Corporate profits falling short of great expectations And companies rush to warn investors

July 04, 1993|By Ian Johnson | Ian Johnson,New York Bureau

New York -- According to the script written by Wall Street six months ago, Corporate America should be readying to announce impressive increases in earnings averaging more than 20 percent. Investors should be rejoicing and preparing to pump money into the lean, mean companies. And the stock market should be ready to rocket to stratospheric new heights.

But over the past few weeks, at least the first act of that play seems to have come unravelled. A slew of big-name companies, from Apple Computer to 3M, decided not to wait until they release second-quarter results and instead warned investors early that earnings had not increased as much as predicted.

Behind the announcements is a change in the way that companies communicate with investors. Earnings -- good or bad -- traditionally have been issued on a set date, but new interpretations of security laws are encouraging companies to break bad news to shareholders as soon as possible.

Besides a desire to appear more open to investors, the early announcements also signal that the economy is not strong enough to support the hoped-for increases in revenues and profits. With economic growth this year likely to be around 3 percent, few analysts now foresee earnings up by the scripted amount.

"Companies are bending over backwards in interpreting their duty to disclose information," said Steven Resnick, senior investment strategist at Cowen & Co. Inc. "Years ago, companies just waited until they released their earnings to break bad news; now they tell earlier."

In addition to Apple and Minnesota Mining and Manufacturing Co., other companies warning that earnings won't be up to snuff include Kmart Corp., USAir Group Inc., H.J. Heinz Co., Hewlett-Packard Co., AMR Corp. and Northern Telecom Ltd. Analysts are also bracing for lower-than-expected earnings from Du Pont Co., Digital Equipment Corp. and International Business Machines Corp.

The legal side of this year's early warnings stems from several cases over the past three years. The best known is a 1992 charge by the Securities and Exchange Commission that Caterpillar Inc. did not adequately disclose that the earnings of an overseas subsidiary were artificially high due to favorable exchange rates. Without admitting any wrongdoing, the company settled with the SEC last year by agreeing to furnish more and better information.

The effect of this SEC pressure has been to push companies to announce bad news as soon as possible and not wait for the standard quarterly reports, SEC spokesman John Heine said.

"It made it clear that the commission expects companies to disclose bad information when they anticipate it," Mr. Heine said.

In mid-June, for example, 3M said its earnings would be up, but not by as much as analysts had expected. Analysts had projected second-quarter profits of $1.59 a share, a 9.7 percent increase, but 3M said the bad economy made it more realistic to expect $1.50 a share, a 7 percent increase.

"We felt it was the best way to go," 3M spokeswoman Mary McCormick said. "It's better to communicate directly when you know that something is not in line with expectations. That way you can avoid legal complications."

Although the news caused 3M stock to drop $10 in one day, to $105.75, the company avoided the possibility of a lawsuit for withholding information and was able to make a clean breast of its problems and encourage investors to look at future prospects.

While no hard and fast guidelines exist for when a company should go public with bad news, David Shulman, equity strategist at Salomon Bros. Inc., said a flag should be preliminary earnings reports that are enough out of whack to influence the stock price.

"If you're going to report earnings that are significantly at variance with the opinion on the Street, you really should divulge. If you knew about it and you didn't, you could get into serious trouble," he said.

Other companies also have seen their stock badly hit by the early announcements -- although analysts say that the stock would have been hit just as hard, and maybe harder, if they had announced later. Kmart, for example, saw its stock drop 6.9 percent the day it made its early announcement of bad news, while USAir's dropped 4 percent and Apple's stock fell 9.6 percent.

"Once you get through this cathartic period, then you can focus on the rest of the year," said Abby Cohen, an equity strategist with the Goldman Sachs Group.

Ms. Cohen said early announcements also help keep companies' credibility with analysts, who study major public companies for Wall Street investment houses.

While companies are announcing the bad earnings ahead of time to appear more open, the immediate cause for the rash of early warnings has been the weak economy.

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