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What's the Deal with the "Lease Accounting" charges hitting retailers?


"Wasn't the goal of the regulations to give investors more and better information?"


As noted by MV News, Circuit City (CC) is pushing back their earnings report by a couple weeks to allow the company more time to determine the exact effects of a change in the treatment of lease accounting rules.

Here's the way it was reported:

Circuit City (CC) said it would delay its earnings release 7-14 days citing delays in accounting for leases. The company believes cumulative impact of multi-year lease adjustments through Feb '05 is less than $0.05 per share.

The company sees EPS for the year at $0.48-0.50, ex-charges related to store closings, vs $0.45 cons.

If you're news-trolling for the purpose of researching companies and seeking trading opportunities, this release may have raised two questions:

1. Is this legit or is Circuit City getting a little "shifty" with numbers already expected to be weak?

2. For the love of Greenspan, what on earth does it mean to assess "the cumulative impact of multi-year lease adjustments"?

The Hydra that is Sarbanes - Oxley

We'll take #2 first since it's hard to go very far without knowing the issue at hand. Earlier this year The powers that be changed the rules affecting the way retailers record their leases on financial statements. Whereas retailers had previously waited until a store was open for business before counting the lease as an ongoing expense (the argument being that building / refurbishing a store was cap-ex) the new rule means that the store rent meter starts running as soon as a retailer takes possession of the dirt.

In short, it means that recorded operating expenses go up retroactively, reducing trailing earnings. The effect for larger retailers going forward is minor and depends on the number of locations being opened and how long it takes to construct them, once the site is secured.

The change is retroactive and impacts every retailer to some degree. What Circuit City is saying, in effect, is (NB: To be read in the tone of a high-school kid asking a teacher for an extension):

"We have to go back for every one of our hundreds of stores and figure out how much rent was paid between the time we took the lease and the time the store opened so we can back out pennies of stated EPS (despite this having no actual financial impact). We're freaking trying to sell ourselves, we've got a plan to move out of all of these stores and into bigger ones and, oh yeah, we're getting our lungs sucked out of our throats by Best Buy (BBY) the web and every Crazy Eddie in America... but we should just ignore all that and pour through real estate transactions from 20 years and 5 management teams past?

"Here's a thought... why doesn't FASB close their eyes and pucker up for a little surprise the freaking....errr.. ahem... Would there be any way to get some extra time?"

This is yet another example of the whack-a-mole life for CFO's since Sarbanes- Oxley. That's what CFO's do now; they stand poised waiting for yet another policy change to pop its head up with the goal of getting into compliance with a quick hammer. As both whack-a-mole and Sarbanes-Oxley progress the policy change moles for CFO's to whack just keep coming faster and faster.

Question #2: Is this a legit reason to delay a report or a Red Flag?


In terms of a justifiable excuse for pushing back the report, I'd give this about a 7 out of 10. Heavens knows I could be accused of not Understanding the bullish thesis for Circuit City. That said, if these guys were ever going to have me as an ally it would be on this issue.

The problem with issuing Circuit City a free pass on this is that the company stands to gain from the delay in any number of ways, none of which justify silence while they finish determining whether the non-cash hit to trailing EPS is 5 or 6-cents. Aiming to please, I've offered a menu of other reasons CC may wish to delay the report. You may pick whichever best fits your take on the company and management:

a. The numbers are so huge, so shockingly large in relation to guidance of Street estimates that Circuit City wants to triple check them before tipping the hand.

b. The numbers are a bit light vs. expectations. The company is frustrated but 90% convinced it's a wider industry issue. Best Buy (Zed to CC's gimp) reports tomorrow. CC usually reports after BBY and, frankly, this is one quarter where they'd like a bigger "issue" to point at when they report it. BBY, in CC's estimation, will provide a nice earnings "wake" for CC's report in 2 weeks.

c. The large institutional holders (two of whom consisting of the company's would-be buyers... and whatever happened to that, anyway?) don't like management. Management, not living under a rock in Uruguay, recognizes that these shareholders would regard a huge miss issued the last week of the quarter as something of a hostile act by managment.

CC shareholders aren't going to be cartwheeling with joy regardless of when they report (in this scenario) but there isn't any sense in ticking them off any more than management has to.

In the pre-Sarbanes-Oxley world pushing back the report at the 11th hour would have been regarded as bad news. At worst it would have suggested a monster miss / restate. At best it would mean that companies were having control issues in operations.

Now companies get a pass, in large part because analysts know full-well the genuine nightmare that compliance has become in the S-O world. In effect, investors have less information and they get it at a later date.

For whatever it may be worth, I still think CC's business plan makes little sense and I remain uninvolved in the stock, beyond interest in the story.

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No positions in stocks mentioned.

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