Yesterday, the staff of Corp Fin issued Disclosure Guidance: Topic No. 9A, which supplements CF Topic No. 9  with additional views of the staff regarding disclosures related to   operations, liquidity and capital resources that companies should consider as a consequence of business and market disruptions resulting from COVID-19.  You might recall that, in March, the staff issued CF Topic No. 9, which offered the staff’s views regarding disclosure considerations, trading on material inside information and reporting financial results in the context of COVID-19 and related uncertainties. (See this PubCo post.) As with the original guidance, the new supplemental guidance includes a valuable series of questions designed to help companies assess, and to stimulate effective disclosure regarding, the impact of COVID-19.  As always these days, the guidance makes clear that it represents only the views of the staff, is not binding and has no legal force or effect.

In the guidance, the staff indicates that Corp Fin is continuing to monitor companies’ disclosures about the impact and risks of COVID-19 on their businesses, financial condition and results of operations. Once again, the staff encourages companies “to provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes of management and to proactively revise and update disclosures as facts and circumstances change. These disclosures should enable an investor to understand how management and the Board of Directors are analyzing the current and expected impact of COVID-19 on the company’s operations and financial condition, including liquidity and capital resources.”

Operations, Liquidity and Capital Resources

The guidance suggests that companies take a harder look at their disclosure obligations in connection with material operational changes made in response to COVID-19, as well as new financing activities to address the adverse financial impact of the pandemic.  These operational adjustments might include, for example, increased telework, supply chain and distribution adjustments, and changes related to health and safety of employees, contractors and customers, including in connection with transitions back to the workplace. Even though SEC rules may not specify metrics or line item requirements for disclosure of these types of adjustments, the staff advises companies to carefully consider whether to disclose this information in the context of the SEC’s principles-based disclosure system, including “how management and the Board of Directors are assessing operational issues.”

In addition, many companies have been compelled to engage in new financing activities, such as new credit facilities or takedowns under existing facilities, capital markets transactions, supplier finance programs, and new or modified customer payment terms. Some of these activities may involve novel terms and structures. The staff advises that companies “provide robust and transparent disclosures about how they are dealing with short- and long-term liquidity and funding risks in the current economic environment, particularly to the extent efforts present new risks or uncertainties to their businesses.” The staff appears to have detected a disparity between disclosures about these activities in earnings releases and the absence thereof in MD&A and recommends that companies consider whether the information is potentially material and should also be included in MD&A.

As with the original guidance, the staff has developed a very useful set of questions for companies to consider to help evaluate their disclosure obligations, copied below in their entirety:

• “What are the material operational challenges that management and the Board of Directors are monitoring and evaluating? How and to what extent have you altered your operations, such as implementing health and safety policies for employees, contractors, and customers, to deal with these challenges, including challenges related to employees returning to the workplace? How are the changes impacting or reasonably likely to impact your financial condition and short- and long-term liquidity?
• How is your overall liquidity position and outlook evolving? To the extent COVID-19 is adversely impacting your revenues, consider whether such impacts are material to your sources and uses of funds, as well as the materiality of any assumptions you make about the magnitude and duration of COVID-19’s impact on your revenues. Are any decreases in cash flow from operations having a material impact on your liquidity position and outlook?
• Have you accessed revolving lines of credit or raised capital in the public or private markets to address your liquidity needs? Are your disclosures regarding these actions and any unused liquidity sources providing investors with a complete discussion of your financial condition and liquidity?
• Have COVID-19 related impacts affected your ability to access your traditional funding sources on the same or reasonably similar terms as were available to you in recent periods? Have you provided additional collateral, guarantees, or equity to obtain funding? Have there been material changes in your cost of capital? How has a change, or a potential change, to your credit rating impacted your ability to access funding? Do your financing arrangements contain terms that limit your ability to obtain additional funding? If so, is the uncertainty of additional funding reasonably likely to result in your liquidity decreasing in a way that would result in you being unable to maintain current operations?
• Are you at material risk of not meeting covenants in your credit and other agreements?
• If you include metrics, such as cash burn rate or daily cash use, in your disclosures, are you providing a clear definition of the metric and explaining how management uses the metric in managing or monitoring liquidity? Are there estimates or assumptions underlying such metrics the disclosure of which is necessary for the metric not to be misleading?”

• “Have you reduced your capital expenditures and if so, how? Have you reduced or suspended share repurchase programs or dividend payments? Have you ceased any material business operations or disposed of a material asset or line of business? Have you materially reduced or increased your human capital resource expenditures? Are any of these measures temporary in nature, and if so, how long do you expect to maintain them? What factors will you consider in deciding to extend or curtail these measures? What is the short- and long-term impact of these reductions on your ability to generate revenues and meet existing and future financial obligations?
• Are you able to timely service your debt and other obligations? Have you taken advantage of available payment deferrals, forbearance periods, or other concessions? What are those concessions and how long will they last? Do you foresee any liquidity challenges once those accommodations end?
• Have you altered terms with your customers, such as extended payment terms or refund periods, and if so, how have those actions materially affected your financial condition or liquidity? Did you provide concessions or modify terms of arrangements as a landlord or lender that will have a material impact? Have you modified other contractual arrangements in response to COVID-19 in such a way that the revised terms may materially impact your financial condition, liquidity, and capital resources?
• Are you relying on supplier finance programs, otherwise referred to as supply chain financing, structured trade payables, reverse factoring, or vendor financing, to manage your cash flow? Have these arrangements had a material impact on your balance sheet, statement of cash flows, or short- and long-term liquidity and if so, how? What are the material terms of the arrangements? Did you or any of your subsidiaries provide guarantees related to these programs? Do you face a material risk if a party to the arrangement terminates it? What amounts payable at the end of the period relate to these arrangements, and what portion of these amounts has an intermediary already settled for you?”

The staff notes here that supplier finance or reverse factoring programs can vary widely and often involve financial institutions as intermediaries. For these types of programs, companies will need to determine the appropriate balance sheet and cash flow classifications of obligations under the programs, which also may impact how the programs are discussed in MD&A.

• “Have you assessed the impact material events that occurred after the end of the reporting period, but before the financial statements were issued, have had or are reasonably likely to have on your liquidity and capital resources and considered whether disclosure of subsequent events in the financial statements and known trends or uncertainties in MD&A is required?”

 Government Assistance – The CARES Act 

Under the CARES Act, companies have been able to obtain various forms of financial assistance, such as loans (forgivable and not forgivable) and tax relief (e.g., deferred payroll taxes, elimination of certain NOL limitations, allowance of NOL carrybacks, acceleration of the refund schedule for AMT credits, and increases in the percentage of adjusted taxable income that can be offset by interest expense deductions). This type of relief could either reduce taxes or result in a tax refund.  The staff advises that companies receiving financial assistance should “consider the short- and long-term impact of that assistance on their financial condition, results of operations, liquidity, and capital resources,” as well as the related disclosures (e.g., MD&A and financial statements) and critical accounting estimates and assumptions. These disclosures should also provide the “required U.S. GAAP disclosures related to any assistance received under the CARES Act, including the accounting principles followed and the methods of applying those principles if they materially affect financial condition, cash flows, or results of operations and related disclosures.”

Again, the staff offers the following questions to consider in this context:

• “How does a loan impact your financial condition, liquidity and capital resources? What are the material terms and conditions of any assistance you received, and do you anticipate being able to comply with them? Do those terms and conditions limit your ability to seek other sources of financing or affect your cost of capital? Do you reasonably expect restrictions, such as maintaining certain employment levels, to have a material impact on your revenues or income from continuing operations or to cause a material change in the relationship between costs and revenues? Once any such restrictions lapse, do you expect to change your operations in a material way?
• Are you taking advantage of any recent tax relief, and if so, how does that relief impact your short- and long-term liquidity? Do you expect a material tax refund for prior periods?
• Does the assistance involve new material accounting estimates or judgments that should be disclosed or materially change a prior critical accounting estimate? What accounting estimates were made, such as the probability a loan will be forgiven, and what uncertainties are involved in applying the related accounting guidance?”

With respect to the last question, for example, the guidance notes that the staff would not object to a company’s accounting for a PPP loan “as either (i) debt pursuant to ASC 470, or (ii) as a government grant by analogy to IAS 20, provided certain conditions are met (e.g., that it is probable that the registrant will meet the terms for forgiveness of the loan).”

Going Concern Considerations

Unfortunately, for a number of companies, the adverse impact of COVID-19 has led to questions about whether the company will be able to continue as a going concern. In that event, management will need to evaluate, based on relevant conditions and events, taken as a whole, that are known and reasonably knowable at the date the financial statements are issued, whether there is “substantial doubt about the company’s ability to meet its obligations as they become due within one year after the issuance of the financial statements.” Initially, the staff advises, the evaluation should “not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented. See ASC 205-40.”  Where there is substantial doubt or the doubt is alleviated by management’s plans, the staff advises that management should provide the appropriate disclosures in the financial statements, including, as required by GAAP, disclosures about “whether there is substantial doubt about a company’s ability to continue as a going concern, the conditions and events that raise such doubt, management’s evaluation of those conditions or events, and any plans to alleviate such doubt.” (FASB ASC Topic 205-40-50)

The staff also recommends that companies consider the following questions regarding the MD&A disclosure:

• “Are there conditions and events that give rise to the substantial doubt about the company’s ability to continue as a going concern? For example, have you defaulted on outstanding obligations? Have you faced labor challenges or a work stoppage?
• What are your plans to address these challenges? Have you implemented any portion of those plans?”

Additional Information

The staff also reminds us of the discussion in Topic No. 9 regarding other disclosures, including disclosure controls and procedures and internal control over financial reporting, and refers us to SEC Chief Accountant Sagar Teotia’s Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19 (post to follow).

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