Wednesday, October 17, 2018

Unfair and misconceived reporting of alleged $37 million “debt” accrued by Tom Delonge’s To The Star’s Academy [“TTSA”]


I've posted some comments about Tom DeLonge in the past which were rather critical of (e.g. about excessive hype and his performance on the Joe Rogan Experience podcast number 1029 in October 2017…), but in the last few days I think some of the attacks on his company, To The Stars Academy, have ignored the detail of the content of relevant financial accounts (yawn) and accounting principles (_yawnnnnn_). 

DeLonge, again, hasn’t exactly helped himself but I feel that I should – just this time – explain a few points that actually back him up. 

I know this stuff is a bit tedious,  but -  hey – ufology and related matters don’t always just involve watching 10 second clips of flying saucers/triangles on Youtube. I’m try to keep the most boring stuff to footnote. 

[Footnotes in a blog/Facebook post??!  I may get banned for this since I seem to be breaking an unwritten rule on the Internet…]

Some of the relevant headlines in the last few days have, quite simply, been wrong. For example, the “Motherboard” website posted an article entitled “Tom DeLonge's UFO Organization Is $37.4 Million In Debt" [see Footnote 2].  (Edit : The Motherboard website has posted a correction while I've been writing this lengthy item - but the correction is wrong as well. :)  The word "debt" has been picked up and repeated in numerous other stories anyway...).







These articles have been prompted by reading (or misreading) the content of the latest financial statement filed by TTSA with the SEC (i.e. the Securities and Exchange Commission). Those accounts are at the link in Footnote 1 below. 

That SEC filing include the following [Footnote 1, at bottom of page 13]:

“.,,,The Company has incurred losses from operations and has an accumulated deficit at June 30, 2018 of $37,432,000. These factors raise doubt about the Company’s ability to continue as a going concern.



As explained below, however, that SEC filing does:
(1)  _NOT_ show that TTSA has a debt of $37 million;
(2) _NOT_ show that TTSA has spent $37 million;
(3) _NOT_ show that TTSA has borrowed $37 million.

Some of those defending Tom DeLonge on the basis that large expenditure is normal for a start-up are implicitly accepting that $37 million has been spent. It hasn’t. Questions about “what has $37 million been spent on” are based on the equally flawed premise that $37 million has been spent. Again, it hasn’t.

Tom DeLonge has posted an attack on one of those articles that was not altogether coherent (and subsequently deleted). That attack suggested that the author of the article should have contacted him first, which is a bit rich since DeLonge and TTSA have rarely responded to anyone I know that has questioned him/TTSA about anything, rather than just posting adulation of him. Also, relevant discussion had been posted online for several days beforehand and TTSA had done nothing to explain itself.  

But I think his main points are (this particular time, on this specific point…) largely right, as I’ll explain below.

The problem is that some of those attacking DeLonge/TTSA are conflating the meaning of the word “debt” and the word “deficit”. They are different words for a reason – they mean different things. J A “deficit” can arise in accounts for a range of reasons. When considering the impact of a deficit, it is – I’m afraid – necessary to look at how the deficit arose. So, let’s do that below.

The meaning of the word “debt” is that something is owed, usually money, by one party to another.  [See Footnote 3]

Quite simply, TTSA’s filed accounting documents do _not_ show that it owes $37 million to anyone.

Instead, those accounts refer to a “deficit”. This is quite different.

The word “deficit” has various meanings, but in an investing context the gist of those meanings is to refer to a loss, or an excess of expenditure/liabilities above income/assets over a period [Footnote 4].  

Before looking at TTSA’s financial statements in relation to the $36 million “deficit”, let’s try a rather simplified hypothetical example.  I’ll take things to extremes to make them – hopefully – clearer and easier to think about. Imagine Bob writes books. Bob forms a company (“Imaginary Incorporated”) to sell those books. For a decade, Imaginary Incorporated sells 1,000 copies of those books each year, at a price of $11 and with costs of production of $1 – giving a profit per book of $10, i.e. $10,000 profit a year.  Then Bob meets Dave. Dave says he is close to finding the cure for cancer. In return for Dave’s assigning rights over the “cure” to Bob’s company (and working as a consultant on finalising the details of that cure), Imaginary Incorporated gives Dave a right to buy 1% of shares in that company at any point in the next 10 years for $1 million [see Footnote 5 if you don’t know about stock/share options]. At the end of the year, when Bob fills in the accounts for Imaginary Incorporated he has to put in a value for the option that the company has given Dave. Imaginary Incorporated has given something away so it has to account for an expenditure/liability in relation to what it has given away. How much was that option worth? Well, the full answer involved applying a financial model/equation known as the “Black-Scholes model” [Footnote 6]. But, just to simplify things a tad, you have to consider what the shares are likely to be worth during that the period during which the option can be exercised. One common way of valuing a company is to look at the annual profits it has made and then apply a multiple (which tends to vary) to that annual profit. To keep the maths simple, let’s take a multiple of 10 – so the value of the company would be 10 times the annual profit of $10,000 – giving  a value of $100,000. On that basis, unless the value of the company were to change dramatically, a right to buy 1% of the company for £1 million would basically be a joke, worth nothing. But in this hypothetical example Bob thinks the company will, or at least might, be worth $100 billion during the next 10 years after developing the cure for cancer and other anticipated benefits. If that expectation were realistic, then a right to buy 1% of the shares (i.e.a value of $1 billion) for the mere price of $1 million would be a valuable right – worth millions if not hundreds of millions of dollars. So, when filling in the accounts, Bob fills in an expenditure/transfer of say $100 million in relation to the option it gave Dave. Imaginary Incorporated made its usual $10,000 profit on the sale of books but because of it giving away a right to buy shares it, for accounting purposes at least, has suffered a loss of millions of dollars based on Bob’s valuation of that right. Note, Imaginary Incorporated has not spent millions of dollars, it has not borrowed millions of dollars, it is not in debt for millions of dollars and – indeed – it never had millions of dollars. Imaginary Incorporated made its usual $10,000 profit on the sale of books but because of it giving away a right to buy shares it, for accounting purposes at least, has suffered a loss of millions of dollars based on Bob’s valuation of that right. Note, Imaginary Incorporated has not spent millions of dollars, it has not borrowed millions of dollars, it is not in debt for millions of dollars and – indeed – it never had millions of dollars. Imaginary Incorporated made its usual $10,000 profit on the sale of books but because of it giving away a right to buy shares it, for accounting purposes at least, has suffered a loss of millions of dollars based on Bob’s valuation of that right. Note, Imaginary Incorporated has not spent millions of dollars, it has not borrowed millions of dollars, it is not in debt for millions of dollars and – indeed – it never had millions of dollars.

Alternatively, imagine that Bob manages – after a fairly intensive global effort - to persuade a few desperate cancer sufferers to buy a tiny, tiny fraction of the shares in Imaginary Incorporated for a total combined investment of US$ 1 million. On the basis of a straight-line extrapolation, the entire company would then be worth billions and the option given to Dave would again – on that accounting basis – be worth millions of dollars. Of course, one could legitimately question whether a straight-line extrapolation would be meaningful in these circumstances since there would be no real prospect of all the shares in Imaginary Inc being sold for billions of dollars as things stood in this hypothetical example…

Okay, let’s turn to the financial statements for DeLonge’s To The Stars Academy. TTSA’s semi-annual period for the period ending 30 June 2018 (filed on 26 September 2018) can be found online at the link in Footnote 1, which is:

Those accounts show relatively little cash being used in operating activities (less than $1 million) [Footnote 1, at page 7] and proceeds from issuing shares also being in the region of just $1 million [Footnote 1, at page 7].  



So, where do the sums of millions of dollars come in?

Page 4 of TTSA’s latest SEC filing [at the link in Footnote 1] refers to “stock-based compensation expense” of “$4,791,042 for Interim 2018” and “$24,744,757 for Interim 2017”.  The SEC filing states that this relates to the vesting of “stock options and restricted stock units”.



Page 11 of TTSA’s SEC filing [at the link in Footnote 1] indicates that – after considering administrative and marketing costs (but excluding stock-based compensation for a moment) – TTSA’s operations have made  a relatively modest, albeit possibly (probably??) unsustainable, loss [less than $1 million] in the period to 30 June 2018. The muliti-million dollar loss arises when you add in the figure for “stock-based compensation”.



Page 16 of TTSA’s SEC filing [at the link in Footnote 1] is the key bit so far as the apparently huge deficit is concerned. That bit includes the following:


[BEGIN QUOTE FROM PAGE 16 OF SEC FILING]
“Stock Based Compensation
 The Company uses ASC 718 and ASC 505 for stock-based compensation. Compensation for all stock-based awards, including stock options and restricted stock, is measured at fair value on the date of grant and recognized over the associated vesting periods. The fair value of stock options is estimated on the date of grant using a Black-Scholes model. The fair value of restricted stock awards is estimated on the date of the grant based on the fair value of the Company’s underlying common stock. For employees, the Company recognizes compensation expense for stock options and restricted stock awards on a straight-line basis over the associated service or vesting periods. For non-employees, the stock-based awards are valued at the value of the stock award on the date the commitment for performance has been reached or their performance is complete. As of June 30, 2018 and December 31, 2017, all non-employee awards had similar vesting terms to those of employees. Determining the grant date fair value of options using the Black-Scholes option-pricing model requires management to make assumptions and judgments. These estimates involve inherent uncertainties and, if different assumptions had been used, stock-based compensation expense could have been materially different from the amounts recorded."
[END QUOTE FROM PAGE 16 OF SEC FILING]




Let’s break that down. 

The value attributed to the stock options and stock awarded as compensation to employees and non-employees is valued according to ASC 718 and ASC 505. ASC stands for “Accounting Standards Codification” and sets out generally accepted accounting practices in the USA [Footnote 7].  ASC 718 contains provisions relating to, among other things, share-based payments to employees (see Footnote 8, para 2.1.3). ASC 505 includes provisions relating to, among other things, share-based payments with nonemployees (see Footnote 8, para 8.2 and illustrative examples in para 9.6).  

So, the multi-million dollar aspect of the deficit relates to assumptions made when valuing the stock and/or stock options given to employees and non-employees. TTSA has put, um, high values on both. This makes it look in their filing like it has given assets worth huge sums away to employees and non-employees. Of course, if different assumptions were made as to the values of the stock and/or stock options then the value of the assets given away could be much, much less. In any event, the assets are stocks and/or stock options – not cash or any assets TTSA has bought. TTSA has, in effect, just given part of _itself_ away (or, in relation to the stock option, given away the right for others to buy part of TTSA _itself_ at a set price within a certain period).  

More details of the relevant stocks and stock options are given on pages 21-22 of TTSA’s latest SEC filing (at the link in Footnote 1). Those pages again contain a statement that “Determining the appropriate fair value of stock-based awards requires the input of subjective assumptions, including the fair value of the Company’s common stock, and for stock options, the expected life of the option, and expected stock price volatility”



I think that the statement in TTSA’s latest SEC filing that TTSA has “incurred losses from operations and has an accumulated deficit at June 30, 2018 of $37,432,000” must be understood in the context of those other parts of the SEC filing.  Similarly, the statement that ”These factors raise doubt about the Company’s ability to continue as a going concern” also must be understood in the context of high values being attributed to stock compensation being given to employees and non-employees. In effect, someone has said, hey, if you’ve given away assets in the shape of TTSA stock and stock options which are (supposedly) worth millions and millions of dollars to get services in the last year or so, how are you going to keep those people happy in the future – are you going to give them more assets (supposedly) worth millions and millions of dollars? But this is all premised on the company having a huge value.

Thus, as stated in my introduction above, the SEC filing does:
(1)  _NOT_ show that TTSA has a debt of $37 million;
(2) _NOT_ show that TTSA has spent $37 million;
(3) _NOT_ show that TTSA has borrowed $37 million.

To that extent, I think that some of the reports and comments online in relation to on DeLonge/TTSA have been misconceived and unfair. Even many of TTSA’s supporters have given defences that are based on misconceptions as to TTSA having “spent” tens of millions of dollars. It hasn’t.



Footnote 1: TTSA semi-annual report to the SEC for period to 30 June 2018 (filed on 26 September 2018):

Footnote 2 : “Tom DeLonge's UFO Organization Is $37.4 Million In Debt”:

Footnote 3 : Definitions of the word “debt” –

Footnote 4 : Meaning of “deficit” in investing context:

Footnote 4 : Basic introduction to stock options:

Footnote 6 : Basic introduction to the “Black-Scholes model”

Footnote 7 : Basic introduction to ASC

Footnote 8 : Ernst & Young 443 page guide to “Share-based payment”

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