London-listed Endace narrows loss

UPDATE Nov 7: London-listed New Zealand technology company Endace has posted an after tax loss of $US107,000 for the six months ending September 30. For the same period last year, the company reported an after tax loss of $US1.1 million. 

Revenue jumped 37% to $US18.7 million, as per an October 14 preview. 

Endace's half-year pre-tax profit (also in line with the October 14 preview) was $US17,000 (or $US200,000 adjusted for share options). In six months to September 2010, the company made a pre-tax loss of $US1.5 million.

No financial outlook was offered in a statement to the market, but the company said it had a strong pipeline of orders. Historically, Endace has made a loss during its first half, but edged into the black for its full-year result as more orders are placed during its second half.

The statement also provides some interesting accounting detail on government grants (previously covered by NBR; below). It notes:

Endace was the recipient of research and development funding in the form of two government grants, totalling NZ$10.6m over a three-year period to September 2013.

The first grant reimburses 50% of the business costs associated with a series of major product developments and has enabled Endace to accelerate a number of significant projects. The second grant funds 20% of eligible R&D expenses incurred, not covered by the first grant.

The two grants combined have contributed $US0.8m of other income and $US1.0m of cash benefit in the six months to September 2011.

Oct 14: Auckland-headquartered global technology company Endace [AIM:EDA] is heading for a first half loss, but has seen a big jump in revenue.

In a first-half trading update, the London-listed company said for the six months to September 30 it expected revenue to of $US18.6 million, a 37% increase over the comparable period last year.

It anticipated a pre-tax profit, adjusted for share option costs, of approximately $US200,000. Cash balances at 30 September 2011 were $2.6 million. (Full results will be released November 1).

CFO Kate Parsons told NBR tax period for the period being worked out. Endace’s sales divisions in the UK and US are liable for taxes in those countries. The company had never made a first-half profit, Ms Parsons said, but anticipated a positive full-year result. The industry was very cyclical, with many customers placing orders toward the end of their financial year.

Secure sales in an increasingly insecure world
Endace makes hardware and systems that helps large organisations secure their computer networks.

NBR understands its blue-chip clients include big telcos such as AT&T and Verizon in the US, investment banks including Morgan Stanley, the NYSE and Nasdaq, and government security organisations in several countries (Endace is also one of the companies liaising with our government’s new National Cyber Security Centre).

Endace chief executive Mike Riley told NBR that the security market was growing quickly. There was rising awareness from governments and large companies about the risks posed by cyber attacks, such as the Stuxnet virus that reportedly took out a power plant in Iran, and the multiple attacks that have taken Sony’s entertainment networks offline (the latest just in the past 24 hours).

Big growth plans
Looking out a half-decade, Mr Riley saw revenue hitting $US200 million, and staff numbers jumping to 600 (that is, more than five times today’s level).

When NBR talked to Mr Riley and Ms Parsons, they had come from Wynyard Quarter on Auckland's trendy Viaduct, which local and central government is planning an "Innovation Precinct." 

The pair saw potential benefits in a cluster of tech and creative companies, and were broadly enthusiastic about the project. However, the company (whose corporate headquarters is currently in the more meat-and-potatoes, light industrial Greenlane) had no speficic plans to join the Precinct at this point. Endace has a history of working closely with the University of Auckland on IT courses (and the university's commercialisation arm, Uniservices). It's looking to establish similar relationships with other universities as its staff requirements grow. 

Perverse incentive?
Like many NZ high-technology companies, Endace has been the recipient of government grants, including $4.4 million from Technology NZ in July 2010 and $6.7 million Technology Development Grant in December.

Concurrent with the grants, Endace announced plans to boost its Hamilton R&D operation from 50 to 90 staff (numbers currently sit around 70, Mr Riley said).

It also moved manufacturing of its network cards from Asia to Christchurch.

Was there a perverse incentive here, NBR wondered? The scenario looks like it could be:

1. The government pushes cash toward a high company

2. Said company brings manufacturing home in a nod to the funding, creating jobs in a nod to the generous state funding

3. The company loses competitiveness long-term, because it’s more expensive to manufacture in New Zealand than China

Mr Riley said this logic did not apply in his company’s case.

Manufacturing was cheaper in China, but physical assembly cost only accounted for about 2% of the final cost of one of Endace’s cards (which have an average sale price of $US7500).

Endace’s target market was a relatively small number of high-end organisations. It’s scale (approximately 3000 cards last year) was nowhere near enough to attract the interest of giant contract manufacturing players like Flextronics and Foxconn.

R&D threat recedes
On the research and development side, it was better to keep the operation close. And Hamilton was cheaper than the UK or the US.

Last year, Endace was one of several tech company’s railing against the government’s plan to abolish the tax break on R&D.

This week, Ms Parsons, who joined as CFO in June, said she preferred the new regime, under which Technology Development Grants from the government (such as the $6.7 million delivered to Endace in December) are only provided if the recipient matches them with its own R&D spending.

R&D spending was now much more clearly defined, Ms Parsons said. Under the old, retrospective tax break system, teams of tax accountant were brought in to wrangle over what constituted research and development. Now,  although there was still some negotiation, money was being funnelled more easily to pure R&D.