Kicking around a new idea: $PSSR Inexpensive and Independent Airspace Technology Company

Summary bullet points:

• $PSSR is a micro-cap with long operating history in aerospace technology and improving balance sheet.

• Book of business is growing with recurring revenue subscriptions and the tailwind of long term industry trends.

• Trading at inexpensive 5x EBITDA despite visibility into continued revenue growth.

In a recent article in the WSJ about a successful test using blockchains (ie bitcoin technology) to record transactions in the credit default swap market, I read the following quote ...

"Some may be reluctant to make changes that threaten their own market share or introduce new complexity to current systems that have been tested and refined over the years."

... and it struck me as something that could have been written about any industry, at any point in time in history.

This post is about technological change in the aerospace industry, NextGEN, and a tiny company called PASSUR Aerospace (PSSR) that until 15 years ago had a niche in "old technology" but is evolving with the "new technology" and could have an opportunity - given its established space in the industry, its slate of solutions that support NextGEN and recent hires - to grow revenues, maintain margins and thereby expand ROE and ROA back towards double digits.

The "old technology" is locating airplanes on a map, once essential, soon to be ubiquitous. The "new technology" is helping their customers - airlines, airports and ATC's - analyze, understand and make sense of enormous amounts of information to make better, faster and more efficient decisions around airspace and airport operations; scheduling, on the ground asset management, and routing.

Many larger companies are focused on using algorithms to provide better information for these customers. PSSR says its competitive advantage is +20 years of data analysis tracking its own and other information for more accurate predictive software.

I see another advantage as the stickiness of real estate in the enterprise, in the airport and ATC - the company has been there for more than 30 years - combined with finding solutions for airline customers that actually improves efficiency (a member of the board Kurt Ekert says he was formerly a sr employee at Continental Airlines when he found the company as a customer and fell in love with the product).

If ...the industry continues to modernize and evolve, if ... the product continues to improve and if ... the company continues to focus on meeting needs of existing customers, the stock could be attractive - revenues have grown recently and deferred revenues (a measure of subscriptions) imply continued growth - while the current valuation of of 5x trailing EBITDA seems to discount much in the way of a positive outcome.

I don't make price targets or predictions but I can imagine a future where continued and consistent steady growth and cash flow justify a higher valuation off of a larger pool of profit, while the balance sheet continues to delever, implying the potential perhaps for material growth to shareholders. Or not?  I am still trying to learn more; continued study and patience will be key.

PASSUR was founded in 1967 and has been publicly traded for more than three decades.

For most of this time, it operated under the awful / awesome name “Megadata” until 2008, when it changed its name eponymously to the pronunciation of the acronym of its heritage product, “Passive Secondary Surveillance Radar”.

Underlying PSSR – the acronym – are fixed radar sites – currently 185 in all - the largest passive commercial radar network in the world - at or near airports mostly in the US but also in Europe and Asia - that provide faster and more accurate position updates to airline operations control and ATC's. (These are the spinning radars that are used as establishing shots in movies, typically followed by skidding wheels on the runway).

The company once sold the machines, then sold the information from the machines as a subscription service. This fixed asset - and the service from it - gave PASSUR its name in the industry for solving the problem of locating an airplane and putting it on a map. As an example of this legacy, after the 1996 crash of TWA Flight 800, its radar network helped establish the precise location of the airplane at the moment it exploded and also the locations of other airplanes in the vicinity that might have witnessed it.

For several decades that legacy business was niche, yet essential and unique in busy airspaces. But new technology - notably ADS-B - is disrupting that position. By 2020 all airplanes flying in US airspace are required to have ADS-B - whether or not this actually happens is unknown - but it would make passive secondary surveillance radar a redundancy.

However PSSR is evolving ... and this brings us to NextGEN 

If you read the newspapers you've heard of NextGEN, perhaps as a bloated and expensive, FAA program; a failure; a plodding success; an over-promised and under-delivered program to - depending on your viewpoint - upgrade airspace technology to improve efficiency and safety in US airspace; or to simply force all the air traffic controllers out of work.

But NextGEN's over riding ambition is to modernize the US aviation system "... to improve the operational performance of the national airspace system."

Because of the collaborative nature of the US airspace, the benefits of any modernization at one airport or in one airplane isn't effective unless surrounding regional airports and airplanes using those airports also upgrade.

In the simplest least complicated explanation of NextGen, it is an effort by the FAA to "quarterback" the collaboration required between the primary agents in the industry ...

Airlines (ie operators)
Airports
Air Traffic Control Towers

... in order to modernize the US airspace.

The whole plan unfolds in a tough politicized environment where there is reluctance to change "... or introduce new complexity to current systems that have been tested and refined over the years" as per the introductory quote.

Big contracts. Government agencies. Modernization. It's all very complicated, long term and likely to benefit the large industry players, right?

The RTCA (Radio Technical Commission for Aeronautics) is an industry advisory committee used by the FAA as a "Public-Private Partnership venue for developing consensus among diverse, competing interests on critical aviation modernization issues in an increasingly global enterprise."

And here - among many places - is where PASSUR plays a part; despite their small size they are trusted, independent and known in the industry, so they have a seat at the table helping to develop, implement and track NextGEN priorities as well as participate in opportunities to improve operating efficiencies in the industry.

Furthermore, their "last generation" technology isn't so last generation; they continue to roll out new SSR systems at airports, as backups and redundancies.

And finally, they have been generating meaningful - and it seems recurring - revenue growth helping airlines and airports use the enormous quantities of data available to airlines from a variety of sources to solve one of three general problems that occur primarily when weather disrupts flights ...

• Better ETA’s and ETD’s to airlines improve on time performance and better prepare for arrivals and departures.

• Better on-the-ground airport information (ie “surface management”) to improve – among other things - turnaround times and on-ground performance.

• Better air-traffic management to safely accommodate increased overall capacity in the airspace and airports.

... in predictable environments these things on their own are not terribly complex but throw in diversions associated (most frequently) with poor weather and non-linear problems around availability of runways, gates, crew time, surface equipment, etc. begin to escalate.

This is where PSSR's service / solution / revenue generation comes in. The company integrates its own sources (PSSR) with other available data sources (ADS-B, ASDE-X, Mode S, En Route Radar, Airline OOOI data, ACARS, fleet databases, etc) as a data feed to flight and airspace information, then runs the data through its own algorithms and uses it to provide better analysis for predictions and performance, which ultimately supports better decision making by its customers.

It sells services and software systems via subscriptions that provide more efficiency in various aspects of the airline industry. Large material customers include $LUV and $JBLU in their most congested regions that experience weather.

I hate to rely on cliches and jargon but this where I'll throw out the term "big data" with a link to an HBR article about how PSSR - and Sears Holding (lol) - are using "big data" to improve operations. (take it FWIW, I felt I had to reference the article).

A key question here when we reflect on the world of big data is why aren't other people doing it, why is PSSR still independent, why aren't revenues higher, etc? 

On the face of it, having better resources to solve these problems sounds like a “no-brainer”. However, based on our research and our understanding of the industry, there are headwinds to customer adoption of both solutions.

• On ETA / ETD, it’s not generally seen as a complicated problem where the benefits of shrinking the ETA / ATA gap is seen as critical. When a plane leaves late it can fly faster, weather remains an acceptable excuse for delays and with the exception of the most congested airports, “good enough is good enough”.

• On on-ground performance and turnaround times, the biggest factor is planing and deplaning customers. A subscription service that improves on ground performance without improving that process does not appear to be a problem customers feel need solving

• And finally, reference the quote at the beginning of this post. A source I spoke with at a competing company who said the PANYNJ, which manages some of the busiest airspace in the world, is a huge obstacle to investment in new technology for reasons as simple as "turf battles".

In light of these obstacles, the answer to selling a customer a solution to a problem they don’t feel they have and in a crowded and competitive field is to increase and improve selling and marketing function. PSSR is doing this, it appears with early initial success albeit with some degradation of margins (EBITDA margins now 28% down from the mid- 30% range; we'll get to this in a minute).

But the investment thesis that underlies the opportunity for material long term gains is that there will be an evolution in how these problems are viewed by the customers.

We have seen examples in other markets and industries where marginal improvements were deemed unimportant and unnecessary until eventually they became essential and ubiquitous.

That is the path to a maximal and exciting return. For the patient investor, if that evolution occurs and customers are willing to pay, there could be material gains. In the meantime, you're getting some solid "blocking and tackling" at a low multiple.

FINANCIAL PERFORMANCE
We see a company growing revenues and backlog, this as a decent cash flow generating growing business trading for a low multiple at today’s prices.

Revenue and Subscription (aka backlog) Growth
The evidence demonstrates that since losing contracts in 2012/2013, quarterly revenues have been growing through 1Q16 (quarter ending 1/31/16) with pronounced sequential and y/y over growth over the last four quarters. The company indicated the "lost contract" was not a recurring revenue "core" program but a one-off for DHS.

This chart tells the current growth story (revenues) as well as the future growth through two balance sheet items that capture the equivalent of “backlog” (ie subscriptions); they are deferred revenue netted against accounts receivables. Higher levels of subscriptions should lead to continued higher levels of revenues over the next 12-months leading to potential growth acceleration.

Balance Sheet Improvement 
When we think about a business and its all-in consistency, we look for companies with good balance sheet management as reflected in growth in shareholder equity. Here the improvement since 2012 has been slow and steady . The bulk of improvement prior to that came via a partial recapitalization / debt to equity conversion in 2012. The company’s primary shareholder GS Beckwith Gilbert owns 4M shares (53%) and is also the note holder on the $3.5M in outstanding debt.

High EBITDA Margins, but Investments in SG&A a Headwind
Until recently, EBITDA has largely kept pace with the growth in revenues. However, new hires in the last 12 months have absorbed a greater share of expenses.

The new hires that impact SG&A include back office talent as well as customer facing talent:

• David Brukman, CTO.
• David Henderson, CFO
• Leo Prusak. Former FAA Deputy Director to head airport operations
• Bob Junge, formerly head of JFK airport operations, to sell airport solutions
• Howie King, formerly of competitor Saab Sensis, to be a director in business development

Other evangelists for the product include …

Jim Barry, CEO
Tom White, head of product
Chris Maccarone, airline performance

The impact of these new hires might be evident in future revenue growth but it is certainly evident in current SG&A which at 1Q16 had increased 38% to $1.6M; it is as high as its ever been and is now up to 48% of revenues, up from the 38% average in the prior five years.

The question of course is, can the revenues scale these new hires? The evidence from recent revenue and subscription growth is that it is on the way.

COMPETITION / CONCLUSION
Current competitors that sell “data driven” solutions tied to weather diversions, on ground performance and operations systems management include SAAB Sensis, Navtech (an airspace technology company recently acquired by Airbus) and IBM / weather channel, but none are as narrow and focused as PSSR.

The risk associated with competition should include the question: "When does google get into this space"? In some respects, though the degrees of complexity are different, the evolution of NextGen is not materially different from the evolution towards self driving cars. Many of us already use devices for routing, ETA management, etc when driving. I would argue its easier to penetrate the automobile since there's no "gatekeeper" (or union) advocating obstacles to automated driving the way there is keeping it out of the ATC or cockpit.

To this aspect, I see the company's legacy through the lens of that initial quote as a benefit. The company's real estate in the cockpit, ATC, and operating control room has value; the company is trusted and present. Best of all, they have been evolving slowly and successfully in the right direction.

As I've dug into this industry, I've been surprised with how "old fashioned" it is. On the front end, the customer interface seems to have leapt forward with ticket ordering and boarding pass apps and the evidence shows that overall safety has improved as well.

However, on the back end, based on what I've learned, many companies continue to operate inefficiently - and more critically - airports, municipal authorities and ATC's are as well. As someone told me recently, "the air traffic control system in this country is so antiquated, it would scare the shit out of you if you knew about it."

Because airlines, airports and ATC's are all partners in the industry ecosystem, the full benefits of an improvement by one agent - an airline say - in on time arrival might not result in faster turnarounds if the airport or ATC doesn't improve efficiency and a gate isn't available. Again, this is the reason for NextGEN.

It makes for an interesting investment quandry, because the situation can go on indefinitely. Ultimately however, my investment thesis is driven by the view that while improvements in efficiency can be overlooked and ignored eventually they became essential and ubiquitous. And in the meantime, you're getting a company that has a long history of quality management,

RISKS

There are obvious risks with investing in general, nano-cap specifically and in particular companies - like this one - with ownership concentrated in the hands of one person.

Beckwith Gilbert owns ~53% of the equity of the company (4.1M shares) plus the $3.5M note paying 6% interest. He is by many accounts committed to the success of the company and was willing to stand by when it had financial difficulties but it is unclear he is committed to returning shareholder value and that's made me cautious on this position in my portfolio.

Two issues specifically give me pause:

1. His compensation. Mr Gilbert is paid  $300k / year for his role as the Chairman, which is as much as the CEO, Jim Barry, who does most of the heavy lifting. I have no view on what Mr Gilbert does to earn his compensation but it is in addition to the interest he receives on his $3.5M in debt to the company. Viewing that $300k comp as a form of interest expense on the debt, the implied rate on the debt is closer to 16%, which is well in excess of junk yields.

At face value, perhaps it should be viewed as an indication of the speculativeness of the investment with as high a degree of risk as a junk bond.

2. A comment to me about his goals for the company. I recently attended the shareholder meeting and followed up with questions after digesting what I'd learned. A final question of mine, which I like to know from all executives of all my investments, is what are the goals for company, or in short: "why"? Why be in business? Why do this? Often its just lip service but sometimes there's a commitment to customers, to employees, to shareholders, etc.

In this case, when asked why they're still independent (given that some have rolled up and been acquired) his answer was along the lines of "b/c it's more fun to be independent and take on the big boys."

And when I asked about the long term goals for the company, where they expected to be, etc. there was no comment beyond "having fun".

I don't think that's untrue - there is something refreshing about that - but what does it mean for shareholders and maybe even about the employees who don't have the same financial independence as he has.

I think its much more fun to have winning investments. 

ABBREVIATED GLOSSARY OF AIRLINE TERMS
ADS-B. Automatic Dependent Surveillance - Broadcast

ASDE-X. Airport Surface Detection Equipment, Model X


ERAM. En Route Automation Modernization.

TAMR. Terminal Automation Modernization and Replacement. "The TAMR program is upgrading air traffic control systems at terminal radar approach control (TRACON) facilities across the national air space (NAS) with the Standard Terminal Automation Replacement System (STARS) platform."

TRACON. Terminal Radar Approach Control

STARS. Standard Terminal Automation Replacement System

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ALL RIGHTS RESERVED. THIS IS NOT A RECOMMENDATION TO BUY OR SELL SECURITIES IT IS MY OPEN BOOK / EDUCATION OF A SINGLE COMPANY THAT LCA AND / OR ITS CLIENTS MAY OR MAY NOT OWN AT ANY GIVEN TIME. THIS IS NOT A SOLICITATION FOR BUSINESS. DO YOUR  OWN HOMEWORK.

Checking in on PSSR

A little more than a year ago I wrote about PSSR, which continues to generate cash and again trades for what seems to be a low valuation, below 6x EV / EBITDA, a 5% FCF yield, exposure to commercial airline, airport on time arrival and FAA technology budgets.

If someone impatient is selling, they're likely turned off by the recent decline in revenues and EBITDA, which have fallen off peak levels even as deferred revenues, which is an indicator of future revenues, has returned to near peak levels.

The company's quarterly statements indicate there's been a non-renewal impacting current earnings. But are these temporary or terminal issues?

In this case, the data indicate that even with Revenues and EBITDA declining - an expected outcome given a non-renewal - Deferred Revenues has grown back towards peak levels. To justify a strong a return on the stock at current levels, we would need to see Deferred Revenues continue to achieve new highs in the coming quarters. They are not there yet.

Our expectation for greater sales is buoyed by increased spending on sales personnel. The company has added former airline / FAA talent to market the product. If these are good hires then they will convert their expenses into sales and earnings.

However, SG&A spend is now up to 55% of revenues. The "normal" level is in the mid-40% range. Back of the envelope, they need to generate at +10% sales growth just to get back to "normal" and probably to justify their return on their SG&A spend and an investor's return on the stock.

No doubt, this is a competitive space and PSSR is a small player. Over the last year, I've talked with a handful of sources in the industry who work for larger competitors that offer a wider array of solutions (Navtech, now owned by Airbus; Jeppesen, owned by Boeing; IBM). None have heard of the company and most stressed the biggest issues facing all operators in the business - long order cycles and the industry's reluctance for technological change - as major headwinds, though one person thought PSSR's role as a big data warehouse with industry level information was qualitatively a positive differentiator.

It is possible that the company's marketing spend, which has propelled SG&A to new highs even as Revenue and EBITDA dip, is as good as torched cash. But deferred revenue growth indicates otherwise and furthermore increased marketing spend by rational actors is the kind of indicator that patient investors observe for signs that weigh the odds in favor of future growth.

A sale might also provide an exit for investors that does not charge our hopes. This is the same company whose Chairman (and largest shareholder) blithely told me two years ago that he's never sold because "it's more fun to compete with the big guys." He will have to prove this spirit for outside shareholders.

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ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS. I MAY OWN POSITIONS IN THE COMPANIES MENTIONED HERE.

"The Past is History, Tomorrow's a Mystery": On Paying Backup Prices for Starting Talent (CTEK, PSSR)

In a post-game interview after beating the Giants in a January 2007 playoff game, Jeff Garcia, then QB for my Philadelphia Eagles, said: "The past is history, tomorrow's a mystery, today's a gift" (sadly he didn't complete the aphorism: "that's why they call it the present.")

The premise of the comment was to "live in the moment" and it was made in response to a question about Garcia's unlikely rise from backup to playoff hero, a role I might add that was reprised and expanded on even more heroically by Nick Foles, 11 years later.

Investors, like athletes, should as much as possible "live in the moment" by putting their heads into their work of reading, learning and analyzing, and then making most of opportunities when offered by the occasionally mis-priced market.

Athletes are "talent" but investors are "talent evaluators". We look for managers and executives at a company, who themselves need to allocate their assets optimally. It is capital allocators all the way down.

And where a professional athlete's drive and focus directs them to only one outcome (with a focus on winning) the investor's world is by nature much more probabilistic. We need to consider the range of potential outcomes from success to failure, the inputs to those outcomes, and weigh the likelihood of each.

In our role as a "talent evaluator," I (and I'm sure many others) place a lot of emphasis on historical results as a reference for understanding what worked and why, and how in our assessment of future outcomes, these same managers are likely to behave given a set of changing circumstances.

But sometimes the near and / or distant past offers little guidance, b/c the product or company is new, or has an unremarkable - or even tarnished past - so the future opportunities aren't immediately apparent on form or financial statement. And since most people tend to repeat their behaviors, for better or worse, something significant needs to have changed for the trajectory to change, or one need be aware of the factors that lead to poor historical results. Getting back to the sports analogy, most viewed Foles' history with the Rams as sufficient to dismiss him as a potential starter, but they may not have understood how capable Jeff Fisher was at ruining QB's.

Companies with unremarkable histories are inherently lonely trades b/c understanding the opportunity requires some knowledge of what's changed / is changing, or requires some digging and / or comprehension of accounting, or simply requires the kind of patience that is unusual on Wall Street. And it usually takes time for these changes to filter through.

A simple example that comes to mind is PSSR, which I've written about previously and which I've patiently been accumulating even as the near history shows profits turning to losses, negative cash flow and evaporating BVPS.

This negative change of recent history is primarily a result of SG&A growth +21% CAGR 1Q15 to 1Q18 TTM while over the same period, revenues growth of +7% CAGR. The slowdown in sales growth was primarily due to a single customer not renewing a contract in 2017. (PSSR is a tiny $18M EV company; investors should consider the risks / consequences given the impact a single contract can have on the P&L.)

If you stopped at this unprofitable inversion, you'd miss the potential conclusion of that spend. When the "S" of SG&A is spent wisely and consistently, that "S"elling effort should result in a resumption of sales growth. It is the job of every investor under any scenario to assess for themselves the reasonableness and probability of "should" and where "should" elevates to opportunity.

This isn't an ideological "should" ("We should have ice cream for dinner every night") but one based on causality and reasonableness ("if you study hard you should do well on the test"). As a caveat, I warn those away from ever investing on the thesis of what Congress "should" do, b/c in my experience at least, it never does.

The nice thing in the case of PSSR (and other subscription-based companies like them), is that the balance sheet offers a peek into the future via deferred revenues, which has grown to new highs, indicating some traction (at long last) that "S"elling is converting into sales.

Therefore, there is a reasonable probability that revenues over the next 12-months should grow to new highs (back of the envelope assumes +$16M in 2018). This would infer some re-normalization of revenue growth > expense growth and a return to profitability.

And this is potentially just the start. Given the growth in demand for air travel concurrent with capacity constraints at airports, et al., one may anticipate that the airline industry should continue to want (and perhaps even rely upon) even in an ADS-B world, the type of technology solutions that PSSR offers (surface management, diversion management, fee management, etc), and that spending for that offering could be sustained by the strong positive economics experienced by the airline industry (provided fuel costs remain stable).

That PSSR has access to permanent capital sourced from their Chairman who is 76 years old, owns 55% of the company and has a long history of operating with an eye towards wise & capital allocation further aids my view. That his age creates a form of impatience makes it even more interesting b/c in a sale, this I believe could go for multiples of the current public market valuation.

Nobody knows the future ("tomorrow's a mystery") but with PSSR the probabilities seem attractive, at least to me.

All that said, it is actually not my endeavor here to write about PSSR but about another opportunity that seems like a lonely trade, where one can pay backup prices for starting talent, and where the past seems unremarkable but the future potentially rewarding.

In this case, I refer to Cynergistek (ticker: CTEK), which at the current price of $4.75 has a roughly $45M market cap company and by virtue of nearly $17M in net debt outstanding, an EV of $62M. At 8x EBITDA, and with foreseeable growth in its high margin cybersecurity business, it seems like an opportunity. And as we discuss later, the filings actually show some championship style historical financial statements, but an investor would need to dig to find them, an endeavor that would require more effort than trying to find pretty much any athletic statistic at the minor league, college or CFL level.

CTEK provides two niche service - cybersecurity and managed print services - to one niche type of customer - hospitals and healthcare institutions. 

About these services, in brief ...

1. Cybersecurity. This is the prize of the company. It is a consulting / staffing business, with low revenues, high margins and high cash flow. It is a service that utilizes highly skilled, trained, personable, customer service oriented folks with advanced knowledge of IT. The contact point with the customer tends to be the CIO or CTO.

2. Managed print services (MPS). This is a cash generator but an otherwise unattractive, low growth, low margin service for managing the purchases of printer supplies (toner / paper) and equipment (printers / copiers). It tends towards high and lumpy but low margin revenues (based on the timing of pass through equipment purchases). Traditionally it utilizes low skilled, personable customer service oriented folks with basic knowledge of IT. The contact with the client is the purchasing office.

... the company itself is the result of an acquisition where publicly traded pure play MPS company "Auxilio" acquired privately held cybersecurity company "Cynergistek", and then changed its name to Cynergistek.

I'll discuss more about this acquisition in a moment, but for now, here's a slide from their investor deck showing services offered. These are primarily consulting type offerings with some staffing and some MPS.

Why in brief this investment works ...

• This is primarily a services business that makes money (broadly speaking) on the bill / pay spread of a utilized employee or contractor. 
• The company has access to talent though a strong military connection that helps provide a quality labor supply, which is often a constraint in services businesses. More importantly, it is a constraint for customers who cannot otherwise access this talent.  
• The company also owns technology that can be utilized for remote / automated engagements, which enables some scaling.
• The risks of a cybersecurity breach means spending on it should no longer be discretionary. 
• Customer spending supports growth in contracts = Grow sales. Leverage O/H. Generate cash. Pay off the debt. Value accrues to shareholders + potential multiple expansion.
• Publicly traded staffing comps trade 10-15x FORWARD EBITDA. This is trading at 8x trailing.   

Why in brief this investment fails ... 

• Customers don't have fat wallets. Post ACA, healthcare institutions have fragile income statements. That means long sales cycles and competition. 
• A corollary to stressed financials is that it can lead to consolidation, which would shrink CTEK's market. 

The optionality of end market expansion beyond the thin-walleted healthcare market into education and academia offsets what I believe to be the biggest risks of the investment.

Since the company recently reported 4Q17 results, let's look at the present through this brief peak into the financials ...

... the contribution of the lower revenue / higher margin cybersecurity business means OpInc + EBITDA growth much faster than revenue growth. Investors who just look at topline growth are missing the picture entirely.

My view is that over time, mix shift towards faster growth / higher margin cybersecurity business justifies a higher multiple even if overall revenue growth slows. If this plays out over time, I'd say at current prices, the present really is a gift to investors.

"The Past is History" (ie a brief look at how we got here)

Going back to early 2000's, Auxilio (as this publicly traded company was previously known) was a pure play MPS business. It was managed capably under prior CEO Joe Flynn, except for the period '06-'09 when he left to pursue other opportunities and the company was incapably managed by someone else (Flynn returned in 2009).

Like everyone, Flynn has positive and negatives. One of this strengths was anticipating that the MPS business wouldn't offer enough growth or profitability for the long term so as far back as 2014, he started pursuing a cybersecurity offering.

He made two small acquisitions to implement the change: Delphiis for $2.7M in mid-2014 and RedSpin for $2.6M in early '15. His weakness however was making / integrating acquisitions. By the end of '16, the goodwill on both those deals was written down.

Then in January 2017, he cracked open his wallet to acquire Cynergistek for $34M. That acquisition cost $27M upfront, consisting of ...

$15M in cash (borrowed from a bank)
$2.8M in stock (1.2M shares valued at $2.40 / share)
and $9M seller's note

... with the potential earnout of an additional $7.5M to the two founders of Cynergistek, Michael "Mac" McMillan and Dr. Michael Mathews. (All the proceeds of the deal went to them).

At the time of the deal, core Auxilio was a $3M EBITDA company. As per deal press release: "CynergisTek generated approximately $15 million in revenues and $5.0 million of EBITDA in 2016." Thus, the acquisition was valued at 7x EBITDA fully loaded.

The two entities together offered a company with 2017 EBITDA of $3M + $5M = $8M, though by the end of this year, despite some cancelled contracts, it got pretty darn close.

Early into the acquisition, the company did a few things that had been anticipated ...

changed its name from Auxilio to Cynergistek to reflect the emphasis on CyberSecurity
moved its state domicile from NV to DE, a shareholder friendly move

... BUT financial results for 1H17 did not set the trajectory of an $8M EBITDA company.

Turns out, both the acquired company and the core company were experiencing contract churn + delays to new contracts. This Q/A b/t Jeff Bash (an investment analyst) and Paul Anthony (CFO) on the 2Q17 conference call sums up the issue ...

... the two key issues with the 1H EBITDA shortfall were ...

1. negative surprises aren't welcome in the investment world.
2. the difficulty the company could have funding the debt, with about 60% owed to a bank and 40% owed to the prior owners of Cynergistek

... then, more surprises post the deal ...

In October 2017, Flynn left, replaced by "Mac" McMillan, founder of the original Cynergistek. (Flynn went to a small private MPS business).
In March 2018, the COO of Cynergistek left, took his earnout with him, and the company refinanced the debt in order to pay off the bank and prior Cynergistek management ahead of schedule

... obviously, not everything went according to plan. It's a bit screwy and a bit weird and for investors who acquired this at the time of the acquisition, a bit frustrating. But, "the past is history" and at the end of all these changes, Michael "Mac" McMillan is like a QB that catches their own pass; he sold his company, pocketed $15M and now runs the company again along with it much larger acquirer.

It's a small sample size and not the easiest data point to find, but the filings from the acquisition show financial information for then privately held Cynergistek that perhaps indicates "major league" talent.

From 2014 to 2016, McMillan's company generated topline growth, margin expansion and strong cash flow generation ...

... that the cash on the b/s doesn't grow is simply a function of an annual "draw" by the business owners of $2M, $4M and $7M in 2014-2016. Even before the acquisitions, this business created a lot of wealth for its owners. Over the two year period, adding back the "draw" they grew BV +80% CAGR

That's where tomorrow's mystery comes in. Is it reasonable that he can continue to create value for owners today? Certainly there are reasons to consider either way.

One can blame prior management for overpaying for Cynergistek (and other acquisitions), for not doing enough due diligence to see that core and acquired contracts were at risk, that perhaps levering up in the near term might create risk.

One could argue, (as I do) that we should see more insider buying by the board and by the newly enriched management team of much more stock at current prices. (I'd also like to see more alignment of incentives towards lower DSO's for line managers and cash earnings for upper mgmt.)

The company has recently cleaned up its debt situation, but one should acknowledge that "putting the pieces into place" is not equal to value creation; rather its the performance of those pieces that creates value for shareholders. They need to continue to show results.

But even as the company digests these changes, it has transformed into a higher value business, though its not necessarily evident right off the bat. You won't see incredible topline growth with the cybersecurity business but rather margins and cash flow generation. And to see evidence that they've done this before, you'd have to dig to find it.

For the patient investor, with the past as history, and today's valuation a gift, tomorrow's mystery does not need to be a complete thriller to experience the opportunity. It could actually be boring, and investors can still win. Just the way I like it.

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ALL RIGHTS RESERVED. PAST HISTORY IS NO GUARANTEE OF PRIOR RETURNS. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS IN THE COMPANIES MENTIONED HERE, WHICH I MAY OWN.

Dear Chairman Letter to PSSR Management ($PSSR)

I think a private company would pay more for PASSUR than the public markets are affording it. I think the company has assets - in senior management, in its niche product, in its reputation - that aren't reflected on the balance sheet or in the stock price. Even the currently bloated sales force could have value to an acquirer.

But I've been wrong before. This is beginning to remind me one of the first companies that really blew up for me, a small closely held telecom svcs provider called Ace*Comm that had a good product but got left out in a market where customers were consolidating and small service providers that remained small missed out. Eventually they sold for $0.60 / share.

I hope the same doesn't happen here.

----

Dear Beck,

Over the past few quarters PASSUR has embarked on a strategy to spend money on new hires in order to ramp business development opportunities.

I’m writing this letter to request some kind of progress report on this effort and express my concerns that perhaps there are alternatives that might better address both the company’s recent lack of growth and improve its capital allocation.

There are two specific issues that I’d like to address around the strategy:

1. While I realize that paying industry veterans to grow the business pipeline is “business as usual” and a “tried and true” tactic, it doesn’t appear to be working. Obviously, the appearance of success and failure is incredibly binary - either orders come or they don’t – and the fact that thus far they haven’t doesn’t mean its failed, it simply remains unknown.

The question, as with all investment decisions, is whether or not to continue the spend towards an uncertain outcome or change tack. Part of answering that question is asking whether or not you can identify, in the absence of substantial new order announcements, if you are hitting pre-determined markers that might offer evidence that we are on the right path.

In short, what can you share with shareholders to demonstrate that in the absence of new orders, this increased spending on new hires / SG&A is actually working?

2. At the last annual meeting, there was some discussion of whether or not you had the right product suite to address the needs of your customers. Specifically, the question was whether or not you needed to add or acquire some skills / capabilities in order to broaden your solution set for customers who might be seeking more comprehensive solutions and also to better leverage your larger sales force, by giving them more to sell.

There is the risk that you are bulking up your sales staff to a sell a product that is too narrow. If this is the case, can you address this through acquisitions / partnerships or would you be better off selling the company to an entity that can plug you into a wider solution and enable you to access the market more efficiently?

In one of our first conversations, you told me that you enjoyed your independence because “it’s more fun to beat the big boys” as a small, nimble and independent company. I get that logic and appreciate that you’re having fun.

However, one should note that you might be having more fun because you’re the company’s highest paid employee. I assure you, it is no fun for your employees to have worthless stock options or for your investors to have worthless stock.

I urge you to please insure that your capital allocation decisions are driven to maximize value for all your stakeholders – your employees, customers and shareholders - and not merely to subsidize your independence, which you may value more than others.

Sincerely

-- END --

ALL RIGHTS RESERVED. PAST HISTORY IS NO GUARANTEE OF PRIOR RETURNS. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS IN THE COMPANIES MENTIONED HERE, WHICH I MAY OWN.

A Few Quick Tidbits on PSSR's 10K

Fiscal year 2017 was the first year since fiscal year 2005 in which the Company did not generate positive income from operations. While the Company fully anticipates returning to positive income from operations in fiscal year 2018, future liquidity and capital requirements are difficult to predict, as they depend on numerous factors, including the maintenance and growth of existing product lines and service offerings, as well as the ability to develop, provide, and sell new products and services in an industry for which liquidity and resources are already adversely affected.

...

The Company relies on a small number of customer contracts for a large percentage of its revenues and expects that a significant percentage of its revenues will continue to be derived from a limited number of customer contracts. The Company's top five customers accounted for 58% of its revenue in fiscal year 2017. The Company's business plan is to obtain additional customers, but the Company anticipates that near-term revenues and operating results will continue to depend on large contracts from a small number of customers. One of the Company's customers, who accounted for 11% of total revenues during fiscal year 2016, did not renew a contract that expired on December 31, 2016.  However, notwithstanding the $1,400,000 loss resulting from the non-renewal of this contract in fiscal year 2017, the decline in subscription revenue in fiscal year 2017 totaled $538,000. The Company anticipates that the $538,000 decline in subscription revenue will be more than offset in fiscal year 2018.

...

they are really ramping up >> The Company has a sales office in Bloomington, Minnesota and McLean, Virginia.  The Company entered into a new five-year lease in December 2017 for a regional office in Irving, Texas, at an average annual rental rate of $60,000.

vs last year >> The Company has a sales office in Bloomington, Minnesota.

...

They called out a new product with heightened relevance >> A new product scheduled to be released Winter/Spring 2018: Regional Diversion Manager ("RDM") addresses the problem of highly disruptive large diversion events when a small set of airports get overwhelmed with diversions, while other airports have unused capacity. The result is extended delays, cancellations, and disrupted schedule recovery. Airlines need to know where everyone is diverting (not just their own flights) as well as the "capability status" of potential diversion airports (gates, fuel, deicing fluid, hardstands), airports, Customs and Border Patrol, and Ground Handlers. Airports need to know how many diversions are headed to them, what type of aircraft, which airlines, and whether crews are likely to time-out. PASSUR RDM addresses these challenges by creating the first-ever platform that ensures real-time information exchange and coordination between airports, airlines, and other key stakeholders during large-scale diversion events. It is designed to reduce cancellations related to diversions, and accelerate the recovery to normal operations.

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ALL RIGHTS RESERVED. PAST HISTORY IS NO GUARANTEE OF PRIOR RETURNS. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS IN THE COMPANIES MENTIONED HERE, WHICH I MAY OWN.

In closing 2018 (LCA Year End Letter: $PSSR, $INS, et al)

I started this blog to write about investment ideas and other investment related thoughts. "An open book" as I called it.

The thing is, I now have an actual book of business. It's small and humble, but growing and I want to dedicate my time and efforts to it. It's called Long Cast Advisers ...

http://www.longcastadvisers.com/

... I recently posted on my firm's website my presentation on $INS for the MOI 2019 Online Conference. That presentation includes information about my firm in general and about that idea specifically. I think it's a fascinating business.

I've also just recently posted our 2018 "year end letter". It's also on the website (see "links & letters" page).

I'm most likely to continue to post primary ideas on my business website rather than here as this is a blog and I am not a blogger. When I started writing this in 2012, I was a former sell-side analyst trying to figure out what to do next, and I was impressed (maybe floored is the right word) by what oddballstocks, otcadventures and countless others were doing with off-street research.

Now, I'm a sole business owner of a one-person investment management firm. If I can simplify for anyone what I've learned in my first three years, I'd say this: If you like researching stocks, don't start an investment management firm b/c it's far more complicated then just picking the right stocks ...

you gotta pick the right stocks
you gotta own them at the right weighting
you gotta find clients who appreciate your worldview
you gotta have enough assets to make it all meaningful
and you gotta manage the administrative burden with an eye on time and costs

... it's complicated but the effort to get it right is enervating and presents an array of constant professional challenges besides the obvious "finding good stocks and owning them at the right concentration."

When it's done right, there are tangible benefits to my clients. When it's done wrong ... oooph, in this business you live with your mistakes a long time. That's where patience comes in. Or as they say in the kitchen, "make it right or make it twice" (at least that's what was said back when).

It's been a most unexpected pleasure forging relationships here through this forum and even deeper relationships with my clients through my business. I aim to focus on that going forward, so I can continue the endeavor of increasing mine and their prosperity.

If it interests you as well, please drop me a line.

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ALL RIGHTS RESERVED. PAST HISTORY IS NO GUARANTEE OF PRIOR RETURNS. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS IN THE COMPANIES MENTIONED HERE, WHICH I MAY OWN.

An Observation on High ROE Companies and their Market Caps

Been awhile since I've written here. I've cooled on the blog to focus on my investment business, Long Cast Advisers, which continues to grow, slowly and thoughtfully. But the not-writing has left me with a hole of sorts. I like researching companies and sharing what I know with others who might be interested. Having been stuck at home with the fam basically the last two years, I can say confidently that folks around here are not interested. So I gotta put it "out there" instead. 

Figured I'd start with a quick review of hits and misses over the years, what's aged well and what hasn't, etc. I went back and briefly scrolled through old posts.  

What's working >> OTCM, CCRD (nee INS), QRHC and CCRN 

What's worked >> (all takeouts) IVTY, ARIS, SEV and CDI

What didn't >> FHCO, PSSR, ESWW and STLY 

What stings the most >> post on not buying OLED. (I generally regret most the things I don't do). 

FTLF gets a special call it. I sold it long ago but kudos to Dayton Judd, who recapitalized it and transitioned into a capital light and pure play brand now generating growth in profits and book value ahead of where it was before he took over. He understood the value of the brand and put the right investments behind it to make this all happen. 

Thinking about "the value of the brand and the right investments", I have stumbled on a chance to share a recent observation, which is a wide disparity in valuation multiples for small companies versus large companies that both have high ROE's. 

But let me take a brief step back ... With regards to finance, every few years there's some new / old idea and even occasionally new / new idea that takes the world by storm (CDO's and MBS, REITS and MLPS, SPACs, etc.) and promise juicy returns for investors. Often they do for some period of time, and certainly enrich the facilitators of these idea, but these rarely endure. 

But there's something foundational about active value investing where the less "new" the better. This is why timeless classics of investing are still relevant even if you've already heard them 1,000 times. I think adhering to the principles of value investing is what makes it so simple and pure, though one get lost at times looking at shiny new things. 

That's how I found myself flipping through Chris Mayer's "100-Baggers". There are always going to be stocks that go up 100x to great fanfare ... and then crash when no one is looking. This book is largely about the durable businesses that continue to operate to plan. It's not a ground breaking book, more of a tasting menu of other great books, and that's not a critique, it's just that the attributes of durable businesses that comprise 100-baggers haven't changed that much, so drawing on the "the Outsiders" and Joel Greenblatt and Michael Mauboussin, etc. is totally appropriate. 

For me it served as a simple reminder of the foundational principles of investing and one of those principles is looking for companies that have high ROEs. 

It's been awhile since I've done a simple "high ROE screen" but I got it in mind and fired up Sentieo's screening to look up companies with ROE between 25% and 45% and found something kind of crazy. Based on the data kicked out by Sentieo (which is sometimes quite wonky) on average, small companies with high ROE's trade at less than half the valuation multiples of large companies with high ROE's (and I included the median to account for outliers). 

This is just an observation. I don't think there's really enough data to draw firm conclusions as to why this might be the case and I don't want to fall into an anova excel-hole at the moment, though I'd be keen to explore how revenue growth might be a factor here. (Happy to share the data with anyone or collaborate on some deeper analysis). 

But my hypothesis is that larger companies whose brands are by nature better known enjoy the premium b/c investors believe the "moat" is wider and deeper, so easier to protect the R of ROE. One thing to note from this observation; investing in small companies with high ROE's might (might!) be a value trap unless there's a pathway to larger growth. 

Another thought is that from a high level, all business is "... a brand with the right investments behind it." That brand can be perceived or actual "better product quality, service, results, etc." Smaller companies are still developing those brands so there's more uncertainty to the brand value vs larger companies where the brand value is already established. 

And one final thought is the value available when a small company with an established brand that has endured years of poor investments gets taken over by someone who can put the right investments behind it. Like FTLF, or maybe that yellow pages company THRYV (which I don't know enough about). It was certainly part of the thesis behind the investment in CCRN and a few others over the years. 

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ALL RIGHTS RESERVED. PAST HISTORY IS NO GUARANTEE OF PRIOR RETURNS. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS IN THE COMPANIES MENTIONED HERE, WHICH I MAY OWN.