With the current quarter coming to a close, companies will soon begin preparing for yet another complex reporting cycle. As the novel coronavirus (COVID-19) and economic uncertainty continue to impact many businesses, companies will need to consider how to reflect management's understanding of the current and expected impact of COVID-19 in their public disclosures. In this Alert, we summarize the recently updated statements and guidance from the U.S. Securities and Exchange Commission (SEC), the status of the SEC's temporary filing relief granted in March 2020, and some preliminary considerations for the upcoming reporting cycle.
SEC Disclosure Guidance
On June 23, 2020, the SEC's Division of Corporation Finance (Division) issued CF Disclosure Guidance: Topic No. 9A, Coronavirus (COVID-19) – Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources (Topic 9A), which supplements the Division's CF Disclosure Guidance: Topic No. 9, Coronavirus (COVID-19) (Topic 9) issued on March 25, 2020 (discussed in our previous Alert).
The Division issued Topic 9 near the end of last quarter in the midst of the broad implementation of shelter-in-place/stay-at-home orders in the United States and in other jurisdictions around the world. Given this timing, Topic 9 encouraged companies to assess and disclose the evolving impact of COVID-19 in their public disclosures, noting that "the effects COVID-19 has had on a company, what management expects its future impact will be, how management is responding to evolving events, and how it is planning for COVID-19-related uncertainties can be material to investment and voting decisions." Topic 9A expands on the guidance provided in Topic 9, urging 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." In particular, Topic 9A focuses on the following three areas:
- Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A)—Operations, Liquidity, and Capital Resources. Topic 9A highlights two types of actions related to operations, liquidity, and capital resources that may require further analysis and disclosure:
While the Division notes that some companies have made disclosures relating to these types of matters in their earnings releases, the Division encourages "companies to evaluate whether any of the information, in light of its potential materiality, should also be included in MD&A."
- operational adjustments that companies have made or are making in response to the COVID-19 pandemic, which may include, among other things, teleworking, supply chain adjustments, and other adjustments to meet health and safety guidelines for a safe return to work; and
- financing arrangements that companies have entered into in response to the effects of COVID-19 on their business, which may include, among other things, drawing down or entering into new credit facilities, accessing capital through the private or public markets, and entering into supplier finance programs.
To assist companies as they analyze their specific facts and circumstances and assess their disclosure obligations, Topic 9A includes a non-exhaustive list of questions for companies to consider in their analysis, including, for example, consideration of the material operational challenges the company is facing, overall liquidity, access to capital and compliance with existing debt covenants, existing and altered terms with suppliers and customers, and consideration and assessment of events occurring after quarter end, but prior to filing that may have a material effect on liquidity. Companies should review carefully Topic 9A and these questions.
- Government Assistance—CARES Act. Companies that have received federal assistance, whether in the form of loans or tax relief, are advised to "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 and critical estimates and assumptions." Topic 9A includes some questions for companies to consider in assessing their disclosure obligations, including, for example, relating to the impact of the loans on the company's financial condition, liquidity, and capital resources, the material terms of the loans or assistance, any limitations on the company's ability to seek other sources of financing, any material impacts of the restrictions imposed by receipt of the federal assistance, the impact of tax relief provisions on liquidity, and whether receipt of the federal assistance will involve new material accounting estimates or judgments or materially change prior critical accounting estimates.
- Going Concern. Topic 9A reminds companies that "[m]anagement should consider whether conditions and events, taken as a whole, raise 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." In cases where "there is substantial doubt about a company's ability to continue as a going concern or the substantial doubt is alleviated by management's plans, management should provide the appropriate respective disclosures in the financial statements" and consider whether additional MD&A disclosure may be needed.
For ease of reference, the list of questions from Topic 9A for each of the foregoing topics has been reproduced in its entirety in the Appendix to this Alert.
SEC Chief Accountant Statement
On June 23, 2020, Sagar Teotia, the SEC's Chief Accountant, issued a Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19 (the June Statement). This Statement follows Teotia's April 3, 2020 Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19, which, among other things, recognized the challenges that companies would likely face in making significant judgments and estimates in light of the evolving nature of COVID-19 and affirmed that the SEC's Office of the Chief Accountant (OCA) would not object to well-reasoned judgments that entities have made in respect of these significant judgments and estimates. In his June Statement, Teotia covered a variety of topics, including, among others:
- Significant Judgments and Estimates. Teotia reaffirms that the OCA would not object to well-reasoned judgments made by companies but added that "[c]ompanies should ensure that significant judgments and estimates are disclosed in a manner that is understandable and useful to investors, and that the resulting financial reporting reflects and is consistent with the company's specific facts and circumstances."
- Disclosure Controls and Procedures and ICFR. Teotia stresses the importance of disclosure controls and procedures and internal control over financial reporting (ICFR), recognizing that some companies have had to adapt their processes to the changing environment. He reminded companies "that if any change materially affects, or is reasonably likely to materially affect, an entity's ICFR, such change must be disclosed in quarterly filings in the fiscal quarter in which it occurred (or fiscal year in the case of a foreign private issuer)."
- Going Concern. The June Statement includes a discussion similar to that found in Topic 9A relating to a company's ability to continue as a going concern, emphasizing that management's review of the company's ability to continue as a going concern should be done in each reporting period, including interim periods, and discussing some of the more technical aspects of that analysis for both management and auditors.
- Recent Issuer Questions and Consultations with OCA Staff. The June Statement discusses OCA engagements with issuers during the prior quarter, including on the financial reporting implications of the CARES Act, debt modifications, hedging, consolidation, business combinations, lease concessions, revenue recognition, and income taxes. The June Statement also reminds stakeholders that OCA staff is available for consultation on these complex and evolving issues.
- Importance of Audit Committees. In one of the final points in the June Statement, Teotia emphasizes the "key role" that audit committees of public companies play in the financial reporting system, adding that the OCA "will continue to be proactive in engaging with audit committee members to understand current market developments as well as to solicit their perspectives on improving the oversight of financial reporting."
Expiring Temporary Relief from Certain Filing Obligations
On March 25, 2020, the SEC issued an Order granting temporary relief to publicly-traded companies from certain filing obligations, including Forms 10-Q and 10-K, subject to certain conditions (discussed in our previous Alert). These conditions included, generally, that the company must be unable to meet the filing deadline due to circumstances related to COVID-19, the company must furnish a Form 8-K (or Form 6-K, if applicable) with certain required disclosures no later than the original filing deadline, the company must make the filing no later than 45 days after the original due date, and the company must include certain disclosures in its delayed filing. The Order applies to filing obligations that are due on or before July 1, 2020, unless extended by the SEC.
On June 26, 2020, SEC Chairman Jay Clayton, and the Directors of the Division of Corporation Finance, Division of Investment Management, and Division of Trading and Markets, issued An Update on the Commission's Targeted Regulatory Relief to Assist Market Participants Affected by COVID-19 and Ensure the Orderly Function of our Markets. Among other things, the Division states that it "believes that further extension of this [temporary relief from certain public company filing obligations] is unnecessary." Therefore, as of the date of this Alert and based on the most recent update from SEC leadership, it is unlikely that the time period covered by this Order will be extended beyond July 1, 2020, and companies will no longer be able to rely on this relief for their current quarter filings. However, companies may continue to file a Form 12b-25, where applicable, if they are unable to file their quarterly report on time.
Preliminary Disclosure Considerations
As the current quarter winds down, we wanted to highlight some preliminary disclosure considerations for the current quarter.
- Guidance. Many companies withdrew or suspended guidance this past quarter. Whether a company will be able to provide guidance for the upcoming quarter with reasonable confidence will be a case-by-case determination. If a company does not believe it can provide a reasonable guidance range, companies should consider providing qualitative information about trends and the factors and uncertainties that are expected to affect financial performance. Companies may also consider providing wider ranges or limiting guidance to measures that can be reasonably forecasted while providing qualitative information about other financial measures.
- Risk Factors. Many public companies added one or more COVID-19-related risk factors in last quarter's filings. For current quarter reporting, companies should assess any material changes from the previously disclosed risk factors. Given the changing nature of the COVID-19 pandemic, companies should review their risk factors, including the COVID-19-related risk factors, in light of more recent developments and the specific impacts of COVID-19, if any, on the company. In particular, companies should review whether previously disclosed hypothetical risks have actually occurred and had an effect on the business or if new risks have been identified, and update language in risk factors accordingly.
- Forward-Looking Statements. On April 8, 2020, SEC leadership issued a statement entitled The Importance of Disclosure – For Investors, Markets and Our Fight Against COVID-19, urging companies to provide more disclosure and, in particular, more forward-looking disclosure (discussed in our previous Alert). While investors and SEC leadership may desire more forward-looking information, companies should be deliberate in determining what forward-looking disclosures it can or should make. To the extent companies provide forward-looking statements, they should include carefully drafted safe harbor language to cover all such statements.
- Critical Accounting Policies and Estimates. Companies should consider any material changes to their critical accounting policies and estimates in light of COVID-19. In addition to the financial reporting challenges discussed in Topic 9A and the June Statement (e.g., relating to the CARES Act, the ability of a company to continue as a going concern), other matters that may require changes to significant judgments and estimates include, among others, goodwill and asset impairment testing, ability to collect receivables, ability to realize deferred tax assets prior to expiration, and revenue recognition. To the extent that there are any material changes to a company's critical accounting policies and estimates, the company will need to describe and disclose those material changes in their quarterly filing.
- ICFR. As noted in the June Statement, some companies have had to make changes to their internal processes due to work from home and other related circumstances. If there have been any changes in a company's internal control over financial reporting in the current quarter that have materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting, then the company is required to disclose these changes in its quarterly filing.
- KPIs and Non-GAAP Measures.
- KPIs. On January 30, 2020, the SEC provided guidance on key performance indicators (KPIs) and metrics in MD&A (discussed in our previous Alert). This guidance provides useful information to those companies that may be adding KPIs or changing the methodology used to calculate KPIs as a result of this pandemic or other reasons. For those companies adding new KPIs, disclosure of additional information to provide adequate context for an investor to understand the metric should be considered. In addition, companies should consider whether to disclose the underlying estimates or assumptions, or the calculation of the metric, particularly if doing so would help make the use of the metric not materially misleading. For those companies revising the methodology of existing KPIs, additional disclosures, to the extent material, should be considered, including, among others, the differences in the methodology used in prior periods, the reasons for the change, and the effects of the change on the metric disclosed in prior periods and the current period.
In addition, in Topic 9, the Division noted that if a company presents a performance metric that adjusts for or explains the impact of COVID-19, then the company should highlight why management found the metric useful and how the metric helps investors assess the impact of COVID-19 on the company's financial position and results of operations (as further discussed in our previous Alert).
- Non-GAAP measures. In Topic 9, the Division also addressed non-GAAP measures. Similar to the use of metrics to adjust for or explain the impact of COVID-19, the Division noted that if a company presented a non-GAAP measure to adjust for or explain the impact of COVID-19, then the company should highlight why management found the measure useful and how the measure helps investors assess the impact of COVID-19 on the company's financial position and results of operations.
Topic 9 also permits companies to reconcile a non-GAAP financial measure to preliminary GAAP results if the GAAP financial measure is unavailable at the time of the earnings release as a result of COVID-19-related adjustments that may require additional analysis and information to complete. If a company reconciles a non-GAAP financial measure to a provisional or estimated range of GAAP financial measures, in reliance on Topic 9, then the company should explain, to the extent practicable, why the line item or accounting is incomplete, and what additional information or analysis may be needed to complete the accounting. Companies should reconcile to GAAP results (not provisional amounts or ranges) in their Form 10-K or Form 10-Q filings.
In reviewing earnings materials and SEC filings, all other principles and requirements of non-GAAP measures continue to apply, including the prominence requirement where applicable. In particular, companies should consider whether the adjustments create prohibited individually tailored revenue measures or adjust for recurring cash operating expenses, which is also prohibited. Consultation with the company's auditors and audit committee on these matters is advisable.
- CARES Act. As discussed above, disclosures relating to any relief or assistance provided under the CARES Act, including the Paycheck Protection Program, will require thoughtful analysis and consideration. Companies should consider whether disclosures need to be made in their results of operations, liquidity and capital resources, and critical accounting policies and estimates sections of their MD&A. Of note, for accounting purposes, the SEC staff stated in Topic 9A that it "would not object to a company accounting for a loan obtained under the Paycheck Protection Program in Section 1102 of the CARES Act 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)."
Current quarter disclosure considerations will also be discussed at the upcoming SEC Roundtable on Q2 Reporting: A Discussion of COVID-19 Related Disclosure Considerations, moderated by SEC Chairman Jay Clayton. The roundtable will be webcast live on the SEC website on Tuesday, June 30, at 4:00 p.m., Eastern Daylight Time.
What to Do Now?
As companies begin preparations for the upcoming reporting cycle, there are myriad considerations for the current quarter that will reflect the impacts of the COVID-19 pandemic. Companies will be reassessing their disclosures from last quarter and making difficult disclosure decisions. In terms of preliminary considerations, companies (regardless of industry) should, among other things, 1) consider the impact of COVID-19 on all aspects of the business and ensure that the past impacts as well as trends and uncertainties that may affect future periods are fully understood, 2) review their risk factors in light of current circumstances and revise, as needed, 3) review their critical accounting policies and estimates early and engage in proactive discussions with their auditors, as needed, and 4) review their KPIs and non-GAAP measures including any adjustments therein made to ensure that the disclosures are accurate and consistent with SEC guidance and rules. For more information on recent SEC guidance and statements, the status of the SEC's temporary COVID-19 relief measures, or any related matter, please contact any member of Wilson Sonsini's public company representation practice.
Wilson Sonsini continues to monitor the global impact of COVID-19 on various industries. Wilson Sonsini's COVID-19 Client Advisory Resource is a collection of alerts, advisories, and programs—all of which are intended to help the management, boards of directors, and in-house counsel of our clients maintain key operational and business functions, despite pressing challenges related to the COVID-19 outbreak.
CF Disclosure Guidance: Topic 9A
Operations, Liquidity, and Capital Resources—Questions
- 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?
- 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—CARES Act—Questions
- 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?
- 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?