Interesting article on IBM from from Forbes 04/01/02
Full Disclosure
Daniel Lyons, 04.01.02
IBM was boldly using revenue from patent licenses and profits from asset sales to shrink its reported overhead costs. That accounting doesn't fly anymore.
In a post-Enron world, murky accounting is punished on Wall Street, and even mighty International Business Machines Corp. is not immune. When the New York Times disclosed on Feb. 15 that IBM had used the $340 million gain from the sale of an optics business to reduce fourth-quarter overhead costs, investors hammered the stock down 5%. Louis V.Gerstner Jr., IBM's boss from April 1993 to Mar. 1 of this year, doesn't want any tarnish on his record. So now it is time for a little restating.
Key number here: "selling, general and administrative expenses," a.k.a. overhead. In its Jan. 17 news release on 2001 earnings, IBM (nyse: IBM - news - people) had SG&A at $15.5 billion, down 8% from six years earlier even as it added $14 billion in annual revenue. To arrive at this number IBM used the controversial method of counting some revenue sources—chiefly patent fees and gains on asset sales—not as revenue but as reductions in SG&A. How's that again? A patent fee has the effect of reducing overhead? "I've never heard of anyone doing it that way," says Fred A. Hickey, an accountant and the editor of The High-Tech Strategist, a financial newsletter in Nashua, N.H.
Selling Spree
IBM has actively shed assets.In most cases itdid not disclose the sale prices listed below in annual reports. In some cases it used gains to lower overhead.
2002 Prices NA
Plants in North America and Scotland; document-services division.
2001 $430 million*
Optical transceiver operation; GPS development group; design and manufacturing plants in Yasu, Japan; Chem Systems, a 100-person consulting group.
2000 $650 million*
Repair center in Amsterdam; Edmark educational software division; 1.8-million-square-foot campus in North Carolina; manufacturing operation in São Paulo, Brazil; chip plant in East Fishkill, N.Y.; plants in Italy and Minnesota; home networking group.
1999 $5.5 billion*
($5 billion from Global Network; $480 million from others) Manufacturing campus in Austin, Tex.; networking unit; factory in Scotland; Mexican subsidiary; semiconductor joint venture in Manassas, Va.; assembly and test plant in Austin,Tex.; Global Network.
1998 $170 million*
Assembly and test operation in Charlotte, N.C.; fulfillment and integration operations in Charlotte, N.C.; Worldwide Chain Store Systems, a subsidiary software unit.
1997 Prices NA
Belgian property unit; circuit-board factory in Austin, Tex.; remarketing division in New Zealand; 155 acres in North Carolina; 70 acres in Austin, Tex.
1996 $700 million*
Campus in Boca Raton, Fla.; Celestica, a contract manufacturer; office tower in Chicago.
1995 Price NA
Plant in Valencia, Spain.
1994 $1.5 billion
Federal Systems unit.
Gerstner, who handed the chief executive title to veteran IBMer Palmisano and retires as chairman at year-end, pushed the company's stock price up almost ninefold in nine years. He didn't accomplish this feat by riding the technology boom in the manner of a Dell Computer or a Cisco Systems. On the contrary, IBM's top line ($86 billion last year) has merely kept up with inflation. Gerstner's legacy, rather, is one of making an aging computer giant leaner and more efficient. But IBM is not as efficient as its January earnings report made it look.
When it came time to file its 10K report with the Securities & Exchange Commission on Mar. 11, IBM did some hasty backpedaling. The new disclosures show that IBM had been low-balling SG&A by $1.7 billion or 10% last year; $1.9 billion or 11% in 2000; and $1.6 billion or 10% in 1999. While this didn't artificially boost net income, it had the cosmetic impact of making IBM look leaner than it was.
In 1999 IBM took a $4 billion one-time gain from the sale of a network to AT&T. It applied a large chunk of this profit to the SG&A line, and that raised eyebrows. The SEC called IBM on the carpet over the 1999 annual report, and issued a rule designed to make it harder to avoid reporting asset gains as nonrecurring revenue. IBM's accountants, however, stood pat—until Mar. 11. Says a former SEC official involved in the flap:"IBM was just putting its thumb in the eye of the SEC and saying, ‘We dare you to do something.'"
IBM resisted fuller disclosure even as asset sales became common in Gerstner's overhaul of the company. In 2000 IBM brought in almost half a billion dollars by selling two factories in Italy and one in Minnesota, plus $90 million for an office complex in Charlotte, N.C. Last year the terms of the deals, unannounced by IBMbut in some cases disclosed in the buyers' SEC filings, included $90 million for a factory in Japan and unspecified sums for a second plant in Japan, a 100-person consulting business and a unit that develops global-positioning systems.
The selloff continued in the new year. In January IBM did two more deals: It sold a document-services division with plants, real estate and 200 employees;it also sold factories in the U.S. and Scotland to Sanmina-SCI, a contract manufacturer, for $200 million, says analyst James Savage of Thomas Weisel Partners. IBMdidn't disclose the terms of either deal. It does admit that it had been tucking gains or losses booked on these sales into its SG&A line.
Even though the controversial accounting, for the most part, had no effect on IBM's net income, it affected how investors judged the quality of that income, whether it was from strength in operations or more from nonrecurring effects. IBM netted $7.7 billion aftertax last year, or a diluted $4.35 a share.
Growth played a small role in generating the huge gains Gerstner delivered for shareholders. He better than tripled the revenue from intellectual property royalties (only $400 million the year he arrived). He moved IBM into services, which explains how head count has grown 40% in six years to 320,000. Typical deal in that genre is the $500 million contract IBM landed this month to run the data processing operations of Nestlé.
The old IBM made its money in manufacturing, marking up boxes steeply and using the gross profit (60% in 1982) to fund free handholding for customers. The new IBM has to compete on price with Dell and Hewlett-Packard, and recover the cost of systems analysts via service contracts. In IBM's lifeblood business, mainframes, prices fell a jarring 98% (in dollars per unit of computing power) between 1991 and 2001.
Making up for only some of this Moore's Law shrinkage in computer prices was a rise in computing power demanded by IBM's large corporate customers. The net effect is that IBM is anything but a growth company. So how do you enrich shareholders in a world like that? Gerstner's real skill is financial engineering. He pushed IBM's tax rate down from 47% in 1995 to 30% in 2001. He rode a bull market in stocks to pension gains, with a better than $1 billion favorable swing between 1995 and 2001 in that expense item (a $732 million pension cost in 1995 morphed into a $437 million gain in 2001). He spent $44 billion of cash buying back 864 million shares at an estimated average cost of $51, making shares held by the surviving shareholders that much more valuable.
This is going to be a tough act to follow for Gerstner's chosen successor, 50-year-old Sam Palmisano. When Gerstner arrived in 1993, he immediately took $8.9 billion in nonrecurring charges, setting the stage for a rebound in profits. Palmisano is evidently not going to open his reign with a big-bath writedown that primes the earnings pump for later years. But he may do something else to pacify Wall Street: usher in a new policy of financial transparency. |
