According to Merriam Webster, a black box is broadly defined as “anything that has mysterious or unknown internal functions or mechanisms.” How appropriate that Jonathan Weil called our attention to an “unconventional profitability metric” used by Black Box (the Company) to report third quarter performance in its January 29th press release (Form 8-K, Exhibit 99.1). As usual, Jon got right to the point, and suggested that using the term “adjusted Ebitda (as adjusted)” was just another ploy to make “earnings look better.” While I generally agree with Jon’s conclusion, I am particularly stunned by the lack of creativity exhibited by the Company’s accountants in naming their performance metrics. After all, even a bean counter should be able to come up with something better. As a grumpy old accountant, I'd recommend using Lynn Turner’s “everything but bad stuff” EBS title (coined over a decade ago)…now that might have been more appropriate! But why did Black Box’s accountants just give up? Well, after a bit of digging, I think I know why. I also discovered that this was just one of five non-GAAP measures used by the Company in its press release, but not in its current 10-Q or 10-K. And finally, Black Box omitted a very important income statement disclosure in its press release that was included in its 10-Q and prior year 10-K. All of this raises questions about the transparency of the Company’s most recent financial disclosures, and what is prompting the recent move to non-GAAP metrics.
But first, even though I have little or no respect for most performance based non-GAAP metrics, I must confess that Black Box’s “unconventional profitability metric” appears to comply with the policies of the U.S. Securities and Exchange Commission (SEC). The SEC outlines its rules for such measures in its Final Rule on Non-GAAP Financial Measures, as well as its Compliance and Disclosure Interpretations on Non-GAAP Financial Measures. In fact, the Company’s cumbersome EBITDA moniker is likely due to SEC guidance to use the word “adjusted” when reconciling net income to a non-standard definition of EBITDA. However, Black Box adopted two separate non-GAAP EBITDA metrics: EBITDA as adjusted and the hilarious “adjusted EBITDA (as adjusted)” term, the two of which differed only by stock compensation expense. The table below shows how these two non-GAAP measures relate to each other, as well as to the more traditional notion of EBITDA. The first column reflects income statement data for the Company’s nine months of operations for the current fiscal year (3QYTD13) as reported in the January 29th press release (8-K, Exhibit 99.1, page 10), while the other three columns reflect related P&L data from prior Company 10-K’s.
As Jon Weil noted, Adjusted EBITDA (as adjusted) provides an improved perception of operating performance (over traditional EBITDA and net income) for the four periods presented. But why is this performance metric needed? Black Box argues that varying stock compensation expense levels could lead to misleading period comparisons (8-K, Exhibit 99.1, page 10). However, I suspect the Company might be feeling a bit sheepish about its high stock compensation expenses given its recent performance declines. In fact, the ratio of stock compensation expense to traditional EBITDA has steadily increased from 7.87 percent in 2010, to 9.43 percent in 2011, to 11.8 percent for the nine months ending December 29, 2012 (traditional EBITDA was a loss for FYE 2012). So, this “excessive” stock compensation does not look quite so bad if you use the non-GAAP performance measures upon which the share awards actually were based (current 10-Q, page 15)…just a thought.
But now this is where it gets really interesting. In addition to these two “new” non-GAAP financial performance measures, Black Box also reported in its recent press release THREE other creative metrics: operating EBIT, operating net income, and free cash flow (adjusted, but not labeled as such). Now we know why the accountants allowed the use of the “adjusted EBITDA (as adjusted)” term…they simply couldn’t think of any more possible names given all of the non-GAAP measures used by the Company!
As with the non-GAAP EBITDA metrics, the below schedule again shows how Black Box’s net income “fails” to capture the Company’s “true” performance. In this case, the non-GAAP metrics titled operating EBIT (as adjusted) and operating net income (as adjusted) both exceeded GAAP net income by significant margins for the nine months ending December 29, 2012 (3QYTD13).
Operating net income (as adjusted) could not be computed for fiscal years 2010 through 2012 as the Company’s operational effective tax rate (yet another non-GAAP metric) was not provided in prior filings.
Black Box also adopted a non-GAAP free cash flow measure that “adjusted” for foreign currency exchange impacts and proceeds received from the exercise of stock options (8-K, Exhibit 99.1, page 8). The below table shows that the Company’s new cash flow metric once again “improves” performance over traditional definitions of free cash flow.
Next, it is quite interesting to note that Black Box does not report ANY of the above listed five non-GAAP metrics in its current 10-Q (quarter ended December 29, 2012), nor were any of them discussed in the prior year 10-K. This is particularly troubling given that the Company asserts that:
Why would the Company feel the need to use these measures to explain performance in its recent press release, but not in the required securities filings for the same period? Very interesting indeed…I wonder what the SEC thinks about this inconsistency in financial reporting? Could Black Box’s sudden interest in non-GAAP reporting be signaling a sustained decline in the Company’s future operating performance? After all, only companies with poor earnings or cash flow prospects generally rely on such metrics, right?
Moreover, could Black Box’s future dividends and share repurchases be at risk? Perhaps so, given that the Company reported actually reported an increase in cash overdrafts for the first time in its current 10-Q statement of cash flows (page 6). And while I’m discussing cash flows, it’s worthwhile to mention that the Company’s operating cash flows for the nine months ended December 29, 2012 as reported in its recent 10-Q were positively affected by asset liquidations for receivables, inventories, and other assets, all of which are not sustainable long-term.
Finally, the Company neglected to include in its income statement press release an asterisk next to cost of sales (Exhibit 99.1, page 5) to clarify that “cost of sales excludes depreciation and intangibles amortization.” Why is this omission such a big deal? Well, the third quarter 10Q (page 4) DOES include this disclosure next to cost of sales, and generally mirrors the press release except for the omitted asterisk. The omitted disclosure also appeared in the prior year 2012 10K on page 29. The result is reduced transparency and comparability of the Company’s press release income statement with those of other companies. Sounds like an accounting and reporting “error” to me, prompting the need for a restatement of the press release exhibit.
In summary, the Company’s “adjusted Ebitda (as adjusted)” metric appears to be the tip of a financial reporting iceberg. Instead of improving financial reporting transparency, Black Box may really be a Pandora’s Box of non-GAAP metrics that obfuscate “true” performance.
This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.