Information technology company PS&C Ltd (ASX: PSZ) recent first half results announcement was the perfect example of corporate spin at work – and one reason why investors need to be wary.
In a two-page announcement to the ASX last week, PS&C announced that statutory net profit after tax was $3.06 million for the six months to end of December 2015, compared to the previous year of $2.03 million (a 51% gain).
The company also announced a 2.5 cents per share fully franked dividend.
Shareholders and investors reading the announcement might have been dancing for joy – given the 51% increase in net profit and the lovely dividend.
However, what the announcement didn't mention was underlying net profit, nor what the previous period's dividend was. Had the company done so, shareholders would likely have quickly abandoned ship.
You see, this time last year, PS&C announced a 3 cent dividend, so a 2.5 cent dividend this year was a cut to the dividend, despite the company reporting a supposedly 50% increase in net profit. No reason was given for the dividend cut this half year.
Other income
Alas, PS&C included $2 million in 'deferred consideration adjustments' as 'other income' – which relates to the 'review of amounts due for earn-out purposes under the share purchase and sale agreements'. In other words, PS&C has agreed to pay out a certain amount to executives/owners of a number of its acquisitions. However, this should ring alarm bells for two major reasons.
In the past, PS&C may have overestimated the amount needed to be paid out, so this adjustment appears to reflect that the company now has to pay out $2 million less than originally thought. Does this mean that the reported net profit was inflated by $2 million, which would imply that underlying net profit fell by 50%?
(Note: I've ignored acquisition expenses of $759,000 given the company also reported $418,000 of expenses last year.)
Earn-outs are usually dependent on the acquired business meeting certain financial targets. For example, when PS&C acquired Pure Hacking in August 2014, the earnout for the 2016 financial year was based on the business generating 3 times the growth in earnings before interest and tax (EBIT) between the 2015 financial year and 2016, and deferred consideration stood at $9.5 million.
Does this mean one or more of PS&C's acquisitions are not working out quite as expected?
No adjusted or underlying earnings?
Additionally, PS&C hasn't reported an 'underlying' net profit amount. Most ASX-listed companies adjust their earnings and net profit to account for one-off items and give investors a 'true' look through at the performance of the business – although there's no requirement for them to do so.
There's only one likely reason why PS&C have – because shareholders wouldn't have taken kindly to a ~50% fall in underlying net profit. Maybe the company was already feeling bad about EBIT (before one-off items) sinking 20%?
Other red flags include negative operating cash flow of $559,000 for this half compared to $1.7 million in 2015 (and much less than reported net profit) and the fact that both the Security and Communication divisions reported big falls in EBIT.
Foolish takeaway
Firstly, I'll clearly state that PS&C are absolutely not doing anything wrong here. But without reporting an underlying net profit, not explaining the $2 million 'other income' in more detail, nor why the dividend was cut, I don't think the company is being completely open with shareholders. It's also possible that I've jumped to the wrong conclusions precisely because the company hasn't been totally clear.
Investors might want to avoid companies who are not totally transparent when it comes to their financial results whether they are small or large. If revenues and profit are being bumped up by one-off items, shareholders should also be informed of what the underlying net profit is.
