Burying Trash In Big Holes On The Balance SheetJulia Flynn
Garbage disposal has smelled like a financial winner for two decades. The mounting volume of solid waste has been a bonanza for Waste Management Inc., Chambers Development Co., and other titans of trash removal, sending their stock and earnings soaring. Trouble is, some of those financial gains may be due to liberal accounting--and that's raising a big stink and problems for the whole industry.
The most graphic example is fast-growing Chambers. Apparently forced by a tiff with outside auditors to publicly acknowledge some clever bookkeeping, Chambers on Mar. 17 refigured its financial results. The revision was stomach-churning: 1991 earnings of a tidy 83 per share suddenly sank to a mere 3 . In response, the company's stock plunged by more than half, to 11 1/2, in a single day; shares now trade at 7.
Yet Chambers, with revenues last year of $355 million, is only one of the waste-disposal companies that seem to be playing cute tricks to beautify their bottom lines (table). Although these maneuvers are evidently legal, they may give investors a distorted financial picture. "Accounting in the waste industry is too aggressive," complains Thomas M. Sprague, who runs Fidelity Investment Co.'s $65 million Select Environmental Services Portfolio. "I don't think Chambers is going to be the last one to run into big problems" because of this.
WIGGLE ROOM. A big reason for the industry's behavior, says Abraham J. Briloff, professor emeritus of accounting at Bernard Baruch College of City University of New York, may be the nature of landfills, large holes where garbage is buried. An asset such as a machine has a usable life that can be readily calculated. Nobody is certain, though, how long a landfill takes to fill up with trash. That gives accountants plenty of wiggle room in deciding how long to allow a company to depreciate landfills. The longer the period, the smaller the hit to annual earnings.
This is only one facet of a broad industry culture that seems to sanction aggressive interpretations of accounting rules. Look at how fast-growing Chambers booked expenses associated with developing landfills. Normally, indirect costs for such things as scouting sites and negotiating with municipalities are treated as current expenses. They customarily go in the present year's income statement. But Chambers, of Penn Hills, Pa., deferred recognizing these payouts until later, spreading them over several years. Plus, it stretched the definition of development expenses to cover such items as public relations and the chief financial officer's time working on the projects. The upshot: lower expenses, higher earnings.
Although the company's stock was battered when these maneuvers were disclosed, the moves were at least permissible under the accounting profession's guidelines. But on Apr. 22, it disclosed in a filing that the auditors, Grant Thornton, believed Chambers had double-counted some deferred expenses. Chambers then fired the firm. Now, aside from its market woes, the landfill operator faces 21 shareholder lawsuits and a Securities & Exchange Commission probe. The company declined comment.
Ogden Projects Inc. in some ways has been even more adventurous than Chambers. Through one apparent accounting shuffle, the company buoyed 1991's balance sheet by $63.2 million, lifting stockholder equity by up to 24.9%, according to Robert L. Renck Jr., managing director of R.L. Renck & Co. Where did the increase come from? It's receivable income--due in 1992, 1993, and "thereafter," according to Ogden Projects' latest annual report.
Unfortunately, the Fairfield (N.J.) outfit hasn't even billed its municipal customers for this yet. Robert M. DiGia, Ogden's controller, concedes that the practice is "unusual" but argues that "there's no question we'll get paid, unless the cities go bankrupt."
`WE DON'T PLAY GAMES.' Consider also Houston's Sanifill Inc., the nation's No. 4 landfill operator. While it steadily adds more dumps, Sanifill has decreased the reserves it set aside in 1991 to close each waste facility once it is full. Sanifill argues that its studies now show this will cost less than expected. That's mainly how it lopped expenses by $2 million last year--and hiked gross profits by the same amount. John H. Sanders, Sanifill's vice-president for finance, calls the approach "reasonably conservative."
The best-watched practitioner in aggressive accounting may be industry leader Waste Management, with revenues last year of $7.55 billion. According to Douglas R. Augenthaler, an analyst at Oppenheimer & Co., the Oak Brook (Ill.) giant bumped up earnings 6.8% last year by counting $53.5 million in gains stemming from stock sales and other securities transactions by three subsidiaries. That's usually reflected on the parent's balance sheet by adjusting the (often higher) new value the market places on its stock in the subsidiaries. Instead, Waste Management lumped the stock appreciation in with its own earnings. Though SEC rules call for disclosing such gains as a separate line item, regardless ef their size, there was no such item in the company's financial reports. James E. Koenig, Waste Management's chief financial officer, denies that it was trying to artificially inflate net income: "We follow proper accounting, and we don't play games." The stock gain wasn't broken out, he says, because it was not "material."
Then there's Waste Management's approach to the many acquisitions it makes. The company often opts to swap stock and use an accounting method called "pooling of interest." Pooling avoids a cash outlay, and it allows Waste Management to book a newly bought unit's entire year's sales and earnings, even if the purchase was on the fiscal year's last day.
Because it considers these purchases so small, the company doesn't follow the accounting rule for pooling that would make it restate prior years' results as if the new units had been aboard then. If it had restated, year-to-year gains may have looked less spectacular. Says Loren Kellogg, publisher of the Financial Statement Alert newsletter: "Just because the accounting literature allows for pooling doesn't mean it should be done."
DOUBLE-BIND. Investors seem increasingly wary of Waste Management's moves. The stock has dipped from 46 in February to 40. Janus Capital Corp., Chambers' largest stockholder, has unloaded its entire Waste Management stake in recent weeks, 5.1 million shares worth $200 million. Fidelity sold half its holdings in Waste Management late last year, partly owing to questions about accounting, says Fidelity's Sprague.Waste Management and Chambers are not the only companies gettinghurt. On Apr. 27, Mid-American Waste Systems Inc. postponed an $80 million common-stock offering, referring to the problems at Chambers as "souring a lot of institutional investors on waste stocks." The Canal Winchester (Ohio) company's stock has fallen from 21 when it filed for the offering in March to 17 1/2 on Apr. 29.
All of this is putting the industry in a severe double-bind. As investors get antsy, the industry now has new incentive to pump up profits. The reason: The waste industry's pell-mell growth is expected to slow. More landfills are on line, and the waste surge is leveling off, thanks to steps such as recycling. Waste companies practicing liberal accounting may end up like other things no one has use for--in the garbage.
PUTTING A SHINE ON THE BOTTOM LINE Some waste-disposal companies use aggressive accounting methods to enhance financial reports. Critics contend they are misleading. Companies maintain they are legal and proper. Among the disputed practices: -- Booking revenues a year or two before they are actually received -- Capitalizing instead of expensing indirect costs of finding and developing new landfills, which defers write-offs until future years -- Cutting annual expenses by depreciating landfills for much longer than their usual life -- Instantly boosting earnings by acquiring other companies using pooling of interest accounting methods -- Reducing financial reserves set aside to close filled-up landfills -- Using stock market gains of a company's interest in a subsidiary to raise earnings, instead of reflecting the gains on the balance sheet DATA: BW