Every public company must decide whether and to what extent to give the market guidance about future operating results. Questions from the buy side will begin at the initial public offering (IPO) road show and will likely continue on every quarterly earnings call and during investor meetings
and conferences.
The decision whether to give guidance, and how much guidance to give, is an intensely individual one. There is no one-size-fits-all approach in this area. The only universal truths are: A public company should have a policy on guidance and the policy should be the subject of careful thought.
Here are 10 rules for giving good guidance, as well as some practical suggestions to consider when drafting a guidance policy.
1: Designate a Limited Number of Company Personnel to Communicate
It is best if guidance and the related cautionary disclosures are given in a controlled environment. Every company should carefully evaluate its internal processes for preparing and providing guidance and designate a limited number of company personnel to communicate with analysts and investors about future plans and prospects.
2 : Adopt an Appropriate Guidance Policy Early and Follow It
Having a policy and following it can go a long way. Companies should tell investors when guidance will be given so investors know what to expect. For example, a company could tell investors that its policy is to give guidance once a year, with the year-end earnings release, covering expectations for the year in process. A company with that guidance policy should then not update its guidance during the course of the year except in extraordinary circumstances, such as a securities offering or a material acquisition or disposition.
This way, in between planned updates, the company can deflect investor questions by explaining that it is the company’s policy not to comment on prior guidance out of cycle.
3: Do Not Rely on Boilerplate Disclaimers
Explain the assumptions underlying each forward-looking statement and disclose the risks that may cause anticipated results not to be realized. The cautionary statements should be tailored to fit the guidance.
All good guidance should be accompanied by dynamic, carefully tailored cautionary statements. These disclaimers should temper the predictions of a rosy future with a balanced discussion of what could go wrong. Risk factor disclosure should also be appropriately updated with each publication; don’t just use the same old boilerplate from prior years.
It is also helpful if the material assumptions on which the guidance is based are disclosed and if the company’s risk factors tie to the achievement of those assumptions. A 10 percent increase in earnings that is premised on cutting redundant overhead costs is not the same as a 10 percent increase that is premised on a substantial increase in market share.
The point of cautionary language is to explain what goes into the “sausage” so investors can make their own informed decisions about the likelihood of the projected outcome actually being realized. Good cautionary disclosure can be an effective insurance policy against future liability if the guidance turns out to be incorrect.
4: Have Prepared Remarks Reviewed by Counsel and Stick to the Script
The earnings call is the most popular forum for issuing guidance. Many companies prefer to give guidance orally on their earnings calls and do not produce a written version of their statements for the related earnings press release.
For a chief financial officer who is comfortable sticking tightly to a prepared script, this is a perfectly acceptable choice. For others, putting it down in writing in the earnings release may be a wise precaution.
The press release and the script for an earnings call are usually the subject of a greater degree of oversight than any casual encounter, and earnings calls are always Regulation Full Disclosure (FD)-driven events since the public is invited to listen in and a recording is typically available on the company’s website for a period of time after the call.
Legal counsel is typically involved in the preparation of the earnings release and can participate in the risk/reward evaluation process as it relates to guidance.
5: Remember Regulation FD
Regulation FD’s prohibition on selective disclosure of material nonpublic information must be taken into account in any discussion of whether to give, update or confirm guidance.
Regulation FD and subsequent U.S. Securities and Exchange Commission enforcement actions have effectively eliminated the historical practice of privately “walking” analysts’ earnings estimates up or down to avoid unpleasant surprises at quarter-end or year-end.
Guiding analysts about future earnings is still permissible under Regulation FD, so long as the analysts and the general public learn all material information at the same time.
The scope of the discussion on the earnings call will set the boundaries of what can be discussed in private meetings between earnings calls, because Regulation FD frowns on answering follow-up questions in private calls or meetings where the public does not have access. Answering questions between earnings calls about topics that were covered at an appropriate level of materiality on the earnings call will generally be acceptable in follow up one-on-one investor meetings.
Venturing into territories that were not covered on the earnings call in subsequent private meetings can raise selective disclosure issues under Regulation FD, which is why most companies elect not to discuss prior guidance at all in private meetings, except to say their policy is not to comment between earnings calls.
In addition, confirming prior guidance can be viewed as issuing new guidance and should be approached with caution. An SEC Staff Compliance and Disclosure Interpretation of Regulation FD (101.01) suggests that a company’s reference to prior guidance will not necessarily be deemed to convey material nonpublic information as long as the company makes clear that (a) the prior guidance was issued as of the earlier date and (b) the company is not currently reaffirming the earlier guidance.
6: Do Not Be Afraid to Say ‘No Comment’
It helps to have worked out in advance which questions the company is prepared to answer and which questions merit only a “no comment” response. There are some questions the company will not want to answer.
There is no requirement that a public company immediately make public all material facts that come into its possession on a real-time basis. However, where a public company’s affirmative and definitive prior statements become clearly and materially false, it should consider issuing a clarifying, correcting or updating statement.
A public company can answer the question “Are you in merger negotiations with XYZ Inc.?” with a “no comment” response and not be obligated to later update that statement if it enters into merger negotiations.
However, if the answer to the first question was “This company will never enter into merger negotiations with XYZ Inc.,” then the company may want to consider an updating disclosure if merger negotiations begin in earnest.
In other words, once the decision is made to speak on a particular topic — expected earnings for the year, for example — it may be problematic to stop talking about it in the future as the facts change.
7: Do Not Comment on or Redistribute Analysts’ Reports
Regulation FD requires that when issuers disclose material information, they must make broad public disclosure of that information. Disparaging an industry analyst is providing material nonpublic information to that analyst and is not allowed in any manner that does not comply with Regulation FD.
Some issuers handle the rogue analyst situation by issuing a press release (or making statements on an earnings call) emphasizing the factors that the company believes will make it difficult to achieve the overly optimistic results predicted by the outlying analysts.
Most companies decline to get drawn into specific public disavowals of rogue analysts’ estimates.
8: Also Remember Regulation G (Non-GAAP Financial Measures)
Companies should only give guidance on a metric that they can accurately predict. Many companies prefer to provide the market with forecasts of an adjusted net income or adjusted EBITDA (earnings before interest, tax, depreciation and amortization) metric that excludes the impact of expected (or unexpected) non-recurring, non-cash and/or unusual items.
Adjusted measures such as these are easier to predict accurately since they are unaffected by many of the income statement items that impact earnings per share.
Public release of these non-GAAP (generally accepted accounting principles) financial measures will need to comply with Regulation G, which requires SEC-reporting companies that publicly disclose non-GAAP financial measures to provide (a) an accompanying presentation of the most directly comparable GAAP financial measure and (b) a reconciliation of the disclosed non-GAAP financial measure to the most directly comparable GAAP financial measure.
The GAAP reconciliation is only required for forward- looking financial measures to the extent available without unreasonable efforts.
9 : Continually Evaluate Whether Circumstances Favor an Update of Prior Disclosures
When management begins to doubt whether the company’s actual results will be in line with prior guidance, the decision whether to make a public statement to that effect is entirely dependent on context — all facts and circumstances must be considered.
As always, the analysis should start with a review of what was said in the first place. Did the company say that it would confirm annual guidance every quarter? Did the company say that it would not? Is it obvious from the facts that the prior guidance is no longer reliable (due to an important acquisition, disposition or industry development)?
If a company expects to exceed its prior guidance by a modest amount, it is probably safe to keep that information confidential and pleasantly surprise the investment community when earnings are announced.
On the other hand, if a company is reasonably sure that it will miss the mark by a material amount, intervening events or market pressures may force an out-of-sequence guidance update.
Context is everything. For a company repurchasing its own shares or involved in a going-private transaction, the fact that current guidance is materially low may be problematic. In the context of a securities offering, however, the opposite is true — materially high guidance is the concern.
Managing expectations to maintain credibility, provide transparency and avoid unpleasant surprises is always the goal.
10: Revisit Rules 1 Through 9 During Intervening Events
Be particularly sensitive to Rules 1 through 9 in the context of an intervening event between quarterly earnings releases and calls, such as an offering of securities, share repurchase program or acquisition or when insiders are buying or selling company securities.
A company should not simply follow its guidance policy blindly. Particularly in the context of securities offerings, sales by insiders or share repurchases, companies need to be alert to market expectations.
Circumstances that might cause a company to want to update guidance can occur very quickly and at inopportune times, and companies need to be able to act quickly in this era of instant information flow.
All of the key players should coordinate and communicate when the need arises so that informed judgments can be made as to what to say to the market and when.
Joel Trotter and Steven Stokdyk are partners with law firm Latham & Watkins LLP, and Nathan Ajiashvili is an associate with the firm. This article is adapted from the firm’s client alert entitled Giving Good Guidance: What Every Public Company Should Know, a comprehensive discussion of the issues facing CEOs, CFOs and audit committee members when formulating a guidance policy. The client alert also contains answers to some frequently asked questions about guidance.
T
his article originally appeared in the April 2013 issue of Financial Executive magazine.