Up a Creek--with Lots of Cash

Many U.S. companies are managing to stay liquid despite sickening drops in net earnings

There's hardly a company more vulnerable to the tech-led downturn than Texas Instruments (TXN ), the Dallas maker of chips for cell phones and other gear. Its net sales fell more than 40% in the third quarter from a year earlier, and it lost nearly $120 million, after raking in profits of almost $680 million the previous year.

But Texas Instruments Inc. didn't get to be 71 years old without knowing how to weather hard times. To preserve its all-important cash, TI has cut capital spending by two-thirds from a year ago. It has laid off 6% of its employees and trimmed inventories to 58 days' worth of sales, vs. the 71 days' worth it held late last year. Because it ties employees' pay to its financial performance, it will save hundreds of millions in profit-sharing expenses due to faltering results.

As a result, TI is hardly pressed to the wall. It has $3 billion in cash and marketable securities, even more than during its boom years. It's certain enough of its finances that it continues to pay $150 million a year in dividends. And TI is even buying back its own shares--$300 million worth in the past six months alone--to cover exercises of employee stock options. Says Chief Financial Officer William A. Aylesworth: "We believe we have a strong balance sheet, especially in view of the severe market downturn."

TI is not alone. As always in an economic slump, cash is once again king, and companies are going all out to make sure they have enough of it. BusinessWeek's flash profits survey found that net earnings fell 54% at 124 bellwether companies in the third quarter. But early indications suggest that cash positions haven't deteriorated nearly as badly as that. At many large companies, they are even improving. Businesses are taking steps to keep cash from going out the door, and they are bringing in fresh money by borrowing to create a cushion to carry them through hard times.

BILLIONS ADDED. Take, for example, the companies in the Standard & Poor's 100. Of those, 22 reported changes in cash flows in their press releases for the latest fiscal quarter. BusinessWeek toted up the changes in cash for the 22 companies and found that they had added $13 billion in cash in the latest quarter, vs. shedding $7 billion in cash a year earlier. General Motors Corp. (GM ) and Ford Motor Co. (F ), which raised cash through debt offerings and securities sales, account for most of the jump, but the others increased their stockpiles, too. Of course, companies that chose not to mention cash in their press releases may not have done as well as the 22 that did report.

Accounting rules go a long way toward explaining why corporate cash positions can improve when profits fall. For one thing, companies have massively overinvested in capital equipment. Now they're writing off unneeded gear and depreciating what's left as it becomes worn out and obsolete. It's appropriate that depreciation and writedowns are squelching profits, because those assets--and therefore the companies--truly aren't as valuable as they were thought to be. But the enormous accounting adjustments don't drain cash, which is what counts for paying the bills. "The drop in profits will be greater than in any post-World War II recession--even though the decline in GDP is relatively modest," says Michael K. Evans, chief economist of American Economics Group Inc. in Washington, D.C.

Companies are also building cash in ways that don't show up in profits, including such maneuvers as cutting inventories, demanding quicker payment from customers, and slowing down payments to suppliers. For instance, using up old parts from inventory saves cash but doesn't boost net income, because accountants deduct parts costs from revenue at the time a sale is booked. Circuit City Stores Inc. (CC ) of Richmond, Va., for example, has cut inventories by getting suppliers to deliver more often in smaller lots. And it's slowing payments--forking over the money when it's owed, but no earlier.

Such squeeze tactics are not the only source of cash for companies. Yet another is slashing capital spending: Orders for new capital equipment fell more than 11% in September. Companies are also cutting dividends, slowing or ceasing stock buybacks, and forgoing acquisitions by cash. All of those measures help cash flows, but they don't do a thing for net income. As another tactic to increase liquidity, corporations are issuing lots of debt: They sold a record $29.7 billion in bonds in the week ended Oct. 26, according to Dealogic CommScan LLC.

The companies in the best shape, though, are those that can generate plenty of cash through operations. United Technologies Corp. (UTX ) CEO George David says that the company's strong credit rating allows it to sell more jet engines because it can extend credit to hard-pressed airlines. Of course, that places an extra burden on the company's finances. To make up for the hit from its concessions to the airlines, David says, United Technologies is cutting capital spending and may postpone some acquisitions. It added $408 million in cash in the third quarter.

While some companies, notably in the telecom industry, built up enormous amounts of debt in the fat years of the late 1990s, others used the good times to clean up their balance sheets. For instance, Gary M. Pfeiffer, chief financial officer of DuPont Co. (DD ), says the company has been able to reduce capital spending by getting better use out of the equipment it already owns. Partly as a result, Pfeiffer says, DuPont has its strongest balance sheet in 25 years despite the worst market in 25 years.

But for young tech companies experiencing their first slump, paying attention to mundane items such as working capital and cash flow is a whole new experience. In early 2000, Palm Inc. (PALM ) of Santa Clara, Calif., was getting beaten up for not meeting demand for its handheld computers, which was growing 100% a year. Now its shares are off 96% from their peak and it's losing money. So Palm has gotten tough with itself. It cut production even more than final sales dropped, so inventories have been shrinking rapidly. That helps cash flow because it's earning revenue without having to buy parts. Palm Inc. executives are so focused on cash that they get daily updates on it from their wireless Palm VIIx handhelds.

Cutting back on share repurchases is one of the simplest ways to improve cash flow. But companies usually do it with a wince--after all, a year or so ago, they were buying shares by the truckload when they were far more expensive. Boeing Co. (BA ) suspended its repurchases after September 11 as part of a cost-savings program that included laying off 20,000 to 30,000 workers. R.R. Donnelly & Sons Co. (DNY ), the world's largest commercial printer, has completed only little more than half of a planned $300 million repurchase program for the year 2001. Its magazine-, catalog-, and prospectus-printing work has slumped. Says CEO William L. Davis: "With a lot of economic uncertainty, we must work hard to protect and preserve cash flow."

REVERSE EFFECT. To be sure, some things companies do to conserve cash in the medium term can actually force bigger outlays in the current quarter. Layoffs, for example, sometimes require big severance payments. For many small companies, moreover, the options for protecting cash are limited. They often can't borrow or sell stock in a downturn. They're also the most likely victims when the big guys squeeze suppliers, notes Aswath Damodaran, a finance professor at New York University's Stern School of Business. "It's the bottom 10% or 20% of companies that are most at risk," he says.

Not to mention another problem: Corporate efforts to save cash aren't an unalloyed benefit for the economy. For every company that cuts capital spending or stretches out its payments, there's another that's not making a sale or not getting its money quickly. Indeed, vigorous efforts to preserve cash are exacerbating the downturn, says Edward E. Yardeni, chief investment strategist at Deutsche Banc Alex. Brown Inc. "It's the law of unintended consequences. What makes sense for any individual company makes a mess for all of them collectively," Yardeni says.

Still, when times get tough, hard-pressed companies don't stop to worry about the collective good. That's why so many of them are zeroing in on cash--and producing gains that don't always show up on the P&L statement.

Corrections and Clarifications In "Up a creek--with lots of cash" (News: Analysis & Commentary, Nov. 12), BusinessWeek incorrectly said that R.R. Donnelley & Sons Co. was the world's largest commercial printer. That distinction belongs to Quebecom World Inc. of Montreal, with $6.5 billion in in 2000 revenues. Donnelley is No. 2, with $5,8 billion.

By Peter Coy in New York, with Michael Arndt in Chicago and bureau reports

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