What Wall St. hates to hear: top executives downplay earnings guidance—some have kicked the habit altogether—and may force the market to go cold turkey with them - Cover Story - Statistical Data Included

Chief Executive, The, April, 2002 by Gregory J. Millman

To the evident chagrin of many analysts, and even before the recent stew of accounting scandals came to a boil, a small group of high-profile corporate chiefs stopped answering questions about what they expected their companies would earn next quarter or next year.

Now the small group is growing into a parade, with some of the most respected management consultants in America cheering it on.

CEOs hardly need to be reminded that the earnings-per-share estimate is arguably the single most influential number in a company's stock price. Although EPS estimates are questionable because they are based on assumptions, they can have a powerful effect on management decision-making. "There's a huge amount of pressure on companies not to come in with negative earnings surprises," says Bill Landuyt, CEO of Millennium Chemicals, a $1.6 billion maker of chemicals that go into flavorings and perfumes in Red Bank, N.J. "It can become a monster. The more you're successful at it, the more it's expected, and the worse the reaction when you don't [meet your estimates] ."

More than one CEO has been terminated for promising more than he or she could deliver. Just look at the truncated corporate careers of Richard McGinn at Lucent Technologies, Donald Roden at Bergen Brunswig, and Martin Grass at Rite Aid. Several factors played a role in each of their hasty departures, but missing earnings expectations didn't help.

In June 2001, newly appointed Gillette CEO James Kilts made a memorable debut. In front of analysts, he excoriated his predecessor Michael Hawley, ousted by the Boston company's board eight months earlier, for raising analyst expectations with EPS estimates and for trying to meet the unrealistic targets by raising prices and cutting advertising. Kilts went on to stonewall question after question about his own expectations, because he blamed the earnings estimation game --the monster to which Landuyt refers --for nearly wrecking the consumer products giant. He says changes made to meet promises resulted in a drop in sales, a buildup of inventory and a turnaround challenge worthy of Kilts, whose resume includes resolving a prior mess at Nabisco.

Despite his illustrious track record, Kilts might have seemed like a lonely voice balking at the market misinformation orgy. But other voices soon joined in.

In October 2001, USA Networks CEO Barry Duller said in a letter to the Securities and Exchange Commission that the earnings estimation game "has little to do with running a business and the numbers can become distractingly and dangerously detached from fundamentals." Duller made it clear he was bent on change. From that point forward, the New York media company would not provide earnings guidance. Rather, it would offer much more detailed information about its business so that analysts could reach their own conclusions.

Similarly, Touch America CEO Robert Cannon, who in mid-February completed his Butte, Mont., company's transition from an energy and communications mini-conglomerate to a telecom pure-play, says that he no longer provides earnings guidance to Wall Street. "Because of the downturn in the sector and the difficult economic environment, it became very difficult to give meaningful guidance, so in the last part of last year we -- like everyone else in our sector--stepped away from doing that," says Gannon.

Although the CEO concedes that "it's hard for people who want guidance to hear this," he also knows from experience the importance of saying no to analysts. "Our stock price in 1997 was about $10 a share, and it moved over a period of a year and a half or two years to the 60s," Gannon says. "We were being compared to other fiber optics companies with even stronger growth in share price." But, he explains, those competitors were knee-deep in debt. Montana Power wasn't, and analysts criticized it for not amassing debt and growing faster. "But now the worm has turned," he says, "and we're applauded for not having gotten into debt, although our stock is now at $5.50. The reality was the market was just overheated."

Sweet dreams

So how do these guys get away with it? As anyone who has taken an accounting course can attest, the relationship of EPS to underlying economic facts is tenuous. Even many people who've never cracked an accounting text are learning that Enron managed to book megamillions in profit today based on assumptions about a distant--and now, clearly, never-to-be--tomorrow. In fact, EPS numbers are so much a creature of assumptions, that skeptics characterize them as made and shaped by accounting rules and loopholes rather than by hard-nosed facts of business life. "If you really want to know about a company, don't look at the earnings statement--look at the statement of changes in cash flow," suggests Millennium CEO Landuyt. "At the end of the day, you can't manipulate the cash number." The emphasis in Millennium's quarterly reports is not so much on earnings as on EBITDA, earnings before interest, taxes, depreciation and amortization -- essentially, cash flow. And Landuyt manages the company according to the gospel of EVA, or economic value added. "EVA is really a proxy for the discounted value of the future cash flow," he explains.