Even a peek into Tyco's ( TYC) closet reveals some pretty ghoulish skeletons. Facing doubts about the trustworthiness of its accounting after its former CEO and finance chief were charged earlier this year with looting the company, Tyco's new management, led by new CEO Ed Breen,
released a long-awaited review of past bookkeeping practices. While Monday's report said there was "no significant or systemic fraud" in past results, it did catalog a range of aggressive accounting maneuvers -- including the practice of manipulating the books of acquired companies -- to make Tyco's results look better. Critical for investors to understand is that Tyco chose not to include the impact of its aggressive acquisition accounting in a $382 million cleanup charge. Instead, that pretax charge, taken in its 2002 fiscal year ended Sept. 30, covers audit adjustments for 2002, as well as corrections of what Tyco calls "errors" in prior years. The report, conducted by David Boies, a well-known outside lawyer, concedes that its authors didn't look closely at many aspects of the company's accounts. It says Tyco did not seek "to go back and identify every accounting decision and every corporate act over a multiyear period that was wrong or questionable, or whether there was a preferable accounting treatment among the alternative accounting treatments available under Generally Accepted Accounting Principles." But even a report of limited scope strongly suggests that the impressive profit margins posted under ex-CEO Dennis Kozlowski and former CFO Mark Swartz were artificial creations. That finding will cast serious doubt on whether Tyco can ever get back to those levels, or whether it is destined to show permanently lower profits. The realization that Tyco's earnings may be structurally anemic will unnerve Tyco's creditors. The company may have to pay back obligations totaling $12 billion in 2003, and is talking with its bankers to find a way to pay back its debts.
Also Monday, the ailing conglomerate released its annual report for its fiscal year ended Sept. 30, 2002. The annual revealed that the Internal Revenue Service and other tax authorities have "raised issues and proposed tax deficiences." TheStreet.com
reported earlier this month that Tyco, which has an extremely low tax rate compared with other corporations, was in discussions with the IRS to reach a settlement on back taxes that could result in Tyco paying out as much as $1.7 billion. The company denied the report at the time and the annual report says that it has provided in its income tax provision for any deficiencies and believes they will not have a "material adverse effect" on its results or financial position.
The decline in profitability means that Tyco's goodwill must be worth much less than the $26 billion stated on the balance sheet. Yet management and Tyco's auditors, PricewaterhouseCoopers, didn't use the opportunity of the annual report to mark down the goodwill. This may be because the reduction, when it comes, is going to be very large and would put the company in violation of a key debt-to-capitalization provision in its agreement with its bankers.