Just after market close on Friday July 31st, 2009, Huron Consulting Group dropped a bombshell on investors by announcing an intention to restate its 2006 to 2009 financial statements due to incorrect accounting of “non-cash charges relating to how payments received by the sellers of certain acquired businesses were subsequently redistributed among themselves and to other select Huron employees”. Shell shocked investors immediately sold HURN stock, causing the stock to fall by an astounding 70% from close of market on Friday at $45 to open at a paltry $12 per share at open of market on Monday August 3rd, 2009, and leading to an instant shareholder value disappearance of almost $700 million.
It is now apparent that Huron had agreements to pay some employees at four of its recent acquisitions “earn-out” compensations based on their unit performance after the transaction was completed. These agreements were on their own quite legal, but their accounting was not quite done right. Instead of charging these compensations to P&L expenses as non-cash charges with negative impact on Huron’s net income, they were booked as purchase price goodwill on the balance sheet, thus with no impact on net income and EPS.
Thus, net income and EPS were overstated for these years, and the restatement has the effect of reducing net income by these incorrectly accounted charges. These restatements are not insignificant, in 2006 net income would have decreased by $4 million from $27 million to $23 million; in 2007, net income would have decreased by $18 million from $42 million to $24 million; in 2008, net income would have decreased by $31 million from $41 million to $10 million; in Q1-2009, net income would have decreased by $4 million from $10 million to $6 million. Cumulatively, the total restated amount was $57 million over these four years.
Upon disclosure, the market reduced Huron’s shareholder value by 12 times the fictitious additional earnings of $57 million. Just before this announcement Huron’s P/E ratio was $44 share price divided by estimated EPS of $3.16 or about 14x. Which kind of makes sense.
Huron started as a spinoff from Andersen in March 2002 with about 25 partners and about 200 consultants, principally from Chicago and some pockets in New York, Houston and other parts of the US. The heart of Huron was the Litigation consulting group from the Midwest offices at 33 West Monroe, Chicago downtown. In a matter of weeks while Andersen was crumbling, Huron was able to pull together its core partners, and with financial backing from Lake Partners and Gary Holdren and Dan Broadhurst in the lead, quickly set up its own operating structure and separate offices. Since the core partners had strong and profitable individual practices, they were able to move their clients and personnel to Huron, and given the imminent collapse of Andersen, this was an appropriate move, though with always the inherent risk of a startup entity. Paul Charnetzki, Jim Rojas, Jim Roth, Lisa Snow, Susan Gallagher, Gerald Richardson, Mukesh Gangwal, Michael O’Connor, Robert Wentland, Timothy Zeldenrust among others formed the core team of Chicago partners who launched Huron. Interestingly, this group was a purely consulting practice and had no connection with the Enron audit which caused the downfall of Andersen.
Even at its inception Huron had strong and profitable practices, and notched up annual revenues of $35 million. It focused on litigation services, forensic accounting, bankruptcy, education and healthcare consulting, all services in good demand. Over the years, it grew with amazing rapidity adding new services, new experts, new consultants and new offices both in the US and abroad. Revenues surged to $100 million in 2003. Huron went public in October 2004 (Nasdaq: HURN) with revenues of $150 million and 600 employees, providing an early and financially rewarding exit for Lake Capital and making the initial core partners quite wealthy independent shareholders. Huron continued to grow to $600 million in revenue in 2008 and with 2,000 employees, bucking the economic downturn with services that were quite recession-proof over the last few years. Huron also made a number of acquisitions during this time extending its service depth and international footprint. In 2009, Huron was expecting revenues of about $700 million and about $65 million in net income.
So what happened?
The media and blogs are conveniently pinning the Huron debacle on its Andersen roots, and hinting that the Enron malfeasance bled into Huron. We don’t fully subscribe to this theory, while Huron’s senior management team certainly was from the core of Andersen Chicago, it was hardly involved with Enron’s audit and was quite angry with the way things turned out for the Andersen firm taking the hit for the bad actions of a few employees.
Rather than jumping on the Andersen bandwagon, we think that what transpired here was the result of simple universal human emotions - fear and greed - playing themselves out. Fear of reporting less than satisfactory results to Wall Street which had very high expectations and the financial greed associated with an increasing stock price were in our opinion the key underlying factors for this debacle.
Put yourself in the shoes of Gary Holdren, Huron’s CEO in 2008. Would you rather report to a tough Wall Street crowd a stupendous 23% increase in sales from 2007 and a nearly flat change in net income OR would you report a robust sales growth and a precipitous decline in net income from 2007 to 2008. While we may never find out if Gary Holdren senior management knew of this accounting treatment, our guess is that they preferred the former position and continued to report false numbers in the fervent hope they never get found out. In the battle of truth versus falsehood, truth unfortunately got trampled by greed.
And ironically it is really not senior management which came out with this revelation. According to Huron’s statement, it came to the attention of the Audit Committee of the Board of Directors that there was something amiss when selling shareholders of an acquisition had an agreement among themselves to reallocate a portion to a Huron employee who was not a shareholder, upon which it launched an inquiry to see if other similar situations existed, and further engaged legal and financial advisors and notified PricewaterhouseCoopers, Huron’s auditors who were apparently unaware of this situation. Reading between the lines, it appears that the Audit Committee stumbled upon something and had the guts to chase it independently, senior management never seemed to be quite ready to disclose its errors.
With all this in the background, we are ready to hand out our kudos and shame awards:
First, kudos to the Audit Committee (John McCartney, Dubose Ausley and James Edwards) for unearthing this issue and pursuing it fearlessly to its terrible end.
Second, shame on senior management to succumb to greed and not complying strictly with accounting standards
Third, shame also on the auditor, PricewaterhouseCoopers for failing to spot this issue, especially in 2008, when the amount of money kept in goodwill was $31 million, three times the true net income of Huron of only $10 million
Fourth, shame on Huron itself for providing accounting, internal audit, internal controls, Sarbanes, and similar advice to its corporate clients, while following shady accounting practices. Physician, heal thyself first.
Finally, our sympathies for all the hard working and honest Huron consultants who had nothing to do with acquisitions or their accounting, and are likely as mad as anyone that this could happen to them.
The Chicago Tribune and Crains Chicago are already asking whether Huron will survive this scandal and continue as a company, given the impacts on its standing and potential large scale departures. We think that while this is a devastating hit on the company’s reputation and stock price, it is not a body blow and (unlike BearingPoint) the business will survive over the long term as its consulting service is quite healthy and utilization % quite reasonable. The first steps to announce the restatement, take the full market hit, fire the CEO and CFO, are all in the right direction. It will be tough going for a while (3 shareholder lawsuits already filed), but mass exodus of consultants seems rather unlikely (really, who’s hiring nowadays), and if the new management team which has already survived the Andersen crisis has the right attitudes and goals, (we hope) will make the move to a reputable consulting firm.
We’ll watch and see how things shape up, but the stock seems to be slightly on the upswing with a 6% move up today, which indicates to us that the market move down was perhaps a touch overdone, considering that core operations are still presumably fine.
It’s not fun to see another offspring of the Big4 firm take a nosedive, but its better to take the hit now and find a road to survival, then continue festering longer and be completely wiped off the map. Having seen what transpired at Andersen in 2002, this seems like déjà vu all over again.
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