GLG News by Utilities and Power Generation Industry: Financial Statement Analysts

George PughPresidentGeorge Pugh & Co

New Leasing Rules Not Likely

August 17, 2006

Analysis of:New Leasing Rules Could Add Assets | www.cfo.com

 

The question, "Will we be shocked when more leases are capitalized on the balance sheet?" S&P says "We already attribute additional debt for operating leases, and we therefore do not currently envision that there will be a material impact to our issuer ratings merely as a result of adding these obligations to the balance sheet, unless the nature of the lease arrangements or their monetary significance were not sufficiently disclosed or otherwise available to Standard & Poor's analysts," said Len Grimando, the firm's director for financial reporting analysis

The original documents are as follows:

www.fasb.org/news/nr071906.shtml FASB Formally Adds Project to Reconsider Lease Accounting

www.sec.gov/news/studies/soxoffbalancerpt.pdf Sec Staff Report On Off-Balance Sheet Arrangements Special Purpose Entities and Related Issues

George PughPresidentGeorge Pugh & Co

The Continuing Life of LIFO

August 16, 2006

Analysis of:Big Oil Accounting Methods Fuel Criticism | online.wsj.com

Rising oil company profits have brought renewed efforts to do away with LIFO (last-in first-out) inventory accounting. A variety of reformers are arrayed in full panoply against advocacy groups like the LIFO Coalition and the National Association of Wholesalers-Distributors on the issue. See this article in CFO for further details: http://www.cfo.com/article.cfm/7213052/1/c_2984368?f=most_read

Using the LIFO inventory valuation method decreases taxable income for the major oil companies. The EU does not allow LIFO so US companies make additional disclosures to satisfy this requirement. For example, Exxon disclosed a LIFO reserve, that is the difference in inventory value under FIFO versus LIFO, of $15.4MMM according to CapitalIQ. Last fall Congress tried to repeal LIFO for oil and gas companies, and this spring Bill Frist tried for a universal repeal to fund a $100 driver credit: both efforts came to naught.

Clearly this issue will keep coming back and expert opinion is divided. Edward D. Kleinbard of Cleary Gottlieb said: "This is the biggest single unjustified tax expense in the entire internal revenue code." His remarks were part of a written submission to the Senate Finance Committee. On the other hand George Plesko testified before the same committee that "it is not clear that there is much of a financial reporting benefit gained...except an infinite deferral of taxes."

This proposed change would result in a number of unanticipated results both at the firm and macroeconomic level.

George PughPresidentGeorge Pugh & Co

New Debt, Investors and the Rating Agencies

July 26, 2006

Analysis of:Corporate Debt Begins to Worry Bond Investors | online.wsj.com

Bond investors and senior personnel from S&P and Moody’s are concerned about the impact of the quantity, quality and purpose of new debt issues.

According to Thomson Financial data, investment grade debt increased 72% for the first half of 2006 compared to the same period for 2005. As debt has increased, ratings have declined with a ratio of 2.7 downgrades to upgrades year to date. Dan Curry, a Managing Director at Moody’s says: "We think issuing debt to repurchase stock or pay dividends is not a good idea—that does not strike us as conservative financial policy."

The rating agencies have reacted strongly to these proposed capital restructurings. In May 2006 Tribune Co. announced a $2.0MMM debt financed share buyback and Moody’s responded by changing the ratings on existing debt to a sub-investment grade. Investor Nelson Peltz has been pressuring H. J. Heinz to cut costs, raise the dividend 17% and buyback $1.0MMM of stock. In response, S&P reduced Heinz’s senior debt rating to BBB+ with a negative outlook.

Clearly both rating agencies have fired a shot across the bow of companies that seem likely to adopt debt financed share buybacks.

George PughPresidentGeorge Pugh & Co

Buybacks and Options, A Recipe for Fraud?

July 12, 2006

Analysis of:Big Companies Put Record Sums Into Buybacks | online.wsj.com

According to the author, "S&P analysts say they see no sign of the buyback wave subsiding. ‘Buyback spending is getting bigger, and it's already off the charts,’ says Howard Silverblatt, S&P's senior index analyst. Repurchases aim to bolster shares but they also signal hesitancy to invest in growth."

This in-house study of the Standard & Poor’s 500-stock index states that companies are reacting to a cooling economy after a long period of growth and high earning. Buybacks increased 22% in the first quarter over the same period in 2005. Interest income is up 60%, comprising 4% of income, and cash holdings have increased to 7.4% of the balance sheet, the highest since 1999.

Later coverage from The Wall Street Journal confirms that institutional investors for the first time since 2002 are avoiding risk in a flight to quality, with the results this article describes.

I will also show that stock buybacks, when combined with stock option plans, can provide both incentives and opportunities for fraud which are more material than backdating or spring-loading option grants which have gotten so much attention of late.

George PughPresidentGeorge Pugh & Co

Enron Lessons Learned

July 6, 2006

Analysis of:Short-Lived Lessons-From an Enron Short” The Wall Street Journal, May 30, 2006 by Jim Chanos. | users2.wsj.com

Mr. Chanos wrote so much and so early on Enron and was so right, that the editorial is a "must read". As policy wonks say, "When you are right too soon, your wrong": I think that saying applies here, in the sense that being right is frequently irrelevant on the Street.

When Mr. Chanos first attracted media attention, I discussed his findings with a friend at Lehman. We both agreed that Mr. Chanos was right, but we also believed that Enron had certainly disclosed what they were doing, that there were some large risks involved in the company and its shares should be shunned.

Now Mr. Chanos offers ten lessons learned. The following discussion emphasizes how the similar warning can be used to avoid future problems.

George PughPresidentGeorge Pugh & Co

The Market and the MCI Fraud

June 21, 2006

Analysis of:Fraud From the Fraudster's Perspective | www.cpa2biz.com

Sukanya Mitra interviewed former MCI senior collections manager Walt Pavlo and Diann Cattani, who had worked in a boutique human resources consulting firm about their frauds. Pavlo and Cattani discuss their motives, techniques, and the causes of detection lag. The article promotes a web panel discussion held May 17, 2006, available on DVD from the AICPA. The back-story for Walt Pavlo can be found in a Forbes article at http://www.forbes.com/forbes/2002/0610/064.html.

Most fraud studies are forensic, building a case for trial. The account of Walt Pavlo’s time at MCI helps to identify the leading indicators of company based fraud, and to develop actionable intelligence in similar situations.

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