Accounting Case:

1
AccountingCase Kendall Square Research

• February 14th 2008
• Perspectives on Management
• Peter Bell

2
(No Transcript)
3
(No Transcript)
4
Kendall Square's Q2 Results Parallelism Can Be
Profitable News Analysis by Norris Parker
Smith, Editor at Large ANALYSIS FEATURES
07/23/93 Waltham, Mass. -- Is it possible to
make money in scalable parallel processing
(SPP)? With second-quarter financial results
showing a net income of just over 1 million on
13.1 million in revenues, Kendall Square
Research has demonstrated once again that
profitability is possible even in today's thin,
highly competitive market. (For Kendall Square
Research's complete second -quarter earnings
statement and balance sheet, select 1858.) KSR is
the only specialist SPP vendor that is a
free-standing, publicly owned venture and so
must report results in detail. Thus, its report
casts light on the otherwise murky, closely held
economics of SPP. In a press conference, CEO
Henry Burkhardt III highlighted two encouraging
sales trends increasing sales abroad
(international sales accounted for 34 percent of
the quarter's revenues) and a sale to an unnamed
"large financial services firm" that will use the
KSR1 system for jumbo databases. Source
HPCWIRE
5
Discussion
6
Accounting Policy

• What is GAAP?
• Generally Accepted Accounting Principles
• set of accounting rules used to standardize the
  reporting of financial statements
• Can differ by country
• Who sets it?
• Why is it important?

7
When is Revenue Recognizable?

• It must be
• realized or realizable
• AND
• Earned
• Criteria
• Persuasive evidence of an arrangement exists
• Delivery has occurred
• The vendors fee is fixed or determinable
• Collectibility is probable.
• Source SEC SAB No. 101, Revenue Recognition in
  Financial Statements, issued in December 1999 and
  www.fasb.org

8
Revenue Recognition

• Revenue usually is the largest single item in
  financial statements
• issues involving revenue recognition are among
  the most important and difficult that standard
  setters and accountants face.
• no comprehensive standard on revenue recognition
  exists,
• there is a significant gap between the broad
  conceptual guidance in the FASBs Concepts
  Statements and the detailed guidance in the
  authoritative literature
• Most of the authoritative literature provides
  industry or transaction-specific has been
  developed largely on an ad hoc basis in various
  pronouncements
• Those pronouncements include Accounting
  Principles Board (APB) Opinions, FASB Statements,
  American Institute of Certified Public
  Accountants (AICPA) Audit and Accounting Guides,
  AICPA Statements of Position (SOPs), FASB
  Interpretations, Emerging Issues Task Force
  (EITF) Issues, Securities and Exchange Commission
  (SEC) Staff Accounting Bulletins (SAB), and the
  like. Each focuses on a specific practice problem
  and has a narrow scope, and the guidance is not
  always consistent across pronouncements.
• Source http//www.fasb.org

9
Analysis

• DSO-235 days at the end of 1992
• 355 Days of Inventory
• 20 Fold increase in revenue over the past year
• Company Stock Option Plan
• Bank Line-Terms
• Prime plus two percent until quarterly earnings
  exceeded 250,000, then line increases to 5 MM
• Tax loss carry forward-no need to account
  conservatively

10
Auditors

• What does an auditor do?
• What is an audit opinion? Why is it important?
• There are only 20 customers? Why not check each
  one?
• Did the PW partner focus on ensuring that
  operating practices were consistent with the
  revenue recognition policy?

11
Wall Street

• Growth Story
• Analysts
• Investment Bankers
• Institutional Investors

12
Restatement
13
Restatements

• A few examples Enron, HealthSouth, Conagra,
  SunBeam, Xerox, Outback Steakhouse, Worldcom,
  Microsoft, Oracle, CA, Sybase, Symantec, Red Hat,
  Macromedia, BMC
• Restatements
• 216 restatements in 1999
• 330 in 2002
• 354 for the 12 month period ending June 30, 2004,
  according to the Huron Consulting Group's
  tracking of Securities and Exchange Commission
  data.

14
What happened?

• Lawsuits/Settlement
• 5.35 MM in cash and additional stock/warrants
  issued to shareholders
• William Koch invested an additional 25 MM
• Thinking Machines (competitor) cancelled IPO
• KSR reported an operating loss of 10.1 MM in the
  first quarter of 1994

15

• January 14, 1994
• COMPANY NEWS KENDALL SQUARE DROPS PRICE
  WATERHOUSE AS ITS AUDITOR
• The Kendall Square Research Corporation has
  replaced Price Waterhouse, its outside auditor
  since its founding in 1986, with Coopers
  Lybrand. The Cambridge, Mass., supercomputer
  maker, whose accounting troubles came to light in
  the fall under Price Waterhouse, said yesterday
  that Coopers would audit its 1993 financial
  statements and restate its 1992 figures. Price
  Waterhouse rescinded its earlier clearance of the
  1992 figures after it became apparent that the
  company had been posting as sales orders from
  buyers who could not pay for the merchandise. The
  accounting developments at the company have
  prompted an investigation by the Securities and
  Exchange Commission, more than a dozen lawsuits,
  and the ouster of the company's founder and
  former chief executive, Henry Burkhardt 3d, and
  two other executives.

16

• September 23, 1994
• COMPANY NEWS KENDALL SQUARE STOCK FALLS ON
  BANKRUPTCY FEARS
• The shares of the Kendall Square Research
  Corporation lost most of their value yesterday
  after the financially troubled supercomputer
  maker said late Wednesday that it might be forced
  to file for bankruptcy. Kendall Square said it
  would stop making supercomputers, its only
  product, and concentrate on licensing the
  underlying technology. The company also announced
  that it would lay off all but 50 of its 180
  employees, effective Oct. 3, and that its chief
  executive and president, Larry Reeder, had
  resigned after little more than a month on the
  job. Kendall Square's shares dropped 1.50, to 25
  cents, in Nasdaq trading

17

• December 31, 1994
• COMPANY NEWS KENDALL SQUARE FILES A CHAPTER 11
  BANKRUPTCY
• The Kendall Square Research Corporation, the
  battered former supercomputer maker, made good on
  earlier warnings and filed for Chapter 11
  bankruptcy protection in Boston yesterday.
  William I. Koch, the company's largest
  shareholder, resigned as chairman and director.
  The company had warned of a possible bankruptcy
  filing in September, when it said it would get
  out of the supercomputer business and reduce its
  workforce to 50 employees from 180. "The filing
  under Chapter 11 is unfortunate, but unavoidable
  as a necessary step to maximize the value of the
  company's assets," Zachary Shipley, the company's
  chief executive, said in a statement yesterday.

18

• Henry Burkhardt III (1945-2000) was born in Ann
  Arbor, Michigan, grew up in South Hadley,
  Massachusetts, and was schooled there. He
  graduated from Phillips Exeter Academy and
  attended Princeton University He began his career
  as a programmer at Digital Equipment Corporation.
  In 1968 he was one of the founders of Data
  General Corporation where he designed their first
  minicomputer, the Nova. He also founded Encore
  Computer and, later, Kendall Square Research
  Corporation. He held eight patents in the fields
  of high-performance computing and parallel
  processing.
• Burkhardt died in August 2000 of pancreatic
  cancer. He is buried in Mount Auburn Cemetery in
  Cambridge, Massachusetts.
• Source Wikipedia

19
Stakeholders
20
Summary

• Operating practices and accounting principles
  must be in sync
• Skepticism often takes a backseat to hope and
  greed
• The unraveling and fall often happen much more
  quickly than the rise
• The price managers pay for inattention to
  financial reporting is extremely high
• Leadership/entrepreneurial spirit-risk
  taking/integrity