Among my stock picks, Evercel Inc (OTC: EVRC) is the one that I am most excited about. Evercel used to make batteries in its heyday. After a series of transformations and a new leadership taking over in 2013, Evercel is a vastly different company and has been steered towards a profitable, shareholder oriented and a growing enterprise, among smaller companies. The current management: CEO Daniel Allen and his team operate as owners, aligned with minority shareholders and most importantly – they make rational decisions. Evercel at present is a holding company that owns 80% of a subsidiary called Printronix and recently along with certain other affiliates , acquired a Mobility accessory company at a bargain price. Before we delve in the latest acquisition, let us analyze Evercel prior to the acquisition which will shed light on what Evercel brings to the party when making new acquisitions and why long-term shareholders should benefit from these actions.
Background on the company
Evercel predominantly developed and sold rechargeable Nickel Zinc batteries in the late 90’s and early 2000. For various reasons they were unable to successfully establish the brand and as losses widened, they reduced US battery operations significantly in 2003 and ceased operations a couple of years later, transferring its battery rights to a Korean company. They made one excellent investment in 2003 , to invest 2 million in private placement for Zipcar. Zipcar went IPO in 2011 and Evercel sold out all the shares in 2011 and 2012 generating about 19 million gain from this investment.
Recognizing the value of the proceeds from this profitable investment, combined with large tax carryforwards due to the company’s prior operating losses, they decided to use the funds to acquire a printing company called Printronix. Daniel Allen who led the acquisition was named CEO of Evercel in Jan 2013.
Evercel now purely operates as a holding company with operating companies as subsidiaries and cash disbursed by the subsidiaries to pay off debt, investments in public and private companies or acquiring companies outright thus replicating the strategy laid out by the world’s greatest investor albeit at a smaller level.
Printronix used to operate two divisions, Line matrix printing and Thermal division. The Thermal division was sold in 2016 (more on this later). The entire company 80% owned by Evercel was bought for 18 million.
Line matrix printing (LMP)
These are high volume, rugged, reliable and cater towards a niche set of applications. The customers mainly are logistics, transportation, automotive, manufacturing and distribution. Banking, government offices in developing world also use these printers but as the developing world keeps rapidly progressing towards digital and reduced reliance on printing, applications that are prevalent in warehouses would predominantly be the main customer of these printers. These business applications are specialized and if there is a need for rugged, industrial and mission critical printing, Printronix LMP printing solution is the only game in town. In fact they virtually have a monopoly in commercial/industrial high-volume printing, with a market share of 90%, thus the gross margins are salivating even in this declining business but also provide a low cost of ownership for the customer utilizing this printer.
These are the more ubiquitous commercial printers that you see every day in grocery stores, post offices etc. Used primarily for printing receipts, barcodes and vouchers.
Dan Allen along with his CEO duties separately manages an investment fund – Corona Park Investment Partners, and through this investment vehicle and his network sources ideas for investments to make in either public stocks or acquiring a small stake in a private company. Printronix does not need any large Capital Expenditures and throws off quite a lot of cash that builds up at the parent company which gets invested. Their recent investment was a resounding success, they invested 10 million in SharpSpring Inc and over a year, the shares tripled and they realized a gain of 10 million with total proceeds of over 20 million attributable to Evercel. Corona Park has a 20% Investment carry so for a hypothetical gain of 100$, 80$ will be applicable to Evercel. The company also has smaller investments in other companies but they are not material in size and still at its infancy.
Now let’s take a look at the financial statements of Evercel Inc, primarily its major subsidiary – Printronix along with timeline notes. 2015 (pro-forma) to 2020 reports the financial statements of only the LMP division as Thermal Printer division was sold in FY 2016.
|Line Item||2020||2019||2018||2017||2016||2015 |
|Cost of Goods||22,266||26,671||28,267||30,070||35,647||43,070||60,953||78,975|
|Income from operations||1,906||10,237||10,878||5,115||(11,824)||2,974||11,283||9,903|
|Net income (as attributable to Evercel)||1,124 (a)||6,845||5,779||3,683||(14,633)||2,301||7,565 (d)||16,531(e)|
|Adjusted income||1,500||6,845||6,500 (b)||3,683||2,300||2,326||6,935||14,742|
- Adoption of ASU 2016-01 requires equity investments to be measured at fair value (except equity method of accounting) and flows to income statement. Net loss of 1410 is in the income statement due to this.
- Removes the effect of discontinuing operations including the closure of a facility.
- Operating expenses in 2016 does not give a true picture since in 2016 the thermal division was sold. Expenses that are attributed to thermal division as part of sales and marketing and administrative show up here. Also includes a 4.5 million good will impairment loss, Special projects costs of 5.3 million, Income tax expense of 2.4 million, restructuring of 2.7 million. A higher than expense for costs related to only continuing division. Amortization and good will expense of 2.9 million mostly to LMP but not to Thermal division.
- Gain on reversal of earnout liability of 617
- Includes a 9,570 income tax benefit due to previous Valuation allowance for Net operating losses and credit carryforwards. Also includes a Gain on fair value adjustment of debt due to refinancing of expensive second lien debt restructuring into a cheaper funding.
|Deferred income tax assets||1,156||–||1,387||3,075||–||5,274||6,964|
|Total current liabilities||8,020||9,235||11,242||8,966||16,750||24,582||27,758|
|Long term debt||–||–||–||–||4,351||31,907||46,340|
|Deferred income tax liabilities||–||1,721||467||–||3,127|
|Shareholder equity (Evercel)||71,856||70,730||56,582||49,756||54,479||42,787||35,767|
|Shares outstanding (million)||33.019||33.002||32.977||32.955||32.631||32.562||31.124|
- Convertible note receivable in SharpSpring with a cost basis of 8 million. Fair value of 16 million included in total assets.
- Convertible note receivable in SharpSpring of value 8 million (both cost and fair value)
- Restricted stock investment of 2285 in TSC Auto ID as part of sale of thermal division to the company that was received as part of the sale other than the profits. . Fair value based on estimation. Final value sold was 2.47 million.
- Includes short term debt of 6822 and 6848 in 2015 and 2014 respectively.
Cash flow statements
|Operating income including non-controlling interest (from Income statement)||1,333||8,743||7,280||6,531||12117||7,540||17,644|
|Cash provided by operating activities||442||7,372||11,686||4,540||3,930||10,670||19,455|
|Cash provided by Investing activities||34,780||(18,604)||(8,167)||11,268||14,689||(3,808)||(782)|
|Cash used in financing activities||–||(100)||(10,660)||(14,660)||(11,005)|
|Net increase in cash||32,961||(11,232)||3,419||5,148||13,288||(7,798)||7,668|
|Cash at beginning of year||25,220||36,452||33,033||27,885||11,993||19,791||12,123|
|Cash at end of year||58,181||25,220||36,452||33,033||25,281||11,993||19,791|
Financial Year TIMELINE
- Purchased Pioneer holdings which was a holding company that owned the operating company Printronix
- Legacy Printronix owed a senior second lien of amount 35.5 million and interest rate at 17%, half of which was cash payable and the other half was added to the principal till the loan was repaid. The high interest rate was onerous and considered the credit and default at the time it was issued. Current management refinanced this loan at considerably cheaper rates and improved the success of the company dramatically and vastly improved the profit generation of the company.
- Refinanced their loans, paid off previous long term debt of 67 million refinanced with debt of 53.5 million with Libor + 3.5% interest rate (47 million LIBOR + 3.5% and 6.6 million SIBOR + 1.38%)
- Realized tax benefits due to previous net operating losses of 9.5 million in addition to operating profits of 9.9 million.
- Bank mortgage on Singapore Printronix facility valued 50% more than what they paid for when they acquired, thus valuing real estate more than at cost.
- New CEO hired to manage Printronix division. Printronix CEO has a lot of experience in printers and has worked at HP extensively.
- Focus on maximization of Line matrix printing by streamlining channel and driving printer refresh and sales. First printer refresh in a while.
- Simplifying the business and removing cost inefficiencies. Consolidating facilities from Singapore/Shanghai to a single facility in Malaysia. Sold off other very small subsidiaries and Printronix remains the only operating subsidiary.
- Reduced loan to 31 million from 47 million long term debt by paying out from net income and cash on hand.
- Sold Singapore building for 9.6 million , a gain of 4 million.
- Tax benefits largely due to realization of carry forwards in the previous year.
- 2016 was a Pivotal year for Evercel.
- Sold thermal division to TSC auto id resulting in extinguishing 28 million of debt and providing 18.3 million in cash (Enterprise value of 52 million). 18 million is exactly the same amount Evercel invested in Printronix for acquisition, but now they still own the line matrix printer division. Market valued the thermal printer more even though margins were less and more competition.
- Line matrix printers now holds a monopoly (> 95%) in that segment across all countries, although it continues to be a declining business.
- The two divisions were competing for the same dollars and resources. Management realized that the sale of the thermal division could allow it to better focus on the LMP division.
- 11.4 million loss from continuing operations does not tell the full story and the costs that are related to both the companies exist in this including restructuring costs, SG&A. Now that they will focus on the Line matrix printer division. There are expenses that are for thermal division that are also included as part of these expenses such as Depreciation, amortization and expensed due to SG&A for Thermal division are included in this. Other costs included are good will impairment of 4.5 million along with factory building of 5.4 million in Malaysia.
- Tax credits sold to the buyer and valuation allowance is written ff. Evercel will not be able utilize tax carryforwards due to its previous operating losses anymore.
- Printronix is debt free, no long term debt remains including the 4.6 million mortgage of the Singapore facility which was extinguished when the facility was sold.
- Consolidated the China/Singapore factory into Malaysia. Consolidated three factories into one reducing the cost footprint.
- Thermal division sale completed and the focus in only on the line matrix printers. Received 3 million that was part of the incentive program based on achieving sale targets for the thermal division.
- Evercel has 28.5 million in cash and securities and 80% investment in Printronix LMP.
- Invested 8 million in SharpSpring which is a cloud based marketing automation.
- Generated 10.4 million in cash flow vs 3.5 million in the previous year. They have successfully managed the expenditure to generate more cash. The previous efforts on consolidation, restructuring have paid off.
- SharpSpring investment a big winner within a year, invested around 10 million (common stock and convertible), shares of SharpSpring tripled within a year.
- Received 26.7 million from Printronix so far in distributions.
- Consumables segment of Line Matrix printing division generated 24 of 60 million revenue. Gross margins are close to 70% for this division.
- Consolidation into Malaysia after investing up to 7 million improved gross margin bp by 380 points. Couple of key customers in Pharma drove the revenue growth.
- Engineering and development reduction in expenses from NA to lower cost region (Malaysia) , cost reduced by 35%. SG&A reduced by about 25%
- Printronix has 17.5 million in cash (80% of which is attributable to Evercel). Evercel has 18 million in cash at the corporate level. Cash is building up year after year.
- Sold SharpSpring at 20 million vs original purchase price of 10 million. This is after the Corona Park investments carry of 20%.
- As of September 2019 Evercel has 33 million in cash (after sale of SharpSpring) and had 17 million in cash attributable to Evercel’s 80% interest in Printronix. Almost 48 million in cash close to 1.5 $ per share against a 2 $ market share.
- 11 million in cash from operations from the Printronix division.
- Printronix winning new customers in China, Korea and Taiwan. It’s the only remaining printer in this domain. Trend continuing to switch from Banking and Insurance to Industrial, logistics, transportation e.t.c. This is expected and profitable.
- Consumables now being driven by cartridges that are enhanced for security based on new printers that replaces the previous spool based printer.
- Through an OEM Printronix introduced a high impact serial dot matrix printer to increase market share and be a single supplier for all printing needs and also to drive the conversion to LMP over the longer term.
- Gross margin of Printronix still at 53.7 % because of previous efforts. Reduced Engineering by 10% by shifting engineering to Asia-Pac region and to drive operating efficiency.
- Received 2.5 million in sale of stock of TSC that bought the thermal division.
- About 60 million in cash in the company. 32.5 million in Evercel and 29.1 million in Printronix (80% Evercel)
- Revenue down 25% to 43 million due to Covid. Gross margin of Printronix still at 50% in spite of Covid and a steep drop in revenue. Revenue at 43 million down significantly due to Covid and Trade wars. Margins for consumables are at 75% increase from 72%
- Income from operations downs significantly to 3.3 million from 10 million. Actual income from continuing operations is at 1.12 million attributed to Evercel.
- PPP loan of 1.2 million
- Company expects to have more restructuring in FY 2021 and is already under the process of restructuring heavily its SG&A expenses.
The first and the most important question after reading the above is : Why would management sell the Thermal Printing division and hold on to a declining Line matrix printing division? Especially considering the financial statements in the year 2016 where the LMP division posted an Owner earnings of around 3 million and for the prior years the bulk of the profits and revenue were from the Thermal division. There are three main reasons.
- The thermal division was always going to be a low margin business and with much competition continuing to exist, the Line matrix printer division would be a monopoly with no new entrants to this field.
- A cleaner balance sheet : 52 million Enterprise value of which 18 million in cash and the extinguishment of debt allows both the parent and Printronix division to be debt free, the price was also favorable to Evercel.
- Focus will now primarily be on the Line matrix Printing division and optimizing the business without distraction or worrying about alienating customers and employees of the other division.
Key Takeaways from financial statements and management actions
- No company or investor likes to buy a business that’s in decline, however a declining business is not a bad business as long as it throws a lot of cash and can be purchased at an attractive price. They key is to thus figure out how much can be generated from this declining business and what is the price to pay. A business in decline would discourage other investors, the chief among those Private equity. As long as the decline rate is gradual, the cash generated from this can be shifted to other areas – acquiring other similar companies or investing in public stock. Dan Allen and his team’s value lies is in recognizing the long term value and there is fewer competition in acquiring such companies.
- In acquiring other companies, the primary guidepost of Evercel is to buy a company that has excellent gross margins, however of equal importance would be to also buy one that has large operating expenses in the form of SG&A and other operating costs. This contrasting guideline is to identify excellent profitable companies from a gross margin perspective but have a bloated cost structure. Evercel management will restructure the acquired business in order to maximize the net income and reduce bloat to a point where the company can operate efficiently.
- Management is very active in responding to business developments. On a constant basis they have restructured the business to maximize cash and profit generation. For Printronix, they installed a new CEO and continued to reduce employee headcount as part of both maximizing efficiency and in line with business development. The restructuring cost line item in the financial statements of years prior to 2018 provides the evidence of such actions.
- Due to the Management actions, the Line matrix Printing division swung to a profit of about 5 million in 2017 from an accounting loss of 11 million in 2016. The efficiencies and management efforts were realized in the upcoming years in 2018 and 2019 where they posted profits of about 10 million in operating income and after taxes and the 80% interest, the net income figure is about 6 million. Clearly management actions such as consolidation of facilities, printer refresh , cross-selling consumables that have excellent gross margins all of these have been vital in stabilizing the business and maximizing the profits from the subsidiary.
- Management is rational, realizing that there is more potential in LMP division rather than thermal printing division , even though the market thought otherwise valuing the thermal division more than the LMP division. Moreover they sold the thermal printing division at a good price. In 2015 the Printronix division generated 11 million operating pre-tax income on a 110 million revenue when Printronix operated both divisions, but in 2018 and 2019 they generated similar amount but on a 60 million and 57 million revenue respectively from only the LMP division. The returns on equity and on invested capital are vastly better in 2019 than in 2015. One might argue that the equity is the same in 2016 and 2018, but in 2018 the quality of shareholder equity is excellent – mostly in cash and no long term debt, whereas in 2016, much of the shareholder equity was tied up in Intangibles and goodwill, that were amortized and/or impaired in 2017.
- Dan and his team are excellent value investors. They used part of the proceeds from the thermal printer sale to invest in SharpSpring at a cost of 10 million and sold within a year and realized a profit of 10 million. They are also extremely patient. From years 2016 to 2020 after the thermal printer sale and except the SharpSpring investment, they haven’t done much other than waiting for opportunities and have allowed the cash to build up at both the parent company and the subsidiary. Management has treated shareholders fairly – no onerous stock options and share dilution over the past 5 years is around 1.5%.
- In 2020 , the revenue and operating profits have fallen off a cliff due to Covid. Whether this decline is structural or temporary is anyone’s guess – the next few years will prove. However considering all of management’s history, I am certain that they will take actions that are necessary to preserve profits.
With 60 million in cash waiting to be deployed, is there another company that could be acquired by Evercel that would fit Dan’s rulebook so that they could apply their leadership and management techniques that they have done with Printronix. Yes and this one is even better.
Evercel’s latest acquisition
ZAGG is a market leader in mobile phone accessories. Their products are varied such as screen protectors, battery packs, wireless chargers, keyboards, earbuds and headphones. They cover the gamut of the mobility accessories for both Android/Apple mobile based platforms and sell under the following brands, InvisibleShield, Gear4, Mophie, Halo, Ifrogz, Braven and the parent brand. Manufacturing is entirely done through third party manufacturers in Asia. Even though they do not own patents or rights for the screen protector raw materials, they have contractual agreements with raw material suppliers and manufacturers to not sell the raw materials to competitors.
They have 628 employees. Verizon and BestBuy accounts for 27% of their sales.
Let’s take a look at their financial data
|For the Years Ended December 31,|
|CONSOLIDATED RESULTS OF OPERATIONS DATA:|
|Income (loss) from operations||10,212||51,696||44,735||(21,360)||25,864|
|Net income (loss)||13,920||39,189||15,100||(15,587)||15,587|
|Earnings (loss) per share attributable to stockholders:|
|Weighted average shares:|
|BALANCE SHEET DATA:|
|Cost of sales||338,553||64.9||352,358||65.5||350,497||67.5|
|Advertising and marketing||19,183||3.7||11,994||2.2||11,101||2.1|
|Selling, general and administrative||135,039||25.9||108,623||20.2||105,398||20.3|
|Gain on disputed mophie purchase price||—||—||—||—||(6,967)||(1.3)|
|Impairment of intangible asset||—||—||—||—||1,959||0.4|
|Amortization of long-lived intangibles||17,005||3.3||11,882||2.2||12,047||2.3|
|Total operating expenses||173,157||33.2||134,177||24.9||124,263||23.9|
|Income from operations||10,212||2.0||51,696||9.6||44,735||8.6|
|Other income (expense)||565||0.1||(483)||(0.1)||698||0.1|
|Total other expense||(4,345)||(0.8)||(2,167)||(0.4)||(1,383)||(0.3)|
|Income before provision for income taxes||5,867||1.1||49,529||9.2||43,352||8.3|
|Income tax benefit (provision)||8,053||1.5||(10,340)||(1.9)||(28,252)||(5.4)|
Over the past 5 years , their share price has gone nowhere. Here are a couple of footnotes on the financial statements.
- In 2019 fiscal year, HALO, Gear4 were acquired, if these companies weren’t acquired, net sales would be down significantly by around 50 million. With existing products the company sales were down materially and would be around 470 million instead of the 520 million shown for Year 2019.
- The company does a lot of sales close to half a billion in revenue and good gross margins of 35% of sales – around 180 million in gross profits.
- Advertising and SG&A has been creeping up due to acquisition of newer brands in 2019 but overall sales was low from all of ZAGG’s brands including the new ones acquired. SG&A is about 25% of revenue and almost 83% of Gross profits.
- Amortization of intangibles are around 17 million , part of it is a real cost such as amortization of patents, but part of it will be customer relationships and tradenames which could be strong or can deteriorate significantly in reality but accounting for amortization does not give a clear picture as its accelerated amortization over a period of 10 years. If ZAGG can have a good relationship with Verizon after 10 years the customer intangibles would have been zeroed out for accounting purposes, but profits will still flow, however if the relationship ends tomorrow, than accounting will understate the reality.
- Long term liabilities have gone up significantly but still manageable, 2 times 2018 Income from operations.
On a quick glance, does ZAGG meet Evercel’s checklist for acquisition ?
- High gross margins which translates to brand recognition, market share leadership and ability to raise prices – Check
- Expensive SG&A or bloated cost structure. Offers possibility of cutting down the fat and root out inefficiencies – Check
- Declining business. Private equity and other companies would not be enthusiastic on acquiring this company. – Check,
- Bargain sale. Mainly due to the Business decline in Covid year and expensive operating costs, the acquisition of this company will not be a high Price multiple of prior year Earnings – Check.
In the last 9 months of ZAGG for FY 2020, COVID was brutal for ZAGG. For the first two quarters under stay-at-home order, the company failed to even produce a gross profit and the shareholder equity dropped from 191 million to 121 million. Their most recent reporting quarter Q3 has been better and they generated a net income of 6 million. Even if they fail to achieve their previous record : net income of 40 million or operating profit of 50 million in 2018, there are a lot of operating inefficiencies that could be reduced such as focusing on the top selling brands, reducing SKUs, reducing the onerous SG&A at ZAGG. If they are able to achieve half the previous record : 20 million Net income or 25 million in operating profit, Evercel would have bought the business of 120 million in shareholder equity for 130 million at about 6x net-income which is a considerable bargain. Granted the sales may keep falling off year over year, but at some point management will stem the bleeding even if it’s in decline and ensuring the business is running well and producing cash. The odds are highly favorable that they will be able to repeat their Printronix’s playbook with ZAGG
A good question to ask is why are the shares cheap if this thesis sounds good. Partly because of the following
- They sell on the Over-the-counter and not at large exchanges,
- The financial reporting is once a year, no quarterly calls or reports.
- They are smaller, the entire company is selling at a market cap of 70 million.
- They are not well understood.
While Evercel’s strategy in buying a declining business is ripe with opportunity, it is also fraught with risk. The main risk that I see is that a business they acquire declines more than the cash flows it generates or is predicted by Evercel and they are unable to repeat the strategy because of adverse business developments. ZAGG could turn out to be dud , it would then be a question of the timeline. The longer it takes, the more profits that can be squeezed out and reinvested elsewhere. The probability that they are unable to get more than they paid for is small in my opinion but not zero. Time of course will show (and perhaps, the share price will tell). In a few years when the fog dies down and when the company up-lists on larger exchange, they would be more visible and hence would command a higher stock price. Until then – fewer competition in buying these shares
The famous and perhaps cliched depression joke on how to get rich is repeated here for emphasis. A young man asks an extremely wealthy man on how he became rich. The wealthy man with a cigar in his mouth says, “It was the year of 1932 and I had only a nickel and I used up the nickel to buy a dusty apple. I polished it up till it was sparkling and sold it for a dime. The next day I bought two apples from the dime I saved and polished it and sold it for two dimes”. The young man asked “Oh, you kept on repeating the process until you got rich”. The old man drew a deep breath and with a smile on his face said “Heck No, a few days later , my father in law passed away and I inherited a million dollars”
Someone forgot to tell the punchline to the folks at Evercel. They are still polishing apples but it is a decent way to make money.
Pre-ZAGG: 60 million in cash (1.8$ per share attributed to Evercel) , Equity of 71 million (2.15$ per share), Pre-Covid after-tax profits of 7 million. Pre-tax Printronix profits of 11 million on 57 million revenue. Total market cap 70 Million (2.15 $ per share) Excellent returns on equity and top-notch management.
ZAGG: Acquired at a bargain price of about 4 to 5 times Net-Income (Pre-Covid) largely with cheap debt, Q3 after the stay-at-home lockdowns were eased was a good quarter . Evercel will restructure ZAGG as it did with Printronix to optimize the business.
Shares cheap because they are traded on OTC and market capitalization is 70 million.
Disclaimer: I own 5000 shares of Evercel at 2.15$ (10,750$). The shares are traded on OTC market. Please use limit order. Spreads between Bid-Ask are historically large and shares are illiquid. Do you own diligence.
If you would like to get past-year’s annual reports/financial statements (Evercel website has the latest) , send me a note.