Small Cap Value Report (Wed 11 Dec 2019) - SPE, KMK, GPH, ECEL, DWF

Good morning, it’s Paul here.

I added a few more sections to yesterday’s report (on PhotoMe and Nexus Infrastructure (LON:NEXS) ) late yesterday afternoon. So if you missed that, here’s the link.

Please see the header above for the 5 companies whose results/trading updates have caught my eye this morning.

Estimated timings – should mostly be done by 1pm today, although I’ll probably add some more sections mid to late afternoon, as yesterday.

Share price:  605p  (down 12% at 08:18)
No. shares:  10.17m
Market cap:  £61.5m

Trading update (profit warning)

Sopheon plc, the international provider of software and services for Enterprise Innovation Management and Strategy Execution Management, provides an update on the Group’s performance for the year ended 31 December 2019.

Here we are, less than 3 weeks from its financial year end, and Sopheon’s profit for the year could still be anywhere in a very wide range of possible outcomes. This is the inherent problem with small software companies – they have hardly any visibility, because the outcome for the year hinges on closing deals in the busy Q4. If things slip into the following year, then it can have a large impact on profits.  I imagine most Sopheon shareholders are already aware of this lumpiness, it just goes with the territory for small cap, software sector.

This is part of what it says today;

Today, overall revenue visibility2 for the year stands at $28m with $9.9m in remaining opportunities with 2019 target close dates…

The figure for potential deal closures by 31 Dec 2019 is so large, that it makes this share pretty much impossible to value. Revised broker forecasts are out today, but these numbers could materially change in the next 3 weeks, if the company does manage to close some more deals.

The split is given of the $9.9m potential deals;

 …Of this, up to $2.7m represents perpetual license fees which, if signed, would contribute to recognized revenue in the current financial year. An additional $4.8m represents potential orders for multi-year SaaS or other recurring commitments, and the balance associated consulting services…

So the $2.7m perpetual licence fees would drop mostly straight through to the bottom line, materially improving the 2019 outcome. Whereas the SaaS deals would presumably have minimal impact on 2019 outcome, because those revenues are spread over multiple years, presumably recognised as revenue on a monthly basis.

Forecast changes – two brokers have put out revised numbers today. I was wondering if we should just ignore revised forecasts, because there’s so much uncertainty about the closing of Q4 deals.

There again, the brokers wouldn’t have put out revised numbers today, unless they’d been given a good steer by the company as to the likely outcome. On balance then, I think it makes sense to see the revised broker figures as being estimates that should probably turn out to be the most likely outcome, or close to it anyway.

On that basis, the announcement today is a big profit miss.  One broker has revised down 2019 adj PBT from $4.9m to $2.7m, a 45% drop.

Another broker drops 2019 from $4.5m to $2.4m, so fairly similar.

Forecasts for 2020 are also slashed.

In EPS terms, it’s rather stark;

2018 actual:  $33.9m revenues, diluted EPS:  65 US cents

2019 forecast:  $29m revenues, diluted EPS:  20.5 US cents.

2020 forecast:  $35.5m revenues,  diluted EPS:  21.3 US cents.

In other words, profitability seems to have crashed by about two thirds from 2018. That looks pretty awful to me. Although the narrative does mention discretionary increases in overheads, to drive growth amp; product innovation.

Looking back to the 2018 results (published on 21 Mar 2019), it stated full year 2019 revenue visibility as being $20.6m. That has only grown to $28m by today – which strikes me as surprisingly little growth.

Deferral of orders – this section of today’s announcement gives convincing-sounding reasons as to why some 2019 sales have slipped into 2020;

In some of these cases, Sopheon has already been selected as preferred vendor. The reasons for the extended buying cycles vary; some relate to extra scoping effort to expand the use of Accolade into a strategic purchase for the customer; others are due to customer specific factors such as Mamp;A, personnel changes or budget consideration impacting decision making. 

Specific examples include a very substantial new SaaS deal with a top tier global customer, where Sopheon is the selected vendor but has since been held up due to customer resource availability due to another system implementation delay. At the other end of the scale, a mid-size perpetual license extension order from an existing customer has experienced delays due to an organizational restructure. The Company now expects both of these examples to sign in the first half of next year.

That’s all great, but the upshot is that it looks like 2019 revenues will fall about 13% versus 2018 actual. No amount of spin can convince me that this is in any way satisfactory. It’s not just timing issues, revenues are falling.

The company focuses our attention on the pipeline growing, but it’s actual sales that count, not sales leads.

Balance sheet – is very strong when last reported at 30 June 2019. The company has done a remarkable job of trading its way out of a previously precarious financial position a few years back. That is very impressive – it’s turned out to be a highly cash generative business.

The cash position has risen slightly compared to the $18.7m reported in the last interims;

The Group’s balance sheet also remains robust, with net cash as at the end of November 2019 at $19.2m.

My opinion – this is a very well-presented profit warning, and seems to have successfully convinced the market that the future is still rosy, and that these are pesky delays, rather than anything more serious.  I don’t think anyone outside the company can really judge things accurately, because we don’t know any of the granularity of the sales pipeline.

If you trust management, and believe in the company’s long-term prospects, then the big drop in share price in recent months could be a good buying opportunity.

If you’re more sceptical, then it might be safer to steer clear.

I don’t have a strong opinion either way. There’s obviously something good here, because the company has traded very well in recent years. Therefore, on balance, I’m starting to lean towards being more positive than negative, although not enough to actually buy any. However, there does seem to be a problem with converting pipeline into actual sales. Given that revenues in 2019 are likely to be well below 2018, I do wonder if there’s a deeper underlying problem here, maybe it’s not just about timing? Who knows. We’ll find out in 2020. I do think the company has quite a lot to prove to the market, to get things back on track – so it might take the share price some time to regain its composure perhaps? It depends. If the company is able to issue updates in 2020, saying that delayed 2019 contracts have indeed been won, then that could trigger a recovery in market confidence, and hence share price maybe?

Stockopedia is sceptical, with “Falling Star” classification, and a lowish StockRank (due to poor value amp; momentum scores). Bear in mind that the large reduction in 2019 amp; 2020 forecast earnings hasn’t come through yet, so the value amp; momentum scores are likely to drop further;

The other thing to bear in mind is that the share price has fallen by more than 50% from its highs of a year ago, so arguably the bad news is in the price now. The recent selling, before the profit warning, looks a bit suspicious – insider dealing possibly?

Share price:  19.5p (up 13% at 10:55)
No. shares:  344.6m
Market cap:  £67.2m

Interim results

Kromek (AIM: KMK), a worldwide supplier of detection technology focusing on the medical, security screening and nuclear markets, announces its interim results for the six months ended 31 October 2019.

This share has been a serial disappointer, and fundraiser (the share count has more than tripled since it floated on AIM in 2013). However, it does seem to have some interesting products amp; sales pipeline, so I’ll spend a bit of time rummaging through the figures amp; commentary issued today. Sometimes jam tomorrow shares do actually deliver, although not very often.

H1 revenue is up 43% to £5.3m

However, it remains significantly loss-making, as you can see from the table below. Remember that these numbers are for just 6 months, so that’s a run rate annually of about £5m losses. Therefore revenue would have to roughly double, to make this a viable business;

It capitalised £1.7m in Ramp;D costs in H1, which means the EBITDA number needs to be adjusted for that. There is a benefit from Ramp;D tax credits though (negative tax charge). Management of Intercede (LON:IGP) (in which I hold a long position) explained the tax regime for Ramp;D to me in a recent meeting, and it’s a very considerable financial benefit, so needs to be factored in (favourably) for valuation purposes. That’s assuming that Govt policy remains the same.

Balance sheet – looks very strange to me.  Receivables are £20.8m – that’s equivalent to over 2 years’s sales, up from an already excessive £13.1m a year earlier.

As noted in the FY 2018/19 results announcement on 27 June 2019, 59% of the balance of trade and other receivables related to the build of amounts recoverable on contract (“AROC”), the majority of which is concentrated with one customer. This reflects the Group’s revenue recognition in line with IFRS 15 on long-term contracts and the position was accumulated over the 12-24 months prior to 30 April 2019.

That seems to be saying that Kromek is booking sales amp; profits through the Pamp;L, but the customers isn’t paying Kromek. It sounds as if there might be a potentially large problem lurking here;

With the exception of fluctuations in foreign exchange, the proportion of AROC has remained static, with no further increase in the position and no additional contract related costs incurred at the end of October 2019. Whilst the Group’s management did not expect to see a significant unwind of this particular AROC balance in this 6-month period given the delivery plan agreed with the customer for product, there has been a delay in an expected payment. However, the Group’s management continues to be in active and regular discussions with the customer regarding firm shipments of completed products and payments, and continues to believe that the recovery of the AROC will be achieved within the 18-month period previously communicated in the FY 2018/19 report.   

I don’t like the sound of that one bit. Kromek has a massive, extended receivable, and there’s been a delay in expected payment. That screams risk to me. Maybe amounts are being disputed by the customer, who knows? It could all turn out fine, but personally I wouldn’t invest where there’s any (even slight) question mark over whether a large receivable is going to be recovered or not.

The cash position looks good, at £13.4m, but note there is also debt, totalling £5.8m, which looks odd. Maybe some of the cash is restricted? If companies have both cash, and debt, I like to find out why. There might be a reasonable explanation, do any readers know?

Outlook – this is where the excitement comes from – large, multi-year contracts;

Kromek is at the early stages of delivering contracts worth approximately £100m won over the past three fiscal years (compared with c. £50m and c. £30m for the three years to 31 October 2018 and 2017 respectively) in its target markets in medical imaging, nuclear detection and security screening, including the seven-year medical imaging contract expected to total $58.1m awarded in January 2019….

The valuation of the company rests entirely on it delivering improved financial performance in future.

Unchanged outlook for FY 2019/20: on track to achieve revenue and EBITDA profit in line with market expectations

That’s fine as far as it goes, but note that forecasts are showing that it remains loss-making at the adjusted operating profit level of -£1.1m loss for this full year, and that’s based on assuming a large increase in H2 revenues.

My opinion – there’s an interesting note from Equity Development out today, which talks up how great the technology is apparently. I’m sceptical. Given the poor track record, and the high risk from excessive receivables, I wouldn’t be able to sleep at night holding this share.

If things go well, it could be a multi-bagger, who knows? I don’t feel able to assess how likely that is or isn’t. The large contracts do sound very interesting/exciting though. It would need a lot more research to ascertain whether risk:reward here is any good. Even then, it would really just be a punt.

It would be good to find some third-party, independent views on its technology, that’s the crux here. If an industry expert or two were to tell me that Kromek’s technology is the bees knees, then it might be worth having a punt on. The danger generally, is that we get all our info from the company itself, and its PR people, which nearly always give an overly optimistic outlook.

Share price:  238p (down 5% at 11:56)
No. shares:  62.8m
Market cap:  £149.5m

Q3 results

Global Ports Holding Plc (“GPH” or the “Group”), the world’s largest independent cruise port operator, today announces its unaudited results for the nine months ending 30 September 2019.

This is a new one for me, it floated on AIM in May 2017. As it’s my first ever look at the company, this won’t cover everything. It takes a while to get to know a company.

It operates these ports;

(work in progress – am on lunch break now)

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