Downfall

In the summer and fall of 1997, a series of announcements emanating from Hamilton, Ontario heralded the ascent of Philip Services Corp. to a position as—by the company’s own estimate—the continent’s largest scrap processing firm.

With the acquisition of some of the industry’s largest scrap firms on both sides of the U.S.-Canadian border, Philip was at the forefront of an industry consolidation trend that looked to be unstoppable. Consolidation was the talk of the scrap recycling industry, and Philip Services Corp. was a name mentioned in most of those conversations.

“Philip Services Becomes the Leading Processor in North America,” read the headline of a corporate press release issued after offers were accepted from Philip to acquire Luria Brothers, Cleveland; Steiner-Liff Metals, Nashville, Tenn.; and Southern Foundry Supply, Chattanooga, Tenn.

But just a few months after the triumphant announcement, the news coming out of Hamilton began taking on a very different tone.

“ONE-TIME CHARGE” LINGERS

In late January, then-president and CEO of Philip Services Corp. Allen Fracassi announced details of a $185 million “one-time year-end charge to earnings” that adversely affected year-end results for the company.

Fracassi cited restructuring charges and the write-down of goodwill as one component of the year-end charge. The other component was tied to a copper inventory discrepancy. “This involves the difference between book inventory and physical inventory, primarily in the company’s yard copper business at two Hamilton facilities,” a Philip Services press release dated January 27, 1998 states. “The company continues to review with its auditors the difference between book and physical inventory. The remainder of this component of the charge relates to trading losses and charges relating to a market revaluation of inventory held for resale by the Metals Services Group.”

But the “one-time charge” proved to be anything but a one-act play. Instead, the announcement was the first in a series of events that has kept Philip Services Corp. at center stage throughout 1998. The drama has included courtroom action, cast changes, and the possible dramatic exit of Philip Services Corp. from the scrap metal stage.

Among the events that have occurred since Philip’s January announcement regarding its 1997 one-time charge:

* A number of shareholder suits were filed in the U.S. against Philip Services and its top officers claiming investors were misled by company statements regarding corporate earnings

* Three weeks before the late January announcement, Philip Services Metal Recovery Group president Robert Waxman resigned from the company, as did his two brothers and his father Chester.

* In early April, 1997’s year-end results were amended to reflect an additional $13.6 million in charges related to “copper swap contracts . . other costs relating to the company’s copper operations.”

* In late April, the 1997 results were again amended to reflect another $30 million in losses from “transactions in the company’s copper operations.”

* On May 7, the same day that a first quarter 1998 loss of $1.4 million was revealed, the resignations of several top officers were announced. Among those resigning were chief financial officer Marvin Boughton and chief operating officer Philip Fracassi, who co-founded the company along with his brother Allen. Allen Fracassi was replaced as president by board member Felix Pardo. Allen remains part of Philip Services’ management team as executive vice chairman.

* The first quarter financial results again referred to “losses in the copper businesses, which are shut down or are in the process of being wound down,” according to Pardo.

* Also in May, Standard & Poor’s downgraded Philip Services’ credit rating and bank loan rating based on recent results and what the rating service termed “unresolved legal and accounting issues.”

* In early June, Philip Services Corp. announced its intention to sell all of its scrap metal operations. If the company follows through on its sale plans, it will be selling more than 50% of its corporate holdings in order to provide capital to continue operating what will remain of the company. Many of the facilities it has for sale—including Luria Brothers, Steiner-Liff and Southern Foundry—have been owned by Philip Services for less than one year.

* Throughout the year’s events, the publicly-traded company’s stock price tumbled lower, from a high of nearly $20 per share in late 1997 to below $4 per share at press time.

A CHANGE IN MOMENTUM

Was Philip Services Corp.’s position at the summit of the scrap recycling industry cut short by a trader conducting unauthorized copper transactions? That has been the company’s contention throughout 1998, though at press time there had still not been any results announced from an ongoing investigation into the unauthorized copper trading.

“We announced at our annual meeting (in late June) that we would be filing a statement of claim by the end of July,” says Philip Services spokesperson Lynda Kuhn. “We have enough information to draft a statement of claim,” she adds.

There are also those who believe the company as constructed by the founding Fracassi brothers was put together hastily and never managed in a manner that would maximize the value of its many assets. A frequent criticism of consolidators in general—that they are fueled by revenue growth without the proper emphasis on long-term profits—has also been leveled at Philip Services.

Should Philip Services Corp. sell off all or most of its scrap operations in 1998, those critics may have fodder for their argument. Certainly, the officers of other scrap consolidators and the industry analysts who have recommended the securities of consolidating companies have acknowledged a ripple effect.

In an interview earlier this year with Recycling Today, Albert Cozzi, president of Metal Management Inc., Chicago, referred to the effect of Philip’s troubles on Metal Management’s stock price. “Certainly, one of our competitors stumbled, and all of the consolidators’ stock prices tumbled when they stumbled,” noted Cozzi.

“They’ve hurt us very deeply,” says a member of a scrap family that sold to Metal Management regarding the events at Philip. “They’ve suppressed the value of the investment,” he says of the price of the Metal Management stock.

What seems apparent is that the momentum of purchases by the other two consolidating companies—Metal Management and Recycling Industries Inc., Englewood, Colo.—has slowed in the late spring and early summer of 1998. What the two companies may need to do to renew investor confidence is operate profitably at a time when scrap prices are declining and scrap demand may temporarily slow down.

LAWSUITS CLAIM INVESTORS WERE MISLED

While fellow consolidators have been disheartened by the events at Philip, a more serious reaction came from some Philip shareholders. After the initial copper shortfall was announced and 1997 earnings were restated, several lawsuits were filed against Philip in the U.S. The complaints, filed in December in several different U.S. cities, accuse Philip Services and several of its executives of more than just mismanagement.

Among the charges in the complaint filed by a Pittsburgh law firm was one that accuses several top officers of Philip—Allen Fracassi, Philip Fracassi, Howard L. Beck, Robert Waxman and Marvin D. Boughton—of deceptive actions. (Most of those named have since resigned from the company, although Allen Fracassi remains as executive vice president.)

The suit alleges that the “defendants engaged in a common course of conduct, commencing at least by May 21, 1997, in violation of the federal securities laws, the purpose and effect of which was, inter alia, to create and prolong the illusion of PSC’s (Philip Services Corp.) success, to inflate the price of its common stock, and to conceal the adverse facts concerning PSC’s assets, revenues, and profits.”

May 21, 1997 was the date the company filed a copy of its annual report with the Securities and Exchange Commission (SEC). Attorneys for the plaintiffs in suits filed against Philip Services charge that officers knew at this time and at the filing time of several subsequent reports that the company would need to write off sizable goodwill charges and that inventory was overstated.

“The Individual Defendants, because of their positions as officers and directors of PSC, had access to adverse non-public information about the Company’s assets, inventory, and accounting practices, and acted to conceal and misrepresent such material information in violation of their duties and responsibilities under the federal securities laws,” a charge in a suit filed in the U.S. District Court of Western Pennsylvania reads in part.

Why would the executives in question delay the “bad news” announcements? Those filing the suits insinuate that the officers needed Philip Services to maintain the image of a company building unchecked momentum as it planned future acquisitions.

“The defendants participated in and consciously, or recklessly, pursued the unlawful conduct herein alleged to inflate the price of PSC common stock in order to . . . allow the Company to issue a new stock offering and a possible new bond offering to re-finance the numerous acquisitions and mergers it had already completed and to finance future acquisitions, including a $1.7 billion offer for Safety Kleen,” a charge in the Western Pennsylvania suit reads.

The company’s bid to buy Safety Kleen, Elgin, Ill., was not accepted. But other acquisitions—particularly those in the scrap metals segment—were financed in part by Philip stock. It is now being claimed that the stock at that time was overvalued.

The alleged scheme to delay the write-offs would “allow the defendants to use inflated PSC stock in exchange for acquisitions during the Class Period, including acquisitions of Luria Brothers, Allwaste, Serv-tech, Southern Foundry Supply Group, Steiner-Liff Metals Group, and Intermetco,” the lawsuit contends.

CYBER-CRITICISM SPARKS A REACTION

While Philip Services legal counsel has been on the defensive end of the shareholder suits, the company has recently taken the offensive on another issue.

Internet message boards provide a place for individuals to write notes back and forth on virtually every subject from global politics to the Spice Girls. Among the thousands of message boards on which computer users can post open (and anonymous) comments are those concerning publicly-traded companies.

The topic or “thread” of discussion on stock-related message boards can vary greatly from company to company, but many do indeed contain rumors and strong opinions.

The message board for Philip Services found on the Yahoo! Internet site [messages.yahoo.com.] developed into a particularly lively forum. Detractors of Philip Services Corp. began posting comments that questioned the behavior of several top Philip officers. Defenders of Philip’s managers posted equally spirited comments. While satire and humor are present in many of the postings, an undertone of hostility is also evident.

The growing popularity of the board and the relentless postings of those critical of the company and its prospects were noticed by Philip management. In June and July, the company began both posting its own messages to the board and seeking courtroom methods of exposing its anonymous critics. The company claims entering the fray was necessary to boost morale among its employees, who grew weary of reading the on-line bashing. (It turns out many of the negative posts came from one person using different IDs.)

After the company secured an order from a Canadian judge that would reveal the identities of anonymous message board authors on that side of the border, Philip Services found itself in the news once again.

The reaction on-line, although not unanimous, was largely negative toward the company. Most of the company’s harshest critics became harsher yet, and many new readers and message posters were drawn to the Philip Services Yahoo! message board after news of the court order was released. Many new posters saw the on-line battle as a free speech issue.

Others asked a more pragmatic question. Why is a company struggling to turn red ink into black spending time and money fighting a skirmish that would seem to have little bearing on the company’s future?

MORE QUESTIONS THAN ANSWERS?

The question relative to Philip’s “cyber-defense” is just one of many that surrounds the Canadian company. More important ones may only be answered if and when Philip releases the results of its investigation into the “rogue trader” who ostensibly set the company’s downfall in motion.

As of press time, Philip Services still retains its scrap processing operations. Exiting from scrap operations would not be minor surgery for Philip Services. By late 1997, the company’s Metals Recovery Group was accounting for two-thirds of the company’s revenues.

The company employs more than 4,000 people—and many of them had probably never even heard of Philip Services Corp. just two years ago.

John DiLacqua, former president of Luria Brothers and now Philip Services senior vice president of U.S. ferrous operations, notes that most of his operations and management people are facing their second major transition in less than one year. “It’s tough enough to do your job well without worrying about who’s going to own you or what your benefits are going to be,” he says of the 1,500 people that are part of his U.S. metals operations.

The future for the former top officers named in the class action securities lawsuits is uncertain. Just one year ago, they were successfully convincing analysts with major investment firms to issue “buy” recommendations for their attractive company. The business press also touted the growing company (including a cover story in the March 1997 Recycling Today).

Now the same individuals are preparing to respond to allegations that they knew for some time that their juggernaut was badly in need of repairs. The legal action taking place on behalf of disgruntled shareholders is just beginning. “We’re very early in the process,” says Neil Selinger, attorney with Lowey Dannenberg Bemporad and Selinger, White Plains, N.Y.

“The 20+ cases that have been filed have all been transferred to a judge in the U.S. District Court for the Southern District of New York. They are being solidified into one action with one master complaint,” he adds.

For Philip Services, just as critical as defending the suit will be selling off operations at a price that will allow them to cancel enough debt to operate successfully in their remaining segments. Although many observers have predicted that the company will exit the scrap metal industry entirely, Philip Services’ Lynda Kuhn says that is not a certainty. “What we have said is that all of the metals businesses can be sold, but we don’t have to divest all of them,” she notes.

What the company will ultimately do is just one more question surrounding Philip Services.

“I’ve heard when all is said and done they may have lost $500 million after they leave the scrap industry,” says one industry observer who believes the company will sell off its scrap assets. “How do they lose that kind of money in the market we had in 1997 and early this year,” he asks.

Right now, a number of people are awaiting answers to that and several other questions involving Philip Services Corp.

The author is managing editor of Recycling Today.

 

Sidebar

From Stud to Dud

Less than one year ago, analysts with major investment firms were issuing “buy” recommendations for Philip Services Corp. At the same time, the business press (including this publication in a cover story in its March 1997 issue) extolled the virtues of the growing company.

Did an inventory or trading scandal turn the company from stud to dud virtually overnight? Or was there a deeper deception being acted out?

In either case, a number of people have been trying to quietly purge the recent events surrounding Philip Services from their systems. A shareholder lawsuit filed in U.S. District Court in western Pennsylvania notes that any inventory mis-statement should have been noticed by the company’s internal audit committee and by outside auditors.

A number of investment analysts have also come away from Philip Services with a losing mark on their records. The shareholder lawsuit cites reports from separate analysts employed by Merrill Lynch, Oppenheimer & Co. and Bankers Trust who released recommendations in mid-1997 in praise of the company. Many of the analysts produced their glowing recommendations after personal meetings with management.

“After meeting with management last week, we have a high degree of confidence in the company’s ability to integrate Allwaste and Serve-Tech successfully,” wrote an Oppenheimer & Co. analyst in August of 1997.

The comments have served as grist for attorneys representing plaintiffs in shareholder suits against Philip’s former top officers. The plaintiffs contend that, by this time, the officers had to be aware that charges related to the mergers would need to be written off in the near future. Those goodwill charge-offs were a major component (along with the copper shortfall) of the red ink that affected Philip in 1997.