As we close in on five months since the beginning of the coronavirus (COVID-19) pandemic in the United States, public companies in the life sciences industry must continually evaluate public disclosures in light of the pandemic’s effect on the company’s operations and financial results. The impact of the pandemic varies from company to company but can include revenue declines, supply-chain disruption, employee restructuring costs, contract terminations or renegotiatons, increased expenses for cleaning measures to address COVID-19 spread concerns, suspended or cancelled clinical trials, and the effects of remote working. As companies prepare earnings releases and 10-Q filings for the 2020 second quarter, the following items should be considered:
- The SEC has encouraged companies to provide as much forward-looking information as possible in its filings to update investors as to the company’s expectations for the impact of the pandemic on the company’s business operations, financial results and liquidity. This includes enhanced disclosures in earnings releases and in periodic report sections such as risk factors and a discussion of known trends and uncertainties in MD&A. At this point, most companies have significant visibility as to the impact of the pandemic and what they expect for the remainder of the year and into 2021. Of course, there is a great deal of uncertainty with respect to how long the pandemic will last and ever-changing federal, state and local government laws, regulations and guidance. However, the SEC has stressed that so long as forward-looking information is accompanied by appropriate cautionary language, the SEC will generally not second guess disclosures made in good faith.
- The SEC has emphasized the importance of disclosure controls and procedures which establish a framework system to ensure all applicable company matters are properly disclosed in accordance with SEC rules. Many companies (particularly small-cap companies) do not have an official “Disclosure Committee”. Though it is not required, we believe that having a committee streamlines disclosure procedures to ensure all important issues are considered, demonstrates the company takes reporting requirements seriously, and can be used to show that a particular failure to comply with SEC disclosure rules (should it occur) was not reckless or intentional. The committee does not need to be overly formal. For life sciences companies, it usually consists of the General Counsel, CFO and/or Chief Accounting Officer, Chief Compliance Officer (and/or other executives in charge of FDA and healthcare regulatory matters), Chief Medical Officer and Investor Relations personnel. One or two meetings in connection with each earnings release and periodic filing with the SEC is sufficient.
- SEC rules require management to provide an annual assessment and conclusion regarding the effectiveness of the company’s internal control over financial reporting (ICFR). In addition, each quarter, companies must assess and disclose whether there has been any material changes in the company’s ICFR. Due to the pandemic and remote working environment, many financial and accounting teams have made material changes to the way their financial reporting system works. If that is the case, this change needs to be disclosed in the next 10-Q.
- The SEC is scrutinizing CARES Act and other government relief disclosures, including disclosure regarding PPP loans and applicable tax relief measures. The SEC recently reminded companies to analyze and disclose both the short and long-term impact of these relief measures on results of operations, liquidity and critical accounting estimates. Also, companies should disclose (if applicable) the effect of government relief on the company’s ability to seek other financing options. In addition, companies should disclose any effect the relief has had on operations, such as a requirement to maintain a certain level of employment in order to meet PPP loan forgiveness requirements.
- In light of the pandemic, the SEC has again emphasized that non-GAAP measures used in earnings releases and SEC reports cannot exclude line items unless they are actually incremental to normal operations and non-recurring. When citing a non-GAAP figure such as Adjusted EBITDA, for example, adjustments to Net Income must be objectively quantifiable rather than estimates. During the second quarter reporting season, we expect to see many companies expressing Adjusted EBITDA (or other similar non-GAAP) figures which include adjustments for the impact of COVID-19. This is generally permissible so long as normal non-GAAP rules are applied (i.e. reconciliation to the most directly comparable GAAP measure) and the adjustments include things that are truly non-recurring such as contract termination costs, employee termination/restructuring costs, costs of suspending clinical trials, and costs for extra cleaning of offices due to COVID-19 spread concerns. However, when citing specific non-GAAP measures, the SEC will not allow companies to adjust for general estimates of lost revenue or items that are the “new normal”. For example, if remote working is now going to be a regular business practice companies should not be presenting non-GAAP measures which exclude those costs. This is not to say companies cannot provide numerical estimates and descriptions of the effect that the pandemic has had on operations, financial results and liquidity. In fact, the SEC specifically wants companies to provide as much detail as possible about the effects of the pandemic and expectations moving forward. Companies may include estimates or figures expressing percentages or dollar amounts that can be attributed to the effects of COVID-19 to the extent known. However, the SEC will not allow companies to present a completely separate non-GAAP measure such as Adjusted EBITDA in comparison to Net Income when Adjusted EBITDA includes adjustments that are not truly quantifiable or non-recurring.