2018 in review….

Given that we are closing in on the end of the year, I thought I would publish a quick recap on those positions that I previously wrote about, namely:

• Pioneering Technologies
• Titan Logix
• Reliq Health Technologies
• Total Telcom

Unfortunately, like most of the Canadian small cap market, all of these are either in the toilet or treading water. However, each of these has its own particular story. Without further ado, I’ll launch into it….

Pioneering has been perhaps the biggest disappointment of 2018, as not only did it fail to meet revenue targets, it’s share price also cratered catastrophically. As of today (December 12th 2018), Pioneering is trading at $0.10, roughly a  90% drop from its price back in late 2017. The short & not-so-sweet reason for this skid is “over promise and under deliver”. Given the attention and buzz that was created around Pioneering in 2016 and 2017, investor expectations became inflated, and when increased sales didn’t show up, the bottom dropped out of the share price.

For those of you that have been following this story, this is all old news. The real question is “what now” ? Now that the market cap is a shadow of it’s former self, is this company on the scrap heap, or does it have a future ?

Clearly, if I knew the answer to this, I’d already be on my island somewhere. That being said, we can take a look at “what is” to determine “what might be”:

• The balance sheet (as of June 2018) remains debt free, with $5.7 MM of cash and short term investments.
• Assuming that sales are still slow to materialize, and cash is still being burned up at the same rate, PTE could be consuming between $225,000 and $360,000 per month, or cash burn of $1.575 MM to $2.52 MM for the 7 months from July – Dec 2018.
• If this is indeed occurring, then cash and short term investments, as of December 2018,  could be as low as $3.2 MM to $4.1 MM.
• This in turn means that net equity per share (using the fully diluted share count) could be as low as $0.13 to $0.15 per share, after adjusting for cash consumed.
• If one eliminates all long term assets, then the Net-Net book value per share (using the fully diluted share count) falls between $0.11 and $0.12 per share.
• Lastly, if one adjusts for potential cash consumed, the adjusted Enterprise value (using the fully diluted share count)  is between $2.35 MM and $3.25 MM.

So, at todays price of $0.10, you are actually buying Pioneering on a “net-net” basis. Is this a good deal ? It depends – if the Pioneering Smartburner is no longer useful, or has become obsolete, then the value of the company is questionable no matter how low the price gets. However, what if sales do (eventually) show up ? Or better yet, what sort of sales have to show up to make a difference ?

If we take a look at the most recent PTE financials (9 months ending June 2018), PTE recorded about $4.5 MM in total costs. Note that we are excluding any gains / losses due to the derivative liability, as this appears to have worked itself off the balance sheet. If we adjust this $4.5 MM for non-cash costs (stock based compensation, amortization and depreciation), it’s reduced to $3.5 MM of cash costs, which suggest that full 12 month costs should land somewhere in the $4.7 MM range, which we will simply round to $5.0 MM. We also know that PTE has managed to maintain gross margins at 50%, so in order to break even on a cash cost basis, PTE needs to see $10 MM in revenue.

Is $10 MM in revenue a pipe dream ? Well, we know that for fiscal 2017, PTE did indeed record $10 MM in revenue at a 50% gross margin, so the answer is “no, it’s not a dream” – they have done it once, and I find it hard to believe that in fiscal 2017 they sold to every possible customer in North America.

Perhaps the better question is why anyone would buy a Smartburner to begin with. Lord knows I wouldn’t – I have a gas stove, and I like instant heat. However, we need to separate the idea of who has the purse strings from what people want. You’ll recall that at some point in your distant past, your parents told you to wear a helmet when you were biking, skiing, or doing most anything that suggested the potential for injury. You, being the disobedient child that you were, likely fought this edict, until such time that your parents reminded you that “while you live in this house, you live by our rules”. They controlled the purse strings, and regardless of your thoughts, you complied. The same is true here – the people that are going to be cooking on a Smartburner sometime in the future won’t be doing so because they want to – they’ll do so because the owner of that home said so.  That owner believes that the “de-risking” of their rental unit is well worth the annoyance of getting used to a Smartburner, as tenants are now less able to burn down the house. With compliant UL858 stoves already in showrooms (I have seen them), the trend for safer coil top stoves is here to stay. Naysayers would suggest that if compliant stoves are on the market, the landlord will just buy one of those. Well, maybe – if you have the nicest landlord in the world. One thing about landlords is they like to control costs. The Association of Home Appliance Manufacturers (AHAM) suggests that a basic coil top stove lasts between 18 and 22 years. If I am a landlord, I’m not shelling out $400 for a new stove if I can make my existing stove (which has another 10 years of life) compliant for half that cost. While you might concede this point, you might also be saying that the vast majority of landlords simply won’t buy a Smartburner, because nobody says they have too – and you are right. Pioneering doesn’t need every coil top stove to be converted, they just need some. To be specific, with over 40 million rental households in the US, they just need a very small slice of some.

So, at the end of the day, I don’t believe Pioneering is heading for bankruptcy. I do believe it was overpromoted (which led to the run to $1.50), but the concept of kitchen fire safety, an aging population, and all those rental households in the US have not gone away. I believe that at the current price of $0.10, PTE may provide some significant upside (assuming sales materialize), and is suitable for very risk tolerant small cap investors. Of course, I may be wrong, and that may cause people to call me various names, some unflattering. That’s ok – I’ve been called many things, and have survived them all. I continue to be long, and have purchased at the current price.

Some of the things I end up going long on gets lots of press – and others don’t. Titan falls into this category, as despite consistent improvement, it keeps skipping along at basically the same price.

Titan year end numbers, released on November 29th, revealed the following:

• Revenue up 28% vs prior year.
• Cost of goods down 3% vs prior year.
• Gross margin up 90% vs prior year.
• All other cash costs up 8% vs prior year.
• EBITDA is still negative but is significantly improved at  -$0.256 MM vs -1.11 MM.
• The company remains debt free.
• Book value is $0.51/share, and net-net value is $0.35 per share.
• Cash & short term investments of $8.27 MM, or $0.29 per share.

While it is true that Titan is still EBITDA negative and burned a whopping $500,000 over the course of the year, this has to be viewed in the context of a recovering energy market. As we all know, commodities are cyclical – when prices are lousy, producers stop drilling, consumers keep consuming, and eventually prices start recovering. Around that time, producers decide to start drilling again, but since bringing new production on isn’t like flicking on the light switch, there tends to be a bit of a lag, at which time price really starts recovering – not exactly rocket science.

So Titan is managing to actually increase revenues (and gross margins)  while keeping a lid on G&A costs – all in the context of an energy market that isn’t running on all cylinders. This begs the question – what will things look like once activity starts to pick up even more ?  While I don’t know the answer to that, I do know that Titan remains a low risk play on the energy sector and has significant upside potential. At this point, the market is valuing a debt free company at slightly more than the assets on the balance sheet, suggesting that any future cash flows will be worth the square root of zero – a proposition which I don’t believe. While I don’t know when the market will notice, I’m glad to wait and potentially pick up more as the price drifts through the low ~ $0.50 range.

I had never actually intended to write about Reliq, but when they released their infamous “we have to restate revenues” press release, they provided a textbook case of a company that I try to avoid like the plague. Overvalued, overhyped, and with a balance sheet and an exploding share count that assault the senses.

To be fair, I should point out that I did indeed own Reliq at one point, as I indicated in my prior post.  However, once the valuation of Reliq started to get beyond what I could understand, I sold for a tidy profit. I will freely admit that the company has never been a favorite of mine, and because of this I cannot profess to have the depth of knowledge that I might have with other positions. That being said, Reliq hasn’t given investors much to be happy about recently, so if you are bullish on Reliq, I’m guessing you’ve done your homework, or you are simply comfortable with the implied risk.

All of that aside, the question as always is “what to do today” ? The share price is obviously much lower, so perhaps this represents a reasonable entry point.

Whenever I’m about to take a position such as this, I try to map out where things are today versus where they might go tomorrow, which is not unlike how I view my position in Pioneering Technologies. For Reliq, I took the time to map out the numbers, as shown below:

This table shows us the value (in terms of Market Cap and Enterprise Value, or EV) as of the most recent financials, and what the EV of Reliq might be as of December 31st 2018 assuming a low cash burn rate of $427,000 per month, and what the EV might be assuming a high cash burn rate of $1.03 MM per month. Both of those cash burn rates tie back to the most recent financials, where it indicated that Reliq used $1.28 MM ($427,000 per month)  after changes in working capital, or $3.1 MM ($1.03 MM per month) if you exclude changes in working capital.

Some of you may have noticed that I tend to focus on the EV/EBITDA multiple as a general yardstick for valuing a company, as this metric rolls market cap, debt, and cash into one ball of wax. As investors, we are always on the lookout for value, and a company that has high EBITDA and a low Enterprise Value is a reflection of that.

In the case of Reliq, I have shown what the EV could look like as of December 31st, and what sort of EBITDA an investor needs to expect in order to justify some sort of reasonable valuation. For instance, if you believe that Reliq will continue to burn cash at the “low” rate, then estimated year end EV of $23 MM suggests that you need to see EBITDA (at some future point in time) of $2.3 MM in order to justify a EV/EBITDA multiple of 10x.

What we can see is that Reliq needs to book somewhere between $5.75 MM of EBITDA for less aggressive investors who are willing to pay 4x EBITDA, and $1.77 MM of EBITDA for those investors who are very aggressive and are willing to pay 14x EBITDA.  Which leads us to the question – is this possible ? The short answer is maybe – but I’m not holding my breath.

If one takes a quick look at the Reliq financials going back to the year ending June 2016, you can see two things pretty quickly. First , EBITDA has been negative for every year, and not a “little bit negative”, or “negative and trending up”. It has simply been negative every year, and has gotten worse each year. In fact, EBITDA in this last quarter at -3.1 MM is worse than each of the fiscal years ending June 2016, 2017, and 2018.

Secondly, one can see that the cash in the company coffers has arrived as a result of share issuance. So, if you work for one of the firms that underwrote one or more of those share offerings, I must commend you on a job well done, as you managed to raise no less than $18 MM since 2016.

So, while I generally don’t shy away from speculative companies, I will be keeping my distance from this one till further notice. Perhaps Reliq will turn things around – but they’ve got a deep hole to dig themselves out of before that happens.

Since my initial post on Total (November 02 2018), not much has really changed, so this will be perhaps my shortest “update”. Nonetheless, Total did issue Q1 financials on the 29th of November ,which were largely neutral:

• Q1 revenues essentially flat at $346K vs $345K prior year .
• Cost of goods up 12% vs prior year Q1.
• Gross margins down 5% vs prior year Q1, at 53% vs 58%.
• All other cash costs down 6% vs prior year Q1.
• EBITDA down 11% at $72K vs $81K vs prior year
• Net earnings of $50 K flat vs prior year Q1.
• The company remains debt free.
• Cash on hand of $1.4MM, or $0.057 per share.

As the cop on the street would say, “nothing to see here, move on”, which is what I expect most of the market did. However, there are a few points worth noting that are still interesting. Firstly, its only fairly recently that Total has managed to be EBITDA and cash flow positive (Q1 of 2015), and since hitting this milestone, this is the best Q1 TTZ has recorded since then:

With the exception of shares outstanding, which have risen by a measly 1% since 2015, every other metric is improved: the cash balance is consistently growing, and EBITDA, cash flow, and earnings are all the highest they have ever been for a Q1. While this doesn’t necessarily predict the future, it sure doesn’t hurt.

Additionally, overall results for Total last year were muted by the fact that they actually lost some customers in the Environmental services sector (in the US). In addition to this, the heater controller segment was impacted by a shortage of vehicle heaters, which dampened their overall sales in this segment. Despite this, Total exited the year with net income of $476K, or EPS of $0.019.

So, while Q1 numbers weren’t blockbuster, they certainly didn’t make us run for the hills either. Based on what we can see today, barring a major catastrophe, it would seem reasonable that Total can at least repeat last years results. If they do manage to do that, then the current price of $0.18 suggests that an investor might see a flat share price or decline to around $0.14. To be fair, Total has traded as low as $0.12 in the last 52 weeks, but it only traded at that level for less than a month. For the vast majority of its “cellar dwelling”, it has tended to trade around $0.14. So, one could see a worst case loss of 33%, or a more likely loss of 22%.

On the other hand, if Total sees expansion in any one of it’s revenue streams, a lot of that incremental revenue flows straight to the bottom line. In my prior post I highlighted how the company now covers all of its costs from its recurring revenue stream, which means that any increases in existing revenue streams (or any new revenue) is “gravy”. To put this in perspective, for the year ended June 2014, Total booked revenues of $765K, whereas for the year ended June 2018 they booked revenues of $1.78 MM – a CAGR of 23%, all while maintaining gross margins of 50% or more. While last years revenue growth was an anemic 2%, Total previously had revenue growth of 6%, 38%, and 54% for the years 2015, 2016, and 2017. The gist of the argument is that it they have managed very significant growth, and I can’t imagine they recently have thrown up their arms and said “that’s good enough”. With management owning almost 30% of the shares, I’m guessing they have a strong interest in growing the company some more.

With this in mind, we continue to hold our position in Total, given that our cost basis is somewhat lower than the current price, and the fact that liquidity is sometimes limited. Assuming that Total does manage to garner more incremental revenues, we believe this could provide upside of 50% or more.

As always, these are only my thoughts & opinions. If you have questions or comments, I can be reached at mark@grey-swan.com.