PCYG - Park City Group Has Quality Characteristics And Can Benefit From FSMA 204

2023-03-22 16:26:04 ET

Summary

• PCYG is a developer of software for supply chain and inventory management. The company's products are currently applied to predictive demand, JIT inventory, and trade by scanning.
• PCYG has been able to grow revenues in this competitive market. Most importantly, it has increased gross margins and kept SG&A expenses frozen. Management shows signs of being conservative.
• The company has also increased its cash flow conversion, reduced its share count, repaid all of its debt, accumulated cash, and is now paying dividends to common shareholders.
• Besides its current market, PCYG is focusing on food traceability solutions in preparation for the industry's adaptation to the FDA's implementation of FSMA 204.
• Trading at a 14.5x ratio of calendar 2023 earnings, I believe the company's shares fairly value the current business and managerial quality but leave the FSMA opportunity unpriced.

Park City Group (PCYG) is the developer of ReposiTrak, a software solution for supply chain management that is trying to become a player in the upcoming food traceability market.

The company has several quality characteristics: top-line growth, cost contention, cash flow generation, conservative capital allocation, insider ownership, the promise of a future growth market, and dividends.

Although PCYG's product is not the only one on its market, and it is not mandated to be successful, I believe the current price to expected earnings multiple provides a sufficient opportunity, given the company's previous execution.

Note: Unless otherwise stated, all information has been obtained from PCYG's filings with the SEC .

Business description

Software for inventory management : PCYG develops supply chain solutions like inventory management predictive models, trade-by-scanning models, and compliance management solutions.

The company's current core product, ReposiTrak, was acquired in 2015, but the company had been working with ReposiTrak before that as well.

ReposiTrak's main capability is to provide a unified database system for inventory management to a retailer's or wholesaler's supply chain without scanning, which reduces costs.

PCYG's customer (a retailer or wholesaler) sets a series of standards, documents, and information that its suppliers must comply with. Each supplier then pays PCYG a relatively inexpensive amount (in the hundreds of dollars per month) to upload that documentation in ReposiTrak.

The solution can also use OCR and AI to filter the documents, request modifications, etc. The platform also allows further integration like predictive ordering or trade by scan (whereas a supplier owns the inventory until this is sold to the final consumer, and therefore carriers the inventory risk and cost despite the product being in the retailer's premises).

Not the only competitor : PCYG's system is not the first supply chain management system. A visit to G2 reveals hundreds of simple to complex alternatives. Big retailer names could also develop their systems in-house.

Competitive advantages : It seems that PCYG has concentrated on providing a model that the retailer chooses but requires costs to be borne by the suppliers (the hub and spoke model).

The price charged for the software is sufficiently low and does not require any additional hardware or labor, which is also an advantage.

Finally, the company has been good at developing institutional relationships and alliances. The Safe Quality Food Institute used ReposiTrak as the base software for all suppliers to update their SQF compliance documents. The company has also become the exclusive partner of several business associations like GMDC , ROFDA , FMI , and NGA . Mostly these associations reunite small and middle-scale businesses.

Cost control : Despite PCYG being unable to grow total revenues substantially, it has significantly controlled costs so that profitability is growing. Since acquiring Repositrak, the company has grown gross profits above revenues and has managed to keep SG&A levels frozen. This is an indication of a managerial team that can grow profitably.

Conservative capital allocation : The company has increased its cash flow, accumulated cash reserves (now at $21 million with zero debt), reduced the share count, and now pays an $0.015 quarterly dividend. In a recent earnings call , the company said that it is not interested in acquisitions because the targets trade at 14 or 15 times non-recurring earnings.

Cash flows are better than earnings : The company is currently generating approximately $5 million in net income, from which it has to pay $500 thousand in dividends to $8.4 million in preferred shares, yielding 7%.

However, the company's accrual earnings include a significant gap between depreciation and amortization and the company's current and average capital expenditures.

The result is cash flows that are higher than net income and growing.

Good managerial team : I like PCYG's managerial team's control of the company's expenses. It is conservative in capital allocation and does not plan to use cash on acquisitions unless earning yields are low enough. Further, compensation is regular, with $2 million in aggregate for the three highest-paid officers. Finally, the company's founder and CEO owns 33% of the common and most preferred stock. Therefore he has incentives that are relatively aligned with the shareholders in my view.

Valuation

The promise of FSMA 204 : In 2011, the U.S. passed the Food Safety Modernization Act . Article 204, which requires complete supply chain traceability, was left to be implemented by the FDA.

Only in 2020, and probably motivated by COVID, the FDA announced that a series of food products would become the test of this full traceability initiative, under which the retailer or restaurant owner has to implement a system that allows him to trace every step of the chain from the original source. These records must be maintained for two years and become available in 24 hours. Therefore, they must be digital. In January 2023, the FDA announced that the deadline for compliance is January 2026.

According to PCYG's management, the industry is not prepared for this, the deadline will be pushed back, and there is no solution comparable to ReposiTrak in low cost and ease of setup. Management has decided to make this the company's strategic focus, abandoning other markets to prepare better for the traceability market (that is, as of 2Q23, still not generating any revenue).

ReposiTrak's advantage, according to management, is that it does not require any scanning and does not require suppliers to use a common ERP system, therefore reducing costs. The company is currently offering a waiver to the setup fee of $2,000 and charges a $300 monthly, fixed, for any supplier, independently of the volume transacted.

Again, ReposiTrak is not the only solution in the space, with G2 listing almost a hundred companies offering under the category of food traceability . However, the promise of a regulatory requirement increasing ReposiTrak's demand exists.

Expected earnings and valuation: The company has done a great job at containing costs despite growing revenues and plans to continue. According to management, there is no need for higher administrative or incremental CoGS to incorporate more customers into the platform.

Indeed that seems to be true for the time being because the company has significantly increased and then maintained revenue per employee.

Management expects next year's revenues to grow at 10%, with the company's gross margins maintained and SG&A expenses not growing.

$22 million in revenues would translate into $18 million in gross profits and $8 million in operating profit (considering $10 million in SG&A expenses). From that, $500 thousand are paid as dividends to the preferred shares. Finally, the company has $45 million in carryforward losses against which to offset income taxes. The result is an expected net income of $7.5 million for the calendar 2023 period (half of fiscal 2023 ending in June 2023 and half of fiscal 2024).

The company trades at a market cap of $110 million, meaning the stock offers an expected P/E ratio of 14.5x or, conversely, an expected yield of 7%.

Conclusions

Normally, I do not recommend companies that trade at a 15x multiple of next year's expected earnings. However, in the case of PCYG, I believe the company's quality and prospects justify the multiple.

The company's management has checked almost every box on the book: cost contention, revenue growth, margin expansion, cash flow conversion, conservative capital allocation, low debt, share count reduction, insider ownership, and now a dividend.

The company has grown without the FSMA 204 regulation market. The 10% revenue growth guidance does not include food traceability as the main engine, which the company believes will become more important in calendar 2024 and 2025.

Therefore, I believe current prices represent the fair value of the company's current operations and prospects, leaving the food traceability market as an opportunity not already priced in.

For that reason, I believe PCYG's stock is an opportunity at these and lower prices.

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