Pioneering Technologies: Where there’s smoke….

PTE logo

It was with a fair bit of dismay that I read the recent headlines that Pioneering was terminating executives with cause. Not only was the company underperforming, it now had the added burden of some very negative press, the likes of which is not seen often. In the 20 years that I have been investing, this was the first time I’ve been stung by an event quite like this. There’s been times in the past where company shenanigans have reared their ugly heads, but usually they are in the form of inflated revenues (and inflated receivables), wildly exuberant press releases, or something that leaves a few more “tracks”. Pioneering, by comparison, did not (and currently does not) have inflated revenues or receivables, and had few press releases over the last year. This, to quote a former Secretary of Defence, was what you might call one of the “unknown unknowns”, or at least it was to me. In any case, there’s another quote that’s probably applicable here, and that is the fact that it serves little purpose to cry over spilled milk. At this point, one must determine what to do next.

What now ? Regardless of the fact that this particular company has caused some severe indigestion, the starting point is still the same: what can one glean from the technicals, the fundamentals, and the market outlook. Once these have been assessed, then one can make a reasoned decision how to proceed. Please note that despite the change to a more “formal” report format, we continue to use green, red, and amber text to highlight particular issues as being positive, negative, or neutral to the investment thesis.

The Technical Perspective: Moving averages are slowly converging. While I generally do not consider myself to be a technician, I do pay attention to moving averages to get a feel for what the current sentiment is like. As one can see from the 3 year chart below, PTE has retraced all of the gains that were made since 2016, and is basically right back where it started from. At this time (February of 2019), the takeaway is that both the 10 and 30 week MAVGs are slowly converging once again. Financials for Q1 are less than a week away, and if (yes, that is an enormous “if”) PTE can show some significant positive progress, one could see some price strength, and the 10 week MAVG could conceivably cross over the 30 week MAVG. However, you will note the heavy use of the words if and could in those prior sentences. Things will, for once, have to get better rather than worse – which is probably a good segue into fundamentals.

PTE Chart Feb 2016 to Feb 2019

The Fundamental Perspective: There’s no debt – but there’s not much cash either. On page 6 of the latest MD&A, PTE indicates that they have $2.30 MM in cash and investments as of January 28th 2019. As per the year end financials, they had (as of Sept. 30th 2018) $3.66 MM in cash and investments. This suggests that they burned $1.36 MM from Oct. 01 2018 to Jan. 28th 2019, a total of 120 days. The very simple math here is that if they cannot get traction with sales, they will burn through their entire cash position in approximately 6 ½ months, or about the middle of August of 2019. While it is obviously impossible to project the exact cash burn rate, this is reasonably close to the high estimate of cash burn that was originally made back in September of 2018. At that time, with $5.70 MM of cash and investments (as per financials dated June 30 2018), it was estimated that the entire cash position could be gone by October of 2019.

Receivables are not out of control. The classic kiss of death, an enormous receivables balance that is going to be collected “any time now” is not present. Additionally, the vast majority of receivables are current (as shown below), which at least provides some comfort that no AR write offs have yet to occur.

PTE receivables at Sep 30 2018

Inventory isn’t out of control – but it is big. As of January 28th 2019, page 6 of the MD&A states that PTE has roughly $8.0 MM of current assets. Given that total liabilities are a paltry $1.38 MM, and there is no long term debt, this should be music to our ears. It is – sort of. The fact of the matter is that $4.1 MM of these current assets is finished goods inventory (see below), and sales have been slow. While it is true that this inventory isn’t perishable, if there is even the slightest chance that this inventory is in question, it puts the entire company at risk. If sales had not dropped so precipitously, we probably wouldn’t even mention inventory. However, given that sales have been slowing down rather than speeding up (or staying flat), we would be foolish not to be aware of this situation.

PTE invetory at Sep 30 2018

G&A expenses have stayed in line with estimates. When we previously reviewed PTE Q3 statements, we estimated that full year G&A costs (including non-cash expenses) should come in around $6.0 MM. Thankfully, this was indeed the case, with full year G&A costs coming in at $6.07 MM. When one adjusts for non-cash expenses, full year G&A cash costs came in at $4.78 MM. While these are up from last year, our concern was that they would continue to increase as the fiscal year progressed, further damaging an already tenuous situation.

Tangible book value is solid – for now. At the time of writing this (February 2019), PTE book value comes in at about $0.15 per share after adjusting for cash burn up to the end of January 2019. So, the optimist would say that at a $0.10 price, one is purchasing the company at a 33% discount to tangible value. Additionally, if one looks at PTE in a net-net context, it is still a bargain, as the net-net value per share, also adjusting for cash burn up to the end of January, is $0.11 per share.

However, it’s no great secret that cash burn, if it doesn’t stop, will eventually scare away even the most hardened of value investors. With this in mind, the table below encapsulates what the tangible value of PTE would look like if the bleeding doesn’t stop. We assume that PTE continues to burn cash at the same rate as it did in the 4 month period from the end of September 2018 through to the end of January 2019, approximately $340,000 per month.

PTE Tangible book value table

As one can see, depending on what one believes, today’s price is either a bargain or a value trap. Given the unfortunate fact that results to date have been poor and the company is currently dealing with its own internal strife, I would not fault investors for cutting bait, as it is difficult to determine whether that light in the distance is the break of dawn or an approaching train. On the other hand, those investors that are extremely patient and extremely risk tolerant will make the astute observation that outsized returns often come in murky, opaque packages. To be clear, the current situation is exactly that.

Outlook – what does the future hold ? PTE needs to repeat or improve on 2017 sales. In fiscal 2017, PTE revenues came in at $10.28 MM with a 50% gross margin.   While this is a far cry from 2018 revenues, the fact that it did indeed occur suggests that it’s not impossible, hence the amber color of this section – it’s not impossible, but recent results aren’t exactly screaming that it will.

With their current cost structure, $10 MM seems to be the low water mark to achieve a cash flow neutral state, assuming 50% gross margin and cash G&A costs of approximately $5.0 MM.

Gross margins are a concern. On page 6 of the most recent MD&A, one can read the following:

PTE MD&A inventory statement

Those last two sentences are a very clear signal that the 50% gross margins that we see today could very well change – and possibly not for the better.

Increased sales are (theoretically) around the corner.  The company makes the following statement on page 5 of the MD&A (below):

PTE Distributor model statement MD&A

The use of words like “traction”, “increased”, “repeat”, and “growing” are strong words, and their use here is interesting. Whereas comments in the MD&A for prior quarters made clear reference to longer sales cycles, there has never been the use of words as pointed as these. This creates a bit of a perplexing situation for us, as on one hand there are clear signals that margins may suffer, whereas here there is a very strong signal that sales should improve. With all of that in mind, until actual results manifest themselves in a tangible way, we remain neutral on statements such as this.

The market opportunity is still there. Some of you may recall a statement made previously, which is repeated here: The market opportunity of over 40 million rental units (https://www.nmhc.org/research-insight/quick-facts-figures/quick-facts-resident-demographics/) is still sitting there. PTE doesn’t need to sell to every single one of them, but it does have to sell to more of them. The problem of kitchen fires is still one that landlords would like to reduce or eliminate, and until that changes, the Smartburner should still be something of interest to them.

Finally – what action are we taking ? We continue to hold PTE – and may even add at these levels. This statement may sound surprising, but it must be viewed within the context of an entire portfolio of companies such as these. Bear in mind that our original position in PTE was initiated at prices similar to what we are seeing today, not at the much higher prices that we saw in 2016 and 2017. While it is very difficult to buy (or even hold) when negativity is so prevalent, it is also the time when everyone else has thrown in the towel. Additionally, while it may be irrelevant to the overall investment thesis, it is nonetheless interesting to note that investment firms with much larger pockets (and audiences) than us issued “Buy” recommendations in 2017, at a time when optimism was at its highest, and leading some investors to buy in close to the peak. Our approach is somewhat different.

To provide some more context, we maintain positions in 10 to 20 small and micro cap companies which we believe may provide very significant upside. Because of our focus on these small (and volatile) companies, we know that we may be subject to larger than normal swings, which goes with the territory. When things get good, they can be very, very good – and when things get bad, the same applies.

In closing, we would say that any investor contemplating a long position in PTE should be extremely risk tolerant, and extremely patient, as it is unlikely that any turnaround will manifest itself over night. As always, if you have comments or opinions, please feel to send an email or leave a comment via the website.

Pioneering Technologies: Post Mortem?

PTE logo

For those of you that have been following this story, you have either thrown in the towel, or are curious as to whether or not this company is alive (or not). Since publishing the initial four part series back in June of 2018, the share price of Pioneering has managed to shed even more value. Anyone that purchased in June of 2018 (or prior to Q3) has lost money, and in no small measure.

Recently I received an email which was basically a “what now” kind of query. Which is why I am following up with this post. For ease of reading, and so that readers can skip to those areas that are of particular interest to them, I’ve decided to follow a point form format. Here goes….

Are you (Grey Swan) still long on PTE, and have you purchased more ? Yes, I am still long, and I have (at these prices) purchased more.

OK. You are still long, and have bought more. Are you insane? That depends on how you view your investment horizon. I tend to have a long hold period (less than 2 years is very short for me), and have held things as long as 10+ years. My most successful investment spanned an 8 year period. During that time, depending on when I might have sold, I could have lost ~ 65%. When I did eventually sell, I ended with a 1200% gain on the entire position, and that was before the shares peaked. The final tranche of shares that I sold realized a gain of 2600%. All that is to say that I am “crazy” by the standards of those who have short investment horizons, but perhaps not crazy for those that have long time horizons.

Why did I buy more shares ? The company is, without a doubt, missing short term revenue targets, and the market is punishing it severely. However, a quick rundown of the Q3 financials provides the following information:

  • There is no debt on the balance sheet: No debt means that insolvency risk is about as close to zero as one can get.
  • G&A expenses have remained static: Total G&A expense for the 3 and 9  months ended June 2018 was $1.5 MM and $4.5 MM respectively. One of the things I was looking for in these statements was no further growth in G&A. The fact that both of these, when extrapolated over 1 year, end up at the same place ($6.0 MM) is a good thing. This suggests to me that the G&A structure is basically “in place”, and that we hopefully shouldn’t see further growth in overhead.
  • Cash + short term investments aren’t all gone: The company has $5.7 MM in cash and short term investments. For the 3 months ended June 2018, they burned $1.07 MM, and for the 9 months they burned $2.02 MM. If we assume they continue to burn cash (and essentially cannot sell significant product volumes) at the 3 month burn rate, then they will use up their entire cash position in about 16 months. If this does indeed occur, then I will be losing a significant amount of money, and I will be eating more than my share of humble pie. However, I believe management is highly incented to make sure this does not happen. Which brings me to my next point.
  • Management still owns a significant number of shares: If you add up the 5 largest holdings of individual insiders (Dueck, Paterson, Pavan, Callahan, & Shah) they total ~ 23 MM shares, or about 35% of the fully diluted share count of 64.5 MM shares.  While it is probably true that these guys are all (likely) wealthier than you or I, they too have “felt the pain”. Collectively, this group of insiders has “lost” a combined ~ $31 MM ($1.50 peak price – $0.15 price today). You can imagine that they are likely very interested in seeing the share price move back in the right direction.
  • UL 858 compliance isn’t sexy: When was the last time you were at a cocktail party and someone wanted to talk to you about “a safer stove”. My guess is never. The concept that PTE is selling (kitchen fire safety) and the niches that it is targeting (Seniors, University, Co-op housing) are boring. Consumer awareness of this issue is still close to zero, as “compliant” stoves likely won’t show up in showrooms till some time in 2019. This story is not blockchain or cannabis, and that being the case, many investors will not become re-engaged with it until the financial results start telling a different story. In the meantime, I would expect that we will see a flat-lined technical chart at best.
  • UL 858 compliance isn’t sexy, but someone is still noticing: There were three recent press releases regarding partnerships with HPN select (purchasing group for Co-op housing), Millers Mutual (insurance company providing insurance discounts), and Buyers Access (purchasing group for multi-family housing). I would imagine that large organizations such as these don’t sit around and draw straws to see “who should we  partner with” or “what should we provide an insurance discount for”.  These are decisions that have to pass through various levels of decision making before they get the green light, and only then after they determine that this will also be good for their organization, not just Pioneering.  When the purchasing group you deal with carries a product, you (as a multi-family landlord) are far more likely to buy it – which in the long run means more sales. 
  • The opportunity is still there: If you do a quick Google search on “how many multi-family housing units in the USA” you will get a number of different answers. If you believe the U.S. Energy Information Administration, the number is around 16.5 MM, and that was in 2005. If you think the National Multi Housing Council is right, then the number is 17.8 MM. For the sake of clarity, these number represent the number of buildings that house 5 or more units. If you are include all rental stock, then this number is closer to 40 MM. These units aren’t going anywhere anytime soon – they are still sitting there. Granted, everyone won’t want to buy a “Smart burner”, but it stands to reason that some will.
  • The company is priced for oblivion. Right now (Q4 2018), at a share price of $0.14, the company has a market cap (using basic shares outstanding) of $7.2 MM. Adjusting for cash on the balance sheet, this implies an Enterprise value of $1.5 MM. If the product that Pioneering is offering is truly useless, and nobody wants to buy it, then this valuation is correct. In turn, if that is correct, then organizations such as HPN Select, Buyers Access, and Millers Mutual have made some very poor decisions. However, my guess is that someone out there finds value in the concept of reduced risk of fire, and in turn, a reduction in related issues such as false alarms and property damage. Like a lot of other shareholders, I’m just going to have to wait.

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

Pioneering Technologies: Part 4

PTE logo

  • Parts 1 through 3 reviewed recent activity, solvency and risk, and future potential.
  • In Part 3, we determined that regulation changes in 2019 could drive large sales.
  • In Part 4, we show how increased sales will impact the company and share price.

We closed Part 3 of our review with the belief that regulation changes to coil top stoves in 2019 would create safety awareness, and in turn, could drive increased sales of the Smart Burner product. Given the very large size of the US market (43.8 MM rental households), we decided that only a small fraction, 274,000, or about 6/10 of 1%, might install a Smart Burner once the regulation change takes effect.

What’s the impact of sales of 274,000 units: Now that we have determined what we believe sales could look like in 2019 (post “regulation change”), we can relatively easily determine what the economic impact (on the company) will look like.
From publicly available information, we can see that the Smart Burner sells for anywhere between $190.77 US and $221.99 US, as per information from both the Staples Supply and Interline Wilmar websites (below):

 

Staples smartburner.png

Source: https://www.staples.com/Smart Burner/directory_Smart Burner

Wilmar smart burnerr.png

Source: https://www.wilmar.com/Search?keywords=Smart Burner&filterByCustomizedProductOffering=False&previouslyOrdered=False

These prices are not reflective of what Pioneering might be receiving, as both Staples, Wilmar, and HD supply act as distributors. Therefore, this leaves us with an unknown: we know how much the distributor receives when the consumer buys a Smart Burner, but we do not know how much Pioneering is receiving from the distributors. However, we do know that the distributors apply their own mark up. If we can make a reasonable estimate as to how much distributors typically mark up an item, then we can effectively determine how much they are paying when they purchase it from Pioneering.

While I am no “supply chain” expert, some web research provides us with the following information:
“The average wholesale or distributor markup is 20%, although some go as high as 40%.”

Source: https://www.pros.com/blog/distributor-pricing-profit-margins-pricing-markups/

This is validated via another source, as shown below:

Reasonable markup to distributors.png

Source: http://www.tom-gray.com/2012/04/26/reasonable-markup-to-distributors/

Both of these data sources suggest that the distributor markup could be anywhere in the range of 20% to 40%. With this data in hand, we can then calculate what the revenue stream to Pioneering would be, using these ranges as bookends. With this information, we can extrapolate what the sale of 274,000 units could look like, under the following assumptions:

• We are only calculating sales of Smart Burners in the US market. Sales in the Canadian market would be incremental to this analysis.
• We are not attributing any value to any other Pioneering products, nor are we attributing any value to the partnership Pioneering has with Innohome.
• We use the lowest price we could find, $190.77 US.
• We assume that COGS (& gross margin) will come in at 50%.
• Because Pioneering is domiciled in Canada, we convert gross margin from US$ to CAD$.
• We use a conservative FX rate of $0.90 US$ = $1.00 CAD$. This is the weakest US$/CAD$ FX rate over the last 5 years, and the average FX rate (2014 to June 2018) has been approximately 0.80. A stronger US$ would improve these results.
• We apply the FX rate directly to the US$ gross margin, rather than attempting to model how the accounting for FX gains or losses would appear on the income statement. We realize that actual accounting gains/losses would be realized via currency hedging, etc.
• After converting gross margin to CAD$, we continue to use CAD$ for the rest of the analysis, as Pioneering G&A costs are denominated in CAD$.
• We assume G&A increases significantly, coming in at an annual amount of $12 MM CAD, double the current G&A costs which are forecast at ~ $6.0 MM CAD for fiscal 2018.
• We ignore non-cash charges such as DD&A, as they are not material (~ $30,000 CAD$ for fiscal 2017).
• We assume a corporate tax rate of 25%.
• We use the total diluted shares outstanding.

The outcomes of a sales volume of 274,000 Smart Burners under various distributor mark up percentages is shown below:

PTE 274000 units.png

When we began this analysis, our thesis statement was that this was “a sales story”, and the key was whether or not Pioneering could increase sales. We believe that with pending regulation coming into effect in 2019, sales are likely to increase, and in doing so, will drive the profitability (and share price) of Pioneering. This being the case, we believe that todays share price weakness is a significant opportunity for those investors that are risk tolerant and have a longer time horizon.
Disclosure: The author of this analysis holds a long position in PTE. The author has received no compensation from Pioneering Technologies for the writing of this analysis.

 

Pioneering Technologies: Part 3

PTE logo

  • Part 1 reviewed recent share price activity from 2016 to today.
  • Part 2 compared Pioneering financials today vs the those prior to latest financing.
  • Company is not at risk of going bankrupt, & balance sheet is solid.
  • However, the question of future sales volumes is still unanswered.

When we ended our discussion of Pioneering in Part 2, the key question we were trying to answer was one of sales: can Pioneering increase sales of the Smart Burner, and when. However, to understand the sales story, we should also understand the product, why it appeals to a particular market segment, and how large this market segment is.

The product is unique.   The Smart Burner is unique in that it prevents a fire from occurring, rather than setting off an alarm after the fact, or putting out the fire via an attached automated fire extinguisher or sprinkler. There are a number of safety devices on the market that do one (or perhaps even both), but one of the key points raised by end users is that prevention of combustion is far superior to an alarm or a product that extinguishes a fire after the fact. End users have highlighted that once an alarm is set off, the building may still need to be evacuated, and the local fire department may be on the way, regardless of whether or not the fire has been extinguished. When viewed in the context of an apartment building, this causes inconvenience for the residents, and may imply some cost to the building operator for each visit by the fire department. Additionally, residents & property are clearly less at risk from a situation where there is no combustion vs one where combustion occurs and is extinguished.

In addition to this, the Smart Burner is unique in that it meets the pending change to UL858 (Underwriter Laboratories) regulation, which will take effect in early 2019. The UL858 change will necessitate that all coil top stoves sold in the North American market must pass an ignition test. The test requires that an electric coil top stove, at it’s maximum setting, must be allowed to operate for 30 minutes with a pan of cooking oil on the element.  The stove must operate for 30 minutes or until such time that the cooking oil ignites. If ignition occurs, then the product cannot be sold North America.

The product is meeting a distinct need.   Statistics indicate that the vast majority of fires start in the kitchen, so the product has a clear application. The pie chart (below) shows quite clearly that over ½ of all residential fires start as a function of cooking. While this particular pie chart represents fires in Great Britain, data from the US National Fire Protection Association (NFPA)  is consistent with British statistics (NFPA data also shown below).

British kitchen fire stats.png

Source: https://www.ifsecglobal.com/innovation-at-ifsec-fire-safety-products-for-the-kitchen-by-innohome/

NFPA kitchen fire stats.png

Source: https://www.nfpa.org/Public-Education/By-topic/Top-causes-of-fire/Cooking

This data suggests that there is a very clear niche market that is currently not being addressed. However, while it is clear that a market exists, we have to ask how large this market is.

 

The size of the potential market is large.  Data sourced from the National Multi Family Housing Council provides the following snapshot of the US housing population:

US households by type.png

Source: https://www.nmhc.org/research-insight/quick-facts-figures/quick-facts-resident-demographics/

From this data, we can quickly see that there are 118 Million households in the US that could potentially install a Smart Burner. Of this total amount, we will ignore the Owner-Occupied segment. Home owners are far more likely to purchase a stove that is esthetically pleasing (glass top, gas, induction) vs one that is utilitarian. By comparison, the 43.8 MM rental units are owned by landlords, who are typically driven by cost and functionality. If we put ourselves in the shoes of a landlord, we can see that traditional coil top stoves are an easy choice for rental units based on the following criteria:

Landlords and stove type

While a landlord may ultimately put in whatever they want, for the various reasons shown above, coil top stoves are an easy choice. Coil top stoves are cheap, simple, pose no extra risk from a natural gas source, have no cooking surface (glass top) that can shatter, and do not require special pots or pans to be used. So from this data, we can say that out of the 118 Million households, the 43.8 Million rental households are the likely candidates for the installation of a Smart Burner.

With this data in hand, we then have to ask ourselves how many of these landlords will install a Smart Burner ? Again, the exact answer is difficult to pinpoint, but to answer this we will look at the implementation of another safety device – the home smoke alarm.

The first battery operated smoke alarm was available as far back as 1969. However, smoke alarms were not widely used, given that there was no law or regulation that required their use. In 1972, about 200,000 smoke alarms were sold in the United States. This changed significantly in 1976, when the NFPA (National Fire Protection Association) passed NFPA101, which was referred to as the “Life Safety Code”. This was the first document that stated “smoke alarms are required to be in every home”. By 1976, 8 Million units were sold, and in 1977, 12 Million units.

Source: http://www.mysmokealarmla.org/history-of-smoke-alarms/

This information highlights two important consumer trends. First, if consumers are left to their own devices, the majority tend not to implement safety improvements. This is not entirely surprising. Readers who live in jurisdictions where it snows have experienced this. While snow tires significantly improve stopping in winter conditions, many consumers prefer to use all season tires in order to save money.

Secondly, when regulation finally takes effect, the purchase of the device can experience a sharp increase. While the parallel between smoke alarms and the Smart Burner is not exactly the same, we are also not suggesting that the increase in Smart Burner purchases would be this significant. What we are saying is that the change in the UL858 standard will create awareness, and consumers (such as landlords) may be more likely to purchase a Smart Burner for their rental units.

This brings us back to our question, specifically, how many of these landlords will install a Smart Burner ?  Based on our smoke alarm example, we know that the introduction of regulation increased sales by a factor of 40 – but this was in 1976. To better understand what total sales of 8,000,000 smoke alarms in 1976 really means, we have to understand what the population of the US was in 1976, which (lucky for us) is relatively easy to do:

US population 1976

Source: https://www.google.ca/search?source=hp&ei=57YNW_WPOJr7jwTnkIqIAQ&q=Population+of+the+USA+in+1976&oq=Population+of+the+USA+in+1976&gs_l=psy-ab.12..0i22i10i30k1.370.6433.0.9649.30.21.0.0.0.0.283.3030.0j13j4.17.0….0…1c.1.64.psy-ab..13.17.3024.0..0j35i39k1j0i67k1j0i22i30k1.0.rgfatTHyJiY

Lastly, because we are comparing “households”, we have to adjust for the number of people per household, which has changed since 1976. Again, this is also easy to find:

US households size in 1976.png

Source: https://www.google.ca/search?ei=8rYNW8H7FqfojwT4_YBA&q=Average+household+size+in+USA+1976&oq=Average+household+size+in+USA+1976&gs_l=psy-ab.3…56520.64131.0.65177.34.23.0.10.10.0.257.2780.0j15j2.17.0….0…1c.1.64.psy-ab..8.25.2622…0j35i39k1j0i131i67k1j0i131k1j0i67k1j0i20i263k1j0i22i30k1j0i22i10i30k1.0.PVxKOQjp-hM

From all of this data, we can infer that in 1976 there were 75,432,526 total households (218,000,000 total population  / 2.89 persons per household), of which 8,000,000 purchased smoke detectors after the introduction of NFPA 101, or a total of 10.6% of all US households.

This answers our question as to what percentage of landlords might purchase a Smart Burner. However, we would suggest this 10.6% to be a “pie in the sky” type of figure. The UL858 change will require that any new coil top stove sold in North America is compliant – not that any homeowner or landlord (who already owns a stove) must be compliant with a stove they already own. We would suggest that once the UL858 change takes effect, and compliant products begin to show up at retailers, consumer awareness will increase, which in turn will spur sales of the Smart Burner. Landlords, seeing that  “safer” stoves are available, may want to achieve a similar level of safety with their existing coil top stoves. By reducing false alarms and potential fires, a Smart Burner may be able to save them money via reduced insurance rates, or simply decreases the risk profile of their housing units. So, some landlords may decide to purchase a Smart Burner to better equip & de-risk their housing portfolio. Like any new (or disruptive) technology, adoption does not occur “en masse”, and different people (and organizations) will take more or less time to decide to adopt a new product or methodology. This is consistent with what is known as “The Technology Adoption Curve”, which is shown below:

Tech adoption curve

Source: http://www.web-strategist.com/blog/2010/01/03/social-technology-adoption-curve-benefits-and-risks/

One can see that “Innovators”, who are early adopters of new technology, make up 2.5% of the potential marketplace. To be very clear, we are not suggesting that a safety device such as the Smart Burner is as sexy (or interesting) as an Iphone, we are simply highlighting what percentage of “innovative” landlords might be tempted to purchase a Smart Burner. In addition to this, it is unlikely that the entire 2.5% of the landlords that are “Innovators” will suddenly rush to order the product come 2019. Because of this, we would suggest that only a portion of this group will be interested in purchasing a Smart Burner in 2019. We would err on the side of conservatism, and in doing so, suggest that perhaps 25% of potential “Innovators” might purchase a Smart Burner in 2019, or 274,000 in total (43.8 MM x 2.5% x 25%).

In summary, our lengthy discussion of the potential market size (and the associated opportunity) highlights a few key points:

  • For various reasons, landlords likely favor coil top stoves for their units.
  • Because of this, landlords will be a very likely market for the Smart Burner.
  • Landlords control approximately 43.8 Million housing units in the US.
  • The UL858 standard change will create more awareness, and potentially more sales.
  • Increased sales of the Smart Burner would most likely happen in 2019 or later.
  • People (or companies) that are early innovators tend to make up 2.5% of the potential population, or approximately 1.1 MM of the potential 43.8 MM rental units.
  • Lastly, because people (and organizations) tend to move slowly, we would suggest that only 25% of the 2.5% of “Innovators” (approximately 274,000) would be initiating orders for the product once regulation changes in 2019.

This information provides a more definitive answer to the question we were left with at the end of Part 2. When we concluded Part 2 of our review, we had determined that the “million dollar question” was if Pioneering could actually sell increased volumes of the Smart Burner, and if so, when might we see these increased sales.  Having answered this question, Part 4 of our review will focus on how such increased sales might impact earnings & share price.

Pioneering Technologies: Part 2

PTE logo

  • Part 1 of this series reviewed recent share price activity.
  • PTE went from ~ $0.20 to $1.50 – and back again as of May 2018.
  • Recent revenue misses have caused massive selling pressure.
  • However, balance sheet is rock solid, with no insolvency risk.
  • Investment thesis boils down to one issue: can PTE increase sales.

In Part 1 of our review, we took a look at the activity of Pioneering common shares from 2016 through to May of 2018, and how they came to run from under $.20 to a high of $1.50 – and back.  In this segment, we take a look at how good (or bad) the company is today, after having given up virtually all of its gains over the last few years. Essentially , is the company worse today than it was yesterday ?

To answer this question, we look first at the most recent financial statements of Pioneering (6 months up to March 31 2018) versus the financials immediately before the February 2017 financing (Audited 2016), beginning with the balance sheet:

 

PTE 2016 2018 compare bal sheet

 

Using the basic share count, what becomes clear from this comparison is that the company today is debt free and has ~ $0.12/ share in cash and short term investments.  Before the financing, Pioneering had $1.3 MM in long term debt and had only $0.07/share in cash. Additionally, the 23.6 current ratio today is significantly improved over the current ratio of 1.47 of December 2016. In terms of potential bankruptcy risk and capital structure, the company is in a much better position today.

This being said, any rational investor would question how long cash reserves can last. Based on the most recent 6 month period (October 01 2017 – March 31 2018) & 3 month period (Jan 01 2018 – March 31 2018) we can see that Pioneering burned $0.954 MM & $1.284 MM respectively, including all changes in working capital. While we don’t know which one of these is indicative of the future, we can assume that the future cash burn could be anywhere between $428,000 / month (using the 3 month value), or as low as $159,000 / month (using the 6 month value), or an average of $293,500 per month.

 

PTE Mar 2018 cash flow.png

 

Now that we have an understanding of what the cash burn looks like, if we then assume that Pioneering continues to sell at these depressed levels, then the company could continue to operate, without requiring incremental financing, for somewhere between 16 months ($6.8 MM / $428,000) and 43 months ($6.8 MM / $159,000).  In essence, both the balance sheet and the cash flow statement confirm that insolvency risk is not an issue, and that dilution via further share issuance is unlikely in the near future.

While a clean balance sheet and cash in the bank are always nice to have, we should also take a look at the income statement to understand how revenues and expenses have changed over this period of time (below).

PTE 2016 2018 Inc St.png

 

At first glance, a few things are immediately apparent. Gross margins have deteriorated, from an average of 66% in 2015 and 2016 versus a significantly lower 52%-53% in 2018. While this is clearly “not good”, gross margins of over 50% are still very robust. It is possible that a significant portion of this deterioration is attributable to the move to large distributors (Wilmar, HD Supply, & Staples), as larger distributors may agree to purchase larger volumes, but at a somewhat reduced price. With this in mind, we will assume the lower gross margins are here to stay. Additionally, one can see that G&A costs have increased significantly, from full year 2016 costs of $3.39 MM to forecast 2018 costs of between $5.9 MM to $6.5 MM.

The increase in costs are not entirely unexpected. We should recall that the companies push into the (very large) US market is a fairly new development, and significantly increases their exposure – and potential sales. As the saying goes, “there is no free lunch”, and it is reasonable to expect some increase in G&A to go along with the anticipated increase in future sales. Additionally, some of the G&A costs noted for both 2016 and YTD 2018 include non-cash charges. We are not referring to DD&A, as these costs are less than $30,000 annually. Rather, we are referring to non-cash compensation expenses that are buried in other G&A line items. Extracts from the notes to the financial statements (below) show the total non-cash charges for each period:

2016 and 2018 stock based comp.PNG

Adjusting for these values, this means that actual cash costs for fiscal 2016 and YTD 2018 come in at $2.80 MM and $2.34 MM respectively. If we then assume that the $614,472 of non-cash costs for the first 6 months of 2018 were evenly distributed throughout the 6 month period, we can then annualize both 6 month and 3 month G&A costs, which gives us a full year estimate for 2018 of somewhere between $4.69 MM and $5.30 MM.

So, after review of all available financial information, we can make the following assertions:

  • Balance sheet has been de-risked, with significant cash on hand and no long term debt.
  • Company has no insolvency risk, and should not require a capital raise for some time.
  • Company can operate at current “depressed” sales level for 16 to 43 months.
  • Gross margin has deteriorated from ~ 66% to ~ 52%.
  • Some of this deterioration may be explained by the move to larger distributors.
  • G&A is significantly higher, even after adjusting for all non-cash charges.
  • However, this too may be a function of the company adjusting cost structure for larger future sales volumes.

While it is clear that PTE shares won’t be hitting $0.00 soon, our original question is only 1/2 answered. While insolvency is a non-issue, & the balance sheet is significantly improved, the income statement appears to be “less improved” at the very least, if not worse. We are still left wondering, is this glass half full, or half empty ?

To answer this question, we first have to determine  if  Pioneering will be able to actually sell increased Smart Burner volumes, and if so, when. This is perhaps the key to the PTE story, and this is exactly what we will discuss in Part 3.

 

 

 

 

 

 

 

 

 

Pioneering Technologies: Part 1

PTE logo

  • Recent revenue misses have caused massive selling pressure.
  • However, balance sheet is rock solid, with no insolvency risk.
  • Investment thesis boils down to one issue: can PTE increase sales.

Who are they and what do they do ?  Pioneering Technologies is based out of Mississauga, Ontario, and produces fire safety products that prevent kitchen fires. Having been listed on the TSX Venture exchange for over 10 years, their flagship product, the “Smart Burner”, allows users of traditional coil top stoves to replace the existing coils with the Smart Burner, which allows for the cooking of food, but prevents temperatures that reach combustion. Pioneering also provides other similar safety products that are cooking related, such as the SafeTSensor for microwave ovens and the Range Minder, which works with gas, ceramic, or coil top stoves. However, we will be focussing on their flag ship product, the Smart Burner, as this makes up the bulk of their sales. Our discussion is broken into four parts as follows:  company activity & share price activity from 2016 to today (Part 1), whether the company is in better or worse shape today (Part 2), why the investment opportunity has upside (Part 3), and what future results and associated share price might look like (Part 4).  The reader should note that all financial values are quoted in Canadian dollars unless otherwise indicated.

Part 1: Why is this chart so ugly ?

PTE no info chart.png

There are two things that the above chart makes very clear. First, any investor who went long on PTE in early 2016 (or earlier) could have done very well, as shares peaked at $1.50 in February of 2017. The second thing that becomes clear is that any investor who went long in early 2017 (or later) experienced a significant loss. So, the question is: what caused the significant run up in share price, and what caused the significant decline?

If we look at the same chart, with a bit more information, we have a better picture of what happened:

PTE info chart.png

The chart above shows price movement along with the timing of non-financial press releases, earnings releases, financings, and analyst research. We categorize a “non-financial press release” as any press release that imparts information outside that of typical earnings news or any significant financial change, such as a financing. For example, a press release announcing a new large customer would be categorized as “non-financial”. While the information may be interesting (it is typically bullish), it imparts information that is entirely at the discretion of the company, and is not required (or mandated) by regulation or law.

One can see that during 2016 there was a total of 11 non-financial press releases, most of which were concentrated in the period between June & October of 2016. These press releases introduced new participants to the Pioneering story, and by creating more awareness, also created more potential buyers of the shares. With this new awareness, the shares rode a wave of popularity, peaking at $1.50 in February of 2017. In March of 2017, the company undertook a private placement at $1.10, which in turn resulted in analyst coverage by the same institution. Bullish coverage followed for approximately 8 months, until Pioneering issued full year 2017 numbers which fell well short of inflated investor expectations. Similar underperforming quarters followed in March and May of 2018, causing further sell pressure, and resulting in a 52 week low (as of May 31 2018) of $0.21.

Seasoned investors will note that this is not the first time this story has played out, as analyst coverage often is overly bullish and creates expectations which are hard to meet within a short time frame. This story is no different. Investors who purchased after Q1 of 2016 saw a relatively consistent stream of positive news, which culminated in bullish institutional coverage. Once results were clearly short of expectations, selling pressure took over, and the share price has yet to recover.

For those readers that are interested, links are included to all the noted non-financial press releases (below).

This concludes Part 1 of this review of Pioneering Technologies. For those that are interested, I will be publishing Part 2 shortly. If you have any questions or comments, you can reach me at mark@grey-swan.com..

https://www.accesswire.com/438618/Pioneering-Technology-to-Present-at-the-2016-Microcap-Conference-in-Toronto-on-April-12th

https://www.newsfilecorp.com/release/20565/Pioneering-Technology-Appoints-Contact-Financial-as-its-Investor-Relations-Firm

https://www.newsfilecorp.com/release/21160/Pioneering-Technology-Teams-with-Siemens-to-Deliver-Energy-Efficiency-Fire-Safety-for-Houston-Housing-Authority

https://www.accesswire.com/441990/Pioneering-Technologys-Smart BurnerTM-Poised-for-Growth-viaNew-US-Distribution-Agreement-with-Market-Leader

https://www.newsfilecorp.com/release/22043/Florida-Universities-Installing-Pioneering-Technologys-Smart Burner-as-New-School-Year-Approaches

https://www.accesswire.com/443905/Multifamily-Residential-Insurance-Carrier-Recognizes–Pioneering-Technologys-Smart BurnerTM-for-Insurance-Discount

https://www.yahoo.com/news/pioneering-receives-largest-single-purchase-120000342.html

https://www.accesswire.com/445303/Massachusetts-Fire-Department-Receives-US-Federal-Grantto-Equip-Local-Housing-Authority-with-Pioneerings-Smart Burners

https://www.newsfilecorp.com/release/22903/U.S.-Property-Management-Firm-Begins-Rollout-Pioneerings-Smart Burner-Across-Apartment-Portfolio

https://www.newsfilecorp.com/release/23018/Pioneering-Technology-Enters-into-Partnership-Agreement-with-European-Cooking-Fire-Prevention-Leader-Innohome-OY

https://www.accesswire.com/447253/Pioneering-Technology-Corporation-to-Present-at-The-MicroCap-Conference-on-October-24-25-in-Philadelphia

https://www.newswire.com/news/pioneering-technology-corp-to-present-at-the-microcap-conference-on-june-27th

https://globenewswire.com/news-release/2017/09/11/1198406/0/en/Pioneering-Technology-Completes-First-Installation-of-New-Product-at-U-S-Ivey-League-University.html

https://www.pioneeringtech.com/pioneering-technology-recognized-again-as-one-of-canadas-fastest-growing-companies/

http://www.marketwired.com/press-release/pioneering-technology-reports-largest-purchase-to-date-2236044.htm

https://globenewswire.com/news-release/2017/11/02/1198411/0/en/Home-Hardware-Expands-Pioneering-s-Smart Burner-Offering-to-Meet-Growing-Consumer-Demand-in-Canada.html

https://www.newswire.ca/news-releases/leading-us-buying-group-partners-with-pioneering-technology-679251733.html