In calculating its earnings for the second quarter, released on July 26, Boeing made the unusual decision to ignore an enticing tax loophole that would have wiped out much of the financial pain associated with a $615 million settlement with the government over egregious ethics charges.
Why take a pass on hundreds of millions in savings? The decision is a shrewd move by Boeing Chairman and CEO W. James McNerney that could save Boeing (BA) lots of trouble in the future. The news came just weeks before Senate hearings about the Boeing settlement and the possibility that the Chicago company would use it to reduce taxes owed the very government that levied the fine. Earlier this month, Senators Charles Grassley, John Warner, and John McCain had voiced reservations about the deal negotiated by the Justice Dept.
With new defense contracts on the horizon and dissatisfaction on Capitol Hill over the settlement, Boeing needed to do something to defuse this political bombshell. "Would Boeing have taken a tax write-off if it could? Sure," says Richard Aboulafia, aerospace analyst for Teal Group consultants. "But it's better to eat the cost and not make yourself a target. This was a savvy move."
Other Pentagon watchdog agencies agreed. "There are enough questions about how this settlement was structured that any other decision by McNerney would have been hard to justify," said Jennifer Porter Gore, a spokesperson for Pogo, a government watchdog agency. quot;We're glad that Boeing is doing the right thing."
Boeing agreed to pay the fine on June 30 for improperly acquiring Lockheed Martin documents related to its rocket launch program and for recruiting Darleen Druyun, a top Pentagon procurement official, at the same time she was overseeing billions of dollars in contracts that Boeing was competing for. The move was part of McNerney's effort to rehabilitate Boeing's reputation (see BusinessWeek.com, 3/13/06, "Cleaning Up Boeing").
The decision to skip the tax deduction cost the Chicago aerospace giant a lot of money in the second quarter. Boeing took a total of $1.07 billion in charges in the period, including $496 million to cover delays in an international airborne surveillance system for Australia and Turkey as well as $571 million of the $615 million settlement. That contributed to a $170 million quarterly loss for the company—the first in three years. Revenues rose 2%, to $15 billion, from $14.7 billion in the year-earlier quarter.
"Without question, the short-term financial impact of the taxability issue is significant," McNerney told analysts and reporters on the July 26 conference call. "However, the long-term value of Boeing's reputation is even more significant." On Wall Street, Boeing shares slipped 4.6%, to close at $79.90.
At least one U.S. senator—Senate Finance Committee Chairman Grassley—applauded Boeing. But he remains critical of Justice for failing to consider the settlement's tax treatment that allowed Boeing attorneys to negotiate a "35%" discount. "That's the right decision," Grassley said in a statement. "However, Boeing's attorneys believed the settlement was tax deductible.…Justice lawyers were asleep at the switch. That's inexcusable."
Grassley, McCain, and Warner had written to U.S. Attorney General Alberto Gonzales objecting to structuring the Boeing settlement in such a way that would allow the company to deduct its payments and "leaving the American taxpayer to subsidize its misconduct." Grassley said he would continue to seek legislation that clarifies whether parts of the settlement are deductible. Warner and McCain could not be reached for comment.
In making his decision, McNerney said he felt strongly that the right thing to do was to not seek tax-deductibility for the settlement charges. "This should be a signal to our employees, customers, suppliers, and our shareholders of our willingness to acknowledge responsibility and to accept accountability and to move forward," McNerney said in the conference call. "Simply speaking, my intent is to focus on the future and put this unfortunate part of our past behind us."