Practical Tips for Navigating The Q120 Earnings Season

The COVID-19 pandemic came on the heels of more than a decade of unabated economic growth. The landscape changed almost overnight and, in the face of many uncertainties, the one thing we know for sure is that the Q1 2020 earnings season will be anything but business as usual. Over the past several weeks, investors and analysts have had an insatiable appetite for information from management teams and the pointed questions being asked are completely different from those that were asked just a quarter ago. They want to know (1) what management is doing to navigate this time of uncertainty, (2) whether the company has financial flexibility to weather an extended coronavirus battle and (3) what a recovery might look like given what may be a vastly different operating and competitive environment. They are testing management's adaptability and foresight to assess which teams are grounded and focused versus unprepared and scrambling.

Right now, this creates a delicate balancing act for any company's communications approach generally and for Q1 earnings reporting specifically. Management teams must resist being too optimistic or too pessimistic. Above all, they need to maintain credibility by explaining what is in their control and what they are doing to leverage those factors. While being as transparent as possible, companies must take extra care to avoid making statements they may later need to change or retract. Against this backdrop, the following are some key points to help companies prepare for earnings in this new paradigm.

Start early and prepare well – Q1 earnings reporting will require more time than usual given the changing landscape, so begin the process early. Take extra time to prepare a thoughtful script for the earnings call and a robust list of answers for the questions that investors care about now. That script and Q&A may look entirely different than last quarter's and should reflect any COVID-19 updates the company provided ahead of earnings. Companies will need to enhance SEC and other disclosures and add COVID-19 to the risk factors in all safe harbor language.

Additionally, we recommend companies create a new and realistic earnings preparation timeline that provides more time on the front end to draft the press release, script and Q&A and keep in mind that FP&A departments will be working overtime to get the numbers ready. This quarter, it will be especially important to track sector and peer group earnings reports to stay on top of what others are communicating in this uncertain time.

Stick with your regular earnings reporting date if possible – While the SEC is allowing companies more time to report earnings, reporting "on schedule" indicates strong internal controls and is still a priority. That being said, some companies that have been especially hard hit may choose to move their earnings date out but still report within the standard timeframe in order to have more time to prepare and to observe how competitors and sector leaders are informing their investors and handling questions. Companies that need to delay their calls beyond the standard deadline should make the delay as short as possible. Companies that plan to report later than usual or to delay their calls should distribute the press release announcing the call date with plenty of notice.

Level-set the discussion with an overview of the company's key value drivers at the start of the call – Rather than jumping right into the results, take a few minutes at the beginning of the call to remind investors what your company does, why your long-term strategy is proven and sound, what your customers rely on you for, and your unique attributes both tangible and intangible. Talk about how, prior to the pandemic, the company was positioned to withstand a downside scenario with assets like a strong balance sheet, a diversified portfolio, a strong capital position, a disaster recovery plan, a flexible approach to growth, a low fixed cost structure, etc. While no one has experienced a crisis like COVID-19, if your company has weathered other storms like the Great Recession, share relevant stories of managing through disruption. For example, JPMorgan Chase & Co. Chairman and CEO Jamie Dimon stressed how the company successfully navigated some unprecedented challenges over the last two decades in his most recent annual letter to shareholders. In doing so, you are reminding investors that you have a history of creating value across economic cycles for all stakeholders – and that your company is most likely to recover sooner and stronger.

Provide an overview of your response to the COVID-19 pandemic – Investors will want to know what your company is doing to manage the situation for all stakeholders:

  • Company. Has management stress-tested the business for the worst-case scenarios and created an action plan for re-allocating resources as things evolve? What steps are being taken to ensure the safety of employees and customers (physical and cyber)? How is the company managing supply chain issues? Has management or the board taken a pay cut to demonstrate their commitment to shared sacrifice? Are there any government programs (CARES Act) that are supporting your industry/company?

  • Employees. What have you done to keep employees safe? How are you managing the shift to employees working remotely? How is technology supporting them? How has the staff been deployed to focus on the near-term priorities? Are there employee engagement or culture initiatives to manage through this challenging time? Employee layoffs or furloughs?

  • Customers. How is the company serving customers, helping customers? How has that changed (i.e. shifting from brick-and-mortar to on-line sales)? What are customers asking for – concessions, discounts or new arrangements? Are you losing customers and why? Are they paying more slowly? How are you maintaining a high-level of customer engagement at this critical time?

  • Vendors and Service Providers. Are you working with them in a fair and equitable way so that they can also survive this business disruption? We are all in this together.

  • Community. What has the company done to be a good corporate citizen? Has the company donated money to any causes to help those affected by COVID-19? In Larry Fink's March 29 letter, he connects ESG and sustainability to COVID-19 and business continuity planning. In general, companies that show "heart" to all their stakeholders will enhance their brand reputation.

Directly address the impact of COVID-19 on your business starting with industry exposure – This includes a review of company exposure – both direct and through the value chain – and a relevant update on current market conditions, including positives and negatives. For example:

  • "Our largest exposure is 60% in industrials, where demand is declining due to..."

  • "Our largest exposure is to travel and leisure, where we have seen a near-complete drop in demand."

  • "Our largest input cost is oil, and weakness in the oil market will likely make a positive contribution."

  • "Our portfolio is highly diversified with exposure equally divided among x, y and z."

  • "The majority of our clients serve retail sporting goods stores and they are telling us that most of their customers are still not open for business."

To make sure you have covered all bases, consider company performance discussion in terms of a free cash flow statement – operations, investments and capital (sources and uses) – and focus on the factors that are in the company's control.

Operations:

  • Revenue. Top-line plus sales resources and sales efforts.

  • Client retention/losses. For companies with recurring revenue, cite client retention rates and reasons for client losses.

  • Margins. What are the primary drivers of margin erosion? Be specific.

  • Trends in payables and receivables. Are your customers paying bills on time?

  • Inventory management and supply chain. Is it smooth or disrupted? Where are the speed bumps?

  • Staffing. Have you reduced your workforce, salaries or benefits? Any costs associated with layoffs?

  • Operating costs. How much have expenses related to travel and conference attendance declined?

Investments:

  • Cap-ex. Does the 2020 capex plan still make sense? Can growth capex be curtailed and to what extent? Can maintenance capex be reduced or is there an opportunity to pull it forward due to downtime?

  • Optional vs. required investments. Property, plant and equipment. What falls in the category of nice-to-have versus need-to-have? What is the maximum amount that can be cut without impacting successful operations and the long-term strategy?

  • Technology. What was the incremental spend to shift employees to work from home? Will you need to increase technology spend short- or longer-term? Are there offsets between increased technology costs and reduced physical plant needs?

Balance Sheet/Capital Sources and Uses:

  • Liquidity. How much cash does the company have and what is the burn rate?

  • Bank debt. How much bank debt is available? Have you drawn down your line? Does your credit facility have an accordion feature? Have the rates, terms, covenants or members of the bank group changed? Has the company asked for any loan deferrals, consents or waivers on any outstanding loans?

  • Other access to capital. Sale/leaseback opportunities?

  • Debt maturities. Looking out five years, how much debt is due and when? How much needs to be refinanced to fund operations? What is the current cost of refinancing debt?

  • Share repurchases. Is the company buying back stock at these depressed levels or conserving cash?

  • Dividend. How safe is the company's dividend going forward? Any plans to suspend or cut the dividend?

  • Equity. Some companies in distressed situations will need to prepare for questions about dilution. Will you need to raise equity to navigate the downturn? On the flip side, for stronger companies with investment opportunities, depressed equity valuations are an expensive way to finance growth. If you pursue an acquisition, would you finance it with equity, debt or cash?

Think ahead about your stance on:

Capital Allocation – This will be a hot topic going forward and, unless a company has substantial cash reserves and has not been impacted by the downturn, most investors would not expect companies to be using cash to repurchase shares right now. That said, there are investors who focus relentlessly on share repurchase programs in times of significant stock price declines, so it's important to be prepared to address this topic.

Dividends – Many companies have already begun reducing or suspending dividends to preserve cash. Companies planning to do either should remind investors that their dividend is an important part of shareholder returns and that they intend to restore it at the first opportunity. Since many stocks are owned in dividend-focused funds there will be forced sellers following a dividend suspension, so companies should consider their stock ownership and whether lowering the dividend would be more advantageous than suspending it.

Insider Buying – Investors will want to know about open market share purchases by members of management or the Board as this signals confidence in both the company's outlook and their ability to navigate the crisis. If there is no insider buying, companies should have an answer to this question. For example, some companies and boards have taken meaningful compensation cuts and are therefore making an investment in the company in an alternative way. Another plausible explanation might be that 90% of the CEO's net worth is already in company stock. Quiet periods might also have impacted the ability of management or the Board in purchasing shares.

Figure out your strategy for recasting guidance – As always, there is no one size fits all approach to guidance. This pandemic is so fluid that for many companies it's impossible to provide credible guidance. Any guidance provided should include underlying assumptions and make clear the factors that are within and outside of management's control. We expect the Street will be much more interested in hearing about how things are going so far in Q2 than what transpired in Q1 results.

Avoid providing best- and worst-case scenarios for now – These are often too specific and prove inaccurate in the rear-view mirror. Consider swapping out exact numbers with terms like "low single digit" or "low double digit" and consider statements such as:

  • "In the past, we have grown in excess of GDP, and we expect to perform better than the overall economy in this environment because of X."

  • "We are currently pacing below last year, and we have not yet reached an inflection point."

  • "The daily news flow is changing rapidly and, as a result, so too is our ability to forecast with accuracy."

Be prepared for questions around industry consolidation – The topic of industry consolidation will be back on the table with many companies trading at low valuations and the expectation that some companies will struggle going forward with limited or no access to capital. Prepare a credible statement that explains management and the Board are always positioned to consider opportunities that are in the best interest of their stakeholders. Be prepared for questions such as: Is there an opportunity for industry consolidation? Would it improve your competitive position? Are you hearing from buyers or sellers?

Festina lente is a Latin phrase that means "make haste slowly" and cautions us to be urgent but controlled – expeditious and prudent. This mindset can serve management teams well as they work tirelessly to serve customers, employees and investors. Make the daily work of work your priority. When investor outreach is required, take a breath and consider all information. Evaluate the unknowns in the context of your experience, informed by your best judgment. Then deliver the strategic communications that highlight the excellence for which your company is known.