But that's not the case at some other companies high on the S&P's Compustat list. Growth in cash from operations at Motorola (#44), for instance, trailed that of net income during the period analyzed by a margin of 128 percent. The company declined to comment, but some analysts contend that for one thing, the bankruptcy of the Iridium satellite communications consortium, in which Motorola invested heavily, has had a significant impact on performance. Indeed, while the company disclosed a $740 million hit to its fourth-quarter earnings last year, these analysts believe the Iridium investment remains a drag on cash flow. During the first quarter of 2000, normally a solid quarter, Motorola posted a $900 million cash flow deficit, its largest in the past nine quarters, according to an analyst who spoke on condition of anonymity. And the company has at least another $374 million to pay on Iridium-related reserves, says the analyst.
To be sure, Motorola also faces profit-margin pressure in several key business segments. In semiconductors, which account for about 20 percent of sales, margins are only in the high single digits. But part of the profit pressure is offset--at least on the income statement--with nonoperating gains. The most noteworthy example came during the quarter that ended last March 31, when Motorola sold an investment booked to the wireless segment. By classifying the gain as operating income, Motorola managed to turn a 41 percent year-over-year decline in quarterly operating income into a 35 percent increase, according to the analyst who requested anonymity.
Recurring Nonrecurrence
Investors often ignore investment gains because they have no assurance that they will recur, and so consider them one-time events that have little bearing on a company's ongoing fortunes. Whether such gains should be ignored is another matter. Some analysts contend they should not be, at least under narrowly defined circumstances.
In the February issue of SoundBytes, a technology newsletter published by Credit Suisse First Boston, analyst Michael Kwatinetz argued that Cisco Systems Inc.'s investment portfolio, for instance, should be considered part of its ongoing business under four conditions. First, the amount of gains realized in a given quarter must be less than 7 percent of the total (therefore foreshadowing about four years of such gains). Second, the company must intend to consistently take this level of gain. Third, the gains must be a result of investments in related businesses. And fourth, the company's investment track record must support the notion that further gains are likely. Because Cisco's investment portfolio meets all four conditions, Kwatinetz wrote, "we believe it's operational in nature."
Motorola, for its part, evidently believes its own gains pass muster. How else to explain the fact that such income is used to reduce the figures it reports for sales, general, and administrative expenses? Again, that isn't necessarily a violation of GAAP. "This use of investment gains is usually disclosed in a footnote," says another analyst. But he notes that that's sufficient for purposes of GAAP if the company can claim the impact isn't material.
Motorola is far from alone in masking operating weaknesses in this fashion. IBM, for instance, used the gain on the sale of Global Network, its telecommunications technology business, to AT&T to reduce its SG&A in 1999 by $2 billion. Cost cutting, of course, translates into more operating cash flow as well as net income. But again, critics contend the accounting treatment, while not a technical violation of GAAP, is misleading. And the fact remains that IBM's growth in operating cash flow for the three years that ended last March trailed that of its net income by 35 percent. (At #102, IBM narrowly missed inclusion in our list.)
Some companies on the list that have significant investment gains don't account for them in this fashion. Texas Instruments, for example, enjoyed a big gain from selling a piece of its equity holding in Micron Technology Inc. earlier this year, a stake it acquired in return for selling Micron its memory-chip business in 1998. TI still holds quite a bit of Micron stock. But rather than treat the recent gain as part of its operations, using it to reduce its SG&A and boost its operating income, TI chose to account for it as an extraordinary item. By treating such nonoperational results as noncash items, says CFO Aylesworth, "we get to operating results that are most meaningful."
But other companies whose cash flow from operations has lagged far behind their net income have employed less meaningful means of reporting their results. DuPont (#79), for instance, switched from accelerated to straight-line depreciation in January 1995, which boosted its earnings without any improvement in its operating cash flow, according to Paul Leming, an analyst for ING Barings. What's more, says Leming, DuPont "constantly" uses nonrecurring items such as restructuring charges to make its net income look better than cash flow would suggest. Citing quarterly statements that are typically accompanied by dozens of explanatory footnotes, Leming says DuPont is "one of the worst abusers of recurring nonrecurring items," though he is quick to note that "it's all GAAP."
DuPont declined to comment.
Honey, We Shrunk the Revenue
Elsewhere, restructurings have produced earnings boosts that have yet to be matched by operating cash flow growth. Consider PepsiCo's results. While the company's moves to spin off its restaurant division in 1997 and take public 60 percent of its bottling operations last year have improved its bottom line, cash flow from operations hasn't kept pace.
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