|Shares Out. (in M):||36||P/E||0||0|
|Market Cap (in $M):||630||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
|Borrow Cost:||Available 0-15% cost|
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Cal-Amp (CAMP) is a $630 million market cap play on the “Internet of Things”, which is widely forecast to grow 15-20% from here to eternity. CAMP’s stock is +250% in 3 years. CAMP’s main products are wireless communication hardware (70% of sales), fleet management software (15%), and home satellite networking hardware (15%). Below is our short thesis in 6 points:
CAMP is a low-quality business with little competitive differentiation or pricing power.
CAMP has been a seriously troubled company at various times over the years. In the mid-80s, early 90s, late 90s, and mid-to-late 2000s, CAMP spent multi-year periods in the red and even flirted with insolvency several times. Its 25-year average ROE is just 1% on a reported basis. Barriers to entry are low.
CAMP appears to have 80% revenue concentration from its top ten customers.
CAMP’s main source of business, the vehicle fleet management wireless equipment industry, sees annual price declines of 8-12% on average. In 2013, China-based Huawei entered the vehicle telematics market and appears to have offered prices ~35% below market in the US.
CAMP’s difficult strategic position has led it to take a potentially disastrous gamble to move up-market and compete with its biggest customers in fleet management, and we believe there have already been repercussions in the form of dual-sourcing from these customers.
CAMP’s business is likely shrinking organically, adjusting for potential accounting gamesmanship.
Adjusting for CAMP’s skyrocketing Days Sales Outstanding (DSO) and estimating their positive impact on the reported P&L, CAMP’s business is shrinking – possibly as rapidly as - 28% yoy this quarter. The market is currently assigning a 15x forward earnings multiple to Street projections that assume +15% growth in the business in 2015.
DSOs are a classic “tell” for some companies’ accounting shenanigans, and in this case could be indicative of pulling forward future demand by giving customers much longer to pay, late quarter discounting to “stuff” its customers and manipulate sales higher, or revenue recognition issues such as recognizing revenue either without full customer acceptance (which CAMP describes as being subjective in its 10-K).
CAMP’s inventory days have also been rising (off of a trough) for four straight quarters and coincide nicely with CAMP’s bizarre DSO build.
CAMP is using creative calculations to hide some things, and appears to be misleading investors about others.
CAMP appears to have changed its DSO calculation right at the same time that its DSOs shot up. When we asked CAMP about its DSO’s at an investor conference, the CEO gave an evasive explanation that fails even to come close to quantifying/explaining the issue.
Our industry scouting suggests strongly that CAMP has put some serious corporate “spin” on conference calls about the cause of issues in its much-hyped insurance telematics business, and that the true cause demonstrates a serious potential problem with this opportunity.
We see a number of earnings pressures building that could potentially result in a meaningful decline in EPS.
CAMP is starting to anniversary quarters of significant DSO build which will only become more difficult through the year. To the extent the DSO has in fact been caused even in part by the aforementioned factors, CAMP will have to pull a few more rabbits out of its hat to grow off of the inflated base periods.
Further out, in mid-2016, a major upgrade cycle benefiting CAMP’s customers is going to come to an end. We see a big headwind to as much as ~20-30% of CAMP’s total revenue.
A cozy channel for CAMP to manufacture sales growth may be on its last legs.
Years ago, CAMP worked out a nice deal for itself to sell discounted product to a customer without recognition of the effect of that discount in its gross margin. CAMP conveniently ramped up sales to this customer when its DSO-adjusted organic growth turned negative.
This deal has all but used up its runway and CAMP could conceivably lose the business or need to start recognizing the impact of these discounts on its gross margin. The latter and more optimistic of these scenarios would cut EBIT by 10% instantly.
Hype about the “Internet of Things” is misplaced when it comes to CAMP’s sub-industry.
CAMP, NMRX, FLTX and TRMB are all exposed primarily to vehicle fleet management/telematics. Gartner and related industry analysts frequently talk about a mid-20s percentage growth rate for Internet-connected devices, but these four public companies show organic growth of around 0% on average, except for FleetMatics, whose revenue growth has never borne much of a relationship to CAMP’s. CAMP gets lumped in with these faster- growing and/or higher-margin business models but it does not merit such comparisons.
One industry employee says he has been “surprised that deals take longer to close than I had hoped since joining...and the industry falls short every year”; another explains that industry forecasts for the Internet of Things are driven mainly by factors well outside of CAMP’s exposure. The “IoT” growth rate is nearly meaningless to CAMP’s business prospects.
In summary, we believe CAMP could have 50-70% downside if we are correct in our assessment of its overstated fundamental outlook and low business/industry quality.
BASIC BUSINESS AND INDUSTRY DESCRIPTION
General business model, description, and key customers
CAMP is primarily a technology hardware manufacturer. It develops and manufactures wireless communication devices. These devices are used to gather or communicate information to one another or to a “home base” that uses that information for various purposes. Most of the company’s business relates to what is known as Mobile Resource Management (MRM) and Machine-to-Machine (M2M) communication. Colloquially the term “Internet of Things” is often used to describe this interaction between the wireless internet and devices operating in the physical world.
Examples of CAMP products include tracking devices that attach to vehicle or tractor fleets, broadband routers, private radios, and satellite reception devices (which is a separately reported segment; its devices are used to receive satellite signals in homes for television viewing, ie. DirecTV).
While CAMP’s primary business is communication devices like the above, it is also engaged in a subscription-based “software-as-a-service,” or SAAS, business. This business represents less than 1/6 of CAMP revenues and is not currently growing. The provision of these services is related to its hardware business, as these two types of product are packaged to serve end users operating vehicle fleets.
CAMP’s revenue mix is approximately 70% wireless communication hardware, 15% satellite reception hardware, and 15% software/services. The segments are “Wireless Datacom,” (the 70% from wireless hardware and the 15% from software/services), and “Satellite,” (the 15% from satellite reception devices).
The company outsources its manufacturing from the electronic component to the device assembly levels. 4/5 of sales come from the US, with the rest from Latin America and the UK largely. Most sales for the company are done by in-house sales personnel in the respective countries where the sales are made. The company spends the equivalent of 9% of its sales on R&D to develop new products. From our industry research and consultations, CAMP has a reputation for making quality tracking devices.
Some of CAMP’s important customers include Echostar, FleetMatics, Numerex, Himax, and Caterpillar. Echostar is the sole customer for CAMP’s Satellite business. Caterpillar is a direct customer of CAMP that is also an end user. FleetMatics, Numerex, and Himax bundle CAMP’s hardware with their own software in order to provide a total mobile resource management solution. One of CAMP’s important suppliers is Telit, an Israeli company that designs modules that go inside the CAMP “box.”
BACKGROUND ON THE WIRELESS/TELEMATICS DEVICE INDUSTRY
Costs in wireless devices, like in most tech hardware companies, follow a predictable path downward over time. All through the value chain, things tend to get cheaper as innovation brings down pricing.
CAMP’s largest input cost is typically the modules for its devices, which pieces containing all of the materials for communication – the radio, processing power for communications, memory, etc. CAMP’s most likely suppliers for modules are Telit or Gemalto, according to our industry contacts; we know from speaking to Telit that they supply at least some modules to CAMP.
The finished CAMP box also has connectors, boards, packaging, cable, memory, a battery, and an applications processor. Ultimately CAMP has a variety of supplier options for these relatively commoditized components.
CAMP does not quantify its customer base outside of mentioning that Echostar, its Satellite hardware customer, makes up ~15% of sales. Some important customers in the Wireless Datacom business are FleetMatics, a provider of vehicle fleet management solutions using CAMP boxes and proprietary software; Numerex, a similar business; Caterpillar, an end user that puts CAMP devices in some of its machinery; and Navman Wireless, which we have an entire section on further in this report due to its cozy relationship with CAMP.
One supplier of CAMP told us (paraphrasing):
Our business is much better than CAMP’s, because CAMP has enormous customer concentration. I believe something like 80% of CAMP’s revenues come from 10 customers.
In some cases, CAMP’s place as a supplier is strong and sticky, such as when its products are customized to go into vehicle tracking applications. In most cases, switching costs are mostly an issue of convenience rather than of reliance, and products are commoditized enough that a price discount can win over relationship selling. This is evidenced by the fact that, as one customer of CAMP’s explained to us, prices tend to fall 8-12% each year for this kind of hardware, which they would not do in a business with an impenetrable station in its customers’ businesses. Another supporting piece of evidence is that Xirgo is reportedly offering discounts of 30%+ on a product portfolio that mirrors CAMP’s perfectly.
Sales of the CAMP product are made through an internal sales force, and 80% of sales are in the US. In the Satellite segment, Echostar purchases virtually all of the equipment that CAMP sells and uses it in provision of its home satellite dish services.
Barriers to entry
The barriers to entry in CAMP’s hardware business (nearly 80% of its sales) are not high. This is evidenced in the following quote by a salesperson from one small competitor we spoke to:
“There seem to be hundreds of [new competitors] – they are coming out of the woodwork. All the time I’m learning of new players. Especially now that China’s in the game, it’s a race to the bottom with them – they use cheap parts, they break, and it’s been like this for a while. Buyers typically know a few players: Enfora, Xirgo, Novatel, CAMP.”
The salesperson’s quote tells us a few things. One, there are low barriers to entry in this business. Two, the Chinese players are new to the game, but are still yet to get their act together (if we are to take this competitor at his word). Three, there are a handful of players. (At least one of these players – Xirgo – is considered within the industry to be an up-and-comer. All things considered, the evolution of the space appears to be quite dynamic, demonstrating low barriers to entry in the telematics hardware business.)
Pricing power/competitive rationality
Given the low barriers to entry and the commoditized nature of these hardware products, pricing power is low and prices regularly decline. Competitive rationality appears to be non-existent.
THE BULL CASE
$3.5bn served available market (SAM)
“So as we talk about our addressable market, as we did our analysis at the end of this last year, we estimate that our current addressable market is around $3.5 billion. And again, for consistency, we've tried to color code this, so it's easy to understand which businesses are exposed to which size of addressable market. You can see our Satellite business here is part of a relatively small addressable market at roughly $400 million, and it's flat, it's not growing. Our Wireless Datacom businesses are exposed to an incremental market opportunity of about $2.1 billion. And you can see our MRM products business, which is the light blue section of the bar stack here on the left, is part of about $1.0 billion addressable market, while our Wireless Networks products and solutions are part of a $2.1 billion addressable market.” – CEO, January 2015
Management estimates that its addressable market for its overall business is in the neighborhood of $3.5bn and that its 2017 addressable market is going to $6.3bn. The growth is said to come from growth in wireless networks and connected devices over time with a 13-15% CAGR.
CAMP’s net income margin is about 5%. In the event that the 2017 addressable market estimate is accurate, CAMP’s current ex-cash market cap of $630m implies that CAMP could have a 0.5x 2017e EV/Sales multiple, and trade at 10x 2017e earnings, if it could capture 20% of its claimed future addressable market. CAMP’s current LTM sales of $240m are equal to 7% of the SAM it claims exists today, so 20% is being quite kind.
Early stages of opportunity in insurance telematics or “usage-based insurance”
One of the applications of CAMP’s product portfolio is what’s known as usage-based insurance, or UBI. UBI is a method insurance companies can use to track policyholders’ driving habits. Telematics makes this possible because it can measure driving speed, location, acceleration patterns, etc.
The opportunity in insurance telematics is hyped as huge and in its early stages. Progressive was the first large insurance company to explore this idea, and for a long time, it held all the patents on this type of program. Since Progressive’s patent expired, the market has opened up. To provide a sense of how big this market opportunity could be, we know from our industry research that Progressive has ~1.7m insurance telematics in the field with a CAMP competitor. At a price point of around ~$30, that means that Progressive may have paid this competitor ~$50m for its units. If CAMP were to win a comparably huge contract, the business opportunity could be equal to almost an entire quarter’s worth of sales. CAMP has taken advantage of this nascent market, with $10-15m of UBI product sales since it began talking about UBI in April 2013. Management describes the insurance telematics opportunity as being in the “first or second inning”.
Evolution into a software-as-a-service (SAAS) company
CAMP has historically been a hardware-focused company, but its management recognizes that a transition to a software/services/subscription model will help increase the value of the business. To that end, CAMP acquired Wireless Matrix, a telematics/usage/asset management solutions provider for vehicle fleets. Wireless Matrix operates a subscription model and has over 400,000 subscribing vehicles on its platform. Success in the SAAS arena offers CAMP the potential for multiple expansion as its multiple grows with minimal incremental cost.
Device upgrade cycle from 2G to 3G, 4G, 4G LTE
Wireless networks in North America undergo periodic upgrade cycles as communications infrastructure gets better and faster. Currently, for instance, AT&T is in the process of tearing down the towers supporting its 2G cellular network, which requires customers operating 2G-based hardware to upgrade their systems to those compatible with more advanced transmission networks (3G, 4G, 4G LTE, etc.). The upgrade cycle from 2G has proved very beneficial to CAMP, whose 3G-compatible devices come at much higher price points than its 2G-based ones did. What’s more, the upgrade cycle from 2G is not yet complete. Future upgrade cycles could pose additional opportunity for CAMP as well.
Big win with Caterpillar and related upcoming opportunities
In 2014, CAMP won a major contract to provide vehicle telematics products to Caterpillar machines at the OEM level. These products enable Caterpillar to offer advanced tracking and usage management capability with its heavy equipment. The contract with Caterpillar is worth approximately $10m over two quarters, or $5m each quarter which is about 1/12 of quarterly sales for CAMP. CAMP management has said that it may provide the opportunity to offer aftermarket support sales as well.
The presence of the Caterpillar contract demonstrates the potential for CAMP to win large contracts in the future. There is no shortage of equipment OEMs looking to add bells and whistles to their product offerings and CAMP could win another one of them at any time.
OUR SHORT CASE
Trends in CAMP’s core Wireless Datacom segment
CAMP reported fiscal Q315 results on 12/22/14, with year-over-year revenue growth in Wireless Datacom of 10% ($54.6m vs. $49.7m a year-ago), and more than all of the growth owing to $5m of revenue from a new Caterpillar deal. Given that this space is said by CAMP to grow in the mid-teens or more, why would one new contract explain all of the growth in that space? This anemic ex-CAT growth profile is apparent even before we get to the massive build in Days Sales Outstanding and CAMP’s feeble explanation for them.
The revenues from the Caterpillar deal, further, have a highly uncertain level of follow-on orders, if any. The opportunity does exist for more CAT business down the road in new unit placements or in aftermarket services and we plan to monitor developments here, but for now, the company has called out the CAT deal as a $10m opportunity - $5m a quarter and then it’s mostly done. When CAT rolls off, we are left with a no-growth business portfolio, +/- the winning or losing of contracts in the future – but the Street models CAMP as a 15% grower.
Overall, the company met earnings expectations but reduced its guidance for the year ended January 2015 (FY15), principally due to lower-than-expected revenues from its insurance telematics business (which we’ll cover later).
CAMP’s accounts receivable: A four-quarter surge
CAMP has a long history of DSOs in a reasonably tight range. We calculate CAMP’s DSOs to have both an average and a median of 42 for the 15 quarters prior to the February 2014 quarter (FQ414). For all but one of these quarters, the range was from 34-46. In the one exceptional quarter in early calendar 2011, when DSOs spiked to 52, the company gave a clear explanation for the build on its earnings call on April 30, 2011:
“The increase in the average collection period in the fourth quarter [of fiscal 2011] is not attributable to any underlying deterioration in the receivables collection experience. Rather, it results from the fact that a significant portion of fourth quarter sales were made in the latter part of the quarter, which has the effect of skewing the collection period upwards as a result of the formula used to calculate this metric.”- CFO Richard Vitelle
Fast-forward to today and we have a very different picture. Starting in the February 2014 quarter, DSO’s broke out of their historical range and surged to 56 – a 34% increase over the company’s historical DSO average (note that there is no seasonality to DSOs for CAMP). The company offered a familiar explanation on the April 25, 2014 earnings call:
“The increase in the average collection period in the fourth quarter [of fiscal 2014] is primarily attributable to the fact that a significant portion of fourth quarter sales were made in the latter part of the quarter, which has the effect of skewing the collection period upward as a result of the formula used to calculate this metric.” –CEO Michael Burdiek
It’s obvious that management simply took the old explanation off of the shelf and trotted it out for this 2014 conference call. However, the similarity between the two situations stops there.
In May 2011, when the end of the quarter immediately following the 2011 DSO spike was reported, DSOs had fallen back to a historically normative level of 41, vindicating the CFO’s explanation that said that sales timing was the major factor. But in May 2014, the DSO level reset back down to...53 days. This represented a level even higher than the one that required special explanation back in 2011.
[Source: Cal-Amp Filings and our calculations]
On the call, there was no mention of why the DSO number was still so far above its historical range, which makes us wonder if management knew that the “sales skew” story could only work so long. For short sellers, the story gets better. In the following quarter ending August 2014, DSOs rebounded to a new record high of 58...and then hit another all-time high of 65 in the quarter after that, ending November 2014. Again, and again, we hear almost nothing from management on the conference calls or MD&A to explain why their supposed “sales timing” explanation did not seem to hold true. We did, however, engage management ourselves to learn more on this issue, and the response is publicly available and discussed below.
If you can’t explain ‘em, hide ‘em
The mere fact that DSOs have been elevated anywhere from 28-56% above their historical average for four quarters, after years of relatively consistently tracking close to their average, is encouraging by itself in terms of setting up a short. But it’s the fact that the company has been taking steps to mask and misdirect the development of this DSO problem that really makes things exciting. We think there’s a reason why they’re going the extra mile to hide their deteriorating ratios.
As logic would dictate, we use a consistent ratio to calculate DSOs for CAMP over many quarters. Our formula is a traditional one: (End of Quarter Accounts Receivable/Quarterly Revenue) * 90. As mentioned above, we estimate a DSO of 65 for the quarter ended in November 2014, for example.
CAMP has long reported its own calculation of this number on its earnings calls. However, the company does not “show its work”. On the earnings call in December 2014, the CFO stated:
“...accounts receivable balance was $45.4 million at the end of the third quarter...an average collection period of 57 days compared to...51 days at the end of the preceding quarter. The increase in the average collection period in the third quarter is primarily attributable to the fact that a significant portion of third quarter sales were made in the latter part of the quarter, which had the effect of skewing the collection period upward as a result of the formula used to calculate this metric.”
Interestingly enough, after several quarters of not giving any explanation of the DSO build, this time management chose to bring it up again (using the same boilerplate language as in the April 2014 and April 2011 earnings calls). However – and this is where things get a little confusing – there is a reason why management did not feel it necessary to discuss the causes of the DSO build in previous quarters. It’s because since February 2014, management appears to have been using a new DSO formula that presents its DSOs as lower than previously calculated.
We were perplexed that management’s DSO calculation was meaningfully different from ours, so we went back over several years to see if our calculations ever tracked with management’s. The result was that from May 2010 to November 2013 (15 quarters), our average and median variations from management’s calculation were both approximately one day’s worth of sales. (As a reminder, we calculate an average and median DSO of 42 for that time period.) It was only on rare occasions that the variance between our DSO tally and management’s DSO tally was higher than two days.
[Our calculation of DSO's vs. Management's disclosure of their own calculation on EPS calls]
We used the same calculation method from May 2010 to today; it appears management changed its DSO calculation as of the February 2014 quarter, when they reported a DSO of 53 days vs. our 56 days calculation. The four most recent quarters show this trend in the brightest possible light:
February 2014: Management 53, Consistent Method 56 (vs. 36 prior year)
May 2014: Management 46, Consistent Method 53 (vs. 43 prior year)
August 2014: Management 51, Consistent Method 58 (vs. 42 prior year)
November 2014: Management 57, Consistent Method 65 (vs. 44 prior year)
It appears that management picked an opportune time to introduce a creative calculation. We asked management some questions on this at a sell-side conference in January 2015. Management had a nicely packaged answer prepared for this question, prompting us to press the point, as transcribed below:
<Q>: [Question Inaudible] (29:28 – 29:46)
<A - Michael J. Burdiek>: So, the question is what's going with DSOs. And two quarters ago, we definitely had a very back-end loaded quarter. So, a significant amount of shipments occurred in the last month out of three of the quarter. When we moved into Q3, obviously, CAT was a big dynamic in play as it relates to every element on the balance sheet, both inventory and receivables. And so, CAT, the ramp happened very, very late in the quarter in Q3 and obviously came on very, very strong. So, that's the principal driver of DSOs remaining elevated in Q3 versus Q2. Inventory, you probably saw moderated, so let's say relatively flat Q2 to Q3. But inventory was a leading indicator of what was going on with Caterpillar.
<Q>: [Question Inaudible] (30:40 – 30:44)
<A - Michael J. Burdiek>: Yes.
<Q>: [Question Inaudible] (30:45 – 30:48)
<A - Michael J. Burdiek>: I think on a metric basis, DSOs have been bouncing around in sort of the 50 to 60 range. Garo, you can correct me if I'm wrong. But I think that's generally been the case. And then they popped over 60 days in Q2 and remained over 60 days in Q3. Any other questions?
We suspect most investors, if they care at all, take this explanation at face value. But we knew that the CAT deal wasn’t nearly large enough, or early enough, to explain this surge in DSOs. CAT is a $10m deal that feeds into the P&L over two quarters – approximately $5m in sales each quarter, starting in fiscal Q315, the quarter ending in November 2014, and are also expected to generate sales in fiscal Q415.
But the build in receivables for CAMP actually started in fiscal Q414 and has been way above trend for the four quarters ending fiscal Q315. What’s more, total sales for CAMP were $0.3m lower in fiscal Q315 than they were in fiscal Q314, but receivables in fiscal Q315 were $14m higher (48% yoy increase) – certainly not an amount that can be explained by $5 million in CAT sales.
What a coincidence!
The DSO build, and apparently the related obfuscation of management’s claims about its own DSO count, began in earnest in February 2014. We think this timing is rather interesting for a few reasons.
First, this initial spike in DSOs happened in a quarter in which sequential-quarter growth in sales was negative for the first time since November 2011. Since then, total business growth, and even organic business growth, had been positive, although slower in recent quarters. Suddenly, when sequential growth went negative, DSOs went from 44 to 56 all at once? Lest this variance seem like esoteric or academic accounting rigmarole, allow us to point out had CAMP’s DSO count stayed flat, A/R would have dropped by about $1m, rather than having risen like it did by $6m. The difference of $7m was equal to 12% of CAMP’s sales that quarter, which is a good shorthand approximation of the amount of the boost if indeed the DSO was the result of channel stuffing or the extension of payment terms and/or discounts to pull forward demand.
Secondly, from our interpretation, management appears to have made the change in its DSO calculation precisely as of the quarter when the DSO spike occurred. From what we can tell, the CFO had been happy to use the same calculation methodology for years – but suddenly, on the same quarter when DSOs spike, he decides he wants to switch to a new method to smooth the reported metric?
Thirdly, as we will discuss further later in this report, it is possible to calculate the amount of sales that CAMP makes to one customer with whom it has a rather unusual relationship, and these sales went up at a remarkable time. As part of its obligation under an acquisition it made from Navman Wireless a few years ago, CAMP provides Navman with discounted product. We can impute from certain data in CAMP’s filings that after four quarters of selling decreasing amounts of product to Navman ($2.5m, $1.7m, $1.5m, $1.4m), CAMP suddenly showed a spike in Navman sales to $4.1m in the February 2014 quarter. While the amount of sales to Navman comes nowhere close to explaining the receivables build, this does suggest to us that CAMP may be using Navman as a channel to dump product, and ramping sales to Navman just as the rest of its business was starting to shrink. CAMP has not highlighted any new or expanded contracts to Navman, and it’s also notable that while CAMP’s LTM sales to Navman are up 75% yoy, the rest of CAMP’s business is up only 8% during that time – before accounting for the potential causes of its massive receivables buildup.
Quantifying the downside
We have attempted to estimate the impact that the DSO build might be having on the financials, assuming that the build is not a benign issue explained by the timing of sales within the quarter (for 4 quarters in a row by an ever-increasing amount but who’s counting). There are a few ways to do this. The simplest way is to look at what sales and profits would be if the entire above-normal DSO build were the result of channel stuffing or revenue recognition. Another way is to look at what could happen in the fifth-quarter lap of DSOs, which applies to the quarter to be reported in late April, 2015.
In the first method, we consider how far above average the DSOs have been in the past four quarters since the elevation began. The DSO historical average (and median) was 42 before the build, since May 2010. DSO’s in the past four quarters were 56, 53, 58, and 65, representing values 34%, 28%, 40%, and 56% above average, respectively. So, we look at what receivables would have been had the average level of DSOs been maintained, which comes to as much as $9m, $8m, $11m, and $16m over the past four quarters. In the most extreme case, all of this would be channel stuffing or revenue recognition, meaning that these sales amounts happened not because of underlying demand, but because CAMP was able to push product out to someone without any immediate economic need for it or recognize revenues without customer acceptance. We can then reduce sales each quarter by these four respective amounts to arrive at what “true” sales for CAMP might have been. Please note that this is an estimate and represents a simplification of what surely has multiple moving parts and explanations.
[Image: our estimate of CAMP organic growth vs our estimate of CAMP DSO-adjusted organic growth]
CAMP’s sales over these four quarters were $60m, $59m, $59m, and $63m. Using the extreme penalty example above, “true” sales would have been $51m, $51m, $48m, and $47m. These numbers obviously represent a sequentially shrinking business for the past four quarters under these assumptions. When paired with the fact that CAMP purchased a small company in the February 2014 quarter that probably does ~$1m/quarter in sales, we “ex-out” both assumed channel stuffing and RSI’s inorganic growth to arrive at horrific year- over-year sales shrink rates: -14%, -7%, -20%, and -28%. The Street models organic growth of 15% for CAMP’s FY16.
In the second method, we take into account the fact that the DSO build has been going strong for four quarters, meaning that it is due for a “lap quarter.” In the quarter ending February 2015 (to be reported in April 2015), CAMP’s guidance implies $68m in sales, for $8m growth or a year-over-year growth rate of 13%, all organic. But what if the $60m of sales in the Feb 2014 quarter included up to $9m in “stuffed” sales not driven by economic demand? In that extreme example, CAMP’s “true” sales were $51m in Feb 2014, and $68m guidance for 2015 would mean CAMP would have to grow organically by $17m, or 33%, year-over-year. While CAT provides $5m of this growth (to the extent one can think of it that way since there were likely meaningful non-recurring contracts in the February ’14 quarter as well), that benefit is very likely to be gone in future quarters which face similarly daunting comparisons.
Even leaving all considerations of DSO aside, CAMP’s organic growth rate has not been that high since November 2012. CAMP’s reported, non-DSO-adjusted organic growth rate since 2012 has been in the (2%) to 22% range, and has not been above 8% since November 2013. We estimate that CAMP’s organic growth going forward ranges from well below Street consensus expectations to dramatically below those expectations.
I GET HIGH GROWTH WITH A LITTLE HELP FROM MY FRIENDS
The Navman Wireless deal: A free lunch
We mentioned the Navman Wireless deal above. This deal dates back to the quarter ended May 2012, when CAMP acquired some products, technologies, and a team of engineers from Navman, a developer of vehicle tracking solutions. CAMP paid for this with a little cash and a lot of “debt,” but the debt takes the unusual form of a note payable amortizing down as CAMP provides 15% discounts on product sales to Navman. Navman is able to buy hardware from CAMP and receive a 15% rebate; for every dollar of rebate, the principal outstanding is reduced dollar for dollar. The original note payable had a face value of $25m.
CAMP got a great deal with this arrangement from an accounting standpoint. As the company explained it to us, the rebate to Navman is effectively a discount that does not hit gross (or operating) margin for CAMP. The rebate shows up in the balance sheet and cash flow statements, but not in the income statement. This allows CAMP to avoid taking a margin hit on what are effectively deeply-discounted sales of hardware. We’ve never seen a deal structured like this and we wonder if this deal may have been mostly about Navman negotiating a large rebate, with the products and engineers acquired being relatively inconsequential and CAMP just looking to solidify a multi-year relationship. The fact that CAMP was willing to “engineer” a way for a large customer discount to avoid the income statement strengthens our beliefs that they may be currently manipulating their financial results.
But the benefits to CAMP don’t stop there. As we mentioned before, CAMP’s sales to Navman ramped up at a curious time – right when CAMP’s overall business showed its first sequential quarterly decline in years. Excluding the growth in sales to Navman, of course, the sequential growth for CAMP was even worse. So we find it a little surprising that CAMP sales to Navman jumped from $1.4m in November 2013’s quarter to $4.1m in February 2014’s quarter (almost tripling) when the rest of the business’ sales shrank by $6m, or almost 10% - excluding DSO adjustments. It certainly seems possible that the long- standing, cozy relationship with Navman could allow CAMP to push extra product to Navman to help meet sales expectations.
And yes, CAMP’s sales to Navman have been elevated in the quarters following that first spike, even as CAMP’s business has been slightly down over that time on a yoy basis – again, excluding DSO adjustments which would make the sales decline look much worse.
While CAMP doesn’t formally disclose them, they do disclose the amount of principal outstanding on the Navman note. One can impute the amount of discount offered to Navman each quarter, and divide that by 15% to arrive at the amount of total sales to Navman.
Anyone who has read the book “The Moon is a Harsh Mistress” by Robert Heinlein (among other sources) will recognize the acronym above, which stands for “There Ain’t No Such Thing As A Free Lunch.” We think CAMP may be about to pay the price for their free lunch with the Navman Wireless deal. Specifically, we know the deal is on pace to expire within 1-2 quarters, and we suspect that the impact of this expiration would be at best neutral, most likely moderately damaging, and at worst very damaging for CAMP.
Our math says that following November 2014, CAMP had $4.2m worth of runway left on the Navman note. That’s just about equal to the $4.1m CAMP sold to Navman in two of the last four fiscal quarters. It looks like the Navman note is likely to be fully “paid” down in the form of these 15% rebates (discounts) by May 2015 at the latest. Realistically, depending on how much of it CAMP paid down in the February 2015 quarter, it will likely be paid down by the end of March 2015.
What happens after the note gets paid down is anyone’s guess – but we can frame the possibilities quite easily:
- The neutral outcome for CAMP is that nothing changes except that the rebate goes away, hence there is no difference on the income statement between a sale to Navman under the deal terms which never reflected the discount in the financials and a sale to Navman after the deal terms have ended. This would be a natural result of a relationship in which Navman really needs CAMP, such as if CAMP’s hardware were so well-integrated into Navman’s solution that Navman could only switch out CAMP at serious cost (CAMP would have a modestly better cash profit on each sale to Navman, but we believe investors are already giving them credit for that by focusing on EPS that already includes it). Based on our conversations with various industry actors and CAMP, we think that this outcome is a real possibility. Even in this scenario, we still believe that CAMP likely pulled forward revenues so the consequences are that the top-line trajectory is overstated and may face difficult comparisons over the next 4 quarters. Further, paying nearly 18% more (15/85) for CAMP’s products in such a competitive environment could invite dual-sourcing.
- The moderately negative outcome for CAMP is that Navman decides that it has enough ability to play off other suppliers to insist that CAMP continue giving it 15% rebates. In that event, the $0.5m or so in discounts/rebates that CAMP is currently giving to Navman will move from a financing cash outflow to a COGS impact, weighing on CAMP’s gross margins. We can quantify this impact – assuming no change in the volume of CAMP’s sales to Navman (average of last 4 Q’s?), a $0.5m hit to gross profit and EBIT is worth approximately 8% of CAMP quarterly EBIT.
- The most negative outcome for CAMP is that Navman views these products as relatively commoditized for its purposes (and our research strongly suggests that CAMP’s world is significantly more competitive than at the time this deal was inked in 2012). This could mean that Navman’s continued use of CAMP might be due only to the fact that it has been getting 15% off the sticker price, and without that discount, Navman might walk away from the CAMP business completely. We think this scenario is less likely than the other two, because Navman would be more likely to push to continue getting CAMP products at a discount, and it is unlikely CAMP would be in a position to walk away from business, even at lower profitability that would lower reported margin/EPS.
The story with Navman, summarized, is that it’s an unusual situation with a strangely-timed ramp in sales and a free lunch on COGS avoidance that one way or another is going away. It may have mild consequences, or it may have moderately negative consequences.
SERVED AVAILABLE MARKET (SAM) DISCUSSION
The dream: Company definition of the SAM and its growth
CAMP management defined its SAM as $3.5bn at its 1/16/15 investor day, using a chart on slide 21 of its investor presentation. The chart, entitled “Large and Expanding Served Available Market for CalAmp,” shows a stacked bar of various market components adding up to $3.5bn for 2014, and to the right it shows this bar growing at a 22% CAGR to $6.3bn by 2017. The slide neatly cites no less than seven sources at the bottom – and there’s our SAM and CAMP’s huge annual growth opportunity.
If only it were that simple.
The reality: CAMP and its peers’ organic growth rates
While this looks like an impressive growth rate, it certainly doesn’t track at all with the organic growth rate of other public MRM hardware and solutions providers. As we have discussed, CAMP’s organic growth rate is slightly negative on a reported basis, and if its DSO build represents unsustainable channel stuffing, the organic growth rate could be in the negative double digits. Surely, this doesn’t square with a SAM that’s growing at 22%. But what about further down the value chain?
Trimble (TRMB) is an MRM company whose solutions operate a variety of fields – oil & gas, agriculture, construction, etc. – to allow customers to manage their mobile assets over wireless connections to the internet. TRMB’s last two quarters showed year-over-year revenue growth rates of 5% and (6%), respectively. TRMB’s Mobile Solutions segment, perhaps the most direct indicator of the growth rate of the MRM market, has shrunk sequentially in three of its last six quarters.
Numerex (NMRX) is an M2M (machine-to-machine) and IoT solutions provider, as well as a CAMP customer. NMRX buys CAMP hardware and uses it in its solutions to end users of M2M/MRM products. NMRX Q414 revenue grew 12% ($2.7m) YOY, but organic growth was negative. Over the reference period, NMRX purchased a company, Omnilink, which likely added at least $3m per quarter in revenue to NMRX’s business. Additionally, more than 100% of NMRX’s revenue growth was in subscription- based services of the type Omnilink provides; hardware revenue for NMRX actually shrank YOY.
FleetMatics (FLTX) is another solutions provider that offers a complete SAAS and hardware solution for vehicle fleet management, and another CAMP customer. FLTX’s growth looks more exciting, at 28% and all organic. Surely FLTX must be an indicator of the incredible growth of the MRM/M2M/IOT market and an optimistic read-across to CAMP?
Not quite. FLTX’s hot streak doesn’t represent a market acceleration. On the contrary, while FLTX is certainly growing and offers a growing source of demand for CAMP devices, its growth has always been high, and the latest quarter’s growth rate was actually the slowest in the company’s history. Indeed, FLTX’s growth has been slowing more or less steadily since 2013.
As an aside, we discussed FLTX with a privately held CAMP competitor who told us that FLTX recently signed a telematics hardware purchase agreement with them. We do not know the size of this deal, but we think that FLTX’s newfound interest in buying from a direct competitor to CAMP is telling. We suspect that FLTX’s decision to pursue the use of a new telematics hardware supplier may have something to do with CAMP’s decision to start competing directly with its customers. We’ll cover this later.
The 2G upgrade cycle (is going away)
Throughout 2013, FLTX enjoyed a growth rate near 40% as it grew its sales force and found new fleet customers. During this time, CAMP’s organic growth rate was close to 20%. Part of this disparity – which obviously still persists, although to a much greater degree today – is due to the fact that CAMP is a more mature business with a number of lower value-added offerings and a stiff deflationary wind in its face, whereas FLTX is a relatively young business with a rapidly expanding sales force and penetration story.
However, although CAMP enjoyed relatively impressive growth in 2013, even that level of growth is misleading as a potential indicator of underlying SAM growth. While CAMP’s management team would have us believe that 2013’s growth was closer to what we should expect of its business than 2014’s growth, 2013’s growth was based on a temporary tailwind that has less to do with SAM expansion and more to do with a shift from old to new units within the same SAM. We refer to the 2G upgrade cycle as referenced earlier in this report, in the “Bull Case” section.
To quickly recap, the 2G upgrade cycle refers to the ongoing process of M2M end users purchasing new wireless equipment that is compatible with more advanced wireless carrier networks. Specifically, AT&T decided in the early 2010’s to phase out all “2G” (second-generation) wireless networks by 2016. To hear one of our industry contacts, a former NMRX salesperson, tell the story (paraphrased):
Today there are millions of vehicles on the AT&T network. CAMP has done a good job of turning those products...a [large] part of their growth has been in the replacement of the old equipment in those vehicles. That replacement may run its course for another six months...
AT&T was the most aggressive carrier in the M2M market space, in the mid-2000s. Verizon was a close second because of OnStar. In the early days of the digital network, 2G was the first to come out. It was very limited in speed. In 2012, AT&T moved to 2.5G, and most M2M guys ignored that. With the release of the iPhone, with the growth of 3G technology, AT&T decided they no longer wanted to maintain a 2G network and a 3G network and plan for LTE as well. So, AT&T put out a formal announcement saying they’d shut down every radio tower that had 2G technology. From 2013 to mid-2016, they are getting everyone off the 2G network. By mid-2016 there will be no AT&T 2G towers left.
This “forced upgrade cycle” was a huge tailwind for CAMP in 2013. Customers of NMRX solutions with CAMP hardware didn’t switch because they wanted to, they switched because they had to. And while many customers initially delayed the switching process because of the spending outlay required, in 2013, they started to come around:
In 2013 when I was at NMRX, we probably had 20,000 subscribers. These customers couldn’t do the upgrade all at once...it took a 12-month period to plan it and make the transition happen. In 2013 and into 2014 when I left NMRX, we were shipping more CAMP product for replacement orders in North America than we were shipping for new orders.
We see this as important in the game of “will the real CAMP please stand up”. CAMP grew in the low 20s in 2013, but we need to account for the fact that at least one important CAMP customer was seeing CAMP product flying off the shelves due to a phenomenon that is going to come to an end in mid- 2016 at the latest. “Once the transition is done, that revenue isn’t gonna recover,” the source told me.
While NMRX of course doesn’t represent the entire CAMP market, it is an excellent read-across for the level of underlying market demand. If NMRX’s example held more or less true for other M2M solution providers, we could do some basic arithmetic to estimate the historical benefit/future impact to CAMP sales:
- 80% of CAMP’s sales are in North America
- 70% of CAMP’s sales are Wireless Datacom hardware; this implies that over 56% of CAMP’s sales are North American Wireless Datacom hardware, given that all sales to Echostar are likely in North America
- If 50% of CAMP’s North American Wireless Datacom hardware sales were from 2G replacement orders, then 50% * 56% = ~28% of CAMP’s total sales could be at risk between now and mid-2016, and more than 100% of its profits under historical gross margin assumptions.
These are rough numbers that demonstrate the potential headwind facing CAMP as the 2G upgrade cycle comes to an end. There are no plans in place currently to phase out any other networks.
CAMP’s history of forecasting the SAM
Here’s a CAMP slide from January 2015:
[Image: CAMP slide showing segmented SAM growing from $3.5bn in 2014 to $6.3bn in 2017]
Looks reasonable enough. Robust growth rates in wireless networks and mobile resource management, flat Satellite revenues, and some benefit from new growth initiatives add up to a 22% CAGR over the next few years. A SAM worth $3.5bn at the end of 2014 is worth $6.3bn at the end of 2017.
But let’s look at a CAMP slide from an October 2013 presentation:
[Image: CAMP slide showing segmented SAM growing from $3.4bn in 2012 to $6.0bn in 2015]
Well, that’s funny – the chart is so similar that it looks like nothing but the numbers on it have been changed. In two years, the SAM is virtually unchanged...but we were supposed to be at $6.0bn by the end of 2015? With prices falling 8-12% a year in the hardware business, the SAM’s volume can expand without benefit to CAMP – this may explain most of the differential between dream and reality.
BECOME A SAAS COMPANY...IT’S SO CRAZY THAT IT JUST MIGHT WORK!
Step I: Buy a shrinking, unprofitable software company for almost 2x sales
In December 2012, CAMP spent $53m on the acquisition of Wireless Matrix, which had revenues of $31m as a provider of fleet tracking applications and satellite communication services to the utility, oil & gas, rail, and municipal verticals, as well as to service fleets of large enterprise customers. The deal was partially funded with $35m of equity. CAMP’s CEO described the rationale on a December 2012 conference call:
“[Wireless Matrix’s] Software-as-a-Service-based, high-margin, recurring revenues account for 85% of their total sales...This strategic acquisition will be a foundational component of our long-term growth initiatives, positioning CalAmp as a leading provider of integrated hardware and software MRM solutions within our core verticals. We are excited by the prospects of leveraging Wireless Matrix's robust mobile workforce management and asset tracking applications to build upon our current product offerings for customers in our energy, transportation and government verticals.”
What the CEO did not tell us was the following:
- Wireless Matrix had shown net losses since 2010
- Wireless Matrix showed operating losses in its last three quarters as a public company
- Wireless Matrix’s revenue was declining for its last three quarters as a public company
- Wireless Matrix’s deferred revenues had shrunk for 7 quarters in a row.
- Wireless Matrix’s subscriber growth in 2012 was 0%
CAMP’s desperation for revenue growth and its precarious position in a commoditizing part of its market appears to have been the dual motivation for management to pay almost 2x sales for an unprofitable company with a shrinking top line. If management believed it could turn Wireless Matrix around, it was incorrect, as CAMP’s quarterly subscription revenues in November 2014 were $10.4m vs. $10.2m in November 2013 – a whopping 2% year-over-year growth rate. CAMP management had this to say:
“Now, the growth we're seeing in the subscription area on the software application front is being offset somewhat by the churn out of Satellite data subscriptions which was a business that came to us through the Wireless Matrix acquisition. It's just a network resale business opportunity. And we expect to continue to see subscriber churn there over time which presents a little bit of a headwind in terms of really seeing an inflection point in our overall subscription revenue growth.” – CAMP earnings call, October 6, 2014
Deferred revenues have also been frozen over the past three quarters, demonstrating a lack of net new subscribers. When I spoke to one industry veteran who was previously a customer of CAMP’s, he said: