Whether to Adjust for COVID-19 in Non-GAAP Financial Measures: A Survey and Overview of First Quarter Disclosure Practices

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One of the key areas of disclosure focus for the Securities and Exchange Commission (SEC) following the emergence of the COVID-19 pandemic was the impact that the pandemic might have on the presentation of non-GAAP financial measures for public companies.  For example, when providing  disclosure guidance for how registrants should approach COVID-19-related considerations in CF Disclosure Guidance: Topic No. 9, issued by the Division of Corporation Finance on March 25, 2020 (CF Disclosure Topic 9), the Staff stated that, with respect to the disclosure of non-GAAP financial measures in the pandemic environment, “where a GAAP financial measure is not available at the time of the earnings release because the measure may be impacted by COVID-19-related adjustments,” the SEC “would not object to companies reconciling a non-GAAP financial measure to preliminary GAAP results that either include provisional amount(s) based on a reasonable estimate, or a range of reasonably estimable GAAP results.”

Nevertheless, it has been our experience (consistent with the survey results summarized below) that most registrants did not include COVID-19-related adjustments in connection with the presentation of non-GAAP financial measures in the first quarter.  This article summarizes our survey results and analyzes factors that may have impacted the determination of most registrants not to include any COVID-19-related adjustments in connection with their presentation of non-GAAP financial measures in first-quarter disclosure materials.

As part of our survey, we reviewed 55 public companies that presented Adjusted EBITDA in their earnings release filed in the period from April 1, 2020, to May 14, 2020.  We chose to focus on Adjusted EBITDA in this survey (recognizing that such measure is utilized more frequently in some industries than others) because such measure is commonly utilized by public companies to measure their operational performance and frequently includes adjustments for items that are believed not to reflect the ongoing operational performance of the company.  While we limited our survey to registrants that presented Adjusted EBITDA, we believe that the survey results have relevance for companies that present other types of non-GAAP performance measures which are adjusted for special items or items outside of the ordinary course of business.

Of the surveyed companies, five companies, or 9%, included an adjustment in their calculation of Adjusted EBITDA related in some form to the COVID-19 pandemic, and 91% did not.  Certain surveyed companies within this 91% group, while not including an adjustment for COVID-19 in the definition of Adjusted EBITDA, noted the impact that the COVID-19 pandemic had on Adjusted EBITDA at either the consolidated or the segment level (for example, by noting that the COVID-19 pandemic had a specified percentage impact on Adjusted EBITDA as the result of the shutdown of a manufacturing facility as the result of the COVID-19 pandemic).

Among the public companies that included some form of COVID-19-related adjustment in their calculation of Adjusted EBITDA, see below for a sampling of the adjustments which were included:

  • Enhanced employee compensation and benefits arising from the COVID-19 pandemic (for example, costs to allay the financial burdens of employees adversely impacted by the pandemic).
  • Incremental costs to support social distancing.
  • Incremental cleaning supply costs needed to sanitize facilities.
  • Costs related to personal protective equipment.
  • COVID-19-related charges.
  • COVID-19-related restructuring costs.

We believe that the following factors may have impacted the determination of most registrants not to include any COVID-19-related adjustments in their calculation of Adjusted EBITDA (or non-GAAP financial measures more generally):

  • A view that – given that the economic impact of COVID-19 may be present for an indeterminate period of time – COVID-19-related expenses should not be viewed as outside of the ordinary course of business of a registrant.
  • The fact that, while COVID-19 has driven increased expenses for a significant number of public companies, the more significant economic impact of COVID-19 for many public companies has been foregone revenue (which typically would not be adjusted for in connection with the calculation of Adjusted EBITDA).
  • The difficulty that some public companies may have had in reasonably quantifying the extent to which incremental expenses were driven by the COVID-19 pandemic as opposed to other factors.
  • The fact that COVID-19 may have had a lesser impact on the first quarter of 2020 (for calendar-year end companies) than it will have on future quarters, given that the economic impact of COVID-19 did not begin to be felt by many public companies until early- to mid-March (or later).
  • The potential reticence of some public companies to become an early adopter of COVID-19-related non-GAAP adjustments when there was no preexisting precedent for making such adjustments in connection with the first quarter earnings process and some uncertainty as to how such adjustments might be viewed.
  • The fact that management and SEC disclosure teams at public companies were heavily focused on other operational and/or disclosure considerations at the time of the first quarter earnings process, such that there may have been limited bandwidth or appetite for focusing on adding a new adjustment in relation to the calculation of a non-GAAP financial measure at this time.

The analysis above does not answer the question of the extent to which additional public companies may include non-GAAP adjustments related to the COVID-19 pandemic on a going-forward basis.  In this regard, some of the factors noted above which we believe drove a determination not to include any such adjustments in the first quarter of 2020 will be less relevant going forward (such as the limited impact of COVID-19 on first-quarter results among some public companies), whereas others (such as the pandemic having the greatest impact on top-line measures, such as revenue or sales) are ongoing.

Overall, we believe that there may be some increase in the frequency of registrants making COVID-19 adjustments in connection with their calculation of non-GAAP financial measures beginning in the second quarter, particularly among companies that have experienced significant expense increases associated with the pandemic.  In this regard, if registrants are able to quantify such expense increases arising from the pandemic and clearly describe the nature of these expenses and otherwise comply with the SEC’s non-GAAP financial measure rules in their public disclosures, we believe that the exclusion of such expenses from a non-GAAP performance measure may be appropriate and consistent with the spirit of non-GAAP performance measures intended to capture the ongoing operational performance of a registrant.  Nevertheless, taking into account the first quarter non-GAAP disclosure practices summarized above, it appears likely that the prevalence of registrants making COVID-19-related adjustments in their calculation of non-GAAP financial measures will be less widespread than may have been anticipated prior to the first-quarter earnings season.

Additionally, while companies that have experienced a significant negative sales or revenue impact arising from the pandemic may not be able to take into account such impact when making Adjusted EBITDA or other non-GAAP financial measure adjustments, such companies (if they are able to reasonably quantify such impact) may want to disclose the quantitative impact that the pandemic had on a non-GAAP financial measure such as Adjusted EBITDA and/or a GAAP measure such as revenue (for example, by stating that “we estimate that the COVID-19 pandemic negatively impacted second quarter [Adjusted EBITDA] [revenue] in the amount of X million”).

In summary, public companies will want to continue to monitor emerging trends (as well as practices of their peers) in considering the impact of COVID-19 on non-GAAP financial measures and disclosure practices more generally.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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