About Me

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This is written with serious investors in mind, though sometimes they're just drafts in progress. I'm a former reporter, private investigator and institutional equity analyst who digs deep to find niche undervalued and undiscovered securities. I manage money for individuals, institutions and family offices via my business Long Cast Advisers. This blog is part decision-diary, part investment observations and part general musings about Philadelphia sports. It should not be viewed as a solicitation for business or a recommendation to buy or sell securities.

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

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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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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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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