By George Wilson
As we are now moving past the middle of July, many of us are reviewing draft Form 10-Qs and grappling with how to disclose the impact of COVID-19’s disruption and uncertainty. Here are a few thoughts for your review process.
1. Don’t forget to update and tailor your risk factors. Even if the impact of COVID-19 on your business has not been dramatic, consider your specific situation and think about whether risk factors should be updated. As we know more about this situation now than we did at the end of the first quarter, risk factors may need to be adjusted for new information. Here is an example from Home Depot, where the company added issues related to COVID-19:
Disruptions in our supply chain and other factors affecting the distribution of our merchandise could adversely impact our business.
A disruption within our logistics or supply chain network could adversely affect our ability to deliver inventory in a timely manner, which could impair our ability to meet customer demand for products and result in lost sales, increased supply chain costs, or damage to our reputation. Such disruptions may result from damage or destruction to our distribution centers; weather-related events; natural disasters; international trade disputes or trade policy changes or restrictions; tariffs or import-related taxes; third-party strikes, lock-outs, work stoppages or slowdowns; shortages of truck drivers; shipping capacity constraints; third-party contract disputes; supply or shipping interruptions or costs; military conflicts; acts of terrorism; public health issues, including pandemics or quarantines (such as the recent COVID-19 coronavirus outbreak); or other factors beyond our control. Any such disruption could negatively impact our financial performance or financial condition.
Also, don’t forget to update your 1995 Private Securities Litigation Reform Act safe harbor cautionary statements for uncertainties surrounding COVID-19.
2. Don’t shy away from forward-looking information where it is required. This is the “known-trend” disclosure in MD&A. If a company “reasonably expects” (a less than 50% probability threshold) that an uncertainty could have a material impact on future operations it should be disclosed in MD&A. Here is an example SEC comment, related to a March 31, 2020 Form 10-Q, about this forward-looking information requirement.
We note that your revenue significantly declined by $65 million, or 92%, from $71 million for the three months ended March 31, 2019 to $5 million for the three months ended March 31, 2020. You indicate this was due to the decrease in the number of railcars delivered (11 versus 641 units) due to lower industry demand, which was partially offset by a higher average selling price for new railcars in 2020. We also note from your earnings call that the lower demand was due to the combination of timing and weakness in the backlog, line changeovers, and a loss of 8 production days at the end of the first quarter related to the Coronavirus. Revise your results of operations to provide qualitative reasons as to why demand was lower. To the extent possible, quantify how the differing factors impacted the overall change in your results of operations. Additionally, quantify how your expected deliveries are expected to ramp up through the year to the extent possible to provide further insight into known trends and uncertainties. We also note from your earnings call a withdrawal of the 2020 guidance for deliveries and capital expenditures, and although no order cancellations, you are not building any railcars that do not have a firm order behind them, and as the Mexico facility is expected to begin production during the third quarter but not without a firm customer order, please address how you expect deliveries to ramp up for the year. See Item 303 of Regulation S-K and SEC Release No. 33-8350.
3. Don’t forget that in addition to MD&A disclosures ASC 275 requires disclosure in the financial statements of material uncertainties. Here is an example from MGM Resorts’ first-quarter Form 10-Q:
Financial Impact of COVID-19. The novel coronavirus (“COVID-19”) pandemic has caused, and is continuing to cause, significant disruption in the financial markets both globally and in the United States, and will continue to impact, possibly materially, our business, financial condition and results of operations. As of March 17, 2020, all of the Company’s domestic properties were temporarily closed to the public and have remained closed pursuant to state and local government requirements as a result of the unprecedented public health crisis from the COVID-19 pandemic. As a result, the Company’s domestic properties are effectively generating no revenue. In Macau, pursuant to a request from the government of Macau, MGM China suspended all operations at MGM Macau and MGM Cotai for a 15-day period that commenced on February 5, 2020, other than operations that were necessary to provide sufficient non-gaming facilities to serve any remaining hotel guests in that period. While the properties have since re-opened, several travel and entry restrictions in Macau, Hong Kong, and certain cities and regions in mainland China remain in place (including the temporary suspension of the visa scheme, the temporary suspension of ferry services and other modes of transportation, and bans on entry or enhanced quarantine requirements), significantly impacting visitation to the Company’s Macau properties, which continues to have a material impact on MGM China’s results of operations. The Company cannot predict the degree, or duration, to which its operations will be affected by the COVID-19 outbreak, and the effects could be material.
As always, your thoughts and comments are welcome!