“While the business climate is definitely quite tough with strong head winds in Europe and the telecom industry experiencing bad times, we are confident of maintaining our leadership position in the Business Optimisation space. Our current quarter results have been impacted by the change in revenue recognition and this will get evened out during the year. This change was essential to be in line with the changes in our revenue model.”
This quote makes it sound like Subex may have changed their accounting policy. The impact of a change of accounting policy always needs to be reviewed with care, to determine whether the change has caused a superficial fluctuation in the reported results, or if it is being used to disguise some more fundamental shifts in business performance. And I would review the impact with care, if I could find any details about a policy change. Anywhere. And I looked. For longer than I would like. Whilst I do not expect an accounting policy change to make press release headlines, it is bad form to refer to it in the release, and then fail to give any more information. Or maybe the phrase ‘change in revenue recognition’ is being used to describe some other, vaguer, explanation for Subex’s poor results. If so, it fails to serve the purpose. There is no way to assess how much leeway to give management for a supposedly one-off poor result, if the explanation of the poor result is too vague to understand.
Because there is no additional data, I can only comment on the Q1 numbers as they stand. And to say they ‘stand’ is generous. It would be more accurate to say that the numbers are precariously leaning over and stumbling around, like a drunk on his way home from the pub. Q1 net income from operations fell to a meagre USD15m, a drop of 24.1% on the previous quarter, and down 25.7% year-on-year. Recently I blogged that Subex was in a stable orbit of generating roughly USD100m in annual revenue, but subsequent quarters will need to see a big improvement if Subex is to avoid a substantial decline in annual revenue. Product income continued to drive the overall numbers, contributing 86.5% of the revenue but precipitously fell by 26.4% since Q4 of FY12. In contrast, service revenues were flat.
Subex has previously made a habit of responding to disappointing sales figures by keeping a tight grip on costs, but they may have reached the point where further efficiencies are very hard to find. Operating expenditures were up by 4.9% since the previous quarter, due to a sharp rise of 16.1% for employee and subcontractor costs. In their press release, Subex indicated their products generated a positive EBITDA of USD1.07m, implying their services are a slight drag on EBITDA. Consolidated EBITDA was USD1m, but this seemed to be propped up by USD1.1m of ‘other’ income, which is not explained further and is up fourfold compared to the last quarter. The company’s loss before tax was USD0.7m, and the after tax loss was USD0.9m, about USD3m down on the profits generated in Q4 FY12.
These poor results follow some depressing action for Subex on the stock markets. Subex shares are currently trading at around 14 rupees (25 US cents), having fallen sharply in late July due to the dilution caused by issuing shares to address Subex’s ongoing FCCB overhang. However, this is only a footnote in a story of decline, with Subex priced as high as 50 rupees a year ago, and over 500 rupees in 2007.
Amidst the gloom, Subex were doubtless glad of some good news to please stockholders, and this comes in the form of a 5-year deal to provide the ROC RA and FMS to 14 opcos in the MTN Group; see the press release here. This must come as a disappointment to rivals such as cVidya, who had previously supplied their MoneyMap product to MTN South Africa.
It would be better not to speculate, though the signing of a multi-year deal may be a clue as to why Subash Menon thinks the ‘change in revenue recognition’ will get evened out over the rest of the year. One of the challenges in revenue recognition is to work out when out when to recognize revenue, and when to recognize losses, for contracts where the work stretches over a long period but where invoicing is infrequent. It is possible that Subex has not changed its accounting policy, and has instead suffered a hit this quarter due to anticipated losses for a large and extended contract. Normal practice is to recognize a share of the contract’s total revenue in proportion to how much of the contracted work has been completed. This is calculated at the time of preparing the accounts, to give a smoother and more meaningful figure than waiting to recognize revenue when the invoice is finally sent out. However, if it is anticipated that a contract will loss-making overall, all of the expected loss must be recognized immediately. Because Subex’s quarterly figures show just the P&L, and not the balance sheet, it is possible that Subex have presented their Q1 revenues net of a new provision for loss-making contracts. Even though the provision would dent the figures in Q1, by having taken the loss then, Subex could enjoy a relative upswing in latter quarters because the losses on ongoing contracts have already been provided for. It is worth reiterating that this is speculation, but it fits with the observation that this market is enduring intense price competition, and that lots of vendors have been tempted into signing loss-making contracts. This theory might also explain the rise in staff and subcontractor costs, because workload could have gone up because of the need to satisfy loss-making contracts. The cutthroat nature of the business assurance market was underlined by the MTN Group CFO’s comment on his deal with Subex:
“Subex was selected for this deployment after a highly competitive bidding process.”
Following the failure of Connectiva, this is a time for vendors to hang tough and try to withstand the ‘strong head winds’ that Subash Menon mentioned. It could be that other vendors are on a similar path to Connectiva, if things do not turn around. That said, sometimes it is not necessary for a business to turn things around for themselves. Sometimes the goal is staying one step ahead of the rivals, and waiting for them to fail…