The Whole Truth
July 1 2002 by Russ Banham
Willem “Wim” Roelandts wants to tell the truth, the whole truth and nothing but. Consequently, the CEO and president of Xilinx, a San Jose, Calif.-based semiconductor manufacturer, recently changed his approach to collecting, evaluating and distributing information about the company’s performance. Having been caught unawares by poor information-Xilinx missed its earnings forecasts four quarters in a row-Roelandts hopes not to be blindsided again. “I’m looking for the most accurate ways possible to predict our future,” he says.
One way is by compiling and disclosing cash flow. “You can’t hide cash flow-you either have the money or you don’t,” he says.
Roelandts, who joined Xilinx in 1997 after 29 years at Hewlett-Packard, also switched from pro forma accounting to reporting based on generally accepted accounting principles, or GAAP. “Pro forma accounting tends not to have standard rules,” he explains. “I wanted to do away with the gray areas, muting the element of surprise.” He revamped the way the company records revenue so that now Xilinx books a sale only after a distributor sells a product to a customer. He makes formal updates mid-quarter to analysts and shareholders over the Internet and has established guidelines for determining “materiality”-the impact of a particular event on corporate performance.
Xilinx is not alone in changing its approach to information to tell the truest tale possible. Companies such as Nationwide Mutual Insurance and Southwest Airlines are also finding that traditional financial metrics fall short when mapping where they want to go and how to get there. After Enron and even the leadership issues dogging the U.S. Catholic Church, CEOs are under pressure to explain corporate prospects openly, fully and honestly.
“A culture of €˜we are the best and the brightest’ and €˜you can’t challenge us because we’re much more powerful and intelligent than you’ emerged during the bull market,” explains Kirk Hanson, executive director of the Markkula Center for Applied Ethics at Santa Clara University in Silicon Valley. That attitude led to moral lapses, he says. So did the pressure to manage earnings. “When books are written about the ’90s, what you’re going to find is not illegal [acts], but certainly ones that get close to the line-fine tuning of business operational data with the ultimate purpose of closely managing the stock prices,” points out George Colony, founder and CEO of $159 million technology research firm Forrester Research in Cambridge, Mass. Both Colony and Hanson hope to see a new culture emerge, one in which CEOs accept the fact that the buck stops with them.
Even those committed to honesty know that truth is hard to find. Realizing they need more than just traditional financial metrics-such as historical figures for accounting purposes-to tell the truth in the fast-changing business world, CEOs are turning to newer measurements that assess everything from marketplaces to resource management.
But a survey of 330 top executives in America and Europe released in June by U.S. accounting and tax firm KPMG LLP in New York found that many lack insightful and reliable information to make strategic decisions, much less implement them. “Many CEOs are dissatisfied with the reliability of traditional measurement tools as their organizations are driven to real-time responses,” says Jack Miller, a KPMG vice chairman.
To better gauge performance, Miller says CEOs need to identify key predictors of performance and routinely measure them. “The kicker is determining the information that constitutes the fundamental drivers of your particular business,” he says, citing inventory growth and employee satisfaction as examples.
Determining which data tell the truest story is a quest not confined to corner offices. Standard & Poor’s recently unveiled a new benchmark designed to gauge earnings more accurately. S&P’s new “core earnings” measure prohibits the 10,000 companies analyzed by the New York-based rating agency from reporting pension fund investment as gains to lift profits. As for stock options granted executives, S&P will now deduct those from per share earnings.
Metrics that matter
Every company has different success factors that, if measured regularly, should provide an accurate reflection of its performance and prospects. At Southwest Airlines, the critical success factor is customer loyalty. Few companies can boast a president and COO whose primary responsibility is to act as an intermediary between customers and operations. But that’s the role Colleen Barrett has created for herself since working her way up, over the past three decades, from Chairman Herb Kelleher’s executive secretary to the No. 3 post at the Dallas-based airline.
“As Herb’s secretary I always handled all customer letters, complaints, commendations-whatever,” says Barrett. “Even though I changed titles, I never changed that role.” Indeed, when Barrett confers with stock analysts, she is as apt to talk about customer service metrics as she is about financials. Southwest measures daily certain metrics important to its customers, including on-time performance. Other data are tracked weekly or monthly. Barrett, for instance, puts together monthly reports on all departments based on quantifiable customer input.
Other executives also tap into predictive information. At Nationwide, a Columbus, Ohio-based property, casualty and life insurer with $26 billion in 2001 premiums, Chairman and CEO W.G. Jurgensen says he focuses on information that “gets behind the numbers and the results.” Jurgensen examines emerging loss trends to determine if the company has improperly insured a peril. “In the insurance business, the key to profitability is to understand yesterday and today to put yourself in a position to accurately predict tomorrow,” he says. “My rule of thumb is this: If there is a 10-percent change in anything, such as sales, number of policies sold, profit margins, turnover, etc., then that is material and deserves in-depth evaluation. We’re also constantly fascinated to understand more about our customers, which is what drives our profitability.”
Other CEOs agree. “Your good customers drive your business,” says Andre Schwager, CEO of Satmetrix Systems, a Mountain View, Calif.-based company that surveys clients’ customers and packages their responses into usable data called a customer loyalty index. The idea is that loyalty drives revenues, and if satisfaction drops dramatically, sales will most likely follow.
President and CEO Richard Harrison of Parametric Technology, a $900 million Needham, Mass., product development company, hired Satmetrix when it decided to launch a new line of products. Through data Satmetrix collected, Harrison learned that his 30,000 customers wanted more long-term relationships with Parametric’s sales representatives and higher-quality products and found both the purchasing and customer-support experience disappointing. “This was critical predictive data for us that took me personally by surprise,” Harrison admits. “Had we simply continued as we were, there would have been some serious performance problems down the line.”
The CEO quickly revised how he compensated salespeople to reduce turnover, introduced an enterprise-wide quality improvement system and invested in broader training of Parametric’s customer-support staff. Once a month, Harrison sits down with an executive-level team to review Satmetrix’s ongoing assessment of customer experiences.
Just as important as collecting good data is figuring out who should get it. Creditors, for instance, consistently need to know what cash flows are going to look like and whether they will be sufficient to cover debt. Shareholders, meanwhile, are interested in how well the company is fulfilling its strategy and how the CEO is creating value for them. Harrison believes Wall Street will be interested in the predictive data on customers that Parametric is collecting as a baseline to compare against. He plans to release 12 months’ worth of it later this year.
Other CEOs are grappling with new ways to create truthful forecasts-a seemingly thankless task. Even with the best information-gathering and analysis tools, a forecast will remain just that-the best guess as to where a company is headed, or as the SEC calls it, “guidance” based on an estimate of today’s knowledge.
An information dearth burned Xilinx by creating false forecasts, which led to unrealistic guidance, which in turn frustrated analysts who pummeled the company’s stock. Xilinx failed to understand the extent of business that its customers (Nortel, Lucent and Cisco) did with their customers (WorldCom and Sprint). When the latter’s sales deteriorated in the dot-com bust, the impact reverberated at Xilinx. Revenues, which had skyrocketed to $1.6 billion in fiscal 2001 from $600 million the previous year, fell back to under $1 billion in fiscal 2002.
“When demand didn’t live up to the forecast, it affected orders for our programmable logic systems,” laments Xilinx CFO Kris Chellam. The company’s December 2000 quarterly forecast was for 10-percent revenue growth. When the quarter ended, however, growth was closer to 3 percent. Xilinx continued to miss forecasts throughout the following year. Four quarters of missed forecasts decimated the company’s stock value, from a peak of around $98 a share in early 2000 to about $19 a share a year later.
Today, Xilinx bases its forecast in large part on the end markets. The company feeds into external data coming from its 15 top global customers and its 20 strategic customers like Nortel, tracking their shipments by product, geography, division and other metrics. “We now track capital spending by the telecom industry,” Chellam says. “We also track the profit performance of the S&P 500 to determine if corporate America is making enough cash flow to spend on IT.” Since implementing the new data-collection strategy, Xilinx has achieved its past three forecasts, lifting its stock price to around $40 a share.
Xilinx discloses enough about customers to let Wall Street draw conclusions, but stops short of revealing everything it knows. “We don’t specifically release our customers’ customers’ data, but we do give qualitative information that takes this into account when we do our analyst conference calls each quarter,” Chellam says.
To stay on top of the latest data, Roelandts, as CEO, schedules full staff meetings twice a month, during which each business unit and functional leader reports a set of data. He meets quarterly with the company’s internal audit committee and its external audit firm to verify that what he’s been told is accurate.
The drumbeat of new regulations governing fair and accurate disclosure is intensifying and speeding changes in the way CEOs distribute information. When the Securities and Exchange Commission issued “Regulation Fair Disclosure,” calling for one-time disclosure to all stakeholders via a press release, Roelandts worked with the National Industrial Relations Institute to convince the SEC that posting the information on the Internet along with a “push” email would be a viable alternative. The SEC agreed.
Xilinx also instituted guidelines for assessing the materiality of an event-a key SEC concern in the wake of Enron. “If an event has bearing on the outside market, I go to our legal people, as well as our internal and external auditors, to understand how much of this should be disclosed or not,” Roelandts says. “If it is a tricky thing, I’ll hire outside consultants who specialize in that area. I try to find out if there have been similar cases in industry to discern how other companies handled the issue.”
KPMG’s Miller says materiality has plenty of CEOs puzzling over this seemingly quixotic demand. “In essence, materiality is a piece of information that would cause a stakeholder to make a different decision about the company,” he explains. “If I were a CEO, I’d want to give stakeholders the information they need to make a decision about doing business with me or investing in me. That applies even to bad information-information that may make them change their minds. That’s the essence of transparency.”
Bad news is never easy to deliver
George Colony at Forrester faced a tragic question of materiality last September when his president and COO Bill Bluestein died suddenly. As he personally grieved he also had to figure out how quickly the company needed to inform Wall Street that a key executive had died. Right away, Colony decided, “We quickly press released it. We didn’t pause.”
But even when it’s not personally painful, sometimes the truth still hurts, and CEOs have to figure out when and how to deliver it. One way to offer less-than-stellar data is in the context of long-term strategy. “That way, it becomes a mere blip,” suggests business ethicist Hanson. “Putting a bad message into perspective is just as critical as conveying the data. When it comes to full disclosure, avoidance behavior can lead to bizarre antics at the eleventh hour when you try to bail yourself out. It is at these instances,” he argues, “that manipulation of accounting data and cooking the books suddenly seems to be a plausible way out.” How true.