Oh no, it is worse… MTSL takes another $561 thousand torpedo

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

USS John Young

In a recent posting (here) I wrote about the fourth quarter and full fiscal 2013 year earnings announcement by MER Telemanagement Solutions, an Israel based company that I have followed for quite a while.

I noted that the company had announced (1) a new high in cash (and cash equivalents) on hand almost exclusively on the strength of a very profitable contract with Simple Mobile, a West-coast based MVNO whose managed services contract with MER Telemanagement Solutions had generated a guaranteed $300 thousand in revenues and cash every month throughout MER Telemanagement Solutions’ fiscal 2013 year; and (2) the end of this revenue and cash stream, effective as of December 31st, 2013.

The termination of the Simple Mobile contract in itself was a disaster, but, unfortunately, things were even worse, with overall revenues and operating profit down significantly year-over-year and net income down $1 million to $1.4 million year-over-year when accounting for a one time $1 million tax charge in the company’s fiscal year 2012.

In my posting I included a computation table, trying to assess the impact of the Simple Mobile contract loss on the 2014 results based on previous results, and — oh, boy! — it was not pretty (here is a direct link to the table,) projecting a revenue drop of $3.6 million (or 28.5%) in 2014 and a net income drop well into the red.

Today, the company filed its 20-F filing with the Securities and Exchange Commission, and, unfortunately, things went from bad to worse. While I, in my table had estimated the Simple Mobile revenue contribution for 2013 to be 28.5%, it showed to be a staggering 33%.

As the company wrote in its very first qualitative statement in the 20-F filing:

If we do not replace the revenues generated by Simple Mobile LLC our operations and financial condition will be adversely affected.

Our principal customer during the three years ended December 31, 2013 was Simple Mobile LLC, a U.S.-based mobile virtual network operator, or MVNO, for whom we provided hosted billing services. In 2011, 2012 and 2013, sales attributable to this MVNO accounted for approximately 16.4%, 22.8% and 33.3% of our revenues, respectively. During 2012, Simple Mobile was acquired by TracFone and in 2013 TracFone migrated our hosted billing services to its own platform and did not renew its agreement with us, which ended in December 2013. If we are unable to replace the revenues generated by Simple Mobile LLC, our operating results and financial condition will be adversely affected.

Not exactly encouraging stuff.

The difference of 4.5% or $561 thousand between our previous estimate and the new announced results is significant enough in itself, but, unfortunately, there is more.

First, this means that the revenue contribution that has to be backed out of the 2014 projections are higher…. arghhh!…. leading to even more loss, in fact an additional loss of $453 thousand for a projected worst-case loss of $1.8 million in 2014.

Second, the significant increase in the Simple Mobile revenue contribution means that MER Teleamangement Solutions’ revenues that were not attributable to Simple Mobile declined a full 17.5% in 2013… a disaster of the highest magnitude.

Here is the updated table:

(c) Per Jacobsen, 2013 and 2014. All rights reserved

(c) Per Jacobsen, 2013 and 2014. All rights reserved

Oh, by the way, this worst case scenario, may not, in fact, be the worst case, since it assumes that the non-Simple Mobile revenue will be stable in 2014. If, instead, the drop in revenues continues, then we need to clear the decks for a much worse worst case.

Now, I hasten to say that there were some good news in the 20-F filing, albeit not much.

First and foremost, the company has reduced its payroll, laying of a large part of its staff. This, of course, was something that I knew had to happen, but that the company for some reason saw fit to not tell its shareholders was happening (read more about this and the company’s puzzling and, in my opinion, warped communications with its shareholders in my previous MER Telemanagement Solutions postings… you can use the nifty XREFs section to get them.)

The reduction is force is deep, but it does not make up for the loss off the Simple Mobile contract (to be fair to the company, almost nothing except a full scale roll-back of staffing in the very early part of 2013 could make up for the catastrophic loss of the Simple Mobile contract) and the extensive cost of winning and launching new managed service of cloud business. So, in spite of the lay-offs — a case of too little, too late — things are definitely looking bad.

Moreover, there were more somber language about the PFIC classification and its potentially adverse impact on United States based shareholders (read more about this here.) As I wrote I this earlier posting, the cash hoarded from the — now dead — contract with Simple Mobile may, in a ironic twist, become a poison pill for United States based holders of shares in MER Telemanagement Solutions.

Interestingly, today, on the tail-end of the filing of the 20-F, when investors (if they could — and cared to — read) should be heading for the hills, the company’s equity exploded. This could, of course, be caused by anything, including investor stupidity or leaking of information that the company is getting sold or having gained another customer, but it certainly does not mean that the company is doing well.

With respect to the potential for the gain of new customers to change the fundamental situation of the company, it may be worth thinking deeply about the depth of the problem to be plugged. As I wrote in an earlier posting (here) where I discussed an, in my opinion, less-than-reputable and poorly researched article by Mr. Sujan Lahiri, a self-confessed post-for-profit contributor to Seeking Alpha:

Mr. Lahiri’s rather simplistic view continues throughout his article. For instance, he writes:

For instance, if MTSL were to land one large customer, EPS could easily grow from current $0.27 to $0.40 per share in the near future. Apply the industry average of P/E 15, and you have a $6.00 share. Another customer could mean $0.50 or $0.60, that’s a $7.50 or $9.00 share. Any extra customers directly add to the profit without a substantial increase in costs. The upside potential is therefore very large.

Well, let’s look at this. The assumption here is that a new customer would add something like $0.13 in earnings in the near future. In real terms this means yearly earnings (not revenues!) of $585 thousand or so, or just about $50 thousand per month. Assuming a liberal 20% margin, this amounts to $250 thousand in revenues per month.

With the Simple Mobile pricing a benchmark for per subscriber revenues, pointing to something like a quarter of a dollar per subscriber per month in revenues, this would mean that the fictive customer would have a subscriber count of one million.

MVNOs or MVNEs with 1 million subscribers are relatively rare, and, importantly, they don’t just emerge in one go (read about subscriber count in the MVNO world in an earlier posting here,) so I think that Mr. Lahiri’s projection of the “near future” earnings is… well… laughable.

So, new customers are definitely not a valid reason for a surge in the per share price of MTSL.

We’ll soon see what gives, I guess.

Donations, please….

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PFIC… What was that again? — A double-edged sword

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

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My recent posting about MER Telemanagement Solutions, an Israel based technology company whose equity, MTSL, is traded on Nasdaq, resulted in some questions from readers of the blog.

In the posting (read it here,) which broadly speaking discussed MER Telemanagement Solutions’ quarterly earnings announcement in which the company announced (1) a new high in cash (and cash equivalents) on hand almost exclusively on the strength of a very profitable contract with Simple Mobile, a West-coast based MVNO whose managed services contract with MER Telemanagement Solutions had generated a guaranteed $300 thousand in revenues and cash every month throughout MER Telemanagement Solutions’ fiscal 2013 year; and (2) the end of this revenue and cash stream, effective as of December 31st, 2013.

In my posting, I pointed out that the straightforward economic loss of the Simple Mobile contract coupled with tremendous expenses related to capturing and launching new customers to replace the loss of the contract could hit MER Telemanagement Solutions and MTSL in ways that had the potential for simply bleeding MER Telemanagement Solutions out:

Also, with the loss of the contract revenue and its high margin there is now, I believe, a substantial risk that the company will be considered a PFIC by the IRS of the United States with serious tax implications for common shareholders in the United States. As the company wrote in its 20-F filing for its 2012 fiscal year:

We may in the future be classified as a passive foreign investment company, or PFIC, which will subject our U.S. investors to adverse tax rules.

This comment caused a couple of comments and questions to arise, intensifying as the per share price of MTSL inexplicably started rising when it should, in fact, decrease, reflecting the potential for loss in the first quarter.

Sidenote: I say inexplicably, but that is not really so. In fact, the price was rising, I believe, as part of a deliberate pattern of stimulating buys intended to pull a number of loss positions out of the fire (due to a series of speculative run-ups and subsequent implosions in the per share price of MTSL over the last year the majority, if not all, of the true free float of MTSL is seriously under water.) However, we will let this lie for now as it has only a tangential connection with the issue of PFIC, which is the point of this posting.

Let me attempt to address these question here (spoiler alert: A PFIC classification of MER Telemanagement Solutions may be really bad news for current United States based holders of MTSL shares and may adversely and seriously impact the per share price of MTSL.)

PFIC is shorthand for Passive Foreign Investment Company, an oddity in the United States tax code that was introduced because the United States Congress was concerned that persons investing in passive assets indirectly — through a foreign investment company — could gain a tax advantages relative to persons investing in the same assets directly.

The resulting law attempts to eliminate this problem, but, unfortunately, also have the potential to impact genuine foreign operating companies, for instance companies that are earning substantial passive income (such as a company that has a large war-chest, generating income.)

The way the law is written it attempts to identify a PFIC by way of two criteria. Either 75% of its gross income is passive income or more than 50% of its assets generate passive income.

I am grossly simplifying here, but if you read my previous postings, I am sure that you can see that there is a real possibility of MER Telemanagement Solutions being categorized as PFIC given its cash position (the result of cash gushing out of Simple Mobile for three years) and its off-the-cliff drop in revenues and income.

For MER Telemanagement Solutions itself the classification as a PFIC will really have very limited direct implications, but for United States based shareholders in MER Telemanagement Solutions it gets complicated and dirty very quickly.

First, any gain recognized by the shareholders becomes subject to ordinary income rates, rather than capital gains rates (a vast difference) and — hold on to your pants here — the gain is subject to a non-deductible interest charge over the holding period for the shares.

And it doesn’t end there. In special cases the income tax rate assessed will not be the United States based shareholder’s “normal” tax rate, but, rather, the highest marginal income tax rate in the United States.

It may be worth saying this again: Rather than paying between 15% and 20% in gain tax, United States based shareholders will be paying between 30% and 40% and they will be paying interest on the gain (deemed interest, in fact!)

Second, there is a paper burden here that is well beyond the casual investors, traders, and speculators (I, unfortunately, do not believe that casual investors, traders, and speculators are plagued by detailed knowledge of the environment that they are operating in, which, of course is why they a-l-w-a-y-s lose money in the market.) Essentially, he or she must make a baffling election between mark-to-market or qualified electing fund treatment, both of which are just as confusing as they sound and require certain detailed disclosures by the PFIC (good luck in getting a company to provide disclosure beyond what it has provided in its filings with the SEC.)

How bad is PFIC classification for a United States based shareholder? Well, I think it is very bad. In fact, I think the acronym PFIC was chosen by some fiendish soul in United States Congress with a twisted sense of humor because it also is the acronym for Progressive Familial Intrahepatic Cholestasis, a very nasty liver disease, to signify precisely how bad it is.

I said before that for MER Telemanagement Solutions itself the classification as a PFIC will have very limited direct implications. Likewise, the classification will not have any direct implications for MTSL shareholders that are not based in the United States. However, the operative word here is direct.

A classification as an PFIC is adverse and will make any sensible investor think twice before he or she invests in MER Telemanagement Solutions by way of MTSL, and, so, we have an indirect effect on both MER Telemanagement Solutions and its non-United States based shareholders in that the price per share of MTSL will drop — perhaps a lot!

The irony should not escape us here. The successful looting of Simple Mobile and accumulation of loads of cash may very well be a textbook case of a Pyrrhic victory.

Yes, that’s also a beaut of a double-whammy. First, a drop because of the changes in the fundamentals and, second, a further drop because of a perverted tax treatment.

Now, over time, the PFIC issue will, of course, go away, since, in all probability, MER Telemanagement Solutions will start bleeding, rapidly eating away of the cash (and cash equivalent) asset that is the underlying problem. But, as a solution there is not much comfort to be had here, I think.

Perhaps this is why the company was talking about M&A alternatives in its earnings report? Well, this is certainly going to be interesting!

Donations, please….

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Breaking, pre-open news — MER Telemanagement in near extremis

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

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Yesterday, after the close of the market, MER Telemanagment Solutions, an Israel based technology company whose equity is traded on Nasdaq, reported its fourth quarter and full year results for the company’s fiscal year 2013, and, frankly, in my opinion it is not looking good.

As the reader of this blog will know I have followed MER Telemanagement Solutions and its equity MTSL, for a while now, noting since the outset that the loss of the Simple Mobile contract constitutes a clear and present danger to the company and its shareholders. If you are new to this issue, you can start reading here and go backwards or you can use the nifty XREFs section to here.

Revenues and operating profit are down significantly year-over-year and net income was down $1 million to $1.4 year-over-year when accounting for a one time $1 million tax charge in the company’s fiscal year 2012.

The $1 million one-time charge in fiscal year 2012, which somewhat masks the enormous drop in net income in fiscal year 2013, was described in the company’s 20-F filing for the 2012 fiscal year:

Taxes on Income.

We recorded taxes on income of $736,000 for the year ended December 31, 2012, compared to taxes on income of $10,000 for the year ended December 31, 2011. Our taxes on income for the year ended December 31, 2012 are primarily attributable to a $1,050,000 charge related to the tax assessment from the Israeli tax authorities relating to an Israeli court’s decision with respect to our 1997 to 1999 tax years, net of a deferred tax asset recognition of $371,000 based on an estimate of future taxable profits and losses in the tax jurisdictions in which we operate, which is expected to be utilize in the foreseeable future. Our low level of taxes on income for the year ended December 31, 2011 is primarily attributable to the utilization of deferred tax assets by our subsidiary in Hong Kong and the state income taxes in the U.S.

Moreover, in the current earnings release the company confirmed that the fourth quarter marked the end of the revenue contribution from the all-important Simple Mobile contract, so, going forward, each fiscal quarter will have $900 thousand, or so, less in revenue and perhaps $450 thousand less in net income, which most probably will result in a loss in each quarter.

Also, with the loss of the contract revenue and its high margin there is now, I believe, a substantial risk that the company will be considered a PFIC by the IRS of the United States with serious tax implications for common shareholders in the United States. As the company wrote in its 20-F filing for its 2012 fiscal year:

We may in the future be classified as a passive foreign investment company, or PFIC, which will subject our U.S. investors to adverse tax rules.

Holders of our ordinary shares who are United States residents face income tax risks. There is a substantial risk that we may become a PFIC. Our treatment as a PFIC could result in a reduction in the after-tax return to the holders of our ordinary shares and would likely cause a reduction in the value of such shares. For U.S. Federal income tax purposes, we will be classified as a PFIC for any taxable year in which either (i) 75% or more of our gross income is passive income, or (ii) at least 50% of the average value of all of our assets for the taxable year produce or are held for the production of passive income. For this purpose, cash is considered to be an asset which produces passive income. As a result of our relatively substantial cash position at the time, we believe that we were a PFIC in certain periods over the last few years under a literal application of the asset test described above, which looks solely to the market value of our assets. We do not believe that we were a PFIC in 2012. If we are classified in the future as a PFIC for U.S. federal income tax purposes, highly complex rules would apply to U.S. Holders owning ordinary shares. Accordingly, you are urged to consult your tax advisors regarding the application of such rules.

The company’s earnings release contained no indications of cost-control measures or new deals, relying rather on the tired we-see-opportunities approach that we have seen from previous quarterly announcements and that I commented on in an earlier posting (here):

In fact, ever since the termination of the Simple Mobile contract was announced it has been clear that the company … is heading directly for exsanguination.

To avoid death, immediate action is needed on two simultaneous fronts: New sales and cost control.

The instinct in a tech company is to overcome a revenue crisis by bringing in new revenues. However, given the sales cycle time for enterprise software sales and the trailing revenue curves for managed services sales, the company’s areas of expertise, the pursuit of additional revenues alone is not going to solve the problem. Rather, the company has to immediately reduce its expenses while, at the same time, building up its sales effort.

Instead of addressing the situation heads-on in its first quarter earnings announcement, the company engaged in some sort of combined danse macabre and tap dance, which I certainly did not find reassuring.

It is hard to give the casual reader a sense of just how catastrophic the loss of the Simple Mobile contract coupled with the company refusal to reduce cost and it hell-bent pursuit of new business at great expense and risk is (read here about how bad it can get when you engage in what I consider to be reckless pursuit of new deals instead of buckling down down and controlling expenses,) but perhaps this table — greatly simplified and making sweeping assumptions where information is not available — can provide some insight:

(c) Per Jacobsen, 2013 and 2014. All rights reserved

(c) Per Jacobsen, 2013 and 2014. All rights reserved

As you can see, the Simple Mobile contract’s revenue and margin contribution was integral to the company’s performance and without it, the company will be hemorrhaging.

Acknowledging this imminent distress, which is now so obvious that no amount of voodoo or fancy leg-work will make it go away, the company closed its earnings announcement by stating that it is considering M&A options at this point, which I interpret to mean that either a fire-sale or a last-ditch clutching on to another company for buoyancy may be imminent. Either way, focusing on M&A — which, as we, know is associated with huge transaction costs and enormous risks — is bad news for the shareholders, I think.

The company did not offer any details about an upcoming earnings call in its earnings release.

Given the excessive — and completely unsubstantiated — speculative run-ups that have taken place over the last year (read more about this by starting here,) there is absolutely no way to predict what will happen to the per share price of MTSL in the very short run, but I am fairly certain that in the near and medium term, once whatever silly movement the market will make today and over the next week has completed its cycle, we will see another substantial drop in the per share price.

I would be remiss if I did not issue an early warning as well. Based on historic developments, I am fully expecting another SeekingAlpha article to arrive soon with unpredictable results (read about the previously published MTSL-centric SeekingAlpha article by Mr. Sujan Lahiri (here) — in my opinion, a prime example of bad research, wrong conclusions, and biased research aimed at generating a short-term run-up in the per share price of an equity.)

It appears that it is time to fire those emergency flares.

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Mind CTI is prepared for 2014

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

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Onwards and up

Mind CTI Ltd. released its financial results for the fourth quarter of fiscal year 2014 and full fiscal year 2014 on Tuesday, February 25th, 2014.

As usual, I have summarized these results and my commentary on these in a dynamic posting that you can find here. The dynamic posting also provides summaries of previous quarters’ results and associated commentaries.

After several quarters of re-gearing, with added expenses and headcount and lowered operating income, the company ended its fiscal year with a bang, turning in a fourth quarter that was way better than expected, establishing a significant foothold for the 2014 fiscal year, and paying its patient shareholders a significant dividend.

On the back-end of significant wins in the fourth quarter of fiscal year 2013, the company appears very optimistic about fiscal year 2014 and it backed this confidence up with a $0.24 dividend, payable in the first quarter of fiscal year 2013, and constituting a 10% yield or better (read more about the very special dividend situation for Mind CTI here.)

For more information, please refer to the dynamic posting (here.)

Donations, please….

As usual, if you found this posting useful or entertaining — or if it saved you time, you can express your appreciation through donation via PayPal right now.   For this type of posting a one-off donation of $10 is suggested — however, any donation is, of course, appreciated.