By Allison Malkin & Tim Dolan
COVID-19, the disease caused by the 2019 novel coronavirus, has created market volatility and has had — and is continuing to have — wide and varied impact on economic factors, from supply chain stability, to labor productivity, to consumer spending. As events change by the day, publicly traded companies are trying to determine if they should continue to provide guidance, and if they do provide guidance (a) whether they should change their approach, and (b) how do they try to factor in the impact of COVID-19 on the US and global economy when it is still very much unknown. In this process, companies should consult the recently issued SEC Directive on COVID-19-related disclosure considerations: https://www.sec.gov/corpfin/coronavirus-covid-19.
Importantly, there is no one size fits all approach as companies in different industries are in very different positions with respect to their ability to provide guidance. Investors understand that these are challenging times for every company from a forecasting perspective. At the same time, they are eager to understand any information about the impact a given company has experienced to date, as well as expense levers and covenant triggers to help assess ratings or investment potential.
When companies are determining what type of guidance to provide (quarterly, annual, or none), they should consider the visibility into current and full year trends. For example, retailers may prefer to provide quarterly guidance and annual guidance, as when they report earnings they are already several weeks into the upcoming quarter and have good visibility into current trends. Wholesalers, on the other hand, may prefer annual guidance only, as spring and fall shipments may shift between quarters from year to year, creating an unpredictable pattern. When not providing quarterly guidance, it is helpful to give qualitative commentary when companies know of circumstances that will likely affect the business. Those “heads-up” comments may mitigate stock price volatility when reporting actual results. Companies with no to very low visibility and those that are very large, are well covered and have predictable revenue and profit may not need to provide specific guidance.
In sectors like technology, where many companies have recurring, subscription-based revenue models they should still be in a position to provide quarterly and annual guidance, while also doing their best to call out the assumptions they are using for the negative impact on their guidance due to the uncertain economic environment.
Even with companies that have a recurring revenue model, there can be differences such as how strategic the solution is being sold, how clear the ROI is, strength of renewal rates, size of deals needing to get closed, and typical length of the sales cycle. Depending on these factors, companies may assume a smaller/larger impact related to the uncertain economic outlook. There are some software companies where it may simply prove too difficult to provide guidance – specifically those that still have revenue models tied to up-front revenue recognition (at the time of sale). During the Y2K crisis, perpetual license companies consistently missed and lowered their guidance, often in a meaningful way.
Coronavirus-Related Guidance
Companies considering how to structure their COVID-19-related guidance may wonder about their disclosures and areas of focus, or whether they should suspend it altogether. For companies affected by the pandemic, focus on providing visibility into the first quarter (or your current quarter if your fiscal year does not align with the calendar year). Companies are typically five to six weeks into the current quarter, so you should be able to report on expectations for that period, as well as shifts from quarter to quarter. Some of your company’s disclosures may include:
Sales
Report on any factors that may affect sales, such as reduction in store hours, store closures, supply chain issues, and order or traffic trends. If you operate in states that have stay-at-home orders that are affecting your company’s ability to operate or staff at full capacity, disclose those challenges.
Expenses
If your company has location closures that have resulted in furloughs and layoffs, disclose the added expense of unemployment compensation costs. Discuss your company’s ability to reduce expenses and the action you’re taking to do so. The company’s ability to reduce capital spending as well as priorities for cash, including buyback, are also important.
Credit
Investors and analysts will want to know how well-equipped you are to weather the storm, which includes access to credit to keep your company’s liquidity at appropriate levels. Discuss the organization’s ability to expand its credit safety net, as well as opportunities to renegotiate agreeements and manage upcoming debt maturities.
Inventory
If your business depends on inventory, note current levels as well as the outlook for your company’s ability to receive product during the next quarter. Indicate whether factories are operating at below optimal capacity or at or near normal, if possible. If your sales are significantly below the level of inventory on the balance sheet and on order, communicate your ability to cut or cancel orders.
Other Relevant Factors
If you have other insight that will be important to investors or analysts, include those disclosures, too. Providing a Q1 guidance range may be difficult, as your company would need to specify what is included and assumed or not included in that guidance. You could, however, mention that prior to COVID-19, the company had expected to achieve guidance within long-term growth goals or was trending at x.
When opting for a full-year approach, provide the known impact on the current quarter based on factors like the supply chain issues, store closures, and sales changes. Explain that this range will be updated quarterly with conditions expected to change based on new information.
Suspending Guidance
In some cases, suspending guidance will be appropriate. Companies may be concerned about hurting the management team’s credibility if results are below expectations, or may be worried that by setting guidance, the company is focusing Wall Street on the short term. Even long-term investors may be reluctant to buy shares in a company that will have COVID-19-related volatility for the foreseeable future.
As result, it may be appropriate to suspend guidance when uncertainty reigns. For example, if guidance has already been given and the company’s management knows they can’t achieve it and can’t provide a reasonable range, suspending guidance is likely the right decision. Suspension might also be prudent if the company has provided long-term guidance and expectations remain the same, but realizing them will take more time, or if there has been a shift in the business and the long-term guidance can no longer be relied upon, but the management team needs more time for analysis.
Also, if current factors are causing short-term disruption, but management can point to a time when guidance can be reinstated, a temporary suspension is likely a good idea. The management team may be able to release certain financial metrics, such as capital expenditures or ability to meet creditor obligations or loan covenants, sharing that information will be helpful.
Structuring guidance in the age of coronavirus is challenging, especially as there are no concrete projections for the length or severity of the pandemic’s impact. If you need more advice on how to structure your company’s guidance, please contact us.
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