IBM Releases Its 10-K Report

IBM(IBM Quote) investors, class is in session.

On Monday after market close, Big Blue addressed in its annual Securities and Exchange Commission 10-K filing how it recorded the sale of an optical unit and also shed more light on its earnings machinations.

Last month, the company took heat for not disclosing exactly how it factored in the $280 million it gained from the Dec. 19 sale of its transceiver unit to JDS Uniphase(JDSU Quote).

IBM explained that it put the money under intellectual property sales, to counterbalance sales and research expenses. The company argues that intellectual property sales have been regularly included in the expense line, a practice some may disagree with, positing that a one-time event shouldn't be used to pay for ongoing expenses.

But the more important fallout from the incident has been positive: It has caused IBM to file a 10-K that details the inner workings of its earnings machine.

IBM's new 10-K tears away the curtain and gives investors a chance to jiggle the company's magic levers. The report details what elements make IBM's earnings fluctuate.

Investors wondering if they had another Enron on their hands will be relieved, but will be reminded that in a company as big as IBM, there are a lot of numbers to pull and push.

"It's smart of them to say, here are some things that impact earnings, and put investors' minds to rest," says Morningstar analyst Joe Beaulieu, who thinks it's good for IBM to be open with its accounting because it's such a widely held stock. But he cautions that investors shouldn't take greater disclosure as a sign that all the earnings they see are straightforward.

"Investors have to realize you do have leeway through GAAP (generally accepted accounting principles) accounting," he said. "In an ideal world, nobody would take advantage of it. People do."

IBM categorizes the contentious $280 million optical-unit sale under "intellectual property and custom development income" as a transfer of intellectual property. This falls on the expense line, a practice IBM says it formalized in 2001, offsetting some of the costs of sales and research and development outlays.

Some investors will wonder how many special sales make up IBM's $1.5 billion 2001 effort to license and sell "technological know-how," as IBM puts it in friendly language belying the typically rigid formality of an SEC filing. IBM's explanation of its methods will not ameliorate the concerns of investors who consider business-segment sales as one-time items that should not help lessen the blow of everyday expenses such as research and development and other business costs.

Additionally, in a two-page summary section and in a lengthy discussion that follows, IBM details a host of complex fluctuating elements that make up IBM's earnings. Those items include interest income on a massive pension plan, money made or lost from IBM's securities holdings, changing policies for recording the amortization of goodwill, and gains from real estate sales and currency exchange rates.

IBM gives the all-caps treatment to an increased $40 million in fourth-quarter goodwill from acquisitions relating to its $1 billion purchase of Informix, emphasizing to investors that it did not affect earnings.

Big Blue details how these might change in 2002, from adherence to two Financial Accounting Standards Board bulletins, which will eliminate an expected $244 million in amortization of goodwill from acquisitions to a projection that intellectual property income might decrease. Even with the optical sale, IBM's intellectual property line decreased by 11% year over year in 2001.

Investors now have a better idea than they have for many quarters of how IBM makes its earnings estimates. That knowledge at least should erase worries about IBM's legitimacy as a real business. Its detailed methods for patching together earnings, however, should both reassure and challenge shareholders. Big Blue may be speaking more clearly with its new filing, but its finances are far from simple.