Lights! Camera! Earnings Call!!

Lets face it – earnings calls are boring. Lawyers will tell you that this is a good thing because you are far less likely to get sued or have regulators come down on you if you don’t do anything splashy. So for most companies the earnings conference call has evolved into an elaborate kabuki theater consisting of 20 – 25 minutes of prepared remarks followed by 25 – 30 minutes of questions from analysts.

The prepared remarks are the worst – many times all you get is a regurgitation of the earnings press release, proving only that the CEO and CFO can read. This is because lawyers, ever fearful of Reg. FD, are reluctant to allow even the smallest snippets of information to vary from what has been “broadly disseminated” in a press release format. So you wind up with a highly paid executive reading dishwater dull financial information to analysts and investors who have already read the press release and put the numbers in their models. My guess is that with earnings season being notoriously busy, most analysts are only listening with half an ear to the prepared remarks while they multi-task on other things.

The question and answer sessions are a bit more interesting, if only because there is some uncertainty at work, both in the questions that are asked and the answers given by executives. Keep in mind however, that companies have a system for controlling who gets to ask questions, and when on the call the questioner will appear. Thus invariably, the company’s favorite analyst (read “biggest booster”) will get the cherished first question position, and the question is likely to be one that management has no difficulty answering. Thus analysts are often reduced to the role of the old Kremlin watchers, where  more information is to be gleaned from nuance, voice tone and innuendo than in the party line answers executives spout.

Now, however, the earnings call may be starting to evolve. Last week Yahoo’s CEO and CFO presented a live webcast of its second quarter earnings call. In most respects, their webcast was just like an earnings call, except you could see the executives. Thus, in addition to voice tone and inflection, analysts and investors could also judge body language. This also means that, unless it was done off camera, no one could surreptitiously slip answers to the executives. This is perhaps a small step, but it does add a few more points that investors can use in judging management.

A few days later, Netflix also broke with the typical earnings call with a slightly different format. In their presentation, which was conducted on Google Hangout via webcam and posted to YouTube, Netflix dispensed with the prepared remarks entirely and went directly to questions and answers. This is probably a good development, as it avoids needless repetition of financial information. The questions were compiled beforehand and posed to management by a reporter and an analyst. This may be a less salutary development, as it favors a single analyst and reporter, and while the company says that it did not see the questions beforehand, this process may be open to manipulation. In addition, because many of the questions were composites, there was no attribution of questions to any particular analyst, which I’m sure did not please the sell side community.

In general, both presentations were well received as bringing something new to the staid conference call format. I can only hope that more companies start to push the envelope in order to make things more interesting and to stand out from the crowd. Because, with disclosure to investors, as with classical economics, more is better - at least until you get to the point of disutility…

Just When You Thought It Was Safe To Go Back on the Call

Strange as it may seem, National Public Radio and Wall Street sell side research share a common business model – they both give the product away and hope you get paid later. The motivations are different; NPR is a not for profit entity while sell side research sits at the heart of profit driven capitalism, but NPR pledge drives and sell side marketing to get commissions directed their way are similar in many respects. Both occur long after the product has been delivered to the user with no obligation for the user to actually pay for it and both attempt to convince the user that they have been given a superior product.

The reason I bring this up is that occasionally NPR comes up with a story that actually has some bearing on corporate earnings and Wall Street, and they recently did so on February 2, 2012 with a piece entitled “Is That CEO Being Honest? Tone Of Voice May Tell A Lot”. You can find it at http://www.npr.org/blogs/thetwo-way/2012/02/02/146288038/is-that-ceo-being-honest-tone-of-voice-may-tell-a-lot.

In the story, NPR examines some software developed by an Israeli company based on research referred to as layered voice analysis. The software picks up on “vocal dissonance markers” that may indicate when the truth is being shaded, or when an executive is trying to avoid saying something that should be said in order to make an answer complete.

Of course, analysts on conference calls listen to tone and inflection all the time, so this of itself is not a news flash. The part of this story that makes it interesting is that the research shows that the analysts are much better at hearing the positive tones in a call than they are at hearing the cognitive dissonance in messages that are being shaded from complete truth. According to the radio story, part of this may be that most analysts stand to benefit more from positive recommendations than negative recommendations. Another part may be that most people are less likely to ascribe nefarious intent when a person sounds less than chipper. To this I will add another factor: most conference calls have taken on a very formulaic approach, and much of the time, corporate management sounds as if they are discussing their immanent root canal surgery with their dentist. Sounding unhappy to be on the call is par for the course and, therefore, it is hard to distinguish an unhappy tone from a less than honest tone. Conversely, any time management sounds happy, it really stands out and is easy to pick up on.

Faithful readers with long memories may recall that I wrote about similar research back in August 2010 in a post titled “Using Computers to Predict If a CEO is Lying”. In that case, researchers from Stanford Graduate School of Business took a look at word patterns during the Q & A sessions of earnings calls to help predict when company management was being deceitful. Now we have software that listens to voice tone that does the same thing. So maybe we are getting closer to the day when management will have no choice but to be completely honest with investors on earnings calls.

It could mark the death knell of the earnings conference call…

Using Computers to Predict If a CEO is Lying

There is an interesting article in today’s Wall Street Journal discussing an academic paper by a couple of Stanford University Graduate School of Business professors. The article is entitled, “For Lying CEO’s, ‘Team’ Not ‘I’” and refers to a Paper entitled “Detecting Deceptive Conference Calls” available at http://www.gsb.stanford.edu/cldr/cgrp/documents/SSRN-id1572705.pdf. Obviously, for anyone involved in conference calls, either on the corporate or the investing side, this is required reading.

What the professors did was interesting: they examined the Question and Answer sessions of 29,663 earnings conference call transcripts between 2003 and 2007 for language features that predict “deceptive” reporting of financial statements. (Note that they were smart enough to ignore the carefully scripted section of the call.) In the professors’ words, “Our primary assumption is that CEOs and CFOs know whether financial statements have been manipulated, and their spontaneous and (hopefully) unrehearsed narratives provide cues that can be used to identify lying or deceitful behavior.” They then compared their predictive results to whether or not there was a later material financial restatement. And what they found was that their methodology had correctly predicted between 50% – 65% of the conference calls as “deceptive” by virtue of their having later resulted in an earnings restatement.

For those of you who want (or need) to know what the linguistic hot buttons are, here are some of the things to watch out for:

• CEOs that speak in terms of third person plural pronouns or impersonal pronouns are more likely to be deceptive. It seems in this case, honest CEOs tend to speak of I and me while dishonest CEOs prefer to refer to the company or team.
• Expressing extreme positive emotions with words such as fantastic is more likely while making a deceptive claim.
• Longer answers also are more likely to indicate that they are deceptive.
• Lack of hesitation – if a CEO is quick off the mark, the authors hypothesize that the answer is more likely one that he has rehearsed and wishes to answer quickly and move on.
• References to general knowledge such as “you know” also appear more frequently in deceptive responses.
• Lack of mention of shareholder value or value creation are also tip offs.

It will be interesting to see if investors pick up on any of this while parsing conference call answers. The Q & A session is already the portion of the call that gets the most scrutiny, and this research will only help to bring more focus to the area.

A Healthy Debate

There’s an interesting column in today’s New York Times entitled “Unhealthy Fixation on Job’s Illness” by David Carr, whose column, The Media Equation, looks at business events form a media perspective. In the column he basically says that the people clamoring for more disclosure on Steve Job’s health are a bunch of blood sucking voyeurs who won’t be satisfied unless they have real time readouts on all of his vital signs. I’ve written about Apple’s lack of disclosure about Steve Jobs in the past and I’ve even created a case study out of this fact set for my class on investor relations at Rice University, so at the risk of being classified as a blood sucking voyeur, I thought I would chime in and try to bring some rationality to the subject.

First, I would agree that, under normal circumstances, the health of senior executives is a private matter that does not require disclosure. While they are paid boatloads of money as if they are the only people that count in the organization, the fact of the matter is that they are mostly interchangeable parts, people that can be substituted for without a material change to the company. However, I also believe that there are certain people who are so identified with a company’s performance in the eyes of investors that a serious threat to their health requires telling shareholders. Warren Buffet of Berkshire Hathaway is one. Bill Gates and Sam Walton, when they were CEOs during their companies go-go years, are two other examples. There may be a few others, oftentimes founders of companies, that fall within this classification.

Companies can also exacerbate the situation and put themselves in a position of having to disclose. They often put boilerplate language in their “Risks” section of their SEC filings, as Apple did, saying something along the lines of: “Much of the future success of the Company depends on the continued service and availability of skilled personnel, including its Chief Executive Officer…”. Once such a statement is in the SEC filings, it would seem to me to be hard to argue that a serious illness to the CEO is not material to investors. After all, you’ve just told them that much of your future success will be attributable to your CEO, and basic finance dictates that a firm’s stock price is the discounted value of its future cash flows and capital gains. Further, if your firm celebrates the cult of the CEO; if the CEO is the only one who ever talks to the street; if your CEO either runs a one man show or give that impression to investors, your firm may be putting itself in a similar spot.

The federal securities laws do not mandate that a company disclose the health of the CEO or any other senior executive. On the other hand, they also do not grant a right of privacy on the issue of health. It all comes down to what would be considered material in the eyes of investors. In the case of Steve Jobs, the media reaction and the stock price movement relating to announcements about his health tell us that investors consider this information material. It may not seem fair, but these things are always viewed in hindsight.

Finally, even if the initial judgment is that disclosure isn’t necessary, you still don’t have the right to mislead, and this is where Apple may be most vulnerable. Once you choose to say something, you have to be truthful and not omit anything which, under the circumstances, might otherwise make the statement misleading. And Apple has had a whole series of statements that appear to be less than completely truthful when it comes to Mr. Jobs’ health.

So, what are the lessons here for corporate practitioners? If you want to plan so that this isn’t even an issue should your CEO get sick there are several things that you can do. First, take a team approach to meeting with investors. Let the Street see that the COO and CFO are also very capable individuals who know the business and can step in quickly should the CEO get ill. This applies to both in-person meetings and quarterly earnings conference calls. Next, get your lawyers to revise the risk section of your 10 – K and 10 – Q filings and remove language about how valuable your senior executives are and what a calamity it would be if you should lose them. Lawyers like to think of these sections as insurance policies against securities law class action lawsuits, but unless you want to disclose health issues, the language may be doing more harm than good. Finally, if you do decide to say something, make sure the disclosure is accurate and complete. Remember, the Securities and Exchange Commission and your mother strongly agree on one thing: It’s wrong to tell a lie.

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…

That You Charlie?

For those of you not blessed with what passed for a multicultural education in the 50s and early 60s, “That you Charlie?” is the tag line from the old Kingston Trio song, Charlie of the MTA. (Three clean cut white guys singing folk songs was about as multicultural as we got back then.)  Charlie was the poor chump who boarded the Boston subway system, the MTA, by paying his ten-cent fare, but when they raised the fare by five cents, Charlie couldn’t get off of the train.  He was condemned to forever ride the MTA, as sort of an urban Flying Dutchman.

The song begins:  “These are the times that try men’s souls. In the course of our nation's history, the people of Boston have rallied bravely whenever the rights of men have been threatened. Today, a new crisis has arisen.”

Recently a new crisis has arisen regarding earnings conference calls.  The Wall Street Journal reported on Saturday that a mystery man has emerged on conference calls at least seven different times in the last few weeks.  Calling himself Joe Herrick of Gutterman Research, he initially poses as a well-known analyst so that he gets into the question queue, then reveals himself as Joe Herrick (a fictional name) and generally asks plausible sounding, highly detailed questions about supply chain management and lean manufacturing.  Company executives, not wanting to look dumbfounded by the questions, have generally attempted to answer the questions, not realizing that they were the victims of a prank.

Some of you may view this as harmless fun, and if I were 15 again, I might too.  Fortunately, I am no longer 15 and I work in a profession that depends on convincing executives that it is in their best interest to speak openly with Wall Street.  It doesn’t help to have some idiot out there posing false questions designed to make fun of the system and make executives look foolish.  If this process continues the result will be that companies will make it harder to participate in conference calls or perhaps even eliminate the question and answer sessions.  No investor relations officer wants their CEO to be the next victim.  Companies will think of more ways to control the process and the information imparted during the calls.  They may start to give passwords to only a few select analysts so that they are the only ones that are allowed to ask questions, as Coke did on a recent conference call.  Any way you look at it, the amount of information imparted on the calls will be reduced, and especially reduced in the area of conference calls that offer the best opportunity to gain incremental information – the Q & A session.  The end result is bad for all investors.

So Joe Herrick, if you are out there, please ride off on the MTA into the sunset and, like Charlie, stay there.  You’ve had your fun, but you’re not helping investors, large or small.

What is Investor Relations Worth (Revisited)

My wife, who claims that one of the great proofs of her love for me is that she allows me to keep a dog, always buys every member of the family a new calendar at Christmas time. This year she bought me a calendar featuring dog cartoons from The New Yorker. The cartoon on the cover shows two dogs and one is saying to the other, “I had my own blog for a while, but I decided to go back to just pointless, incessant barking.” Of course, sometimes it’s hard to tell the difference.

One of the most common laments I hear from investor relations officers is that it is difficult, if not impossible, to measure the value of investor relations. It reminds me of the old saying about advertising: “Half of my money is wasted on advertising, the problem is, I don’t know which half”. I suppose it can also lead to IROs questioning their own worth, but we need not stray into such troublesome waters here.

Good investor relations is especially difficult to measure, as there generally are no baselines to gauge it against. You try to look at competitors’ valuations, companies with similar characteristics, the market in general and whatever else comes to mind. From that you hope that a pattern emerges, but whatever pattern may be there is often lost in the overall performance of the company. You often feel as if you’re dancing around the issue without really coming to grips with it.

When things go spectacularly wrong, however, there is a chance to measure damage more precisely. Academics call this an event study and crank out hundreds of them in learned papers accompanied by complex mathematical equations of the sort that gave me nightmare during my freshman year of college. My goals here are a bit more modest.

You might recall that Sallie Mae (NYSE:SLM) hosted a conference call with analysts on December 19, 2007 that was one of the worst examples of its kind. On the day of the call, Sallie Mae lost $3 billion of market capitalization. A month has now passed and given that Wall Street always initially overreacts to both good and bad news, I thought that after a month’s time it would be instructive to see where things stand.

Devoted readers of this blog (yes, there are a few) will recall that back in August of last year I quoted a study by Rivel Research where a survey of buy side investors showed that they thought good investor relations could add as much as 10% to a stock’s value, while poor investor relations could subtract as much as 15% from the value of a stock. From this perspective, here is how Sallie Mae’s disastrous investor relations foray into conference calls stacks up against the broad market and the NYSE Financial index:

Date                         SLM      SPX 500    NYSE Financials
12/18/07                 28.87    1454.98     470.55
12/19/07                 22.89    1453.00     471.25
1/14/08                   20.30   1416.25      450.55
first day % chg      -20.7%  -0.14%       +0.15%
One month % chg -29.68% -2.66%     -4.25%
(Note: I have chosen the date of 1/14/08 as the measurement date because that represents the highest price for SLM in the week leading up to the one month mark from the conference call in question.)

So comparing Sallie Mae’s best price against the worst performing index, they underperformed by approximately 25%. I think this lends some credibility to the values that Rivel research assigned to investor relations. Granted, it is a case study of one (and an extreme one at that) and by itself would not stand up to rigorous academic peer review, but it sure points in the right direction and seems to be in the same range.

So, investor relations officers take heart! There is meaning and value to your function! You add value to your company even if you just convince your senior management to prepare for conference calls and not wing it. Remember, the smartest thing you may do is to convince people not to speak unless they have something intelligent to say.

How Not to Run a Conference Call

Yesterday Al Lord, the CEO of SLM Corporation (Sallie Mae) held a conference call to reintroduce himself to the analyst community (He had previously served as SLM’s CEO and CFO). The purported purpose of the call was to bring some transparency to his role as CEO and to talk about some broad issues and goals for SLM. He certainly brought transparency to his role as CEO. What the Street saw was an executive who was by turns vague, defensive, arrogant and profane. Investors’ reactions were what you might expect – the stock traded down 20%, the worst one-day drop in the company’s history. As this is an example that we can all learn from, I thought I would dissect the call in more detail for our edification.

There were many issues that needed to be addressed on the call – a failed buyout bid and ensuing litigation, lowered credit ratings and the need to shore up capital at the company, the CEO’s recent sale of 1.2 million shares and steps needed to return the company to a growth mode following the nine months the failed buyout bid was pending. To the CEO’s credit, he raised all the issues in his prepared remarks. Unfortunately, he didn’t clearly explain any of the issues or set out concrete steps to achieve his goals. Then he acted surprised and defensive when during the Q & A session analysts tried to get a bit more specificity out of him.

Take for example, the issue of shoring up capital. According to the transcript, Al Lord said: “My goal, first goal, probably my first goal and second goal, is to strengthen our balance sheet. The deal, the unfinished deal, cost us a single-A rating. We're now BBB. First objective is to solidify that BBB, next goal is to improve it from BBB to single-A. It is very much my first priority. In order to do that, obviously, we're going to add capital …” There was nothing said about how capital was going to be added. Predictably, the first question during the Q & A session was about how the capital was going to be raised. Here’s a portion of the exchange:

Analyst: “I wanted to ask -- you're going to shore up the balance sheet. Does that mean you're going to be selling equity?”
Al Lord: “The most preferred type of equity is common equity. At this point, I'm not going to get very precise with you. The idea is to strengthen the equity, the capital count with financing somewhere beneath the long-term credit line.”
Analyst: “Do you think you would need to raise to get back to the credit rating you would like? And what are your thoughts about the dividend?”
Al Lord: “This is the last question I answer that's more than one part. We will look at the dividend in the second half of the year.”
Analyst: “Okay. And you didn't mention how much equity you were going to need to get back up to the single-A rating.”
Al Lord: “You're talking to the wrong guy. I don't know that answer.”

This exchange is a microcosm of what went wrong with the call. The first answer is vague and indirect. A simple yes would have sufficed, as the answer seems to imply that SLM will be selling equity and would prefer to sell common equity. The answer to the last question is simply a stunner in its arrogance. Here the CEO has stated that his first (and second) priority is to add capital, yet he can’t be bothered with the details. This guy used to be the CFO, so it’s not as if he came out of sales and marketing and doesn’t know his way around a balance sheet. This is not the way to inspire confidence in the market place. There are lots of ways to answer that question without giving specifics, such as “We’ve just started studying the issue, so we’re not prepared to comment on exact amounts yet”, or “There as so many variables that can come into play as we work to improve our capital structure that it would be premature to comment on amounts of equity required just yet.”

I could go on, as there are plenty of other examples of what not to do in a conference call, from failed humor to profanity, but it’s a bit like shooting ducks in a barrel – it’s way too easy, and besides, this post would be too long. The fact that the market removed $3 billion from SLM’s market cap probably says more than I can.

So, it makes for great theater, but what can we learn from the call? Here are a few thoughts:
1. Broad, rambling statements of goals don’t cut it with an audience of equity analysts. These are people whose job is to parse the details to construct models of future earnings. General statements coupled with a refusal to go into specifics will drive them nuts. If you can’t be clear and concise, it’s better not to say anything at all.

2. Tone, attitude and preparation matter. Al Lord clearly did not want to answer questions from pesky analysts and wasn’t prepared. This sends a message that he doesn’t care about his investors and is a shoot from the hip sort of executive.

3. Never, ever, use an expletive on a conference call. Before this, Jeff Skilling of Enron fame held the award for dumbest thing ever said on a conference call when he called an analyst a particular body part. Al Lord has clearly taken the award from Skilling, by ending his conference call with “let’s get the [expletive] out of here.”

On that note, I will get the heck out of here.