SAN FRANCISCO -- As Ricky would say to Lucy, "Somebody's got a lot a 'splainin to do."
The Learning Co.
-- which TLC is acquiring -- both plummeted 20% Wednesday before trading in the stocks was halted. The gremlin: A research analyst at a small firm in the Pacific Northwest who called into question TLC's accounting practices. A few hours after the report was issued, it was pulled down from
research database, but not before both stocks were whacked.
Pacific Crest Securities
research director Jeff Goverman, was reacting to some new and awkward wording in a routine TLC
Securities and Exchange Commission
10-Q filed Tuesday. With TLC's chief financial officer in the Bahamas (according to one analyst, though the company declined to comment) and the rest of the Street caught unaware, Goverman sounded the alarm in a morning research note and investors bailed. Other analysts spent the day at their phones and writing new reports, in one case calling Goverman's note "simply not true."
The drama is swirling around TLC's accounts receivable, or the money the company is owed on unsettled claims and transactions. In the SEC filing, TLC mentioned for the first time a new facility set up to factor, or help manage the credit risk of, its accounts receivable in Europe in addition to factoring facilities it has in the U.S. Then, in the sentence that set off the fury, TLC wrote, "Each of these facilities were fully utilized at June 30, 1998."
The phrase "fully utilized" suggested that these facilities were already tapped out. So when Goverman issued a note this morning warning that TLC's receivables were significantly larger than what its balance sheet had said -- $45 million larger than the $105.2 million recorded for the quarter ended June 30. Goverman didn't return repeated phone calls to his office.
Some analysts suggested that Goverman thought the new European factoring facility would be recorded just like the U.S. facility. But the receivables at the European facility stay on TLC's books; those at the U.S. facility do not.
The timing of the research note could hardly have been worse. Not only are the two companies planning to merge, but also their shareholders are slated to vote on the proposed deal in only 12 days. TLC was down 5 1/8 to 20 5/8 and Broderbund fell 4 to 16 3/8 in mid-afternoon when trading in their shares was halted.
More worrisome than the number itself was the chance of an accounting snarl hanging up TLC's merger with Broderbund. TLC's stock has risen 60% this year largely on expectations of a good fit with the entertainment and education software maker. Broderbund's is down 20% this year.
The research note had the effect of yelling fire in a theater crowded with previous TLC accounting questions. As long ago as Jan. 17, 1997,
reported that investors were dumping TLC stock on the heels of significant accounting concerns (with the
memorable line "we're not talking limbo, we're talking lame-o. 'Cause there's no better word for the recent stock performance of The Learning Company").
After the market closed, TLC issued a statement saying that it didn't see its accounts receivable affecting its earnings. TLC's statement reiterated that point and also reiterated TLC's commitment to its proposed merger with Broderbund, which declined to comment.
Other analysts were quick to reiterate their buy ratings after doing some number crunching. "We believe there is no issue here -- there is no fundamental change in the way the company is handling its collections," said Michael Wallace, an analyst at
Warburg Dillon Read
, which has no underwriting relationship with TLC, in a research note. "We believe the concerns are unwarranted, and the sell-off overdone."
Events conspired to exacerbate the impact of the accounts-receivable issue on the stock. "There are some things in their accounting that if explained properly probably would have pushed the stock down a quarter of a point," said an analyst at a company with no underwriting relationship to TLC. "But the CFO is on vacation, so the stock got clobbered." Other analysts said short sellers quickly spread the rumor to drive it down further.
Short sellers were helped by skittishness that many other investors feel in holding a stock that has risen fivefold in the past two years without posting a single profitable quarter. "To have some selling pressure on the stock, given its lack of earnings, isn't unusual," said Lewis Alton, principle at
L.H. Alton & Co.
, which has underwritten both Broderbund and
, TLC's predecessor. "This is not necessarily the type of market where people are willing to pay more for the future. People want to see performance closer in."
"It's too bad that someone has over-interpreted a 10-Q and cost investors so much as a result," says Larry Marcus, an analyst with
BT Alex. Brown
, which is advising TLC on the merger. "It'd be nice if there were more thoroughness. But this sell-off is a buying opportunity and I'm reiterating the strong buy."