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Behind MacDonald Dettwiler's surging profits

Investors in MacDonald Dettwiler and Associates Ltd. , who were asked recently to tender their shares in a buyback, might have hesitated, as the numbers the company highlights show it has robust profits growing at double-digit rates.

Those numbers, however, might not paint the clearest picture of performance at the B.C. company – ironic, since MDA, as it's known, makes its business delivering high-quality data and information to corporate and government customers.

Rather than emphasize profit calculated according to International Financial Reporting Standards (IFRS), MDA prefers the metrics "operating EBITDA" and "operating Earnings." In the first half of 2011, operating EBITDA increased 18 per cent, to $94.9-million, from the previous year. operating earnings grew 22 per cent to $55.6-million.

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The company says the use of these measures "provides more insight into [MDA's] performance." Operating earnings provides a "more meaningful way to compare financial results from one period to another," it says, while operating EBITDA "capture[s]the profitability of its business before the impact of non-operational items."

But, as Veritas Investment Research Corp. analyst Dimitry Khmelnitsky notes, both metrics exclude the costs of stock-based compensation, and operating EBITDA also leaves out corporate overhead.

"While management is free to define non-GAAP operating performance metrics as it wishes," Mr. Khmelnitsky writes in a recent report, "it is noteworthy that MDA's competitors, such as Raytheon Co. and General Dynamics Corp., as well as other companies included in MDA's management compensation benchmarking, such as Bombardier Inc. and CAE Inc., do not exclude corporate and stock-based compensation costs from their non-GAAP EBITDA and/or operating earnings metrics."

Of course, rather than relying on MDA's own metrics, investors could turn to the company's net income figures, which are calculated according to rules laid down by IFRS. The net income figures include estimates of the value of stock compensation and also show healthy profit growth.

But since the company says it dislikes how the net income calculation treats share-based compensation because such compensation is volatile and "is not reflective of actual cash outlays by the company," Mr. Khmelnitsky adjusted MDA's earnings for those real cash costs. And the impact was significant.

He's unable to come up with a definitive number, as MDA is not regularly disclosing the actual cash costs of its stock compensation. A one-time disclosure upon its conversion to the IFRS accounting rules, however, showed first-quarter costs of $19.4-million, up 486 per cent from $3.3-million in 2010's first quarter.

Include those first-quarter cash stock-compensation numbers, along with corporate overhead, from operating EBITDA, and you get a first-half number of $69.7-million, down 2 per cent from 2010. Operating earnings of $36.2-million in the first half decline 14 per cent from the 2010 period.

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These Veritas estimates are generous, in my view, as they assume zero cash costs for stock compensation in the second quarter – unlikely, since, as Mr. Khmelnitsky notes, securities filings show the number of stock-based awards exercised for cash by MDA's top executives increased by 19 per cent year over year in 2011's second quarter.

Is this an ongoing problem? The company told Mr. Khmelnitsky that the first-quarter stock number was not reflective of ongoing expense, as it reflected one-time stock costs for employees of a business segment it sold. "Based on this, future cash cost would decline," he writes. "Unfortunately, management did not provide us with a clear answer as to whether the cash cost of share-based awards pertaining to continuing operations has increased year over year."

MDA spokeswoman Marissa Poratto declines to comment, saying the company has a policy of not addressing analyst reports. At the same time, she recommended I look at the reports of other non-Veritas analysts, some of whom, as it happens, have "buy" recommendations on the stock. (Although they reject MDA's presentation by deducting corporate expenses from EBITDA in their own analyses.)

both metrics exclude the costs of stock-based compensation, and operating EBITDA also leaves out corporate overhead. Mr. Khmelnitsky's report came out late last month, giving Veritas clients some time to decide whether to tender their shares back to the company for a price of no less than $53. The buyback offer expired Tuesday, so other shareholders didn't have the benefit of the analysis. MDA now trades at around $44.

Undervalued, for a company that just paid 20 per cent more for its stock? Perhaps. But it certainly helps to know this double-digit profit grower may actually have declining earnings when all the data are known.



Special to The Globe and Mail

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More

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