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Best of 2005: Ready, Set... Earnings Release



Editor's Note: This article was published on 5/3/2005

In my humble opinion, one of the trickiest jobs in this business is to game a stock's reaction to a quarterly release. So many times we see companies "beat" and the stock tank, and vice-versa, only to find out that the Street's focus was on some obscure metric buried inside the report. To minimize the risk of getting blindsided - or to take advantage of opportunities - I find it helpful to lay-out in easy to see form the key consensus numbers and a sampling of sell-side estimates. This avoids having to shuffle through reports or screens to figure out what is going on relative to expectations. I then compare where the stock price was when the estimates were published, and lastly I review the prior quarter's Q&A call transcript to refresh myself on what the company said about its business, to get a feel for what areas the analysts were most interested in, and to find out if there is an "elephant in the room".

Let's look at an example. Tekelec (TKLC) is on deck to report its Q1 later today. It's a small cap telco tech company that I have been following for a while. The stock has been hammered by 50% in just 5 months and it now trades at the lowest EV/sales in the last 7 years - yes, even lower than during the telco meltdown.

The red numbers in the spreadsheet (below) show the current consensus. The other figures are individual sell-side firms' estimates. Lastly, I have listed TKLC's guidance from the last call. Here is how I use the information.

Revenues: The consensus is toward the high end of guidance. However, the estimates were published when the stock was trading in the $18-20 range. My sense is that a weak number, but within guidance, is probably not going to have much of an impact given today's much lower stock price. However, a low number this Q makes within-range guidance for Q2 more important. The risk, IMHO, is to the upside given the strong bookings and book-to-bill the co. reported last quarter.

EPS: The consensus is at the high end of guidance. Unless this number is way off, I think the same analysis relevant to "Revenues" applies here.

Gross Margins: this is probably the most important number of the release. Why? Sell-side estimates are bunched tightly around the co.'s guidance, but the analysts expressed a lot of interest last Q as to how a growing mix of sales from the Santera division (switching products) might negatively impact margins. A good showing in GM, especially together with a strong revenue number from the "Switching" group, could provide a strong catalyst for the stock. Of course GM will likely impact EPS, but IMHO, a strong EPS number because of strong GM would be much more important than a strong EPS number despite so-so GM.

Operating Expenses (R&D and SG&A): consensus again bunched close around guidance. The tone from the sell-side reports suggests an expectation that Opex will creep higher. With that in mind and given the recent weakness in the stock price, I think the Opex number is probably the least important figure in the release.

Book-to-Bill, Orders and Backlog: last Q the B2B was 1.4 to 1. A repeat of such a strong number could really jazz things up. I do not expect it and I don't think many people do. Orders and backlog are always very important. And while they may not move the stock price immediately to the upside, they can be useful to mitigate the impact of weak revenue guidance for the forward quarters.

The Intangibles: it is critical to know if there is an, "elephant in the room," and what that is. Unfortunately, the "elephant" is often an arcane element of the co.'s business, which requires one to dig pretty deep to find it. If there is an "elephant", good news about "it" can often overshadow bad numbers, and vice-versa. In TKLC's case, the "elephant" is TKLC's relationship's with Alcatel (ALA). For now the two companies are strong partners: TKLC provides "gateway" gear to ALA, while Spatial Wireless provides soft switches; ALA puts the two together and sells them in a bundle that has been widely adopted by customers. However, recently ALA bought out Spatial and the speculation is that ALA will soon develop its own "Gateway" product at the expense of TKLC. IMHO much of the recent stock price decline is the result of this dynamic, and no amount of number crunching would reveal this issue.

If TKLC were to suggest that the "elephant" is no longer an issue, the stock is likely to jump, notwithstanding the numbers for this Q or the next. If there is any suggestion that the relationship with ALA is at risk, no "beat" of the estimates will help, and the stock could have meaningful downside. If the uncertainty on this issue persists, then the quarterly numbers will likely retake the spotlight.

So there you have it. Again, the purpose of the above is not to suggest buying or shorting TKLC per se, we don't do that in the 'Ville, but rather to lay out one approach to preparing for an earnings release. Hopefully being just a little more ready than the next person to decipher good news from bad will leave some profits in our pockets.

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