As many of you might suspect, this grumpy old accountant is not a big fan of last year’s JOBS Act. As so eloquently communicated by Andrew Ross Sorkin in “JOBS Act Jeopardizes Safety Net for Investors,” my primary concern is the decreased amount of time that investors now have to analyze critical corporate information. Three weeks is simply not enough to evaluate the financial viability of a company before it goes public. As Mr. Sorkin suggests, the Act:
So, when Model N founder and CEO Zack Rinat told Maxwell Murphy at the CFO Journal recently that the Company believes in “complete transparency,” and won’t use the JOBS Act to hide material information from investors, I just had to take a look. Now I can’t promise the Company that it would have avoided my scrutiny had it gone through the normal IPO filing process, but it sure would have gotten some good comments that would truly have helped the CEO honor his transparency pledge to investors. My review of Model N’s Amendment No. 4 to Form S-1 Registration Statement filed on March 15, 2013 (S-1), did not disappoint.
Two things immediately tipped me off that this was going to be an interesting read. First, there was the unlabeled circular graphic presumably depicting the life cycle of revenue management using the Company’s solutions that preceded the table of contents. Not until page 86 of the S-1 does the Company actually attempt to explain this illustration. Then, there was the Company’s motto, “More Revenue, Made Simple.” I found this marketing hype particularly annoying since it challenges the intelligence of experienced business professionals who recognize there is nothing easy about creating customer value. So, right out of the gate we have transparency issues.
Next, there is the issue of what the Company actually does. The reader must wade through page after page of MBA speak (85 pages in fact) to learn what the Company’s strategy and business model is. Why mystify us with such terms as “revenue management solutions, strategic end-to-end process, application suites, and domain expertise” when the Company is nothing more than another software provider attempting to remedy the age old problems of transaction processing, reporting, and system integration. Why all the marketing spin, legalese, and accounting verbosity? All of this detracts from transparency.
Then, there are the numerous questions raised by the Company’ s historical operations. We learn early on that an investment in Model N is quite risky (S-1, page 4). Recent operating losses, dependence on a few key customers (75 percent of revenues come from 15 customers), reliance on a single product, and a single industry focus all make this grumpy old accountant wonder what makes this Company “worthy” of an IPO.
And then you have the declining margin issue masked in the Summary Consolidated Financial Data (S-1, page 8). Margins on license and implementation products have decreased from almost 62 percent in 2010 to 54.81 percent at the end of the most recent fiscal year end. Why is this? Wouldn’t it be more transparent to explicitly report this very troubling trend in the introductory summary table?
Instead, we don’t even see these negative margin trends until page 59 of the S-1. Sure, Model N provides exhaustive detail of revenue and cost of goods sold changes, but it does so without answering the million dollar question: why the margin erosion? Excuse me, but this is a pretty significant transparency deficiency.
And of course, as with so many IPO’s today, the Company feels compelled to spin its losses into profits via non-GAAP performance metrics (i.e., adjusted EBITDA). When we get to the EBITDA reconciliation (S-1, page 10), we learn that the biggest reconciling item is for something called “LeapFrogRx compensation charges,” but the LeapFrogRx transaction has not been detailed up to this point in the S-1. Again, is this what transparency is all about? And this is significant. If not for the LeapFrogRx compensation charges and stock-based compensation, there would have been no need for “adjusted EBITDA” at all! By the way, the LeapFrogRx transaction is not even mentioned until page 49 of the S-1, and we don’t get any of the specifics until much later in the actual financial statements (S-1, F-21 and F-22).
As an aside, I particularly got a kick out of the Company’s justification for paying an excess purchase premium for LeapFrogRx: synergies in skill-sets, operations, customer base and organizational cultures. Goodwill impairment can’t be far behind, can it? And, oh by the way, why is stock-based compensation going up as the Company begins to lose money (S-1, page 9)? Another transparency issue?
As I navigated the Company’s risk factor section (S-1, page 15), I was stunned to see accounting policies listed as a risk factor! Essentially, Model N is “warning” potential investors that its reported revenues may be lower than they “really” are because of accounting. Specifically:
Does the Company require a specific type of accounting to report profitability? Unbelievable! Such disclosure does little to enhance transparency.
And the Company continues to imply that accounting will somehow “hurt” the business (S-1, page 31) in the following risk disclosures:
Why is the Company warning us so much about the accounting? Is there a problem? Should we even be relying on the S-1? Again, transparency sure seems to be an issue.
And if Model N is so transparent, why did it take advantage of certain exemptions from reporting requirements that public companies make, including not complying with auditor attestation requirements of Section 404 of Sarbanes-Oxley, reduced disclosure of executive compensation, etc. (S-1, page 32). And then there is the issue of how Model N management intends to use the funds received in the IPO. Surely, a Company wouldn’t do an IPO if it didn’t have some idea of how the proceeds would be used. Yet, once again, Model N fails the transparency test by not telling us its plans for the monies raised (S-1, pages 36 and 41).
And then there are the bookkeeping errors (S-1, page F-18). Is it really transparent to label accounting mistakes as “out-of-period adjustments?” You make the call.
Finally, it is noteworthy that Model N reported income tax expense in 2012 even though it reported a pre-tax loss for the period. The reason: a significant increase in its valuation allowance for deferred tax assets suggesting poor future operating performance prospects even with an IPO (S-1, F-32). Then there is the issue of whether the IPO will trigger Section 382 limitations on the Company’s net operating loss carryovers. While the Company does identify this as a risk (S-1, page 34), it seems to suggest that this “might” occur when in reality the likelihood is significantly greater than might. This disclosure clearly plays down the loss of this asset, and again causes one to question the Company’s transparency.
This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.