Steps Down With Immediate Effect – Diploma and IDOX

The phrase “stepped down with immediate effect” is used by companies to announce the instant departure of a director. It usually simply means they have been fired. It is of course frequently bad news as it often follows past uninspiring events and it means that the company has to scratch around for a replacement or ask another director to step into the breach.

This week I saw such announcements on a couple of my holdings. The first was Diploma Plc (DPLM) where the CEO Richard Ingram was the victim. The announcement also said “the Board believes that a change in the CEO is in the best interests of the Company and its shareholders”. The surprising aspect here was the Mr Ingram had only joined the company a few months ago and the trading announcement issued on the same day was positive. Mr Ingram had been recruited to replace long-serving CEO Bruce Thompson who retires at the end of September. Clearly the recruitment process seems to have failed but there is always a high chance of failure when recruiting a senior position from outside. John Nicholas, the Chairman, is taking over on an interim basis rather than Mr Thompson. Better to admit a mistake sooner rather than later.

The share price initially dipped on the morning of the announcement, but then rose as much as 4% during the day. Clearly some investors saw it as good news.

This morning there was a similar announcement this morning from IDOX (IDOX). Long-serving CFO Jane Mackie has resigned and leaves the board with immediate effect. That’s perhaps not greatly surprising as she was the CFO in the period when IDOX had to back-track on some rather aggressive revenue recognition practices. A new CEO has recently been appointed so a change in CFO was not surprising. However Ms Mackie is not actually leaving the company until February 2019 which certainly gives the company plenty of time to find a replacement.

The share price of IDOX has fallen by 1.8% today at the time of writing, but I rather judge this as positive news so it might recover I suspect in due course unless there is other news announced. The departure of a finance director sometimes means they have just given some unexpected bad news to the board. I do recall in my early career to suddenly finding my finance director boss was departing for that very reason after a stormy board meeting. He was rather easy going so it was great to be junior to him, but that character defect did not impress the board.

Let us hope that is not the situation at IDOX.

It is unfortunate for investors that such announcements tend to be somewhat cryptic in nature. Often a “settlement agreement” with the departing individual has yet to be proposed or agreed so they don’t want to prejudice the legal negotiations by saying more. But of course they might well inform their major investors while private investors are left guessing.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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It’s a Bleak Mid-Winter

It’s a bleak mid-winter, everybody is hunkering down against the icy winds, Royal Mail have given up delivering post even in the London suburbs, and retailers are suffering. Well no, actually it’s the second day of Spring but the first was the coldest one on record. It’s not surprising that many people have a jaundiced view of the science of global warming.

But the stock market is drifting down and the news from many companies is dire. Let’s review some of those to start with. Note: I hold or have held some of the companies mentioned.

Safestyle (SFE) sell replacement plastic windows. You would have thought households would be rushing to replace their tired and leaking windows in the bad weather but apparently not. On the 28th Feb they announced a profit warning and the share price fell 37% in the next two days. Is that because of difficulties in installing in the bad weather? No, that will come later no doubt. The problem was lack of order intake so far this year. The real problem is “the activities of an aggressive new market entrant” in an “already competitive landscape” – the latter presumably referring to consumers cutting back on big ticket items. Historically the company showed great return on capital and good profits but the old problem of lack of barriers to entry of competition seems to be the issue.

Carpetright (CPR) also issued a profit warning yesterday. They now expect a loss for the year and blame “continued weak consumer confidence”. It seems they need to have a chat with their bankers about their bank covenants, but the latter “remain fully supportive”. I suspect the real issue here is not consumers (most buyers replace carpet in one room at a time so they are not exactly big purchases) but competition, including from Lord Harris’s son (Phil Harris was the founder and Chairman of Carpetright for many years). Other carpet suppliers (such as Headlam which I hold) have not seen such a major impact, but perhaps they are not as operationally geared as Carpetright. Or the bad news will come later.

Many retailers have faced a changing market – the market never stands still, with internet sales impacting many. Both Toys-R-Us and Maplin have gone into administration. The latter have no doubt been particularly hit by the internet and Amazon, but they have also suffered by private equity gearing up their balance sheets with very high levels of debt. Neither seemed particularly adept at keeping up with fashion. Might just be a case of “tired” stores and dull merchandise ranges. But why would anyone buy from a Maplin store when they could order what they needed over the internet (from Maplin, Amazon or thousands of other on-line retailers) and get it delivered straight to their door in 24 hours? In addition, many such on-line suppliers avoid paying VAT so Maplin was going to suffer from price comparisons.

But there has been some better news. IDOX (IDOX) published their final results yesterday – well at least there was no more bad news. They issued previous profit warnings after a dreadful acquisition of a company named 6PM, and the CEO, Andrew Riley, then went AWOL on health grounds. In addition there were problems with inappropriate revenue recognition, a common issue in software companies. Mr Riley has now definitely departed permanently and former CEO Richard Kellett-Clarke continues to serve as interim CEO.

The latest financial figures report revenue up 16% for the year although some of the increase will be from acquisitions. The profit figures reported on the first page of the announcement are best ignored – they talk about EBITDA, indeed “adjusted EBITDA” and “adjusted earnings”. I simply skipped to the cash flow statement which indicated “net cash from operating activities” of £13.4 million. That compares with a market cap at the time of writing of £152 million, so the cash earnings yield might be viewed as 8.8%.

They did spend £24.3 million on “investing activities”, mainly financed by the issue of new shares, last year and much of that might effectively have been wasted. But cash flow going forward should improve. Unadjusted diluted earnings per share were very substantially reduced mainly due to increased overheads, higher amortisation and high restructuring and impairment costs. These certainly need to be tackled, but the dividend was increased which shows some confidence in the future.

The share price perked up after the results announcement but some commentators, such as my well-known correspondent Tom Winnifrith, focused on the balance sheet with comments such as “negative current assets” (i.e. current ratio less than one) and less polite phrases – he does not pull his punches.

Any accountant will tell you that a company with a current ratio (current assets divided by current liabilities) of less than 1.4 is likely to go bust simply because they risk running out of cash and will not be able to “meet their debts as they become due” (i.e. will become insolvent).

Am I concerned? No because examination of the balance sheet tells me that they have £19.8m of deferred income in the current liabilities (see note 18). This represents support charges which have been billed in advance for the year ahead. Such liabilities are never in fact crystalised in software companies. So deducting that from the current liabilities results in a current ratio that is a positive 1.7.

The balance sheet now does have substantial debt on it, offset by large amounts of “intangible” assets due to capitalisation of software development costs which many folks would ignore. The debt certainly needs to be reduced but that should be possible with current cash flow, and comments from the CEO about future prospects are positive. That is why the share price rose rather than fell I suggest on the announcement, plus the fact that no more accounting issues had been revealed.

There are promises of Spring next week, so let us hope that this will improve the market gloom that seems to be pervading investors of late. Even retailers may do better if shoppers can actually get to their shops. We just need the sun to come out for a few days and flower buds to start opening, for the mood to lighten but I fear my spring daffodils have been frozen to death.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Persimmon Directors, IDOX Profit Warning and Transplants

This morning house building company Persimmon announced that Chairman Nicholas Wrigley and Non-Exec Director Jonathan Davie were departing. The company says that both of them recognise that the 2012 LTIP “could have included a cap” and “in recognition of this omission” they have tendered their resignations.

Holders of Persimmon shares like me, or indeed anyone who has followed the debate on excessive executive pay, will be aware of the outrageous pay that has resulted at this and other companies because of the adoption of complex and aggressive LTIPs. Often these schemes have paid out unanticipated amounts, because the directors seemed not to understand their complexities or the possible outcomes. In the case of Persimmon it has meant that as much as 10 per cent of the value of the company has been paid out to the beneficiaries, allowing the CEO to pocket more than £100 million.

Neither of course did the shareholders understand these schemes and hence voted in favour of them regularly. So long as the company financial performance was good, some shareholders considered the payouts were justified. So the Board of Persimmon “believes that the introduction of the 2012 LTIP has been a significant factor in the Company’s outstanding performance over this period, led by a strong and talented executive team”. No mention of the main factors that have driven performance – high house prices supported by interest rates lower than they have been for thousands of years, the rapid growth in households from immigration and other factors, the Governments “help to buy scheme”, and other contributors. When companies are making hay, few shareholders will pay much attention to remuneration schemes or vote against them which is surely an argument for Government intervention in this area.

The company has appointed a new Chairman of the Remuneration Committee, who is Marion Sears. Will policies and practices change as a result? I doubt it because back in 2015 I argued with her at the AGM of Dunelm where she chaired the Remuneration Committee and subsequently exchanged emails on the complexities of the bonus scheme at that company. I also said to her that it was “difficult to understand the implications of the new policy on the overall remuneration of the senior executives and its sensitivity to different scenarios” and argued that the performance targets were not stretching.

I have come to the conclusion that all traditional LTIP schemes are dysfunctional and I therefore vote against them. There are better ways of recognising superior management performance.

IDOX

Another company I have held for a long time is AIM listed software company IDOX. This company was very successful under the leadership of former CEO Richard Kellett-Clarke. Two days ago the company issued a profit warning (not the first) saying that results for the year ending October 2017 will be delayed until next February. The announcement indicated some concerns about revenue recognition, complicated by the “sudden absence” of the CEO, Andrew Riley, on sick leave.

This is the kind of announcement that investors hate. No real details, and no information on when or if Andrew Riley might return. All we know is that the EBITDA forecast is reduced again to approximately £20 million. But at least we know that Kellett-Clarke is back as interim CEO.

There were concerns expressed by me at the last IDOX AGM about revenue recognition, high debtors and the apparent offering of long payment terms to customers (effectively providing them credit). I opined at the time that this was no way to run a software company because even if the customers are credit worthy, projects can run into unforeseen difficulties causing the customers to argue about the bills. I reduced my holding in the company substantially at the time as a result although it’s still one of my bigger holdings. Leon Boros also made negative comments about cash flows at the company and some investors were shorting the stock at the time – they are probably doing so again.

Comments on bulletin boards also raise the issue about the restating of accounts at 6PM, an acquisition that IDOX made in December 2016. But this is old news. Reference to accounting restatements at 6PM were made in the offer document (page 15, where it says for example that “the Directors expect that the value of the net assets of 6PM under IDOX accounting policies will be reduced materially”). Indeed 6PM subsequently filed accounts in Malta where they are registered showing substantial losses in 2016 and restating the 2015 and 2014 numbers. I thought the acquisition was a dubious one at the time for various reasons and voted against it. But these adjustments were surely known about earlier in the year so the latest announcement suggests some other problems.

Needless to say, with all these uncertainties and lack of clarification from the company (which we may not get until February it seems), all the likely share buyers have disappeared because it becomes very difficult to value the business. Simply too many unknowns. I will be encouraging the company to clarify the position a.s.a.p., but the “transplant” of the CEO, even on a temporary basis, might provide some reassurance that the problems will be sorted.

On the subject of transplants, one public consultation that is of personal interest to me is the Government’s consideration to change the default on organ donation to be an “opt-out” system as opposed to the current “opt-in” arrangement. In other words, unless you had specifically opted out, then it would be assumed that you had no objection to your organs being used for transplantation. Relatives may still be consulted though.

It is hoped that this will increase the number of transplants that are performed. There are a large number of kidney transplants performed each year, with lesser numbers of liver, pancreas, lung and heart transplants. The NHS says that 50,000 people are alive today who would not otherwise be so as a result (including me of course). But there are still long queues of people awaiting transplants. In the case of kidney patients, the alternative of dialysis reduces quality of life substantially and also reduces life expectancy significantly so it is a very poor alternative. Dialysis just keeps you alive, but a transplant gives you a new and better future.

For my financially informed readers, you also need to bear in mind that transplants save the NHS money because maintaining a kidney transplant patient costs a lot less than looking after dialysis patients.

Scotland, Wales and other countries have introduced opt-out systems already. Go here to respond to the public consultation on the matter: https://www.gov.uk/government/consultations/introducing-opt-out-consent-for-organ-and-tissue-donation-in-england

I hope readers will support this change to the law.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Abcam AGM, Cambridge Cognition, Ultra Electronics, Wey Education and IDOX

Yesterday I attended the Annual General Meeting of Abcam (ABC) in Cambridge as I often do as I have held the stock since 2006. Share price then (adjusted for consolidation) was about 50p and it’s now about 950p so I like most investors in the company, I am happy. Alex Lawson will be doing a full write-up of the meeting for ShareSoc so I will only cover a few points herein.

One shareholder expressed concern about the rising costs. The company is clearly making heavy investments in new infrastructure and more management. Although revenue was up 26.5% last year, earnings per share were only up 11.8% (unadjusted) and operating margin has been falling. Also Return on Capital Employed (ROCE) has been falling – only 12.3% last year when it used to be in the high teens.

Apart from opening a new building next year, they are implementing an Oracle Cloud software solution to replace their historic purpose-built legacy software systems. The total cost of that project is £44 million (see page 23 of the Annual Report) when profits last year were only £42 million post tax. In other words, all of last years profits could be taken to be consumed by this project. This project has been running for some time and I have asked questions about it in previous years. This year I asked: “is the project on schedule and on budget”. I did not get a straight answer. But it was said that initial cost estimates have expanded, and additional modules been added (for example warehouse management). It should “go live” in the current financial year. From those and other comments made, I got the impression that this is a typical IT project that is too ambitious and costs are escalating while delays have arisen. Those “big bang” IT projects rarely go according to plan, but management are often suckers for them.

Now it may be arguable that older systems need replacing (for example, the CEO mentioned it was impossible to bill in Swiss francs that at least one customer would prefer), and maintaining old code was clearly proving to be difficult. The massive investment in this area alone may be justified by the company’s ambitions to “double the 2016 scale by 2023 by investing in operating capabilities” as the CEO mentioned. The expectation is that growth will improve revenues and hence margins in due course.

One more way that costs have been rising is increased pay for management. CEO’s pay alone up from £614k to £1,378k in the last year (“single figure remuneration). In addition, I commented negatively on the fact that the LTIP target had been adjusted for the “scale and complexity of the transformational programme” of the new ERP system implementation, i.e. costs are much higher than expected so the LTIP target has been made easier to achieve!

At least Louise Patten (acting Chairman now after departure of Murray Hennesey for a proper job, and Chair of the Remuneration Committee) admitted later that LTIPs are often problematic but institutions like them. LTIPs at Abcam have rarely paid out, and management at many companies seem not to value them highly. There are better bonus scheme alternatives.

I also spoke briefly to a representative of Equiniti, the company’s registrar, about the difficulty of voting electronically. He is to look into it. Amusing to see the company slogan on his business card is “Our mission is making complex things simple”, exactly the opposite of my experience!

In the morning I also visited Cambridge Cognition (COG) who have offices in the village of Bottisham east of Cambridge. Although their offices are in what appear to be wooden huts, they are well furbished. The company specialises in cognitive health (brain function). Sixty per cent of its revenue comes from clinical trials for pharmaceutical companies, thirty per cent from research institutes and academia and ten per cent from healthcare and consulting.

On clinical trials they do about 15 deals a year so by their nature they are lumpy one-off deals. Total revenue was £6.8 million last year. Before last year revenue was flat but it grew last year and is forecast to grow this year.

A lot of pharma companies are actively researching alzheimers and other degenerative brain diseases, and developing products to assist – as the population ages such diseases are becoming more prevalent. Cambridge Cognition’s technology relies on historically well validated studies. The company provides a lot of consulting support in clinical trial sales.

Such deals include 30 to 40% of software which is billed and paid for on normal 30+ days terms, with the services paid for as provided. One issue that arose is that their accountants are likely to require them to change so as to allocate the software revenue over future periods due to IFRS 15 because they host the software. This is the same problem that Rolls-Royce have tripped up on, and it is also an issue at Ultra Electronics (ULE) according to a report in the FT yesterday. That company also issued a profit warning on Monday and the share price fell 19.5% on the day. I used to hold it but not of late. The FT writer suggested it was time to “exit”. Cambridge Cognition did suggest though that they would not need to restate last years accounts, and the change might actually smooth their revenue figures. IFRS 15 is an important correction to historic aggressive revenue recognition policies in some companies.

Otherwise Cambridge Cognition have some interesting technology – for example using smart watches to monitor brain function during the day, and using speech recognition to perform analysis. Whether these can be turned into profitable markets remains to be seen. One of the original ideas in the company was to provide their software on i-Pads for general practitioners to use in diagnosis but that never took off due to changes in purchasing arrangements in the NHS who of course are notoriously difficult to sell to (and budgets of late for technology seem to have been cut). If anyone wants more background on Cambridge Cognition you are welcome to contact me.

A few weeks ago I purchased a minute number of shares in Wey Education (WEY). Minute because although it looks an interesting business I thought the share price was way too high on any sensible fundamental view. This morning the company announced a share placing to make an acquistion. This will be at 22p which is a 33.3% discount to the price on the 14th November according to the company. Clearly advisors and institutions took the same view as me on the previous share price. Has the share price collapsed this morning as a result? It’s down but not by much so far. Wey Education does look like one to monitor (which is why I bought a few shares) but I think I’ll stand back from the speculation for the present while the market is so twitchy.

This looks like one of those hot technology stocks that are all the rage of late (the company provides education over the internet as an alternative to school attendance). But investors are clearly getting more nervous about many of those stocks in the last few days – it’s no longer “keep buying on momentum” as some share prices have fallen back from their peaks (Abcam is one example), so it’s now sell, sell, sell. And if a company indicates that the outcome for the year will not be as good as the optimistic broker forecasts suggest, as IDOX did mid-afternoon yesterday, then the share price gets hammered. Announcements mid-afternoon of this nature are never a good idea. Interesting to note that Richard Kellett-Clarke is to remain on the board after all as a non-executive. He was previously CEO. That might inspire more confidence in the business as these kinds of hiccups did not occur during his regime.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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