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years in the period ended January 31, 1988, in conformity with generally accepted prin-
ciples applied on a consistent basis.

Ernst & Whinney
Stamford, Connecticut
March 30, 1988
682 Corporate Financing Policies




16-32
Corporate Financing Policies




EXHIBIT 4
CUC International, Abridged Interim Financial Statements for Nine
Months Ended October 31, 1988
CUC International, Abridged Interim Financial Statements

CONSOLIDATED BALANCE SHEET

October 31, 1988
(Dollar amounts in thousands) (unaudited) January 31, 1988
..........................................................................................................................




CUC International
ASSETS
Current Assets
Cash and cash equivalents $ 32,003 $ 25,953
Receivables 38,118 33,201
Other 4,164 3,468
Total Current Assets 74,285 62,622
Deferred membership charges, net 37,223 22,078
Prepaid solicitation costs 25,538 17,089
Prepaid commissions 5,397 6,267
Contract renewal rights and intangible
assets, net 64,419 61,245
Properties, net 19,805 16,048
Other 2,040 1,519
Total Assets $228,707 $186,868
683
Corporate Financing Policies




16-33 Part 3 Business Analysis and Valuation Applications




CONSOLIDATED BALANCE SHEET (continued)

October 31, 1988
(Dollar amounts in thousands) (unaudited) January 31, 1988
..........................................................................................................................

LIABILITIES AND SHAREHOLDERS™ EQUITY
Current Liabilities
Members™ deposits $ 4,485 $ 4,997
Accounts payable and accrued
expenses 50,017 36,063
CUC International




Federal and state income taxes 1,264 423
Current portion of long-term obliga-
tions 1,494 1,404
Total Current Liabilities 57,260 42,887
Convertible subordinated debentures 12,000 12,000
Long-term obligations 2,673 3,767
Deferred income taxes 16,844 14,624
Other 1,402 1,229
Total Liabilities 90,179 74,507

Shareholders™ Equity
Common Stock 203 197
Other shareholders™ equity 138,325 112,164
Total Shareholders™ Equity 138,528 112,361
Total Liabilities and Shareholders™
Equity $228,707 $186,868
..........................................................................................................................
684 Corporate Financing Policies




16-34
Corporate Financing Policies




CONSOLIDATED INCOME STATEMENT
(unaudited)

Three Months Ended Nine Months Ended
October 31 October 31
................................. ....................................
(In thousands, except per share
amounts) 1988 1987 1988 1987
......................................................................................................................................
Revenues
Membership and service fees $70,131 $50,696 $192,016 $143,409




CUC International
Other 938 386 2,297 1,693
Total Revenues 71,069 51,082 194,313 145,102

Expenses
Operating 24,320 16,258 64,123 47,608
Marketing 23,524 17,761 65,647 50,625
General and administrative 11,787 8,721 32,363 25,097
Total Expenses 59,631 42,740 162,133 123,330

Operating Income 11,438 8,342 32,180 21,772
Provision for income taxes 4,577 3,672 12,854 9,591
Net Income $ 6,861 $ 4,670 $ 19,326 $ 12,181

Net Income Per Common Share $.33 $.24 $.93 $.63
Weighted Average Number of
Common and Common Equiva-
lent Shares Outstanding 20,752 19,665 20,870 19,231
......................................................................................................................................
17
17 Ma na g e m e nt C o mm u n ic a t i o n s
chapter



M anagement communication is increasingly important as ¬rms in-
vest in complex product and production technologies and in intangible assets such as re-
search and development. These outlays can be quite dif¬cult for outsiders to value, since
they do not have access to the same data as management. As we discuss in this chapter,
¬nancial reports provide a low-cost way for management to communicate with inves-
Business Analysis and
3
Valuation Applications
tors. However, ¬nancial reports are not always effective as a communication vehicle. We
therefore examine how alternative forms of communication can be used by management
to mitigate information problems with external investors.
Several questions can be addressed by analyzing management™s communication
strategy:
• Management can ask: Is our current communication strategy effective in helping
investors understand the firm™s business strategy and expected future performance,
thereby ensuring that our stock price is not seriously over- or undervalued?
• Securities analysts can ask: Do management™s communications provide us with
credible information that is useful for forecasting a firm™s future performance?
What types of information can we reasonably expect management to provide us?
And how should we interpret information provided by management?
Throughout this book we have focussed primarily on showing how ¬nancial state-
ment data can be helpful for analysts and outside investors in making a variety of deci-
sions. In this chapter we change our emphasis and focus primarily on management™s use
of ¬nancial analysis to help communicate effectively with external users. However, as
we note above, analysis of management™s communication strategy is also likely to be
useful to securities analysts.


COMMUNICATING WITH INVESTORS
Some managers argue that communication problems are not worth worrying about. They
maintain that as long as managers make investment and operating decisions that enhance
shareholder value, investors will value their performance and the ¬rm™s stock according-
ly. While this is true in the long run, since all information is eventually public, it may not
hold in the short- or even medium-term. If investors do not have access to the same in-
formation as management, they will probably ¬nd it dif¬cult to value new and innovative
investments. In an ef¬cient capital market, they will not consistently over- or undervalue


17-1




685
686 Management Communications




17-2
Management Communications




these new investments, but their valuations will tend to be noisy. This can make stock
prices relatively noisy, leading management at various times to consider their ¬rms to be
either seriously over-or undervalued.
Does it matter if a ¬rm™s stock is over- or undervalued for a period? Most managers
would prefer to not have their stock undervalued, since it makes it more costly to raise
new ¬nancing. They may also worry that undervaluation is likely to increase the chance
of a takeover by a hostile acquirer, with an accompanying reduction in their job security.
Managers of ¬rms that are overvalued may be concerned about the market™s assessment,
since they are legally liable for failing to disclose information relevant to investors.1
They may therefore not wish to see their stock seriously overvalued, even though over-
valuation provides opportunities to issue new equity at favorable rates.


A Word of Caution
It is natural that many managers believe that ¬rms are undervalued by the capital mar-
ket. This frequently occurs because it is dif¬cult for managers to be realistic about their
company™s future performance. After all, it is part of their job to sell the company to new
employees, customers, suppliers, and investors. In addition, forecasting the ¬rm™s future
performance objectively requires them to judge their own capabilities as managers.
Thus, many managers may argue that investors are uninformed and that their ¬rm is un-
dervalued. Only some can back that up with solid evidence.
If management decides that the ¬rm does face a genuine information problem, it can be-
gin to consider whether and how this could be redressed. Is the problem potentially serious
enough that it is worth doing something to alter investors™ perceptions? Or is the problem
likely to resolve itself within a short period? Does the ¬rm have plans to raise new equity or
to use equity to acquire another company? Is management™s job security threatened? As we
discuss below, there is a wide range of options for management in this situation.


Key Analysis Questions
We recommend that before jumping to the conclusion that their ¬rm is under-
valued, managers should analyze their ¬rm™s performance and compare their own
forecasts of future performance with those of analysts, using the following
approach:
• Is there a significant difference between internal management forecasts of fu-
ture earnings and cash flows and those of outside analysts?
• Do any differences between managers™ and analysts™ forecasts arise because
of different expectations about economy-wide performance? Managers may
understand their own businesses better than analysts, but they may not be any
better at forecasting macroeconomic conditions.
687
Management Communications




17-3 Part 3 Business Analysis and Valuation Applications




• Can managers identify any factors that might explain a difference between
analysts™ and managers™ forecasts of future performance? For example, are
analysts unaware of positive new R&D results, do they have different infor-
mation about customer responses to new products and marketing campaigns,
etc.? These types of differences could indicate that the firm faces an informa-
tion problem.



Example: Communication Issues for FPIC Insurance Group
FPIC Insurance Group Inc. is the largest provider of liability insurance for doctors and
hospitals in Florida. In the period 1996 to 1998, FPIC reported stable returns on equity
of 13.8 percent, average growth in both revenues and net income of 28 percent, and
growth in book equity of 2.8 percent. On December 31, 1998, the ¬rm had a book value
per share of $15.85, a price-to-book value of 2.23, a price to earnings multiple of 15.9,
and an equity beta of 1.57.
In August 1999, the ¬rm™s stock price declined from $45.25 to $14.25. The stock de-
cline began on August 10, the day the company reported a 48 percent jump in second-
quarter pro¬ts to $7.4 million. The earnings increase was in part attributable to the
FPIC™s Florida Physicians unit releasing $8.1 million in reserves it had set aside against
future claims, compared with $4 million in the year-ago quarter. In addition, the com-
pany reported higher-than-expected claims in a health insurance plan offered to Florida
Dental Association members.

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