A (Kitchen) Sinking Feeling at IBM

The kitchen-sink charge was a trusty '90s tool for managing earnings, and it should've died with that decade, along with business-to-business exchanges, Zip drives and the Backstreet Boys.

So what to make of the big charge IBM (IBM - Cramer's Take - Stockpickr) took in the second quarter of 2002?

IBM earnings, released Wednesday after the close, appeared to exceed by a penny the Wall Street consensus estimate of 83 cents a share. But results were muddied by $2.1 billion in "incremental charges" in the quarter that made the true earnings at the tech giant almost impossible to assess.

Investors groaned when, earlier this year, IBM announced it was going to take this charge, which covers the expenses of realigning its microelectronics business, laying off workers and selling its disk drive operations. The fear with big charges like this is that operating expenses that used to be included in Street earnings get piled into a charge investors are expected to net out. Results from the discontinued operations were included in the 84-cent number.

The spin IBM execs have put on the charge is curious. Company officials say that some of the measures that the charge is based on will enable the company to meet the consensus earnings forecast for 2002 of $3.98. That implies IBM would be missing earnings if it hadn't taken these measures.

Of course, IBM says it's merely being proactive in taking steps to shore up ongoing margins. And, yes, investors do need to track normalized earnings. But investors would be better served by looking at results with and without charges.

We might be able to leave this discussion right there -- at a stalemate. But Wednesday, IBM said it was going to increase the range of the charge by a half-billion dollars -- to $2.5 billion to $3 billion, from $2 billion to $2.5 billion. The increase is because IBM now thinks it will have to take a bigger writedown when it sells its hard disk-drive operations. Fair enough. But any time a charge starts to grow in size, investors need to be really cautious.

Due to this very sort of noise in IBM earnings, investors also need to look at cash-flow measures. But the company gives no useful cash-flow figures in its earnings release. The cash flow data in the second-quarter release for the first half don't track at all with cash-flow statements included in the first-quarter Securities and Exchange Commission filing. As a result, it's impossible to update Detox's free cash-flow analysis of IBM.

IBM's stock is more than 40% below its 52-week high because investors are worried about earnings power at Big Blue. In light of nearly opaque earnings releases like this, it's no wonder.