MANAGING ACQUISITION DATES AND AVOIDING RESTATEMENTS

Although the pooling-of-interests method has been abolished, M&A ac­counting remains an area in which analysts must be on their toes.

For example, one M&A-related gambit entails the GAAP-sanctioned use, for financial reporting purposes, of an acquisition date other than the actual date on which a transaction is consummated. Typically, companies use this discretion to simplify the closing of their books at month- or quar­ter-end. For example, if an acquisition agreement is completed on May 27, the acquirer may begin reporting the acquired company’s results in its own figures as of May 31.

In 1999, Navigant Consulting (formerly known as Metzler Group and unrelated to the travel-management company Navigant International) ex­ploited the acquisition-date leeway in an unusually aggressive fashion. The utilities consulting company acquired Penta Advisory Services in mid­September, but designated July 1 as the acquisition date. Following stan­dard practice under purchase accounting rules, Navigant included Penta’s revenues in its own totals from the acquisition date forward. Navigant’s rev­enue therefore received a boost for the entire third quarter, even though Penta entered the corporate fold only at the tail end of the period.

To be sure, the numbers involved were small. Penta’s trailing-12-months revenues were in the range of $5 million to $6 million, while Navigant’s 1998 sales were $348 million. Nevertheless, Merrill Lynch analyst Thatcher Thompson took management to task for shifting the acquisition date by 2½ months.

Thompson was not the only commentator with qualms about Navi- gant’s merger accounting, notwithstanding its number-three ranking, at the time, on the Forbes list of the Best Small Companies in America. Other critics focused on management’s exploitation of the standards, which were later tightened up, governing the classification of acquisitions as material to overall financial results. Under Securities and Exchange Commission rules, companies do not have to restate previous statements to reflect the revenues and earnings of acquired businesses deemed immaterial in size. Navigant grew rapidly after going public in 1996 by making many moderate­size acquisitions. Individually, the acquired consulting businesses were im­material under GAAP, but collectively, they had a large impact on the company’s results.

Barron’s columnist Barry Henderson estimated revenues for Navigant’s 1998 acquisitions for the final three quarters of 1998 by tracing the increase in shares outstanding, quarter by quarter.¹⁰ He deducted the number of shares representing exercise of management stock options to estimate how many shares were issued to pay for acquisitions. Multiplying this figure by the share price gave the estimated dollar amount paid for acquisitions dur­ing the quarter. (To be conservative, the journalist used the minimum stock price for the period.) Next, Henderson divided the estimated aggregate ac­quisition price by 2.2, the multiple of trailing-12-months revenue that Navi- gant said it usually paid for consulting businesses. The answer represented a reasonable estimate of the revenues produced by the “immaterial” com­panies acquired during the second through fourth quarters of 1998. If Nav- igant had been required to restate its 1998 first-quarter results for these transactions, Henderson concluded, revenue would have been $83 million to $84 million, instead of the $79 million reported.

As it turned out, investors were wise to react to the red flag raised by Navigant’s liberal accounting for acquisitions. On November 22, chairman and chief executive officer Robert P. Maher resigned under pressure, touch­ing off a 48% plunge in Navigant’s stock. The company’s directors had un­covered evidence that Maher and two other senior officials were involved in “inappropriate” stock purchases.

In brief, Maher borrowed $10 million from the company in August 1999, saying it was for a real estate investment.¹¹ Navigant’s board subse­quently came to believe that he in fact advanced the funds to Stephen Denari, the company’s vice president of corporate development. Denari had borrowed a like amount to purchase Navigant shares at $28.39¹² from the former owner of a company that Navigant had acquired for stock. A short while later, the shares soared to $54.25 when Navigant hired a financial ad­viser to explore strategic options, including a possible sale of the company.¹³

Besides leading to the CEO’s resignation, these machinations affected the accounting for four acquisitions that Navigant had treated as pooling- of-interests transactions in the first quarter of 1999. To qualify as a pooling under APB 16, a business combination must entail no planned transactions that would benefit some shareholders. For example, there can be no guar­antee of loans secured by stock issued in the combination, which would ef­fectively negate the transfer of risk implicit in a bona fide exchange of securities. Reacquisitions of stock and special distributions are likewise prohibited. After a review by a special committee of the board of directors, Navigant’s auditors reclassified the earlier pooling transactions as pur­chases. The retroactive change necessitated a 34% downward restatement of the company’s operating income for the first three quarters of 1999, re­flecting the goodwill amortization required under purchase accounting.