Sure does not seem that QCOM falls into this group. Could be a time to buy.
P R E S E N T A T I O N S
R E V I S I T E D
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Accounting Expert Howard Schilit
According to Dr. Howard Schilit, who advises institutional investors, understanding a company’s accounting policies within the context of its operations is essential to assessing the company’s health. Investors need to determine which category a given company falls into:
The underlying business is healthy, but the company uses aggressive accounting practices.
The underlying business is beginning to deteriorate, and the company uses accounting techniques in an attempt to change assumptions about itself or to camouflage problems.
Examples
Category One
Company: AOL
Five years ago, AOL’s revenue was growing very rapidly, but the company was incurring substantial costs to sign up new customers. They recorded those costs as “deferred subscriber acquisition costs,” capitalizing the cost and writing it off over a period of 12 months. Schilit’s group was concerned about this aggressive accounting because it inflated the company’s earnings. A year later, AOL increased the amortization to 18 months, then to 24 months in 1996. At that point, Schilit’s group put an alert on the company. The company saved itself by using two of Schilit’s “Seven Accounting Shenanigans.” First it shifted normal operating expenses onto its balance sheet, pushing them to a future period (Shenanigan No. 4), then took a one-time write-off for $385 million, the amount of the deferred subscriber acquisition costs (Shenanigan No. 7.) However, in AOL’s case, because the business was fundamentally healthy, the strategy worked, and Schilit removed the alert.
Category Two
Company: Medaphis
Medaphis is a healthcare information company. Schilit’s group first raised concerns about the company in 1995. Medaphis used “percentage of completion accounting,” recording revenue by taking the percentage of the cost incurred to the total estimated cost. Almost every major brokerage firm wrote rebuttal of Schilit’s report. In 1996, analysts noticed a new footnote under “equity earnings in joint venture” for $11 million, which was put under “recorded sales.” In reality, sales were flat and margins were down. The stock “blew apart” in the summer of 1996.
Schilit’s Words of Wisdom
If a company’s business, in your judgment, is booming, and the accounting for the revenue recognition is clean, it’s usually a company that’s going to do well for a while. If a company is growing almost exclusively by making acquisitions, you have to ask—is any real organic growth coming from the businesses? What are the major acquisitions, and how are they doing?
An accounting fraud doesn’t happen in a vacuum. It occurs in a company where
business deteriorates
Wall St. still loves the company
the company acts irrationally instead of reporting true information. It’s risky if an accounting change is made in concert with a deterioration of the business.
Net income and cash flow from operations should track pretty closely. When cash flow from operations lags behind net income, usually the results are going to be very bad.
Schilit’s Message to CFOs and CEOs
“If your business is starting to struggle, get the message out as quickly as you can. Let your constituents, especially the key sell-side analysts who follow your company, know what the company is planning to do to solve the problem. Will the stock get hit? Of course. Will long-term investors bail out? Probably not.
Accounting Issues for Internet Companies
Accounting rules were written a few generations ago, before the advent of today’s information-based economy. Problems arise when companies in new kinds of industries say “the old rules don’t apply to us.” The FASB has to come up with new guidelines for these new businesses. Schilit doesn’t yet have an opinion whether Amazon.com is going to be one of the "great collapses" or whether it will become a "Wal-Mart online. " A lot has to do with the patience of investors.
From a Presentation at NYSSA, November 30, 1999, by Dr. Howard Schilit, President, Center for Financial Research & Analysis
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