As several Wall Street Journal articles recently have highlighted, when pricing a deal near the end of a fiscal quarter or at the start of a new fiscal quarter, but before a company's 10-Q has been completed (or nearly completed), underwriters and issuers need to consider carefully the extent that they can provide financial updates to potential investors in an offering document. In connection with that evaluation, even if an earnings release is expected to be issued prior to the printing of a final prospectus, underwriters should ask, early in the process, whether the issuer's accountants will be able to provide the customary comfort on the interim numbers included in the release (the so-called "SAS 71 review"). Depending upon the company, the accountants may not necessarily be in a position to "comfort" the numbers in an earnings release. The question for the underwriter then becomes whether to include the financial update in the prospectus without the customary comfort or to eliminate any reference in the prospectus to the upcoming financial results. As a general disclosure matter, the more recent the information available to prospective investors the better. But from a liability perspective, should interim numbers be included if they cannot be "comforted" by the accountants?
The Wall Street Journal recently reported on the effect of an earnings disappointment by a large telecommunications company. Shortly after closing a $1 billion debt offering, the company warned the street that its earnings would come in significantly below expectations. The CEO indicated in the article that the company did not know of the earnings shortfall until the day it was announced. After the announcement, the prices of the company's stock and bonds fell. To placate incensed bondholders, the company enhanced the bonds' yield by permitting bondholders to "put" the bonds to it at par several years earlier than the original terms of the bonds. In addition, it was reported that one of the underwriters for the deal "offered compensation of about $13 million to debtholders."
"Surprises" can be unfortunate, especially in the context of a securities offering. So the more information the better, assuming it is accurate. To the extent that prospective investors can receive a financial update beyond the information provided in the audited and unaudited financials included within an offering document, the likelihood of a "surprise" can be mitigated. Underwriters should learn early in the process whether the company's accountants will be reviewing interim earnings numbers. If so, there should be no issue including a financial update. If not, two questions arise: (i) how comfortable is the company with its preliminary numbers, and (ii) assuming the company is comfortable with its numbers, can the underwriters feel the same level of "comfort" without a sign-off from the accountants.
If the company is not yet comfortable, and the numbers remain in "flux," clearly there can be no financial update included in the offering document. If the company is, in fact, comfortable with its preliminary numbers and has issued its earnings release, and its accountants can provide the customary level of comfort, the financial update should be included. If the company is comfortable with its numbers, but the accountants are unable to "comfort" the numbers, should the underwriters include any of the updated information? These issues are always more problematic when earnings are released several weeks before a company's 10-Q is ready for filing with the SEC.
If the company does not expect any financial surprises, yet the underwriters are unable to diligence the company's numbers, the financial update probably is best left out of the offering document, assuming that the company has not yet released its earnings. If the company has released its earnings, yet its accountants have not been involved in the process at the time of pricing or closing, what should be done? It seems difficult to us in that circumstance to leave interim financial information out of an offering document while the company, in the ordinary course of its business, has disseminated that information through other channels. In these times, one can assume that the information will quickly permeate the market. Yet this approach obviously leaves the underwriters with the exposure of not having certain financial information in the offering document "expertized." For that reason, as we said above, it is important to manage the "comfort" process early in the transaction. If the underwriters are required to "go naked" on certain numbers, it becomes much more critical that they diligence those numbers, to the extent practicable, in order to provide themselves with an adequate "diligence" defense. It even may be necessary or desirable to include cautionary language (beyond that typically associated with interim unaudited financial statements) informing investors that the interim earnings numbers, while "released," remain subject to further adjustments, and that the company's accountants have not, at the time of the transaction, reviewed any of those numbers.
However, the most important thing to keep in mind is to raise the issue within the company and with its accountants early in the offering process. Will the accountants be able to "comfort" the numbers included in an earnings release or other preliminary financial numbers? Learning the answer to these questions may alleviate some potential last minute stress.