The SEC responded to the year of the corporate scandal by recommending new rules for pro-forma reporting. But some have been slow to comply.When the SEC announced late last month that it was considering a new rule that would police the use of so-called pro-forma earnings by public companies, it was an important step for corporate disclosure for two reasons. First, the move was widely portrayed as the SEC moving to crack down on one of the excesses of the bull market, which it obviously was. Although pro forma had long been considered a viable accounting treatment for companies undergoing a significant period of business transition, there was widespread belief that the accounting practice was being overused - and in some cases abused - by companies that wished to make their results look stronger than they actually were under the stricter GAAP (Generally Accepted Accounting Principles) auditing treatment. Yet the SEC's proposed rule change was also important because it marked a direct attempt by the SEC to monitor the content of earnings releases. On matters of corporate disclosure, the SEC has historically concentrated on monitoring corporate filings. When it came to the content of quarterly earnings releases, the SEC would typically only get involved in cases of outright fraud and deliberate misrepresentation of facts. Yet this year's unprecedented spate of corporate scandals pushed the SEC to begin to set some ground rules for earnings releases. Nevertheless, as 2002 heads for a close, it remains doubtful that the move will presage a further push by the SEC into the area standardizing the corporate earnings release. Indeed, the proposed rule change itself was none too earth-shattering. It simply asks that companies that use pro-forma earnings reconcile them to GAAP somewhere in the release, and requires that companies do not use the pro-forma convention in a "misleading" manner. While the SEC's rule change is a step toward regulating corporate earnings releases, there still seems to be some hesitation to institute anything that could be viewed as too sweeping. Yet earnings releases have become a critical aspect of corporate disclosure in the past decade, as the internet revolution has meant that releases are accessible to every investor nearly the instant they are released. "As more individual investors access the capital markets, press releases are becoming an important place where investors get information," says Bill Janci, an account executive at GA Kraut. "A lot of individual investors don't have access to lot a of things that institutional investors do, so the release has become very important to them." So it appears that after a year of unprecedented scandal, during which every nearly every corporate-reform advocate has declared that increased transparency is necessary, when it comes to earnings releases, at least a large part of the responsibility for increasing transparency has fallen back to the companies themselves. So, how's corporate America actually doing? According to statistics compiled by PR Newswire, there has been some progress. For instance, one of the measures some corporate-reform advocates - including NIRI - have been advocating is the inclusion of a balance sheet with all earnings releases. As of the second quarter of 2002, the percentage of Fortune 500 companies that include their balance sheets in earnings releases jumped to 60%, up from 47% in first quarter of 2001, according to PR Newswire's findings. Still, that means that 40% of the Fortune 500 did not include a balance sheet with their results during the period. The lag on balance sheets While the vast majority of companies include income statements with their earnings releases, there continues to be a lag in getting companies to release balance sheets with earnings releases. (An income statement lists a company's revenues and expenses for the given quarter and the subsequent profit or loss posted in the period, while a balance sheet lists a company's assets and longer-term costs and liabilities.) Some argue that by not including a balance sheet in an earnings release, companies are providing an incomplete financial picture to investors. While income statements are a measure of short-term performance, many view balance sheets as important for gauging the long-term financial health and position of a company. "One of the things a balance sheet tells you is what the company's real cash position and cash generation are," says Howard Zar, EVP of IR at Porter Novelli. "There are things on the balance sheet that might tell you quite a bit about the health of the company." Still, some IR pros that counsel clients on the importance of releasing a balance sheet say many companies are not necessarily omitting their balance sheets as an attempt to obscure their true financial health. "A lot of companies many not have their books in order in enough time to put out their balance sheet with their earnings release," says Janci. "And they want to get their earnings out when all their peers have their earnings out, so they don't necessarily want to wait a week or two to make sure that the balance-sheet statements are in line, when the rest of their sector has already reported." Nevertheless, Janci says some companies are making investments that should help remove the obstacles that currently impede companies from quickly producing a balance sheet. "One of our clients just installed some new Oracle software for its financials accounting," says Janci. "That's really helped them speed up the process by about 80%. I think as more companies adopt such a technology, you'll see the reporting periods shorten and an increase in balance sheets in releases." During the same quarter, only 26% of the Fortune 500 offered investors a cash-flow statement - the third major financial statement - with their earnings release. Nonetheless, it marked a rise of 9% over Q1 2001. Cash-flow statements detail the flow of cash in and out of the company in a given period of time. "I don't think we're seeing many cash-flow statements because I don't think companies have really begun to value them as something that investors are eager to see," says Gregory Petit, senior managing director at Hill & Knowlton. "I also think it's partly a function of the economy. Companies with poor cash flow are not going to decide this is the time to wave their cash-flow statements around." Greater discussion of results Reform advocates have also been asking for more robust discussion of the results in the earnings release. While a detailed discussion of a company's financials is typical in SEC filings, some companies compile only a superficial analysis of their results in their earnings releases. While it's difficult to measure the quality of the management discussions for hundreds of public companies, PR Newswire says that the word count in earnings releases of its client base has swelled by 28% in 2002. "I think we're seeing that companies are perhaps more willing to go out of their way to make sure investors have what they need in order to make a clear investment decision," says John McInerney, senior director at Citigate Financial Intelligence. "We are seeing companies releasing more detailed information, and they're giving more complete discussion of the information that they release. That said, I don't think more always means better. Length doesn't always mean clarity." However, others wonder if the longer word count is less to do with an overarching trend toward transparency, and more to do with hedging bets. "A lot of the earnings releases are now more than ever full of cover-your-tail-type language," says one IR pro. "I'm interested in seeing how much longer the safe-harbor disclaimer clause has gotten in releases." In fact, a random sampling of 20 PR Newswire clients found that safe-harbor word count has jumped about 5% year over year. Though that proves some cynics to be partially right, it's still a comfortingly small number compared to the overall 28% increase in word count. Investors' tails are being covered, too.
FORTUNE 500 EARNINGS ANALYSIS The items Fortune 500 companies chose to include in their earnings releases: RESEARCH CRITERIA Q2 2002 Q1 2001 CHANGE (%) FROM (%) (%) Q1 2001 TO Q2 2002 Balance sheet 60 47 13 Income statement 94 84 10 Cash-flow statement 26 17 9 Historical comparisons 93 85 8 Notes to Financials 66 46 19 3 Financials* 23 14 9 * Denotes inclusion of balance sheet, income statement, and cash-flow statement. SOURCE: PR Newswire.