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First Derivatives - are its reported earnings real? After 20 years is KPMG sure?

By Tom Winnifrith, The Sheriff of AIM | Thursday 18 October 2018

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

A few days ago I showed hard evidence that the 2002 IPO of First Derivatives (FDP) was based on false earnings. That was dismissed by supporters as being so long ago that it did not matter. It does! But how about we move to the issue of whether reported earnings in the past three years are "real" or cooked up. I suggest it may well be the latter in which case the stock is going to tank at some stage, soon, when investors realise this. Let me explain...

If the analysis below, provided by someone far smarter than I am, is correct then earnings for the past three years have been massively overstated and the idea that this is a growth stock would be shown to be fantasy. Thus the shares would be massively de-rated on the back of far lower earnings. A double whammy. Let the recently crowned AIM casino entrepreneur of the year, Brian Conlon of First, or his troop of patsy sell side analysts explain this away.

As Lucian Miers mentioned the other day, in First’s 2018 accounts, the cash flow statement shows £8.3 million in dividends paid, but Note 13 shows £5.3 million in dividends paid.

That £3 million difference almost certainly represents the net income from Kx that is due to the minority interest shareholders. By leaving this share of net income off the P&L, First has monstrously overstated its net income and thus earnings per share. By way of example, in the 2018 financial year the company reported profits of £10.2 million – £3 million of this actually belongs to Kx shareholders.

That means that if First had correctly represented its relationship to the Kx minority holders in the P&L, its reported profit would be £7.2 million, or 30% lower. In fact, the economic reality is that the profit attributable to First shareholders was just £7.2 million, and by reported £10 million excluding the amount due to the minority interest, First overstated its reported profits by 42%! I think this is a bit of a bombshell don't you?

Because First has employed this accounting treatment over the past few years, its net income has been systematically overstated. Of course patsy analysts at places such as Liberum and Goodbody have not twigged this and thus investors such as the Globo (GBO) fraud cheerleader Harry Nimmo at Standard Life are blissfully unaware of this.

First’s explanation for excluding the minority interest is that it claims that the “anticipated acquisition” method applies – the existence of the put option means they book a non-current liability instead of running a minority interest through the P&L

Has anyone ever seen this before? Go on Goodbody or Nimmo find me an example. There seems no logical justification for this. Of course the scandal plagued Belfast office of KPMG has signed off on First's accounts for 20 years and has clearly blessed this approach which may be legal but I cannot see how it presents a true and fair picture of what is really going on.  This approach obfuscates the financials and the earnings power of the company.

My real grip with First, apart from the IPO book cooking signed off by dodgy spiv broker JM Finn of 3DM infamy, the bogus customer wins and the series of dodgy related party deals, is that this company is just a woeful generator of free cash. But some folks (noticeably the patsy sell side analysts) ignore such matter and just bang on about the reported EPS and EPS growth. I suggest that even that approach is now very questionable indeed.


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