CAPSTONE CASE 3: SPATIAL TECHNOLOGY, INC.

A. Describe Spatial Technologys business model in terms of revenues,

profits, and cash flows.

As we can see ,Spatial is the originator of a 3D modeling file format (SAT) and
object manipulation protocol intended to facilitate general 3D modeling and
animation. Its revenues historically have been due to prepaid royalties, licensing
fees, and maintenance and training for users of its 3D products and formats.
Exhibit 6c displays the statement of cash flows for the past three years. Only
recently have operating cash flows become positive. Spatial still faces cash flow
challenges.

B. What intellectual property, if any, does Spatial Technology possess?

Spatials file format (SAT) and modeling approach are its primary intellectual
property. Although parts of this IP are protected, Spatial, in an attempt to have its
approach adopted as an industry standard has published its file format, making it
readily available to adopters and competitors.

C. Describe the experience and expertise characteristics of the management

team.

The management team has a founder that is well known in the field with previous
successful experience. The operations and financing members of the team have
been subject to turnover. The team seems to be stronger on technical expertise.

D. Describe Spatial Technologys pricing and marketing strategy.

Spatial has adopted a strategy of forward-funding itself by taking large amounts

of prepaid royalties. Historically, its two primary revenue areas were royalties
and licenses. More recently, much of its revenue has been from maintenance and
training. Spatials marketing strategy has varied, including some historical
efforts to sell to the retail market. Spatials marketing strategy is primarily to sell
to software vendors who incorporate Spatials technology in their own shipped
products.

E. Discuss the competition faced by Spatial Technology in conjunction with 3D

modeling technology in general and specifically with it ACIS product.

Spatial competes with others firms trying to win the adoption race for formats and
approaches in mathematical 3D modeling and animation. It also competes with
some of its adopters where the line is gray between what Spatial provides and
what some of its competitors provide (e.g. Autocad).
F. Describe the four successful rounds of venture financing (A through D) achieved by
Spatial Technology in terms of sources and amounts. What additional financing
sources have been used?

Round A for $1,000,000 was raised from Nazem & Co. shortly after organization. Round
B for $7,300,000 was from institutional investors and a potential customer (Hewlett
Packard). Round C for $3,100,000 was again raised from the institutional investors.
Round D for $2,742,557 was raised from 3 of the institutional investors and Hewlett
Packard.

G. Conduct a ratio analysis of Spatial Technologys past income statements and

balance sheets. Note any performance strengths and weaknesses and discuss any
ratio trends.

As the project at hand will involve valuing Spatial, we have chosen to concentrate our
ratio analysis on percent of sales. The following is the historical presentation of the
income statement and balance sheet percent-of-sales ratios.
(answer at table)

H. Use cash flow statements for Spatial Technology, Inc. to determine whether the
venture has been building or burning cash, as well as possible trends in building or
burning cash.

It is pretty clear that the venture has been burning large amounts of cash in the past three
years. Although the operations have recently been a net source of cash, recent investing
and debt reduction activities have consumed most of the cash provided by operations.
Spatial is positioned to go cash flow positive.

I. Discuss possible reasons why the plan by Spatial Technology for an initial public
offering (IPO) of common stock at the end of 1992 was withdrawn.

The primary issues resulting in pulling the 1992 IPO were an insufficiently broad
management team and instability in Spatials core product along with customer
frustration and complaints.

J. Describe the IPO market conditions in 1996 and discuss possible reasons why the
proposed IPO at a price of about $10 per share planned for October 1996 and
involving Dain Bosworth as lead underwriter failed.

The official reason for the failure was insignificant demand for the shares. However,
there were several contributors to the underwriters failure including insufficient
knowledge of the investor base prior to attempting to close the book. There appears
to be some belief by Spatials management that the investment bankers did not
sufficiently understand the technology and business model to provide a proper pitch for
Spatial (to attract the right clientele of investors).
 K. Evaluate the compound return on investments made at startup, Round A, Round
B, Round C, and Round D if the acquired shares eventually sell at $10 and $5.
Evaluate the compound return on all investments of each existing investor.
Analyze the incentives of each investor and founder for taking the Cruttenden
Roth offer to execute a $5 IPO.

This exercise can be done in a number of ways depending on how in depth the instructor
wants the students to go. We typically explain the use of the XIRR function which
conducts an IRR analysis given specific dates (rather than assuming columns are exactly
one period apart). In Excel, this function is found in the Analysis Tool Pack add-ins.

This analysis treats Sowar's warrants as part of his return on investment (rather than as
compensation) and treats all options as exercised. As 19,999 of the options have exercise
price of $5, the answer will be the same if one assumes that these are not exercised in the $5
scenario.

7/15/86 9/15/86 6/15/89 4/15/91 2/15/9 10/10/96 XIRR

3
Sowar $ (2,000.00) $ 1,069,996.50 (at $5) 84.62
%
$ (2,000.00) $ 2,819,991.50 (at $10) 102.93
%

L. Using the provided financial statements as a starting point:

1. Prepare and present a DCF valuation and pro forma financials with
five years of explicit forecasts using license fees and royalties growth
rates consistent with recent history (e.g., two to three years) at
Spatial.
2. Modify your analysis to consider a more successful scenario where
Spatials main revenue sources (combined) grow at 50 percent for
five years and then flatten to a more sustainable growth rate.
3. Prepare and present DCF valuations and pro forma financial
statements (five-year explicit period) that justify a $10 and a $5
share price at the IPO. Make sure the ratios embedded in your
projections conform to reasonable operating ratio assumptions.
4. In all cases be sure to explain your modeling assumptions on revenue
and costs and provide a summary comparison of the four scenarios.
(answer at the table)
M. Discuss the $5 and $10 IPO prices for Spatial within the context of
comparable firms and their multiples. (There are some glimpses of multiples
in the case materials, but you may wish to use some outside reference
materials. Please state your sources.)

We find a $5 valuation possible but only under optimistic

scenarios and improved ratios. The $10 valuation is typically seen as impossibly
optimistic. This is a good example of how softer valuation methods based on
temporarily inflated P/E or other multiples may not provide values that can be
supported by any foreseeable rational projections for the firm. It is important,
however, that students see how the simple comparisons (like P/E multiples) and
more rigorous financial projections interact with each other for a more balanced
overall view of the firms prospects and value.

N. Prepare an executive summary discussing the events and decisions (technological

and financial) leading to its current situation, the options it currently has, and
you recommendations for Spatials near future. Would (could) you have done
anything differently overall view of the firms prospects and value ?

Typically, the students executive summaries discuss the implausibility of the $10
valuation and the serious concerns related to achieving the future required to
substantiate a $5 valuation. Students also discuss Spatials turbulent past with its
products and customers and its managerial challenges (which continued after the IPO).

O. Take a position on whether you would recommend the $5 IPO. Take a

position on whether, as an investor, you would have purchased shares in the $5
IPO.

Answers will vary, but some students will recommend investing at the $5 price.
Perhaps surprisingly, some will say they wouldnt personally invest but might
recommend it to others. Of course, this could be the beginning of an interesting
discussion on exactly why they would arrive at such a potential conflict.

P. Discuss what you believe will be the strategic (product lines, licensing,
competitors, etc.) outlook for Spatial and what you believe will be the financial
markets view of a publicly traded Spatial Technology.

In many cases, students will research the post-IPO Spatial, which was publicly
traded for several years before being acquired. The market that Spatial tried to
develop has continued to provide opportunities, challenges and segmentation.
The financial markets treated Spatial somewhat typically for a while with ups
and downs before settling, like many recently IPOd firms at a price significantly
below the IPO price. Spatial was subsequently acquired but has continued in its
mission to the current time.