Wednesday, April 18, 2007

“The Number is the Number”...Most of the Time

I had dinner recently with an old friend—he was chief financial officer of a company I followed years ago, and recently turned up as CFO of another company I keep an eye on.

We talked mostly of how his work has changed since Sarbanes-Oxley made daily life so miserable for some public company executives that they’ve taken their companies private.

Not my friend.

He loves being in a public company, and, like a lot of other executives I’ve talked to in the last couple years, says that while the Sarbox regulations went too far and were way too expensive to implement, the regimentation was something public companies needed to do eventually anyway: "We just never made the time."

Furthermore, as a CFO he likes the fact that there’s less uncertainty about the numbers, fewer shades of gray: everything has a rule behind it, and every quarter the numbers fall out where they fall out, unlike
the old days, when auditors gave companies more leeway with reserves, receivables and all manner of book-entries.

As he put it while looking down at an imaginary P&L next to his dinner plate:

“The number is the number, and that’s it.”

Which is why I found it so remarkable that IBM could report a bottom-line number last night that, at $1.21 per share, was exactly the same as the consensus earnings estimate from Wall Street's Finest: $1.21 per share.

Not a penny more, not a penny less.

You’d think that a company that generated $22 billion in revenue from all manner of product lines, in all manner of countries, with all manner of foreign exchange translation issues to deal with—not to mention amortization costs, stock-based compensation costs, restructuring costs and retiree benefit costs—might, in this Sarbox-restrictive environment in which “the number is the number,” have a hard time hitting the so-called consensus estimate to the penny.

But IBM hit the number on the screws.

And not even what management described on the conference call as a “fall off in the third month of the quarter” in IBM’s U.S. enterprise business, which is the source of this morning’s downgrades by a couple of Wall Street’s Finest, stopped IBM from hitting the number.

Just like the old days!

Jeff Matthews
I Am Not Making This Up

© 2007 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


Kevin said...

You infer earnings management based solely on the fact that IBM's earnings matched the street "consensus," but offer no other evidence that something is amiss. "What are the chances of that?!!?" is the accusatory question left unsaid. It shouldn't surprise you that some companies are better at managing expectations than others, and perhaps IBM is just better at conveying information to analysts (and the broader public) than other companies; hence their forecasts are more accurate.

On top of that, is it really so surprising that the company's reported earnings and the average of the analysts' forecasts should match? After all, aren't analysts the one group of outsiders that should know the company best? I mean, that's their job, right?

Or maybe companies should start misreporting earnings so that they do not perfectly align with analysts' expectations - at least then they would avoid the accusation that they've misreported earnings to meet analysts expectations.

Sam E. Antar said...


About earnings management:

In the words of Captain Renault: I'm shocked, shocked to find that gambling is going on in here!

Can you imagine the impact if IBM missed their expected EPS by just one penny?

About shades of gray:

Accounting is more of an art than a science. All items (including cash, yes cash, too) on financial statements are estimates. Certified Public Accountants are supposed to exercise their “professional judgment” to determine amounts to report on financial statements.

Every CFO uses a range of “estimates” determined by the exercise of “professional judgment” to decide the earnings his company can report.

In every company, prior to releasing its earnings reports, there is a discussion to determine the “proper” amount of earnings based on their exercise of “professional judgment.”

Most companies tend to be more conservative during good quarters in order to save excess reserves as a cushion for bad quarters. Those excess reserves then help soften the impact of bad quarters in order to meet Wall Street’s expectations.

CFO’s and their accounting advisors can be conservative or aggressive in their exercise of “professional judgment.”

I have no doubt that IBM’s latest EPS could have been reported at a minimum of a penny more or even a penny less.


Sam E. Antar (former Crazy Eddie CFO & convicted felon:

Jeff: I am not making this up.

Remember what you previously wrote?

I whispered to the Toys “R” Us guy sitting next to me, “I take it you guys do that too?”

He said, “Yeah, but we don’t talk about it!”

Source: Jeff Matthews Is Not Making This Up - September 28, 2006: Where’s Sammy Antar When You Need Him?

deodand said...

Well Kevin, you need to try and calculate the probability that a company with multiple billion dollar revenue streams can predict a number like that so accurately. Which I think was Mr. Matthews' point.

As to whether analaysts are the the "one group of outsiders that should know the company best?" I can only say, in the fashion of Nelson Muntz, "Ha-ha!"

Competitors, customers, suppliers, insiders, and ex-employees will know far better the true state of affairs than these trumped up, glorified, pig-kissing PR men known as analysts.

I am sure there are good ones, but the bad so out-reek the rest the whole barnyard stinks.

Gone to the blogs said...

Like any large, well run company, IBM can "backward solve" their discretionary accruals, deferrals, gains and losses after quarter's end in order to print the EPS number they (and the Street) want. It's neither new, nor shocking. EPS is a cosmetic number that plays well in the Journal and on the front page of a sell side note, but anyone who knows what they are doing looks at the balance sheet and cash flow anyway.

Kevin said...

Deodand - more often than not, "customers, suppliers, insiders, and ex-employees" are not outsiders (particularly the insiders). Regarding customers - I think it is debatable whether they have better knowledge than analysts. Shareholders, I would think, would prefer they did not.

Regardless, my point is that an isolated incident should not be used to paint a picture of malfeasance. Frankly, I don't know what IBM's history is with respect to "hitting its numbers", but that history seems far more relevant than what happens in a single quarter (and I believe a more judicious presentation of the topic would have included that information).