William Dunk's 2004 Annual Report On Annual Reports

The Uncertain Club vs. The Globe Trotters

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To get a feel for the current batch of annual reports, a close reader should check into Uncertain, Texas, population 205, altitude 195, incorporated in 1961. It’s “near Uncertain Landing, so named because steamboat captains in earlier days often had trouble mooring their vessels.” There, back in the early 1900s, you could find the Uncertain Club, a hunting, fishing, and boating society, which today would harbor legions of uncertain businessmen. Uncertainty is where it’s at. (www.lone-star.net/mall/txtrails/uncrtin.htm)  

In August 2004, the global price of oil shot over $45 a barrel, headed, we predict, to $60 or $70. In 1971, U.S. oil production peaked; and it is now in slow decline. Somewhere between 2015 and 2025, a similar stall in total world output, known as a Hubbert’s peak, will occur, since our accessible reservoirs of petroleum are running dry. (See www.hubbertpeak.com) This oil shortfall has forever changed the world economy, and left businesses the world over confused, mildly impotent, and conspicuously uncertain.            

Businessmen are muddled. Of the 2003 batch of annual reports, we find that Michael A. Volkema of Herman Miller gives the clearest, boldest declaration about the muddy estate of the business mind on the cover of his report: 

Our business reality has beenin a wordunreal. Over the past year, the economyespecially the business-to-business sectorwas suspended in a state of wait-and-see. Wars and rumors of terrorist threats kept many people and businesses awash in anxiety. When the present is characterized by chaos and confusion, and the future prospects are just too uncertain to predict, buying office furniture generally drops near the bottom of the priority list. 

In fact, Miller itself is so anxious that the very design of its report, once clever and ebullient, has become straitened and impoverished, probably a bad sign at a design-driven company. Sales have plummeted from $2.0 billion in 2000 to $1.3 billion in 2003, so perhaps it’s wise for it to adopt a frugal look. Volkema, by the way, has been cheered by a modest bounce in sales during 2004. 

It is against this background that General Electric, which often best grasps the issue of the moment, headlined its 2003 report “Growing in an Uncertain World.” As we pointed out in our Global Province Letter of 18 August 2004, “The Global View from Mount Olympus,” GE is boldly repositioning itself across the world, expanding into infrastructure markets, pulling back a bit from certain financial markets, even though GE Finance had been the company’s profit catalyst in John Welch’s Magic Kingdom. This is remarkable because just a few years ago GE was a global laggard. It’s been snapping up assets overseas ever since. 

While the causes of uncertainty are global, and any successful response to them has to be equally global, the signs of business distress have been especially acute in the largest, most advanced economiesin the U.S., Japan, and Germany. The trough in the latest recession has been deeper than usual, and the overall recovery has been anemic. During this Clinton-Bush fallback and the pricking of the stock bubble, American personal incomes fell two years in a row. The last time they fell for even one year was in 1953, and possibly a double dip has not happened since the Great Depression. (See NY Times, July 29, 2004, pp. 1& 8) Similarly, the layoff rate of 8.7% from 2001 to 2004 rivaled the 1981-83 rate of 9%, which had been the steepest since the Great Depression. (See NY Times, August 2, 2004, p. 2) The economy is still patchy, even though GNP growth has, on the other hand, shown gale-force strength at times, warming the hearts of bullish economists. Both the U.S. and Japan have suffered terribly from the bubble-style fiscal management of their governments in the last quarter of the twentieth century that has compounded the shock delivered by unprecedented global forces. As of 2003-2004, U.S. businessmen still do not know if the economy is on the mend or just pausing before it bolts downward. 

Berkshire Hathaway’s 2003 report reflects the trials of the U.S. economy. It’s essentially a big domestic investment company. You could call it the house that “float” built, and for a long while its float (temporary spare cash) has caused all its boats to rise. Chairman Buffett crows about 2003 in this regard: “Float reached record levels and it came without cost as all major segments contributed to Berkshire’s $1.7 billion pre-tax underwriting profit.” We call “float” “Warren’s bubble.” 

Nonetheless, Buffett’s somewhat churlish tone convinces the careful reader that all may not be well in his Empire. He spends large parts of the report saying how poorly companies are governedthat board members are not truly independent and chief executives are, oft as not, gigantically over-compensated at shareholder expense. Incidentally, Fortune 500 companies now regularly have big sections in their reports telling you how well governed they are (as does Buffett). Both Intel and Wal-Mart, for instance, use the letters of their non-executive chairmen to brag that their Boards run a tight ship. 

Perhaps Buffett is reacting as much to an America where it’s gotten harder to find companies in which he should invest. In this, he’s not alone; hedge funds here and in Great Britain are having real performance problems. (See The Economist, “From Alpha to Omega,” 17 July 2004, pp. 69-70.) There’s too much money chasing too few opportunities. Dedicated as he is to buying large chunks of domestic companies at the right price, he is now wandering far afield. He’s off buying junk bonds, making more acquisitions, speculating in foreign currencies, even buying 13.35% of the H Shares of PetroChina Limited, though some of the Western oil majors have pulled out of a joint investment with PetroChina. 

This is not the Berkshire Hathaway in which we invested in the early 1970s when it still sounded like a textile company, and today we would rate it a more risky investment. In several places, we notice, Buffett says the easy gains are over. For instance, he talks about his “AAA fixed-income securities that have been quite profitable in the past few years. These opportunities come and goand at present, they are going.” Importantly, one should examine page 2 of Buffett’s report where he lays out Per-Share Book Value Gains of Berkshire. “Our equity holdings, including convertible preferreds, have fallen considerably as a percentage of our net worth, from an average of 114% in the 1990s, for example, to an average of 50% in 2002-03.” For the last 5 years, book gains have been below his average of 22.2% for the full period of 1965-2003, in spite of a pretty good 2003 (21.0%). Understand that Buffett would prefer for us to pay attention to intrinsic value, though he only provides book value statistics. Berkshire, as we know it, is a young company (1965), and it appears to be having a hard time making a global adjustment, reflecting instead the stresses of the U.S. economy where there’s not enough gain and lots of pain. Buffett needs to steal a page from Sir John Templeton who fathomedearlythat you’re not a diversified investor unless you’re global. Berkshire is coming up shorter in 2004. 

Most distressing about Berkshire 2003 was that it terminated its “Designated Gifts Program.” We called this Berkshire’s “charity dividend.” Shareholders formerly got to divvy up Berkshire’s gift cash in proportion to the amount of stock they held. We regarded this as Berkshire’s single most important innovationthe area where Berkshire truly distinguished itself. Some of the anti-abortion ideologues objected to a few gifts that were sent to pro-choice organizations and were boycotting some products. So Berkshire caved in and now makes no charitable contributions at the corporate level. We would think that Berkshire should contribute more, not less, as a huge, maturing company in a troubled world.  This relates to the concept of stewardship, which we will discuss later in this report. 

Berkshire, which should be systematically deploying much more of its cash and energy abroad, reminds us of the central thesis of this report. Are you global enough or not? That, by all indications, should be the central question we ask of all companies big or small. Increasingly, we will be measuring companies and investments by the degree to which they are globalized. Southwest Airlines in 2003 is the only profitable major U.S. air carrier to speak of, and its report trumpets zest and optimism. Yet its margins are narrowing, and, worryingly, it has not gotten itself overseas. 

We turn to Fiskars 2003 (Finland) and Vorwerk 2003 (Germany) to see the fruits of globalism and the agony of provincialism. Fiskars fell last year a 100 Euro points on the sales line and in per share equity. It’s a troubled company based in Finland, though 2/3 of its sales are in the U.S., where it should probably be headquartered. Management is uncertain about its prospects in the very “uneven” U.S. economy. Like another wonderful Finnish company, Nokia, which is in the midst of a turnaround, Fiskars seems out of touch with the world in which it must function. 

Vorwerk 2003, on the other hand, has burst its German bonds and truly become a world company. Doing business in excess of 50 countries, it now generates “46 percent of its business volume outside Germany.” “The direct sales companies were” its “chief engine of growth ... with the largest division, Vorwerk Kobold Systems, showing the strongest growth.” Significantly, we think, its direct sales apparatus puts it closely in touch with the global customers on which it relies. Increasingly, we will be looking at all aspects of a company’s sales apparatus to understand how “globalized” it has become. 

There’s yet another reason to look at Vorwerk. For years it has been a European leader in its corporate communications. Its reports have been consistently innovative and witty for more years than we can remember, outclassing those we see on either side of the Atlantic. In fact, we now find that the U.S., once the world leader in annual reports, is now an also-ran. A retired executive, Manfred Piwinger (it takes just one man) got the company off on a string of winners during his tenure. This year the report deals with “curiosity,” perhaps the root of all evil, but certainly the source of innovation. Vorwerk, and several other leading companies, perceive that “curiosity” that breeds systematic innovation is the only answer to the demands of the global economic system. 

We have attributed business uncertainty to cataclysmic global forces such as the energy crisis, inadequate political leadership after the Cold War, and erratic, runaway application of technologies, particularly in the information processing area. In advanced economies, the depth of the “recession” and the paltriness of the “recovery” has exacerbated the fears of and induced paralysis in business leaders. This has led to meager capital investment, part of our present economic impasse. But we find yet another cause of uncertainty to be even more consequential in 2003. 

Business dialogue has broken down. Journalism, particularly cable journalism, has simply turned into an attack diatribe that precludes useful discussion throughout society. GE’s MSNBC and CNBC units particularly exemplify this bitter trend. The antics of politicians have inhibited responsible debate, so that neither party will talk about Washington’s Big Secret, which has been acknowledged in Congressional Reports not widely discussed: when you add up the off-balance sheet obligations of Medicare and other benefit schemes, our Government is broke. Sarbanes-Oxley, far from creating more transparency at corporations, has, by common admission, put the damper on business openness, while mainly enriching lawyers and accountants. We learn less, not more, about corporations from their public documents.  

The fact is that we don’t know one enterprise in America that is without operational difficulties, but none of this grim reality made its way into 2003 reports, with the possible exception of Herman Miller and a few other unusually candid companies. 

A case in point is Intel, though we could mention hundreds of other fine companies that aren’t discussing their painful difficulties. In its president’s letter, Intel intones: 

In 2003, we turned a key corner in our pursuit of growth. Over the last few years, we have worked to lay the ground for the future.... This year’s results show that our efforts are beginning to pay off. 

CEO Craig Barrett and his colleague Paul Otellini also wax poetic about “product innovation” and “advanced manufacturing.” Thereafter, non-executive chairman Andrew Grove tells us how well governed Intel is. Subsequent quarterly reports also chortle about the numbers Intel is posting. 

It’s in the July 30, 2004 San Jose Mercury that one learns Intel’s chip development is suffering. The launch of its Pentium 4 chip has been delayed; its Tejas chip project has been cancelled; the Grantsdale chipset has been recalled, and the company has put off the introduction of a chipset named Alviso. A local analyst at Insight 64 in Saratoga, says this is Intel’s horrible year, or “annus horribilus.” There’s trouble under the hood at Intel, whatever the financial results. It’s competitor, Advanced Micro Devices is creeping up from the outside. Companies with good financial results and grave operating difficulties number in the thousands, and we require more dialogue about them to retool our economy. 

One systemic indication of corporate breakdown is the stress felt by all employeesfrom top to bottomin America’s corporations. Their health is suffering terribly from the stress and overwork, further contributing to America’s healthcare crisis and the soaring corporate health bill, now showing gains of 11-14% each year. (For more on this problem, see The New York Times, “Always On the Job, Employees Pay With Health,” September 5, 2004, pp. 1 and 23.) As it turns out, the effects of burn-out are being felt in most of the developed economies around the globe. 

Interestingly, in 2003, as we’ve said, governance has become the theme du jour in annual reports, and everyone touches on it. As Mr. Buffett points out, governance is a problem, but probably the issue is most relevant at the very companies he is reputed to most admire. It’s the 800-pound global gorillas (companies so large that their every move affects the lives of people in every hamlet across the globe) where correct governance by motivated directors is vital to communities stretching well beyond Wall Street. And, in fact, these great multinationals have not, as we move into the 21st century, grasped the concept of stewardship, which the Rockefellers and Morgans had to learn at the beginning of the 20th. 

Both Wal-Mart’s Chairman and CEO acknowledge that “as the largest, and possibly most visible, company in the world, we are being held to an increasingly higher standard of behavior.” But Wal-Mart’s employment practices, community behavior, and, in some quarters, product quality, are increasingly at question. Our field studies of Wal-Mart reveal that it is “talking softer,” but still pursuing its rigid business formula. Microsoft 2004 is belatedly addressing computer security issues, and some lay at its feet the issue of totally vulnerable world networks and breakdown-prone computer systems. As effective monopolies, these companies/institutions must focus on the task of bettering the economic environment, rather than exerting the full power of their market presence. It becomes the duty of Board of Directors to rein in their managers. This requires a deep societal commitment. 

Similarly, one would look at the governance of China’s biggest oil company PetroChina 2003, which reported a 2003 revenue increase of 24.28% and a profit bump of 48.40%. It is up yet another 17% in the first-half of 2004. It has to weigh the human costs of its activities, having laid off “58,300 people” from 1999 to 2002, having incurred a serious “gas blowout...at the Company’s Lucjia No. 164 gas well at Kaixian Chongging,” and having endured the dreadful SARS outbreak that rippled through Chinese industry during the year, to which the company “calmly responded,” according to the Chairman. 

In this vein, readers of this report are advised to look at China’s huge and growing health care and pollution problems as amply described in the August 19, 2004 issue of The Economist. China’s top political leadership grasps their seriousness, and it’s hoped that their concern will infuse China’s leadership cadres. Even as China experiences electricity shortages, its pollution clouds are thickening. While PetroChina does have a “Health, Safety, and Environmental Protection Committee,” it is unclear whether it is moving to contain the side effects of its activities or to rein in the wasteful use of resources that is endemic in China, although it is clearly aware of these problems. Writ large, it is hard to tell whether the business leaders of the world’s most dynamic capitalist economy (with growth rates of 7 or 8 percent) are tempering the profound effects they are having on their nation. 

If, as we believe, each of the world’s great companies is troubled by severe operating issues, only some of which are understood by management, and if their managers are muzzled by the times and not airing the depths of their problems, we are severely impeded in understanding the new global economy, to which we must respond. That’s what Annual Reports 2003 imply. We lack the hard data and the perceptions that will permit us to deal with 2004 and 2005. 

Shakespeare’s Troilus and Cressida, his most cynical play, shows heroes who could not be heroes, because their world was turning upside down. A goddess was not a goddess, a person beloved turned into a stranger. Troilus, in one soliloquy, says of Cressida:

This is, and is not, Cressida
Within my soul there doth continue a fight
Of this strange nature, that a thing inseparate
Divides more wider than sky and earth.

Things were changing beyond recognition. In Annual Reports 2004 we see that the world as we know it is coming apart, wider than heaven and earth, such that businessmen know now what to do and are mute about the dissolution they are experiencing. It’s enough to make for inertia and uncertainty.


Companies Mentioned in the Report



Web Site

Stock Symbol

Advanced Micro Systems



Berkshire Hathaway www.berkshirehathaway.com NYSE: BRKa
Fiskars www.fiskars.fi OTC: FKRAF.PK
General Electric www.ge.com NYSE: GE
Herman Miller www.hermanmiller.com NASDAQ: MLHR
Intel www.intel.com NASDAQ: INTC
Nokia www.nokia.com


PetroChina www.petrochina.com.cn NYSE: PTR
Sarbanes-Oxley www.sarbanes-oxley.com  
Southwest Airlines www.southwest.com NYSE: LUV
Vorwerk www.vorwerk.com  
Wal-Mart www.walmart.com NYSE: WMT


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