Wachovia finds American Greetings reserves explanation reasonable

By Ronda Fears

Nashville, Tenn., July 8 - American Greetings Corp.'s explanation regarding its first-quarter decline in reserves for sales returns appears reasonable, said Wachovia Securities convertible analyst Sri Nadesan.

"Despite the recent decline in the stock price, down about 25% since early May, we believe the American Greetings 7% convertible is trading at about its fair value even without assuming an increase in stock dividend during the remainder of the life of the convertible," Nadesan said in a report Monday.

"We continue to suggest that investors use a credit spread of 650 bps on the convertible. We believe continued investment in the convertible should be based on multiple expansion on the stock price."

Last week, a Wall Street Journal column highlighted the issue of how the fine-tuning of reserves could offer companies a degree of freedom regarding reported net income, mentioning American Greetings among others.

At the end of fiscal first quarter 2003, or May 31, American Greetings' reserves for sales returns and doubtful accounts declined to $143.7 million from $213.3 million at the end of fiscal first quarter 2002.

Based on this, the article suggested American Greetings may have boosted first-quarter fiscal 2003 net income by lowering the sales returns reserve.

The article mixed up annual flow revenue numbers with first quarter-end static reserve numbers for American Greetings, Nadesan said.

"American Greetings responded promptly to the WSJ article and made some important points," the analyst said.

"The company said it has not changed its method of accounting for sales returns and that the net reduction in reserves had 'virtually no impact' on first-quarter fiscal 2003 net income."

The company also highlighted three reasons for the decline in reserves for returns.

The company changed to a scan-based trading model with two of its large customers, which accounted for about 20% of its net revenue for fiscal 2002. This switch was in fiscal first quarter 2002 and appears to have increased the reserves for returns in that quarter as American Greetings made commitments to buy back inventory to implement the new model.

The company says its efforts to reduce seasonal shipments over the past year resulted in lower seasonal returns, which allowed it to lower reserves.

And, the company says it has resolved some past-due accounts that resulted in lower reserves.

The reserves for returns and doubtful accounts in the first quarter of fiscal 2002 were $213.8 million, which at 38% of gross receivables was the highest in the nine quarters since the first quarter of fiscal 2001.

In fiscal first quarter 2003, this reserve was down to $143.7 million, or 30% of gross receivables. The reserves amount as a percentage of sales has been fluctuating between 26% in fiscal third quarter 2002 and 38% in fiscal first quarter 2002.

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