Skip to main content

As software sector investors brace for warnings this week, they mightwant to keep in mind one lesson from last quarter's dismal results: Justbecause a company does not preannounce does not mean that it's out of the woods.

Two of the largest software makers --


(ORCL) - Get Free Report


Siebel Systems


-- illustrated this point in theirprevious quarters. First, Oracle said it did not need to issue a profitwarning because its earnings would meet Wall Street estimates -- althoughthey ended up falling short of company guidance. Then Siebel didn't preannounce that its license revenue was far short of severely trimmed WallStreet estimates, saying there were no "public guidelines" for such awarning.

On Wall Street there's a wide range of opinions about when a companyshould preannounce. Some say companies don't need to warn if earnings estimatesfall short of the consensus but revenue meets estimates. Others say that earnings shortfalls require a warning regardless of the revenue figure. And then, as Siebel and Oracle show, companies set theirown rules.

And those rules might get tested once again with third-quarterearnings, which already have produced the largest number ofpreannouncements among tech companies since last year. That rise, combinedwith the examples set by Oracle and Siebel this summer, could set the stagefor a few more disappointments from companies that forgo preannouncementsaltogether.

"It has sort of become a game," Pacific Crest Securities softwareanalyst Brendan Barnicle said of preannouncements. "Every company has itsown view, and every situation in every quarter is different."

So when does a company have to preannounce?


Securities and Exchange Commission

provides no specificguidance on preannouncements, said spokesman John Nestor. Rather, theissue is covered under broad antifraud statutes that require companies todisclose material information about themselves and their finances. Thatwould apply to "something a reasonable person would want to know beforedeciding whether to buy, sell or hold," Nestor said.

"If you have a statement out there that now needs to be corrected andyou don't correct it, you're clearly subject to someone taking actionagainst you for misrepresentation or omission," Nestor added.

Software companies, which close a large chunk of their business in thelast few weeks and even days of the quarter, typically preannounce resultsduring the first week of the following quarter because that's when theyhave a handle on preliminary numbers.

But at least one software maker --

JDA Software


-- already haswarned investors it will not meet its license revenue targets.

In the broader tech sector, the number of companies that issuedthird-quarter warnings already is higher than those that missed in thesecond quarter. Thomson Financial/First Call has counted 138 negative, 57 positive and57 on-target preannouncements in the third quarter. (The firm does nottrack software company preannouncements.) That's better than a year ago,when there were 158 negatives, 41 positives and 41 on-targetpreannouncements. But it's worse than the second quarter, when there were114 negatives, 75 positives and 57 on-targets.

The ratio of negative-to-positive preannouncements, currently at 2.4,also has worsened from 1.5 in the second quarter, noted Chuck Hill, FirstCall's director of research. "The expectations were so high in tech for thethird and fourth quarters that reality is now setting in," he said.

On July 1, estimates for the tech sector were forecasting an 81% jumpin third-quarter earnings from the year-ago period, which suffered lownumbers because of Sept. 11. But analysts have significantly ratcheted downthose estimates, which now sit at 35% year-over-year growth.

To Warn or Not to Warn

Hill argues companies should preannounce whenever the numbers arematerially different from either guidance or expectations. The trouble is,he acknowledged, interpretations can vary over what is material. "To somepeople a penny is not material, to others it is," he said. "It's all in theeye of the beholder."

As preannouncements have become pervasive over the past two years, companies have tried to avoid warnings by declining to forecastresults for the next quarter or year, Kay Doremus, a senior sectoranalyst who covers technology for Banc of America Capital Management, saidafter the second-quarter earnings season.

The popular justification among the companies, which undoubtedly holdssome truth, is that they don't have the visibility to give a target range fornext quarter's results. But "corporations believe since there is noguidance provided, there is no need to preannounce results," Doremus said.

First Call's Hill doesn't buy that reasoning. Even if a company hasn'tissued guidance, he said, it should warn if it knows its numbers will fallshort of estimates.

Morgan Stanley analyst Chuck Phillips disagrees, arguing a companyshould preannounce if numbers diverge from guidance rather than fromconsensus estimates.

Despite missing guidance materially, some companiesconclude they don't need to preannounce if their numbers are still higherthan the lowest estimate on the Street, Phillips wrote in an emailfollowing last earnings season.

That's especially unfair to retail investors because they don't haveaccess toall the estimates, Phillips said. And not even all institutional investorsuse analyst estimates, though they do track management's targets, Phillipspointed out in a July note.

"If they miss their publicly stated targets then they shouldpreannounce, because that's a material event," Phillips argues. "Attemptingto avoid bad news by ignoring your own guidance is asking for trouble."

Indeed, if a company's numbers are bad, failing to preannounce ismerely postponing the inevitable because the stock will ultimately get hitanyway, as proved by Siebel. After its second-quarter surprise, Siebel'sshares plummeted to a three-year low.

"You can get hammered sooner or later," said First Albany analyst MarkMurphy. Murphy said he wouldn't be surprised if, following Siebel'sexample, a couple of other companies decide not to preannouncedisappointing results. But "longer term, I'm not so sure because maybe thetrend here is faster disclosure toward information," he added, citing thenew rule that requires insiders to report trades within two days.

Bank of America's Doremus, meanwhile, drew an even broader lesson fromlast quarter's warning season. "I think the lesson we have to draw is thatthe demand in the technology sector is still very weak despite the positivechanges in the economic indicators, and that weakness is expected to persistthrough this year and maybe even through the first half of next year," shesaid.