Criterion Research Identifies Companies Where Receivables Growth Signals Earnings Quality Problems.

NEW YORK -- Criterion Research Group, LLC today identified six companies whose stocks are likely to under perform due to the high levels of non-cash items, particularly receivables, in their earnings. The growth in receivables at these companies was not matched by corresponding growth in sales or bad debt reserves, which can signal earnings quality issues. The reported earnings of these six companies, like nearly all companies whose earnings consist largely of non-cash items, also called accruals, are significantly higher than their cash flows.

The six companies are Anixter International Inc. (NYSE: AXE), Global Payments Inc. (NYSE: GPN), Laserscope (NasdaqNM: LSCP), MGI Pharma Inc. (NasdaqNM: MOGN), Travel Zoo Inc. (NasdaqNM: TZOO), and Turbochef Tech Inc. (AMEX: TCF).

These companies were identified by Criterion's proprietary accrual model, which divides over 5,000 companies into risk categories based on the total accrual component of their earnings. Accruals are management's estimates of future cash flows and expenses that often turn out to be wrong due to error or management's prerogative to increase earnings.

Extensive back testing of the model has demonstrated that companies in its highest risk categories are much more likely to experience poor forward stock returns and widening bond spreads. Companies with high accrual components to their earnings also experience more shareholder class actions, earnings restatements, and SEC enforcement proceedings, though these are very low frequency events that are experienced by very few companies.

According to the model, companies with high receivables may be boosting revenue and earnings in several ways: by booking sales to customers with weak credit profiles; by improperly recording sales; by under-reserving for bad debt expense; or by not properly writing off receivables that are not realistically collectable. While receivables growth alone does not signal these problems, the model's diagnostics also revealed that these companies do not have the corresponding growth in sales or reserves for bad debt that would explain the high growth in receivables.

The model explains how to determine whether high accruals, such as receivables, can represent a real problem. For receivables, the model prompts the user to examine whether reserves for bad debt as a percentage of receivables have declined, and then to examine the make-up of the customer base to see if it warrants such a decline. Alternatively, if a user determines that sales are growing faster or at least in line with an increasing market share, or if a company is booking improved sales to more credit-worthy customers, then the growth in receivables may not be viewed negatively.

The model provides similar diagnostic tools that explain the risks of high accruals in 11 to 12 other categories, including inventories, other current assets, accounts payable and intangibles. Accounts receivable contains the bulk of non-cash items in 25 percent of the 5,300 companies in Criterion's model for the four calendar quarters ending September 30, 2004.

"The model can save significant time and help investors, D&O insurers, and corporate directors identify stocks and bonds that will under perform and accounting practices that can lead to class actions, earnings restatements and SEC enforcement proceedings," said Neil Baron, Criterion's chairman.

Baron observed that the Report of the Special WorldCom Investigative Committee noted that WorldCom's directors had not created a system that would alert them to accounting irregularities. "The ability to identify unusual accruals at companies in high risk categories could red flag the types of abuses that created personal liability on the part of the WorldCom directors," he said.

Developed in conjunction with three accounting professors from The Wharton School, Criterion's accrual model divides more than 5,000 public companies into 10 risk categories based on the total accrual component of their earnings. Companies in the highest risk categories have the largest accrual and lowest cash components to their earnings. Criterion's model provides an accrual risk category for every company that files with the SEC.

For non-financial companies, Criterion's model now identifies the accruals that are impacting earnings most. Also, for the companies that are in Criterion's two highest risk categories, the model explains what problems each specific accrual can signal and recommends how a user can determine whether those problems actually exist.

About Criterion Research Group

New York-based Criterion is an independent research firm providing its quantitative earnings quality model with respect to more than 5,000 companies to institutional investors, director's and officer's liability insurance companies, corporate board members and accounting professionals. Neil Baron and James Nadler, who oversaw the development of Fitch Investor's Service into a major bond-rating agency, founded the firm in November 2002. Criterion's research is entirely subscription based. Institutional investors interested in subscribing can visit www.criterionllc.com or contact Brett Tarleton at [phone] or at [e-mail].