EAX - Energy Action

[craft]

Hey craft

I'm willing to give these guys a pass. IMO, they are capitalising an expenditure that can be traced directly to a discrete revenue stream, instead of just apportioning some marketing spend or sales team expense to "customer acquisition" ala JIN. Like V, I like the cashflow statement more than the P&L.

I get the matching of expenses to revenues argument but....

I’m still having trouble with this.

To me wages are an expense when incurred and if you look at the deferred tax liabilities the tax office (hard task master) also treats them as a current expense.

There is no potential to claw back the wages if things don’t turn out as planned – so why put them on the balance sheet effectively as a pre-payment.

If the commissions weren’t capitalised but just run through as normal wage expenses (treated as the tax office treats it) then reported earnings would not have been +21% but – 15%. Not immaterial.

Perhaps the accounting treatment was to massage the headline number otherwise impacted by the change from trailing to upfront commission.

What was the pressure to swap from trailing commission which matched the employee rewards to the revenue timing for the company?

Obviously I’m with you on liking the cashflow statements – which brings me to another slight yuk in the EAX report. Note 20 the reconciliation from cash flow to profit isn’t as informative as it could be.

I agree my nitpicking here doesn’t necessarily change the whole investment thesis (have held) but Hmmmm all the same for me. Why should owners have to read between the lines to get the full picture.

 

[McLovin]

I get the matching of expenses to revenues argument but....

I’m still having trouble with this.

To me wages are an expense when incurred and if you look at the deferred tax liabilities the tax office (hard task master) also treats them as a current expense.

There is no potential to claw back the wages if things don’t turn out as planned – so why put them on the balance sheet effectively as a pre-payment.

I've never seen a power contract before but I assume that you just can't walk away from them, without some stiff penalties. So, as I said, it seems unlikely that they will have a lot of contract loss before the end of the amortising period. It's an area with a lot of grey in the middle. I guess you have to make a line call on whether you're comfortable with the accounting treatment or not, to me it doesn't seem like a red flag, although I'd be inclined to adjust the earnings in my workings in the future to try and see through it.

Can I ask you the question in reverse, when do you think it's appropriate to capitalise acquisition costs?

If the commissions weren’t capitalised but just run through as normal wage expenses (treated as the tax office treats it) then reported earnings would not have been +21% but – 15%. Not immaterial.

Sure, but there would be a fair bit of one offiness to this year's profit number if they had expensed all current contracts in this period.

What was the pressure to swap from trailing commission which matched the employee rewards to the revenue timing for the company?

This is an interesting question, perhaps the employees no that the secret ingredient is just cough medicine and they could easily replicate it?

 

[craft]

I've never seen a power contract before but I assume that you just can't walk away from them, without some stiff penalties. So, as I said, it seems unlikely that they will have a lot of contract loss before the end of the amortising period.

Nearly 90% of the contracted revenue is for their own activ8 energy efficiency business, not with third party energy retailers via the energy exchange business. I’m guessing but I suspect the active8 contracts are pretty loose if a customer wants out early.

It's an area with a lot of grey in the middle. I guess you have to make a line call on whether you're comfortable with the accounting treatment or not, to me it doesn't seem like a red flag, although I'd be inclined to adjust the earnings in my workings in the future to try and see through it.

Yep its grey – that’s why how it’s handled is so illuminating.

Can I ask you the question in reverse, when do you think it's appropriate to capitalise acquisition costs?

When costs incurred are above and beyond business as normal. Eax is just conducting business as normal as far as I’m concerned. Lots of companies sell their services under contracts with duration longer than 1 year most don’t capitalise employment expenses.

Sure, but there would be a fair bit of one offiness to this year's profit number if they had expensed all current contracts in this period.

How much one offiness? There’s no way I can judge realistic wage costs in the last half due to the accounting treatment. It would have been just so much cleaner to take the commission payment straight to the P&L and commented that ‘X’ amount of the lower profit was due to the change of employment arrangements.

In trying to work out the wage expense for the half I don’t like the 1.7 million commission payment being called one off as I’m sure some of this would have otherwise fallen into this period. Whilst being on things I don’t like about the cash flow – I don’t like the “strong operating cash flow up 27% statement” firstly because of calling the whole 1.7 one off and also if note 20 was more transparent it would be a lot more obvious that working capital ‘noise’ flatters this year’s cash flow by 2 million+ compared to last years. All up operating cash flow looks weaker to me plus I can’t work out what’s really happening with wages their major expense and it didn't look that good last half when It was more transparent.

Nothing I’ve raised is a definitive red flag and could easily be overlooked if you have confidence in management. but for me - In summing up, it's the Constitution, it's Mabo, it's justice, it's law, it's the vibe and ”” No, that's it. It's the vibe

This is an interesting question, perhaps the employees no that the secret ingredient is just cough medicine and they could easily replicate it?

Hmmmmm

ps

Just playing devils advocate, wouldn't have bothered looking into the reports if the company didn't have some appeal - have a good weekend.

 

[Ves]

Craft - still thinking about this, certainly not ignoring you.

But would like to say that the more I think about it, the less the $1.7 million "one-off" payment makes sense. It would be helpful if the company gave some more explanation on this matter and what it means in a "normalised sense."

It should seem that since commissions are now paid in full upfront, rather than on a trailing periodical basis that short-term cash flow will always suffer and their internal leverage and returns on capital will be reduced.

The rest of it is a can of worms in terms of what this means for the quality and stickiness of their client base and the competitive moat around their business. I think the only the answer can only be truly revealed by the passing of time and diligent monitoring of the situation by investors.

Very thought provoking - I did notice the numbers in my assessment of the annual report, but the issues surrounding them did not snowball into anything as in-depth as this. Gotta keep training that inverted thinking mechanism in my brain.

PS: I still need to listen to the audio presentation on BRR media. Not sure if McLovin or yourself have tried listening to it.

http://www.brrmedia.com/event/11468...r-nathan-cain-francis-chief-financial-officer

 

[craft]

Gotta keep training that inverted thinking mechanism in my brain.

Be patient. Get bitten on the **** enough times by managers that prefer to show you only the blossom but not the thorns and it comes naturally soon enough. On the flip side you have to be careful not to turn a mole hill into a mountain.

Slowness of information is an oft used argument against fundamental investing – we are supposed to be the last to know – but there are normally plenty of early warning signs if you scratch around.

You got set early, you have gained some altitude, and I’d dare say you have some more insight then those just looking at the headline number or the jump in the share price. That’s a good place to be, allows you to be alert but not alarmed. Sometimes Mole Hills are just Mole Hills.

 

[Ves]

Hey McLovin, you still following this one?

The market was really upset by the last result.... but looks like selling is picking up again two months or more later.

Been a lot in the media about federal governments and energy etc. and when you add the company's troubles with acquisition integration and suffering margins / contract renewals in their most profitable segment it doesn't look as rosy.

Any insight?

 

[McLovin]

Hey McLovin, you still following this one?

The market was really upset by the last result.... but looks like selling is picking up again two months or more later.

Been a lot in the media about federal governments and energy etc. and when you add the company's troubles with acquisition integration and suffering margins / contract renewals in their most profitable segment it doesn't look as rosy.

Any insight?

Hey Ves

Nope, I got out of this when it was still above $3. There was no single reason it was more just a lot of small things that in the end put me off. You still in?

 

[Ves]

Hey Ves

Nope, I got out of this when it was still above $3. There was no single reason it was more just a lot of small things that in the end put me off. You still in?

Yep, tempted to add a few more. Didn't really get as many as I wanted the first time it was around $2. Will look at it closely. I doubt it's going any where before March results (market has fallen out of love, hotcopper has dried up...)

 

[McLovin]

Yep, tempted to add a few more. Didn't really get as many as I wanted the first time it was around $2. Will look at it closely. I doubt it's going any where before March results (market has fallen out of love, hotcopper has dried up...)

I haven't kept up with them since I sold. Let me have a read up and see where there at.

 

[skc]

Any insight?

I spent a bit of time on this a few months back and decided it wasn't a stock worth investing at this time.

What appeared attractive in the first place was the reverse auction platform (or the AEX business)... but that business appears to be heading in the wrong direction. Every metric on page 15 of the half year presentation were worse off. The "energy sites" on the platform are becoming smaller, which means more sales staff at lower margins. Also, 77% of customers are due for renewal in the next 18 months... they call it the "renewal cliff opportunity" and I think it should be perceived as a major risk. How much lower can prices get by going through AEX again? I couldn't find any historical indication on renewal success rates...

The Activ8 feeds from the AEX business so it bears much the same risks.

The "PAS" business is just run of the mill stuff which is low margin busy work without little competitive advantage.

So all in all it doesn't fill me with confidence that the company in on track for growth.

 

[Ves]

Hi skc,

Good points on the renewal cliff.

As far as I remember the big high margin bucks is in the contracting business Activ8 (which performed poorly in 2014). It may be a lot lumpier than it seems.

Without looking any further, perhaps the recurring revenue "buzz" that they used to sell to investors is a bit misleading. Off the top of my head it has more to do with the contract monitoring & bill management side of things & there's also some spill-off from the reverse auction model.

What I'm getting at.... the profit split seems to be more geared towards the high margin activ8, rather than the segments with recurring revenue which are lower margin.

The newer acquisitions also looked a bit more working capital heavy too, hence lower dividend (but higher EPS which suits the remuneration hurdles ).

The price I paid I can justify ($1.80) but anything near $3-4 was far riskier for me so never added.

 

[shouldaindex]

On the watchlist.

Needs $2m H1 earnings in Feb to make things interesting, or else I think it's got flaws in it's business proposition (as mentioned above).

 

[Ves]

I'm out. The best parts of their business aren't making as much money any more.

edit: I also lost faith / trust in their management team, they seem to have more excuses than solutions (ie. "it will be better by next half").

 

[McLovin]

I'm out. The best parts of their business aren't making as much money any more.

edit: I also lost faith / trust in their management team, they seem to have more excuses than solutions (ie. "it will be better by next half").

You reckon the lack of profitability has something to do with this? Which is also why they changed the way they were remunerated because if they left that was it?

This is an interesting question, perhaps the employees no that the secret ingredient is just cough medicine and they could easily replicate it?

I agree about managment. Perpetually promising big things.

 

[Ves]

You reckon the lack of profitability has something to do with this? Which is also why they changed the way they were remunerated because if they left that was it?

It probably explains some of the erosion in their excess returns, but I also think the higher margin segments are much more volatile / lumpy, or even cyclical perhaps, than they first looked when it listed. The talk of "delayed contracts" seems to support this theory too. Perhaps their client base isn't as big as it looked and makes it harder for them to ride through these delays without earnings before materially affected.

My view is they have made acquisitions (low margin, high working capital businesses) and cash flow has stayed the same. They have taken a hit else where. Some did argue the "increased EPS" they advertised was linked to management remuneration incentives, rather than growing actual free cash flow (which it doesn't if you need more working capital).

 

[McLovin]

In Feb they gave guidance of $4.2m-$4.8m. Today it's been revised down to $2.6m-$3.0m. They're not getting much spark out of the much touted renewal cliff and they've also discovered some metering irregularities.