In every company’s 10K or 10Q, the management discussion and analysis (MD&A) presents an opportunity beyond mere regulatory compliance. It’s meant to present a view of the company ‘through the eyes of management’, as the SEC says. But it’s also a chance for management to really show its cards, no matter what hand it is dealt. What has it learned over the past quarter or year, and what does it expect going forward?
Instead of answering these questions directly, too many companies get stuck in a rut and fail to address new issues – issues that were probably not in the picture when their MD&As first took shape. The themes of MD&As are cyclical, coming and going from quarter to quarter and year to year, points out Brian Lane, partner at Gibson Dunn & Crutcher and former head of the SEC’s division of corporation finance. ‘Don’t keep the same old boilerplate the company has used for its risks for the last ten years,’ he says. ‘Things change.’
Lane believes careful consideration of related risk factors should be a priority for IR people working on the MD&A. They need to ask senior management and operations chiefs: what keeps you up at night? What are you most worried about affecting the company’s business, good or bad? ‘If the IRO gets an answer back that says, Yes, we are worried about something, shouldn’t that show up somewhere in the disclosure?’ Lane asks. ‘Companies have to be cognizant of things that are not only relevant to a company’s present but also to its future.’
This year, with disclosure under tight scrutiny and executive pay receiving particular attention from shareholders, companies are paying a lot more attention to fine-tuning their MD&As. The top themes, according to Lane, are creeping interest rates, high fuel prices and natural disaster recovery.
Fast forward
David Dragics, vice president of IR at CACI, an Arlington, Virginia-based government information technology business, says disclosure is the core of the MD&A, and he has seen improved transparency in MD&As in the past year. ‘It’s a slow process and it’s never going to be all that the SEC wants it to be, but it is going to be more than we have now,’ he notes.
Despite the SEC repeatedly delaying the phasing-in of accelerated filing deadlines, Dragics expects tightened timeframes in 2006. He says investors can expect to see more 10Qs coming out at the same time as earnings releases so they get complete disclosure all at once instead of in two separate steps – a long-term trend that will improve transparency.
‘Questions that you get now on an earnings release would be answered almost simultaneously with the 10Q filing,’ Dragics explains. ‘Why kill yourself to go through preparation of an earnings release and then kill yourself again for the preparation of a public filing? Just do it all at once.’
Another trend to watch out for as the year unfolds is an increase in footnotes about the expensing of stock options and other stock-based compensation. ‘We will begin to see more clarity on explaining stock-based compensation,’ Dragics says. ‘Investors will be taking a hard look at MD&A and all the footnotes to see the impact of any dilution.’
Just the facts
Transparency in the MD&A can take many forms. Andrea Resnick, vice president of investor relations and corporate communications at New York leather goods marketer Coach, cites a focus on plain language as a major and worthwhile MD&A trend in 2005. She is not alone among her peers in feeling that complicated jargon masks holes in disclosure. Simplifying the way the MD&A is communicated lends itself to more meaningful disclosure.
Resnick has also seen more considered MD&As with less boilerplate in 2005, compared with the past when MD&As had a tendency to ‘simply regurgitate prior years.’ She confirms that investors want to read about competitive pressures and risks as well as expansion plans. Other common themes she expects in 2006 include the impact of foreign currency transactions, business interruption and disaster recovery, stock option expensing, gas prices and pension considerations in light of the Financial Accounting Standards Board’s (Fasb) recent focus on calculation of pension benefit obligations.
As you like it
More disclosure of pension assumptions and more reader-friendly MD&As also come to mind for Mark Oberle, vice president of investor relations at Celanese, a Dallas, Texas-based chemical company. ‘These trends are a key part of a commitment to transparency,’ he says. ‘I feel very strongly about improving the quality of non-financial information.’
Celanese’s next 10K will likely delve into the cost of fuel and other related raw materials. That’s a theme expected in many other companies’ MD&As, often associated with those all-too familiar names: Katrina and Rita.
Companies all over the US felt the financial impact of the hurricanes, though few were as hard hit as Entergy, an electric power production and distribution company whose territory includes the worst hit parts of the gulf coast. ‘With both Katrina and Rita, we’ve had financial impacts we’ve never experienced at Entergy from any natural disaster – and we deal with hurricanes and ice storms nearly every year,’ says Paul LaRosa, Entergy’s director of IR.
A lot of the impact came from sheer physical damage, the like of which Entergy had never experienced before. The effect was a lost stream of revenue that was still ongoing by year-end, more than four months after Katrina, because many Entergy customers still didn’t have homes to receive their power in. One subsidiary, serving New Orleans, had to file for bankruptcy because it had lost so many customers while spending around $300 mn to restore power where it could.
Rising interest rates added to the hurt for Entergy as it borrowed money to rebuild. ‘Higher borrowing at higher interest rates obviously has an impact on us,’ LaRosa says. ‘Utilities are typically interest rate-sensitive, and we are no different.’ Even the higher cost of natural gas hurt Entergy because it uses gas to generate electricity and is limited in how much of the inflated cost it can pass on to customers.
For other companies facing such issues, LaRosa suggests the MD&A should provide information that is relevant, detailed, digestible and helpful to the reader in understanding the overall financial picture. In fact, that’s good advice for any company, at any time – not just in hurricane season.
