Versant Analyst ( May/07 ) has $1.75 targetVersant's research report in May 07, did not include the PURE acquisition, whose revenue and technology assets will be transformational to TOR.
...With most of the KOC units being shipped in
March, the company has posted the best quarter in
its history, with $16.4M in revenues. Adjusting for
warranty provisions, the company almost came to
breakeven, with an EPS loss of $0.01 per share.
We are maintaining our target at $1.75, using an
8× EV/EBITDA multiple.,
...At current prices, the stock still looks reasonably
inexpensive considering the still sizeable quotation
pipeline, now at $65M and $0.39 in net cash per
share at the end of Q3.
..FOCUS POINTS
▪ Record Q3 revenues of $16.4M.
▪ EPS loss of $0.01 after adjusting for warranty
provisions. Reported EPS loss was $0.04.
▪ $0.39 in net cash and investments per basic
share.
▪ Triton and KOC installs could trigger more
orders in the North Sea and Middle East.
▪ Portfolio of quotations is up 20% to $65M.
....Adjusted EPS was slightly better than expected: Gross margin for the quarter was negatively impacted by a $1.6M warranty provision charge tied to the KOC units, which the company expects to reverse within the next 12-18 months. Without this, and other warranty provision adjustments, gross margin would have been 4.9% instead of the -3.6% reported. EPS was reported as a $0.04 loss although adjusting for all the warranty provision adjustments, which
were not factored into our estimate, EPS loss would have been $0.01, slightly better than our projected $0.02 loss.
....Triton and Expro units up and running: A key announcement in the quarter was that the Triton (North Sea) and Expro (Angola) units are fully operational. This is a major milestone for the company, as the company seeks to prove out the commercial viability of its products and provide referenceable customers. These events may trigger more orders in the next year.
....The commissioning on the KOC units later this year will also provide a showcase centre to demonstrate the TORR products in the Middle East.
...Gross margin hit by warranty provisions .When recognizing the revenues for the KOC units, the company takes up to 10% of that amount and adds it to cost of goods sold, grossing up this amount
and making gross margin negative. In the quarter, the provision for the KOC shipment was $1,633,739. Excluding this provision from cost of goods sold would have pushed gross margin up from the -3.6% reported, to 6.4%.
If we account for these two items having had a beneficial impact
on cost of goods sold in the quarter, then we would have obtained a fully adjusted gross margin of 4.9%.
Warranty provisions are typically reversed 12-18 months after units have been shipped and TORR is reasonably certain that the units are operating as expected without any need to incur subsequent costs.
....Quotation pipeline is up
At the end of the quarter, the company had $65M in quotations in the sales pipeline, a 20% increase over the $54M it had at the end of Q2. The quality of the portfolio has been upgraded in the last few quarters and now includes only those opportunities for which the company believes to have a significant chance of winning. The criteria for being included in the sales pipeline include a
likelihood of over 20% of becoming a purchase order in the foreseeable future.
...The current portfolio includes a large proportion from Middle Eastern opportunities with the rest of the opportunities stemming from the North Sea and Gulf of Mexico regions.
...Trials also underway
The company has had three new successful trials in the Middle East. These trials were conducted on one onshore and two platform sites. Through a partner in Western Canada, the company will conduct further trials on a second site north of Alberta, following previous successful trials on an initial site.
Neil Linsdell, CFA cites a historical closing ratio of 50% on opportunities where field trials are agreed to.
...Commissioning of Triton platform could attract more customers
The TORR unit shipped to the Triton platform in the North Sea a year ago was finally commissioned and started-up in the quarter. This delay had an impact on subsequent sales in the North Sea; however, we believe that a number of potential clients, that liked the TORR unit in trials, were waiting to see the Triton unit in full production before placing their own orders. Once we see a
few months of production, we expect to see additional North Sea customers place orders. The North Sea is home to as many as 300 platforms that could be customers for TORR.
... Moreover, the OSPAR commission, whose objective is to reduce pollution and maintain a safe maritime environment, will start
imposing compliance obligations on offshore oil platforms. TCI is now
focusing its efforts on 13 platforms specifically identified as being in need of TORR’s product. Taking the Triton order as a reference point, these 13 platforms could imply an immediate opportunity of up to $50M, with recurring revenues from replacement RPA cartridges beyond that.
...Sales force focused on the Middle East
The company has decided to restructure its direct sales force in order to better focus their offering and serve their clients. The Middle East remains a key focus area where the company will follow its previous plan of establishing a support and services office which will cater to the needs of Kuwait Oil Company and
other anticipated large clients.
.... True profitability of TCI in the future will derive
from the RPA cartridge (recurring) sales and associated services. In other regions, the company is looking for key contacts to help drive opportunities.
...In Houston, an experienced local agent was recently appointed, and the company intends to incrementally allocate its resources in the region as sales traction builds up. Although the most immediate opportunities are in the Middle East, the Gulf of Mexico and the North Sea, the company plans to also expand its network into Asia and the former Soviet Union.
.....Partners not included in sales pipeline
In addition to the in-house sales force, TORR works with key industry players that sell or license the TORR technology. Partners include: Expro, Siemens Water Technologies (formerly USFilter), Weatherford, FORES Engineering (formerly Tecsol) and Schlumberger.
... TORR Canada does not typically have detailed insight into the activities of these partners’ activities promoting TORR
products and does not include any order potential in the $65M quotation pipeline previously mentioned.
....Accounting change will make financial results less lumpy
We expect fiscal 2007 to be a good year for TORR as it recognizes revenues on the KOC order. The company will now recognize revenue from the design, fabrication and delivery of TORR systems under contract accounting using the completed contract method. The company changed to this method during the quarter to more appropriately reflect the production type nature of the business. Under
TORR the previously used completed contract method, contract revenue billed and related contract expenses were deferred until the production of a unit is completed, delivery to the customer occurs and there is reasonable assurance of collection. The affect will be to somewhat smooth out the revenue recognition and better reflect business activity at the company. We have therefore also
increased our F2008 estimates to account for revenue recognition that we had previously expected only to occur in F2009.
VALUATION & RECOMMENDATION
We are maintaining our target of $1.75 and Speculative Buy recommendation.
Although we do not anticipate any large or material contracts to be announced before the end of the 2006/7 fiscal year, we do caution investors that shares in TORR can and likely will jump sharply and quickly if the company does announce any sizeable orders, or potentially any sizeable bids.
As we are nearly complete F2007, we are providing a target price for F2008.
.