By Melissa Davis
Editor’s Note: To simplify matters, TheStreetSweeper has provided links to many of the documents that it used to prepare this investigative report – along with the detailed instructions necessary to replicate its calculations and verify its claims – in a lengthy series of endnotes that appear at the bottom of this story.
Ebix Inc (NASDAQ:EBIX) better learn how to control its appetite. The last time that the hungry rollup company raided the cookie jar, the firm may have finally pushed its luck a little bit too far.
After relying on a blatant accounting trick to artificially sweeten its fourth-quarter earnings – and then concealing the hefty gain that allowed it to beat profit estimates that it would have otherwise missed – Ebix left behind some rather incriminating evidence. In the formal 10-K report that it filed a few days after it pulled that brazen stunt, the company provided enough fresh clues to reveal (among other juicy secrets reserved for later stories) the following:
· Ebix added millions of dollars to its net income last year by impatiently reversing most of its reserves for potential “earn-out” payments to the very acquisition target responsible for the celebrated European contract that the company just won.
· Following its acquisition of two companies in the first half of 2014, Ebix swiftly reversed all of the potential earn-out bonus for the first and most of that for the second by the end of that same year. Ebix recognized at least a portion of the resulting decline in its earn-out liabilities as net income and may have aggressively booked far more generous gains before its recent acquisition targets ever got a legitimate chance to actually prove themselves.
· After reversing most of the reserves that it established for earn-out payments to many of the firms that it has purchased in recent years – without formally impairing any of the goodwill assigned to those companies – Ebix must have finally resigned itself to the inevitable. Since its goodwill balance increased by a smaller amount than the goodwill assigned to the firms that it purchased during the fourth quarter, Ebix clearly recognized some kind of write-down but apparently decided to bury that disturbing evidence.
Ebix ignored a request by TheStreetSweeper to quantify the reserves that it originally established for each one of the firms that it acquired over the past several years, along with any adjustments that it made to those contingent liabilities and any gains that it recorded as a result, in spite of the profound difference that earn-out reversals have repeatedly made in its financial results.
Recipe for Disaster
As a rollup company that would look virtually worthless without the staggering goodwill on its balance sheet, Ebix might understandably wish to postpone the dreaded impairment process for as long as it reasonably can. Given the aggressive formula that Ebix has used to value both the earn-outs and the goodwill associated with its acquisition deals, however, the company can only blame itself for any looming impairment charges that it now faces. By relying on a minuscule 1.75% discount rate to calculate the contingent liability for potential earn-out payments to acquisition targets that invariably fail to meet its lofty goals – and then reversing most of the wildly excessive reserves that it established into its reported earnings – Ebix has practically asked for serious repercussions on down the road.
“A lower discount rate makes the goodwill higher,” noted Dr. J. Edward Katz, a long-time accounting professor at Penn State University. “When you see these earn-out reversals, you should also see something happening with impairments to goodwill …
“I’m not sure what the logic is, but FASB (Financial Accounting Standards Board) rules don’t require impairment,” Katz marveled. “That’s the perverse effect of the FASB decision: It allows management significant influence or control in terms of managing earnings.”
No kidding. Ebix has practically bent that flexible rule to the breaking point.
By now, Ebix has purchased so many companies that it should know whether its acquisition targets stand a reasonable chance of approaching its goals. Once government authorities began investigating the company for everything from tax evasion to money laundering a couple of years ago, however, Ebix suddenly lost its touch and started to look downright clueless, for some curious reason. After reversing a mere $700,000 worth of earn-out payments into its reported profits during 2012, its official 10-K filings show, Ebix has since gone on to book more than $10 million worth of gains from those earn-out reversals – supplying the company with at least 15% of its annual net income – for the past two years in a row.
The following chart vividly illustrates just how much those earn-out reversals impacted the company’s results in 2014 alone.
Contribution from reversal of earn-out payments into reported profits
Impact of earn-out gains included in profits reported to Wall Street
Provided all of the upside to consensus estimates
(missed without any gains)
Transformed a miss into massive upside instead
Turned a narrow miss into a handy beat again
The Bitter Truth
If anything, Ebix has grown increasingly impatient to reverse earn-out payments into its reported profits over the course of the past year. It clearly jumped the gun in at least one case that looks impossible to justify, and it may have exercised even less restraint in a couple of others that could prove equally difficult to explain.
Let’s start by focusing on the example with the highest shock value right now.
When Ebix announced its purchase of Qatarlyst back in the spring of 2013, the company pointed directly at the gigantic overseas contract that it recently won as one of the primary drivers behind that acquisition deal. Under the official terms of that buyout agreement, its regulatory filings show, Ebix offered to supplement its $5 million upfront payment for Qatarlyst – an obscure firm with little revenue (let alone profits) at the time – by rewarding the company with potential earn-out bonuses if it managed to achieve certain revenue targets over the course of the following three years. Based upon the balance in its contingent liability account for earn-out payments at the end of 2013, its 10-K report for that year reveals, Ebix must have reserved $9.45 million (after currency adjustments) – almost twice as much as it initially spent on Qatarlyst in the first place – to cover those potential bonus payments.
Fast forward to the very next year. Armed with its new partner, Ebix submitted a formal bid to oversee a massive insurance exchange in London and then seemed to lose its faith in the company that it had purchased to bolster its chances of securing that valuable contract. Ebix slashed its reserves for potential earn-out payments to Qatarlyst by $5.83 million during the third quarter of 2014 alone, its regulatory filings indicate, and booked the resulting gain as net income without bothering to identify its actual source. After that, its recent 10-K further suggests, Ebix most likely reversed another $2.7 million worth of those earn-outs into its profits during the fourth quarter – with that handy gain accounting for the generous upside that it reported instead of a disappointment miss – even as the two-way contest for its cherished London contract progressed toward a favorable end.
Take a look at the following chart, prepared with painstaking effort by relying entirely on the figures that Ebix has stingily disclosed to fill in any holes, for a striking snapshot of the numeric evidence meticulously extracted through that laborious exercise.
Contingent Liability Account Balances for Potential Earn-Out Payments
End of 2013
End of 2014
– $2.25M payment
– $992K[iii] reversal
– $770K[v] reversal
– $419K reversal[vi]
– $563K reversal[vii]
– $5.8M[ix] reversal
– $2.7M[x] reversal
+ $1.61M (new) [xi]
– $1.61M reversal[xii]
+ $4.83M (new)[xiii]
– $107K reversal[xiv]
– $4.12M reversal[xv]
Vertex, i3, Oakstone
+ $3.61M (new)[xvi]
If Ebix refrained from actually booking a gain on the earn-out that it reversed for Qatarlyst last quarter, it must have taken an even more aggressive step by recognizing gains on the earn-out payments that it cancelled for companies that it had just acquired earlier that same year.
Ebix has disclosed just enough information to establish this much for sure. Following its acquisition of Healthcare Magic in the second quarter of 2014, Ebix trimmed its reserves for potential earn-out payments to that company and booked the resulting gain as net income the very quarter after it closed that brand-new acquisition deal. Since Ebix had already set that precedent by the time that it reversed a whopping $4.124 million worth of potential earn-outs for Healthcare Magic in the following quarter, the company may have felt comfortable enough to book a hefty gain on that steep reduction in its contingent liability without thinking twice about crossing the line.
The remaining possibility looks just as bad, if not even worse. When Ebix “purchased” CurePet in the first quarter of last year, it basically got that company for free. Instead of shelling out any cash to cover an upfront payment for that acquisition deal, Ebix simply agreed to forgive the debts that CurePet owed to the company and offered to reward the firm with future bonuses if it could achieve certain revenue targets over the course of the next several years. Toward the end of 2014 – the first year in that ongoing, 36-month evaluation period — Ebix actually indicated that CurePet would soon get the chance to start meeting those goals.
“These number do not include any contribution from our pet exchange,” Ebix Vice President Darren Johnson emphasized last November, when the company hosted its third-quarter conference call. “We expect to start generating revenues from two key veterinary schools, beginning Q1 2015.”
Instead of waiting a few short months to see if that new business actually started to materialize, however, Ebix inexplicably reversed the entire $1.614 million that it had earmarked for potential bonus payments to CurePet during the final quarter of last year. Whether or not Ebix aggressively booked a gain on the cancellation of that particular earn-out remains to be seen; only the company itself can say for sure. Regardless, this much looks perfectly clear. Given the lack of alternative possibilities afforded by its own financial disclosures, Ebix relied on the earn-outs that it reversed for at least one of the acquisition targets highlighted so far to supply the handy gain responsible for its “blowout” fourth-quarter results.
A Horrible Desert
Don’t be surprised if Ebix starts impairing its goodwill pretty soon. At this point, even the company itself must have finally realized that it cannot avoid that treacherous process forever. The firm recently lowered the value of the goodwill that it had recorded on its balance sheet prior to last quarter, after all, even though it stopped short of reporting a formal impairment charge that might set off an immediate alarm.
Ebix probably should have double-checked its math, however, if it hoped to cover its tracks well enough to limit any risk of easy detection. Instead, Ebix made at least one glaring mistake that, in turn, called attention to yet another that might have otherwise remained hidden for a while.
Let’s go ahead and expose both of those buried secrets right now. Despite the $60.2 million worth of goodwill that Ebix assigned to the firms that it acquired during the fourth quarter of last year, its regulatory filings show, the company reported a smaller $52 million sequential rise in its goodwill balance for that very same period. Ebix also recorded a curious $2.13 million sequential decline in its earn-out liabilities for newly acquired businesses during the fourth quarter, its financial statements further reveal, even though it had just purchased three different companies and offered every one of them some kind of future bonus (while reserving an estimated $3.61 million to cover those potential earn-out payments) as an incentive for meeting it financial goals.
If Ebix disguised the equivalent of an impairment charge by making adjustments elsewhere on its balance sheet, the inexplicable reductions in both its goodwill balance and its earn-out liabilities for newly acquired businesses actually start to make a whole lot of sense.
Unless Ebix can somehow come up with a more logical explanation of its own, the company should probably forget about even trying to raid its favorite cookie jar again. Granted, with less than $5.5 million worth of earn-outs left to reverse – down from more than triple that amount in mid-2014 – Ebix might have found itself scrounging around for a few leftover crumbs pretty soon, anyway.
Either way, Ebix better hope for a miracle that’s powerful enough to finally transform the company into a legitimate success. Otherwise, Ebix could swiftly run out of reasons to brag and face the uncomfortable prospect of apologizing for its lackluster performance instead.
Talk about a radical idea. The last time that Ebix beat consensus estimates by reversing an earn-into its reported profits – quietly booking a $2.7 million gain that matched the estimated reduction in potential bonuses for a firm that had just provided the company with a fresh excuse to brag – its leader sounded far too proud to even consider such an embarrassing possibility. Simply review a few of the boastful comments that Ebix CEO Robin Raina made during the company’s most recent conference call, and try to imagine him ever swallowing his enormous pride.
“In recent times, there has been a lot of press and speculation regarding the London marketplace reinsurance aggregation exchange,” Raina happily volunteered as a tantalizing reminder of the rumors that had recently set the company’s volatile stock on fire. “I can now confirm that, after an extensive evaluation, Ebix has been selected to deploy the entire aggregation exchange. At this point, for confidentiality and competitive reasons, I cannot divulge any more details on the start date and the size of this proposed exchange, except to say that it is planned to be the world’s leading reinsurance exchange for arguably the largest insurance market in the world …
“Ebix has delivered a very strong finish to the year, with record revenues, great earnings and operating cash flows,” Raina had by then already declared without bothering to mention the handy gain that happened to provide the company with any sort of bragging rights at all. Meanwhile, “we made progress on a number of fronts in the year 2014 towards making the company even more transparent and predictable for our shareholders … We will continue to endeavor to deliver shareholder value on a recurring and an as-is basis. We intend to do that through increased transparency, better outreach, accretive acquisitions, a focus on high-margin services, dividends and ongoing share buybacks.
“Q4 of 2014 was an example of that effort.”
Be careful. Given all of the disturbing revelations in this report (documented in the detailed endnotes below), that glorious promise now sounds more like a dangerous threat instead.