Recent SEC Emphasis on Cash & Liquidity MD&A

Background

In the year ended June 30, 2024, the SEC issued 1700 comment letters to registrants, the highest volume in recent history. From 2020-2022, the SEC averaged just over 1000 comment letters per year. Amid this rise in comment letter issuance, management discussion and analysis (MD&A) has emerged as the greatest focus of these letters.

MD&A was a point of emphasis in at least 34% of 2024 comment letters. Among these letters, nearly a third of these comments were related to cash and liquidity matters. The relevant literature governing MD&A disclosure requirements is Item 303 of Regulation S-K (S-K 303).

MD&A is a central component of financial disclosures. According to S-K 303, “The objective of the discussion and analysis is to provide material information relevant to an assessment of the financial condition and results of operations of the registrant”. MD&A serves to augment shareholders understanding of the registrant’s results and processes.

The SEC prescribes the standards and focus of MD&A disclosures in S-K 303, stating: “The discussion and analysis must focus specifically on material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future financial condition”. Thus, MD&A should help paint a picture to investors of material events and concerns that reflect the views and perspective of management.

With regards to specifically cash and liquidity MD&A requirements, S-K 303 states that the objectives of the requirements are to, “Analyze the registrant's ability to generate and obtain adequate amounts of cash to meet its requirements and its plans for cash in the short-term and separately in the long-term.” S-K 303 further asks: “The discussion should analyze material cash requirements from known contractual and other obligations. Such disclosures must specify the type of obligation and the relevant time period for the related cash requirements.” This article will focus on the 4 specific requirements related to cash and liquidity matters laid out in S-K 303.

Identify known trends or demands that will likely affect liquidity

Registrants are required to identify and discuss known trends or demands that are likely to materially affect the liquidity of the registrant (S-K 303 (b)(1)(i)). When a company experiences a material change in forecasted cash or liquidity it should be discussed by management in annual disclosures.

Valero Energy Corporation (Valero) recently received a comment letter from the SEC regarding this issue in relation to its 2023 10-K filing. The SEC noted that elsewhere in Valero’s 10-K, Valero mentioned that their growth capital investments declined from a level of $1.37 billion in 2022 to $430 million in 2023.

The SEC requested that Valero modify their MD&A to include some discussions on this potentially significant change, commenting: “Please expand your disclosures in your periodic reports as necessary to discuss and analyze the reasons for the decline in your growth capital investments, and the potential impact of the decline in growth capital investments on your short and long-term liquidity and profitability”. Valero responded by indicating that in future disclosures they would include further management discussions that would “more clearly describe the potential variability within growth capital investments attributable to Valero”.

https://www.sec.gov/Archives/edgar/data/1035002/000103500224000042/filename1.htm

Identify and separately describe sources of liquidity

Registrants are required to “identify and separately describe internal and external sources of liquidity” (S-K 303 (b)(1)(i)). This requirement is to assist current and prospective shareholders in having a better understanding of cash flows of an organization and where they primarily come from, as well as other forms of liquidity a company has access to.

In September of 2024, International Bancshares Corporation (IBC), a bank holding company headquartered in Texas, received a comment letter from the SEC asking that IBC provide further information on their sources of liquidity and overall financial condition. The SEC requested that IBC “revise [their] future periodic filings to disclose quantitative amounts of material sources of liquidity, to the extent it is necessary to understand [their] financial condition”. 

IBC did disclose in their 10-K some of their sources of liquidity such as deposits and lines of credit. However, this request from the SEC to enhance disclosures surrounding internal and external sources of liquidity showcases the SEC’s emphasis on MD&A depth and content. IBC recognized this deficiency and committed to “disclose quantitative data with respect to material liquidity sources and will include a discussion of material short- and long-term cash requirements from known contractual commitments”

https://www.sec.gov/Archives/edgar/data/315709/000155837024013034/filename1.htm

Describe material cash requirements and the anticipated source of those funds

Like liquidity disclosures, registrants are required to “describe material cash requirements, including commitments for capital expenditures [and] the anticipated source of funds needed” (S-K 303 (b)(1)(ii)(A)). This requirement is designed to provide more precise information to current and prospective shareholders regarding a company’s capital requirements and structure.

In a comment letter to American Woodmark Corporation (Woodmark) from February 2023, the SEC requested that Woodmark revise their 10-K to include greater detail on some of their interest payment obligations for their long-term debt. In the letter, the SEC asked that Woodmark “disclose estimated interest payments on your debt to fully analyze material cash requirements, to the extent material”.

Woodmark acknowledged that they would revise future disclosures to include estimated interest payments on their long-term debt each year. In their response Woodmark also laid out their debt payment obligations for the next five years to satisfy S-K 303’s requirements. The MD&A disclosure requirements laid out in S-K 303 regarding capital resources and requirements help shareholders to have a better understanding of cash obligations and needs of the registrant. 

https://www.sec.gov/Archives/edgar/data/794619/000079461923000010/filename1.htm

Indicate any likely material changes in the mix and cost of capital resources

Registrants are required to “Indicate any reasonably likely material changes in the mix and relative cost of [capital] resources” (S-K 303 (b)(1)(ii)(B)). When material capital structure changes occur in an organization, management should provide commentary and disclosure regarding the nature and scope of such changes.

In September of 2023, Global Crossing Airlines Group (GlobalX), an airline headquartered in Florida, received a comment letter from the SEC requesting that they make substantial upgrades to their capital structure disclosures. The SEC remarked that GlobalX’s liquidity and capital resources MD&A disclosures were “comprised entirely of a recitation of the reconciling items and line item activity reported in the operating, investing and financing sections of your cash flow statements”. 

The SEC specifically referenced the need for GlobalX to “discuss any reasonably likely material changes in the mix and relative cost of [capital] resources, including any reasonably likely changes among equity, debt, and any off-balance sheet financing arrangements”. GlobalX recognized the need for enhanced MD&A disclosures and committed to providing a “more informative discussion and analysis of cash flow” in their future filings.

https://www.sec.gov/Archives/edgar/data/1846084/000119312523239135/filename1.htm

Conclusion

The SEC has recently placed increased emphasis on MD&A, likely due to its importance in providing valuable insights to users of financial statements. S-K 303 outlines requirements designed to give shareholders meaningful information about a company’s operational results. Companies can view these requirements as opportunities to enhance investor understanding of their business, operating environment, and the impact of factors that may not be fully captured in the financial statements.

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