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for week ending April 13, 2002
- Business Week: Can IBM Keep Earnings Hot? Crafty financial moves are losing their clout. Excerpts: "As IBM Chairman Louis V. Gerstner Jr. prepares to retire at yearend, he can claim credit for one of the most dramatic corporate rescue missionsin history." ... "Still, Gerstner can't escape nagging concerns that he managed this feat in part by bolstering earnings through creative financial steps. Critics say he has pushed and pulled a variety of levers--including gains from an overfunded pension plan, income from one-time asset sales, and $44 billion in share repurchases--to squeeze double-digit growth in earnings per share while eking out an annual average of just 5% revenue growth. "It's amazing
what Gerstner has done," says analyst Robert Tracy of Apogee Research Inc. 'Out of this turnip comes a gallon of blood.' Now, the levers are starting to jam. A financial analysis by BusinessWeek shows that earnings not from operations last year accounted for some $2.3 billion, or more than 20%, of IBM's $10.9 billion in pretax income. This year, IBM faces lower pension-fund returns, the potential for larger write-offs for bad debts, and fewer share buybacks. That means nonoperational financial methods are likely to contribute no more than 10%, or $1.1 billion, to an estimated $11.8 billion in pretax income."
The most powerful tool in IBM's financial kit--its pension plan--is starting to rust. If a company's pension-fund assets are estimated to be earning more than its expenses, accounting rules require that it add the difference to income. Problem is, IBM has assumed an aggressive 10% annual rate of return for its pension plan, which contributed $904 million, or 8.3%, to 2001 pretax income. In fact, the value of IBM's pension assets fell nearly 6% last year. In 2002, IBM cut the expected rate of return to 9.5%, which IBM estimates will reduce pension income by $350 million. But that may still be too high: Rivals Compaq Computer Corp. and Hewlett-Packard Co. use a 9% rate, according to Banc of America Securities.
- Financial Times: Big blues. Excerpts: "Among the controversial questions that have beset the entire technology industry is whether stock options, handed out liberally to employees, have been used to massage earnings. Mr Gerstner was certainly a big believer in options. If IBM were to show the cost of stock options as an expense in its profit and loss account - in common with other tech companies, it does not - its reported earnings would be 15 per cent lower. The impact on today's figures would be double the level of two years ago, according to Mr Milunovich." ... Fans of the Gerstner approach point out that he set out to remake IBM's bureaucratic culture, and that the liberal use of options was a key to making employees think more like shareholders. But purists argue that the use of options has simply allowed tech companies to relegate a large slice of their employment costs to the footnotes to their accounts, artificially inflating earnings in the process. The way IBM accounts for its pension fund obligations is more controversial still. Like all companies, IBM estimates of the costs of its pension fund - or, in its case, the profits it can report from the fund - by using subjective assumptions. But in Big Blue's case, those assumptions are more rose-tinted than some." If link is broken, view Adobe Acrobat version [PDF--49 KB].
- Wall Street Journal: IBM Warns Sales, Earnings Will Not Meet Expectations. Excerpts: "IBM's warning -- the first in more than a decade from a company known for the steadiness of its growth -- also raises the possibility that recent corporate-accounting scandals may be pressuring big companies to take more conservative, less aggressive, approaches to their reporting." ... "IBM has unique issues not mirrored in the rest of the technology sector. Much of its reported earnings gains under Mr. Gerstner were related to special items, such as cuts in its tax rate and gains in pension-fund investments. 'For about five years, American companies have used every conceivable accounting trick in the book. I believe IBM was among the maestros,' said Princeton University economist Uwe Reinhardt, who teaches accounting." If link is broken, view Adobe Acrobat version [PDF--66 KB].
- Wall Street Journal: IBM Shares Rebound on News That SEC Won't Pursue Probe. Excerpts: "International Business Machines Corp. stock fell more than 5% Thursday on a report that the Securities and Exchange Commission had begun an inquiry into the company. But the stock regained much of its value in after-market trading after the SEC said it had closed the probe without taking action."
... "The SEC has been at odds with IBM over accounting issues during the past. In 1999 SEC staffers questioned IBM's accounting for the sale of a unit, and the following summer, the SEC suggested that IBM amend its 1999 statement to change the way it reported that gain; IBM declined. In 2000, however, IBM acquiesced to the SEC's request that it more fully disclose the magnitude of its gains from its pension funds." If link is broken, view Adobe Acrobat version [PDF--22 KB].
- Wall Street Journal: ISS Backs Retirees' Bid To Alter Verizon Exec Pay Method. "Institutional Shareholder Services, an influential proxy advisory firm, is supporting a proposal submitted by a retirees' organization to exclude pension income in calculating compensation for executives of Verizon Communications." ... "Proposals to separate pension gains from determining executive compensation also have been submitted to shareholders of AT&T Corp., International Business Machines Corp., General Electric Co., and Qwest Communications International Inc. this year." If link is broken, view Adobe Acrobat version [PDF--23 KB].
- Janet Krueger provides a business analysis that supports voting for IBM stockholder proposal #3 on executive compensation. Following a numeric analysis in her post, Ms. Krueger comments: "Executive compensation should be based on real profit, not on accounting profit! The fact that IBM's executives are able to collect extra bonus pay based on this income is particularly disturbing when you observe that the surplus in the pension fund dropped by 10.052 billion dollars during the same year -- the loss in pension fund assets in 2000 was over 100% of IBM's income before taxes. Calculating an exective's bonus based on pension income accrued in previous years, while not forcing them to accept any penalty at all for huge pension losses in the current year, just can't be movitivating them to focus all of their attention on managing the current year's actual operating costs and revenues!"
- New York Times: Do You Plan to Retire? Think Again. Excerpts: "Americans have traditionally relied on Social Security and, whenever possible, company-paid pension plans to support them in old age. Social Security still holds up its end. But the company plans are disappearing, and their replacement, 401(k) accounts, which people use to save for their own retirement, are falling short." ... "Corporate America has certainly lobbied for this approach; companies have found that 401(k) accounts are less expensive to support than the old company-guaranteed pensions, even allowing for company contributions to the 401(k) plans. And the Bush administration, pushing to convert some of Social Security into private savings accounts, issued a report recently that encouraged people to increase their savings and learn to invest them wisely.
'We as a nation have chosen to have a voluntary retirement system' as the second-tier pension on top of Social Security, said Alicia Munnell, director of the Center for Retirement Research at Boston College. 'The problem is, there are a lot of ways to fall through the cracks.'" If link is broken, view Adobe Acrobat version [PDF--26 KB].
- TheStreet.com: The 401(k) Could Prove a History-Making Fiasco. Excerpt: "It's starting to look like 401(k) plans will go down in history as a costly failure. In fact, the abandonment of old-fashioned pension plans is likely to leave many Americans poorer in their old age. Evidence shows that as 401(k)s have taken hold, employees have lost ground in their retirement savings -- even during one of the greatest bull markets in history. In the last 10 or 15 years, companies have increasingly pushed the burden of managing pensions onto their workers. During the market's boom years, workers rarely complained. Indeed, few regretted the disappearance of defined-benefit plans in an era in which 401(k) plans offered access to double-digit stock market gains.
- New York Times: Critics Charge Pension Bill Favors Highly Paid Workers. Excerpts: "Current rules, dating to a 1986 pension law, require that to qualify for favorable tax status, pension plans must meet very specific tests for the balance between benefits for lower paid and higher paid workers. But a provision tucked into the House bill during a Ways and Means Committee hearing last month would scale back those requirements, allowing companies to test their plans against more subjective standards and giving the Treasury Department authority to approve plans that do not meet today's tests.
The provision, which some pension law experts said would significantly weaken employee protections, was championed by business interests and supported by Representative Bill Thomas, the California Republican who is chairman of the committee. The provision was also supported by the bill's chief sponsors, Representative Rob Portman, Republican of Ohio, and Representative Benjamin L. Cardin, Democrat of Maryland. Mr. Portman said the provision is expected to be inserted into the other House bill on the floor Thursday.
'This provision is an outrage,' said Daniel Halperin, a pension law expert at Harvard Law School and a Treasury official during the Carter administration. The language in the bill, he said, is an attempt to 'basically gut' current rules intended to ensure that companies offer roughly proportional retirement plans to highly paid and more moderately compensated workers." If link is broken, view Adobe Acrobat version [PDF--27 KB].
- Associated Press: House Passes Pension Reform Bill. Excerpts: "Democrats opposed the legislation because they said it did not provide enough protections for workers caught in another Enron-type bankruptcy. The top Democrat on the tax-writing Ways and Means Committee, Rep. Charles Rangel of New York, said the reason for Republican support was clear: 'It's corporate contributions, stupid.'" ... "Democrats failed to get included measures to allow workers to serve on employer pension boards and to require corporate executives to notify workers when they sell company stock. They also strongly opposed a provision allowing workers to receive investment advice from the same companies that manage their 401(k) retirement accounts, saying that advice would be tainted by financial conflicts of interest."
- New York Times: Bush Weighs In on Debate Over Stock-Option Rules. Excerpt: "In an interview today in The Wall Street Journal, Mr. Bush took issue with a proposal supported by Alan Greenspan, chairman of the Federal Reserve, that would force companies to record such options as expenses, like other forms of compensation. Instead, Mr. Bush said, he would simply require that companies add exercised options to the number of shares outstanding when calculating a company's per-share earnings." ... "Critics have raised two main objections to the current handling of options. First, unlike other forms of pay, they do not appear as an expense on a company's income statement and, therefore, can inflate a company's earnings. Moreover, the stock that is granted dilutes the value of shares held by other stockholders. The notion of recalculating the way exercised options affect the corporate bottom line has garnered support not only from Mr. Greenspan, but from a bipartisan group of lawmakers who have recently introduced legislation. They include Democratic Senators Carl Levin of Michigan, Mark Dayton of Minnesota and Richard J. Durbin of Illinois, and Republican Senators Peter G. Fitzgerald of Illinois and John McCain of Arizona. The legislation is also supported by many of large institutional investors and pension funds." If link is broken, view Adobe Acrobat version [PDF--24 KB].
- SmartMoney: Pay Attention to Pension Plans. Excerpts: "Last year the 25 companies in the Dow Jones Industrial Average that offer pension plans saw $72 billion wiped from their balance sheets, thanks to a killer combo of falling stock markets, lower interest rates, and the relentless duty to pay out benefits to pensioners. That was last year, and so far the markets aren't doing much to rebuild those balance sheets this year. And thanks to the way pension accounting works, we can use last year's balance-sheet train wreck to predict with near exactitude a major earnings hurdle for 2002. For these 25 companies, there will be a hit to pretax earnings of $6.3 billion. That means that as the economy tries to recover from recession, the first $6.3 billion in earnings growth for these companies will be gobbled up in increased pension expenses.
Pension expenses and credits under generally accepted accounting principles, or GAAP, are calculated (to simplify only slightly) by taking the market value of plan assets at the beginning of the year, and applying an expected long-term rate of return. Because that rate of return will be applied to an asset base that is 13.8% smaller than it was a year earlier, the resulting gains will be commensurately lower. Making matters worse, three companies in this universe have announced that they will be using lower expected rates of return for this calculation next year including IBM and General Electric, which have two of the largest pension funds.
- Washington State Labor Council, AFL-CIO: Retirement Disasters Loom for Many Baby Boomers. Excerpt: "Defined contributions, often set up as 401(k) plans, became popular during the Wall Street boom of the 1990s when it appeared that stock market gains would create great retirement wealth for those highly invested in stock plans. But with Enrons debacle, with stock prices falling from $90 a share to virtually pennies, employees watched their retirement wealth turn to worthless paper. Now that the stock market appears to have stalled into a more normal cycle, those counting on huge stock gains for retirement security may be beginning to realize that they are vulnerable to large risk." ... "One group that wont likely have as many problems with retirement security will be union members, because the vast majority have defined benefit pensions as part of their union contracts benefit package. In contrast, less than half of the non-union workforce even has a pension, and most of those are the unpredictable defined contribution type. Only 16 percent of non-union pensions have guaranteed defined benefits. Its predictable that theyll have problems ahead."
- "alliance_organizer": "Every year, companies pay consultants millions of dollars to stop their workers from forming their own union. These busters all read from the same script. Their goal is to scare and confuse us so that we won't be talking about the workplace concerns that we all share. The busters generally won't deal directly with employees - to do so means they have to file federal forms detailing their contracts and prices. Instead, they orchestrate the unionbusting scripts and direct management to do their dirty work." Read more...
- "jezzthomas" comments on how things changed for him when his call center was outsourced to IBM in January, 2001.