The last thing any company wants these days is to have Enron-style concerns raised over its accounting practices. Last week, Edison Schools Inc. learned just how sensitive Wall Street is to the issue: The school management company’s stock plunged 11 percent after a report raised questions about how it adds up its revenues.
Bloomberg News, a financial-news service, published a report Feb. 13 that raised doubts about whether $96 million in revenues claimed by Edison last year belongs on its books. Edison executives called the report “irresponsible” and defended their company’s way of counting revenue.
The controversy has erupted just as Edison is in the final stages of competing for two major contracts in Philadelphia—one to consult on management of the 200,000-student school system, which was recently taken over by the state, and another to partner with community groups to operate currently low-performing schools.
The accounting dust-up comes as the 11-year-old company has faced other recent bumps. In Baltimore, two of the three schools it runs under a contract with the state of Maryland showed disappointing results last month on state tests. In Wichita, Kan., the school board voted to remove Edison from running two of four schools the company operates in the 49,000-student district.
And there have been reports of tension in the 1,800-student Inkster, Mich., district, the first entire school system to be managed by Edison.
Practices Debated
The Bloomberg report raised concerns about whether it was proper for Edison to include in its revenue portions of its contracts with school districts related to teachers’ salaries and other expenses.
Bloomberg cited Edison’s contract to operate seven schools in the 246,000-student Clark County, Nev., school district, which includes Las Vegas. The report said Edison counts the contract as providing $40 million in annual revenue. But the company never actually receives $30 million of the total, which the district pays directly for teachers’ salaries, pupil transportation, and utility bills, Bloomberg said.
The news service quoted an accounting professor who said the practice violated principles of the Financial Accounting Standards Board. But it also quoted another accounting expert who said the practice was in a “gray area” of accounting rules.
The Feb. 13 report prompted an immediate sell-off of Edison stock, which dropped from an intraday high of close to $15 a share on Feb. 13 to an intraday low of $10.70. It closed at $12 that day, but rebounded somewhat to close at $12.75 on Feb. 14.
Jeffrey M. Silber, an analyst who follows Edison for the New York City investment firm Gerard Klauer Mattison & Co., said that Wall Street is especially sensitive about companies that have accounting practices that appear at all similar to those of Enron Corp., the Houston energy-trading giant that is now in bankruptcy and the subject of high-profile investigations.
“Wall Street has caught Enron-itis,” he said. “All you have to do is say ‘accounting issues,’ and people will sell [the stock] first, and ask questions later.”
Edison executives vigorously defended their accounting practices.
“This is a policy we are required to use by our accountants,” Christopher Whittle, Edison’s chief executive officer, said during a Feb. 13 conference call with analysts.
He said the company typically contracts with school districts on a per-pupil-revenue basis. Edison then hires teachers for the schools it operates. The company says such teachers are “joint employees” of Edison and the district. They are eligible for Edison stock options.
But rather than establish a separate payroll system, Edison asks the district to handle the mechanics of paying the teachers in its schools. Edison pays the district for that service, just as it sometimes “buys back” pupil- transportation or food services, Mr. Whittle said.
Edison provided a statement from its accountant, PriceWaterhouseCoopers, that said, “We are highly confident that Edison’s revenue recognition policy is the proper treatment under [Generally Accepted Accounting Principles].”
Lauren Fine, a managing director of Merrill Lynch & Co. in New York City, is one of several analysts following Edison who issued reports late last week essentially agreeing with Edison’s view. Because the company is responsible for the risk related to paying teacher salaries, it is proper for Edison to record that part of each contract as revenue, Ms. Fine said.
“The question is ‘Was the company doing something fraudulent, and is there a problem with its revenue recognition?’ The answer is no,” Ms. Fine said in an interview. “The accounting is an overblown concern.”
“But it is witch-hunt season” on accounting issues, she said.
Wichita Whittled
The accounting issue took the spotlight away from Edison’s quarterly earnings report, which showed that it lost $8.3 million on revenues of $133.3 million for the three months ending Dec. 31. The net loss of 15 cents per share was better than analysts’ consensus estimates of 21 cents per share.
Because Edison has never earned a profit, its education clients and potential clients have joined Wall Street in paying attention to the company’s finances.
“Anyone who owns the stock is well aware they are expected to lose money for some time,” Ms. Fine said. “What we are looking for is progress.”
She said the quarterly report, despite the hefty loss, had positive news in that Edison was controlling its costs. But Ms. Fine was concerned that the company has missed its revenue targets.
“There were no real new issues regarding the overall development of the company,” Ms. Fine said in her report last week. “A resolution in Philadelphia and/or new school contracts are the necessary next step for the stock.”
Mr. Whittle said during the conference call that Edison is entering its prime season for announcing new contracts for next school year. The company operates 136 traditional public schools and charter schools serving 75,000 students this year.
In Philadelphia, a commission appointed by the governor and the mayor expects to decide by late March whom to hire as a consultant to help manage the district. But the timetable is less clear on when the panel may award contracts to the many for-profit companies, community groups, and other organizations seeking to operate individual schools, Mr. Whittle said.
In Wichita, meanwhile, the school board voted 6-0 on Jan. 28 to take back two Edison-run elementary schools at the end of the current school year.
Superintendent Winston Brooks said the two schools have experienced sharp enrollment declines, constant teacher turnover, and disappointing performance on achievement tests. Edison will continue to operate another elementary school and a middle school in Wichita, for the time being at least.
“Our board put Edison on notice that if it didn’t show greater interest in Wichita public schools, then further action could occur,” Mr. Brooks said.
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