This Antitheft Company Is Feeling Insecureby
This should have been a banner year for Ronald G. Assaf. Nearly 30 years after he co-founded Sensormatic Electronics Corp., the maker of antitheft and security devices appeared to be hitting its stride. Revenues of the company, based in Deerfield Beach, Fla., have grown at a 40% annual clip over the past three years and were expected to hit an estimated $920 million for the year ended June 30. In January, it completed the acquisition of a major competitor's operations in Europe. And Sensormatic is gearing up for a high-profile role as a sponsor and the provider of electronic security systems for the 1996 Olympics in Atlanta.
Instead, Assaf finds himself defending the company's accounting practices and business prospects, shoring up damaged credibility, and countering contentions that Sensormatic's products cause problems with pacemakers. In March, he was jolted by the unexpected resignation, for personal reasons, of Michael E. Pardue, who served as chief operating officer, chief financial officer, and liaison with Wall Street. Assaf admits the company's controls and systems have been inadequate. On July 7, Sensormatic said earnings would be substantially below expectations and below last year's fourth quarter.
Most troublesome was an Aug. 31 announcement that release of 1995 results would be delayed, pending an extended audit by Ernst & Young that is to be completed by mid-September. The audit is examining whether revenue was properly booked before products were shipped and whether costs associated with the merger with Knogo Corp., the European rival, were properly expensed. The company says it doesn't believe there will be any "major write-offs."
Wall Street short-sellers, who thrive on signs of accounting shenanigans, have targeted the company. While that put pressure on the stock, it was the July 7 announcement that caused the stock to fall to 23 from a high of 36 two days earlier. On Sept. 6, it was selling at 237/8.
Sensormatic primarily makes and markets devices that foil employee theft and shoplifting, especially the familiar white plastic "alligator" tags for apparel. In recent years, it has diversified into antitheft systems for "hard goods," such as power drills and sunglasses, and security systems for commercial and industrial clients.
"EARLY WARNING SIGN." The shorts point out that while Sensormatic dominates the market, it faces growing competition, especially from rival Checkpoint Systems Inc. And they contend--while Assaf denies--that Sensormatic's electromagnetic systems interfere with the functioning of pacemakers. The Food & Drug Administration is exploring the effect of electronic article surveillance on pacemakers and similar devices.
But on Wall Street, it's the accounting issues that reverberate. While Sensormatic is a manufacturer, its balance sheet makes it a finance company of sorts. Sensormatic leases systems and offers favorable financing to buyers. Historically, it has carried a hefty accounts-receivable balance. To maintain cash flow, it sells finance firms portions of the accounts receivable, as well as leases, with full or partial recourse to the company.
But recently, its accounting for revenues from deferred sales and sales-type leases has caught the attention of critics. Howard M. Schilit, an accounting professor at American University and president of the independent Center for Financial Research & Analysis, commented in a December report that Sensormatic's revenue accounting, while permissible under generally accepted accounting principles, was "overly aggressive." Sensormatic records revenues at the time of sale, rather than when payments are substantially received.
The resulting shortfall from the gap between net income and cash flow from operations, Schilit says, is problematic. In the nine months ended Mar. 31, for example, the company had net income of $69 million and a negative operating cash flow of $50 million. Bank borrowings rose to $122 million, from $6.7 million during the same period in 1994. "I know of no better early warning sign of a company in trouble than one whose cash flow from operations is significantly less than net income over a period of time," he says.
The company has also come under fire from short-sellers and a shareholder lawsuit filed on Aug. 3 against the company and Ernst & Young for other accounting practices. The suit, claiming violations of securities laws, contends the company lowered its reserves for doubtful accounts even while its revenues and receivables were increasing. For the quarter ended Mar. 31, the suit notes, revenues increased 47% over the comparable earlier period, but Sensormatic's allowance for doubtful accounts as a percentage of gross receivables dropped to 3.9% from 4.9%. That, in turn, buoys earnings. "If they had not reduced their reserves, chances are they would not have made the Wall Street estimates," says short-seller Bart Blout.
CREDIBILITY ISSUE. Assaf denies the suit's allegations and claims that the company has never had a problem with bad accounts. With large retailers such as Wal-Mart Stores Inc. and Kmart Corp. as clients, he says, the reserve ratio could be reduced. While both inventory levels and bank debt are higher than he would like, Assaf insists the company is financially sound and is projecting positive cash flow in 1996. The company's accounting policies have been consistent, he claims, and the extended audit has nothing to do with the issues raised by short-sellers. "They've been attacking our accounting for a year, and there's nothing wrong with our accounting," he says.
Assaf, though, doesn't dispute PaineWebber Inc. analyst Steven M. Fortuna's view that, considering the earnings shortfall and audit problems, "management's credibility is at issue." Says Assaf: "Our growth has probably outpaced our systems and management controls, and we have a challenge here." So do Sensormatic's shareholders.
SENSORMATIC'S WILD RIDE
1968 Ronald Assaf co-founds Sensormatic Electronics, which becomes top provider of antitheft devices to retailers. Company chalks up fairly consistent revenue and earnings gains.
DECEMBER, 1994 Company's accounting practices come under review by Center for Financial Research & Analysis, which terms them "aggressive." Short-sellers begin targeting the stock, citing other accounting issues. Company defends its accounting practices. Stock begins falling.
MARCH, 1995 Michael Pardue, COO and CFO, announces his resignation, which shocks analysts.
JULY 7 Announces earnings won't meet analysts' projections for fourth quarter and full year, blaming shortfall in anticipated revenue and higher expenses from European acquisition. Stock drops 35%. Shareholders file lawsuits.
AUG. 31 Announces that 1995 results will be delayed pending an extended audit expected to be completed by mid-September.