SuperCom Finally Reports Third-Quarter Results - More Troubles Ahead For Investors
Must Read | Dec. 23, 2015 3:34 PM ET | 5 comments | About: SuperCom, Ltd. (SPCB), Includes: OTIV
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary
Investors might face another dismal quarter as management fails to reiterate the recently revised full-year guidance.
The acquisition of LCA seems directed at misleading investors as well as potential customers.
Management again failed to disclose a major lawsuit filed against the company.
SuperCom's comfortable cash balance is going to decline.
Contrary to the company's announcement on the preliminary results call three weeks ago, management this time refrained from holding a conference call.
After already issuing highly disappointing preliminary third-quarter results three weeks ago, SuperCom (NASDAQ:SPCB) eventually managed to release the final numbers after the close of trading on December 22.
While the results themselves contain no surprises, actually the wording of the press release when compared to the formulation used in the preliminary results has attracted my attention. These were management's comments three weeks ago:
(...) SuperCom has revised its guidance for the full year 2015. The Company believes that revenue for the full year will exceed $30 million. The Company further believes that EBITDA for the full year of 2015 will exceed $9 million.
"Our financial performance in the third quarter and full-year were impacted by our inability to recognize more than $10 million of revenues that were expected this year, mainly due to delays associated with foreign government customers," commented Mr. Arie Trabelsi, President and Chief Executive Officer of SuperCom. "This delay, while inherent in our business, is frustrating, but we believe we will be able to recognize this revenue in 2016. As a result of these delays, we are adjusting our full-year outlook. Our confidence in our continued growth in 2016 and beyond remains intact. We continue to be successful in identifying, bidding upon and winning business. Our quarterly results can be erratic based on complex revenue recognition challenges, but nothing that has occurred has changed our medium and long-term outlook."
Management was actually hard pressed by analysts on the conference call with regard to its confidence in delivering roughly $9 mln in revenues for the fourth quarter, a close to 60% quarter-on-quarter increase. The answer of the company's acting CFO at this time was:
That's okay that we are a month before the end of the quarter and the numbers that we just mentioned we believe that we have all the full confidence to recognize in full and everything else is just going to be an upside too.
Management also reiterated its confidence in the continued growth of the company and provided de facto guidance of $35-50 mln for FY2016 on the conference call.
Now, let's look at the very short management commentary alongside the company's final third-quarter results release:
"As we already expressed on November 30th, 2015, we faced a number of challenges during the third quarter but the underlying fundamentals of our business remain strong," commented Arie Trabelsi, SuperCom's President and CEO. "Recent international events have put a renewed focus on the importance of global security, border control and secure verifiable identification. Countries around the globe are facing well-documented challenges related to border security which reinforce the need for more advanced identification around the world."
Mr. Trabelsi added, "Strong market demand, our growing array of innovative technology offerings and solutions, and our valuable pipeline of opportunities gives us confidence in implementing our business plan for 2016 and beyond. We continue to believe the company's shares remain undervalued, and we will continue opportunistically repurchasing shares under our current buy-back program," Mr. Trabelsi concluded.
So just three weeks later management is neither reiterating its full-year 2015 guidance nor its belief in renewed (organic) growth starting in 2016. While these discrepancies might just be the result of a very unfortunate choice of words, I tend to believe that management is already telegraphing another potential revenue miss for the fourth quarter and subsequent disappointing FY2016 guidance.
Moreover, management surprisingly again failed to disclose a major lawsuit recently filed by the former owner of the company's Smart ID business, On Track Innovations Ltd. (NASDAQ:OTIV) on October 19 as stated in OTIV's most recent 10-Q:
In December 2013, the Company completed the sale of certain assets, subsidiaries and intellectual property ("IP") relating to its Smart ID division.(...) During the nine month periods ended September 30, 2015 and September 30, 2014, the Company recorded profit from contingent consideration in the amount of $848 and $500, respectively, from which $461 and $270 were recognized during the three month periods ended on such dates, respectively, according to an earn out mechanism.(...)
In June 2015, the purchaser of our Smart ID division, SuperCom Ltd., or SuperCom, raised cash through an equity public offering. Based on certain provisions of the Smart ID division sale agreement, such an event entitles the Company to additional consideration. After repeated demands for payment, on October 19, 2015, the Company filed a lawsuit in the District Court in Lod, Israel, against SuperCom, requesting, among other things, monetary relief in the amount of NIS 28.9 million (approximately $7.4 million) with respect to additional consideration owed to the Company for the sale of our Smart ID division. SuperCom is required by applicable law to file a response by November 20, 2015.(...)
At least the company as of late has made use of its recent one million share buyback authorization and purchased 500,000 shares in the open market at an average price of $4.90. But instead of immediately retiring the shares, management decided to hold them in treasury for the time being, which is rather unusual and points to management's intentions to make use of the shares at a later date. Hopefully, they won't be awarded to management or used for acquisition purposes short term.
On a different note, SuperCom today announced another acquisition, US-based Leaders in Community Alternatives, Inc. (LCA). LCA is a provider of electronic monitoring programs to 10 Californian counties with approximately 10 million residents. While the acquisition is meant to be accretive, actually some of the claims made by SuperCom's management in the press release are thwarted by LCA's business model:
(...) LCA's wide-ranging programs provide accountability and protect public safety, all while offering a path for offenders to break the cycle of recidivism.
"I am very excited about this highly strategic acquisition that will be accretive upon closing and provide us with a strong, referenceable base of long-term government customers in the United States that we believe we can leverage to expand our electronic monitoring business globally," commented Ordan Trabelsi, SuperCom's President of the Americas. "In addition, the acquisition unites LCA's ability to provide proven, industry-leading solutions and evidence-based practices to government agencies with SuperCom's advanced electronic monitoring technology and world-class engineering capabilities." He continued, "LCA shares SuperCom's core values of utilizing technology and innovation to make this world a safer place, and we're confident we can leverage their capabilities and deep industry experience for the benefit of populations in the U.S. and around the world."
For 2015, LCA is expected to generate more than $9 million in revenues, be profitable, and achieve double-digit revenue growth. The company's revenue base is recurring and primarily derived from contracts with various government agencies in the U.S.
In fact LCA's electronic monitoring business is providing the so-called "offender pay programs" and the company notes on its website that "LCA's services are typically provided at no cost to the county". Offender pay is actually a highly challenging business given that the typical offender has neither the money nor the responsibility to successfully complete the program. While some counties offer funding assistance, LCA still needs to collect substantial amounts from the offenders being monitored.
So clearly the company's electronic monitoring revenue base is not really recurring and might in fact fluctuate substantially over time dependent on the number of offenders successfully undergoing their monitoring program and associated funding assistance. Moreover, LCA faces heavy competition from some of the largest security services providers in the world as evidenced by the company losing a major contract with the San Francisco Sheriff's Department to G4S back in 2008. LCA claimed millions of dollars in damages in a subsequent trial, but ultimately lost the case in 2012.
Looking at the numbers, LCA's 2015 revenues will supposedly exceed $9 mln which would represent double-digit year-on-year revenue growth with the business being profitable. Unfortunately, we don't know the average revenue performance over the last few years to assess the company's true underlying growth profile. But given the low purchase price at just 0.33x FY15 revenues (plus potential earn-out payments), I would suspect LCA's revenue profile to be pretty uneven to say the least and its margins to be far below SuperCom's previous corporate average. So the company now is effectively buying the revenue it so far has failed to generate organically. While the purchase could add more than 30% to SuperCom's FY16 revenues, investors will have to prepare for a material impact to gross margins next year.
But given management's comments in the press release, the main reason for the purchase (besides creating the illusion of growth) seems to be SPCB's need for "a referenceable base of long-term government customers in the United States".
So SuperCom is spending $3 mln to effectively buy some low-margin revenues while at the same time pimping its customer list with references the company never managed to acquire organically.
Suffice to say, investors shouldn't like this new acquisition as its main purpose is seemingly to mislead both investors (in terms of the company's growth prospects) and potential customers (in terms of high profile references).
Investors should also note that quite contrary to the announcement made on the preliminary results call, management this time refrained from holding a conference call. Obviously, it wasn't exactly inclined to get further pressured by analysts with regard to the lack of guidance reiteration and just another questionable acquisition.
Lastly, investors need to prepare for the company's cash balance to decline materially over the next few quarters as SuperCom already spent $2.5 mln for share buybacks in Q4 and will spend another $3 mln for the LCA acquisition in Q1/FY2016. Add some legal costs to defend against OTIV and the armada of class-action lawsuits, and the company's unrestricted cash balance might move closer to $20 mln during 2016. Should the company indeed have to compensate OTIV partially or even in full cash might move down even further.
Bottom Line
There might be more trouble ahead for SuperCom's already badly stricken shareholders as management decided not to reiterate the just recently reduced full-year 2015 guidance in today's Q3 earnings press release and moreover refrained from holding the regular conference call. Instead, the company announced a questionable acquisition of a regional US-based provider of electronic monitoring services, which clearly looks directed at addressing the company's organic growth failures while at the same time providing a major face lift to SPCB's governmental customer references at the expense of substantial overall margin reduction. Moreover, management again concealed the major lawsuit recently filed by OTIV. Given the increased spending on share buybacks and the LCA acquisition coupled with an expected rise in legal costs due to class action lawsuits as well as the potential requirement to settle the OTIV lawsuit, SuperCom's cash balance might come down materially over the next few quarters.
Investors should continue to avoid the shares.
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