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Broadcom Warrants Report Provides Relief

3/25/2001 7:00 PM Eastern

Broadcom Corp. last week revised its 2000 revenue downward, due to a change in accounting practices, and received an unexpected benefit: Its stock price went up.

In a climate in which investors take earnings and revenue revisions as a call to sell their stock, Broadcom investors were buying, pushing the stock as high as $33.94 each-up $3.44, or 11.3 percent-before it closed at $31.63, up $1.13 or 3.7 percent on March 21.

Despite the climb, Broadcom shares are still trading well below their 52-week high of $274.75.

Broadcom shareholders have been anxiously waiting for the chip maker to finish investigating claims that its practice of issuing stock warrants to certain customers of recent acquisition targets had falsely inflated revenue.

Apparently, the results of the investigation were far less severe than investors anticipated they might be. And the change ended up lessening Broadcom's annual loss by about 1 cent per share.

Five companies that Broadcom acquired last year issued the warrants, in exchange for long-term product purchase contracts with customers.

Some analysts and investors had expressed concern that the practice of issuing those warrants constituted a product discount. And the fact that Broadcom was charging those warrants as goodwill, rather than as a reduction to revenue, made some observers wonder if the company was drastically overstating its true revenue results.

After a Feb. 27 article in
The Wall Street Journal
dissected the warrants practices, some shareholders filed lawsuits. On March 6, Broadcom said it would investigate the matter, and hired an independent auditor, Ernst & Young International, to look at the accounting practices.

Since then, the climate in the broadband sector has changed. Broadcom's customers, facing their own problems with declining demand, don't need as much product as they once thought. Broadcom's stock has declined more than 90 percent since most of those acquisitions were made, making the notion of exercising those warrants much less attractive.

As a result, Broadcom said three of the five companies that received the warrant incentives have terminated those programs. Broadcom said it is negotiating to terminate or modify the warrants held by the other two customers.

Broadcom also said it will no longer charge the warrants to goodwill in the future, instead recording them as a reduction of revenue.

In a conference call with analysts last Wednesday, Broadcom president and CEO Henry Nicholas said that the effect would be to reduce revenue by $38.6 million, or 10 percent, in the fourth quarter, to $340.2 million from $378.8 million.

The accounting change also improved Broadcom's loss per share by 2 cents for the year, to $687.8 million, or $3.13 per share, from $693.4 million ($3.15). The fourth-quarter loss was unchanged at $768.3 million ($3.28).

Going forward, Broadcom chief financial officer Bill Ruehle said the change would result in a 2001 revenue reduction of less than 3 percent.

Had the five companies that had been issued the warrants exercised them, Nicholas said, it would have diluted Broadcom stock by about 13 million shares. But now, with only two of five companies still able to exercise warrants, potential dilution is 3 million shares, or about 1 percent. That number is less than the total amount of stock issued to employees in each quarter.

"The impact is now very small," Nicholas said last week during a conference call with analysts.

He added that customers were happy to terminate deals that required them to commit to buying a large amount of product for a long period of time, especially in the current economic climate. He said Broadcom did not have to offer other incentives or discounts to entice them to terminate.

"In no case did we have to give anything to customers," Nicholas said. "Given the current economic conditions, customers are always glad to be released from guaranteed purchase and performance contracts. They were happy to be released."

September