As calendar year companies begin preparing for their first quarter Form 10-Q filings, COVID-19-related disclosures will be top of filers’ minds. Yet, frequent and rapid changes in the impacts of COVID-19 and the varied responses of companies and governments can make that preparation extremely challenging. Below are disclosure considerations for companies to keep in mind as they begin preparing their Form 10-Q filings.
This section is one of the areas that companies should be particularly focused on as they prepare their Form 10-Qs. Companies should read this section with fresh eyes in light of the current impacts their businesses are experiencing due to the ongoing pandemic. If COVID-19-related risk factors have previously been issued, such as in a Form 8-K for filing extension relief, companies should include those risk factors as part of their Form 10-Q filing and update those disclosures as necessary. Additionally, companies should continually review their risk factor disclosures up until the filing of the Form 10-Q to make sure any recently identified risks are disclosed. Since the SEC will likely place an emphasis on reviewing COVID-19 disclosures, it is especially important for companies to follow the language in Item 105 of Regulation S-K and refrain from presenting risks that could apply generically to any registrant.
Companies should think about the more novel ways that COVID-19 may impact or has impacted business. For example, many companies for the first time may have a significant portion of their workforce working remotely. This may present new or heightened risks for companies such as potential loss of productivity, greater cybersecurity concerns, and greater difficulty maintaining internal controls over financial reporting. If a company’s officers have taken a pay cut or a company has canceled dividend payments, risk factors that touch on these areas may need to be updated as appropriate. If a company has a significant portion of its employee population in an area disproportionally affected by COVID-19 or has an employee (including an executive officer) or board member who has tested positive, one or more current risk factors may need to be updated or an entirely new risk factor may need to be crafted. Risk factors dealing with business continuity or employee retention are examples. Other areas to consider include credit facility draws and covenant concerns, customer and supplier creditworthiness, and the ability of supply chain operations to meet the company’s obligations.
Companies should read through the risk factors section to make sure they are not describing any risks as hypothetical that have already occurred. The SEC has brought charges for this type of disclosure and recently warned companies about doing so in its “Statement and Guidance on Public Company Cybersecurity Disclosures” issued in February 2018. It is reasonable to expect that future enforcement actions could focus on companies disclosing as hypothetical COVID-19 risks that have already occurred.
Management Discussion and Analysis
The SEC has repeatedly made clear that MD&A disclosures should provide a narrative that enables investors to see a company “through the eyes of management.” In providing this narrative, companies are required to discuss their financial condition, changes in financial condition and results of operations, and disclose any other information necessary to an understanding of these items. As part of these disclosures, companies need to discuss events, trends, or uncertainties that are reasonably likely to have a material effect on their financial condition, liquidity, or results of operations, or that would cause reported financial information not to be necessarily indicative of its future financial condition or results of operations.
The SEC’s Division of Corporation Finance issued “Disclosure Guidance Topic No. 9” on March 26, which provided guidance with respect to COVID-19 and related market and business disruptions. Two sets of questions that the Division of Corporation Finance highlighted in this guidance specifically focus on these requirements for MD&A disclosures:
- How has COVID-19 impacted your financial condition and results of operations? In light of changing trends and the overall economic outlook, how do you expect COVID-19 to impact your future operating results and near-and-long-term financial condition? Do you expect that COVID-19 will impact future operations differently than how it affected the current period?
- How has COVID-19 impacted your capital and financial resources, including your overall liquidity position and outlook? Has your cost of or access to capital and funding sources, such as revolving credit facilities or other sources changed, or is it reasonably likely to change? Have your sources or uses of cash otherwise been materially impacted? Is there a material uncertainty about your ongoing ability to meet the covenants of your credit agreements? If a material liquidity deficiency has been identified, what course of action has the company taken or proposed to take to remedy the deficiency? Consider the requirement to disclose known trends and uncertainties as it relates to your ability to service your debt or other financial obligations, access the debt markets, including commercial paper or other short-term financing arrangements, maturity mismatches between borrowing sources and the assets funded by those sources, changes in terms requested by counterparties, changes in the valuation of collateral, and counterparty or customer risk. Do you expect to disclose or incur any material COVID-19-related contingencies?
As the guidance notes, these questions are only illustrative. In assessing applicable material disclosure obligations, companies should also review any previous public statements regarding the impacts of COVID-19 on their business. For example, if a company announced it was suspending dividends as a result of COVID-19, there will likely be a discussion of this in the liquidity section. Companies should also review changes to the risk factors section for COVID-19-related disclosures as those will help inform the MD&A discussion. Finally, companies should closely review their first quarter earnings call transcripts to ensure consistency.
In Disclosure Guidance Topic No. 9, the Division of Corporation Finance encouraged companies to proactively address financial reporting matters earlier than usual as COVID-19 impacts will likely make it more difficult for companies and auditors to complete the work required to maintain timely filings. Additionally, the Division of Corporation Finance included two sets of questions touching on financial statement considerations:
- How do you expect COVID-19 to affect assets on your balance sheet and your ability to timely account for those assets? For example, will there be significant changes in judgments in determining the fair-value of assets measured in accordance with U.S. GAAP or IFRS?
- Do you anticipate any material impairments (e.g., with respect to goodwill, intangible assets, long-lived assets, right of use assets, investment securities), increases in allowances for credit losses, restructuring charges, other expenses, or changes in accounting judgments that have had or are reasonably likely to have a material impact on your financial statements?
Companies should carefully consider these two sets of questions as they prepare the financial statements included in their Form 10-Q filing, as well as the “Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19” issued by the SEC’s Chief Accountant on April 3. Additionally, companies should focus on any adverse effects that COVID-19 has had on its financial reporting systems, internal controls over financial reporting, and disclosure controls and procedures. Finally, given the continually and frequently changing impacts from COVID-19, companies should continue to analyze whether there are any events that occurred after the end of the quarter but before the filing of the Form 10-Q that have a material effect on the financial statements and warrant additional disclosure.
Previously Issued Earnings Guidance
For calendar year companies who provided first year and/or full year 2020 earnings outlooks, this guidance was most likely given before companies began experiencing COVID-19-related impacts. While there is no requirement to do so, companies may be considering whether to update or withdraw previously issued earnings guidance. Any disclosures a company chooses to make in this regard must comply with Regulation FD and be materially complete, not misleading, and should be useful to investors.
Forward-Looking Statement Safe Harbor
Companies should review and update their forward-looking statement language as appropriate. As the Division of Corporation Finance reminded companies in Disclosure Topic No. 9, COVID-19 disclosures likely involve forward-looking information based on assumptions and expectations about future events. This type of information, which is provided to help keep investors informed about material developments, can be given in a way to allow companies to avail themselves of the safe harbor in Section 21E of the Exchange Act.
Given the increase in teleworking and shelter-in-place or stay-at-home orders, companies should plan early with the Form 10-Q signatories for executing the signature page and certifications. Current SEC rules require a signatory manually sign a signature page, and files must retain those signature pages for five years. On March 24, the SEC issued a statement that provides guidance for companies affected by COVID-19 in complying with this rule.
Conditional Regulatory Relief
For companies that have difficulty filing their Form 10-Q in a timely manner due to COVID-19, the SEC has provided conditional regulatory relief as discussed here and here.
For more information, please contact us or your regular Parker Poe contact. You can also find the firm's other COVID-19 alerts here.