By Stephen Phillips
IBM Corp drew damaging criticism, yesterday, from an accounting watchdog over its policy of bundling one-time gains and other non-operating activities into operating income in its earnings reports. A report by forensic accounting specialist, Howard Schilit, of the influential Center for Financial Research and Analysis in Rockville, Maryland, pointed out that Big Blue was able to bloat its recently-announced third-quarter results by $4bn using the practice.
IBM booked the sum, reaped from the sale of its Global Network businesses to AT&T Corp, in its selling, general and administrative expenses, known as SG&A, thus lowering reported costs and boosting reported operating income. Although revenue grew a slender 5% to $21.14bn for the three month period ended September 30, operating income was up 23.4% on the corresponding period last year at $2.68bn, as operating expenses fell by 7.8% to $4.88bn. SG&A expenses alone fell by 13.7% to $3.5bn.
The issue is significant because investors follow operating income, which excludes tax, interest on loans or investments, and other items distant from day-to-day trading, as a barometer of a company’s market viability. Meantime Lou Gerstner, IBM’s chief executive had trumpeted strong expense management as a driver behind the third-quarter gains and as a reason to expect improved results to come.
A report in yesterday’s Wall Street Journal, carrying the report’s judgements, sent IBM’s share price into a 5% tailspin before it rallied partially to close down 1.88% for the day at $104.06. The news had threatened to wipe out the gains IBM’s share price has made since the hardware, software and services giant reported the disappointing revenue figures for its third quarter, late last month. In early November IBM’s share price stood at $90, compared to its 52-week high in early July of nearly $140.
Taking IBM’s earnings over the nine month period to September 30, Schilit, who commands a close following among investment managers, said in the report that, without the AT&T gains, Big Blue would have posted $6.5bn of operating income, instead of the $8.9bn reported.
IBM explains its one-time charges and gains in footnotes and management discussion sections in its quarterly earnings reports filed with US federal government financial reporting watchdog, the Securities and Exchange Commission. But Schilit said the convention of not splitting out one-time items as a separate accounting line was pretty unusual among companies. Although it is not in breach of financial reporting rules, it muddies the water, he added. Meantime, Paul Kepple, a senior accounting fellow at the SEC, told the Wall Street Journal that the $4bn gain booked for the quarter would seem to be material and thus should generally be treated as a non-operating item.
However IBM, which has backed its one-time gains and charges into SG&A since about 1994, categorizing them as general expenses, has also had earnings depressed under the practice. The inclusion of restructuring write-down costs drove down early-1998 reported earnings, sending the company’s shares into a decline at the time.
IBM could not be contacted for a reaction to the report’s judgements as ComputerWire went to press.
