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JWI 531 (1202) Page 1 of 10

JWI 531: Financial Management II

Week Ten Lecture Notes

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INVESTOR RELATIONS What It Means Investor relations encompasses the collection and communication of information regarding the financial health and investment prospects of the company The CEO and CFO have the most important roles in this by ensuring that the financial statements of their organization are properly assembled using Generally Accepted Accounting Principles (GAAP). While the CFO will own the “technical” aspects of this, both are responsible for communicating the organization’s financial results to investors and answering questions about its performance. They are the public face of the company to the investment community. Why It Matters

• It is the responsibility of the CFO and CEO to build enthusiasm and sustain the confidence of investors. They must present the company in a positive light while, at the same time, honestly and accurately describing its performance and prospects.

• As an investor or competitor, understanding how written reports and public statements are used to communicate business transactions is key to evaluating the financial health of the organization.

• Composing financial statements requires management to make many choices. You need to understand where and how these assumptions and judgments have been made when you read financial reports.

“Knowing the numbers allows you to probe

the business and pose questions that will get you to the fundamental strength and health of the company. You’ll want to do that, and

you’ll want to feel comfortable with that. You have to know how to ask the questions

about the stuff you need to make the gut judgments to go forward.”

Jack Welch

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JWI 531 (1202) Page 3 of 10

THE CHALLENGE AND OPPORTUNITY FOR MANAGERS

Having explored the processes and rationale for taking companies public, we have set the stage for the final week of our course in which we examine the roles of the CEO and CFO in leading investor relations and public reporting. While the specific focus this week is on investor relations in public companies, the broader underlying theme is communication. Through clear and consistent in communications from the investor relations team, analysts and investors are better equipped to understand what they should be looking for both when they read the SEC-required reports and when they hear the CEO and CFO giving guidance on earnings calls. This clarity and consistency helps to establish a partnership of trust between the company’s leadership and the investment community. CFOs play a critical role in communicating with investors about the organization’s financial health. They also have a role to play in modeling the values and behaviors needed to ensure clear and actionable internal communication about financial matters. This communication is not just about explaining how the company is doing. It is about establishing a culture where financial leaders are seen as trusted strategic partners in running the business. Managers and business-unit leaders need this communication in order to inspire and align internal stakeholders. They need it to equip team members with the tools and information to make better business decisions. And they need it to feel confident and enthusiastic investing their time, talent, and energy in a business that is supported by a sound financial strategy. As we acknowledged at the beginning of this course, it can be daunting for non-financial managers to decipher the language and practices of finance strategy. We are confident, however, that you are seeing a payoff as you improve your understanding of how the numbers work in your organization. We’ve stressed the need for all managers to be familiar with both external financial statements and internal capital investment and operating budgets, as well as other reports. While financial managers will be the ones preparing these, every senior manager in the organization must understand the financial story being told through these vehicles. Jack often uses the word “dig” when referring to financial data because some of the information you need to understand what’s really going on isn’t always found on the surface. Your goal as a leader should be to “think like a CFO” and to understand: (1) how every business transaction will be recorded in the organization’s financial records, (2) how transactions impact its public financial statements, and (3) how finance strategy must be aligned with all business functions in order to compete and win.

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JWI 531 (1202) Page 4 of 10

YOUR STARTING POINT

1. What are the responsibilities and goals of the investor relations function in public companies?

In what ways can some of the practices they use be leveraged to improve communications within organizations?

2. As an investor or a competitor, how can you leverage the quantitative and qualitative data available through investor relations teams’ communications and activities to make better investment and business decisions?

3. Which financial reporting filings are required by the SEC? What information do these contain,

and when must they be filed?

4. What flexibility do companies have when making decisions about how financial events are

recorded, or about how the activities of different business units can be rolled up or broken out?

5. What is guidance? What obligations do public companies have in providing guidance?

6. What are the most common communication channels and practices used in investor relations? What purpose do each of these serve? How are they structured?

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JWI 531 (1202) Page 5 of 10

COMMUNICATING FINANCIAL RESULTS

Investor Relations While you have undoubtedly heard the term before, you may have never dug into the various functions it encompasses and the reason it exists. Bragg presents the following synopsis:

“Investor relations is a function almost exclusively found within publicly-held companies. It provides information about the financial and operational performance of a company to members of the investment community. In addition, it maintains relations with those investors who may be interested in making additional investments in the company in the future. Thus, the function maintains a two-way line of communications with the investment community. These capabilities can be translated into the following investor relations goals.”

• To maintain an active market in the company’s stock • To obtain a fair valuation • To enhance the company’s ability to cost-effectively raise capital as needed

The CFO Guidebook, p. 285

Communication – What, Where, How, and When? To get a better sense of how all the pieces fit together, think of investor relations as a collection of activities across a spectrum ranging from required and regular to optional and less frequent. You should begin by visiting the investor relations pages of several companies’ websites to see how they are organized and what information they contain. There, you will find links to important information, including SEC filings and general updates on the business. You will likely discover that some organizations are very active in their investor relations and provide extensive communication about their financials and their business. Others will share only the minimum amount of information required by law. The absolute minimum for any public company are the mandatory filings required by the SEC. Bragg writes,

“The investor relations function disseminates a mix of information that is required under financial regulations, or which it voluntarily issues. The information released is intended to give recipients a detailed knowledge of how a company operates, its financial performance, governance, and future prospects. The intent is to give someone enough information to make an informed decision to invest (or not) in a business.”

The CFO Guidebook, pp. 285-286

To get a better sense of the scope of investor relations, we will consider these communications in order from required to optional. As you review each of these, think about whether there may be counterparts or lessons from the practice that can be leveraged internally.

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JWI 531 (1202) Page 6 of 10

SEC Mandated Communications The minimum responsibility of investor relations is assembling and submitting the filings that must be made to the SEC. In preparing these, CFOs need to make a number of decisions about how financial events get recorded and how different segments of the business get broken out. GAAP allows some flexibility in this area so that businesses of different types and different structures can report financial events in ways that accurately reflect what really happened. However, the underlying principle is that the methodology must be consistent from quarter to quarter and year to year. Any deviations or changes in this, as well as any one-time events, must be clearly explained. A summary of the critical SEC reporting requirements is presented in our readings this week, the most important of which include:

• Form 10-Q, which must be filed at the end of the first, second, and third quarters (pp. 316-317) • Form 10-K, which must be filed at the end of the fiscal year, and contains additional reporting

requirements (pp. 317-320) • Form 8-K, which is used to disclose a broad range of material events that can impact the

business (pp. 320-324) • Regulation FD, which mandates that companies immediately release to the public any material

non-public information that has been disclosed to individuals outside the company (p.297) While there are many reporting requirements in both the 10-Q and 10-K, one of the most valuable to investors is earnings per share. There are two types that must be reported on the Income Statement.

• Basic earnings per share is the amount of a company’s profit or loss for a reporting period that is available to the shares of its common stock that are outstanding during a reporting period. If a business only has common stock in its capital structure, it presents only its basic earnings per share for income from continuing operations and net income. (p. 308)

• Diluted earnings per share is the profit for a reporting period per share of common stock outstanding during that period; it includes the number of shares that would have been outstanding during the period if the company had issued common shares for all potential dilutive common stock outstanding during the period. If a company has more types of stock than common stock in its capital structure, it must present both basic earnings per share and diluted earnings per share information; this presentation must be for both income from continuing operations and net income. (p. 310)

The Earnings Call Earnings calls present an opportunity for the CEO and CFO to discuss recent financial results with the investment community and provide guidance on future earnings. The calls normally occur immediately following the quarterly 10-Q releases and the annual 10-K release. They are typically no more than one hour in length, and are scheduled after the markets have closed so that investors have an opportunity to analyze the contents and releases before the market reopens. Bragg presents an overview of the standard processes and topics covered in earnings calls (pp. 286-288). While presenters are free to structure the calls as they wish, following standard protocols helps participants know what to expect. A typical call devotes no more than 20-30 minutes to the scripted presentation, and opens the remainder of the time for questions from analysts and investors who have queued up on the phone line.

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JWI 531 (1202) Page 7 of 10

Guidance Since the reporting required by the SEC is largely historical in nature, it does little to keep investors apprised of likely future events. Investor relations teams want to generate interest in the company in order to build an active market where new investors will participate in buying stock. For this to happen, they need to provide guidance on where the company is going. Ideally, the story they will be able to tell is optimistic, but more importantly, it must be accurate. This is essential in building a relationship of trust. Without guidance, analysts and investors are left on their own to develop views of the future. This tends to result in increased speculation and sometimes wildly diverging opinions, leading to increased volatility in stock prices (p. 289). It is worth noting that not every company issues guidance. If the business is relatively new, is in rapid growth mode, or perhaps is entering into new markets that are speculative, actual performance could diverge significantly from the guidance, thus undermining leadership’s credibility. Being too aggressive with guidance can lead to management being forced to take overly risky actions to meet the guidance estimates, while being too conservative may fail to generate enthusiasm in the company or may quickly be seen as sandbagging if it becomes a recurring event.

“[A] comfortable level of guidance is appreciated by the investment community, since they will find that the company can nearly always deliver on its promises – and a business that reports reliable results is one for which more analysts are willing to provide coverage.”

The CFO Guidebook, p. 291 When you listen to guidance, you should expect the following:

“The minimum amount of information to include in guidance is the projected earnings per share. Investors may expect other information taken from the income statement, such as revenues and net income. The gross margin number is also sometimes included in guidance, as well as the order backlog. It is generally not advisable to issue a massive amount of information, for investors will come to expect it, and generating this material on an ongoing basis may prove to be time-consuming and expensive.”

The CFO Guidebook, p. 290

Road Shows and Continued Communication As Bragg notes, “Investor relations should be an ongoing activity, rather than something that a business only engages in when it goes public or needs to raise additional funds” (p. 286). While road shows, whether they are fundraising or non-deal road shows (pp. 293-297), serve an important role in keeping the company’s message and mission in the public eye, managers and business leaders can adopt the practice for internal use. Host a lunch for your colleagues and use the opportunity to share what’s going on with your team/division. Explain the positive financial impact you are having on the organization, answer questions and discuss ways to improve the lines of communication, and forge tighter connections between the business strategy and finance.

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JWI 531 (1202) Page 8 of 10

Course Wrap-Up We have covered a lot of ground in this course and provided you with a broad overview of the role of finance strategy in building a great company. You’ve been exposed to a number of financial management tools and concepts over our ten weeks together. We have:

1. Introduced the roles of financial leadership and finance strategy 2. Explored ways to identify and manage risk 3. Identified which metrics have the greatest impact on an organization’s financial health 4. Considered mergers and acquisitions as a growth strategy 5. Discussed ways to improve forecasting and planning 6. Strengthened the connection between the capital budgeting process and business strategy 7. Learned about best practices in cash management 8. Examined how to fund growth through debt and equity 9. Studied capital markets and the role they play in the creation of wealth 10. Reinforced the importance of clear communication and financial reporting

What a journey! We hope you feel more confident leveraging financial strategy tools and techniques now that you’ve finished the course. As you gain more experience with these, your ability to track down and analyze more detailed information will grow. Your analysis skills will allow you to carefully examine key indicators of financial health and performance, such as liquidity, profitability, capital structure, and asset management. These metrics are made more insightful through regular review of specific indicators or ratios. Remember, static data alone will not give you what you need to paint a complete picture. It’s the analysis of how these data are trending and how they relate to key benchmarks that is necessary to make informed decisions. The real purpose of this analysis is, of course, is not to determine “where have we been?” but “where are we going?” As Jack says, “You have to dig, and keep on digging.” By using what you have learned in this course, you can dig deep into the financial performance of your organization and those of your competitors, and not have to rely solely on the opinions of others. You can also build stronger ties between financial and non- financial leaders in your organization. Best wishes on applying your newly acquired skills, and for continued success in your career!

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JWI 531 (1202) Page 9 of 10

SUCCEEDING BEYOND THE COURSE

As you read the materials and participate in class activities, stay focused on the key learning outcomes for the week and how they can be applied to your job.

• Explore the role of the CFO in investor relations The CFO plays a critical role in investor relations. You can take advantage of that by listening to earnings calls and getting to know how the CFOs of different companies present the numbers. At first, they may all sound the same. But the more you listen, the more you will pick up on subtle differences, and those differences may help you read between the lines of what is being said and what is not being said. As you develop your finance skills, you may even find yourself gravitating toward taking on more financial management responsibilities. Once you learn to think like a CFO, there’s no going back. Whether you aspire to that role or not, the skills you have developed will be critical in helping you build a stronger, more competitive organization. And don’t ignore the internal application of investor relations practices. Think about how your communications can help build an enthusiasm in others to invest their careers in the business.

• Leverage financial reporting and key metrics to guide investment decisions Commit to using the insights and skills you have developed in this course to become a better investor. Don’t just rely on advice, tips, and hunches. You have the skills you need to unpack financial statements and leverage the data they contain to become a more informed consumer. These same insights can guide your management practices. Learn from the reports you read, and develop your sense of what good metrics look like. Use these as benchmarks against which to measure your own organization, and to improve its performance.

• Review sources of financial information available through technology

We live in a time of unprecedented access to information. Use it. As a business leader, you can’t afford to be in the dark about what the economy is doing and what your competitors are doing. Continue to visit sites like Morningstar and MarketWatch. Sign up for apps from CNBC and Bloomberg. Read The Wall Street Journal every day. Information is the most valuable tool you have available. Yes, there will be lots of contradictory analysis and opinions out there. That’s okay. In fact, it’s what makes the markets. Remember, that for every buyer of a stock, there is a seller on the other end of the trade. But the more you read, the more you will be able to cut through the noise and hype and get at what really matters.

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JWI 531 (1202) Page 10 of 10

ACTION PLAN To apply what I have learned this week in my course to my job, I will…

Action Item(s) Resources and Tools Needed (from this course and in my workplace) Timeline and Milestones Success Metrics