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If Jones Apparel Group’s $810 million noncash writedown for goodwill and trademarks is any guide, accountants might exact an even bigger toll on fourth-quarter profits than stingy consumers.
This story first appeared in the January 23, 2009 issue of WWD. Subscribe Today.
Jones said Thursday that the aftertax charge, related mostly to its acquisitions of Nine West and Maxwell Shoe Co., and retail weakness would result in losses of $10.07 to $10.11 a share for the quarter, down from losses of $1.01 a year ago.
And Jones isn’t alone. Fashion companies of all stripes could post far steeper losses than weak sales would dictate as they write down goodwill. Simply put, goodwill is the valuation placed on assets from acquisitions and needs to be adjusted on a regular basis to keep market capitalization and shareholders’ equity in relative balance.
While it often doesn’t reflect the true health of a company, it’s important because it can have a major impact on loan terms and other fiscal instruments.
Possible writedowns ahead for some, including Macy’s Inc. and Sears Holdings Corp., could reach into the billions of dollars. For example, Sears has goodwill of $1.66 billion; Liz Claiborne Inc., $676.8 million; Oxford Industries Inc., $248.6 million; Casual Male Retail Group Inc., $63.1 million; Destination Maternity Corp., $50.4 million, and Hartmarx Corp., $38.8 million.
Firms are required to evaluate the goodwill on their books annually. And even if it’s not time for their scheduled review, many companies might decide to take a second look this quarter given accounting rules that could view the economic downturn as a triggering event, said Steve Barr, spokesman at auditor PricewaterhouseCoopers.
“It’s reasonable to expect that, given the current economic environment, we will see companies evaluating goodwill impairments,” he said.
For many, it will amount to an accounting insult after financial injury caused by the recession.
Even without the charge, Jones said 2008 earnings would be less than previously projected. The company also took steps to save about $33 million annually and reduced its quarterly dividend to 5 cents a share from 14 cents. Without going into specifics, the company said it would cut staff and eliminate unprofitable divisions.
“While our previous guidance considered the difficult retail environment prevailing at that time, conditions significantly worsened as the quarter ended,” said Wesley Card, president and chief executive officer. “The resulting increase in promotional activity by our customers and in our own retail operations impacted our results.”
Without the charge, Jones said adjusted fourth-quarter losses from continuing operations would range from 3 to 6 cents, where analysts were looking for a loss of a penny. Adjusted earnings for the year are slated for 85 to 88 cents a share, down from the 93 to 98 cents the company previously projected.
The firm also cut its planned capital spending to $45 million this year from about $70 million in 2008. At the end of the year, Jones had approximately $335 million in cash on hand.
The company declined to elaborate.
Investors pushed shares of the firm down 48 cents, or 11.8 percent, to $3.60 on Thursday.
Jones’ flagging stock price — the issue is down 83.7 percent from its 52-week high of $22.12, reached on Sept. 8 — is partially to blame for the quarter’s charge.
“As a result of the extremely challenging market conditions and the resulting decline in our stock price, we were required under the accounting rules to record noncash goodwill and trademark impairment charges in the fourth quarter,” said John McClain, chief financial officer.
Many other companies could get caught in the same vise and opt to write down goodwill, a balance sheet stand-in for intangible assets such as brand names and business reputations that were picked up through acquisitions.
How pressing such write-offs are is an open question.
“While this is important, it’s not a cash charge — it’s an accounting charge,” said David Botwinick, managing director at MHM Mahoney Cohen, CPAs, speaking generally. “It’s all on paper. What it means is interpreted by the person it’s important to.”
Even if beauty, or economic unsightliness, is in the eye of the beholder, such charges can trigger important provisions in loan agreements or cast in a new light deals that were inked when the market was at a high.
“It doesn’t mean the acquisition was bad strategically,” said Ed Henderson, vice president and senior analyst at Moody’s Investors Service. “Given this market, it just looks like almost everybody overpaid. The amount that is reflective of that is goodwill.”
Macy’s, which used to be known as Federated Department Stores, could have one of the quarter’s largest write-offs. Or the firm’s accountants might also determine that charges are not needed.
When Macy’s purchased rival May Department Stores in 2005, it took on $12 billion in debt and acquired assets valued at $23.79 billion. Among the assets, stores, inventory and other physical assets were worth $14.2 billion. So Macy’s, as accounting standards dictate, classified much of the remainder as either goodwill — $8.95 billion — or intangible assets — $679 million. As of Nov. 1, Macy’s had goodwill of $9.12 billion on its balance sheet.
The financial crisis, the recession and Macy’s performance drove the value of all of its shares down to a total of $3.95 billion Thursday, meaning the firm’s accountants might have to wipe away a big chunk of its goodwill to restore balance to its finances.
For example, earlier this month, grocery chain Supervalu Inc. registered a $2.9 billion loss for its third quarter, the result of a $3.1 billion aftertax charge to write down goodwill and intangible assets. On a smaller scale, Claiborne’s loss of $435.7 million in the fourth quarter of 2007 was driven by a $343.1 million goodwill charge.
A large charge could have been a serious problem for Macy’s, but the firm renegotiated its bank agreement in December so a writedown for goodwill would not impact its access to credit.
With the credit markets tied up in knots, refinancing has been more expensive and difficult to execute. Macy’s had to pay lenders a fee to amend its credit arrangement, while agreeing to higher fees and interest rates. Other firms, including Claiborne and Jones, recently refinanced to smaller, more expensive credit deals. Claiborne’s eliminated leverage and asset coverage covenants, while Jones’ covenants were “adjusted to provide Jones with greater flexibility in the operation of its businesses during these unprecedented economic times,” the company said in December. Failure to conform to performance covenants in credit arrangements can result in termination of credit lines or force companies to renegotiate them.
If Macy’s does end up taking a goodwill writedown, it might take the opportunity to do some additional housecleaning.
“There is a chance that, if they announce a writedown, that they would close stores in conjunction with that,” said Deborah Weinswig, equity analyst at Citigroup Global Markets, noting the retailer could shutter at least another 50 of its 848 stores. Macy’s recently said it would close 11 locations, and Weinswig said it could also consolidate its four Macy’s divisions into one unit this year.
Although a big writedown might make for 10-digit losses, Wall Street would probably not be fazed since the company rejiggered its credit agreement.
“I don’t think this would catch people by too much surprise,” Weinswig said. “If this is part of a new, longer-term strategy, I think investors would applaud it, whatever that strategy might be.”