Profit Data Thicken Fog Over Wall Street

Here’s a taste of what’s in store for the diligent investor who attempts to actually read through third-quarter corporate profit reports:

* Coca-Cola Co. last week said “third-quarter currency-neutral earnings per share before nonrecurring items were 45 cents,” which the company described as a 7% increase from a year earlier and a “strong” showing.

But on a “reported” basis, Coke said, profit was 43 cents a share, including a 2-cent nonrecurring gain for a deal involving one of its bottling firms, a 3-cent charge for “nonrecurring incremental marketing investments,” and a 1-cent “negative currency impact.”

Actual net income in the quarter wasn’t up 7%, but rather was virtually unchanged at $1.074 billion versus $1.067 billion a year earlier, according to Coke’s statement.

* McDonald’s Corp. said its reported earnings were $545.5 million in the quarter, or 42 cents a share, “in line with previous guidance.” The fast-food giant calculated the gain in per-share results as a 5% increase from a year earlier, excluding the effects of translating foreign currencies into dollars.

But that $545.5-million figure included a $137-million after-tax gain related to the public stock offering of the company’s Japanese unit, and $84 million in after-tax charges primarily for closing 154 foreign restaurants.

McDonald’s actual operating income--sales minus basic business operating costs excluding interest expense and taxes--plunged 18% in the third quarter from a year earlier, the company’s data show.

No wonder Chief Executive Jack M. Greenberg conceded he was “not pleased with our overall results,” even though the news release led with the idea that per-share income was up 5%.

* While Coke and McDonald’s were profitable by any measure in the quarter, Sun Microsystems Inc. had a miserable showing. The company said it lost $158 million as sales tumbled 43%.

But depending on what your definition of a “loss” should include, Sun’s results could look even worse: The company said it recorded an additional $36 million in losses for “special items” including losses on investments, a write-off for research, and a “facility disinvestment charge.” Thanks to a $14-million tax benefit because of those items, however, Sun’s net special-items loss was $22 million, it said. That lifted the total loss for the quarter to $180 million.

At a time when fundamental analysis of companies and their stocks has never been more important--the need to understand exactly what underlies a stock’s price in terms of real earnings--translating corporate profit reports arguably has never been more difficult.

The language in the reports is tortuous and there is no uniformity in how companies arrive at what is presented to investors as the “bottom line.”

Indeed, anyone who thought references to operating earnings, reported earnings, net income, pro forma income and one-time items were hard to compare in previous quarters may tear their hair out reading third-quarter reports.

In an analysis written last month, Morgan Stanley investment strategist Steven Galbraith reflected on one client’s plaintive request regarding earnings: “We just want to know what’s real.”

How did it come to this? Certainly, running a multinational company has gotten more complicated in the last decade. Many companies have argued for years that accounting methods haven’t changed fast enough to reflect the financial realities they face, and that they need more leeway in calculating and reporting results.

What also hasn’t changed is companies’ desire to put a positive spin on earnings reports, however dismal the news may be.

Regulators, including the Securities and Exchange Commission and the Financial Accounting Standards Board, can and do hold companies to specific rules in how they tally their official income statements and balance sheets. But regulators can’t control how companies explain their results in news releases--the part of the reports investors are most likely to read.

Hence, the statements companies issue are a jumble of apples, oranges and grapefruit as far as investors are concerned. Net income as described by one company may not bear any resemblance to net income as described by a rival, at least in their news releases.

Some analysts argue that the FASB, which sets accounting practices, made matters worse with a ruling it issued in September. The board decided that any losses companies incurred as a direct result of the terrorist attacks can’t be classified as “extraordinary,” but rather must be lumped in with normal costs of doing business.

That could allow companies to lay all the blame for lousy third-quarter results on the economic fallout from the attacks, rather than try to show how poor their earnings might have been even if the attacks hadn’t occurred.

At this point, however, many investors may not much care about parceling third-quarter numbers in that way. After all, everyone knows the economy was weak before the attacks, and that things got worse after Sept. 11.

A more important issue may be the new surge in corporate write-offs tied to restructuring efforts.

“Restructuring” became a business buzzword in the early 1990s as American companies sought to shed the baggage of the 1980s and streamline operations for what was expected to be a slow-growing economy--one in which profits would be harder to come by.

The word strikes terror in the hearts of many workers because it usually means layoffs, plant closings and other cost-cutting steps are afoot. That was the case in the early-’90s and it is happening again in a big way.

Morgan Stanley calculates that, even before the terrorist attacks, major American companies’ write-offs for extraordinary (i.e., one-time) charges and the cost of discontinued operations would total $110 billion this year, topping the previous record of $106.5 billion set in 1992.

The 2001 total of write-offs now is sure to be much higher, Morgan’s Galbraith said. Investors, Galbraith noted, have always been of two minds on restructuring charges. The positive view is that paring corporate operations to reduce costs and get rid of excess capacity (too many restaurants, or assembly lines, or consultants) sets the stage for an eventual profit rebound when demand recovers. That’s what happened in the late 1990s following the early-’90s restructuring mania.

The negative view of heavy write-offs is that they may indicate that a company’s management grossly miscalculated--with shareholders’ money--in building or buying facilities, or in hiring, during the economic boom.

As Galbraith put it, “One year’s [earnings] charge is often a reduction in a prior year’s overstated earnings.”

Investors who remain wary of the stock market may not be able to fully articulate their suspicions, but one factor may be the general confusion over 2001 earnings--what’s real and what isn’t. That confusion isn’t likely to be allayed by third-quarter profit reports.

Another concern may stem from the new wave of restructuring write-offs and other “one-time” charges. In effect, the same corporate managements that over-expanded and overpaid for acquisitions in the last few years now are seeking to wipe the slate clean and start fresh.

That may ultimately help some crushed stocks recover, but shareholders may rightly ask why the companies, and the stocks, were so badly blindsided in the first place.

In particular, Galbraith advises that “investors should be extremely leery of companies that have made the term ‘nonrecurring charge’ an oxymoron.”

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Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to www.latimes.com/petruno.