As the due date for third quarter 10-Qs quickly approaches for calendar year accelerated filers (and all other filers), you should consider taking a close look at your liquidity and capital resources disclosures under management’s discussion and analysis of financial condition and results of operations. As you know, under MD&A companies are required to:
Identify any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way. If a material deficiency is identified, indicate the course of action that the registrant has taken or proposes to take to remedy the deficiency. Also identify and separately describe internal and external sources of liquidity, and briefly discuss any material unused sources of liquid assets [Regulation S-K Item 303(a)(1) (emphasis added)].
With respect to capital resources, each company must:
Describe any known material trends, favorable or unfavorable, in the registrant’s capital resources. Indicate any expected material changes in the mix and relative cost of such resources. The discussion shall consider changes between equity, debt and any off-balance sheet financing arrangements [Regulation S-K Item 303(a)(2(ii) (emphasis added)].
In MD&A for interim periods, companies are required to provide discussion and analysis of material changes in liquidity and capital resources [Regulation S-K Item 303(b)]. Thus each company must carefully consider whether intervening events and developments require that previous disclosures be updated or expanded.
For purposes of MD&A, the term “liquidity”
refers to the ability of an enterprise to generate adequate amounts of cash to meet the enterprise’s needs for cash. Except where it is otherwise clear from the discussion, the registrant shall indicate those balance sheet conditions or income or cash flow items which the registrant believes may be indicators of its liquidity condition. Liquidity generally shall be discussed on both a long-term and short-term basis [Regulation S-K Item 303(a), Instruction 5 (emphasis added)].
The purpose of this disclosure is to “provide to investors and other users information relevant to an assessment of the financial condition and results of operations of the registrant as determined by evaluating the amounts and certainty of cash flows from operations and from outside sources” [Regulation S-K Item 303(a), Instruction 2 (emphasis added)].
Additional SEC guidance regarding discussion and analysis of liquidity and capital resources under MD&A can be found on the SEC’s website at:
- Interpretation: Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations, December 23, 2003;
- Commission Statement about Management’s Discussion and Analysis of Financial Condition and Results of Operations, January 22, 2002; and
- SEC Interpretation: Management’s Discussion and Analysis of Financial Condition and Results of Operations; Certain Investment Company Disclosures, May 18, 1989.
In light of the recent “credit crunch” and the general slow down in the economy, companies should discuss any material effects these developments have had, or are reasonably likely to have, on their liquidity and capital resources, including cash from operations, borrowing arrangements and access to capital markets. For example:
- Have the conditions in the capital markets had, or are they reasonably likely to have, a material impact on the company’s ability to finance its operations?
- Have traditional sources of capital/liquidity become unavailable or more costly?
- Have expansion plans or planned capital expenditures been cancelled or delayed as a result?
- Will any such cancellations or delays affect anticipated earnings such that previous guidance, whether provided in SEC reports or other, less formal, settings, needs to be updated?
Where material, this discussion also should include indirect impacts on liquidity related to the company’s customers and suppliers. For example:
- Have changes in credit or payment terms imposed by the company’s suppliers or vendors had a material impact on liquidity or on how the company will finance its operations?
- Have credit or liquidity problems experienced by the company’s vendors/suppliers compromised important sources of supply to the company?
- Has the company’s exposure to counterparty credit risk under over-the-counter derivative agreements increased substantially as a result of credit or liquidity problems being experienced by those counterparties?
- Has the payment performance of the company’s customers adversely affected the company’s cash flow from operations?
- Has the company increased reserves for doubtful accounts in a material amount?
Given the breadth and gravity of the current situation in the capital markets, companies should carefully consider whether additional discussion may be required to give investors a complete picture of the “known trends” or “known demands, commitments, events or uncertainties” that will have or are reasonably likely to have a material affect on the company’s ability to generate the cash it needs.
McGuireWoods LLP regularly assists both large and small public companies in connection with disclosure and compliance matters under the federal securities laws, and is actively engaged in monitoring developments in these areas.