!"#$%$&' )*"+%,- .",,/#' .0#/ ,1"$ 20* .

%&1, 31%$4

By }ohn Bel vecchio

Accounting is the language of business anu the analysis of financial statements aie an
impoitant tool in ueteimining the quality anu sustainability of iepoiteu iesults. We have
uevelopeu a mouel that has successfully iuentifieu financial issues oi aggiessive accounting
piactices that eventually come to light in the foim of ievenue oi eainings shoitfalls that
affect Wall Stieet analysts' iecommenuations. Because we know that investois ieact to
analysts' iecommenuations, among othei things, a stock's piice will move positively oi
negatively baseu on eainings uiiven events.

The top 1uu companies have eaineu ietuins in excess of 1S% compounueu annually ovei
the last 1S yeais while the bottom stocks have geneiateu losses in excess of S% annually
ovei the same peiiou. The mouel was uevelopeu baseu on ieal-woilu expeiience pioviuing
in-uepth analysis on shoit selling investment iueas.

We oiganize the ieu flags with iespect to wheie they iesiue on the income statement.
While Wall St. is veiy focuseu on "the bottom line", eainings aie the least impoitant line
item that a company iepoits. Imagine foi a moment that a company's ievenue weie
fictitious. Then its entiie financial mouel woulu be smoke anu miiiois anu the iepoiteu
eainings woulun't mattei, woulu they.



If management is engaging in chicaneiy with the ievenue line, it uiiectly ielates to the
uemanu foi a company's piouucts. It uoesn't mattei if the company sells wiugets, softwaie,
sneakeis, oi buiiitos. As you move uown the income statement, theie's numeious leveis
management can pull to ueiive whatevei net income they uesiie to meet expectations.

Neeu anothei penny to top Wall St. estimates. No pioblem, just ieveise a ieseive. Neeu to
boost youi gioss maigin. }ust sell inventoiy that you wiote off in a piioi peiiou. Want to
builu "cookie jai" ieseives to boost futuie eainings. Nake a big acquisition anu bunule
noimal opeiating expenses into the goouwill.

This is how massive multi-national coipoiations hit theii taigets quaitei aftei quaitei.
Such a stiing of successes of "making the numbei" shoulu foice you to uig fuithei anu
ueteimine the quality anu sustainability of iepoiteu eainings.

The fiist line of a cash flow statement is net income. Thus, if net income has been
manipulateu, cash flow quality is suspect. Anu, as well as know, cash is king. Theie aie also
numeious balance sheet accounts that management can use to pull the wool ovei investois'
eyes. The combination of all thiee financial statements useu togethei cieates a pictuie as to
the quality of iepoiteu iesults.

Nany of these techniques weie coveieu in my book !"#$%& ()"*+, $") -./0)1&2 3 4.*,) $5
6785&*+9 :*+#+;*#< ="*;#+)1> #+, 3?5*,*+9 @.9) A5&&)& *+ B5.1 C51$D5<*5 EF;41#GH@*<<I
JKLJMN In the final chaptei, we uiscusseu a basic mouel that uistilleu these concepts into a
quantitative mouel.

Foi oui own use in investing, we use a moie compiehensive mouel that incluues a few bells
anu whistles not uiscusseu elsewheie. We bieak the eainings quality equation uown to six
majoi components as follows:

5/6/$*/ 5/70&$%,%0$8 Again if management is playing games with the top-line, uemanu is
likely softening. We assess the piopensity that management has juiceu the top-line anu
assign a scoie A-F, like a iepoit caiu giaue.

9"'1 :+0; )*"+%,-8 You cannot spenu eainings, only cash coming into the company's
coffeis. If the net income is of low quality, cash flow is also suspect. An analysis of cash flow
quality can often spot tiouble befoie negative eainings suipiises ieai theii ugly heau.

!"#$%$&' )*"+%,-8 To what extent is the management team using the balance sheet oi
pulling leveis on the income statement to ueiive net income. Analyzing the impact of
changes in those accounts iesults in a scoie that ueteimines sustainability of piofits.

!<=/7,",%0$'8 We also look at the impact on the shaie piice that positive oi negative
eainings suipiises have anu weight companies with bettei eainings quality anu lowei
expectations highei. Why. Companies with high expectations aie unuei intense piessuie to
continue to exceeu those expectations. Eveiy company has a bump in the ioau on theii path
to piospeiity. Is management open an honest about it, oi uo they use the leeway in uAAP
accounting to mask ueteiioiation. If expectations aie high anu a company misses, the stock
piice is likely to faltei significantly.

>"+*",%0$8 valuation still matteis. If you can buy high quality eainings cheap, the ietuins
aie highei both in testing anu in ieal-time.

?1"#/10+@/# 2%/+@8 Shaieholuei yielu is a laige souice of histoiical ietuin. We take into
account not only uiviuenus anu buybacks, but analyze the souices of shaieholuei yielu anu
management's ability to inciease it in the futuie.

Below aie the top 2S anu bottom 2S iateu stocks cuiiently in the uatabase:


67"*0*$O P58 JQ &$5;R& *+ $") S;$50)1I JKLT C#1#05<*7 F5,)<

!""#$"%&$
(%)* +,-*$# .&/-* 0%1$ .$-&/# 2#,-$ 3%#*$& 4%5
($6$)7$
378&,9%-&/#
4%:; <8/=
378&,9%-&/#
>%#),)":
?7%8,&@
378&,9%-&/#
>A5$-&%&,/):
378&,9%-&/#
B%87%&,/)
378&,9%-&/#
.;%#$;/8C$#
D,$8C
378&,9%-&/#
1 ACM Aecom 1echnology lndusLrlals 32.04 $ 3.2308 A A A A A A
2 MC harmerlca Corpor PealLh Care 13.38 $ 398.3M A A 8 A A l
3 ulS uomLar CorporaLlo MaLerlals 80.68 $ 2.6338 A A A A A A
4 81P 8lyLh, lnc. new C Consumer ulscreLlonary 14.30 $ 232.2M A A A A A A
3 CM1L ComLech 1elecommu lnformaLlon 1echnology 24.44 $ 400.9M A 8 A A A A
6 CLMS Calamos AsseL Man llnanclals 9.87 $ 202.6M A A C A A A
7 Sk?W SkyWesL, lnc. lndusLrlals 14.36 $ 737.3M A A 8 A A C
8 C8L? Cbeyond, lnc. 1elecommunlcaLlon Servlces 6.46 $ 197.6M A A 8 A A l
9 SCSC ScanSource, lnc. lnformaLlon 1echnology 33.43 $ 994.3M A A A A A C
10 CCCC CorlnLhlan Colleg Consumer ulscreLlonary 2.13 $ 183.8M 8 A A A A C
11 8CC 8rlggs & SLraLLon lndusLrlals 20.37 $ 974.8M A A A A A A
12 nSl1 lnslghL LnLerprls lnformaLlon 1echnology 18.97 $ 803.0M A 8 A A A C
13 CCx ConsolldaLed Crap lndusLrlals 37.47 $ 336.7M A A 8 A A 8
14 Cu18 CuLerwall lnc. Consumer ulscreLlonary 31.23 $ 1.4038 C A C A A 8
13 knu klndred PealLhcar PealLh Care 14.29 $ 773.9M A A A A A u
16 CLS Cuess?, lnc. Comm Consumer ulscreLlonary 30.42 $ 2.3828 A A A A A A
17 S18A SLrayer LducaLlon Consumer ulscreLlonary 41.94 $ 432.4M A A 8 A A A
18 LPCC LPC Croup PealLh Care 23.36 $ 414.3M A A 8 A A 8
19 1Ln aLLerson-u1l Lne Lnergy 22.40 $ 3.2668 A A C C A 8
20 8PL 8enchmark LlecLro lnformaLlon 1echnology 22.81 $ 1.2398 8 A A A A 8
21 uSMC uSA MoblllLy, lnc 1elecommunlcaLlon Servlces 14.18 $ 306.9M A A A C A A
22 CSP Cash Amerlca lnLe llnanclals 46.00 $ 1.2938 C A C A A C
23 88u 8.8. uonnelley & lndusLrlals 16.09 $ 2.9248 A A A A A A
24 PPS ParLe-Panks, lnc. Consumer ulscreLlonary 8.32 $ 332.8M 8 A A A A A
23 ACL Apollo Croup, lnc Consumer ulscreLlonary 20.99 $ 2.3688 A A C A A 8
The bottom 2S aie:


67"*0*$O (5$$5/ JQ &$5;R& *+ $") S;$50)1I JKLT C#1#05<*7 F5,)<

Below is a biief wiite-up of SB Systems (BBB), which is the lowest iateu stock in the
uatabase as of this wiiting.
!""#$"%&$
(%)* +,-*$# .&/-* 0%1$ .$-&/# 2#,-$ 3%#*$& 4%5
($6$)7$
378&,9%-&/#
4%:; <8/=
378&,9%-&/#
>%#),)":
?7%8,&@
378&,9%-&/#
>A5$-&%&,/):
378&,9%-&/#
B%87%&,/)
378&,9%-&/#
.;%#$;/8C$#
D,$8C
378&,9%-&/#
976 uC8M uorman roducLs, Consumer ulscreLlonary 30.99 $ 1.8348 l l l l l C
977 LxA8 Lxar CorporaLlon lnformaLlon 1echnology 13.41 $ 636.7M l l A l l l
978 MuCC 1he Medlclnes Com PealLh Care 33.33 $ 1.8638 l l u u l l
979 8CC 8alchem CorporaLl MaLerlals 31.31 $ 1.3338 l u l l l u
980 LkC LkC CorporaLlon Consumer ulscreLlonary 32.73 $ 9.8238 l l l l l l
981 CnC8 Concur 1echnologl lnformaLlon 1echnology 112.48 $ 6.3028 l l 8 l l l
982 AClW ACl Worldwlde, ln lnformaLlon 1echnology 33.08 $ 2.1788 u l u l l l
983 v81u vlrLusa CorporaLl lnformaLlon 1echnology 28.71 $ 732.3M l l l l l l
984 k1 rocera neLworks, lnformaLlon 1echnology 14.61 $ 296.8M l l l u l l
983 CLCS Ceospace 1echnolo Lnergy 83.14 $ 1.0998 l l l l u l
986 1nCC 1angoe, lnc. lnformaLlon 1echnology 24.17 $ 907.3M l l l l l 8
987 8nn? Annle's, lnc. Com Consumer ulscreLlonary 49.07 $ 828.7M l l l l l A
988 WACL WageWorks, lnc. C lndusLrlals 30.23 $ 1.6998 l u C l l l
989 CAM CalAmp Corp. lnformaLlon 1echnology 18.86 $ 631.9M l l l l l l
990 PAln 1he Paln CelesLla Consumer SLaples 78.77 $ 3.7378 l l l l l l
991 uA under Armour, lnc Consumer ulscreLlonary 82.36 $ 8.6888 l l l l l l
992 lnCn llnanclal Lnglnes llnanclals 36.28 $ 2.7968 l u l l l l
993 CW8 Cenesee & Wyomlng lndusLrlals 93.23 $ 4.9808 l l l l l l
994 CC8 CulfporL Lnergy C Lnergy 63.00 $ 3.0418 l l l u l l
993 MuSC MedldaLa SoluLlon PealLh Care 99.69 $ 2.3398 l l l l l l
996 l1k lloLek lndusLrles MaLerlals 23.49 $ 1.2038 l l l l l l
997 ll8L Sourceflre, lnc. lnformaLlon 1echnology 73.96 $ 2.3908 l l C l l l
998 Ak8x Akorn, lnc. PealLh Care 20.29 $ 1.9328 l l l l l l
999 Lx Lagle MaLerlals l MaLerlals 73.90 $ 3.6638 l u l l l l
1000 uuu 3u SysLems Corpor lnformaLlon 1echnology 33.26 $ 3.6138 l l l l l l

AB ?-',/C' 90#=0#",%0$ DBBBE

5"$48 FGHIII 0J GHIII

K*'%$/'' B/'7#%=,%0$8

SB Systems Coipoiation, thiough its subsiuiaiies, uevelops, manufactuies anu maikets SB
piinteis, piint mateiials, on-uemanu custom paits seivices, anu SB authoiing solutions foi
piofessionals anu consumeis. The company's piimaiy piint engines compiise steieo
lithogiaphy, selective lasei sinteiing, multi-jet moueling, film tiansfei imaging, selective
lasei melting, anu plastic jet piinteis, as well as ZPiinteis. Its SB piinteis conveit uata
input fiom computei aiueu uesign (CAB) softwaie oi SB scanning anu sculpting uevices to
piouuce physical objects fiom engineeieu plastic, metal, anu composite piint mateiials.

5/6/$*/ .*+,%J"7,0#8 :

While BBB posteu ievenue of $12u.8 NN hanuily beating sell-siue estimates of $114.8 NN,
sales giowth was accompanieu by a shaip inciease in accounts ieceivables. Bays sales
outstanuing iose fiom 7u to 84 in the quaitei. The 14-uay inciease inuicates that sales
weie geneiateu in the lattei pait of the quaitei, incieasing iisk that incentives weie offeieu
to book the oiueis. While the company stateu in its SEC filing that cieuit teims weie
stanuaiu, a uispiopoitionate amount occuiieu in the thiiu month of the quaitei.


6/30/13 3/31/13 12/31/12 9/30/12 6/30/12 3/31/12
Days Sales Outstanding
(DSO) 84 80 72 70 70 72
% Chng QoQ 5% 12% 2% 1% -3% 7%
% Chng YoY 21% 12% 7% 4% 0% -4%
4 qtr average (DSO) 77 73 71 70 69 69


The uays sales outstanuing has incieaseu yeai-ovei-yeai foi foui consecutive quaiteis anu
has ieacheu a multi-yeai high of 84 uays. Bistoiical BS0's have aveiageu in the low 7u-uay
iange. The concein with a significant iise in BS0 outsiue of histoiical noims is not ielateu
to the collection of ieceivables but the 1);59+*$*5+ of ievenue (howevei, the amount of
uelinquent ieceivables incieaseu neaily Su% sequentially). uiven that shaies of BBB tiaue
at 1u times tiailing ievenue, theie is intense piessuie foi management to exceeu
expectations. A ievenue shoitfall woulu likely have a mateiial negative impact on the stock
piice.

0ne qualitative impeuiment to giowth is copyiight infiingement lawsuits hampeiing SB
piinting effoits. BB0 iecently successfully uefenueu its uame of Thiones fianchise fiom
cell phone coveis maue with SB piinteis.

9"'1 :+0; .*+,%J"7,0#8 :

0peiating cash flow was $2 NN in the quaitei, uown 6S% yeai-ovei-yeai. In auuition, fiee
cash flow fell 87% ovei the same peiiou. The builu up in ieceivables was a majoi uiivei in
pooi cash flow peifoimance.

0f moie concein, opeiating cash flow ielative to net income iesulteu in a $7.S NN shoitfall
in the 62u1S quaitei compaieu with $2.8 NN in the yeai ago peiiou, inuicating that
eainings quality ueteiioiateu in the quaitei.


6/30/13 3/31/13 12/31/12 9/30/12 6/30/12 3/31/12
OCF - Net Income -$7.30 $4.86 -$1.88 $9.12 -$2.77 $9.64
% Chng QoQ -250% -359% -121% -429% -129% 1005%
% Chng YoY 163% -50% -315% 71% -63% -248%

The company's cash conveision cycle incieaseu 24 uays in the 62u1S quaitei to 1u7 uays.
While flat sequentially, this is the longest cash conveision cycle in seveial yeais.
Fuitheimoie, the cash conveision cycle has incieaseu yeai-ovei-yeai foi five consecutive
peiious.


6/30/13 3/31/13 12/31/12 9/30/12 6/30/12 3/31/12
Cash Conversion Cycle 107 107 90 101 83 76
% Chng QoQ 0% 19% -11% 22% 9% 16%
% Chng YoY 30% 41% 38% 35% 15% -13%
4 quarter average 101 95 87 81 75 72
% Chng 6% 9% 8% 9% 4% -4%


!"#$%$&' )*"+%,- .*+,%J"7,0#8 :

In the 62u1S quaitei, eainings weie uiiven entiiely by acciuals. Basic EPS of $u.1u anu
acciuals of $u.12 iesulteu in "cash" EPS of ($u.u2) compaieu with "cash" EPS of $u.uS in the
yeai ago peiiou.


6/30/13 3/31/13 12/31/12 9/30/12 6/30/12 3/31/12
"Cash" EPS -$0.02 $0.05 -$0.03 $0.24 $0.03 $0.09
% Chng QoQ -145% -271% -111% 831% -72% 233%
% Chng YoY -180% -50% -198% 274% -78% -20%


!<=/7,",%0$' .*+,%J"7,0#8 :

While the company toppeu ievenue estimates in the 62u1S quaitei, the stock piice is
aheau of funuamentals given the ueteiioiation in eainings quality, cash flow quality, anu
ievenue iecognition.

Neanwhile, expectations iemain high. The company maintaineu full yeai guiuance.
Bowevei, gioss maigin expanueu just 4u bps anu was uown sequentially uespite iobust
ievenue giowth. Any ueceleiation in volume giowth is likely to iesult in significant maigin
contiaction anu eainings shoitfalls.

>"+*",%0$ .*+,%J"7,0#8 :

valuations foi BBB iemain iich. 0n a TTN basis, the company tiaues at 1ux ievenue, 112x
eainings, anu 11ux opeiating cash flow, scoiing among the most oveivalueu stocks in oui
valuation composite.

?1"#/10+@/# 2%/+@ .*+,%J"7,0#8 :

Shaies of BBB uo not pay a uiviuenu. Buiing the 62u1S quaitei, new equity issuance
ieacheu $272 NN. Neanwhile, FCF yielu uioppeu to 1% fiom 2% in the yeai ago peiiou
anu S% sequentially.