.
Practical Expedients and Exemptions
The Joint Venture has elected to utilize either the right to invoice practical expedient or the series-based variable consideration allocation framework for most transaction processing services not subject to contingencies. The Joint Venture also has elected to exclude sales taxes and other similar taxes from the measurement of the transaction price in contracts with customers. Therefore, revenue is recognized net of such taxes.
In certain customer arrangements with customers, the Joint Venture determined there are certain promised goods or services which are immaterial in the context of the contract from both a quantitative and qualitative perspective, and therefore, the goods and services are disregarded when assessing the performance obligations in the customer arrangement.
The Joint Venture has elected to apply the significant financing practical expedient, and as a result, the Joint Venture will not adjust the promised amount of consideration in a customer contract for the effects of a significant financing component when the period of time between when the Joint Venture transfers a promised good or service to a customer and when the customer pays for the good or service will be one year or less.