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Buybacks a good buy; a season of warning; accounting ethics from Honest Abe; pro forma performances; accountants battle back; and more.
CFO Staff, CFO Magazine
November 1, 2000
When the market was at its peak last year, buybacks were the last thing on CFOs' minds. But now that the market is a little less enthusiastic, CFOs are back in buyback mode. Companies launching or boosting stock repurchase programs in the past three quarters include giants such as Exxon Mobil, BP Amoco, Ford, and Hewlett-Packard, as well as smaller companies such as Quantum Corp., which has repurchased almost 12 percent of itself in the past four quarters.
"For midsize companies, it's about asking yourself how many opportunities do you have to invest in things that will drive revenue and earnings growth," says Richard Clemmer, CFO of the $4.7 billion computer storage supplier. "If you're investing at the level required, a buyback is the best way to return value to the shareholders. Especially if your company is trading below book value."
Companies usually offer at least one of five basic reasons for a buyback: to boost stock price, to rationalize the company's capital structure, to substitute cash dividends for repurchases, to prevent dilution from stock options grants, or to give excess cash back to stockholders, according to a recent study of buybacks between January 1, 1991, and December 31, 1996.
However, the study, conducted by San Diego State University professors S.G. Badrinath and N. Varaiyat for the Financial Executives Research Foundation, shows that the results of buybacks often belie the stated rationale. For instance, one of the biggest surprises, says Badrinath, was that companies do not substitute repurchases for dividends as a way to give cash back to stockholders. Of the companies studied, dividend payout ratios actually increased after share repurchases were complete.
The study also revealed another fly in the buyback ointment. The study shows that while earnings-per-share does rise substantially after buybacks, the EPS of nonrepurchasing firms in the same industry rises even faster during the same period. The buyback merely serves to close the EPS growth-rate gap.
On the bright side, the stock price of repurchasing firms rises at the same rate as industry averages in the three years following a buyback, but rises substantially slower before a repurchase. —Kris Frieswick
Amid the surge of earnings preannouncements that roiled the stock market in September and early October, most commentators saw signs of an economic slowdown. They were only partly right, because quarterly warnings about corporate profits will be more common now that CFOs risk SEC sanctions if they're caught telling their favorite analysts to shade their numbers.
"It's now safer to preannounce than to jawbone" if estimates are too high, says Chuck Hill, research director at First Call/Thomson Financial. Passed in August, the SEC's new regulations against selective disclosure spurred a record number of negative preannouncements in the third quarter. As of October 10, 337 companies--including DuPont Corp., Intel Corp., and Eastman Kodak Co.--said they would not meet expectations, up 20 percent over a comparable period in 1999. Preannouncers generally were hammered by the market for their forthright disclosure. The carnage prompted hedge fund manager James J. Cramer, in a recent commentary on TheStreet.com, to observe that without the hidden hand of guidance, "the world will be fairer, but far more rocky." —Stephen Barr
Have you ever been in the middle of an ethical dilemma at work and asked yourself, "I wonder what Abe Lincoln would have done?" Craig Gilbert has--often enough to have documented his thoughts in a course book entitled Honest Abe Teaches CPA Ethics.
Gilbert grew up in Springfield, Ill., in the shadow of Abraham Lincoln's legacy. During his years as a practicing CPA, Gilbert began to see strong parallels between the American Institute of Certified Public Accountants' Code of Ethics and many of our 16th President's fabled writings and speeches. As an example, Gilbert cites a speech Lincoln gave as a freshman representative in which he asked President Polk to answer concerns about the Mexican War "fully, fairly, and candidly. Those words, says Gilbert, "cover the CPA code of ethics in a nutshell."
Gilbert's book and course work ($59; from Front Row Systems Inc., of Atlanta) have recently received National Association of State Boards of Accountancy registration. Nancy Moate, CFO of World Marketing Alliance Inc., in Duluth, Ga., may be the first in line to apply for professional credit. Having recently completed Gilbert's course, Moate often finds Abe's adages popping up in her thoughts during her workday. "CPAs tend to get focused on technical issues in continuing education," says Moate. "Lincoln's words help you focus on personal responsibility. We're losing our focus on that in this country."
In the interest of honesty, Gilbert points out that he first "tried using the Bible for the course, but my knowledge of it was too weak." Then, too, the prophets are such a tough act to follow. —Leslie Schultz
The jury is in on commercial air travel, yet the thought of owning your own jet is nothing more than a comforting fantasy as you wait out another flight delay. But more companies are finding they can own a fraction of a jet, say one-sixteenth, and enjoy the convenience without crushing up-front costs.
The fractional jet industry can't claim it's cheaper than commercial air travel, but when time is computed into money, the industry can make a strong argument, says Michael Riegel, vice president of Dallas-based Bombardier Business Jet Solutions Inc., a firm that offers partial jet ownership. One-sixteenth of a Lear Jet 31A costs about $400,000 (plus hourly and monthly fees) and provides 50 hours of flying time per year. But the efficiency that private jets deliver, including management teams working en route and the ability to reliably make meetings, creates a valid return, says Riegel. —George Donnelly
Popular Test with Feds
The Mitre Corp. is giving new meaning to "20 Questions." The Bedford, Mass.-based nonprofit, which provides systems, engineering, and IT support to the government, has created a software package for recertifying recipients of procurement cards in its organization.
The package provides a 20-question electronic quiz to cardholders when it's time to reissue their plastic. The idea behind the quiz is to ensure that the cardholder has kept abreast of procurement policy and practices changes that have occurred between renewal periods, which are two years apart.
"We felt it was important that cardholders be kept up to speed periodically," says Mitre purchase card administrator Judi Pepper. One way the company does that is through periodic bulletins on procurement developments. Another is through the software quiz, which tests a cardholder's knowledge of federal acquisition regulations, government cost-accounting standards, and audit compliance procedures for the various agencies with which Mitre does business. The test is corrected automatically, and the results are sent to cardholders and program managers simultaneously. Cardholders aren't reissued a card until they pass the test.
The program worked so well that Mitre made the software freely available to the Feds. Now more than 100 agencies have requested it. Before the program, some 80 percent of all purchases below $2,500 were made with purchase orders; now only about 20 percent use POs. That has resulted in significant savings, since it costs about $100 to process a PO, compared with $12 to $15 to process a p-card transaction. —John P. Mello Jr.
Pro Forma Performances
Are GAAP net earnings on the endangered species list? Pro forma per-share figures in earnings announcements, a number derived after removing an expanding list of items and sometimes real cash expenses, seem to be crowding out traditional earnings in many industries. But who can blame the CFO? The special packaging of financial data helps boost valuation expectations, according to a recent study.
The pro forma movement has evolved out of the acquisition frenzy of the past few years, says Gerald White, president of Grace & White Inc., an investment adviser in New York. Factoring out goodwill, in-process research-and-development write-offs, and other merger-related charges has encouraged a growing trend. "Pro forma somehow got created and I don't know who did it first," says White. "What disturbs me is when companies say you should exclude certain categories of expense. It's no longer this quarter; it's every quarter. That's what I think is dangerous." Stock option expenses, for example, are routinely excluded when arriving at a pro forma number, and some companies have taken things a step further by backing out the taxes they have to pay when employees exercise option grants.
The earnings release is not directly regulated by the Securities and Exchange Commission. "The rule that governs is the antifraud provision," says SEC spokesman John Heine, adding that communications can't be misleading or false--or omit information that makes them misleading or false.
Misleading, however, is a broad term. "It's a quandary. Are companies misleading investors when they report certain elements but dress them up to look like something more familiar?" asks Patrick Hopkins, an assistant professor at the Kelley School of Business at Indiana University. "It's self-serving behavior in the guise that the companies are helping you out."
Hopkins co-authored a study that shows that when companies isolate their goodwill amortization for the benefit of analysts, they are rewarded with higher valuation targets. "Packaging matters," says Hopkins. "We've known that for years in marketing, so why should that be any different when presenting the corporate face and financial results?"
Companies naturally defend the practice as a way of presenting a clearer picture of how they're actually performing--and moreover, they say, everyone else is doing it. "It's pretty well standard in the technology industry," says Kevin McCarty, head of investor relations at Liberate Technologies, which provides software for interactive television applications. Liberate, which went public in July 1999, announced its first-quarter results with a pro forma net loss of 9 cents per share. Actual net loss, however, was 90 cents per share, once acquired R&D and amortization of purchased intangibles, warrants, and deferred compensation were included. "It's giving you two bottom lines to look at," says McCarty. "The top bottom line is closer to actual operating results." —George Donnelly
Track Stars Cool Off
Has the tracking stock craze run its course? Since the spring downturn in the stock market, a dozen would-be trackers have been held or canceled. Issues including Staples.com, New York Times Digital, and Cendant Corp.'s Move.com are either indefinitely on hold or languishing on bankers' desks, waiting for market conditions to improve (see chart, above). Certainly part of the reason is the broad pressure on technology issues, which most trackers are. But critics say another, longer-lasting reason is the lackluster performance of most tracking issues, which has made institutional buyers more skeptical of the issues' supposed value.
"Over the long run, the numbers show that with tracking issues, most shareholders [of the tracking stock] get the short end of the stick," says Joe Cornell, a principal of Spin-Off Advisors LLC, an independent research firm based in Chicago. "The biggest downside we see is the lack of an opportunity for a change of control with trackers, as opposed to spin-offs."
Of the 31 tracking stocks issued since General Motors Corp. created the first one in 1984, only 9 have outpaced the S&P 500 since their issue date, and 6 of them were issued last year, according to Spin-Off Advisors, including 3 from Genzyme General Corp.
So is tracking stock permanently derailed as a restructuring tool? Patricia Anslinger of McKinsey & Co. doesn't think so. "Tracking stocks aren't dead, but there will be fewer done for the wrong reasons," she says. —Ian Springsteel
Accountants Head to Washington, D.C.
It's one of the nastiest political campaigns in recent memory. And we're not talking about the Presidential election. The bitter conflict between the accounting profession and the Securities and Exchange Commission over new rules on auditor independence has left both sides bruised and battered, but mostly steadfast in their seemingly incompatible positions.
"Shame on everybody," says Michael Cook, who retired in May as chairman of Deloitte & Touche LLP, one of the Big Five firms most vigorously fighting the SEC efforts. "This situation--the high level of distrust and name-calling--is awful. The bickering has deteriorated to the point where no one is acting in the public interest."
While there is some agreement about the need to modernize rules on investments by auditors and their families, the accounting profession is largely apoplectic about the SEC's proposals to restrict the consulting services that firms can provide to their audit clients. "I just don't see where the ability to reconcile the different views is," says Cook.
For his part, SEC chairman Arthur Levitt has been adamant in his conviction that auditors' judgments are clouded by their efforts to sell nonaudit services, which are growing at a much faster clip than traditional assurance work. In a widely cited statistic, he has noted that audit services have dropped to about 33 percent of revenues at the major accounting firms, down from more than 50 percent a decade ago.
"I can't help but wonder what impact this changing business mix has had on a culture that has prided itself on objectivity," Levitt remarked in a recent speech.
To which Big Five executives would respond: no impact at all. "I'm not aware of a single documented case in which a bad audit happened because the auditors were intimidated" by a consulting relationship, Jim Copeland, CEO of Deloitte & Touche, told CFO magazine in a recent interview. The worry, if Levitt curtails the types of nonaudit services a firm can offer, is that audit quality would diminish and the profession would be less attractive to new recruits.
At a Senate Banking Committee hearing on the issue, Sen. Phil Gramm (RTex.) said that given the sweeping nature of the proposal, the burden of proof remained on the SEC, which asked for a closed-door briefing with lawmakers in early October.
As for CFOs, they wholeheartedly support the SEC's aim of enhancing investor confidence in the integrity of financial reports. But many have been less than enthusiastic about the need for new regulations in this area.
In testimony at the second of three public hearings, Merck & Co. CFO Judy Lewent described the "rigorous evaluation process" the audit committee used before permitting Merck's auditor, Arthur Andersen LLP, to provide nonaudit services in "limited circumstances." Deeming this approach "effective in addressing potential issues of independence," Lewent expressed concern that the SEC might "substitute a detailed set of rules and regulations for Merck management and audit committee oversight."
Similarly, Gary Pfeiffer, CFO of DuPont, stated that the SEC's proposals "would be best used as guidelines for audit committees rather than as detailed rules." He also agreed that companies should disclose the nonaudit fees they pay to their auditors--something DuPont has done since 1992 --but suggested that the disclosures the SEC has called for go too far.
But even without concrete proof that auditor independence has been corrupted, Levitt seems determined to enact new rules by the end of the year. Two Big Five firms, Ernst & Young LLP and PricewaterhouseCoopers LLP, have offered a compromise in which they would accept limits on some consulting, such as internal-audit outsourcing and information-systems work. But the three other major firms have been more willing to play hardball, including lobbying Congress to intercede.
Ironically, the profession's best hope of winning this ugly war may be to delay any action until after the Presidential election, when a new SEC chairman, who has one of Washington's choicest political positions, is expected to be named. —Stephen Barr
Salvaging the Dot-coms
One company's distress is another company's business model. And as dot-com after dot-com loses fuel and starts heading for a nosedive, there's an Internet company in place to provide parachutes or ultimately sift through the wreckage, if need be.
The company, iSolve.com, is a surplus asset management Web site that has positioned itself to rescue or ultimately help liquidate Internet company assets. In the worst case, says iSolve CEO Lance Lundberg, his company will help dispose of the little remaining in hard assets, such as servers and desk chairs. But Lundberg says iSolve can provide more proactive solutions, such as trying to preserve intellectual assets by taking excess inventory off the hands of business-to-consumer dot-coms in exchange for advertising time procured through its venture backers. For example, "A dot-com that sells lingerie recently misjudged a fashion trend," he says. "We actually bought it on a barter basis. They took media time for it." In turn, iSolve moved the merchandise through its site. The company also works to fold back-end operations into other dot-coms that have excess capacity, a move that can cut costs and keep a business afloat.
But Internet barter and salvage is only a part of iSolve's business. Within the crowded surplus inventory space, the company has distinguished itself by buying up an assortment of surplus goods, including 800,000 pounds of pasta, folding lawn chairs, a variety of cigars, and high-end pens. "If you don't become a market maker to some degree, you tend to get a bunch of listings at wish-list type of prices, and they just sit there," says Lundberg. The company has partners in the "extreme value" retail industry that serve as customers and experts in assessing surplus merchandise value so that a dot-com doesn't overpay for, say, thousands of pounds of plastic bags. "We saw iSolve as an extension of our procurement activities," says Robert A. Roberts, a director at Liquidation World Inc., an extreme value retailer that operates 86 retail outlets in Canada and the Pacific Northwest. "We have a fairly large buy group, but they can't be everywhere at all times." Roberts says iSolve's Internet potential to move goods often gets the attention of company executives looking to add a few points to the bottom line. Surplus "tends to be an orphaned responsibility in any major company," he says. "I can't think of any company that doesn't have a surplus inventory problem." —George Donnelly
IRS Eases Rules on Property Exchanges
A change in Internal Revenue Service procedures has clarified the rules for reverse like-kind exchanges, a move that may encourage corporate expansion.
The law governing like-kind ex-changes, Section 1031 of the Internal Revenue Code, was adopted in 1921 to remove from a profit-and-loss statement property exchanged for like-kind property to be put to productive use in trade or business.
Before the adoption of the new procedures, confusion surrounded these kinds of transactions, especially when a property purchased for exchange purposes had to be bought before an existing property could be sold. Often a third party had to be enlisted to buy the new property and hold it until an existing property could be disposed of.
Businesses constructing "reverse" exchanges--that is, exchanges in which a new property was bought before an old property was sold--had only general tax law principles to guide them, explains Moore McLaughlin, a partner with Plourde Bogue McLaughlin Moylan, in Providence. "Now we know that if we do an exchange exactly as it's spelled out in the revenue procedure, then we're going to be safe," he says.
Businesses are attracted to ex-changes because of their tax benefits. If a company has been carrying a property on its books for a number of years, the new guidelines make it easier to avoid the tax consequences of disposing of the property.
"A company can build a new facility, sell its old one, join the two events into a like-kind exchange transaction, and avoid tax on the sale of the old facility," says Lou Weller, a principal in the National Real Estate Tax Services Group in the San Francisco office of Deloitte & Touche. —John P. Mello Jr.
Fly by Numbers?
The future is cloudy for an international initiative to standardize company travel identification codes across airlines after major U.S. corporations--concerned that access to such data would make it easier for the airlines to collude on prices--fought to ground the plan.
"The corporate [identification] number is a gross violation of my company's privacy," wrote James F. Lennon, global travel leader at PricewaterhouseCoopers LLP, in his comment letter to the Department of Transportation (DoT). "Before providing data today, I require confidentiality, restrict use of data to my preferred carrier, and require limits on its proper use. The corporate number denies my company these fundamental protections."
The identification system, proposed by the International Air Trans- port Association (IATA), would provide an airline with monthly aggregated data on its corporate customers, regardless of the channel through which a customer purchased tickets, as well as a clearer picture of corporate travel patterns.
The DoT approved the system for antitrust immunity in early June, then reversed itself later in the month. While disapproval from the DoT wouldn't prohibit the codes from being used, it would leave carriers vulnerable to Department of Justice investigations.
Thanks to an earlier version of the system that IATA claims the DoT approved "several years ago," airlines are technically safe to use the codes so long as they print them on the face of the tickets. But, because that stipulation has proven so unpopular and has been adopted by only "a handful of airlines," IATA is seeking approval for an amended version to keep the code off the tickets.
But corporate clients show no signs of being appeased. Morgan Stanley Dean Witter & Co. and McDonald's Corp. followed PricewaterhouseCoopers with similar letters to the DoT, provoking a lengthy response from American Airlines that accused objectors of signing form letters that "showed a fundamental misunderstanding of the IATA proposal."
"It defies common sense to argue, as some have, that the use of this eight-digit code would violate privacy interests or be anticompetitive," the airline's attorneys said in their August 28 letter to the DoT. "Using a standard code will not give American any greater ability to identify corporate customers of other airlines or discover what fares or performance goals are in the contracts of other airlines." The code would, however, allow any airline that participated in the itinerary to see the data, American conceded.
The DoT decision, which has no deadline, would apply to any carrier flying from the United States to a foreign destination. "I think it [the Department of Transportation] carries a huge amount of weight, when you figure the 10 most powerful airlines are in the [United States]," says Cyndi Perper, president of the Alexandria, Va.-based National Business Travel Association, which opposes the measure. —Alix Nyberg
Seniors Apply Themselves
Move over, Gen-Xers. A new law passed in April allows people age 65 and over to earn as much income as they want without compromising their Social Security benefits, reversing the previous policy of subtracting $1 in benefits for every $3 earned above a threshold amount ($17,000 in 2000). But it remains to be seen if employers are ready to make the most of the change.
A program to train seniors on electronic cash registers, funded by franchise licenser Riese Restaurants Inc., in New York, has been oversubscribed since it began about five years ago, says Jim Ladota, vice president of human resources for Riese. Nearly 100 percent of the graduates quickly find jobs in Riese-licensed restaurants or elsewhere. "We will employ them, but a lot of them get employed before they even finish the class," says Ladota, noting that such retailers as Gap Inc. are among the most active recruiters in the program.
Corporate America, however, has so far been fairly unresponsive to hiring older workers, specialists say. "We have seen a pretty robust pickup in the number of résumés listed since that measure was passed, but what we haven't seen is an increase in the number of jobs offered," says Don Rizzo, president of Seniorjobs.com, a career Web site for people age 55 and over.
Adds The Senior Staff president Bill Payson, "There are hardly any companies in the United States that are willing to retrain people before they hire them. It's cheaper to steal someone from the competition." The Senior Staff, a San Jose, Calif.-based career Web site for IT specialists over age 35, has signed on 10,000 job-seekers, but so far only about 100 employers. —Alix Nyberg