Chapter 9

Scouring the Notes to the Financial Statements

In This Chapter

Describing the notes and their importance

Understanding the fine print of accounting methods

Finding out about financial commitments

Getting acquainted with mergers and acquisitions

Reading notes about pensions and retirement

Detailing segmented businesses and significant events

Keeping an eye out for red flags

Would you ever sign an important contract without reading the fine print first? I didn't think so. Remember this philosophy when you read financial statements because the corporate world certainly doesn't escape the cliché about sweeping ashes under the rug. Hiding problems in the notes to the financial statements is a common practice for companies in trouble.

In this chapter, I explain the role of the notes as part of the financial statements, I discuss the most common issues addressed in the notes, and I point out some key warning signs that raise a red flag if you see them mentioned in the notes. And to help you become a note-reading expert, I refer to the financial reports of Hasbro and Mattel (both toy companies) throughout the chapter. (You can view their complete annual reports at www.hasbro.com and www.mattel.com.)

When searching for a company's financial reports on its website, first find the corporation information section. Within that section, you find the investor-relations section, which contains links to the company's annual and quarterly reports.

Deciphering the Small Print

Figuring out how to read and understand the small print of the notes to the financial statements can be a daunting task. Most times, companies present these notes in the least visually appealing way and deliberately fill them with accounting jargon so they're hard for the general public to understand. By making these notes so difficult to decipher, companies fulfill their obligations to the Securities and Exchange Commission (SEC) to give the required financial report to the reader, but at the same time, they make it hard for the reader to actually understand the information presented.

But don't give up. These notes contain a lot of important information that you need to know, including accounting methods used, red flags about a company's finances, and any legal entanglements that may threaten the company's future. I point out the key sections of the notes to the financial statements and what types of information to pluck out of these sections.

The first indication of the notes to the financial statements appears at the bottom of the financial statements. You see an indication that the accompanying notes are an integral part of the statement. In the same small print, you find the actual notes on numerous pages after the financial statements.

The information on the financial statement is just a listing of numbers. To really analyze how well a company is doing financially, you need to understand what the numbers mean and what decisions the company made to get the numbers. Sometimes a line item refers you to a specific note, but most times, you see only a general reference to the notes at the bottom of the statement.

The notes have no specific format, but you're likely to find at least one note regarding several key issues in every company's financial report. Read on to find out what these key issues are.

Accounting Policies Note: Laying out the Rules of the Road

The first note in almost every company's financial report gives you the ammunition you need to understand the accounting policies used to develop the financial statements. This note explains the accounting rules the company used to develop its numbers. The note is usually called the “Summary of significant accounting policies.” Issues discussed in this note include:

• Asset types: The types of things the company owns. (See Chapters 4 and 6 for more information on assets.)
• Method of valuation: How the company values its assets. (See Chapters 4 and 6 for more information on valuation.)
• Methods of depreciation and amortization: The methods the firm uses to show the use of its assets. (See Chapters 4 and 6 for more information on depreciation and amortization.)
• How revenue and expenses are recognized: How the company records the money it takes in from sales and the money it pays out to cover its expenses. (See Chapters 4 and 7 for more information on revenue and expenses.)
• Pensions: The obligations the business has to its current and future retirees.
• Risk management: What the company does to minimize its risk.
• Stock-based compensation: Employee incentive plans involving stock ownership.
• Income taxes: The company's income tax obligations and the amount the company paid in taxes.

Carefully read the summary of significant accounting policies. If you don't understand a policy, research it further so you can make a judgment about how this policy may impact the company's financial position. You can either research the issue yourself on the Internet or call the company's investor relations office to ask questions. Also, compare policies among the companies you're analyzing. You want to see whether the differences in the ways companies handle the valuation of assets or the recognition of revenues and expenses make it more difficult for you to analyze and compare the results.

For example, if companies use different methods to value their inventory, this can have a major impact on net income. I explain the impact of inventory valuation on net income in Chapter 15. Many times, you don't actually have enough details to make apples-to-apples comparisons of two firms that use different accounting policies, but you need to be aware that the policies differ as you analyze the companies’ financial results, and be alert to the fact that you may be comparing apples to oranges.

Depreciation

One significant difference in accounting policies that can affect the bottom line is the amount of time a company allows for the depreciation of assets. One company may use a 15- to 25-year time frame, and another may use a 10- to 40-year span. The time frame used for depreciation directly impacts the value of the assets, which is recorded on the line item of the balance sheet called Cost less accumulated depreciation. A faster depreciation method reduces the value of these assets more quickly.

Depreciation expenses are also deducted from general revenue. A company that writes off its buildings quickly — say, in 25 years rather than up to 40 years — has higher depreciation expenses and lower net income than a company that takes longer to write off its buildings. I discuss how depreciation works in greater detail in Chapter 4.

Revenue

You can find some noteworthy differences between companies by reading the revenue recognition section of the summary of significant accounting policies. Differences regarding the timing of revenue recognition can impact the total revenues reported. For example, one company may recognize revenue when a product ships to the customer. Another company may recognize revenue when the customer receives the product. If products are shipped at the end of the month, a company that includes shipped products may include the revenue in that month, but a company that recognizes revenue only when products are received may not include the revenue until the next month.

Other revenue-recognition differences to pay attention to include the following:

• Sales price: Some companies sell products with a fixed sales price, but others indicate that prices aren't fixed and are determined between the company and the customer.
• Collectibility: Some companies may indicate that whether they report income depends on whether all the revenue is likely to be collected. Successful collection can depend on the business environment, a customer's financial condition, historical collection experience, accounts receivable aging, and customer disputes. If collectibility is uncertain, the revenue isn't reported. I talk more about accounts receivable collections and how to analyze them in Chapter 16.

Expenses

Expenses differ widely among companies. As you read this part of the accounting policies note, be sure to notice the types of expenses the company chooses to highlight. Sometimes the differences between companies can give you insight into how the companies operate. Here are two key areas where you may see differences in how a company reports expenses:

• Product development: Some companies develop all their products in-house, whereas others pay royalties to inventors, designers, and others to develop and market new products. In-house product development is reported as research and development expenses.
• If the company develops new products primarily by using outside sources, these expenses are in a line item for royalty expenses.
• Advertising: Some companies indicate that all advertising is expensed at the time the advertising is printed or aired. Others may write off advertising over a longer period of time. Companies that depend on catalog sales typically spread out their ad expenses over several months or even a year if they can prove that sales continued to come in during that longer period of time.

As you compare two firms’ financial reports, look for both the similarities and differences in their accounting policies. You may need to make some assumptions regarding the financial statements, to compare apples to apples when trying to decide which company is the better investment. For example, if the companies depreciate assets differently, you must remember that their asset valuations aren't the same, nor are their depreciation expenses (based on the same assumptions).

Sometimes you find a special note when a significant event impacts company operations. Such an event did occur for Mattel, and it's reflected in a special note entitled “Note 4 — Product Recalls and Withdrawals.” During 2007, Mattel had several major recalls because of defective products manufactured in China. In response to these recalls, Mattel wrote:

• As a result of third quarter 2007 recalls, Mattel intentionally slowed down its shipments out of Asia while it conducted extensive product testing in the third quarter 2007. Also, export licenses at several manufacturing facilities in China were temporarily suspended in September 2007 while safety procedures were reviewed, but all licenses were in place on December 31, 2007. Mattel's ability to import products into certain countries was also temporarily impacted by product recalls as certain countries and regulatory authorities reviewed Mattel's safety procedures; however, these import and export issues were largely resolved early in the fourth quarter of 2007 and did not have a significant financial impact on Mattel's 2007 results.

Although Mattel states the recalls didn't have a significant impact on its bottom line, costs to straighten out this mess legally and administratively totaled $42 million, according to Note 4. Product recalls cost the company another $68.4 million. Luckily for Mattel, the company was able to put a fix in place before its key fourth-quarter sales period during the holiday season. Otherwise, some popular Mattel toys may not have been available for Christmas and Chanukah shoppers. But that $110.4 ($42 + $68.4) million equaled about 18 percent of Mattel's net income of about $600 million, which, to me, seems like a significant impact.

Figuring out Financial Borrowings and Other Commitments

How a company manages its debt is critical to its short- and long-term profitability. You can find out a lot about a company's financial management by reading the notes related to financial commitments.

You always find at least one note about the financial borrowings and other commitments that impact the short- and long-term financial health of the company.

Mattel has one note that summarizes everything under one umbrella called “Seasonal financing and long-term debt.” Hasbro splits this note into two. One is called “Financing arrangements,” for the short-term borrowings and other special arrangements, and the second is called “Long-term debt.”

No matter how a company structures its notes related to financial borrowings and other commitments, as you read the notes, break the information into two piles: long-term borrowings and short-term borrowings. The long-term borrowings involve financial obligations of more than one year, and the short-term borrowings involve obligations due within the 12-month period being discussed in the financial report.

Long-term obligations

For accounting purposes on the financial statements, only two types of debt are recognized: current debt and long-term debt. Current debt is due over the next 12 months, and long-term debt includes debt that a company must pay during any period beyond the next 12 months. Both medium- and long-term notes or bonds fall into the long-term debt category. Medium-term notes or bonds are debt that a company borrows for two to ten years. Long-term notes or bonds include all debt borrowed for more than ten years.

In the discussion of long-term financial debts, you find two key charts. One chart shows the terms of the borrowings, and the other shows the amount of cash that the company must pay toward this debt for each of the next five years and beyond.

Table 9-1 shows Mattel's long-term debt.

Table 9-1 Mattel's Long-term Debt

If a company is managing its debt well, it frequently looks for opportunities to lower its interest expenses. Because interest rates have dropped considerably, when you see interest rates on these charts that are significantly higher than interest rates available in the current market environment, you need to wonder whether the company is doing a good job of managing its debt.

Table 9-2 shows Hasbro's long-term debt information.

Table 9-2 Hasbro's Long-term Debt (Carrying Cost)

I take a closer look at this issue and how it impacts the companies’ liquidity in Chapter 12. I also show you how potential lenders analyze a company's borrowing habits.

Short-term debt

Short-term debt can have a greater impact than long-term debt on a company's earnings each year, as well as on the amount of cash available for operations. The reason is that companies must pay short-term debt over the next 12 months, whereas for long-term debt, they must pay only interest and some of the principal in the next 12 months.

The type of short-term debt you see on a firm's balance sheet varies greatly, depending on the type of business. Companies whose sales are seasonal may carry a lot more short-term debt to get themselves through the slow times than companies that have a consistent cash flow from sales throughout the year.

Seasonal companies carry large lines of credit to help them buy or produce their products during the off-season times so they can have enough product to sell during the high season. For example, a company that sells toys sells most of its product during the Christmas or other peak toy-selling seasons; during the other times of the year, it has very low sales. So Mattel and Hasbro — both toy companies with significant seasonal financing needs — maintain large lines of credit to be ready for Christmas and peak toy-selling seasons.

Another way that firms raise cash if they don't have enough on hand is to sell their accounts receivable (credit extended to customers). A company can sell the receivables to a bank or other financial institution and quickly get cash for immediate needs instead of waiting for the customers to pay. I talk more about accounts receivable management in Chapter 16.

Be sure to look for a statement in the financial obligations notes that indicates how the company is meeting its cash needs and whether it's having any difficulty meeting those needs. Some companies use “financial obligations” in the title of the note; others may have one note on short-term debt obligations and another on long-term debt obligations.

Lease obligations

Instead of purchasing plants, equipment, and facilities, many companies choose to lease them. You usually find at least one note to the financial statements that spells out a company's lease obligations. Many analysts consider lease obligations to be just another type of debt financing that doesn't have to be shown on the balance sheet. Whether the lease is shown on the balance sheet or in the notes depends on the type of lease:

• Capital leases: These leases provide ownership at no cost or at a greatly reduced cost at the end of the lease. This type of lease appears as a long-term debt obligation on the balance sheet.
• Operating leases: These leases offer no ownership provisions or provisions that require a considerable amount of cash to purchase the leased item. This type of lease is mentioned in the notes to the financial statements but doesn't appear on the balance sheet as debt.

Companies that must constantly update certain types of equipment to avoid obsolescence use operating leases rather than capital leases. At the end of the lease period, the companies return the equipment and replace it by leasing new, updated equipment. Operating leases have the lowest monthly payments.

When reading the notes, be sure to look for an explanation of the types of leases the company has and what percentage of its fixed assets are under operating leases. Some high-tech companies have larger obligations in operating-lease payments than they do in long-term liabilities. When calculating debt ratios (ratios that show the proportion of debt versus the type of asset or equity being considered; I show you how to calculate debt ratios in Chapter 12), many analysts use at least two-thirds, and sometimes the entire amount, of these hidden operating-lease costs in their debt-measurement calculations to judge a company's liquidity.

When you see operating leases that total close to 50 percent of a firm's net fixed assets or that exceed the total of its long-term liabilities, be sure to use at least two-thirds of the obligations, if not all the payments, in your debt-measurement calculations. The fact that these obligations are only mentioned in the notes to the financial statements doesn't negate their potential role in creating future cash problems for the company.

Mergers and Acquisitions: Finding Noteworthy Information

Sometimes one company decides to buy another. Other times, two companies decide to merge into one.

If a company acquires another company or merges during the year the annual report covers, a note to the financial statements is dedicated to the financial implications of that transaction. In this note, you see information about

• The market value of the company purchased
• The amount paid for the company
• Any exchange of stock involved in the transaction
• The transaction's impact on the bottom line

When a company acquires another company, it frequently pays more for that acquisition than for the total value of the purchased company's assets. The additional money spent to buy the firm falls into the line item called Goodwill. Goodwill includes added value for customer base, brand name, locations, customer loyalty, and intangible factors that increase a business's value. If a company has goodwill built over the years from previous mergers or acquisitions, you see that indicated on the balance sheet as an asset. I discuss goodwill in greater detail in Chapter 4.

In an acquisition, the acquired company's net income is added to the parent company's bottom line. This addition occurs even if the closing of the sale takes place at the end of the year. Many times, this addition can inflate the bottom line and make the net income look better than it actually will be when the companies are fully merged. Be sure to look closely at the impact any mergers, acquisitions, or even sales of parts of an acquired company have on net income.

A merger or acquisition may positively impact the bottom line for a year or two, and then the company's performance drops dramatically as it sorts out various issues regarding overlapping operations and staff. Many times, the announcement of a merger or acquisition generates excitement, causing stock prices to skyrocket temporarily before dropping back to a more realistic value. Don't get caught up in the short-term euphoria of a merger or acquisition when you're considering the purchase of stocks. Read the details in the notes to the financial statements to find out more about the true impacts of the merger or acquisition transaction.

Pondering Pension and Retirement Benefits

You may not think of pension and other retirement benefits as types of debt, but they are. In fact, for most companies that offer pension benefits, the amount of money they owe their employees is higher than the amount they owe to bondholders and banks. Some companies offer both pensions (which are an obligation to pay retirees a certain amount for the rest of their lives after they leave the company) and other retirement benefits (which include contributions to retirement savings plans such as 401(k)s or profit-sharing plans).

When looking at the note about pensions and other retirement benefits, find out which type of plan the company offers:

• Defined benefit plan: The company promises a retirement benefit to each of its employees and is obligated to pay that benefit. This type of plan includes traditional retirement plans, in which employees get a set monthly or annual benefit from the company after retirement.

  Defined benefit plans carry obligations for the firm for as long as an employee lives — and sometimes for as long as both the employee and his spouse live. Determining how much that benefit will cost in the future is based on assumptions regarding how much return the company expects from its retirement portfolios and how long its employees and their spouses will live after retirement. As people live longer, pension obligations become much greater for companies that offer defined benefit plans. Many companies are phasing out this type of retirement benefit.

• Defined contribution plan: The employer and employee both make contributions to a retirement plan. A 401(k) is an example of a defined contribution plan. The company isn't required to pay any additional money to the employee after the employee retires and pulls her retirement funds from the company's plan, rolling the funds into individual retirement savings or an annuity option. An annuity is a type of insurance policy that guarantees a set payment based on terms set up at the time the annuity is purchased.

In the notes to the financial statements, you find a calculation of the expected pension expense, the funding position of the plan, and the expectations for the future obligations of that plan based on complicated assumptions figured by an actuary (a statistician who looks at life span and other risk factors to make assumptions about the company's long-term pension obligations). Insurance companies commonly use actuaries to determine costs for life, health, and other insurance products.

In the pension and retirement benefits note, you find a chart that shows the annual payments the company is currently making to retirees. If you see these payments increasing more rapidly each year, it may be a sign of a long-term problem for the business. Companies need to provide a table that shows the current plan assets at fair value and projects their ability to meet pension obligations in the future.

You need to compare certain figures that companies use in calculating their estimates for pension obligations. Companies in similar industries typically use similar assumptions. Numbers to watch include the

• Discount rate: The interest rate used to determine the present value of the projected benefit obligations
• Rate of return on assets: The long-term return the company expects to earn on the assets in the retirement investment portfolio
• Rate of compensation increases: The estimate the company makes related to salary increases and the impact those increases have on future pension obligations

Each of these rates requires assumptions about unknown future events involving the state of the economy, interest rates, investment returns, and employee life spans. A company can do no more than make an educated guess. To be sure that the company's guesses are reasonable, all you can do is check that it makes guesses that are similar to the guesses of other companies in the same industry. Also look for information in the notes about whether the company's retirement savings portfolio is sufficient to meet its expected current and future pension obligations. This information is usually shown in a chart as part of the note. If the company's retirement savings portfolio falls short, it may be a red flag for future cash-flow problems.

Breaking Down Business Breakdowns

Can you imagine what it takes to manage a multibillion-dollar company? Just reading the numbers can be a daunting task. Think about how many products are sent out to make that many sales and how many people are needed to keep the business afloat.

Most major firms deal with their massive size by splitting up the company into manageable segments. This division makes managing all aspects of the business — from product development, to product distribution, to customer satisfaction — easier.

These segments help the company more easily track the performance of each of its product lines. In the notes to the financial statements, you find at least one note related to these segment breakdowns. This note gives you details about how each of the company's segments is doing, as well as the product lines that fall under each segment.

You may also find some details about these areas:

• Target markets: These markets are the key market segments that the company targets, such as age group (teens, tots, adults), locations (north, south, east, west), or interest groups (sportsmen, hobbyists, and so on). Target markets are limited only by the creativity of the marketing team, which develops the groups of customers that it wants to win over.
• The largest customers: The company usually names the top customers that buy its products. For example, a manufacturer that sells a large portion of its products to major retailers such as Wal-Mart and Target usually gives some details about these relationships. If a small number of companies make up most of the customer base, this could be a sign of a problem in the future if one of the primary customers decides to stop using the company.
• Manufacturing and other operational details: The company gives you information about how it groups its product manufacturing and where its products are manufactured. If the firm manufactures its products internationally, look for indications about problems that may have occurred during the year related to those operations. Sometimes labor or political strife can have a great impact on a company's manufacturing operations. Also, weather conditions can greatly impact manufacturing conditions. For example, if the company's manufacturing for a certain product line is in Singapore, and Singapore experienced numerous damaging storms, the company may indicate that the problem occurred and that it had difficulty producing enough product for market.
• Trade sanctions: All companies that operate internationally must deal with trade laws, which differ in every country. Some countries impose high tariffs on products coming from outside their borders, to discourage importing. Sometimes countries impose sanctions on other countries for political actions they disagree with. For example, the U.S. doesn't allow trade with Cuba for political reasons, so a business that buys products from Cuba can't import into the U.S.

If a company faces specific marketing or manufacturing problems, you also find details about these problems in the note about segment breakdowns. Don't skip over this note!

How a company breaks down its management segments varies depending on the industry and management preferences. Some companies divide into regions based on geography; others designate segments based on product lines or customer target groups.

If a company operates internationally, you usually see the U.S. market segments separated from the non-U.S. segments, and sometimes you find the international portion broken into regions, such as Europe, Asia, or the Middle East.

You don't find any hard-and-fast rules about how to segment a business. How a company segments itself depends on how the company has operated historically or what management style the company's executives adopt.

Reviewing Significant Events

Each year, every company faces significant challenges. One year, a firm may find out that its customers are suing it for a defective product. Another year, a business may get notice from a state or local government that one of its manufacturing facilities is polluting the environment.

You may also find in the notes mention of significant events that aren't related to external forces, such as the decision to close a factory or combine two divisions.

You can look in a number of places in the notes for information on significant events. Sometimes an event has its own note, such as a note about the discontinuation of operations. Other times the event is just part of a note called “Commitments and Contingencies.” Scan the notes to find significant events that impact the company's financial position. You're most likely to find significant events regarding topics such as the following:

• Lawsuits: The company may explain any pending lawsuits (usually in the “Commitments and Contingencies” note), which can sometimes have a huge impact on the company's future. For example, Dow Corning, which is owned by Dow Chemical Corporation, is still suffering financially from lawsuits by women who face significant health problems from breast implants the company made. The breast implants first hit the market in 1962. Suits were filed against the company beginning in the 1990s, when the breast implants ruptured and caused health problems. Dow Corning ended up in bankruptcy trying to settle these lawsuits.
• Environmental concerns: These concerns can become a significant event if the company is involved in a major environmental cleanup because of discharges from one of its plants. Cleanup can cost millions or even billions of dollars. For example, Exxon has paid more than $7 billion in reparations and fines for damages related to the Valdez oil spill in Alaska's Prince William Sound in 1989. BP has paid $4.5 billion in a settlement and may still be held liable for billions more, pending a civil trial, after its Deepwater Horizon oil rig exploded in the Gulf of Mexico in 2010.
• Restructuring: When a company decides to regroup its products, close down a plant, or make some other major change to the way it does business, this action is called restructuring. You usually find an individual note explaining the restructuring and how it will impact the company's income in the current year and future years.
• Discontinued operations: Sometimes a company decides not to restructure, but closes down an operation entirely. When this happens, you're likely to find a separate note on the financial impact of the discontinued operations, which likely includes the costs of closing down facilities and laying off or relocating employees.

Many times the information included in these notes discusses not only the financial impact of an event in the current year, but also any impact expected on financial performance in future years.

When a company discusses lawsuits and potential environmental liability cases in the notes, it commonly indicates that, in the opinion of management, the matter in question won't result in a material loss. Use your own judgment after reading the details that management provides. If you think the company may be facing bigger problems than it mentions, do your own research on the matter before investing in that company.

A company facing a lawsuit isn't necessarily a matter of great concern. Given the litigious nature of society, most major corporations face lawsuits annually. But sometimes these suits do raise red flags.

Finding the Red Flags

As you probably know by now, companies love hiding their dirty laundry in the small print of the notes to the financial statements. As you read through the notes, keep an eye out for possible red flags.

Whenever you see notes titled “Restructuring,” “Discontinued operations,” and “Accounting changes,” look for red flags that may mean continuing expenses for a number of years. The company may detail the costs of any of these changes. Be sure to consider long-term financial impacts that may be a drain on the company's future earnings — which may mean stock prices will suffer.

Also be on the lookout for potential lawsuits that may result in huge settlements. If you see that a lawsuit has been filed against the company, search for stories in the financial press that discuss the lawsuit in greater detail than what's included in the notes.

Significant events aren't the only sources of red flags. You may also see signs of trouble in the way the company values assets or in decisions it makes to change accounting policies. The notes involving the long-term obligations the company has to its retirees may also be a good spot to find some potential red flags.

The financial press often mentions red flags that analysts spot in companies’ financial reports. Read the financial press to pick up the potential problem spots, and look for the details in the financial statements and the notes to those statements.

Finding out about valuing assets and liabilities

Valuing assets and liabilities leaves room for accounting creativity. If assets are overvalued, you may be led to believe that the company owns more than it actually does. If liabilities are undervalued, you may think the company owes less than it actually does. Either way, you get a false impression about the company's financial position.

When you don't understand something, ask questions of the firm's investor relations staff until they present the information in a manner that you understand. If you're confused about the presentation of asset or liability valuation, I guarantee that other financial readers are confused as well. I often find that the more convoluted a company's explanation is, the more likely you are to find out that the company is hiding something.

Considering changes in accounting policies

How a company puts together its numbers is just as critical as the numbers themselves. The accounting policies the company adopts drive these numbers. Whenever a firm indicates in the notes to the financial statements that it's changing accounting policies, your red flag needs to go up. I discuss the key accounting policies and how they can impact income in the section “Accounting Policies Note: Laying out the Rules of the Road,” earlier in this chapter. You can find more details about accounting policies in Chapter 4.

Changes in accounting policies aren't always a sign of a problem. In fact, many times, the change is related to requirements the Financial Accounting Standards Board (FASB) or the SEC specifies. Regardless of the reason for the change, be sure you understand how that change impacts your ability to compare year-to-year or quarter-to-quarter results.

If you see a change in accounting methods, but you don't see an indication that the FASB or SEC required it, dig deeper into the reasons for the change and find out how the change impacts the valuation of assets and liabilities or the company's net income. You can find some explanation in the accounting policies note, but if you don't understand the explanation there, call the investor relations department and ask questions.

Decoding obligations to retirees and future retirees

As noted in the “Pondering Pension and Retirement Benefits” section earlier in this chapter, obligations to retirees and future retirees can be a bigger drain on a company's resources than debt obligations. The note to the financial statements related to pension benefits is probably one of the most difficult to understand. Look specifically at the charts that show the company's long-term payment obligations to retirees and the cash available to pay those obligations. If you find any indication that the company may have difficulty meeting the obligations mentioned in either the text of this note or the charts, it may be a sign of a major cash flow problem in the future. Don't hesitate to call and ask questions if you don't understand the presentation.