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E.A.I. Fiscal Health at Issue in Suit by 2 Stockholders

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Two shareholders of Education Alternatives Inc., which has watched its stock plunge 60 percent since November, allege in a recently filed lawsuit that the firm's accounting methods overstate its financial health.

The price of stock in the for-profit school-management firm last week hovered at about $21 per share, down from the $48.50 peak it hit in November.

John T. Golle, the chairman and chief executive officer of E.A.I., last week maintained that his company has done nothing wrong, is in good shape, and will continue to grow. He said in an interview that deliberate misinformation has been driving the stock's decline.

"We believe the charges in the suit to be without merit, and we will defend our company with intensity,'' Mr. Golle said in a prepared statement.

The suit, filed in U.S. District Court late last month by two investors, claims that E.A.I. has issued statements and used accounting methods that paint an overly positive picture of its current and future financial position.

As a result, the suit contends, the plaintiffs bought--and E.A.I. officials sold--stock in the company at an "artificially inflated'' price.

Arthur Andersen & Co., a major accounting firm that audits E.A.I.'s books, was also named in the stockholders' suit. It last month issued a statement describing the allegations as "preposterous and totally without merit.''

"We will vigorously defend our work,'' said the statement, which asserted that the stockholders had filed the "kind of frivolous suit that makes tort reform vital.''

But a financial expert quoted in the Feb. 28 issue of Business Week asserts that E.A.I. may be using inappropriate accounting methods and, as a result, may be misleading investors.

Two Views of Revenue

The central question being raised by investors is how E.A.I., the first company of its kind, should calculate its revenues.

The firm's primary mission is to take over schools and school systems and, by operating them more efficiently, free up money to help it implement new educational programs and also turn a profit.

Because a key part of E.A.I.'s plan is controlling cash flow, Mr. Golle said, it makes sense for the firm to count as revenue the full amount it is paid per student to run schools or districts.

Specifically at issue is E.A.I.'s contract to manage nine Baltimore schools, where it is completely in control of budgeting. The firm counts as revenue the entire payment it receives from the district--more than $26.7 million this year--although it is contractually obliged to use a substantial amount of the funds to pay teachers or reimburse the district for various expenses.

Officials of Arthur Andersen and E.A.I. said such practice is an accepted accounting procedure that does not affect the company's reported net income, cash flow, or financial position. The Securities and Exchange Commission, they noted, reviewed the system without finding fault.

"It is the right way to account for the money, plain and simple, and we are not changing it,'' Mr. Golle said.

The lawsuit and some investment experts allege, however, that the accounting method makes the firm seem bigger than it is. With the addition of the nine-school Baltimore contract, they noted, E.A.I. revenue increased from $2.9 million to $30 million a year.

The rest of the firm's work consists of providing specific consulting services to a handful of other public and private schools, including some in Baltimore where it does not have control over an entire school budget.

"In my judgment, the financial statements are misleading,'' said Howard M. Schilit, an associate professor of accounting at American University and the author of a recent book that aims to debunk corporate accounting gimmicks.

He contended that E.A.I. should keep its books like other consulting firms, and count as revenue only money that clearly is payment for its management services.

The suit claims that stock prices were pushed to artificially high levels by the accounting methods that exaggerated the company's size and by Mr. Golle's predictions of company growth that had "no reasonable basis.''

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