Monday, November 20, 2006 11:59:30 PM
Reading the 10-Q filing
There was a bit of a disconnect today in the 10-Q. What used to be easy to read suddenly became difficult, and the resulting confusion lead to a drop in the share price. The price drop was triggered by a Net Income value that was so low (in fact it was negative $875,053 when we were expecting roughly a positive $900,000) that it actually looked like a mistake to many … at least it did to me. So what went wrong, and where did this Net Income come from?
Net income starts out with Revenue .. roughly the cash that our customers give us for the products or services that we provide. Relative to the very good Q2, our Q3 Revenue was 69.5% higher, so that’s not the problem.
From The Revenue you have to subtract the Cost of Sales … the stuff that directly supports the sales effort or the costs of the products or services provided … to get the Gross Profit. For Q3, there was an increase in the Cost of sales due to increased printing and distribution costs resulting from increased sales of printed advertising. Even with the Cost of Sales increase, this wasn’t the problem either, as the resulting Gross Profit for Q3 was still 63.3% higher than the Q2 value. So what’s left that caused the problem?
To get from Gross Profit to Net Income you have to subtract the Administrative Expenses … rent, salaries, and lots of other stuff. Since the beginning of 2004, and before Q3 of this year, these expenses were pretty steady at about half a million dollars per quarter (more or less) except for a couple of years ago in Q4 of 2004 which came in at $1.04 million. Today’s 10-Q had administrative charges of $2,259304 … about $1,750,000 higher than normal, driving what would have been Net Earnings to be proud of, into the toilet.
During Q3, Mr. Mak (the president) received 2,000,000 shares of 144 Restricted Common Stock, and 500,000 shares of Asia Global Holdings Corp. Series A Convertible Preferred Stock, convertible at a ratio of 200:1. This has been discussed here before, but the reason I’m mentioning it is because of how it is handled in the financials of the company. Even if Mr. Mak was restricted from selling (or converting) any of these shares, this award still has to go into the books and be accounted for. In the old days (before 2002), this share award might not have had any effect on the Net Earnings at all. Perhaps you have heard of the Sarbanes-Oxley Act of 2002 though. It is a United States federal law passed in response to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, and WorldCom (now MCI). In general it is a big problem for small companies. It’s expensive to administer, and has been described as punitive, and misleading, in what it does to the companies bottom line.
As stated in today’s 10-Q concerning Administrative Expenses … “Increases are primarily attributable to a non-cash charge of $1,819,250 representing the fair value of common stock issued for management services, business advisory, and legal and professional services rendered.”
This is what hit us ... the Sarbanes-Oxley accounting entry covering share awards to employees, and had nothing to do with Q3 other than that is when the commitment was made. The shares are for both past and future service, and were awarded (in part) to offer an incentive to management to run the company so as to drive the share price up as high as possible.
It’s done. It had to be done to comply with this new law. Get over it. It is time now to decide whether the company has, or doesn’t have the right stuff to make themselves (and us) a pile of money.
The chart tells the story. The top line is our increasing revenue. The middle line is our increasing Gross Profit. The bottom line is our “interrupted” Net Income … the one that many people look at first.
NOTE: We’re only dealing with a potentially confusing interruption in the expected flow of Net Income here. It is my expectation that the Net Income figure will be back on the expected line again next quarter, marching along with Revenue and Gross profit as if this quarter had never happened, and giving us a Q3 to Q4 increase in Net Income so large as a result, that once again it will look like a mistake. The Q4 “mistake” will make us all much happier though than the Q3 one has.
This is an extremely strong company, and it might not take long for the market to notice what actually caused today’s aberration.
PS: The Net Income in today’s Q3 report would have been a profit of $944,197 rather than a loss of $875,053 if the Sarbanes-Oxley required entry of a charge of $1,819,250 had not been required. Plot the $944,197 Net Income (the “real” Net Income) on the above chart your self to see where it would have landed.
rjc
There was a bit of a disconnect today in the 10-Q. What used to be easy to read suddenly became difficult, and the resulting confusion lead to a drop in the share price. The price drop was triggered by a Net Income value that was so low (in fact it was negative $875,053 when we were expecting roughly a positive $900,000) that it actually looked like a mistake to many … at least it did to me. So what went wrong, and where did this Net Income come from?
Net income starts out with Revenue .. roughly the cash that our customers give us for the products or services that we provide. Relative to the very good Q2, our Q3 Revenue was 69.5% higher, so that’s not the problem.
From The Revenue you have to subtract the Cost of Sales … the stuff that directly supports the sales effort or the costs of the products or services provided … to get the Gross Profit. For Q3, there was an increase in the Cost of sales due to increased printing and distribution costs resulting from increased sales of printed advertising. Even with the Cost of Sales increase, this wasn’t the problem either, as the resulting Gross Profit for Q3 was still 63.3% higher than the Q2 value. So what’s left that caused the problem?
To get from Gross Profit to Net Income you have to subtract the Administrative Expenses … rent, salaries, and lots of other stuff. Since the beginning of 2004, and before Q3 of this year, these expenses were pretty steady at about half a million dollars per quarter (more or less) except for a couple of years ago in Q4 of 2004 which came in at $1.04 million. Today’s 10-Q had administrative charges of $2,259304 … about $1,750,000 higher than normal, driving what would have been Net Earnings to be proud of, into the toilet.
During Q3, Mr. Mak (the president) received 2,000,000 shares of 144 Restricted Common Stock, and 500,000 shares of Asia Global Holdings Corp. Series A Convertible Preferred Stock, convertible at a ratio of 200:1. This has been discussed here before, but the reason I’m mentioning it is because of how it is handled in the financials of the company. Even if Mr. Mak was restricted from selling (or converting) any of these shares, this award still has to go into the books and be accounted for. In the old days (before 2002), this share award might not have had any effect on the Net Earnings at all. Perhaps you have heard of the Sarbanes-Oxley Act of 2002 though. It is a United States federal law passed in response to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, and WorldCom (now MCI). In general it is a big problem for small companies. It’s expensive to administer, and has been described as punitive, and misleading, in what it does to the companies bottom line.
As stated in today’s 10-Q concerning Administrative Expenses … “Increases are primarily attributable to a non-cash charge of $1,819,250 representing the fair value of common stock issued for management services, business advisory, and legal and professional services rendered.”
This is what hit us ... the Sarbanes-Oxley accounting entry covering share awards to employees, and had nothing to do with Q3 other than that is when the commitment was made. The shares are for both past and future service, and were awarded (in part) to offer an incentive to management to run the company so as to drive the share price up as high as possible.
It’s done. It had to be done to comply with this new law. Get over it. It is time now to decide whether the company has, or doesn’t have the right stuff to make themselves (and us) a pile of money.
The chart tells the story. The top line is our increasing revenue. The middle line is our increasing Gross Profit. The bottom line is our “interrupted” Net Income … the one that many people look at first.
NOTE: We’re only dealing with a potentially confusing interruption in the expected flow of Net Income here. It is my expectation that the Net Income figure will be back on the expected line again next quarter, marching along with Revenue and Gross profit as if this quarter had never happened, and giving us a Q3 to Q4 increase in Net Income so large as a result, that once again it will look like a mistake. The Q4 “mistake” will make us all much happier though than the Q3 one has.
This is an extremely strong company, and it might not take long for the market to notice what actually caused today’s aberration.
PS: The Net Income in today’s Q3 report would have been a profit of $944,197 rather than a loss of $875,053 if the Sarbanes-Oxley required entry of a charge of $1,819,250 had not been required. Plot the $944,197 Net Income (the “real” Net Income) on the above chart your self to see where it would have landed.
rjc
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