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Adding to one of the few ideas that is working: Empire Industries

My portfolio has been behaving poorly over the last month and a half.  I’ve had very little confidence to add to positions in the face of these headwinds. That said, one of the few positions that has bucked the trend and that I have added to is Empire Industries.

Empire reported its first quarter results at the end of May.   The results were a step forward.  The company had $32 million in revenue, which was up significantly from the fourth quarter but fairly consistent with the level of the previous few quarters.  Gross margins of 22% were an improvement over the last few quarters, as was the EBITDA margin of a little over 9%.   The gross margin number has been improving of late (they had been in the high teens up until the last couple of quarters) as the company has shifted toward manufacturing the second generation of their attractions products and moved away from custom designs.  On the call management suggested that this level of margins, and maybe a little higher, would be sustainable going forward.

Along with the results the company announced the wind down of the steel fabrication business.  Some of that business will be moved towards providing support for Dynamic Attractions, while the rest has been shuttered.  Given that the business lost over $2 million last year and allows them to cut $1 million of overhead costs, I’m not sad to see it go.

I thought that Guy Nelson, Empire’s CEO, was particularly positive on the call.  He said that the “market for our immersive attractions is growing rapidly”, the Q1 results “prepare the company for strong results in the future”, and the backlog is “indicative of how we are the supplier of choice among the world’s top theme parks”.  They have “a record backlog of proposals in our pipeline” and its “safe to say that you can look forward to more contract announcements in the future”.

The big news that was announced just prior to earnings of was the $125 million four year contract announced earlier in May.  This is a huge contract, much bigger than previous contracts that have been in the $30-$50 million range.  They said they believed it was the biggest contract ever announced in their industry.  I honestly was surprised that the stock didn’t move higher on this news.

As I already mentioned, Nelson said on the call that it was “safe to say” there would be more contracts in the future.  True to his word, the company announced a $40 million USD contract with an Asian theme park operator last week.  Again, the stock popped on the news, but remains more subdued than I would have anticipated.

Including both of these new contracts, the companies backlog stands at roughly $300 million (CAD).

So what does that mean?  Well, at the current share price (~0.60c) Empire has a market capitalization of $40 million.  Add on $25 million of debt and the total enterprise value is $65 million.  For that price you get a company with trailing twelve month (TTM) revenues of $132 million, so the stock is trading at a little less than 0.5x TTM sales.

In the past you’d argue back that Empire’s businesses are low margin, so the multiple should be low.  But with the wind down of the steel fabrication business and the spin-off of the hydrovac business, and with the shift to higher margin second gen products for Dynamic Attractions, this is less the case now.  Gross margins for Dynamic Attractions are still low, but they are no longer mid-teens.  They are now over 20% and maybe can tick even a couple of points higher as they increase their second generation business and integrate the in-house manufacturing of their remaining steel fab assets.

Moreover, revenues are likely to grow over the next couple of years.  The $300 million in backlog is double its peak level over the last few years.  Over that time Empire has operated Dynamic Attractions at a revenue level that has been about ~80% of backlog (Dynamic Attractions revenue has been about $100 million annually while the backlog, while volatile, has fluctuated around the $120 million level).  Given that the backlog has now doubled, how much can we expect a commensurate move up in revenues?

It may have made sense for the company to trade at a low multiple when the steel business and hydrovac business were revenue drivers, when the media attraction business had lower margins and a smaller backlog and thus some uncertainty around its sustainability.  But now, with a backlog of over $300 million (or more than two years of revenue at the current rate) and when it’s “safe to say” there are more contracts coming, it just doesn’t make sense to me.

So what’s it going to take to move the stock? Well I think that one thing holding back the stock is its accounts receivable.  So far we haven’t seen revenue convert into cash.  The company has accounts receivable of $37 million.  This is actually an improvement over the 3rd quarter of 2016, when it was as high as $44 million.  That means days sales outstanding is 111, which seems very high to me.  It also means that the company has to maintain a lot of bank debt in order to balance their cash needs.

Also helpful would be one more contract to just put them over the top, and maybe a another quarter showing similar or hopefully even better gross margins and 10% conversion to EBITDA.

When I model out how the business could improve further, its not too difficult to see EBITDA getting to $5 million quarter.  As I show below, assuming the same operating costs as the first quarter, a 15% jump in revenue (which shouldn’t be out of line given the large increase in backlog) and a couple basis point improvement in gross margins (brought on by the continuing shift to second gen products and the wind-down of the steel fab business), and you are almost there.

But we’ll see.  So far there are sellers in the mid 60c range that have to be overcome before any move higher can take place.  The stock has languished for years.  The current price movement may simply be a function of a few legacy holders taking the opportunity to get out.   Whatever the reason, I’m willing to bet that there is a reasonable chance that the stock moves higher in the coming months.

New Position: Betting on a narrowing discount for NL Industries

Two weeks ago I took a position in NL Industries.

I don’t expect this position to be a long-term hold for me.  There are a number of things not to like about the stock.  Nevertheless the beaten up share price over the last couple of months presents a disconnect to the underlying assets that is historically large and I think has a reasonable chance of being corrected over the coming weeks and months.

NL Industries has 49 million shares outstanding.  At $8 that gives it a market capitalization of $400 million.  They have about $100 million of cash on the balance sheet.  They have no debt, but do have a long-term liability for environmental remediation that is $115 million.  These costs are associated with previously operated lead smelters and mining operations.  They also have legal proceedings ongoing, which I will get to shortly.

NL Industries is a holding company that has ownership in two businesses.  The first is Kronos.  Kronos is a large, titanium dioxide pigment producer.  NL Industries owns 30% of Kronos.  Kronos used to be a wholly owned subsidiary but they have slowly divested that into the public market.

Titanium dioxide is used to create a white pigmentation in paints, plastics, and other coatings.  Those that follow this blog might remember that I have previously held a position in another titanium dioxide producer, Tronox, and from that experience I learned that this is a tough business.  Kronos has a 9% market share in the Titanium dioxide market worldwide.

The titanium dioxide market is quite cyclical.  Kronos stock traded to as low as $3 at the trough of the last cycle, but we are now on an upswing as demand has been rising and little new production is on the horizon.  The stock has risen from $12 to $18 since the beginning of the year.

The second business that NL Industries owns is CompX.  Their ownership in CompX is 87%.  CompX is a manufacturing company.  They have a segment that manufactures locks and another that manufactures marine components.  CompX has been consistently profitable and free cash flow positive for the last 3 years, but has not shown any growth over that time.

In addition NL Industries owns 14.4 million shares of Valhi, which is a related company that also owns a stake in Kronos.   These shares are worth a little less than $50 million.  The relationship with Valhi is complicated as Valhi in turn has 83% ownership of NL Industries.  Valhi is 93% owned by the private company Contran, which is owned by the family of Harold Simmons.  There are a number of interesting articles on the late Mr. Simmons and his controversial life (here and here for example).

While the ownership structure likely raises some questions about the long-term direction of the business, my thesis here is very short-term, so I am not going to dwell on it.  By the time any strategic concerns are realized I should be long gone from the stock.

Getting back to the assets, neither Kronos or CompX are particularly bad businesses, but neither is either a particularly good business.  Kronos is cyclical and requires large capital expenditures.  CompX is in a low growth end market.  I probably wouldn’t invest directly in either company.

What makes NL Industries interesting is that their stake in these businesses far exceeds the market capitalization of the stock.  CompX has a market capitalization of $170 million.  NL Industries has a 88% interest in them, so that is worth $150 million.  Kronos has a market capitalization of $2.2 billion.  The 30% ownership that NL Industries has is worth $660 million.

Thus, NL Industries has a market capitalization of about half of its underlying ownership in Kronos and CompX.

The story would be that simple, but it isn’t.  There is one remaining caveat.  The company has went through a number of lawsuits with respect to its production of lead based paints back in the 1980s.  Almost all of these suits have been ruled in their favor.  But there is one exception and that is the lawsuit brought about by the county of Santa Clara.  Their suit, like all the others, alleges that NL Industries and other lead paint producers are responsible for compensation and abatement costs because they sold lead paint back before it was realized how dangerous it was.  The suit is against NL Industries, Sherwin Williams and ConAgra.  You can read about the details in their 10-K.

This suit has gone back and forth.  The original verdict dismissed the claims, but an appeal overruled and ordered NL Industries and its counterparts to pay damages ($1.1 billion).  But this ruling was not final and there is now a second appeal in process.  This SeekingAlpha article outlined a few different legal opinions that expressed surprise  at the second ruling and that expect it will be overturned on the next appeal.  What is surprising is that at the time the lead paint was being sold, there were minimal concerns about its long-term environmental effects.  It is unusual to hold a company accountable in such circumstances.

Its important to note that the lawsuit has been ongoing for some time and there hasn’t been any developments since January 2014 when the appeal overturned the original verdict.  Also worth noting is that the stock did not react much at the time of the January 2014 appeal result.   There is also nothing in the immediate future that will change the state of the trial.  The timeline for the second appeal trial has yet to be set.  My point here is that insofar that this risk should be reflected in a discount of NL Industries to its underlying assets, that discount shouldn’t be any different today than it was 3 years ago.

Keeping that in mind, when I look back at the stock price of NL Industries, Kronos, and CompX over that time, I notice that the current relative price is close to the bottom of the relative range of NL Industries.  To throw out a few data points:

NL Industries trades in a range of  40-75% of the value of its underlying ownership in Kronos and CompX.  Other than when the titanium dioxide industry was in the depths of a recession (in late 2015, early 2016) the stock tended to trade closer to the higher end of the range.   Right now it trades at under 50%.  Other times when the delta became that large, it eventually rebounded back to the 75% range.  If I’m right, the stock should move back to $11 or $12, which would be a nice gain.

The risk of course is that A. the rebound does not occur this time or B. that Kronos, which is a very volatile stock, falls significantly from its current near-52-week highs.  I am wary of both possibilities, and am not making this a large position for that reason.  It’s a 3% position in my value portfolio.  I am also not planning on holding this stock for too long – hopefully it rebounds back into the usual range and I sell for a nice profit.  If it doesn’t rebound relatively quickly, I don’t plan to overstay my welcome.

Week 309: One Step Back

Portfolio Performance


Top 10 Holdings

See the end of the post for my full portfolio breakdown and the last four weeks of trades

Thoughts and Review

April and May have been frustrating months.  My portfolio has been down about 2.5%, which isn’t terrible, but as the market has kept moving to new highs it has felt quite a bit worse.

Looking at the performance of my individual positions, I would attribute my under-performance to the following themes:

  1. Investments in sectors that are doing poorly
  2. Companies that have exciting potential but its still not showing up on the income statement
  3. Upside exhaustion

On the first point, I’ve had positions in oil and gas and biotech, and these sectors have been somewhere between lackluster and dismal.  Regarding oil, its been a tough time to own Journey Energy, Zargon Oil and Gas, and Vaalco Energy.  Each has performed about as poorly as every other oil and gas name.  I’m reluctant to cut these stocks loose though, I think each is cheap based on current prices and I’m not really in the camp that thinks we are heading back to $30 oil for any significant time.  And as I’ve said before, if we do, the Canadian dollar is going to collapse, which will more than “hedge” any oil exposure that I have.

My biotech positions have been similarly crummy.  Eiger Pharmaceuticals is the poster boy for this, having declined from $11 to under $7 in the last few months.  I’ve held off adding to Eiger up until last week, when I put in some bids in the high $6 range that got filled.  I am looking at a few other biotech names that I am looking to add on weakness.

Likewise, the performance of Novabay and Bovie Medical has been dismal.  I sold Bovie Medical after their first quarter results and a conference call that I just didn’t find inspiring.  Novabay, on the other hand, I feel more constructive about.  The stock is down to an enterprise value of a little over $25 million (or was as of the weekend when I originally wrote this).  The company is guiding to sales of $18 million for 2017, which is 50% growth over the $12 million in revenue for 2016.  It seems like the stock is being crushed off of a notice of deficiency from the New York Stock Exchange.  It’s a very low volume pull-back, which suggests it a couple of folks getting spooked out.  It doesn’t seem like a big deal to me?  I’m sure they will resolve it.

On the exciting potential but still not revenue bucket we have CUI Global, RMG Networks and Radisys.   Radisys hasn’t done terribly,  its about the same level it was in April (which is not really a positive thing to say), but RMG Networks and CUI Global have both been crushed.  RMG Networks needs to get some of these trials and engagements contributing to revenue and until they do I’m not going to be buying the stock.  I’m still wary of this name; it could pan out in a big way but it seems like there is a lot of hand waving about what’s to come that has been going on for a number of quarters now.  I’m waiting, but not as patiently as I once was.

I added a position too soon with CUI Global.  I bought the stock after some very weak results in the low-$4’s but that hasn’t proved to be even close to the bottom.  Fortunately I only bought a little, and have subsequently added at $3.70 and again at $3.40.

I have some conviction that CUI Global has the technology to generate significant revenues over time and that its just a matter of time before we see those materialize.  In particular, one day they are going to see the regulatory issue that their customer Snam Rete is having that is preventing installations get resolved, and when it does the stock is going to pop big-time.  I noticed there were some small insider buys at the $3.40 level so I’m not the only one who thinks this is a decent value here.

As for the third theme, I had great runs from Combimatrix and Identiv and they simply ran out of legs.  I continue to hold both, believing their momentum will resume after this breather.

I took new positions in Sito Mobile and Psychemedics this month and have already written about both.  There are a couple of others that I will try to write about shortly.  I also reduced my position in Medicure, which I talked about here, and exited my positions in BSquare and Versapay.

Neither Versapay or BSquare have shown me that they can convert their leads into sales.  Versapay announced another quarter of decent growth on a year over year basis but still very low revenue on an absolute basis.  They are not cheap on a multiple of revenue.  BSquare isn’t gaining traction fast enough for my liking with its DataV product.  The company recorded no new bookings in the first quarter and their DataV backlog declined from $5.7 million to $3.2 million.  I’m actually a little surprised both stocks have held up as well as they have after what in my opinion were somewhat lethargic quarters.


Portfolio Composition

Click here for the last four weeks of trades.

Psychemedics: A reasonably Priced Gamble

I got the idea for Psychemedics from Mike Arnold, who mentioned the stock a couple of months ago.


I don’t think Mike owns the stock.  Mike believes in portfolio concentration.  Diversifying to 2 or more companies would be seen as a dilutive exercise to him. 😉

I, on the other hand, can’t have enough stocks in my portfolio.  I think this one is worth a buy.  Here is the deal.

Psychemedics provides alcohol and drug testing via hair samples.  They have a patented technology that digests the hair and then releases any residual drug trapped in it.   They then use a proprietary enzyme immunoassay on the liquid mixture to evaluate the presence and level of drug residual in the sample.  Its based on knowledge that blood will carry chemicals, including some that are markers of drug or alcohol use, to the hair follicles, where they become trapped in the protein mixture.

Using hair to test for drugs is a somewhat new, at least in terms of being an accepted alternative to urinalysis.  But it does have advantages.

First, its not nearly as easy to trick the process.  With urinalysis, you can replace the sample or tamper with the sample using chemicals.

Second, urinalysis is only testing for drug and alcohol use in the recent history, usually 3-5 days, hair sampling is testing for a far longer period.  Most tests that Psychemedics performs are looking back 90 days.  The chemicals are deposited in the hair soon after ingestion, so theoretically you can look back as far as the hair has grown for.

Because its harder to game the system air testing typically gives more positives than urinalysis.  In their 10-K Psychemedics notes that when compared to urinalysis “in side-by-side evaluations, 5 to 10 times as many drug abusers were accurately identified by the Company’s proprietary methods.”

The downside is that hair testing can’t be used for to test for-cause, like in the case of a drunk driver.  Drug ingestion does not appear in the hair above the scalp for 5-7 days after use.  Hair testing is also priced “somewhat higher” than urinalysis (from the company, I don’t have specific numbers).  And there are some concerns that hair can become contaminated from the environment or that different hair colors are more susceptible to accumulating chemicals, but I didn’t get the feeling that these were wide spread concerns.

Hair sampling appears to be gaining acceptance.  The Psychemedics process is used for testing by 10% of Fortune 500 companies.  And in 2016 Brazil mandated a hair testing hurdle for professional drivers.

The Brazil requirements created a step change in the results of the company.  Prior to the legislation the company operated at roughly a $7 million revenue rate per quarter.  Since the testing has been mandated, that level has stepped up to $10 million.  You can see how that step change occurred in the second quarter of last year:

Brazil also has room to grow further.  In September 2018 a second phase of the Brazilian law will be enacted that will reduce the number of years between testing from 5 to 2.5.

Note that there were some problems in Brazil earlier this year when their Brazilian distributor, Psychemedics Brazil, lost a court case for uncompetitive practices.  A SeekingAlpha short piece came out shortly after to drum up some fear about the event.  The company clarified that the Brazilian distributor was not owned by Psychemedics and that they expected no interruption in Brazilian revenues as a result.  I read through the court document and thought it probably wouldn’t have much of an effect on their results.

The second potential growth area is the United States.  This is where it really gets interesting.  In the United States the federal government hasn’t recognized hair as a reliable sample for federally regulated employees and programs.  However, there was a bill passed in 2015 that changed that, as it would allow for hair testing of Federal employees as well as for workers needing to meet Federal requirements.

While the bill past some months ago, its implementation is being held up by Health and Human Services (HHS), which has so far yet to issue standards on the tests.  In March the American Truckers Association (ATA) called on the HHS to hurry up and give some guidance.

ATA spearheaded efforts to allow carriers to use hair testing as an alternate test method to traditional urinalysis in the most recent highway bill, but to date HHS has yet to issue the necessary standards to allow those tests to go forward. This week, the HHS agency responsible for developing those standards, the Substance Abuse and Mental Health Services Administration, holds its Drug Testing Advisory Board meetings to consider hair testing, putting HHS well behind its congressionally mandated deadline.

“Many trucking companies are using urinalysis to meet federal requirements, while also paying the additional cost to conduct hair testing,” Spear said in his letter. “We are frustrated that the previous administration failed to meet the statutory deadline and believe your leadership will finally see a resolution to this long-standing and important safety rule.”

The opposition to hair testing seems to come from the Democrats, while the Republicans are in favor of it.  I have no idea what the reasons behind the divide are but I bet they have more to do with constituencies and political support than the value of hair testing.  Neverthless, with a Republican controlled everything right now, I would think the odds are that it is resolved in Psychemedics favor.

I have to admit I haven’t found any source to quantify the size of the opportunity if the HHS issues guidelines and the bill takes effect.  My assumption is that it’s material.

The nice thing about Psychemedics is that you have this growth optionality that really doesn’t seem to be baked into the price.

The market capitalization of the stock is $122 million.  The company has roughly the same amount of cash as debt, with neither being substantial.  Free cash flow for the past 12 months was $11.5 million.  EBITDA was a little over $15 million.  So the stock trades at about 11x free cash flow and 8x EBITDA.

Its not amazingly cheap but also its not particularly expensive.  I like the idea on the basis that we see further revenue growth from Brazil and maybe an announcement in the United States that takes things to another level.  It’s worth a bit more than a starter position for me.

Sito Mobile – Its Complicated

I bought Sito Mobile about the same time I made this tweet about the company.

I was wrong with the header bidding angle, but have been right about the company (so far).

Header bidding is an advertising technology designed to source the best pricing for ad space on webpages.  This isn’t the ad space that Sito Mobile operates in.   Sito operates in the mobile app ad space.  They have an interesting offering.  Here is how Sito described what they do at the Cowen Conference last year (I’ve paraphrased a little for brevity).

What you see here is a day in the life of a mobile user.  Its important to note that when we interact with our phone and click on an app, we are raising our hand and saying serve me an ad.  Our platform sees every one of those bid requests.  If you look at this user (see timeline above), this person wakes up in the morning and clicks on their weather app.  Every time that they click on an app we gather information.  We gather a minimum of 3 data points and depending on the app and agreements, up to 30 datapoints.  At minimum we gather the geo-location, time stamp, and the device ID.   All the data is anonymized.  That’s the foundation of how we create something called player cards.

The next time we see this device ID at a geo-location its 7:15AM.  It’s an elementary school.  The next time we see the device ID its at a geo-location that is a Planet Fitness.  So you now see a pattern.  Next we see it at a grocery store.  Last we see it at 10:04AM is at a location we’ve seen the device 382 times in the last 30 days, so we can infer that this is likely the home address.  Then we can get additional data from the Wifi about number of devices and carrier for that home address.  We can then layer on third party data from Axiom and DLX and the like to layer on things like household income, demographics around that area, and we start to build a profile.  We never know 100% but in this case we have a high degree of probability that this is a Mom, age 35-44, Caucasian, lives in zip code with average household income of $220,000, college educated, likely own their own home, average length of residence is 7 years, married and has average of 2 children ages 2-9.

That now goes into an audience that we create.  We then layer in her interests and that resulting player card can then be used to target advertisers who want to speak to this consumer.

Once a user has been targeted with the ad, Sito can follow-up on the path that the user follows.  Via it’s Verified Walk-in product Sito can report back whether the user subsequently entered the premises of the ad vendor, thus verifying whether the targeted ad was a success.

While some would legitimately remark that it’s scary how much can be known about you by carrying your smart phone around, the other way to look at it is that it is that the platform should result in more relevant ads being presented to users.  The mobile location history that Sito collects allows it to profile the user, understand their interests and routines, and then target an ad that is appropriate and maybe even useful.  And because of the real-time location data, the ad is also relevant to their current location.  The verified walk-in allows Sito to report back to the advertiser with accurate metrics about the campaigns success.  The value proposition makes sense to me.

The stock price suffered into the new year for two reasons.  First, the company badly missed expectations in the fourth quarter.  The fourth quarter should be the best one for advertising.  Yet media placement revenue was down from $10.4 million in the third quarter to only $8.3 million in the fourth quarter.

This was compounded by news of malfeasance by the CEO and CFO.  Apparently they were making unapproved purchases with company credit cards, debit and withdrawals from payroll funds.  In total $330 thousand dollars that were misappropriated.  In February these executives resigned.

So there was concern that the companies growth trajectory  was failing and concern about the void at the executive level.  The stock plummeted down into the $2’s.

I got interested after the company released its first quarter results.  In fact I think (I can’t remember for sure) I got the idea after reviewing a list of percent gainers the day that they reported.

The first quarter results were better than the fourth quarter. Revenue was down from the fourth quarter (not unexpected given that January is typically a dead month for advertising) but up 34% year over year.  More impressive, the company said that it had its best month ever in April, generating over $4 million in revenue, and they guided to a range of $10 million to $13 million in revenue for the second quarter.  This would be far above the $8.3 million of media placement revenue for the prior year.

So I like the offering and I like the recent growth trajectory.  When I bought the stock at $3 the market capitalization was a little over $60 million, which meant that it was trading at less than 2x forward revenue, quite cheap if the company has indeed regained its growth mojo.  Even now, at $4, its still only 2x revenue, which is not an expensive price tag if 30% revenue growth is really in the cards.

So it’s a simple story.  Growth business, product/service that makes sense, they even have a wealth of data that they have archived over the past couple of years that they are beginning to monetize as data as a service and that will provide an additional revenue stream.  Simple.

Except its not. The complicating factor comes from two activist groups that are looking to replace the board, replace the new CEO and CFO and I think put the company up for sale.

The two groups are the Baksa Group and TAR Holdings.  The latter company is owned by Karen Singer, wife of Gary Singer, who had this interesting article written about them a few years ago.  I didn’t know anything about either of these groups before investing in Sito.  Singer and TAR own over 10% of Sito while the Baksa Group own a little less than 7%.

The groups say that they are not affiliated, though they seem to support each others claims and want essentially the same thing.  What they want is the removal of the executive team (the CEO and and CFO) and replacement of 4 of the 5 directors.  In this filing (one of many) the Baksa Group describes their position and what they are looking to change.

There are lots of complicating and curious angles here.  Just to throw out a bunch of facts: Stephen Baksa was a director of Sito from 2011 to 2014.  The Baksa group appears to be supported on the board by one of the Sito Directors Brent Rosenthal (the only director they don’t want to replace).  One of the Baksa nominees purportedly has a “working relationship” with the Singers.  Some of the Baksa nominees sit on the board or are affiliated with a company called Evolving Systems.  Karen Singer owns 21% of Evolving Systems.  A couple of Singer’s relatives work with Evolving Systems.  And it seems like all of this activism started shortly after a March meeting between Sito management and Thomas Thekkethala, who is the CEO of Evolving Systems and was to become one of Baksa’s board nominees, where they met  to “discuss a potential licensing arrangement that would allow the Company to market its products to Evolving Systems’ customers outside the United States”.  It was 4 days after that meeting, on April 4th, that Sito adopted a poison pill and the activist ball got rolling.

I don’t really know what to make of the activist angle.  Maybe this is all a way for Evolving Systems to take over Sito, maybe there is something else going on.  I really have no idea.  I’ve read through all the filings and I honestly couldn’t pick out any tidbits that gave me certainty about the outcome.  Where we stand now is that the Baksa group has delivered a proxy signed by 58% of common shareholders supporting their proposals to remove the current executive and directors and replace them with the Baksa slate.  Sito has responded that they are having a third party do a count and validate the results and will report back next week.

While I am really not sure about the outcome, it seems to me that its at least possible that this ends in some sort of acquisition of the company.  Management has their backs against the wall with the recent proxy.  The easiest way out of the corner is a takeover, either by Evolving Systems or some other white knight.  And if it doesn’t happen, there are always the fundamentals to fall back on, which is the real reason I bought the stock.

Q1 Earnings: Identiv

I wasn’t planning on writing anything about Identiv’s first quarter.  There was nothing that stood out about the results.  The company reported so-so year over year growth (7%) that was hindered a little by slower growth in their Physical Access segment (5%) which is seasonally weak in the first quarter.  The Credentials segment grew at 11% and the Identity segment grew at over 20%.

The company reiterated guidance, which was set at $64-$68 million in revenue for the full year 2017 and EBITDA of $4-$7 million.

Nothing exciting.  Until the company decided to offer stock.

The news came out on Thursday.  It was priced by Friday morning at $4.85 and oversubscribed.  The pricing was favorable when compared to the close Thursday night (there was essentially no discount) but when you consider the stock has had maybe 3 or 4 up days in the last month, not so much.

So why did they do the offering?

The simplest explanation is that the stock price has moved significantly in the past few months, the company has only a small cash position on the balance sheet ($7 million) and the board thought it was prudent to raise funds (it ended up being about $12 million).  This would be the Occam’s Razor explanation.

While it’s probably as simple as that, there are some circumstances that make me wonder if other reasons were at play.  First, why would they do a share offering so close to the annual shareholders meeting?  It seems odd to raise the ire of shareholders right before they get their chance to speak to management unless the timing was precipitated by some specific need of cash.

And speaking of the word precipitate, there was an awkward exchange on the first quarter conference call between Stephen Humphreys (Identiv’s CEO) and an analyst.  The analyst asked about the recent shelf that Identiv filed.  Humphreys provided the usual run-around, the marketplace is exciting, looking for opportunities, making sure they have access to funds if something comes up.  But he also said there was “nothing precipitous”.  That seems to me like an odd phrase to use if you are one week away from issuing equity.  He didn’t have to give that color.  So why did he, or what changed in the following 7 days?

Also on the call was an odd disclosure by Humphreys about potential opportunities.  In his prepared remarks Humphreys explained the three tiers of growth for the company.  First is the base business growth.  Second is finding upside in their existing platform of products, new target markets or solution packages.  And the third is “disruptive growth”.  Humphreys spent some time on this, explaining how the company positions itself for a “black swan” event and “aspire for moon shots” with its “disruptive and transformational solutions”.  There was nothing specific in these remarks, which made me think it was odd to mention it at all.  What was the point?  Put yourself in the position of CEO.  What would cause you to decide to write prepared remarks discussing moonshots and black swans?  Would you really decide to do that on a purely hypothetical basis?

Finally there is the move in the stock price.  I was pretty surprised to see Identiv rocket up over a dollar after announcing the public offering.  I’ve seen an offering lead to a positive move in the price of shares, but its usually happens to a company where investors are concerned about solvency and the offering puts those concerns to rest.

So I don’t know. Maybe the move was just a reaction from a very oversold state.  Or maybe it had to do with the underwriter.  Whatever it was, there was nothing I could find in the prospectus or its follow disclosures to justify the reaction.  They were very standard documents.  It will be curious to see what transpires over the next few weeks and to see what they use the cash for.

Q4 Earnings: Medicure

I didn’t love everything I read in Medicure’s fourth quarter results.  So much so that I reduced my position.  Here’s why.

With the acquisition of Apicore, Medicure took on much more debt than they previously had.  In order to acquire Apicore they added about $60 million of debt.  The debt isn’t cheap, at 9.5% plus 400,000 warrants that they issued for shares at $6.50 (they say in the MD&A that the effective interest rate is 12%).   With a market capitalization of $100 million, the additional debt is not inconsequential.

The debt isn’t crippling, but it makes it crucial that Apicore performs in an accretive manner.  But from the disclosures provided by Medicure, it’s not clear to me just how accretive Apicore is.

The Apicore deal closed December 1st, 2016, and the one month numbers were excellent, sales of $7.8 million and gross margins of $4.5 million (after adjusting for inventory at the time of the acquisition).  But on the conference call the company said that December is by far the strongest month for Apicore and that we should not expect that level of results over the full year.  In the financial statement Medicure disclosed that had Apicore been part of Medicure for the full year, net income would have actually been lower, which is a bit worrisome:

On the other hand, in the quarterly presentation Medicure gave color around additional EBITDA from Apicore had they been consolidated for the full year 2016.  It is significant (around $6 million).  But I don’t know how to reconcile that with lower the net income?

Its not so much that I think that Apicore is going to be dilutive to earnings.  I doubt that.  It’s just that the company hasn’t made it clear what to expect so it’s difficult to forecast going forward.

The other development that gives me pause is that there has been a move to 2-6hr infusions of Aggrastat.  Basically physicians are using Aggrastat for shorter durations.  This helps them limit side effects and they are seeing acceptable efficacy.  The company described this as a positive development because A. Aggrastat is the only glycoprotein inhibitor (GPI) that has shown efficacy at the shorter infusion time, and B. the reduced side effect profile will lead to usage by physicians previously wary of using GPIs.  I quote/paraphrase the comments around this from the call below:

Only about 15-20% of physicians use a GPI.  This used to be 75%.  The reason for decline is bleeding risk.  Because Aggrastat doesn’t have a minimum infusion time, it is better positioned for physicians that don’t use or minimize use of GPIs

While it may end up being positive, I can’t help but think that in the short run this is a headwind for Aggrastat demand.  Physicians are going to be using less Aggrastat, that seems like the bottom line here until these other factors catch up.

The final thing that I didn’t love about the disclosures is I found some mistakes in it.   For example, on page 25 of their MD&A the total debt does not add up from the constituent pieces.  Similarly, on page 24 their operating income isn’t right in their EBITDA reconciliation (though the actual EBITDA end result is fine).

Nevertheless there are positives.  With the acquisition of Apicore, Medicure has a number of generics on the horizon that will generate growth.

In March Medicure announced FDA approval for tetrabenazene, which is a generic form of a drug used for Huntington’s disease called Xenazine.  Xenazine had over $300 million in sales in 2015, so if the generic can take a decent percentage of that it could be material.  They also filed an abbreviated new drug application (ANDA) for a generic in December and have two others in the development stage.  In total there are 15 ANDA’s in the pipeline.

So there is quite a bit of potential for growth.  But it could still be a number of quarters off.  Meanwhile the stock has an enterprise value of over $150 million and trailing EBITDA of $15 million, so it’s not particularly cheap.  I do like the growth pipeline though.  I’m just not sure at this point, so I took some off.