Grumpy Old Accountants

Ebix: Did Bad Writing Signal Bad Accounting?

Dr. Catanach is a professor in the School of Business at Villanova University, as well as the Cary M.
Maguire Fellow at the American College Center for thics in Financial Services. !is consulting an"
research interests relate primarily to #usiness ris$ management, financial statement analysis, an"
performance management issues. !e has previously serve" on the faculties of the University of
Virginia an" %&SAD. !e o#taine" his un"ergra"uate an" masters "egrees from the University of &ew
Me'ico an" his (h.D. from Ari)ona State University. Dr. Catanach has #een a license" Certifie" (u#lic
Accountant since *+,- an" a Certifie" Management Accountant since *++*.
This essay relects the opinion o the author and not necessarily that o The American
!ollege" or #illano$a %ni$ersity&
'uly (" )*+,
(oor #i'.the Company an" its flam#oyant, turnaround expert CEO have ha" a challenging ten months. First, on September 28, 2012, an
Atlanta U.S. "istrict court rule" that an investor lawsuit alleging false statements #y the Company in its financial reports coul" procee" /see
0-*0 *-12, page *34. &e't, came the revelation in &ovem#er 0-*0 that the U.S. Securities an" 'change Commission /SC4 was investigating
the Company for its accounting practices5 revenue recognition an" financial reporting internal controls. 6his was followe" #y news on 7une
*8, 0-*9 that the U.S. Attorney in Atlanta is investigating the Company for intentional misconduct. An" this last #it of news not only scuttled an
offer #y :ol"man Sachs :roup, %nc. to #uy the Company for ;<,- million, #ut also wipe" out almost ;9-- million in mar$et capitali)ation. At
least for the time #eing, =o#in =aina>s "ream of owning 0+ percent in the ?new@ company, an" silencing the short1sellers who have #een
houn"ing the Company for the past two years, is "ea". But is #a" accounting really to #lame for #i'>s recent misfortunesA Br coul" it #e
something elseA
Chat you as$A Cell, a recent column #y 7ean aglesham title" ?Accounting Fraud Targeted@ might Dust offer a clue. 6his article mentions the
SC>s use of new software to analy)e the *-12>s management "iscussion an" analysis /MDEA4 section loo$ing for signs of possi#le earnings
manipulation an" other financial reporting frau" #ehaviors. So, coul" ?#a" writing@ have trippe" up the CompanyA After all, on the surface,
the Company>s num#ers seem Dust fine5 increasing revenue, operating income, earnings per share, an" assets. As you might e'pect, this
grumpy ol" accountant Dust ha" to con"uct his own ?te'tual analysis.@
Cithout any fancy frau" "etection software at my "isposal, % "eci"e" to arm myself with the latest !A "argon as an ?enabler,@ so that %
might ?drill down@ into #i'>s MDEA. % was not "isappointe" at all. Bn page two of the Company>s 0-*0 *-12 alone, % was rewar"e" with
such confusing an" incomprehensi#le phrases as ?powerhouse of #ac$en" insurance transactionsF complimentary accretive acGuisitionsF
carrying "ata from one en" to another seamlesslyF #est of #ree" functionalityF integrates seamlesslyF #est of #ree" solutionF resources an"
infrastructure are leverage"F an" acGuisitive growth vs. organic revenue growth #ecomes rather o#scure.@
An" page three continue" with ?revenue #ase" contingent purchase consi"erationF contingent rewar"F an" consistent en"1to1en" vision.@ By
the time % got to page 3, % was running out of ?bandwidth,@ #ut still foun" references to ?uniGue positionF cutting e"ge solutionsF an" en"1
to1en" solution.@ % as$e" myself why a software company felt it necessary to o#fuscate /that>s a grumpy ol" wor"4 its strategy an" #usiness
mo"el. %s this the $in" of writing that regulators are targeting with their software to ferret out ?wor" shell games@ #y pu#lic companiesA 6his
writing style sure ma"e my antennae go upH
Chile #a" writing or suspicious language is not illegal per se, it "oes re"uce reporting transparency, an" actually ma"e this grumpy ol"
accountant want to ta$e a closer loo$ at the num#ers. Ies, #i' pro#a#ly woul" pro#a#ly accuse me of ?boiling the ocean.@
=ecently, the popular press has highlighte" a num#er of concerns at #i' that potentially affect the Company>s financial reporting5 revenue
recognition, accounting for income ta'es, an" au"itor changes. %t is not surprising that the SC is intereste" in the Company>s revenue
recognition practices given all the pro#lems "iscovere" with accelerate" income recor"ing #y companies in the software an" service
in"ustries. After all, many of these companies /inclu"ing #i', see 0-*0 *-12, page 384 avail themselves of the su#Dective multiple
"elivera#les revenue recognition rules which give management significant "iscretion over when sales revenues are reporte". See ?#$% T&ro's
(ts Accountants )nder t&e !us* !ut +&,-@ an" ?T&e !eaut, of (nternet Compan, Accounting@ for more grumpiness on multiple "elivera#les
accounting. So, it>s not really surprising that the regulators want to ?peel the onion@ on #i'>s revenue recognition practices.
But is there more to the SC>s revenue concerns than simply the prover# ?tell me who you go with, an" %>ll tell you who you areA@ Cell, there
are a few Guantitative hints that might #e signaling revenue overstatements. First, the quality of revenues ratio /cash collecte" from
customers "ivi"e" #y revenue4 is less than one for all fiscal years from 0--, through 0-*0. Also, the quality of earnings ratio /operating cash
flow /BCF4 "ivi"e" #y net income4 is consistently #elow one #etween fiscal years 0--, an" 0-** #efore ma$ing a slight come#ac$ in 0-*0 to
*.-08. An" finally, the excess cash margin metric /which compares BCF an" operating earnings4 not only "ecline" precipitously from 0-**
to 0-*0, #ut actually #ecame negative, suggesting that operating earnings are growing more Guic$ly or "eclining slower than BCF. So, a
closer loo$ at revenue seems a reasona#le ?actionable@ item.
An" then there are #i'>s e'traor"inarily low effective ta' rates, which some suggest may reflect an artificially lowere" income ta' e'pense,
which inflate" profits over the past several years. % use" the conservatism ratio /reporte" income #efore ta'es "ivi"e" #y ta'a#le income4 to
e'amine the aggressiveness of the Company>s ta' strategy. A higher ratio generally in"icates that management is more aggressive with its ta'
policies. Cell, #i'>s conservatism ratio has stea"ily increase" from *.08J in 0-*- to *.830 in 0-*0, clearly confirming aggressiveness in ta'
reporting. 6he Company "oes try to e'plain this as follows /0-*0 *-12, page <045
"The Company's consolidated worldwide effective tax rate is relatively low because of the effect of conducting operating activities in
certain foreign jurisdiction with low tax rates and where a significant portions of its taxable income resides."
But one "oesn>t fully appreciate the "isparity #etween where income was earne" an" where it was ta'e" until one e'plicitly compares the following
ta#les. (age <J reports the sources of pre1ta' income #y countryKregion as follows5

Clearly, the #ul$ of 0-*0 revenues originate" in the Unite" States an" Australia. Iet, accor"ing to page <9, pre1ta' income #y countryKregion
was as follows5
#i'>s ta' planning strategy somehow transferre" ta'a#le revenues to the lowest ta' paying Duris"ictions, namely Singapore, %n"ia, an"
Swe"en. But "oes the *-12 rea"er have any i"ea as to how this was "oneA &oH Such techniGues typically involve some type of transfer pricing
techniGue where a su#si"iary in a low ta' Duris"iction, provi"es a service to the revenue generating su#si"iary in a high ta' country. 6he
?low1ta'@ su# #ills the ?high1ta'@ su# at mar$et rates for the services, thus lowering ta'a#le income in the ?high ta'@ Duris"iction an" raising it
in the ?low ta'@ Duris"iction. But given the Company>s penchant for MBA1spea$, why hasn>t the strategy #een "iscusse" in the ta' "isclosures,
particularly given its "ramatic impact on the #ottom line an" effective ta' rate.
An" while %>m on the effective ta' rate /6=4, how a#out the unusual 6= reconciliation /presente" #elow4 which #rea$s out 6= from
ongoing operations from 6= after "iscrete itemsA %f the Company is willing to go to this e'tent to "isaggregate 6=, why not "escri#e the
ta' planning strategy an" transfer pricing mechanicsA Clearly this cannot #e consi"ere" a ?best practice.@
An" then there is the issue of multiple au"itors. Accor"ing to the Au"it Analytics "ata service, the Company has change" au"itors a num#er
of times moving from larger to smaller firms5 2(M: from 0--- through 0--9, BDB from 0--8 through 0--J, !a#it Arogeti E Cynne from
0--< through 0--,, an" Cherry Be$aert E !ollan" from 0--+ to the present. &ow to #e fair, one change "i" relate to a firm merger an"
another involve" a (u#lic Company Accounting Bversight Boar" /(CABB4 registration issue. Iet, it is Guite o#vious that the #ig firms were
Dust not ?drinking kool-aid.@ An" are we naLve enough to #elieve that the Cherry Be$aert au"itors are really capa#le of au"iting an
international firmA An" "on>t you won"er Dust what au"it proce"ures they applie" to #i'>s ta' transfer pricing scheme to ascertain the
propriety of income shifting from ?high ta'@ to ?low ta'@ Duris"ictions.
But this grumpy ol" accountant has some of his own accounting issues with #i', namely accounts receiva#le an" intangi#le asset valuation.
6he Company appears to #e grossing up its #alance sheet #y inclu"ing "eferre" revenues in accounts receiva#le /0-*0 *-12, page 384.what>s
with thatA %n the ol" "ays, you recor"e" "eferre" revenues when you receive" cash #efore income was earne". More trou#ling is the
une'plaine" "ecline in #a" "e#t e'pense an" the allowance for "ou#tful accounts, as revenues an" receiva#les increase /0-*0 *-12, pages 33
an" *-J4.
6hen there is the intangi#le asset issue. 6he vast amount of assets acGuire" in 0-** an" 0-*0 were goo"will an" intangi#les, ,9.* percent an"
+*., percent, respectively. So significant are these ?invisi#le@ assets that they account for <+.93 percent of total assets at the en" of 0-*0 /i.e.,
goo"will, intangi#les, in"efinite1live intangi#les4. 6his woul" "efinitely #e a critical au"it area for this grumpy ol" accountant. An" it>s not
Dust the magnitu"e of the intangi#les that #others me. BCF as a percentage of total assets has "roppe" significantly "uring 0-*0 from *<.*,
percent in 0-** to *9.++ percent in 0-*0. Any guesses as to which assets are not generating cashA An" for the past three fiscal years, BCF to
goo"will has stea"ily "ecline" from 0,.J< percent in 0-*- to 0<.03 percent in 0-**, to 00.*9 percent in 0-*0. Sure soun"s li$e an impairment
issue to me. An" "on>t forget, BCF woul" even #e lower were it not for the Company>s aggressive ta' planning /i.e., income shifting4 strategy.
Chich intangi#le is the pro#lemA
Cell, goo"will is the li$ely can"i"ate given its impact on the #alance sheet. But the other intangi#les coul" #e a pro#lem as well. For
e'ample, ta$e a loo$ at contractual customer relationships inclu"e" in in"efinite live" intangi#les. %n this case, #i' values these assets using
"iscounte" cash flow mo"els over perio"s ranging from *3 to 0- years /0-*0 *-12, page 3J4. %t woul" really #e interesting to see the au"it test
wor$ on this.hea"s up (CABBH Bh, then there are the estimate" lives for purchase" intangi#les which also appear e'cessive /0-*0 *-12,
pages 3J an" J04. leven year lives on customer relationships..pleaseH
6here also are a few hopefully minor points that % wish % coul" ?dialogue@ with the Company a#out. Chy are there no acGuisition e'penses,
integration costs, or restructuring charges given the Company>s rapi" ?inorganic@ growthA Chy the previous netting of e'cess ta' #enefits in
the statement of cash flows an" lac$ of "iscussion of impact on reporte" BCF /0-*0 *-12, page 3-4A !ow can the Company Dustify one
reporting segment when it has glo#al operationsA Chy "oes such a successful company self1insure for health insuranceA 6hese are the types
of Guestions that promote grumpiness.
An" then there are the mar$et pressures that may #e provi"ing incentives to management to engage in less than transparent reporting. For
e'ample, the following create performance pressures for managers that might promote aggressive reporting5 the nee" to pay an" increase
"ivi"en"s /0-*0 *-12, page *J4F the history of rapi" growth an" profita#ility /0-*0 *-12, page *+4F contractual incentives relate" to "e#t
covenants which must #e maintaine" /0-*0 *-12, page 9*4F an" pressures to o#tain capital to stay competitive /e.g. the .oldman "eal4. An"
the Company also triggers a fairly significant management an" control re" flag. &ot only is the CB the foun"erKrescuer of the current
company, #ut he also has significant wealth tie" up in it with his +.3 percent ownership sta$e /0-*0 *-12, page +<4. Finally, there are the
issues of e'treme competition an" pressure to innovate that characteri)e the Company>s software in"ustry.
So, is the Company ?e'cessively@ concerne" with share price an" earnings per shareA Cell, recent share repurchase activity an" the
authori)ation to procee" to the /100 million le0el may offer a clue /*-12, page *<4. But the !eneis& earnings manipulation model only provi"es a
hint of earnings gamesmanship with a pro#a#ility of manipulation of slightly more than one percent for fiscal years 0-*- through 0-*0.
Cell, there you have it.that>s my ?elevator story@ on #i'. % really trie" to avoi" ?scope creep@ in my ?proactive@ efforts to ?gain
traction@ in ma$ing my case for writing Guality an" financial reporting transparency at #i'. Coul" a Dargon1free an" transparent
approach to financial "isclosure really have helpe" the Company>s causeA My ?rough order of magnitude@ suggests no.#ut you ma$e
the call.