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Financial Management: LINKEDIN Company Diagnostic based on 2011 10-K

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Evaluation of the firm's health, management, performance and risk profile using LinkedIn's 2011 10-K and other freely available sources. …

Evaluation of the firm's health, management, performance and risk profile using LinkedIn's 2011 10-K and other freely available sources.

Report contents:
A. LinkedIn Company Overview.
B. Trend Analysis of Sales and Earnings Growth.
C. Analysis of Operating Efficiency, Liquidity and Solvency.
D. Analysis of Cash Flows.
E. Is LinkedIn's internal proxy non-GAAP Adjusted EBITDA really the important indicator the firm's 10-K says it is, or is it just "window dressing" the firm's earnings?

Appendix A - Calculations and Ratios

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  • 1.     LinkedIn: Company Case Financial  Management  Class  203a   Alexandra  Brooks,  !""#!$%#   brooksal@uci.edu        
  • 2.   LinkedIn: Company Case | 2  CONTENTSA.   Overview 3  B.   Trend  Analysis  of  Sales  and  Earnings  Growth 5  C.   Analysis  of  Operating  Efficiency,  Liquidity,  and  Solvency 7  D.     Analysis  of  Cash  Flows 8  E.     Own  Question 12  Appendix  1  –  Calculations  and  ratios 14            
  • 3.   LinkedIn: Company Case | 3  A.   Overview1.   Company  name  and  locations  Name:  LinkedIn  Corporation  Head  office:  Mountain  View,  California,  USA.  Other   primary   locations:   Amsterdam,   The   Netherlands;   Delhi,   India;   Dublin,   Ireland;   Melbourne,   Australia;   Paris,   France;  Stockholm,  Sweden;  Omaha,  New  York,  Chicago,  and  San  Francisco,  USA,  Brazil,  Germany,  Italy,  and  Spain.  2.   Where  in  the  life  cycle  is  LinkedIn?  LinkedIn  Corporation  is  currently  in  its  growth  phase,  it  was  co-­‐founded  in  2003  by  former  CEO  and  current  chairman  Reid   LinkedIn  Co and  currenHoffman.   In   2011   the   company   was   the   first   major   social   networking   company   to   file   an   IPO   and   the   biggest   internet   IPO   networking company  usince   Google.   The   company   used   the   proceeds   for   more   investment.   Having   built   a   competent   management   team   led   by   manageme the  last  2  yformer   Yahoo!   executive   CEO   Jeff   Weiner,   the   company   has   in   the   last   2   years   begun   to   go   through   a   phase   of     small   locations  in member  baacquisitions,   opening   new   sales   office   locations   internationally   as   well   as   continuing   to   invest   in   R&D   and   member   languages.  acquisition  in  order  to  attain  a  critical  mass  of  member.    More  than  half  of  its  member  base  comes  from  outside  the  US,  and  it  offers  its  services  in  half  a  dozen  languages.  3.   Using  its  financial  report,  provide  an  overview  of  LinkedIn’s (a) Core  activities:  LinkedIn  generates  revenues  from  enterprises  and  professional  organizations  by  selling  its  hiring  and  marketing  solutions  both  offline,  through  the  company’s  field  sales  organization,  and  online,  through  its  the  website.  It  also  generates  revenue  from   subscription   service   fees   from   members,   who   are   either   private   individuals   or   enterprises,   subscribing   to   LinkedIn  premium  services.   (b) Primary  goal  and  the  main  strategies  being  pursued  to  achieve  the  goal(s);  LinkedIn’s   mission   is   to   “connect   the   world’s   professionals   and   make   them   more   productive   and   successful.”   The   firm  proposes  its  solutions  benefit  professionals  and  seeks  to  connect  them  with  enterprises  and/or  professional  organizations      
  • 4.   LinkedIn: Company Case | 4  seeking  the  world’s  best  talent.    The  10-­‐K  also  states  the  firm’s  belief  that  its  members  come  first  and  that  this  long-­‐term  approach   enables   the   organization   to   invest,   innovate   and   pioneer   in   unexplored   segments   of   the   industry   in   order   to  increase  the  value  proposition  of  its  proprietary  platform  and  data.  LinkedIn   lists   six   key   points   as   part   of   its   core   strategy.   These   include:   viral   growth,   serve   as   the   professional   profile   of  record,  be  the  essential  source  of  professional  insights,  accessibility  for  members,  increasing  monetization  while  creating  value   for   members,   and   also   expanding   internationally.   The   company   says   that   it   has   seen   significant   growth   in   the  international   member   base   and   has   established   operations   in   Australia,   Brazil,   Canada,   France,   Germany,   India,   Ireland,  Italy,  Japan,  the  Netherlands,  Singapore,  Sweden  and  the  United  Kingdom.    It  adds  that  it  intends  to  expand  sales,  technical  and  support  operations  in  additional  locations,  and  expanding  the  member  base  by  supporting  local  languages.   (c) Primary  opportunities  and  risks  associated  with  the  goals  and  strategies.  • The  firm  is  investing  heavily  into  new  technologies  in  order  to  deliver  consistently  high  website  performance  and  new  tools  and  services  for  members  in  order  to  maintain  LinkedIn’s  brand  leader  position;  conversely  this  investment  may  not  result  in  the  level  of  performance  required  in  order  to  grow  the  membership  base  and  if  the  security  of  the  website  is  compromised  this  may  also  affect  LinkedIn’s  business.  • Putting  members  first  is  a  cornerstone  of  the  company’s  philosophy  and  the  management  believes  this  is  the  best  way  to  build  a  critical  mass  of  members  that  will  result  in  beneficial  network  effects  promoting  user  experience,  increasing  value  for  all  members.  The  risk  however,  is  that  this  strategy  may  conflict  with  the  short-­‐term  interests  of  the  business,  and  the  end  result  may  not  be  the  long-­‐term  benefit  envisaged.  • The  company’s  current  expansion  in  international  markets  opens  up  the  opportunities  to  successfully  enter  new  markets  and  increase  the  LinkedIn  footprint,  however,  operating  in  different  countries  means  different  laws  and  compliance  could  induce  the  firm  to  incur  additional  costs  and  change  its  business  practices.      4.     What  “industry”  is  LinkedIn  in?    Is  your  company  an  industry  leader?    The   Internet   Information   Provider   (IIP)   industry   is   populated   by   customer   facing   firms   that   generate   their   sales   by  specializing   in   creating   and   /   or   aggregating   content   and   then   attracting   visitors   to   their   site   through   the   generally   free      
  • 5.   LinkedIn: Company Case | 5  provision   of   such   content.   Companies   that   are   part   of   this   industry   have   mass   consumer   focused   Web   sites   that   supply  “neutral”   information;   supplying   information   from   a   variety   of   sources   and   generally   refrain   from   selling   a   proprietary  product   to   readers   –   that   is,   in   the   main   they   aren’t   selling   tangible   items   like   property   or   services   to   viewers.   Their  customers,   in   a   business   model   sense,   are   not   visitors.   The   visitors   serve   to   convince   advertisers   to   buy   ad   space   or  solutions  on  the  site  or  across  their  networks.  In   comparison   to   the   other   players   in   its   industry,   LinkedIn’s   Market   Capitalization   is   relatively   small   at   $9.6bn;   the   top  players  in  the  industry  include  internet  and  software  corporation  Google  ($200bn),  and  social  media  site  Facebook  (offered   1for  IPO  later  in  2012  with  some  analysts  estimating  a  valuation  of  $100bn.) .    Job  board  Taleo  acquired  recently  by  Oracle  for   $1.3bn   competes   against   LinkedIn’s   hiring   solutions   business,   while   LinkedIn’s   most-­‐like   social   networking   public   2competitor  is  German  professional  networking  site  Xing  (valued  at  €267.50m/$352m.)  In  relation  to  its  segment,  which  could  be  described  as  “business-­‐related  social  networking”  it  is  the  market  leader  with  a   3reported  150m  members.  Competitors  include  France’s  privately  owned  Viadeo,  established  in  2004  (with  40m  members ),   4and  German  XING  (11m  members )  established  in  2003.  B.   Trend  Analysis  of  Sales  and  Earnings  GrowthTable1: LinkedIn - Common Size statement of operations data (redacted)             Year  Ended  December  31   000s$  /  %   2011   2010   2009   2008   2007   Net   $522,18 100%   $243,09 100%   $120,12 100%   $78,73 100%   $21,48 100%   revenue   9   9   7   3   6   Cost  of   81,488   15.6%   44,826   18.4%   25,857   21.5%   18,589   23.6%   7,384   22.7%   revenue   S  &  Mktg   164,703   31.5%   58,978   24.2%   26,847   22.3%   16,986   21.5%   5,037   15.5%   expense   Product   13,222   25%   65,104   26%   39,444   32%   29,366   37%   11,578   35%   develop’   Expense   Gross   440,751   84.4%   198273   81.6%   94,270   78.5%   60184   76.4%   25102   77.3%   margin   OpEx   496,344   95%   223,523   92%   123,482   102%   84,272   107%   32,918   101%   Operating   22942   4.3%   18966   7.8%   (3125)   (2.7%)   (4232)   (5.3%)   341   1.04%   Income                                                                                                                                                      1  Top  Internet  Information  Providers  Companies  by  Market  Cap  http://finance.yahoo.com/q/in?s=LNKD  accessed  3/13/12  2  Xing  AG  snapshot  http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?ticker=O1BC:GR  acc  3/7/12  3  Viadeo  Homepage  http://www.viadeo.com  accessed  3/13/12  4  XING  homepage  http://www.xing.com  accessed  3/13/12    
  • 6.   LinkedIn: Company Case | 6   Net   11912   2.3%   15385   6.3%   (3973)   (3%)   (4522)   (5.7%)   328   1%   Income   Other   2903   0.55%   610   0.25%   230   0.02   1277   1.62%   773   2.3%   income   (expense)   net   Other  data                       Adj  EBITDA   98,713   18.9%   47,959   19.6%   14,651   12.2%   5,461   7%   3,480   11%   #  members   144,974   90,437   55,111   32,307   16,712   (000s)      1. Sales growthLinkedIn  has  experienced  accelerated  revenue  growth  as  the  adoption  of  social  media  in  business  enters  the  mainstream  and  infiltrates  the  professional  community.  LinkedIn’s  corporate  webpages  report  that  as  of  February  9,  2012  the  website  has  over  150m  members  (145m  members  were  reported  as  December  31,  2011),  in  200  countries,  and  that  professionals   5are  signing  up  to  join  LinkedIn  at  a  rate  that  is  faster  than  2  new  members  per  second.    The  company  has  shown  consistent  growth   over   period   2008   to   2011   seeing   net   revenue   grow   from   $78.8m   to   $522.2m,   a   compounded   annual   growth   rate   of  approximately  88%.  The   mix   of   revenue   generation   from   the   firm’s   hiring   solutions,   marketing   solutions   and   online   sales   of   premium  subscriptions  has  also  shifted  over  the  past  few  years.  Since  2008,  net  revenue  from  its  hiring  solutions  has  increased  as  a   6percent  of  revenue  to  49%  at  the  end  of  Q1  in  2011  indicating  growing  market  penetration  of  online  hiring  solutions.  Over   the   next   two   to   three   years,   we   should   expect   to   see   sales   continuing   to   grow   as   the   company’s   international  operations   ramp   up,   its   membership   base   grows,   and   the   rise   in   hiring   and   marketing   solutions   are   adopted   by   firms  seeking  to  bypass  traditional  recruitment  and  marketing  methods  in  order  to  access  talent.  I  assess  that  as  the  company  has  a  management  team  that  will  be  able  to  manage  through  the  different  stages  of  growth  and  handle  the  challenges  to  come.   Now   that   membership   has   passed   100   million   members   the   firm   is   entering   territory   where   it   has   enough   critical  mass   in   terms   of   being   part   of   people’s   on-­‐line   brands   it   will   be   difficult   for   a   firm   to   launch   a   competing   offering   –  excepting  the  entrance  of  a  lower  cost  substitute  into  the  market.                                                                                                                                                      5  LinkedIn:  About  Us  http://press.linkedin.com/about  accessed  3/13/2012  6  LinkedIn  Corp  Form  424B4  filed  05/09/11    
  • 7.   LinkedIn: Company Case | 7  2. Operating incomeOperating  earnings  outpaced  sales,  although  there  was  some  volatility  in  year-­‐over-­‐year  in  this.  Over  the  past  five  years  the  company’s  operating  earnings  have  remained  volatile  as  LinkedIn  has  concentrated  on  growing  its  offering  and  acquiring  members  in  order  to  attain  critical  mass  during  its  start-­‐up  phase.    Looking  at  the  firm’s  common  size  statement  it  is  evident  that  as  the  company  is  moving  into  its  post-­‐IPO  phase.  Product  development  spend,  sits  at  quarter  of  revenues  in  2011,  trending  down  from  over  a  third  in  2007/2008.    On  the  other  hand,  sales  and  marketing  expenses  have  risen  consistently  from  only  15.5%  five  years  ago  to  nearly  a  third  of  revenue  in  2011.    Operating  costs  have  fluctuated,  remaining  high.  Gross  margin  has  consistently  improved  over  the  period,  while  costs  for  SG&A  and  Depreciation  and  Amortization  (not  shown  in  common  size  statement)  have  remained  relatively  constant  at  around  15%  and  8.5%  respectively  (averaged  over  the  period  2008-­‐2011.)  3. Net incomeAs  with  operating  income,  the  firm’s  net  income  has  been  volatile,  emerging  from  losses  incurred  in  2009  and  2009,  in  2010.    As  detailed  above  this  is  due  to  the  company  focusing  its  resources  on  developing  its  products,  entering  new  markets,  and  member  acquisition.    Other  income  (loss)  expense,  net  over  the  period  has  moved  from  positive  to  negative.  The  firm  reports  this  as  primarily  of  the  interest  income  earned  on  cash  and  cash  equivalents,  investments,  foreign  exchange  gains  and  losses,  and  changes  in  the  fair  value  of  a  warrant  during  2010  and  2009.    Therefore  taking  into  account  the  firm’s  international  expansion,  a  strengthened  dollar  since  2009  has  impacted  net  transaction  losses  on  foreign  exchange.  C.   Analysis  of  Operating  Efficiency,  Liquidity,  and  Solvency  1. Operating efficiency: Turnover ratios.LinkedIn’s  Asset  Turnover  ratio  is  fluctuating  around  between  1.3  and  0.9,  the  market  average  is  low  around  0.3,  the  industry  at  0.67  indicating  that  LinkedIn’s  asset  turnover  is  more  efficient  than  its  immediate  competitors  and  the  IIP                                                                                                                                                        7  Hoovers  Corporation  Profile:  Competitive  Landscape  -­‐  accessed  2/25/2012      
  • 8.   LinkedIn: Company Case | 8  industry  as  a  whole.    Likewise  the  increasing  Property  &  Equipment  ratio  indicates  the  company  improving  its  effective  use  of  its  fixed  assets  to  generate  revenue  and  is  nearing  the  fixed  asset  average  for  the  industry.  Finally  using  the  3-­‐fiscal  data  available,  the  company’s  receivables  turnover  is  fluctuating  above  the  industry  average  indicating  a  better  than  average  ability  to  extend  credit  and  collect.  Other  measures  that  an  analyst  would  rely  on  would  be  average  time  spent  on  the  site  by  members,  page  views,  user-­‐generated  transactions,  and  percentage  of  members  returning  frequently  to  the  site.    These  are  non-­‐financial  metrics  but  indicative  of  the  firm’s  business.  2. Liquidity:Over  the  past  3-­‐fiscal  years  both  LinkedIn’s  Current  and  Quick  ratios  have  hovered  above  the  industry’s  average  ratio.    As  the  data  is  limited  no  trend  was  easily  discerned  for  either  ratio.  The  Current  ratio  sits  well  above  the  minimum  ratio  of  1  to  pay  off  debts  and  coupled  with  a  healthy  looking  receivables  turnover  ratio  the  company’s  operating  cycle  looks  efficient.  The  Quick  (or  Acid  Test)  ratio  again  indicates  that  the  company  can  and  has  been  able  to  cover  its  immediate  liabilities.  The  higher  values  indicate  that  the  company  is  more  liquid  than  the  industry  as  a  whole.  The  CFO  turnover  ratio  deals  with  the  company’s  ability  to  cover  current  liabilities  from  the  firm’s  own  operations.    This  ratio  is  >1  and  is  slowly  trending  upwards.  This  ties  in  with  the  company’s  reliance  on  investor  capital  during  its  start  up  phase,  giving  it  the  firm  its  ability  to  cover  its  liabilities  and  remain  relatively  liquid.  3. Solvency:The  company  does  not  have  any  debt  of  material  capital  lease  obligations.  The  company  reported  no  off  balance  sheet  arrangements  for  2011,  2010,  or  2009.    In  terms  of  liability,  the  firm’s  debt  to  equity  ratio  (total  liabilities/total  SE)  is  trending  down  indicating  that  the  company’s  liability  position  is  moving  back  from  a  position  where  LinkedIn’s  creditors  had  more  money  in  the  company  than  its  equity  holders,  even  more  so  considering  the  2011  IPO.  The  firm’s  ROA  has  for  the  past  4-­‐fiscal  fluctuated  slightly  above  the  market  average  of  0.88%  indicating  above  average  manageme  D.     Analysis  of  Cash  Flows  1. What were LinkedIn’s 2 largest sources of cash? The 2 largest uses of cash?    
  • 9.   LinkedIn: Company Case | 9  a)  During  the  past  3  fiscal  years  the  two  largest  sources  of  cash  to  the  company  was  the  Initial  Public  Offering  in  2011  that  raised  $248.8  million  and  its  follow  on  offering  later  that  year  which  raised  $177.7  million.  These  are  recorded  on  the  company’s  2011  consolidated  statement  of  cash  flows.  b)  LinkedIn’s  two  largest  uses  of  cash  were  the  purchase  of  investments  at  $251.1  million  in  2011,  and  purchases  of  property  and  equipment  totaling    $152.2  million  between  the  period  2009  and  2011.  These  are  recorded  on  the  company’s  2011  consolidated  statement  of  cash  flows.  2. For the past 3-fiscal years, has LinkedIn’s cash flows from operations(CFOs) been adequate to fund its growth initiatives? How has LinkedIn fundedthe CFO’s shortfalls to fund growth?Over  the  years  2009  and  2010  the  company’s  CFOs  were  not  adequate  to  fund  its  growth  initiatives,  therefore  it  is  apparent  that  the  company  has  been  reliant  upon  early  investment  from  venture  capital  firms.  Investors  of  the  company  include  5%   8stockholders  founder  Reid  Hoffman,  Sequoia  Capital,  Greylock  Partners,  and  Bessemer  Venture  partners.  In  2011  the  company  closed  its  IPO  and  follow  on  offerings  unlocking  capital  for  the  organization.  3. Based on your review of the cash flow statement, has LinkedIn’s growthbeen driven by organic growth or acquisitions?Although  positive  throughout  2012  peaking  at  $17.9m  following  the  firm’s  IPO,  the  company’s  Free  Cash  Flow  (FCF)  ended  2011  relatively  low  at  $3.57m.  In  prior  FYs  2008  through  2010  the  FCF  oscillated  from  -­‐$10.42m  (Q4  2008)  to  $8.09m  (Q4  2010).  The  lack  of  free  cash  can  be  explained  by  the  company’s  significant  investments  into  technology  infrastructure,  product  development,  and  sales  and  marketing  in  order  to  maintain  is  competitive  advantage  and  stay  ahead  of  the  competition.  Since  starting  in  2003m  LinkedIn’s  growth  has  been  driven  by  a  organic  growth,  since  2010  the  company  has  begun  to  make  acquisitions,  a  number  of  small  companies,  although  in  comparison  to  the  increase  in  revenues,  this  is  still  limited  –  members  are  not  being  purchased,  it  is  likely  more  technology  and  talent.  The  annual  report  states  its  aim  that  in  2012,  it  will  continue  to  invest  in  product,  engineering,  and  sales  infrastructure  in  order  to  capitalize  on  the  long-­‐term  opportunity.                                                                                                                                                      8  LinkedIn  Press  Pages:  Investors  http://press.linkedin.com/investors  accessed  3/17/12.        
  • 10.   LinkedIn: Company Case | 10  4. If LinkedIn continues to grow at its recent historic rate, does it appearthat its CFOs can fund this growth? How might it fund future growth?As  of  December  31,  2011  the  company  reported  having  cash  and  cash  equivalents  of  $339.0  million  and  short-­‐term  investments  of  $238.5  million.  It  is  likely  that  the  existing  cash  and  cash  equivalents  and  short-­‐term  investment  balances,  together  with  cash  generated  from  operations,  will  be  sufficient  to  meet  working  capital  expenditure  requirements  for  at  least  the  next  12  months.    If  however,  the  company  is  unable  to  fund  the  costs  of  growth  internally  then  the  company’s  management  and  board  will  have  to  decide  whether  or  not  to  incur  debt  from  a  bank  or  the  bond  market,  (if  they  are  able  to  find  terms  that  are  acceptable  to  them)  or  to  sell  more  stock  which  will  be  dilutive  to  the  current  stockholders.  5. During  the  past  3-­‐fiscal  years,  what  dollar  amount  of  common  stock  did  LinkedIn  repurchase  and  what  dollar  amount  of  dividends  did  it  pay?Over  the  period  2009  –  2011  the  company  repurchased  $953,000  of  its  common  stock  related  to  unvested  stock  options,  at  the  original  exercise  price  due  to  the  termination  of  employees.    The  company  has  not  repurchased  stock  for  any  other  reason,  as  reinvesting  capital  into  the  company  would  yield  a  higher  return.    The  company  has  not  issued,  and  has  no  future  plans  to  issue  a  dividend,  opting  to  retain  all  future  earnings  for  use  in  the  development  of  the  business  or  for  general  corporate  purposes.    The  company  does  not  have  any  debt  or  material  capital  lease  obligations.  E.     Accounting  Policies    1. Identify  and  describe  three  of  LinkedIn’s  significant  accounting  policies/issues.     (a)  Accounting  issues     (b)  How  does  LinkedIn  handle  this  accounting  issue?   (c)  Appropriateness   1:  Allowance  for  doubtful   The  firm  maintains  an  allowance  for  doubtful   I  think  the  treatment  of  this   accounts   accounts  receivable  based  on  historic  loss  patterns,   accounting  issue  as  a  whole  is   the  number  of  days  that  billings  are  past  due,  and  an   appropriate,  however,  the   evaluation  of  potential  risk  of  loss  associated  with   treatment  does  not  specify  if  credit-­‐ delinquent  accounts.  The  allowance  is  the  company’s   worthiness  and  current  economic   best  estimate.  As  at  December  31,  2011  the   trends  would  also  be  taken  in   allowance  for  doubtful  accounts  represents   account.     approximately  5%  of  accounts  receivable  (around   $5.5m.)      
  • 11.   LinkedIn: Company Case | 11   2:  Determining  the  fair   Estimates  intangible  assets  such  as  goodwill  are   There  are  no  mentions  of  any   value  of  assets  acquired   based  on  information  obtained  from  management  of   analytical  tests,  or  how   from  purchased   acquired  companies  and  historical  experience.    These   management’s  experience  complies   businesses  and  liabilities   parameters  include  but  are  not  limited  to:  a)  the   with  the  guidelines  set  out  in  ASC-­‐ assumed  especially  with   time  and  expenses  that  would  necessary  to  recreate   350.    Due  to  the  inherently   respect  to  intangible   the  asset;  b)  the  profit  margin  a  market  participant   uncertain  and  unpredictable  nature   assets  (including   would  receive;  c)  cash  flows  that  an  asset  is  expected   of  intangible  assets  such  as   goodwill).   to  generate  in  the  future;  and  d)  discount  rates.   goodwill,  an  analyst  would  need  to   Testing  for  goodwill  impairment  was  adopted  during   assess  the  competency  of   the  third  quarter  of  2011  in  line  with  FASB  guideline   management  in  depth  before   420.   deciding.   3:  Management  decision   The  accounting  policy  lays  down  specific  criteria  as  to   The  company  is  currently   to  lease  office  facilities   what  constitutes  a  capital  (ownership  for  accounting   undergoing  considerable  growth   under  operating  leases   purposes)  or  an  operating  (off  balance  sheet,  rental   and  has  just  floated,  using   as  opposed  to  capital   expense)  lease.    The  company’s  most  significant   operating  leases  will  reduce  any   leases.   estimates  used  by  management  in  accounting  for   Debt  to  Equity  ratio  and  increase   property  leases  are:  a)  Expected  lease  term;  b)   ROA  allowing  it  appear  more  liquid   Incremental  borrowing  rate;  c)  Fair  market  value  of   and  maintain  investor  interest.     leased  asset    2.    In  light  of  LinkedIn’s  core  activities,  goals  and  strategies,  discuss  why  each  of  the  accounting  policies/issues  identified  is  significant:• Allowance  for  doubtful  accounts  –  as  the  company  is  undergoing  rapid  expansion  of  its  operations  and  growth  ensuring  that  potential  cash  flow  issues  are  warded  off  is  important.    This  fiscal  conservatism  allows  the  company  a  cushion.    Furthermore  assuming  the  company  has  made  sufficient  provision  in  its  allowance  for  doubtful  accounts,  reported  earnings  will  not  be  penalized  by  bad  debts  when  bad  debts  occur.  The  company’s  bad-­‐debt  expense  ratio  to  revenues  has  declined  from  1.2%  in  2008  to  0.4%  in  2011.  • Valuation  for  goodwill  and  intangible  assets  –  the  company  has  made  several  acquisitions  of  small,  private  companies,  primarily  to  acquire  talent  and  technology.    Such  legal  and  competitive  intangibles  include  developed  technology,  non-­‐compete  agreements,  workforce  in  place,  in-­‐process  research  and  development  and  a  patent.  The  company’s  goal  in  2012  is  to  continue  expending  substantial  financial  and  other  resources  on  five  main  areas,  including  technology  infrastructure  and  product  development,  potential  sources  of  intangible  assets  and  goodwill.  • Office  facility  leases  –  the  company  has  all  of  its  office  leases  structured  as  operating  leases,  by  adopting  this  accounting  treatment,  this  means  potentially  smoother  time-­‐series  of  Reported  Earnings,  higher  net  income      
  • 12.   LinkedIn: Company Case | 12  and  times  interest  earned  ratios  towards  the  start  of  the  contract.    Because  the  operating  leases  will  be  expensed  this  also  will  assist  with  cash  flow  by  not  tying  up  cash,  allowing  “off  balance”  sheet  financing  resulting  in  lower  debt  to  equity  ratio,  and  higher  ROA.  3.    In  general,  do  you  think  LinkedIn  does  a  satisfactory  job  of  discussing  its  accounting  policies?The  disclosures  describe  the  company’s  accounting,  explains  its  estimates,  quantifying  how  different  estimates  could  impact  the  business.  The  accounting  policies  put  forward  by  the  firm  allow  the  reader  to  gain  a  reasonable  understanding  of  the  business’s  condition  of  its  operations.  The  use  of  plain  English  and  layout  of  the  discussion  is  also  helpful  for  the  reader.    4.    MD&A:  Do  you  think  LinkedIn  does  an  adequate  job  of  discussing  its  operations,  financial  position,  and  cash  flow  issues?  I  believe  that  LinkedIn’s  MD&A  section  does  an  adequate  job  of  covering  the  firm’s  operations,  financial  position,  and  cash  flow  issues.    The  report  is  succinctly  written,  in  plain  English  and  gives  an  adequate  “top  down”  assessment  based  on  the  previous  years’  activities,  it  gives  the  reader  an  indication  of  the  management’s  stance  and  style.    It  also  sets  out  the  company’s  plans  for  the  coming  year  highlighting  the  risks  and  additional  interpretive  considerations  that  need  to  be  borne  in  mind  when  making  an  assessment.    The  messaging  within  the  MD&A  generally  matches  the  rest  of  the  audited  10-­‐K.    One  area  that  could  be  improved  in  the  discussion  is  the  Revenue  Recognition  section,  which  clearly  states  the  different  revenue  models  but  does  not  discuss  at  what  point  revenue  is  recognized/payment  made,  although  this  is  laid  out  in  another  part  of  the  document.    The  company  also  refers  to  the  use  of  Adjusted  EBITDA  as  an  important  measure  used  by  the  management  and  board  of  directors.    The  use  of  what  is  essentially  a  measure  of  profitability,  not  a  measure  of  actual  cash  earnings  could  be  window  dressing  by  the  company  of  its  earnings,  although  the  company  clearly  states  that  other  measures  should  be  referred  to  when  assessing  the  company.  E.     Own  Question    1.    Is  LinkedIn’s  internal  proxy  non-­‐GAAP  Adjusted  EBITDA  really  the  important  indicator  the  firm’s  10-­‐K  says  it  is,  or  this  just  window  dressing  the  company’s  earnings?        
  • 13.   LinkedIn: Company Case | 13  Why  it’s  important  to  ask:  LinkedIn’s  Q4  earnings  announcement  caused  an  18%  spike  in  the  company’s  stock  price  in  February;  some  might  argue  the  firm’s  healthy  looking  Adjusted  EBITDA  ($34m)  was  partially  responsible.    It’s  apparent  that  other  social  Internet  information  provider  companies  are  also  using  their  own  versions  of  the  EBITDA  metric  to  ‘tweak’  earnings  figures  and  transform  net  losses  in  previous  years.  LinkedIn’s  adjusted  EBITDA  differs  from  standard  EBITDA  by  its  inclusion  of  stock-­‐based  compensation.  Is  the  stock-­‐based  compensation  component  relevant?Attempt  at  answering:  First  in  order  to  see  the  difference  in  the  numbers  I  compared  the  traditionally  calculated  EBITDA  with  LinkedIn’s  adjusted  EBITDA  and  the  percentage  difference  between  the  two:   2011 2010 2009* 2008* 2007 Std.  EBITDA 68,945 39,127 8,499 856 1805 Adj.  EBITDA 98,713 47,959 14,651  5461  3480 %  difference   35.5%   20.3%   53.7%   145.8%   63.4%  *Net  income  loss  recorded  for  company  in  this  year.  The  difference  over  time  is  that  the  earnings  of  the  company  look  better  by  a  fifth  in  2010  to  nearly  150%  in  2008  (a  year  when  the  company  recorded  a  net  income  loss  of  $4,552,000)  using  the  adjusted  figures.    Researching  this  deeper  it  appears  that  other  social  network  related  businesses  use  variations  of  this  metric,  like  Groupon,  Zynga  and  Overstock.com.  Each  has  its  own  version  of  non-­‐GAAP  “adjusted“  EBITDA.  Interestingly  Facebook’s  IPO  prospectus  has  bucked  the  trend   9with  no  mention  of  EBITDA  or  adjusted  EBITDA  or  any  non-­‐GAAP  measures  included.One  could  assume  that  the  companys  reliance  on  attracting  and  retaining  talent  through  its  issuance  of  stock-­‐based  compensation  could  be  a  relevant  expenditure  that  affects  profitability.  Also  stock-­‐based  compensation  is  a  non-­‐cash  item  -­‐  the  shares  are  not  free.  It  is  a  mixed  bag,  because  it  aligns  the  management  or  employee’s  interests  with  shareholders  to  see  a  rising  share  price  but  also  incentivizes  risk  taking.    ]  It  appears  that  the  use  of  positive-­‐adjusted  EBITDA  is  the  organization’s  way  of  glossing  over  the  firm’s  difficulty  in  achieving  profits  during  its  pre-­‐IP0  growth  phase.  In  order  to  gain  further  insight  I  looked  to  see  if  there  is  a  Q&A  dealing  with  the  use  of  Adjusted  EBITDA  on  the  LinkedIn  investor  relations  website  in  order  to  understand  the  inclusion  of  stock-­‐based  compensation,  there  was  none.  If  I  were  to  research  this  further  I  would  contact  the  investor  relations  department  at  LinkedIn  for  a  background  brief.                                                                                                                                                      9 Facebook’s biggest surprise – no funny numbers, Gary Weiss, Forbeshttp://www.forbes.com/sites/thestreet/2012/02/15/facebooks-­‐biggest-­‐surprise-­‐no-­‐funny-­‐numbers  Accessed  3/18/12