TOPICS IN INTERNATIONAL
MANAGEMENT
Atkinson Graduate School of Management
Willamette University
Dean Gardner
CFO, International Garden Products, Inc.
Partner, Tatum, LLC
February 26, 2008
Dean Gardner
• BBA in Marketing; MBA in Finance; both from
The University of Texas at Austin.
• Schlumberger Ltd.; 14 years; Internal Audit,
Controllership, Treasury, Tax; Europe, Africa,
North and South America.
• Tektronix, Inc.; 4 years; Pacific Asia CFO in
Hong Kong; VP CFO of Video Division.
• Mitsubishi Silicon America; 3 years; CFO.
• Tatum LLC, 5 years; Interim CFO for Electronic
Arts and nLight Photonics; Executive Consultant
(Sarbanes Oxley 404) for TriQuint
Semiconductor; CFO for International Garden
Products.
TOPICS FOR DISCUSSION
• Revenue Recognition
• Transfer Pricing
• Foreign Currency Risk
• Foreign Corrupt Practices Act
• Questions?
REVENUE RECOGNITION
• When is a sale really a sale?
• Why does it matter?
ELEMENTS OF A SALE
• Has the customer asked for the product or
service?
• Has the product been shipped or the
service completed?
• In the case of a product sale, has the risk
of ownership passed to the customer?
• Will the customer pay for the product or
service within customary credit terms?
• Was the revenue recognized within cutoff?
WHY IT MATTERS
• “Phantom” sales can lead to a jail cell and to a
decline in the company’s market value.
• Customer relations will suffer if they receive
unsolicited product and invoice.
• Revenue recognized “out of period” is not
properly matched with costs.
• “Channel Stuffing” causes ill will and problems
with inventory returns.
• Extended credit terms causes cash flow
problems.
TRANSFER PRICING
• What is transfer pricing?
• Why does “getting it right” matter?
• How do you get it right?
TRANSFER PRICE DEFINITION
• A transfer price is the price that a company
charges a related company in another country
for a product or service.
• Example: GM USA in Detroit produces and sells
an engine transmission system to GM China.
GM China builds the transmission into a GM
automobile and sells the car in China. The
transfer price charged by GM USA is a sale
(revenue) for GM in the USA. The transfer price
paid by GM China is a cost of goods sold (the
GM car) in China.
WHY DOES IT MATTER?
• If the transfer price is too high:
– GM USA is overstating the profit on the sale in
the USA, making the IRS happy.
– GM China may be paying higher Chinese
customs duties on the inflated price.
– GM China is understating the profit on the
sale of the car in China, due to the overstated
cost of the transmission, making the Chinese
tax authorities unhappy.
WHY DOES IT MATTER?
• If the transfer price is too low:
– GM USA is understating the profit on the sale
in the USA, making the IRS unhappy.
– GM China may be paying lower customs
duties on the understated price, making
Chinese tax authorities unhappy.
– GM China is overstating the profit on the sale
of the car in China, due to the understated
cost of the transmission, making the Chinese
tax authorities happy.
GETTING IT RIGHT
• GM needs to understand its tax position in the USA and
China (effective tax rates, accumulated losses, customs
duties rates, etc.).
• GM needs to decide on what a “reasonable” and
“supportable” margin on the sale is, both in the USA and
China.
• The price charged by GM USA should be supportable by
either equivalent “arm’s length” pricing (example: what
would GM sell that transmission to Volkswagen for?) or
by an equivalent “arm’s length” margin (example: what
implied margin would Ford or Toyota make on the sale of
that transmission, as part of a car, in China).
FOREIGN CURRENCY RISK
• What is foreign currency risk?
• Why does it matter?
• What can you do?
WHAT IS FX RISK?
• When a company conducts business
transactions (buying, selling) in a currency
other than the one that it reports its
financial results in (its Functional
Currency), it runs the risk of reporting
results that are better or worse than
expected when the exchange rate
between the two currencies changes.
WHY DOES IT MATTER?
• Langeveld Bulb Co., previously part of
International Garden Products, purchases,
processes and packages flower bulbs in
Holland; all Euro based costs.
• Langeveld imports these packages of bulbs into
the USA and sells them to Costco, Wal*Mart,
Home Depot and Lowes in US dollars.
• Langeveld’s functional currency is USD. What
happens when the Euro gains 50% in value
versus the dollar and cost increases are
impossible to pass on to the big retailers? A
disaster!
IGP BULB EXAMPLE
• Before the devaluation: sold bulbs to Lowes for
$100 and a cost of $60 for a gross margin of $40
(40%). This was a very profitable business.
• After the 50% devaluation: Langeveld could be
selling bulbs to Lowes for $100 and a cost of
$90 for a gross margin of $10 (10%).
• This actually happened to Langeveld’s $80
million/year bulb business from 2002 to 2008!
Langeveld took steps to reduce the devaluation
impact on the gross margin, but could never
regain all the lost ground.
WHAT CAN YOU DO?
• Purchase Euro currency forward to try and lock in an
exchange rate for your Dutch purchases and expenses
(financial hedge).
• Try to grow bulb sales into the European market to the
equivalent size of your US business (natural hedge).
• Try to source bulbs outside of the Euro area (limited
success).
• Shift as much production and production costs as
possible from Holland to the USA.
• Try to pass on all of your incremental costs to your
customers in the USA (not a realistic strategy!).
• Do nothing and wait for the dollar to strengthen against
the Euro (don’t try this one, either!).
WHAT IS THE FCPA?
• Law passed by the US Congress designed to address bribery and
other corrupt practices by US businesses outside of the USA.
• The law covers all companies, including foreign companies, who
have securities registered in the USA. It also covers all individuals
who are citizens, nationals or residents of the USA as well as private
companies operating under the laws of the USA.
• The law requires transparent accounting: complete accounting and
adequate descriptions of ALL transactions carried out by a business.
• The law prohibits making a payment to any foreign official for the
purpose of obtaining or retaining business for or with, or directing
business to any person. There is no materiality level.
• The FCPA does not prohibit the making of facilitating or “grease”
payments if they are customary and not against local laws. The
primary distinction is that grease payments are made to an official to
expedite his performance of the duties he is already bound to
perform.
• Discussion of my actual experiences with FCPA issues.
QUESTIONS AND
DISCUSSION
THANK YOU!