Forescout Technologies Inc.

On Feb 6, 2020 Forescout Technologies, Inc. (“FSCT” or “the Company”) announced its purchase by Advent International for $33/share in a $1.8bn deal. We believe investors ascribe too high a probability that it is a done deal. Upon conducting a forensic analysis of deal proxy statements, we observe that some financial forecasts reviewed by Forescout internally may not have been shared with prospective acquirers – and that some of these forecasts were materially worse than those known to be disclosed to buyers. Whether or not this represents a breach of reps and warranties, we believe it should serve as grounds for Advent to negotiate a lower share price. Advent’s interest in revisiting the terms should be high given that the deal was struck just weeks prior to the WHO declaring COVID-19 a pandemic, which we believe dramatically alters the financial outlook for Forescout, a negative EBITDA business which was already under growth pressures and missing its guidance. Importantly, with the onset of the pandemic, Spruce Point estimates that it is likely in Advent’s interest to walk away from the deal – even after taking into account its $112M termination fee. We believe Advent substantially overpaid, underscored by Investcorp’s recent purchase of Avira in early April. Avira, a profitable cybersecurity company, was acquired at a revenue multiple >50% less than Forescout’s. We believe that Advent can, and should, use this as leverage to renegotiate the deal price lower by 35%-50%. In our opinion, Advent, a steward of public pension capital, must negotiate a lower deal price more reflective of Forescout’s ominous outlook, rather than unjustly enriching management with a $100m payday, and early VCs for having created limited / no value as a public company.

Was Forescout’s Complete Financial Outlook Shared With Prospective Buyers? Upon a close forensic analysis of the deal proxy statement, Spruce Point believes that some financial forecasts prepared by management may not have been shared with prospective buyers. In particular, forecasts which projected FY20 sales 8%-9% lower than the Company’s primary “Target Plan” were prepared and analyzed internally at various points through the acquisition timeline, but appear not to have been submitted to potential acquirers. In each case, these internal financial forecasts appear to have represented plausible outcomes for Company performance based on management’s best
knowledge of the state of the business at the time, and, accordingly, should have been shared alongside its more optimistic forecasts. One of these forecasts was management’s preliminary Q1 and full-year FY20 revenue guidance which it planned to (but did not) share on its Feb 6, 2020 (Q4 FY19 earnings) – a call which was cancelled upon the morning’s deal announcement. With the Q1’20 guide a full 20% below consensus Q1 estimates and suggesting year-over-year contraction, the announcement could have dealt a crushing blow to the stock, possibly altering the course of any acquisition talks. With Advent – a financial buyer – having shown a relatively high level of sensitivity to forecast adjustments over the course of the negotiation, Spruce Point believes that the later  disclosure of this guidance revision lower in the deal proxy may serve as motivation for the firm to walk away from the deal, or at least demand renegotiation.

A Busted Dinosaur IPO Under Greater Pressures Remarketing Debt Capital In A Highly Discriminating Environment: It took Forescout 17 years to IPO, giving analysts reason to dub it a “dinosaur” IPO. As a public company, we believe FSCT created little/no value for shareholders, and was showing signs of fundamental strain even prior to the onset of the COVID-19 pandemic: a disappointing Q3 FY19 preannouncement sent shares tumbling down ~37% as top-line growth decelerated to single-digit levels for the first time in years. Spruce Point finds evidence of widespread dissatisfaction among its employee base, notably the front-line sales force which has shown significant turnover. The product itself has also received increasingly unfavorable reviews through the past several years as the competitive landscape has grown more crowded. Based on our primary due diligence, we learned that competitors are bundling more solutions, and cyber deals for small and medium sized businesses are being delayed, leading to pricing
pressure. With a large percentage of its customers tied to government spending where margin upside is generally limited, a history of negative EBITDA and free cash flow,
and an uncertain SaaS transition, investors should be worried about $400m of debt capital needed to fund the transaction during a newly disclosed “remarketing” period.

A Favorable Cost / Benefit Analysis Gives Advent Leverage To Demand New Terms: Spruce Point estimates that, given (1) Advent’s potentially incomplete view into Forescout’s financials during the negotiation process, and (2) pandemic-related developments which we believe erodes the Company’s outlook going forward, a conservative reevaluation of the deal featuring NO multiple compression could see Advent value FSCT more than 20% below the $33/share deal price. Despite facing a $112M termination fee, a straight-forward cost/benefit analysis reveals that, at the current terms, Advent would do better to walk away from the deal rather than complete it. We believe that, in a more realistic scenario in which Forescout’s projections are revised downward, and the multiple compressed, FSCT shares should be valued between $17- $22 regardless of whether the deal is renegotiated or annulled completely, yielding 35%-50% downside to the $33 price.



WD-40 Company (Update 1)

WD-40’s recent Q2 2020 earnings support our original thesis and management refuted none of our concerns. We remain confident the business is under pressure, with sales and earnings declining even before the full effect of COVID-19. We believe the problems will only intensify once the Americas and EMEA businesses realize the economic impact of the virus. As the financial stress on WD-40 grows and earnings become under additional pressure, we believe the current dividend is at risk to be cut.

Financial Results Missed Street Expectations On The Top And Bottom Line: Sales: $100m vs. $103m and EPS: $1.04 vs $1.21e

Working Capital Intensified To New Highs. Working capital as a % of sales continues to escalate compared to the previous financial crisis when the metric declined. Spruce Point’s working capital analysis has been a successful indicator of numerous past financial disasters.

Dividend At Risk Of Being Cut. Evidence WD 40 In Discussions With Lenders About Dividend: On the most recent call, WD 40’s CFO stated the current strategy is to pay out 50% of earnings. As strong headwinds put the business under pressure and earnings in jeopardy, we believe the dividend is at risk of being cut. Share repurchase program was suspended.

Management Dodged Important Questions And Refuted None Of Spruce Point’s Concerns. Analysts started asking tougher questions on the most recent earning call regarding end market exposure and sales by channel. Management has not quantified the exposure and has spun its answers to discuss points they want to address. WD 40 continues to talk up e commerce, but has not addressed how they will safely ship the product in regions requiring air transportation. We continue to believe the product is not well adapted for an e commerce world.

Management Gave No Confidence That Lower Oil Prices Will Benefit WD 40. This Contradicts Recent Sell Side Bulls. Management stated, “only a small amount of the total cost to produce a can of the WD 40 Multi Use Product directly correlates to the price of a barrel of crude oil,” and it will “most likely be a net positive to gross margins”. These stand in contrast to its chart which shows 33% of a can’s cost attributable to petroleum based specialty chemicals. Analysts confidently boosted earnings for lower oil prices.

New Risk Factor Added Should Be Alarming Since It’s More Strongly Worded Than Peers. New risk factor warning of potential future write offs supports our belief that WD 40’s customers are under pressure. Current allowance for doubtful accounts is significantly below its peers’ average.

Shares Are Still Materially Overvalued For A Declining Company. WD 40 trades at 6.1x, 28x and 39x 2020E EV/Sales, EV/EBITDA and P/E, respectively for a declining non recession proof business. We still see long term price potential of $75 –$85 per share (55% downside) and expect analysts to start cutting price targets


Align Technology, Inc.

By now, investors in Align Technology, Inc. (“ALGN” or “the Company”) are used to hearing that competitors are, for the first time, beginning to penetrate the clear aligner space. The bullish consensus: dental equipment competitors can coexist with Align, but cannot yet compete toe-to-toe with the 20-year incumbent.

The reality: the economics of clear aligners are on the precipice of a radical shift – and it has little to do with SmileDirectClub or other direct-to-consumer players. Once considered high-value-added “dental tech,” FDA-approved aligners of similar quality to Invisalign – Align’s clear aligner product – are now being printed at scale by commodity 3D printing labs, which price their aligners at less than half the cost of Align’s. Meanwhile, patent expirations have ushered in under-the-radar developments in aligner design software which are removing the final barriers to the widespread adoption of 3D printers by orthodontists – many of whom are infuriated with Align’s aggressive tactics, and who are actively exploring their options in a market which, for the first time, offers numerous (cheaper) alternatives to Align. On-the-ground diligence reveals that large dental players are already slashing aligner prices in response to these shifts, in some cases to as low as a third the price of Invisalign. We believe that it is only a matter of time – perhaps accelerated by industry cost pressures brought on by the pandemic – until Align is forced to follow suit.

Third-Party Labs Turning Aligners Into Commodities: For close to 20 years, Align operated as the lone major player in the clear aligner space, with other large dental equipment suppliers only recently entering the industry. Over just the past two years, however, patent expirations and developments in 3D printing have enabled dozens of third-party printing labs to begin to produce FDA-approved aligners of their own, threatening to transform the clear aligner from “high-tech” dental equipment into a low-value-added, easy-to-source commodity. What’s more, the former developer and provider of Align’s own polymer has developed a new plastic which can be used by third-party labs to produce aligners of comparable quality to Invisalign. Spruce Point has obtained term sheets from one such third-party lab which reveal that dental practitioners can save over 50% per case on average by sourcing from it rather than Align, and that a typical practice – depending on its volume – could increase its cash flow by close to 10% simply by switching from Align. We find evidence that large orthodontic organizations are considering switching from Align to third-party labs, and that other major dental players are already slashing prices to as low as 33% of Align’s in response to this competition. We believe that Align will inevitably be forced to follow suit – or else lose significant case volume – as third-party labs grow increasingly mainstream.

Under-The-Radar Improvements In Workflow Technology Make In-House 3D Printing A Threat: Until now, Align bulls have generally considered in-house 3D printing an inconvenient alternative to Align, as in-house printing forces orthodontists to bring entirely new workflows into their offices. Through a proprietary survey of high-volume orthodontists, together with conversations with industry experts, we find that interest towards in-house printing is in fact extremely high among doctors, who are attracted to the potential efficiencies and cost savings. We find that broader adoption of in-house printing has been constrained NOT by limited demand, but by the relatively limited supply of quality technological infrastructure to support this workflow – in particular, high-quality CAD/CAM aligner design software. However, with Align’s patents on this technology recently having expired, major innovations are coming to this space as we speak. Notably, uLab Technologies – a company founded by former Align executives and employees who were themselves behind the most successful attempt to compete with Align during the 2000s – is in the process of rolling out CAD/CAM software which experts believe to represent a step change over existing solutions. The full-scale launch is expected to occur this spring. With the final barriers to widespread in-house printing adoption set to fall in the near term, we expect interest in 3D printing – which offers even greater cost savings than third-party labs – to expand dramatically.

Emergent Competition Already Putting Pressure On Align: Though still relatively novel, Spruce Point observes that these competitive forces are already beginning to pressure industry pricing and threaten Align’s case volume. Our diligence reveals that a large dental service organization (DSO) representing up to 12% of Align’s US aligner volume is actively exploring opportunities to source aligners from third-party labs. Meanwhile, we are told that 3M is offering orthodontists lab fees as low as $500-$600 per case – less than one third the price of a comprehensive Invisalign case. We believe that this is just the beginning of a longer-term trend.

Widespread Dissatisfaction With Align Could Accelerate Customer Losses: Align bulls are quick to argue that the Company’s brand and practitioner network protect it from new competition. We find that orthodontists are, almost universally, anywhere from dissatisfied to infuriated with Align, which continues to raise prices aggressively on orthodontic practices even as costs fall across the rest of the space, and which has threatened orthodontists’ control over the teeth alignment industry by selling to dentists and backing direct-to-consumer players. With competitive options proliferating across the space for the first time in ~20 years, Spruce Point observes that even Align’s highest-volume orthodontists are actively pursuing alternatives – and doubly so as they pause normal operations in response to the COVID-19 pandemic, which has given them a unique opportunity to explore cost-saving measures.

Growth Into The Purported TAM Will Be More Difficult Than Expected: Management claims that Align captures just 1.5M of over 8M annual worldwide malocclusion cases which Invisalign can be used to treat, and that there are more than 300M additional candidates who would benefit from more minor treatments with clear aligners. However, we estimate that Align is already close to 80% penetrated among US orthodontists, making further growth into the domestic orthodontic channel difficult – particularly as increasing competition induces churn and causes utilization to fall. Meanwhile, cheaper competitors and DTC players like SmileDirectClub will make it difficult for Align to capture meaningful share of lower-complexity cases without reducing prices materially.

Management Reducing Transparency While Showing Little Confidence In The Business: After reducing disclosures which would have made it easier for investors to see the impact of competitive pressures on Company results, management expanded a number of risk factors in its most recent 10-K in ways that suggest that more aggressive competition is on the way. At the same time – just as sales growth decelerates and margins compress – insiders are selling their holdings of ALGN shares in size, while simultaneously increasing the Company buyback by 4x. With the Company experiencing declining growth as it is pinched by a more crowded competitive landscape, pivoting to M&A to support future growth, and buying back shares just as insiders sell out, Spruce Point feels that Align exhibits many of the classic characteristics of a business under pressure.

COVID-19 Pandemic Poses Unique Short-Term Risk, While Competitive Threats Could Inhibit Rebound: Shares in ALGN have largely traded in-line with the market as investors bet on when restrictions on normal economic activity will be lifted. However, with clear aligner therapy – an elective, cosmetic treatment – falling among the least critical of medical procedures, Align bears outsized risk to the potential lingering effects of the disease, which may not only depress discretionary spending for an extended period, but also prevent orthodontic offices from reopening entirely for up to a number of months, and discourage patients from entering what may be a high-risk, aerosol-laden environment thereafter. Meanwhile, our diligence indicates that orthodontists are using their time off to evaluate their practices’ cost structures and identify areas of potential cost savings – a trend which could result in accelerated switching away from Invisalign as the competitive landscape becomes increasingly crowded with low-priced providers. We estimate that case volume could fall by anywhere from 30% to 90% worldwide YoY in Q2, with the lingering effects continuing to drive declines of 20-30% for the rest of the year. We believe that near-term earnings revisions in the face of the ongoing crisis will serve as catalysts for downward moves in the stock, as revisions have before.

Not A Post-Pandemic Bounce Back Candidate, Even As Shares Trade Down: As ALGN shares trade lower with the market as the pandemic grows increasingly drawn-out, bulls with faith in the long-term growth story likely see the stock as a strong “buy low” opportunity. Spruce Point strongly disagrees: not only does Align bear outsized risk to the continued prevalence of COVID-19 beyond 2020, but the proliferation of competitors and alternative aligner printing technologies will, in our opinion, prevent the Company from bouncing back with the same force as the rest of the dental/orthodontic space. Spruce Point sees 40%-55% downside in ALGN to $80-$115 per share on disappointing case volume growth in FY21 and ongoing ASP pressure amidst an expanded competitive landscape. ALGN’s ~24x FY21 earnings multiple could also compress as investors increasingly understand the competitive forces facing the Company going forward, bringing the potential for even greater downside to ALGN shares.


WD-40 Company

Spruce Point believes that WD-40 (Nasdaq: WDFC or “the Company”) is widely misunderstood and believed to be defensive, but in reality, is facing both long and short-term secular pressures. With the Company recently upsizing and drawing down 100% of its credit facility, a size 1,500% larger than the previous recession in 2008-2009, we believe a massive hole in its balance sheet has been exposed. Our forensic review and channel checks indicate record bloated inventories, and material financial strain. We believe it will have to drastically reduce its optimistic 3-7% sales target and re-set investor expectations meaningfully lower. Trading near all-time highs and at an unprecedented 6x sales and 28x EBITDA, we believe shares are a horrible risk/reward. We see 55% – 60% downside risk ($75-$85/share).

WD-40 relies on a trade secret, and has no patents, to protect itself in the market place from dozens of cheaper all-purpose and specialty lubricants in a variety of saturated retail channels, and user end markets

WD-40’s heaviest users are maintenance and repair specialists, notably in the auto market. A long-term challenge facing it is the electrification of cars, which have fewer moving parts and require less regular maintenance. In addition, WD-40 sells into the bicycle and motorcycle markets. Each of these markets are also under long-term pressure from changing customer preferences, in addition to the electrification of the market. Independent bicycle dealerships are in long-term decline, while children (the next generation of users) are also purchasing fewer bicycles

We believe the product is also coming under increasing regulatory scrutiny. By analyzing changes in its product fact sheet, we see that more disclosures about the hazardous nature of the chemicals contained in the product are being highlighted. Because of these hazards, we believe WD-40 is not well suited to an e-commerce environment. In fact, WD-40 recently added a disclosure statement in its product fact sheet that it does not recommend transporting it by air. The FAA also added WD-40 to its list of products that cannot be carried on, or packed in luggage, by the public when flying commercial air

Late Friday on March 27th, WD-40 drew down the remainder of its $150m credit facility. During the prior crisis, it had a small $10m facility that was never utilized. We believe this gigantic draw down exposes a major hole and problem with its business. WD-40 is levered only 0.7x Net Debt to EBITDA and projected to generate $30m+ of free cash flow. Why would it need to max out its credit line?

In our view, WD-40 has no visibility in an economic recession. It missed FY 2009 sales and EPS estimates by 13% and almost 10% at the mid-points, respectively. In FY 2008 it missed sales and EPS by 5% and 13% and the mid-points, respectively. This time around, the economic crisis is greater, and we expect a much larger miss of its targets.

WD-40’s business has grown much more international today vs. the last financial crisis 10yrs ago. Today: 63% international sales vs. 52% during the last crisis. WD-40 now obscures country-level revenue detail. However, we estimate the U.K is 37% of total revenues vs. 9% during the last crisis. We estimate 75% of WD-40’s cash is in its U.K. subsidiary. First Brexit, and now a coronavirus scare, has sent the Pound to multi-year lows which we believe has compounded WD-40’s challenges.

Working capital strain has materially intensified. Based on our analysis, working capital to sales is currently 16.3% of sales, almost double the 8.6% of sales in 2007. By closely examining the composition of WD-40’s inventory accounts, we observe that Finished Goods make up an increasing percentage of the overall balance, and more than prior to entering the last crisis. Days of Inventory and its Cash Conversion Cycle are near all-time highs. In our opinion, this suggests that inventory is building up and not selling-through to customers.

As a 65+ year old company relying on a core lubricant product, it’s easy to understand that finding new markets and introducing new and successful products can be challenging. We observe that WD-40 is taking actions consistent with a mature company, including investing less and less in R&D every year, and covering-up disclosures about challenged products and ventures (recently WD-40 BIKE). WD-40 continues touting geographic expansion with a $1bn market opportunity. A year ago, it even listed Venezuela and Iran as market opportunities for its products. However, it recently omitted these countries from its latest investor presentation.

By far, WD-40 has been promoting its ambitions in China, once claiming sales would be $100m. Yet, 17 years ago it admitted that 25% of the market was counterfeits. We find evidence that counterfeits continue to plague its growth ambitions there. Asia-Pacific and China have recently become an extreme weak spot for the Company, and while it blames the issue on “formulation changes” and China holidays, we suspect there are more structural issues that will hamper its ability to reach its lofty Chinese goals.

WD-40 is also promoting a new product for the recreational vehicle (RV) industry, but the timing of the introduction is terrible given that nearly all major RV industry players have suspended production, and there’s concern that long-term industry sales have peaked. With respect to channel distribution, we find that WD-40 has already penetrated major categories: mass merchants (WalMart, Target), home improvement stores (Home Depot, Lowes, Ace Hardware), auto repair shops (AutoZone, Advanced Auto, Pep Boys), drug stores (Rite Aid, CVS), and dollar stores (Family Dollar, Dollar General). Our channel checks show some retailers offering their own store brands, like WalMart, and in some cases offering competing products up to 60% lower in price than WD-40’s comparable product. In the home improvement and auto center market, we find that PB Blaster is becoming a formidable competitor, driving more intense price promotion.

WD-40 recently started disclosing reductions to sales for rebates, coupons and cash incentives. The disclosure may have been pushed by the auditor, which recently added rebates and marketing program accruals as a “Critical Audit Matter”. By closely analyzing recent trends, we find that WD-40 gave its largest incentives in Q1 2020. We believe this supports our channel check concerns.

A majority of the executives are 60+ years old, and with a small company of ~500 employees, investors should pay attention to recent management transition plans. Unfortunately, not all are in shareholders’ best interest such as the CEO now assuming the Chairman role. WD-40 recently promoted internally a new Chief Accounting Officer. A background check reveals that during her previous tenure at Cymer (formerly: Nasdaq: CYMI), it disclosed accounting errors and a material weakness related to income tax accounting. It’s noteworthy that WD-40 just disclosed a $0.63 per share reserve for uncertain taxes.

In our view, there is evidence insiders act in their own best interest. Insiders have misdirected 62% of total free cash flow since 2007 towards stock repurchases at increasingly inflated prices. This has allowed insiders to materially reduce their ownership and capital at-risk. Current insiders own a record low 1.9% of total shares. In addition, we see evidence of management making usual adjustment to EBITDA bonus targets by ignoring certain expenses that look ordinary and necessary to execute its business plan. WD-40 would benefit from replacing its auditor PwC, which has audited the Company for so long that no one is even sure when the relationship began. The current audit partner has a self-proclaimed focus on healthcare and biotech, not retail or chemicals

Despite a $2.7 billion dollar market cap, WD-40 is largely under-followed by the sell-side brokerage community. Instead, it appears the CEO has sought endorsement from retail investors through channels such as CNBC’s Mad Money. The two analysts covering it have price targets of $210 and $225, implying approximately 15% of upside on average. Yet, we don’t believe either analyst has conducted a rigorous forensic review and channel checks that indicate significant financial strain and long-term challenges that will cap upside potential. The analysts push the Company narrative that WD-40 is recession resistant, yet don’t point out that during the last crisis WD-40 wildly missed its targets and experienced declining sales and EPS. We believe this time around, the magnitude of the miss will be greater.

Collectively, the analysts still see top line growth this year of 1.3% which will rebound to 6.6% in FY 2021. We view both of these forecasts as wildly optimistic in light of continued long-term challenges, and price increases put though in the recent past which aren’t likely to be repeated. To be clear, we view analysts’ estimates as aggressive even before the recent economic turmoil brought about by the virus. Sell-side analysts also point to the recent plunge in oil as a catalyst to buy the stock. While we acknowledge that 33% of WD-40’s cost to produce a can is petroleum-based specialty chemicals, this benefit comes at the same time as severely depressed economic activity also affects sales. In addition, WD-40’s competitors (already pricing products below WD-40) get the same benefit and can become even more price aggressive to take share.

Furthermore, the magnitude of oil’s decline during the last crisis is comparable to today’s from a percentage decline of approximately 70%. We see that it took until Q3 for the Company to say that oil benefited gross margin by 200bps, and that was a full year after oil peaked over $140/bbl in July 2008. What’s also important to realize is that WD-40 had ~40 days of inventory outstanding then vs. ~80 today. As a result, we believe it will take even longer for it to realize the full benefit of lower oil. WD-40’s valuation relative to its own selected peers set of specialty chemical and auto part distributors exposes its extreme valuation. Its valuation becomes even more expensive once it becomes evident that overly aggressive estimates for 2020-2021 will be difficult to achieve. The multiple has actually expanded during the current crisis to all-time highs, and the bullish analysts’ even think there is more room for valuation expansion. We beg to differ. Only distorted financial logic would argue that WD-40 should experience multiple expansion while an enormous hole in its balance sheet exists.

Currently trading at 6x and 27x 2020E consensus sales and EBITDA, WD-40 is priced beyond perfection. Once investors come to grips with the reality that WD-40 will repeatedly miss aggressive forecasts set by management, and reiterated by analysts, we believe its multiple will compress to more realistic levels in-line with low/no growth consumer product and specialty chemical peers. At a generous 2x and 12x sales and EBITDA multiple on our lower financial forecasts we estimate 55% – 60% downside risk.

For investors holding out hope that WD-40 is a take-over target, we point out that larger companies such as Dupont and Newell Brands have competing products in the space; neither have invested in developing the product category, or made an offer for WD-40. Furthermore, any financial or private equity buyer would struggle to make the math work at its current excessive valuation.


Amcor Plc

    • Amcor plc (“AMCR” or “the Company”) is a roll-up, and newly created S&P 500 company, formed through a stock-for-stock merger between Amcor (Australia) and Bemis (U.S.). Its shares trade on both on the NYSE: AMCR and ASX: AMC. As two companies in the global packaging industry with large exposure to the consumer and beverage industry (PET bottles, plastic bags, tobacco), we believe Amcor is facing cost and revenue challenges as the world moves toward healthier and more environmentally conscious solutions. Based on our forensic review of the deal rationale touted by Amcor, we are able to disprove or question a majority of its promotional selling points. We also believe Amcor is obscuring significant financial strain (organic revenue decline 3.0% – 4.0%, cash overdrafts and cash flow contraction) that will place its dividend and BBB investment grade credit rating at risk. We see 40% – 60% downside risk as investors recalibrate the long thesis.
    • An “Organic” EPS Growth Story Through Suspect Cost Synergies And Obscured Tobacco Dependence: Nearly 10% of sales are tobacco cartons, yet Amcor’s recent SEC filings and investor presentations disclose “tobacco” zero times! Based on our research, we learned that tobacco cartons once accounted for up to 30% of Amcor’s EBITDA, and may generate margins 1,000bps higher than other businesses. Tobacco sales are declining mid-single digits globally, and Amcor has obscured its goodwill and entities associated with tobacco packaging acquisitions. Amcor even changed its goodwill impairment testing from “quantitative” to “qualitative” factors in 2019. Goodwill accounting is a current hot topic for the SEC, which is investigating Newell Rubbermaid. Other dependencies include plastic bottle sales to Pepsi (~8% sales), and packages to KraftHeinz (~3.5% sales), which is also under SEC investigation. Amcor claims $180m of Bemis deal cost synergies and avoids discussion of sales synergies. Based on our analysis, deal costs are rising faster than planned, and sales are vanishing. Amcor stopped disclosing Bemis’ sales contribution one full quarter post deal closing. Financial reporting practices for material acquisitions are 12 months of post closing disclosure. Our analysis suggests both Bemis and Amcor sales are organically declining 3.0% – 4.0% and its cost synergy targets, relative to other industry deals, are very aggressive. Amcor’s claim in Feb 2020 that it’s increasing cost synergy guidance from $65m to $80m appears dubious in light of evidence that R&D spending is running $35m below plan. Amcor was adamant at the deal announcement that cost synergies would not include R&D cuts.
    • Signs of a Cash Crunch Calling Into Question Management’s “Enhanced Financial Profile” Claim: We believe Amcor presents an inaccurate view of its cash by obscuring clear presentation of rising cash overdrafts and restricted cash. Recently disclosed European filings (30% of sales in Europe) show that Amcor’s cash pool fell into a deficit after a multi-year surplus. Amcor claims rising volumes in Europe, yet didn’t disclose intentions to shut two Flexible facilities in Finland. Rising dependence on cash overdrafts has been a major harbinger of financial strain in companies we’ve warned about (notably XPO and Maxar Technologies), and also played a part in the collapse of the scandal at MDC Partners. Amcor is also intensifying its use of commercial paper (CP), a risky strategy given it was recently downgraded by credit agency Fitch, and as a BBB credit, is close to junk status. As a junk credit, Amcor’s access to the CP market could be restricted, its cost of capital rise, and its liquidity reduced. Amcor embellishes its liquidity by claiming its CP is “long-term” debt, but we believe it should be viewed as short-term.
    • Investors should have limited confidence in Amcor’s financial reporting given unresolved material weaknesses that have lingered for 18 months. We find evidence of revenue, capex and even interest income revisions. Amcor is understating its true leverage, and its dividend is not safe even assuming base case market projections come true
    • Why Free Cash Flow Won’t Improve And The Dividend Is At Risk: In its recent quarter, Amcor became more aggressive with add-backs in its free cash flow presentation, a classic sign of strain. The CFO claims cash flow will seasonally improve through June 2020 (2H’20), but this conflicts with an on the record statement by Bemis’ CEO before the deal closed that its strongest cash generation is in Q3 (June-Sept). Amcor has said that its 3.5% capex to sales spend is “a healthy amount”, but based on our analysis, the average industry capex spend is 5.5%. While all Amcor’s close peers maintain or increase capex spending, we believe Amcor is materially underinvesting in the near-term, a strategy that will depress future free cash flow. Pre-deal Amcor said it required $400m of annual capex to maintain organic growth. However, our analysis shows legacy Amcor capex is running 30%-35% less. We believe Amcor will soon face a crossroads in its financial strategy between completing a $500m share repurchase program, increasing capex to remain competitive, and paying a generous $725m/year dividend. Absent a suspension of repurchases, we believe Amcor will be unlikely to maintain its current dividend.
    • Leverage Is Greater Than It Appears: Amcor does not include leases in its presentation of Net Debt to investors. Leases currently amount to $580m, and are now recorded on the Company’s balance sheet. In addition, Amcor has $354m of unfunded employee benefit liabilities. Going against Financial Accounting Standards Board guidance, Amcor does not clearly mark restricted cash amounts in its cash flow statement. However, it disclosed deep in its footnotes that $13.5m was deposited with a Brazilian court to defend a case. In addition, one rating agency views $150m of cash as restricted and necessary for working capital needs. On the surface, the Company tells investors it is levered 2.9x Net Debt / PF Adjusted EBITDA, but with these basic adjustments, we estimate leverage is 3.3x.
    • Unresolved Material Weaknesses And A Chief Accounting Officer That Appears To Have Misrepresented Himself: Amcor disclosed two material weakness of accounting, disclosure and financial control matters that haven’t been resolved in 18 months. The Company hasn’t been specific about areas affected. Based on our review, we find it has made unusual revisions to revenue, capex, and most alarming, interest income. This bolsters our concerns that cash could be misrepresented. Amcor’s Chief Accounting Officer is Jerry S. Krempa, who came from Bemis where his biography publicly states that he is a CPA. However, based on our background check, his CPA was listed as “REVOKED” by the state of Minnesota for disciplinary reasons in January 2017. In light of our observations, we believe investors should demand a full investigation into Amcor’s financial affairs.
    • Poor Insider Alignment And Corporate Governance Practices: In our view, Amcor’s transformation to a global company has left it far behind best practices in global corporate governance. Amcor’s insiders own a measly 0.2% of the stock, and show signs of acting in their own self-interest. To illustrate, Amcor subtly changed the vesting period for long-term stock compensation from 3 to 2 years, consistent with our view that management wants to cash out fast, and is aware the merger is underperforming expectations. Amcor measures its performance relative to a basket of Australian companies (most of which are not even in the paper/packaging industry). This makes no sense given only ~3% of Amcor’s revenues and assets are in Australia. From a governance perspective, we are concerned that Amcor’s lead audit partner at PwC is an industry specialist in Pharma and Life Sciences, and not paper/packaging. In addition, the recent audit chair, another senior PwC global executive, left abruptly amidst heightened scrutiny in Australia about the closeness of the firm to various Australian company Boards.
    • Few Shareholder Benefits Created By Dual Listing And Slanted Analyst Base: A Poor Risk/Reward Investment Opportunity: Investors were sold by management that the deal would create “flow-forward” and new index buying demand from a dual U.S./Australian listing. However, based on our analysis we don’t believe this is accurate. We find that Bemis’ top fundamental owners have been selling stock. We believe that Amcor has a large Australian retail investor base that is being baited by local analysts with overly-optimistic price targets. As noted earlier, despite just ~3% of its business based in Australia, 8 out of 12 sell-side analysts covering Amcor reside in Australia. The average price target of A$16.59 / US$10.75 implies 19% upside, and incorporates management’s commentary at face value that it can pull-off a complicated global merger between two disparate cultures, grow revenues 1.5% – 2.0%, while expanding margins and cash flow through multiple different restructuring and cost cutting programs. All of this would be difficult to achieve in a normal environment, setting aside global growth fears from the Coronavirus (Amcor has >$225m of revenue in and around lockdown zones in Italy). Our forensic analysis suggests it may be outright impossible for Amcor to meet lofty analyst expectations, with revenues already vanishing, deal costs higher than planned, and critical maintenance and growth capital expenditures being delayed. Amcor’s valuation is in-line with industry peers, but should trade at a discount to reflect our documented concerns about the accuracy of its financial statements, fragile financial condition and unsustainable dividend policy. Amcor investors should study the recent $5bn Westrock/Kapstone packaging deal as a comparable example of what to expect. The combined company has repeatedly missed sales forecasts, and is now expected to decline, resulting in significant multiple contraction. Westrock is comparably levered to Amcor, has higher margins, and also has a ~5% dividend yield. If we applied Westrock and its closest peers sales multiple of 1.0x – 1.2x to Amcor, it’s easy to justify 40% – 60% downside risk to Amcor’s share price.

Dropbox, Inc.

    • Dropboxs (“DBX” or “the Company”) was once seen – and is still seen by most investors – as the quintessential Silicon Valley software unicorn: a fast-growing, highly cash-generative SaaS company with a sticky customer base and a long runway for upsells. Spruce Point finds overwhelming evidence that the story has changed: Dropbox is a decelerating business in an increasingly low value-added space, with little network effects or barriers to entry. Meanwhile, management’s recent attempt to reaccelerate growth appears to be falling flat. We have collected unique data showing that its late FY19 decision to raise prices after creating a more “business-friendly” platform – dubbed the “New Dropbox” – has enraged some of its core individual/SMB user base, and has given customers new reason to consider switching. Some investors take solace in Dropbox’s seemingly healthy cash flow, but Spruce Point believes that its FCF margin is misunderstood by the Street by as much as 2x. Dropbox is a melting ice cube, and management’s last-ditch turnaround attempt is poised to disappoint lofty analyst expectations. Spruce Point believes that its new normal of accelerated churn, increased capex, and rising customer acquisition costs will come to bear on results as soon as the next few quarters.
    • Increasingly Low Value-Added Industry: In the decade since Dropbox was one of the first to market with retail cloud storage in the late 2000s, industry behemoths like Google, Microsoft, and Apple have begun to offer cheap or free storage plans as part of broader cloud software solutions, causing Dropbox’s paid user growth to begin to approach single-digit levels. Margin expansion – as high as 1,500 bps per year as recently as FY17 – has also skidded to a virtual halt. Dropbox is effectively a “pure play” company in an industry which is becoming increasingly commoditized to the point of near-zero returns at the extreme.
    • Missing The Boat On The Remaining TAM: File storage and sync competitors such as Box, as well as other new entrants, are focusing their efforts on the enterprise vertical, where companies are increasingly looking to outsource file storage onto the cloud in a secure manner. Dropbox initially carved out its niche among retail and SMB users, and has failed to make similar inroads among large corporates. Industry experts tell us that Dropbox is virtually “nowhere to be seen” on the marketing trail in the enterprise vertical, as it does not meet many of the stringent compliance and cybersecurity needs of large businesses in heavily-regulated industries. The initial response to Dropbox’s new feature rollout appears to be “too little, too late” among these potential customers.
    • Not-So-Sticky Customer Base Given A New Reason To Switch: In an attempt to appeal to the enterprise market – and to raise prices on existing customers – Dropbox rolled out an entirely new platform (“Dropbox Spaces”) in Sept 2019. The customer response appears to be extremely negative, with users speaking out across forums to voice their displeasure with the price hike. Spruce Point’s proprietary customer survey reveals that half of Dropbox users – individual and business alike – do not believe that the new features justify the price hike, and that two thirds do not believe that it would be difficult to shift to a different cloud storage provider. Our survey results also indicate that the changes to Dropbox’s platform and pricing structure will result in accelerated churn in the near term, about which management is rarely transparent in its own right. Not surprisingly, key Dropbox executives are departing just as these changes take effect.
    • Cash Flow Potential Misunderstood By A Significant Margin: We find that Dropbox, like most aggressive tech companies with poor business models which we’ve evaluated, tries to spin a rosy “Non-GAAP” measure of Free Cash Flow, suggesting 30% FCF margins. However, Dropbox depends heavily on capital lease spending – effectively deferred capex – that is growing faster than the market believes, yet which its proprietary FCF metric ignores. This capex, along with rising customer acquisition costs and heavy share repurchases to offset stock compensation programs, will cause Dropbox’s cash flow to fall significantly below expectations.
    • Spruce Point Sees 25%-60% Downside Given Near-Term Headwinds And Cash Flow Adjustments: Analysts have largely maintained their lofty pre-IPO price targets on DBX, seeing 50%+ upside despite tangible evidence that the growth story is faltering. Bulls may think that its 3.8x NTM sales multiple is starting to “look cheap,” but this view ignores the declining quality of DBX revenue, tied to a fickle customer demonstrating rising churn, and to a service with a declining value proposition. We see a major reset coming as management’s levers to increase ARPU disappear, its TAM taps out, and more human capital departs in search of the next hot Silicon Valley growth story. As revenue challenges mount, we believe investors will focus more on the economics of Dropbox’s cash flow. While it currently trades at 105x our projected 2020 FCF, we believe that maturing “SaaS” plays with higher margins trade at 25x-50x, implying material downside risk.

LHC Group, Inc.

    • LHC Group (“LHCG” or “the Company”) is a roll-up of post-acute home health centers which, in Apr 2018, completed a transformative merger of equals with fellow home health services provider Almost Family (“AFAM”). The merger was pitched to investors as a highly-synergistic deal which would produce a company capable of consistent mid-single-digit organic growth. However, Spruce Point’s forensic analysis of Company filings suggests that, whereas AFAM was expected to grow annually at 5-6% following the deal, the business is now contracting. At the same time, management appears to have taken steps to obfuscate AFAM growth and to avoid including it in organic sales, despite the fact that the deal closed ~21 months ago. With AFAM included in LHCG organic sales, as it should be, organic growth would fall from a reported ~7% to less than 2%. Meanwhile, surreptitious purchase accounting adjustments and questionable “one-time” acquisition-related charges have erased nearly 15% of the announced deal value. With LHCG’s true organic growth far below reported levels, and with management appearing to have serious problems integrating AFAM into LHCG, we question not just LHCG’s reported organic growth and adjusted earnings figures, but the continued viability of management’s roll-up strategy itself – and, consequently, the growth-driven narrative underpinning the bull case for the stock.
    • AFAM Appears To Be Contracting: Disclosures regarding acquired inorganic revenue imply that AFAM has severely underperformed both Company and sell-side expectations. We estimate that AFAM revenue is now contracting after it was first expected to grow 5-6% per year. Management appears to avoid reporting AFAM growth, or has cherry-picked unrepresentative metrics which superficially project the appearance of improvement.
    • Management Jumping Through Hoops To Flatter Organic Growth?: Management excludes AFAM from organic sales even though it was acquired ~21 months ago. This omission inflates reported organic growth by ~500 bps, from less than 2% to ~7%. Selective divestments of underperforming locations also inflate reported organic growth. This has saved a key LHCG metric – one followed closely by sell-side analysts – from collapsing at the hands of AFAM headwinds.
    • The Cause – Bungled Integration? Or Customer Reallocation?: AFAM throughput appears to have suddenly collapsed immediately after the deal’s closure, and has since fallen more than 30% below pre-deal levels. Throughput at legacy LHCG locations has simultaneously expanded by close to 10%. Could AFAM’s apparent contraction be explained by the cannibalization (purposeful or not) of AFAM locations by legacy LHCG locations? If so, LHCG’s high single-digit reported organic growth is being supported directly by cutbacks at locations not yet included in the organic base, which will inevitably weigh on organic growth once they are in fact included (as they should be already). We also find that, after claiming that the integration would be extremely swift, management has since subtly pushed forward its integration timeline on an almost quarterly basis. Today, more than two years after management first stated that the integration was already nearly complete, it is still in the process of integrating AFAM into LHCG’s software, and had integrated only about half of AFAM locations by the end of last quarter. We harbor significant doubts as to the competence of LHCG management and the continued viability of its roll-up strategy given these apparent integration issues.
    • Concerning Purchase Accounting Adjustments: Management appears to have gradually increased AFAM’s bad debt allowance from $27M to $65M, suggesting that nearly half of acquired AFAM receivables may be uncollectible. The post-M&A purchase accounting adjustment window may also be giving LHCG a chance to take effective asset write-downs which do not flow through the income statement, and, therefore, which do not hit earnings. This, combined with ~$67M worth of integration costs through ~2 years and counting, has destroyed over $100M of shareholder value for holders of LHCG, nearly 15% of the AFAM purchase price.
    • We See 40%-60% Downside After Taking Into Account LHCG’s True Organic Growth, Earnings, And Business Risks: LHCG remains a popular “buy” among analysts enamored by the Company’s seemingly-robust organic growth profile and runway for tuck-in M&A, particularly following an Oct 31 update to Medicare’s Patient-Driven Groupings Model which was broadly perceived to be supportive of continued industry consolidation. Even then, the average analyst price target implies only 3% upside from current levels. Why should investors own stock in a Company which, in our opinion, misrepresents its organic growth profile by 500bps, and whose management cannot effectively carry out its strategy at large scale? We expect organic underperformance and disappointing earnings to result in significant valuation compression from LHCG’s current 20.6x ‘20E EBITDA multiple – an all-time high for the stock.

Plug Power Inc.

    • Plug Power (“PLUG” or “the Company”) is a manufacturer of hydrogen fuel cell systems with a ~20 year history of setting unrealistic goals and resorting to onerous financing, endless equity raises, and creative accounting to support unsustainable growth. It appears to be repeating this pattern of behavior today. The stock has advanced to a five-year high and $1.5B market cap (fully-diluted) on the back of rapid multiple expansion as analysts claim that PLUG has turned a corner by producing back-to-back quarters of positive EBITDA – a first for the Company. A closer analysis, however, reveals that this is largely attributable to a recent accounting change, amended lease agreements which conveniently take advantage of it, and dubious non-GAAP adjustments which defy reasonable accounting logic. Adjusting for these factors wipes out PLUG’s recent “inflection” to profitability and suggests that Company economics remain largely unchanged. PLUG has burdened itself with expensive debt and unfavorable customer agreements to support top-line growth and the appearance of profitability. A strained balance sheet and rapid cash burn could soon force Company to dilute investors even further, while, at the same time, it loses access to the leaseback arrangements supportive of the accelerated sales growth which has made dilution palatable of late.
    • A Long History of Unrealistic Targets and Broken Promises: Management is fond of saying that “we’ll be profitable this year.” It never is (until this year, or so it says). For ~20 years, management has stoked investor confidence by citing big TAMs, futuristic use-cases, and the latest investor buzzwords, creating a dedicated following of growth-oriented retail investors singing PLUG’s praises across internet chatboards. Underneath it all, PLUG has never turned a sustainable profit and has failed time and again to meet management’s promotional targets, both near and long-term. Institutional investors have almost entirely exited the stock as they see little reason to believe management’s promotional targets – nor that management will keep any promises not to dilute shareholders.
    • Dependent on Vendor Financing, Unfavorable Customer Agreements, and Expensive Debt for Growth: While large customer wins have supported sales growth at PLUG through the past five years, they came at a steep price. Much of this growth was facilitated by PLUG’s decision to provide expanded lease financing directly to customers in ~2014, likely at the behest of large, powerful customers such as Walmart and others. Sale/leaseback agreements with third parties, intended to support this lending, have tied up PLUG’s balance sheet in over $150M of restricted cash required by its financing partners to guarantee its leases with customers. PLUG’s attempts to finance customer arrangements through other means have resulted in excessive shareholder dilution – by a third of the total float in 2017 alone – despite management’s stated commitment to seek financing which would prevent it from having to distribute equity. Maintaining current sales and earnings growth rates will required similar dilution or leveraging up, which is becoming more and more unrealistic as the Company’s balance sheet becomes increasingly strained.
    • Recent Inflection to Profitability Attributable to Accounting Changes and Non-GAAP Adjustments: Since first embracing vendor financing as a route to growth, PLUG has crafted a panoply of non-GAAP metrics designed to recognize sales and profit associated with leased equipment up front. With its recent (accelerated) implementation of ASC 842 in late 2018, it was given a golden ticket to undertake the aggressive revenue and profit recognition that it had attempted to do several quarters prior, before receiving heavy pushback from SEC comment letters. PLUG immediately restructured its sale/leaseback agreements in late 2018 in a way that allowed it to maximize the benefit of this accounting change, and soon thereafter raised revenue guidance on claims of “ongoing development of its business pipeline.” Reversing this accounting windfall shows that sales growth and underlying profitability improved little, if at all, through late 2018-19. Further, in its recently-issued non-GAAP metrics, PLUG is also attempting to accelerate the top-line benefit of these agreements while removing the impact of inextricably-linked costs, skewing investors’ understanding of profitability.
    • Recent “Inflection to Profitability” Excites Investors, But Will Inevitably Be Short-Lived: PLUG shares trade at an all-time high $1.5B valuation and a peak EV/Sales multiple, on investor confidence that its recent “inflection” is a sign that the Company has finally turned the profitability corner. However, continued paper profitability will depend on continued growth through operating-type sale/leaseback agreements, for which the Company is rapidly running out of capacity given its $180M TTM cash burn and ballooning debt . Future growth facilitated by vendor financing, the source of most of its recent growth, must inevitably rely on alternative forms of financing which lack the advantageous accounting treatment of operating leasebacks, and which could entail further shareholder dilution.
    • Spruce Point’s Conclusion – PLUG Is Uninvestible: PLUG has never generated a meaningful profit in its ~20 year history, and almost all of its recent sales and earnings growth has been supported by either unsustainable financing or shareholder dilution. The Company does not have a clear path to profitability or steady growth without continuing to access these financing channels, some of which may become inaccessible to it in the near term. There is no reason to own PLUG shares unless, and until, the Company proves that it can grow and produce a profit on sustainable financing.
    • Non-credible management frequently announcing unrealistic targets that it consistently fails to achieve
    • “Smart” institutional investors’ avoidance of the stock suggests they have no trust in the Company
    • Capital structure deteriorating with escalating debt, and shareholders will inevitably bear the cost through more dilution
    • Recent “inflection” to profitability a product of accounting rather than underlying fundamental improvement
    • Absent access to capital, PLUG is worthless – and all assets have been pledged to creditor

Canadian Tire Corporation, Ltd.

    • Spruce Point has significant concerns about Canadian Tire (TSE: CTC or “the Company”), one of the largest retailers in Canada. Canadian Tire is a challenged brick-and-mortar retailer perceived as a dependable mid-single-digit grower on an increasingly precarious foundation of unsustainable debt. CTC is facing a credit downgrade due to its misunderstood and over-levered balance sheet, which has forced it to sell profitable assets in order to continue its capital return plan. Current leverage of ~3.5x is significantly above rating agency guidance of 2x needed to prevent a downgrade and requires debt reduction of ~C$1,600m, but has no free cash flow after promised dividends and buybacks. CTC’s stale brand and dated model, together with broader retail headwinds, have made its financial results dependent on aggressive accounting practices, which are potentially misleading investors by covering up poor organic growth. The market is blissfully ignorant to the Amazon displacement effect that our data shows is accelerating. Recent cost reduction measures and return of capital policies to investors are ill-fated, too little and too late. Outside of retail, CT Financial Services’ is a fast growing, risky business with a deteriorating credit card portfolio. We believe CTC will begin to under-perform optimistic expectations and the combination of these factors should result in a valuation at a significant discount to the market and its peers.
    • An Antiquated And Structurally Non-Competitive Brick And Mortar Retailer With No Clear Focus And No Competitive Advantage
    • CTC’s retail footprint consists of Canadian Tire, Mark’s and FGL Sports banner stores with products ranging from automotive, tools & hardware, home goods and sports & recreation.
    • While SSS (same store sales) have grown modestly, we believe a significant part of the growth is not sustainable due to the declining number of stores and a rapidly saturated market
    • CTC’s has no competitive advantage and often leaves customers “frazzled-looking” due to the vast stores and cluttered aisles. The 4 P’s of marketing suggest that CTC is at a clear disadvantage in the retail market:
    • Product: Diverse assortment with no clear focus, sweet spot is mostly lower quality, mass market products (low ticket items of ~$50). Price: Not price competitive, products are often marked down on “flyer” sales, least competitive shipping fees vs. peers (no free shipping) and offering free shipping will destroy already contracting margins. Place: Brick and mortar business model with stores often located in close proximity, or sometimes in the same shopping center as, competitors including Walmart, Costco, Home Depot and Lowe’s. Major U.S. retailers continue to expand in Canada and gain market share. As Canadian e-commerce continues to grow, and mobile adoption increases, CTC’s business lags peers. Promotion: Promotes through “old-fashion” flyers, credit card promotions and Canadian Tire Money. Weak social media presence.
    • Canadian Tire Gas+ is experiencing margin pressure due to increased competition in the market – we anticipate this to continue due to the ~9% discount Costco Gas offers its customers. Website traffic and mobile app data suggest CTC is struggling relative to its peers. Website visitors are 25x more likely to visit and mobile app users who use Amazon’s app too has increased from 50% to 75% over the last 2 years. Amazon’s Showroom: CTC has one of the lowest conversion rate for customers who made a purchase vs. people who visit its stores. E-commerce lags peers and CTC cannot match the level of investment in technology as its competitors.
    • Don’t Bet On Botched Acquisitions Saving CTC: Helly Hansen, acquired in Q3’19, continues to underperform expectations and we believe is losing market share outside of Canadian Tire banner stores. Yet, we believe management has led analysts to believe the deal is a raging success. We believe the acquisition of Party City Canada will be a larger failure than Helly Hansen – Party City continues to struggle in the U.S. (PRTY shares are down 70% since November 7th, 2019) and we see no reason its Canadian business will not suffer a similar fate.
    • Declining Organic Growth, Compressing Margins and Multiple Signs of Financial Stress. CTC’s underlying retail business is struggling and has experienced gross margin compression – CTC retail reported gross margin figures mask underlying weakness due to the addition of Helly Hansen, a higher margin business. Recent announcement of a $200m cost savings plan is destined to fail; management’s plan was very broad, lacking tangible specifics, and reminds us of numerous failed retail turnarounds all claiming $200m of cost savings as a magic number (Sears, JCPenney, Circuit City). CTC’s Executive leading the efforts has a history of failed turnarounds at BlackBerry and Celestica.
    • There are many signs of financial stress: Rising inventory levels in dealer channels suggests a slowdown in dealers’ ability to sell to end market customers. Receivables growth is significantly outpacing revenue growth over the past 21 months. Worsening cash flow dynamics as days inventory increase and days payable decline year-over-year. Further stress evident as cash conversion cycle is peaking over the last three quarters. Dealer model highly dependent on leverage – guarantees result in increased exposure for CTC.
    • We Believe There Is A High Probability Of A Credit Ratings Downgrade Which Is Forcing The Company To Sell Assets And Reevaluate Capital Allocation – Required Debt Reduction Of ~C$1,600m vs. FCF Of ~C$200m. Multiple rating agencies have warned of a credit downgrade if leverage is not reduced. Our analysis supports the view it will be nearly impossible to delever while maintaining current levels of dividends and share repurchases without selling assets. Current Adjusted Net Debt / Adjusted EBITDAR leverage: 3.45x; BBB rating by DBRS, BBB+ by S&P. A downgrade would result in a rating on the cusp of non-investment grade (junk) status and potentially higher cost of capital.
    • Management has stated its investment grade rating is a top priority but is acting in a different manner: CTC has continued to buyback shares while its leverage remains above the level required to prevent a credit downgrade. Management has shown no ability to create value from share repurchases. CTC is also increasing its dividend by ~9% in a period where it should be conserving cash. Forced to sell assets to delver: recent actions to conserve cash are counterproductive to accreting shareholder value. Divesting stake in CT REIT is dilutive to EPS and shareholder value – sell-side analysts believe this is a positive and shows CTC’s financial flexibility. We believe this shows Canadian Tire needs to raise cash. Recent increases in disposal of investment properties also signals the Company is in need of cash to delever. CTC was unable to fund its acquisition of Helly Hansen and Party City Canada with its current balance sheet and was required to sell down its REIT stake to finance the transactions.
    • Major Push To Grow Credit Card Business, And Fuel Retail Sales Growth, Has Resulted In Risky Lending Practices Which Should Worry Investors And Pose A Significant Threat To Overall Credit Quality. Credit risk is higher than traditional banks given the nature of Canadian Tire’s business – CTC credit card customers are typically higher risk than traditional users. CTC credit cards are used as a mean for financing a purchase, rather than traditional use as a method of payment. CTC Triangle Rewards Program has been an effort to boost retail sales and drive store traffic at the expense of higher risk lending practices. While management has said “we’re not concerned about the level of risk in the portfolio,” filings show 68% of recent loan growth came from moderate and high risk customer classifications. Net charge-offs for “seasoned” loans is at historic highs despite the majority of high risk growth over the past 12 months. This is a leading indicator for an increase in future credit losses as loans begin to mature. Delinquencies have performed worse compared to other banks over the past 2 years, a signal that should worry investors.
    • Multiple Factors Have Resulted In Reported EPS Growth Greater Than CTC’s True Underlying Earnings Growth. When adjusting CTC’s EPS for what we believe to be one-time benefits, the YoY EPS growth rates drop significantly. Recent benefits have helped CTC hit its EPS growth target of 10%+. We believe investors will be caught by surprise when this growth returns to normal levels. Many of the EPS benefits have been a result of management’s aggressive changes to its accounting practices including: altering expected credit losses by modifying model assumptions, changed estimates affecting the present value of loss recoveries and changes to the Company’s depreciation method.
    • Several Signals In CTC’s Corporate Governance Policies And Insiders’ Recent Behavior Should Concern Investors. Canadian Tire and CT REIT are uniquely hiding their credit agreements from investors and keeping their debt structure opaque. Current calculation of executive incentive compensation is not in shareholders’ best interest and is not transparent to investors. CTC’s Chairwomen was a Director and a member of the audit and corporate governance committee for Hollinger leading up to its fraud. Multiple recent insider resignations are a negative signal given the recent business struggles. Diana Chant’s, an Audit Committee member, recent ownership history at the bare minimum required as a Board member raises concerns about her trust in the future of the business – does she know something the public doesn’t?
    • Terrible Risk / Reward Opportunity And Significant Downside To Current Share Price.
    • Spruce Point has a history of successfully exposing poorly positioned Canadian companies before the market realizes fundamentals have changed (eg. Maxar, Just Energy, Dollarama). Canadian brokers incorrectly believe CTC is a best-of-breed retailer that can withstand competitive pressures, grow 4-5%, expand gross margins ~20bps and is worth C$167 per share (~10% upside). Analysts have priced in full credit for CTC’s nebulous cost cutting program.
    • Based on a sum-of-the-parts value, CTC trades at a significant premium to our downside case.
    • Spruce Point believes CTC’s retail segment should be valued on a cash flow basis which is a more accurate representation of fair value due to the segments poor cash flow conversion and distorted “normalized” results. CTC’s declining margins and weak competitive positioning to U.S. retailers and online competitors deserves a valuation multiple at a significant discount to its peers.

Cintas Corp.

    • Based on a new public FOIA and our research, we believe Cintas’ Fire Protection Services business has committed fraud and is causing a public safety hazard by having workers conduct fire and safety inspections without proper licenses or permits, and falsify inspections. We call on Cintas to conduct a review to assure stakeholders it’s not a systemic issue placing Cintas in non-compliance with its credit agreement. Fire Protection is its fastest growing segment. Our research indicates that Cintas’ has a poor reputation, and that new private equity and public money is entering the space, which will compress its growth and margins. In addition, we believe that Cintas is facing financial strain in its core uniform rental business from its 2017 levered acquisition of G&K for $2.1bn. With sell-side analysts failing to acknowledge any of these problems, or conduct a nuanced valuation of its various business segments to reflect divergent growth and risk profiles, our variant view suggests 60%-75% downside.
    • We Believe Cintas Overpaid For G&K, Is Struggling To Integrate It, And Spinning A Weak “Beat And Raise” Story to consolidate share and extract synergies, Cintas acquired G&K Services in 2017 for $2.1bn with new debt. Based on proxy statement disclosures, Cintas paid an additional $425m above its initial offer to acquire a business that was described to us as having a poor reputation. Cintas touted a “Beat and Raise” story post acquisition, but based on our forensic review, it appears that Cintas may have suppressed G&K’s sales, only to raise sales guidance by a similar amount to the sales that had been suppressed. Even worse, evidence points to Cintas over-estimating expenses, only to roll-them back and claim outperformance. In addition, Cintas said one thing, but did another by subtly changing capital priorities (cutting capex, increasing share repurchases) in an effort to artificially grow EPS. For FY 2019, we estimate Cintas had no underlying outperformance relative to initial guidance.
    • Recent changes in revenue disclosure reveal for the first time that Cintas’ fastest organically growing business is fire inspection, which has grown at a 3 year CAGR of 14%, above the historical and projected industry growth rate of 8% as illustrated by National Fire Prevention Association.
    • Based on our research, the biggest fundamental challenge in the industry is a qualified labor shortage. Cintas has used an “affiliate network” to expand its reach, but this approach brings challenges such as monitoring the quality and capability of its workforce.
    • Using a Freedom of Information Act (FOIA) request, we find that Cintas was charged with fraudulent business practices. Upon a fire outbreak in Aurora, IL, it was determined that Cintas had 8 of 12 inspectors unlicensed and unfit to carry out inspection duties for the 22 properties within Aurora’s jurisdiction. These inspectors were thus falsifying inspection records. Based on our research, we believe this may not be an isolated incident, and that Cintas may have breeched its credit agreement by incorrectly representing that it holds all the necessary licenses to conduct its business in compliance with the law.
    • Cintas must conduct an independent and formal review to assure all its stakeholders that it is in compliance with all applicable laws, and holds all necessary permits when conducting life-critical inspection operations.
    • Cintas is also being sued in a wrongful death lawsuit for inaccurate inspections in a mining accident that was documented by the Mine Safety and Health Administration. Incidents such as this, while very unfortunate, add complex tail risks to its business
    • Given lapses in judgement such as this, and based on industry conversations, it doesn’t appear to be a secret in the industry that Cintas has a poor reputation. As a result, new money is flooding into the industry to disrupt Cintas’ national market position. We find evidence that historical contracts that locked in customers for 3-5 years are being shortened to just 1 year, and that prices are compressing; both are negative outcomes for Cintas.
    • Fueled by cheap financing and the ability to leverage contractually mandated inspection revenues, private equity players are creating regional platform acquisition vehicles to seize market share from disgruntled Cintas customers. In addition, APi Group, a large national competitor was just acquired by a UK SPAC, and will be listed on the NYSE, giving it broader access to public capital to compete against Cintas.
    • Spruce Point has various concerns about the Board including a lack a separation between its Chairman and CEO, Board and family relationships that are not independent, unjust compensation practices, and the closeness of Cintas with its auditor.
    • Ernst & Young has been Cintas’ auditor since 1968. The engagement partner at Ernst & Young is Craig Andrew Marshall. Mr. Marshall is also the audit engagement partner at Papa John’s International (Nasdaq: PZZA). Papa John’s dismissed Mr. Marshall and E&Y in 2018. Since hiring KPMG in early 2019, Papa John’s disclosed a new material weaknesses of financial controls and reporting. Both Cintas’ CFO J Michael Hansen and its VP/Treasurer Paul Adler both worked at Ernst & Young. Spruce Point believes it is time Cintas shareholders appoint a new auditor and fresh eyes to look at its accounting practices.
    • Cintas’ just appointed Karen Carnahan to its Audit Committee. Cintas claims she is “independent”, yet as a 30 year former Cintas veteran and Treasurer connected to CEO Farmer, we question why is she joining now in light of our views that Cintas is experiencing financial stress? Furthermore, we find that she serves as a Trustee of another Audit Director’s company, and is likely paid; can she act independently?
    • Cintas management, with the blessing of the Board, claimed great performance for the G&K deal. Special bonuses were awarded to executives for completing the deal, despite our evidence it has weakened the overall financial profile of Cintas.
    • Cintas’ annual incentive plan is based on sales and EPS growth, along with non-financial goals. In 2019, 41.75% of CEO Farmer’s bonus was tied to EPS performance, while for most other executives, it accounted for 50% of the bonus. Cintas conveniently achieved almost the maximum EPS target within one penny, and claims its $7.60 EPS took into consideration various “one-time items”. Yet, in FY 2019, Cintas adopted a new revenue recognition method that boosted pre-tax income by $22.3m and Diluted EPS by $0.15 cents. Why wasn’t this considered a “one-time” or “extraordinary” boost to income?
    • Analysts and investors love Cintas for its consistent ability to grow earnings, while returning capital through share repurchases, and a modest dividend yield. The consensus view is that it can produce 5-6% organic sales growth and 10-11% EPS growth by using its market dominance in stable industries to satisfy customers.
    • As a result, analysts’ reward Cintas with the highest multiple among its commercial and safety publicly traded peers. The average analyst price target is $255 per share. Yet, at the current share price of $259, there’s 1% implied downside on valuation alone, and materially more downside based on increasing business pressures.
    • Our view of Cintas is markedly different from consensus and we believe: There is a uniform displeasure with Cintas’ billing practices, one-style approach to customers, and willingness to skirt the law with fraudulent business practices that place lives at risk. The G&K acquisition has worsened Cintas’ overall financial profile through greater capital intensity, bloating of receivables and bad debts, and greater exposure to cyclical industries such as oil and gas. Cintas corporate governance is substandard for its size and position as an S&P 500 company. Notably the CEO/Chairman roles are not split, it allows pledging of stock by executives, and the Board is stacked with long-time allies of the CEO with business connections between Board members. As a result, the expansion of Cintas’ valuation multiple over the past few years is unwarranted.
    • Analysts fail to critically evaluate each of Cintas’ business lines and apply a proper valuation to reflect the different growth and risk profiles.
    • Despite trading a 4x sales and 18x EBITDA, not a single one of Cintas’ business lines can be justified at this valuation by looking at recent acquisitions completed. Transaction values are closer to 1x – 2x of revenues. When summed together, the fair value of Cintas’ business is $69 – $107, or 60% – 75% downside.

Hill-Rom Holdings, Inc.

    • Hill-Rom (“HRC” or “the Company”) is a low-quality medical equipment roll-up which is rapidly approaching the end of its current growth cycle. HRC is a jumble of hospital furniture and medical device businesses assembled in part through $3.5B-worth of hasty acquisitions executed throughout the 2010s. Its atrocious record of M&A has left management to divest of a graveyard-full of failed acquisitions – many of them now a fraction of their initial sizes, and some exited at nearly complete losses. Analysts nonetheless give management credit for diversifying outside of capital goods, growing “core sales,” and expanding margins, largely through M&A (despite its failures) and recent product releases. However, Spruce Point finds that sequential new product growth has plateaued for three straight quarters, and is set to translate into depressed annual growth as the plateau rolls into Q4. Excluding the incremental contribution of these product releases, HRC’s organic “core growth” has been flat at best – a fact which has until now been hidden by new products and management’s discretionary and suspiciously fluid definition of “core growth.” Spruce Point also finds that nearly all margin expansion can be attributed to recent divestitures of low-margin businesses and acquisitions of higher-margin targets, leaving HRC with seemingly no route to higher profitability without continued M&A – an avenue which will be limited to it as it nears self-imposed leverage limits. Meanwhile, key executives have dumped stock and fled the Company at a break-neck pace through the past two years, perhaps in anticipation of its growth reverting to stagnant levels just as management prepares to release renewed long-term guidance.
    • A History Of Value-Destructive M&A : In an attempt to make up for slow top-line growth driven by low demand for low-tech hospital furniture, management has spent ~$3.5B on M&A since FY09 on businesses across numerous sub-sectors and geographies. However, it has subsequently exited or divested of many of these businesses, usually at a loss after experiencing material top-line contraction. The sell side has cheered both Hill-Rom’s acquisitions and its divestitures, interpreting the former as an avenue to sources of more recurring sales and the latter as part of an initiative to exit low-growth and low-margin business lines. Spruce Point, however, sees them for what they are: evidence of management treading water as it burns cash to acquire businesses which it subsequently drives into the ground under a corporate culture which, per formers, prioritizes hitting numbers above all else.
    • Failure To Fully Write Down Assets: HRC has taken impairments of varying sizes in conjunction with a number of its divestitures of failing business lines. However, we identify two such exits for which management appears to have taken either no impairment or only an insufficient one. We believe that just over $500M of goodwill and other intangibles must be written off of Hill-Rom’s balance sheet, representing approximately 11% of Hill-Rom’s total assets.
    • Non-Stop M&A And Confusing Math Masks A Slow-Growing Business: As management exits failing acquisitions, it instructs analysts to evaluate growth using its proprietary “core growth” metric, which adjusts growth for the negative impact of planned divestitures even before they occur. Management conveniently “re-bases” core growth every few quarters by adding new slow-growth business lines to non-core revenue, supporting consistent mid-single-digit core growth even as these ring-fenced verticals drag on total sales. Why should investors give Hill-Rom credit for achieving higher growth when this growth is achieved by exiting businesses (typically at a loss) which it acquired and killed over the course of just several years? Why does management exclude divestitures from “core growth,” but include the inorganic sales contributions of new acquisitions? Management has been able to present top-line growth of almost 300 bps greater than total growth in some quarters by selectively adjusting the many puts and takes which make up “core growth.”
    • Free Cash Flow Inflated From Chronic Mis-Forecasting of Capex And Low R&D: HRC has consistently misguided investors about capex requirements almost every year since FY10, and has underspent on capex against pre-year guidance by 20-30% since FY16. With most of its fixed asset base having a 10 year stated life, we expect years of capital neglect to weigh on future cash flow growth. HRC suggests that new product releases are a key driver of growth, but how will it continue to generate new product sales as it shrinks its capex and R&D spend even as core sales increase? Spruce Point has found that companies which mismanage capex often subsequently disappoint investors with material margin contraction (e.g. Caesarstone, A.O. Smith, and Gentex).
    • Slowing Revenue Growth From New Products Sets Hill-Rom Up To Disappoint: New product releases such as its Centrella “smart” bed have prevented Hill-Rom from showing dramatic core sales contraction over the last two years: these new products have grown from generating zero revenue prior to 2017 to over $400M in FY19 (expected). Management claims that it has accelerated the hospital bed repurchasing cycle by transforming the bed from a mere piece of furniture into a vital piece of hospital room technology. However, former employees and industry experts suggest that new product revenue will quickly normalize after a brief initial period of sales uptake. After adjusting for M&A and incremental sales contributed by new products, Spruce Point believes that Hill-Rom’s underlying sales growth has been effectively flat at best, versus management’s reported “core growth” of 2%-6% through the past two years. As the recent plateau in sequential growth from new products is set to become visible in annual growth starting this quarter, we believe that Hill-Rom may be set up to post disappointing growth in Q4 and in subsequent years as Company growth reverts closer to its ex-new product sales growth rate of ~0%. Heightened Company leverage close to its stated maximum of 4.5x will limit the extent to which management can keep core growth afloat through ongoing M&A, and could represent significant tail risk should the hospital purchasing environment weigh more heavily on growth.
    • Few Avenues To Margin Expansion: Almost all EBITDA margin expansion since FY16 can be attributed to divestitures of lower-margin business and acquisitions of higher-margin businesses. Price increases, endless restructuring, and supposed post-acquisition synergies appear to have had almost no positive impact on profitability. The sell side continues to see room for close to 250 bps of margin expansion through FY21, but, with divestitures set to cease next year and with limited capacity for further M&A, Hill-Rom will likely achieve less than half the sell-side’s expected level of margin expansion.
    • Aggressive Accounting Practices Under CFOs Tied To Roll-Up Train Wrecks Flatter Earnings: Management appears to have under-allocated for numerous reserve accounts consistently through the past four years. Spruce Point believes that management’s practice of under-reserving could have contributed a cumulative ~$55M to Hill-Rom earnings over this period. Hill-Rom would have to take a one-year hit of ~16% to earnings to bring its reserves back to prior levels. Management is also liberal in defining earnings adjustments, which together account for ~50% of non-GAAP income. Included in these adjustments are acquisition-related expenses and restructuring charges, despite the fact that Hill-Rom conducts frequent M&A, and that it has engaged in restructuring every year since it split from Hillenbrand in 2008. Growth via sloppy acquisition rather than internal reinvestment has shifted spending out of capex and into M&A, which, alongside frequent downward capex guidance revisions, has allowed management to hit implied FCF targets. Worryingly, these practices have taken place under recently-departed CFO Steven Strobel – Audit Chair of Newell Brands, a levered roll-up whose stock collapsed amidst allegations of mismanaged inventory channel build-up – and his replacement, Barbara Bodem, a recent alum of scandal-tainted pharma roll-up Mallinckrodt.
    • Accelerated Executive Exits Harbinger Of Disappointing Long-Term Guidance?: Over the past two years, HRC has lost its CEO, CFO, CIO, and two of its three division heads. It is currently on its fifth CFO since 2010. Executives frequently leave after having spent just one or two years (or fewer) at the Company. Employees report that management is increasingly focused on hitting financial targets to satisfy Wall Street, which has taken a toll on morale. We believe that HRC may be preparing to re-set expectations for the worse when it releases its new Long-Range Plan in Q4: rather than set unrealistic and unhittable long-term targets, it may be in the new management team’s interest to lower sales growth targets and impair zombie goodwill sooner rather than later.
    • Slowing Growth And Earnings Adjustments Leave HRC Shares Overvalued: Spruce Point believes that the Street overestimates Hill-Rom’s forward sales growth due to its focus on the “core growth” metric and its lack of appreciation for slowing new product sales. We believe that investors will be disappointed by slower-than-expected sales growth and stagnating margins as the recent round of divestments is set to end. We also believe that investors should not give management credit for earnings growth achieved through dubious adjustments and reserve reductions, which have boosted earnings materially through the past four years. Spruce Point sees 25-55% downside in HRC shares when each of these factors is taken into account.

Monolithic Power Systems, Inc.

    • Spruce Point has significant concerns about Monolithic Power Systems (Nasdaq: MPWR), a designer and manufacturer of power management solutions. Despite being headquartered and publicly listed in the U.S., MPWR operates largely as a foreign company with ~90% of its production, and 58% of sales reported in China. After a close on-the-ground and forensic financial investigation, Spruce Point finds evidence that suggests $245 – $265m (~40%) of its sales are irreconcilable. With MPWR’s shares valued among the highest in the semiconductor space, and fundamental and accounting pressures mounting, we see the potential for 75% – 85% downside risk ($21 – $35 per share).
    • Key Disclosures At IPO Have Vanished: MPWR used to disclose backlog, distributors, end customers, and manufacturing partners, but has ceased all of these disclosures. It remains heavily dependent on distributors, which is a notorious way companies can manipulate results.
    • Days Inventory Exploding, A Red Flag That Foreshadowed Two Past Semiconductor Accounting Scandals; Vitesse Semi and Sipex Corp: MPWR’s days inventory outstanding are currently 180, and have grown consistently over the past few years while most semi peers have been stable. Based on our analysis, the long-term industry average is 106 days. If we assume $245 – $265m and $93m of potential revenue and inventory overstatement, respectively, MPWR’s pro forma inventory metrics fall exactly in-line with peers. A former MPWR audit member concealed his connection to the scandal at Sipex Corp, which restated revenues lower by 35% and slashed gross margins by 1,590bps.
    • MPWR Has Been Dodgy About Disclosing Product Average Selling Prices (ASPs): Despite >70% historically, and now >90% of product sales reported as DC to DC converters, MPWR has claimed it cannot provide color on ASP trends. However, as noted in its Risk Factors, and consistent with the semi industry, prices tend to decline over time. Yet, the CEO once claimed that ASPs have been stable throughout time.
    • Former CFO Rao Claimed ASPs and Margins Don’t Go Up With New Products: Rao made this statement in January 2016. Less than a month later, she abruptly resigned. Post an SEC comment letter in 2014 asking for price drivers to revenue, MPWR revealed that from 2013-2016, prices declined on average by 5% per year.
    • A Former Employee Told Us He Left MPWR Recently Due To Ethical Concerns And Having Seen Inventory Manipulation: “...if they need to hit a number to show a sale, they will force the distributor ..They’ll make a deal. They’ll cut a deal with the distributor and they’ll convert that inventory to distributor owned inventory to show that they met their numbers for the quarter”.
    • $126M Spent On Real Estate, Notably A Large Recent Office Purchase At A 35% Premium: Beyond dividends, MPWR has a voracious appetite for real estate. Of particular concern, it abandoned a land acquisition and 50,000 sqft HQ development project in favor of an even larger 75,000 sqft commercial office building in Kirkland, WA this year. The local media called the 35% premium paid by MPWR “insane” given that the prior owner purchased the property just 9 months earlier, and made no capital improvements. According to a local broker, MPWR will occupy “only a small portion” of the building. The $53m purchase was funded by cash repatriated from Bermuda, a notoriously opaque financial center. MPWR paid $707/sqft when it its average rent expense is just $16/sqft (44x buy vs. rent).
    • Trading at a substantial premium to semiconductor peers at 10x, 37x, and 37x 2019E Sales, EBITDA, and P/E, MPWR’s share price incorporates an unfounded belief it is a best-of-breed takeover target. Yet, industry takeout multiples are closer to 3.3x, 17.5x, 39x. Based on our conversations with people familiar with MPWR, we believe its “cowboy” culture is not a good cultural fit with traditional more conservative industry players. As such, we see little chance a takeover ever materializes.
    • Analysts also take MPWR’s results at face value, and we don’t believe they’ve consider the fact that ~$260m of revenues cannot be reconciled in its China tax filings, and de minimis inventory was reported. At worst, this explains phantom sales and inventory which continues to balloon, and allows gross margins to appear stable and growing in the notoriously volatile semiconductor industry.

Premier, Inc.

    • Premier, Inc. (“PINC” or “the Company”) is a group purchasing organization (GPO) which, due to a unique pre-IPO restructuring agreement, is temporarily generating twice the earnings which its business model can sustain organically. In exchange for rights to Premier equity, its “member owner” hospitals agreed to five or seven-year contracts through which they would accept administrative fee rebates (“sharebacks”) roughly half what they could get from competing GPOs. Those contracts are nearing expiration. Complacent sell side analysts, satisfied by Premier’s historical renewal rates among member owner hospitals accepting below-market sharebacks, forecast Premier earnings as though its prevailing economics are sustainable in perpetuity. However, with most member owner equity now having vested, hospitals with expiring contracts are far less incented to remain with Premier at sub-market shareback rates. Premier’s two largest members, whose below-market contracts are set to auto-renew on Oct 1, 2019, could announce their intention to opt out by next week (effective Oct 1, 2020), with remaining member owners set to announce the same as soon as Oct 1, 2020 (effective Oct 1, 2021). This would cause Premier to underperform FY22-23 consensus revenue by >26% and EBITDA by >50%.
    • Unique Pre-IPO Restructuring Skews Company Economics: Premier was mutually owned by its member owner hospitals prior to its 2013 IPO. To free up cash for Premier to invest in ancillary services, these hospitals agreed to accept sharebacks of 30% – less than half the market rate of 60-75% – in exchange for equity in Premier and modest tax-related distributions. These agreements were structured to last only five or seven years. While most member owners signed to five-year deals renewed their agreements on similar terms, they most likely did so to avoid having to forfeit their as-yet unvested equity (~30% of their respective equity allocations at the time). Premier’s two largest GPO members, whose seven-year contracts expire on Oct 1, 2020, will have no unvested equity remaining by the time their deals are scheduled to expire, and therefore have far greater incentive not to renew their Premier-friendly deals on the Oct 1, 2019 opt-out deadline. As admin fees carry 100% incremental margins, changes in net admin fees have an overwhelming impact on Premier’s bottom line. The loss of Premier’s two largest GPO members or the restructuring of their agreements could cut Premier’s FY21 EBITDA by 9-17%.
    • Increased Shareback Could Be Highly Material To Hospitals With Expiring Deals: Greater New York Hospital Association (GNYHA), Premier’s largest GPO member and a 10% Premier customer, is one of the hospitals whose contract is set to auto-renew next week. By analyzing tax filings, Spruce Point has found that, by receiving a market-rate shareback, GNYHA’s total income could increase by 33%. We believe that GNYHA may have a responsibility to its member hospitals to seek sharebacks more in-line with market rates, and anticipate that it may not renew its current agreement.
    • More Opt-Outs Likely To Follow: Member owners which renewed their five-year agreements in Oct 2017 can opt out once again as soon as Oct 1, 2020 (effective Oct 1, 2021) without losing unvested equity. Should all member owners receive market-rate sharebacks of 60-75%, Premier’s FY22-23 EBITDA would be cut by more than half.
    • Complacent Sell-Side Assumes Favorable Economics Can Last Forever: Premier’s ~95% renewal rate during its 2017 renewal cycle appears to have convinced the sell side that renewal risk is near-nonexistent. It ignores the fact that, unlike the 2017 renewal class, member owners whose contracts are due to auto-renew next week will have no remaining unvested Premier shares, and will therefore no longer have to accept below-market sharebacks for access to Premier equity. Analysts also appear to underestimate the prevailing market shareback rate by benchmarking against MedAssets. MedAssets, a GPO which was until recently public, reported superficially below-average sharebacks due to its practice of bundling GPO agreements with ancillary services. Our market intel confirms that the market-level shareback is 60-75% and rising.
    • Emerging Signs That Hospitals Are Prepared To Exit: Member owners are divesting of Class B shares at an accelerating pace, perhaps reflecting their knowledge that Premier’s economics are set to correct in the near future. Large hospitals such as Johns Hopkins Medicine have already exited, sacrificing some of their unvested Class B shares to do so. New language introduced in Premier’s most recent 10-K (filed Aug 2019) suggests that renewal risk is rising.
    • PINC Shares Valued As Though Current Economics Are Sustainable: PINC trades at a 6.6x FY22 EV/EBITDA multiple based on the sell-side’s inflated future earnings estimates. Reverting member owner hospitals to sustainable market-level sharebacks would cut consensus FY22 EBITDA in half. PINC should also trade at a lower EBITDA multiple, as Premier’s true underlying economics are worse than the market believes. Valuing PINC shares at 4-5x FY22 EBITDA on an estimate of EBITDA >50% below the Street would imply that PINC shares are worth $8-$15, 55%-75% below current levels. Losing hospitals to competing GPOs could result in even more downside.
    • Spruce Point believes that the circumstances facing Premier are extremely similar to those faced by education technology provider 2U (NASDAQ: TWOU) through 2018-19. In July 2018, Spruce Point published a “Strong Sell” recommendation on 2U, Inc. (NASDAQ: TWOU) which showed that the company’s tuition “take rate” (i.e. revenue share) on its online degree programs was under significant pressure: while 2U claimed historical take rates of over 60%, our FOIA requests demonstrated that intense competition had brought the market rate down to ~40%. Sell-side analysts nonetheless continued to assume that 2U could maintain its historical take rate until only recently, when management admitted on its Q2 earnings call that its core business was under fundamental pressure. The stock fell more than 60% the following day. Spruce Point believes that the circumstances facing Premier are very similar: while the sell side believes that Premier’s above-market shareback rates can last indefinitely into the future, Spruce Point finds evidence that near-term catalysts could force Company economics back in-line with the rest of the market.

Church & Dwight Co., Inc.

    • Spruce Point has significant concerns about Church & Dwight (NYSE: CHD), an S&P 500 company, and roll-up acquiror of personal care and consumer products. Under its older leadership, management pursued a conservative strategy to leverage its core Arm & Hammer brand by diversifying and integrating acquisitions, while still prioritizing product innovation, and manufacturing excellence. With the elevation of Matt Farrell to CEO in 2016, Spruce Point believes CHD’s strategy has pivoted towards extreme financial engineering, aggressive accounting, and managerial self-enrichment practices. As fundamentals deteriorate in CHD’s retail environment, and it’s now clear that 60% of its legacy Power Brand acquisitions are failing, Spruce Point believes that CHD’s recent Waterpik and FLAWLESS levered acquisitions were made in desperation at outlandish valuations. If history is any guide, recent deals will disappointment investors. With CHD’s shares at a 8% premium to average analyst price targets, and debt rising, investors seeking safety in CHD’s stock face 35%–50% downside ($40 – $52/share).
    • Old School Brands Traditionally Following A Copy-Cat Like Strategy Against Leaders Proctor & Gamble, Clorox, And Others. Best known for its iconic Arm & Hammer brand, CHD embarked on an acquisition strategy in the early part of the 2000s to diversify into condoms, sex toys, hair care, rectal cream, vitamin gummies, oral care and other assorted product categories. However, we believe 6 out of 10 of its “Power Brands” acquired pre-2017 are struggling or outright failures. With 23% of sales through Wal-Mart, and reliance on struggling brick-and-mortar channels such as ULTA, Sally Beauty, Bed, Bath & Beyond, pharmacy (ex: Walgreens, CVS, Rite Aid), and discount stores, we believe CHD is experiencing channel pressures, and has been slow to transition to online sales and marketing to millennials. These factors, along with an increasingly promotional environment, has been pressuring margins.
    • Long promising international growth opportunities, CHD hasn’t been strategic about acquiring brands that can readily be sold in foreign markets (most notably vitamins) and has failed to implement common sense strategies (e.g., multilanguage labeling) to accelerate and scale the “export” strategy. Our research indicates that recent international success is attributable to new market entries, establishing distribution agreements and putting through significant price increases. We don’t believe that any of these drivers are sustainable and that CHD is now too late to many of its core product categories around the world. As a result, we believe that international growth is likely to disappoint
    • Investors Fail To Appreciate The Change of Leadership Style Under Matt Farrell, An Executive Who Blind-Sided Investors At Alpharma. In early 2016, Matt Farrell and Rick Dierker were appointed CEO and CFO, respectively. Based on our interviews of former employees in key roles, CHD experienced a culture shift that would deemphasis manufacturing, R&D and supply chain investment in favor of greater financially engineered acquisitions. One former employee even described management as “financial magicians”. We believe investors fail to appreciate the abysmal failure overseen by Farrell when CFO of Alpharma (formerly NYSE: ALO). While we acknowledge that some of Alpharma’s issue may have pre-dated his arrival in 2002, there is evidence that under Farrell’s leadership, the situation became even worse, culminating in Alpharma issuing more material weaknesses, a “non-reliance” opinion on its financial statements, a covenant breach, and later a DOJ settlement for bad sales and payment practices to promote unsafe products
    • Under Pressure To Financially Engineer Results, CHD’s Two Recent And Expensive Deals Already Showing Signs of Disappointment. In August 2017, CHD spent $1 billion to acquire Waterpik, a dental water flossing product that has been flipped twice by private equity owners. From the deal conf call, management showed little understanding of the business, punting on simple questions such has what % of sales is online, and the split of kit vs. consumable sales. When we asked a former long-time executive about the deal: “Waterpik has been for sale for years, and I’m a bit surprised they bought it given product liability concerns”. Sales Decline Quickly Post Acquisition: CHD obscured the contribution of sales by Waterpik post acquisition, lumping results in consumer domestic and international with smaller acquisitions Anusol and Viviscal. However, total consumer revenues from acquisitions declined from $102m (Q4’17), to $85m (Q1’18), to $79m (Q2’18) in the following quarters that can be cleanly analyzed. The FDA also recalled products mid 2018 for safety issues.
    • Margins Already Failing: Documents show Waterpik’s gross margins were 47.7% – 49.1% pre-acquisition, and the CFO said he expected 200-300bp gross margin expansion. Fast forward to early 2019, the CFO’s recent comment that gross margins are now “on par” with the company’s gross margin (pre-China tariffs), indicate that margins have contracted lower and are now closer to 44%
    • Spruce Point Has Identified Many Flaws In The Flawless Acquisition That Should Give Investors Grave Concerns. In May 2019, CHD announced it acquired FLAWLESS hair care removal product for $450m. The product has grown quickly to $180m of sales since its 2017 launch, but has unproven staying power in a rapidly maturing category. Management is using bold and potentially misleading language to promote the deal, even claiming to be creating a “brand new category” for an “unmet need” and that it will “blow out” sales. Spruce Point finds undeniable evidence of aggressive accounting, revenue recognition problems, and operational delays at FLAWLESS: Notably, we have sourced Nielsen retail data for recent FLAWLESS product introductions. The data shows slowing growth for its headline Finishing Touch FLAWLESS brand, and rapid maturation cycles historically for new product introductions. FLAWLESS and CHD’s Batiste are sold at ULTA Beauty, which just cut guidance, and said recent new product cycles in women’s cosmetics are not driving growth.
    • CHD Touts Its Industry Leading Cash Conversion >100% of Net Income, But It’s Not As Sexy As It Appears. Aggressive M&A Accounting: On average, CHD accounts for 96% of its deal values as intangibles and goodwill, enabling it to receive tax deductions over 15yrs that improve cash flow. As an example of how aggressive management has been towards applying this strategy, it said on the FLAWLESS conference call that it had no synergies, yet later marked $82m of the value as goodwill and attributed it to synergies!

Penumbra, Inc.

    • Penumbra, Inc. (“PEN” or “the Company”) is a one-trick-pony surgical instrument company which, in our opinion, produces a low-tech and undifferentiated product in an increasingly competitive space. Penumbra was first to market with an aspiration catheter (“AC”) FDA-approved to treat acute ischemic stroke (“AIS”). Major medtech companies have entered the space within the last 9 months and, per the medical community, offer neurovascular ACs at least as good as Penumbra’s at far superior economic terms, often as part of discounted bundles. While analysts are aware of the new competition, they seem blind to the pace of Penumbra’s market share losses: IQVIA transaction data reveals that its U.S. neuro AC sales growth has contracted in recent months. Heavy competition and a limited TAM will also curtail peripheral AC sales – a revenue stream which analysts see as a major growth engine for Penumbra. Non-core M&A, distributor acquisitions, and rising DSOs suggest that management – which has a history of promotional activity – may be reaching to defend its medtech hype train as competitors eat at Penumbra market share. We believe that underestimated competition could cut Penumbra’s expected sales growth by nearly half in FY20, from 20% to close to 10%.
    • Wave Of Competition Entering Penumbra’s Vertical For The First Time: Penumbra was the first to market with an AC cleared by the FDA for treatment of acute ischemic stroke. Major medical device companies left the space alone for most of the 2010s, instead focusing their efforts on stent retrievers – the standard of care in mechanical thrombectomy until recently. However, now that aspiration thrombectomy for ischemic stroke has gained wider acceptance as a cheaper (by 30-50%) and sufficiently-effective approach, four major device companies have entered the space within the last two quarters.
    • Rapid Pace Of Market Share Loss Deeply Misunderstood By Market: Analysts have grown to understand Penumbra as a dominant player in its vertical, with ~90% share. While they recognize that competition is coming, they have no historical basis for modeling the pace of market share loss, and appear to assume only low-to-mid single-digit annual losses through the coming years. IQVIA Medical Device and Supply Audit (MDSA) data, which project nation-wide sales for individual medical devices from a panel of 650 U.S. hospitals, indicate that, even as the mechanical thrombectomy market grows, Penumbra is losing U.S. share so rapidly that monthly unit sales have been DOWN through 5 of the last 6 months, with monthly declines of up to 28%. Our conversations with doctors corroborate this data, with many neurosurgeons indicating that, over just the last 6 to 9 months, they have shifted from using Penumbra in 70-90% of neuro aspiration therapy procedures to just 10-30% of these procedures.
    • Penumbra’s Core “Device” A Commoditized Plastic Consumable Sold Cheaply By Competitors: While Penumbra has had the only AC approved for acute ischemic stroke treatment through most of the 2010s, ACs are functionally little different from intermediate guide catheters, mechanical thrombectomy accessories priced 75% or more below ACs. Many doctors have used these catheters as “off-label” ACs due to price differences or product preferences. Large medical device companies will have, and have had, little trouble entering the market with products already equivalent or superior to Penumbra’s. They also sell their ACs in bundles with SRs and other adjacent products, which support per-item savings of up to 33%. Penumbra – an almost purely AC-driven company with a poorly-rated “3D separator” SR and few other products – cannot offer similar bundles and is likely to experience significant pricing pressure as the sector migrates to this purchasing model.
    • Promotional And Aggressive Management Playing Defense Against Slowing Growth?: Industry contacts indicate that management is highly promotional and liberal in their spending on medical professionals. Open Payments data from the Centers for Medicare & Medicaid Services reveal that Company spending on doctor travel reimbursement – often to sites like Las Vegas and Miami – is unusually high. They have also granted an unusually large quantity of stock to non-employee doctors, which we find suspicious for a young medical device company which has been eager to find clinical support for its products. Further, we observe hallmark executive actions which may signal a coming sales slowdown: rising DSOs, non-core M&A / distributor acquisitions, hyping up secondary businesses, and aggressive stock sales.
    • A Commoditized, One-Product Company Valued As A Growth Story: PEN is valued on par with high-tech medical device companies with significant IP protection. PEN’s products are far more commoditized and subject to competition, which it is now experiencing for the first time. Valuing PEN in-line with a more appropriate peer universe of commodity producers would reduce PEN’s multiple from 10x to 5-6.5x FY20 sales. Even bullish sell-side analysts have an average price target 7% below current levels as valuations have climbed to nosebleed levels through the past several weeks. Spruce Point sees 40-55% downside ($85-$110) in the stock after adjusting future sales growth to reflect the onset of competition and applying a more reasonable 5-6.5x FY20 sales multiple.



Mettler-Toledo International, Inc.

    • Spruce Point has significant concerns about Mettler-Toledo. Since CEO Olivier Filliol took over in 2008, Mettler’s ability to never miss quarterly Wall St earnings estimates raises doubts about the quality of its financial statements. Run by secretive management in Switzerland, and with key U.S.-based financial, tax, and audit managers all having worked at current auditor PwC, we worry that adequate, independent questioning of its financial results are lacking. Prior allegations of financial misreporting 15yrs ago may hold weight in light of our fresh look at the allegations and broader information available today. We find strong evidence of aggressive financial, tax and accounting policies used to bolster earnings, notably outlandish share repurchases that are being conducted at 36x P/E, which rewards management with cash bonuses for buying stock. Our diligence into Mettler’s China business through tax filings shows evidence of significant profit overstatement, and cash running through shell entities, and an empty office, and a location where individuals on site had never heard of Mettler. We call for an independent committee to evaluate our findings.
    • MTD trades 14% above the current average analyst price targets of $705/sh and at an all-time high valuation multiples, yet is not expected to grow any faster than its peers such as Thermo Fisher (TMO), Ametek (AME), Agilent (A), Waters (WAT), PerkinElmer (PKI), Bruker (BRKR) and Bio-Rad (BIO) to name a few. A rotation into perceived safety stocks provides an incredible short-term inflation in the share price.
    • Insiders are selling a record amount of stock despite owning <4% of the company. Notably, one of the biggest holders is the Chairman, who signaled his intention to sell 33% of his holdings in Feb 2019
    • Mettler has exceeded sell-side quarterly EPS targets 100% of the time since 2008, and by no coincidence, management has always met 100% of its annual cash bonus targets. This is a miraculous achievement given our belief it has a ruthless culture that fires business managers quickly that don’t hit numbers:
    • Able to navigate black swan currency events: EUR/CHF and USD/CHF are two of its biggest FX exposures. In 2015, during the unexpected Swiss Franc revaluation, causing a 20%+ move, Mettler claimed only a modest guidance revision, and that it had miraculously timed an increase to 90% of its EUR/CHF hedge. Yet, it rapidly borrowed money and its audit director abruptly resigned thereafter.
    • No material customer concentrations: Mettler claims no customer is >1%, however, we believe it may be exposed to Pitney Bowes, a significant customer based on import trade records, who is facing increasing bankruptcy risk and a disruption headwind is not priced in.
    • While claiming no need for financial restatement, Mettler stated further “the Audit Committee and the Board have determined that it would be in the best interests of the Company to make changes in the leadership for the oversight and control of its financial operations to correct the “tone at the top” and ensure it is consistent with the Board’s commitment to maintaining strong corporate governance. The Company will enhance the accounting organization, both by adding personnel to that function and by increasing training for all members of the organization.” Many of the same managers are still at Mettler (notably CEO Filliol) from the time of this investigation
    • Relationship Too Close With PwC, An Auditor Slapped With Dozens of Lawsuits For Failing To Catch Fraud
    • CEO With A Potentially Misrepresented Bio Undermines Confidence
    • Various company sources suggest he ran the Analytics Division, was Head of Marketing, Sales, Service, and ran the China business too all at the same time, a major concern we will detail further. With a CEO in charge of so many aspects of the business, we worry that Mettler does not have the appropriate separation of duties in place. This concern is mirrored by the fact that long time CFO William Donnelly was in charge of Investor Relations, Finance, Supply Chain Management, Information Technology, and the Blue Ocean Program all at the same time
    • Employee allegation of financial misconduct came weeks after Filliol was promoted to Head of Marketing, Sales, & Service. We estimate Filliol has extracted $257m from Mettler (salary, bonus, stock sales) and controls another $270m of stock post the implementation of aggressive financial, accounting and tax policies, notably diverting billions of cash flow to buybacks while always hitting cash-incentive based Adjusted EPS targets that don’t adjust for excessive stock repurchases
    • Evidence of Massive Cost Capitalization of Software And A 12yr ERP Implementation Dubbed “Blue Ocean”. Around the time CEO Filliol took charge in 2007, Mettler embarked on its “Blue Ocean Program” described as “a new global operating model, with standardized, automated and integrated processes, with high levels of global data transparency”.  12yrs later, Mettler claims the program has another 15-20% to completion. Mettler stopped disclosing direct costs related to the program in 2012, and has made $133m of total restructuring payments since 2009 (recognizing them every single year
    • Numerous Signs of Aggressive Accounting and Financial Policies To Embellish Margins. From our experience, it is more common to see companies fudge financial data – sales and EBITDA – than employee data. We observe that Mettler’s EBITDA margins are slightly above the average of its industry peers. However, its revenue and EBITDA per employee is the worst among peers. This is atypical among the data observed, where companies with above average margins tend to have above average sales and EBITDA per employee results, while those with below average margins exhibit below average per employee metrics. Most of Mettler’s lab products are <$10k, though claimed to be premium and market-leading
    • We sent our investigators to China to see what we could learn. Mettler has a complex structure of 10 entities, but there are three entities that account for a substantial portion of financial activity. When investigators visited Mettler’s two registered addresses in Shanghai accounting for >$700m of sales, they found an empty office in a building, and another gated building with no signs of Mettler. When asked, people on site had never heard of Mettler. This raises the possibility Mettler is engaging in a tax dodge scheme
    • Mettler’s total assets in China per its tax filings are lower than reported in SEC filings. The Chinese fillings of the 10 subsidiaries record $564m in assets vs $1.2bn in SEC filings. We estimate inflated asset values could be a hallmark of inflated profits of $50m/yr
    • Mettler has largely eschewed a balanced M&A program and greater R&D spend in favor of share buybacks. We estimate since 2008, it has deployed 83% of operating cash flow to stock repurchases, a percentage far in excess of its analytical instrument peers
    • Part of management’s annual cash bonus is tied to “Adjusted EPS”, which ironically doesn’t adjust for it artificially increasing EPS with repurchases at ever increasing multiples. The repurchase strategy is experiencing diminishing returns
    • Now trading at 37x book value, 7x, 26x, and 36x 2019E sales, EBITDA, and P/E, Mettler is the most expensive stock among its peer group, and will face significant comp challenges and headwinds from slower growth being signaled in Lab spending and in China
    • Six analysts are a “Hold” and two are “Underweight”, and two are “Sell”. With the average analyst price target at $705, there’s an implied 14% downside on valuation alone
    • However, we believe investors will re-calibrate Mettler’s true EPS once they re-think the past allegations of financial issues raised by a former employee, proof of a qualified audit opinion in India, and reassess the probability and risk of financial restatement.
    • By normalizing street estimates for aggressive accounting choices, never-ending restructuring charges, and lower sales and profits in China, we estimate normalized Adj EPS of $18.09 – $20.31, materially lower than consensus at $22.70. Mettler’s valuation premium should contract as investors re-think the quality of earnings and management. By valuing shares at our normalized earnings and a slight discount to industry multiples, it’s easy to justify 30%-50% downside risk ($410-$575/sh).



Axon Enterprises, Inc.

  • Axon Enterprises (Nasdaq: AAXN), the maker of the Taser stun gun, has been positioning itself more as SaaS provider of analytics through body cams to law enforcement agencies. With a history of SEC inquires, delinquent filings, and material weaknesses, we believe Axon will shock investors with significant earnings disappointment and increasing cash burn as it fails to scale beyond these niche businesses. Furthermore, we believe investors misunderstand Axon’s exposure to China tariffs, which will constrain margin growth, and its aggressive revenue recognition policies, which have pulled forward revenues. As part of our research, we spoke with a law enforcement expert at one of the 5 largest police departments in the US, a former Axon product executive, and a leading global competitor. With its shares and valuation trading near an all-time high, and analysts price targets of $72 (implying 9% upside), we think the risk/reward is terrible and believe investors should brace for 40% – 60% downside risk ($27.50 – $40.00).

  • Taser’s core stun gun product is mature with limited domestic unit growth opportunities. A new Taser 7 introduction, over three years in development, is unlikely to materially change this trend aside from a short-term benefit

  • Meanwhile, its faster growing Software and Sensors (including Axon Cloud) is experiencing a slowdown, while its margins are also contracting. We believe these trends will continue as costs escalate from offering unlimited video storage, and competition increases

  • Now 5 years into the Taser 60 program introduced in 2014, and with the Taser having a 5yr expected life, we believe its early mover advantage is being eroded by competitors pricing and solutions on the software and sensor side. Axon’s best gains are now behind it

  • Axon’s Q1 operating cash burn was the worst in its public history. In addition, Axon quietly increased its line of credit from $10m to $100m (without filing an 8-K), an odd move given it has $350m of cash on its balance sheet, no debt, and is forecasted to produce profits this year of $56m according to analyst projections

  • Axon raised $234m of equity in June 2018 for no defined purpose, has spent only $5m on the plagued acquisition of VIEVU, and announced its intention to build a new HQ despite underlying Taser unit growth struggles. From our experience exposing Chinese financial schemes, capital raises for undefined purpose and suspect capex projects are significant red flags

  • We believe Axon has concealed its dependence on Chinese imports. It removed the word “China” from its recent 10-K, but in Q1’19 said that “tariff and customs expenses” weighed on margins without quantifying the amount or country source

  • Based on import records, we believe Axon has become increasingly dependent on China imports tied to the body cam business in the past few years, and given on-going tariffs, we believe these costs will weigh on margins, and could easily cause it to miss 2019E EBITDA by 10%. Based on our field research (not disclosed by Axon), we find some evidence it has implement upwards of 5% price increases in Q1’19, yet despite this increase, gross margins were still under pressure and missed company estimates by 250bps

  • There are many data points to cast doubt on the accuracy of Axon’s margins beyond it having recently reported a material weakness tied to revenue recognition and cost of sales, fail to promptly address SEC comment letters, and have its CFO resign:

  • Axon released its Taser 60 plan in 2014, allowing customers to save by bundling and paying for product and services over 5 yrs. Axon increasingly recognizes revenues under “multiple performance obligation” accounting tests which gives it discretion to decide the timing and value of revenue recognition. It claims its bundles have “stand-alone” value, and books revenue for hardware upfront. Bolstering our concerns, public contracts we’ve evaluated include no stated value for the hardware. We estimate this has inflated revenues by 6% – 9% in the past few years

  • In addition, Axon has never disclosed errors or accounting issues tied to compensation expenses. However, Spruce Point has unearthed 401k plan filings at the IRS where Axon admits errors dating back to 2014. SEC reported expenses do not match IRS filings

  • Axon’s $17m acquisition of VIEVU in May 2018, during a company reposting period, stoked a $1.8bn increase in market value. Based on our estimate, the market for bodycams is at best a $356m market, but the TAM is constrained, margins are shrinking and losses are accelerating

  • Axon stated significant cost synergies as part of the deal rationale. However, more than a year later, Axon still operates a separate call center for VIEVU. Based on our work, it appears that sales declined sharply after the acquisition, while losses intensified. We believe there are no synergies, and VIEVU was a defensive acquisition to buy into the NY Police Dept. We also find that Axon took an enormous inventory reserve amounting to 70% of the total amount of inventory it acquired in the transaction

  • Axon has rapidly inflated its Total Addressable Market (TAM) from $4.8bn (2016), $6.5bn (2017) to $8.4bn (2019). Yet, by closely analyzing assumptions, it becomes obvious that much of this TAM is largely unproven, and being exaggerated with unrealistic pricing assumptions:

  • Axon Records / Dispatch: Significant entrenched competition in these critical areas will make it extremely difficult to crack this market. Axon has given the records away for free to try to whet customer appetite. However, the purchasing decision is not always tied to police chiefs, where they have their best relationships. We believe the market is dominated by Motorola, Tyler Technologies, and CentralSquare Technologies. These three players have largely consolidated the market through acquisitions, leaving Axon no alternatives to buy its way into the market, and punting its future on a greenfield development strategy with a high risk of failure

  • Analysts’ average price targets for Axon is $72.30, or just 9% upside from the current price. A majority of analysts (9) are bullish, but there are five (5) that are neutral or expect Axon to perform in-line with the market. Four (4) brokers fail to offer a price target

  • Analysts have bought into the narrative that Axon is a superior “razor / razor blade” model with a promising recurring revenue and cloud business. However, we believe this is a one-time boost from a move to the Taser 60 subscription model in 2014, that is now maturing five years into the program. All the while, future growth opportunities will remain challenging, and analysts have amnesia as it relates to Axon’s past SEC investigations, material weaknesses, and legal spats and view them as one-off “non-recurring” issues. Based on our recent findings, we beg to differ, and don’t believe that Axon is worthy of its super valuation of 7.4x, 46x, 65x 2019E sales, EBITDA and EPS, respectively

  • Meanwhile a key executive and Board member recently departed, which we believe signals waning confidence in Axon’s future, and supports our case that Axon has a technology roadmap challenge, and constrained ability to acquire deeper penetration in its verticals. Axon’s EVP of World Wide Products, recruited from Apple, quietly left in less then two years. Brett Taylor, Chairman of Axon’s Technology Committee (and M&A Board member), also just resigned as disclosed on June 14th

  • We believe a majority of the brokers pitch Axon’s stock to retail investors. Sophisticated institutional investors have been selling shares over time, side-by-side with insiders



Verint Systems, Inc.

  • Verint Systems Inc. (VRNT or “the Company”) is a call center software provider which has fallen far behind the industry’s evolving technological standards and which is making up for slow growth with aggressive M&A and dubious accounting. While Verint reported 8% sales growth in FY19, we believe that, netting out M&A contributions, FX, and the effects of ASC 606, organic growth – which the Company never discloses – was negative. Despite Verint spending ~$1B on M&A since FY15, sales have grown at only a 2% CAGR, and FCF / share has declined at a CAGR of 1%. Management nevertheless rewards itself with compensation 3x that of its most comparable (but far healthier) peer, hitting comp targets through nonsensical earnings adjustments which appear nowhere in its filings except deep in the appendices of its proxy statements. Management’s questionable conduct persists over calls for improved governance and transparency, which have culminated in a proxy battle with long-time shareholder Neuberger Berman. Its disregard for shareholders concerns us given its deep connections with other infamous frauds and history of engaging in dubious business practices to flatter reported results. Even then, bulls interpret reported growth as a sign that the purported cloud-oriented strategy is working, leaving VRNT trading at all-time high multiples even as organic growth sputters and ASC 606 benefits anniversary.

  • A Poor Business Lagging Peers: Verint’s core business is “customer engagement solutions” – a euphemism for call center software. Industry incumbents Verint and NICE were once near-duopolists, but NICE acted on the industry’s shift to the cloud much more effectively, and it continues to grow alongside technologically-savvy upstarts at a high-single-digit rate, while Verint suffers from the industry’s rising technological demands and lower barriers to entry.

  • Aggressive Spending On Low-Quality M&A Obfuscates Organic Growth And Appears To Create A Cookie Jar For “Beat & Raises”: Since FY15, Verint has spent ~$1B on M&A. KANA, its biggest acquisition, failed spectacularly in our view, as sales growth immediately turned negative once the acquisition was anniversaried. Verint has continued to pursue smaller tuck-in acquisitions since, but most deals go unannounced, and are not explicitly named in SEC filings. We believe that, after taking into account M&A, FX, and the effects of ASC 606, organic growth was in the low single digits in FY18 and negative in FY19, far below reported top-line growth in the high single digits. Last quarter, management raised guidance by just $20M upon acquiring ForeSee Results, Inc., whereas court filings indicate that ForeSee was generating ~$80M in sales at the time of the bankruptcy of its former parent, Answers Corp. (2016), and was projected to grow to $130M by this year. We believe that subsequent sales growth characterized as organic was largely driven by this and other acquisitions, and that its underreported inorganic sales contribution created a “cookie jar” which Verint used to beat Q4 and raise FY20 guidance.

  • Key Executives With Dubious Pasts: Dan Bodner has been CEO of Verint since its founding in 1994. For much of the 1990s and 2000s, it was a subsidiary of Comverse Technology, whose CEO, CFO, and GC orchestrated a massive options backdating scandal during this time. All three sat on Verint’s Board and were the sole members (with Bodner) of key Board committees. A later investigation found that Verint had carried out aggressive business practices under Bodner to decrease sales volatility and inflate reserves. CFO Douglas Robinson worked for Computer Associates for 17 years through the 1990s and 2000s, including stints as a senior member of the finance department. CA was similarly shown to have engaged in aggressive revenue recognition practices to inflate sales and earnings. Though Robinson was never implicated, his close association with CA’s finance department at the time of the fraud concerns us.

  • Aggressive Accounting Measures And Non-GAAP Add-Backs Inflate Performance: We find it curious that, in FY19, for the first time, management announced that it would capitalize commissions. Whereas Adj. EBITDA and Non-GAAP Income were reported to have grown by 16% and 18% in FY19, respectively, growth in these metrics would have been just 2% and less than 0% when capitalized commission costs alone are added back to expenses. We also estimate that ~11% of Adj. EBITDA and ~45% of Non-GAAP Net Income are attributed to add-backs which we consider unusual or otherwise unjustifiable. As is the case with many companies researched by Spruce Point, Verint shows a widening gap between unadjusted and adjusted EBITDA, suggesting that management is growing increasingly aggressive to present attractive results as organic sales and earnings continue to underperform.

  • Questionable ASC 606-Related Accounting Changes Inflate Sales And Earnings Growth: ASC 606 adoption boosted Verint revenue by $47M (5%) and net income by a massive $51M (75%) in FY19. This is entirely out of line with peers such as NICE, whose revenue declined due to ASC 606, and whose net income went largely unaffected. Management also claims to have made changes to its business practices in anticipation of its adoption of ASC 606 – something we find oddly suspicious – and, in FY19, to have double-counted revenue which it had recognized as revenue in prior periods. Of course, it made all of these changes with far less transparency than peers such as NICE, which was not only far less aggressive in its application of ASC 606, but which, unlike Verint, provided clear reconciliations against its financial presentations under ASC 605 standards.

  • Non-Transparent Earnings And Cash Flow Adjustments Help Management Achieve Comp Targets: Performance metrics used by Verint to determine management compensation are riddled with questionable add-backs which are included in no other financial metrics reported by the Company. Management inexplicably adds net interest expense back to operating cash flow to achieve its cash flow targets. Also included in its adjustments are phantom “non-recurring payments” which appear nowhere else in Verint’s financial statements. Further, management recognizes material contingent consideration write-downs on an annual basis, thereby increasing its performance metrics as these reversals boost Company earnings. In so doing, management effectively gives itself credit for its poor acquisitions failing to meet their financial targets. We wonder how Verint’s acquisitions could be underachieving their targets when management appears to understate their prospective inorganic sales contributions.

  • Proxy Fight With Neuberger Reveals Atrocious Governance: Neuberger Berman sees that Verint is struggling to keep up with industry-wide technological change and has pushed it to add new Board members and focus on the cloud. Management has been playing coy with Neuberger for months: it fails to respond to requests in a timely manner, has Neuberger-recommended Board members interview with employees who report directly to the CEO, never appears to seriously consider recommended Board members in the first place, and offers bizarre compromises to Neuberger in an attempt to settle the dispute. While stating publicly that it is focused on the cloud, management tells Neuberger that the cloud is not a primary focus, and that “customers are not interested in the cloud.” We see management’s double-speak, evasiveness towards Neuberger, and generally irregular behavior a significant red flags.

  • Reported Cloud Revenue An Inappropriate And Non-Transparent Measure Of Cloud-Related Sales: Management recently began to report a number of proprietary cloud sales metrics as investors such as Neuberger demand more transparency on cloud-related growth. Company disclosures are inconsistent regarding the fact that its reported cloud sales figures include sales from term-based licenses, for which it can now more aggressively recognize revenue under ASC 606. Accordingly, its cloud sales metrics present a skewed view of its “recurring” cloud-related sales, which will be lumpier than investors currently believe and which could easily disappoint in the near future if the pace of customer adds slows. Industry experts generally do not consider such term-based arrangements to accurately represent true cloud / SaaS revenue, which is more typically arranged in subscription-like agreements, and which therefore produces a steadier and less volatile stream of revenue than would Verint’s term-based contracts for its “hybrid cloud” services.

  • Insiders Bailing As VRNT Is Up 45% YTD And Trading Near All-Time Highs: The Street believes that VRNT trades at a ~35% discount to peers based on an improper view of Adj. EBITDA and net debt. Even then, the avg. analyst price target of $66 yields just 8% upside. After restating EBITDA for questionable add-backs and newly-capitalized expenses, and after removing non-transparent restricted cash items from liquidity, we find that VRNT trades at almost exactly its peer median multiple, despite contracting organic sales and stagnant cash flow. Meanwhile, insiders are dumping the stock just as it approaches all-time highs (up 45% YTD). We believe that its current multiples – its highest in recent history, and comparable to high-quality take-outs SAAS and BSFT – are unsustainable as M&A fails to grow cash flow, as it falls further behind BPO software peers and out-of-favor with SaaS-oriented investors, and as it laps FY19 ASC 606 tailwinds. We value the slow-growing Company at an EV/EBITDA multiple of 8-10x for a price target of $17-25, yielding 60-70% downside.



Kornit Digital Ltd. (Update 1)

  • Spruce Point believes Kornit Digital (“the Company” or KRNT) saw 2018 revenues, and particularly cash flow, driven entirely by Amazon’s expansion of its Merch program, which are likely to taper based on a slow-down of program growth, and would leave a gaping hole in Kornit’s aggressive revenue growth strategy. Forensic evidence from warrants granted to Amazon suggests that 105% of 2018 operating cash flow came from Amazon gross payments, and a cessation of new orders and rebate incentives coming due will depress future results. In addition, we believe Amazon is expanding into Japan, and that Kornit is not well positioned to win. Investors’ faith in Kornit’s financial results needs to be evaluated relative to its CFO having been the CFO at MRV Communications, which suspended reliance on its financials related to an option-backdating scandal. With shares up 55% YTD and trading near all-time highs at a substantial premium to digital printing peers, Kornit has 75% – 85% downside risk ($4.50 – $9.30/ sh)

  • Kornit’s revenues to Amazon were 17% in 2018, and grew substantially after Amazon faced environmental permitting delays in 2017. The sales to Amazon are primarily linked to printers supplied to its Merch by Amazon program, which allows merchants to design and sell printed shirts and sweaters, while outsourcing production and logistics to Amazon. Caution: Based on shipping records and weight tonnage, we can estimate unit printer shipments. We believe Kornit has discounted list prices to Amazon up to 50%. We also cannot accurately back into Kornit’s 2018 reported revenues, and have extreme concerns about the potential for revenue recognition issues.

  • While the program enjoyed early success, Spruce Point believes US program growth has plateaued, and has hard evidence that printer orders delivered to Amazon in the US have dramatically slowed YTD 2019. Furthermore, we believe Kornit will lose Amazon’s next leg of expansion of the Merch program to Japan:

  • Selling digital printers is akin to selling a commodity product in a hyper competitive industry. In order to entice Amazon, Kornit issued it cashless warrants (a weak form that requires no capital commitment by Amazon) for its stock, which should be viewed as price discounts and are netted against sales.

  • Based on the warrant vesting formula, we can determine that total payments by Amazon to Kornit in 2018 were 105% of total 2018 operating cash flow. This suggests underlying organic cash flow decline from its remaining business.

  • In addition to warrants (and price discounts to list price), Amazon also gets price rebates, and Kornit is not adequately disclosing the rebate terms in the contract or in the 20-F. This amounts to an effective “triple incentive” to win Amazon.

  • Based on our research, we believe the rebates will kick-in up to a year afterwards, causing short-term inflation in Kornit’s cash flow, and will be a drag on Kornit’s operating cash flow in 2019.

  • If Kornit received a multiple closer to printing and computer equipment peers, and our concerns about Amazon come to fruition, it’s easy to justify a price target of $4.50 – $9.30 or 75% – 85% downside risk.


Kornit Digital Ltd.

  • Spruce Point believes Kornit Digital (“the Company” or KRNT) saw 2018 revenues, and particularly cash flow, driven entirely by Amazon’s expansion of its Merch program, which are likely to taper based on a slow-down of program growth, and would leave a gaping hole in Kornit’s aggressive revenue growth strategy. Forensic evidence from warrants granted to Amazon suggests that 105% of 2018 operating cash flow came from Amazon gross payments, and a cessation of new orders and rebate incentives coming due will depress future results. In addition, we believe Amazon is expanding into Japan, and that Kornit is not well positioned to win. Investors’ faith in Kornit’s financial results needs to be evaluated relative to its CFO having been the CFO at MRV Communications, which suspended reliance on its financials related to an option-backdating scandal. With shares up 55% YTD and trading near all-time highs at a substantial premium to digital printing peers, Kornit has 75% – 85% downside risk ($4.50 – $9.30/ sh)

  • Kornit’s revenues to Amazon were 17% in 2018, and grew substantially after Amazon faced environmental permitting delays in 2017. The sales to Amazon are primarily linked to printers supplied to its Merch by Amazon program, which allows merchants to design and sell printed shirts and sweaters, while outsourcing production and logistics to Amazon. Caution: Based on shipping records and weight tonnage, we can estimate unit printer shipments. We believe Kornit has discounted list prices to Amazon up to 50%. We also cannot accurately back into Kornit’s 2018 reported revenues, and have extreme concerns about the potential for revenue recognition issues.

  • While the program enjoyed early success, Spruce Point believes US program growth has plateaued, and has hard evidence that printer orders delivered to Amazon in the US have dramatically slowed YTD 2019. Furthermore, we believe Kornit will lose Amazon’s next leg of expansion of the Merch program to Japan:

  • Selling digital printers is akin to selling a commodity product in a hyper competitive industry. In order to entice Amazon, Kornit issued it cashless warrants (a weak form that requires no capital commitment by Amazon) for its stock, which should be viewed as price discounts and are netted against sales.

  • Based on the warrant vesting formula, we can determine that total payments by Amazon to Kornit in 2018 were 105% of total 2018 operating cash flow. This suggests underlying organic cash flow decline from its remaining business.

  • In addition to warrants (and price discounts to list price), Amazon also gets price rebates, and Kornit is not adequately disclosing the rebate terms in the contract or in the 20-F. This amounts to an effective “triple incentive” to win Amazon.

  • Based on our research, we believe the rebates will kick-in up to a year afterwards, causing short-term inflation in Kornit’s cash flow, and will be a drag on Kornit’s operating cash flow in 2019.

  • Kornit uses the non-standard Monte Carlo analysis to value the warrants, instead of the more common Black-Scholes method, allowing it wider discretion to value the warrants. It claims it cannot issue warrant expense guidance. Warrants are effectively options, and plenty of public companies issue guidance on stock compensation expense.

  • Kornit avoided including warrants in its diluted share count calculation, despite the fact 1.1m are vested and exercisable, with an approximately market value of $16m. Kornit’s diluted EPS is lower than it appears.

  • Warning: There’s a discrepancy between reported Amazon revenues in Kornit’s filings. In addition, because it appears Kornit received more cash than revenues booked from Amazon, deferred revenues should have increased more than reported.

  • Warning: Kornit initially tried to exclude the warrant cost from Non-GAAP EPS, an aggressive tactic that the SEC questioned, and made it restate results. In our view, this illustrates how aggressive management is using the warrants.

  • Extreme Warning: Kornit’s CFO was the CFO, and named in the option backdating scandal, at MRV Communications (Nasdaq: MRVC), which was delisted to the pink sheets, restated financials and settled a shareholder lawsuit. He omits from his bio that he started his career at Ernst & Young, which served as MRVC’s auditor and as Kornit’s. We observe that Kornit backdated the warrant expense in 2016 – before the Amazon deal was announced in Jan 2017. The backdating amount in Q4’16 has represented the single largest charge since inception, which suggest front-loading of expense recognition and could allow Kornit to inflate future revenues.

  • Kornit’s second biggest customer, Cimpress NV (Nasdaq: CMPR) known for its Vistaprint business, revealed in late Jan 2019 that it is under severe pressure, and going through a management shake-up. Kornit conceals the extent of its exposure to Cimpress.

  • Kornit’s long-time CEO abruptly and unexpectedly resigned in the middle of 2018, right after shipments were made to TX and PA, and ahead of the miraculous recovery in its financial performance and stock price explosion. Before leaving, he received a “special bonus” for what amounts to the ordinary role of helping the company raise capital.

  • The new CEO has issued wildly optimistic long-term revenue goals of $500m. Kornit focuses investors to revenue over cash flow, which has remained elusive. To illustrate, from 2015-2017 it converted just 1.5% of sales to cash.

  • After presenting its long-term vision to investors, Kornit’s earliest and biggest shareholder, sold all of its stock in December 2018. The appears to be a vote of no confidence in management’s long-term growth plan.

  • Kornit’s current valuation is at an all-time high, and significantly above its long-term average. In addition, when viewed in the context of its competitors’ multiple and other low-technology computer and printer peers, Kornit’s valuation is at an extreme we’ve never seen. Kornit’s average sales, book, and cash flow multiple are 4.4x, 4.0x, 80x vs. current 5.6x, 5.8x, and 182x on our estimates. Digital printing peers trade at 1x, 1.4x, and 9x.

  • If Kornit received a multiple closer to printing and computer equipment peers, and our concerns about Amazon come to fruition, it’s easy to justify a price target of $4.50 – $9.30 or 75% – 85% downside risk.



  • PetIQ, Inc. (“PetIQ,” “PETQ,” or “the Company”), a recent JOBS Act IPO, is the product of an acquisition of an unattractive veterinary services business by a shady veterinary drug distribution business. The distribution business, built on the ethically-nebulous practice of veterinary drug diversion into the retail channel, appears to depend heavily on access to vendor rebates for earnings, and is currently at risk to changes in drug manufacturers’ approach to retail distribution. PetIQ’s planned rollout of 1,000 new pet wellness centers could also burn over $200M in cash over the next five years without even achieving break-even profitability until FY23. The Company has already changed its story and growth targets numerous times despite being public for just 20 months, and is not fully transparent about the risks facing both businesses. Management is asking investors to trust it to execute despite having missed nearly all prior projections. Further, we find that PetIQ management – whose CEO has close ties to the notorious Petters Ponzi scheme and the Fleming Corp accounting fraud (which go undisclosed on his online bio) – has a history of engaging in business practices which have come under legal and regulatory scrutiny. Investors should proceed with extreme caution.

  • PetIQ Occupies A Murky Space In The Pet Pharmaceuticals Market: PetIQ purchases prescription and OTC veterinary pharmaceuticals from veterinarians and licensed distributors. Manufacturers have historically restricted themselves from selling to non-licensed distributors or directly into the retail channel in order to protect veterinarians from retail competition for pet medicine sales. However, veterinary drugs do ultimately reach the retail channel – both brick-and-mortar and online – through non-veterinarian distributors (such as PetIQ) which purchase excess product from veterinarians, and which often form arrangements with veterinarians to purchase inventory in size. While not technically illegal in most states, the practice is frowned upon by vets, and has been the subject of congressional hearings and FTC commentary through the last several years. PetIQ’s General Counsel, who presumably blessed its business practices – yet whose personal bankruptcy was never disclosed to investors – recently resigned in Mar 2019. Manufacturers are increasingly beginning to bypass the grey market and sell directly to retail – as is Merial with its Frontline product, as of FY18 – showing cracks in PetIQ’s economic ecosystem. Wider competition in the pet medicine distribution space and greater transparency into distributor margins among retailers could bring PetIQ product segment operating margins – 8-9% as of today – closer to the 1-3% margins shown by other pharmaceutical distributors.

  • Core Pharmaceutical Distribution Business Is Under Pressure: Consumers are shifting away from topical flea and tick medications (30-40% of PetIQ sales) in favor of more dependable and hassle-free oral and other treatments. Frontline, one of PetIQ’s major sellers, is facing pressure from both this and the proliferation of cheaper substitutes. Consumers are also reporting that Frontline has become less effective following a recent formula change.

  • Recently-Acquired Services Segment From VIP Will Deliver Slow Sales Growth And Burn Significant Cash: Whereas PetIQ management has publicized its new services business as a 25% organic grower, total segment growth was just 9% in FY18, and we estimate that growth from existing stores was just 1-2%. Management is planning to roll out 1,000 new health and wellness centers in retailers such as Walmart through 2023, and expects each store to offer 30% contribution margins at maturity, but we estimate that the roll-out could burn $200M of cash through the next five years (perhaps more thereafter) while just barely achieving break-even profitability in FY23.

  • Suspicious Circumstances Around VIP Acquisition: PetIQ eliminated $111M of inter-company sales in the combined company’s pro forma 2017 income statement (over half of PetIQ’s COGS), revealing the closeness of the relationship between PetIQ and VIP. Of the $220M purchase price, $76M was allocated to VIP’s “customer relationships” which were written down twice from $90M, suggesting that these relationships were of declining quality or were reduced to suppress amortization and cut prospective GAAP losses in half. After the acquisition, over 100% of earnings for the pro forma 2017 combined company were attributable to vendor rebates, which grew by 175% in the year prior to the deal. We find it suspicious that PetIQ would spend $220M on the $250M-revenue VIP business after its EBITDA appears to have declined for two straight quarters and go negative prior to the acquisition.

  • Acquisition Driven By Fragile Industry Dynamics: Spruce Point believes that PetIQ was motivated to acquire VIP for more direct access to manufacturer relationships and vendor rebates as it outgrew the capacity of its previous vendors. At the time, this arrangement would have been beneficial to Merial as well, as it would have allowed Merial to drive retail sales of its pet medications more directly while maintaining the appearance of selling only to vets. However, now that Merial has begun selling directly to retail, PetIQ is at risk of seeing its margins regress to those of pharmaceutical distributor peers as retailers gain greater visibility into distributor margins and wholesale pricing.

  • A Company With A Dubious Past And A History of Questionable Vendor Arrangements: PetIQ appears to have been born as W.T.F. Wholesale in the early 2000s. W.T.F. formally closed shop in 2011 – but not before accepting hundreds of thousands of dollars’ worth of product from veterinary suppliers without paying, after which it appears to have continued to do business as “True Lines Distributors,” as alleged in lawsuits. True Lines was a subsidiary of “True Science Holdings, LLC,” which became PetIQ in 2016. True Science appears to have formed non-arms-length relationships with veterinary drug wholesalers through the first half of the 2010s. A former supplier alleged that, during this period, True Science used these close relationships to manufacture artificially inflated assets and earnings. He also alleged that its accounting practices triggered a federal investigation in 2014.

  • CEO With A History Tied To Vendor Rebate Schemes: CEO McCord “Cord” Christensen was a major funnel of investor money into the Petters Ponzi scheme – a fact which goes unmentioned on his online bio. He was characterized as an unknowing victim in court proceedings, but was closely associated with Petters as an employee and business partner through the 2000s, and controlled several entities which recruited millions of dollars of investor money for Petters. He was also involved with subsidiaries of Fleming Corp, which was identified as an accounting fraud for inflating earnings through the improper application of vendor rebates. The fraud was so egregious that the business was nicknamed “Flem-ron” in the scheme’s fallout.

  • Downside Risks To Valuation Abound: We believe that PetIQ earnings are heavily dependent on access to manufacturer rebates. We consider these earnings of low quality at best. With Merial now selling Frontline directly to retail, we expect the value of PetIQ’s rebates to dwindle as Merial and larger retailers increasingly squeeze its markups. Should regulation surrounding the grey market change – for example, if regulators legitimize the retail channel for veterinary drugs – PetIQ could be at risk of disintermediation, and industry legitimization would likely lead to greater industry competition and pressure PetIQ’s unusually high margins. We also wonder whether PetIQ’s demonstrated profitability is sustainable given its questionable rebate accounting. The possibility of further regulatory investigation into PetIQ’s accounting builds further downside risk into the stock.


Aerojet Rocketdyne Holdings, Inc.

  • In our opinion, Aerojet Rocketdyne (NYSE: AJRD) – formerly Gencorp (NYSE: GY) – is facing fundamental pressures, masked by complicated and aggressive accounting, which gives investors a potentially misleading impression of stability and growth. While holding no conference calls, and having only four analysts cover the stock, we believe the market is fundamentally ignoring ~$900M of liabilities associated with the business, making the Company 5x more levered than it appears and its valuation “cheap”. Furthermore, analysts blindly pencil in 4% revenue growth in the next two years, despite hundreds of millions of dollars in revenue programs that are disappearing. We see 40% – 60% downside once investors piece the puzzle together.

  • Aerojet’s primary rocket propulsion business has historically benefited from high barriers to entry, oligopolistic pricing and favorable cost-reimbursable contracts. In our opinion, these dynamics appear to have enabled the Company to win business and protect margins, despite many claims it lacks a culture of innovation

  • These dynamics have shifted in recent years with the emergence of disruptive low-cost competitors driven by lionized CEOs (Blue Origin / Bezos and SpaceX / Musk ), and the impact of the Northrop’s Orbital ATK acquisition on AJRD’s missile business

  • The winding down of various platforms (AJ-60 + RS-J8) and failure of AR1 to low cost competitor Blue Origin’s BE-4 engine for the Vulcan Rocket. We believe the loss to Blue Origin was the death blow to Aerojet by losing ULA, its only customer in space launch. ULA, a material 17% customer, is expecting to coming under pressure: earnings are forecasted to be down 47% in 2019. Spruce Point estimates these losses eliminate $300m of expected revenues in the near and long-term

  • Revenues from RS-25 for the SLS program (14% of 2018 revenues), are set to decline from the Sept 2018 completion of a $2.0bn contract, and the run-off from the 2015 $1.5bn contract to be completed by 2023. Longer-term challenges remain with NASA’s over-budget Space Launch Systems (SLS) program dubbed the “rocket to nowhere”, and a recent change of tone at NASA suggest it is taking steps to find cheaper commercial alternatives to the RS-25.

  • In 2018, Aerojet benefitted from boosts in missile orders from key programs which are set to decline by 5% and 11% in 2019/2020, respectively, according to the recent March 2019 DoD budget request. We estimate that Aerojet’s revenues increased $117m in 2018 from the growth in just two key programs: Standard Missile and THAAD. These two key programs are budgeted to decline by 2% and 35% in 2019 and 2020, respectively

  • Management And The Board Have Little At Risk Owning Just 3.0% Of The Company (1.9% ex: Chairman Lichtenstein’s Ownership). Years Ago, The Employee Savings Plan Was A Material Owner >10%, Now It’s Effectively 0%. Short-Term Incentive Bonus Definitions Becoming Much More Subjective, Conveniently Allowing The Board To Lavish Management With Credit For Maximum Cash Compensation

  • Upon Hiring, The CFO’s Bio Claimed He Was A CPA, Yet His Bio Now States He “Completed Exam Requirements”. General McPeak was the Lead Director at Miller Energy Resources (NYSE: MILL), a bona-fide accounting fraud that went to zero. The SEC charged management with securities violations and even fined the auditor. Perry was CFO and Treasurer of United Industrial Corp during a period the SEC blasted it for fraud concerning foreign corruption and stated the Company “lacked meaningful controls to prevent illicit payments.

  • By applying a discounted multiple range to our adjusted enterprise value and financial results, we derive a price target of $13.00 – $20.00 (40% – 60% downside) including entitled land value. Follow the money: Many long-term owners are consistently selling stock and reducing ownership. Aside from passive investor Vanguard, Aerojet has attracted only one new fundamental investor of size in recent years


Dexcom, Inc.

  • Dexcom, Inc. (“Dexcom,” “DXCM,” or “the Company”) manufactures continuous glucose monitoring systems (“CGMs”) for diabetic patients. It competes with Abbott’s FreeStyle Libre in the stand-alone CGM space. Dexcom’s G-Series has until now been considered the gold standard, with the Libre a cheaper, user-friendly alternative. However, Abbott is set to release the Libre 2 in the U.S. imminently – in a matter of weeks or months, we believe – and will close most, if not all, of the technological gaps which separate it from Dexcom’s G-Series. CGM commoditization will promote heavy price competition – and Abbott, as the low-cost manufacturer by a factor of 4, can put heavy pressure on Dexcom profits with little downside to its own margins. The Street believes that the down-market Libre is not a serious threat to Dexcom’s market, but the Libre has taken >70% incremental share of the U.S. Type 1 (“T1”) market and >95% incremental share of the U.S. Type 2 (“T2”) market since first being released in the U.S. – even before the release of the more advanced Libre 2. We believe that the G6’s target U.S. T1 market offers just 1-2 years of remaining patient growth, severely restricting Dexcom’s patient base until the release of the T2-oriented G7 in late 2020-21 at earliest. Importantly, we also find evidence that Dexcom’s recent sales growth acceleration was driven by an effective price increase and stockpiling of cheaper legacy G-Series models – and is not an indication of recent patient growth (which management conveniently stopped disclosing).

  • Abbott Set To Close Technological Gap Between Libre And Dexcom G-Series: Until now, Dexcom’s alarm-equipped, accurate G-Series has been considered the gold standard of stand-alone CGMs, with Abbott’s Libre (new in the U.S. as of 2018) a low-cost, easy-to-use alternative. Abbott, however, is set to release the Libre 2, which includes a similar high/low glucose alarm and is sufficiently accurate to serve the needs of most, if not all, diabetics. Priced at an ~80% discount to the G6, the Libre is the far more sensible option for T2 diabetics, and even T1 diabetics – a surprisingly price-sensitive population, per our proprietary survey – will be drawn to the cheap yet advanced Libre 2. Whereas Dexcom was once a technologically-superior first mover, it is now fighting with near-equals for mass-market adoption.

  • Dexcom Has Few Avenues To Near-Term Patient Growth: U.S. T2 patients did not adopt CGMs in material size until the release of the far cheaper Libre 1. Abbott is now taking >95% incremental share of U.S. T2 patients, suggesting that T2 patients may have never been part of the G-Series TAM. Dexcom will effectively be locked out of the T2 market until it releases a cheaper, down-market CGM similar to the Libre (late 2020-21 at earliest, per management, after having failed to meet its initial target of 2018). Libre is also taking >70% incremental share of U.S. T1 patients, even before the technologically-comparable Libre 2 hits the market. With the U.S. T1 market already ~50% penetrated (with a likely ceiling of 70-80%), Dexcom has limited room for patient growth through the next 1-3 years as T1 patient adoption decelerates, as it competes against the cheap yet technologically-comparable Libre 2 in its core T1 market, and as it fails to make significant headway in the T2 market – by far the largest source of CGM patient growth through FY19-21 and beyond.

  • Abbott’s Economies Of Scale As A Large Medical Device Player Could Overwhelm Dexcom Amidst Industry Pricing Pressure: The leveling of the technological playing field between Abbott’s and Dexcom’s CGMs will likely bring downward price pressure to the space, particularly given the Libre’s current ~80% discount to the G6. Abbott is the low-cost CGM manufacturer by a factor of 4, and could overwhelm the one-product Dexcom in an aggressive price war. If Dexcom is forced to price its current CGM lineup on par with the Libre, Abbott could wipe out Dexcom’s gross profit in its entirety given Dexcom’s while taking only a 100 bps hit to its own gross margin, per our estimates. Dexcom’s vast scale disadvantage could also potentially prevent it from ever producing a cheaper T2-targeted CGM profitably.

  • Investors Misinterpreting Recent Growth Acceleration As Growth In Patient Base: Bulls believe that recent sales growth acceleration to >50% yoy has been driven largely by patient base expansion. However, the decoupling of transmitter sales growth from sensor sales growth suggests that the growth acceleration is a consequence of A) recent effective sensor price hikes and B) stockpiling of cheaper legacy G-Series sensors ahead of the release of the more expensive G6. Management no longer discloses patient base growth as of February 2019, hiding any recent slowdowns in patient base growth from investors’ view.

  • A Risky One-Product Company Valued As A Growth Story: DXCM is valued at a 57% premium to peers on its seemingly exciting growth story despite exposure to competition / TAM saturation. Even bullish sell-side analysts see only ~5% upside, and smart money seems to be wary of DXCM’s growth prospects. We see 45-60% near-term downside in DXCM shares on disappointing sales growth and a multiple rerating, and even more potential future downside on longer-term price pressure.


iROBOT CORP (Update 5)

  • Spruce Point has discovered new evidence that SharkNinja (“Shark”) – a major competitor of iRobot (IRBT or “the Company”) – is primed to release a new, high-end, smart, and home connected robot vacuum cleaner (RVC) priced at a 25% discount to the comparable Roomba i7. Another competitor has already begun selling a comparable product at close to half the price of the i7. Whereas Shark and other competitors have until now taken share primarily at the lower and middle tiers of the robot vacuum market, they now will compete at the premium tier. The consensus among bulls is that Roomba is a technologically superior product and the market leader at the premium tier, affording it some protection from pricing pressure. We believe that this narrative is no longer valid: iRobot will now face legitimate competition at the high end of the market.

  • Management has attempted to drum up investor confidence by pitching the potential of its non-Roomba products – specifically, its robot mop (Braava) and forthcoming robo-lawnmower (Terra) – but we believe that guidance is aggressive on the former (by management’s own admission), and we are skeptical that the latter will meet with commercial success in the U.S. Investors should brace for significant disappointment.

  • Release Of High-End RV950 Shark Robot Vacuum Appears Imminent: Spruce Point recently discovered that Shark is prepared to release the RV950 – a high-end robot vacuum with features comparable to those of the Roomba i7, but priced at a 25% discount. Product listings for the vacuum have already been prepared on Wayfair and Walmart’s online stores. Shark’s entry into the lower and middle tiers of the market in 2017 represented one of the first non-Roomba robot vacuum product launches by a recognizable and respected home appliance brand, and Shark has since competed aggressively with iRobot’s mid-tier vacuums and has successfully taken market share. We believe that Shark will apply similar competitive pressure to the higher end of the robot vacuum market with the launch of the RV950.

  • RV950 Representative Of Trend Of Heightened Competition At Top Tier Of The RVC Market: We see the impending release of the RV950, and other recent product launches, as evidence that iRobot competitors – once considered “off-brand” or “no-name” products occupying the lower end of the market – are rapidly closing the technological gap between themselves and Roomba, and that robovacs are thus becoming increasingly commoditized. Formerly-unknown brands are quickly gaining respect from the tech world and are seen as legitimate Roomba alternatives. Even then, competing products continue to be priced at a material discount to comparable Roombas. We estimate that pricing pressure at the high end of the market could cost iRobot ~12 points of gross margin on its Roomba segment.

  • Aggressive Braava Projections Unlikely To Come To Fruition: Management is aiming for Braava to contribute 10% of FY19 total sales. Given iRobot’s FY19 sales guidance, this implies that management expects Braava sales to grow by over 50% in FY19. This would be entirely out of line with historical growth rates and with Braava’s recent performance in markets in which it has achieved some level of popularity – namely Japan. We believe that Braava sales will grow by no more than 20-25% in FY19 at the high end. Management’s Braava guidance also implies that it expects Roomba sales to grow by just 14-17% in FY19, a meaningful step down from recent growth rates.

  • Terra A Poor Fit For The U.S. Market: After nearly a decade of development, iRobot finally announced the launch of its robot lawnmower on the Q4 FY18 call. iRobot has a tremendously poor record of developing and selling products outside of its core Roomba line – particularly products meant for outdoor use. We believe that the Terra is a poor fit for the U.S., where lawns are large and difficult to navigate by global standards. In Europe, where the robot mower market is already developed, iRobot will compete with established, respected brands with technologically-advanced mowers, yet with sufficiently deep pockets to weather a price war. This stands in contrast to the conditions which led to Roomba’s success in the U.S., where it came to dominate the market by establishing itself as a first mover and a relatively premium product.

  • Valuation Makes Little Sense: IRBT shares have run up from $75 to as high as $130 through the recent bull market on little more than sporadic optimism regarding U.S.-China trade talks. We find it puzzling that IRBT shares reacted so positively to what was at best a mixed Q4 earnings call. We believe that increasing competition and downward pricing pressure will continue to weigh on top-line growth and margins, and that multiples are tremendously overextended – how else could every single sell-side price target be below current share prices? A potential tariff hike to 25% remains a material risk for iRobot, and could drive another ~15% downside to IRBT shares.


Carvana Co. (Update)

  • Spruce Point believes that the recent terrible financial results reported by Carvana continue to validate our concern about its uneconomic business model that isn’t scaling, is capital destructive, and favors insider enrichment over shareholder wealth creation. Our revised price target is $7.50 – $19.60 (56% to 83%).

  • Q4’18 Results Disappoint By A Mile..Retail Units: 27,750 (vs Bloomberg cons 29,200, vs guidance 27,500 – 30,000)

  • Reported Revenue: $535m v $605m expected (original guidance: $570m – $630m)

  • At The Current Burn Rate of $1.1m/Day, Carvana Had Just 70 Days of Operating Cash On Hand At Yr End

  • We estimate just $12.8m of unrestricted cash on hand by March 1st

  • 100% Gross Margin Finance Revenue Driving GPU: Carvana generates an outsized share (~50%) of GPU from 100% gross margin finance and insurance (F&I) sales, vs. <20% for KMX. Underlying GPU on car sales alone are >10% below industry average and less than half that of KMX

  • In Spruce Point’s opinion, Carvana will require more equity capital to continue operations, and has limited flexibility to incur more debt given its deep junk CCC rating. Yet, despite the accelerating cash burn, management received a 100% increase in cash compensation at the approval of an “independent” Board, further compounding the pain to investors.

  • Other liquidity alternatives include going further into debt by tapping the floor plan facility and/or sale leaseback agreements with $331m of capacity. However, this could be incrementally negative from a credit perspective

  • We caution investors that Carvana’s stated belief that it won’t need to raise additional debt or equity appears aggressive. Importantly, management has a poor track record of hitting its stated financial targets.

  • “The Board also approved annual base salary increases for the Company’s executive officers as part of its annual performance review, including Ernie Garcia III, the Company’s Chief Executive Officer, whose annual base salary was increased from $400,000 to $885,000, Mark Jenkins, the Company’s Chief Financial Officer, whose annual base salary was increased from $375,000 to $735,000, and Benjamin Huston, the Company’s Chief Operating Officer, whose annual base salary was increased from $375,000 to $735,000. The salary increase were approved retroactively to January 1, 2019, consistent with the Company’s practices for annual merit increases.”

  • By reporting on Feb 27th, Carvana is already 2/3rds through the quarter and should be able to provide investors visibility into expected results


Amdocs, Ltd.

  • Amdocs (DOX or “the Company”) is a cryptic entity based in the tax-dodge haven of Guernsey that provides revenue management, BPO and IT services primarily to telecoms. Industry forces have dragged on sales growth to the point that Amdocs appears to be in organic decline. We believe that DOX has engineered superficial top and bottom-line growth alongside unusually stable margins through opaque M&A, aggressive percentage-of-completion accounting, software cost capitalization, and repeated one-off net tax benefits. Challenged FCF growth, self-imposed minimum cash balances, and likely leverage limits will constrain DOX’s ability to pursue growth via M&A going forward. We are also concerned that DOX is accelerating its earnings-inflating cost capitalization scheme by constructing a new Israeli campus. An obscured JV loan, receivable factoring, and capex statements which hide asset sales all point to slowed underlying FCF growth. With insider ownership at an all-time low, evidence that management is milking DOX’s cash through aggressive option comp schemes, and Board members tied to allegations of option back-dating and software cost capitalization, we believe that shareholders should keep a vigilant eye on management’s accounting practices and compensation decisions.

  • Suspiciously Steady Margins: Amdocs shows remarkably steady margins for a firm which frequently absorbs acquisitions ($1.6B since 2012), which should have some degree of operating leverage, and whose business has come under pressure from its largest customer (AT&T). Peers and telcos show much more natural margin variability. Unusually steady margins support our suspicion that Amdocs engages in aggressive percentage-of-completion accounting.

  • Growing Divergence Between Adjusted And GAAP Metrics: Amdocs’ proprietary Adjusted EPS measure has grown steadily through the last 5 years, while GAAP EPS and cash flow have been flat to down over the same period despite the Company’s M&A-fueled growth. Spruce Point has observed both of these patterns among numerous companies on which it has published research, and feels that they are strong indicators of impending financial strain.

  • Questionable One-Off Tax Items: DOX claims up to $60M of one-off net tax benefits on a yearly basis, with the specific sources of these benefits changing almost every year (it claimed $28M in benefits related to its spending on its new campus in FY 2018). We do not believe that these benefits – worth 10% of EBT in FY 2018 – are a sustainable source of earnings. Excluding these items, Amdocs’ tax rate looks much closer to that of most companies.

  • Struggles Generating Cash: In Dec ‘18, DOX began to disclose that it factors accounts receivable (on non-transparent terms). It also obscured a loan issued via a recently-formed JV to finance its new HQ, despite saying previously that it could finance the project internally without material impact to results.

  • Who Signs DOX’s 20-F And Credit Agreement: We observe that DOX’s Head of IR/Secretary signs its 20-F and Credit Agreement. Our research shows that this is a highly unusual practice: the CEO generally signs the 20-F, while the CFO and/or Treasurer normally signs Credit Agreements.

  • Closely Tied To A Low-Growth Industry: As IT support for major telcos, Amdocs’ organic growth is ultimately tied to a stagnant industry – AT&T in particular (~30% of sales). Management attempts to describe industry trends such as consolidation as a tailwind for the Company, but, in reality, slow growth among telcos translates into slow organic growth for Amdocs – particularly as elements of revenue management software become less complex.

  • Management Engages In Frequent M&A To Grow Sales: Amdocs has purchased a jumble of IT and media businesses through the past decade to support growth where it can’t generate its own. Many of these businesses appear to be only tangentially relevant to Amdocs’ core services, and are only partially integrated into Amdocs once acquired. Without these acquisitions, we estimate that Amdocs generates zero to negative organic growth.

  • Management Not Transparent About Inorganic Sales Contributions: Management is frequently asked on earnings calls about the contribution of acquired businesses to total revenue. It often writes them off as “small” even when the announced purchase price is relatively sizable – and, when it does give more granular details, it appears to understate their likely contribution, thus inflating implied organic revenue growth.


XPO Logistics Inc.

  • Spruce Point has been following XPO Logistics (NYSE: XPO) for years, a transportation and logistics roll-up founded by Bradley Jacobs, co-founder of United Rentals (URI) which collapsed in an accounting scandal during his leadership. Based on our forensic investigation, we believe XPO is executing an identical playbook to URI – resulting in financial irregularities that conveniently cover its growing financial strain and inability to complete additional acquisitions despite repeated promises. Given its unreliable and dubious financials, $4.7 bn debt burden, inability to generate sustaining free cash flow, and dependency on external capital and asset sales, we have a worst-case terminal price target of zero.
  • XPO has completed 17 acquisitions since Jacobs took control in 2011 and deployed $6.1 billion of capital. Yet by our calculations, the Company has generated $73m of cumulative adjusted free cash flow in an expansionary economic period. In our view, this is indicative of a failed business strategy yielding a paltry 1.2% return on invested capital. XPO is dependent on external capital, asset sales, and factoring receivables to survive and is covering up a working capital crunch that can been seen by bank overdrafts – just like Maxar Technologies (MAXR). As credit conditions tighten, cost of capital increases, and XPO’s business practices come under greater scrutiny (eg. U.S. Senate), its share price could swiftly collapse in Enron-style fashion.
  • CEO Jacobs has surrounded himself with a web of associates from his United Waste Systems and United Rentals days. Two of his partners, Mike Nolan and John Milne, were convicted of accounting fraud. XPO’s director G.C. Andersen recently employed Milne at his financial advisory firm during a time the company worked on private placements (potentially XPO’s deals) and was sanctioned by FINRA. This wasn’t disclosed to investors. XPO’s audit committee director, Adrian Kingshott, has omitted from his bio his role in the distribution of note securities in the $700m Marc Drier Ponzi scheme.
  • In our opinion, XPO has used a nearly identical playbook from United Rentals leading up to its SEC investigation, executive felony convictions, and share price collapse. We find concrete evidence to suggest dubious tax accounting, under-reporting of bad debts, phantom income through unaccountable M&A earn-out labilities, and aggressive amortization assumptions: all designed to portray glowing “Non-GAAP” results. Additionally, we provide evidence that its “organic revenue growth” cannot be relied upon, its free cash flow does not reflect its fragile financial condition, and numerous headwinds will pressure earnings.
  • XPO insiders have aggressively reduced their ownership interest in the Company since coming public, and recently enacted a new compensation structure tied to “Adjusted Cash Flow Per Share” – defined in such a non-standard way that it is practically meaningless. Conveniently, it ignores any measure of capital efficiency, which is critical in the capital intensive transportation industry, and would expose XPO’s poorly constructed roll-up. In our opinion, the Board is stacked with rubber-stamping Jacobs loyalists, none of which have requisite experience in the transportation and logistics industry. As noted above, the Board includes an audit committee member who abetted a notorious $700m Ponzi scheme.
  • XPO has recruited 19 brokers to cover it, with only 1 “Sell” opinion and an avg. fantasy price target of $114 (implying 90% upside). No analyst has conducted a forensic look at XPO’s earnings quality, or revealed its Board and management’s connections to convicted felons. XPO promotes itself to investors as a “technology” company and how it uses “robots” for warehouse automation, but ignores its growing financial strain, precarious $4.7 billion debt load, and inability to hit its cash flow target. Warren Buffett famously said, “Only when the tide rolls out do you know who as been swimming naked” – words of wisdom for XPO shareholders. A crisis of confidence in management and a loss of access to capital could wipe out shareholders. In the interim, we see 40% – 60% downside risk as the market reassess XPO’s earnings quality, outlook, and sum-of-parts multiple.

    iROBOT CORP (Update 4)

      • Spruce Point has released a number of reports on iRobot (IRBT or “the Company”) highlighting impending competitive pressures and defensive distributor acquisitions designed to forestall revenue growth contraction and margin compression. We have evidence that the competitive forces which we foresaw are materializing, resulting in significant ASP declines, market share losses, and cash flow contraction. With the uplift benefit from distributor acquisitions set to lapse, and with punitive Chinese tariffs set to expand from 10% to 25% in 2019, we believe that iRobot’s is set up for significant revenue growth deceleration, margin contraction, and earnings headwinds next year. As a result, we see 70-80% downside risk.


      • Technological Advantages Dwindling: As the first mover in the robot vacuum space, iRobot has until now enjoyed perceived technological dominance over other brands. That advantage has narrowed materially: more established consumer technology brands have entered the market, and consumers have taken notice that competitors meet or exceed Roomba’s technological capabilities.


      • Amazon Enabling And Promoting Aggressive Competition: Amazon is becoming an increasingly important sales channel for iRobot: it was responsible for ~25% of iRobot sales in Q3, up from just ~10% in Q3 of the prior year. iRobot products generally do not receive preferential placement on Amazon search pages, due to both its high price tag and aggressive promotional activity among peers. Amazon also has less incentive to promote brands with high name recognition than do brick-and-mortar stores. Amazon enables a level of competition which undermines the importance of iRobot’s recognizable brand.


      • Industry Competition Dragging On Sales Prices: Robot vacuums are classic deflationary pieces of technology: commoditized products which experience rapid industry catch-up with each incremental technological development, and which have little room for substantive differentiation (but which require consistent R&D spend nonetheless). iRobot has not been able to raise product prices materially for years, and is pushing sales by offering a wider range of products priced below its top-line vacuum. This strategy will drag on margins over time.


      • Worrisome Cash Flow Developments: iRobot’s net spending on working capital has ballooned in the wake of its distributor acquisitions – a concerning development resulting in YTD operating cash flow contracting by 21% YoY. We believe the financial strain was telegraphed in July when iRobot unexpectedly doubled its line of credit from $75 to $150m for no obvious reason, given that it has $126m of cash on hand, and that it was on pace for $50m+ of operating cash flow. Rising DSOs may be a signal of channel-stuffing at its own distributors. Massive inventory growth and record DIOs may also be both a signal of slowing sales growth ahead and a result of management accumulating lower-cost inventory in anticipation of tariffs.


      • Tariffs Potentially A Highly Significant Drag On Earnings: Management has been dodgy about the potential impact of tariffs when asked about it on calls. Investors now have a better sense of the impact of a 10% tariff following the Q3 call, but management continues to avoid discussing the potential impact of the impending 25% tariff – perhaps in hopes that the tariffs are cancelled before it would have to do so. We expect iRobot to take a massive 70% hit to FY 2019 EPS should the 25% tariff to be instituted on Jan 1 remain in place through the year (barring the passing-on of tariffs cost increases to customers, which we feel iRobot has limited ability to do). Sell-side analysts are either ignoring tariff risks or entirely off on the potential magnitude of the impact.


      • Insider Selling Is Exploding Out Of Control: In our first report on iRobot, we noted that insiders were selling the stock aggressively: insider ownership fell from ~60% in 2005 to ~12% in 2013 – and then to 5% only a year later. Insiders have continued to be sellers through the last several years, and insider ownership is now at an all-time low of 3.5%. While iRobot appears desperate to dangle carrots to the press – in particular, partnerships with big name technology companies – its insiders have enacted a record amount of 10b5-1 stock sale programs. For example, in Feb 2017, only CEO Colin Angle had a 10b5-1 stock sale program in place, but by May 2018 a total of six directors and executives were unloading shares under similar stock sale programs.


      • Share Price Above Even Lofty Sell-Side Targets: IRBT shares have soared from ~$60 in mid-2018 to close to $100 today, and reached as high as ~$115 ahead of CEO Angle’s much-anticipated presentation at the Disrupt SF conference – where, yet again, after years of hyping the Company’s potential in other home robotics categories, he failed to deliver anything new beyond the stagnant Roomba product. All sell-side analysts remain perennially bullish on the Company’s growth story, but the rapid rise in IRBT shares forced some analysts to issue downgrades on the basis of valuation alone. Long-term institutional shareholders continue to sell, while those buying classify IRBT under “consumer discretionary” and “homebuilding” and not technology!


    • High Valuation, Slowing Growth, Changing Distribution Model And Tariff Threat All Pose Risks To IRBT Shares: We see up to ~50% downside in IRBT shares on valuation alone, even when taking consensus earnings estimates for granted. The prospect of slowing sales growth and margin compression would imply even more significant downside, and 25% tariffs would wipe out a large chunk of earnings for however long they remain in place. We can envision a scenario in which business deterioration and 25% tariffs wipe out all 2019 EPS. Given the fundamental threats to the business, current trading multiples, and the possibility that iRobot must bear 25% tariffs for an extended period of time, we value IRBT shares at $20 – $30/sh, 70%-80% below current levels.

    Download the report to read more.

    Dollarama Inc.

  • Dollarama (DOL or “the Company”) is a dollar store which, following a series of price hikes over the course of several years, is no longer a true “dollar store.” As a result, DOL has fallen out of favor with value-oriented customers, causing average store traffic to contract and thus necessitating further price hikes to support SSS growth. Management is nonetheless aggressively pursuing unrealistic growth targets even as competitors flood the discount retail market and threaten its improbable margins. DOL’s shares trade at a 50% premium to peers in the value retail space – even following a ~20% drop after a disappointing Q2 – questionable governance and poor earnings quality notwithstanding. We believe that DOL will continue to miss lofty investor expectations, and that its premium valuation will continue to be pressured.
  • Undifferentiated Products: Dollarama sells a variety of low-priced products, mostly sourced directly from China. Its purported advantage in “sourcing” is contradicted by conversations with industry sources as well as numerous IP infringement lawsuits filed against the Company.
  • Moving Upmarket Is A Risky Strategy: Faced with years of negative average traffic growth and an increasingly saturated market, Dollarama is driving comparable store sales growth by selling higher-priced items. However, in doing so, it is quickly losing its reputation as a true “dollar store,” and per-store traffic numbers are declining as a result. Big Lots (NYSE: BIG) undertook a similar strategy in the 2000s, but reversed course after admitting its failure.
  • Saturation Is Imminent: Dollarama cited a 900 store target at the time of its IPO in 2009, when it had just 585 stores. Management has since revised this number upwards multiple times: first to 1,200, then to 1,400, and most recently to 1,700. Our analysis shows that this target is unrealistic, and that the market is already bordering on oversaturation. Dollarama’s FY ‘19 store opening pace has thus far been its slowest in years.
  • Margins Inexplicably High And Likely Unsustainable: Gross margins of 39-40% are remarkably high for a discount retailer, but intensifying competition, rising labor costs, rising transportation costs, and a lapsing currency hedge benefit all threaten Dollarama’s high profitability levels. Patterns in Dollarama’s hedging profits and gross margins ex-hedging suggest that management may be leaning on its FX-related profits to prevent its headline gross margin number from declining (see note on next page).
  • Founding Family (And A Director) Have Significant Related-Party Deals: The Rossy family launched Dollarama from its legacy retail chain in 1992 and owns significant real estate assets that are employed by the enterprise. This may have played a role in management’s recent decision to acquire Dollarama’s existing Montreal distribution center from the Rossys rather than open a second distribution facility in western Canada, as have most peers.
  • CEO Stepped Down And Installed His Son: Larry Rossy stepped down as CEO in 2016 (and as Chairman in 2018), selecting as his replacement his son Neil – previously Dollarama’s Chief Merchandising Officer. We question whether a thorough and arms-length search was conducted to fill this position.
  • Opaque Supplier Relationship: As part of a deal struck in 2013, Dollarama supplies goods (at an undisclosed profit margin) to Central American discount retailer Dollar City in exchange for an option to acquire the chain in 2020. However, Dollarama currently has no formal stake in Dollar City, and therefore does not consolidate Dollar City’s results. We are concerned that Dollar City could be overpaying its vendors to lessen the financial burden on Dollarama.
  • Insider Ownership Declining: Former CEO Larry Rossy has sold or transferred ~75% of his shares since the 2009 IPO. Bain Capital liquidated the last of its shares in 2011 at a split-adjusted price of $5 per share, 1/8th the current price. The current CFO owns no shares and regularly liquidates options.
  • Currency Hedge Supposedly A Pure Offset To CAD Depreciation, But Has Been A Material Profit Center: Dollarama claims to hedge currencies only to lock in consistent prices (in CAD) on which its customers can rely. However, in practice, the Company adjusts prices to match non-hedged competitors, leaving us to wonder why it hedges at all. Much of the recent hedge benefit appears to have reversed, but gross margins ex-hedges conveniently rose by just enough over the last two years to maintain steady profitability. If nothing else, we question whether Dollarama’s elevated margins are sustainable.
  • Tenant Allowances And Leasehold Improvements Are Amortized Over Very Different Periods: While accounting rules may give sufficient leeway to permit this difference, we question why lease term assumptions should differ for these two capital accounts. Earnings quality suffers notwithstanding.
  • Leverage Is Increasing: Dollarama makes long-term financing decisions using short-term debt, the cost of which has risen with recent debt issuances and is likely to continue to increase with rising interest rates – and as the Company’s credit profile grows riskier. We question management’s decision to increase leverage to support buybacks and dividends simply because the earnings yield is above the after-tax cost of debt. We also worry about the state of the balance sheet should the economic environment turn, or should the business decline more rapidly.
  • Depreciation Is Well Below Capex And Has Been For Years: Capital spending easily bests industry peers, both as a percentage of sales and vis-à-vis steadier D&A charges. The mismatch with D&A suggests poor quality of earnings at the very least. Meanwhile, management’s growth orientation has diverted capital spending away from store remodeling, giving stores a stale and dated feel despite rising price points.
  • Valuation Is Indefensible: DOL currently trades at a ~50% premium to peers and carries among the highest multiples of any global retailer. Higher only are the valuations of crème de la crème global fashion brands – Hermes, Prada, Ferragamo, etc. Such lofty multiples are inappropriate for a dollar store with serious near-to-medium-term business risks. Analyst estimates are not sufficiently skeptical of management’s targets in light of these concerns.
  • Even If Nothing Goes Wrong, The Stock Is Overvalued: Even if Dollarama executes its growth plan perfectly, maintains its world-leading margin, and retains a hefty valuation premium to its peers, the stock is at best fairly valued at ~$43.
  • Under More Reasonable Assumptions, DOL Stock Is Overvalued By 40% At Current Levels: Even assuming that Dollarama achieves full market penetration – with no negative impact on per-store revenues from competition or cannibalization – the stock is worth $28 under normalized margins and at a multiple closer to peer norms, down ~40% from current levels.

    Mercury Systems Inc. (Update)

    • Spruce Point finds evidence to suggest that Mercury Systems (Nasdaq: MRCY) could be one of the companies affected by the alleged Super Micro Computer, Inc. (Supermicro) hack, and can demonstrate recent actions taken by management to obscure the relationship. We believe the Street is structurally misunderstanding the magnitude of the revenue delays and cyber compliance costs that Mercury – a company presently without a Chief Information Security Officer (“CISO”) – will face going forward. Based on our expert calls, we expect that cybersecurity-related costs could mount to 10% of revenues. Given that management felt it necessary to hide its relationship with Supermicro, we believe that Mercury needs to disclose to investors the materiality of its exposure to Supermicro components, the financial impact of any product changes/recalls/replacements, and its plans to ensure the “security” of its mission-critical products on a go-forward basis.


    Exposure Emanating From “Technology Partner” Supermicro


    • On October 4th, Bloomberg published an in-depth article highlighting how China infiltrated 30 U.S. companies by inserting a tiny chip into Supermicro motherboards. Navy systems were mentioned specifically as an affected target. Mercury Systems and two of its recent acquisitions – Themis Computers ($175 million / Feb 2018) and Germane Systems ($45 million / July 2018) – each sells servers and other related IT equipment containing Supermicro motherboards to the Navy and other military branches.


    • Providing secure and resilient solutions to prime and government customers is the essence of Mercury’s business. Mercury mentions the words “secure” and “security” over 100 times in its annual report.


    • Mercury, Themis, and Germane all listed Supermicro as a “technology partner” on their respective websites until last week, when nearly all references to the relationship were abruptly and surreptitiously removed between October 8-9 without explanation.


    • The existence of Supermicro motherboards in Mercury’s rugged servers presents difficult-to-quantify tail risks, but could force product recalls and expensive supply chain adjustments, among other costly actions. As a precedent example, the Navy placed restrictions on IBM’s BladeCenter server line in 2015 over supply chain security concerns, less than a year after Chinese IT hardware manufacturer Lenovo acquired IBM’s server business. (USNI Article)


    • A recent GAO report entitled “DOD Just Beginning to Grapple with Scale of Vulnerabilities” highlighted how testers playing the role of adversary were able to take control of systems relatively easily and operate largely undetected. Based on conversations with industry experts, we believe that the requirements for winning government business will be (and are being) rewritten with an emphasis on cyber resilience and a much higher cybersecurity standard. We suspect that new contracts awards are likely to be delayed as a result


    • Based on our research, Mercury appears ill-prepared to address these new requirements given its relative shortage of cybersecurity personnel, and the fact that both its long-time CIO and long-time CISO recently departed in August 2018. We estimate that Mercury could have to spend up to 10% of revenue on cyber-related costs going forward, or otherwise make a costly acquisition to comply with these new customer expectations.


    • Mercury has quietly hinted at some of these concerns through subtle changes to its 10-K risk factors and safe harbor provisions, and through recent job postings in supply chain procurement and quality control.


    Henry Schein, Inc.

    • Spruce Point has a Strong Buy opinion on Henry Schein (HSIC) and sees 30% to 50% upside potential
    • We believe the upcoming spin-off of HSIC’s animal health distribution business will unlock substantial value for shareholders. Currently, investors are somewhat negative on HSIC’s dental business, and pricing and margin challenges are already widely known. HSIC currently has an 11% short interest that reflect this concern.
    • However, we believe investors are overlooking HSIC’s fast growing animal health business, that stands to benefit once it spins and merges with the privately held Vets First Choice (VFC).  HSIC brings strong relationships with vets worldwide, and VFC brings a high margin tech platform and pharmacy solution to help vets sell more to clients, while improving health outcomes for its client’s pets.
    • We have done unique due diligence on VFC, and believe it is growing materially faster than the numbers that were presented to Wall Street analysts/investors in April 2018. We’ve built an algorithm that runs US zip codes through VFC’s vet finder and believe they are on pace for on-boarding 9,000 vets vs. the 5,100 last disclosed à significant upside.  We have also conducted  ~100 surveys to determine customer satisfaction and revenue uplift potential from this synergistic merger. The feedback has been overwhelmingly positive.
    • The market env’t for animal health stocks is very strong: Eli Lilly just spun and IPO’ed Elanco last week, which was very well received. We believe that HSIC/VFC will be the fastest sales and EBITDA growth story in the industry, which should position it for significant multiple expansion. We like this situation because spin-offs tend to outperform the market once the new management team can have a greater alignment and incentive structure (we do believe that legacy VHC owners have a lot of skin in the game). VFC is run by the Shaw family which created billions of dollars of value at Idexx. We expect a significantly expanded shareholder base that can own VFC/HSIC and more analysts to assume coverage to say “buy” once the spin is completed. Our base case is ~30% upside to approximately $106 per share with up to 50% or $126 per share in a bull case scenario.


    Weis Markets Inc.

    • Poorly positioned regional supermarket in the hypercompetitive Northeast region that is a step behind in the megatrends pressuring the supermarket industry. Despite cutting prices, Weis is still not competitive across a basket of staple food products at price points 15% to 20% higher than peers
    • Credit card data and consumer insights from Earnest Research on 42,000 Weis customers shows that over the past three quarters, unique shoppers, average transactions per shopper and total transactions have declined YoY. Weis has mitigated these negative trends with an increase in average ticket price per shopper. However, in 2Q18 it posted the lowest YoY growth in recent quarters (3.5%). Tangible evidence that
      ultra low cost grocers, Aldi and Lidl, continue to gain Weis customers
    • Numerous violations by the Pennsylvania Bureau of Food Safety and the FDA for sanitary problems, including food contamination and pest control concerns
    • Recent financial results and stock performance being driven by aggressive accounting changes to cash flow, and a few one-time issues that made comparisons look easy in early 2018. These will become material headwinds in the coming quarters
    • Unreliable comparable store sales metrics as a result of vastly reduced disclosures, followed by three auditors since 2014. Recent Q2’18 metrics being qualified and bolstered by inclusion of estimated sales from July 4th. Underlying organic growth conservatively estimated to be down 2% and can no longer be masked by acquisitions from 2016
    • Negative unit store growth in 2018, including three undisclosed store closures. $101m capital spending plan announced in April 2018 necessary to drive maintenance and refurbishment to forestall market share loss and remain competitive
    • Poor governance and investor communications include no conference calls, deficient SEC disclosures in our opinion, no alignment of employees with shareholders, and beholden to the Weis family to act for the public shareholders’ best interest
    • Inflated valuation making Weis the most expensive supermarket in the United States for no obvious reason. Declining organic growth, gross margins, and poor returns on capital make Weis an unattractive target. It currently trades beyond any reasonable valuation multiple an acquirer would pay for the stock
    • Price target of $17.60 to $26.40, or 45% to 65% downside, on forecasted earnings of $1.47 per share, down 19% due to negative operating leverage, and a multiple range of 12x to 18x consistent with peer trading valuations and takeover multiples in the supermarket industry


    Maxar Technologies Ltd.

    Strained by the levered acquisition of Space Systems Loral in 2012 at the cycle peak, MacDonald Dettwiler’s (MDA) acquisition of DigitalGlobe (DGI) in 2017 was done out of necessity to cover-up growing accounting and financial strains. Rebranded Maxar Technologies (MAXR), the combined company has pulled one of the most aggressive accounting schemes Spruce Point has ever seen to inflate Non-IFRS earnings by 79%. However, with end markets weakening, and burdened by $3.7 billion of rising debt with almost no cash and free cash flow, Maxar must eliminate its dividend immediately, or risk wiping out equity holders.

    CEO Howard Lance is a former Group COO/President of NCR, a successful Spruce Point campaign that fell 40% after we highlighted numerous accounting concerns, and it failed to find a buyer after a strategic process. He was also the Chairman of the Board at Change Healthcare Holdings through 2017 and Harris Stratex (Nasdaq: HSTX, now called Aviat Networks (AVNW)). Both companies blindsided investors when informing them that the financial statements could not be relied upon, and material weaknesses of controls existed

    Engaging In A Massive M&A Accounting Scheme To Cover Past Problems: In Feb 2017, management said it didn’t identify any material inconsistencies in DigitalGlobe’s financials between GAAP and IFRS. It then backtracked and revised financials that artificially inflated revenues by 4-6% and EBITDA by double digits. However, this is only the tip of the iceberg. We previously illustrated our concern that MDA appeared to be overcapitalizing costs by inflating intangible asset purchases. Thus, it came as no surprise to us when Maxar used the DigitalGlobe acquisition to inflate intangible assets even further. However, the $1.1 billion inflation was an order of magnitude that shocked us. MDA made reference to DigitalGlobe’s “world leading (satellite) constellation” as a strategic rationale of the acquisition – yet it impaired the satellite assets at deal closing, and inflated its intangible asset accounts by a commensurate $1.1 billion

    Numerous One-Time Gains Being Used, Some In A Non-Transparent Manner: It appears Maxar has accelerated recognition of investment tax credits, and amended its post-retirement benefit plan to book one-time gains. In the case of the benefit plan gain, Maxar booked a $24.6m gain in Q4’17 (flattering EBITDA by 13.5%), which was not fully disclosed across its investor communications, nor do we believe analysts have adjusted their models to account for it. As a result, we believe Maxar will have a large headwind in Q4’18 and disappoint

    Deleveraging Plan Is A Fantasy And The Dividend Must Be Eliminated: Maxar is claiming it will deleverage and drive higher cash flow, but the numbers tell a different story: leverage is rising and it appears it is out of cash by reporting cash overdrafts! In addition to a large interest expense and capex burden (which we believe will remain at $300m+/yr as opposed to declining per management), Maxar is committed to a $68m/yr dividend and must pay down $25m/yr of its Term Loan B. These means it has no excess cash flow to accelerate debt reduction. Maxar is borrowing money to pay the dividend. Maxar should immediately cut or eliminate the dividend and direct capital towards debt reduction

    Up To 100% Long-Term Downside On Normalized Financials: Maxar trades at 10.5x and 43x on our normalized 2018E Adj. EBITDA and EPS for a business we estimate is declining organically 12.7%, and dangerously levered 5.8x. Valued on its free cash flow, expected to produce $0-$50m, Maxar could be viewed as worthless. Using below industry average P/E and EBITDA multiples to reflect Maxar’s distressed state and specious financial statements, we estimate an intermediate trading range of $20.00-$25.00 per share (45%-55% downside)

    2U, Inc.

    • 2U, Inc. is a money-losing education technology provider that partners with universities to market and manage online graduate degree and short course programs. Its one size fits all model is being disrupted by fee-for-service players with lower take-rates. Our Freedom of Information Act (“FOIA”) documents offer compelling evidence that 2U’s long term guidance will disappoint investors.
    • Significant Number of Programs Are Underperforming:  The Street is neglecting to understand the range of outcomes for both existing and future graduate programs.  We have assembled a proprietary historical revenue model that estimates revenues for each individual graduate program using a combination of FOIA requests, conversations with industry participants, company filings, transcripts, publicly available enrollment data, and tuition costs. This proprietary model reveals a wide range of outcomes between programs that are successful and those that we would classify as failures.  Most importantly, we have found that eight of the 14 programs launched between 2013 and 2015 are underperforming 2U’s steady state program expectations. Further, based on our findings, we believe that four of the top seven programs have peaked and/or seen enrollment declines.  Our FOIA request for new student enrollments for MBA@UNC reveals that the 2U enabled MBA@UNC is now in decline as the last four starts have all seen YoY declines.  We believe the Street is dangerously extrapolating 2U’s guided steady state program performance to model 2U’s new and future programs.
    • GetSmarter Acquisition Likely A Diversion For Slowing U.S. Growth: At Spruce Point, we’ve successfully shorted numerous companies where we spotted early underlying business challenges being deflected by acquisitions.  In the case of 2U, we find that it made its first acquisition of GetSmarter in May 2017, allowing it also to diversify internationally. We believe this validates our view that domestic growth is slowing. GetSmarter also exposes 2U to short courses, which is a lower quality business, with shorter duration revenue visibility, and fewer barriers to entry.
    • Recent Equity Raise of +$330m Raises Questions: Alongside the COO appointment, 2U did a secondary stock issuance and raised $330m at $90/share (a 5.8% discount to the closing price of $95.53). The language in its capital raise differs from its capital raise just eight months prior (September 2017).  The use of proceeds has now been expanded to include acquisitions, despite it having recently acquired GetSmarter, and not proven its ability to make good on its deal promises. Previous to this recent capital raise, 2U had $182m of cash on its balance sheet and has been talking to investors about its ability to become cash flow positive. Spruce Point believes 2U’s most likely motivation for issuing stock was to grab the money while investors aren’t attuned to its growing program failures and rising competitive threats. Otherwise, it is likely 2U is signaling a deferral of its time line to reach positive free cash flow.
    • A Terrible Risk/Reward Owning 2U With Analysts Seeing Just 6% Upside, We See 30% – 50% Downside Risk:Insiders have made out like bandits, selling $148m of stock, despite 2U burning $225m of negative free cash flow since 2011. Approximately 25% of sales have been the CEO, who just adopted a new 10b5-1 program in March 2018 ahead of its recent capital raise, and can start selling again next week post lock-up. Analysts have relentlessly said “Buy” but at the current time analysts have an average price target of $99/sh, which represents just 7% upside, a poor risk/reward. Analysts fail to appreciate the change in competitive dynamics, and extrapolate 2U’s current performance into the future without having done the exhaustive FOIA and program analysis we’ve undertaken.  Once reality sets in that 2U’s best days are behind it, and it begins disappointing unrealistic Street expectations, we expect significant valuation compression risk given its shares trade at 9.5x and 180x 2019E sales and Adj EBITDA, respectively.


    Momo, Inc.

    • Spruce Point and its China-based investigator has spent months doing primary forensic research into Momo, Inc. (Nasdaq: MOMO or “the Company”) and sees $23 to $32/sh, 30% to 50% downside risk. Momo’s investor base is compromised of two distinct cohorts, fundamental investors taking management’s word at face value and momentum/swing traders trying to play the stock’s trend.  Both of these groups are oblivious to the serious risks underpinning a Momo investment.
    • Momo’s current investor base is primarily comprised of U.S. retail investors and a select number of institutions, almost exclusively in small position sizes, looking to play the recently white hot China live streaming space through one of a handful of US listed companies
    • If Momo were simply a North American based company selling a new technology (e.g., VR, AI), investors could conduct significant English based market research, evaluate the product, understand the regulatory environment and make an educated assessment as to whether this is a fad or the next big thing.  However, given the newness of the product space and the evolving nature of the competitive landscape it would still remain a speculative investment
    • Additionally, if Momo were a North American based company, investors could take confidence in the fact its activities are likely to be transparently disclosed, fairly presented, legal and that management is acting in the best interest of shareholders.
    • Unfortunately, Momo isn’t a North American based company and this compounds the risk of an investment substantially.  Momo is a China based media company, offering a Mandarin based product to Chinese consumers and conducting business under the oversight of the MOC and SARFT.  In order to credibly understand trends in this foreign market, an investor must conduct the same level of company,  industry and regulatory diligence in Mandarin that one would conduct in English.  Anything short of this is simply a gamble
    • When making a Chinese based VIE investment, the emphasis placed on performing forensic research into governance, ownership, the legality of operations and related party transactions takes on much greater importance than a comparable North American investment given different corporate governance practices in China.  Spruce Point doesn’t believe that an appreciation for the risks of a Chinese VIE based investment can be achieved without thorough diligence of the VIE structure and its subsidiaries.

    Healthcare Trust of America, Inc.

    • HTA’s Chief Executive Officer Has A History of Failure And Non-Shareholder Friendly Outcomes: At Spruce Point, we like to follow executives who have destroyed shareholder value in the past as this pattern often repeats itself. HTA’s CEO and Chairman Scott Peters has been linked to multiple bankruptcies and liquidations (Grub & Ellis, NNN Realty Advisors, G REIT, T REIT, and Golf Trust of America).  Furthermore, we highlight a corporate and personal web of inter-relationships that links both HTA and CEO Peters to multiple bad players in the REIT industry, including Tony Thompson who was barred by FINRA and Nick Schorsch, Former Chairman of American Realty Capital Partners (ARCP, now VEREIT (NYSE: VER)), whose firm manipulated non-GAAP results and had its CFO convicted of fraud.
    • HTA’s Existence Began As A Non-Traded REIT Prior To A Direct Listing On The NYSE: Spruce Point has had many successes shorting companies that have taken back-door or non-traditional listing channels to come public, most notably the early China scams. Within real estate, the Non-traded REIT (NTR) industry is known to be a conflict-ridden business.  NTRs are sold to retail investors through broker-dealers who earn egregious commissions (upwards of 10%).  In general, for every $10 share purchase, about $1.50 is spent on up-front fees and acquisition expenses, leaving only $8.50 to be invested.  After Scott Peters (and his executive team) scraped fees from raising $2.2bn under the NTR umbrella, management listed the Company on the NYSE in 2012 without raising capital via a traditional IPO. In doing so, we believe public investors may not have received the benefits from a rigorous underwriting and due diligence IPO process.
    • In Our Opinion, HTA Is Likely Manipulating Its Quarterly Same-Property Cash Net Operating Income (SPNOI) Results: We have conducted a statistical analysis of quarterly SPNOI performance, and believe it is highly likely that this measure is being managed in a manner to show consistent results.  In our analysis, we compared HTA’s quarterly SPNOI results with its Medical Office Building (MOB) peers. HTA demonstrates the least volatility (i.e. lowest standard deviation) by a significant margin.  We point to potential accounting maneuvers and culprits of how the comparisons have remained so consistent throughout its public history, and share scary similarities of reported results with the Brixmor accounting scandal.
    • We Can’t Reconcile HTA’s Same-Property NOI Margin Profile: Same-property revenues have grown on avg. by 1.9% and same-property expenses are down by 1.1% since 2013, yet, there is no commensurate SPNOI margin expansion.  We provide an illustration of how we believe HTA’s margin profile should be expanding according to its reporting, and illustrate why the math doesn’t appear to work. HTA may be achieving its consistent SPNOI results though uneconomic means: e.g. entering into expensive long-term fixed-price contracts, and/or selling properties at unattractive prices.
    • Serious Concerns With The CFO And Accounting Function: Despite CFO Robert A. Milligan claiming to have worked for Bank of America/ML from July 2007 – Jan 2012 as a VP in corporate banking advisory, there is no FINRA record to evidence his employment. Milligan’s public profile also says he is CFO/Treasurer/Secretary, yet he also signs HTA’s SEC filings as Principal Accounting Officer (he is an MBA, not a CPA). HTA has a named Chief Accounting Officer, David Gershenson, as part of its executive team. SEC rules state that the Chief Accounting Officer must sign the 10-K filing; why hasn’t he done so? HTA’s accounting function appears in disarray with a majority of the staff sitting in South Carolina, two thousand miles away from its executive office in Scottsdale, Arizona. Our analysis shows that a majority of HTA’s accounting team has been in place less than one year, suggesting significant internal turnover and an inexperienced team overseeing the numbers.Download the report to read more…

    U.S. Concrete Inc.

    • Previous Failure: U.S. Concrete filed for bankruptcy after the financial crisis: The industry is difficult given the commodity nature of the products, intense competition, and need to be close to the customer because shipping costs are material
    • Becoming More Dependent on Shady Acquisitions: USCR has acquired over 20 companies since 2012. It recently outbid industrial giant Vulcan Materials for Canadian small cap Polaris Materials and also purchased firms with alleged historical ties to organized crime
    • GAAP vs. Non-GAAP Strains: In 2017 there were a record number of adjustments to results, and yet Adjusted EPS grew by just 4%
    • USCR Claims Mid To High Single Digit Organic Growth: Evidence suggests organic growth is overstated, and mostly a function of pass through commodity price increases. We note realized prices by USCR hit a 5yr low in 2017, and have continued lower in Q1’18
    • USCR Makes Organic Growth Difficult To Calculate: USCR selectively discloses figures in periods when good, not bad. The Company has generally done a poor job of breaking out acquisition contributions in SEC filings
    • CEO Concerns and Rapid CFO Turnover: A routine background check of the CEO reveals an undisclosed DWI arrest for reckless driving, calling into question his judgement. USCR is on its fourth CFO since 2012. Recent CFO John Tusa, Jr. resigned after serving a little more than one year
    • Two Ways To Value USCR Point To 60% – 90% Downside Risk: Given our analysis that shows distortions in USCR’s Non-GAAP figures, we believe the best way to value the Company is on Free Cash Flow. We expect further deterioration which began three years ago, and apply a 20x – 25x multiple to reflect a discount to the peer average for its above average exposure to ready-mix, poor roll-up economics, and growing liquidity risk. Secondly, we adjust USCR’s book value for an estimated $60 – $85 million of overcapitalized costs to its vehicle property accounts and apply a 1.0x – 1.5x multiple range. These valuation perspectives indicate 60% to 90% downside or approximately $6.00 to $25.00 per share

    Kratos Defense & Security Solutions, Inc. Update

    1. Adjusted for a change in revenue accounting principle, Kratos Q1 revenues missed expectations by 6%

    2. Kratos operating income performance was aided by unexplained decline in depreciation (notably in its promoted Unmanned Systems (drone) segment), despite a material ramp in capex

    3. Kratos Q2’2018 revenue guidance of $140 to $150m also fell short of expectations for $154 million

    4. In a potentially deceptive manner, Kratos reduced its normalized free cash flow guidance for 2018 by 36% to 58%

    5. New anomalies in Kratos financials call into question the accuracy of Its cash balances

    6. Kratos trades at an irrational 160x 2018 free cash flow despite revenue disappointments, a new high in DSO, and evidence that suggests management is using deceptive free cash flow forecasts

    7. Kratos would be worthless if given an industry free cash flow multiple. Giving them the benefit of the doubt, it is very easy to justify 45% to 75% downside risk ($3.15 to $6.30/sh)

    Mercury Systems Inc.

    Mercury Systems Inc. (NASDAQ: MRCY) provides sensor and safety critical mission processing subsystems for various defense and intelligence programs in the United States. Mercury appears to be caught in the perfect storm of slowing growth, rising costs and debt. There are multiple material adverse changes currently facing Mercury which suggest 50% to 85% downside risk ($7 to $23 per share).

    • Mercury’s Adj. EBITDA margins of 23.4% are extremely high for a government subcontractor, and have grown 450bps in the last three fiscal years, allowing Adj. EBITDA to balloon 112% while its free cash flow grew zero over the same period. Free cash flow is now trending down over the last 12 months. Days inventory and its cash collection cycle are near all-time highs; accounts receivables recently started to exceed sales
    • Historically, radar systems is Mercury’s largest business, but now appears to be declining, while “Other Revenues” is the fastest growing segment. Mercury changed its financial presentation to bolster gross margins, while guidance for gross margins has quietly been talked down. For the first time in Q2’18, Mercury missed its gross margin (and EPS) target
    • Mercury sells itself as growing revenues organically 9.5% (double its end markets), yet we find evidence these results are not sustainable and growth may slow to 6.5% in CY 2018. Mercury announced the purchase of Themis Computer on Dec 21, 2017 (four days ahead of Christmas). It paid a rich 13.7x EBITDA multiple, and borrowed $189m on its line of credit. In our opinion, the deal appears motivated to avoid missing Wall Street’s expectations. Consistent with prior practice, we expect Mercury to issue stock to pay down its line of credit, which at the current share price, amounts to 4m new shares
    • Mercury added one sentence to its latest 10-K to disclose it expects to lose its Small Business status in FY 2018, a factor that will cause a Material Adverse Effect by disqualifying it from certain business opportunities and increasing costs of compliance

    Globant SA

    Globant SA (NYSE / LUX: GLOB) is a poorly organized roll-up of digital IT outsourcing companies. GLOB receives the highest valuation in its sector by convincing investors it achieves consistent 20% p.a. organic sales growth. However, our forensic analysis disproves management’s bold claims, and suggests that its growth is in fact rapidly decelerating below target. Once investors realize GLOB uses aggressive accounting and financial presentation methods to paper over a cash degenerative business, while insiders quietly unload millions of dollars in stock, we expect shares to be materially re-rated lower by 40% to 50%.

    Cash Flow And Adjusted Earnings Metrics Reported By Globant Are Potentially Deceptive: We warn investors not to rely on Adjusted EBITDA as a cash flow proxy. Globant’s bulls will point to a growing upward trajectory in Adjusted EPS and EBITDA. We caution investors to be skeptical, since Globant’s Adjusted EBITDA of $64.6m in 2016 translated into a paltry $7.4m of free cash flow. Globant does not even provide investors regular cash flow statement reporting. Globant does not appear to generate recurring cash flow from outsourcing technology services. Rather, it generates cash from trading investment securities. Globant regularly trades securities and its stellar track record has generated a cumulative $68m of cash flow in the period from 2011 to 2016. In regards to earnings, we have provided an adjusted income statement based on Globant’s core business of outsourcing IT and software solutions. We arrive at EPS results that are on average 36% lower since 2013 than the Adjusted EPS that Globant reports. Recent 2017 IFRS results declined 15% YoY, and didn’t grow at all based on our normalized Adjusted EPS calculations.

    Evidence of Accounting Games: Globant lacks consistency with adjustments and add-backs, and even tries to convince investors to ignore depreciation and amortization expense when presenting its adjusted results. We have found instances where the same category of expenses are not treated uniformly in its reconciliation of Adjusted Net Income; Globant makes the adjustment when it is favorable to add back the one-time item and ignores the adjustment when it is unfavorable. There is also a pattern where Globant continuously revises IFRS or adjusted numbers.   The 2016 financials have been published three times (4Q16 press release, FY16 20F, and the 4Q17 press release) and we identify changes in each subsequent release. We also found potential evidence of manipulation in quarterly earnings to meet consensus expectations. Globant’s 4Q16 Adjusted EPS was originally reported within its guidance and matched consensus expectations of $0.31   When 4Q17 was reported on 2/15/18, we found that its 4Q16 Adjusted EPS was subsequently revised to $0.27 which would have represented a $0.04 miss versus consensus.

    Insiders Selling Is Staggering:  Insiders have sold (or transferred) over 70% (+$80m) of shares since Globant’s IPO in July of 2014.  We think investors may be unaware of the magnitude of selling by Globant’s founders and other insiders.  Globant’s status as a foreign private issuer allows it an exemption from reporting the customary insider disclosure via Form 4s to the SEC.  Globant chooses to file paper forms with the SEC via Form 144s.  Ironically, since the Luxembourg dual listing in August of 2016, Globant now files insider selling transactions electronically with the Luxembourg stock exchange.   We find it peculiar that Globant now files insider selling transactions electronically with the Luxembourg exchange and does not follow that same protocol with the SEC.  Further, the four founders all set up both revocable and irrevocable trusts.  All four founders in aggregate transferred over 3.0m shares (~$40m and ~10.4% of total share count) to irrevocable trusts at some point between August 2014 and January 2015.  We believe that this transfer was done quietly with the potential motivation to allow for further insider selling

    Corporate Strategy Initiatives Are Not Showing Signs of Progress:  In 2016, Globant introduced a new company wide model called 50-Squared.  The main goal of 50-squared is to focus Globant’s team on the top 50 highest potential accounts that have the capacity to grow exponentially over time.  We took a close look at its top 5 clients.  Four of its top clients (excluding its top client, Disney) only grew by an average of 2% in 2017.  We don’t see evidence that this strategy is gaining acceptance with its most important clients.

    Kratos Defense & Security Solutions, Inc.

    Terrible Business Through Multiple Reinventions Now Hyping Drones: Originally a dotcom darling named Wireless Facilities that IPO’ed in 1999 with hopes of being the leading provider of outsourced services for wireless networks, the Company collapsed and later took a large accounting restatement when material weaknesses were revealed. Under new management, a name change to Kratos in 2007, and a divestment of businesses, the Company started focusing its efforts on products and solutions related to Command, Control, Communications, Computing, Combat Systems, Intelligence, Surveillance and Reconnaissance (“C5ISR”). After failing to execute on these opportunities, Kratos is now promoting its billion dollar opportunities in unmanned systems (drones) in the hopes of finally turning the corner to sustain profits and free cash flow, both of which have been forever illusive for shareholders

    Warning About Management History Associated With Past Scandal: Kratos is led by Eric DeMarco (CEO) and Deanna Lund (CFO) since 2003-2004. These executives joined from Titan Corp, where DeMarco was COO and Lund was Titan’s Controller. Titan was a tainted defense contractor that in 2005 paid the largest fine in history (at the time) to settle criminal and civil charges that it violated the Foreign Corrupt Practices Act. Lockheed Martin aborted a takeover of Titan Corp after conducting its due diligence on this matter. According to shareholder lawsuit documents, Titan engaged in a scheme to inflate revenues and book fictitious receivables. Titan used “middlemen” and “private consulting companies” with ties to foreign government officials to secure business. The litigation says confidential witnesses claim DeMarco knew about the corruption and DeMarco was responsible for transferring funds to Benin, the African country involved. DeMarco was also allegedly the source of the “percentage of completion accounting techniques learned from the ‘Andersen school of accounting’ that allowed Titan to either overstate or prematurely state revenues at the company.

    Beware History of Failure To Meet Expectations, Cash Flow Struggles More Evident: Bulls are buying into Kratos story that it can reach $800m of revenues (pre PSS divestiture) at 10% EBITDA margin, while generating positive free cash flow. Our analysis of its ability to hit its financial targets (especially free cash flow) suggests investors should brace for disappointment. In addition to recent executive turnover in key positions (chief accountant, drone president, and CIO), Kratos quietly started disclosing a large loss accrual on contracts, rising 500% between 2015 and 2016. Its business mix has deteriorated (declining backlog and highest % of fixed-price, high risk contracts in its history). Its historical backlog definition is very aggressive, so take it with a grain of salt. However, most alarming in Q3’17 Kratos materially increased its cash burn estimate, cut drone capex in Q4’17, has DSOs rising to multi-year highs, and unexpectedly sold its PSS segment at a depressed value to raise cash

    Analysts See +29% Upside, A Terrible Risk/Reward Considering We See 40%-70% Downside: Kratos has among the highest valuation in the aerospace and defense sector (20x and 70x 2018E EBITDA and P/E), despite having weak margins, poor management that cannot prevent activities that run afoul of laws, suspect accounting that doesn’t depreciate corporate segment assets, and a history of failure. Its valuation is at a multiyear high, based on the hope that this time is different. Analysts are bullish, and some arbitrarily pencil in a few dollars per share for “future potential drone opportunities.” Many long-term fundamental Kratos holders have ditched the stock, leaving rules-based indices to buy. Valuing Kratos at a discount to peers on EBITDA, free cash flow, and book value we estimate 40%-70% downside ($3.15-$6.30/sh)

    Realty Income Corp.

    The Allure of Rising Magic Dividends: Realty Income (“O Realty” or “the Company”) promotes itself as “The Monthly Dividend Company®” and preaches“The Magic of Rising Dividends” – it even goes so far as to market itself differently to retail investors vs. sophisticated institutional investors. The Company is very dependent on issuing stock at inflated prices to fund its acquisitive growth strategy, keep its cost of capital low, and consistently raise its dividend. The model has worked well for years when times were good, but we believe this magic cycle is about to break down as investors reassess O Realty’s growth profile amidst  deteriorating tenant quality, rising interest rates, and a more volatile and discerning capital market backdrop.

    Deceptive Same Store Property Reporting:  Our forensic accounting work indicates that the true underlying economic performance of O Realty’s properties, as measured by Same Store Rents (SSR) are declining vs. the company’s promotion that it is growing.  The Company disclosed its SSR growth rate of 1.2% in 2016.  Our industry normalized definition of same store property performance suggests that that SSR declined by 0.8% in that period – an astounding 2.0% overstatement.  Once investors come to grips with our irrefutable conclusion, we expect a major revaluation in O Realty’s share price. There are ample case studies to show 40%-50% share price declines when investors revalue a REIT’s declining performance. For example, Wall Street has penalized a few REITs (DDR, BRX, KIM) that own retail properties where the same store growth profile has swung from positive to negative growth. We believe that O Realty is the next REIT that is going to be penalized for a deteriorating growth profile by investors.

    Investors Should Be Concerned By Background of Management and Audit Committee Oversight By Board: We find that O Realty’s executive management team is comprised almost entirely of ex-investment bankers, trained in the art of financial engineering. It should, therefore, come as no surprise that O Realty could use financial magic to embellish its performance. We have little faith in the Company’s audit committee raising any objections or concerns about management’s practices. We find that the audit committee is comprised of a PGA golf professional, and former executives from Wells Fargo and KPMG, two of the most scandal-ridden financial and accounting organizations in recent history. Given all the factors we have noted, it makes sense that insider ownership trends are at all-time lows, and lowest amongst its REIT peers.

    Tenant Quality Deteriorating As Retail Landscape Changes:  We conducted a deep dive into the tenant quality and find that O Realty has outsized risk exposure to drug stores, grocery stores and movie theaters — three retail subsectors facing disintermediation.  Drug stores (O’s largest sector exposure) are consolidating their retail footprint (i.e. Walgreens purchase of +2,000 Rite Aid stores), while SSS performance at the store front is down. Even worse, headlines such as Amazon teaming up with Berkshire Hathaway and JPMorgan to disrupt the healthcare business present a now tangible long-term risk that the traditional drug delivery value chain through a retail footprint could move increasing online.

    Ballard Power Systems

    Ballard’s stock had a tremendous run in 2017 (+167%) based on strong revenue growth, margin improvement and a perception that the commercialization of fuel cells is on the horizon (i.e., “hype”).  This improvement occurred despite Ballard’s portfolio largely consisting of businesses in run off (e.g., backup power, materials handling), experiencing uncertainty (portable power) or in very early stages of development (e.g., drones).  The primary force underpinning recent growth and future expectations has been Ballard’s China partnership efforts with Synergy Ballard JV (customer/partner) and Broad Ocean (customer/distributor).  At current valuations an investment in Ballard with an intermediate time horizon is essentially a bet on China Heavy-Duty Motive (“HDM”) success. We have conducted on the ground due diligence in China and believe that Ballard’s Chinese growth ambitions are likely to fail from weak partnerships with Broad Ocean and Synergy, and a market that is not developed enough to support fuel cell vehicle growth; Déjà vu, Ballard’s last China deal with Azure resulted in a contract breach and revising guidance lower in early 2015; investors should brace for similar disappoints this time around too

    China Industry Challenges
    Unfortunately, the Chinese hydrogen fuel cell market is still in very nascent stages of development.  We believe there are currently only 36 licensed fuel cell vehicles on the road in China, only six refueling stations (one is public), and limited planning being devoted to hydrogen sourcing and transportation.  In Spruce Point’s view, the lack of refueling infrastructure, confusion around refueling subsidies and abysmal refueling station economics pose the greatest threat to fuel cell vehicle (“FCV”) commercialization.  Not surprisingly, there are only two scale auto manufacturers of hydrogen fuel cell vehicles today and we expect this number to grow to only six by the end of 2018.  At this point, it still remains highly uncertain if China will develop the fuel cell vehicle market beyond an experimental phase

    As it pertains to Membrane Electrode Assemblies (“MEA”)/Stack/Engine production in China, the focus area for Ballard, there are actually two (rarely discussed) competing “value chains”.  We believe that Ballard’s partners, Yunfu City Government (Synergy) and Broad Ocean, are relatively weak given their lack of network into the central ministries of China and their limited success to date in partnering with the State-Owned Enterprise’s (“SOE”) that are the primary agents for delivering on policy

    Ballard Partner Specific Challenges
    It wasn’t long ago that Broad Ocean was a humble manufacturer of electric motors for appliances (e.g., air conditioners).  As the US property cycle peaked, Broad Ocean decided to diversify itself with the purchases of Prestolite (auto electronics) and Shanghai Edrive (electric vehicle power trains) in 2014 and 2015, respectively.  When Broad Ocean announced the Ballard deal in 2016, it had no prior hydrogen fuel cell experience, but likely hoped to leverage the company’s local connections with automakers in the electric vehicle space.  Unfortunately, Broad Ocean has failed to deliver partnership opportunities to Ballard with the likes of BAIC (Shanghai Edrive’s largest customer) and Yutong (leader in Chinese bus production), both of whom have chosen Sinohytec despite relying heavily on Shanghai Edrive for electric vehicles

    Matthews International Corp.

    Matthews Int’l (Nasdaq: MATW) is comprised of three unrelated businesses in the death care (“Memorialization”), branding and packaging services (“SGK Brand Solutions”), and Industrial Technologies. In our view, each business is mediocre and struggling from a variety of issues, resulting in organic sales to decline in aggregate.

    Serious Financial Control Issues and Governance Concerns:We have little reason to trust MATW’s ability to maintain financial order. Setting aside the fact that Schawk had previously restated financials, reported material weaknesses, and received a Wells Notice from the SEC, in July 2015 MATW revealed a material weakness of financial controls when it disclosed theft from a long-time employee of nearly $15m, making MATW the subject of Western Pennsylvania’s largest corporate embezzlement in history. This event came after another MATW employee was sentenced to jail in Jan 2015 for running a fake invoicing scheme. By Nov 2015, MATW declared its Material Weakness had been solved, and changed auditors from PwC to E&Y in December 2017. Spruce Point believes that investors should be extremely cautious in light of our own findings that MATW:
    1) incorrectly accounts for dividends and share issuance in its equity accounts, 2) has taken frequent and large charges that don’t reconcile between its SEC filings and investor presentations, and have not resulted in meaningful cash flow gains, and
    3) management’s compensation has risen at a 30% CAGR during this same period of mediocre performance

    Mounting Evidence of Dubious Financial Results:MATW has taken classic measures to obscure its problems such as realigning segment reporting and promoting highly “adjusted” figures. MATW has reported $176.8m of pre-tax charges since 2012 (with ~$165m related to acquisitions and strategic cost reductions). Charges have totaled a whopping 16% of its deal costs. When put into context of other successful calls Spruce Point has made identifying companies struggling to integrate targets (eg. NCR, ACM, ECHO, CECE, GEF), MATW is the worst we’ve ever seen! When we look closer at its operational footprint, we find little evidence that it has accomplished anything. SG&A margin is rising as are other fixed cost of operations. Not surprisingly, management is now touting “adjusted free cash flow” metrics, which we think overstates 3yr cumulative cash flow by nearly 30%. With sales slowing, and accounts receivables ballooning, Matthews quietly initiated an accounts receivable securitization facility in April 2017;  in our view, a tacit admission by the Company its cash flow isn’t as robust as it appears

    Sum-of-Parts Valuation Gets Us To 55%-65% Downside: We believe MATW should fire management and split up the Company. However, we believe this would expose MATW’s extreme overvaluation. Shares might “look” cheap at 1.6x, 10x, and 14x 2018E Sales, EBITDA, and P/E but it’s because Street estimates take management’s highly adjusted results at face value, and pencil in low single digit growth. Even management doesn’t seem confident in its outlook, and only says adjusted earnings will grow at a rate consistent with FY2017, without further elaboration. Yet, the analysts covering MATW see 48% upside to nearly $78/sh – a major disconnect! Given our evidence that adjusted financial results appear dubious, we base our valuation on GAAP results, assume no growth, and apply peer trading multiples at a slight discount to reflect MATW’s mediocre businesses and below average margins and growth. Our sum-of-the parts valuation implies $18.50 – $24.50 or approximately 55% – 65% downside

    Echo Global Logistics (Update)

    Echo Global Logistics (“ECHO” or “the Company”) was founded in 2005 to roll-up the transportation logistics / brokerage sector.

    Our Initial Concerns About ECHO From September 2016 Proved Prescient: In our initial report entitled “Logistical Nightmare”, we warned about ECHO’s terrible management, failed roll-up strategy in the transportation logistics sector, aggressive use of Non-GAAP results, and its inability to maintain its competitive position in an increasingly technology-centric environment, would all lead to severe disappointment. ECHO’s analysts were calling for a $29 price target at the time, but with shares at $27, we argued the risk/reward was skewed towards 50% – 60% downside. With successive earnings disappointments, and mounting evidence that ECHO’s acquisition of Command Transportation in 2015 was a bust, ECHO suspended long-term guidance and its acquisition strategy in July 2017. ECHO’s share price reached a low of $13.00, hitting our long-term price target range.

    Command Deal Increasingly Looks Like A Bust:  Our initial report warned that ECHO significantly overpaid for Command Transportation, and encumbered its assets with $230m of debt for a people-intensive asset light business. ECHO hyped $200 – $300m of revenue synergies, and an integrated technology platform that would provide significant earnings leverage. After millions spent on integration costs, capital expenditures and even a fancy new headquarters,  ECHO has failed to come even close to its revenue synergy target.

    AeroVironment Inc.

    AeroVironment (Nasdaq: AVAV) is a defense contractor that sells small unmanned aircraft systems (“UAS”) –colloquially known as drones –to the US and allied governments (~90% of its business) and also operates an unrelated business tied to electric-vehicle charging (“EES” ~10% of business). Our fundamental and forensic research suggests looming disappointment and 30% -50% downside ($24 -$34 per share).

    AVAV Nearly Identical To Our iRobot Short, Another Over-Hyped Play On A Laggard In Its Industry:Spruce Point conducted an extensive evaluation of AVAV, and find it to be a nearly identical stock promotion to iRobot. AVAV is being hyped as a play on drones, but its products are stagnant and being out-innovated by peers. Like iRobot, we find: 1) Foolish stock promoters, including a former one tied to a notorious Ponzi scheme, 2) Poor governance + unjust insider enrichment, 3) Continuous insider selling,4) Poor capital allocation, 4) Frequent accounting errors + warranty revisions, and 5) Nonsensical and distorted valuation

    AVAV’s Drones Fail In Real-World Conditions; Its Technology And R&D Have Fallen Behind:While hope springs eternal that AVAV will one day broaden its horizons by selling its drones to businesses and not militaries, the market has overlooked the evidence that its drones work poorly even for military uses. An internal Department of Defense document released via FOIA request shows that one of AVAV’s key products “did not meet key performance parameters,” calling into question its usefulness in actual combat. Problems included poor landing accuracy (with a 44% failure rate), an inability to cope with high winds (a feature that was supposed to be designed into the product), and an unexpectedly heavy and fragile carrying case. Military test operators used words like “chintzy,” “cumbersome,” and “horrible” to describe AVAV’s drones.

    Stock Promotion Runs Deep At AVAV, Valuation Can Correct 30%-50% As Disappointment Looms Large:Insiders have consistently sold shares (47% post IPO to 11% ownership currently), while a laundry list of rogue brokers have relentless pumped AVAV since its IPO (remember Stanford Financial or Jesup & Lamont?). Also don’t be Fooled when Mr. Motley says “buy” -recall they have also relentlessly promoted iRobot. True to form, AVAV has exhibited terrible FCF generationand margins, high management turnover, unwillingness to engage activist investors, and limited long-term share price upside until recent ETF buying. Even typically optimistic sell-side analysts don’t currently recommend AVAV, with zero buy ratings and an average price target of $40 (implying 17% downside). AVAV’s valuation current peak valuation of approximately 3x and 30x 2018E Sales and EBITDA will eventually normalize with defense industry peers and with its own historic valuation. As a result, we see 30%-50% downside in its share price, or $24 to $34 per share, representing a terrible risk/reward.

    Tootsie Roll Industries

    Tootsie Roll Industries (NYSE: TR) is a producer and marketer of candies and lollipops under the brands Tootsie Roll, Blow Pops, Junior Mints, Andes Candies and others. For years, the bull case has assumed Tootsie’s brands were iconic and “hope” that its  founders would eventually sell the Company at a rich premium. Based on extensive fundamental and forensic research, Spruce Point sees flaws with this thesis and 25% – 50% downside once investors evaluate our compelling research.

    Tootsie dates back to the early 1900s and its brands are withering along with its core customers. Sales haven’t grown in 6yrs and we estimate it is losing market share in North America. Our channel checks reveal it uniformly receives the worst product placement on the shelves (esp. during key Halloween selling season). Tootsie’s products fail to address consumer demand for healthier products, and it has resisted industry self-regulatory movements to limit marketing to children. Early adoption of new FDA labeling requirements show Tootsie has shrunk its serving size, an implicit acknowledgement consumers are eating less candy. Enhanced sugar disclosure requirements now show significant added sugar content to its products. Families and kids take notice: we estimate a box of Junior Mints, a popular Tootsie product, contains 185% of daily added sugar needs.

    Tootsie is notoriously secretive about its financials: it doesn’t hold investor conference calls, invite analyst coverage, and has a minimalistic IR website. Its SEC filings omit significant information material to investors’ understanding of its business including: 1) product mix and pricing trends, 2) commodity cost impact to margins, 3) R&D expenditures. Tootsie also inflates its gross margins in a material way by excluding shipping, warehousing, and freight costs. This leads to an 800bps gross margin overstatement. Compare Tootsie’s adjusted gross margin of 31% with peers Hershey and Mondelez at 46% and 39%, respectively, and it’s easy to see that Tootsie is running an inferior candy operation. Even worse, we believe Tootsie has inflated operating cash flow by ~$50m since 2012 though early termination of its split dollar life insurance policy. In essence, Tootsie lent money to these policies for the benefit of its executives, and is now tapping the cookie jar to reclaim funds and boost cash flow.

    In our opinion, Tootsie is run for the benefit of insiders, while taking advantage of common shareholders through lavish compensation and excessive perks. Its dual class share structure allows Class B shares controlled by insiders to limit common stock voting control, while the Board is stacked with the CEO’s allies, none of which have experience in the food industry. Insiders have rigged the bonus structure in a way that virtually guarantees the maximum bonus every year, while allowing the top 6 executives to extract ~19% of adjusted SG&A in annual compensation (and grow comp more than 3x the rate of sales). Tootsie offers none of its employees equity or stock options, which virtually guarantees that no one will care about maximizing the share price Download the report to read more.

    Envirostar Inc.

    Envirostar (NYSE/MKT: EVI), formerly known as DRYCLEAN USA, is a distributor of commercial and industrial laundry and dry cleaning equipment.  With its shares up >600% since 2016, it has become one of the most overvalued microcaps in the stock market as index funds blindly pile in. Investors are ascribing nonsensical multiples to its recent acquisitions, and failing to exercise caution.

    Spruce Point has been a dogged proponent against investing in roll-up strategies, which are often just financially engineered plays designed to game index funds into overpaying for stocks, with little focus or incentive for management to create organic growth or value creation through operational improvement. We made early and successful calls identifying problematic roll-ups across many industrial sectors, AMETEK (test equipment), Greif (packaging), CECO Env’t (pollution control) and Echo Global (logistics). We view Envirostar as one of the worst + most speculative roll-up stories we’ve seen; already three quarters post closing its biggest deal of Western and EVI’s margins, profits, and cash flow are contracting

    Envirostar is the most expensive and financially weakest roll-up stories we’ve ever evaluated. Be careful: Envirostar has paid an average of 0.5x sales for recent deals, yet public investors are overpaying now by 5x. At the current enterprise value of $320m, the market is ascribing a value of 2.2x, 32x, 61x to our estimates for CY2018 sale/EBITDA/EPS results. Blue chip industrial distribution peers with significantly higher margins trade at 1x, 11x and 21x, respectively.

    Download the report to read more.

    iROBOT CORP (Update 3)

    • Shark entered the robotic vacuum market as we predicted in June, a major negative!
    • We believe SharkNinja strives to be the #1 or #2 leader in markets it enters. Based on its track record in traditional vacuums and blenders, we believe SharkNinja is a credible threat to iRobot
    • SharkNinja’s displacement of Dyson in vacuums was a result of a laser-like focus on the consumer, and its ability to engineer a superior product at a value price point.  As an organization, Linkedin data shows that SharkNinja employs more engineers than sales or marketing people
    • We believe Dyson failed to gain traction with its robotic vacuum because its price point of >$1,000 was simply too high, and it did not deliver meaningful performance advantage to the customer. Simply stated, Dyson could not offer a compelling value proposition while SharkNinja appears well positioned to do so
    • Given SharkNinja’s marketing prowess stated to be $130m annually (2014 figures), we wouldn’t be surprised to see it spend at least 10% or more of this annual budget to ensure the success of its debut robotic vacuum series

    Download the report to read more.

    TSO3 Inc.

    Spruce Point is pleased to release its report on TSO3 Inc. (TSX: TOS and OTC: TSTIF)

    TSO3 Is Just Another Canadian Healthcare Promotion:  The Canadian markets are littered with recent examples of healthcare stocks in need of urgent medical attention, wounded from over-promotion, questionable practices, and poor performance. Short sellers made early warning calls on many names down >80%: Valeant, Concordia, Nobilis, CRH Medical

    Disclosure Issues & Obfuscating Its Actual End Market Sales: TSO3 is not disclosing its installed base and the reason is obvious – if it did, investors might see just how poor its product’s end market acceptance actually is. In Q3’16, TSO3 suggested it would provide clarity on its installed base in early 2017 – investors are still waiting…. TSO3 even stopped disclosing consumables sales in Q2’16. It currently recognizes as revenues shipments to Getinge, its 3rd party distributor (183 units since Q1’16).  However, our math and field checks suggest at best 10 units are actually installed at end customers (95% difference to shipments).

    TSO3 Using the “Partnership” Playbook To Hype Its Potential: Déjà vu, TSO3 is repeating a twice failed playbook.  Recently from 2009-2013, alongside of 3M: TSO3’s single product cycle ended with no material sales, termination of their partnership, and a legal settlement in favor of 3M.  TSO3’s prior two generations of this product also failed (the current 3rd generation VP4 appears eerily similar to the 2nd generation – not surprising given the low R&D spend).

    TSO3 Overstating Its Total Addressable Market (TAM):  All good promotions involve baiting investors with big addressable market opportunities. TSO3 appears to have overstated its true market potential by >30% units and C$170m. We provide evidence of the Company playing fast and loose with its numbers.

    Download the report to read more.

    iROBOT CORP (Update 2)

    Spruce Point is pleased to release its updated report on iRobot Corp (Nasdaq: IRBT)

    New research into iRobot’s recent distributor acquisitions further calls into question the reliability and accuracy of the Company’s financial guidance. If iRobot cannot give further clarity, we believe its guidance should be suspended.

    Distributor acquisitions need to be heavily scrutinized given the related-party nature of the transactions. Its Japanese and European distributors act as exclusive agents for iRobot with nearly 100% of revenues from iRobot products.

    •The 2017E sales implied from Robopolis from iRobot’s incremental margin contribution forecast doesn’t make sense

    Further evidence of issues with the Japanese distributor acquisition emerge from our research. Download the report to read more.

    Dorman Products Inc.

    Dorman Products (Nasdaq: DORM) is an aftermarket auto parts distributor stuck between a rock and a hard place as it sells both through Amazon, which is seeking to grow further into online auto parts distribution, and through the biggest brick and mortar retailers (Adv. Auto Parts / O’Reilly / AutoZone), which account for a majority of its sales, and are struggling with slower growth and margin pressure.  Spruce Point has conducted a deep fundamental and forensic accounting review of DORM and believe its opaque disclosures, aggressive accounting, and precarious industry positioning do not warrant its significant share price outperformance and premium valuation relative to peers. As a result, we see above average risk of continued earnings disappointment and meaningful share price correction.

    Revenue growth has slowed from a 13% CAGR (2009 to 2015) to less then 6% in 2016 (adjusted for extra week).  Furthermore, if you look under the hood, DORM’s net revenues are an estimate and therefore subject to significant manipulation.  Our adjusted gross sales estimate (we define as total product places on the shelves of customers) slowed to an abysmal 1.5% in 2016. Analysts expect DORM to continue growing top-line sales at 7% which we believe to be difficult given its largest customers are growing low single digits.

    We believe DORM’s earnings leverage is waning. Revenue and gross profit from active accounts slowed to low single digits in 2016. The weakening of the Chinese Yuan has been a hidden tailwind to gross margins in the last three years since DORM sources products heavily from China/Taiwan.  We estimate that DORM’s gross margins benefited by ~350bps cumulatively from 2014-2016. DORM doesn’t discuss any of these FX benefits in its MD&A, and now the Yuan is on a strengthening cycle.  DORM also embarked on an ERP implementation which was 163% over budget, and allowed it to capitalize $38m of costs from 2011-14. DORM has not amortized any of these costs, thereby inflating its earnings per share by $0.07c by our estimate

    DORM portrays itself as debt-free, but is heavily dependent on factoring receivables, which we believe should be evaluated as debt. The % of revenues that are factored annually has risen from 21% in 2009 to 65% in 2016 and exposes DORM to the increasing interest rate env’t.  DORM’s working capital to sales ratio is at a multi-year high, while operating cash flow in 2016 abnormally increased from inventory declining – suggesting it liquidated or deferred new purchases to generate cash. DORM is also shifting its business strategy to invest in many undisclosed JV/minority investments, while opaque related-party purchases are increasing

    Download the report to read more.

    Gentex Corp.

    Gentex (Nasdaq: GNTX) is a supplier of dimmable mirrors for the auto and airline industry. Its products are commoditized and require nothing more than plastic moldings, mirrors, chemicals, printed circuit boards, and other inputs such as compasses. Its financials suggest it to be a wildly profitable company, yet our forensic analysis uncovers numerous red flags to suggest otherwise.

    Gentex’s IPO in the early 1980s is littered with red flags. Its dimmable mirror was a carrot to bail out its struggling smoke detector business, and its management put no capital at risk. Gentex’s success has defied all the odds: it now commands a $5bn market cap and claims >90% market share. Its lead IPO underwriter and banker, OTC Net founded by Juan Carlos Schidlowski, was a notorious penny stock promoter who was later charged by the SEC and fled the country.

    Gentex’s 40% gross margins are vastly superior to all global auto suppliers and are likely overstated by 2x. We believe it’s aggressively leaving costs in inventory (inventory growth is 3x revenue growth) while inflating capex through nonsensical projects (e.g. its North Riley Campus is 90% over initial budget). We commissioned a product tear down by IHS, an automotive expert, to examine its components. In our view, Gentex’s rhetoric pertaining to its mirror’s level of proprietary components and vertical integration is likely exaggerated. We also have documented proof of capex misstatement.

    Despite margins and profitably that dwarfs auto supply peers, Gentex policies that are touted as shareholder friendly are not what they appear. Its dividend growth has been well below the rate of its reported free cash flow growth, which is likely overstated, and its share repurchases are mostly to offset dilution. Gentex has amassed an abnormal amount of cash on its balance sheet, and has irregular Level I and II classifications. We believe Gentex has shunned M&A to avoid outside scrutiny. The only acquisition of note in its history was of HomeLink, a related-party deal where we find issues.

    Download the report to read more.

    iROBOT CORP (Update)

    Spruce Point is pleased to release its updated report on iRobot Corp (Nasdaq: IRBT)

    With iRobot’s share price up 300% since 2016, investors are cheering the re-acceleration of sales and earnings growth following years of disappointment, and ascribing a peak valuation to plateauing earnings. Spruce Point believes the financial improvement reflects temporary factors and may not be sustainable. We expect new competition to storm the market, and challenge iRobot’s US market share dominance.

    iRobot’s recent financial performance reflects restocking of its supply chain after years of false starts, the removal of the struggling military business, and the acquisition boost from its Japanese distributor. We believe these factors will create very difficult comparisons for iRobot to lap in the future, and create headwinds for future share price appreciation. Furthermore, we believe recent gains are a result of lowering the price of its Roomba to move down market, which we believe is a long-term negative on margins for a technology hardware company with a narrow product focus

    Investors are overlooking financial control issues tied to iRobot’s recent acquisition of its Japanese distributor. The Company suspiciously retracted certain statements made about Japanese sales growth (reversing big gains to declines), and made revenue and earnings revisions which don’t add up. Spruce Point has previously pointed out early warning signs at Sabre and Caesarstone, both which made related-party distributor acquisitions ahead of extreme financial revisions. Market observers will note that Valeant’s attempt to buy Philidor was another canary in the coal mine. Download the report to read more.

    Radiant Logistics Inc.

    RADIANT LOGISTICS INC. (“RLGT” or “the Company”) is a company that specializes in transporting unique or difficult shipments.

    Radiant’s CEO Bohn Crain and first General Counsel Cohen were executives at Stonepath Group (AMEX: SRG / OTCBB SGRZ), whichcrumbled when it admitted financial and accounting irregularities tied to revenue overstatement / expense understatement. An SEC inquiry commenced, allegations of fraud were made, and Stonepath was delisted, and faded to the pink sheets and insolvency

    The SEC has already questioned Radiant’s accounting, and it has made the scary disclosure that its margin method, “Generally results in recognition of revenues and purchased transportation costs earlier than the preferred methods under GAAP which does not recognize revenue until a proof of delivery is received or which recognizes revenue as progress on the transit is made.”

    Don’t expect Radiant’s minor league auditor named Peterson Sullivan to spot problems, Radiant pays them minuscule audit fees and three Peterson employees (2 partners) have been cited in less than two years for professional misconduct by the PCAOB and SEC Ltd. (Nasdaq: WIX or “the Company) is an Israeli based technology service provider offering a free website solution that depends on upselling customers on additional features. With WIX’s share price up approximately 300% in the last twelve months, we believe investors are overlooking many issues that could cause a substantial price correction:

    WIX’s “unicorn” model appears too good to be true and there are emerging cracks beginning to appear in its financial statements including subtle revenue and tax restatements, and anomalies in its cost structure. WIX portrays itself as a well oiled machine with world record gross margins at 85% and that it will have spent ~$30m on capex from 2010 – 2017 to accumulate >100m registered users, engineer a negative churn business that produces $400m of revenues, $1.4 billion of collections, and is worthy of a $4bn market cap. Based on our analysis, these results merit scrutiny (e.g. try finding another negative churn business or capex efficient model). The SEC recently issued comment letters to WIX questioning its aggressive Adj. EBITDA presentation and its pace of revenue recognition and expense deferral. After two EBITDA revisions already, investors should be suspicious, but we believe more revisions may come. WIX is dropping subtle hints in its 20-F that because it is no longer an “emerging growth company” under Section 404 of Sarbanes Oxley, it will face stricter financial control.

    WIX insiders have incentives to heavily promote its shares and left clues to suggest it intends to dilute with 2-3 million new shares We estimate its two founders are sitting on $225m of option gains needing to be monetized. Options under the 2013 plan start becoming fully vested in 2017. Early venture backers (Benchmark, Insight, Bessemer) have exited and only one initial backer remains. None of WIX’s top shareholders are Israeli funds. WIX has lured in retail investors and US funds through repeated Cramer Mad Money episodes. Now that WIX Is claiming it has reached a cash flow positive inflection point, and has ample cash on the balance sheet, we find evidence of pending dilution.


    PTC Inc.

    PTC’s Conversion Story From Perpetual Licenses To Subscription Model Is Late To The Game, And An Excuse For Management To Explain Away Poor Results And Deteriorating Economics. Its Conversion Uses Gimmicks And A Questionable Value Proposition To Compel Users To Subscribe.

    Investors Are Ignoring PTC’s Weak Financial Results In Favor of Dubious Metrics Such As “Bookings”, “ACV” and “Unbilled Deferred Revenue” – Read The Fine Print, They Have No Correlation To Future Revenues. We Even Spoke With PTC’s Former EVP of Sales To Ask His Opinion What These Metrics Mean, And He Couldn’t Explain Them. We Can’t Even Find Evidence That PTC’s $20M Mega Deal With The Air Force (It Booked And Said Closed In Q4’16) Even Exists With PTC As The Prime.

    PTC’s 5 Yr. Recurring Restructuring Odyssey Appears To Be An Elaborate Accounting Scheme To Sell Investors On Meaningless Non-GAAP Figures. We’ve Done A Deep Dive Analysis And Are Shocked By PTC’s Overstatement Of Office Locations, And Irreconcilable Employee Headcounts. Are They Just Firing And Re-Hiring People To Expunge Expenses? We Believe Its Restructuring Directly Violates SEC Guidelines Given Its Inability To Make Reliable Estimate. PTC’s CFO Was Chief Accounting Officer At Autodesk During A Period It Had an SEC Investigation And Said Its Financials Could No Longer Be Relied Upon.

    While All Analysts Say “Buy” Six Insiders Have Stock Sale Programs, And They Only Own 1% Of The Company. Analysts’ See Upside To $60 (+12%), But We See 50% – 60% Downside As Our Long-Run View. This Represents A Terrible Risk/Reward For Owning PTC’s Shares. PTC Is Trading At Peak Valuation With Little Covenant Cushion; Careful Investing To All…


    CECO Environmental Corp.

    Spruce Point is short CECO Environmental (Nasdaq: CECE, “CECO” or “the Company”), a poorly constructed roll-up serving the environmental, energy, fluid handling and filtration industrial segments. Based on our forensic financial analysis, insider behavior, and anticipated changes in the regulatory environment driving its business, we believe CECO is at high risk of a covenant breach in 2017.

    CECO has been touting to investors that it has been successful in delevering its balance sheet post-PMFG acquisition, and that its current Net Debt to EBITDA ratio is down from 3.6x to 1.6x as of 9/30/16. On the surface, this appears impressive, but the picture is not so simple. CECO should be pointing investors to is “Leverage Ratio” covenant per its credit agreement which looks at gross leverage (not net of cash) and includes significantly more debt obligations beyond just its term loan…


    MGP Ingredients, Inc.

    MGP Ingredients (“MGPI” or “the Company”) Is A Commodity Ingredient and Alcohol Producer Now Being Spun As A Sexy Transformation Story Into A Premium Producer of Branded Whiskey and Bourbon. MGPI is a simple story to understand. It operates two businesses: an ingredients business run from Kansas and an alcohol distillery in Indiana. Both of these facilities are old assets and prone to substantial operational hazards. Most recently, MGPI has experienced fires, work outages, and chemical disasters requiring the hospitalization of innocent people.

    MGPI’s shares have appreciated 1,000% since 2014  as investors have cheered the Company’s decision to hire new management, reprioritize its businesses away from commodity ingredients, and focus on “higher margin” premium alcohol beverages. MGPI has also recently benefited from a temporary, yet unsustainable, increase in earnings from its 30% joint venture with Seacor (NYSE: CKH) called Illinois Corn Processing (ICP).

    On the surface, the Company’s transformation strategy appears wildly successful. Its EPS has risen from a loss of ($0.29) in 2013 to positive earnings of $1.50 per share in the LTM 9/30/16 period. Over the same period, sales have essentially been flat, but gross margins have expanded from 6.4% to 18.1%

    Spruce Point Believes Investors Should Be Cautioned Not To Extrapolate Recent Earnings Performance. We Believe There Are Numerous Business Risks And Cracks In The Growth Story That Are Not Being Adequately Discounted…


    The Ultimate Software Group, Inc.

    Our interest in Ultimate Software (“ULTI” or “the Company”) was initially peaked when a little-known firm called Soapbox Research published a skeptical report highlighting aggressive software development cost capitalization, potential revenue exaggeration, bloated stock compensation expense, and corporate governance concerns.

    One of our most successful shorts in the past few years was Caesarstone (“CSTE”), an Israeli quartz counter top manufacturer. We noted that its margins were suspiciously higher than its peers, and raised concerns about the potential for cost capitalization related to its U.S. plant expansion. We also worried about the governance structure, and influence of the Kibbutz (a communal / family-like structure). To support our short thesis, we conducted deep fundamental analysis and received the Company’s quartz supply contract (through a Freedom of Information request) to illustrate why we believed its margins were unsustainable. The parallels between Caesarstone and Ultimate Software are striking:

    Burlington Stores, Inc.

    Burlington (“BURL” or “the Company”) Is An Old School Retailer Now Being Spun As A Sexy New Growth Story Amidst An Intensifying and Ultra Competitive Retailing Environment.

    Burlington Stores (formerly Burlington Coat Factory) is an “off-price” discount retailer based in Burlington, NJ that sells men’s and women’s clothing, home furnishings, and accessories. It competes with the likes of TJX Companies (T.J. Maxx, Marshalls), Ross Stores, and countless other retailers offering shoppers a discount to the M.S.R.P.

    Burlington Has Been Touting impressive Comparable Store Sales (“CSS”), Gross Margin, and EPS Gains, While Shrinking Same Store Inventory. We Don’t Think It Can Last. Spruce Point Has Identified Numerous Financial Presentation, Accounting, And Business Issues That Could Be Signaling A Slowdown In Future Financial Results.

    Echo Global Logistics

    Echo Global Logistics (“ECHO” or “the Company”) was founded in 2005 to roll-up the transportation logistics / brokerage sector. Founded by the same people behind Groupon, and another public company noted originally by Barron’s in 2007, Echo has yet to be fully exposed until now.  Led by Eric Lefkofsky and his partner Brad Keywell, these inter-related, yet distinct publicly traded businesses share the same founders, business address, auditors, and same modus operandi of hyping “proprietary” and “disruptive” technologies capable of earning “massive” profits in large, fragmented markets. In our opinion, time and results have shown these predictions have failed to live up to initial expectations, and have lead to large shareholder losses to post IPO investors, but enriched its founders and early backers who quickly dumped stock.


    AECOM (“ACM” or “the Company”) is a global engineering and construction firm based in Los Angeles, and is an enormous roll-up that came public in 2007. Bowing to pressure from an activist to maximize shareholder value, URS Corp (URS) sold itself in October 2014 to AECOM (for approx. $5bn –a cash/stock deal which included the assumption of $1bn in URS debt). The URS deal is the largest in AECOM’s history. 

    The URS deal was touted as giving AECOM “heft” in the oil and gas market, at exactly the wrong time! As shown by the investor presentation, URS also added exposure to the mining and industrial sectors –other areas that have shown persistent weakness since 2014.

    Spruce Point has been following AECOM, and has generally viewed its post-deal financial results with skepticism. Our view was fortified when on Aug 10, 2016 after reporting Q3’16 results, AECOM filed an amended 10-K/A.

    Sabre Corp.

    Sabre Corp. (Nasdaq: SABR) is a travel tech company with a core business of operating a Global Distribution System (“GDS”), a platform that facilitates travel by bringing together content such as inventory, prices, and availability from a broad array of travel suppliers for a range of travel buyers such as online/physical travel agents and corporate travel departments. As a middleman between buyers and suppliers, Sabre’s biggest risk is disintermediation, whereby its consumers bypass its network, through emerging threats from Google, or even worse, suppliers imposing fees to customers for using it (e.g. Lufthansa).

    As a result of underlying business pressures, we believe insiders were likely aware that revenue and earnings estimates would not be met in 2015… Download our report to learn more.

    Planet Fitness, Inc.

    Questionable Business Strategy with Unachievable Revenue Goals: The fitness industry is intensely competitive, subjecting Planet to the whim of changing consumer preferences (yoga, boot camp, barre burn, adventure courses), potential technology disruption from wearables, and rife with examples of chains that over-expanded and failed (e.g. Bally Total Fitness, Curves, Town Sports). Planet Fitness (“Planet” or “PLNT”) tries to differentiate itself with a “no judgment” model for the casual fitness user that doesn’t want to be “gymtimidated,” at no-commitment, and a low entry price of $10/month (plus initiation fees). On average, its clubs have 6,500 members, and it needs both densely populated markets and members who won’t use its gyms to make its financial model work! Furthermore, we believe Planet’s revenue targets and growth rate are unrealistic and likely to disappoint current expectations. Download our research report to learn more…

    Tower Semiconductor Ltd.

    In our opinion, Tower is a collection of old semi foundries cobbled together from acquisitions, which produce significantly below industry average GAAP gross margins (from 2012-2014 Tower 9% vs. 23% peer average). Having gone through numerous financial restructurings in the past, Tower promotes large revenue goals reaching $1bn, and a large Non-GAAP EPS headline of questionable merit, but has amassed ($695m) of negative cumulative free cash flow since 2004! Not having the capital support or free cash flows to fund the large capex requirements to compete in the semiconductor manufacturing industry, Tower spends just 15% of sales on capex vs. peers at 40% of sales. Download our research report to learn more…

    The Intertain Group Ltd.

    Formed from Canadian shell companies, Intertain has completed four acquisitions, each of which has gotten larger and fed Intertain’s ‘growth at any cost’ mentality which is likely to end in disaster. Intertain’s initial transaction was with Amaya Inc (a 2.7% owner), whom is currently being investigated (by FINRA) for insider trading (the largest investigation ever in Canadian history). Intertain acquired Amaya’s InterCasino brands for C$70m. Amaya acquired these assets through its acquisition of Cryptologic (where Intertain’s CEO was General Counsel). Our diligence suggests Cryptologic paid a ‘nominal amount’ for the Malta’s InterCasino gaming license. Our research closely explores Intertain’s acquisitions and finds significant issues for a majority of the deals, notably the Gamesys acquisition.

    IRSA – Inversiones y Representaciones S.A.

    Spruce Point is pleased to release its latest report on IRSA Inversiones y Representaciones S.A.(NYSE: IRS), Cresud S.A.C.I.F. y A. (Nasdaq: CRESY), and IDB Development (Tel Aviv: IDBD). IRSA is a Latin American real estate company. IRSA recently invested $300m+ in IDB Development Corp. (TLV: IDBD), an Israeli holding company with interests in real estate, communications, agricultural products, insurance and technology. IDBD is burdened with $6.7 billion of net debt, going through a restructuring process, and has a “going concern” warning from its auditor. It is dependent on further capital injection commitments from IRSA of approximately $185m through 2016…


    Since Spruce Point’s initial report on Caesarstone (Nasdaq: CSTE or “the Company”), which highlighted many fundamental issues facing the Company, along with potential accounting irregularities. In our opinion, many of the open questions remain inadequately addressed, or completely ignored, by the Company and its group of supporting analysts. Spruce Point’s follow-up report reiterates open questions and delves deeper into the issues we believe are facing Caesarstone.

    This report will highlight additional potential accounting issues which are related to capital expenditures.


    Spruce Point is pleased to release its latest report on CAESARSTONE SDOT-YAM LTD. (NASDAQ: CSTE). Caesarstone’s (CSTE) price recently corrected after Q2’15 earnings beat Wall St. estimates, but it cut its sales guidance from $515-$525m to $495-$505m, while maintaining its EBITDA guidance. We believe this is the canary in the coal mine, and CSTE is at continued risk of missing its goals in light of flat import tonnage growth and rising competition. CSTE trades at 3.4x and 13.5x 2015 Sales and EBITDA, respectively, a substantial premium to building products peers at 1.3x and 12.0x on the premise it can maintain share and grow sales 15% p.a. We believe CSTE should trade at a discount to peers of 8x – 10x EBITDA given our concerns about product and earnings quality, its shares would be worth $11 – $29 (~40% – 75% downside) on a normalized 10-20% EBITDA margin range. Since its 2012 IPO, its controlling shareholder has reduced its ownership from 79.0% down to 32.6%; we expect continued stock liquidations by its majority owner


    Spruce Point is pleased to an updated report on NCR Corp.(NYSE: NCR). In our follow-up report, we will profile a blatant example of poor judgment and capital allocation to support our opinion that NCR’s shareholders should demand immediate change at the executive level. But first, let’s review NCR’s recent quarter and further dispel any notion that value enhancing alternatives are imminent and that NCR had a stellar quarter where it “Beat” street estimates.


    Spruce Point is pleased to release its latest report on GREIF INC (NYSE: GEF/GEF.B). Greif (GEF) is in the business of industrial packaging products and services. Its businesses appear largely commoditized, are capex intensive, and under severe pressure from FX headwinds ( Venezuela, Brazil, Russia, Europe) and slackening demand tied to pressures in various end markets ( e.g. energy ). Overall, the company is experiencing deflationary-like pricing power and very low single digit / declining volumes.


    Spruce Point is pleased to release its latest report on AMETEK Corp (NYSE: AME). With Limited Organic Growth, Ametek is Under Pressure as its Strategy Appears to be Hitting a Brick Wall. It Underinvests in R&D and Buys What it Cannot Develop. This Strategy Inherently Benefits its Margins and EPS, Which We Have Evidence that Suggests Are Overstated By Up to 600bps.



    Spruce Point is pleased to release its latest report on iRobot Corp (Nasdaq: IRBT). Media Hype of a Robotics Revolution (Similar To 3D Printing Craze) Is Overblown. IRBT Is Hyping Its IP Portfolio, But Lacks A Monetization Strategy. The Hype Is To Divert Attention From Its Core Problems


    Prescience Point is pleased to release its latest report on LKQ Corp (Nasdaq: LKQ). The 122 page report outlines extensive research into the companies financial reports and we believe the following: LKQ is an ineffective roll-up, they are caught in a massive margin squeeze, problems with their new growth story, dramatic overvaluation, and previous fraud and failures.


    We believe shares of Fleetmatics Group PLC (“the company”, or “FLTX”) are grossly overvalued, reflecting few, if any, of the serious risks that warrant questioning the credibility of the company’s financial statements.


    Just Energy (NYSE: JE / TSX: JE) is a company that U.S. consumers and investors are quickly realizing has become toxic to their wallets through deceptive energy marketing practices, and harmful to their brokerage accounts.


    Prescience Point believes shares of InnerWorkings, Inc. (Nasdaq: INWK or “IW”) are grossly overvalued and poised to collapse by as much as 55%. We believe the company is inflating its revenues in violation of GAAP principles by misapplying gross revenue accounting, placing it in violation of its credit agreement.


    Prescience Point follow-up report on Boulder Brands’ (Nasdaq: BDBD), consisting of a deep-dive look at the company’s Q4’2012 results and management’s 2013 guidance. In short, the story does not add up and we expose the red flag components of its missing pieces.


    Amidst a storm of investor distaste for U.S.-listed Chinese equities, and with its shares trading at a fresh 5-year low earlier this year, AsiaInfo-Linkage, Inc. (ASIA) followed the precedent of numerous other Chinese companies in announcing it had received a “Go-Private” proposal on January 20, 2012.


    In this report, we explore United States Antimony Corp (Amex: UAMY) which made its graduation from the bulletin board to the AMEX on May 21st at approximately $4.00 share, giving the company a $275 million valuation.


    On February 23rd, Bazaarvoice (Nasdaq: BV) raised $114 million at its initial public offering by selling 9.5 million shares at $12 per share. The expected pricing range was $8.00 – $10.00 per share, and the shares ultimately closed at $16.50 on the first day of trading. At today’s price of $17.00, the company’s fully diluted enterprise value is approximately $1.1 billion.


    LQMT is a highly promoted penny stock with a market cap that exceeds $125 million, and highly speculative business prospects. However, a little due diligence reveals a company with a troubled past, as highlighted in an earlier article written by StreetSweeper in 2010, a convoluted capital structure, and a virtually insolvent business.


    Global Sources Ltd. (Nasdaq: GSOL) is perhaps the original and oldest existing China RTO Company in the US stock market. In March 2000, Global Sources exchanged 100% of its shares for a 95% stake in Fairchild (Bermuda) Ltd., a subsidiary spun‐off from the now bankrupt Fairchild Corp. Through this deal, Global Sources obtained a public listing on the Nasdaq in order to provide liquidity to shareholders and a venue for raising additional source of funds for expansion.


    A closer look into Camelot Information Systems (“CIS”) and their position in the Chinese Information Technology industry reveals numerous question marks investors should consider.


    All around the world, biodiesel is a challenging business with high capital costs, cyclical gross margins and returns on capital. There are limited barriers to entry as production processes to make biodiesel are well understood and can be accomplished by specialty chemical plants of all sizes.


    ZST Digital Networks (OTCPK:ZSTN) came public in October 2009 and raised $25 million by offering 3.1m shares at $8 per share. The offering was led by Rodman & Renshaw and Westpark Capital, two ubiquitous underwriters in the market for bringing Chinese companies public in the U.S. through reverse takeovers (RTOs).