In our last comments on iMergent, we promised further discussion of the company’s accounting vulnerabilities. When a short seller calls “accounting irregularities” on a company, they might just be accused of pounding the table on their own position. Yet, when the company in question is currently the subject of numerous Attorney General Investigations, a Formal SEC Investigation, and a business that Forbes Magazine singled out this month as a paradigm for dirty companies on the AMEX, a warning of accounting irregularities begs to be given additional weight.
Stocklemon believes that iMergent is guilty of using cookie jar accounting to pad current earnings. This “voodoo” accounting employed by iMergent could be the reason why the company has lost all coverage from major brokerage houses and is now reports numbers to the public without independent scrutiny.
First Hand Caught in the Cookie Jar
In 2005, iMergent confessed a huge restatement of prior earnings, and rolled up a mass of prior years’ unreported losses. The losses were due to overestimating collectability of receivables from its installment contract sales to its typically poor quality credit risk customers.
Hidden by these massive adjustments were their repeated acts of “cookie jar” accounting, where they shuttled dollars in and out of receivables, reserves, and net profit, as necessary to massage their earnings for the benefit of shareholders.
As the stock tanked from 25 to 4 last year, iMergent issued these multi-year restatements under the cover of late filing and the absence of a conference call to discuss them.
For a “normal” company, a massive confession/restatement like this one would be an opportunity to “clean house”, to sweep out the closets, dump out all the bad news and take a fresh start.
Not iMergent. They simply used the revision of their entire accounting policy and all the confusion created by a set of massive one-time adjustments (which obstruct investors’ ability to draw meaningful comps to prior periods) to start a whole new cookie jar.
Most cookie jar accounting serves to “smooth earnings” and, although subtle, is banned corporate behavior. But cookie jars also have a more sinister use – misleading investors to believe there is a pattern of increasing earnings when actually the business is stagnant or declining. With the amount of complaints online and government regulation along with dissatisfied customers, it does not take Warren Buffet to figure out this is a terminal business model.
And now, the other hand… This strategy only works until the cookie jar runs out… and the jar at iMergent is running low.
In a call with First Albany (before they dropped coverage), management of iMergent was astoundingly candid about the company’s reserve policy. They implied that the company was at times over-reserving against bad debt, which could, in future periods improve earnings. SEC files show the agency was curious enough about this to inquire further as to its validity.
In the company's reply to SEC questions, they clarified how exactly the reserves are figured out and also supplied statistics for defaults. This Rosetta Stone, posted on the SEC website not more than 2 weeks ago. The company explained the issue to the SEC with facts it had never previously disclosed to investors.
Their better credits (the "A"s) defaulted at a 26% rate and the lower quality credits (the "B"s) defaulted at a 53% rate. The company also stated that they didn't make a determination of reserves when finance receivables were perfected (created), rather they would look at the pool of receivables at quarter-end and then determine what reserve level was appropriate. The result was that when the prior reserve was deemed higher than necessary, the recently added reserves would get a lower reserve allocated -- which has the direct result of improving non-GAAP earnings!
Hidden under the massive restatements of June 2005, an anomaly appears which raises serious questions about IIG's use of reserves to benefit future earnings. Buried in the restatement, and not explicitly disclosed, IIG reserved an astounding 79% of revenues for bad debt reserves, dropping their new contracts written (from which the reserve has been deducted) to a historic low $14.6 million. This made their loss for the quarter even worse (because of the restatement it was already gigantic, so nobody noticed).
It also created a brand new cookie jar to pad future quarters. Strangely, at the same time, the company, explaining why their sales conversion rate had dropped, stated that new policy changes were resulting in increased credit quality. This is contradictory to a reserve rate nearly double its historical levels. Stocklemon believes iMergent’s current results have been benefiting from the new cookie jar.
As recently as March 2005 the company stated that the eventual default rate for finance receivables was 47%, which begs the question as to why higher reserves were ever materially above that. The company refuses to update the overall default rate, as they say it won't impact GAAP earnings. True enough, but it directly impacts non-GAAP earnings. Since the September 2005 quarter with a 57.5% reserve ratio, the company has grown gross receivables by $14.8 million, yet reserves have only grown by $1.2 million for an 8% suggested reserve ratio. While the company will suggest that that is mainly due to losing the lower quality credits (which we showed may have been artificially created last year) it suggests very strongly that the company was using those higher reserves to benefit current earnings.
In fact, were the ending June 2006 reserve materially higher, it would have had a dramatic impact on non-GAAP earnings as demonstrated by this table: Most companies would report non-GAAP so as to give a clear picture of profitability without options expenses or goodwill. iMergent wants you to focus on non- GAAP so you do not factor in their customer with a 550 FICO Score who may or may not pay 18% interest on his “software loan”.
Therefore, it is the opinion of Stocklemon that if this company reserved properly, their NON-GAAP would be 24% lower than their GAAP earnings.
Receivables still not visible
Imergent’s receivables and reserves accounting can only be relied upon if the company’s cash is indeed “unrestricted” and the receivables are real. Considering the company they sold their receivables to:
1) was set up with a Storesonline Website
2) doesn’t seem to have any factoring business beyond iMergent
3) runs out of a 2000 sq ft house in Incline Village NV
4) bought the receivables on a “non-recourse” basis, but still periodically puts bad contracts back to iMergent for “replacement”
...this transaction fails to dispel the questions looming over the quality of iMergent’s receivables.
Imergent bears very strong resemblance to former Stocklemon subject Housevalues.com (SOLD). At the heart of both is an accounting model that systematically leaves out certain key metrics needed by the investing public to determine the true health of the company. Add to that an unending litany of consumer complaints, and you have the reason for the reporting omissions – an unsustainable business model – the last thing management wants to admit.
When Stocklemon reported on Housevalues.com, the stock was $15 a share and Avondale and Piper both had lofty price targets on the stock. Today it is $5.65, trading not far above its cash.
In contrast to Housevalues.com, iMergent has no analyst coverage. There’s no independent scrutiny holding management to a standard of reporting sufficient to shed light on their real business operations.
At the Edge of Unprofitability
Besides the consumer complaint red flags, and the ongoing stream of state AG investigations, the company is sliding towards unprofitability. Their sales conversion rates are flat to declining (the company blames this on sticking to better credit risks, a story unsupported by the reserves analysis). In fact, were it not for interest on its cash, and the commissions from third-party upsales, the company would not now be profitable.
With the current trend in Imergent’s business, Stocklemon believes that IIG is worth no more than a number slightly higher than their cash position (which also is a hazy topic).
Audit committee revolving door
Maybe this voodoo accounting is also the reason that 2 of the 3 audit committee members just left iMergent. To replace them we have been introduced to Craig Rauchle, president of Inter-Tel and Todd Goergen, manager of Ropart Asset Management. Maybe the shareholders of Intertel should note that while the President and COO should be busy building shareholder value, he is going to dedicate his time to “creating internet tycoons” and giving away free lunches so lower income consumers can sign up for 18% financing.
It is the belief of Stocklemon that neither Rauchle of Goergen are representing the best interests of their investors and shareholders as they join an enterprise that has this much scrutiny from the US and foreign governments.
We have to give iMergent credit on one front. They have found a novel way to save money on customer service… they just outsourced it to the Utah Division of Consumer Protection (see .pdf file).
Stocklemon welcomes iMergent to refute any of the above statements and we will give them fair space on Stocklemon to issue any statement related to this issues discussed above.
Cautious investing to all.
Disclosure: Author is short IIG