Guidance in the Season of the COVID-19 Virus

    Posted by Drew Bernstein on Mar 12, 2020 11:41:55 AM

    In Advisory

    As the Dow Jones officially entered bear market territory and the WHO declared COVID-19 to be a pandemic, over 150 companies have lowered or withdrawn their earnings guidance as of March 11, 2020. As an increasing number of countries take dramatic steps to slow the spread of the virus and the disruption to business operations increases, that list is sure to grow.

    Management should maintain close communications with their auditors and audit committees as they report year-end results and provide guidance. China, as the first major economy to experience disruption from the COVID-19 virus, is in the position where the timing of audit fieldwork has been substantially delayed by the travel restrictions in February. The SEC has provided conditional relief to companies whose annual reports with audited financials would have normally been due between March 1 and April 30.

    Companies with significant operations in any of the countries impacted by the virus will need to pay additional attention to how they report unaudited financials in earnings reports and ensure they have a reliable basis for any statements concerning future expectations. The SEC has made it clear that while they are willing to grant companies additional time when required, they expect a high standard of financial reporting and audit procedures to be applied in the reporting season of COVID-19.

    While every company’s situation is unique, some universal principles should inform the decisions that companies make.

    • Update Stale Guidance Promptly – If data indicates that previously issued guidance for the first quarter or full year of 2020 is no longer reliable, withdraw and revise it immediately. In a recent release, the SEC Commissioner Jay Clayton stressed that: “We also remind all companies to provide investors with insight regarding their assessment of, and plans for addressing, material risks to their business and operations resulting from the coronavirus to the fullest extent practicable to keep investors and markets informed of material developments.” By neglecting to update guidance, companies who provided it are implicitly allowing investors to trade on inaccurate information.
    • Be Specific Where You Can, But No Further – Investors will appreciate specific information that helps to bracket the impact that COVID-19 has had on business operations, as long as that information is reliable. As an example, Chinese electric vehicle company NIO Inc. disclosed that its February shipments had dropped by 12.8% in February, which contrasted favorably with a 78% overall drop in new vehicle purchases in China. But they did not extrapolate that trend to the future. Sportswear giant Adidas forecast a $1.14 billion hit to sales in the first quarter due to the drop in demand in Greater China but emphasized the rapid spread of the virus made it challenging to predict the impact in other markets going forward. Providing new guidance only to withdraw it a few weeks or months later is counterproductive.
    • Provide a Strategy to Survive – Already companies in highly vulnerable sectors such as airlines and hospitality are disclosing dramatic plans to restructure their costs and conserve cash in response to changing travel patterns – including temporary layoffs, reductions in capital expenditure, halting of share buybacks, and adjustments to executive pay packages. As the impact of disruption spreads to discretionary consumer items, automotive, and other sectors, investor scrutiny of how a company will sustain its cash flow and viability during the epidemic will increase. Management is well advised to get out in front of these issues early on.
    • Highlight Positive Contributions – In China, where there was a far-reaching social mobilization to contain the spread of the virus starting in February, some companies have gone out of their way to describe how their employees and technology contributed to the effort. For example, discussed how it donated over one million face masks, leveraged its logistics company to make emergency deliveries of medicine and food in Wuhan, and launched free online medical and psychological consultation services. Specific industries, including online delivery of consumer necessities, distance learning, and medical sectors, may benefit if containment and social distancing measures are implemented. However, companies should be sensitive that any hint of profiteering from a far-reaching medical emergency could result in damaged reputations and consumer backlash.

    Management and boards of public companies will face difficult choices in the coming weeks how best to keep investors informed while dealing with limited information and facts that change from day-to-day. Decisions are sure to be closely scrutinized by regulators, and missteps could open the door to legal exposure and impair management credibility.