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EchoStar Should Address SEC Issues Fully, Swiftly

By | March 15, 2004

      It was difficult for me not to wonder a couple of years ago whether Englewood, Colo.-based EchoStar Communications [DISH] might fall victim to some of the accounting pitfalls that plagued other public companies that used Arthur Andersen LLP as an auditor. Arthur Andersen was a once-distinguished member of the world’s biggest accounting firms before it came crashing down amid scandalous bookkeeping practices at some public companies it audited.

      EchoStar seemed to have escaped unscathed from absorbing any of the fallout from aggressive accounting practices at the time. Last week’s announcement the company likely would need to restate its 2001 financial results due to over-accruing for smart cards suggests EchoStar was not completely immune from accounting ills.

      However, it appears to be a fairly obscure accounting matter that has caused EchoStar to stumble, and the amounts involved are comparatively small for a company of its size. Indeed, EchoStar’s outlook still seems bright as Wall Street satellite analysts suggested last week that investors should pounce at any weakness in the company’s stock price to add to their holdings.

      The specifics of the accounting problem announced last week are that the SEC informed EchoStar that the company had over-accrued $17 million and $9 million for the replacement of smart cards during 2001 and 2002, respectively. Those cards, which prevent non-subscribers from receiving EchoStar programming, become obsolete over time due to piracy. From 1996 through 2002, EchoStar gradually established a reserve to accrue for the estimated cost to replace the smart cards used in satellite receivers sold and leased by EchoStar to its customers.

      The good news is the SEC concluded EchoStar’s accrual to replace the smart cards was appropriate. That bad news is the SEC determined EchoStar should not have accrued a liability for smart cards in satellite receivers that it owned and leased to consumers.

      Encouraging Sign

      An encouraging sign is that no other outstanding accounting issues concerning EchoStar’s financial reporting have surfaced, company officials said. EchoStar is expected to request a 15-day extension to report its fourth-quarter and full-year 2003 results. While other accounting resolutions are possible, EchoStar would be required to have its 2001 financial statements re-audited by its current auditing firm, KPMG, unless the SEC reconsiders its current position about the need to accrue for the smart cards.

      Reversal of the accrual would not affect EchoStar’s previously reported free cash flow, but it would increase earnings for those years and would improve EchoStar’s past pre-tax losses on a dollar-for-dollar basis. There can be no assurance that the results of any such re-audit would not require other modifications to EchoStar’s 2001 financial results or results for other years, company officials said. EchoStar officials expressed hope that a re-audit could be completed and their company’s Form 10-K filed with the SEC by March 30.

      Quick Resolution?

      The step for EchoStar to take right now is to address any and all SEC accounting issues fully and swiftly. As officials from EchoStar, KPMG and the SEC discuss the best course of action, the focus should be on addressing anything questionable now to avoid further restatements later.

      On the surface, EchoStar’s bookkeeping issues appear to be fairly minor, at least when measured against the outright fraud that prosecutors are alleging occurred at such failed public companies as Enron, Adelphia Communications and WorldCom. Clearly, running afoul of SEC accounting rules in any manner is serious. To EchoStar’s credit, it appears to be cooperating with the SEC to fix whatever irregularities occurred.

      The best public-relations strategy in such instances is to fully disclose the problem, rectify it to the satisfaction of the SEC and correct any internal practices to avoid future missteps. That path is the one that EchoStar should take, and its Chairman and CEO Charlie Ergen should lead the way. Concern about corporate malfeasance generally led the SEC to require Ergen and the CEOs of 944 other public companies to certify their financial statements, beginning Aug. 14, 2002. The same law calls for prison terms of as many as 20 years for any top corporate officer who allows seriously misleading material to be included in company financial reports. A good leader does not need the threat of a penalty to tell his employees that operating with integrity and full compliance with the law is the only path to be followed. Ergen has a great opportunity to demonstrate moral leadership, and he needs to do so.

      Notable Exception

      The satellite industry has been relatively free from accounting problems. The one notable exception involved Orbital Sciences [ORB] when it restated past financial statements several years ago on different occasions. Orbital subsequently has recovered financially but coverage of the stock on Wall Street has dwindled. EchoStar is too important a company to risk anything other than full disclosure and total cleansing of any bookkeeping problems as soon as possible. A quick and complete resolution of the matter now would allow the company to recover and to retain the trust of investors and the general public.

      –Paul Dykewicz

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