part 1b

DUE DILIGENCE CHECKLISTS

(See Note 1 at end of document)

Note: Items in black are required for the project assignment. Items in green may or may not be readily accessible. If they are accessible, do them if time permits. Otherwise, glance at them to get a better understanding of the company. They may also help in the weeks to come.

Industry Overview

1. What is the size of the industry?

2. How is the industry segmented?

3. What is the industry's projected growth and profitability?

4. What are the factors affecting growth and profitability?

5. What are the trends in the number of competitors and their size, product innovation, distribution, finances, regulation, and product liability?

Corporate Overview

1. When and where was the company founded and by whom?

2. What is its history of product development?

3. What is the history of the management team?

4. Has the corporate location changed?

5. Have there been ownership changes?

6. Has there been an acquisition or divestiture?

7. What is its financial history?

Organization and General Corporate Issues

1. Obtain the articles of incorporation and bylaws. Review for the existence of preemptive rights, rights of first refusal, registration rights, or any other rights related to the issuance or registration of securities.

2. Review the bylaws for any unusual provisions affecting shareholder rights or restrictions on ownership, transfer, or voting of shares.

3. Review the terms associated with any preferred stock or unexercised warrants.

4. Describe any antitakeover provisions.

5. If the company is publicly held, update all periodic filings for the past, including the 10-K, 10-Q, 8-K, and Schedule 13D.

6. Review annual reports to shareholders.

7. Obtain a list of all states in which the company is qualified to do business and the list of those states in which it maintains significant operations. Determine if there is any state in which a company is not qualified but should be qualified to do business.

8. Review all pending and threatened legal proceedings to which the company or any of its subsidiaries is a party. Describe principal parties, allegations, and relief sought. This includes any governmental or environmental proceedings. Obtain copies of existing consent decrees or significant settlement agreements relating to the company or its subsidiaries.

9. If there has been a change in accountants during the past 5 years, find out why.

10. Research any press releases or articles about the company within the past year (see Bloomberg.com, Nexis, Equifax, etc.).

11. Review all related-party transactions for the past 3 years.

Treasury

1. Document banking relationships, available credit lines, and collateral.

2. Document all hedging activities, and identify all areas of risk.

CAPITALIZATION AND SIGNIFICANT SUBSIDIARIES

1. Check out the footnotes to financial statements for debt agreements to which the company or any subsidiary is a party, as well as all debt guarantees. Note any restrictions on dividends, on incurring extra debt, and on issuing additional capital stock. Note any unusual consent or default provisions. If subordinated debt securities are being issued, compare new subordination provisions with the provisions for other agreements for compatibility. Review the latest borrowing base certificates. Inquire about whether there are any defaults or potential defaults.

2. Check out the footnotes to financial statements and review all documents affecting ownership, voting, or rights to acquire the company’s stock for required disclosure and significance to the purchase transactions, such as warrants, options, security holder agreements, registration rights agreements, shareholder rights, or poison pill plans.

ASSETS

1. Check out footnotes to financial statements and schedules for information regarding asset leases, and if possible, review for term, early payment, and bargain purchase clauses.

2. Check out footnotes for detail of accounts receivable.

3. Check out footnotes for a listing of inventory items, and if applicable, discuss the obsolescence reserve.

LIABILITIES

1. Check out the footnotes and review the terms of any lines of credit.

2. Review the amount and terms of any other debt agreements.

FINANCIAL STATEMENTS

1. If possible, obtain audited financial statements for the last 3 years. Otherwise, review them for the last 2 years.

2. Determine the revenues and, if possible, profits per employee.

3. If applicable, what is direct labor expense as a percentage of revenue?

4. Also, if possible, determine profitability by product, by customer, and by segment.

EMPLOYEES

1. Using the footnotes, obtain copies of any director compensation agreements.

2. Using the footnotes, obtain copies of any option plans.

3. Using the footnotes, summarize any old amounts and terms to officers, directors, or employees.

4. Do the footnotes contain any union labor agreements?

5. Summarize the names, ages, titles, education, experience, and professional biographies of the senior management team.

6. Obtain a copy of the organization chart.

PAYROLL

1. Verify if any special bonuses are to be paid to acquire employees in the event of a merger or acquisition, and quantify the amount.

2. Discuss the employee benefits.

HUMAN RESOURCES

1. Using the footnotes, determine the matching contribution levels for pension plans.

2. Using the footnotes, determine the pension plan eligibility criteria and vesting period.

CULTURE

1. What are the decision-making processes of the company?

2. What are the performance monitoring and bonus payment systems of the company?

3. How does the company resolve conflicts?

4. What types of formal and informal communication systems are used by the company?

5. What is the command structure of the company?

Revenue

1. Summarize sales by customer for the current and past year.

2. Summarize sales by product for the current and past year.

3. Determine the seasonality of revenue, if applicable for the company.

Internet

1. Does the company use the Internet for internal use as an interactive part of operations? What functions are used in this manner?

2. In what way could operational costs decrease if the company’s customers interacted with it through the Internet?

Software Development

1. Who are the key development personnel involved with the creation, coding, and evaluation of software products? What are their tenure and educational backgrounds?

2. How much money is invested annually in the development? As a proportion of sales?

3. What is the company’s strategy in designing new products (e.g., quality, support, special features)?

Complexity

1. Evaluate the number and variability of revenue sources, if possible and practical.

2. Review the volatility of the effective tax rate.

3. If there is a tax deferral, investigate the differences between tax and book income.

Note: Items in black are required for the project assignment. Items in green may or may not be readily accessible. If they are accessible, do them if time permits. Otherwise, glance at them to get a better understanding of the company. They may also help in the weeks to come.

Marketing

1. What types of advertising and promotion are used?

2. Does the company have a website? Who owns the site and how is it hosted?

3. Does the company use e-mail for marketing notifications to customers?

4. What are the proportions of sales by distribution channel?

5. How many customers can the company potentially market its products to? What would be the volume by customer?

6. What is the company’s market share? What is the trend?

7. Are there new markets in which the products can be sold?

Sales

1. What is the sales strategy (e.g., add customers, increase support, increase penetration into existing customer base, pricing, etc.)?

2. What is the structure of the sales organization? Are there independent sales representatives?

3. Into what category do customers fall—end users, retailers, OEMs, wholesalers, and/or distributors?

4. If possible, identify the top 10 customers, based on sales volume. What is the historical sales volume to all customers for the past 3 years?

5. Does the company have an Internet store? Does the site accept online payments and orders?

6. What percentage of total sales comes through this medium?

7. What is the structure of the technical support group? How many people are in it, and what is their compensation?

Research and Development

1. Obtain a summary of all R & D projects currently underway, including their current status, estimated time and cost to complete, and estimated unit costs as compared to target costs.

2. Estimate the types of patents that may be filed as a result of current R & D projects, and determine how these patents could be used to enhance the company’s competitive position and/or block the positions of competitors.

3. Estimate the worst-case, average-case, and best-case scenarios for revenue streams resulting from current R & D projects.

Other

1. If possible, discuss revenue recognition policies.

2. Determine risk management strategies and insurance coverage.

3. Evaluate the company’s benefit plan to determine its cost, as well as the amount of employee participation.

4. Look through the footnotes and obtain a list of significant accounting policies.

The items below represent the ratios to be calculated for the Week 7 portion of the Due Diligence Project. You can find the actual formulas for each of these ratios in Appendix B of our textbook. As always, feel free to contact me with any questions or if you need assistance.

Asset Utilization Measurements

· Breakeven point

· Goodwill to asset ratio

· Interest expense to debt ratio

· Investment turnover

· Days of working capital

· Sales per person

· Sales to equity ratio

· Sales to fixed assets ratio

Operating Performance Measurements

· Gross profit percentage

· Net income percentage

· Profit per person

· Cash flow return on assets

· Cash to current liabilities ratio

· Expense coverage days

Liquidity Measurements

· Accounts payable turnover

· Current liabilities ratio

· Current ratio

· Inventory to sales ratio

· Inventory turnover ratio

· Quick ratio

Capital Structure and Solvency Measurements

· Debt to equity ratio

· Times interest earned ratio

Return on Inventory Measurements

· Earnings per share

· Price earnings ratio

Note 1

The checklist is a modified version from the Steven Bragg’s original textbook (The New CFO Financial Leadership Manual, 3rd ed.).