I've chuckled at a few comments on various boards that predict a huge second quarter 2009 "currency tailwind" benefit for Schering-Plough, given the recent weakening of the U.S. Dollar (especially v. the euro). That is a fantasy view. As ever, real life is just a little more complicated than that.
So here is CFO Bob Bertolini's "GAAP real-life" at Schering-Plough -- as it consolidates up about 70 percent of all its sales -- sales that are denominated in non-U.S. currencies.
First, although the dollar has weakened from its absolute highs around Year-End 2008, it is still about 30 percent stronger than where it was when I last went through this exercise (v. Euros). . . so, all we will see, I predict, in Q2 2009 results at Schering-Plough, is a slightly less fierce headwind due to currency translations -- not a "tailwind". Not anything close to a tailwind, or even a "neutral", or near-zero effect -- and here's why: Schering's accounting policies naturally cause a "delay" in the appearance, in the GAAP financials, of the effects of "real-time" currency market-moves. Schering uses current, or spot-rates to value non-U.S. cash-flow and earnings, but uses "historical" -- usually a "trailing average" of some kind -- to set the currencies rates at which it then values, retrospectively, the proerty, plant, equipment, inventories, bonds etc. -- all the non-U.S., non-monetary (or monetized) -- assets and liabilities.
CFO Bertonlin then nets the two, in-country, and reports "out" a net number -- for consolidation up into the parent-public company's GAAP financials.
Thus the lag/delay/mismatch.
See this, from page 61 of Schering-Plough's most-recently filed SEC Form 10-K -- [Ed. Note, however -- the statements in brackets below, or "[]" -- are my explanatory commentary]:
. . . .To date, management has not deemed it cost effective to engage in a formula-based program of hedging the profits and cash flows of international operations using derivative financial instruments. . . .
The net assets of most of Schering-Plough’s international subsidiaries are translated into U.S. dollars using CURRENT [I.E. "SPOT"] exchange rates. The U.S. dollar effects that arise from translating the net assets of these subsidiaries at changing rates are recorded in the foreign currency translation account as a separate component of Shareholders’ Equity. For the remaining international subsidiaries, non-monetary assets and liabilities are translated using HISTORICAL [USUALLY "TRAILING AVERAGE"] rates, while monetary assets and liabilities are translated at CURRENT rates, with the U.S. dollar effects of rate changes included in the Statements of Consolidated Operations. . . .
Moreover, Schering-Plough's "euro-denominated notes and euro-denominated term loan have been designated as economic hedges of the net investment in a foreign operation. In accordance with SFAS 52, the foreign currency transaction gains or losses on these euro-denominated debt instruments are included in foreign currency translation adjustment within other comprehensive income. . . ."
That is also from pages 61-62 of the most recent Form 10-K. In fact, during the first half of 2008, Schering-Plough booked between 7 and 8 percent increases, on almost $5 billion in quarterly sales, that were entirely due to "currency translation inflation". That is gone, now -- and "currency translation deflation" is what Schering will see in 2009, at that line. It already did, in Q1 2009 -- to the tune of 9 percent Katrina-esque "headwind". So -- "Let's go to the satellite image, shall we?" Yes, let's -- click it to enlarge:
What it all means is that most of any "gain" CFO Bertolini sees in-country, anywhere in the European Union, will be at least partially offset -- by a correlative 'decrease' in the value of the euro-notes, and euro-loans Schering-Plough's European operations owe. Schering treats them as a "hedge" against euro-denominated earnings and sales, under SFAS 52.
So as ever -- real life, in the real multi-national pharmaceutical company world, for CFO Bob Bertolini, is just a little more complicated than many amateur internet would-be prognosticators would seem to imagine.
The net take-away is we should expect a continuing, but slightly-moderating, currency "headwind" in Schering-Plough's second quarter 2009 financial results, when the same are reported on July 21, 2009. Here endeth the lesson.
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