I’ve been getting a number of questions regarding laborSMART’s balance sheet, specifically the convertible debt. I will take this opportunity to add some real world color.
Looking just at the balance sheet from Q3 2015, one would gasp in horror, and rightly so. However, there are those things called Notes to Financial Statements. We even have another note about those notes in the 10Q. It reads something like “these financial statements should be read in conjunction with the Notes to Financial Statements”.
Let’s be honest with ourselves. No one reads the notes. It’s like trying to read hieroglyphics. The folly in reading the balance sheet without reading the notes, is that we only get a partial picture. The Notes to FS give the detail that explains what is represented by each number as well as all the accounting voodoo it entails.
Again, it’s frustrating to try to read this stuff, especially regarding derivatives and conversion feature liability. I can’t even prepare them myself anymore (I did them myself the first year we were public). We have a highly paid (and totally worth it) accounting rocket scientist prepare this stuff now. He’s even told me “this stuff really is rocket science”. Not a joke.
I’ll pick the hottest conversation topic and try to cut out all the voodoo and rocket science.
Convertible debt-I covered this on our recent conference call with the highlighted version. Here’s a no-voodoo included recap:
BS shows $3.5m convertible debt. This means if everyone converted, it would take $3.5m in stock to pay them off.
Of this $3.5m total, about 45% or so is the discount, meaning the note holders gross profit. There’s also some accrued interest in there.
Put another way, about half the 3.5m is actual cash we received that we owe. The other half is the expense of the cash we received.
From a negotiating standpoint, the number that matters is how much cash do the note holders have exposed. Then, we and they must ask the question, “if I get this exposure down to 0 over X period of time, is it worth losing out on the profit?”
We committed to pay them out in cash on a pretty short time table (max deal is at 12 months). They agreed to give us say-so over the ability to convert. Our aggregate cash payment commitment is roughly the amount of cash they have at risk with some interest added in depending on which payment schedule they agreed to. Seems like a fair trade.
Now here’s the fun part where I actually enjoy the rocket science /voodoo.
For easy math, let’s say it’s 50/50. Half the $3.5m is the cost of the borrowed money. The other half is cash we received and cash the creditors have at risk.
If we pay $1.75m cash over 12 months and the note holders are in agreement this is the full value owed, what happens to the other $1.75m we are showing on the BS as convertible debt?
It represents an expense that has to be “un-expensed”.
