U.S. Securities and Exchange Commission
LITIGATION Release No. 18271 / August 5, 2003
ACCOUNTING AND AUDITING Release No. 1828 / August 5, 2003
Securities and Exchange Commission v. Alexander H. Edwards, III, U.S. District Court for the Middle District of Florida (Civil Action No. 8:03-CV-1647-T-26MAP.
FORMER PRESIDENT OF SRI/SURGICAL EXPRESS, INC. SETTLES SECTION 10(b) CHARGE CONCERNING SRI'S OVERSTATED REVENUE
SRI, ITS FORMER COO, AND CFO ALSO SETTLE CEASE AND DESIST PROCEEDING
A. The Edwards Complaint
The U.S. Securities and Exchange Commission today filed a settled civil enforcement action in U.S. District Court in Tampa, Florida, against Alexander H. Edwards, III, former president of SRI/Surgical Express, Inc. (SRI), a Florida hospital supply company that trades on the NASDAQ National Market System under the symbol STRC. The complaint alleged that Edwards caused SRI to enter into two transactions that resulted in SRI overstating its Fiscal 2001 third quarter revenue by $832,000 even though neither of the counter parties ever agreed to accept delivery of, or pay for, additional products in SRI's third quarter. More specifically, the complaint alleges:
- The first transaction involved Jewish Hospital Healthcare System ("JHHS") based in Lexington, Kentucky. A few weeks prior to the September 30, 2001 close of SRI's third quarter, Edwards told JHHS that SRI was having trouble balancing inventory among its various facilities. Edwards asked if SRI could pre-bill JHHS for 60 to 90 days of inventory. Edwards explained that he did not expect JHHS to pay SRI any of the invoices for goods billed and not delivered. Instead, and consistent with their contractual arrangement, Edwards acknowledged JHHS would only pay for the products it received. In or about October, Edwards sent the purchasing agent's controller invoices totaling $753,480 for the entire pre-billed inventory. As a result, SRI improperly recorded $753,480 in sales revenue in its third quarter, even though SRI did not deliver $753,480 worth of additional supplies to JHHS in that quarter.
- The second transaction involved UMass Memorial Medical Center ("UMass") in Worcester, MA. Shortly before the close of SRI's third quarter, Edwards asked if UMass would accept early shipment of some inventory that SRI had customized for it. Edwards explained that he was interested in shipping an additional 30-day supply of inventory to the depot SRI used to service UMass in exchange for a discount in the purchase price. Although the UMass officials asked Edwards to put the proposal in writing, Edwards never provided UMass with any written documentation. Accordingly, UMass never ordered any additional supply of products under the arrangement Edwards proposed. SRI's accounting group prepared invoices based on its understanding of the transaction as relayed to it by Edwards. As a result of this purported transaction sale, SRI recorded approximately $88,000 of sales revenue on its books and records.
- As SRI's president and sales director, Edwards was reckless in not knowing that these transactions were not sales.
Without admitting or denying the allegations in the complaint, Edwards consented to the entry of a Final Judgment permanently enjoining him from future violations of (or aiding and abetting violations of) Sections 10(b), 13(b)(5), and 13(b)(2)(A) and (B) of the Securities Exchange Act of 1934 ("Exchange Act") and Exchange Act Rule 13b2-1. The Final Judgment also imposes a $50,000 civil penalty.
B. The Cease-and-Desist Order Against SRI, its former COO and CFO
The Commission also issued a settled cease-and-desist order today (the "Order") against SRI, its former COO Wayne R. Peterson, and its former CFO James T. Boosales. The findings in the Order involved the premature recognition of customer orders at the end of SRI's 2001 second and third quarters. More specifically, the Order found that:
- SRI's internal controls contained a significant loophole that allowed its revenue recognition policy to be circumvented. SRI did not record the date or time that it actually delivered the shipments to its customers. As a result, the only dates in SRI's records were the "order request" date and the "ship confirm" date, and both of these dates could be manually overridden.
- In mid-to-late June 2001, COO Wayne R. Peterson informed SRI's operations staff that SRI's revenues were falling short of the company's internal expectations. Peterson emphasized that SRI needed to sell an additional day and a half worth of product by month's end. In response to Peterson's directives, certain operations personnel instructed their facilities to invoice as much product as possible over the remaining days of the second quarter. An operations employee emphasized that plant managers he supervised could invoice products that had been pulled, packed and staged for delivery if necessary at the end of the quarter. Other operations personnel also instructed their respective plants to move orders that had been staged for delivery from Monday to Friday to help alleviate the shortfall. SRI operations personnel manually changed dates in the company's computer system to accelerate the recognition of the revenue.
- SRI's Assistant Controller observed an unusual spike in quarter-end revenue and found a number of instances in which one customer's account reflected two orders on Friday, June 29. Unable to find any logical reason for these double orders and believing that some mistakes had occurred, with CFO James Boosales' authorization, he moved approximately $150,000 worth of the backdated sales into the third quarter. Despite his efforts to correct SRI's second quarter revenue, the Assistant Controller did not catch all of the prematurely recognized customer sales. As a consequence, SRI's second quarter revenues remained overstated by $120,000 in SRI's second quarter Form 10-Q for the period ended June 30, 2001.
- In September 2001, the last month of SRI's fiscal third quarter, with just five days remaining in the quarter, SRI had a $2 million shortfall from its revenue goal. Peterson encouraged the plants to increase customer inventory levels and provided the operations staff with specific revenue targets for each plant. In Peterson's presence, an operations supervisor commented that the facilities might have to "borrow from next week" to meet those targets. Specifically, Peterson heard someone commenting that "borrowing from next week" might have an adverse effect on Monday's revenue. Peterson did not ask what measures the plants would undertake to reach their respective revenue goals. Some operations personnel told their plants that moving orders that had been staged for delivery from the fourth to the third quarter was a tool they could use to reach their respective targets, and many of the plants resorted to this practice. As a result, SRI employees prematurely recognized $216,000 worth of orders in the third quarter.
- On November 27, 2001, SRI restated its third quarter financial results. SRI reversed out the prematurely recognized customer orders and the JHHS and UMass sales, thereby reducing its third quarter revenue by $1,034,000. SRI restated its earnings per share to $0.22 per share-well short of analysts' expectations.
- The Order notes that the Commission took into account remedial acts promptly undertaken by the respondents and cooperation afforded the Commission staff.
SRI, Peterson, and Boosales neither admitted nor denied the findings in the Order. In the Order, the Commission ordered that: (1) SRI cease and desist from committing or causing any violations and any future violations of Sections 13(a), and 13(b)(2)(A) and (B) of the Exchange Act, and Rules 13a-13 and 12b-20 thereunder; (2) Peterson cease and desist from committing or causing any violations and any future violations of Section 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder; and (3) Boosales cease and desist from causing any violations and any future violations of Section 13(b)(2)(B) of the Exchange Act.