Homework answers / question archive / ACG 6687, FRAUD AND FINANCIAL REPORTING PRO FORMA EARNINGS ASSIGNMENT Purpose of the Assignment As providers of external accounting information, it is important for us to understand how external parties use and interpret the information we provide

ACG 6687, FRAUD AND FINANCIAL REPORTING PRO FORMA EARNINGS ASSIGNMENT Purpose of the Assignment As providers of external accounting information, it is important for us to understand how external parties use and interpret the information we provide

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ACG 6687, FRAUD AND FINANCIAL REPORTING PRO FORMA EARNINGS ASSIGNMENT Purpose of the Assignment As providers of external accounting information, it is important for us to understand how external parties use and interpret the information we provide. This assignment illustrates how investors and analysts use the information to value a company’s stock. The Issue The Great Atlantic and Pacific Tea Company, Inc. (NYSE: GAP) On March 16, 1999, GAP announced results for the fourth fiscal quarter of 1998, ended February 27, 1999. A copy of the press release containing the announcement and other pertinent extracts from GAP’s 1998 Form 10-K is included with this assignment. Following the announcement, the analyst tracking services First Call, Zacks, and I/B/E/S reported the following earnings surprise information for the quarter: Tracking Service First Call Zacks I/B/E/S Consensus Forecast $0.18 $0.18 $0.18 Actual EPS $0.19 $0.19 $0.19 While each of the tracking services reported actual EPS at $0.19, GAP’s fiscal 1999 Form 10-K indicates that EPS for the quarter, computed according to GAAP, was a loss of -$2.31. The Assignment 1. Identify the reason(s) for the difference between the actual EPS numbers reported by the analyst tracking services and the EPS number computed according to GAAP and reported in the 10-K. Please be specific in describing these differences. (You may wish to provide a reconciliation between net income and pro forma earnings so that you don’t miss anything.) 2. Please explain pro forma earnings, in general. Discuss the both the pros and the cons of allowing firms to present pro forma information. 3. Analysts pay attention to pro forma numbers- and seemingly ignore the GAAP EPS. Why do analysts behave this way? What is your opinion of this practice? 4. Which of the alternative EPS numbers do you think best represents the “true” performance of GAP for the quarter? Explain your answer in detail speaking directly about the adjustments that GAP made. Make sure you explain what they did under GAAP and why (or why not) the pro forma presentation does (does not do) a better job. Exhibit 1 THE GREAT ATLANTIC & PACIFIC TEA COMPANY, INC. ANNOUNCES FOURTH QUARTER AND YEAR END RESULTS Strong Sales Trend Continues With 4.8% Comparable Store Sales Gains Strategic Initiatives Program on Track MONTVALE, NJ--MARCH 16, 1999-The Great Atlantic & Pacific Tea Company, Inc. (NYSE: GAP) ("A&P") announced today fourth quarter and year end results for fiscal 1998 ended February 27, 1999. Sales for the twelve-week quarter were $2.43 billion versus $2.50 billion for the corresponding thirteen-week quarter last year. Comparable store sales increased by 4.8%. For the quarter, the Company posted a net loss of $88.6 million or $2.31 per share, versus the prior year's net income of $13.4 million, or $.35 per share. Excluding the impact of charges related to strategic initiatives under the previously announced "Project Great Renewal" and operating losses of the stores identified for closure, the Company would have earned $7.3 million or $.19 per share. Fiscal 1998 sales were $10.18 billion in fifty-two weeks, compared to $10.26 billion in fifty-three weeks in fiscal 1997. Comparable store sales for the year were positive 1.9%. For the year, the Company posted a net loss of $67.2 million or $1.75 per share, versus net income of $63.0 million or $1.65 per share for the fifty-three week prior year. Excluding the impact of charges related to Project Great Renewal initiatives and operating losses of affected stores for the 4th quarter, the Company would have earned $51.3 million or $1.34 per share. Last year's results, for both the quarter and the year, include the benefit of an extra week, a lower reported tax rate from the Company's Canadian operations, and operating losses of the stores identified for closure. Christian Haub, President and Chief Executive Officer, said: "I am pleased with our Company's progress in 1998, including an accelerated capital plan, improved merchandising, better operating standards, and elimination of underperforming stores and markets. Our new stores are performing well, and our position in core markets continued to improve. Progress is visible throughout the Company, culminating in the 4.8% comparable store sales gain in the fourth quarter. Our associates at all levels have shown support and enthusiasm for our change programs. Their response gives us great confidence that A&P will perform at higher levels in 1999 and beyond." On December 8, 1998, the Company announced a series of strategic initiatives designed to improve operating and financial performance. These initiatives, which the Company is calling "Project Great Renewal," included accelerating the new store and Food Basics conversion programs, realigning distribution functions, closing manufacturing facilities and exiting 132 underperforming stores (127 stores identified on December 8, and 5 additional stores identified at the end of the fourth quarter). The Company has already closed 66 of the exit program stores, including all stores in the Richmond Virginia market, and will complete the exit program in the next nine months. In fiscal 1998, the company opened 46 new stores, more than any year this decade, and remodeled or expanded 65 stores. As part of its ongoing store modernization program, in addition to the exit program the Company closed or replaced 76 smaller stores. In fiscal 1999 the Company plans to open 55 new stores, and in addition recently announced an agreement to acquire 6 stores from Schwegmann's in New Orleans. Mr. Haub commented: "The new store and capital redeployment strategies of Project Great Renewal are well underway. We are also meeting our timetable for the cost savings and loss elimination initiatives. We expect these initiatives to lead to $90 million of annualized earnings benefits, including $57 million in fiscal 1999." Founded in 1859, The Great Atlantic & Pacific Tea Company, Inc. is the nation's oldest supermarket company and one of America's top ten supermarket chains. The Company operates more than 800 stores in 18 states and Canada under the following trade names: A&P, Waldbaum's, SuperFresh, Farmer Jack, Save-A-Center, Super FoodMart, Food Emporium, Kohl's, Dominion and Food Basics. # FOURTH QUARTER EARNINGS ( UNAUDITED ) (In thousands, except share amounts and store data) SALES (3) 12 WKS ENDED FEB. 27, 1999 $2,426,323 13 WKS ENDED FEB. 28, 1998 $2,503,136 52 WKS ENDED FEB. 27, 1999 $10,179,358 53 WKS ENDED FEB. 28, 1998 $10,262,243 COST OF MERCHANDISE SOLD (3) (1,746,380) (1,789,668) (7,260,110) (7,327,365) GROSS MARGIN (3) 679,943 713,468 2,919,248 2,934,878 STORE OPERATING, GENERAL AND ADMINISTRATIVE EXPENSE (4) PROJECT GREAT RENEWAL CHARGE (5) (LOSS) INCOME FROM OPERATIONS INTEREST EXPENSE (702,316) (680,608) (2,870,486) (2,779,619) (213,153) 0 (213,153) 0 (235,526) 32,860 (164,391) 155,259 (18,472) (18,928) (71,497) (78,190) INTEREST INCOME 1,418 2,754 6,604 5,831 (LOSS) INCOME BEFORE INCOME TAXES BENEFIT (PROVISIONS) FOR INCOME TAXES VALUATION ALLOWANCE REVERSAL BENEFIT (LOSS) INCOME BEFORE EXTRAORDINARY ITEM EXTRAORDINARY LOSS-DEBT EXTINGUISHMENT NET (LOSS) INCOME (252,580) 16,686 (229,284) 82,900 103,730 (3,328) 101,820 (19,314) 60,300 0 60,300 0 (88,550) 13,358 (67,164) 63,586 0 0 0 (544) ($88,550) $13,358 ($67,164) $63,042 ($2.31) $0.35 ($1.75) $1.66 - - - (0.01) ($2.31) $0.35 ($1.75) $1.65 38,308,002 38,251,162 38,293,859 38,249,832 839 936 839 936 55 52 55 52 BASIC (LOSS) EARNINGS PER SHARE: (1) (2) (LOSS) INCOME BEFORE EXTRAORDINARY ITEM EXTRAORDINARY LOSS-DEBT EXTINGUISHMENT NET (LOSS) INCOME PER SHARE-BASIC (6) WEIGHTED AVERAGE COMMON SHARES OUTSTANDING STORES OPERATED AT END OF QUARTER FRANCHISED STORES SERVED END OF QUARTER NOTES: (1) Included in the fourth quarter ended February 27, 1999 net loss of $88.6 million or $2.31 per share are after-tax charges amounting to approximately $156.2 million or $4.07 per share relating to Project Great Renewal, partially offset by the reversal of the Canadian deferred tax asset valuation allowance amounting to $60.3 million or $1.57 per share. The net total of the after-tax charges amounted to approximately $95.9 million or $2.50 per share. (2) Included in the 52 week period ended February 27, 1999 net loss of $67.2 million or $1.75 per share are after-tax charges amounting to approximately $178.8 million or $4.66 per share relating to Project Great Renewal and other charges, partially offset by the reversal of the Canadian deferred tax asset valuation allowance amounting to $60.3 million or $1.57 per share. The net total of the after-tax charges amounted to approximately $118.5 million or $3.09 per share. (3) Included in sales, cost of sales and gross margin are $150.0 million, $124.6 million and $25.4 million, respectively, of sales and costs relating to initiatives under Project Great Renewal for both the 12 and 52 week period ended February 27, 1999. (4) Included in store operating, general and administrative expense are costs approximating $77.6 million for the 12 week period and $112.3 million for the 52 week period ended February 27, 1999 related to the Great Renewal Program. (5) The Project Great Renewal Charge relates to write-off of fixed assets, a charge for the present value of store leases and severance. (6) The Earnings Per Share ("EPS") calculated on a diluted basis is the same as the basic EPS. FOURTH QUARTER EARNINGS ( UNAUDITED ) (In thousands, except share amounts and store data) ADJUSTED (1) 12 WKS ENDED FEB. 27, 1999 REPORTED 12 WKS ENDED FEB. 27, 1999 ADJUSTED (1) 52 WKS ENDED FEB. 27, 1999 REPORTED 52 WKS ENDED FEB. 27, 1999 SALES $2,276,316 $2,426,323 $10,029,351 $10,179,358 GROSS MARGIN RATE 28.75% 28.02% 28.85% 28.68% STORE OPERATING, GENERAL AND ADMINISTRATIVE EXPENSE RATE PROJECT GREAT RENEWAL CHARGE RATE (LOSS) INCOME FROM OPERATIONS (LOSS) INCOME BEFORE EXTRAORDINARY ITEM NET (LOSS) INCOME (27.44%) (28.95%) (27.50%) (28.20%) EBITDA (2) $82,066 BASIC (LOSS) EARNINGS PER SHARE: (LOSS) INCOME BEFORE EXTRAORDINARY ITEM EXTRAORDINARY LOSS-DEBT EXTINGUISHMENT NET (LOSS) INCOME PER SHARE BASIC WEIGHTED AVERAGE COMMON SHARES OUTSTANDING STORES OPERATED AT END OF QUARTER FRANCHISED STORES SERVED AT END OF QUARTER (213,153) (213,153) 29,845 (235,526) 135,635 (164,391) 7,321 (88,550) 51,283 (67,164) $7,321 ($88,550) $51,283 ($67,164) $369,298 $0.19 ($2.31) $1.34 ($1.75) $0.00 $0.00 $0.00 $0.00 $0.19 ($2.31) $1.34 ($1.75) 38,308,002 38,293,859 839 839 55 55 NOTES: (1) The as adjusted amounts for the 12 and 52 weeks ended February 27, 1999, exclude the impact of charges related to the strategic initiatives under the previously announced "Project Great Renewal" and the operating losses of the stores identified for closure for the 12 weeks ended February 27, 1999. The results for the 13 and 53 weeks ended February 28, 1998 include the benefit of an extra week, lower reported tax rate from the Company's Canadian operations and operating losses of the stores identified for closure. (2) EBITDA represents Earnings Before Interest, Taxes, Depreciation and Amortization. The EBITDA for the 12 and 52 week periods ended February 27, 1999 exclude the costs resulting from the Company's Great Renewal Program, other costs and the losses for the 12 week period ended February 27, 1999 of the stores identified for closure. Exhibit 2 Extracts From The Great Atlantic and Pacific Tea Company’s Form-10K for 1998 Extract 1 From “SUMMARY OF QUARTERLY RESULTS” (Dollars in thousands, First Second Third Fourth Total except per share data) Quarter Quarter Quarter Quarter Year - ---------------------- -----------------------------1998 Sales $3,078,386 $2,330,249 $2,344,400 $2,426,323 $10,179,358 Gross margin 886,313 673,278 679,714 679,943 2,919,248 Depreciation and amortization 72,194 54,167 55,081 52,221 233,663 Income (loss) from operations 44,231 28,653 (1,749) (235,526) (164,391) Interest expense (21,032) (15,781) (16,212) (18,472) (71,497) Net income (loss) 19,169 10,951 (8,734) (88,550) (67,164) Per share data: Net income (loss) basic and diluted .50 .29 (.23) (2.31) (1.75) Cash dividends .10 .10 .10 .10 .40 Market price: High 34.25 33.63 27.63 34.00 Low 29.63 23.56 22.13 25.43 Number of stores at end of period 919 913 907 839 Number of franchised stores served at end of period 53 53 55 55 Extract 2 From “NOTES TO CONSOLIDATED FINANCIAL STATEMENTS” SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES STORE AND FACILITIES EXIT COSTS In May 1998, the Company named a sole Chief Executive Officer of the Company. Following such announcement, the Company initiated a vigorous assessment of all aspects of its business operations in order to identify the factors that were impacting the performance of the Company. As a result of the above assessment, in the third quarter of fiscal 1998, the Company decided to exit two warehouse facilities, a coffee plant and a bakery plant in Canada. In connection with the exit plan, the Company recorded a charge of approximately $11 million which is included in "Store operating, general and administrative expense" in the accompanying Statement of Operations. The $11 million charge was comprised of $7 million of severance, $3 million of facilities occupancy costs for the period subsequent to closure and $1 million to write-down the facilities to their estimated fair value. The Company has paid $3 million of the severance cost as of February 27, 1999, and expects the remainder to be paid by the end of fiscal 1999. As of February 27, 1999, the Company has incurred $0.3 million of occupancy costs. At February 27, 1999, the Company had closed and terminated operations with respect to the warehouses and the coffee plant. The volume associated with the two warehouses has been transferred to other warehouses in close geographic proximity. Further, the manufacturing processes of the coffee plant have been transferred to the Company's remaining coffee processing facility. The processing associated with the Canadian bakery has been outsourced effective January 1999. In addition, on December 8, 1998, the Company's Board of Directors approved a plan which included the exit of 127 underperforming stores throughout the United States and Canada and the disposal of two other properties. Included in the 127 stores are 31 stores representing the entire Richmond, Virginia market. Further on January 28, 1999, the Board of Directors approved the closure of five additional underperforming stores. In connection with the Company's plan to exit these 132 stores and the writedown of two properties, the Company recorded a fourth quarter charge of approximately $215 million. This $215 million charge was comprised of $8 million of severance, $1 million of facilities occupancy costs, $114 million of store occupancy costs, which principally relates to the present value of future lease obligations, net of anticipated sublease recoveries, which extend through fiscal 2028, an $83 million write-down of store fixed assets and a $9 million write-down to estimated fair value of the two properties which are held for sale. To the extent fixed assets included in those stores identified for closure could be utilized in other continuing store locations, the Company has or will transfer such assets to those continuing stores. To the extent such fixed assets cannot be transferred, the Company will scrap such fixed assets and accordingly, the write-down was calculated utilizing an estimated scrap value. This fourth quarter charge of $215 million was reduced by approximately $2 million due to changes in estimates of pension withdrawal liabilities and fixed asset writedowns from the time the original charge was recorded. The net charge of $213 million is included in "Store operating, general and administrative expense" in the accompanying Statement of Operations. The Company has paid $1 million of the severance costs as of February 27, 1999 and expects the remainder to be paid by May 2000. In addition, the Company also paid $1 million of store occupancy costs since the date of closure of the 66 stores closed as of February 27, 1999. The total severance charge of approximately $15 million resulted from the termination of 1,273 employees. The following tabular reconciliation summarizes the activity related to the aforementioned third quarter charges of $11 million and the fourth quarter charges of $215 million. Reserve Balance at Original Utiliz- Addition Adjustment Feb. 27, Dollars in thousands Charge ation (1) (2) 1999 - -------------------- -------- ------- -------- -----------------Store Occupancy $113,732 $ (1,100) $1,900 $ $114,532 Fixed Assets 93,355 (92,639) (716) Severance and benefits 15,102 (3,794) (1,242) 10,066 Facilities occupancy 4,018 (311) 331 4,038 -------- -------------------------Total $226,207 $(97,844) $1,900 $(1,627) $128,636 ======== ======== ====== ======= ======== (1) The addition represents an increase to the store occupancy reserve for the present value interest accrued. (2) The adjustment represents changes in estimates from the original date the respective charges were recorded. The adjustment to severance and benefits relates to a change in the estimate of the calculated pension withdrawal liability. As of February 27, 1999, the Company has closed 66 of the 132 stores identified, including all 31 stores in the Richmond, Virginia market. The remaining 66 stores will be closed over the next three quarters of fiscal 1999. At February 27, 1999, $45.4 million of the reserve is included in "Other accruals" and $83.2 million is included in "Other non-current liabilities" in the accompanying consolidated balance sheet. Based upon current available information, Management evaluated the reserve balance as of February 27, 1999 and has concluded that it is adequate. Included in the accompanying statement of operations are the operating results of the 132 underperforming stores which the Company is exiting. The operating results of such stores are as follows: Fiscal (Dollars in thousands) 1998 Sales $788,014 - ---------------------Operating Loss $(57,462) -------- Fiscal 1997 $928,671 $(34,448) -------- Fiscal 1996 $1,000,364 $---------(14,543)