You know, an earnings report is a funny, funny beast. Most companies look at this press release as yet another opportunity to spin their results -- bury the bad, highlight the good. This sometimes happens even if the bad is "our top five customers all deserted us" and the good is "our catalog inventory process is ahead of schedule." In fact, you can sometimes tell when a company has had a lousy, lousy result when it goes from posting the following headline:
SpectraSite Reports Record Revenue, Cash Flow, and Tenant Growth for Third Quarter 2000
To this one:
SpectraSite Reports Second-Quarter Financial Results [note: 2002]
Three months after this second headline, SpectraSite was in bankruptcy. So when things were great -- or at least when the company had a few statistics that looked great -- SpectraSite's headline trumpeted some successes, even as the company rotted underneath.
We've written about press-release shenanigans many times in the past, like Rich Smith's very funny send-up on Xybernaut (which also declared bankruptcy) and its love for "record" this and "record" that, and Tim Beyers' highly recommended "Press-Release Bingo," starringARM Holdings (Nasdaq: ARMHY ) . Even Dean Foods (NYSE: DF ) -- which I chose at random and highlighted in February 2004 -- got in on the act of shuffling the best data in given quarters to the top of the deck. Each of these instances highlights something that is crucial for investors in determining whether to trust a company's management with their investment dollars. Be careful with the company that shouts its successes from the mountaintops, but clams up on its failures, or blames forces outside its control.
We've celebrated the companies that are consistently at their best when they talk with shareholders. You know the usual suspects: Berkshire Hathaway (NYSE: BRKa ) (NYSE: BRKb ) , Kraft (NYSE: KFT ) , Costco (Nasdaq: COST ) , and White Mountains (NYSE: WTM ) . These are companies run by folks who don't mind telling you what they got wrong, what went well that they really shouldn't take credit for, and how shareholders should view their companies. Kraft's recent earnings report boldly announced "mixed" results, while Costco called attention to a review of its stock option practices, a problem many companies would like to forget.
These -- and there are others -- should be viewed as the gold standard. It is the opposite of what most companies do, and a look at the box scores for these companies suggests that their iconoclasm has -- at a minimum -- not exactly harmed their long-term performances.
In short, an earnings report should be an attempt to inform shareholders, not to spin them. Below is a sample of what I'd like to see.
Otter's Dodgeballs Announces Third-Quarter Results
Otter's Dodgeballs (Ticker: OBALL) announced that it had produced generally accepted accounting principles (GAAP) earnings of $0.87 per diluted share for the third quarter. This compares with $0.81 for the previous quarter and $0.80 for the same quarter last year. Total revenues for the quarter increased 6% from $111 million to $117.6 million. Free cash flow to investors increased 5% from $0.91 per share to $0.95. In the quarter, the company repurchased $1.2 million in debt, decreasing total leverage from 17% of assets down to 13%.
[See, nothing fancy. These are the base numbers that investors need to know. Earnings, revenues, cash flows, leverage. No "eyeballs." No out-of-context figures, no harping on "records." Here's what they are.]
Otter Pater, the CEO of Otter's Dodgeballs, said, "My colleagues delivered an outstanding performance in the most recent quarter, one that may not be fully reflected in the most recent results but the execution of which will pay off in years to come for our shareholders. Before we get into these results, let's discuss what went well, and where we need to improve. The dodgeball business can be difficult, so I'd like to use this space to make investors aware of what elements they need to consider to properly value our company.
"First and foremost, dodgeball is highly cyclical. Every few years we will see a sudden spike in its popularity, usually starting in the college and university communities. We are in such an upward swing right now. This is good for us, obviously."
[Note that the CEO lays the improvement of the overall business where it belongs: with an improvement in popularity external to his own, or his company's efforts. How many companies' managements have the wind at their backs but try to convince shareholders that they're actually causing the wind to blow?]
"While business momentum can help, even in the best of environments companies manage to screw up. Our 'win-a-free-ham (or non-meat alternative)' program captured just the right voice with our customers and likely markets, giving Otter's Dodgeballs the ability not just to ride in with the tide, but also to wrest away market share from our competitors. We grew from a 7% share to a 14% share -- an extraordinary achievement. From advertising to sharp pricing and point-of-sale marketing, our efforts here were superior."
[This is true. It's a win, and the company deserves credit.]
"Top-line growth isn't helpful, though, unless it is economically viable. Here there will be challenges ahead. Some of our biggest customers, most notably Wal-Mart, continue to press us on pricing. We will not sell products uneconomically. Should this pressure not abate, we will have to look for alternative sales channels. This would cause some dislocation in our results, and it may look bad for a while. In fact, it may be bad. But it will still be better than selling more dodgeballs, but losing money on each sale."
[A warning, and a real one. Given, for a change, in advance.]
"You should also note that our results on the top line were assisted by the fact that 24% of our sales are overseas. Continued weakness of the dollar improved our domestic currency results by 2%. Do not expect such a tailwind to be repeatable.
"Here's what we are doing well -- our sales promotions are a smashing success, our operations have never been more efficient, and our research and development program is doing excellent work in determining new product offerings. You should note that our gross margins and net cash generation from operations are at record highs. Again, some of this comes from currency translation, and some comes from the pricing power of a heating-up dodgeball market. But this company retains more cash per dollar of sales than any of its competitors, and while we will not hesitate to sacrifice this record if we see an opportunity to capture long-term economic gains, in the absence of such, we are very proud of this achievement. Some of our competitors are expending excessive resources on new e-dodgeball programs. We do not believe that the market is as robust as they believe. Should we be wrong, given that the total expenditure among these companies exceeds the assumed addressable market, we will seek to make opportunistic acquisitions to catch up. We do not believe this is the case."
[Clear enunciation of a strategy, including a strategy not to get involved in a capital-eating arms race.]
"Our share buyback program continues apace -- we repurchased 2,000 shares this quarter. We have authorization from you to repurchase as many as 1 million shares, 13% of our float. At the present time, we do not believe that purchasing shares at current prices represents an ideal use of capital. Should this condition continue, we will consider alternative forms of return of capital, including increasing the regular dividend, or payment of a special dividend."
[Translation: Our stock is priced very high.]
"When reading our financial tables below, please note that we consider approximately 85% of our capital expenditures for the quarter to be mandatory as part of the replacement cycle of existing infrastructure, while the other 15% is money we are spending in order to build out facilities to produce new products like the Dodgeball Infuriator 2000. As we tend to build when others are afraid, and batten down when the world seems to be our oyster, we note once again that our total capital expenditures are presently a fraction of our competitors'."
[Tells you exactly how the company views its capital expenditures, including that which is required spending and that which is elective. Note also that the company includes a cash flow statement in its earnings report, something that most, bafflingly, do not.]
"Enjoy the quarter -- it was a good one. But a company should not be defined by a quarter, as the tailwinds that we now have could reverse course in a hurry. We see to it every waking day that our management of your resources ensures that we do not get ahead of our headlights during the good times, and we seek to take advantage of the inevitable times of fear when they arise. The result has been long-term financial performance that exceeds that of our industry. And for this I am very grateful to my partners."
The end. No excuses, no taking credit for things that he (or the company) didn't control in the first place. And investors, rather than being hoodwinked into thinking the company did better than it actually did, have a clear idea of Otter's Dodgeballs' operational, competitive, and financial positions.
Isn't that what these reports are for?
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This article was originally published by Bill Mann on July 24, 2004. It has been updated by Fool sector head Joey Khattab, who does not own any of the shares mentioned.