Comment on the performance
The revenue for the group for the year has actually declined in the year. The scenario states that the Samba Co revenue has remained the same in both years, so this decrease appears to represent a decline from the remaining companies in the group.
Whilst there has been an overall decline in revenue, the gross profit margin has improved in 20X9 (44·9% increased to 45·8%). Samba Co has a significantly higher gross profit margin (81%) in relation to the rest of the group, suggesting that the rest of the Pirlo group operates at a lower gross profit margin.
The operating profit margin of the group has deteriorated in 20X9 (13·5% has decreased to 11·9%). This is initially surprising due to the significant increase in the operating profit margin of Samba Co (41% has increased to 66%). However, the increase in Samba Co’s operating profit margin may not represent a true increase in performance in Samba Co due to the following:
– Samba Co has recorded a $2m profit on disposal of its properties, which will inflate its profit from operations in 20X9.
– In addition to this, Samba Co has been charged a lower rate of rent by Pirlo Co, which may also have the impact of making the profit from operations in 20X9 higher than the previous period if the rent is lower than the depreciation Samba Co would have recorded.
This concern is further enhanced when the share of the profit of the associate is considered. This has contributed $4·6m to the profit for the year, which is nearly 40% of the overall profit of the group.
The combination of these factors raises concerns over the profitability of Pirlo Co and any other subsidiaries in the group, as it appears to be loss making. Some of these losses will have been made through the loss of rental income through the new arrangement.
The joining fee paid to Samba Co’s previous directors is a one-off cost paid by Pirlo Co. Consequently, it is included in the consolidated statement of profit or loss for the year ended 31 December 20X9. A similar amount was paid by Samba Co in the form of an annual bonus in the year ended 20X8. Therefore, 20X8 and 20X9 are comparable but the joining fee represents a cost saving for Pirlo Co in future years.
The decline in interest cover appears to be driven by both the decrease in profit from operations and an increase in finance costs. As Samba Co has a large amount of debt, and much lower interest cover than the group, this should increase in future periods.
The disposal of Samba Co appears to be surprising, given that it generates the high margins compared to the rest of the group.
The loss on disposal of Samba Co should be brought into the consolidated statement of profit or loss. This would reduce profit from operations by a further $14m and would reduce the operating profit margin further to 5·4%.
The sale of Samba Co at a loss is very surprising given that it appears to contribute good results and has a history of strong performance.
Whilst selling Samba Co at a loss may be a strange move, Pirlo Co may believe that the real value of the Samba Co business has been secured by employing the two founding directors.
Conclusion
The disposal of Samba Co does not appear to be a good move, as the Pirlo group seem to be losing its most profitable element.
The Pirlo Co directors seem to have made a risky decision to move into the software development industry as a competitor of Samba Co.
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