PRLS – Peerless Systems, A Net-Net Stock in Search of a Business

Peerless Systems Corporations (Stock: PRLS) is a company that specialises in licensing technology related to imaging solutions to OEM customers. PRLS sold their business in 2008 but still holds licenses to serve their current customers. Their Imaging business licenses are still profitable as seen in the ‘business section’ later in this report.

Since the sale of essentially their only business, PRLS have become an investment vehicle. In the ownership section I go through the background of the current CEO and why his future decisions may be beneficial to owning PRLS. According to the company “in fiscal 2014, our strategy may include establishing a new venture that utilizes the expertise of management and the Board of Directors, as well as identifying acquisition candidates and investment opportunities.”

The Company has only 3 full time employees that hold the fort and renew the licensing.

PRLS board approved, in 2008, a 4 million share repurchase. As of the last quarter they have approximately 500k shares still to be repurchased as per their mandate.

Peerless Systems Ownership

Timothy E. Brog has been the CEO since August 2010 and Chairman of the Board since July 2008. He currently holds just over 500k shares which is approximately 18% of PRLS. Mr Brog has previously been the portfolio manager of Pembridge Value Opportunity Fund from 2004 to 2007. Being a successful value investor it would suggest that management’s interests are aligned with the shareholders.

Mr. Brog salary is questionable at 445k in 2013 and 653k in 2012. These figures are below the average for a publicly traded company but since PRLS does not need full time management this is something to keep an eye on.

On July 11, 2013 Tim was reappointed CEO and received 250k restricted shares as per his signing ‘bonus’. This contract included that he forfeit the 150k shares that he received in 2010 when he was first appointed as CEO (thus he received an extra 100k shares to what he already received). The fair value of this bonus according to their calculations (Monte Carlo Simulation) was $812K.

PRLS Business

		Adjusted		Adjusted
	Jul 31, 2013	Jul 31, 2013	Oct 31,2013	Oct 31,2013
Revenue	847,000	847,000	920,000	920,000
Cost of Goods Sold	– 43,000	– 43,000	– 86,000	– 86,000
Gross Profit	804,000	804,000	834,000	834,000
Selling, General, &Admin. Expense	– 667,000	– 274,000	– 723,000	– 410,000
Operating Income	137,000	530,000	111,000	424,000
Other Income	– 702,000	–	– 372,000	–
EBIT	(565,000)	530,000	– 261,000	424,000
Income Tax Expense	166,000	185,500	1,000	148,400
Net Income	(399,000)	344,500	– 260,000	275,600

This is the P&L for the company if we were to look at the business alone. As previously mentioned the business is declining with the team are not looking for new business. Their revenue stems mainly from 3 OEM customers (Kyocera Documents Solutions Inc., Novell Inc. and Oki Data Corporations). Two of these have finished their ‘block contracts’ and are currently on a pay-per-use basis. The clients not renewing their contract suggests this is still a short term fix and will most likely look for a substitute product in the long term.

To create the business P&L I have made the following changes:

I have deducted the expense the company included in ‘Selling, General & Admin’ that is to do with the bonus the CEO received by signing the contract as mentioned in the ‘Ownership Section’. These costs were calculated at a fair value of $812K that was split between 3 quarters. $393K recorded in July 2013 quarter, $313K recorded in the Oct 2013 quarter and $106k to be recorded in the next quarter ended Jan 2014. In receiving the bonus of 250,000 shares he had to forfeit 150,000 shares and this value has not be taken into consideration in the costs applied. This therefore suggests that they have exaggerated the costs by the value of 150k shares (approximately $485k).

I have also deducted the ‘other income’ that is due to trading losses. This I have separated and looked at in the following ‘trading’ section.

I have used a flat 35% Tax rate for the P&L.

Trading Losses

According to their filings for the 9 month period ended 31 Oct 2013 PRLS has lost a total of 1,488,000 through sale of marketable securities in the 2013. This is due to the ‘sell off’ of their current equities.

Peerless Cash Flow

Over the last 9 months PRLS has increased cash from $8,866,000 to $11,051,000 while decreased their market securities investments from $2,910,000 to $102,000.

PRLS Share Repurchases

For the last quarter just over 80k shares were repurchased at an average price of $3.66.

Peerless System Balance Sheet

The current balance sheet as at 31 Oct 2013.

	Book Value	Adj. Book Value	Percent
Cash And Cash Equivalents	11,051,000	11,051,000	100.00%
Marketable Securities	102,000	–	0.00%
Accounts Receivable	1,684,000	1,515,600	90.00%
Total Inventories	–
Other Current Assets	190,000	95,000	50.00%
Total Current Assets	13,027,000	12,661,600	97.20%
Other Long Term Assets	6,000	–	0.00%
Total Assets	13,033,000	12,661,600	97.15%
Accounts Payable & Accrued Expenses	270,000	270,000	100.00%
Other Current Liabilities	82,000	82,000	100.00%
Total Current Liabilities	352,000	352,000	100.00%
Long-Term Debt	–	–
Deferred Tax And Revenue	282,000	282,000	100.00%
Total Liabilities	634,000	634,000	100.00%

The balance sheet is mainly cash. I have reduced Accounts Receivable by 10% to be prudent and reduced the ‘other assets’ but 50%. I have given no value to their marketable securities of $102,000 but this figure is not significant.

To summarize their balance sheet:

Shares	2,776,000
Price	3.65
	Total	Per Share	Percent
Market Value	10,132,400	3.65	100.00%
Book Value of Equity on Balance Sheet	12,399,000	4.47	122.37%
Adj. Book Value	12,027,600	4.33	118.70%
Margin Of Safety	1,895,200	0.68	18.70%

 

Risks

Their imaging business is not a going concern and will stop producing cash flow for PRLS although there is no certain timeframe.

They are sitting on substantial cash not producing any return.

They enter a new business or buy shares that end up eating through their cash reserves.

There are costs to keep PRLS public.

Bottom Line

Even though the business is a net-net and the balance sheet is as strong as one could be I believe PRLS still does not know where they are heading and right now the costs of doing nothing is significant (CEO costs and keeping the Company public).

The main upside is if their current customers stay with the firm as the imaging business is still very profitable with the current cost structure. A few more quarters with the same revenue and costs structure would increase the margin of safety.

PRLS is still looking to repurchase nearly half a million shares out of their current 2.7m outstanding shares (approximately 18% of the float). As the share price is lower than their book value this is like the Company buying a dollar for 80 cents and thus increasing the value for the current shareholders.

At this point I believe it is better to keep an eye on PRLS but if the price were to fall even further to $3.40 levels I would look to make a small investment (1-2%).

Note: Analysis by Erwin, reviewed by me