Maybe Things Were Not So Simple and Straightforward...

Apple seems to be providing a lot of grist for my mill lately.  I really don’t want to pick on Apple – I love their products.  This blog post is being written on one of four Macs my family owns, we have any number of iPods in the house and one of my kids even has an iPhone.  You would have to drag me kicking and screaming back into a Windows/PC environment.  Sadly, Apple, which is famous for its secretive corporate culture, looks as if it will have to be dragged kicking and screaming into good disclosure practices. 

Last week, I wrote about the situation at Apple with Steve jobs – see the post dated January 6, 2009, “The Weighty Issue at Apple”.  Earlier today, acknowledging that “my health-related issues are more complex than I originally thought” Steve Jobs announced that he was taking a medical leave of absence until the end of June 2009.  This announcement is the latest in a string of vague statements surrounding the health of the CEO of Apple.  First, there was the announcement in 1994 that he was “cured” of pancreatic cancer following a nine month period in which they concealed the fact that he was suffering from cancer.  Then four years later, following an appearance where he looked like death warmed over, a company spokesperson declared that he was suffering from “a common bug”.  Last week, following more rumors and a drop in the stock price, the story was that he was suffering from “a hormone imbalance” that was robbing his body of proteins, but we were assured that “”The remedy for this nutritional problem is relatively simple and straightforward…”  

If you are an Apple investor, you have to be really frustrated by all of this.  At this point you would think that Apple would have figured out that investors think the health of their CEO is very important to the future course of Apple (what a securities lawyer might call “material”).  Just look at what happens to the stock price every time there is a rumor about Steve Jobs’ health.  While I don’t like advocating looking in the rear view mirror to determine if something is material, plaintiffs’ lawyers do it all the time, so it’s a necessary evil.  The Apple statements thus far have only served to feed the continuance of rumors.  When I look at what they’ve said so far I come to the conclusion that they are either: 1. In denial, 2. Just don’t know, 3. Are staying relentlessly on message to protect the chairman, or, 4. Are doing what the Chairman wants in order to preserve a continuing stream of paychecks.  

I come back to what I wrote last week, which is that early and full disclosure, as distasteful and intrusive on the CEO’s privacy as it may be, is better for the company in the long run in terms of establishing and maintaining credibility.  So far, Apple’s credibility on this issue is extremely low.  So low in fact, that you might even say that it carries no weight.

The Weighty Issue at Apple

In an interesting investor relations development Monday, Apple CEO Steve Jobs announced that he is suffering from hormone imbalance, causing him to lose weight.  Now, you may ask, “Why is an announcement about someone’s weight loss important from an investor relations standpoint?”  There are a number of answers to that question, but the short one is that this is the first time Steve Jobs and Apple have taken a straightforward approach to the disclosure of his health as it may affect the company.  Of course, it may be that in light of their lack of candor in handling the issue in the past, this may be too little, too late, but that remains to be seen. 

Many companies take the approach that the health of their employees is a private matter, whether that employee is a clerk or the company CEO.  Certainly, if you take the position that all employees are interchangeable parts of the whole, and the illness or death of one will not have a material impact on the operations of the company, this would make sense.  Of course, it’s a bit less defensible if the CEO is making millions of dollars.  It seems to me that when companies grant executives huge compensation packages they are admitting that the loss or incapacitation of that employee will have a material adverse impact on the firm.  Presumably companies expect to get a return on their investment in their employees, so if the CEO is making millions of dollars, the loss of the CEO will result in the loss to the firm of at least that much, if not more, in firm earnings.  It’s even less defensible when, as is the case with Steve Jobs, the CEO is widely credited with personally turning around the company. 

Be that as it may, there is no SEC rule requiring that a company disclose or discuss the health of its CEO.   On the other hand, there is no right to privacy under the federal disclosure laws and regulations.  The SEC regularly requires company executives to disclose such personal information as compensation, perks, the purchase, sale and holdings of company stock and company dealings with family members, among other things. What investors must rely upon regarding CEO health is the general rule regarding disclosure of material events, which is to say, “Information is material if there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision.” And “There must be a substantial likelihood that the disclosure of an omitted fact would have been viewed by the reasonable investor as having significantly altered the “total” mix of information made available.”

So let’s look at how the facts apply to the relevant rule.  Several years back, in October of 2003, Steve Jobs was diagnosed with pancreatic cancer.  The company did not disclose the illness at the time, and Mr. Jobs was one of the fortunate few that contract a curable form of pancreatic cancer.  Jobs elected not to immediately undergo surgery for the removal of the tumor, instead trying to cure the tumor through a special diet.  After nine months of staying silent, Jobs finally underwent the surgery and only then announces that he had been suffering from cancer, but now he was “cured”.  So the first investor relations question that comes up is whether Apple acted properly is staying silent for so long.  I am willing to bet that a whole slew of lawyers working for Apple, including the company’s securities law lawyer, the general counsel, outside securities law firm and possibly even special counsel for the Board of Directors, looked at this question.  And what a surprise, they came to the conclusion that the chairman wanted. 

It seems to me that it would have been difficult for Apple to maintain that the possible incapacitation of their CEO was not a material event, especially in light of the statement concerning “Factors That May Affect Future Results and Financial Condition” on page 49 of their Fiscal Year 2003 Report on Form 10K (filed in December, 2003, after Jobs had been diagnosed with cancer), which stated “Much of the future success of the Company depends on the continued service and availability of skilled personnel, including its Chief Executive Officer…”  The only way Apple could have justified not disclosing the illness at that time was the line of reasoning first set out in SEC vs. Texas Gulf Sulphur Co. that because Jobs was still waiting to see how the cancer was responding to treatment, the issue was not yet ripe for disclosure.  Conveniently, the issue then became ripe for disclosure once Jobs was “cured”.

In part because of the way the original illness was disclosed, compounded by the secrecy that surrounds everything Apple does, the issue has refused to go away.  This past summer, four years later, Steve Jobs made a speech at an Apple technical conference, introducing the Apple 3G iPhone. He appeared noticeably thinner and speculation ensued that he was having a recurrence of his cancer.  In response to questions, an Apple company spokeswoman said Jobs had been hit by a “common bug” and was now on the mend with the aid of antibiotics.  In spite of this, rumors surrounding Jobs’ health have continued to circulate throughout the remainder of 2008.  

In December 2008, Apple announced that Steve Jobs would not be making a keynote address at the annual Macworld conference in January 2009, a speech that he had customarily given in the past.  Speculation and rumors concerning the state of Jobs’ health immediately increased and the stock dropped 10%.  On January 5, 2009, Apple released a letter from Steve Jobs to the public. In the letter Jobs states:

“I have been losing weight throughout 2008.  The reason has been a mystery to me and my doctors.

…Fortunately, after further testing, my doctors think they have found the cause – a hormone imbalance that has been “robbing” me of the proteins my body needs to be healthy.

The remedy for this nutritional problem is relatively simple and straightforward and I have already begun treatment”. 

The problem here is that in making the most recent statement, Jobs seems to be contradicting the Apple spokeswoman’s “common bug” statement of last summer.  If the reason for his weight loss was a mystery to his doctors, it could not have been a common bug.  So why should investors believe Apple this time?  Further, in terms of information content, there is not a lot of substantive information for investors.  One doctor interviewed by the Wall Street Journal has been quoted as saying “To an endocrinologist, the most vague statement you can ever make is the term ‘hormone imbalance’”. 

The investor relations conclusion I draw from all of this is that early and full disclosure, as distasteful and intrusive on privacy as it may be, is better for the company in the long run in terms of establishing and maintaining credibility.  If Apple had come out soon after the initial diagnosis of cancer in Steve Jobs they could have engendered tremendous sympathy and good will.  A continuing stream of disclosures could have kept rumor and speculation to a minimum.  Yes, the stock would gyrate, but the gyrations would be based on credible information, not rumor and innuendo.  I think that if you are the highly visible CEO of a publicly traded company, your privacy takes a back seat to the information needs of investors.

The Readers Vote

I’ve been writing this blog for about 18 months now and being a trained MBA, thought it would be a good exercise if I went back and reviewed the statistics around what people preferred to read.  After all, “If you can measure it, you can manage it”.  Besides, I thought some of my readers might find it interesting as well.  Additionally, if you are relatively new to the blog, there might be something I’ve written in the past that may be useful.

After 18 months of building up a readership base, Investor Relations Musings draws between 800 – 1,300 readers per month, which when you consider that there are only approximately 6,500 publicly traded companies in the U.S., isn’t bad.  More surprising to me, is that during those 18 months, I’ve had visits from 77 different countries, with any given month drawing from 30 – 35 different countries.  Although the vast majority of readers come from the U.S., 5 of the top 10 countries visiting the blog come from India, China and the Far East.  

When I examined the most popular posts, I found that the interests of readers were evenly split between humor, practical advice and the disaster of the moment.  Herewith a look at the top 10: 

1.  Essential Life Skill for the Investor Relations Professional, September 18, 2007.  A humorous look at what you need to survive in the profession, with tips about how to learn to talk with your mouth full.

2. Starbucks Grande Mistake, January 31, 2008.  My take on Starbucks decision to stop disclosing same store sales.  It turns out that people love to read about brand name companies.

3.  Why Not Just Tell Us Why You Fired Him?, October 14, 2008.  When Walgreens CEO was dismissed by the Board but it was gussied up as a “retirement”, my thought was that investors deserved better information about why he was fired and what it meant for the future of the company.

4.  Road Shows and Hedge Funds, November 12, 2007.  A look at the practicalities surrounding why sell side firms set up road shows with lots of hedge funds on the guest list.

5.  How Many Investor Relations Officers Does It Take to Change a Light Bulb?, June 8, 2007.  This one combines humor with thoughts on what it takes to be good at investor relations.

6.  How Not to Run a Conference Call, December 20, 2007.  Commentary on Sallie Mae’s disastrous conference call.

7.  What is Investor Relations Worth?, August 20, 2007.  The first of a series of posts pointing out the research that attempts to quantify the value of investor relations.

8.  Principle Based Disclosure for Investors, September 5, 2007.  Some thoughts on how to simplify the maze of regulations surrounding disclosure.

9.  How to Read 10K and 10Q Reports, September 10, 2008.  CVS Drugstores was a poster child for how investors can use the year over year change in language in 10K and 10Q reports to raise interesting questions.

10.  Blogging and Investor Relations, June 16, 2008.  Every IR officer wants to know about blogs, but nobody wants to do one (except Dell). 

If you haven’t had a chance to read these posts, I hope you’ll give them the once over.  As always, I will strive to be interesting, informative, opinionated and occasionally humorous. 

Starbucks and Disclosure of Same Store Sales

Last January, Starbucks announced that it was no longer going to provide same store sales numbers to investors as it executed its turnaround strategy.  At the time I said it was a mistake (see my post “Starbuck’s Grande Mistake” January, 31, 2008) and I still continue to think so.  But it’s been almost a year and I thought I would go back and see what Starbucks has done on this single, but important, disclosure item.

On a quarterly basis, they’ve been true to their word.  In the third quarter of 2007, before the ban on disclosing this metric, Starbucks’ press release mentioned comparable store sales 11 times, including citing the percentage increase as a highlight.  The 10 Q report for the same period mentioned comparable store sales 16 times.  (Lest anyone out there think that I am a geek sitting here counting words, let me assure you that my computer performs this task much better than I can.  It’s extremely useful when comparing one period’s reporting to another.  See my post “How to Read 10 K and 10 Q Reports, September 8, 2008.  I may be a geek when it comes to investor relations, but I’m not a total geek.)

Now move forward a year to the third quarter of 2008.  Starbucks’ press release only mentions comparable store sales twice.  The first time, in discussing sales results, they say: “The company’s lower than expected revenue growth was driven by continued slow traffic trends in the U.S., which resulted in a mid-single-digit decline in U.S. comparable store sales, and was a slight deterioration from the second quarter.”  So now Starbucks has taken away a lot of discussion and precise numbers from a year ago and replaced it with ambiguity.  If I’m an analyst and I hear “mid-single-digit”, my reaction, fair or otherwise, is that the decline is in the upper end of that range.  In the same release, of even more interest, is the way Starbucks phrases things when discussing their targets: “These targets reflect the company’s current assumption that fourth quarter company-operated comparable store sales trends will remain relatively stable with the third quarter.”  As someone who has written his share of press releases, I’ve got to admire the way Starbucks took a trend of mid-single-digit declining comparable store sales and made it sound stable.  In a fashion similar to the press release, the 10 Q report for the same period only mentions comparable store sales 3 times without citing a specific amount.

So when I went to this year’s Fourth Quarter Press Release and Annual Report on Form 10 K, I expected to see a similar dearth of discussion surrounding comparable store sales.  To my surprise, I found that this year’s 10 K actually has more mentions of comparable store sales this year (22 vs. 20), while the Press Release saw a moderate decline in mentions from 13 a year ago to 9 this year.  Not only that, but both the release and the 10 K filing mention specific numbers when discussing comparable stores sales. It was one of those moments when you lean back from your computer screen and go, “Huh”.  It also meant a lot more work, because now I had to go through the 10 K filing in detail to try and figure out what was going on. What I found was that this year’s Management’s Discussion and Analysis contained slightly more mentions of comparable store sales than in last year’s report, while everything else in the filing was pretty much the same year over year.  It was as if Starbucks had never changed its mind on disclosing the metric.

Obviously, I’m not privy to the internal discussions Starbucks has when preparing their securities filings, but, in my opinion, one of two things happened: either the accountants and the lawyers simply marked up last year’s 10 K and nobody else paid any attention to the filing (unlikely given that the 10 Q reports had significantly fewer mentions of comparable store sales) or the lawyers finally got some backbone and said something along the lines of, “Look, this number is so important and the trend is so significant, that you have to disclose it and talk about it.”  I wish I could have been a fly on the wall during those discussions.  Whatever the reasons, I am glad to see that the company is disclosing such an important number.  It would also appear that the company is continuing to discuss comparable store sales, as they discussed them at an analyst conference yesterday.

The takeaway for investor relations professionals for all of this is that you can’t hide important metrics about your company when the trend turns bad.  When Starbucks stopped disclosing same store sales numbers it was just as the numbers were headed south after many years of strong positive sales growth.  If the numbers were important when they were good, they are important when they are bad.  All Starbucks did was postpone the inevitable to the end of the year.  It was very short-term thinking on their part to think that they could spin the issue when it revolved around such a key number.

Some of My Favorite (IR Website) Things

Now that Thanksgiving is over, I thought that I would get in a Christmas holiday mood by listing some of my favorite (IR website) things. (Obscure fact of the day: The song “Some of My Favorite Things”, was sung by Julie Andrews in the movie The Sound of Music during a Summer thunderstorm, although it is now mostly associated with the holidays due to its optimistic lyrics.)  I’ve been working on a project lately that scores investor relations websites and it’s given me the opportunity to view many companies’ efforts in this area.  Overall, it seems as if investor relations web sites are becoming more robust.  I’ve been impressed with the variety and ingenuity exhibited on some of the sites I’ve seen.

As you might expect, not every site does everything, so for the benefit of those investor relations officers that don’t have time to conduct a review of other web sites, I thought I would list some of my favorite features:

Charting – there are lots of charting sites available, but some things can be done better on the company page.  For example, interactive charts with links to events and press releases are very helpful.  Many times I’ve stared at a stock price chart with a big dip or rise and wondered, “What happened here?” An interactive chart that leads you straight to the event saves a lot of time and effort.  Another helpful feature is being able to specify an exact time frame for your chart.  After all, most investors don’t invest on the exact day necessary to fit into the standard time range specified on most web sites.  I also found that charts that let you specify other companies to chart against very useful, although I’m sure many companies are not thrilled about having their competitors charted on their site.

I also found sites that provided a glossary helpful.  Every industry has its acronyms and special catch phrases and to the extent these can be explained and accurately defined, a lot of questions and head scratching can be eliminated.  In retail, for example, a common measure is same store sales, but many companies calculate it slightly differently.  A clear definition of how the measure is calculated can save IROs a lot of heartburn.  Along similar lines, another interesting feature I came across was a page that discussed other, non-company indicators as they may affect the company.  An obvious example, (I live in Houston) is the link between the price of oil and the performance of the oil companies.  Other companies have exposure to things such as inflation, commodity prices and consumer spending to name a few, and a page where companies gather the data and discuss their outlook on these trends is quite useful not only as a data source, but also as an additional insight into how the company thinks about how it is linked to the greater economy.

Finally, while most companies today provide links to their recent earnings conference calls, very few provide a transcript of the call.  Although you miss the tenor of the speaker’s voice when you rely upon a transcript, it is a more time efficient way of reviewing a conference call.  It would be fairly simple for most companies to post a transcript and save us all the additional hassle of going over to the Seeking Alpha web site to get it.

There are still plenty of IR sites out there that look as if the task was simply handed off to a third party provider with the lowest price option selected (frequent readers of this blog will know that I am generally incapable of writing a post without saying something critical), but overall my assessment is that the amount of data being presented is increasing and the ease with which investors can use the information is getting better.  So, from an investor relations standpoint, things are improving.  Now, if we could only say that about the economy…

Putting a “Hook” into Your IR Message

In the music business, received wisdom is that a song needs a “hook” if it’s going to be a number one hit.  In other words, a song has to have a memorable thought, idea or catch phrase so that listeners will remember it.  The idea translates well into much of what we do in investor relations.

Yesterday Robin Tooms of Savage Brands and I put on a Webinar entitled, “Attracting Investors with a Strong Financial Brand".  For me, it was an opportunity to step back and think about some of the more strategic aspects of investor relations. In IR we are often consumed with the tactical issues; the latest earnings release, the next investor conference, the endless minutia of analysts’ questions and the like, and we fail to put things in a framework that help investors understand what our companies are all about.  Thinking of your company as a financial brand helps to put your company in a context where many of the things your firm does fall into place and help explain one another. 

Some companies have such strong cultures that their financial brand is easy to see. The example I spoke about on the Webinar was Wal-Mart.  Everything Wal-Mart does is predicated on delivering the lowest possible price to their customer.  Their philosophy is simple – if you deliver low prices to customers, they will shop in your stores in large numbers and you’ll make lots of money.  Once an investor understands that this low price philosophy permeates everything that Wal-Mart does, they have a much better understanding, not only of the financial implications (gross profit margins low, SG&A even lower), but also how Wal-Mart gets there through its relationships with suppliers, cost containment and even their passionate anti-union stance. 

Sometimes it’s not quite as obvious and it takes a little thinking about how you should be positioning the “brand”.  When I was at Walgreens, the stereotype of the company was that it was just a drugstore chain, which as all the analysts knew was vulnerable to: (pick one, depending on the decade) combination supermarkets/drugstores, deep discount drug stores and Wal-Mart and hence could not possibly be competitive on price. In addition, nobody could understand why the company was building so many stores so close together, as there were already plenty of drug stores in America in retail shopping centers.  (As an aside, allow me to add that Wall Street analysts are notoriously bad at strategic thinking about companies.  Companies that allow Wall Street to set their strategic agendas are almost certainly doomed, as they will be buffeted by the latest trends taught in business schools unrelated to the hard facts of the marketplace and the company’s underlying culture. (See my post, “When Culture Meets Financial Theory” from September 24, 2008.)  It’s even worse than when the company brings in a bunch of consultants to help set the future course of the company.)  The response, or “brand message” to all of this was simple: Walgreens sells two things – healthcare and convenience.  When put into that context, much of what Walgreens was doing became more understandable.  The competitive response to the various retail formats, all of them big box retailers, was to be more convenient.  This explained why price, which Wal-Mart has used so effectively on most competitors, was not as effective on Walgreens, because Wal-Mart, with their giant stores, just wasn’t convenient.  It also explained why Walgreens was building so many stores – you needed to be close to the customers in order to be convenient.  And it explained why Walgreens wasn’t buying a lot of the existing drug stores, as those stores sat back in shopping centers right next to the supermarkets and were not as convenient as the new stores Walgreens was building on busy street corners.  The list goes on, but I think you get the idea.  Walgreens stated what made it unique and used it to explain many aspects of its operations and philosophy. 

We operate in a time when our message to investors is at risk of becoming ever more fragmented as the means of delivering it proliferate.  Think about Twitter – how do you convey a coherent message in 144 characters or less?  Either that or we run the risk of becoming increasingly bland as Reg. FD forces companies to be relentlessly on message.  If you can go beyond the tactical considerations of what the regulations require to be disclosed and whether or not something is material to provide a coherent context to your company – a financial brand – you will help your company and increase your value to investors. 

Either that, or you’ll be ready for a career in marketing…

The Curious Effect of Falling Stock Prices on Diluted EPS

As I’ve watched companies report earnings for the quarter that ended September 30^th, I’ve noticed a strange phenomenon – companies are getting help to their Diluted Earnings Per Share line from falling stock prices.  It’s no secret that the stock market has been brutal over the course of the past six months, and company equity values have taken a beating.  But there has been one small side benefit to the decline in stock prices.  Of course, companies won’t come out and tell you what it is.  You have to be a pretty savvy investor and know your way around a company’s financials in order to figure it out. 

Here’s how it works:  many companies have issued a large number of options over the last decade and have a large number of options that go into the diluted earnings per share calculation.  To grossly oversimplify things, the more options a company has outstanding and the deeper they are in the money, the greater the number of shares in the denominator for purposes of calculating diluted (as opposed to basic) earnings per share.  So far, so good, as long as the stock price moves in a smooth fashion.  However, when you get a steep drop in the stock price, many of a company’s options go under water.  When an option’s exercise price is above the fair market value of the stock, the options are excluded from the diluted earnings per share calculation, and they are anti-dilutive.  (This sounds to me suspiciously like anti-matter, but I don’t think accountants are that imaginative.) The result is that companies with large numbers of stock options and steep price drops in the stock price wind up with fewer fully diluted shares in their diluted EPS calculation and hence a higher diluted EPS number.  Good luck getting them to fess up to that however, they do their best to bury the calculations deep in the 10K or 10Q.

Sometimes the numbers can be startling.  A few years back Microsoft had 649 million shares excluded from the calculation of diluted EPS because they were anti-dilutive.  Talk about a big overhang on EPS if the stock price ever recovers.  More usually, the anti-dilutive effect is smaller, say one or two cents per share in each quarter.  The point here is two-fold: first, in Wall Street’s eyes, one or two pennies per share per quarter is a lot; when companies miss by that much, they get punished; and second, this is a non-operational benefit that companies are getting due to the bear market.  Companies are quick to tell you when non-operational issues hurt the EPS line, so why do they stay so quiet when it runs in their favor?

Finally, as long as I’m on my soapbox, where have all the highly paid Wall Street analysts been on this issue?  I have not seen a single analyst report that mentions this.  So here’s some advice to all my sell side friends – when diluted and basic EPS suddenly start looking the same where in previous years diluted was lower than basic, the company is probably getting some non-operational help from anti-dilutive options. Things aren’t as good as they seem.

Now, just like anti-matter coming into contact with matter, I will disappear.