I am still in the process of sorting through the historical financial statements, and the very poor disclosure has substantially hampered my efforts. I've got plenty of questions about where the Co-Op is classifying its rent expense, where its liability in back rent payments to the University shows up on the balance sheet, what its debt covenants are, which ones the Co-Op has violated and the ensuing penalties, specific detail on payroll expense, sales/marketing expense, and interest expense, among others. Let's hope the audited financial statements for fiscal year 2007, which should be available after 11/10/2007, will provide a much clear picture of what's going on with the Co-Op.
There has been some disagreement on this blog about just how profitable or unprofitable the Co-Op is. On the one hand, the Co-Op reported net income of $809,299 in fiscal 2006 from continuing operations, which basically means the 55th Street and 53rd Street stores. The audited financial statements did not disclose net income by individual store, so I cannot find any evidence of the $1 million in profits that has been mentioned on the blog before. (If anyone does have knowledge of where I can find these numbers in the audited financial statements, then please point me in the right direction!)
Now, any credit or equity analyst worth his/her salt can tell you that net income is easily manipulated through the various accounting rules. For example, the Co-Op has classified the 47th Street store as a "discontinued operation" back in fiscal 2005, so the on-going and significant rent obligation on that space is not part of the calculation to arrive at last year's $809,299 profit. Unfortunately, just because the Co-Op has discontinued operations doesn't mean it can also discontinue rent payments to Certified. If you disregard the discontinued operations and solely focus the continuing operations of the Co-Op (the 55th Street store), yes it is profitable. However, I would argue that it is simplistic to look at the 55th Street store in isolation. The money-suck originating from the 47th Street store has been sitting in discontinued operations from FY 2005 through FY 2007, and the first three months of FY 2008 – and it doesn't look like this will change any time soon based on President Poueymirou's comments at the Annual Meeting. For this reason, it would be irresponsible to ignore the discontinued operations sink hole when evaluating the financial health of the Co-Op. If you count all the on-going obligations associated with discontinued operations, then the Co-Op is clearly in the red. Obviously, the $809,299 in earnings last year is just a profit on paper – otherwise, it would show up as cash on the balance sheet, as a positive contribution to retained earnings (which drives membership equity toward positive numbers), and the Co-Op should be issuing a nice dividend check to its members.
One key number that seemed to bring the situation home to members at the annual meeting is the Co-Op's negative shareholders equity. For those who aren't accountants, shareholders equity (membership equity, in the case of the Co-Op) can also be thought of as the Co-Op's net worth, or tangible book value. Technically, it is calculated by taking total assets minus total liabilities -- $4,823, 219 in assets - $6,496,066 in liabilities, which leaves -$1,672,847 in membership equity (based on the FY 2006 balance sheet). In this case, since it is negative, that essentially means that the value of the Co-Op's assets have fallen below the value of the liabilities used to obtain those assets. This is analogous to the situation that some homeowners find themselves in, after having bought their homes at the top of the market and taken out big mortgages to finance the deal, but now struggling to pay on a mortgage that exceeds the market value of their home as the housing market dips. Based on the Co-Op's operating performance over the last few years, I am expecting membership equity has slipped further into the red in FY 2007.
Because it's so easy to manipulate the calculation of net income, I prefer to look at the statement of cash flows, where it is generally harder to sweep ugly things under the rug and you can get a better picture of what cash is coming in and going out. Leeway in accounting rules can create paper profits (and provide false reassurance), but its only cash that counts when the music stops because that's how you pay off your obligations and secure what you need to continue operating. The Co-Op generated $296,000 in cash from operations in fiscal 2006 – which is considerably smaller than the $809,299 in profits from continuing operations. This is a major red flag to me. In well-managed entities, cash flow from operations typically exceeds net income, and importantly, growth in cash flow exceeds growth in net income. Since I have not yet received 2003-2004 or 2007 financial statements, I can't comment on the growth trend, but clearly, cash flow from operations is trailing net income in absolute numbers.
Humor me with one last calculation that can provide insight into the financial health of this organization – the cash burn rate. The Co-Op burned through $13,016 each month of fiscal 2006 ($295,971 cash flow from operations - $77,159 in capital expenditure - $375,000 in debt paid off during the year/12 months) = -$13,016). Ideally, this number should be positive, which would indicate the entity is generating net cash and can shoulder investments necessary to improve the business. But, in the Co-Op's case, it's in negative territory, which means the entity is spending $13,016 more than it is generating in cash. In general, unless this condition is corrected, the Co-Op will not be able to pay debts when due, including the upcoming $529,711 portion of long-term debt that must be paid in fiscal 2008.
Since the Co-Op is already insolvent, a discussion of the nuts and bolts of bankruptcy might be helpful in the next installment.