Hey everyone. Stronglong's post from this morning deserves a repost as it was very well thought out using conservative analysis. I will be adding it to the header in a new section named "Memorable Posts." Special thanks goes to Neutral-Ice as he continues to assist me in keeping the header up to date. I will also be adding his "Evolution of the CT" graphic as that was a very nice effort on his behalf. My hat's off to both these intellectial individuals for their efforts.
RedCloud
Posted by: Stronglong
In reply to: None
Date:4/3/2006 9:04:57 AM
Post #of 26186
Ok folks, here is my take on HISC’s 2005 Annual Report. Many thanks to all who have alerted everyone on I-Hub that the report is out. Have to warn you first...this is a bit long.
Before I begin, would like to state that I am trying to give a balanced (i.e. strengths, weakness, opportunities and risks) view of the company from what I have dug out of the report. I hope this will help shed more light on the fundamentals of the company and what all of us could be looking out for in the months to come to measure the company’s progress. Please note that one great thing about finally seeing the 2005 Annual Report is that we finally have some hard numbers to play with, get the key ratios and most importantly, use these numbers as a base year (compare the company’s progress in 2006 and beyond). The progress of the company can now finally be measured in hard, tangible numbers, with 2005 as a base year (starting year of operations).
I say this now and I will say it at the end again: please note that the analysis I am giving below is not a buy or sell recommendation. Everything in this post is solely my own thoughts on HISC and in my opinion only.
Ok here goes…
STRENGTHS
(1) For a base year (start up year), the company is doing extremely well. It is already profitable ($618,637 profits, on sales of $3.4 million), a rare occurrence for new companies. The Profitability and Solvency ratios are excellent for a new start up.
(2) The key profitability ratios: Profit margins are great (although lower than my original estimate of 25%, 18% is still very good and offers a good economic moat). ROE (23.3%) and ROA (14.8%) are impressive, showing that they are not relying too much on raising equity (excessive selling of shares) or issuing debt.
(3) The key solvency ratios: Current ratio (3.35) and quick ratio (1.64) are excellent. These numbers are usually associated with blue chip companies, not start ups. This is thanks to HISC management having judiciously avoided debt while making good progress in pushing sales ($3.4 million, as limited as it might be, it helps support the firm in its start up stage), generating profits ($618,637, precious cash) and bolstering cash flow – the life blood of all firms.
(4) The Debt-Equity ratio is similarly encouraging. At 14.7%, or 0.147, this is way below the prudent ratio level of 50% suggested by the international debt rating agencies, Moody’s and S&P.
(5) Management has kept costs largely in check, given that most of the expenses for a new company come from selling, general and administrative expenses (SGA) and R&D costs. SGA makes up a relatively comfortable 66% of total revenue, although I expect this percentage to drop when the company expands its sales at a faster pace than SGA rising this year. R&D costs appear to have been capitalized as well with its proprietary software capitalized to the tune of almost $1 million. I expect R&D costs to fall significantly as well as a percentage of total revenues given that the CT is ready to launch on a nationwide scale.
(6) HISC appears to be an asset light business, with fixed assets of only $168,564 needed to generate sales of $3.4 million in 2005. This is a fantastic sales/assets ratio (20.2) as it shows that the company will not be burdened by huge fixed asset investments in the future to generate their sales growth. Warren Buffet loves such “asset light to generate huge sales” businesses.
(7) The OS remains at a decent level (862 million) compared to many pink sheet companies I have seen that issued billions and billions of shares. While I’m marginally disappointed that the OS has risen a bit, I’m nevertheless encouraged that the proceeds from the sales of stock in 2005 has been used wisely; namely to build up its inventories and capitalize its software. These two alone took up almost $2 million of the $3 million raised through share sales, but will stand us in good stead as the company aggressively sells its products (inventories are ready to go + software R&D is completed) – you have already seen from Neutral’s earlier pictures on how the CT has evolved! More importantly, unlike fruits and vegetables, these inventories will not rot in the near term if somehow the company does not achieve its sales targets, an event in any case that I regard as unlikely.
So the main encouraging thing I take from this report is that HISC is a company that has been generating sales, turning out a profit, have a decent asset base vis-à-vis its liabilities and maintaining a prudent debt level. This means that the company is on a sound financial footing in the near term, with little risk of bankruptcy. I must highlight again that its really encouraging that many of the financial ratios and numbers quoted above are numbers commonly associated with blue chips, and not new start-ups whom usually need to take on high levels of debt and sell shares continuously to compensate for the lack of sales or cash flows in the development stage. HISC has successfully prepared a good foundation from which they can grow their business.
WEAKNESS
(1) As with all development stage companies, a lot of cash has been used up to purchase inventories, capitalizing their software and paying operating expenses (as seen in the Cash Flow Statement). While this is a good thing as it positions the company for rapid growth, the company cash level is low ($279,890). If they need more cash, it can only be through either increased sales (which I am expecting) or increased debt and equity financing. Sales numbers and new contracts will be crucial in the months ahead.
RISKS
(1) The company is not able to bring in new sales or sign new contracts. An unlikely event in my opinion, but nevertheless still a risk.
(2) The company might need to issue new shares or take on debt to meet operating expenses (SGA or R&D) if sales or new cash do not come in.
OPPORTUNITIES
(1) Uplist to BB will improve HISC’s standing among investors and create new awareness of this stock.
(2) Sales numbers are expected to accelerate from here. The annual report noted the backlog of $8 million from Pro Sec, so we can already assume that that is in the bag. So at the very least, we already have $8 million in the bag. This is not even including the expected $25 million + the numerous other deals signed with Rentrop Tugboats etc that will add to their sales numbers. We have at least a 900-1000% growth in sales numbers from 2005 for 2006 (from $3.4 million to at least $33 million once the ActSoft deal goes through).
(3) Sprint/Nextel have just commenced marketing the CT to the nation-wide market. A good boost to sales can be expected here given their numerous outlets. How much – I have no idea at the moment.
(4) The Army is reportedly testing the CT in September/October. That would be huge for sales if they take it up.
(5) New markets seem to be opening up for HISC on a weekly basis. From ports, to ship companies, to phone companies, to police, to army, to even boy scouts! – the possibilities seem to be endless. Its now up to HISC to seize these opportunities
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Ok, now to revising my valuation of the company. The difference from my earlier analysis is that I have:
(1) Revised the profit margin downwards (25% to 20%) to be extremely conservative
(2) Expected revenues stay the same ($55 million)
(3) OS revised upwards (770 million to 861 million)
(4) Growth of 3% annually for next 5-10 years used for my discounted cash flow analysis instead of 0% growth previously used as that is not realistic for a growth company (for sales to stay stagnant at a low base). However, to be conservative, I’m using a 3% annual growth instead of the 10% annual growth that HISC should comfortably hit as a rapid growth company over the next 5-10 years.
(5) Overall valuation range in my opinion is now 25-38 cents, a change from 22-53 cents earlier. I have decided to be more conservative on the higher end and more realistic on the lower end to reflect the greater shine given in recent weeks to HISC’s growth prospects over the longer term but at the same time, add more conservatism on the margins and earnings growth that HISC might enjoy this year.
REVENUES/PROFITS/MARGINS
First, the expected profit margins:
- I am revising the profit margins down from 25% to 20%. Existing margins are 18%, but I am expecting the ActSoft sales inclusion to raise the margins given that ActSoft’s margins have been around 36 to 41%. To be really, really conservative, I will just take 20% as a guide for 2006.
Second, the expected revenues:
- To me, the company’s projected revenue target for 2006 is still $55 million, until someone tells me otherwise. We already have revenues of $8 million (Pro Sec) + XPress ($500,000) + ActSoft ($25 million expected once it goes through) in the bag for 2006. That alone is worth $33.5 million. So there is another $21.5 million worth of sales to go. Some confirmed orders that have come in but no numbers yet include Coxsackie Transport, Garda World, the Royal Canadian Mounted Police, the Knox County Tennessee School System, and the Chili House Restaurant chain in Amman, Jordan.
Thirdly, the expected profits:
From the use of 20% profit margin as a guide and assuming the $55 million revenue is met (to be monitored as 2006 moves along), then we have expected profits of $11 million for 2006.
VALUATION
OS is now at 861 million, up from the 770 million figure I used earlier. As I have stated earlier, this is always tricky, but I will continue to use my 2 earlier valuation models.
(1) The first is the standard P/E ratio of 30-40 applied to fast growing small/micro cap companies in the US (which HISC belongs to). To be conservative, I will use 30.
So with expected profits of $11 million in 2006, that translates into EPS of 1.28 cents. Multiply that by a P/E of 30, and we get an expected share price of $0.38, or 38 cents.
(2) The second is the very conservative discounted cash flow model - I will just assume a modest 3% earnings growth to infinity (very modest considering that most of us who invest expect to see HISC growing faster than that annually over the next 5-10 years). This essentially is the model that Buffet uses in analysing the value of a company over the long run. And since I expect HISC products to be in the marketplace and to be in great demand for some time (because of the wide variety of uses that the CT can be used for), I think this is a fair extremely conservative model to use.
Essentially, the maths would be:
EPS of 1.28 cents for 2006
Discounted rate of 8% (I will be conservative - the historical average 30-year long bond rate over the last 50 years or so has always been around 6-8%, unlike the 5.93% now)
So, 1.28/(0.08 – 0.03) = $0.256 or 25.6 cents
So on both models with conservative assumptions, I personally do find HISC to be relatively undervalued at 4.1 cents (you might of course disagree with me...) now given the expected merger with ActSoft, uplist to BB and the sales numbers coming in over the next few weeks/months.
Will continue monitoring the sales figures carefully and update this model as new numbers come in.
Do let me know if there is anything wrong with the analysis above – I am still looking to humbly learn if there is anything that is way off. As always, bashers, please stay away!
I must warn the bashers not to take my post out of context as I WILL come down hard on you. If I am not around, then you can bet your a** that RCP will! LOL!
Don’t forget…..please do not buy or sell HISC based on my analysis above. I am NOT making a buy or sell recommendation. Everything in this post is solely my own thoughts on HISC and in my opinion only.
Warmest regards,
Stronglong
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For all you mathematical buffs out there, here are some of my workings:
Outstanding Shares = 862 million
Profitability Ratios
Net profit margin = 618,637/3,446,921 = 17.95% = 18%
ROE = Net Income/Equity = 618,637/2,657,765 = 23.3%
ROA = Net Income/Total Assets = 618,637/4,184,068 = 14.8%
Solvency Ratios
Current Ratio = Current Assets/Current Liabilities = 4,015,504/1,197,099 = 3.35
Quick Ratio = Quick Assets/Current Liabilities = Cash + Account Receivables/Current Liabilities = 1,963,062/1,197,099 = 1.64
Leverage Ratios
Debt/Equity Ratio = Total Debt/Total Equity = Long Term Liabilities + Short Term Debt/Total Equity = 329,204 + 62,583/2,657,765 = 14.7% or 0.147.
AI
