The Portable MBA in Finance and Accounting, 3rd Edition

66 Understanding the Numbers

years. This might seem inconsistent with the term nonrecurring.Phillips Pe-
troleum provides the following explanation of the special items:

Net income is affected by transactions defined by management and termed spe-

cial items,which are not representative of the company’s ongoing operations.

These transactions can obscure the underlying operating results for a period

and affect comparability of operating results between periods.^33

While Phillips Petroleum uses specialto describe what we have referred to as
nonrecurring,the above description of its special items is consistent with ear-
lier discussion in this chapter.
Phillips provided the following discussion of the effects of the informa-
tion in Exhibit 2.22 on net income:

Phillips’s net income was $609 million in 1999, up 157 percent from net income

of $237 million in 1998. Special items benefited 1999 net income by $61 mil-

lion, while reducing net income in 1998 by $138 million. After excluding these

items, net operating income for 1999 was $548 million, a 46 percent increase

over $375 million in 1998.^34

The above comments reveal a sharply lower growth in profit in 1999 after ad-
justing for the effects of the nonrecurring (special) items. A 157% increase in
net income drops to 46% after adjustment for the nonrecurring items. Notice
that the above discussion refers to the adjusted net income numbers as the “net
operating income.” This is consistent with the characterization of the special
items as “not representative of the company’s ongoing operations.” Neverthe-
less, we will continue to use the term sustainableto refer to earnings that have
been adjusted for nonrecurring items.
Presenting information on nonrecurring items in MD&A schedules is still
a fairly limited practice but may be on the rise.^35 Though helpful in locating
nonrecurring items, such schedules must be viewed as useful complements to
but not substitutes for a complete search and restatement process. Textual dis-
cussion and disclosure of the effects on nonrecurring items on earnings is far
more common than user-friendly schedules. The disclosures of C.R. Bard Inc.
are illustrative:

In 1999, Bard reported net income of $118.1 million or diluted earnings per

share of $2.28. Excluding the impact of the after-tax gain on the sale of the car-

diopulmonary business of $0.12 and the impact of the fourth quarter write-

down of impaired assets of $0.11, diluted earnings per share was $2.27.^36

Bard included information on revised results for each of the three years in-
cluded in its 1999 annual report. The adjusted earnings-per-share series pro-
vides a better indicator of underlying trends in operating performance and is a
more reliable base on which to develop projections of future earnings. The as-
reported and revised earnings-per-share information is summarized in Exhibit
2.23. As is common, the adjusted earnings, from which the effects of nonre-
curring items have been removed, are less volatile.