The Securities and Exchange Commission on Feb. 19 asked publicly traded companies with operations in China to disclose any coronavirus (COVID-19) threats or risks in their upcoming financial reporting.
SEC chairman Jay Clayton acknowledged that the material effects of the coronavirus may be difficult to measure and predict and will likely vary across industries. Since then, the situation has rapidly evolved, with parts of China easing restrictions and quarantines, while at the same time the virus has spread to other countries, including the United States.
It remains too early to measure the impact the coronavirus will have on companies. However, here are three strategic risks CFOs and other top executives should consider when assessing the threat.
The coronavirus may have an impact on a company’s revenue through production slowdowns, difficulties in delivering goods or services to the market, significant drops in demand for the company’s goods or services, and delays in customers paying outstanding invoices.
The coronavirus outbreak may not impact a company’s balance sheet or cash flows until a quarter or two in the future, so CFOs should think ahead. If the disease slows or disrupts a company’s revenue stream, it may put a strain on its cash holdings or force it to dip into liquidity reserves.
CFOs should review their companies’ existing credit and debt facilities to ensure that cash is available. This review should include a close examination of any financial covenants and potential monetary and legal penalties for late or missed payments. It should also include an assessment of the impact a disruption of revenue could have on the company’s ability to access credit facilities or the capital markets.
Finance chiefs should also be in regular contact with lenders and rating agencies to discuss the impact a slowdown in production may have on their ability to meet current lending requirements. Delayed or missed payments may require additional borrowing or result in a lower credit rating, which could negatively affect the company’s bottom line far longer than the coronavirus itself.
Many companies have in place business interruption or contingency plans for when production is unexpectedly disrupted. CFOs should review the viability of those plans and ensure that the plans are effective over the short, mid-, and long terms for a contingency such as the coronavirus and make any necessary adjustments now.
If a company does not have an adequate plan in place, it’s not too late to implement one.
These plans will likely need to be reviewed regularly and adjusted as the situation continues to evolve. In the short term, companies with plans to repurchase shares or increase dividends may need to forgo or delay them until their cash flows stabilize.
Reducing costs in other parts of the company may also be effective in addressing production slowdowns. In the mid- to long term, a company may consider implementing hiring freezes or putting existing employees on furloughs to minimize labor costs.
The ultimate impact the coronavirus will have on business operations may not be realized immediately and may ultimately be modest. However, well-developed and well-implemented contingency plans can minimize any such impact and put a company in a better position to recover.
Supply Chain Concerns
Visibility into a company’s supply chain is crucial to the company’s success because it allows responses to unexpected disruptions. Delays or disruptions in receiving materials from suppliers may in turn lead to late deliveries to customers and could strain or end existing customer and supplier relationships.
Companies should evaluate the potential impact any such delays or disruptions could have on these relationships and keep key customers and other business partners informed of the situation.
Additionally, companies should be prepared to potentially prop up or float a key or sole supplier to maintain its own customer relationships and delivery obligations. As mentioned, utilizing capital from other parts of the company to ensure on-time delivery to customers may lessen the stress on a company’s supply chain.
Furthermore, a breach of contract with a supplier or customer for failure to deliver on time could impose additional liability on companies beyond just lost revenue. CFOs should review their business interruption insurance and evaluate what is and is not covered by coronavirus-related production slowdowns.
Similarly, some supply contracts include force majeure clauses, which allow parties to delay or, in some cases, terminate performance of contracts because of a “superior force” making performance impractical or impossible. This may differ from “Act of God” clauses that typically only protect against natural disasters like hurricanes or tornadoes.
Companies should review their contracts and consider if they contain any similar provisions that could apply to pandemic health issues like the coronavirus.
If a coronavirus-related disruption to a company’s supply chain has the potential to become material, additional disclosures to investors and the public may be necessary in a company’s periodic reports.
Company Guidance and MD&A Disclosures
Shareholders and potential investors rely heavily on earnings releases and guidance when making investment decisions. The recent market volatility demonstrates substantial investor uncertainty regarding the severity and duration of the coronavirus.
In light of the fast-evolving situation, CFOs should consider their company’s recent guidance to determine if it is appropriate to provide any updates to the market. They should be aware that confirming guidance may be considered either updated or new guidance.
Therefore, companies should take measures to ensure that they update or affirm guidance in a manner compliant with Reg FD and take care when speaking with investors or analysts in one-on-one settings or at conferences.
Reviewing internal processes and guidelines on discussing guidance will help avoid any foot-faults. When asked about guidance, companies can state that any guidance or forecasts speak as of the date given and the company is not giving any updates or confirmations at this time.
Companies likely have already acknowledged in their public disclosures that the coronavirus may pose some risks to their business. If those risks become known trends and uncertainties, it should be covered in the Management Discussion and Analysis section of their public filings.
Companies should begin considering how the coronavirus may impact their business and how it will be discussed in the MD&A in future periodic reports.
At this time, it’s likely too early to determine the impact the coronavirus will have on a company’s bottom line, and the true impact may not be felt for some time. However, companies need to be prepared without acting irrationally.
CFOs should evaluate their liquidity position, communicate with customers and suppliers, and consider their guidance as they position their companies to weather the uncertainty associated with the coronavirus.
David A. Brown is a partner and Luke Trompeter an associate at law firm Alston & Bird LLP.