Berkshire Threaded

Background of Harvest Road

4.1 Harvest Road was established in 1996 and publicly listed on the Australian Stock Exchange in September 1999. It has a market capital of $15 million with 90 million shares issued in the market (at the price of $0.165 per share as at 7 April 2007 - refer to Appendix A). Having its headquarters based in Perth, Western Australia, Harvest Road has branch offices in Sydney, Melbourne, Canberra and Mexico City.

4.2 Harvest Road specializes in the field of information technology ("IT") and is involved in the development of specialised content management systems (i.e. online learning and knowledge management systems) for use in organisations. It has an impressive client portfolio which includes government bodies (i.e. Latin American Institute of Educational Communication - a United Nations organization), multi-national companies as well as universities.

4.3 The company is also the developer of the HarvestRoad Hive's®, a software designed to meet the functional and implementation demands of various national and state-based curriculum content management requirements. On this note, the HarvestRoad Hive's® was used in integration with WebCT, WebMentor and Blackboard LMS which are deployed at Open Learning Australia (a consortium of seven universities - including Griffith University and Murdoch University) and several other universities in the United Kingdom and the United States of America.

Analysis of financial statements of Harvest Road

4.4 In order to evaluate the business success and long-term business viability of Harvest Road, it is essential to perform analysis on the company's operating performance (i.e. efficiency and effectiveness in utilizing resources to produce returns on investments) as well as financial condition (i.e. measure of ability to satisfy obligations). This is performed by analyzing the profitability, asset management turnover, liquidity and gearing ratios, coupled with other information that is available on the company. On this note, it is also crucial to understand the dynamics of such software development companies and the risks involved in conducting research and development.

Profitability

4.5 First and foremost, it is observed that the net profit margins of Harvest Road were on the down side in the past four out of five years (between 2002 and 2006). As recorded, the net profit margins were -11.97% in 2006, -69% in 2005, 29.31% in 2004, -234.70% in 2003 and -232.13% in 2002 (refer to Appendix B). Seemingly, the figures suggest that Harvest Road had performed adversely in 2002 and 2003 in generating profits from its operations. It was then followed by a tremendous rise in net profit margin rise in 2004 (i.e. improvement of 264.01% from 2003 to 2004) and two subsequent years of negative returns.

4.6 Based on the information that is available, we construe that the vast improvement in 2004 net profit margin was due to the successful development of the HarvestRoad Hive® in 2003 (refer to Appendix C) and the subsequent introduction of the product to various corporate clients such as the Mexico's Latin American Institute of Education Communication ($10 million deal which is payable in a period of 3.5 years) and IBM. This point is supported by the substantial increase in the trading revenue (i.e. from $1.064 million to $8.979 million - refer to Appendix D) and receivables between 2003 and 2004 (i.e. increased from $0.145 million to $5.44 million - refer to Appendix E).

4.7 Nonetheless, the net profit margin had subsequently decreased from 21.31% in 2004 to -69% in 2005. This could be due to the fact that Harvest Road had focused on establishing of new markets in Britain and Europe and resulted in spending of additional funds on marketing activities instead of generating revenue (refer to Appendix F). In this instance, although the revenue made in 2006 could not compare evenly with the figure in 2004, Harvest Road may have the potential of generating more profits in the near future as new markets are opened. On this note, it is also apparent that the success of Harvest Road is closely relevant to the development of new software products.

Asset Management Turnover

4.8 Next, the Balance Sheet shows that the net assets of Harvest Road were in line with the fluctuation of the revenues earned between 2002 and 2006. In this instance, the ratios of total assets turnover indicate that the company had achieved improvement in 2006 as compared to 2005 (i.e. improved from 65.74% in 2005 to 98.32% in 2006). This implies that the company might have made better use of it's assets in generating of revenue as compared between the two years.

Liquidity

4.9 In terms of liquidity, calculations show that Harvest Road had maintained its current ratio at a 'healthy' range (i.e. between 2.45 and 2.76) in the past three years (2004 - 2006). On the book, such figures may imply that the company is sufficiently liquid and is able to meet its short-term obligations (i.e. current assets are sufficient to cover current liabilities).

4.10 Nonetheless, the cash ratios illuminate the opposite. Conversely, the cash ratios suggest that Harvest Road may face liquidity predicament as the actual cash liquidity of the company has constantly been below one (refer to Appendix G). In this instance, the Balance Sheet shows that majority of Harvest Road's current assets were actually receivables rather than cash or cash equivalents. In other words, current liabilities were incurred correspondingly