Versatility, Inc. Case Study, IPO Initial Public Offering

A company goes public to raise funds it plans to use in stimulating internal growth of sales. The company’s MD&A focuses on the “Versatility CallCenter” as a major feature of the company’s sales success to date. Footnote 3 to the 10-Q is suggesting that at least part of the servicing of this product will be discontinued. This seems to be a stunt to future revenue growth. More concerning, however, is the forgiveness of accounts receivable. The company mentioned in its 10-K dated 4/30/1997 that almost $3.0m of customer accounts were more than 90 days delinquent and that the company did not intend to extend those payment terms again once they came due. What this “forgiveness” of accounts suggests is that the company wishes to continue booking sales from those same delinquent customers. Also, the basis on which those receivables were originally derived may be questionable, and also may have something to do with the pending litigation discussed in the legal proceedings.

To justify the IPO price, Versatility likely emphasized a few key financial statement items. First, yearly revenue was growing by around 50% per year in the two years preceding the IPO. Next, earnings per share appeared to be climbing from 1996 to 1997 thanks to a well-time write-off of capitalized software. Warning signs of potential problems (of material amounts) included: the detail about legal proceedings, the forgiveness of accounts receivable, the write-off of capitalized software, the large negative value for cash from operations, and the rapid rise in the accounts receivable balance compared to growth in sales.

Other posts on the Versatility, Inc. case study:
Versatility, Inc. Case Study, Cash Flows
Versatility, Inc. Case Study, Preferred Stock
Versatility, Inc. Case Study, Mortgage Guaranty
Versatility, Inc. Case Study, IPO Initial Public Offering
Versatility, Inc. Case Study, Accounts Receivable

Versatility, Inc. Case Study, Mortgage Guaranty

Before the sale, the Company likely had the most to risk as it was a guarantor of the mortgage loan made by the commercial bank to the Partnership. An increase in the property’s value would slightly benefit the Company. Following the sale, the “partners” (CEO, Senior VP, and Director of Product Development) would bear the most risk from the arrangement, however their loan was now from their own company, greatly diminishing their level of risk since, as officers of the company, they held the execution of that lease’s terms. In essence, the officers made a loan to themselves, from themselves (their own company), for personal financial gain.

I believe this loss from legal proceedings is part of a legitimate claim. The company states that it does not wish to comply with the arbiter on what it believes is firm legal footing. I think the company is trying to get out of its legal obligations by using some fancy legal footwork, despite that a wrong seems to have clearly been committed. I would suggest the company recognize a loss of $267,000, the original arbiter’s number, because this number has been derived on a solid basis of information, and seems likely to be required ultimately.

Other posts on the Versatility, Inc. case study:
Versatility, Inc. Case Study, Cash Flows
Versatility, Inc. Case Study, Preferred Stock
Versatility, Inc. Case Study, Mortgage Guaranty
Versatility, Inc. Case Study, IPO Initial Public Offering
Versatility, Inc. Case Study, Accounts Receivable

Versatility, Inc. Case Study, Preferred Stock

The company claims its calculation of earnings per share is based on the assumption of complete dilution through exercises of stock options and convertible preferred shares. Assuming all possible dilutive actions concerning shares are taken, the EPS results presented will occur.

In January 1996, 992,061 shares of preferred stock were sold for a total of $3.5m, equating to a cost of only $3.50 per share. Given Versatility’s IPO in December of the same year, it appears that those investors who were allowed to purchase shares in the preferred offering were given a fantastic deal, seeing as the December IPO converted all preferred shares into common shares at a 1:1 ratio. Considering the Statement of Cash Flows, it seems that the preferred stock offering in January 1996 may have been geared toward benefitting insiders. The offering price of $3.50 was too low compared to $15 per share in the December IPO. Besides the offering price being too low, the number of shares issued, 992,061 is an awful peculiar and odd number that suggests the share offering was geared around flexibility to participants. The company may have needed cash to finance its operations, however this plight is fueled by an unacceptably high A/R balance, seen at 4/30/06. I also feel that it is no coincidence that the company recorded a software impairment charge of $829k in 1996, dragging down earnings for that year and positioning 1997 earnings to appear as a grand success of growth and financial management at Versatility. I have no doubt that as FY 1997 was shaping up to be a great year for Net Income, the Versatility IPO fetched a whopping $15 per share, thereby further exaggerating the preferred share offering earlier in 1996.

Other posts on the Versatility, Inc. case study:
Versatility, Inc. Case Study, Cash Flows
Versatility, Inc. Case Study, Preferred Stock
Versatility, Inc. Case Study, Mortgage Guaranty
Versatility, Inc. Case Study, IPO Initial Public Offering
Versatility, Inc. Case Study, Accounts Receivable

Versatility, Inc. Case Study, Cash Flows

The Statement of Operations shows fast-growing revenue for both licensing and servicing activities, which seems normal for a young software company with a decent product. What concerns me most about this statement is the notable jump in Operating Expenses. Specifically, SG&A has grown more than threefold between April 30, 1995 and April 30, 1997, from $4.6m to $15.3m. This exhibition that the company does not have expense growth under control is also a concern. Revenues can develop a decreasing trend overnight, but oftentimes expenses are difficult to back down.

By writing-off capitalized software in 1996, the company effectively cut its net income in half from $1.3m to $657k. Net income for 1997 was $1.9m, but would have been $829,000 lower had the company recorded the write-off during that year. Despite still selling the product, the company claims in the notes to its financial statements that it recorded the write-off because management had determined that “no net realizable value in the asset remained.” This paradox seems odd, and suggests that management may have accelerated the write-off rather than allowing it to occur naturally as depreciation/amortization expense in future years.

Other posts on the Versatility, Inc. case study:
Versatility, Inc. Case Study, Cash Flows
Versatility, Inc. Case Study, Preferred Stock
Versatility, Inc. Case Study, Mortgage Guaranty
Versatility, Inc. Case Study, IPO Initial Public Offering
Versatility, Inc. Case Study, Accounts Receivable

Versatility, Inc. Case Study, Accounts Receivable

The balance of the cash account was diminished before year-end by a ballooning accounts receivable balance and heavy investment purchases. The account was more than replenished, however, when sales of common stock brought in $30.6 million.

For the period of Fiscal Year 1997, Versatility’s accounts receivable balance nearly tripled from $5.7m to $16.0m. Sales revenue during the period failed to even double, climbing from $16.5m to $27.4m. In footnote 1 to the financial statements, the company specifies that revenue for licensed software is recognized when the software is shipped. The fact that sales is increasing by such a slow rate compared to A/R is a negative sign, and one that requires further investigation. Reading through the MD&A reveals that several of the company’s key customers have been unable to pay on accounts owed, and have since become delinquent. Roughly $3.0m worth of A/R on Versatility’s books is classified this way, and it is even more concerning that management notes that its customers continue to exercise enough leverage of Versatility that its payment terms continue to be extended. In my opinion, A/R is growing too fast for the rate of growth in sales, and should be considered a warning sign.

Other posts on the Versatility, Inc. case study:
Versatility, Inc. Case Study, Cash Flows
Versatility, Inc. Case Study, Preferred Stock
Versatility, Inc. Case Study, Mortgage Guaranty
Versatility, Inc. Case Study, IPO Initial Public Offering
Versatility, Inc. Case Study, Accounts Receivable