Standard

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Standard Poors Core Earnings
Revised November 8, 2002
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Agenda

• What it is
• Why we publish Standard Poors Core Earnings
• How its defined
• Plans for Standard Poors Core Earnings

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Standard Poors

• Standard Poors Core Earnings is supported by
  Standard Poors three major units
• Developed by Investment Services
• Prepared in consultation with Corporate Value
  Consulting
• Utilized by Credit Market Services as part of its
  debt analysis

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Standard Poors Core Earnings

• Standard Poors Core Earnings is
• a standardized calculation of earnings from a
  companys core business, designed to capture
  long-term true earnings power of the business

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Something Was Needed

• Investors want an earnings measure they
  understand and trust. Without any definition of
  earnings measures, there is no consistency across
  companies or through time.
• Standard Poors recognized that inconsistency
  and confusion were hurting investor confidence.
• Just calling for change was not enough someone
  had to propose a definition, listen to comments
  and build a consensus.
• Standard Poors has stepped up.

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Standard Poors Core Earnings vs. GAAP

• Concerns about GAAP
• GAAP net income doesnt tell the whole story.
• GAAP lets companies write their own definitions
  for operating earnings.
• GAAP tries to be all things to all people.
• Standard Poors response
• Standard Poors Core Earnings targets a
  companys core business.
• Standard Poors Core Earnings focuses on
  consistent comparisons.
• Standard Poors Core Earnings is used in
  investment analysis.

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Standard Poors Core Earnings vs. GAAP

• Unlike GAAP, Standard Poors Core Earnings does
  not smooth out the volatility that is really
  present in earnings and operations. However, the
  Standard Poors Core Earnings history we have
  developed will mute that volatility. In addition,
  we have provided guidance on how investment
  managers can easily take pension interest costs
  i.e., market-induced volatility out of the
  Standard Poors Core Earnings calculation.

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Standard Poors Core Earnings and Analysis

• Standard Poors supports analysis using
  Standard Poors Core Earnings
• Data in Standard Poors Compustat
• Recognition of the SP 500
• Analysis that will be added in Standard Poors
  Stock Reports and other Standard Poors
  services for brokers, analysts and institutional
  investors
• Standard Poors is an independent source of
  analysis, information and data Standard Poors
  does not have apparent or potential conflicts.

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How to Define Standard Poors Core Earnings

• Begin with as-reported earnings, a widely used
  measure defined with GAAP
• Make adjustments to focus on the companys core
  business

• As-reported EPS is GAAP net income excluding
  discontinued operations and extraordinary items.
• It is the longest time series for SP 500 EPS,
  extending back over decades.

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Standard Poors Core Earnings Defined
Included in Standard Poors Core Earnings Excluded from Standard Poors Core Earnings
Employee stock option grant expense Goodwill impairment charges
Restructuring charges from on-going operations Gains/losses from asset sales
Write-downs of depreciable or amortizable assets Pension gains
Pensions costs Litigation or insurance settlements
Purchased RD Reversal of prior-period charges and provisions for bad debt
Unrealized gains/losses from hedging activities
MA-related expenses
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Earnings Measures Compared
Standard Poors Core Earnings GAAP Net Income (SP As-Reported) Operating Earnings
Stock option expense Included Excluded Excluded
Net pension Income Excluded Included Included
Restructuring charges Included Included Excluded
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Our Perspective

• Standard Poors is not rewriting GAAP or trying
  to do FASBs job.
• Standard Poors is not suggesting new SEC
  regulations or new legislation.

• We are using existing accounting and reporting
  concepts to give investors and analysts a better
  understanding and more complete information about
  companies.

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Stock Option Grant Expense

• Stock options are compensation, just like wages,
  salaries and benefits. Therefore
• Expenses related to stock option grants should be
  treated like other compensation costs in
  calculating earnings.
• Expenses should be reported quarterly rather than
  annually.
• Employee stock option grant expense is included
  in Standard Poors Core Earnings.
• Standard Poors takes no position on the tax
  treatment of stock option grants.

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Times Are Changing
Companies expensing options as of May 1, 2002
Wynn Dixie (WIN) and Boeing (BA) Companies
expensing options as of November 4, 2002
128 companies for updates see www.coreearnings.co
m
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Pension Accounting in 1-1/2 Lessons

• Net pension gains (pension income after
  pension-related expenses) are funds held in a
  trust for retirees and future retirees. These
  gains are not corporate funds. Therefore, net
  pension gains should not be included in Standard
  Poors Core Earnings.
• Pension expenses include service costs and
  interest costs
• Service costs are deferred compensation,
  representing the benefits that accrue from the
  current years labor services.
• Interest costs are financing costs, reflecting
  the passage of time as the moment when benefits
  will be paid draws closer.
• These costs should be covered by the pension
  fund. Specifically, the actual return on pension
  plan assets should cover interest costs.

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More Pension Accounting

• For Standard Poors Core Earnings, pension
  costs include
• Service costs
• Interest costs to the extent that they are not
  covered by actual returns on plan assets
• Because any pension gains become part of the
  pension fund assets for the benefit of retirees
  and employees, these are not corporate funds and
  are not part of Standard Poors Core Earnings.

• Companies do not benefit from funds reserved for
  pension beneficiaries.
• However, pension plan assets can, actual returns
  permitting, cover pension interest expense.

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Questions on Pension Accounting and Pension
Interest Costs

• Interest costs are charges in years when the
  pension plan makes little money. Doesnt this
  make earnings very volatile?
• It can have that effect. Interest costs are real
  costs and, if the pension plan returns cant
  cover these costs, the company is responsible.

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Questions on Pension Accounting and Pension
Interest Costs

• How does FASB treat interest costs?
• FASB looks to the pension plan first to cover
  interest costs, as Standard Poors Core
  Earnings does. Then FASB uses expected returns
  rather than actual returns. While the expected
  returns eliminate the volatility, they also
  obscure the true impact of pensions on earnings.
  An important note Pension interest charges this
  year can be a warning that a companys cash flow
  and net earnings next year could be reduced by a
  required contribution to its pension fund.

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Questions on Pension Accounting and Pension
Interest Costs

• Is there another way to measure pension costs
  without making earnings volatile?
• As long as one wants a year-by-year measure of
  the true earnings, the volatility will be there.
  However, in most years, actual pension gains
  cover most or all of the interest costs. For
  analysts who want to make other adjustments, such
  as using a multi-year moving average, Standard
  Poors Core Earnings data show pension interest
  as a separate item. It is easy with Standard
  Poors data to take this cost out of Standard
  Poors Core Earnings for each company and each of
  our indices.
• If the SP 500 is up 7.8 in 2003, Standard
  Poors estimates, there will be no pension
  interest costs charged against Standard Poors
  Core Earnings for the SP 500.

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Restructuring Charges

• Operating earnings often exclude restructuring
  charges that are part of ongoing operations.
• GAAP defines discontinued operations.
• Charges that are not related to discontinued
  operations should be included in Standard
  Poors Core Earnings.
• If a company subsequently reverses a prior
  provision, that reversal is not credited to
  Standard Poors Core Earnings.

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Other Provisions

• Discussed in detail in the white paper published
  in May 2002 and the Technical Bulletin published
  in October 2002
• Available at www.standardandpoors.com

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Plans for Standard Poors Core Earnings

• Standard Poors Core Earnings and detailed
  information will be provided in Compustat.
• Standard Poors will continue to publish and
  use as-reported and operating data for the SP
  500 and our other indices, in addition to
  Standard Poors Core Earnings.
• We will forecast Standard Poors Core Earnings
  for companies we follow analytically through our
  Equity Research Department.

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Standard Poors Core Earnings Data

• SP 500 earnings measures compared
• Table showing as-reported earnings and Standard
  Poors Core Earnings for the SP 500, and the
  pension interest costs
• Table showing Standard Poors Core Earnings for
  GICS Sectors in the SP 500 (per share data)
• Table showing Standard Poors Core Earnings for
  GICS Sectors in the SP 500 (return on sales
  data)
• Chart showing option expense by GICS Sector for
  the SP 500
• Chart showing pension adjustments by GICS Sector
  for the SP 500

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SP 500 Earnings Measures Compared
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As-Reported Earnings and Standard Poors Core
Earnings
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Standard Poors Core Earningsby GICS Sector
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Standard Poors Core Earnings by GICS Sector
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Option Expense as a Percent of Revenues
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Pension Interest Expenseas a Percent of Revenues
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Further Steps

• Standard Poors will continue to work with key
  leaders in the investment community to develop
  consensus to support more informative and
  accurate earnings information.
• Standard Poors will support Standard Poors
  Core Earnings with data and analysis, including
  full data in Compustat, EPS data on indices,
  forward EPS estimates on over 1,200 companies in
  Standard Poors equity analytical universe, and
  other efforts.
• Standard Poors CVC will provide assistance to
  corporations in the use of Standard Poors Core
  Earnings in their financial reporting.

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Thank You.

• 800-523-4534
• www.standardandpoors.com
• www.coreearnings.com
• Core_earnings_at_standardandpoors.com