Frank Voisin is the author of the popular value focused website Frankly Speaking, found at http://www.FrankVoisin.com
The market likes consistency in operations, but intelligent investors should also consider consistency in disclosures. The more consistent a corporation’s disclosures, the easier it is to make comparisons and determine the true state of the company’s performance. When companies suddenly change their disclosures without providing a concrete rationale for the change, investors should be worried that there is some bad news being covered up. Indeed, many of the accounting gimmicks covered in the excellent Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports (read my multi-part review here), are identifiable by those who watch for inconsistencies in disclosures, definitions and assumptions.
Consider the case of ADTRAN, Inc. (NASDAQ: ADTN) a provider of equipment and services for communications networks. I am always concerned when looking at companies in this niches because they tend to be overly reliant on a small number of major mobile network operators. Consequently, I pay close attention to disclosures about major customers and revenue concentration. I was quite concerned by what I found at ADTN.
The company’s 2010 10-k includes this statement:
Single customers comprising more than 10% of our revenue in 2010 include Qwest Communications International, Inc. at 20%, AT&T Inc. (NYSE:T) at 18%, and Verizon Communications Inc. (NYSE:VZ) at 11%. The revenues from all of these customers are reported in both the Carrier Networks and Enterprise Networks segments. No other customer accounted for 10% or more of our sales in 2010.
This is exactly the kind of disclosure I look for: a clear and concise discussion of who its major customers are and what percentage of sales each accounts for. I usually track these figures over time, so when I checked the recently filed 2011 10-K, imagine my surprise when I found that this year, investors received this:
Single customers comprising more than 10% of our revenue in 2011 include AT&T Inc. and CenturyLink, Inc. The revenues from both of these customers are reported in both the Carrier Networks and Enterprise Networks segments. No other customer accounted for 10% or more of our sales in 2011.
How much of the company’s sales were attributable to AT&T? How about CenturyLink, Inc. (NYSE:CTL)? From this statement only, there is no way to guess. The answers are elsewhere. I checked and the company has provided this information for each of its major customers in each of the previous eleven years. Suddenly there is a break in the consistency, and this should invite investor scrutiny.
The information is provided (indeed, it has to be), but rather than being up front, it is buried down in Note 11 “Segment Information and Major Customers” near the end of the 10-K. The company even made the odd choice to bury the data under the heading “Sales by Geographic Region” when this information has nothing to do with geography. Here’s what they say (emphasis mine):
Single customers comprising more than 10% of our revenue in 2011 included two customers at 25% and 10%, respectively. Single customers comprising more than 10% of our revenue in 2010 included three customers at 20%, 18%, and 11%, respectively. Single customers comprising more than 10% of our revenue in 2009 included three customers at 22%, 19%, and 11%, respectively. No other customer accounted for 10% or more of our sales in 2011, 2010 or 2009.
Here we see that the company doesn’t provide information about which of its two major customers is the larger purchaser. Again, they’ve done this for every year since 1999, so why stop now? Perhaps because sales to one of these customers has plummeted.
In 2010, Qwest (now CenturyLink) and AT&T comprised 38% of sales which were closely split between the two. In 2011, while the aggregate concentration of these two dropped to 35%, the gap between the two expanded from 3% to 15%. In 2010, sales to the second largest customer accounted for 18% of total revenues, or $109 million. In 2011, sales to the second largest customer accounted for 10% of total revenues or $71.7 million, for a decline of 34%. This is a dramatic decline in sales to its largest customer, but only those investors who found the strange lack of disclosure up front and hunted to the end of the 10-K could find this information. Otherwise, the offset in sales to the largest customer masked much of the decline.
I decided to check out the company’s 2011 conference call transcripts to see what happened. First, in Q1, the company said this:
Sanjiv Wadhwani – Stifel, Nicolaus & Co., Inc.
Jim, could you talk about the 10% customers for the quarter?
Sanjiv, Yes. As you know in the past, historically, we have given a 10% breakout customers on the quarterly calls. We have recently received letters from certain customers requesting that we not do that any longer. Therefore, that’s the practice that we’re going to take going forward. However, we did see three 10% customers in the quarter. And that’s the extent that we can talk about it at this point, Sanjiv, because of customer request.
Note that the customer request covers quarterly calls, not 10-K. The information is still in the 10-K, just buried and no longer specific to the customer. The company should stick to its track record of providing this important information up front. Later in the same call, the company said this (emphasis added):
Ehud Gelblum – Morgan Stanley (NYSE:MS)
Okay, that’s cool. Now when you look at some big customers. And I know certainly after you got these letters, you don’t want to talk about customers all that closely. But again, we have CenturyLink, Qwest, and we have a slightly different merger going on with AT&T and T-Mobile, which sort of really have nothing to do with you. But there’s been some thought out there that possibly AT&T may be slowing down expenses, or slowing down spending deployments, based on that. Are you seeing any, at either of these two mergers, are you seeing any difference in spending patterns? And if you feel like generalizing to a more general comment, that’s fine as well.
Yes, I mean that — and I will tell you that the tone of, from customers, around talking about their business is probably as loud as it’s ever been, so we really don’t want to talk too much. If I must set the market in general, and if I talk about it from a product-line basis, maybe that’s a better way to look at it, our Broadband piece did very well. That included performances pretty much across the customer base that we would expect to see at this point in time. And so really, no surprises there. I’m not sure of much more I can tell you.
Ehud Gelblum – Morgan Stanley
So it doesn’t sound like you’re seeing any change in buying behavior from your customers.
Well, I’ve heard the same thing that you were talking about with one of the largest carriers, and I’m not sure if we really commented about that in Q4, but I know there was a lot of talk about kind of delayed purchases and things like that. And we didn’t disagree with those comments. And we fully kind of understood what they were doing and