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!