William Dunk's 1997 Annual Report On Annual Reports
A CONFEDERACY OF DUNCES
Several years ago, a wonderful, charming, laughing, but disturbing novel made its way upriver from the deepest South (New Orleans) to instruct the nation about the artful chaos and unhappy nether worlds that flourished way down there. Published after the author's death, Confederacy of Dunces probably captures more than New Orleans. Its currents speak to the present estate of large parts of the Confederacy. Lately we have John Berendt's Midnight in the Garden of Good and Evil: A Story of Savannah to remind us that the New Old South is a very special society.
Arguably, this "confederacy of dunces" (Bill, and Newt, and Trent et. al.) now sits atop our federal government, producing a tone and an aimlessness that confounds the body politic. With the end of the Cold War, we no longer are taking aim at a clear target. Instead, we and the Russians improvise, from day to day, in the absence of clear policy. Old wounds and polarization run through the national psyche. We think it can be argued that the same tendencies cloud our economic climate. This can be seen in the current batch of annual reports where parallels to our political life can be detected:
a. Uneasy complacency - In politics, everyone won re-election, but each wonder if it was a hollow victory. Clinton is in the presidency, and the Republicans are in the Congress, but they don't know whether campaign finance and other excesses will bring them down.
Similarly, Michael Eisner 1997 at Walt Disney eloquently states the case for unease. Disney has gone from success to success. But he remembers his times at ABC and Paramount which both began "to stagnate after a decade of success. Some executives grew complacent and self-satisfied . . . I had found in my career that managing your way out of failure is often easier than managing sustained success. . . I wanted to be decisive."
Good year or bad, chief executive after executive turns out in 1997 to be worried about what comes next. Often because they're wondering how to sustain the unsustainable stock valuations they've been accorded by the market, even though Warren Buffett and Alan Greenspan have already told them the prices are too high and will not hold.
b. Much activity connoting nothing - There's a fair amount of centrist legislation in the hopper pushed by both Clinton and the Republicans. There are trips to China and Helsinki. But nothing suggests that any of this is making us stronger or healthier. We don't know where we're heading, but we are very busy getting there.
One of this year's good reports - GTE - demonstrates this same headlong rush to we know not where, right on the front cover. It says (Cover I, II, 1, 2, & 3), "Within one hour of the signing of the Telecom Act, GTE was out of the starting gate and far ahead of the competition, with an agreement to begin providing long-distance service. Twenty-five days later GTE was selling long-distance service. . . ." It's a turnabout for any of the carriers to act fast, but we don't know if this activity is, to paraphrase Keats, inspired by divine vision or simple madness.
c. Extraordinarily prolix - Nobody ever accused Bill Clinton of being Calvin Coolidge. The President still rambles on and on about almost everything in endless forums. The drone often hides inconsistencies and lack of substance.
Years ago, when I had an annual report firm, our research revealed that people read 1 and 2-page letters, while tuning out longer extravaganzas. Be that as it may, the average letter is now 4 pages. And many captains of industry are competing with the President. Disney (8 pages), Kimberly-Clark (10), The Progressive Corporation (8), and Black and Decker (9) are just a few of the wordy works available to shareholders.
A particularly interesting example, however, is the Harman International Annual Report. Chairman Sidney Harman's 8-page essay even includes a picture of the Chairman with President Clinton at a California factory, leaving just one page for President Girod to comment on operating performance. Does all this wordiness stem from a joining at the hip of politics and business?
Amidst this paradoxical tone of confident insecurity, energetic aimlessness, and expansive inconclusiveness, America's annual reports for 1996 show (a) that corporate results were more mixed than the annual numbers suggest, (b) that the restructuring of the 1980's, once thought to be at an end, is a permanent way of life for Corporate America, and (c) that this economy is so full of surprises that most executives lack a clear idea of how to win in the years ahead:
a. Mixed Results - Analog Devices reported increased revenues of 27% and earnings per share growth of 37%, yet revenues were essentially flat in the second, third, and fourth quarters of 1996. Wal-Mart reports, "In fiscal 1996, we achieved record sales of $93.6 billion and record earnings of $2.7 billion. . . . Although this was an acceptable year by most standards, it was not a Wal-Mart year." Black and Decker talks of steady progress for 3 quarters, but "our fourth quarter results were lower than expected." All this means that markets, customers, and demand are extraordinarily fickle now. Investors should be watching quarterly results, particularly the revenue line, very closely--more closely than they would in a more stable economic environment.
b. Age of Permanent Restructuring - Sara Lee shows in a helpful chart that it took special charges in 3 out of the last 10 years (page 1). Special charges, accounting changes, re-structurings are now a way of life, even casting some doubt on the numbers corporate auditors offer us as a reflection of corporate performance. With all the write-offs, can we accept the numbers given for continuing operations?
Alcoa shows special items in every year since 1990. Black and Decker shows discontinued operations from 1990 to 1996. Kimberly Clark notes restructuring changes in 1995, 1993, and 1992. Sprint shows at least 3 sets of earnings per share figures for 1996 alone (pp. 2, 3, and 29), depending on how you look at its numbers. This constant restructuring does not suggest that managements were either right or wrong to revamp their enterprises, but it does make it hard to compare financials from different years. As does the similar endless trail of acquisitions. This relentless slicing and splicing, which seemed to accelerate in 1996, is encouraging for the short-term investor, who is looking for a quick run-up, but quite confusing for the long-term investor.
We would suggest that chief executives are writing long letters, not just because they like to talk, but because they're uncertain how to deal with uncertain times. The mass of words covers profound uncertainty. The bulk of their responses are taking two forms. Either they preach "Transformation Theology," hoping they're creating a New Age Company that will see them well past 2000, or they itemize endless goals and objectives, thinking that such a MBA checklist will keep their spaceship airworthy in the years ahead.
IBM's Gerstner begins this year's letter with change and transformation: "Last year I told you that the transformation of IBM had progressed to the point. . . ." The headlines in Cabot 96 are about "transforming Cabot's Businesses," and the report includes a special page called "New Thinking." Others use metaphors to communicate transformation: Sidney Harman talks of creating a "digital organization" for a digital age. The graphics of Progressive Corporation have Russian artists "use their own faces and bodies as a canvas for the transformation. . . ," an effort to picture Change as Progressive's guiding idea. Progressive, a remarkable company, consistently produces noteworthy reports. Another company, saying it has finished its "transformation," has named itself Transitional Hospitals Corporation, but it obviously has not completed its transition. It's not quite clear what these, or a score of other organizations, are changing to--just that they're determined to change.
The other way to deal with uncertainty is to announce endless strategies, goals, objectives, etc. Louisiana Pacific lists, on its cover, "Six Strategies for Achieving Quality Growth." Black and Decker has 4 corporate objectives, but goes on to list a launching list of 5 broad steps it will pursue to get there. And so it goes.
Neither process--grasping for transformation or pushing at objectives--would seem to be a substitute for a crisp, organizing idea that's meant to shape a company's progress. But a few do seem to have a real growth strategy. We have said for a couple of years that the most forward-thinking reports are focused on how companies can grow in a slow-growth age. Last year, leading edge companies were most often looking to grow through rapid new product development.
This year, companies leading the pack are focused on growth through service. That is, they are trying to sell services that are linked to the products and technologies they know well. GE says:
Services is so great an opportunity for the Company that our vision for the next century is a GE that is a "global service company that also sells high-quality products".
The list of companies with an explicit service strategy is very broad, including Brite Voice (which aims to be more than 50% services), Billing Information Concepts (spun off from U. S. Long Distance), Connecticut Water Service, IBM, etc. Companies like this, which expect to create sustainable double-digit service growth to augment products which are or will be stagnant, seem to merit special investor focus. Others are pursuing the same strategy somewhat less explicitly, with both Alltel (telecommunications) and Dresser (energy equipment), for instance, talking about providing "solutions" (service packages), instead of just equipment.
John M. Harland in Atlanta, an old and usually profitable check printer, is a dramatic illustration of the transition to services. Fastening on a new strategy in 1996, Harland ditched its Check Store, its consumer operation, and took a big restructuring change, its profits having retreated from their crest in 1992. "Harland built its reputation as a check printer," but now it recognizes that it has a giant opportunity in "database marketing," "helping financial institutions identify profitable customers, developing sound marketing strategies and execute information-driven plans." Harland, it seems, intends to grow by helping its customers grow. This arena of new services for profit based on information technology (the 96 crop of reports suggests) will be a theme for investors for the rest of this decade.
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