Cash Flow Trends and Their Fundamental Drivers: A Continuing Look Comprehensive Industry Review (Qtr 4, 2008)

This research report is one of a series that looks at the cash flow performance of Corporate America. Our primary focus is on free cash margin, or free cash flow measured as a percent of revenue. We also look at the drivers or components of free cash margin in an effort to determine factors behind observed changes. In the current study we conduct a comprehensive review of 20 four-digit GICS non-financial industries and their 61 six-digit GICS sub-industries for a series of rolling twelve-month periods from the first quarter of 2000 through the fourth quarter of 2008. Recession notwithstanding, due to declining capital expenditures and reduced working capital requirements, free cash margin held up reasonably well during the twelve months ended December 2008. The metric declined to 4.12%, down from a high of 5.14% reached in June 2004, and more recently, the 4.93% level reached in December 2007 and 4.44% in September 2008. With free cash margin at 4.12%, corporate America is generating 4.12 cents of free cash flow for every dollar of revenue generated. The number of industries experiencing declining free cash margin increased from our last report. For our sample as a whole, free cash margin last bottomed at 2.43% during the 2001 recession. We continue to believe that during the current recession, free cash margin will likely decline to levels that are at or below those found in the 2001 recession, suggesting a continuing contraction of free cash flow of 50% or more from current levels. However, a continuing focus on maintaining low working capital levels and reduced capital expenditures may leave companies better off on a cash flow basis than they were in 2001

The Effects of Recent Accounting Changes for In-process Research and Development

The newly-revised SFAS No. 141 (R), Business Combinations, offers some important changes in accounting for in-process research and development (IPR&D). Long expensed at the time of acquisition, IPR&D will henceforth be capitalized and subsequently amortized, though abandoned projects will be written off. The expectation is that earnings in years following an acquisition will be lower, though the impact is entirely dependent on whether new acquisitions result in additional amounts of capitalized IPR&D and the amortization period for previously-capitalized amounts. In this study we look at the significance of IPR&D over the period 1998 through 2006 relative to selected measures, including net sales and total assets, for a large cross-section of firms and within five technology industries. We then recast pretax income in 2006 for our sample and for fifteen firms from the five industries assuming IPR&D incurred over the 2003 – 2005 time period had been capitalized and subsequently amortized. Across our sample period we find that the median firm that incurs IPR&D spends about 1.47% of sales and .91% of assets on those acquired projects. The effects, however, in certain industries and at selected companies were much greater. We also find that pretax income in 2006 is reduced by approximately 1.12% if IPR&D were capitalized and amortized over afive-year period. What is unclear is the extent to which companies may need to take charges for IPR&D projects abandoned in the future. Analysts and investors will want to be prepared for all of these changes as they begin to review financial statements for technology firms in 2009 and beyond

The FASB's Basic Ownership Approach and a Reclassification of Preferred Stock as a Liability

In Preliminary Views: Financial Instruments with Characteristics of Equity, the FASB expresses a preference for a basic ownership approach for distinguishing between liabilities and equity. Under this approach, preferred stock, long considered a component of shareholders’ equity, would be reported as a liability. If this change takes place, the impact on the balance sheet and income statement, including measures of leverage and interest coverage will be great, especially for companies that have relied heavily on preferred stock for financing. In this study, consistent with the proposal, we revise balance sheet and income statement measures of leverage, interest coverage and pretax income and seek to identify sectors and some companies where the effects will be greatest. Debt covenants for companies that use significant amounts of preferred stock may need to be revised. There may also be pressure to refinance outstanding preferred stock with debt or common equity. Overall, we find that the median firm with outstanding preferred stock would see its liabilities to equity ratio increase by 4.17%. The median company would see a decline of 5.99% in times interest earned and a 6.37% decline in pretax income

Cash Flow Trends and Their Fundamental Drivers: A Value-Weighted Index of the S&P 500 Non-Financials

With this report, we introduce a series of cash flow indices for the non-financials of the S&P 500. Each index, consisting of cash flow measures and their fundamental drivers, are calculated as a value-weighted average. The objective is to permit us to look closely at the cash flow performance of the S&P and to better isolate the factors underlying that performance. Future reports will look at industry subsets of all public companies, such as technology, biotechnology, and other groups that are of particular interest. Our analysis of the S&P 500 indicates that counter to recent trends, various cash flow measures were down in the four-quarter period ending December 31, 2005. The decline was driven by decreases in revenue and operating cushion, and by an increase in the cash cycle. Also of note, our earnings quality indicator, EQI, continued a declining trend begun in 2003. Data for this research was provided by Cash Flow Analytics, LLC. Charles Mulford is a principal in Cash Flow Analytics, LLC

Net Income Plus Depreciation, Operating Cash Flow and Buildups in Operating Working Capital

While there are many advantages to a simple and readily available proxy for operating cash flow, there are inherent shortcomings as well. Such is the case with net income plus depreciation & amortization, a metric sometimes referred to as "cash earnings." In particular, net income plus depreciation & amortization does not take changes in operating working capital into account. This report identifies several companies where in recent years, net income plus depreciation & amortization has been growing but where reported operating cash flow has been lagging. At these companies, operating working capital, including accounts receivable and especially, inventory, is not being realized and is increasing, in some cases, rapidly. The rapid growth in such accounts calls into question the sustainability of future earnings as the risk of write down and accompanying loss increases. While a write-down can be averted if accumulating operating working capital is ultimately realized, such was not the case at KB Home, or DR Horton, Inc., where write-downs of the companies' inventory of landholdings were recently announced

The Effects on Measures of Profitability and Leverage of Recently Enacted Changes in Accounting for Minority Interests

The recently enacted FASB Statements 160 and 141(R) bring changes to accounting for noncontrolling interests (formerly known as minority interests) for companies with fiscal years beginning after December 15, 2008. In particular, SFAS No. 160 will change the presentation of minority interests on the financial statements. The minority interests in shareholders' equity will be required to be reported as a component of total shareholders' equity. In addition, consolidated net income as presented on the income statement will include minority interests in income. For clarity, companies are instructed in both cases to break out the portions of equity or income attributed to the minority interest, but the "bottom line number" will change with the enactment of these statements. This report examines the consequences of these changes for companies reporting minority interests. In particular, we find that (1) shareholders’ equity will increase by 2%, though 10% of the companies will see increases of over 25%; (2) income from continuing operations will increase by 3%, though 12% of the companies will see increases of over 25%; (3) liabilities to shareholders’ equity will decline by 2%, though 10% of the companies will see declines of over 20%; and (4) times interest earned will increase by 1%, though 9% of the companies will see increases of over 10%. Investors, analysts and other users of financial statements will want to be prepared to take these upcoming accounting changes into account

Mass-radius relationships for exoplanets

For planets other than Earth, interpretation of the composition and structure depends largely on comparing the mass and radius with the composition expected given their distance from the parent star. The composition implies a mass-radius relation which relies heavily on equations of state calculated from electronic structure theory and measured experimentally on Earth. We lay out a method for deriving and testing equations of state, and deduce mass-radius and mass-pressure relations for key materials whose equation of state is reasonably well established, and for differentiated Fe/rock. We find that variations in the equation of state, such as may arise when extrapolating from low pressure data, can have significant effects on predicted mass- radius relations, and on planetary pressure profiles. The relations are compared with the observed masses and radii of planets and exoplanets. Kepler-10b is apparently 'Earth- like,' likely with a proportionately larger core than Earth's, nominally 2/3 of the mass of the planet. CoRoT-7b is consistent with a rocky mantle over an Fe-based core which is likely to be proportionately smaller than Earth's. GJ 1214b lies between the mass-radius curves for H2O and CH4, suggesting an 'icy' composition with a relatively large core or a relatively large proportion of H2O. CoRoT-2b is less dense than the hydrogen relation, which could be explained by an anomalously high degree of heating or by higher than assumed atmospheric opacity. HAT-P-2b is slightly denser than the mass-radius relation for hydrogen, suggesting the presence of a significant amount of matter of higher atomic number. CoRoT-3b lies close to the hydrogen relation. The pressure at the center of Kepler-10b is 1.5+1.2-1.0 TPa. The central pressure in CoRoT-7b is probably close to 0.8TPa, though may be up to 2TPa.Comment: Added more recent exoplanets. Tidied text and references. Added extra "rock" compositions. Responded to referee comment

United in Separation? Lozi Secessionism in Zambia and Namibia

Secessionism perseveres as a complex political phenomenon in Africa, yet often a more in-depth analysis is overshadowed by the aspirational simplicity of pursuing a new state. Using historical and contemporary approaches, this edited volume offers the most exhaustive collection of empirical studies of African secessionism to date. The respected expert contributors put salient and lesser known cases into comparative perspective, covering Biafra, Katanga, Eritrea and South Sudan alongside Barotseland, Cabinda, and the Comoros, among others. Suggesting that African secessionism can be understood through the categories of aspiration, grievance, performance, and disenchantment, the book's analytical framework promises to be a building block for future studies of the topic