Delta Capital-Return Plan Puts Focus on Cash Flow

A brief introduction

Delta Airlines initiated a shareholder cash return plan in its capital deployment strategy announced Wednesday, May 8. The carrier will be paying out a quarterly dividend of 6 cents a share beginning Sept. 10 for shareholders on record as of Aug. 9.

At the end of the first quarter, Delta had 855 million shares outstanding, and will be paying out dividends worth approximately $50 million every quarter or $200 million every year at the current payout rate. In addition, the carrier announced a share buyback program worth $500 million that ends in June 2016. Together, through these two channels, Delta plans to return over $1 billion to its shareholders over the next three years.

Accounting Effects

According to this estimation, there are several journal entries need to be recorded for dividends payments and stock repurchase.

Dr. Cash Dividend (-RE)               $200,000,000

Cr. Dividend Payable (+L)                $200,000,000

Dr. Dividend Payable (-L)             $200,000,000

Cr. Cash  (-A)                                    $200,000,000

(Dividend assumed to be paid next year)

Assume that Delta will buyback its stocks evenly next three years, so it needs to pay $500,000,000/3=$16,666,666.67 for stock repurchasing.

Dr.   Treasury Stock (-CC)            $16,666,666.67

Cr. Cash (-A)                                     $16,666,666.67

 

Reasons for Delta Capital-Return Plan

It is most probably that Delta wants to send out a positive message to investors. These developments send out a positive message to the investor community that Delta has sufficiently de-leveraged and therefore de-risked its balance sheet and that it sees stable earnings in the foreseeable future.

Dividends payment would less the Retained Earnings and stock repurchase would decrease the number of shares outstanding, thus it might boost the price by increase the market demand for its stock and can also increase the EPS, which can offset the diluted effect due to the dividend payment.

 

Public Concerns

However, Delta’s stock price plummet from $18.57 to $ 17.70 (4.68% decrease) on May 9th and just rebounded a little higher at $18.64 on May 16th, which reflects that the public suspend on the effect of its plan. 

It can affect its liquidity because a big chunk of free cash flow would be used for dividends payment and buybacks;

The cash paid plan would make Delta vulnerable to the market changes such as fuel prices increase and lower prices from competitors.

It has witnessed a volatile past and Delta’s stock price just recovered. Put forward such strategy can bring more uncertainty and risks for its future.

Given all these analyses, can Delta afford its plan to return capital? The airline will have to maintain stable operating cash flows to be able to make pension contributions and give cash back to shareholders.

Source:

http://blogs.wsj.com/cfo/2013/05/08/delta-capital-return-plan-puts-focus-on-cash-flow/

 

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How Apple increased its stock price

Many investors and financial analysts claim that Apple’s stock price is significantly undervalued. The stock price could be much higher if the company did not hold a significant amount of cash ($145 billion) on which it receives very low return. If the company used this cash to pay dividends instead, the shareholders could put this money to better use. Consequently, the stock price would increase.

There is  reason why Apple doesn’t want to return all the cash to shareholders. Significant parts of the cash (about two thirds) is held abroad in lower-tax jurisdictions. Thus, if Apple decides to pay dividends, it will need to transfer these funds to the United States and pay US taxes on this income. Instead, the company expects that there will be federal tax relief in the future and it will be possible to avoid this extra taxation.

The company has found a solution. For the first time in nearly two decades, Apple has issued bonds raising $17 billion. The bonds’ interest rates are almost as low as the interest on the debt of the United States Treasury. The funds from the bond issuance will help finance buying back the company stock and paying dividends to shareholders to the tune of $100 billion in total.

This decision helps Apple meet shareholder expectations while at the same time avoiding a potentially big tax hit. Since the announcement of the dividends, Apple stock price has risen by 10%.

Sources:

1) Unusual Moves in Confronting Apple’s Huge Pile of Cash, STEVEN M. DAVIDOFF, FEBRUARY 12, 2013, http://dealbook.nytimes.com/2013/02/12/unusual-moves-in-confronting-apples-mountain-of-cash/

2) To Satisfy Its Investors, Cash-Rich Apple Borrows Money, PETER LATTMAN AND PETER EAVIS, APRIL 30, 2013, http://dealbook.nytimes.com/2013/04/30/apple-raises-17-billion-in-record-debt-sale/

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Delta Initiates Dividend, Stock Buyback

On Wednesday, Delta Airline announced a major turnaround. The company initiated dividend payout of roughly 1.35% annual yield and authorized $500M stock repurchase program or about 3% of its current market capitalization. The news highlights the improving condition of the airline industry as a whole. While many airlines are still struggling to return to profitability seen in the late 1990s when dividend payments and stock buybacks were common practice, recently several large air carriers have made similar moves. In an effort to return value to shareholders, Alaska Air Group authorized shares buyback and Southwest Airlines did both: initiated dividend payouts and share repurchases.

At an investor meeting in New York, Delta announced that it expects higher earnings capacity and improved cash flow. Recently, its chief executive also pointed out improved balance sheet and highlighted company’s debt that stood at $10B versus $17B just four years ago. The company plans to further reduce its debt burden and anticipates additional repurchase initiatives going forward.

While Delta shares have rallied 52% this year, the move failed to impress investors. The shares of the company were 5% lower the day after the announcement.  It is unclear whether other airlines will follow suit, but with the falling gas prices and improving US macro-economic data the future of the airline industry is looking brighter.

Source:

http://online.wsj.com/article/SB10001424127887324244304578470681886203740.html?KEYWORDS=buyback

 

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What would you do with 40 Billion in Cash?

We’ve all seen the headlines. Samsung is back and better than ever. Its cash and cash equivalents grew from approximately $22 billion in 2010 to 40 billion in 2013 with the help of its latest smartphone release, the Samsung’s Galaxy S4 in April 2013. Nothing left to do but celebrate right? You’re wrong. As the late rapper Biggie Smalls once said “the more money we come across the more problems we see”, and Samsung is no different.

Here is where the problem lies. As a stockholder in a company that has considerably increased its profits, I will undoubtedly seek a higher return on my investment in the form of an increase on dividends. We’ve seen this situation most recently with Apple shareholders. They began requesting an increase on dividends because Apple amassed a stockpile of $145 billion in retained earnings, while paying shareholders less than $3 per share.

With Apple’s news still fresh in the minds of Samsung investors, Samsung is now placed in a difficult position. Should they increase dividends that are currently “1% of the share price”, resume stock buybacks that haven’t occurred since 2007, acquire other companies, or focus on R&D for future projects.

According to an official at Samsung it is the latter. In prior years Samsung reinvested a significant amount of money in areas that would create future profits. Although their profits increased from 2011 to 2012, they kept spending relatively the same amount, approximately $16 billion on capital expenditures in both years. This has also contributed to their increase in Retained Earnings.

Hong Kong Based Analyst, Mark Newman predicts that Samsung will use their stockpile of cash for a large acquisition and stock buyback. I’m no expert but I do agree with Mr. Newman’s second prediction. If Samsung doesn’t want an Apple sized problem on its hands it better start showing shareholders the money.

Bibliography

  • Wakabayashi, Daisuke, and Min-Jeong Lee. “Samsung’s Sweet Problem? Nearly $40 Billion in Cash.” Wall Street Journal [New York] 8 May 2013: B1+. Print.
  • Svensson, Peter. “Apple to Dole out $100B to Shareholders.” Yahoo! News. Yahoo!, 23 Apr. 2013. Web. 08 May 2013.

 

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Nice Visualization on Apple’s Revenues

This is an awesome way visualize every dollar coming into Apple and going out.

See the little developer payment in the lower right? That’s a billion right there. I stared at this for 20 minutes and am still in awe.

(Bigger version available here: http://imgur.com/fpGeLbd)

fpGeLbd

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What Becomes of a Broken Start-up

 

Here’s an article from valleywag.com, a Gawker product covering Silicon Valley, detailing what one poor sap happened to collect from his investment in Meez.com. Who would have thought that a business model consisting of paying for avatars and virtual coins could never sustain itself? (More after the entry)…

 

This Is What It Looks Like When You Lose All of Your Startup Money

Well, technically not all of it. After working as a programmer for online gaming community Meez.com, our tipster saw his scoop of the corporate money sundae reduced by 8,000,000 to 1, leaving him with just a little more than it cost to mail him this check. “Sometimes you win,” he told us, “but you rarely hear about the losers.”

Meez was never a terrific idea, nor a particularly original one—users were encouraged to customize a cartoonish 3D avatar and purchase virtual good with “coinz”—in turn purchased by dollars. Sound familiar?

It might’ve been cutesy and derivative, but according to the company, it was also profitable—a rarity even for the best ideas. Meez was greeted by write-ups in the San Francisco ChronicleForbes, andTime—although the latter named it one of the “five worst websites” of 2007. From that point on, it was clear a pixellated tween dollhouse wasn’t going to be a longterm moneymaker, and the site’s brief popularity diminished. So did its bank accounts.

Meez found itself $16 million in the hole with no way of paying it off, so it pulled one of modern finance’s most dazzling sleights of hand: it recapitalized, diluted everyone’s stock in the company, and cashed them right out.

By 8,000,000 to 1—meaning a check for $0.56.

This left our friend at Meez, who not only had his own stake in the company, but had spent thousands to enlarge it, with less than a dollar. I asked Meez CEO John Cahill what this stake might’ve been worth before the insane dilution, but he answered only that it’d be “very hard to put a number on it”

What does one do here, left without enough money to eat dollar nuggets at McDonalds? Nothing—because it was never real money to begin with, remember? Our tipster just realized that too late:

“People all too often don’t hear about the harsh reality that sometimes happens. You bust your ass for years and inflict a self brainwashing mentality that your product kicks ass, only to find out that it a series of mistakes were made that end up forcing a company into the situation that we see here.”

Paper wealth can just as easily become paper poverty.

 

 

In auditing news, here’s a list of (NSFW) words from an E&Y software designed to weed out the suspicious terms used by “persons of interest.”

Enjoy

 

 

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Unearned Revenue & Prepayment Situations

Unearned revenue (deferred revenue) refers to funds received by a seller for goods or services not yet delivered to the buyer.

The following situations are good examples of deferred revenue:

1. When an individual makes an initial deposit as downpayment towards purchasing a land, the seller has recognized unearned revenue upon this deposit, its only when the land title is transferred to the buyer and sale transaction is complete, the seller shall recognize it as Earned Revenue.

2. In case of an airline and railroad, the passenger purchases the ticket in advance of the travel, here the service provider will recognize it as earned revenue once the transportation is delivered. In the AMR Corp. case, this was found on the liabilities side of the balance sheet, under AIR TRAFFIC LIABILITIES (Unearned Revenue).

In accrual accounting, revenues are recognized as earned when two conditions are satisfied:

  1. The revenues are earned. This means the goods and services for the revenues have been delivered, and
  2. Revenue are realized (or realizable). There is a reasonable expectation that that cash will be received.

The journal entry transaction are as follows:

If the revenue will be earned in the near term, say, within a month and within the current accounting period, the revenues may be treated as ordinary earned revenue, in which case the journal transactions are the same as for ordinary revenue:

Dr. Cash     (+A)                   500

Cr. Sales revenue   (IS, +RE)           500

However, when it is clear that the revenue will not be fully earned for several months, or until the next accounting period, the journal transactions is as below:

Dr.   Cash       (+A)             500

Cr.  Unearned Revenue   (+L)       500

The process is complete, when the goods and services have finally been delivered:

Dr.   Unearned Revenues    (-L)    500

Cr.    Sales Revenue             (IS, +RE)              500

Prepayment and deferred payment situations

Prepayment and deferred payment situations present a special challenge to the company’s bookkeepers and accountants, because it is possible for actual payment and actual delivery to fall in different accounting periods. In order to avoid violating the matching concept, bookkeepers make an initial two entries to register the first transaction event, and then, later, makes adjusting entries to register the second transaction event.

Prepayments (payment precedes delivery of goods or services)

  • From the seller’s viewpoint : The seller will recognize unearned revenue as revenues received for goods and services that have not yet been delivered. Unearned revenues are recorded as liabilities until the product or service has been delivered.
  • From the buyer’s viewpoint: The buyer recognizes it as prepaid expenses, when paying for services or goods before delivery. Examples would be prepaid insurance or prepaid rent.

Deferred Payments (delivery of goods or services precedes payment)

  • From the seller’s viewpoint: Unrealized revenues are revenues earned by the seller and are posted on the asset account, as accounts receivable, until the payments are actually received.
  • From the buyer’s viewpoint: Accrued Expenses are posted in the balance sheet as a liability, for goods and services purchased and received but not yet paid for.

For cash basis accounting system, the bookkeeping practice is much simpler. In cash basis accounting:

  • Expenses are recognized when cash is paid
  • Revenues are recognized when cash is received.

Unearned revenues with other prepayment and deferred payment situations described above, are used in accrual accounting but not cash basis accounting.

http://www.business-case-analysis.com/unearned-revenue.html

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Recognition of Revenue in the Global Airline Industry

Because of the industry low margins, revenue recognition is one of the most critical accounting policies for airlines. This publication from KPMG discusses some key accounting considerations for revenue recognition policies in the airline industry. Even though the publication focus on IFRS/IAS standards, I think that the issues discussed offer insights equally applicable to GAAP standards.

Specifically, the KPMG paper examines more closely five issues: recognition of unredeemed tickets, treatment of trade discounts and commissions, taxes and airport charges, fuel surcharges, financial statement disclosures.

Unredeemed tickets

Part of the tickets sold by airlines can have lives of one year or more, or may be specific to flight and if not used cannot be refunded. For these tickets, airlines companies decide about the timing as to when recognise the revenue based on statistical data. Assumptions are therefore very critical and can have significant impacts on financial results. Another critical area is related to non refundable tickets, especially for low cost companies. In this cases, revenue are often recognised when the airlines close the flight, meaning that the flight is completely booked.

Commission and discounts

The second issue discussed is related to commission and discounts for travel agencies, which still account for a large proportion of airline industry ticket sales. Discounts, which are offered as an incentive to encourage the purchase of tickets, should be recognised as a reduction of the gross revenue. Commissions to agencies however should be recognised as an expense at the same time as the revenue to which commissions are related are recognised.

Taxes and airport charges

When tickets are sold, airlines companies act as collectors of taxes on behalf of governments. Amounts received from customers have to be distinguished between amounts for airline services and amounts for third parties (governments or airports). Additionally, taxes and airport charges should be accounted as a payable in the liabilities of the balance sheet and therefore should be excluded from the amounts collected from passenger revenue.

Fuel surcharges

Due to the recent continuous increases and fluctuations on the oil prices, many airlines companies have decided to add fuel surcharges to the tickets price, in order to minimise the impacts of the oil price. Fuel surcharges are a component of the ticket fare and they are recognised as revenue at the time when the passenger flies.

Disclosures

Finally, disclosures on financial statements are very important in order to analyse financial statements, Usually, the types of disclosures that appear on financial statements are:

  • Definition of Revenue;
  • Timing of Revenue Recognition;
  • Where in the Income Statements commissions are recognised;
  • Revenue Recognition basis for unredeemed tickets;
  • Amount of Revenue net of discounts;
  • Amount of deferred income or unearned revenue.

As shown in the summary of KPMG publication, recognition policies of revenue/expenses are critical to analyse financial statements of airlines companies. In fact, adoption of different policies can have deep impacts on accounting, financial and managerial performances. Therefore, it is better to fully understand policies adopted by companies in order to compare and analyse companies’ results.

Here you guys the link:

http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Documents/recognition-of-revenue.pdf

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American Airlines Resumes Flights After a Computer Problem

This article discusses a problem that American Airlines had with its computer systems last Tuesday, April 16th.  Due to the nationwide problem, AA was forced to ground all of its flights from midday until approximately 4:30PM.  More than 400 flights were cancelled and many more were delayed.  AA said that the problem was due to an inability to gain access to its electronic reservation system, called Sabre, commonly referred to as the “brains of an airline.”  A spokesperson for Sabre stated that the problem did not come from its computer system.  Sabre is responsible for the bookings and reservations made by customers, as well as other tasks such as printing boarding passes, ticketing, online check-ins, and tracking bags.

Such problems have happened in the past, especially when airlines merge.  While AA and United Airways are about to merge once AA comes out of chapter 11 bankruptcy, their systems are not close to being integrated together.  In response to the problems, officials from AA announced that they would waive fees for passengers wishing to change their reservations and would provide refunds to those people who wished to cancel their flights on Tuesday.  AA is a service provider that uses the accrual basis of accounting.  The decision by the AA officials, in light of the April 16th events, to refund tickets and allow schedule changes free of charge affects their accounts.

When AA receives money from a ticket sale for a flight on a later date, GAAP dictates that it records this as a liability account for the unearned revenue labeled “Air Traffic Liabilities.”  By offering this refund, the “Air Traffic Liabilities” account would be debited, but not because the service was provided.  Instead, cash would be credited because the money is being refunded to the customers.  A slightly more complicated situation would arise if these tickets were non-refundable and if accounting policies mandated that these sales, since they are non-refundable, be recognized on the date of sale.  In such a theoretical situation, the refund would cause the account for the recognized revenue to be debited.

Offering the free of charge schedule changes also affects their revenues but in a different way.  It does not affect a specific account that was already adjusted due to a prior transaction.  Instead, offering these free schedule changes decreases their potential net profit, as they are not getting paid for something they normally would be getting paid for.  The expenses for each flight change transaction remains the same, since the same process is taking place, but there are no revenues to cover these expenses.  As a result, AA’s potential net profit decreases.

Source: New York Times – http://www.nytimes.com/2013/04/17/business/american-airlines-cancels-flights-after-outage.html?_r=0

 

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Microsoft’s Profits Fall as Sales of Personal Computers Shrink

The article discusses Microsoft’s unexpectedly low earnings for the fiscal first quarter in September 2012 and attributed the slump to the declining personal computer market.  They had a 22% decline in net income from the year-earlier period, which was lower than analysts expected.  Microsoft still gets most of its sales from PCs and directly devices related to PCs, although they are slowly transitioning to other technologies such as smart phones and tablets.

The article also discusses Microsoft’s new operating system Windows 8 and its release date of October 26th and the article states that Microsoft has deferred revenues of $1.36 billion dollars due to the software upgrades and the pre-order sales of this new system.  Accounting for this unearned revenue, Microsoft still would have been flat on its expected revenues, but by less than 1% from the prior year.

Specifically owed to the Windows 8 release, deferred revenues make up 8.5% of it’s would-be total revenue.  Micrsoft therefore has 1.36 billion in cash and accounts receivables as assets on its balance sheet and 1.36 billion as unearned revenues as a liability.  Generally Accepted Accounting Principles tell us that we cannot recognize revenue until 1) the earnings process is complete, 2) one can quantify/measure the revenue, 3) the risk and rewards of the product/service have been transferred to the buyer, and 4) payment is assured.  Microsoft understands that although cash has been received, the product has not yet been delivered and therefore, cannot attribute the cash to revenue.

This article shows how the clear discrepancy between cash and accrual accounting methods can affect companies.  Once Windows 8 is (was) released, they can credit the $1.36 billion in revenue on their income statement (RE), and debit the unearned revenue on their balance sheet.  Microsoft’s 2012 Annual Report actually shows that Windows & Windows Live Division’s unearned revenue had increased to $2.44 billion at the fiscal yearend.

Source: http://www.nytimes.com/2012/10/19/technology/microsoft-profit-falls-as-pc-sales-shrink.html?_r=1&

Source:  New York Times  Date:  October 18, 2012

 

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