Chicago Sun-Times
March 17, 2003
BY SANDRA GUY Business Reporter

The first warning sign of Spiegel Inc.'s financial implosion flashed in the fall of 1999.

The financial results showed an odd juxtaposition: record earnings and a huge spike in the amount of money the retailer's credit-card holders owed.

Credit-card receivables jumped 38 percent to $762 million in September 1999 from a year earlier. But at the same time, revenues increased only 9.6 percent to $706 million.

Another red flag in the third quarter of 1999: Spiegel had $169 million in negative operating cash flow, according to an analysis by StockDiagnostics.com, an investment firm that looks for anomalies in companies' financial reports.

In the second and third quarters of fiscal 2000, huge jumps in credit-card receivables that dwarfed revenues recurred. Yet, by the end of 2000, Spiegel executives were touting record sales and profit.

"People weren't paying their credit-card bills, but Spiegel kept selling to them," said Michael Markowski, director of research at StockDiagnostics.com.

To make matters worse, Spiegel relaxed its criteria for credit-card applicants to pump up earnings.

That is a recipe for disaster, said Kevin Silverman, retail analyst at ABN Amro Asset Management's Chicago office.

"If your credit department is driving decisions at the retail merchants, your eye is off the ball," Silverman said.

Until Spiegel was forced earlier this month to suspend its credit-card programs, its retail units depended heavily on shoppers buying on credit. Last week, the company for the first time acknowledged that a Chapter 11 bankruptcy protection filing was a possibility.

Why was Spiegel so hungry for growth, even at the risk of turning into a sub-prime lender?

The Downers Grove-based parent of Eddie Bauer stores and Spiegel and Newport News catalogs suffered four straight quarters of revenue declines in 1998, and Eddie Bauer lost its fashion edge among the upscale outdoorsy crowd.

"Clearly, much work remains to be done to ensure consistent growth for the Spiegel Group in the future," wrote Michael Otto, Spiegel's chairman and a member of the German family of Otto Versand catalog fame, in the company's 1999 annual report.

Spiegel never managed to achieve consistent growth, but its executives' success in 2000 in boosting earnings, and thus the company's share price, has drawn the Security and Exchange Commission's attention.

Spiegel's agreement early this month to settle civil fraud charges brought by the SEC requires that a court-appointed examiner delve into the company's books. The examiner will look at financial papers dated Jan. 1, 2000 to the present.

The SEC accused Spiegel of reckless behavior, and alleged that the company deliberately did not file its financial reports in order to hide its crumbling books.

The settlement doesn't end the SEC's investigation into Spiegel and its executives.

Until the SEC took action, retail analysts and investors believed the Otto family would bail out the company as it had in the past.

Now, an Otto family rescue is unlikely, said Boniface "Buzz" Zaino, portfolio manager at Royce & Associates Inc. in New York, who sold his shares last week. Zaino had been Spiegel's largest non-voting shareholder.

The Otto family owns all of Spiegel's voting stock, and Spiegel's board of directors is made up entirely of company executives and current or retired directors of Otto Versand. The directors with ties to Otto Versand live in Germany.

The Ottos bought Spiegel in 1982 because it was similar to their own catalog business, said Silverman of ABN Amro.

But the Ottos clung to the idea of a Big Book catalog for too long, Silverman said. One reason might be the difference between catalog retailing in the United States and Germany.

A catalog is still a convenient way to shop in Germany, partly because of that country's shorter shopping hours and reliable postal system. In the United States, the "big book" catalog featuring a wide variety of goods has been killed by big box retailers like Wal-Mart, he said.

The company made several fashion missteps, too. Its Eddie Bauer chain, acquired in 1988 from General Mills, introduced casual office clothing that alienated its core customers, and the clothes sold through the Spiegel and Newport News catalogs were slow to keep up with the latest styles.

Finally, the company never held down the costs of shipping its goods and struggled to make its supply chain efficient, Silverman said.

Yet the biggest downfall remains the earnings pump-up, analysts said.

Markowski of StockDiagnostics.com warns investors to be wary of companies that claim record earnings, especially when their operating cash flows are negative.

Meanwhile, Spiegel has hired a corporate law firm that helps retailers in reorganizations and bankruptcy filings, and named turnaround expert William Kosturos as its interim CEO.