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Preparing for Q3 Earnings Season: Investor Edition

Tuesday, October 6, 2020

The COVID-19 pandemic and the related market conditions create many new uncertainties for auditors, audit committees, investors and management of public companies. To prepare for third quarter reporting, we took a look back at what we learned from the second quarter earnings season. Overall, we found company management at many entities are tailoring their communications to provide information to investors about the impact of COVID-19 on their operations.

The World Health Organization declared that COVID-19 was a pandemic on March 11, 2020; therefore, the second quarter reporting of calendar 2020 included a full quarter of impact from the pandemic. We reviewed a sample of publicly available Q2 calendar 2020 earnings releases to see how companies’ non-GAAP measures were impacted by COVID-19.  There are three main takeaways from our review:

  • There was an increase in the dollar amounts of non-GAAP adjustments.

Not unexpectedly, we observed an increase in the dollar amounts of non-GAAP adjustments for items such as goodwill impairment charges, other non-cash asset impairment charges and restructuring charges. This trend was observed mainly in industries that were most impacted by the pandemic.  Consider the commercial airline industry whereby many of the major airlines based in the United States commenced restructuring initiatives in response to the decline in customer demand for commercial air travel. When viewed together, the largest five commercial airlines the United States, which account for over 70% of the domestic marketshare,1 reported significant increases in the dollar amounts of non-GAAP adjustments for the two quarters ended June 30, 2020 compared to the corresponding period in the prior year. Such increases were primarily attributable to impairment charges, restructuring charges and severance charges related to voluntary employee separation programs in response to the pandemic, and in aggregate these GAAP adjustments for the largest five commercial airlines in the United States increased by over 2700% for the two quarters ended June 30, 2020 compared to the two quarters ended June 30, 2019. They also were largely reduced by non-GAAP offsets for grants or other funds received under the CARES Act payroll support program. Two of the five largest airlines recorded non-GAAP adjustments in the two quarters ended June 30, 2020 related to the payroll support program that exceeded their respective total pre-tax income for the two quarters ended June 30, 2019, pre pandemic. Non-GAAP adjustments for restructuring charges, including asset impairment charges and voluntary separation programs are not new as a result of the pandemic; however, many of the companies attribute the increase in the dollar amounts of such adjustments in 2020 to COVID-19.

  • There were some non-GAAP adjustments directly attributable to COVID-19

In addition to the non-GAAP offsets related to the CARES Act discussed above, some of the more common non-GAAP adjustments in calendar Q2 2020 directly attributable to COVID-19 were as follows:

– Incremental employee compensation, such as hazard pay or COVID-19 bonuses
– Personal protective equipment charges
– Incremental sanitation and cleaning costs incurred in response to COVID-19

  • There was a range of detail in the COVID-19 non-GAAP adjustment disclosures.

Entities that provided more detail in their disclosure included a more comprehensive description of each component of its COVID-19 non-GAAP adjustment with a corresponding amount to clearly communicate what comprised the COVID-19 adjustment and how it was being defined. On the other end of the spectrum we observed companies include vague descriptions as to how the COVID-19 non-GAAP adjustment was being defined such as “direct and incremental costs related to COVID-19.” We also noted non-GAAP disclosures where the COVID-19 direct impacts were combined with other items such as asset write downs or severance restructuring charges such that it was unclear what portion of the non-GAAP adjustment related to COVID-19 direct impacts and what portion related to severance or restructuring.

COVID-19 Investor Considerations

As highlighted in our recently issued publication, The Role of Auditors in Non-GAAP Financial Measures and Key Performance Indicators: Present and Future, transparency is critical to ensuring that the users of the non-GAAP financial measures have the information that is needed to make informed investment decisions. Given that the auditor provides no assurance related to information included in earnings releases and analyst presentations, and typically performs no procedures with respect to such information, investors may want to consider the following when reviewing non-GAAP financial measures that include adjustments for COVID-19:

  • Are the COVID-19 non-GAAP adjustments clearly defined?
  • How long is the company forecasting such COVID-19 adjustments to continue?
  • Do these COVID-19 non-GAAP adjustments represent a balanced picture (e.g., do the adjustments reflect both positive and negative impacts)?
  • How do the entities COVID-19 non-GAAP adjustments and disclosures compare to other companies in the industry? Are the amounts comparable?

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1. Based on domestic market share as of June 2020 according to data by Statista.

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Other CAQ Non-GAAP resources