Are there hidden dangers lurking at D4T4 Solutions or a growth opportunity?

D4T4 Solutions (or, used to be known as IS Solutions) is a data company that deals with data collection, management, analytics and (of course) solutions.

Apart from these broad keywords, I’m no tech geek. My skill relies on making sense of the company’s financials.

In this post, I will format point by point on what I know about D4T4 Solutions.

 

Business Growth

First, this is a small software company that is averaging 10% in revenue growth for the past 13 years. A little slow for a software firm with current revenue of £17.67m.

 

The Costs of Hiring  

Second, like all software businesses, the costs of hiring the right talent is crucial and doesn’t come cheap.

Currently, D4T4 is paying each staff an average (including bonuses) roughly £67k with each member contributing sales of over £164k each for the business.

Here is the change in costs per employee and sales per employee: –

 D4T4 staff costs and productivity

Like all “light-capex” businesses (apart from making acquisitions), wage cost is the main costs of the business. Now, wages account for 40% of total sales from 58% in 2004.

Acquisition

Third, they made a big acquisition in Celebrus Technologies for £7.5mln. A look at Celebrus Technologies accounts show for £7.5m, D4T4 is getting: –

£2m in revenue;

-£6.3m in net income*.

*Most of this net income comes in the form of forgiveness of group undertaking amount payable to Speed-Trap Holdings Limited, which came to £6.8m. (Whatever that means!)

Therefore, the only data that is reliable is Celebrus’s revenue.

The one worrying thing about this acquisition is the amount of goodwill that was required to make this purchase. D4T4 actually bought Celebrus for £8.5m because £1m worth of shares contingent upon no warranty claims being made.

So, Celebrus net assets were valued at £836k, which means goodwill amounts to £7.68m.

But, the Chief Executive did say that Celebrus is integrating well with D4T4: –

In that case, the acquisition looks justified on the basis that Celebrus is a growth subsidiary and D4T4 Solutions will recoup the initial investment in under ten years.

The Celebrus acquisition (according to management) is paying “dividends”, with a 48.8% growth from last year. Now, it represents 28% of group sales, up from 18%, meaning sales are at £5m, more than doubled from two years ago.

 

Revenue Breakdown

Fourth, the breakdown in revenue on D4T4 shows they are getting over 50% of sales from projects that are worth £9.47m, down from £10.67m last year. 2015’s projects were £6m.

But, as the Chairman alludes, these projects can turn into recurring revenue streams, which currently amounts to £4.5m, down from £5m, down 10%.

Over two years, projects grew from £6m to £9.47m, but recurring revenues fell from £4.7m to £4.5m.

So, the immediate assumption is (at least) the new projects are likely to be “one-off” events.

One bright spot is their licensing division that grew by 54% to £3m in 2016 and another 25% to £3.7m this year. Despite that, overall sales still fell by 5%.

 

Another thing is they have ONE major customer that accounts for £8m in sales for the last two years. If that contract ends, the shares could crash. It brings me back memories of another company called “MBL Group”, where they had one major customer called Morrison that accounts for 70% of their sales. One day contract was closed and MBL’s shares nosedive with me sitting on a 70% loss!

 

If you look at the geographic segment, we see the UK Operations taking a big hit when sales from that region fell from $4.9m to £2m. But, Europe saw an increase of £1.7m from last year.

Whether operations are moving towards Europe because of (i.e. “BREXIT”) or this is a natural occurrence, we don’t know.

Did D4T4 Solutions deliberately push costs towards 2015?

Fifth, if we study their profitability ratios, it raises this concern.

D4T4 Solutions profitability ratios

The returns did fall to 5% in 2015 from the usual 12-15% for over a decade.

Another perspective, both the accounting profits and cash profits are leaning towards a YES answer.

D4T4 profit dips

It looks unnoticeable on the above chart, but net profit did dip from 793k in 2014 to £532k in 2015, despite the period stretching 15 months! The same happened to net cash profit when it dipped from £750k profit to £208k loss!

If you adjust these costs, then 2016 see lower earnings and the profitability ratios should report 15%, instead of 20%.

In 2017, earnings were helped by an increase in receivables of £1.5m, despite sales dipping. That was reflected in the cash statement when net cash earnings fell to £2.53m from £6m.

 

 

What do the Interim Results and Trading Updates tell you about D4T4 Solutions?

Sixth, D4T4 Solutions isn’t so confident with the trading update suggesting that revenue is coming in below last year at circa £17m down from £18.6m. Well, the annual results are sales of £17.6m.

 

This is despite the company reporting interim sales growth of £10m, up from £8.47m.  If you look at their interim balance sheet, trade receivables are responsible for the sales increase, as it jumped from £2.7m to £6.97m in 12 months, resulting in an extra £4.2m in credit sales!

Another suspicion is interim net profit in 2016 was £1.82m up from £1.25m. But the difference is the reporting of net cash loss at £2.44m (thanks to the increase in receivables) from last year net cash profit of £2.5m.

Also, that £5m cash balance has disappeared to £1.45m.

Remember the above focuses on the interim report.

BTW, Cash balance did rise from £5m to £6.2m, so it could be down to seasonal.

D4T4 Solution Forecast

Seventh, analysts are forecasting sales for 2018 of £23.2m. But if you look at 2017’s sales forecast, they were expecting £18.45m.

 

 

Share Price Forecast

Despite management saying things are looking rosy (except their latest trading update), things are being affected by macroeconomic factors.

Base-Case Scenario; – The shares will hover between £1.40 and £1.80 in the next 12 months. (Chance of occurring is 35%) The results were a minor setback because of the extraordinary performance in 2016. But if analysts forecast for 2018 is accurate, then the shares will continue appreciating.

 

Best-Case Scenario; – The shares trade between £1.70 and £2.10 in the next 12 months. (Chance of occurring is 20%) It is the case of the bull market ignoring the fundamentals, where mediocre shares are enjoying higher valuation.

 

Worst-Case Scenario; – The shares could trade back towards their 200-day moving average of £1. (Chance of occurring is 60%)

As investors in the past two years put their faith in management and believing in the story (like in 2016). Now, they have lost some confidence. The interim results were the first clue because sales were over £10m, but the full-year is below £18m. Whereas in 2016 interim sales were £8.47m, but the full-year came to £18.45m.

The difference is the business relies on the second-half for better performance.

So, don’t be surprised if the shares sold off from current levels.

 

Final Thoughts

D4T4 Solutions look promising on the surface but dig deep and you expose some weaknesses by crunching ratios and spotting trends.

Today, results were a mixed bag, which is why the shares are getting sold off heavily (down 11%).

These are the concerns: –

  1. Earnings are being slightly distorted by changes in receivables and payables.
  2. Recurring revenue isn’t growing meaning projects are “one-off” gigs.
  3. Cash Balance volatility.
  4. UK operations seeing a major decline?
  5. Slow growth from a small software firm.

But, my major concern is they rely on ONE major customer that accounts for 50% of group sales for the last two years. If that contract disappears, D4T4 shares will tank.

 

On the flip-side, we can say a few positive things: –

  1. Business is growing in the last decade;
  2. The Celebrus acquisition is yielding positive integration (sales of £5m, up from £2m in two years);
  3. Licensing division is growing lightning fast (50% and 25% growth in the past two years);
  4. Low debt levels;
  5. Despite, slight earnings manipulation, they are much higher than two to three years ago. This is evident from net cash earnings.

 

Overall, I think this business is too risky for me (partly because of the one customer accounting for 50% of sales).

Also, I like to see more recurring revenues, but with management indicating some uncertainties, I would advise not to invest at current share price.

This may not be a popular post, but it is a different opinion.

If like this post, then please share your thoughts and subscribe to the website. Thanks!

 

 

Disclosure

The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.

Finally, the writer does not own the company’s stock, unless stated otherwise.

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