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Telit Communications: what the bears saw, it's about the balance sheet stupid

By Tom Winnifrith, The Sheriff of AIM | Saturday 12 August 2017


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.


After my earlier story about the covenant breach which is, I am increasingly sure, a smoking gun, I explore some trends shown by the financial statements of Telit Communications (TCM) that may have been some the red flags that resulted in hedge funds making Telit the most heavily shorted AIM company - this is all about the balance sheet. It also highlights why some type of fund raise, equity or debt, was almost inevitable in May - without it the lights would have been switched off by now.

Let us start with the scale of spending on intangible assets. In common with all technology business, Telit spends significant amounts on research and development. During the year, cash outflow is capitalised and then amortised to income after the assets comes into use over several years.

As the table below shows Telit has been spending an increasing amount on the development of intangibles (broadly in line with growth in turnover) and the amortisation charge lags this spending so it gives a positive boost to income and cash flow statement as shown below:

Capitalised Amortized Difference
In year In Year Between profit
and cashflow in year

 

$,000

$,000

$,000

2013

11,177

7,994

3,183

2014

26,071

10,396

15.675

2015

26,106

13,532

12.574

2016

30,771

18,201

12,570

Total

94,125

50,123

44,602

2017 H1

17,944

11,331

6,613

 

The figures are from the cashflow statements. The amounts capitalised is in respect of development expenditure only whereas the amortisation charges and includes amortisation for other intangible assets and as such table understates the gap between cash outflows and stated profitability.

Telit has a further 434.7 million of intangible assets or 41% of total balance sheet development assets which are not currently being amortised as they remain in development. Such assets by their nature are not yet generating any revenue which adds to the cashflow strain. This further exacerbates timing difference between cash outflows and the eventual charge of amortisation to the income statement.

Net debt position: Telit’s financial position deteriorated from net cash of $1.139 million at end of 2015 to net debt of $17.865 million at end of 2016. Even after raising $49.7 million from an equity placing in the six months ended 30 June 2017 net debt was only reduced to $9.268 million.

Notwithstanding the consistently high level of cash outflows versus declared profits, Telit had started to pay dividends starting on 27 May 2016 based on a proportion of declared profits which further exacerbated its cashflow problems. Surely a prudent finance director would have highlighted the dangers associated with paying a dividend for a business burning cash at the rate that Telit was.

Trade Creditors: A classic approach for a business under severe cashflow strain which it doesn’t to be shown in either its net debt position or to remain within covenants is to delay paying creditors. Telit’s financial results, show a very marked increase in the quantum of trade creditors (some of which is attributable to growth in the group) but also due to an almost 75% increase in payment terms as following table shows:

$’000 Days
2013 51,860 92
2014 70,463 105
2015 77,627 135
2016 113,681 159

At some stage trade creditors are going to refuse to accept ever longer terms of trade and trade with a different counterparty. Given what happened at the interim stage that day is looming fast.

More red flags with your tea vicar?


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