Sales and marketing practices the subject of numerous State Attorney General investigations, a formal SEC investigation related to potential violation of securities laws (including the alleged disclosure of earnings forecasts to select investors, a Reg. FD ‘no-no’), and alleged accounting irregularities—all these price-busting concerns aside, the share price of iMergent, Inc. (IIG-$25.18) has soared 95 percent in value during the last year.
Headquartered in Orem, Utah, the company sells its proprietary StoresOnline Pro software and training services, developed to help users build a successful Internet strategy to market products, accept online orders, analyze marketing performance, and manage pricing and customers. In connection with Internet software, iMergent also offers website development, website hosting, marketing and mentoring products and services.
iMergent typically reaches its target audience through concentrated direct marketing efforts to fill Preview Sessions, in which a StoresOnline expert reviews the product opportunities and costs. The sessions lead to a follow-up Workshop Conference, where experts train potential users on the software and services and encourage them to make purchases.
In online testimonials, management buttresses its claims that its “eServices offerings leverage industry and customer practices and are also designed to help decrease the risks associated with eCommerce implementation by providing low-cost, scalable solutions with ongoing industry updates and support.”
Critics allege, however, that (i) the seminars are really just high-pressure sales pitches and (ii) the web packages are 'overpriced' and consumers can find most of the items listed either for free, or at a much lower price than the $5,000 charged by iMergent for its suite of StoresOnline offerings.
Of concern, Attorney Generals in states across the Union—from Florida to California—have filed numerous actions against the Company in the past three years, alleging that the Company may have engaged in unfair business practices and/or consumer fraud (e.g. misrepresented the website’s income potential).
And, it gets worse. On May 29, 2007, The State of Utah—where the Company has its headquarters—the Division of Consumer Protection issued (another) order demanding that iMergent and subsidiary StoresOnline cease and desist operations in the state until the company registers as a "business opportunity seller." [Adjudication is stayed pending exhaustion of “administrative remedies and judicial review.”]
IMergent’s activities have not been limited to these shores. The Company has been hosting free dinner events across Asia and the South Pacific—from Singapore to Australia—leaving a history of alleged online scams in its wake.
Summary of Material Accounting Policies
- Red Flag: The Company is subject to numerous legal petitions seeking refunds of good/services purchased together with unspecified statutory damages. Yet, iMergent has recorded a liability of $0 as of March 31, 2007, for estimated losses resulting from the foregoing legal proceedings against the Company!
Of equal—or greater concern—to the 10Q Detective, is the questionable accounting practices we have unearthed in our review of the Company’s quarterly filings.
On May 7, iMergent announced its fiscal results for the three and nine-months ending March 31, 2007. Chairman and CEO Don Danks was “excited to report a 68 percent increase in net income to $4.7 million during the quarter, on total revenue of $42.6 million. Net income per share was $0.36 this quarter, compared to $0.22 in the prior year.”
Danks continued, "The key driver for our strong revenue growth during the quarter was an increase in the number of workshops in combination with the improvement in the percentage of attendees purchasing our software at our workshops. This improvement was attributable to refinements made in our workshop and preview presentations, which resulted in increased revenue and Net Dollar Volume of Contracts Written (NDVCW) per workshop and strengthened our margins.”
According to the company, it defines NDVCW as the gross dollar amount of contracts executed during the period less estimates for bad debts, discounts incurred on sales of trade receivables, and estimates for customer returns. Although NDVCW is not a U.S. generally accepted accounting principle (GAAP) metric, the company believes NDVCW is a consistent and relevant metric to understand the operations of the company.
Management now expects NDVCW to grow approximately 45 percent to 50 percent over fiscal 2006 NDVCW of $99.8 million. Management previously expected NDVCW growth to be 40 percent over the prior year?
IMergent recognizes revenue in one of two ways: (1) Cash Product Sales are recognized after the expiration of a three-day right of rescission; and (2) For products purchased by customers under extended payment term arrangements (EPTAs), the Company continues to defer and recognize revenue as cash payments are received from customers, typically over two years.
The Company records an appropriate allowance for doubtful accounts at the time the EPTA contract is perfected
Purchases under EPTAs as a percentage of total workshop purchases averaged 40% in recent quarters with a simple annual finance charge of 18% per annum.
- Red Flag: Trade Receivables as a percentage of Current Assets have jumped 570 basis points in the first nine-months of fiscal 2007 to 34.3 percent. IMergent is becoming more dependent on EPTAs as a recurring source of income. In the third quarter ended March 31, 2007, interest income of $1.84 million contributed about 9 cents to earnings.
Management has experienced past difficulties in selling these installment contracts at levels that provide adequate cash flow for its business, and a recurrence of this inability to monetize these trade receivables generated from its workshop business would likely require the Company to raise additional working capital to allow it to service these assets on its own. Since May 2004, iMergent has not sold installment contracts with any recourse provision.
- Red Flag: As of March 31, 2007, Allowance for Doubtful Accounts rose to 54.2% of trade receivables, an increase of 290 basis points from June 30, 2006.
For our readers not familiar with accounting nuances, the allowance for doubtful accounts—an area that involves ‘management discretion’—is a contra-asset account. It is a reduction to accounts receivable on the balance sheet. Instead of charging off customer accounts receivable losses directly to the income statement when they occur, using the allowance for doubtful accounts "smooths out" the income statement impact of bad debt by charging an equal amount of bad debt expense to the income statement each period and offsetting this entry to the contra-asset account called allowance for doubtful accounts.
However, the exact amount of future bad debt write-offs is always an unknown. And managements tend to hide behind the skirt of “historical precedent” when determining the bad debt expense for each quarter. Ergo, as there is plenty of room for judgment in this exercise, it can be an area used to boost earnings.
Reserving 50 cents of each dollar owed in trade receivables either means iMergent’s products are not as profitable to customers as alluded to in their testimonials and/or management is overstating bad debt expense in the current period to squeeze more profits out of future quarterly earnings.
In 2005, in a letter generated by the SEC to iMergent, management was asked to qualify prior statements made by CEO Danks in a First Albany Sales Force Call held on February 25, 2005, regarding the policies and procedures used to determine the Company’s allowances for doubtful accounts.
To wit: “These statements appear to indicate that reserves are consistently recorded at rates in excess of your actual bad debt experience…. This practice was characterized by your CEO as “conservative” and he indicated that you “over reserve” and will be able to “add income as we collect more than we’ve reserved for.” These statements appear to indicate that reserves are consistently recorded at rates in excess of your actual bad debt experience.”
- Red Flag: In our view, management is understating SG& A expenses.
The Company expenses costs of advertising and promotions as incurred, with the exception of direct-response advertising costs. SOP 93-7, “Reporting on Advertising Costs,” provides that direct-response advertising costs that meet specified criteria should be reported as assets and amortized over the estimated benefit period. The conditions for reporting the direct-response advertising costs as assets include evidence that customers have responded specifically to the advertising, and that the advertising results in probable future benefits.
The Company says it uses direct-response advertising to register customers for its workshops.
Further, management is purportedly able to document the responses of each customer to the advertising that elicited the response. Advertising expenses included in selling and marketing expenses for the three months ended March 31, 2007 and 2006 were approximately $8,161,000, and $4,557,000, respectively, and for the nine months ended March 31, 2007 and 2006 were approximately $21,784,000 and $14,500,000, respectively.
Internet training workshops conducted during the current quarter increased to 320 (including 91 that were held outside the United States) compared to 189 (including 7 that were held outside the United States) during the prior year quarter.
As of March 31, 2007 and June 30, 2006, the Company recorded approximately $5,273,000 and $1,855,000, respectively, of direct-response advertising related to future workshops as prepaid expenses. The Company justifies this deferral of expenses because even though the average number of “buying units” in attendance at workshops during the current quarter was 95—comparable to the prior year quarter—about 31% of the buying units made a purchase at the workshops during the current quarter compared to 26% during the prior year quarter.
Nonetheless, this ease of converting expenses to assets gives a boost to earnings [another way to massage quarterly numbers].
- Red Flag. In an industry with low barriers to entry, iMergent spent less than one-million on all its R&D efforts in 2006! Small business owners—were it not for iMergent’s aggressive sales teams [nine in total]—might more readily look to a software product, such as Office Live by Microsoft (launched in November 2006), which offers professional website development and CRM tools for only $39.95 per month. One year of use with Office Live still pales in comparison to the average $5,000 start-up costs spent by the sucker—oops—sorry—customers at iMergent workshops.
Beware of computer programmers that carry screwdrivers. ~ Leonard Brandwein
iMergent is a one-product software company with questionable accounting practices and SEC and AG oversight.
In addition, management seems to be in the habit of heralding the promises of new online relationships, yet few of these announced deals result in material (new) revenue streams for iMergent.
These troubling concerns should give prospective investors reason to do additional due diligence.
Editor David J. Phillips does not hold a financial position in iMergent,Inc. The 10Q Detective has a Full Disclosure Policy.