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October 15, 2004

Explaining Quarterly Conference Calls

One of my most important jobs as a money manager is to keep up with the latest corporate news. During the first half of each calendar quarter, much of this work is done by listening to the quarterly conference calls companies conduct when the y report their quarterly earnings. Typically, a company will report its earnings via press release before the stock market opens in the morning or shortly after the market closes. A conference call is usually scheduled within a few hours of the press release, although sometimes companies report after the close hold their conference calls the next morning. I use a service named CallStreet to find out when the conference calls will occur. For the week of October 18, Call Street lists about 750 scheduled conference calls! There are about 30 by companies I care about for one reason or another, and I have 18 listed on my calendar. I'll probably listen to 5 to 10, read transcripts of another 5 to 10, and rely on Wall Street research for the balance....

While this seems daunting and continues for at that pace for about three weeks every "earnings season," I think it is important to get broad exposure to these calls. I follow virtually every industry but my expertise is in media and telecom stocks. It is crucial for me to place each company's results and comments in perspective to what is happening with their comments. For example, this past week, most of the major newspaper companies reported earnings and held calls. I listened to Gannett and Dow Jones live and relied on transcripts and Wall Street research for E.W. Scripps, New York Times, and Knight-Ridder.

The structure of the call is for the CEO, COO, and CFO to recap quarterly results, discuss the company's outlook (or "guidance" in Wall Street lingo), and take questions from Wall Street analysts and portfolio managers. The calls usually last one hour with the recap and guidance taking 15 to 30 minutes. For larger companies, the Q&A is usually limited to the analysts that work for the major brokerage firms like Goldman Sachs and Morgan Stanley. For mid-size and smaller companies, the Q&A is often open to anyone as long as you are pre-registered with the company.

For most large company calls, I listen to the webcast. The webcast is designed to insure that the company is meeting its Regulation Full Disclosure requirement of disseminating material information simultaneously to all interest parties. I can’t ask questions on webcasts, but that is usually not a problem as my goal on conference calls is get a sense of how management feels about its current and future results and how Wall Street is likely to react in the short and long term. It is unlikely I will gain much insight from asking one specific question. I find it more valuable to listen to management's tone and phrasing when they are recapping the results, and, especially to listen to how management interacts with and reacts to the questions from Wall Street analysts and portfolio managers.

One thing that many investors don’t understand is that what matters on Wall Street is how the quarterly results are relative to expectations, rather than how the results are in an absolute sense. Furthermore, understanding what expectations are built into the stock is crucial to formulating a strategy for trading a stock in response to new information such as a quarterly earnings report and conference call.

To help gain better insight into the quarterly conference call process, below is a series of postings I wrote for StreetInsight.com in anticipation of and during Dow Jones quarterly earnings call on October 14th. StreetInsight.com is the professional level service of theStreet.com designed for professional money managers. It costs over $2,000 to be a subscriber, for which you receive daily commentary from actual portfolio managers including yours truly. Contributors write about their market outlook, the trades they are completing for clients, and the research they are dong on industries and companies. Another service of StreetInsight.com is to provide live commentary on quarterly conference calls of important companies.

Sorry for the length of this post, but I hope you find it interesting and gain some insights into the workings of Wall Street and Northlake Capital Management. Without further ado, here is my work on Dow Jones as an example of the "quarterly conference call." It starts with a preview, then gives and a brief immediate reaction to the press release, followed by a recap of the call and the question and answer session, and concluding with a brief summary.

Dow Jones Reports Tomorrow
10/13/04 02:05 PM EDT

Dow Jones & Co. (DJ:NYSE) reports on Thursday morning. I'll be covering the call for Street Insight, and I'm sure Mr. Kass will be watching closely given his long position in DJ shares.

Since peaking last fall and winter above $50, DJ shares have traded to the low $40s. In the last few months a tight range has developed between $40 and $42 on average volume. The shares jumped Tuesday on good volume on the back of a new buy recommendation from Lehman Brothers. The shares trade at more than 30 times 2004 estimated EPS of $1.28 and at 25 times current estimated 2005 EPS of $1.65. Enterprise Value to EBITDA, a widely used valuation measure for media stocks, is 12 times for 2004 estimates and 10 times for 2005 estimates.

DJ maintains a premium valuation to the newspaper group due its perceived operating leverage and possibly due to its private market value.
Current expectations for the quarter are for EPS of 15 cents on revenue of $401 million. EPS would be flat on a year-over-year basis on a 6% increase in revenue. On September 8, management guided EPS to 14 cents from prior guidance of 20 cents. The 20 cent number had been as high as 24 cents early in the year when it looked like a strong first quarter was the beginning of a long awaited upturn in Dow Jones fortunes.

The culprit in the missing recovery is lagging business-to-business spending in the Wall Street Journal. In particular, technology and telecom have continued weak. Other categories like financial, travel, auto, luxury, classifieds, and consumer electronics have shown reasonable growth.
The bull case for DJ is that the company has the highest operating leverage among the newspaper group and ultimately a recovery in technology ad spending will lead to strong earnings and EBITDA growth. Evidence of the operating leverage is seen in consensus fourth quarter 2004 estimated EPS of 49 cents, up 14%, on a projected 5% gain in revenue.

DJ has seen its fortunes sag sharply since the 2000 peak when the company earned $3.32 with EBITDA of $600 million. In 2004, consensus calls for $1.28 in EPS and $280 million in EBITDA. In 2000, the Print division (mostly WSJ) had EBITDA of $465 million. In 2004, the division will contribute only $80 million in EBITDA.

Bullish analysts believe DJ can move toward its peak earnings over the next few years as a full ad recovery develops. In that case, DJ would be a high growth stock in a dull newspaper industry, justifying the current premium valuation to the group. If I were interested in the newspaper group, I'd keep a close eye on DJ. After all, why bother to own a stock if you don't have the potential for operating or financial leverage. Arguably, DJ could have both with free cash flow providing a form of financial leverage.

On the call, I'll be looking for commentary on the fourth quarter advertising outlook, with particular emphasis on the technology sector. I expect that fourth-quarter guidance will be below consensus, but I am probably not alone in that view given very poor September ad trends at the WSJ. I'll also be looking for further color on the company's recent announcement of a Weekend Edition. Finally, deployment of free cash flow and possible future acquisitions will be of interest.

Dow Jones Lowers Guidance
10/14/04 9:49 AM EDT

As outlined is yesterday's preview, Dow Jones (DJ:NYSE) did, in fact, guide 4Q lower, now looking for slightly above 2003's 43 cents vs. a current consensus of 49 cents.

The culprit appears to be continued weakness in advertising at the Wall Street Journal, which declined 10% in September, 6% for the entire third quarter, and is expected to be "down slightly" in the fourth quarter.

More color on this report in our coverage of the earnings call at 10 a.m. EDT.

Third-Quarter Overview
10/14/04 10:03 AM EDT

Dow Jones reported third quarter earnings of 15 cents on revenue of $395 million. The EPS was in line with lower guidance issued by management in early September, while revenue was about $6 million below expectations. Fourth quarter EPS were guided to "slightly above" fourth quarter of 2003's 43 cents. This is below current consensus estimates of 49 cents.

In its press release, management notes that the third quarter results were hurt by a 6% decline in linage at the Wall Street Journal due to "very weak" technology advertising. Financial advertising also was weak, while Classifieds showed growth. September was the worst month of the quarter for the Journal, with linage falling 10%. Management notes that despite the weakness in their flagship, the company was able to produce revenue growth due to continued gains in its Electronic Publishing and Community Newspaper divisions. A portion of the gains in Electronic Publishing were due to acquisitions, however.
The 7% EPS gain on a 5% gain in revenue, while the company's largest operation saw revenue declines, does indicate that management is applying strict cost controls. However, without a return to strength in business to business (B2B) advertising, investors will likely not see the operating leverage that potentially sets Dow Jones apart from other newspaper companies. Slightly up EPS guidance for the fourth quarter indicates that operating leverage will remain elusive and that the Dow Jones story remains at least a few months away from seeing the key catalyst it requires.

Looking further at the release, Print Publishing revenue fell $4 million or 1.9% in the third quarter. As mentioned, the Wall Street Journal saw a 6% revenue decline in the quarter. The International edition saw a revenue decline of 20% in the quarter, with September tumbling 28%. Barron's ad pages fell 5.1% in the quarter and 2.8% in September with one less issue. The weak top line results led to an increased operating loss in the seasonally weak quarter of $16 million versus $11 million a year ago.

Electronic Publishing revenue grew 23% in the quarter to $98 million driven by acquisitions. Operating margins in the division expanded from 21.5% to 22.2%. Indicators of internal growth include a 2.8% gain in Dow Jones Newswire terminals and an increase of 2.2% in Wall Street Journal Online subscribers.
Ottaway Community Newspapers saw a 4.9% gain in revenues to $87 million. Ad linage grew 4.4% in the quarter and September saw an 8.8% gain. Operating margins expanded 60 basis points to 26.8% driving an operating income gain of 7.9%.

The press release did not include a balance sheet but did note that debt was $197 million at the end of the third quarter, down from $215 million in the second quarter and flat year over year. Dow Jones has a strong balance sheet.

Additional Highlights
10/14/04 10:17 AM EDT

Management is reviewing the quarter basically covering data included above. A few additional highlights include:

Seventh straight up EPS quarter.

B2B advertising remains volatile and weak tech spending expected to continue in fourth quarter.

Color remains a bright spot with ad pages up 13% in the quarter against a very tough comparison. Color pages are up 26% year to date.

Newsprint costs up 7%, spilt evenly between volume and price.

Advertising Revenue
10/14/04 10:24 AM EDT

Management notes that ex-technology, ad revenue would have been up low single digits due to strength in color, consumer, classified, wholesale financial, and professional services advertising. Also, ad revenue is growing faster than linage indicating pricing is holding. The benefits of color ads are evident in this measure of advertising yield.

Tech Advertising Driven Lower
10/14/04 10:29 AM EDT

Tech advertising was driven lower by software companies. Some went dark, some went elsewhere. Mgt is working to bring those that went elsewhere back. I'd note this weakness is consistent with the horrid results from a broad array of software companies over the summer. Mgt feels spending will remain weak for tech in the fourth quarter but will not as bad as in the third quarter.

Expected Ad Rev at Journal
10/14/04 10:32 AM EDT

Mgt is moving on to guidance. Ex-technology expect low-single-digit ad increase at Journal but weak tech will result in mid-single-digit revenue decline at Journal.

Expenses and Operating Profits
10/14/04 10:48 AM EDT

Overall revenue for DJ will be up mid-single digits. Expenses up 5% but ex acquisitions, newsprint, and currency only up 1%. Operating profit will rise double digits resulting in slightly positive EPS growth. Again, this is lower guidance than current consensus. Worth noting that the stock is holding well despite the guidance and shares pushed above top end of recent trading range yesterday. As always, how the stock reacts to news can be as important as the news itself.

Queries on Ottaway Margins, Electronic Publishing and More
10/14/04 10:59 AM EDT

Q: Why are Ottaway Margins Up?

A: Solid top line mostly. Margins are approaching unsustainably high level and may fall in this division in 2005.

Q: What is the interest in share repurchase?

A: Company has list of 5 conditions for share repurchase, 4 of which are now met. However, working on new five year plan for whole company and prefer alternative investments with higher return than share repurchase. This sounds like a "no" answer as acquisitions will continue.

Q: What is the growth rate in Electronic Publishing ex-acquisitions and how do acquisitions impact margins?

A: 9% internal revenue growth and acquisitions are dilutive to margins. This leaves upside to future margins which is important given that Electronic Publishing is a growth area for the company.

Q: More color and revenue growth vs. linage at the Journal?

A: Yield while good was not as strong as prior quarters due to mix issues. Classifieds are gaining share due to weak B2B and are a low-yield area. Also commented on weakness in IPO tombstones and noted too much attention is paid to this as even down 50% it is only costing the Journal 1% of its total ad revenue.

Q: How do you approach acquisitions? What is interesting?

A: Focus will be on electronic publishing and Ottaway Community Newspapers. Do not expect any "huge" deals. Several hundred million per year is likely and no strain on balance sheet or cash flow.

Comments on the Weekend Edition
10/14/04 11:20 AM EDT

Q: Anecdotal comments on Weekend Edition?

A: Very positive reaction so far from advertisers, particularly in consumer and financial areas. More enthusiastic about prospects now than before announced. Still will be dilutive in '05, more so in '06 due to full year of publication.

Summary: Lack of Visibility on Operating Leverage Restricts Enthusiasm
10/14/04 11:57 AM EDT

I'm a little surprised that DJ shares are not acting worse given the guidance. On the call, none of the analysts seemed concerned and they certainly weren't confrontational. I think the guidance was expected despite the higher consensus estimates.

For DJ stock to work big, the company needs to accelerate B2B growth in its print publications. Consumer growth is fine, but carries higher costs as the Journal is a B2B publication, and expanding to consumers requires investments as with Personal Journal and Weekend Edition.

Overall, the fact that the stock is holding up despite another delay in the development of the story is a good sign. This fact -- more than the recent quarter or what I heard on the call -- makes me a bit more interested in DJ. I'm not long and don't plan on getting long in the near term. However, on my list of priorities, DJ has moved up a bit.

Posted by Steve Birenberg at October 15, 2004 06:31 PM in All Positions