Nationals hit with accounting changes

Monday, April 1, 2002

NEW YORK-A change in how companies track and pay down goodwill resulting from acquisitions has affected earnings of most of the industry's national installation companies for the quarter that ended Dec. 31.

Protection One reported a charge of $660 million in the first quarter of 2002 as a result of the Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets." The standard eliminates the opportunity for companies to continue to pay down, or amortize, goodwill over a period of time, usually a 20-year term, said Jack Mallon, a security industry analyst.

Because security companies are valued by the multiples of recurring earnings, Mallon said, acquisitive companies in this industry often accrue large amounts of goodwill because the multiple is often more than the book value of the company.

"The plus is that they don't have to write off goodwill on an ongoing basis, but the minus is that they may be forced to take off mega-value on their balance sheet if they can't support the value" of the asset, Mallon said.

Protection One, faced with having to write off accrued goodwill from hundreds of acquisitions in the 1990's, essentially lowered the company's book value from $1 billion at the end of 2001 to $403 million, beginning Jan. 1. The loss in book value was so steep, said Darius Nevin, Protection One's chief financial officer, because the acquisitions were completed at a time when values in the security industry were much higher than they are today.

"This is a question of having paid more in the past (for acquisitions) and still having more on your books than the fair value of the accounts to date," Nevin said. "What we have is a confluence of a change in accounting principle at exactly the moment when values in our industry are down."

With nearly $1.28 billion spent last year alone to buy small security firms, in addition to its acquisitions of Cambridge Protection Industries, Edison Select and Sensormatic Electronics, Tyco International will also likely be hit with a big charge stemming from goodwill.

The company said in its quarterly filing, for the period ending Dec. 31, 2001, however, that it is in the process of appraising its units to determine their fair value, a process which was expected be completed March 31.

The company's quarterly filing did reveal the result of another change in accounting rules, Staff Accounting Bulletin No. 101, which addresses how companies recognize revenue. That change has resulted in a $653.7 million cumulative after-tax charge recorded in Tyco International's first quarter fiscal 2001 results.

To comply with SAB 101, the company reviewed all of its revenue recognition practices and identified certain provisions in a limited number of sales arrangements that had delayed the recognition of revenue under the new bulletin, the company said in its filing.
Brink's Home Security has also reported a $52 million non-cash after-tax charge as a result of accounting changes.

The rule changes are unlikely to have as great an effect on smaller or privately companies, said Greg Spurr, managing director of MCG Capital Corp., since their main objections are to minimize earnings on their balance sheet to avoid paying more in taxes.