Shares in junior technology and cloud services business Bulletproof Group Ltd (ASX: BPF) tumbled more than 10 per cent this morning after the group warned underlying earnings before interest and tax could be down around 25 per cent in financial year (FY) 2016.
Bulletproof earns its keep by helping private businesses or public enterprises transition all their information technology operations and data management records to the cloud. This is a strong growth area with plenty of demand and the stock is up more than 50 per cent over the past year on the back of the company's decent track record.
However today's earnings fall is a significant concern, with it blamed on higher costs as it spent more on professional services teams that were underutilised over the second half of FY16 in particular. Staff costs tend to be high for IT consulting businesses, which is why they're reliant on a strong stream of new business to keep cranking revenues and earnings.
Bulletproof also identified its newly-acquired New Zealand IT services business as a disappointing performer over the second half of the year, due to project delays and a general lack of new business.
Greater investment in application product development also contributed to rising costs that did not translate into the revenue gains anticipated. The company flagged that it expects to see the fruits of these investments in FY17 as new products and services gain appeal with clients to hopefully boost margins and revenues.
It's also worth noting that the anticipated underlying EBIT of between $600,000 and $700,000 is before net acquisition costs and other financial liabilities revalued over the year. The company did assure investors it is cash flow positive for the year, although the underlying profitability of the business has evidently suffered a second half slowdown and the full year result is unlikely to be pretty.
IT consulting or contracting businesses like Bulletproof, Melbourne IT Limited (ASX: MLB) and Empired Ltd (ASX: EPD) tend to have high fixed costs in the form of well paid staff, which means when revenues flatten the effect on the businesses' bottom line can be severe.
Bulletproof still expects revenues to grow this financial year, although it remains in a competitive space with not much in the way of a moat even though it is reportedly a market leader in the provision of Amazon web services.
The stock sells for 35 cents after this morning's falls and the company will need to deliver on its ambitions for a stronger FY17 on the back of recent investments in order to justify today's valuation.
