About Me

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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Monday, December 21, 2015

The patient investors' year end review (with add'l comments on $FRMO and $SEC.TO)

The end of the calendar year is upon us. A time to reflect on the prior year and ahead to the next with plans and "resolutions".  I wanted to take a moment to do the same.

I wrote 34 posts in 2015, starting with a review of Betterment for my sister and an observation about the how Wall Street and the Philadelphia 76ers both sell "the wonderous future" while delivering sub par results.

The year included commentary on 14 separate stocks by my count in various levels of detail and analysis. I write about what I like most and know best, observing that I wrote most frequently about ARIS, ESWW, FHCO, FLTF & STRL.

When I find new ideas to write about, I will. I don't know how this blog will evolve in the future but it has more than a handful of readers that are not robots (unless of course we are all robots). I continue to enjoy writing it and most importantly it helps me organize my thoughts.

Beyond the blog, this was the year that my company, Long Cast Advisers, achieved registration as an investment adviser in New York state and started taking clients. I opened an investment account under the name of the LLC during the year to start to establish a "professional track record". That account initiated investing in June 2015 and is up 11% as of this writing vs. the SPX - 4%, the RYO (Russell 1000) -5% and the RTY (Russell 2000) -11%.

The time frame for these results is too short to be relevant but I think the inputs reflects the themes and processes that are critical to the long term success as an investor, which are patience, in depth research and portfolio concentration.

As of this writing this "professional" portfolio is comprised of six stocks: ARIS, FHCO, FRMO, FTLF, SEC.TO,  and STRL. ARIS and STRL are the biggest contributors to gains and nothing has been a terrible detractor. In football parlance, turnovers kill drives and we've had no turnovers.

Two of these stocks - FRMO and SEC.TO - are very recent additions to the portfolio. I haven't written about them, because all they are are balance sheets and balance sheets are complicated in a boring sort of way. In this case, you just to read a bunch of filings. Both are investment managers, one trading at 2.5x book value the other at 0.6x.

The expensive one is managed by Murray Stahl and he needs no introduction. He writes on issues related to finance and trends in tradeable securities such as ETFs and the opportunities that arise when their algorithms are in phase. He also writes about specific stocks in a subscription newsletter I hear about. He thinks into the future and two specific investments on the balance sheet - exchanges, to be precise - attract me to the stock even at these multiples.

One is the Minneapolis Grain Exchange, which he started acquiring in 2014 and just had its highest volume month. He's also  been buying seats on the Bermuda Exchange because he says it's the largest market for Insurance Linked Securities.

These assets - and a few others - are readily discussed in his shareholder letters and quarterly reports. I think of exchanges like payment platforms that generate cash on the backs of someone else's hard work (though when I think about it, what business isn't a payment platform, and if it isn't, why is it in business?) These particular exchanges may be wonderful cash machines if the volumes continue to grow. I imagine whoever has been the selling the stock lately has a shorter term focus than I do.

The 0.6x investment manager is Senvest Capital, managed by Richard Mashaal of an entity his father Victor Mashaal started.

The company is essentially the Mashaal family office fund, with ~50% of the stock owned by pere et fils. Returns are down down 12% this year but they grown equity from $284M in 2011 to $821M in 2014, or 43% CAGR vs ~18% for the S&P. Equity at 3Q15 remains is around those 2014 levels.

I doubt they are going to continue to grow SE by 43% CAGR but they take big long term bets on parts of the small cap market that I don't have the bandwidth to analyze deeply and I want to get a sliver of exposure to it at a discount to book value.

I think about the both of these companies like "investments in the minds of ..." stocks. Other stocks of this type that I've looked at include Biglari Holdings at 1.4x book, ALJJ at 2.9x and Greenlight Re at 0.8x where funds have returned -20% YTD. (I like on the GLRE website it says the "investment accounts are managed by DME Advisors LP" as if we don't know the manager is David Einhorn. I wonder if it says his name in up years?).

It's possible that SEC even at 0.6x is a terrible investment. It's on the radar simply b/c it hit a bunch of home runs in a few good years and this isn't really the picture of steady consistency. Also, they've been reorganizing their structure and adding a presence in NYC, ie expanding which most certainly means more G&A and potentially means they are confusing luck with intelligence. But if it's successful there's a lot of sizzle on the steak and you're not paying a lot for that option.

All of these companies in my portfolio I'm comfortable owning for the long term, though FHCO will require some changes in their consumer strategy, their capital allocation strategy or simply a change in management to work. That is something I want to figure out how to address.

And then there is long list of stocks on my radar for deeper analysis, etc. It hopefully never ends. When I get my teeth into an idea, time disappears. I am grateful that I get to do what I love.

Beyond stocks, I'm trying to figure out the fundraising aspects of the firm (from smiles to teeth gnashing). It is a quandry for every new business, but especially in the investment management world.

The difficulty is explaining what differentiates me from everyone else who says they're patient long term investors, and that's essentially ... everyone else. And then as well how to package my product without hype and deliver a message with integrity that resonates beyond just "growing capital" and "a solid foundation of wealth" and other white bread bullshit. It needs to pull together a lot of je ne sais quoi themes that resonate with me and hopefully with clients, like the "where are the clients yachts" concept, the dangerous stupidity of the biz-fo-tainment industry, the impact and attitude of thinking like an owner and not just a shareholder, etc. I'll figure it out at some point.

The goal of the service is investing client funds in a portfolio of small cap stocks that will outperform the market with lower risk. It sounds so easy on paper but as I've transitioned from doing it as an amateur personal investor with a diversified portfolio of  hits and misses to a professional and concentrated portfolio with hopefully many more hits than misses, I can see that this endeavor - both the investing side, the marketing side and the business administration side - is one of the hardest things to do well and with enough consistency to prove that it's not blind luck. I hope to prove it over time.

I'll conclude by thanking all the you readers - including the robots (01110100 01101000 01100001 01101110 01101011 01111001 01101111 01110101) - for their your participation and hope this blog has added value to them you, as an investment tool, or as a way to consider new ideas in the world of small cap equities, or simply even to pass the time.

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THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES. DO YOUR OWN WORK BEFORE INVESTING IN EQUITIES.

Sunday, November 29, 2015

ARIS' annual report: Guides to 20% topline + margin expansion towards high teens

Last week, ARIS released its annual report. The shareholder letter highlighted very briefly (one page) the company's evolution from a two product / four vertical company with 70% of its revenues in the no growth / high cash flow e-catalogue business to a company with five products addressing lead generation and business management software, et al. and serving eight different verticals.

The letter also included a bit of forward looking guidance:

"As we look forward to FY16, we expect our current organic growth rate and the impact of the acquisitions we completed in FY15 to generate $47M to $49M in revenues. We also expect to see continued improvement in adjusted EBITDA and cash flows. We are on pace to achieve a $50M annualized revenue run rate in the back half of FY16 and a $10M adjusted EBITDA run rate shortly
thereafter."

IF they're right - and I always take guidance with a grain of salt b/c who knows the future? - it would imply 20% topline growth AND expanding EBITDA margins all within the structure of the company as it looks today.

If that means no more equity dilution, than conceivably EPS would grow faster than revenues and this would be the third straight year of substantial EPS growth.

I've been thinking a lot about EPS growth since meeting a PM friend of mine who uses sustainable EPS growth as one of the five metrics in his investment framework.

It resonated with me b/c I've never really weighted EPS that heavily, preferring instead to focus on cash flow or margins, but it's a great little metric that captures in one line and over time: operations, tax, capital management, acquisition strategy (b/c there's no GAAP EPS growth with goodwill writedowns) and or course equity dilution.

I've written in the past about the destructive nature of ARIS'  share dilution but based on where the company is today, I think we are past the point of using expensive shares for acquisitions and moving towards inexpensive debt. (I say "expensive shares" b/c although the valuation of the shares were cheap when the deals were consummated, if the stock does what I anticipate it will, these purchases will seem very expensive in hindsight).

With a strong balance sheet, recurring revenues and solid cash flow, debt becomes a more palatable option for future growth, though even better would be organic growth. There is for example, the opportunity to grow their subscriber base with the new platform of projects as well as a high churn rate ~15% that should be converted into organic growth.

This will be the year where the company proves whether these acquisitions truly created a portfolio of services and solutions that resonates with customers. If it does, as my research indicates, then the stock remains very inexpensive.

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THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY SHARES. DO YOUR OWN HOMEWORK. I MAY OWN THIS OR ANY OTHER COMPANY I WRITE ABOUT.

Wednesday, November 25, 2015

revisiting ESWW so I can sleep better at night

I've written a few short pieces in the past on ESWW, a tiny US manufacturer of diesel particulate filters, and just wanted to take a pre-holiday opportunity to revisit what's going on and as usual am happy to share what I find here.

The lede is that the stock has been a bit more active than usual and there's a new CEO. I like the former CEO a lot and he'll remain on as Chairman and apparently still work closely with the company and this is great news.

The new hire, Patrick Barge, has great experiences on paper and - who knows - he could be the person who lifts the company from the gritty turnaround that's achieved operational excellence and cash flow on a shoe string budget to an innovative company focused on R&D and new product manufacturing in the transportation diesel emissions after market. If the Volkswagon scandal tells us anything its how ubiquitous these systems are even though few end-customers know about them and they are little valued until the penalties of non-compliance become onerous. And I'll get to that aspect later.

The bigger picture as an investor is how deep into the weeds is it worth going for a company with just a few hundred thousand shares outstanding and a highly concentrated ownership structure (80% owned by one group) that concurrently holds the company's expensive convertible debt. Going into the investment, I thought "what could go wrong investing alongside a titan of finance" and although the business seem to be going in the right direction, the uncertainty around ownership will remain an issue until the debt converts or is paid off or the owners do something else. Whether or not the risk and concern of that "something else" is worth the massive valuation discount when I bought it is too soon to tell, but either way, it's a lesson I've paid to learn.

Barge according to his self reported resume is a mechanical engineer who rec'd a masters at this now defunct graduate school for the french textiles industry, many of whose graduates work in engineering, sales or quality control in various industrial or technology companies (BASF, Suez, Johnsons Controls and Thuasne). He appears to have "grown up" - so to speak - at Cummins where he worked in air and liquid filtration systems - including diesel emissions - with increasing levels of responsibility, most recently running the European geography of Cummins Emissions Solutions where he ran a P&L north of $300M.

Prior to that - and for a longer period - he was at Cummins corp HQ in Indiana doing R&D and new technologies where his budget was $150M with "700 employees in 6 technical centers located in 5 global locations".

This all sounds like good news, but it's still his first go around in the C-suite and there's no getting around that. And then there are questions ...

Why does someone go from +$300M budget and multi-national management to $25M peak revenues and two facilities? How much will they have to invest in new machinery to build out the operations this guy is used to? In what direction does the business go in the hands of an engineer with R&D experience sitting in an under utilized but high tech emissions testing facility an hour's drive from Trenton? Are they moving from a mesh metal weave to fabrics and if so is there a local supplier of polymers / fabrics who might have more insight into the market? What does he know about cash flow generation? Will he be able to thrive like his predecessor on a shoe string budget? etc. etc.

... in the absence of a conversation with him, I'm left to grasp at quotes from the press release on the hire ...

Old CEO: "We are thrilled to have Patrick join us as CEO at this critical phase of growth for ESW Group ... I look forward to working closely with him to drive growth within our rapidly evolving diesel aftertreatment and emissions market"

New CEO: "I am excited to leverage my relevant experience and seasoned leadership to help the ESW team achieve the next level of success within the aftermarket and OEM channels, as well as in the development of other potential markets"

So it sounds to me like the former CEO will remain a hands on Chairman (yay!) hopefully managing the financial / cash flow strategies as he's done so excellently in the past and the new CEO who is an expert in the niche industry, will have a lot of room to position the company more deeply into existing markets and also into new as yet unnamed markets. And the focus is growth.

In short, it looks good on paper.

I originally bought the company b/c Mark Yung was turning around a poorly run business that was thinly traded and valued at 1x-2x EBITDA, (the calculation of enterprise value being dependent on how one looked at the convertible option derivative liabilities).

The company's management prior to 2010 had a colorful history (ie a bunch of crooks), but in 2010 Yung took over in and hit the cover off the ball in a market with terrible crosswinds including changing regulatory deadlines, intense competition and highly reluctant customers. From 2010 to 2014, while acquiring one troubled competitor out of bankruptcy, he more than doubled revenues, grew EBITDA margins from -40% to +20% and FCF from - $2M to +$4M. The last we heard, ESWW had a banner 2014 year, with $25M in revenues, $6M in EBITDA and ~$57 in EPS.

Unfortunately, we don't know much about the financials anymore since the company "went dark" in April 2015,  and there hasn't been any new financial information since.

We know however that theirs is a lumpy business and that two major drivers of performance in 2014 - a municipal contract in Chicago and CARB compliance deadlines in California - are unlikely to repeat. The former b/c the contract was due to complete and the latter b/c of lack of enforcement by the CARB of regulations that require legacy trucks to retrofit with expensive diesel particulate filters as well as resistance from truck drivers against installing retrofit DPF's, fires supposedly caused by DPF's and a lawsuit from the California Alliance for Business against the CARB (and other parties - case # 13CV01232  - in Glenn County Court, CA).

This is where we circle back to VW. When CARB starts to enforce the regulations with costs more onerous than the retrofit investment, then we'll see a change in adoption. But so far they haven't and California distributors of DPF filters and their suppliers are suffering.

It's hard to be sure whether or not the groups opposed to CARB are gadflies, wackadoodle freedom fighters or have a legitimate claim, but they fight with an unusual zealotry and with a good social media presence, so that can't be overlooked. We're also in an environment where the regulations seem to fall heaviest on the smaller independent businesses who tend to be a sympathetic group even if they are rolling coal.

But as crazy as this fight appears, I'd be surprised to see environmental regulations rolled back. And by the way, there are a lot of these DPF's on the road, in all kinds of diesel cars and trucks, so there's a wide opportunity around testing, cleaning, OEM supplies, aftermarket replacements, etc. This is a wide space they can play.

Now that the company seems to have someone who can anticipate and manage the market and not just a financial and operating guru who got the ship on an even keel, then it seems like the business could be set up for a bright future even if 2015 is a down year.

About 700 shares traded hands this week, a large amount relative to avg daily vol over the last three months of 40 shares. I don't know how one would assess the opportunity since they've gone dark except maybe using CDTi's "Heavy Duty Diesel Systems division" as a proxy though their product is a pos (I've been told) and their products have verification issues with CARB. Through 9-mos sales in that division are down 25% y/y weighed down by some of the similar issues facing ESWW. Except in my channel checks  with distributors, they love the ESWW product and speak less highly of CDTi's.

Taking everything together, a still difficult environment, slow rollout of penalties to motivate compliance for older fleets and a lack of large contracts I still think even if 2015 is a down 25% year, with the new CEO steeped in this world paired with a Chairman who can focus on the financial aspects the potential for a brighter (and cleaner) future remains high. We will remain patient investors.

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THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL STOCKS. DO YOUR OWN HOMEWORK. I OWN SHARES OF THIS COMPANY. IT IS THINLY TRADED AND NO LONGER DISCLOSES ITS FINANCIALS.

Tuesday, November 17, 2015

A few lovely surprises this earnings season (STRL, FTLF, EVI and ARIS)

There were a few lovely little surprises this earnings season but none brought a smile to my face more than hearing that STRL had hired Ron Ballschmiede as their CFO.

Ron was previously the CFO of CBI, including the six years that I was a sell side analyst covering the E&C industry, and he is great.

To be frank, he joined CBI when it was in a period of dire need after one of those ridiculous petite-scandals that corporate america engages in every so often. In this case, in 3Q 2005 the company delayed filing its 10Q b/c of alleged accounting issues and then in winter 2006, filed this statement paying an underling in the accounting office $1.7M in hush money. A few days later, the CEO and CFO were fired. Phil Asherman, a former FLR biz dev guy was elevated to CFO and Ron was hired six months later.

I recall, during his tenure as CFO, in no small detail and with plenty of professional regret on my part, when CBI was losing boatloads of money on an LNG regas project in Wales (a project he inherited mind you), when much that could go wrong did including a labor force protesting work conditions daily and in 2008 the rainiest summer in UK history, when the company's balance sheet was so stressed it had $88M in cash compared to $1B in deferred revenue (ie cash collected from customers ahead of work to be completed), when it seemed to me the company was close to running out of money and I had a conversation with him where he calmly reiterated that construction companies - contrary to popular opinion - don't need a lot of cash on hand as long as the customers are willing to patiently accommodate temporary problems.

He was right, I was wrong, and the shame on my part was downgrading the stock in 4Q08 when shareholder equity was ~$600M vs $2.9B today.

I learned a number of lessons in that experience, as an analyst and as an investor, and also gained an enormous amount of admiration for a guy who is now the CFO of our wee +$90M mkt cap company that is also in need of an accomplished CFO who can lay the foundation of a professional organization. It should bring a smile to all the faces of STRL investors b/c he knows the construction business, the processes, the accounting and the institutional investors well in excess of what should be expected in that role and for a small company such as ours. We are lucky to have him. (He's also the person who hilariously once counselled me, "If you sit down at the airport, you've arrived too early").

Second to that satisfaction is a little vanity on my part seeing the amended 10Q STRL just filed. Something about the initial Q struck me as weird when they reported a swing to losses in the the Myers JV. So after the earnings call I asked the interim CFO about it (he is wonderful in his own right and for many sound reasons has zero interest in being a full-time CFO) and I really liked his frankness: "those parenthesis you see, they don't belong there."

To avoid this mistake in the future, I offered to proofread their filings a few days before their release but I doubt that's something anyone will oblige.

Other good surprises for the quarter included ...

FTLF: Getting back on track with revenues up 14% y/y and now having lapped the worst of its channel disruption and with the IFIT acquisition under its belt on track for $30M revs and 10% EBITDA margins, still trading at just 6x proforma EV despite growth and profitability.

EVI: The quarter wasn't great b/c of a delayed equipment delivery but customer deposits were the highest ever at $5.8M and a special $0.20 dividend was declared. I also just attended my first shareholder meeting and got a firsthand account of plans / expectations for buy / build strategy and how they intend to consolidate their fragmented, regional and balkanized industry. While I fear equity dilution to fund future deals, the suggestion that they use rights offerings to raise money would allow investors to substantially maintain their ownership levels.

ARIS: Still flying under the radar despite top line growth, cash generation and margin expansion. Returns are expanding to low teen ROE and ROA and high S/D ROIC. With several acquisitions under its belt, and I believe a focus on customer retention and organic growth, I see a lot left in the tank for a company whose stock is trading at 11x EBITDA vs a peer group north of 15x.

... of my larger holdings sadly only STLY continues to underperform. My initial views on the company was that the furniture business sucks, that management destroys value, that there's no growth, no margin, no competitive advantage, and that it's not a business I want to own. Somehow I convinced myself that activist investors who own large chunks of it would push out the CEO and turn things around but in talking recently with a source in the business, as he put it: "there are always wall street folks who think they can turn it around. It has a great brand within the industry, but customers have no idea what it makes, their styles are out of fashion and the industry's distribution model is broken."

While STLY doesn't put a smile on my face, I was more right than wrong in the quarter and more importantly the lessons I learn today as I continue to grow in this business will, I believe, provide a framework for better decisions in the future.

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THIS IS NOT A SOLICITATION OR AN ENDORSEMENT OR A RECOMMENDATION  TO BUY OR SELL SECURITIES. DO YOUR OWN HOMEWORK BEFORE INVESTING.

Thursday, October 22, 2015

One More Letter to $FHCO After they Blocked my Effort to Improve Exec Comp

A few weeks ago I sent a letter to the Chairman and Board of $FHCO asking for a proposal to be included in the proxy re: chg'd exec comp.

With a board that avgs 71 y/o and +13 years of svc I'm not surprised they responded with obstructions and not open arms. Since I am not a shareholder for the continuous year (thank goodness for my portfolio) they won't consider it.

But the thing is, the same people running the company are the same people who've been there since the product was approved by the FDA in 2009, and its still not on drugstore shelves, which means either the product sucks, they suck, or somewhere in between. I'm in the group that thinks its somewhere in between.

Yet, even if the product sucks (and I've been assured by some it does and others it doesn't) there are so many condoms on the shelves of every drugstore I've ever been to, at least one female condom can fit there as well, even if its just a novelty. If it ain't the FC2 it will be something else someday.

And thus this letter (see below). I cut the part where I pan their decisions to hire an ex-pharma exec and an ex-marketer of IUD's (who is also on the board), b/c it seemed appropriate to be nice. But I am dumbfounded, speechless, nonplussed in the true definition of the word, why they'd hire execs with those kinds of expertise for a product that's the anti-IUD and the anti-pharmaceutical. It's like hiring a vasectomy surgeon to sell condoms. They need brand strategy and consumer distribution expertise not ex-pharma folks.

In my view, at least if we can align comp structure, I know they won't be paid unless my capital is put to best use, which so far, it hasn't.

Here is the full letter going out to the board today and please remember this is not a solicitation to buy / sell / transact business just shared out loud thoughts and ideas.

-- END --

Dear OB:


I was disappointed by your response to my letter regarding my shareholder proposal for changing executive compensation. I had hoped you would welcome the proposal not put up roadblocks to cause its exclusion.

My goal in recommending an alternative comp structure is simple and threefold
To find a system that is fair to executives
To find a system that incentivizes good long term capital allocation not short term goals
To find a system that aligns the interests of shareholders and management

The current compensation plan isn’t fair.
As your filings point out, you have no control over the timing of public sector purchasing patterns. Since the public sector remains your largest customer, one order, the timing of which you have no control over, can determine whether or not executives are compensated.

Last year, executives did not receive bonuses. This year, because of the Brazil tender, they likely will (including yourself). The key point is that your current executive compensation system doesn’t reward decisions from the FHCO C-suite, but rather decisions made in developing world health departments thousands of miles away.

Executives should be compensated for the decisions and efforts they make, not someone else’s.

The system doesn’t motivate long term planning or capital allocation.
Your current plan is based on one year sales and margins over which – as you’ve long established - executives have limited control. As a result, spending on marketing campaigns or strategies with long term payoffs negatively impacts the compensation for executives, disincentivizing long term planning.

Executives should not be compensated solely on short term results as your current policy now holds.

The system doesn’t align interests of shareholders and management.
Ending the dividend to invest in your business is an equivalent indication that you can allocate capital better than your shareholders can. The system I recommended in my proposal rewards good capital allocation and ensures that the capital you’ve taken from shareholders is put to the best and highest use, as your shareholders themselves likely would have done with their dividends.

A plan that promotes good capital allocation would incent better decisions and might improve outcomes.

I hope you and the board will address the shortcoming of your current executive compensation plan and consider implementing one – perhaps along the lines of the ones I recommended in my earlier letter - that is forward thinking and rewards good long term capital planning.

Above all, I want to see evidence of a management team that makes sound long-term high-return capital decisions while providing safe, low cost and accessible choices in women’s reproductive health. I imagine we stand on common ground with respect to that goal.

A few additional comments.
As you are aware, I previously recommended in prior communications with you and Ms. King two low cost ideas to help expand your product reach.

1. Explore a partnership with SHE Sustainable Health Enterprises.

SHE, as you know, has created a program to locally manufacture and distribute affordable menstrual pads in Africa (Saathi does a similar program in India). They have a partnership with J&J and their founder, Elizabeth Scharpf, is an advocate for expanded use of the female condom.

In fact, in an interview I read online, she is asked: “You’re going to a desert island, and you’re allowed one food, one drink and one feminist. What do you take?” and she answers: “Cherry pie, champagne and whoever invented the female condom.”

It is easy to imagine a wealth of opportunities available through a partnership with SHE to reach a shared customer base in Africa, your largest market. I previously recommended you reach out to her and I've emailed with her several times. In response to my suggestion, both you and Ms. King replied: “She didn’t return a phone call”. That is not leadership regarding a potential partnership with an influential advocate of your product.

2. Expand your creative / brand development.

I have also suggested that you hire a creative / brand team from one or two “innovator cities” (perhaps offering equity as a form of long term alignment) to test creative programs and get your product on shelves. This suggestion was simply ignored and I see no evidence to support your statements that you have already initiated a successful brand building strategy.

I think we both agree that bending the consumer sales curve will require smart long-term investments in sales, marketing and distribution today, with the benefits in years 2, 3 and beyond. I also think we both agree that getting the right consumer brand strategy is the key to fixing recent cash flow degradation, stagnant shareholder equity, rising competition, and risks associated with a being one-product company.

So please consider changing your incentives to align them towards the long term investments required to bend the sales curve. Doing so will help provide shareholders more faith and trust that decisions from management and the board are made with optimal long-term capital allocation in mind.



Tuesday, October 13, 2015

Another year, another attempt to improve exec comp at $FHCO

A few weeks ago, I submitted the following letter to the board of FHCO and its CEO / Chairman OB Parrish regarding executive compensation. Alas, I haven't been a shareholder for the last continuous 12-months, a good thing for my portfolio  since the stock is down more than 50% y/y but a bad thing for myself as shareholder since comp is a strong way to align goals, and they are prejudiced against short-term shareholders.

My effort is to comp execs on ROIC. My reasoning is that once they stopped paying shareholders a dividend to invest in the business their capital allocation decisions should have become paramount.
They haven't, and shareholders suffer.

They SHOULD invest in their business no doubt. The industry has changed - the product is no longer a monopoly - and the company has spent considerable money and efforts to broaden its consumer appeal, but without articulating or explaining the strategy and with no improvement in the goals they seek to attain.

I believe they are going about it all wrong - old fashioned ex-pharma marketing - versus just getting it on shelves, and I've suggested low cost creative and strategic partnerships to no avail. I think they are afraid to make fun of themselves and therefore try something risky (the consumer product is risque).

Whatever ... since I can't effect how they are going to spend their money at least I can try to make sure they understand that cost of money and try to ensure compliance with a return.

So while the board has discretion to consider this proposal it is unlikely hey will oblige. With an average age of 71 years and an average length of service of 14 years this is not a group that invites new ideas.

Dear Mr. Secretary

Last year I wrote a letter to the Board regarding a proposal on executive compensation that I had hoped would be addressed at the annual meeting. However, the letter was sent too late for the deadline.

I am writing a similar letter with substantially the same proposal for inclusion in the proxy materials for the 2016 shareholder meeting (see below).

In the year since I wrote the initial letter, the stock has lost 65% of its value. Concurrently, year-to-date unit sales are up 44% and year-to-date revenues and operating income have grown 33%. So management is likely to receive its bonuses even after a year of shareholder suffering and negative cash flow generation. There is clearly a misalignment.

A compensation system that incentivizes principles of good capital allocation will re-align interests between owners and managers, ensure optimal investments in the business and re-instill confidence that management is making wise, capable and thoughtful decisions that will reward shareholders over the long term. I sincerely hope the Board allows shareholders to consider this proposal at its next meeting.

Sincerely
Long Cast Advisers, LLC

CC:
O.B. Parrish, CEO & Chairman
Brian Bares, Institutional Shareholder


A PROPOSAL TO CHANGE EXECUTIVE COMPENSATION

The current executive compensation system is based on unit sales and operating margin targets. It has as its greatest virtue, simplicity. It is not ideal but neither is it inappropriate for a single product company in an industry characterized as a monopoly.

However, recent issues have arisen that require exploration of a new executive compensation plan:

The industry is no longer a monopoly.
The company has cancelled its dividend.
The company is seeking to use capital once reserved for shareholders in the form of dividends for internal growth and / or acquisitions.
The company, once a great cash flow generator, is currently a cash flow user.

With these changes, especially the cancellation of the dividend and the recent cash “burn”, it is obvious that the role of management has expanded from one of maintaining market share to one of capital allocation.

I therefore propose that the board terminate the current compensation plan and adopt one based on capital allocation and cash flow. I suggest one of three options: Returns on Incremental Invested Capital (ROIIC) targets, Economic Value Add, or Cash EPS. Any of these would be better choices for a company that diverts capital from its shareholders to fund internal and acquired growth.

A compensation structure that rewards wise, capable and thoughtful capital allocation would be the best way to ensure that the owners of the company, who no longer have access to the company’s capital via dividends, are getting the greatest value for their shares.

Tuesday, September 15, 2015

$FTLF: Positive reflections on an initial (small sample) channel check

I have been looking at $FTLF as an investment idea and posted my initial thoughts here >> http://goo.gl/UnuzIs << but i've been struggling with an internal conflict b/t the investment thesis, which looks good to me on paper, and the product, which makes me feel uneasy.

So I recently visited two corporate GNC stores and three local franchise stores to check in and hear what they had to say about $FTLF and $IFIT products. This is an insanely irrelevant sample size. GNC has ~3,500 domestic corporate owned stores and ~1,100 domestic franchise stores and I've visited 0.10% of them.

Still, with the risk of spreading the contagion of availability bias, here's what I learned from visiting 0.10% of GNC stores in a small sample channel check.

Corporate stores (2): 
Both stores had a small section of iSatori bio-gro and hyper-gro on hand.

At one store, a bit run-down and poorly lit, the dipshit kid who helped me said they wouldn't recommend the iSatori product "... b/c nobody buys it".  uh ...

He couldn't tell me anything about it.

The other store was clean and well lighted and the dude working there was insanely nice, very knowledgeable and totally jazzed about the iSatori bio-gro. "I'm a biology major so i try to understand how these products work ... it's an IGF4 stimulator ... the only product like it on the market ... the only way to get the same effect is with a much more expensive growth hormone."

He says he was not trained or paid to say that.

My takeaway is that IFIT's bio-gro has a good product, but they pay way too much to market it through the "traditional" advertising channels of meathead spokespeople (ie CT Fletcher's "I COMMAND YOU TO GRO!").

IFIT pays $0.24 / dollar of revenue on sales & marketing and generates the same 2x sales / total assets as FTLF, which spends only spends $0.12 / dollar in revenue. No wonder FTLF has ~20% ROA. Now imagine for a minute the same product sold through FTLF's channels at 2x the margin.

It was a little disappointing that the MetisNutrition line hadn't yet reached the GNC corporate stores, but the product just launched.

Franchise stores 
I happened to arrive at a franchise store while the owner was there and he owns three of them in the area, so these comments refer to all three stores.

I was told that musclepharm, BSN, Optimum and Cellucor all pay for their wall space and are in corporate and franchise stores equally.

FitLife products (NDS, PMD and SirenLabs) were all in the middle aisle, facing the wall, a less prominent position. (I think they called it a camel shelf, or something?)

The manager at the store raved about the product. He loved it for a variety of reasons:

1. it sells well and there are "zero returns, none!" apparently returns are a huge hassle.
2. the brands are consistent and have longevity. they don't change around the ingredients and they don't continually introduce new brands that are confusing to the sales people.
3. the product works, he said.

a few other tidbits ...

1. he said the brands reminded him of cellucor from a few years ago when cellucor was called nutrabolt, started out as a small business, grew through product development and word of mouth, and now is a GNC anchor product. but today's cellucor is different than the past, with too many new brand intros and a lot of returns.
2. he of alluded to musclepharm being a joke
3. on the distribution transition, they used to order direct from FTLF maybe a pallet every quarter. Now that they order via corporate GNC every two weeks and since they don't have to stock up, the orders are about 5%-10% less volume. but its steadier.
4. the product is now more expensive to them since they buy from GNC with a markup.

this final point highlights a negative aspects of the change in distribution channel and also a risk for $FTLF

  • the product price to the franchise has increased and could cut into the franchise owner's margins. the owner I spoke said it is still a high margin product, but that's narrowed. FTLF mgmt says the higher prices are offset by a termination of shipping costs and credit card fees, so on their end the impact is a wash. 
  • the risk is that GNC can pretty much do whatever it wants. while i'd assume there is a contract b/t GNC and FTLF on frequency and size of price increases let's face it, GNC controls the distribution channel ... and therefore can do whatever it wants. 

5. post summer is the slowest seasonal period for the business. everyone met their summer goals. it picks up again in January.

... my takeaway, from the franchise stores is that FTLF is punching above its weight, outperforming other products in the sports nutrition business without wall access space or end caps or expensive advertising.

Again, small sample, but exciting for me to hear and its developing some trust in the product. I called it "snake oil" in the prior post and I think that was overly harsh. I will amend that. 

Finally, "Sudbury Capital Fund" recently filed a 13G on the stock, representing a 5% position (432k shares) >> http://goo.gl/G8osCL << The fund has another disclosed position in RLJ Entertainment, so I'd guess this fund is going after small value.

Not sure how they acquired so many shares without moving the stock so probably acquired from another large holder. The fund is run by Dayton Judd >> http://goo.gl/s6bW7n << I google mapped his office in Texas just to get a sense of where it is. It's located - the cliche of Texas - roughly equidistant from a gospel church, a gun store, a bbq pit and a DQ.

All this is to conclude that I'm getting over my fear of the product and there will be more store visits in the future.

-- END --

ALL RIGHTS RESERVED THIS IS NOT A SOLICITATION NOR A RECOMMENDATION TO BUY OR SELL SECURITIES LCALLC MAY OWN SHARES OF STOCKS MENTIONED.

Friday, September 11, 2015

Rubbing My Nose in My Own Mistakes

As I transitioned in 2014 from sell side research (ie analyzing companies, industries, valuations, etc on behalf of hedge fund and mutual clients) to investing professionally with mine and other people's money, I made a handful of mistakes.

That will happen.

The important thing is burying my noses in them so I understand where my process failed and they don't happen again.

Here are some observations from rubbing my nose in my own mistakes with brief mentions of $OLED, $FHCO and $STLY. (Adding $CCJ, which I totally forgot to mention). All of this happened in the fall of 2014.

1) Overcoming the sense that "I need to be doing something." 

ALL mistakes I've made this past-year ultimately flowed from this one.

On the sell side analysts are not allowed to own the companies they cover and know best. So the stocks I bought for myself had to be super interesting and well researched for me to squeeze the extra work into a 60 hour / week day job.

There was enforced patience. I only bought things that were the most interesting and highest conviction and then I simply waited. A lot of great returns were generated this way.

Fast forward to professional investing and there was this initial compulsion to be "doing something". It's an unusual experience to sit around and read, talk to people, follow leads, learn new markets and industries, read some more, and then ... do nothing

But the source of my success in the past was - slightly tongue in cheek - doing as little as possible, finding, researching and waiting only for the most interesting ideas. Hewing to this model will help avoid this simple mistake in the future.

2) Buying before completing my research.

My equity research relies heavily on the work I did as a reporter and private investigator many years ago bridged with more traditional financial analysis. So in addition to the basic equity research of ...

reading into the company
the competitors
the industry
building a historical model and thinking about drivers of the business
making assumptions on growth rates
flexing the valuation

... there's also a lot of researching the CEO and CFO to get a sense of what makes them tick, what motivates their roles, what are their strengths and weaknesses, capital allocation capabilities, and any other tidbits I can find.

And then there's also thinking about two additional points
i) what needs to go right for the stock to work
ii) and especially what are the risks to owning it

there are no short cuts to any of these areas. Three mistakes I've made in the past year were made from buying a stock before completing my research.

3) Going against my gut. 

I have a pretty good sense of what interests me and what doesn't. Not everything that interests me is a good investment and not everything that's a good investment interests me, but I only want to spend my time on businesses I understand that appear undervalued and / or mis-priced.

When I go outside my circle of competence, it's an uncomfortable feeling.

These three case studies converged all around the same time and combine all three mistakes. 

Case study: OLED. I wrote about it here >> http://thepatientinvestors.blogspot.com/2014/06/oled-my-gut-says-overlooked-value-but.html << Everything about it looked interesting but I didn't understand the business and I didn't have the stomach for the volatility. So I avoided it ... but then emotion got the better of me and bought it on the way up and sold it on the way down. Then the stock took off. Absolute amateur hour. I rub my nose in it everyday.

Case study: STLY. My first impression was this is a shitty business with god-awful management. And nothing has changed. But a value investor friend owns it and I allowed myself to be talked into it even though it's a shitty business with god-awful management. I've come to learn that value recognition is possible from an engaged activist investor who is likely to take over the company at some point in the not too distant future, so I continue to own it. But I bought it feeling the need to be doing something, going against my gut and without finishing all my research.

Case study: FHCO. It's the kind of interesting and weird business I like. I bought it after it cratered to ~$4 / share when they cancelled their dividend. I'd seen that Brian Bares owned it, and I've read his book and like his style. I didn't mind that the product is essentially irrelevant in the US, b/c most of the business is in Africa and S. America. I could deal with the fact that their monopoly was broken b/c they average EBITDA of ~$0.15 / unit and they are still profitable at $0.10 / unit. Plus if there's a competitor it only affirms the market.

But it did not take too many conversations to lose trust, faith and confidence in [prior] management. I won't go into all the details of their ineptitude but had I talked with them more substantively ahead of time I would have seen it quickly. So I sold it at a loss. Interestingly, prior management is now gone and I've revisited the stock at ~$1.40 / share. It is a cash flow machine.

Case study: CCJ. Again, this was around the time I'd just decided to start my own firm and felt the need to be doing something. It's just absolute insanity. I was thinking about uranium, china's desire to build 120 nuclear power plants, the collapse of mining markets in general, my expectation that the decline in mining markets / oil sands production might improve labor rates at the Cigar Lake mine and in general just had uranium and CCJ on my mind when I saw a Barron's article that mentioned a fund buying the stock and I bought some before I'd even cracked a filing.

Then only after buying it, I read about it, learned about the Canadian tax revenue issue, the incredible capital intensity of the refining operations, the trading operations, etc. etc. etc. I'm reminded of a lesson I learned a long time ago; "think before you speak". Do some research before you buy a stock!

***

It's painful to recollect all this stupidity / absence of judgement / willful avoidance of the simple processes I'd used with prior successes. But the lesson was to reflect on what's worked in the past - I've fortunately had a lot of experience with successful investments - and to not change what's worked simply by virtue of transitioning from a hobby to a profession.

So it's been a short but steep learning curve.

Looking ahead, all patient investors should realize that investing is deeply personal and one of the most differentiated enterprises out there. No one does what you do. Your intellectual capital is your edge. There is no comfort in crowds. In the absence of "consensus" you have to find your own evidence. Understanding this has been a big step in the learning process for me, and I hope to always be learning. That's one of the big draws of this business.

Finally, of course I will make mistakes in the future. Anyone whose not afraid to own them, acknowledge them, honestly assess what went wrong and learn from them should do well. Rubbing ones nose in them isn't such a bad idea either, at least to make sure you don't do them again.

-- END --

ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES. STOCKS MENTIONED IN THE POST MAY BE OWNED BY LCALLC

Tuesday, September 8, 2015

$ARIS: Response from CEO on letter sent earlier this summer

Earlier this summer I sent a letter to the CEO and board of $ARIS regarding my optimism with the forward outlook for the company, tempered with my concerns about continued share dilution.

http://goo.gl/FYzx89

As the letter indicated, the company had grown substantially over the last seven years but on a per share basis - the only metric that matters to shareholders - growth was negligible and I'd hoped they would stop the dilution going forward.

I received the reply just below. Talk is cheap of course and no commitments were made, but if mgmt and the board are aware of and equally burdened by the dilution, then there's potential for behavioral change going forward. My takeaway is that access to less expensive debt is more likely to provide growth capital going forward, nothing that hasn't already been publicly disclosed.

As a small investor with a nascent investment management firm, I enjoy focusing on smaller companies for three primary reasons ...

1) offers opportunities to compound growth faster, not available with larger companies due to "the law of large numbers"
2) offers opportunities to engage with mgmt, which due to scale is not available with larger companies
3) tends to be less efficient. since size and liquidity govern AUM causing otherwise intelligent investors to seek alternative markets. a patient investor can benefit from inefficiency on the purchase and reap rewards on the eventual harvest, or simply own great businesses forever.

... I believe $ARIS exemplifies all three attributes of smaller market companies and I hope to own it for a long time.

***

Thank you for your letter of August 11th. We have forwarded your letter to the Board of Directors and appreciate you taking the time to share your perspective.

When I became CEO of ARI in 2008 it was clear to me that ARI’s lack of “scale” was a driver of the then share price of under $0.50 and a market cap of under $5M. We recognized that we needed to grow the business and that our overall objective of growing shareholder value could not be obtained in the markets we served, with the two products we offered. As a result, we began executing a plan to grow the total addressable market we served both organically and through acquisitions. We also undertook an initiative to increase the number of recurring revenue products that we could offer to those markets while also looking for products that had a higher price point. In summary, our plan was to increase the total addressable market, increase the number of products we offered into those markets, and increase the average recurring revenue per dealer for those offerings organically and via acquisitions.

From a financial perspective, early on it was difficult to drive acquisitive growth using debt as our overall EBITDA levels were low and our lending relationships were such that to increase our debt levels would come with a significantly higher interest rate and more restrictive loan covenants. In addition, we took advantage of a unique opportunity to purchase 50 Below out of bankruptcy and had to finance that acquisition knowing it would take some time to generate positive EBITDA. As you know, we have completed several acquisitions and two capital raises in recent years. In addition, in the last 15 months we have experienced a significant increase in our EBITDA. I believe that these events have put the company in a much better position to finance acquisitions with debt than we were just a few years ago. Our ability to obtain that debt is primarily tied to our ability to generate EBITDA. Our current banking relationship has expressed comfort in allowing us to borrow up to three times our adjusted EBITDA with an interest rate that caps out under 5%. We are now realistically within striking distance of $50M in sales and have seen EBITDA improve by over 50% on a trailing twelve months basis compared to our prior fiscal year. With our scale, we are now generating more EBITDA than we have in the past and this dramatically improves our ability to complete acquisitions using senior debt. For example, if ARI generated $7.5M in EBITDA we could then borrow up to $22.5M in addition to 3x the target's EBITDA. This gives us a great deal of capacity to complete acquisitions without raising equity capital and it is our intention to take advantage of this capacity in the future. We have also adjusted our acquisition criteria to look for businesses that are immediately, or in a short time, accretive to the company’s EBITDA results. As the business scales and we continue to improve our operating results I believe the EPS will also improve. I do agree that the key to this is scaling the business from here without significant dilution.

We do plan on improving our subscriber reporting, starting with our Q1 FY16 results and appreciate your feedback on that item.

We continue to promote buying to our board and executive team and we will continue to encourage our management team and board to invest in the company using their own funds. As you know we did have 3 board members purchase another 49,000 shares on the open market in our last trading window (July 15). While I did not purchase in July I own over 150,000 shares the majority of which I purchased on the open market (these are outside the stock options or the restricted stock I have).

Again, thank you for taking the time to share your views with the board and me. We take your feedback seriously and we will carefully consider your comments as we grow ARI to the next level. We all agree, it is an exciting time to be an ARIS shareholder!


If you have any questions please feel free to contact me anytime. 

-- END -- 

ALL RIGHTS RESERVED BY LONG CAST ADVISERS LLC. THIS IS NOT A RECOMMENDATION TO BUY OR SELL SECURITIES NOR AN ADVERTISEMENT OR SOLICITATION. LCALLC / ITS FOUNDER OWNS SHARES OF $ARIS IN ITS BUSINESS AND/OR PERSONAL ACCOUNT

Monday, August 31, 2015

$FTLF: A good business with good mgmt, but how does a bias against a product fit with investing?

Fitlife Brands - $FTLF - came across my radar at the IDEAS conference in Boston in June. Since that conference, I've researched the stock, built the model, and have spent an inordinate amount of time thinking about the company and the industry.

The company, at the current price of $1.70, is valued at 6.5x proforma EBITDA but I see an avenue towards $2.60 / share for the stock. During a prior growth phase (2013-2014), it traded at 10x EBITDA and if it goes back to those levels - comps get easier in the back half of the year - that's the pathway to 50% upside. Furthermore, the company is well run, well managed, is profitable and generates cash.






On the downside, I calculate balance sheet liquidation at $0.70 / share; that's simply working capital less net debt, a best case scenario for what happens if the doors close tomorrow.

But buried in working capital is a deferred tax asset of $6.5M, representing the tax adjusted value of $19M in NOL's. That DTA is offset by a substantial $5.8M valuation allowance but if the company continues its profitability and the valuation allowance goes away, you could say that about 30% of the proforma market cap is in that deferred tax asset. That DTA fully valued is worth another $0.70 / share, bringing the downside to $1.40. I think the market tends towards simpler multiples and on that end, the company has traded as low as 5x, which infers $1.30 / share downside.

All these attributes make the company a potentially interesting investment - 50% upside vs 25% downside - but the industry also presents it's own characteristics that bear on the company's valuation. It is fragmented, competitive, with low barriers to entry, and endures the vagabond nature of consumer tastes, government regulations and media ridicule. Sometimes it is in fashion and sometimes it is out; currently it is out of favor in all three areas.

Qualitatively, I'm not totally comfortable with the company or the industry. I don't look kindly on the pills and powders market. I don't use "five hour energy" drink. I don't drink red bull. So while I try to keep my financial judgement independent from my emotions, my entire view of this thesis is clouded by my intuition that I do not want to invest in snake oil a product that concerns me [i've since conducted a small sample of channel checks and the feedback from sales people on the product is positive >> http://goo.gl/d130zS].

I keep circling around these two mutually exclusive issues. On one hand the value of a well run business that generates cash and on another an industry that repels me. My hope is that writing this helps to frame the broader question about what my goals are as an investor, b/c the qualitative aspects do (and I think should) overlap with the financial. It's part of who I am as an investor and I don't want that to change. I'm hoping that this writing helps me come to a conclusion. (I bought a few shares to see if I was comfortable with it and my head hasn't exploded ... yet).

I'll start with the  core business.  At the moment, FTLF is an OTC listed / SEC filing $12M mkt cap company that makes branded sports nutritional supplements. These are pills and powders for "getting ripped" (maximizing workouts or accelerating recovery) and "meal replacement" (losing weight).

According to their investment presentation (i'm rounding), ~70% of the business is sports related and ~30% diet related plus a small ~5% "other" health / inflammation / vitality. Here's the latest presentation ...

http://www.sec.gov/Archives/edgar/data/1374328/000141588915002907/ex99-2.htm

... But that's all backward looking stuff.

Looking ahead, the company is in transition. Two things are changing ...

1) it's acquiring a competitor called iSatori for ~$7M, using 4M shares of stock on top of the existing 8M. (~50% dilution). The acquisition will double revenues. (That's ~0% growth of per share revenues by the way). However, after the deal, company will buy back at least 0.6M shares and up to 1.4M shares.

2) distribution channel is changing materially. Where it used to sell direct to GNC franchise stores (ie direct to individual stores paid for directly by the franchisee) now they've gotten so big, GNC is making them sell into a centralized distribution channel for re-distribution to franchise stores. Since GNC makes it's money selling wholesale to franchisees, I view this sort of like the mafia trying to take a cut on sales.

... as a result of these two changes the future looks different than the past. I summarize the combined proforma "back of the envelope" baseline of what the company looks like after the iSatori acquisition. Note that this proforma drives my above noted valuation:

$30M rev and 10% EBITDA margin business.
12M shares out after the deal
~.1$1M in net cash.
hence, ~$20M EV  business, $3M EBITDA = 6.5x multiple.

From a baseline of $30M in revenues, I think short term operating success looks like $40M in revenues and 10% margins. That means growing sales ~25% from here.

Looking back historically, from 2011 to 2014, mgmt grew sales 18% CAGR and shareholder equity 28% CAGR. And they nearly doubled my estimate for revenue / customers. These are substantial growth rates ...





... can they do that going forward?

I realize the 1H vs 1H comps suck, notably: Revenues down, margins down and DSO's up. These are initial artifacts of the transition in the GNC distribution system notably:

i) ahead of the wholesale transition, franchises stocked shelves, leading to revenue bubble and falloff.
ii) meanwhile the shift towards GNC wholesale distribution lead to longer DSO's b/c big corporate can pay when it wants.
iii) though they get paid later, there are no more credit card fees charged as a reduction in sales (when they sold direct to franchises they were typically paid by c/c).
iv) mgmt believes that net / net margins will not change but I anticipate some slippage and 10% EBITDA drives my back of the envelope assumption

... Obviously, given the 1H15 vs 1H14 comps, changes in the distribution channel - the "GNC mafia" - these are all headwinds the company needs to do something.

Adding new brands, new doors and new customers from this iSatori acquisition might help.  Can't fault them for trying. Change is part of business. They are not standing still. Kudos to a management team that adjusts, evolves and adapts, I can say that for sure! But the acquisition isn't so simple, and I'll discuss this a bit more later.

So what's it worth here? On a core basis, it's trading for 14x trailing TTM EBITDA but core is irrelevant due to the aforementioned changes. It's trading at 6.5x proforma EBITDA (assuming $30M sales / 10% EBITDA margins).

In 2013 and 2014 it traded around 10x trailing EBITDA. If it trades at 10x against a baseline $3M in EBITDA, this is a $2.60 stock. Even if it never grows, a revaluation based on acquired income leads to a 50% return in a years time. Are the micro-cap markets that inefficient that it can't see through the coming change? It's certainly not the only thesis.

Or maybe it can trade as low as 5x EBITDA? That infers $1.30 / share. Or the aforementioned $1.40 in balance sheet value, when considering the $19M NOL / $6.5M DTA?



Making decisions is hard. What else do we need to know about the company to help define the options?

The product. FTLF uses contract manufactures to make various formulations of its pills and dry powders. The company packages and brand and puts the product on store shelves, primarily in GNC franchise and corporate stores, and makes a margin there. The business is driven by new brands, new "doors" and same store sales.

The products are generally comprised of caffeine + extracts of various plants and herbs and / or their active derivatives that act as stimulants, appetite suppressants that increase /decrease blood pressure and/or blood flow and help alertness, appetite control, energy, etc.

It sells these products under five brands ...

Three brands - NDS, PMD and SirenLabs - are sold almost exclusively through GNC franchise stores.
MetisNutrition - recently launched and sold exclusively through GNC corporate stores.
CoreActive - the smallest brand - sold through independent channels.

... As you can see, the business is heavily reliant on GNC for distribution.

Here is the label of ONE of their SirenLabs diet pills the "Neuro Lean" ...

http://www.gnc.com/graphics/product_images/pGNC1-18884757_gnclabel_pdf.pdf

... amplify that a little bit and you'll see, below the main ingredient anydrous caffeine (ie its powdered form) other ingredients ...

Beta Phenylethylamine HCL - A central nervous system stimulant that boosts metabolism and is similar to caffeine but helps burns calories.

ADVANTRA Z - Also known as "Bitter Orange”. It's an appetite suppressant and stimulant that includes Synephrine, which is a powerful stimulant. This product is manufactured by NutraTech >> http://goo.gl/jOeF7a

NELULEAN - Extract of the Nelumbo Nucifera plant (aka "lotus"). Here's a little pdf on the product >> http://goo.gl/gVwust << but the company that makes it is "IN ingredients" >> http://goo.gl/AyIc31 <<

ALPHA YOHIMBINE - Opens blood vessels and improves blood flow which may aid in weight loss.

... and that's just in the "B.A.D. Fat Annihilation  Blend".

Alert 1: I really don't like these products. I'm sort of disgusted by it. If my kids used it, I'd probably sit them down and talk with them about their dangers, lack of regulation, etc. It gets back to the question, do I want to invest in a product that seems to me like "snake oil" whose value to the customer I really don't understand?

My disposition against the product might be a hurdle to my investing in the company. Is that crazy talk for an investor? I think it's a bias based on availability of information and personal belief. I mean, I've never seen anyone in a GNC store but the company does $1B in gross profit, $500M in OpInc and $260M in annual net income, so I should trust that info, right? And it can't be all bad if people use it?

Putting aside my external feelings, two things make the company unique ...  

1. FTLF is run by business people. The CEO John Wilson worked for $KO and the CFO Mike Abrams is a former investment banker at HC Wainwright and Burnham Hill.

Having spent some time researching its large competitor MusclePharm ($MSLP) and the soon to be acquired iSatori (IFIT), both of which are managed by athletes and weightlifters, the benefit of having business minds behind the enterprise can't be understated.

2. The company spends less than its peers on sales / marketing. Competitors (including iSatori) use expensive endorsements or meaty pitchmen to sell their products. FTLF instead goes to the franchisee and sells a copycat of a highly advertised competitor that generates a higher margin for the franchisee.

On one hand, it's a brilliant strategy to essentially outsource the advertising and capture the customer in the store. On the other hand, it can be a temporary advantage and potentially a race to the bottom.

... considering these characteristics, we have a low capital intensity / high variable cost business and it has the potential for high returns if the brands catch on with consumers, the product sells and overhead costs are kept low. These are some raw ingredients for a pretty good - not great - but pretty good business. 

Alert #2: What makes it unique also creates potential issues with the acquisition. iSatori is run by a muscleman, not a businessman. It advertises via paid endorsements. It has a much higher percentage of S&M / revenues than FTLF (24% for IFIT vs 12% for FTLF).

To add to the potential for executive tension, the CEO of IFIT (Stephen Adele) and its largest shareholder (Russell Cleveland) will together be the largest shareholders of the combined company with 32% of the outstanding shares after the deal.

In order to reduce this imbalance in ownership, after the deal closes in 3Q or 4Q15, FTLF has ...
i) an option to purchase 570k shares back from Adele and
ii) the right of first refusal on 800k shares of stock to be owned by Cleveland
... assuming the option is triggered with Adele at current prices $1.70, it would cost the company $1M to acquire the shares and reduce the share count to 11.5M. It's unclear what will happen to the shares held by Cleveland or who will buy them.

These slightly complicated post-deal repurchases are actually good for investors by reducing sharecount but the wider concern of mine is the risk of tension in the mgmt suite given the differences in operating styles. 

One tidbit offsets my fears about the acquisition. According to the S-4 IFIT's interim-CFO Seth Yakatan who is helping to negotiate and move the deal forward is taking all stock - no cash - as comp for his work. He's betting on the company.

The trick will be growing doors and revenues. This brings us back to the GNC angle

1. GNC franchise stores are already pretty well saturated. The company sells to 1,400 GNC franchise locations in the US and overseas. GNC has only 1,100 franchise locations in the US (and about 2,000 interationally). So they're pretty well penetrated in the domestic GNC channel.

Therefore, the key new channels are from international growth (which faces a headwind from f/x), iSatori (we don't really know how they're going to use that channel), and the new Metis line that will sell into GNC corporate stores, which are currently under-penetrated. According to FTLF's, presentation they add new brands every six months.

2. Also, as a tailwind, GNC is increasing its emphasis towards franchise stores. So that should make available new doors into an already deeply penetrated market.

Given the company's success in the past selling direct to GNC franchisees, I anticipate that it should be able to penetrate independent stores available to them in the IFIT channel. 

Alert #3, competition, et al. FTLF hasn't hit on a totally new business model - lots of companies use contract manufacturers - and their's isn't the only one with good management.

Also, competition in the industry is fierce. Here's the boilerplate from MSLP's 10K, which says it better than I do: "The nutritional supplements market is very competitive and the range of products is diverse. Competitors use price, efficacy claims, customer service, name recognition, trade relationships and new product innovation to create share of market.

Our range of competitors includes numerous nutritional supplement companies that are highly fragmented in terms of geographic market coverage, distribution channels and product categories.

In addition, large pharmaceutical companies and packaged food and beverage companies compete with us in the nutritional supplement market. Many of these companies have greater financial and distribution resources available to them than MusclePharm and many of these companies can compete through vertical integration.

Private label entities have gained a foothold in many nutrition categories and are direct competitors. A few of these are private label entities have become market leaders. In this industry, most of the companies are privately held.

With respect to retailer sales, we cannot fully gauge their sizes and our relative ranking. The world of nutritional supplements is constantly changing and we believe that retailers look to partner with suppliers who demonstrate financial stability, brand awareness, market intelligence, customer service and science. With this in mind, we believe we are competitive in all of these areas."

It's a mouthful, but worth reading twice. $MSLP is a much larger $65M mkt cap company managed by traditional industry leaders (muscle men not business men) best evidenced by their perennially negative returns, cash flow burn and especially the amateur way they published earnings followed two weeks later by a major restructuring announcement. The stock has lost 70% of its value over the last year. On an EV / revenue basis this unprofitable cash flow burning company in restructuring mode trades at roughly the same multiple as FTLF's proforma figures.

Interestingly, $MSLP's recently hired Bill Phillips as a "strategic adviser". Bill was Stephen Adele's boss at EAS before Adele started iSatori. This is an incestuous business.

Media ridicule = the "Post-Oz" era. See this January 2015 interview with Adele regarding the "state of the industry" and the headline noise >> http://goo.gl/z6oxq3 << I appreciate his intellectual honesty on all the bad news in play.

But as a comp for what "success" looks like, in June 2015, WhiteWave $WWAV acquired prvtly held Vega for 5x revenues ...

http://goo.gl/Qahmao

... good management and having the right product can create such outliers.

An option on "success mode". When you start to think about the baseline business $30M revenues / $3M EBITDA, what multiple to put on it, the value of the NOL's, etc. we haven't even broached the possibility of "success mode" that looks like Vega in the future. B/c as a branded consumer product that uses 3rd party contract manufacturing, it could have high returns IF it attracts a loyal customer base.

Admittedly, that's a huge "IF": Every consumer product aims for "that thing" that leads to love and loyalty, few reach it and none can predict it. Here, at the very least, you're not paying for success mode.

So what is all this worth? To summarize the observations so far:

1) It seems to have a VERY talented management team focused on profit and cash flow
2) It is deeply penetrated into it's leading distribution channel - GNC franchise stores - and GNC is expanding its franchise stores.
3) However, GNC has changed the way FTLF sell to the stores and this is (temporarily?) disrupting revenues and (temporarily?) weighing on the valuation.
4) It is acquiring a competitor (iSatori / $IFIT) that offers additional brands and distribution channels. The additional "retail brands" and "retail doors" are both positives
5) But IFIT manages and markets itself completely differently from core FTLF. The differences in management styles, creates the possibility for turbulence, a negative.
6) There's a big NOL that doesn't seem to be properly valued
7) The pills and powders industry makes me a little uncomfortable as a consumer and is itself undergoing a bit of a regulatory transition and "headline noise".

I think I conclude that FTLF is a pretty well run business, it solves a less than obvious problem for the franchisee and at 6x proforma EBITDA "success mode" is simply an option.

It has an opportunity to open new doors, new brands and generate growth and cash flow. It has grown revenues +15% CAGR in the past. I think those line up as a good opportunity. Plus, there's an avenue for a revaluation to 10x EBITDA. But I would need to either hold my nose or find a way to rationalize my external / unrelated bias against the product in order to make this a substantial investment.

Completely tangential moment as conclusion. This is the 30th anniversary of the release of the album Born to Run. I remember exactly when I got the album: I won it at Phillip Josephs's bar mitzvah, which happened to fall on my birthday! I had no idea of its' value - hadn't yet heard of the Boss - but when the older kids offered to buy it from me for $20, I knew it was worth something, so I kept it. Played it all the time. I still have it. Years later, I married a Springsteen fan, so maybe all these things come together.

I mention all this not just b/c it's a great album, and it's his 3rd album by the way, and very different from the first two and they are all great, but b/c the way I acquired it - and kept it - which is relevant to stock market investing. It's almost an innate experience to sense something's value when other's desire it and want to pay more for it. Even a kid can recognize this. It's harder to know the value when no one wants to pay a premium for it. That's an important point, I think, when it comes to investing.

-- END --

All rights reserved and copyrighted by Long Cast Advisers, LLC. This is not a solicitation for business or a recommendation to buy or sell securities. I own shares of FTLF. 

Saturday, August 29, 2015

$ARIS: Letter to the CEO & Board on the destructive impact of share dilution

I sent this August 11, 2015 to the CEO, CFO and the Board. There's a cautionary tale on the impact of dilution that isn't specific to micro caps caps but effects them greatly simply due to smaller shares outstanding. 

I wonder if capital allocation is something executives figure out and improve on over time? My general view is that people tend to not look constructively on their own behavior and therefore tend to not change their behavior, but I hope in this case they do. 

Dear Roy –

It’s an exciting time to be an ARIS shareholder.

I’m writing to you to commend you for the great work you’ve done since your elevation to CEO and President in 2008 and also to share three concerns that, if resolved, would translate your progress to date into more significant returns for shareholders.

Since taking over ARIS in 2008, you’ve done an impressive job leading and growing the company. Revenues, EBITDA and cash flow are up 12%, 15% and 18% CAGR, respectively and I believe sustainably. These results are driven by both organic growth and acquisitions that have expanded the company to new end-markets served and services offered.

Concurrently, the market value of the company is up ~25% CAGR as well, an impressive rate of growth that reflects the changes you’ve implemented.

And with the recent acquisition of DCi, you’ve added a tool in the automotive space that’s essential to your customers. DCi is a bit like the ARI business from 2008; a small no growth cash flow engine. And combined with TCS and TASCO you have the ingredients to create a sticky, recurring business that addresses the automotive end market with a product that's desired by customers and cannot be easily emulated elsewhere.

This letter however is not just about patting you on the back it is also about advising you and your board cc’d to really internalize the detrimental impact of the past seven years of share dilution and urge you to think more constructively and objectively about its impact going forward.



As the above table demonstrates, when we look at your financial performance on a per share basis – and as a part owner of your business, it is the only way for me to think about it - the results are largely unimpressive. Revenues and EBITDA flat. EPS down 11% CAGR.

I’d be remiss if I failed to point out one bright spot; the growth in book value per share. Though it comes off an extremely low base, it is the only remaining financial emblem of your value creation to date when viewed through the lens of share count dilution.

I can imagine back in 2008, a plan discussed and agreed to by the board to grow the company through acquisitions using a combination of debt and equity. This plan I imagine balanced benefits of increased liquidity, trading volume and a larger product offering against the disadvantages of shareholder dilution.

I would like to know if such a plan existed and if so, I should hope it is now complete. ARI’s portfolio of end markets and services has dramatically expanded and with 17M shares now outstanding, there’s plenty of stock to trade, particularly with an average daily volume of only 30,000 shares.

So I am writing to urge you and the board cc’d here to stop the share count dilution and suggest that on the next conference call you make it plain and clear that you pledge to stop the share count dilution and live only on your free cash flow and where necessary, low cost debt that is available to you.

Furthermore, as I’ve previously mentioned [in earlier conversations], I urge you to provide more disclosure around your subscriber numbers, whose growth is a major factor in organic growth (price being the other). This disclosure would provide valuable information to investors and a simple target around which to configure incentives.

And finally, there would be no better way for you, your executives and the board to indicate your trust and faith in the company that I share than buying its shares in the open market with your own money and not through stock grants and options.

In summary,

·        Stop the dilution
·        Disclose your subscribers
·        Buy the stock with your own money in the open market

Shares are not free money; they come with incredibly high costs in future value and their persistent use destroys everything you’re trying to build. It is simply impossible for any of us to earn a reasonable return on our investments with continued dilution of our capital.

With the business today more firmly ensconced in larger end markets and with additional services, I’m confident that sound and strategic management that generates organic growth will yield the cash flow necessary, over time and with patience, to grow the business while satisfying the required returns for its owners and executives.

Sincerely / 

Long Cast Advisers, LLC

Tuesday, July 21, 2015

Revisiting $FHCO

I have a draft post I've long been working on about investing mistakes I've made in the past year and $FHCO is atop the list. I'll summarize it here and note that the 34% I lost on the investment (MY OWN MONEY) from Oct '14 to Mar '15 wasn't "the mistake" but the outcome of the mistakes I list below. There were five of them, by my count, all of which lead to important lessons for me and I will bury my nose in these mistakes so I don't make them again ...

1. the need to be "doing something". when i bought the shares in Oct, I had just made the decision to form my business and I felt the need to be "doing something" to "be busy". I realized on reflection that what's worked for me in the past is the patience to invest only when the time and opportunity were right, not on some arbitrary calendar. Wearing a professional's hat can't change that.

2. i was attracted by what other people were doing instead of what seemed right to me. a friend in the small cap space brought the stock to my attention and other folks I knew swore by him. I've subsequently learned that he and I are very different investors - he buys a few shares of everything while I'm a concentrated investor - so we have different thresholds on what makes a good investment.

The lesson with this (along my experience working at a hedge fund around the same time) is that investing is a deeply personal experience.  I can't stress that enough. All the stuff they teach in business school about finance and valuation or what you read from "the experts", that might get you 99% of the way there, but that last 1% makes all the difference. What someone else sees as value, might not appear that way to another, and vice versa. That's a beautiful thing and a very important lesson.

3. i didn't talk to experts. As a former PI I pride myself on this aspect of my due diligence but I bought shares before I'd reached out to sources in public health who subsequently (and unanimously) told me that the product is a joke in the US. I've since learned that the largest consumer users in the US are gay men but since the product is FDA approved only for vaginal and not anal intercourse, they can't market to them.

4. i didn't talk to mgmt. I bought it at $4.40 before my impressions with mgmt were fully formed and sold it at $2.90 after they were fully formed.

5. didn't fully understand the market. i was attracted to the nifty, quirky and seemingly cheap story without fully understanding the market, the buyers, and most importantly the growing competition from Cupid in India.

... and so with these mistakes, I got involved and lost money - my own money, not client money - but I've come away with valuable albeit expensive lessons.

Yet, here we are with the stock at $1.40 and I'm revisiting this company. Maybe it's insane. The stock is cheap at 4x EBITDA but whose to say it won't get cheaper? There are few hard assets and just $0.50 in working capital / share and another $0.50 in deferred tax assets that would benefit an acquirer.

But the CEO who recently wrought massive destruction in shareholder value via a "strategic initiative" just resigned - on the one-year anniversary of the announcement of said strategy - and positive changes MIGHT be afoot now that the owner / operator / founder OB Parrish who owns 4% of the company is resuming control.




$FHCO is the Female Health Company. The company manufactures the Female Health Condom under the brand FC2. It's a $40M market cap company with $24M in sales on 43M units sold (2014). The company will exceed both these figures in 2015. Yet, the stock is trading below where it traded in '08/'09 when it was doing less sales and lower margins with roughly the same share count as it has today.

By way of background, the female condom was invented by a Dutch physician, who patented it and sold the rights to the predecessor company, Wisconsin Pharmacal Company. Then, through a series of dispositions, around 1995 / 1996 Pharmacal was split into two companies, with rights to the female condom put into one entity that was eventually renamed Female Health Company and run by OB Parrish. The other company, after changing hands several times, still exists today and is now run once again by OB's former partner John Wundrock ...

http://www.pharmacalway.com/

... so it looks like both these entrepreneurs are back where they started 20 years later.

The original product was the FC1 and an improved product, the FC2 was introduced in 2007 with production consolidated in Malaysia in 2009, where it can currently produce 100M units / year. (The FC1 was discontinued).

For the last few years, the company has consistently sold the products for ~$0.55 / unit and with EBITDA of roughly $0.15 / unit. (The apparent decline in rev / unit in 2015 reflects a change in the way a 5% discount was accounted for, previously in COGS now a reduction in sales).

In the early days, the company intended to sell the product directly to US consumers and in that effort supported local TV advertising where, as the story goes, a UN employee saw the ad and that opened the door for a more global and institutional business.

As a result of the global sales, the bulk of the business today is to developing-world ministries of health and / or institutions that provide public health reproductive services in the US and overseas sold via partnerships with local distributors in public tenders. US revenues account for just 5%-10% of revenues in any given year.

Given the nature of these tenders, sales and shipments are lumpy but the company has been profitable and cash flow positive, with the exception of this year, when cash flow has been negatively impacted - according to the company - by a large receivable to the Brazilian gov't ("120-day pmt terms"). I presume lack of focus on working capital contributed to the prior CEO's "resignation".

But competition is bringing structural changes to the market and this makes things different than they were 5 yrs ago. The global market has seen new entrants from China and India (I think Cupid is the most serious competitor) ...

http://goo.gl/wreSpO

... while in the US, a variety of new designs are pending via among other things, a Gates Foundation grant ...

http://goo.gl/xZUCWk

... this competitive threat lead then CEO Karen King, to announce last year, July 2014: "... a series of strategic initiatives that we believe will ultimately generate greater value for our shareholders and other stakeholders.

In order to position the Company to pursue a growth strategy, the Board of Directors has elected to suspend the payment of quarterly dividends at the present time and devote cash flows towards these strategic initiatives that have the potential to accelerate the Company's long-term growth in revenue and earnings."

http://femalehealth.com/press-release/?releaseid=2048082

The initiative had two buckets ...

1. US consumer growth. First, they hired Susan Ostrowski - a sr. exec in pharma and chem sales and marketing - tasked with growing the US consumer market, and that they would spend more money on sales and marketing to do so.

2. Product diversification. They also announced "we will evaluate investments in new products, technologies and/or businesses that complement the core competencies and strengths of the Company ... we believe the risks associated with a single product offering, along with the significant volatility in purchasing patterns for FC2, can be mitigated by the presence of a more diversified portfolio of business activities."

... and here we are a year after cancelling the dividend and announcing the "strategy" and they

haven't acquired anything,
are no further along in articulating what they're going to acquire
are no further along in growing sales in the US market,
have a legacy sr pharma exec running a social media / marketing strategy
and that marketing strategy is costing incremental +$1M / year
meaning to break even on it, they'll need to sell an incremental 1-2M units to US consumers

A comment I heard on the lack of progress towards an acquisition was the fact that they're too small to field a dedicated M&A team to make an acquisition, which of course begs the question on why they went down the path to begin with.

And there are still a few other issues to mention  ...

the company has been operating at a cash flow deficit for the first time in my modeled history (going back to 2008) ... working capital has expanded ... DSO's are over 100 days ... and profitability / unit has shrunk b/c of the marketing spend to sell the product to a US consumer who won't buy.

... my guess is that along with the failed strategic change, the inability to manage cash flow lead to the CEO's resignation.

So here we are today and it's an awful mess. What was a $10 stock two years ago is now trading for $1.40 even though 2015 sales and units should approximate 2013 levels.

But in the convoluted world of investing, the bad news is an opportunity. With the stock hammered, trading at ~4x EBITDA (3x assuming a "normal" DSO), the CEO that lead the strategy now out, the company's founder OB Parrish is back in control.

Given the destruction in his net worth over the last year, I'm anticipating a finer pencil on the "strategic plan" implemented last year - may be a reversal or a change or an adjustment - so that the company can be run with a better eye on operations, leading to a resumption in cash flow generation and possibly a dividend and buybacks, or at the very least a better articulated strategy going forward with honest intellectual engagement on what's possible and probable.

In addition to Parrish the largest non-institutional shareholders Dearholt and Wenninger - and including the board members who are advising on next steps - have LONG been involved with the company ...

http://goo.gl/Iu2QdW
http://goo.gl/K1yMlz

... I don't know what the future holds but the company will host its F3Q15 conf call on July 30th and more details should be discussed then. They say you can't cross the same river twice but I've recently initiated a small position ahead of the call anticipating positive changes.

-- END --

All rights reserved and copyrighted by Long Cast Advisers, LLC. This is not a solicitation for business or a recommendation to buy or sell securities. I own shares of FHCO.