Despite months of accounting scandals and widespread criticism of hyped results, some companies just don't seem to get it. Citigroup (C
), Northrop Grumman (NOC
), and BellSouth (BLS
), among others, all dressed up their recent third-quarter announcements in creative--though legal--ways. "There is still a tendency to use too much spin in press releases," says Philip Livingston, president of Financial Executives International, a trade group of financial officers and controllers.
The Securities & Exchange Commission is under congressional orders to stomp out the bad stuff and put rules about earnings releases in place by February. It offered a foretaste on Oct. 30, when it sketched out new regulations that would require companies to show how numbers they present differ from generally accepted accounting principles (GAAP). The SEC also aims to stamp out "material misstatements or omissions" in company announcements.
But the reform drive hasn't quite quashed the temptation for companies to put the best possible spin on their numbers. Consider Citigroup's third-quarter earnings announcement on Oct. 15. The financial behemoth counted the gain from the sale of its headquarters on New York's Park Avenue for $1 billion toward what it calls "core earnings," a measure of ongoing operations. The $323 million aftertax profit from the one-time transaction generated half of the 19% growth in Citi's core earnings.
Citigroup CFO Todd S. Thomson says accounting rules required it to count the gain. It was also fair because the bank's business includes a property investment portfolio. Besides, he says, most of the real estate gain booked was from the 60% of the building it had leased to other companies; gains from space it occupies itself are being taken over 15 years. GAAP discourages exclusions of all but the most extraordinary losses and gains from results. But counting it as part of its ongoing "core earnings" won't reassure its investors. "Including it was a matter of judgment erring on the side of aggression," says Lawrence A. Cunningham, professor of law and business at Boston College. "It is out of step with the climate."
Thomson says the gain is one of several items. For example, Citi reduced core earnings by $215 million for fines it paid to settle government charges about practices years ago by Associates First Capital Corp., a consumer-finance company it bought in 2000. However, it doesn't help that Citi omitted a key fact when it compared its results with last year's: It didn't highlight that, because of an accounting rule change, it didn't have to reduce earnings by about $100 million a quarter to amortize goodwill this year, as it did last year. The apples-to-oranges comparison made the latest results look 3% better. Thomson dismisses the matter as "not a huge number for us" compared with peers.
Last year, Citi did think it was important. Then, it showed in its handout how much more the company would have earned had the rule change already been in effect. The Financial Accounting Standards Board, which ordered the change, also thought it was important to require companies to show its impact in official quarterly reports filed with the SEC a few weeks after earnings announcements. "This is very disappointing," says Charles L. Hill, research director at earnings tracker Thomson First Call. "They should just put it in the earnings release, too."
Citi wasn't alone in stretching the definition of ongoing business. A full 40 cents of the $1.17 per share earnings Northrop Grumman Corp. reported on Oct. 17 came from taking back into profits a $60 million reserve made a year earlier to cover the cost of halting construction of two cruise ships whose buyer went bankrupt. Northrop no longer builds cruise ships. But, says spokesman Frank Moore, the transaction reflects work done in the third quarter when Northrop found a buyer. Poppycock, says Robert E. Friedman, a stock analyst and accounting expert at Standard & Poor's: "It is a distortion of current earnings performance. It should be stripped out in calculating the company's underlying earnings."
Some companies are still learning. Earlier this year, IBM (IBM
) caught a lot of flak for not disclosing that an asset sale had been used to cut corporate overhead by some $280 million. Subsequently, it stopped the practice and increased disclosure. But in its most recent earnings conference call, on Oct. 16, the company volunteered that real estate sales had lifted earnings by $29 million, or 1.7 cents a share pretax--a point that wasn't in IBM's written earnings announcement. Small though it sounds, the gain accounted for more than half the 2 cents improvement in IBM's per share earnings from last year's third quarter. Chief Financial Officer John Joyce conceded in the call that IBM is not in the real estate business but argued that the company's ongoing outsourcing business frequently leaves it with assets to sell. "We pride ourselves on straight talk to investors," says spokeswoman Carol Makovich.
Even companies that apparently lay everything out sometimes hide important items in plain sight. BellSouth Corp. is meticulous in reconciling its preferred "normalized earnings" accounting with GAAP, setting out the differences in tables instead of dense text. The problem: a confusing 10 columns of variations from GAAP for investors to sort through. A close scrutiny of the latest quarter's table shows that 30 cents out of $1.59, or 19%, of normalized earnings per share this year came from not deducting losses on foreign exchange. Virtually all other companies count any currency losses when figuring their announced earnings, according to Joseph W. Cooper, research analyst at Thomson First Call. BellSouth spokesman Jeff Battcher says, "Our exposure to Latin American currencies is so great that this gives investors a better snapshot of our business."
To be sure, there have been significant improvements in recent months. Many companies are giving investors more information in their earnings releases than before. A survey of 2,400 members of the National Investor Relations Institute found more than four-fifths of companies now include balance sheets. Many are also giving cash-flow statements--which in the hands of a skilled financial analyst can give a quick check on whether accounting tricks have been used to give earnings a lift.
The new SEC rules should help clean up numbers some more. But they won't stop every executive from playing the gray areas of accounting judgments. If executives will spin numbers in this environment, they will in any. Investors will always need to look out for themselves.
By David Henry with Heather Timmons in New York
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