Proposed refinements to Jalali revised Q1 earnings forecast.
Thank you, Jalali, for post 713. This offers us all an opportunity
to put our analysis on the line, BEFORE THE Q1 EARNINGS ARE ANNOUNCED.
I hope that others will take the opportunity to tell Jalali and myself
where you believe we are in error. Let me summarize the highlights of
the Jalali forecast for Q1:
Revenue: 6,075K (45K per technical consultant (TC) x 135 TC)
Gross Margin: 44% (2,675K (revenue after deduction for direct costs)
devided by 6,075 gross revenue)
EPS: -(0.05)/Share
Out of respect to Jalali's post lets get it clear that he DID NOT say
that DDIM would report a loss of .05/share. He said they would IF they
deferred only an additional 63K as product development of Ardes 2K. The
following is my proposed refinement of Jalali's forecast.
Revenue: IMO DDIM will report revenue of 7,000K (7M). Jalali choose
to assume that technical consultant productivity would remain constant
@45K since it has remained fairly flat for the past 4 quarters; a fair
assumption. I chose a different method for estimating revenues,
relying primarily upon the rate of growth demonstrated by DDIM revenues
over the past 4 quarters. In 1996 DDIM's reported quarterly revenues
were: Q1-2.6 million Q2-3.0 million Q3-3.9 million Q4-5.3 million
Accordingly revenue growth between each quarter was:
Between Q2 and Q1 (3.0/2.6)=115% growth,
Between Q3 and Q2 (3.9/3.0)=130% growth,
Between Q4 and Q3 (5.3/3.9)=136% growth.
As you can see, although revenue growth continued to increase during
Q3 and Q4, importantly the RATE of revenue growth began to plateau and
begin to demonstrate a more steady growth rate of approximately 33%
each quarter. This is still a HUGE growth rate, even if it is flat,
but in the current situtation I think we have to give DDIM the benefit
of the doubt and say they will continue to show revenue growth of 33%
a quarter until they demonstrate otherwise. An important caveat is due
here. This will be the LAST quarter my form of analysis has any chance
of accuracy. Why? Obviously because this is the last quarter where
there will be no Ardes 2K revenue. For purposes of Q1 DDIM is still
a consulting firm, capitalizing costs on a product that has now
achieved economic feasability.
Applying a revenue growth rate of 33% to last quarters revenue of 5.3
million gives you my Q1 revenue estimate of 7,049K which for argument
sake I round off to 7 million.
Now for the gross margin of 44%. I don't have a lot of argument with
Jalali on this. GM has been pretty stable in the past. GM should be
close to its historical levels, again because this is still just a
consulting firm for purposes of Q1 revenue reporting. The only note I
would make is that the '96 General, Admin. & Sales Expenses were probably
a little higher as a % of revenue than they will be in Q1 '97. I
expect gross margin of 47%. Why? Because in '96 DDIM was 'ramping'
up for the expected release of Ardes 2K. In their earnings release for
Q2, Q3 and end of year they consistently stated that they were expanding
their 'infrastructure' to a level that would be able to handle the
sales staff for when Ardes 2K sales began. Once in place the administrative
'infrastructure' costs do not increase proportionately with revenue
growth. It should stabilize and stay fairly flat. This gives the
company a 'little extra' gross margin. How much? You tell me. I say
about another 3%. Applying my estimated gross margin of 47% to 7M
revenues gives me 3,290K revenue before indirect costs.
IMO Jalali put his finger on THE KEY ISSUE for Q1 reporting, and that is,
HOW MUCH MORE WILL DDIM DEFER as product development costs for Ardes 2K?
Jalali reminds us that in June of '96 the company said that it 'planned'
to invest up to 1.5M and that as of Dec. '96 they had already deferred
1,437K; leaving only another 63K to defer if they were to stay within
their June '96 'plan'. I don't think Jalali really believes DDIM will
only defer 63K in Q1. I suspect that he believes, as I do, they they
will defer a lot more. In fact, IMO since no Ardes 2K revenue will
be reported in Q1, the company can (and may) capitalize all of their
advertising and personnel expenses until sales begin. They also have
the option of expensing any or all of these items. What will they do?
IMO THEY WILL DO WHATEVER THEY NEED TO DO TO SHOW A PROFIT.
Essentially, these several hundred thousand dollars of 'product
development' costs can be deferred or expensed at DDIM chosing in Q1.
This gives them a lot of room to manipulate the bottom line however
they se fit. As a result I do not expect them to show a loss by any
means. To the contrary they could post a .05-.06 gain and the press
release could scream about how they have exceeded earnings projections
by 500-600%! What goes around, comes around though. The more they
capitalize these Ardes 2K costs, the greater their direct costs are
when Ardes 2K revenue comes in during Q2 and beyond. Capitalizing
all of these costs now makes current profitability look good but its
building in a limited gross margin on their primary product and will
ultimately make it more difficult for them to continue to show revenue
growth of 33% per quarter. Intestingly, if DDIM IS ABLE to continue
with revenue growth of 33% throughout '97 they will report total '97
revenue of approximately 45 million. This is one reason I suspect why
the longs are long.
To me the fascinating thing is that after Q1 the firm will shift revenue
focus from a consulting firm to a sales firm. In the Jan. 27, 1997
news release regarding Ardes 2K DDIM chairman Larry Martin is quoted
as saying, "Studies show that most commercial and government
organizations have chosen to fix their millenium problems with in-
house personnel. There are not enough third party experts in the world
to take care of this enormous problem by the year 2000 so companies
have to do it in house. But there isn't time for these organizations
to figure out how to do it by themselves". IMO this reflects a clear
shift in managment focus AWAY from consulting activities and towards
SALES activities. This release is only a couple of months old. I
thought it was a HUGE shift in this firms entire business focus that
has not been adequately discussed by investors here. Can a high quality
small consulting firm become a quality medium to large sales firm?
Do the longs disagree with my observation that the firm seems to be
shifting revenue focus at least for the duration of the 2K problem from
consulting to sales?
At any rate, with all the forgoing as background, here again are my
guesstimates of Q1:
Revenue: 7 million
Gross Margin: 47%
EPS: .04
Jalali, thanks again for giving us a starting point for debate. |
