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1998-06-15 09:16:52


The High Cost of Not Fixing Y2K: Yardeni



Economist Ed Yardeni warned a Senate Banking subcommittee that there will be high costs of not fixing y2k -- far higher than fixing it. The problem is, we are not getting accurate information from U.S. corporations of the extent of their vulnerability to such a failure.

This concerns the United States. What nobody is talking about is the likelhood that the rest of the world will not get y2k fixed. Over 75% of the world's code is outside the U.S. If the rest of the world fails, which now seems likely, then it doesn't matter what American corporations do. They will go down in a worldwide technological and social collapse.

This is one of many Catch-22 problems associated with y2k. No one wants to waste his company's money on repairs that will be destroyed by the failure of others to spend their companies' money. It's a Yugo situation:" "You go first."

This is why y2k is a systemic problem. It cannot be fixed.

You will find no evidence in corporate disclosures that it can be fixed.

* * * * * * * *

Senate Banking, Housing and Urban Affairs Committee

Subcommittee on Financial Services and Technology

Hearing on Disclosure of Year-2000 Readiness

Prepared Testimony of Dr. Edward Yardeni Chief Economist& Managing Director Deutsche Morgan Grenfell

10:00 a.m., Wednesday, June 10, 1998

My name is Ed Yardeni. I am the Chief Economist and a managing director of Deutsche Bank Securities, a global investment banking firm. . . .

Most managements have taken the position that Y2K is not "material" and, therefore, does not require full disclosure. Those that reported the estimated cost of their Y2K project all concluded that it is too small to have a material impact on their financial outlook. I strongly disagree. It is true that the cost of fixing Y2K for most companies is not material because the monies are coming out of current information technology (IT) budgets. However, the cost of failing to fix the problem could be very material, so investors must be kept informed, on an ongoing basis, about the potential for failure.

I can't stress this enough: The biggest risks confronting investors are not the costs of fixing Y2K in 1998 and 1999, but the much greater costs of business disruptions, malfunctions, and outright failures in 2000. It is precisely this vitally important information that is missing in every one of the reports I read. The fact that most companies chose to completely ignore Y2K in their quarterly filings--or simply copied the statement from the annual report--suggests that they have no intention of keeping their investors informed about their progress, or lack thereof. . . .

My bottom line is that very few of the S&P 500 corporations are providing investors with the information they must have to evaluate the possible adverse impact that Y2K might have on earnings. They are violating the spirit, if not the letter, of the SEC's guidance. The problem is that the SEC Bulletin does not have the force of a SEC ruling. I believe that the SEC must immediately issue a Y2K ruling, that will mandate the level of disclosure specified in Senator Bennett's bill. If the SEC fails to do so, then Congress should enact CRASH as soon as possible.

Let me list my findings:

1) Of the S&P 500 companies, 409 filed 10Ks, i.e., annual reports, after the SEC guidelines were revised on January 12, 1998. Of these, 399 mentioned Y2K in their annual reports, and 10 did not do so.

2) In their quarterly disclosures, 220 companies did not mention Y2K.

3) Only 168 of the 500 companies, or 34%, reported their estimate for the total cost of their Y2K project in either their annual or quarterly filings.

4) Only four companies revised their numbers upward from their annual to their quarterly reports.

5) The total outlays on Y2K estimated by the 168 companies reporting this number is $11 billion. This number is identical to the one derived for the Fortune 500 by the Federal Reserve Board, as reported by Fed Governor Edward W. Kelley, Jr. in his testimony before the U.S. Senate Committee on Commerce, Science, and Transportation on April 28, 1998.(5)

6) Only 66 companies have reported how much has been spent to date on Y2K. These companies estimate that their total costs will be $4.8 billion, and they have spent $1.1 billion so far. . . .

I believe that corporations are not disclosing enough information about Y2K. Nearly all the statements on the subject are only two or three short paragraphs, at most. The basic message is an optimistic one: "We expect to have the problem fixed, but our operations could be disrupted if we don't, or if our vendors fail to fix their Y2K problem." . . .

After reading through hundreds of corporate Y2K statements, I believe that most of them were either written, or very heavily edited, by lawyers. The corporate attorneys' main job in this case is to protect their companies from lawsuits. Unfortunately, this parochially commendable goal is not in the best interest of the public or even their own companies. I am amazed at the similarity of so many statements. Clearly, corporations have violated the SEC guideline requiring specifics rather than boilerplate. . . .

General Motors discusses Y2K in its annual report, but the topic is not mentioned at all in the subsequent quarterly filing. GM states that it spent $40 million during 1997, mostly to assess the problem. It expects to spend about $360 million-$500 million on the remainder of the project, with the majority expected to be incurred in 1998. GM's "target date for completing its Year 2000 modifications is December 31, 1998, with additional testing and refinements to identified systems planned for 1999." The company acknowledges that the "inability of GM or significant external interfaces of GM to adequately address Year 2000 issues could cause disruption of GM's business operations."

In the April 27, 1998, issue of Fortune, Ralph J. Szgenda, the chief information officer of General Motors, said that there are "catastrophic problems" in every GM plant. I called the reporter to verify this blunt quote, and was informed that the word "catastrophic" was repeated several times during the interview with GM's top IT man. Of course, the word "catastrophic" does not appear once in GM's all-too-brief discussion of Y2K in its annual report. I wonder why GM did not update investors on its progress in its quarterly filing. Is the company on schedule to finish most of the project by the end of the year? What about its vendors? Which ones are at risk of failing to meet the millennium deadline? What about GM's Asian vendors, given that the turmoil in that region may be distracting many companies from giving enough attention to Y2K?

Ford says in its annual report that, "at present it does not anticipate any significant exposure related to the year 2000 issue for its current or future products." No such assurances are given about past products. Why not? Is there a chance that cars built prior to 1997 won't function properly in 2000? The automaker believes that Y2K will not have a material effect, unless suppliers or dealers have problems, in which case Ford "could be adversely affected." No update was provided in the quarterly filing. . . .

In its annual report, IBM sees no material impact, but admits that "it is uncertain whether, or to what extent, the company may be affected..." The company's great concern is lawsuits "for damages from products and services that were not Year 2000 ready. . . .

AT&T provided investors with one short paragraph on Y2K in both its annual and quarterly reports. The company expects to spend $350 million on Y2K in 1998, and was still "assessing the impact to us, if any, in 1999." Much more information is provided to the public at AT&T's website, but most of it is vague and of little investment value.

In its annual report, Worldcom informed investors, "At this time, the company believes that the cost of addressing Year 2000 issues is not material to its future operating results or financial position." Yet, management admitted that it was still gathering information about its suppliers: "In the event that any of the company's significant suppliers do not successfully and timely achieve Year 2000 compliance, the company's business or operations could be adversely affected." . . .

In its annual report, Lucent was confident that "based on available information, that it will be able to manage its total Year 2000 transition without any material adverse effect on its business operations, products or financial prospects." In the first-quarter report, management hedged by observing that "given the uncertain consequences of failure to resolve significant Year 2000 issues, there can be no assurance that any one or more such failures would not have a material adverse effect on Lucent."


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