Retailers' Charges Attracting Investor Scrutiny

As Wall Street takes a magnifying glass to companies' books, it's starting to see some one-time charges in a different light.

Companies have a good deal of latitude in determining which expenses qualify as operating costs and which don't, a question that's important because it affects reported earnings. In normal times, analysts and investors tend to give executives the benefit of the doubt on these matters. But these times are anything but normal, what with the Enron scandal echoing through the halls of Congress and various other companies facing SEC inquiries of varying degrees of severity.

Now, as giant discounter Wal-Mart (WMT) prepares to kick off retail earnings season, analysts and investors are increasingly scrutinizing one-time charges. And as the decline in shares of companies like Tyco shows, when Wall Street decides it doesn't like a company's bookkeeping -- whether the accounting's proper or not -- there's often hell to pay.

The Other Side

Take New York-based Ann Taylor (ANN), which last month set a $17 million pretax charge to cover various costs. Some analysts raised an eyebrow at the company's writedown of certain costs associated with ordering spring and fall merchandise, saying order cancellations are simply part of doing business.

"I think that clearly falls on the other side" of what is normally considered a proper charge, says one hedge fund manager who is short Ann Taylor stock. "Retailers always overorder or underorder. To say that a routine act of doing business is a charge is absurd."

Indeed, in the wake of the Sept. 11 terrorist attacks many retailers found themselves trying to cancel orders for holiday merchandise, this person says. Yet he can think of no other retailer that took charges for those costs. Ann Taylor representatives didn't return a call seeking comment.

Of course, a single item that raises questions wouldn't in itself be cause for concern, investors say. But observers note that Ann Taylor issued earnings warnings in each of the four quarters of 2001; the company's results in some cases diverged wildly from what Wall Street was expecting. That kind of track record can cause people to question whether the expenses covered in the latest period's charge were legitimately nonoperating.

Moreover, retail investors note that the best-managed companies, the leaders in the industry such as Wal-Mart and Home Depot (HD), rarely, if ever, announce one-time charges. Charges complicate the business of gauging earnings quality: companies normally tout their earnings figure prior to the charges, and that can make it difficult to compare one year's financials to another.

"I think that's always a concern," says Brian Postol, who covers retail companies for A.G. Edwards. "It's something in this environment that's not well received."

Widening Sweep

The Enron scandal and the ensuing accounting worries have some analysts dusting off charges from last year, taking a particular look at how companies account for inventory markdowns and job cuts.

"The piece that is frequently bogus is the one-time charge related to head-count reduction," says the hedge fund manager, who is short Ann Taylor.

In a testament to the heightened nerves on Wall Street, even charges at smaller companies that are normally off investors' radar screens are getting a second look. Witness Linens 'n Things (LIN).

The company, a much smaller rival to Bed Bath & Beyond (BBBY), recently took a $23.7 million after-tax charge to write down fixed assets, terminate leases and mark down inventories to close 17 stores. Some observers note that the charge marks a break from the company's past practice of running store closings through operations. Linens 'n Things went so far as to state in its 1996 IPO prospectus that "the Company's policy for costs associated with stores closed in the normal course of business is to charge such costs to current operations."

Shelly Hale, who covers the company for Banc of America Securities, published a report critical of the charge. She said that Linens 'n Things closed an average of 13 stores a year between 1996 and 2000 without taking any charges. Moreover, the charge Linens 'n Things took amounts to $1.4 million a store, up from the $200,000-per-store average for charges incurred in closing 66 stores between 1993 and 1995, when the company was still part of CVS predecessor Melville Corp. Hale has a market perform rating on Linens, and her firm doesn't have a banking relationship with the company.

William Giles, Linens 'n Things' chief financial officer, says the company will give a more detailed breakdown of the charges in the footnotes of its annual report in March. He says the earlier store closings were mainly at smaller locations with leases that were close to expiration. "In most of those cases they were older stores with little asset value," he says. "There's no change in the way we are accounting for anything."

Indeed, Linens 'n Things, based in Clifton, N.J., has plenty of defenders. "If they have made a corporate decision to get rid of bad stores, why not do it?" says Gary Balter of Credit Suisse First Boston. "They can do it, they are following the rules. This is not Enron." (He has a hold on the stock, and his firm does not have a banking relationship with the company.)

Of course it isn't. But lately Wall Street has shown that a company needn't be Enron to face harsh scrutiny.

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