CHAPTER 20 Delivering the Goods

Once IR and management have determined conservative earnings guidance,

a target audience, a uniform approach with PR, and all the necessary infrastructure

and disclosure needs, the stage is set for delivery. The basics of

delivery are earnings announcements, conference calls, and pre-announcements.

Long-term investors manage their risk by assessing management performance

as frequently as possible. They like to know what they can expect

and when they can expect it. Moreover, if things are going to materially

change from what’s expected, these money managers want to know as soon

as possible. Predictability is good, surprise is bad, and when it comes to performance,

the pattern of delivery can sometimes be as important as the actual

results.

To that end, earnings announcements should never be a big surprise, especially

if the company has established guidance and committed to refining

that guidance throughout the year.

But even with the most conservative guidance, some factors are still out

of management’s control, such as the weather or the economy. Even under

negative circumstances there are always ways to make bad events not so

bad. The ways and means of disclosure can have a profound effect on valuation

over time.

EARNINGS ANNOUNCEMENTS

IR must make its company’s story stand out above the thousands of publicly

traded companies that interact with Wall Street everyday. To do this, to

make an initial contact interesting, IR must reach out and grab the audience.

The most basic piece of the delivery stage is the earnings release, the vehicle

through which quarterly earnings results are expressed and distributed

to investors. Because the majority of public companies are on a calendar

year, the announcements are usually clustered around the same four periods

each year (late April/early May, late July/early August, late October/early

November, and February/March), with the sell- and buy-sides geared up to

handle the high volumes of information in these short windows. Because the

volumes of reporting companies are so large, analysts look to quickly review

the press release, take from it the key points, and move on to the next reporting

company. The release must be concise, contain only the most important

information, and supply a dose of context with a brief management

comment. It must also include financial tables—outlining results and any

other information that management believes will help shareholders better

analyze the company.

Content

The earnings release is widely distributed to the buy-side, the sell-side, and

the financial media. (Appendix A offers two examples of earnings releases.)

As with any press release, the headline describes the purpose of the release

and should act as a hook to draw investors’ and analysts’ attention

(“Octagon Inc. Reports Third-Quarter Financial Results”). The subheads

should highlight the quarterly performance and/or the most material content

in the release: “Exceeds First Call Earnings Per Share by 23% / Management

Raises Guidance for Fiscal 2004.” These subheads are important because

the news wires tend to pick them up and highlight them. In the above example,

everyone is aware that Octagon beat its earnings estimate significantly

and that the full-year expectations are being increased. If the increased guidance

portion of the release had not been packaged as a subhead, however,

odds are high that the media outlets might have ignored this very material

piece of information.

The second part of the release should include bulleted highlights from

the quarter, such as revenue growth over the prior period, EBITDA if appropriate,

Free Cash Flow, new customers acquired during the quarter, and

anything else management believes is a critical driver of the business. However,

the limit is about five items, so IROs should prioritize and settle on

metrics that the analyst and portfolio manager would want, not necessarily

items of which management is most proud. The key here is to deliver the

right message in a succinct fashion.

After the highlights, a quick paragraph can appear describing the results

for the quarter as they relate to revenues, net income, and diluted earnings

per share, and the year-over-year comparisons. That section should be followed

by a quote from the CEO that talks about the quarter.

Next, a paragraph can outline other drivers for the period, such as new

customer counts, average weekly sales, and strategy points. Still later might

be a paragraph discussing the balance sheet—cash balance, long-term debt,

and shareholder’s equity. The final quote should be from the CEO and is

most effective when talking about strategy and his or her overall vision for

the company and shareholders. Finally, before the financial tables, a guidance

section should appear that addresses the upcoming quarter and the full

year. There should also be a full description of the business in safe-harbor

language that protects forward-looking statements.

Remember that this is only an outline. The final product must be a combination

of IR, management, and legal counsel. However, be succinct and

avoid endless paragraphs of information or language that doesn’t immediately

imbed itself with investors. While too many quotes can also be a distraction,

in the past, they were less important because analysts and investors

could cull the specific information from releases or just call management to

gain additional insight. But subsequent to Reg FD, management must be

more careful about the added color they give in private calls. For that reason,

the release and the quotes are both templates for disclosure, so any direct

word from the company must be deliberate and thought out.

THE CONFERENCE CALL

Conference calls are one of the most common and expected vehicles for

communicating quarterly financial performance. Before Reg FD, an overwhelming

majority of larger companies conducted them, but not every

small-cap company followed suit. These days, nearly every company conducts

them, and all companies Web cast them.

The simultaneous Web cast allows everyone to be on the call, from big

institutional investors to individuals who own 100 shares. It’s an opportunity

to listen to management explain quarterly results and convey their vision

of the future. More importantly, because it reaches the masses, the conference

call and Web cast function as the company’s disclosure template until

the next quarterly call. In other words, if it’s discussed on the conference

call, on record, the CEO, CFO, or IRO can talk about it on private phone

calls, at exclusive Wall Street conferences, or in one-on-one meetings. The

conference call is the ultimate safety net for Reg FD.

In terms of structure and content for the call, the first section should be

an introduction from the IRO or legal counsel that includes who will be on

the call, what topics will be covered, and a reading of the Safe Harbor language

that protects the company should actual performance not match fore-

Delivering the Goods 163

casts. This section should be followed by the CEO, who discusses the quarter

in general, and addresses mostly qualitative initiatives that went on during

the three month period. Next up is the CFO who discusses in great detail

the top-line and its drivers, a line-by-line examination of expenses (not only

as a percentage of sales but versus the prior-year period), a balance sheet review,

and guidance. Finally, the CEO wraps up the call, but before Q&A, he

or she should comment on strategies and plans for the upcoming quarter

and year and leave the audience with three or four points why the company

is interesting at this particular point in time.

Analysts and portfolio managers know that the conference call is the

most efficient and effective way for management to communicate with The

Street, and because of this importance, the calls must always be scripted,

with topics and speakers specified and limited.

Scripting the Call

Part of the analyst’s job is to distill the company’s message into a persuasive

and credible opinion and share that view with clients in the investment community.

Therefore, IR should draft the conference call script with this perspective

in mind.

The IR professional should ask, If I could write the analyst report after

the call, how would it look?

This approach underscores the necessity for making key points and

highlighting the positives of the business in a way that the analyst and portfolio

manager are used to seeing. To that point, the script must be realistic

and credible, but take license to discuss strategic or operational initiatives

with enthusiasm. The hope is that these highlights make their way to analysts

in the next morning’s First Call notes in the same manner that they

were presented. In fact, that’s the entire goal of the call: getting management’s

exact point of view in the analysts’ research coverage, and having

them understand and buy into the strategy, all while keeping their First Call

estimates within management’s range.

As stated, the number-one rule for conference calls is that every word

must be scripted. In fact, management should begin preparing the script,

with IR, about three weeks in advance so that the CEO and CFO are fully

prepared. Why script every word? Because the call should last only 20 to 30

minutes, and without the script CEOs can frequently get off message and

speak in tangents about issues that may not be relevant to the call. In that

case, management has just wasted one of its four annual earnings calls by

rambling and looking unprepared. Our hunch is that analysts and portfolio

managers will pick up on that fact and think twice about getting involved.

Staying on script is also essential because today’s conference calls are

transcribed, widely distributed, and scrutinized. Oftentimes, portfolio managers

want to read the conference call transcript, hear about progress from

management directly, and check that view with the sell-side. That’s why

scripting each word, rather than working off bullet points or ad-libbing, is

necessary. Transcripts are a new form of research report complete with estimates

from management, and it’s a huge advantage if IR views it as such.

(Appendix B offers an example of a conference call script.)

Writing the script is a process that includes the following steps:

Management discussions: Executives are constantly crunched for time,

and SEC requirements don’t help that process at quarter’s end. IR’s lead on

preparing for the conference call helps management begin the process and

avoid mistakes that can accompany a last-minute rush.

Therefore, three or four weeks before the call, IR should talk to the

CEO and CFO, review the performance for the quarter, and determine what

topics will be most relevant for the call. These would include strategic issues,

financial performance, and a recap of material announcements during the

period. Once discussed and approved, IR then has an idea of what management

believes is important or material to communicate.

Also, although other departments within the company should not speak

on the actual call, they should be represented. For example, if an important

marketing initiative is launching in the second half of the year, it should be

discussed and scripted into the appropriate section. Or if the controller

has a better interpretation of why an important expense line-item didn’t

meet expectations, it can be discussed with IR and incorporated. When

senior management can speak in detail to these issues, analysts are impressed

and left with the perception that management is very much in-tune

with the business and running a tight ship. The comfort level that affords investors

is so highly coveted by sell- and buy-side analysts that a premium

multiple is often paid for stocks where management is communicating at

such proficient levels.

During the internal due diligence, IR has to set the tone of the call and

judge everything relative to valuation. Much information will be contributed

from the definition stage, but it’s always worth a quick revisit as definition

can change frequently, in tandem with stock movements. For example, if

things are going poorly for a company and the stock is already down, the

strategy for the conference call is very different than if the news is bad and

the stock is at a 52-week high. Capital markets experience and expertise can

tell management in what context to deliver the news.

Street recon: IR that is tapped into Wall Street perceptions already knows the overarching messages that should be stressed or defended in any

given quarter and will incorporate it with the messages that come from the

original meeting with management.

IR should query as to the specific concerns that analysts and investors

have regarding the company—for example, recent expense escalations, offbalance-

sheet debt, or the effectiveness of a certain marketing campaign.

Also, IR that has the connections to seek out and understand the “bear

story” on a company is invaluable and allows management to address specific

negatives on each call.

The process of collecting information from analysts or portfolio managers

can be very difficult, however, in that Wall Street professionals have

little time to share their perceptions, particularly around earnings season.

Accordingly, IR must build long-standing relationships, and capital markets

knowledge increases the odds that those relationships will develop.

Talking the language of the portfolio manager or analyst is the best way to

start an intelligent dialogue, garner real feedback, and pass it on unfiltered

to management.

Writing the drafts: Once IR has spoken to management and the outside

world, it should take the lead in writing the conference call script, adhere to

an agreed-upon format, and deliver the initial draft to the CEO and CFO

within a preset schedule.

For example, about a week after the initial meeting with management,

IR should have a first draft of the release and script ready to go. 48 hours

later, management should agree to give comments back to IR, and the whole

process should be repeated as the financials come together and the auditors

do their job.

Then, about a week before the call, the conference call invitation

should be sent to the wire utilizing the distribution list that was compiled in

the earlier stages of delivery. Once the CEO, the CFO, and IR have turned

two or three drafts of the script, with each party adding and subtracting

ideas, the final draft should be shown to legal and the audit committee for

final approval.

Being proactive: IR and management must collectively decide which issues

to emphasize during the quarter. IR may encourage a reluctant management

team to discuss a tough issue in the script rather than address it in

Q&A because it’s a proactive way to control the information and mitigate

risk. If, for example, the issue is ignored in the script because the CEO deems

it too uncomfortable to discuss, she may find herself off balance in Q&A,

fumbling for an answer that’s scribbled down on a cheat sheet. If scripted

from the beginning, however, the CEO can simply refer back to her prepared

remarks on the topic and move on to the next question. An example of a tough issue for a CEO might be downward margin trends in the face of rising

sales or the loss of a major customer or why the company doesn’t give

guidance. Allowing sophisticated portfolio managers or analysts to lead a

company down a line of questioning that the CEO is already uncomfortable

with can only make management look bad, and unfortunately the entire dialogue

will be transcribed for the world to see. That’s too much risk, and

there’s no reason to incur it.

Be prepared: Given the opportunity to be extemporaneous and not follow

a script, management might get off message and use a phrase, or even a

qualifier like “significant,” to describe a new initiative. A simple word or

nuance can send an unintended signal to analysts and portfolio managers

who are trained to quantify everything they hear from management. For example,

on a conference call, management might be talking about an initiative

for the upcoming year, and although it won’t be a contributor to earnings,

the CEO who’s not scripted might say, “it’s going to be a significant

part of our business going forward.” This might encourage analysts to incorporate

the new business line into their models and increase their earnings

estimates. If this unwanted analysis skews the average First Call estimate

upward, the company has just put itself in position to miss estimates. For

these reasons, management must be very careful even with what it believes

is mundane language.

Therefore, the point of a script is to stick to it, and management and IR

should practice to ensure that the executives can deliver the prepared remarks

with familiarity and ease. Additionally, IR should know, from its

Street reconnaissance and industry knowledge, the questions that are likely

to be asked. These questions can be subtly addressed in the script with some

pre-emptive language to nullify the question altogether. At the very least,

they should be written and reviewed so that management can prep for the

interaction.

In this preparation, IR should highlight specific talking points, as well as

issues to avoid, so that management can steer back to port if the call gets

bumpy. Preparation helps management present well and build credibility,

which is the name of the game when it comes to valuation. Ultimately, the

CEO and the CFO must come across as confident, answer all questions thoroughly,

and articulate a clear vision for the future.

Front and Center: Topics and Their Speakers

The voices on the conference call become the public voices of the company,

and the public role of the company executives should reflect their jobs.

Therefore, have two or three speakers at most represent the company. The first is the CEO. Not too many investors would buy a stock without listening

to, if not sitting down in person with, the CEO. The next individual

on the call might be the chief operating officer, who handles the day-to-day

operations. Finally the CFO should be on the call.

On an obvious level, this introduces the sell- and buy-sides to the executives

in charge, putting a voice to the vision, operations, and numbers. On

a subliminal level, it shows a cohesive, connected team in which the members

understand the business and their roles. By giving each executive specific

issues to cover, IR helps senior management put their best face forward

to The Street.

For purposes of disclosure and liability the company should be very particular

about who is on the call and who will interact with the investment

community on a day-to-day basis. One of the oldest analyst techniques is to

call different executives in the company—the CEO, the COO, and then the

CFO—and ask the same few questions to each, and look for points of discrepancy

that reveal incremental information.

To avoid this, a formal policy should be in place. The best analogy to

help clients understand the ramifications of no policy is to imagine the conference

call as a trial. If IR is the defense attorney, he must decide who will

be put on the witness stand. There are pros and cons for each person. For

example, it would be great to have the head of marketing explain the new

program for the upcoming year or the head of human resources talk about

the latest batch of hires. Better yet, the head of technology could talk about

the new Web initiative. Of course, if only IR were doing the questioning

after prepared remarks, it would be an easy choice to let these people speak,

but the line is filled with money managers, hedge funds, and short sellers.

Much like a trial, allowing someone to speak during prepared remarks

opens them up to questioning on the conference call, phone calls after the

conference call, and potentially questions during the quarter via email or

phone. The head of marketing would be viewed as another company source

from whom to gather information, and analysts and portfolio managers may

start calling multiple senior-level workers within the company. Therefore, to

control the information that is directed to Wall Street, IROs must limit the

number of participants on the call and make sure everyone has a unified

message, particularly intra-quarter.

What to Watch For on Conference Calls

Conference calls can succeed or fail for several reasons, and success relies on

preparation and management’s ability to hone in on content and delivery.

For analysts and portfolio managers, some things just don’t sit well.

Tell just enough: A company that spends five minutes on prepared remarks

and leaves the rest to Q&A gives too much room for analyst interpretation.

It can also send a message that the company isn’t taking the call

seriously or that they’d rather not share their information. On the other side

of the spectrum, a company that spends 45 minutes on prepared remarks is

simply taking up too much time, and that drain prevents investors and analyst

from participating in a Q&A session afterward, which is critical. Fortyfive

minutes shows that a company doesn’t know how to concisely tell its

story to the world. When in doubt, companies that want to disclose many

variables should put them in a supplemental disclosure section of the press

release for all to see.

Stay on point: The script should help management address specific topics

and avoid irrelevant or confusing tangents and trouble spots. Executives

must spend time on the focus of the call, possibly an earnings miss, in great

detail, before moving on to strategy and the company’s outlook. Glossing

over these points positions the CEO as unrealistic and a potential investment

risk. That’s why the script, with related investment community feedback

built in, is so important.

Don’t hype: Executives work hard all year with few moments to stand

up and garner recognition for the company’s operating results. The call may

seem like the perfect time for this, although in actuality, it’s not the right

forum. Management must allow the analysts and portfolio managers to

characterize the performance. Management should keep it somewhat matter

of fact and stay even-keel, whether times are good or bad. The Street wants

to hear the explanation behind recent performance and the essence of what

will happen for the remainder of the year.

Don’t hide: Regardless if the management team decides to be proactive

or not in the script, problems can’t be glossed over. Executives who talk

about positive issues when a big negative is looming are making a big mistake

and jeopardizing their own credibility. Management should state the

facts, the reasons behind them, and the actions being taken to fix the problem.

Management shouldn’t take the siutation personally because quarterly

misses happen every day on Wall Street. Management should be up-front

and overly available. How a management team handles the bad times on

their conference calls can define their public company careers and be a major

determinant of valuation.

Watch words: As stated earlier, it’s not just what is said, it’s how it’s said.

In conference calls, the littlest things might matter the most. The Street always

pays close attention to nuance, innuendo, and tone. Their job is to

quantify everything that management says, and determine what that means

to EPS.

Believe it or not, a certain word or a shift in tone or inflection can affect

the interpretation of information and shift the investor’s mindset up or

down. The difference between “very good” and “good” has meaning to the

analyst and portfolio manager. If these words are not quantified, the meanings

can be widely interpreted.

Analysts and portfolio managers cringe when they hear certain words or

phrases. Phrases such as “explosive earnings” or “our guidance might prove

to be very conservative” can ruin IR’s plan. The phrases are factored into the

share price immediately and many times set an unintended bar by which

management will be judged.

Dealing with shorts on the call: Short sellers are not necessarily the

enemy, although they certainly don’t brighten management’s day. They are

usually short-term players who have made a bet against the company because

the stock has increased in value, and in their minds the earnings don’t

justify the multiple. There’s risk involved in shorting stocks, however, so if

they borrow and sell short, they’ve probably done some solid research to arrive

at their bearish opinion.

If IR knows that the short interest in the stock is high, they need to prepare

the script with proactive explanations that address each point of the bear

story. Because the company does not want to enter a public debate on a conference

call, short sellers should not be confronted. Management should simply

put forth its counterarguments and then, if necessary, agree to disagree.

Although someone betting against management can lead to an emotional

situation, executives need to be matter-of-fact on the call and understand

that it’s not personal. The shorts may think the company is great, just

too expensive. Or they may be making a short-term bet. At the end of the

day, however, management shouldn’t waste time confronting short sellers on

the call. Delivering solid EPS growth over time is the only way to send these

players on their way.

Other Interested Parties

The earnings announcement and conference call typically get beyond the

sell-side and the buy-side. In fact, there are several constituencies to consider,

and management should have a systematic procedure in place to disseminate

and explain the quarterly information.

Stakeholders: Employees, vendors, and customers should be notified

first and foremost on any important company news. The employees are the

heart and soul of any organization, and one way to keep them motivated is

to keep them involved and educated. Any procedure for communication

should include an internal process that precedes, within Regulation FD constraints,

the external one. The CEO, not the local media or the Internet,

should be the first source of information for employees on company news.

If it’s feasible, and if it would underscore goodwill in a relationship,

strategic partners such as vendors and customers should also have an announcement

tailored toward them. An announcement after the market

closes and moments before the call to The Street keeps the team in sync. This

is especially important if it’s a cost-cutting measure or a merger that will result

in the closing of certain operations or layoffs. No one wants to hear

about their plant closing on the radio in the carpool.

Other agencies: Sometimes additional phone calls are required following

the announcement. A company with a pending lawsuit was about to announce

the judgment. IR called NASDAQ and told them to halt trading;

then the company made the announcement. The judgment was going to be

considered material to shareholders, and trading volume would definitely be

affected. To encourage an orderly market and decrease volatility, IR wanted

to make sure the news was evenly disseminated.

IR’s responsibility is to know who has to be called and when on any announcement

that may have a consequence for that agency, even if the market

is closed.

It’s All in the Timing

Just as important as the content and structure of the release and conference

call is the timing. Many companies may not give the issue much thought, but

it’s an important part of reducing risk in the overall communications

process.

Analysts see companies release their earnings throughout the day. Some

would be the first ones out at 7:00 a.m., others at 11:00 a.m., a few at 3:00

p.m., and many at 4:00 p.m. or later. The subsequent conference calls might

also be scattered throughout the day. This shotgun approach just isn’t

smart, and IR should take control of the process and educate management

on timing.

The first series of checks IR should make are to competitors’ schedules.

Look on any of the information services and determine when the competition

is reporting. Most companies make that information public well in advance.

If they don’t, IR might look at prior-year releases to get a feel for timing.

Once a reporting grid is composed, IR should evaluate timing with

management and pick a release date that’s relatively vacant from peer reporting.

There’s no need to rush. It’s more important to be ready, on a date

when none of management’s competitors will be releasing results.

Rushing to get auditors in and out so that earnings can be reported

quickly just doesn’t seem to make sense, particularly in the new age of information.

In fact, there are no negative ramifications of reporting four

weeks after the quarter closes rather than three. The better route is to take

the time to ensure that results are accurate, sign off on them feeling confident,

script the call, practice Q&A, and listen to other industry calls. To that

last point, reporting later rather than sooner gives IR and management time

to gather competitive information by listening to other industry conference

calls. IR can read each competitor’s release and conference call transcript

and get a feel for industry results as well as perceptions and tones on Wall

Street. As a result, management is more prepared, and the risk of surprise is

materially reduced. Therefore, being one of the last companies in an industry

to report can be a good thing. If there is a risk in waiting, however, it

would manifest itself during a quarter where peers are reporting bad news.

Under this circumstance, the company’s stock would likely trade down with

the group before it has a chance to put out its earnings and control the information.

Pre-announcements can take care of this problem, a topic that is

addressed later in the chapter.

So how about time of day?

Many companies report earnings in the morning before the market

opens at 9:30 a.m., then conduct their conference call at 11 a.m. Better yet,

some companies release earnings at 11 a.m. and conduct the call at 1 p.m. In

theory, management probably thinks that it would lose the audience if it reported

either before the market opened or after it closed. That theory, however,

is just a guess on management’s part, and IR should do some educating

based on its capital markets perspective.

When the earnings release hits the tape during market hours—let’s say,

11 a.m.—traders, institutional salespeople, and investors immediately call

the analyst to decipher the information. Since the analyst hasn’t talked to

management yet, and legally cannot until the conference call because of disclosure

issues, they really can’t give an informed opinion to the world.

 “[XYZ Company] is planning to report its 16 week Q1:04 EPS before

the market open on May 13, with its conference call after the close.

The gap between the EPS press release and the conference call could

create material volatility during the day of May 13 if there are ambiguities

in the press release.”

—From an analyst’s email, April 28, 2004.

Therefore, the trading desk will make a snap judgment on its stock position

without company comment and without analyst comment. With that

judgment can come volatility in the stock. This process becomes even more

complex when the earnings release is complicated. If Reuters or Bloomberg

picks up the wrong headline or misinterprets the release, for example, the

market may move unnecessarily, which can have a serious effect on the stock

price, and whipsaw shareholders.

Companies should distribute their releases and conduct their conference

calls after the market closes. Specifically, the announcement should hit the

tape at 4:01pm and the call should start at 4:30 p.m. or 5:00 p.m. EST.

This method is good for several reasons, including the fact that there’s

less distraction on the trading floor and less opportunity for an unnecessary

reaction, based on a confusing release. For example, a retailer might have inventory

levels that appear higher than sales can sustain. Investors who see

this on the balance sheet might hit the sell button if the release is distributed

during market hours, prior to a conference call. But if the market is closed

and the company has a chance to explain that these inventory levels are built

into the projections for new store openings, investors may hesitate before

selling the stock, or not sell it at all.

The other advantage of distributing the release after the market closes is

that the sell-side has time to collect its thoughts, ask management questions,

and prepare a written conclusion for their First Call update. During the day,

the analyst is barraged with calls, the market is open, and the stock freely

moves as the conference call is being conducted. In addition, traders may be

out to lunch and institutional salespeople may be focused on other ideas or

they may be escorting management teams to buy-side meetings. In other

words, the release and the subsequent analyst call are diluted in the commotion

of the day. If the market is closed, none of these issues are present

and management is maximizing the opportunity to tell its story in a risk-free

environment.

Therefore, understanding the atmosphere on the other side of the capital

markets, the life of the portfolio manager, and the day of the sell-side analyst

helps to clarify why IR should choose this approach. To further maximize

the effort, it’s extremely beneficial to understand how the day of the

sell-side begins.

The Morning Meeting

To truly understand the analysts, their obligations, and their relationships

with the sales force, one has to understand the morning meeting at an investment

bank.

The morning meeting is the primary means of formal communication

between an analyst and the institutional sales force. This is ultimately where

investment ideas are introduced, debated, and delivered. For example, the

analyst makes his/her argument to buy or sell a stock, and if it’s persuasive,

the sales force, which can number from 10 to 50 individuals, will pick up

their phones and call roughly 10 or more institutional investors each (Fidelity,

Putnam, and Capital Research to name a few). This communication

channel is very powerful, to say the least, and one that IROs should take advantage

of.

Every day, Monday through Friday, from 7 a.m. to 8 a.m. or thereabouts,

investment banks and brokerage firms conduct the morning meeting.

Picture a large trading floor, fluorescent lights, rows of desks, stacks of

computer screens, and the buzz of suits and skirts adjusting their headsets,

folding their newspapers, finishing off their coffee, getting ready for the day.

At the front of the room is a podium with a microphone that will connect

the speaker’s voice to the vast network of salespeople who listen to the investment

bank’s ideas on any given morning.

Controlling the proceedings is a facilitator, the morning meeting gatekeeper.

He runs the show on a daily basis, and along with the director of research

preselects a handful of analysts to present their ideas each day. Competition

to present one of those ideas is fierce, and analysts must lobby for a

spot on the schedule. This selection is important to analysts for a couple of

reasons. First, getting on the morning meeting and having their investment

ideas supported by the sales force makes a name for the analyst among institutions,

and these institutions vote for analysts and determine a portion of

their compensation. Second, being on the morning meeting means that the

analyst in question is most likely upping or lowering their rating on a stock,

and those actions facilitate commission business on the trading desk. Again,

this is a determinant of analyst compensation. Therefore, the analyst is always

looking for undervalued or overvalued ideas and to bring those ideas

to the morning meeting.

So the key for IR is to understand the analyst’s mentality and find a way

to be one of those few Buy ideas on the morning meeting. That’s how to fully

maximize an earnings release and conference call and how to maximize the

relationship with any investment bank.

The first lesson on how to make the cut for the morning meeting is to be

an undervalued, interesting company with trusted management. Hold-rated

stocks aren’t presented in the morning meeting. Why? Because, a Hold rating

doesn’t generate a nickel of commission business. Therefore, it’s imperative

to be a Buy.

Getting to the Buy Rating

Positioning a stock as a Buy rating is the reason that IR must go to such

lengths in the definition stage to craft a message and package it in the way

analysts and investors can relate. The objective is to have it play out something

like this:

IR joins a quirky consumer company, refines its comp group, and determines

that it should be valued on EBITDA versus earnings. It’s a more accurate

valuation method for this capital-intensive company and casts it as undervalued

in the new peer group. Then, IR garners feedback from

management, the buy-side, and industry sources, drafts the earnings release

and conference call script, and prepares thoroughly for Q&A. IR, along

with management, also sets conservative guidance and conducts the conference

call at 5 p.m. EST, thereby controlling the dissemination information.

After the call, the analyst likes management and their approach and

views the numbers as conservative relative to the peer group. With time to

collect his or her thoughts, a well-thought-out research report is written, incorporating

management’s conservative guidance. Given the fact that estimates

are low, a great argument can be made that the stock is a Buy. The analyst

lobbies the gatekeeper to get his or her idea on the morning meeting,

and because management and IR have packaged the product conservatively

in both the release and the call, the green light is given and the analyst is

awarded the lead-off spot for the morning meeting.

The result: IR, along with management, has almost made the stock a

Buy through a strategic approach that fully understands how an investment

bank operates. If these practices are followed every quarter, particularly conservative

guidance, the institutional profile of the company will no doubt be

raised, volume will likely increase, and a higher valuation will ensue.

On the other hand, a promotional management team with aggressive

guidance doesn’t stand a chance of getting on the morning meeting because

of the increased risk to earnings estimates. The institutional sales force and

the buy-side will rarely support the stock when management has established

a pattern that is not conservative. There’s just too high a risk of losing

money. Whereas in the case above, management has essentially made the analyst

look good to the sales force because earnings are positioned to exceed

guidance. This in turn generates a buying opportunity and commissions for

the analyst’s firm. For the company, the multiple increased and the cost of

capital declined.

Had the company stretched with its guidance and released earnings during

the day, the stock would have immediately moved to a level commensurate with the perceived risk to earnings, and by the next morning there

would have been no investment call to make.

Putting It Together

Here are a couple of examples of how the entire process works.

Zippa!, the popular apparel brand mentioned earlier, discovered after

the IR audit that not only wasn’t it being clear in its definition, specifically

with regard to its product diversification, but that it hadn’t clearly communicated

this reality to The Street. Once the company had packaged this “new

product” for the investment community and established earnings guidance,

IR scripted a call that would clarify their old-to-them, but new-to-The-

Street, position.

After delivering the new message, backed up by numbers, in an aftermarket-

hours conference call, analysts walked away with a new understanding

of Zippa!. The company was clearer about its business and conservative

in its guidance. New analysts picked up coverage and delivered the

new thesis, old analysts changed their views, and despite the fact that Zippa!

missed its sales estimate, the stock increased nearly 20 percent the day after

the call. The PR group was thus positioned for positive stories in the media,

articles that could speak to the financial strengths and diversity of the business.

This approach took much of the risk perception out of the stock. None

of this was new, nothing had changed with regard to the way the company

did business. It was just delivering the critical information to Wall Street in

a way it could understand. Erasing the disconnect between perception and

reality.

After the call, several analysts called to thank the IR team, saying it was

one of the best messages they’d ever heard. Analysts and investors had unknowingly

foundered when it came to Zippa!, although the fault was really

in the company’s historic communications practices. IR made the analysts’

job much easier because issues were formally addressed in an open forum

with plenty of time for questions and answers. With access to new information

that before wasn’t readily available, the investment community recognized

a new positioning for Zippa!, right up there with a more mature,

global businesses. The conference call improved The Street’s perception of

the company, took risk out of the stock, and positioned it for a higher multiple,

creating tens of millions of dollars in value for shareholders.

Soft Sofas, a company in the home furnishings sector, had slow sales one

quarter and achieved Wall Street’s expectations only through a one-time gain

because of an asset sale. This result was technically a miss and would be viewed negatively by analysts. They began their conference call talking

about new initiatives and glossing over the financials. Big mistake.

The analysts and portfolio managers on the call, professionals at dissecting

financials, took notice. Management obviously missed estimates and

was trying to take attention away from that fact. Nothing could penalize

management more, and the odds that Soft Sofa would get on any morning

meeting schedule at any investment bank for the foreseeable future were seriously

jeopardized (other than as a Sell recommendation).

Soft Sofas should have started the conference call by announcing that

sales were down and then talk about the problems that contributed to this

slump and what factors were offsetting hoped-for growth. If management

had acknowledged the problem, identified its source, and given new guidance,

Wall Street would have handicapped the company’s ability to fix the

problem, lowered estimates, and if the stock dropped materially, had the

analyst on the morning meeting schedule to talk about the equity as undervalued.

By communicating this understanding, along with a strategy for

change, management could have built the kind of credibility that can never

be attained by trying to avoid issues with hype.

PRE-ANNOUNCEMENTS

The last agenda item on delivery is the pre-announcement. Management

competency is measured by more than the strategic vision to build a business;

it also includes the ability to understand the audience and communicate

the business. As far as Wall Street is concerned, earnings guidance is a

great indicator of management capacity because it tests the budgeting and

forecasting process and shows that management isn’t afraid to set the bar for

performance.

Granted, Wall Street also understands that factors beyond management’s

control cause earnings to drop. When the problem is the economy,

the weather, competition, or a national security incident, an earnings miss is

usually explainable. What is not easy to explain, however, are hiccups in the

core business where management should have had control. Managing the

unexpected is part of the job, and management that has been conservative in

setting the bar, even if it means a lower short-term stock price, has given its

estimates breathing room to deal with the unexpected.

The reason the market rewards upward earnings revisions is the perception,

right or wrong, that the executives are operationally sound and that systems

are in place to measure and predict financial performance. Wall Street

101: the market likes predictability and certainty, not risk and volatility.

Take, for example, this quote from a March 18, 2004, analyst’s report

on a restaurant conglomerate. “We have low confidence in our EPS estimate

of $1.46 and $1.56 for FY04 and FY05 respectively, due in part to management’s

frequent guidance revisions, none provided in press release, and also

to the ongoing and much discussed traffic volatility at (one of the company’s

restaurants).” The analyst maintained his Hold rating.

Missing estimates also puts the analyst in a precarious position. In addition

to his own research, the analyst counts on management for reliable

guidance, and if credible, the sales force and investors also buy into those

numbers. If a company misses estimates during a quarter and the earnings

are trending lower, the analyst is going to lose credibility when the quarter

sinks beneath them. Though a number that materially beats estimates is positive

for investors in the short term, any experienced analyst will wonder

how well management is able to forecast.

Missing the Number, but Mitigating the Penalty

“Weaker than expected earnings” was the key phrase. A trader was quoted

in the article, saying: “Frankly, expectations were too high. Companies

haven’t released many pre-earnings announcements and analysts were backing

out numbers, and no one was telling them otherwise.”

If, during the quarter, management can see that the company is going to

materially miss or exceed earnings estimates, the best thing to do is to preannounce

a new guidance range as soon as possible. Getting information

out early, in good times and bad, keeps Wall Street in the loop while minimizing

surprises. And yet, while we recognize management’s obligation to

get news out as soon as they know about changes, releasing news too early

can be costly. For example, if business is trending down during the quarter

and halfway through the three-month period management revises guidance,

that’s fine—unless the company misses revised guidance, which is totally

unacceptable. Therefore, management should wait until three-quarters of

the quarter has passed, when a tangible range is known. That way, management

is not adjusting guidance without feeling 99 percent confident in

the new range.

 “The tech stock rally deflated yesterday due to weaker than expected

earnings from [a Web commerce company] that torpedoed the sector

on fears that similar companies were overvalued.”

—The New York Times, October 2001.

The second part of any pre-announcement strategy is announcing the

date and time of the earnings call, probably three or four weeks later, and

making sure that it’s clear that annual guidance will be addressed again at

that time. Why is this important? If, for example, management brings down

second quarter guidance on May 30th, a month before the end of the quarter,

with no corresponding conference call, analysts may be left wondering

what to do with their annual estimates. By announcing that annual guidance

will be addressed on the upcoming call, management has just bought time

with the analysts and will likely be given the grace period before the analysts

move numbers.

Less so these days, but certainly in the late 1990s, most stocks had a

whisper number circulating. This number is exactly what it sounds like: the

estimate that the market believes as information buzzes around Wall Street.

It’s always higher or lower than First Call published consensus, but for discussion

purposes, let’s say it’s higher.

Pre-announcements help mitigate the whisper number by defining expectations

into a range. This is particularly critical with a growth stock

that’s performing well, because in the absence of an earnings pre-announcement

Wall Street is free to manufacture information leading up to the conference

call. This is the ultimate in losing control of the communications

process and allowing rumors to define expected financial performance. It

not only creates volatility but most likely puts management in position to

fall short of expectations. By pre-announcing a range, the whisper number

is eliminated.

Another reason to pre-announce earnings is if an upcoming shortfall is

caused by industry-related problems. If that’s the case, getting the news out

as soon as possible is even more important, but again, not before management

is comfortable with the revised range. On such industry-related news,

companies in the same industry will tend to move up and down together. Because

a company’s peers are likely also feeling the same effect, it’s best, if

possible, to be the first in a peer group to adjust expectations. That

way, management is on the offensive rather than reacting to a competitor

miss and any Reg FD issue is eliminated. To that point, if management is

the first to pre-announce the industry issue and new earnings estimates,

they are free to discuss it, within reason, with the buy- and sell-side. The

industry peers who don’t pre-announce will likely get a large volume of

calls that they won’t be able to field because commenting would risk a Reg

FD violation.

Ultimately, pre-announcing every quarter, even when there isn’t a material

variance from expectations, is a good policy because it doubles the

amount of communications with Wall Street from four (earnings releases) to eight (earnings releases and pre-announcements). By increasing the communication,

consistency and transparency are increased, and management’s

credibility can follow. The eight communication points also free management

of potential Reg FD violations, as referring back or forward to the latest

communication is very easy. In other words, the more communication,

the fewer windows to talk about material, nonpublic information.

Exceeding the Number, and Increasing the Reward

Many CEOs have realized the hard way that being better than expected

does not always turn out to be better than expected. In most cases, when a

company materially beats earnings estimates and waits to announce it until

the release date—for example, the First Call consensus is $0.10, and the

company reports $0.20 on earnings day—they will see their stock increase

that day.

However, Wall Street veterans look at that behavior and wonder if the

same policy goes when management misses numbers. The smart portfolio

managers ask themselves if the company can also surprise on the downside

by that much, and come to the conclusion that the company cannot forecast

its business. This can be disconcerting to the analyst or portfolio manager relying

on management for consistency and guidance. The pattern, more than

the content in this case, becomes discounted into valuation.

When an analyst recommends a stock, he or she wants to address their

sales force as many times as possible, particularly when the stock is behaving

in line with the rating. The morning meeting section taught that conservative

guidance, and meeting or exceeding guidance, can start a powerful

cycle of addressing the sales force and penetrating institutional accounts.

Octagon Inc. was in the last third of its quarter. The First Call consensus

estimate was $0.20, and the company’s own forecast, as disseminated

on the last conference call, was $0.17 to $0.20. If management

believed there was absolutely no way that earnings would be lower

than $0.22 and they’d probably be $0.25, an appropriate move would

be to pre-announce earnings and increase the range to $0.20 to $0.22.

That way, when reporting the actual quarter three to four weeks

later, management would have already known that it would report

$0.22 at minimum and most likely $0.25. If $0.25 it would be an upside

surprise, and if management reported $0.22, it would still be

within the increased range.

Therefore, if IR and management are conservative, and use pre-announcements

to raise guidance and update the market each quarter, the analyst has

that many more times to address the sales force and reiterate conviction

about the stock. Each case becomes an opportunity to generate commissions,

create a payday for the firm and analyst, build credibility for management,

bolster valuation, and reduce the company’s cost of capital.

Pre-announcing elevated to an art form can be about breaking one piece

of good news into two: giving the analyst two good data points to talk to

clients about and two pluses for addressing the sales force.

Without conservative guidance, however, management doesn’t have the

leverage to do this. Rather, they only introduce risk into the stock and increase

the company’s chance of missing estimates. Pre-announcing regularly,

particularly when times are good, reinforces the company’s upward trend,

labels management as conservative, and builds credibility.

Safety First—The Pre-Announce for Prevention

Sarbanes-Oxley and Reg FD reduce volatility in our view, because all analysts

and investors receive the information simultaneously. Unlike the Wild

West atmosphere of the 1990s, when analysts regularly extracted material

information in closed-door meetings with management teams, strict enforcement

limits incremental information.

Therefore, why wouldn’t companies pre-announce every quarter, if for

nothing else to reduce the chances of a material slip up in a one-on-one call?

With four set pre-announcements, the public information is always fresh

and management can breathe easy in casual conversations.

Another safeguard is Stock Watch, an organization that keeps an eye on

trading. If there is heavy trading volume, Stock Watch is going to call the

company and ask if they have any news. If the company says no, then they

better not come out with new information in the near future. And if the

company has a practice of pre-announcing whenever it thinks it’s going to

miss or exceed the estimate, or just in the normal course of business, then

The Street believes management and stays with guidance.

Road shows, which are discussed in the next section of the book, should

always be scheduled after the earnings calls so that the information is disseminated

before management begins the process. But in cases when that’s

not feasible, companies may want to consider pre-announcing quarterly results

or material news before the scheduled events so that management can

speak freely. If a pre-announcement is not feasible before presenting publicly,

management should be counseled to refer back to material in the last public

conference call. Legally, the company can’t break any new ground.

How to Pre-Announce

For all pre-announcements where there is a material miss—that is, actual

earnings are off by more than 20 to 30 percent—a conference call is in order

to quickly explain the problems and potential solutions. Although the last

thing management wants to do is talk about it, that’s exactly what it must do.

The conference call gives analysts and investors a chance to ask questions

and, for the misses, vent their frustration. The conference call also benefits

the analysts who have the luxury of hearing the details in an open

forum with the buy-side. Less pressure is then on the analyst because everyone

has heard the information in this forum. The analyst need not figure it

out from a short press release and a 10-minute follow-up.

When a company supports a pre-announcement with a conference call,

the odds are that the stock will decline less than it otherwise would have.

The signal also goes out that management is visible in bad times as well as

good, which is critical.

A Feel for When

Because of The Street’s estimate hypersensitivity, pre-announcements can be

a tricky business.

In the middle of its second quarter, a company in the apparel industry

was on target to hit its estimates, but felt that it would miss the third quarter

and had uncertainty about the full year. Management was reluctant to

change anything. IR urged them to bring down the fourth quarter, even

though they weren’t sure. Management took our advice and the stock

dropped that day.

However, it gave management a slight cushion to focus on the business

and not the stock price, because the new full-year guidance was conservative.

If the company had maintained the original fourth quarter estimate

they would have been in a nail-biting situation for six months, wondering if

estimates were too high. They would also have been in a Reg FD pickle

when asked about their comfort level with annual estimates.

Getting It Right

The approach to pre-announcing must be consistent because the behavior of

management oftentimes, more so than the actual event, will be factored into

long-term valuation.

If a company only pre-announces when there is a material variance from

the consensus estimate, then Wall Street knows that if there’s no pre-release

during any particular quarter, then the company is tracking toward the number. On the other hand, if there’s never a pre-release and the company falls

into a potential “make a quarter, miss a quarter” pattern, Wall Street will be

tentative to get involved and the multiple might suffer. Therefore, to mitigate

volatility and the guessing games on Wall Street, and prevent management

from violating disclosure laws, a consistent pattern of pre-announcing and

refining conservative guidance is recommended. Management can also use

other, non-earnings-oriented releases—for example, an announcement of a

new marketing initiative—to update the market on numbers.

Putting It All Together

The following case study of a real company with a fictional name engaging

in the delivery stage of IR illustrates how consistent and conservative earnings

guidance, combined with pre-announcements and the right message,

completely engaged Wall Street via research and the morning meeting, created

commission business, made management look great, and drove the

multiple to premium status.

Rebuilding Credibility

Orange Foods was a large restaurant chain that had a history of inconsistent

performance relative to earnings expectations. They’d hit their

number and then lowered guidance regularly. Analysts were generally

negative on the company because of this inconsistency, and management

was universally perceived as not managing The Street properly.

Orange Foods began working with our IR team on October 1,

2001. The assessment of the problem was that the CEO was very

wrapped up in communicating a growth story on par with the best of

the industry, rather than acknowledging the limitations of his own concept.

In reality, this company just wasn’t capable of hyper-growth despite

its underlying quality, reputations, and brand.

This unrealistic communication led IR to plot a more conservative

strategy. On October 24, management took the advice and formally

brought earnings guidance down again. Only this time, it was not a

small adjustment. IR suggested lowering guidance by at least 20 percent.

The IR advisors told management that the stock would likely drop

materially and, in fact, that happened. It sparked the following comments

from four analysts:

(continued)

Analyst A: “Orange Foods reported Q3 earnings that were $0.01

below our estimate and more importantly revised Q4’01 and FY 2002

downward. Orange Foods cited choppy sales and margin pressure. We

are revising our estimates downward although our 2002 estimate is at

the top of the company’s revised range. We reiterate Buy rating.”

Analyst B: “We are lowering estimates and our rating to Market

Perform from Buy. Orange Foods trades at 24.9x our 2002 EPS estimate

and a discount to the group multiple of 30.7x”

Analyst C: “Despite drastic and likely conservative stance by management,

we are maintaining our BUY rating (although lowering estimates)

given that the new guidance will likely become immediately embedded

in the stock—moving it to relatively attractive valuation levels.”

And then there was this:

Analyst D: “We are reducing our rating from Strong Buy to Buy. Although

the guidance reduction is more aggressive than we believe is necessary,

we prefer to have a base to work with and be in position to only

make positive changes to our EPS estimates as our analysis dictates.”

Analyst D offered IR’s desired result. Despite an initial 15 percent

dip in the stock price, management was now viewed by the sell-side as

conservative rather than aggressive, and all of the analysts revised their

estimates to the exact range set by management.

Though two of the analysts lowered their rating, there seemed to be

an awareness that the estimates were conservative. The helpful observation,

especially to institutional investors, was that Orange Foods was

trading at a discount to its peers.

Most rewarding, between the lines of what they wrote, both analysts

C and D were telling investors to take a second look at the stock

despite the ratings downgrade in Analyst D’s case. These situations

make a company interesting to Wall Street.

A month later, in November 2001, several analysts wanted management

out on the road to visit investors. Why? Because the stock’s

risk profile had been greatly reduced, thanks to conservative guidance.

The sell-side knew it and felt comfortable that management was positioned

to meet or exceed estimates for the next few quarters. Because

analysts’ credibility is linked to the companies they bring to investors on

non-deal road shows, they always look for companies with conservative

estimates—that is, stocks that are Buys.

This stock was now a Buy largely because of management’s own actions. The new conservative guidance was responsible for the analysts

having a higher level of conviction in their writing and when talking

to their sales force or to investors.

Analyst C, who took management to buyers in early November,

said, “We hosted Orange Foods management in San Francisco and

Denver earlier this week. Despite recently lowered FY 2002 outlook

and some near-term loss of top-line momentum, we still believe that the

underlying business model is robust, providing ample, high return

growth for several more years. Our $0.80 FY 2002 EPS estimate is

predicated on 1% comps and should prove conservative.”

Conservative guidance also brought new analysts to the table because

they knew their chances of being wrong on their recommendation

were very low. Accordingly, another analyst, Analyst E, launched

coverage in November and said, “We are enthusiastic about the longerterm

prospects for the stock, but believe an increase in consensus EPS

estimates will be necessary to move the stock out of its current period

of malaise.” We knew this was more likely than not given the guidance,

meaning management and the analyst would look great as the year

wore on.

In the meantime, IR felt that management was clearly delivering on

expectations. All of the research reports were extremely positive in

their outlook, despite the ratings, and that was what mattered most.

The buy-side worries less about the actual rating then the text.

After all, what’s the difference between Strong Buy, Buy, Accumulate,

or Outperform? These are, as mentioned earlier, investment banking

ratings designed not to offend management teams so that investment

bankers can pitch their wares. The buy-side knows this, and for that

reason they look more at the text and the estimates than the rating. The

moral of the story for the CEO is not to worry about any rating shortterm;

worry about what’s written.

To that point, on December 11, 2001, Analyst D reiterated her Buy

Rating after taking the company out on the road. The analyst wrote:

“Company has news to talk about. We are raising our target price to

$25 and reiterating our BUY Rating.” The analyst also said, “We believe

that our current EPS forecasts for both Q4’01 and FY 2002 are

likely to prove conservative. We are therefore raising our target P/E

multiple to 30x to reflect the company’s return to 30% EPS growth.”

(continued)

This was the first time an analyst had increased the target multiple

for the stock to 30x. Before this, Orange Foods had, despite higher

earnings estimates, been trading at a discount to the group. Here the analyst

argued for 5 extra multiple points on the stock, and with the 20

million shares outstanding, this was an argument that the company was

worth an incremental $100 million.

On January 10, 2002, Analyst D reiterated her Buy Rating again

when Orange Foods announced preliminary Q4 results, confirmed

comfort with the current Q4 EPS estimate range, and established a

range for Q1. In the release IR stated that: “. . . based on these preliminary

results, management is comfortable with fourth quarter

2001 earnings per share guidance at the high end of the previously

announced $0.14 to $0.16 range.” IR also announced that Orange

Foods had “established guidance for the first quarter ended March 31,

2002. Based on current visibility, management expects a first quarter

2002 earnings range of approximately $0.17 to $0.19 per share based

on . . .” Also, “. . . its comfort with previously announced 2002 EPS

guidance of $0.80 to $0.84 per share.”

This announcement allowed IR to share another positive data

point with The Street: that management was comfortable with the previously

announced range. The management sell-side relationship was

blossoming. Analysts who took the company on the road and recommended

a Buy looked great, and investors were happy with management’s

certainty.

Things were even better in reality. Management had set themselves

up to release several positive data points down the road. For one, they

were fairly confident that they would at least hit the very high end of

the fourth quarter range, although it looked as though they might beat

it by a penny. Two, the earnings guidance range set for Q1’02 was very

conservative with virtually no risk. Three, 2002 estimates were conservative

and beatable, if business stayed the same.

Even though the First Call estimates were going up, they were going

up in line with management’s guidance and comfort level. Management

was in full control in this case, never having to worry about the estimate,

meaning fewer phone calls from concerned analysts and buysiders

and more time to run the business, which was invaluable.

“Conservative” in this case meant realistically looking at the business

and factors in management’s control and taking a discount to that

estimate for factors outside of management’s control—factors that inpevitably have an effect every year. These consensus estimates gave Orange

Foods a safety net to deal with unforeseen circumstances.

On January 29, 2002, the company announced Q4’01 EPS a penny

better than the range with which they were comfortable on January 10.

They reiterated conservative guidance for the March quarter, all of fiscal

2002, and fiscal 2003 despite pressure from the sell-side to raise

guidance.

Analyst E maintained the market perform but on valuation only,

cited 30.2x the 2002 estimate, and wrote, “Because Orange Foods is accelerating

its unit growth, margins may be under pressure, creating

slightly above average risk regarding negative EPS surprises.”

Analyst C maintained the Buy. “Estimates for 2002 look conservative.

We believe our ’02 estimate of $0.82 is conservative by at least

5%. Therefore, we continue to believe that EPS estimates will continue

to be upwardly revised.” But he did not raise his estimate, which was

key. He followed management’s guidance, so he and his firm were positioned

to look good. He had a Buy, and he would look great if the company

increased earnings.

Analyst A maintained the Buy Rating, arguing for 30x 2003 $1.01

estimate.

And then another nation was heard from. From a research firm

with no investment banking that, in an effort to gain credibility, only

carried Buy or Sell recommendations, Analyst F recommended a Sell.

He wrote, and this is a Sell recommendation mind you, “We believe

there is minimal earnings risk to the story but the valuation is high.

Shares have rocketed back to 30x consensus. We continue to be a believer

in the long term prospects of the company but would wait for a

more attractive entry point.” Victory for IR and management.

For the first time in awhile, Orange Foods felt it had nothing to

worry about with The Street. They’d kept expectations low, left behind

their traditional “make a quarter, miss a quarter” pattern, and kept several

“arrows in the quiver,” meaning there was a good chance guidance

would increase in the future. Instead of blindly communicating aggressive

guidance at the beginning of the year, management would start off

lower, and as the year went on and results came in, only then would

they raise guidance, and only when they were sure.

This approach would reduce risk materially and attract investor

(continued)

interest. The company might arrive at the same actual earnings at

the end of the year, but the way they got there built credibility and

valuation.

Analyst E wasn’t buying it, however, and felt the chances were

slightly higher than normal for an earnings miss. Behind the scenes, IR

knew this analyst was at risk as Orange Foods would continue to revise

upward throughout the year. Additionally, Analyst F had written what

we read to be a very positive Sell report. The analyst downgraded based

only on valuation and argued to buy on the dips. On the other end of

the spectrum, Analysts A and C had written about how conservative

management was and how consensus would go up over time. This was

very powerful and a direct result of the strategy.

The next month, February 4, a recommendation from Analyst G

caught IR’s eye. This analyst had been following the industry for a long

time and would not recommend a stock if he thought management

credibility or earnings were shaky. Management’s constant reiteration

of conservative quarterly and yearly guidance was the difference. He

raised the stock to a Buy, saying, “We have seen steady improvement in

stores and believe that the company is setting itself up to steadily outperform

on an earnings basis. . . . The bar has been lowered sufficiently

to provide an easy platform for management to exceed.”

In March, another analyst came on board, initiated coverage and

recommended a Buy. Analyst H said, “The balance sheet is sound and

financing is in place, allowing management the ability to execute their

growth plan without raising additional equity.”

This phrase came verbatim from the conference call script. By providing

the analysts with specific, reliable, and quotable information, IR

made it easier for the analysts to write what the company wanted them

to write, and management took control of its Wall Street destiny.

Another analyst covering the stock, Analyst I, wrote a 30-page report

on the company with an Outperform Rating. “Orange Foods is

currently trading at 24.1x our 2002 estimates (stock traded down 20%

recently), a premium valuation, yet one that reflects investor confidence.

. . .” This quote was great and showed a 360-degree turn on

Wall Street. Whereas prior to our engagement with the company, analysts

argued that Orange Foods should trade at a discount to the group,

they were now arguing for a premium valuation to the group. This

stance implied a lower cost of capital, which was key.

Obviously, at this point, the strategy was really taking hold. All of the analysts were speaking very highly of the company regardless of

their ratings. They knew management’s conservative stance on guidance

would ultimately make them look good. Additionally, the quote

from Analyst I showed IR that management was being rewarded with a

higher multiple because they understood how to manage The Street.

In early April, Orange Foods announced that it was comfortable

with the high end of the previously announced range of $0.17 to $0.19

per share for the first quarter ended March 31, 2002. On April 23,

2002, Orange Foods beat that range and announced $0.20 as the quarterly

result. Management knew in early April that $0.20 per share was

very likely, but not guaranteed, and reiterated comfort with the $0.17

to $0.19 per share range to maximize the announcement and generate

two positive data points versus one. One of those announcements, possibly

generating the $0.20 per share, would be perceived as an upside

surprise relative to expectations, although if they earned $0.19 it would

have been viewed positively as well. If $0.20 was the result, analysts

would have a boost and Orange would have created two opportunities

for analysts to share good news with their sales force.

In fact, $0.20 was the ultimate result after the auditors had closed

the books. Analysts raised numbers by $0.01 (the “overage”) and estimates

were revised upward. But management kept a tight leash and

conveyed specific guidance for the upcoming quarter, the full year

2002, and 2003. At this point, the stock hit $26, up from $17 in October,

just six months before.

IR also found that the company now had more buy-and-hold investors

than traders who fed off volatility. The new investor base loved

the slow and steady philosophy. Moreover, the First Call numbers were

still at the range set by management, keeping the stock interesting to

everyone on Wall Street.

In May, two new sell-side firms came in with coverage. Both rated

Orange Foods a Long-Term Buy. More analysts were attracted to Orange

Foods because they knew management was being conservative. If

these analysts thought First Call was too high, they would have thought

twice about risking their reputations and publishing on the stock. If

they did, it would likely have been a lower rating, and the conviction

level most likely would have been suspect. In June another firm initiated

coverage with a Buy recommendation.

(continued)

After initiating strategic IR efforts, Orange Foods’ management team

took control of Wall Street and repositioned its stock conservatively relative

to expectations. As the stocks outperformed, the analysts looked smart, the

buy-side was happy, and management was perceived by investors as savvy,

thereby raising its credibility. The company stayed the course and consistently

matched or overdelivered on what they promised. Finally, this had

vast, positive effects on media coverage and employee morale.

DEFINITION AND DELIVERY

There are many nuances to strategic IR that come together in the delivery

stage. The content, method, and timing of disclosures is a culmination of uncovering

value, building or redefining the investment thesis, and targeting

the landscape in a conservative manner. IR starts with honing in on the definition

and moves on to polish a delivery that is effective, as well as timeand

cost-efficient for management.

On July 2, Orange Foods raised its guidance for the second quarter

from $0.19 to $0.21 to $0.21 to $0.23 per share versus First Call,

which was $0.21. The company also increased full-year 2002 guidance

to $0.85 to $0.88 per share and 2003 guidance to $1.01 to $1.05 per

share. On July 3, Bloomberg’s Starmine service published a report

targeting Orange Foods as one of several companies with the propensity

to surprise on the upside. On July 19, another analyst rated Orange

Foods a new Buy.

On July 23, 2002, Orange Foods posted earnings of $0.23 per

share, achieving the high end of the range. Again they reiterated conservative

2002 and 2003 guidance and encouraged analysts not to

move numbers. Analysts followed suit.

By the end of the year, of the 10 analysts who published Orange

Foods research, 70 percent maintained some form of Buy rating versus

30 percent prior to this strategic IR initiative. All continued to be

within the desired First Call range, and the analysts benefited greatly as

Orange Foods rounded out the year beating numbers for three consecutive

quarters.

Commissions were generated for the sell-side, returns were generated

for the buy-side, and credibility (and plenty of it) was generated

for the CEO & CFO. Based on this performance, these executives

would be candidates to eventually move on to bigger public companies

and really build their careers and personal wealth.

Once IR and management have determined conservative earnings guidance,

a target audience, a uniform approach with PR, and all the necessary infrastructure

and disclosure needs, the stage is set for delivery. The basics of

delivery are earnings announcements, conference calls, and pre-announcements.

Long-term investors manage their risk by assessing management performance

as frequently as possible. They like to know what they can expect

and when they can expect it. Moreover, if things are going to materially

change from what’s expected, these money managers want to know as soon

as possible. Predictability is good, surprise is bad, and when it comes to performance,

the pattern of delivery can sometimes be as important as the actual

results.

To that end, earnings announcements should never be a big surprise, especially

if the company has established guidance and committed to refining

that guidance throughout the year.

But even with the most conservative guidance, some factors are still out

of management’s control, such as the weather or the economy. Even under

negative circumstances there are always ways to make bad events not so

bad. The ways and means of disclosure can have a profound effect on valuation

over time.

EARNINGS ANNOUNCEMENTS

IR must make its company’s story stand out above the thousands of publicly

traded companies that interact with Wall Street everyday. To do this, to

make an initial contact interesting, IR must reach out and grab the audience.

The most basic piece of the delivery stage is the earnings release, the vehicle

through which quarterly earnings results are expressed and distributed

to investors. Because the majority of public companies are on a calendar

year, the announcements are usually clustered around the same four periods

each year (late April/early May, late July/early August, late October/early

November, and February/March), with the sell- and buy-sides geared up to

handle the high volumes of information in these short windows. Because the

volumes of reporting companies are so large, analysts look to quickly review

the press release, take from it the key points, and move on to the next reporting

company. The release must be concise, contain only the most important

information, and supply a dose of context with a brief management

comment. It must also include financial tables—outlining results and any

other information that management believes will help shareholders better

analyze the company.

Content

The earnings release is widely distributed to the buy-side, the sell-side, and

the financial media. (Appendix A offers two examples of earnings releases.)

As with any press release, the headline describes the purpose of the release

and should act as a hook to draw investors’ and analysts’ attention

(“Octagon Inc. Reports Third-Quarter Financial Results”). The subheads

should highlight the quarterly performance and/or the most material content

in the release: “Exceeds First Call Earnings Per Share by 23% / Management

Raises Guidance for Fiscal 2004.” These subheads are important because

the news wires tend to pick them up and highlight them. In the above example,

everyone is aware that Octagon beat its earnings estimate significantly

and that the full-year expectations are being increased. If the increased guidance

portion of the release had not been packaged as a subhead, however,

odds are high that the media outlets might have ignored this very material

piece of information.

The second part of the release should include bulleted highlights from

the quarter, such as revenue growth over the prior period, EBITDA if appropriate,

Free Cash Flow, new customers acquired during the quarter, and

anything else management believes is a critical driver of the business. However,

the limit is about five items, so IROs should prioritize and settle on

metrics that the analyst and portfolio manager would want, not necessarily

items of which management is most proud. The key here is to deliver the

right message in a succinct fashion.

After the highlights, a quick paragraph can appear describing the results

for the quarter as they relate to revenues, net income, and diluted earnings

per share, and the year-over-year comparisons. That section should be followed

by a quote from the CEO that talks about the quarter.

Next, a paragraph can outline other drivers for the period, such as new

customer counts, average weekly sales, and strategy points. Still later might

be a paragraph discussing the balance sheet—cash balance, long-term debt,

and shareholder’s equity. The final quote should be from the CEO and is

most effective when talking about strategy and his or her overall vision for

the company and shareholders. Finally, before the financial tables, a guidance

section should appear that addresses the upcoming quarter and the full

year. There should also be a full description of the business in safe-harbor

language that protects forward-looking statements.

Remember that this is only an outline. The final product must be a combination

of IR, management, and legal counsel. However, be succinct and

avoid endless paragraphs of information or language that doesn’t immediately

imbed itself with investors. While too many quotes can also be a distraction,

in the past, they were less important because analysts and investors

could cull the specific information from releases or just call management to

gain additional insight. But subsequent to Reg FD, management must be

more careful about the added color they give in private calls. For that reason,

the release and the quotes are both templates for disclosure, so any direct

word from the company must be deliberate and thought out.

THE CONFERENCE CALL

Conference calls are one of the most common and expected vehicles for

communicating quarterly financial performance. Before Reg FD, an overwhelming

majority of larger companies conducted them, but not every

small-cap company followed suit. These days, nearly every company conducts

them, and all companies Web cast them.

The simultaneous Web cast allows everyone to be on the call, from big

institutional investors to individuals who own 100 shares. It’s an opportunity

to listen to management explain quarterly results and convey their vision

of the future. More importantly, because it reaches the masses, the conference

call and Web cast function as the company’s disclosure template until

the next quarterly call. In other words, if it’s discussed on the conference

call, on record, the CEO, CFO, or IRO can talk about it on private phone

calls, at exclusive Wall Street conferences, or in one-on-one meetings. The

conference call is the ultimate safety net for Reg FD.

In terms of structure and content for the call, the first section should be

an introduction from the IRO or legal counsel that includes who will be on

the call, what topics will be covered, and a reading of the Safe Harbor language

that protects the company should actual performance not match fore-

Delivering the Goods 163

casts. This section should be followed by the CEO, who discusses the quarter

in general, and addresses mostly qualitative initiatives that went on during

the three month period. Next up is the CFO who discusses in great detail

the top-line and its drivers, a line-by-line examination of expenses (not only

as a percentage of sales but versus the prior-year period), a balance sheet review,

and guidance. Finally, the CEO wraps up the call, but before Q&A, he

or she should comment on strategies and plans for the upcoming quarter

and year and leave the audience with three or four points why the company

is interesting at this particular point in time.

Analysts and portfolio managers know that the conference call is the

most efficient and effective way for management to communicate with The

Street, and because of this importance, the calls must always be scripted,

with topics and speakers specified and limited.

Scripting the Call

Part of the analyst’s job is to distill the company’s message into a persuasive

and credible opinion and share that view with clients in the investment community.

Therefore, IR should draft the conference call script with this perspective

in mind.

The IR professional should ask, If I could write the analyst report after

the call, how would it look?

This approach underscores the necessity for making key points and

highlighting the positives of the business in a way that the analyst and portfolio

manager are used to seeing. To that point, the script must be realistic

and credible, but take license to discuss strategic or operational initiatives

with enthusiasm. The hope is that these highlights make their way to analysts

in the next morning’s First Call notes in the same manner that they

were presented. In fact, that’s the entire goal of the call: getting management’s

exact point of view in the analysts’ research coverage, and having

them understand and buy into the strategy, all while keeping their First Call

estimates within management’s range.

As stated, the number-one rule for conference calls is that every word

must be scripted. In fact, management should begin preparing the script,

with IR, about three weeks in advance so that the CEO and CFO are fully

prepared. Why script every word? Because the call should last only 20 to 30

minutes, and without the script CEOs can frequently get off message and

speak in tangents about issues that may not be relevant to the call. In that

case, management has just wasted one of its four annual earnings calls by

rambling and looking unprepared. Our hunch is that analysts and portfolio

managers will pick up on that fact and think twice about getting involved.

Staying on script is also essential because today’s conference calls are

transcribed, widely distributed, and scrutinized. Oftentimes, portfolio managers

want to read the conference call transcript, hear about progress from

management directly, and check that view with the sell-side. That’s why

scripting each word, rather than working off bullet points or ad-libbing, is

necessary. Transcripts are a new form of research report complete with estimates

from management, and it’s a huge advantage if IR views it as such.

(Appendix B offers an example of a conference call script.)

Writing the script is a process that includes the following steps:

Management discussions: Executives are constantly crunched for time,

and SEC requirements don’t help that process at quarter’s end. IR’s lead on

preparing for the conference call helps management begin the process and

avoid mistakes that can accompany a last-minute rush.

Therefore, three or four weeks before the call, IR should talk to the

CEO and CFO, review the performance for the quarter, and determine what

topics will be most relevant for the call. These would include strategic issues,

financial performance, and a recap of material announcements during the

period. Once discussed and approved, IR then has an idea of what management

believes is important or material to communicate.

Also, although other departments within the company should not speak

on the actual call, they should be represented. For example, if an important

marketing initiative is launching in the second half of the year, it should be

discussed and scripted into the appropriate section. Or if the controller

has a better interpretation of why an important expense line-item didn’t

meet expectations, it can be discussed with IR and incorporated. When

senior management can speak in detail to these issues, analysts are impressed

and left with the perception that management is very much in-tune

with the business and running a tight ship. The comfort level that affords investors

is so highly coveted by sell- and buy-side analysts that a premium

multiple is often paid for stocks where management is communicating at

such proficient levels.

During the internal due diligence, IR has to set the tone of the call and

judge everything relative to valuation. Much information will be contributed

from the definition stage, but it’s always worth a quick revisit as definition

can change frequently, in tandem with stock movements. For example, if

things are going poorly for a company and the stock is already down, the

strategy for the conference call is very different than if the news is bad and

the stock is at a 52-week high. Capital markets experience and expertise can

tell management in what context to deliver the news.

Street recon: IR that is tapped into Wall Street perceptions already knows the overarching messages that should be stressed or defended in any

given quarter and will incorporate it with the messages that come from the

original meeting with management.

IR should query as to the specific concerns that analysts and investors

have regarding the company—for example, recent expense escalations, offbalance-

sheet debt, or the effectiveness of a certain marketing campaign.

Also, IR that has the connections to seek out and understand the “bear

story” on a company is invaluable and allows management to address specific

negatives on each call.

The process of collecting information from analysts or portfolio managers

can be very difficult, however, in that Wall Street professionals have

little time to share their perceptions, particularly around earnings season.

Accordingly, IR must build long-standing relationships, and capital markets

knowledge increases the odds that those relationships will develop.

Talking the language of the portfolio manager or analyst is the best way to

start an intelligent dialogue, garner real feedback, and pass it on unfiltered

to management.

Writing the drafts: Once IR has spoken to management and the outside

world, it should take the lead in writing the conference call script, adhere to

an agreed-upon format, and deliver the initial draft to the CEO and CFO

within a preset schedule.

For example, about a week after the initial meeting with management,

IR should have a first draft of the release and script ready to go. 48 hours

later, management should agree to give comments back to IR, and the whole

process should be repeated as the financials come together and the auditors

do their job.

Then, about a week before the call, the conference call invitation

should be sent to the wire utilizing the distribution list that was compiled in

the earlier stages of delivery. Once the CEO, the CFO, and IR have turned

two or three drafts of the script, with each party adding and subtracting

ideas, the final draft should be shown to legal and the audit committee for

final approval.

Being proactive: IR and management must collectively decide which issues

to emphasize during the quarter. IR may encourage a reluctant management

team to discuss a tough issue in the script rather than address it in

Q&A because it’s a proactive way to control the information and mitigate

risk. If, for example, the issue is ignored in the script because the CEO deems

it too uncomfortable to discuss, she may find herself off balance in Q&A,

fumbling for an answer that’s scribbled down on a cheat sheet. If scripted

from the beginning, however, the CEO can simply refer back to her prepared

remarks on the topic and move on to the next question. An example of a tough issue for a CEO might be downward margin trends in the face of rising

sales or the loss of a major customer or why the company doesn’t give

guidance. Allowing sophisticated portfolio managers or analysts to lead a

company down a line of questioning that the CEO is already uncomfortable

with can only make management look bad, and unfortunately the entire dialogue

will be transcribed for the world to see. That’s too much risk, and

there’s no reason to incur it.

Be prepared: Given the opportunity to be extemporaneous and not follow

a script, management might get off message and use a phrase, or even a

qualifier like “significant,” to describe a new initiative. A simple word or

nuance can send an unintended signal to analysts and portfolio managers

who are trained to quantify everything they hear from management. For example,

on a conference call, management might be talking about an initiative

for the upcoming year, and although it won’t be a contributor to earnings,

the CEO who’s not scripted might say, “it’s going to be a significant

part of our business going forward.” This might encourage analysts to incorporate

the new business line into their models and increase their earnings

estimates. If this unwanted analysis skews the average First Call estimate

upward, the company has just put itself in position to miss estimates. For

these reasons, management must be very careful even with what it believes

is mundane language.

Therefore, the point of a script is to stick to it, and management and IR

should practice to ensure that the executives can deliver the prepared remarks

with familiarity and ease. Additionally, IR should know, from its

Street reconnaissance and industry knowledge, the questions that are likely

to be asked. These questions can be subtly addressed in the script with some

pre-emptive language to nullify the question altogether. At the very least,

they should be written and reviewed so that management can prep for the

interaction.

In this preparation, IR should highlight specific talking points, as well as

issues to avoid, so that management can steer back to port if the call gets

bumpy. Preparation helps management present well and build credibility,

which is the name of the game when it comes to valuation. Ultimately, the

CEO and the CFO must come across as confident, answer all questions thoroughly,

and articulate a clear vision for the future.

Front and Center: Topics and Their Speakers

The voices on the conference call become the public voices of the company,

and the public role of the company executives should reflect their jobs.

Therefore, have two or three speakers at most represent the company. The first is the CEO. Not too many investors would buy a stock without listening

to, if not sitting down in person with, the CEO. The next individual

on the call might be the chief operating officer, who handles the day-to-day

operations. Finally the CFO should be on the call.

On an obvious level, this introduces the sell- and buy-sides to the executives

in charge, putting a voice to the vision, operations, and numbers. On

a subliminal level, it shows a cohesive, connected team in which the members

understand the business and their roles. By giving each executive specific

issues to cover, IR helps senior management put their best face forward

to The Street.

For purposes of disclosure and liability the company should be very particular

about who is on the call and who will interact with the investment

community on a day-to-day basis. One of the oldest analyst techniques is to

call different executives in the company—the CEO, the COO, and then the

CFO—and ask the same few questions to each, and look for points of discrepancy

that reveal incremental information.

To avoid this, a formal policy should be in place. The best analogy to

help clients understand the ramifications of no policy is to imagine the conference

call as a trial. If IR is the defense attorney, he must decide who will

be put on the witness stand. There are pros and cons for each person. For

example, it would be great to have the head of marketing explain the new

program for the upcoming year or the head of human resources talk about

the latest batch of hires. Better yet, the head of technology could talk about

the new Web initiative. Of course, if only IR were doing the questioning

after prepared remarks, it would be an easy choice to let these people speak,

but the line is filled with money managers, hedge funds, and short sellers.

Much like a trial, allowing someone to speak during prepared remarks

opens them up to questioning on the conference call, phone calls after the

conference call, and potentially questions during the quarter via email or

phone. The head of marketing would be viewed as another company source

from whom to gather information, and analysts and portfolio managers may

start calling multiple senior-level workers within the company. Therefore, to

control the information that is directed to Wall Street, IROs must limit the

number of participants on the call and make sure everyone has a unified

message, particularly intra-quarter.

What to Watch For on Conference Calls

Conference calls can succeed or fail for several reasons, and success relies on

preparation and management’s ability to hone in on content and delivery.

For analysts and portfolio managers, some things just don’t sit well.

Tell just enough: A company that spends five minutes on prepared remarks

and leaves the rest to Q&A gives too much room for analyst interpretation.

It can also send a message that the company isn’t taking the call

seriously or that they’d rather not share their information. On the other side

of the spectrum, a company that spends 45 minutes on prepared remarks is

simply taking up too much time, and that drain prevents investors and analyst

from participating in a Q&A session afterward, which is critical. Fortyfive

minutes shows that a company doesn’t know how to concisely tell its

story to the world. When in doubt, companies that want to disclose many

variables should put them in a supplemental disclosure section of the press

release for all to see.

Stay on point: The script should help management address specific topics

and avoid irrelevant or confusing tangents and trouble spots. Executives

must spend time on the focus of the call, possibly an earnings miss, in great

detail, before moving on to strategy and the company’s outlook. Glossing

over these points positions the CEO as unrealistic and a potential investment

risk. That’s why the script, with related investment community feedback

built in, is so important.

Don’t hype: Executives work hard all year with few moments to stand

up and garner recognition for the company’s operating results. The call may

seem like the perfect time for this, although in actuality, it’s not the right

forum. Management must allow the analysts and portfolio managers to

characterize the performance. Management should keep it somewhat matter

of fact and stay even-keel, whether times are good or bad. The Street wants

to hear the explanation behind recent performance and the essence of what

will happen for the remainder of the year.

Don’t hide: Regardless if the management team decides to be proactive

or not in the script, problems can’t be glossed over. Executives who talk

about positive issues when a big negative is looming are making a big mistake

and jeopardizing their own credibility. Management should state the

facts, the reasons behind them, and the actions being taken to fix the problem.

Management shouldn’t take the siutation personally because quarterly

misses happen every day on Wall Street. Management should be up-front

and overly available. How a management team handles the bad times on

their conference calls can define their public company careers and be a major

determinant of valuation.

Watch words: As stated earlier, it’s not just what is said, it’s how it’s said.

In conference calls, the littlest things might matter the most. The Street always

pays close attention to nuance, innuendo, and tone. Their job is to

quantify everything that management says, and determine what that means

to EPS.

Believe it or not, a certain word or a shift in tone or inflection can affect

the interpretation of information and shift the investor’s mindset up or

down. The difference between “very good” and “good” has meaning to the

analyst and portfolio manager. If these words are not quantified, the meanings

can be widely interpreted.

Analysts and portfolio managers cringe when they hear certain words or

phrases. Phrases such as “explosive earnings” or “our guidance might prove

to be very conservative” can ruin IR’s plan. The phrases are factored into the

share price immediately and many times set an unintended bar by which

management will be judged.

Dealing with shorts on the call: Short sellers are not necessarily the

enemy, although they certainly don’t brighten management’s day. They are

usually short-term players who have made a bet against the company because

the stock has increased in value, and in their minds the earnings don’t

justify the multiple. There’s risk involved in shorting stocks, however, so if

they borrow and sell short, they’ve probably done some solid research to arrive

at their bearish opinion.

If IR knows that the short interest in the stock is high, they need to prepare

the script with proactive explanations that address each point of the bear

story. Because the company does not want to enter a public debate on a conference

call, short sellers should not be confronted. Management should simply

put forth its counterarguments and then, if necessary, agree to disagree.

Although someone betting against management can lead to an emotional

situation, executives need to be matter-of-fact on the call and understand

that it’s not personal. The shorts may think the company is great, just

too expensive. Or they may be making a short-term bet. At the end of the

day, however, management shouldn’t waste time confronting short sellers on

the call. Delivering solid EPS growth over time is the only way to send these

players on their way.

Other Interested Parties

The earnings announcement and conference call typically get beyond the

sell-side and the buy-side. In fact, there are several constituencies to consider,

and management should have a systematic procedure in place to disseminate

and explain the quarterly information.

Stakeholders: Employees, vendors, and customers should be notified

first and foremost on any important company news. The employees are the

heart and soul of any organization, and one way to keep them motivated is

to keep them involved and educated. Any procedure for communication

should include an internal process that precedes, within Regulation FD constraints,

the external one. The CEO, not the local media or the Internet,

should be the first source of information for employees on company news.

If it’s feasible, and if it would underscore goodwill in a relationship,

strategic partners such as vendors and customers should also have an announcement

tailored toward them. An announcement after the market

closes and moments before the call to The Street keeps the team in sync. This

is especially important if it’s a cost-cutting measure or a merger that will result

in the closing of certain operations or layoffs. No one wants to hear

about their plant closing on the radio in the carpool.

Other agencies: Sometimes additional phone calls are required following

the announcement. A company with a pending lawsuit was about to announce

the judgment. IR called NASDAQ and told them to halt trading;

then the company made the announcement. The judgment was going to be

considered material to shareholders, and trading volume would definitely be

affected. To encourage an orderly market and decrease volatility, IR wanted

to make sure the news was evenly disseminated.

IR’s responsibility is to know who has to be called and when on any announcement

that may have a consequence for that agency, even if the market

is closed.

It’s All in the Timing

Just as important as the content and structure of the release and conference

call is the timing. Many companies may not give the issue much thought, but

it’s an important part of reducing risk in the overall communications

process.

Analysts see companies release their earnings throughout the day. Some

would be the first ones out at 7:00 a.m., others at 11:00 a.m., a few at 3:00

p.m., and many at 4:00 p.m. or later. The subsequent conference calls might

also be scattered throughout the day. This shotgun approach just isn’t

smart, and IR should take control of the process and educate management

on timing.

The first series of checks IR should make are to competitors’ schedules.

Look on any of the information services and determine when the competition

is reporting. Most companies make that information public well in advance.

If they don’t, IR might look at prior-year releases to get a feel for timing.

Once a reporting grid is composed, IR should evaluate timing with

management and pick a release date that’s relatively vacant from peer reporting.

There’s no need to rush. It’s more important to be ready, on a date

when none of management’s competitors will be releasing results.

Rushing to get auditors in and out so that earnings can be reported

quickly just doesn’t seem to make sense, particularly in the new age of information.

In fact, there are no negative ramifications of reporting four

weeks after the quarter closes rather than three. The better route is to take

the time to ensure that results are accurate, sign off on them feeling confident,

script the call, practice Q&A, and listen to other industry calls. To that

last point, reporting later rather than sooner gives IR and management time

to gather competitive information by listening to other industry conference

calls. IR can read each competitor’s release and conference call transcript

and get a feel for industry results as well as perceptions and tones on Wall

Street. As a result, management is more prepared, and the risk of surprise is

materially reduced. Therefore, being one of the last companies in an industry

to report can be a good thing. If there is a risk in waiting, however, it

would manifest itself during a quarter where peers are reporting bad news.

Under this circumstance, the company’s stock would likely trade down with

the group before it has a chance to put out its earnings and control the information.

Pre-announcements can take care of this problem, a topic that is

addressed later in the chapter.

So how about time of day?

Many companies report earnings in the morning before the market

opens at 9:30 a.m., then conduct their conference call at 11 a.m. Better yet,

some companies release earnings at 11 a.m. and conduct the call at 1 p.m. In

theory, management probably thinks that it would lose the audience if it reported

either before the market opened or after it closed. That theory, however,

is just a guess on management’s part, and IR should do some educating

based on its capital markets perspective.

When the earnings release hits the tape during market hours—let’s say,

11 a.m.—traders, institutional salespeople, and investors immediately call

the analyst to decipher the information. Since the analyst hasn’t talked to

management yet, and legally cannot until the conference call because of disclosure

issues, they really can’t give an informed opinion to the world.

 “[XYZ Company] is planning to report its 16 week Q1:04 EPS before

the market open on May 13, with its conference call after the close.

The gap between the EPS press release and the conference call could

create material volatility during the day of May 13 if there are ambiguities

in the press release.”

—From an analyst’s email, April 28, 2004.

Therefore, the trading desk will make a snap judgment on its stock position

without company comment and without analyst comment. With that

judgment can come volatility in the stock. This process becomes even more

complex when the earnings release is complicated. If Reuters or Bloomberg

picks up the wrong headline or misinterprets the release, for example, the

market may move unnecessarily, which can have a serious effect on the stock

price, and whipsaw shareholders.

Companies should distribute their releases and conduct their conference

calls after the market closes. Specifically, the announcement should hit the

tape at 4:01pm and the call should start at 4:30 p.m. or 5:00 p.m. EST.

This method is good for several reasons, including the fact that there’s

less distraction on the trading floor and less opportunity for an unnecessary

reaction, based on a confusing release. For example, a retailer might have inventory

levels that appear higher than sales can sustain. Investors who see

this on the balance sheet might hit the sell button if the release is distributed

during market hours, prior to a conference call. But if the market is closed

and the company has a chance to explain that these inventory levels are built

into the projections for new store openings, investors may hesitate before

selling the stock, or not sell it at all.

The other advantage of distributing the release after the market closes is

that the sell-side has time to collect its thoughts, ask management questions,

and prepare a written conclusion for their First Call update. During the day,

the analyst is barraged with calls, the market is open, and the stock freely

moves as the conference call is being conducted. In addition, traders may be

out to lunch and institutional salespeople may be focused on other ideas or

they may be escorting management teams to buy-side meetings. In other

words, the release and the subsequent analyst call are diluted in the commotion

of the day. If the market is closed, none of these issues are present

and management is maximizing the opportunity to tell its story in a risk-free

environment.

Therefore, understanding the atmosphere on the other side of the capital

markets, the life of the portfolio manager, and the day of the sell-side analyst

helps to clarify why IR should choose this approach. To further maximize

the effort, it’s extremely beneficial to understand how the day of the

sell-side begins.

The Morning Meeting

To truly understand the analysts, their obligations, and their relationships

with the sales force, one has to understand the morning meeting at an investment

bank.

The morning meeting is the primary means of formal communication

between an analyst and the institutional sales force. This is ultimately where

investment ideas are introduced, debated, and delivered. For example, the

analyst makes his/her argument to buy or sell a stock, and if it’s persuasive,

the sales force, which can number from 10 to 50 individuals, will pick up

their phones and call roughly 10 or more institutional investors each (Fidelity,

Putnam, and Capital Research to name a few). This communication

channel is very powerful, to say the least, and one that IROs should take advantage

of.

Every day, Monday through Friday, from 7 a.m. to 8 a.m. or thereabouts,

investment banks and brokerage firms conduct the morning meeting.

Picture a large trading floor, fluorescent lights, rows of desks, stacks of

computer screens, and the buzz of suits and skirts adjusting their headsets,

folding their newspapers, finishing off their coffee, getting ready for the day.

At the front of the room is a podium with a microphone that will connect

the speaker’s voice to the vast network of salespeople who listen to the investment

bank’s ideas on any given morning.

Controlling the proceedings is a facilitator, the morning meeting gatekeeper.

He runs the show on a daily basis, and along with the director of research

preselects a handful of analysts to present their ideas each day. Competition

to present one of those ideas is fierce, and analysts must lobby for a

spot on the schedule. This selection is important to analysts for a couple of

reasons. First, getting on the morning meeting and having their investment

ideas supported by the sales force makes a name for the analyst among institutions,

and these institutions vote for analysts and determine a portion of

their compensation. Second, being on the morning meeting means that the

analyst in question is most likely upping or lowering their rating on a stock,

and those actions facilitate commission business on the trading desk. Again,

this is a determinant of analyst compensation. Therefore, the analyst is always

looking for undervalued or overvalued ideas and to bring those ideas

to the morning meeting.

So the key for IR is to understand the analyst’s mentality and find a way

to be one of those few Buy ideas on the morning meeting. That’s how to fully

maximize an earnings release and conference call and how to maximize the

relationship with any investment bank.

The first lesson on how to make the cut for the morning meeting is to be

an undervalued, interesting company with trusted management. Hold-rated

stocks aren’t presented in the morning meeting. Why? Because, a Hold rating

doesn’t generate a nickel of commission business. Therefore, it’s imperative

to be a Buy.

Getting to the Buy Rating

Positioning a stock as a Buy rating is the reason that IR must go to such

lengths in the definition stage to craft a message and package it in the way

analysts and investors can relate. The objective is to have it play out something

like this:

IR joins a quirky consumer company, refines its comp group, and determines

that it should be valued on EBITDA versus earnings. It’s a more accurate

valuation method for this capital-intensive company and casts it as undervalued

in the new peer group. Then, IR garners feedback from

management, the buy-side, and industry sources, drafts the earnings release

and conference call script, and prepares thoroughly for Q&A. IR, along

with management, also sets conservative guidance and conducts the conference

call at 5 p.m. EST, thereby controlling the dissemination information.

After the call, the analyst likes management and their approach and

views the numbers as conservative relative to the peer group. With time to

collect his or her thoughts, a well-thought-out research report is written, incorporating

management’s conservative guidance. Given the fact that estimates

are low, a great argument can be made that the stock is a Buy. The analyst

lobbies the gatekeeper to get his or her idea on the morning meeting,

and because management and IR have packaged the product conservatively

in both the release and the call, the green light is given and the analyst is

awarded the lead-off spot for the morning meeting.

The result: IR, along with management, has almost made the stock a

Buy through a strategic approach that fully understands how an investment

bank operates. If these practices are followed every quarter, particularly conservative

guidance, the institutional profile of the company will no doubt be

raised, volume will likely increase, and a higher valuation will ensue.

On the other hand, a promotional management team with aggressive

guidance doesn’t stand a chance of getting on the morning meeting because

of the increased risk to earnings estimates. The institutional sales force and

the buy-side will rarely support the stock when management has established

a pattern that is not conservative. There’s just too high a risk of losing

money. Whereas in the case above, management has essentially made the analyst

look good to the sales force because earnings are positioned to exceed

guidance. This in turn generates a buying opportunity and commissions for

the analyst’s firm. For the company, the multiple increased and the cost of

capital declined.

Had the company stretched with its guidance and released earnings during

the day, the stock would have immediately moved to a level commensurate with the perceived risk to earnings, and by the next morning there

would have been no investment call to make.

Putting It Together

Here are a couple of examples of how the entire process works.

Zippa!, the popular apparel brand mentioned earlier, discovered after

the IR audit that not only wasn’t it being clear in its definition, specifically

with regard to its product diversification, but that it hadn’t clearly communicated

this reality to The Street. Once the company had packaged this “new

product” for the investment community and established earnings guidance,

IR scripted a call that would clarify their old-to-them, but new-to-The-

Street, position.

After delivering the new message, backed up by numbers, in an aftermarket-

hours conference call, analysts walked away with a new understanding

of Zippa!. The company was clearer about its business and conservative

in its guidance. New analysts picked up coverage and delivered the

new thesis, old analysts changed their views, and despite the fact that Zippa!

missed its sales estimate, the stock increased nearly 20 percent the day after

the call. The PR group was thus positioned for positive stories in the media,

articles that could speak to the financial strengths and diversity of the business.

This approach took much of the risk perception out of the stock. None

of this was new, nothing had changed with regard to the way the company

did business. It was just delivering the critical information to Wall Street in

a way it could understand. Erasing the disconnect between perception and

reality.

After the call, several analysts called to thank the IR team, saying it was

one of the best messages they’d ever heard. Analysts and investors had unknowingly

foundered when it came to Zippa!, although the fault was really

in the company’s historic communications practices. IR made the analysts’

job much easier because issues were formally addressed in an open forum

with plenty of time for questions and answers. With access to new information

that before wasn’t readily available, the investment community recognized

a new positioning for Zippa!, right up there with a more mature,

global businesses. The conference call improved The Street’s perception of

the company, took risk out of the stock, and positioned it for a higher multiple,

creating tens of millions of dollars in value for shareholders.

Soft Sofas, a company in the home furnishings sector, had slow sales one

quarter and achieved Wall Street’s expectations only through a one-time gain

because of an asset sale. This result was technically a miss and would be viewed negatively by analysts. They began their conference call talking

about new initiatives and glossing over the financials. Big mistake.

The analysts and portfolio managers on the call, professionals at dissecting

financials, took notice. Management obviously missed estimates and

was trying to take attention away from that fact. Nothing could penalize

management more, and the odds that Soft Sofa would get on any morning

meeting schedule at any investment bank for the foreseeable future were seriously

jeopardized (other than as a Sell recommendation).

Soft Sofas should have started the conference call by announcing that

sales were down and then talk about the problems that contributed to this

slump and what factors were offsetting hoped-for growth. If management

had acknowledged the problem, identified its source, and given new guidance,

Wall Street would have handicapped the company’s ability to fix the

problem, lowered estimates, and if the stock dropped materially, had the

analyst on the morning meeting schedule to talk about the equity as undervalued.

By communicating this understanding, along with a strategy for

change, management could have built the kind of credibility that can never

be attained by trying to avoid issues with hype.

PRE-ANNOUNCEMENTS

The last agenda item on delivery is the pre-announcement. Management

competency is measured by more than the strategic vision to build a business;

it also includes the ability to understand the audience and communicate

the business. As far as Wall Street is concerned, earnings guidance is a

great indicator of management capacity because it tests the budgeting and

forecasting process and shows that management isn’t afraid to set the bar for

performance.

Granted, Wall Street also understands that factors beyond management’s

control cause earnings to drop. When the problem is the economy,

the weather, competition, or a national security incident, an earnings miss is

usually explainable. What is not easy to explain, however, are hiccups in the

core business where management should have had control. Managing the

unexpected is part of the job, and management that has been conservative in

setting the bar, even if it means a lower short-term stock price, has given its

estimates breathing room to deal with the unexpected.

The reason the market rewards upward earnings revisions is the perception,

right or wrong, that the executives are operationally sound and that systems

are in place to measure and predict financial performance. Wall Street

101: the market likes predictability and certainty, not risk and volatility.

Take, for example, this quote from a March 18, 2004, analyst’s report

on a restaurant conglomerate. “We have low confidence in our EPS estimate

of $1.46 and $1.56 for FY04 and FY05 respectively, due in part to management’s

frequent guidance revisions, none provided in press release, and also

to the ongoing and much discussed traffic volatility at (one of the company’s

restaurants).” The analyst maintained his Hold rating.

Missing estimates also puts the analyst in a precarious position. In addition

to his own research, the analyst counts on management for reliable

guidance, and if credible, the sales force and investors also buy into those

numbers. If a company misses estimates during a quarter and the earnings

are trending lower, the analyst is going to lose credibility when the quarter

sinks beneath them. Though a number that materially beats estimates is positive

for investors in the short term, any experienced analyst will wonder

how well management is able to forecast.

Missing the Number, but Mitigating the Penalty

“Weaker than expected earnings” was the key phrase. A trader was quoted

in the article, saying: “Frankly, expectations were too high. Companies

haven’t released many pre-earnings announcements and analysts were backing

out numbers, and no one was telling them otherwise.”

If, during the quarter, management can see that the company is going to

materially miss or exceed earnings estimates, the best thing to do is to preannounce

a new guidance range as soon as possible. Getting information

out early, in good times and bad, keeps Wall Street in the loop while minimizing

surprises. And yet, while we recognize management’s obligation to

get news out as soon as they know about changes, releasing news too early

can be costly. For example, if business is trending down during the quarter

and halfway through the three-month period management revises guidance,

that’s fine—unless the company misses revised guidance, which is totally

unacceptable. Therefore, management should wait until three-quarters of

the quarter has passed, when a tangible range is known. That way, management

is not adjusting guidance without feeling 99 percent confident in

the new range.

 “The tech stock rally deflated yesterday due to weaker than expected

earnings from [a Web commerce company] that torpedoed the sector

on fears that similar companies were overvalued.”

—The New York Times, October 2001.

The second part of any pre-announcement strategy is announcing the

date and time of the earnings call, probably three or four weeks later, and

making sure that it’s clear that annual guidance will be addressed again at

that time. Why is this important? If, for example, management brings down

second quarter guidance on May 30th, a month before the end of the quarter,

with no corresponding conference call, analysts may be left wondering

what to do with their annual estimates. By announcing that annual guidance

will be addressed on the upcoming call, management has just bought time

with the analysts and will likely be given the grace period before the analysts

move numbers.

Less so these days, but certainly in the late 1990s, most stocks had a

whisper number circulating. This number is exactly what it sounds like: the

estimate that the market believes as information buzzes around Wall Street.

It’s always higher or lower than First Call published consensus, but for discussion

purposes, let’s say it’s higher.

Pre-announcements help mitigate the whisper number by defining expectations

into a range. This is particularly critical with a growth stock

that’s performing well, because in the absence of an earnings pre-announcement

Wall Street is free to manufacture information leading up to the conference

call. This is the ultimate in losing control of the communications

process and allowing rumors to define expected financial performance. It

not only creates volatility but most likely puts management in position to

fall short of expectations. By pre-announcing a range, the whisper number

is eliminated.

Another reason to pre-announce earnings is if an upcoming shortfall is

caused by industry-related problems. If that’s the case, getting the news out

as soon as possible is even more important, but again, not before management

is comfortable with the revised range. On such industry-related news,

companies in the same industry will tend to move up and down together. Because

a company’s peers are likely also feeling the same effect, it’s best, if

possible, to be the first in a peer group to adjust expectations. That

way, management is on the offensive rather than reacting to a competitor

miss and any Reg FD issue is eliminated. To that point, if management is

the first to pre-announce the industry issue and new earnings estimates,

they are free to discuss it, within reason, with the buy- and sell-side. The

industry peers who don’t pre-announce will likely get a large volume of

calls that they won’t be able to field because commenting would risk a Reg

FD violation.

Ultimately, pre-announcing every quarter, even when there isn’t a material

variance from expectations, is a good policy because it doubles the

amount of communications with Wall Street from four (earnings releases) to eight (earnings releases and pre-announcements). By increasing the communication,

consistency and transparency are increased, and management’s

credibility can follow. The eight communication points also free management

of potential Reg FD violations, as referring back or forward to the latest

communication is very easy. In other words, the more communication,

the fewer windows to talk about material, nonpublic information.

Exceeding the Number, and Increasing the Reward

Many CEOs have realized the hard way that being better than expected

does not always turn out to be better than expected. In most cases, when a

company materially beats earnings estimates and waits to announce it until

the release date—for example, the First Call consensus is $0.10, and the

company reports $0.20 on earnings day—they will see their stock increase

that day.

However, Wall Street veterans look at that behavior and wonder if the

same policy goes when management misses numbers. The smart portfolio

managers ask themselves if the company can also surprise on the downside

by that much, and come to the conclusion that the company cannot forecast

its business. This can be disconcerting to the analyst or portfolio manager relying

on management for consistency and guidance. The pattern, more than

the content in this case, becomes discounted into valuation.

When an analyst recommends a stock, he or she wants to address their

sales force as many times as possible, particularly when the stock is behaving

in line with the rating. The morning meeting section taught that conservative

guidance, and meeting or exceeding guidance, can start a powerful

cycle of addressing the sales force and penetrating institutional accounts.

Octagon Inc. was in the last third of its quarter. The First Call consensus

estimate was $0.20, and the company’s own forecast, as disseminated

on the last conference call, was $0.17 to $0.20. If management

believed there was absolutely no way that earnings would be lower

than $0.22 and they’d probably be $0.25, an appropriate move would

be to pre-announce earnings and increase the range to $0.20 to $0.22.

That way, when reporting the actual quarter three to four weeks

later, management would have already known that it would report

$0.22 at minimum and most likely $0.25. If $0.25 it would be an upside

surprise, and if management reported $0.22, it would still be

within the increased range.

Therefore, if IR and management are conservative, and use pre-announcements

to raise guidance and update the market each quarter, the analyst has

that many more times to address the sales force and reiterate conviction

about the stock. Each case becomes an opportunity to generate commissions,

create a payday for the firm and analyst, build credibility for management,

bolster valuation, and reduce the company’s cost of capital.

Pre-announcing elevated to an art form can be about breaking one piece

of good news into two: giving the analyst two good data points to talk to

clients about and two pluses for addressing the sales force.

Without conservative guidance, however, management doesn’t have the

leverage to do this. Rather, they only introduce risk into the stock and increase

the company’s chance of missing estimates. Pre-announcing regularly,

particularly when times are good, reinforces the company’s upward trend,

labels management as conservative, and builds credibility.

Safety First—The Pre-Announce for Prevention

Sarbanes-Oxley and Reg FD reduce volatility in our view, because all analysts

and investors receive the information simultaneously. Unlike the Wild

West atmosphere of the 1990s, when analysts regularly extracted material

information in closed-door meetings with management teams, strict enforcement

limits incremental information.

Therefore, why wouldn’t companies pre-announce every quarter, if for

nothing else to reduce the chances of a material slip up in a one-on-one call?

With four set pre-announcements, the public information is always fresh

and management can breathe easy in casual conversations.

Another safeguard is Stock Watch, an organization that keeps an eye on

trading. If there is heavy trading volume, Stock Watch is going to call the

company and ask if they have any news. If the company says no, then they

better not come out with new information in the near future. And if the

company has a practice of pre-announcing whenever it thinks it’s going to

miss or exceed the estimate, or just in the normal course of business, then

The Street believes management and stays with guidance.

Road shows, which are discussed in the next section of the book, should

always be scheduled after the earnings calls so that the information is disseminated

before management begins the process. But in cases when that’s

not feasible, companies may want to consider pre-announcing quarterly results

or material news before the scheduled events so that management can

speak freely. If a pre-announcement is not feasible before presenting publicly,

management should be counseled to refer back to material in the last public

conference call. Legally, the company can’t break any new ground.

How to Pre-Announce

For all pre-announcements where there is a material miss—that is, actual

earnings are off by more than 20 to 30 percent—a conference call is in order

to quickly explain the problems and potential solutions. Although the last

thing management wants to do is talk about it, that’s exactly what it must do.

The conference call gives analysts and investors a chance to ask questions

and, for the misses, vent their frustration. The conference call also benefits

the analysts who have the luxury of hearing the details in an open

forum with the buy-side. Less pressure is then on the analyst because everyone

has heard the information in this forum. The analyst need not figure it

out from a short press release and a 10-minute follow-up.

When a company supports a pre-announcement with a conference call,

the odds are that the stock will decline less than it otherwise would have.

The signal also goes out that management is visible in bad times as well as

good, which is critical.

A Feel for When

Because of The Street’s estimate hypersensitivity, pre-announcements can be

a tricky business.

In the middle of its second quarter, a company in the apparel industry

was on target to hit its estimates, but felt that it would miss the third quarter

and had uncertainty about the full year. Management was reluctant to

change anything. IR urged them to bring down the fourth quarter, even

though they weren’t sure. Management took our advice and the stock

dropped that day.

However, it gave management a slight cushion to focus on the business

and not the stock price, because the new full-year guidance was conservative.

If the company had maintained the original fourth quarter estimate

they would have been in a nail-biting situation for six months, wondering if

estimates were too high. They would also have been in a Reg FD pickle

when asked about their comfort level with annual estimates.

Getting It Right

The approach to pre-announcing must be consistent because the behavior of

management oftentimes, more so than the actual event, will be factored into

long-term valuation.

If a company only pre-announces when there is a material variance from

the consensus estimate, then Wall Street knows that if there’s no pre-release

during any particular quarter, then the company is tracking toward the number. On the other hand, if there’s never a pre-release and the company falls

into a potential “make a quarter, miss a quarter” pattern, Wall Street will be

tentative to get involved and the multiple might suffer. Therefore, to mitigate

volatility and the guessing games on Wall Street, and prevent management

from violating disclosure laws, a consistent pattern of pre-announcing and

refining conservative guidance is recommended. Management can also use

other, non-earnings-oriented releases—for example, an announcement of a

new marketing initiative—to update the market on numbers.

Putting It All Together

The following case study of a real company with a fictional name engaging

in the delivery stage of IR illustrates how consistent and conservative earnings

guidance, combined with pre-announcements and the right message,

completely engaged Wall Street via research and the morning meeting, created

commission business, made management look great, and drove the

multiple to premium status.

Rebuilding Credibility

Orange Foods was a large restaurant chain that had a history of inconsistent

performance relative to earnings expectations. They’d hit their

number and then lowered guidance regularly. Analysts were generally

negative on the company because of this inconsistency, and management

was universally perceived as not managing The Street properly.

Orange Foods began working with our IR team on October 1,

2001. The assessment of the problem was that the CEO was very

wrapped up in communicating a growth story on par with the best of

the industry, rather than acknowledging the limitations of his own concept.

In reality, this company just wasn’t capable of hyper-growth despite

its underlying quality, reputations, and brand.

This unrealistic communication led IR to plot a more conservative

strategy. On October 24, management took the advice and formally

brought earnings guidance down again. Only this time, it was not a

small adjustment. IR suggested lowering guidance by at least 20 percent.

The IR advisors told management that the stock would likely drop

materially and, in fact, that happened. It sparked the following comments

from four analysts:

(continued)

Analyst A: “Orange Foods reported Q3 earnings that were $0.01

below our estimate and more importantly revised Q4’01 and FY 2002

downward. Orange Foods cited choppy sales and margin pressure. We

are revising our estimates downward although our 2002 estimate is at

the top of the company’s revised range. We reiterate Buy rating.”

Analyst B: “We are lowering estimates and our rating to Market

Perform from Buy. Orange Foods trades at 24.9x our 2002 EPS estimate

and a discount to the group multiple of 30.7x”

Analyst C: “Despite drastic and likely conservative stance by management,

we are maintaining our BUY rating (although lowering estimates)

given that the new guidance will likely become immediately embedded

in the stock—moving it to relatively attractive valuation levels.”

And then there was this:

Analyst D: “We are reducing our rating from Strong Buy to Buy. Although

the guidance reduction is more aggressive than we believe is necessary,

we prefer to have a base to work with and be in position to only

make positive changes to our EPS estimates as our analysis dictates.”

Analyst D offered IR’s desired result. Despite an initial 15 percent

dip in the stock price, management was now viewed by the sell-side as

conservative rather than aggressive, and all of the analysts revised their

estimates to the exact range set by management.

Though two of the analysts lowered their rating, there seemed to be

an awareness that the estimates were conservative. The helpful observation,

especially to institutional investors, was that Orange Foods was

trading at a discount to its peers.

Most rewarding, between the lines of what they wrote, both analysts

C and D were telling investors to take a second look at the stock

despite the ratings downgrade in Analyst D’s case. These situations

make a company interesting to Wall Street.

A month later, in November 2001, several analysts wanted management

out on the road to visit investors. Why? Because the stock’s

risk profile had been greatly reduced, thanks to conservative guidance.

The sell-side knew it and felt comfortable that management was positioned

to meet or exceed estimates for the next few quarters. Because

analysts’ credibility is linked to the companies they bring to investors on

non-deal road shows, they always look for companies with conservative

estimates—that is, stocks that are Buys.

This stock was now a Buy largely because of management’s own actions. The new conservative guidance was responsible for the analysts

having a higher level of conviction in their writing and when talking

to their sales force or to investors.

Analyst C, who took management to buyers in early November,

said, “We hosted Orange Foods management in San Francisco and

Denver earlier this week. Despite recently lowered FY 2002 outlook

and some near-term loss of top-line momentum, we still believe that the

underlying business model is robust, providing ample, high return

growth for several more years. Our $0.80 FY 2002 EPS estimate is

predicated on 1% comps and should prove conservative.”

Conservative guidance also brought new analysts to the table because

they knew their chances of being wrong on their recommendation

were very low. Accordingly, another analyst, Analyst E, launched

coverage in November and said, “We are enthusiastic about the longerterm

prospects for the stock, but believe an increase in consensus EPS

estimates will be necessary to move the stock out of its current period

of malaise.” We knew this was more likely than not given the guidance,

meaning management and the analyst would look great as the year

wore on.

In the meantime, IR felt that management was clearly delivering on

expectations. All of the research reports were extremely positive in

their outlook, despite the ratings, and that was what mattered most.

The buy-side worries less about the actual rating then the text.

After all, what’s the difference between Strong Buy, Buy, Accumulate,

or Outperform? These are, as mentioned earlier, investment banking

ratings designed not to offend management teams so that investment

bankers can pitch their wares. The buy-side knows this, and for that

reason they look more at the text and the estimates than the rating. The

moral of the story for the CEO is not to worry about any rating shortterm;

worry about what’s written.

To that point, on December 11, 2001, Analyst D reiterated her Buy

Rating after taking the company out on the road. The analyst wrote:

“Company has news to talk about. We are raising our target price to

$25 and reiterating our BUY Rating.” The analyst also said, “We believe

that our current EPS forecasts for both Q4’01 and FY 2002 are

likely to prove conservative. We are therefore raising our target P/E

multiple to 30x to reflect the company’s return to 30% EPS growth.”

(continued)

This was the first time an analyst had increased the target multiple

for the stock to 30x. Before this, Orange Foods had, despite higher

earnings estimates, been trading at a discount to the group. Here the analyst

argued for 5 extra multiple points on the stock, and with the 20

million shares outstanding, this was an argument that the company was

worth an incremental $100 million.

On January 10, 2002, Analyst D reiterated her Buy Rating again

when Orange Foods announced preliminary Q4 results, confirmed

comfort with the current Q4 EPS estimate range, and established a

range for Q1. In the release IR stated that: “. . . based on these preliminary

results, management is comfortable with fourth quarter

2001 earnings per share guidance at the high end of the previously

announced $0.14 to $0.16 range.” IR also announced that Orange

Foods had “established guidance for the first quarter ended March 31,

2002. Based on current visibility, management expects a first quarter

2002 earnings range of approximately $0.17 to $0.19 per share based

on . . .” Also, “. . . its comfort with previously announced 2002 EPS

guidance of $0.80 to $0.84 per share.”

This announcement allowed IR to share another positive data

point with The Street: that management was comfortable with the previously

announced range. The management sell-side relationship was

blossoming. Analysts who took the company on the road and recommended

a Buy looked great, and investors were happy with management’s

certainty.

Things were even better in reality. Management had set themselves

up to release several positive data points down the road. For one, they

were fairly confident that they would at least hit the very high end of

the fourth quarter range, although it looked as though they might beat

it by a penny. Two, the earnings guidance range set for Q1’02 was very

conservative with virtually no risk. Three, 2002 estimates were conservative

and beatable, if business stayed the same.

Even though the First Call estimates were going up, they were going

up in line with management’s guidance and comfort level. Management

was in full control in this case, never having to worry about the estimate,

meaning fewer phone calls from concerned analysts and buysiders

and more time to run the business, which was invaluable.

“Conservative” in this case meant realistically looking at the business

and factors in management’s control and taking a discount to that

estimate for factors outside of management’s control—factors that inpevitably have an effect every year. These consensus estimates gave Orange

Foods a safety net to deal with unforeseen circumstances.

On January 29, 2002, the company announced Q4’01 EPS a penny

better than the range with which they were comfortable on January 10.

They reiterated conservative guidance for the March quarter, all of fiscal

2002, and fiscal 2003 despite pressure from the sell-side to raise

guidance.

Analyst E maintained the market perform but on valuation only,

cited 30.2x the 2002 estimate, and wrote, “Because Orange Foods is accelerating

its unit growth, margins may be under pressure, creating

slightly above average risk regarding negative EPS surprises.”

Analyst C maintained the Buy. “Estimates for 2002 look conservative.

We believe our ’02 estimate of $0.82 is conservative by at least

5%. Therefore, we continue to believe that EPS estimates will continue

to be upwardly revised.” But he did not raise his estimate, which was

key. He followed management’s guidance, so he and his firm were positioned

to look good. He had a Buy, and he would look great if the company

increased earnings.

Analyst A maintained the Buy Rating, arguing for 30x 2003 $1.01

estimate.

And then another nation was heard from. From a research firm

with no investment banking that, in an effort to gain credibility, only

carried Buy or Sell recommendations, Analyst F recommended a Sell.

He wrote, and this is a Sell recommendation mind you, “We believe

there is minimal earnings risk to the story but the valuation is high.

Shares have rocketed back to 30x consensus. We continue to be a believer

in the long term prospects of the company but would wait for a

more attractive entry point.” Victory for IR and management.

For the first time in awhile, Orange Foods felt it had nothing to

worry about with The Street. They’d kept expectations low, left behind

their traditional “make a quarter, miss a quarter” pattern, and kept several

“arrows in the quiver,” meaning there was a good chance guidance

would increase in the future. Instead of blindly communicating aggressive

guidance at the beginning of the year, management would start off

lower, and as the year went on and results came in, only then would

they raise guidance, and only when they were sure.

This approach would reduce risk materially and attract investor

(continued)

interest. The company might arrive at the same actual earnings at

the end of the year, but the way they got there built credibility and

valuation.

Analyst E wasn’t buying it, however, and felt the chances were

slightly higher than normal for an earnings miss. Behind the scenes, IR

knew this analyst was at risk as Orange Foods would continue to revise

upward throughout the year. Additionally, Analyst F had written what

we read to be a very positive Sell report. The analyst downgraded based

only on valuation and argued to buy on the dips. On the other end of

the spectrum, Analysts A and C had written about how conservative

management was and how consensus would go up over time. This was

very powerful and a direct result of the strategy.

The next month, February 4, a recommendation from Analyst G

caught IR’s eye. This analyst had been following the industry for a long

time and would not recommend a stock if he thought management

credibility or earnings were shaky. Management’s constant reiteration

of conservative quarterly and yearly guidance was the difference. He

raised the stock to a Buy, saying, “We have seen steady improvement in

stores and believe that the company is setting itself up to steadily outperform

on an earnings basis. . . . The bar has been lowered sufficiently

to provide an easy platform for management to exceed.”

In March, another analyst came on board, initiated coverage and

recommended a Buy. Analyst H said, “The balance sheet is sound and

financing is in place, allowing management the ability to execute their

growth plan without raising additional equity.”

This phrase came verbatim from the conference call script. By providing

the analysts with specific, reliable, and quotable information, IR

made it easier for the analysts to write what the company wanted them

to write, and management took control of its Wall Street destiny.

Another analyst covering the stock, Analyst I, wrote a 30-page report

on the company with an Outperform Rating. “Orange Foods is

currently trading at 24.1x our 2002 estimates (stock traded down 20%

recently), a premium valuation, yet one that reflects investor confidence.

. . .” This quote was great and showed a 360-degree turn on

Wall Street. Whereas prior to our engagement with the company, analysts

argued that Orange Foods should trade at a discount to the group,

they were now arguing for a premium valuation to the group. This

stance implied a lower cost of capital, which was key.

Obviously, at this point, the strategy was really taking hold. All of the analysts were speaking very highly of the company regardless of

their ratings. They knew management’s conservative stance on guidance

would ultimately make them look good. Additionally, the quote

from Analyst I showed IR that management was being rewarded with a

higher multiple because they understood how to manage The Street.

In early April, Orange Foods announced that it was comfortable

with the high end of the previously announced range of $0.17 to $0.19

per share for the first quarter ended March 31, 2002. On April 23,

2002, Orange Foods beat that range and announced $0.20 as the quarterly

result. Management knew in early April that $0.20 per share was

very likely, but not guaranteed, and reiterated comfort with the $0.17

to $0.19 per share range to maximize the announcement and generate

two positive data points versus one. One of those announcements, possibly

generating the $0.20 per share, would be perceived as an upside

surprise relative to expectations, although if they earned $0.19 it would

have been viewed positively as well. If $0.20 was the result, analysts

would have a boost and Orange would have created two opportunities

for analysts to share good news with their sales force.

In fact, $0.20 was the ultimate result after the auditors had closed

the books. Analysts raised numbers by $0.01 (the “overage”) and estimates

were revised upward. But management kept a tight leash and

conveyed specific guidance for the upcoming quarter, the full year

2002, and 2003. At this point, the stock hit $26, up from $17 in October,

just six months before.

IR also found that the company now had more buy-and-hold investors

than traders who fed off volatility. The new investor base loved

the slow and steady philosophy. Moreover, the First Call numbers were

still at the range set by management, keeping the stock interesting to

everyone on Wall Street.

In May, two new sell-side firms came in with coverage. Both rated

Orange Foods a Long-Term Buy. More analysts were attracted to Orange

Foods because they knew management was being conservative. If

these analysts thought First Call was too high, they would have thought

twice about risking their reputations and publishing on the stock. If

they did, it would likely have been a lower rating, and the conviction

level most likely would have been suspect. In June another firm initiated

coverage with a Buy recommendation.

(continued)

After initiating strategic IR efforts, Orange Foods’ management team

took control of Wall Street and repositioned its stock conservatively relative

to expectations. As the stocks outperformed, the analysts looked smart, the

buy-side was happy, and management was perceived by investors as savvy,

thereby raising its credibility. The company stayed the course and consistently

matched or overdelivered on what they promised. Finally, this had

vast, positive effects on media coverage and employee morale.

DEFINITION AND DELIVERY

There are many nuances to strategic IR that come together in the delivery

stage. The content, method, and timing of disclosures is a culmination of uncovering

value, building or redefining the investment thesis, and targeting

the landscape in a conservative manner. IR starts with honing in on the definition

and moves on to polish a delivery that is effective, as well as timeand

cost-efficient for management.

On July 2, Orange Foods raised its guidance for the second quarter

from $0.19 to $0.21 to $0.21 to $0.23 per share versus First Call,

which was $0.21. The company also increased full-year 2002 guidance

to $0.85 to $0.88 per share and 2003 guidance to $1.01 to $1.05 per

share. On July 3, Bloomberg’s Starmine service published a report

targeting Orange Foods as one of several companies with the propensity

to surprise on the upside. On July 19, another analyst rated Orange

Foods a new Buy.

On July 23, 2002, Orange Foods posted earnings of $0.23 per

share, achieving the high end of the range. Again they reiterated conservative

2002 and 2003 guidance and encouraged analysts not to

move numbers. Analysts followed suit.

By the end of the year, of the 10 analysts who published Orange

Foods research, 70 percent maintained some form of Buy rating versus

30 percent prior to this strategic IR initiative. All continued to be

within the desired First Call range, and the analysts benefited greatly as

Orange Foods rounded out the year beating numbers for three consecutive

quarters.

Commissions were generated for the sell-side, returns were generated

for the buy-side, and credibility (and plenty of it) was generated

for the CEO & CFO. Based on this performance, these executives

would be candidates to eventually move on to bigger public companies

and really build their careers and personal wealth.