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in Exhibit 3, the allowance for doubtful accounts from ¬scal 1993 to ¬scal 1995
has remained constantly between ¬ve and six percent of receivables outstanding.
The Company™s evaluation of the allowance for doubtful accounts is in¬‚uenced
by several factors. First, the aging pro¬le of the accounts receivable outstanding
”amounts past due for more than 30, 60, 90 days, etc.”at quarter-end is some-
what longer in the Company™s presentation and appears to give more cause for
concern about aging and ultimate collection than is warranted. While the aging
pro¬le may show amounts that are technically 30, 60 or even 90 days past due,
internal approvals and processing of accounts payable for many retailers normal-
ly take between 30 and 90 days, resulting in more aged accounts receivables out-
standing. In addition, like many other companies which do business with retailers,
the Company has experienced a historical pattern of longer payment cycles by
major retail customers. Delayed payments are often a business practice by large
retailers, and not an indication of credit unworthiness. Through working to accel-
erate collection of receivables, the Company historically has accepted the longer
collection cycles as part of its strategy to maintain and further penetrate this im-
portant market segment. The lost interest income due to the delayed payment is
just another cost factor that is considered by the Company in the pricing of its
products.
Second, as Sensormatic™s sales to larger, relatively high creditworthy custom-
ers have increased, the required allowance for doubtful accounts, as a percentage
of total sales, has decreased. In addition, a number of European customers have
agreed to a payment arrangement on sales-type leases whereby a direct debit is
made to the customer™s bank account on scheduled dates. This is a common prac-
tice in Europe.
A third factor relates to acquisitions. Receivables acquired through acquisi-
tions, such as those of Knogo in the most recent ¬scal year, are initially recorded
net of allowance for doubtful accounts, as is required by U.S. GAAP. This lowers
the percentage relationship between the allowance for doubtful accounts and re-
ceivables in the year of the acquisition relative to prior years.
Finally, the Company normally retains a security interest in most underlying
equipment for which a deferred or installment receivable is outstanding, and it re-
tains legal title to equipment under a sales-type lease agreement. In either case, if
necessary, the Company can repossess, refurbish and resell the equipment. The
high resale value of used equipment enables Sensormatic to resell the repossessed
equipment and substantially reduce its ultimate loss on the receivable or lease.
708 Management Communications




17-24
Management Communications




With respect to the Sensormatic™s risks of repurchasing receivables and leases, Sen-
sormatic argued that, based on its experiences, some form of payment program could be




Sensormatic Electronics Corporation
worked out with the customer. Sensormatic™s management explained8:
The Company establishes a liability, reported in Accrued Liabilities, for estimated
future losses attributable to a risk of default. This liability is generally based on a
portfolio basis rather than on a speci¬c identi¬cation approach and is, as a per-
centage of outstanding receivables and leases, much lower than allowances for
doubtful accounts relating to receivables and leases on the balance sheet. Even if
the receivable or lease is repurchased, the Company™s experience is that in many
cases, some form of payment program can be worked out with the customer. An
example which illustrates this is the case of Macy™s Department Store. When Ma-
cy™s ¬led for bankruptcy in early 1992 under Chapter 11 (reorganization), the
Company repurchased the Macy™s installment sales receivable it had sold to a ¬-
nancing institution (approximately $7 million). The Company recorded the receiv-
able on its balance sheet and an allowance for doubtful account based on its best
estimate of the potential ultimate loss from default. Ultimately, the Company did
not incur any such loss. Even while under Chapter 11, Macy™s was allowed to con-
tinue making scheduled payments to Sensormatic and recently paid off its obliga-
tion ahead of schedule. In addition, Macy™s made a number of additional
purchases of Sensormatic EAS equipment while still in bankruptcy.


RECENT DEVELOPMENTS
Since Barron™s criticism of Sensormatic™s accounting policy in March 1995, short inter-
est in Sensormatic shares increased to 4 million shares (out of 73 million shares out-
standing) at the end of June 1995 (see Exhibit 5 for the trend of Sensormatic shares sold
short). On July 7, 1995, with the pressure of short-sellers™ criticism in the background,
Sensormatic announced that its fourth-quarter earnings would be substantially lower
than analysts™ earnings forecast. Sensormatic never had a down quarter in the prior ten
years. Sensormatic™s management stated that costs related to higher expenses and Sen-
sormatic™s acquisition of rival Knogo Corporation™s overseas electronics security busi-
ness for $103 million in stock in January 1995 contributed to lower earnings. On the day
of this announcement, Sensormatic shares fell $123/8 to close at $23. The 35 percent
drop was the biggest percentage decline among U.S. stocks on that day.
A few weeks later, on August 31, Sensormatic announced that its ¬scal 1995 result
would be delayed pending an extended audit by Ernst & Young. The expanded audit fo-
cused on two speci¬c accounting issues: (1) shifting revenue between reporting periods
and (2) one-time expenses related to the Knogo acquisition. Upon the announcement of
extended audit, Sensormatic share price dropped by a further 17 percent.

.........................................................................................................................
8. Ibid.
709
Management Communications




17-25 Part 3 Business Analysis and Valuation Applications




Sandwiched between the bad news in early July and the bad news in late August,
moreover, was the disclosure of shareholder class-action lawsuits. Three shareholders
Sensormatic Electronics Corporation




¬led lawsuits after the stock drop in July, claiming the company lowered reserves for
risky accounts while its revenues and receivables increased dramatically. According to
these lawsuits, Sensormatic made earnings look better by lowering reserves for doubtful
accounts.
However, some investors believed that the bad news could not overshadow the under-
lying strengths of Sensormatic™s business. On September 15, 1995, billionaire investor
George Soros ¬led forms with the Securities and Exchange Commission disclosing his
6 percent stake, valued at about $104 million, in Sensormatic.
On October 3, 1995, Sensormatic released ¬nancial results for the fourth quarter and
¬scal year 1995, following the completion of an expanded audit. The expanded audit
identi¬ed two accounting problems. First, in certain instances, the company booked
sales in a quarter for products that were physically shipped several days following the
quarter™s end. Correcting for this error would shift $35 million in revenues from ¬scal
1995 to 1996. Second, related to Sensormatic™s acquisition of Knogo Corporation™s in-
ternational operations, the company capitalized items that should have been expensed.
The company was estimated to take a one-time nonrecurring charge of about $8 million
in ¬scal 1995 to correct for this error.
Sensormatic™s management stated that the extended audit results suggested that im-
proper accounting was not material to Sensormatic. One analyst said, “It is de¬nitely a
sigh of relief that this accounting issue is behind us. The disaster many feared”and
some hoped for”didn™t occur.”9 With no major surprises, on October 3, 1995, Sensor-
matic™s share slipped 12 cents to $22.88 in normal trading volume.
After the expanded audit was over, Assaf, the CEO and chairman of Sensormatic,
stated:
The fourth-quarter earnings disappointment, the audit adjustments, and the third-
quarter restatement demonstrate a need to better assure compliance with our ¬-
nancial and administrative controls. However, the accounting issues related to ex-
tended audit are different from the attack made by short-sellers. [Short-sellers]
have been attacking our accounting for a year, and there is nothing wrong with
our accounting [related to short-sellers™ arguments].10
On October 5, 1995, Sensormatic issued a 20-page white paper, as a response to al-
legations that Sensormatic™s accounting methods did not give an accurate picture of the
company™s ¬nancial position. At the end of October, 1995, Sensormatic™s share price re-
mained at $21 and had a short position of 6 million shares (see Exhibits 4 and 5).

.........................................................................................................................
9. Excerpts from the Wall Street Journal, October 3, 1995.
10. Short-sellers sell borrowed shares of stock, betting the price will fall so they can pro¬t when they buy the shares
back later. Short-selling is inherently riskier than ordinary investing. If you sell a stock short, the share price can rise
an unlimited amount, allowing the potential for unlimited losses. If you buy a stock “long””betting the price will go
up”you can only lose what you invested.
710 Management Communications




17-26
Management Communications




EXHIBIT 1
Sensormatic Electronics Corporation:




Sensormatic Electronics Corporation
Example of Accounting Treatment of Alternative Revenue Transactions

CONTRACT TERMS
Date of Contract: 1/1/95 Date of Shipment: 1/15/95 Date of Installation: 2/15/95
Accounts Deferred Installment Sales-Type
Receivable Receivable Receivable Leases
Contract Price:
Sales Price $1,000 $1,000 $1,000 n/a
Monthly Payments n/a n/a $20.50 $21.00
Stated Interest Rate n/a n/a 8.50% none
Payment Terms:
Single Payment due 3/15/95 7/15/95 n/a n/a
Monthly Payments due:
# of months n/a n/a 60 60
Final payment due n/a n/a 1/15/00 1/15/00

Market Interest Rate
(Based on Length of Contract) n/a 6% 9.50% 9.50%

Income Statement Recognition (for Quarter ended 3/31/95)
Revenue $1,000 $971 $976 $1,000
Cost 450 450 450 450
Gross Pro¬t $550 $521 $526 $550

Balance Sheet Recognition (at June 30, 1995)
Account Receivable $1,000
Deferred Receivable $971
Installment Receivable $976
Net Investment in Sales-Type Lease $1,000

Source: White Paper, Sensormatic Electronics Corp., September 1995.
711
Management Communications




17-27 Part 3 Business Analysis and Valuation Applications




EXHIBIT 2
Bad Debt Expense as a Percent of Revenues
Sensormatic Electronics Corporation




% of Revenues
6


5


4


3


2


1


0
1981


1982


1983


1984


1985


1986


1987


1988


1989


1990


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