Oddly enough… I don’t think that there is major fraud occurring at Avid, a stock that I have blogged about a few times in the past.
Why I don’t think that there is major fraud
Suppose that management was committing fraud to inflate earnings. This would typically leave some type of falsified asset on the balance sheet:
- Fake cash.
- Fake inventory.
- Fake receivables.
Fake cash is unlikely. Cash is the easiest thing to audit. While publicly-traded companies sometimes do falsify cash balances in very rare instances, such a fraud would likely be discovered very quickly when the numbers are double-checked in a restatement.
Faking the other assets is unlikely because inventory, receivables, and PP&E have gone down in the last reported quarter (Q3 2012) versus the last set of audited financials (Q4 2011). So I don’t think that Avid has been hiding its losses in a major fashion.
What might be happening
The restatement will supposedly cost between $25-34M according to Avid’s press release. Part of me thinks that the restatement doesn’t actually cost that much.
I’d be interested to see what happens when insider bonuses are calculated. Some insider bonuses are based off of ROIC. This calculation depends on operating earnings. If the operating earnings calculation were to exclude restatement costs, then it would make sense for management to aggressively classify expenses as part of the cost of the restatement. This would increase some insider bonuses. When a proxy statement is ultimately filed, it should state how insider bonuses were calculated. Avid has not filed a proxy statement since 2012, partly because it decided not to hold an annual shareholders’ meeting.
When a proxy statement is finally published, it should be clear whether or not management has an incentive to inflate restatement costs.
May 13, 2013 update on the restatement
This SEC filing discusses two additional issues with Avid’s financial statements:
The Company also reported that it was reassessing its accounting for certain restructuring expenses related to lease obligations and other exit activities. Based on its continuing reassessment, the Company has concluded that the restructuring expenses may have been cumulatively overstated by approximately $4.0 million on a pre-tax basis at September 30, 2012. Furthermore, as part of the restatement review, the Company determined that the divestiture of the Company’s consumer product lines in July 2012 may qualify to be presented as discontinued operations under GAAP, requiring reclassification of all historical revenues and expenses attributable to the consumer product lines to income or loss from discontinued operations.
Classifying expenses as “restructuring” increases management’s bonus compensation. The YE2011 proxy statement states:
Operating earnings for purposes of the 2011 executive bonus plan is a non-GAAP measure and excludes the following from our reported operating loss of $20.8 million: amortization of acquisition-related intangible assets, legal settlements and acquisition-related costs, stock-based compensation, restructuring costs, loss on sale of assets and bonus provision in excess of final calculation. These items were excluded from operating earnings because our compensation committee believes they do not reflect the operational aspects of our business.
If Avid truly did overstate restructuring expenses, then it is possible that the accountants aggressively classified expenses as restructuring to increase insider bonuses. So far, it seems that there isn’t just one cockroach in the kitchen. Previously the only accounting issue that was disclosed was a technicality where Avid did not properly account for implied post-sale software updates.
The simplest explanation for Avid’s restatement
In my opinion, the simplest explanation is that there was erroneous accounting that inflated insider bonuses. This has low financial impact on Avid and doesn’t suggest that its GAAP losses were significantly understated. However, it reflects very poorly on management’s integrity and their lack of focus. It also reflects poorly on the current board of directors, who should be coming clean with Avid shareholders and explaining the latest developments to them.
*Disclosure: I am currently shorting AVID common shares. Unfortunately I don’t think that there is major fraud at Avid and therefore Avid is not as great a short position as it could be. The reason I am shorting Avid is because I think that management is destroying the company and that intense competition will continue to take Avid’s market share.