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IBM lashes back
CFO John Joyce throws down the gauntlet to the company's critics.
April 18, 2002: 10:58 AM EDT
By David Futrelle, CNN/Money Contributing Columnist

NEW YORK (CNN/Money) - There weren't any big surprises in the numbers that IBM reported Wednesday night.

They were lousy, as IBM warned last week they would be, with earnings down more than 30 percent year-over-year. (See more.)

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What was a little more surprising was CFO John Joyce's spirited defense of IBM's accounting on the company's conference call. Worries about IBM's so-called "financial engineering" have weighed heavily on IBM shares recently, with the stock trading down about 30 percent from its January highs.

And Joyce isn't exactly pleased about that. "We have been astounded over the kinds of things we've read about IBM in the last few months," he declared. "We're proud of our accounting and disclosure practices."

Though Joyce said he "had no interest in rehashing any of it," rehash he did.

First, the JDS thing

The first topic he took on was the controversy surrounding IBM's sale of its optical transceiver business to JDS Uniphase. IBM has come under fire for using the $300 million it received to boost operating income. Critics say the sale should be "other income," since such transactions are not a good reflection of the business is doing and how it will do in the future.

Joyce's defense was somewhat less than wholly convincing. He said it is "absurd" to characterize the income as "'non-operational.' "The simple fact is that generating intellectual property and deriving value from it is absolutely fundamental to IBM." The company spends more than $5 billion on R&D, after all, and when it can't make use of the research itself, it tries to realize value by selling it to others.

Makes sense to me. But Joyce didn't get at some of the key issues that have troubled some critics. For one thing, IBM wasn't exactly forthcoming about the deal. Though Joyce had mentioned the sale in IBM's fourth quarter conference call in January, he didn't mention that it had been a $300 million deal. (Even for a company as big as IBM that's not small potatoes.)

And most investors knew nothing of it until the deal was featured in a New York Times article in February. Critics also wondered why it happened on the last day of the fourth quarter, raising the suspicion that IBM was resorting to some last-minute wheeling and dealing to make its numbers.

Moreover, the way in which IBM accounted for the deal struck many as mighty peculiar. IBM recorded the sale as if it were a reduction in costs -- specifically, a reduction in sales, general and administrative expenses (SG&A). When the details about the deal came out, critics wondered how exactly the sale of a business unit could be construed as the same sort of thing as, say, a reduction in rent.

Though IBM had been recording such deals that way for years, Joyce noted that the company will now break them out in a separate line in its annual report as "Intellectual Property and Custom Development Income."

Score a half point for the critics (the numbers are being broken out), a half point for IBM (they're being broken out as Intellectual Property income).

And now the revenue thing

Joyce also took on a bigger issue that's been weighing on the stock: IBM's seemingly miraculous ability to squeeze out double-digit earnings growth despite revenue growth in the single digits.

The feat is made possible in part because of an overfunded pension plan, stock repurchases and lowered tax rates. "We don't view [share repurchases and tax reduction] as 'non operational,'" Joyce argued. "We consider this to be good management."

Good management it may be, but earnings growth from such measures can't be sustained indefinitely. Eventually, IBM will need to lift sales growth.

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More broadly, Joyce argued that IBM has seen good growth in profits despite not-so-good growth in revenues because the company has deliberately chosen not to chase after "profitless revenues" like some tech firms he declined to name. "We did not chase the dotcom bubble," he noted. "Instead, we positioned ourselves for leadership in the profitable segments of the industry."

If that's indeed the case, we'll see it in the numbers in the quarters to come. We didn't exactly see it in the quarter just ended.

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