Park City Group PCYG S W
October 07, 2015 - 8:28pm EST by
sunshine
2015 2016
Price: 10.64 EPS 0.14 1.25
Shares Out. (in M): 20 P/E 76.0 8.5
Market Cap (in $M): 212 P/FCF 53.0 8.2
Net Debt (in $M): 0 EBIT 3 24
TEV ($): 204 TEV/EBIT 67.9 8.5
Borrow Cost: Tight 15-50% cost

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Description

We believe that shares of Park City Group (“Park City” or the “Company”), a provider of cloud-based supply chain management solutions to the consumer goods industry, are grossly overvalued and represent a compelling short opportunity. At current levels, they do not adequately reflect the risk inherent in (1) use of accounting firm with history of past transgressions (2) blatant adoption of highly aggressive and questionable accounting practices, (3) overstated market opportunity, (4) Management actions not consistent with fiduciary responsibilities, (5) intentional obfuscation of underlying profitability, and (6) valuation that is detached from reality.

 

We estimate that in a “best case” scenario for the bulls, fair value is at least 50% below where the stock currently trades and significantly lower if our thesis is to be believed.

 

 Company Description

 

Park City Group (“Park City” or the “Company”) provides a platform for trading partners to share and analyze business data throughout the supply chain to improve operational efficiency. The company's primary solutions include Scan Based Trading, ScoreTracker, Vendor Managed Inventory, Store Level Replenishment (SLR, providing visibility into store level activity), Enterprise Supply Chain Planning Suite, Fresh Market Manager, and ActionManager (providing automated method to manage the whole business process). In addition, the Company's Business Analytics Group and Professional Services Group provide consulting services, such as business optimization, technical services, and training.

 

In addition, the Company recently acquired ReposiTrak, a solution that enables food retailers to remain in compliance with rapidly evolving regulations in the Food Safety Modernization Act (FSMA) including maintaining documents/records of their supply chain. ReposiTrak offers Compliance Management System (records access, maintenance and retention of regulatory documents) and Track & Trace System (near real time identification of the supply chain path taken by recalled products).

 

The Company has over time evolved its business model to be majority subscription based, deriving over 80% of its revenue from subscription and 20% from license as of FY2015.

 

The Company claims to have invested over 17+ years of development and ~$125M of invested capital in its propriety platform.

 

Park City’s principal shareholder is CEO Randy Fields of Mrs. Fields Cookies fame who owns ~30% of the fully diluted common shares outstanding. Insiders as a group, own ~38% of the fully diluted common shares outstanding.

 

Short Thesis

 

Red Flag 1: Audit Firm with History of Past Transgressions Validating the Books

 

HJ & Associates is a marginal audit firm based out of Salt Lake City, Utah. The firm (it would appear from their website) is set-up to service SMBs (e.g., offering part-time CFO services etc.) though it counts 23 public companies in its roster (Note: Data as per Capital IQ). Interestingly enough, of these 23 companies, 16 companies have a Going Concern opinion – a testament to the quality and type of companies that HJ & Associates audits. Additionally, the firm has also been subject to PCAOB (Public Company Accounting Oversight Board) deficiency reports for 2006, 2010 and 2013.

 

http://pcaobus.org/Inspections/Reports/Documents/2014_HJ_Associates_LLC.pdf

 

http://pcaobus.org/Inspections/Reports/Documents/2012_HJ_Associates_LLC.pdf

 

http://pcaobus.org/Inspections/Reports/Documents/2006_HJ_Associates.pdf

 

Given the aggressive and questionable accounting practices that Park City Group is engaged in and documented in this write-up, we are astonished that HJ & Associates has been able to sign off on the Company’s financials. However, we remain confident that the risk associated with a restatement is high and it is a matter of “when” and not “if”.

 

Red Flag 2: Highly Aggressive and Dubious Accounting Practices

 

Park City has been engaged in accounting practices which we find to be increasingly suspect and which significantly enhance the risk of a restatement. Specifically, ReposiTrak up until its acquisition by Park City on June 30, 2015, was the single largest customer and contributed a meaningful percentage to the Company’s overall revenue. For example, revenue from ReposiTrak constituted 21% of the Company’s FY15 revenue and 20% in FY2014. The way the accounting worked is unbelievable and definitely a worth a mention. Park City would extend funds to ReposiTrak for working capital purposes. ReposiTrak as a customer of Park City was charged fees for leveraging the Company’s technology platform/infrastructure in addition to other support services. ReposiTrak given its anemic financial profile and lack of overall sales was unable to pay off the fees which were then subsequently categorized not as A/R (heaven forbid should you need to increase your reserve against bad debt) but as Notes Receivable on Park City’s balance sheet.

 

“Approximately $2.3 million net was advanced to ReposiTrak for working capital purposes during the year ended June 30, 2015, which amount was evidenced by the issuance of promissory notes by ReposiTrak to the Company.”

 

“Of the fees paid to us during 2014 by ReposiTrak, approximately $1.2 million was paid in cash from proceeds of loans by the Company to ReposiTrak which are evidenced by promissory notes.”

 

$ Millions

FY2014

FY2015

Reported Revenue

$11.9

$13.6

Less: ReposiTrak Revenue

    2.3

    3.0

Net Revenue

  $9.6

$10.6

 

Note: ReposiTrak revenue as a % of total reported revenue may not foot to the 21% and 20% figures cited due to rounding

 

Given the increasingly close relationship between both companies, as clearly evidenced by the omnibus agreement referenced below, we find it shocking that this arrangement can be considered at arms-length and Park City considered as an “independent contractor”.

 

http://www.sec.gov/Archives/edgar/data/50471/000141588913001875/ex10-19.htm

 

We view this as a violation of Variable Interest Entity (VIE) accounting and hence are of the opinion that the Company needed to consolidate the financials of ReposiTrak, thereby absorbing the expenses in addition to benefiting from the revenue recognized. The below language from FASB provides context for our assertion.

 

“The reporting enterprise, its related parties, or both participated significantly in the design or redesign of the entity, and the entity is neither a joint venture nor a franchisee”

 

http://www.fasb.org/st/summary/finsum46r.shtml

 

Red Flag 3: Overstated Market Opportunity for ReposiTrak

 

Management has been exceptionally upbeat about its growth prospects for ReposiTrak, claiming a $1B+ market opportunity for Food Safety. This opportunity is being driven by the Food Safety Modernization Act. The FSMA is aimed at preventing outbreak of food borne diseases through preventive controls and increased compliance. Per the FDA website below major components of the FSMA include:

 

Preventive controls - For the first time, FDA has a legislative mandate to require comprehensive, prevention-based controls across the food supply to prevent or significantly minimize the likelihood of problems occurring

 

Inspection and Compliance - The legislation recognizes that inspection is an important means of holding industry accountable for its responsibility to produce safe food. FDA is committed to applying its inspection resources in a risk-based manner and adopting innovative inspection approaches”

 

http://www.fda.gov/Food/GuidanceRegulation/FSMA/ucm247559.htm

 

The Company is using a “Hub and Spoke” go to market approach. Specifically, the Retailers are the Hub and are being offered the software for free. The Spoke are the Suppliers that are charged a monthly fee ranging from $100 per month per Retailer connection up to a maximum of $300, to as low as $25 per month. Each link between a Retailer and Supplier is considered a connection. Each Supplier can have multiple connections (i.e., more than one Retailer). Management claimed 2,500 connections as of FY2015 with a target of adding 6,000 for FY16 for a cumulative total of 8,500 connections.

 

Management claims that its endorsement as technology provider of choice by Retailer Owned Food Distributors & Associates (ROFDA), an organization of 14 wholesale food distributors, representing 20% of the supermarket industry and nearly 50,000 suppliers, will be the catalyst to drive significant adoption of its offering, going forward.

 

However, we believe, Management is significantly overestimating its market opportunity/underestimating the competitive dynamic for a couple of reasons. Firstly, food safety compliance is not a new area, with several vendors (AssurX, EtQ, Intelex, Plex Systems, Safefood 360, SafetyChain etc.) offering solutions that are arguably more comprehensive in scope and scale relative to ReposiTrak. Second, by offering the solution free to Retailers and charging Suppliers, makes it difficult for Retailers to enforce the use/adoption of the solution by the Suppliers – especially those suppliers that are relatively small and don’t have any incentive/motivation to pay up – the market that Park City is currently targeting (long tail problem).

 

$ Millions

FY2014

FY2015

Total ReposiTrak Revenue

 $ 0.2

$0.8

Less: Operating Expenses

    2.9

  3.6

Loss From Operations

 ($2.7)

($2.8)

 

Source: http://www.sec.gov/Archives/edgar/data/50471/000141588915003084/ex99-1.htm

 

Brean Capital (that also happened to underwrite the Company’s secondary offering on May, 2015) has modeled an exponential ramp in revenue as per below:

 

$ Millions

FY2016

FY2017

FY2018

Total ReposiTrak Revenue

  $12.2

$44.8

$101.7

 

 It is worth noting that prior to Park City filing its 8-k with ReposiTrak revenue broken out for FY15, Brean Capital was projecting $2.2M versus $0.8M as reported. Given the magnitude of the miss (~64%), we do not place any stock (pun intended!) in their estimates. In a more recent development, the lead analyst (or should I say cheerleader!) covering Park City Group, left Brean Capital to take on the CFO mantle at the Company. At least, we can say that he has put his money where his mouth is!

 

Additionally, it is intriguing that if the opportunity in Food Safety is as massive as articulated vociferously by Management, why is Management trying to target additional areas which can distract them from succeeding at the task at hand. 

 

“Now, in addition, I want to be cautious how I say this, but in the course of this fiscal year, we will be attempting to engage Park City Group and ReposiTrak in pilot of our technology in two new industries. I mentioned the one in the previous conference call, and that's in pharma. We definitely want to try ReposiTrak in the pharma industry.” - Randy Fields, CEO, Q4, 2015 Earnings Call

 

“We are going to do the same thing in food service. Food service, we think is an interesting area.”  - Randy Fields, CEO, Q4, 2015 Earnings Call

 

 Red Flag 4: Management Actions Are Not Consistent with Their Fiduciary Responsibilities to Common Shareholders

 

Park City acquired ReposiTrak on June 30, 2015. The purchase price consisted of 873,438 shares of the Company valued at $10.8M based on the closing price as of that date. What we find most intriguing is that at the time of the acquisition, Park City had the opportunity to acquire 75% of Repositrak’s stock for $450k thereby valuing the business at $600k. However, the Company decided to purchase the remaining 25% of the Company for $10.8M thereby valuing it at ~$43.0M.

 

“On July 19, 2012 the Company granted options to purchase 660,000 shares of ReposiTrak common stock as part of an exclusive rights agreement with Park City Group, Inc. The immediately vested options were granted at $0.15 per share and had a 10 year life.”

 

“On June 30, 2013 the Company granted warrants to purchase 300,000 shares of ReposiTrak common stock as part of a note payable to Park City Group, Inc. The immediately vested warrants were granted at $1.17 per share and had a 9 year life.”

 

 http://www.sec.gov/Archives/edgar/data/50471/000141588913001875/ex10-19.htm

 

http://www.sec.gov/Archives/edgar/data/50471/000141588915003084/ex99-1.htm

 

In today’s world of high flying private company valuations, a 72x increase in less than 3 years is staggering and a complete breach of Management’s fiduciary responsibilities pending clear justification for their actions. What is even more shocking is that a valuation of this magnitude was afforded to an entity that was solely dependent on Park City for its technology infrastructure, development and customer support and was in no condition to continue as a going concern as evidenced by the multiple outstanding notes payables. Funnily enough, HJ & Associates put out a going-concern opinion on ReposiTrak after signing off on ReposiTrak’s audited financials for FY14 and FY15.

 

“During the year ended June 30, 2015, the Company had a net loss of $3.1 million, negative cash flow from operations of $3.1 million, and negative working capital of $3.9 million. Historically the Company has had operating losses, negative cash flows from operations, and working capital deficiencies. Whether, and when, the Company can attain profitability and positive cash flows from operations is uncertain. The Company is also uncertain whether it can obtain financing to complete the rollout of its business plan. These uncertainties cast significant doubt upon the Company’s ability to continue as a going concern.”

 

However, in the spirit of full disclosure, the auditors did withdraw their going-concern opinion the next day in an amended 8-k filing. Regardless, we find this odd and it further validates our concern about HJ & Associates as highlighted already above.

 

 Additionally, the CEO, his wife and a Company Director own preferred stock that enables them to receive dividend payments (7% per annum if paid in cash and 9% per annum if paid in kind). It is unbelievable from the below, that the CEO continues to enrich himself by paying out dividends on the preferreds to the detriment of the common shareholders.

 

$ Millions

FY2013

FY2014

FY2015

Net (Loss) Income

$0.3

($3.0)

($4.0)

Dividends on Preferred Stock (Total)

  0.9

   0.6

   0.6

Dividends on Preferred Stock (Paid in Cash)

  0.5

   0.6

   0.2

 

 Red Flag 5: Management Obfuscating Lack of Free Cash Flow Generation

 

Management has come up with its own definition of Free Cash Flow (FCF), which it uses to highlight the cash flow generation power of the business. We find it both strange and unusual that a Company would cherry pick what it wants to include in its definition of a relatively straightforward metric.

 

“Free cash flow includes net cash provided (used) by operating activities less replacement purchases of property and equipment. Capital expenditures related to long-term investments and new technology developments are omitted.”

 

As you can see below, there is a significant divergence between the true FCF generation or lack thereof and what the Company is communicating to the Street. 

 

$ Millions

FY2013

FY2014

FY2015

OCF

($0.2)

($0.1)

$1.7

Less: CapEx

  (0.4)

  (1.7)

  2.6

FCF

($0.6)

($1.8)

($0.9)

 

Note: CapEx includes cash advanced on Notes Receivable net of payments received on same therein

 

FCF as provided by Management:

 

$ Millions

FY2013

FY2014

FY2015

FCF

($0.6)

($0.6)

$1.7

 

 Red Flag 6: Valuation Completely Detached From Reality 

 

Park City Group currently has a market capitalization of ~$204M and trades at 8.6x TEV /FY16 Revenue. Note that FY16 revenue estimate is per Brean Capital. To put this in context, see below table:

 

Revenue ($ Millions)

FY2015

FY2016

Legacy Park City

$10.6

$11.4

ReposiTrak

    0.8

  12.2

Total Revenue

$11.4

$23.6

 

Source: Brean Capital

 

From the above, it is clearly evident where the projected growth in the business is expected. Let’s for argument sake give Brean Capital 100% credit for the legacy Park City revenue and be generous in giving them 60% credit for their projections for ReposiTrak. Based on that, the revised revenue figures look like as below:

 

Revenue ($ Millions)

FY2015

FY2016

Legacy Park City

$10.6

$11.4

ReposiTrak

    0.8

    7.3

Total Revenue

$11.4

$18.7

 

 Additionally, applying a more than generous 5.0x TEV/FY16 Revenue multiple, gives us a TEV of ~$94M. Adjusting for Cash, Debt and Preferred Stock, yields a market capitalization of $102M and a price per share of $5.27 which is ~51% below where the stock currently trades. We view this as a best case scenario for the bulls. Should our thesis materialize, we expect the stock to trade significantly lower than the “best case” scenario we have just laid out.

 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Deterioration in business fundamentals over the next 12 months; Company does yet another secondary offering further diluting existing shareholders; Restatement of financials

 

 

 

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