Blackboard's Earnings: To GAAP or Not to GAAP?

| About: Blackboard Inc. (BBBB)

Blackboard (NASDAQ:BBBB) has just swallowed up WebCT. This kind acquisition wreaks havoc with the income statement for a considerable time. The asset side of the balance sheet shows goodwill in the amount of 102M and an additional 57M in other intangible assets. These intangible assets have to be amortized and this process will result in significant non-cash expenses on the income statement. For example, the 4Q 2006 income statement shows a 5.4M expense arising from amortization of intangibles resulting from acquisitions. For the full year 2006, the expense is 18M.

To give a better picture of the company's operations, it provides some non-GAAP results in addition to the standard GAAP picture. The problem with non-GAAP metrics is that there is no standard. Each company is free to provide whatever non-GAAP metric it chooses and there is no guarantee of consistency from one company to the next.

For some time now, Blackboard has been providing what it calls non-GAAP cash net income. To come up with this, the company ignores two non-cash expenses:

1. The amortization of intangibles resulting from acquisitions.
2. Expense due to non-cash stock-based compensation.

They also take into account the change in taxes which results from backing out these expenses.

In the press release, the company provides a simple reconciliation between GAAP net income and non-GAAP cash net income. For 4Q 2006, GAAP net income is 201K while non-GAAP cash net income is 4.6M. For the full year 2006, GAAP net income is (10.7M) while non-GAAP cash net income is 6.5M. They also provide non-GAAP cash net income for the year-ago quarter and for 2005. The per share information is also provided. They point out that these non-GAAP results provide an additional basis for comparisons to prior periods. This can be helpful when trying to compare pre-acquisition quarters with post-acquisition quarters.

Beginning in 1Q 2007, the company will no longer report non-GAAP cash net income. Instead, it will report what it is calling non-GAAP adjusted net income. This is similar to non-GAAP cash net income except that it will exclude only the amortization of acquired intangibles resulting from acquisitions and the associated tax impact. It will not exclude the expense due to non-cash stock-based compensation.

I think this is good step. It is misleading to report a metric which excludes stock-based compensation. This is an expense (even though it is non-cash) which has a real impact on long-term shareholders. By excluding only the amortization of acquired intangibles, we will be able to judge the performance of the company without the drag on earnings produced by that expense. As the company works its way through the process of digesting the acquisition, this will be a good metric to use for evaluating operating performance.

In the press release, the company provides a simple reconciliation between GAAP net income and non-GAAP adjusted net income. For 4Q 2006, GAAP net income is 201 K while non-GAAP adjusted net income is 3.4M. For the full year 2006, GAAP net income is (10.7M) while non-GAAP adjusted net income is 1.6M. They also provide non-GAAP adjusted net income the first 3 quarters of 2006. The per share information is also provided.

The company has issued guidance for 1Q 2007 and for the full year 2007. It provides guidance with respect to GAAP net income as well as non-GAAP adjusted net income. For 1Q 2007, the company projects GAAP net income in the range 1.3M – 1.8M (.04 - .06 per diluted share) and projects non-GAAP adjusted net income in the range 4.4M-4.9M (.15 -.17 per diluted share). For the full year 2007, the company projects GAAP net income in the range 10M – 12M (.33 - .40 per diluted share) and projects non-GAAP adjusted net income in the range 22.5M – 24.5M (.75 - .82 per diluted share).

Clearly, for the time being, we cannot value BBBB on GAAP earnings. The non-GAAP metric they will provide beginning in 1Q 2007 will give us a much better way to interpret the results of operations. Of course, it is also important to look directly at free cash flow and owner earnings.

The earnings picture of BBBB is more cumbersome to analyze than that of many other companies. Simply looking at GAAP metrics won't do. Some companies barrage us with all sorts of non-GAAP considerations in their earnings report to the extent that it sometimes seems as if they are deliberately trying to keep us from seeing a clear picture of the results. In the case of BBBB, however, it seems to me that their use of non-GAAP adjusted net income is fully justified and, indeed, quite helpful in analyzing the results of operations.

Disclosure: Author has a long position in BBBB