Case Study 3 Financial Data Analysis

To complete the following analyses, you must have the corresponding Excel file provide prior to the start of class. Example 1 Background OpenAMC Corporation ("AMC") is one of the world's leading providers of technologies and services enabling the delivery of richer digital interactive television experiences. OpenAMC's platform software is currently deployed in over 54 million digital set-top-boxes in 96 countries, reflecting solid industry-leading growth from network operators expanding into new markets, and from existing customers enhancing their digital services with new functionality. OpenAMC offers advanced digital television solutions on disparate networks and on various software platforms, including electronic program guides, video on demand, personal video recorders, interactive shopping, interactive and addressable advertising, games and gaming, a full-featured IPTV solution, and a variety of consumer care and communication applications. The company continually expands its suite of market-leading solutions as new methods of distributing digital media emerge and partners with network operators in capitalizing on the growth opportunities that lie ahead. OpenAMC is headquartered in San Francisco, California, with offices worldwide. OpenAMC operates in the U.S. through its wholly owned subsidiary AMC, Inc., a provider of software that enables digital interactive television. OpenAMC created a wholly owned intellectual property (“IP”) holding Swiss subsidiary, OpenAMC A.G. Accordingly, OpenAMC’s current international structure includes OpenAMC, Inc., OpenAMC A.G., and a number of foreign subsidiaries, including OpenAMC Australia Pty Limited (“OpenAMC Australia). OpenAMC Australia performs administrative, localization, technical support, sales support, marketing, and other services requested by OpenAMC, Inc. and OpenAMC A.G. It is compensated for these services jointly by OpenAMC, Inc. and OpenAMC A.G. by a commission calculated as a reimbursement of all its costs plus a mark up of 8.0% of costs. Please find below the FY2005 P&L data for OpenAMC Australia, as provided by client.

Revenues (Third Party) $ 3,477,010 Intercompany Revenues (OpenAMC US) $ 1,909,902 Total Revenue $ 5,386,912 Cost of Goods Sold $ 456,788 Gross Profit $ 4,930,124 Operating Expenses (Third Party) $ 2,100,000 Operating Expenses (Sales/Marketing) $ 1,768,428 Total Operating Expenses $ 3,868,428 Income/Loss $ 1,061,696

Issues 1. Given the facts and financial data provided above, what do OpenAMC Australia’s financials tell you

about its operations? How should these financials be applied when analyzing intercompany transactions?

2. What other relevant questions should an analyst ask about the operations?

Steps for Analysis 1. Step 1: Calculate the margins achieved by OpenAMC Australia P&L for FY2005, based on data

provided by client.

2. Step 2: Calculate ROS and OI/TC. Note levels.

3. Step 3: Segregate the results associated with the provision of consulting services to third parties from the results associated with the intercompany services.

4. Step 4: Recalculate ROS and OI/TC for separate sets of results.

Example 2 Background AST Limited (“AST HK”), established in 1988, is a wholly-owned subsidiary of AST Holdings Limited (“AST”), a leading provider of semiconductor assembly, test, and integrated circuits package design services located in Hong Kong. AST HK assembles a broad selection of advanced leaded and ball grid array packages utilizing advanced technology characterized by higher electrical and thermal performance. Collectively, the services offered by AST HK are referred to as the “assembly, test, and design” or ATD services. AST US, also established in 1988, is a wholly-owned subsidiary of AST HK. During FY2005, AST US acted as the exclusive sales representative in the U.S. of the ATD services performed by AST HK. Specifically, AST US identifies and refers clients to AST HK. For its services, AST US is reimbursed by AST HK with a gross margin of 8%. Please find below the FY2005 P&L data for AST-US, as provided by client.

Sales-AST HK $ 98,442,038 Sales-US Testing Services $ 116,916 Total Sales $ 98,558,954 Contract Service-AST HK $ 90,674,238 Customer Compensation Charge $ 9,706 Total Cost of Sales /Services $ 90,683,944 Gross Margin $ 7,875,010 Personnel Expenses $ 5,000,000 Facilities Expenses $ 792,597 Selling Expenses $ 842,268 G&A Expenses $ 1,369,249 Total Operating Expenses $ 8,004,114 Net Income from Operations $ (129,104) Bad & Doubtful Debt $ 4,400 Interest (Income)/Expenses $ - (Gain)/Loss on Sales of F/A $ 2,797 Sundry Expenses/(Income) - Interco $ (952,798) Administrative Expenses/(Income) $ (4) Sundry Expenses/(Income) $ (7,789) Total Other Income/Expenses $ (953,394) Total Income/Expenses $ 7,552,945 Net Income Before Tax $ 450,239 Provision for State Inc Tax $ 3,000 Provision for Fed Inc Tax $ 2,300 Total Provision for Taxes $ 5,300 Net Income After Tax $ 444,939

Issues 1. What do AST US’ financials tell you about its activities?

2. What potential issues can you identify from this data?

Steps for Analysis 1. Step 1: Calculate the margins achieved by AST-US for FY2005, based on data provided by client.

2. Step 2: Calculate ROS and OI/TC.

3. Step 3: Consider party performing the test and assembly services, how operating expenses are reimbursed.

Example 3 Background WebB Technologies, Ltd. (“WebB-Israel”), is an Israeli corporation that, together with its subsidiaries (collectively “WebB”), is engaged in the design, development, marketing, and support of a suite of enterprise web applications. WebB-Israel is the parent company of WebB Technologies, Inc. (“WebB-US”), a wholly-owned United States (“U.S.”) subsidiary. During FY2005, WebB-US purchased software products from WebB-Israel primarily for resale in the U.S. market. In addition, WebB-US provided technical training, support, and deployment-related consulting services to customers in the U.S. market for WebB-Israel. For its services, WebB-US is reimbursed for its costs associated with the provision of such services plus a markup of 10%. Please find below the FY2005 P&L data for WebB-US, as provided by client (in USD ‘000). Additionally, the client represented to us that approximately 80% of the activities performed by the G&A personnel relate primarily to the provision of supportive services for the Israeli parent.

License Revenue $ 4,500 Service Revenue - Intercompany $ 2,697 Total Revenue $ 7,197 COGS License $ 230 COGS Service $ - Total COGS $ 230 Gross Margin $ 6,967 R&D $ 1,650 S&M $ 600 G&A $ 3,065

Amortization of Goodwill, other intangibles, & deferred stock comp. $ - Bad Debt Expense $ - Restructuring Charges $ 355 Total Operating Expenses $ 5,670 Total Costs & Expenses $ 5,900 Operating Income/Loss $ 1,297

Issue 1. What would be the appropriate approach to analyzing the results associated with the provision of

intercompany services?

2. What additional data should the analyst have to appropriately perform this analysis?

Steps for Analysis 1. Step 1: Calculate the margins achieved by WebB-US.

2. Step 2: Calculate ROS and OI/TC.

3. Step 3: Consider reclassifying restructuring charges and apportioning G&D expenses between intercompany services and consulting services.

4. Step 4: Recalculation ROS and OI/TC after adjustments.

Example 4 Background SI Technology, Inc. (“SI-US”), together with its worldwide subsidiaries (collectively, “SI”), is a corporation based in the U.S., with its principal executive offices located in San Jose, California. SI was incorporated in Delaware in 1995 and became a publicly held company in 2004. SI designs, develops, markets, and supplies proprietary global positioning system (“GPS”) semiconductor solutions primarily used in mobile consumer and commercial applications. These GPS solutions are designed to provide location awareness capabilities to allow users to determine and use location information to gain access to applications and services, as well as to be combined with wireless connectivity to enable a range of tracking and location applications. Under the SI corporate structure, SI Technology Holdings, Inc. is the parent company of the worldwide organization and wholly owns SI-US, SI Technology KK, SI Technology Gmbh, and SI Technology AB. SI-US wholly owns SI Technology (Cayman), Ltd. (“SI-Cayman”). SI-Cayman is the parent company of SI Technology Pte. Ltd (“SI Singapore”), SI Taiwan, SI Technology Pvtd., SI UK, SI China, and SI Bangalore. To facilitate its global business operations, on January 2, 2007 SI-US entered into the following intercompany agreements:

• License Agreement (“License Agreement”), entered into on January 2, 2007, whereby SI-US granted SI-Cayman a non-exclusive, royalty bearing, license to market, sell, and distribute GPS products which incorporate, or are made in accordance with, SI-US’s technology in existence prior to January 2, 2007, in its defined territory, which is the entire world except for North America; and

• Agreement to Sharing Costs and Risks of Intangible Development (“Cost Sharing

Agreement”), entered into on January 2, 2007, whereby SI-US and SI-Cayman agreed to pool their resources for the purposes of further developing SI-US technology and marketing intangibles on the basis of the benefits each party expects to derive.

You have been asked to prepare a royalty analysis to assess the royalty to be paid by SI-Cayman to SI-US as consideration for the licensed intangibles. The client provided us with 5 year projected P&L data for SI, as a consolidated entity to be used to approximate the future profitability of SI-Cayman.

The table below contains the P&L data for SI consolidated, for FY2006 through FY2011 (in USD ‘000,000). 2006 2007 2008 2009 2010 2011 Total Product Revenue 175.1 342.0 513.0 729.0 1093.5 1202.9 Unadjusted Cost of Sales 80.5 157.3 236.0 335.3 503.0 553.3 Adjustment for COS stock option expense 0.4 0.8 1.1 1.6 2.4 2.7Adjusted COS 80.9 158.1 237.1 337.0 505.4 556.0 Gross profit 94.1 183.9 275.9 392.0 588.1 646.9 Unadjusted R&D 31.5 61.6 92.3 131.2 196.8 216.5 Adjustment for R&D stock option expense 11.8 23.0 34.5 49.0 73.4 80.8Adjusted R&D 43.3 84.5 126.8 180.2 270.3 297.3 Unadjusted Sales Expense 7.8 15.2 22.9 32.5 48.7 53.6 Adjustment for sales stock option expense 1.1 2.1 3.2 4.6 6.8 7.5Adjusted Sales Expense 8.9 17.4 26.1 37.0 55.6 61.1 Marketing 9.5 18.6 27.9 39.7 59.5 65.5 Adjustment for marketing stock option expense 1.3 2.6 3.9 5.6 8.4 9.2Adjusted Marketing expense 10.9 21.2 31.9 45.3 67.9 74.7 G&A 14.2 27.7 41.6 59.0 88.6 97.4 Adjustment for stewardship and duplicative expense -0.7 -1.4 -2.1 -3.0 -4.4 -4.9 Adjustment for G&A stock option expense 2.8 5.5 8.3 11.7 17.6 19.4 Adjustment for stewardship for stock option expense -0.4 -0.8 -1.2 -1.8 -2.6 -2.9Adjusted G&A expense 15.9 31.0 46.5 66.1 99.1 109.0 Operating Profit 15.2 29.8 44.7 63.5 95.2 104.7

Issue As in the example above, often as part of the royalty analyses, we are provided projected P&L data by the client. 1. What are the routine sanity checks that should always be performed when employing projected

financial data in our TP analyses? What does the data tell you about the company’s growth potential?

2. Review the P&L data provided, assess the quality of the data, and identify potential questions you would ask the client.

Steps for Analysis 1. Step 1: Calculate annual revenue growth and the profit margins projected by SI.

2. Step 2: Review line items, growth rates, and profit margins to identify potential questions.

Case Study 3 Financial Data Analysis – Answer Key

Key to Example 1 Step 1: Calculate the margins achieved by OpenAMC Australia P&L for FY2005, based on data provided by client.

% of

Revenue Formula Revenues (Third Party) $ 3,477,010 64.5% (a) Intercompany Revenues (OpenAMC US) $ 1,909,902 35.5% (b) Total Revenue $ 5,386,912 100.0% (c)=(a)+(b) Cost of Goods Sold $ 456,788 8.5% (d) Gross Profit $ 4,930,124 91.5% (e)=(c)-(d) Operating Expenses- Third Party $ 2,100,000 39.0% (f) Operating Expenses- Sales/Marketing $ 1,768,428 32.8% (g) Total Operating Expenses $ 3,868,428 71.8% (h)=(f)+(g) Income/Loss $ 1,061,696 19.7% (i)=(e)-(h)

Step 2: Note that selected profit level indicators (ROS and OI/TC) clearly indicate that the company is providing more than routine sales and marketing services.

ROS 19.7% (i)/(c ) OI/TC 24.5% (i)/((h)+(d))

Step 3: To appropriately analyze the return associated with the provision of intercompany services, the results associated with the provision of consulting services to third parties should be segregated from the results associated with the intercompany services. P&L Associated with the Provision of Intercompany Services

% of Revenue Revenues (Third Party) 0.0%Intercompany Revenues (OpenAMC-US) 1,909,902 100.0%Total Revenue 1,909,902 100.0% Cost of Goods Sold 0 0.0% Gross Profit 1,909,902 100.0% Operating Expenses -Third Party 0 0.0%Operating Expenses - Sales/Marketing 1,768,428 92.6%Total Operating Expenses 1,768,428 92.6% Income/Loss 141,474 7.4%

Key to Example 1, continued

Selected Profit Level Indicators ROS 7.4%OI/TC 8.0%

P&L Associated with the Provision of Consulting Services

% of Revenue Revenues (Third Party) 3,477,010 100.0%Intercompany Revenues (OpenAMC-US) 0 0.0%Total Revenue 3,477,010 100.0% Cost of Goods Sold 456,788 13.1% Gross Profit 3,020,222 86.9% Operating Expenses -Third Party 2,100,000 60.4%Operating Expenses - Sales/Marketing 0 0.0%Total Operating Expenses 2,100,000 60.4% Income/Loss 920,222 26.5%

Selected Profit Level Indicators ROS 26.5% OI/TC 36.0%

Step 4: By analyzing the PLIs for the consulting services segment, the analyst will notice that both the operating margin and the return on total cost are comparatively high. This might be an indication that OpenAMC-Australia may employ some intangibles (possibly pertaining to OpenAMC-US) in providing the consulting services.

Key to Example 2 Step 1: Calculate the margins achieved by AST-US for FY2005, based on data provided by client.

% of TR Sales-AST HK 98,442,038 99.9% Sales-US Testing Services 116,916 0.1% Total Sales 98,558,954 100.0% Cost of Sales/Services Contract Service-AST HK 90,674,238 92.0% Customer Compensation Charge 9,706 0.0% Total Cost of Sales /Services 90,683,944 92.0% Gross Margin 7,875,010 8.0% Personnel Expenses 5,000,000 5.1% Facilities Expenses 792,597 0.8% Selling Expenses 842,268 0.9% Gen & Adm Expenses 1,369,249 1.4% Total Operating Expenses 8,004,114 8.1% Net Income from Operations (129,104) -0.1% Bad & Doubtful Debt 4,400 0.0% Interest (Income)/Expenses 0 0.0% (Gain)/Loss on Sales of F/A 2,797 0.0% Sundry Expenses/(Income) - Interco (952,798) -1.0% Administrative Expenses/(Income) (4) 0.0% Sundry Expenses/(Income) (7,789) 0.0% Total Other Income/Expenses (953,394) -1.0% Total Income/Expenses 7,552,945 7.7% Net Income Before Tax 450,239 0.5% Provision for State Inc Tax 3,000 0.0% Provision for Fed Inc Tax 2,300 0.0% Total Provision for Taxes 5,300 0.0% Net Income After Tax 444,939 0.5%

Step 2: Calculate selected PLIs

ROS -0.13% OI/TC -0.13%

Key to Example 2, continued

Step 3: Analysis The P&L presented below seems to indicate that AST-US is actually performing the testing and assembly services itself. Note that the company shows $98 million in revenue. In fact, the company is recording on its books all revenue pertaining to the Hong Kong operations. In addition, the transfer pricing of 8% GM does not cover the company’s operating expenses. Is the TP price properly set - should they consider a mark-up on costs?

Key to Example 3 Step 1: Calculate the margins achieved by WebB-US and selected PLIs

% of TR License Revenue 4,500 63% Service Revenue - Intercompany 2,697 37% Total Revenue 7,197 100% COGS License 230 3% COGS Service 0 0% Total COGS 230 3% Gross Margin 6,967 97% R&D 1,650 23% S&M 600 8% G&A 3,065 43% Amort of Goodwill, other intangibles, and deferred stock compensation 0 0% Bad Debt Expense 0 0% Restructuring Charges 355 5% Total Operating Expenses 5,670 79% Total Costs & Expenses 5,900 82% Operating Income/Loss 1,297 18%

ROS 23%OI/TC 17%

Step 2: Interpret the results In addition to providing supportive services to its Israeli parent, Webb-US in fact develops and license software to third parties (see the R&D spend line). To appropriately analyze the results, the restructuring charges need to be moved below the OI line and G&D expenses be apportioned between the intercompany services and consulting services.

Key to Example 3, continued

Income Statement Associated with the Provision of Intercompany Services

% of TR License Revenue 0 0% Service Revenue - Intercompany 2,697 100% Total Revenue 2,697 100% COGS License 0 0% COGS Service 0 0% Total COGS 0 0% Gross Margin 2,697 100% R&D 0 0% S&M 0 0% G&A 2,452 91%

Amort of Goodwill, other intangibles, and deferred stock compensation 0 0% Bad Debt Expense 0 0% Restructuring Charges 0 0% Total Operating Expenses 2,452 91% Total Costs & Expenses 2,452 91% Operating Income/Loss 245 9%

ROS 9%OI/TC 10%

Key to Example 3, continued

Income Statement Associated with the Software Development Business

% of TR License Revenue 4,500 100% Service Revenue - Intercompany 0 0% Total Revenue 4,500 100% COGS License 230 5% COGS Service 0 0% Total COGS 230 5% Gross Margin 4,270 95% R&D 1,650 37% S&M 600 13% G&A 613 14%

Amort of Goodwill, other intangibles, and deferred stock compensation 0 0% Bad Debt Expense 0 0% Restructuring Charges 0 0% Total Operating Expenses 2,863 64% Total Costs & Expenses 3,093 69% Operating Income/Loss 1,407 31%

ROS 31%OI/TC 45%

Key to Example 4 Step 1: Calculate the margins projected to be achieved by SI 2006 2007 2008 2009 2010 2011 Total Product Revenue 175.1 342.0 513.0 729.0 1093.5 1202.9 Unadjusted Cost of Sales 80.5 157.3 236.0 335.3 503.0 553.3 Adjustment for COS stock option expense 0.4 0.8 1.1 1.6 2.4 2.7Adjusted COS 80.9 158.1 237.1 337.0 505.4 556.0 Percent of Revenue 46.2% 46.2% 46.2% 46.2% 46.2% 46.2% Gross profit 94.1 183.9 275.9 392.0 588.1 646.9 Percent of Revenue 53.8% 53.8% 53.8% 53.8% 53.8% 53.8% Unadjusted R&D 31.5 61.6 92.3 131.2 196.8 216.5 Adjustment for R&D stock option expense 11.8 23.0 34.5 49.0 73.4 80.8Adjusted R&D 43.3 84.5 126.8 180.2 270.3 297.3 Percent of Revenue 24.7% 24.7% 24.7% 24.7% 24.7% 24.7% Unadjusted Sales Expense 7.8 15.2 22.9 32.5 48.7 53.6 Adjustment for sales stock option expense 1.1 2.1 3.2 4.6 6.8 7.5Adjusted Sales Expense 8.9 17.4 26.1 37.0 55.6 61.1 Percent of Revenue 5.1% 5.1% 5.1% 5.1% 5.1% 5.1% Marketing 9.5 18.6 27.9 39.7 59.5 65.5 Adjustment for marketing stock option expense 1.3 2.6 3.9 5.6 8.4 9.2Adjusted Marketing expense 10.9 21.2 31.9 45.3 67.9 74.7 Percent of Revenue 6.2% 6.2% 6.2% 6.2% 6.2% 6.2% G&A 14.2 27.7 41.6 59.0 88.6 97.4 Adjustment for stewardship and duplicative expense -0.7 -1.4 -2.1 -3.0 -4.4 -4.9 Adjustment for G&A stock option expense 2.8 5.5 8.3 11.7 17.6 19.4 Adjustment for stewardship for stock option expense -0.4 -0.8 -1.2 -1.8 -2.6 -2.9Adjusted G&A expense 15.9 31.0 46.5 66.1 99.1 109.0 Percent of Revenue 9.1% 9.1% 9.1% 9.1% 9.1% 9.1% Operating Profit 15.2 29.8 44.7 63.5 95.2 104.7 Percent of Revenue 8.7% 8.7% 8.7% 8.7% 8.7% 8.7%

Step 2: Data analysis

• Margins are constant over 5 years. This is an indication the projections do not account for business growth, economies of scale, efficiencies and inefficiencies in performing certain business functions.

• The revenue has dramatic growth rates (the company is anticipated to grow from 175 million to 1 billion in 5 years). The question that one should ask is whether the industry cycles and SI’s technology would theoretically accommodate such a growth.

• The R&D spending, held constant vs. revenue, is growing dramatically (in flat dollars). This may not be able to be sustained operationally unless the company plans on acquiring other companies for their R&D workforce. Efficient integration of such workforce remains as a question, and as such, the growth rates appear unreasonable.

• Stock option expenses (in total, relative to revenue or relative to the appropriate line item) are significant, indicating that the company is relatively immature.