i) 1-page summary of the case:
Diligent: Revenue RecognitionProblems(Links to an external site.)someTitle Chapter 4 Case study 2 dIlIgent: revenue reCognItIon proBlems 129 C a se s tu d yDIlIgent: Revenue RecognItIon pRoblems* On 7 August 2013 the business press reported: ‘Software company Diligent delivered yet another blow to investor confidence with its admission its financial accounts for the past three years and for the March quarter are inaccurate and unreliable. After this announcement Diligent shares fell to $5.80 from $8.20 in early June.’ [see Exhibit 1] In a statement to the New Zealand Stock Exchange (NZX), Diligent announced that it would restate its financial statements for the fiscal years ended 31 December 2010, 2011 and 2012 and the fiscal quarter ended 31 March 2013, and that its previously reported results for these periods should no longer be relied upon. The New Zealand-listed US-based governance software maker said it had mistakenly captured sales at the beginning of the month rather than when contracts were signed. Also, costs of software developed for the company’s own use were reported incorrectly. The statement to the NZX also stated that the errors were ‘material for the purpose of requiring a restatement in the company’s historical financial statements’. On 17 October 2013 Diligent announced: ‘To date, no new material adverse revenue recognition issues have been discovered during the restatement process. However, the restatement process is very complex and time consuming and involves reviewing the recognition of revenue for approximately 20 000 transactions over the period covered by the restatement. Diligent remains focused on completing the restatement process and announcing its restated financial statements and the preliminary half year announcement as soon as possible. Diligent is working with its new US independent registered public accounting firm, Deloitte & Touche LLP to complete the reaudit of its historical financial statements and has also engaged additional external resources to assist with completing the restatement process. Alessandro Sodi, Diligent’s President & Chief Executive Officer, said “completing the restatement quickly is one of the highest priorities in the Company and the Board and management team are focused on the completion of both the restatement and reaudit.” ’ Background: Diligent Diligent Board Member Services, Inc. is headquartered in New York, NY. In December 2007 it listed on the NZX at $1 per share after raising $24m in an IPO. In October 2010 Diligent announced the successful completion of a NZ$1.86 million share placement of three million ordinary shares at a price of NZ$0.62 per share. Diligent’s common stock trades on the NZX under the symbol ‘DIL’ and is subject to NZX Listing Rules. However, because it is incorporated in Delaware with over 500 shareholders, it is also subject to the US reporting and regulatory requirements of the Securities and Exchange Commission (SEC) and the Securities Exchange Act of 1934. SEC filings can be found on the US SEC website, which includes financial reports (10-k and 8-k filings). Diligent has been consulting and hosting secure websites for mutual funds, banks and insurance companies since 1994. In 2000 it started developing Diligent Boardbooks® an online software application that boards, management and administrative staff use to compile, review, update and archive board material during and after board meetings. As at November 2013, Diligent serves over 1950 registered users, over 85 boards, over 270 sub-boards, meeting groups and committees, and over 60 corporations. questIons It is now early November 2013. Aaron Yu, a senior analyst who covers the ‘finance & other services’ sector on the NZX, picks up the 1 March 2013 update from Diligent (see Exhibit 3) and reflects on their past problems and future prospects. *Michael Bradbury prepared this case. This case is intended solely as a basis for class discussion and is not intended to serve as an endorsement, source of primary data, or illustration of effective or ineffective management. The research assistance of Jie Wu is gratefully acknowledged. Sue, W, Phillip, L, Palepu, Bradbury, & Healy 2014, Business Analysis and Valuation: Using Financial Statements - Text and Cases Asia Pacific Edition, Cengage Learning Australia, Melbourne. Available from: ProQuest Ebook Central. [20 September 2020]. Created from swin on 2020-09-20 20:11:42. C op yr ig ht © 2 01 4. C en ga ge L ea rn in g A us tr al ia . A ll rig ht s re se rv ed . $9 $8 $7 $5 $4 $3 $2 $1 $0 $–1 1 J an 0 8 12 D ec 0 7 1 J ul 08 1 J an 0 9 1 J ul 09 1 J an 10 1 J ul 10 1 J an 11 1 J ul 11 1 J an 12 1 J ul 12 1 J an 13 1 J ul 13 30 S ep 13 $6 DIL Share Price (Unadjusted) (12/12/2007 to 30/09/2013) Ad ju st ed S ha re P ric e Date Average Close Price PART 2 Business AnAlysis And vAluATion Tools130 C a se s tu d y This is Diligent’s third recent accounting-related embarrassment. In April, Diligent revealed that it had not complied with new rules to be audited by a registered auditor. It then changed auditors to Deloitte Touche LLP from Holtz Rubenstein Reminick LLP. Before this, Diligent’s remuneration committee was discovered to have accidentally issued senior executives with millions of additional share options to which they were not entitled. A series of control weaknesses resulted in a public censure by the NZ Markets Disciplinary Tribunal for breaches of NZSX listing rules (see Exhibit 4). Aaron wonders if other firms in the ‘finance & other services’ sector on the NZX sector face similar revenue recognition problems. Aaron has noted that your recent accounting qualifications would be useful in investigating this issue. Aaron asks you to report on the following: 1 Diligent reports in both the US and NZ environment. What are the differences (if any) between revenue reporting under US GAAP and NZ GAAP (international financial reporting standards)? 2 What are the likely accounting adjustments that Diligent will have to make to restate its financial statements? (Exhibit 5 summarises Diligent’s financial statements.) In particular Aaron has asked you to comment on the following statement by the company: ‘The errors did not affect total revenues, the timing of cash flows received, or the overall cash flow and liquidity position of the company.’ 3 How can we judge whether a firm faces revenue recognition problems? Undertake a literature review related to revenue recognition problems. In particular, are revenue recognition problems related to incentives to mis-report or other factors (such as extreme growth)? 4 Assess whether firms in the same sector are likely to face revenue recognition problems: Aaron suggests you compare Diligent to Xero Limited. Xero provides a platform for online accounting and business services to small business and their advisers. It was started in 2006, listed on the NZX in June 2007 and on the Australian Securities Exchange in November 2012. Xero’s summarised financial data is reported in Exhibit 6. exhIbIt 1 stock price performance of diligent, december 2007 to september 2013 Source: NZX. Sue, W, Phillip, L, Palepu, Bradbury, & Healy 2014, Business Analysis and Valuation: Using Financial Statements - Text and Cases Asia Pacific Edition, Cengage Learning Australia, Melbourne. Available from: ProQuest Ebook Central. [20 September 2020]. Created from swin on 2020-09-20 20:11:42. C op yr ig ht © 2 01 4. C en ga ge L ea rn in g A us tr al ia . A ll rig ht s re se rv ed . Chapter 4 Case study 2 dIlIgent: revenue reCognItIon proBlems 131 C a se s tu d yexhIbIt 2 time line of significant events for diligent from 2007 to 2013 Date Event December 5, 2007 Listing January 8, 2008 To announce $11 925 ahead of prospectus forecast for sale revenue for 2007 4th quarter May 23, 2008 Announced the forecast revenue for June 30, 2008 ($1 263 748) October 24, 2008 Announced a merger with Bridgeway Software, Inc. December 5, 2008 Diligent will be subject to regulation by both the New Zealand Securities Commission and the US SEC. File quarterly financial reports on form 10-Q and file annual reports on form 10-k January 20, 2009 Spring Street to invest Diligent 2 M into new Diligent equity. ($0.1 per share) January 27, 2009 Carroll Capital to invest US$1 million into new Diligent equity. ($0.1 per share) January 29, 2009 Cancellation of 14M shares executed March 30, 2009 Annual report for 2008. The revenue is $2.93 million, a growth of 70% to 2007 March 19, 2010 Annual report for 2009. Revenue is $5 million. January 6, 2011 Diligent commences operations in the Asia-Pacific region March 23, 2011 Annual report for 2010. Revenue is $8.3 million. March 27, 2012 Annual report for 2011. Revenue is $17.97 million. March 11, 2013 Announced Diligent is not aware of material information and results in a price increase of $1.42 or 26%. March 19, 2013 Announced changes in consolidated statement of cash flow for 2012 May 13, 2013 10-Q report announced first quarter revenue is $15.1 million, a growth of 84% to 2012 June 20, 2013 Announced an error in a company revenue recognition practice July 12, 2013 Announced a delay of second quarter 2013 update due to the need to complete its previously disclosed review of revenue recognition practices August 6, 2013 Provides update on review of revenue recognition and intends to restate financial statements Source: Diligent announcements to NZX. exhIbIt 3 Information provided by diligent in their full year report released on 1 march 2013. ‘Fiscal Year 2012 was an outstanding year for Diligent Board Member Services, Inc. (“Diligent” or “the Company”) in terms of New Sales, Cumulative Sales, revenue growth, margin expansion and profitability. The Company’s strong financial results highlight its winning business formula, which in our view include: 1) a unique user experience, 2) a best-in-class multi-tenant “Software-as-a- Service” (SaaS) offering, 3) market leadership, 4) a powerful, dynamic SaaS business model, 5) scalable technology that easily adapts to customer requirements, and 6) superior customer