"We realize IBM has been caught performing some sleight-of-hand with nonrecurring items," wrote Carol Levenson, an analyst for New York advisory firm Gimme Credit, in a recent report. But Levenson noted that she was satisfied that this legerdemain "will come out in the wash of the cash flow statement."
On the other hand, additional disclosures that may at first glance seem trivial, such as additional footnote detail, can reveal important information about a company's financial condition. Witness what General Electric has brought to light through added disclosure.
Granted, the company has made significant changes in the wake of Enron, not in its accounting but in its funding practices. For starters, its finance subsidiary, GE Capital, has increased its backup lines from a relatively paltry 30 percent of short-term debt to somewhere between 50 percent and 60 percent. (Standard corporate practice among lower-rated companies is 100 percent.) The company also is decreasing its dependence on commercial paper — which, at $117 billion at the end of 2001, amounted to roughly 67 percent of its total funding — to no more than 35 percent by the end of 2002, and has issued some $58 billion in longer-term debt so far this year with that goal in mind.
These moves have reassured some analysts that GE remains deserving of a triple-A credit rating. As GE CFO Keith Sherin recently told us, "We want a triple-A rating, and we don't want to have investor concerns about liquidity."
But skepticism about GE lingers. Toronto-based credit-rating agency Dominion Bond Rating Service figures that if all of GE Capital's off-balance-sheet securitizations were added back to the debt it consolidates, the finance subsidiary's leverage ratio would rise from 13.5 times tangible assets to closer to 16 (as of year-end 2001). And even with its longer footnotes, "it's still difficult to fully understand GE Capital's operations," Gimme Credit's Kathy Shanley recently wrote. As a result, the credit analyst added, "it is entirely fair for investors to keep the heat turned up."
It may be small consolation to GE, but our survey suggests that other companies will also be sweating for some time.
Ronald Fink is a deputy editor of CFO.
No More Holes?
While unwinding a synthetic lease for a $35 million mixing plant, doughnut retailer Krispy Kreme Doughnuts Inc. has plugged other gaps in its disclosure and governance. For starters, the company has added new detail to its footnotes concerning loan guarantees to franchisees. Previously, the amounts involved were reported only in the aggregate. But in its fiscal year 2002 annual report, Krispy Kreme's footnotes specify the amounts of each guarantee.
Why not go a step further and put them on the balance sheet? CFO Randy Casstevens explains that different treatment is called for because the company's obligations are much less certain under the loan guarantees than they were under the synthetic lease. Whereas Krispy Kreme would have been required to take action at the end of the lease's term by refinancing or purchasing the facility, it has to make good on its loan guarantees only if the franchisees cannot meet their financial obligations. And while he says Krispy Kreme must analyze that likelihood on a quarterly basis, performance is by no means a foregone conclusion. As a result, says Casstevens, "there's a smaller likelihood that you'll have to perform under the terms of the guarantee."
The company has also taken other steps to improve its governance practices. To eliminate potential conflicts of interest, it has abandoned an arrangement that allowed some 30 managers and the company's shareholders to invest in franchisees. Also, Krispy Kreme has agreed to start reporting insider stock transactions on its Web site within two business days, established a governance committee, and decided to seek two more independent directors for its 11-member board, thus providing a majority of seven independent directors.
Casstevens concedes that it is difficult to draw any definitive connection between these efforts to improve governance and disclosure practices and the performance of the company's stock. But, he insists, "we aren't doing it to get kudos, we're doing it because we felt it was the right thing to do."
Yet in the current environment, doing the right thing can't hurt. —R.F.
Better Numbers?
The CFO survey of corporate financial reporting.
This past June, CFO magazine E-mailed a questionnaire on financial reporting practices to some 3,000 senior financial executives, drawn randomly from our circulation list. We received 180 responses, 141 from executives at publicly traded companies, the majority with annual revenues exceeding $1 billion. The results below are based on the responses from the public companies.
The sample is too small for drawing definitive conclusions about the financial reporting practices of America's 17,000 public companies. Nevertheless, the results are suggestive and even surprising. For example, 42 percent of the companies in the survey that use special-purpose entities (SPEs) to keep debt off their balance sheets guarantee or otherwise protect the investment of third parties in those SPEs — precisely the practice that led to Enron's downfall.
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