Tuesday, January 13, 2015

The return of cookie-jar earnings: United Technologies edition

I was just listening to a November presentation made by United Technologies - a large and very fine American company. Mostly I was listening for the comments on Pratt & Whitney as Bronte has multiple investments in the jet-engine business.

But I was struck with the forthrightness with which Gregory Hayes (now the Chief Executive Officer) discussed earnings manipulation. You can find the transcript here. To quote:
So we'll be able to deliver on the numbers that we had talked about earlier in the year, which essentially was in a range. We started out at $6.55; we're now at $6.75 to $6.85. We'll be right around $6.85 when the year is said and done. Still some puts and takes, some headwinds around currency. But top line looks solid at $65 billion; bottom line looks solid around $6.85. 
I'd just point out, tax extenders is not in our numbers for the year. Who knows if we're going to get extenders here in the last couple of weeks of the year. My own view is that if we get extenders, we'll probably just restructure against that benefit or do something else, as opposed to trying to pass along another dime that's probably not going to give anybody much of a benefit. So I think we're done at $6.85.

So if President Obama signs a tax bill they won't reflect that properly in their earnings they will just take a restructuring charge so they don't need to show the earnings to you.

In other words they will create "cookie jar earnings".

Cookie jar earnings were all the rage when I got into this business. Alex Berenson even wrote a book about them. What shareholders wanted was smooth earnings growth regardless of the vagaries of economic cycles - and people created cookie jars and manipulated earnings to show precisely that.

Listening to United Technologies I felt about 15 years younger. What is old is new again.


Disclosure: No position in any mentioned stock.


CrocodileChuck said...

Believe Jack Welch was the master of this with the insurance businesses within GE Capital in the '90's

Anonymous said...

And early days of Microsoft which became b-school accounting case study

Anonymous said...

Hello John,

I've red your posts on UTX and helicopters, I suggest you consider a short in Finmeccanica. The company is terrible, over-indebted and loosing money in all of its segment but helicopters (that have propelled backlog recently). They're a collection of small businesses, all of them too small and lacking scale to be competitive. Investors have the perception of a "turnaround" but the management has too much political opposition to do the right thing and divest the lemons, and as we speak they're burning more cash...

Anonymous said...

The new guy is just carrying on the tradition at UTX. Followed them for a while...they've been pretty decent at giving investors a roadmap every quarter to their "core" earnings, or something like that. But absolutely, a serial charge-taker, and earnings manager. Never take their reported earnings at face value.

Anonymous said...


Your enthusiasm for Rolls Royce seems to be based on the potential success of the A350, with the assumption this would be a higher-margin engine than many of the current RR engines.

But the economic profit and cash for these A350 engines would only come years later. RR has a tradition of front-loading a big chunk of its profit for linked total care contracts, but this only creates accounting profits. So even if the A350 program is a success, it might further depress the economic profits and cash flows in the first 5-10 years of the program.

In addition, this company has higher-than-normal profit volatility (another consequence of front-loanding the profit on linked total care contracts).

Given these issues, what makes you so positive on RR?

Paul said...

Goes back further than that. Was being done by big companies in the 70s and 80s. I think Jack Welch may have been the all time champ.

Faisal said...

Isn't the accounting principle of "conservatism" being followed here rather than any manipulation?

dearieme said...

Accountants: are they just kitty-fiddlers?

John Hempton said...

I agree the short term on Rolls does not look good and the A350 profits (which will be considerable) are rear weighted.

Question: In five years will profitability be higher, lower. If so by much?

How about ten years?


Unknown said...

and there first earning quarter preview is been released check out at: http://tinyurl.com/oe5ttjm

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