siddharth rajeev, b.tech, mba, cfa anthony de ruijter, ba
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Siddharth Rajeev, B.Tech, MBA, CFA
Anthony de Ruijter, BA
February 15, 2018
2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Wi2Wi Corporation (TSXV: YTY): Earnings Growth in Q3 – FINAL REPORT
Sector/Industry: Electronic Components www.wi2wi.com
Market Data (as of February 14, 2018)
Current Price C$0.17
Fair Value C$0.30
Rating* BUY
Risk* 4
52 Week Range C$0.06 - C$0.19
Shares O/S 145,527,418
Market Cap C$24.74 mm
Current Yield N/A
P/E (forward) N/A
P/B 3.52x
YoY Return 142.86%
YoY TSXV -0.31% *See back of report for rating and risk definitions
* All of the figures are in US$ unless otherwise specified.
Highlights
Wi2Wi Corporation (“Wi2Wi”, “company”) reported a 7.1% YoY revenue decline in Q3-2017 to $2.31 million. Nine-month revenues were down by 1.5% YoY to $7.23 million. Considering that our previous report was published in September 2016, we are not comparing the actual results with our old forecasts.
Net margins have improved QoQ and YoY, as revenue
generation shifts to a higher margin product mix. The company has introduced 10 new products to address
customer specific requirements over the nine months ended September 30, 2017.
At the end of Q3-2017, the company had $2.16 million in
cash ($0.5 million of which is categorized as restricted cash). Working capital and the current ratio were $4.43 million and 3.1x, respectively. The company has no debt.
We are maintaining our fair value estimate at $0.30
per share.
Key Financial Data
(in US$, 1000s); YE - Dec 31 2014 2015 2016 2017E 2018E
Revenues 8,047 14,306 10,045 9,534 11,500
Gross Margin 41.8% 33.4% 34.0% 32.3% 36.1%
EBITDA (357) 634 139 268 525
Net Income 2,019 1,620 7 42 303
EPS (basic) 0.02 0.02 0.00 0.00 0.00
Total Debt 2,926 - - - -
Assets 9,783 7,712 7,620 8,275 9,675
Return on Equity n/a 7.7% 0.7% 0.7% 4.6%
Return on Inv. Capital -17.5% 6.4% -1.0% 1.0% 3.9%
EV / Revenues 2.2 0.5 0.5 1.8 1.5
P / E -17.2 31.1 162.8 453.1 62.7
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Q3 revenues
down 7.1%
YoY
Wi2Wi’s revenues dropped 10.2% QOQ, and 7.1% YOY to $2.31 million in Q3-2017. For the nine month period, revenues dropped 1.5% to $7.23 million. Revenues and gross profits are shown in the table below. Note that segmented revenues were not disclosed by management. STATEMENTS OF OPERATIONS Q3-2016 Q3-2017 Q3-YOY 2016 (9M) 2017 (9M) 9M-YOY
(in US$, 1000's) - YE Dec 31st 30-Sep 30-Sep 30-Sep 30-Sep
Revenues 2,482 2,306 -7% 7,338 7,228 -1.50%
Cost of Revenues 1,660 1,540 4,993 4,914
Gross Profit 822 766 -7% 2,345 2,314 -1%
Source: FRC
Management have advised that the company is transitioning from low margin and highly price sensitive markets, to a higher margin, lower volume product mix in premium markets. Our revenue forecasts for FY2017, and FY2018, are $9.53 million, and $11.5 million,
respectively.
STATEMENTS OF OPERATIONS 2017E 2018E
(in US$, 1000's) - YE Dec 31st 31-Dec 31-Dec
Revenues 9,534 11,500
Cost of Revenues 6,454 7,353
Gross Profit 3,080 4,147
Research and development 937 1,725
Selling, general and administrative 1,823 1,610
Stock based compensation 52 288
Total Operating Expenses 2,812 3,623
EBITDA 268 525
Amortization and Depreciation 198 222
EBIT 70 303
Share listing expense
Securities
Income from transfer of technology
Gain on bargain purchase
(Gain)/loss on conversion of debt
Other expense 10
Interest expense
Income before Income Taxes 80 303
Provision for income tax 38 0
Net Income 42 303 Source: FRC
Go forward strategy: The company introduced 10 new products for the nine months ended September 30, 2017. Furthermore, management reported that production capacity has been
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Gross
margins
increased and manufacturing operations streamlined, though definitive figures were not disclosed. The company expects to continue to invest substantially in R&D, in order to continue development of its product offerings. There is quite a significant time lag between investment in the company’s business segments and realized revenues. Management reports that investment in the Frequency Control and Timing Devices division takes 24-36 months to generate revenues, due to the need for qualification testing, government approval, and the nature of the target markets e.g. Military, Space, and Avionics. Investment in Wireless Connectivity products tends to require 12-24 months (depending on application) before meaningful revenues manifest, with products meant for medical uses potentially requiring longer due to U.S. Food and Drug Administration (“FDA”) requirements. Products with smart home applications may require less time to generate revenues. In addition, the company has expanded its staff in order to accommodate and accentuate future growth. Management have advised that their engineering staff in Hyderabad, India has grown to nine people, from five. We see this as supportive of revenue growth, as R&D is required to support continued product development. Gross margins increased QoQ in Q3-2017 to 33.2%, compared to 30.3% in the previous quarter, but remained flat on a YOY basis. For the nine month period, the company’s gross margin was 32%.
Margins Q3-2016 Q3-2017 2016 (9M) 2017 (9M) Industry AverageElectronic
ComponentsSemiconductor
Gross 33.1% 33.2% 31.96% 32% 23.3% 15.2% 31.4%
EBITDA 1.5% 2.9% -2.5% 2.8% 22.1% 12.8% 31.4%
EBIT -0.7% 0.4% -4.7% 0.8% 11.0% 4.3% 17.7%
Net (normalized) 0.3% 0.7% -3.6% 0.4% 8.3% 3.2% 13.5% Source: FRC
The following table shows the company’s R&D expenses and selling, general and administrative (“SG&A”) expenses as a percentage of revenues. R&D expenses were $0.22 million (down by 17.9% YOY) and SG&A expenses (excl. stock-based compensation) were $0.474 million (down by 0.21% YOY) in Q3-2017. These expenses totaled $0.69 million, or 29.9% of the revenues, up from 29.7% in Q3-2016. However, for the nine months ended September 30, 2017, the sum of these expenses were 28.7% of revenues, down from 32.5% for the nine months ended September 30, 2016. The main reasoning for this included the transitioning of the Wireless Connectivity engineering department to lower-cost Hyderabad (reflecting a drop in R&D expense) and consolidation of SG&A expenses.
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Expenses (% of Rev.) Q3-2016 Q3-2017 2016 (9M) 2017 (9M)
R&D 10.6% 9.3% 11.8% 10.0%
SG&A 19.1% 20.6% 20.7% 18.7%
Total 29.7% 29.9% 32.5% 28.7%
Source: FRC
Wi2Wi reported EBITDA of $0.2 million, and net income of $27k (EPS: $0.00) for the nine months ended September 30, 2017, versus -$0.18 million and -$0.26 million (EPS: -$0.00) for the nine months ended September 30, 2016. Our base-case forecasts are shown below. STATEMENTS OF OPERATIONS 2017E 2018E 2019E 2020E 2021E 2022E
(in US$, 1000's) - YE Dec 31st 31-Dec 31-Dec 31-Dec 31-Dec 31-Dec 31-Dec
Revenues 9,534 11,500 14,458 18,960 26,021 37,350
Cost of Revenues 6,454 7,353 8,853 11,113 14,695 20,527
Gross Profit 3,080 4,147 5,605 7,847 11,327 16,822
Research and development 937 1,725 2,169 2,844 3,903 5,602
Selling, general and administrative 1,823 1,610 1,880 2,275 2,862 3,735
Stock based compensation 52 288 361 474 651 934
Total Operating Expenses 2,812 3,623 4,410 5,593 7,416 10,271
EBITDA 268 525 1,196 2,254 3,911 6,551
Amortization and Depreciation 198 222 563 854 1,101 1,311
EBIT 70 303 632 1,400 2,810 5,241
Share listing expense
Securities
Income from transfer of technology
Gain on bargain purchase
(Gain)/loss on conversion of debt
Other expense 10
Interest expense
Income before Income Taxes 80 303 632 1,400 2,810 5,241
Provision for income tax 38 0 0 0 0 0
Net Income 42 303 632 1,400 2,810 5,241
Source: FRC
We are maintaining our long-term revenue forecast assumptions, including growth of the company’s wireless connectivity segment revenues to $25 million, and revenue growth of 10% p.a. for the company’s frequency control and timing devices segment. However, we extend the company’s $25 million wireless connectivity revenue milestone to 2022 from 2020, as per management’s recent disclosure on the time required to realize revenues on R&D expenditures (as discussed above).
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Cash Flows
Balance
Sheet
Stock Options
and Warrants
Market
Overview
Free cash flows (“FCF”) were $0.91 million in the first nine months of 2017.
Summary of Cash Flows 2016 (9M) 2017 (9M)
(US$, 1000's) 30-Sep 30-Sep
Operating $40 $1,102
Investing -$88 -$193
Financing $0 $185
Effects of Exchange Rate
Net -$48 $1,094
Free Cash Flows to Firm (FCF) -$48 $909 Source: Financials Statements
At the end of Q3-2017, the company had $1.66 million in cash, and $0.5 million in restricted cash, for a total of 2.16 million. Working capital and the current ratio were $4.4 million and 3.1x, respectively. The company has no debt.
Liquidity & Capital Structure 2014 2015 2016 Q3-2017
(US$, 000s) 31-Dec 31-Dec 31-Dec 30-Sep
Cash (1000's) 645 953 563 2157
Working Capital (401) 4,012 4,235 4,434
Current Ratio 1.0 2.8 3.1 3.1
LT Debt (1000's) - - - -
Total Debt (1000's) 2,926 - - -
LT Debt / Capital - - - -
Total Debt / Capital 72.2% - - -
EBIT Interest Coverage - 2.72 - - Source: Financials Statements and FRC
The company currently has 4.57 million options (weighted average exercise price of $0.16), and 12.66 million warrants (weighted average exercise price of $0.09) outstanding. 4.21 million options and 12.5 million warrants are currently in the money. The company has the potential to raise $1.73 million if all the in-the-money options and warrants are exercised. A large portion of the company’s business is in the production of frequency control and timing devices. This involves the production of crystal oscillators, components used in timing devices. Crystal oscillators have extensive applications across multiple industries, including electronics, internet technology, aerospace and defense, and transport. The crystal oscillator market is a largely mature industry, with competition coming mainly from a few large players. According to Markets and Markets, the crystal oscillator market will grow to $3.28 billion by 2022, from $2.4 billion in 2015, representing a CAGR of 4.56%. According to the same source, the wider timing devices market will grow to $5.92 billion by 2022, from $3.89 billion in 2016, representing a CAGR of 7.27%.
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Internet of Things (“IoT”) is a network of equipment, vehicles, devices and other physical objects that allows for the collection, transmission and exchange of data via the internet. IoT has the potential to influence almost all aspects of life, significantly improve the quality of life for consumers, and the productivity of businesses, while cutting costs. The IoT space is set to expand significantly, with Business Insider Intelligence reporting that there could be up to 22.5 billion IoT devices by 2025. This is up from an estimated 6.6 billion devices in 2016, which represents a CAGR of 27.8%. Furthermore, Business Insider forecasts that between 2016 and 2021, investments in the IoT space will total $4.8 trillion.
Source: Business Insider Intelligence
The outsized forecasts for the potential size of the IoT market are based on IoT’s many applications, commercial and otherwise. The potential benefits of wireless connectivity are relevant to many industries, as demonstrated below:
Heat Map of IoT Opportunities by Industry and Application
Source: Forrester Research
Global mergers and acquisitions (“M&A”) activity has also increased significantly in the
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Valuation
and Rating
IoT space, with a particularly active year in 2016. Deal activity jumped dramatically to $54 billion over 119 transactions, due to several high-profile transactions including Softbank’s (TSE: 9984) $31.4 billion acquisition of ARM, as well as 5 other deals over $1 billion.
Source: Drake Star Partners, IOT Agenda
Discounted Cash Flow (“DCF”) – Based on our revenue forecasts discussed earlier, our DCF model gives a fair value estimate of C$0.28 per share (previously C$0.26 per share), as shown below: DCF Valuation (US$, 1000s) 2017E 2018E 2019E 2020E 2021E 2022E Terminal
Funds Flow from Operations $82 $812 $1,557 $2,728 $4,561 $7,485
-increase in w/c -$181 $1,067 -$378 -$577 -$903 -$1,444
Cash Flows from Operations -$99 $1,879 $1,179 $2,151 $3,658 $6,041
-capex -$70 -$2,500 -$2,500 -$2,500 -$2,500 -$2,500
Free Cash Flows -$169 -$621 -$1,321 -$349 $1,158 $3,541 $59,792
Present Value -$169 -$564 -$1,080 -$257 $768 $2,112 $35,667
Discount Rate 11.1%
Terminal Growth 3.0%
Present Value $36,477
Cash - Debt $1,657
Fair Value (C$) $38,134
Shares O/S 152,043,990
Value per share (C$) $0.28
Long-term C$: US$ - 1.1 Source: FRC
We used a discount rate of 11.1%, which we estimate is in line with the average of the Electronic Components industry and the Semiconductor industry. Multiple data sources were used to arrive at this estimate. Our DCF model increased as we reduced the corporate tax rate used in our models from 35% to 21%, reflecting recent changes by the Trump administration. The increase in value-per-share, however, is muted due to a substantial increase in outstanding shares since our initiating report, due to an equity financing in April 2017. Comparables Valuation: The following tables show metrics of companies operating in
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Fair value estimate baseed on EV/R
2022 Revenue Estimate (US$, 000s) $37,350
EV / Revenue (comparables) 2.7
EV Estimate (present value) - US$, 000s $60,155
Cash - Debt (US$, 000s) $1,657
Fair Value Estimate (US$, 000s) $61,812
Fair value per share (C$) $0.47
C$: US$ (long-term average estimate) - 1.1
Risks
the wireless connectivity & frequency control / timing devices markets.
Name EV/Rev EV/EBITDA P/E
Semiconductor 3.6 10.8 21.2
Electronic Components 1.8 10.8 21.8
Average 2.70 10.80 21.50 Source: FRC
As shown below, the average fair value estimate based on EV / Revenue and EV / EBITDA of comparables is C$0.36 per share (previously C$0.28 per share). The increase is due to the increase in valuation multiples in the semiconductor and electrical components industries since our initiating report.
Fair value estimate baseed on EV/EBITDA
2022 EBITDA Estimate (US$, 000s) $6,551
EV / EBITDA 10.8
EV Estimate (present value) - US$, 000s $42,206
Cash - Debt (US$, 000s) $1,657
Fair Value Estimate (US$, 000s) $43,863
Fair value per share (C$) $0.33
Source: FRC
We are maintaining our BUY rating and fair value estimate at C$0.30 per share. The following risks may cause our estimates to differ from actual results (not exhaustive):
The electronic components industry is dominated by large players and is highly competitive.
The industry is rapidly evolving due to technological advancements. There is a significant lag period between investment in new product lines and
generation of revenues. The company’s ability to adapt to technological advancements will play a vital role
in its long-term success. Delays in product roll out in wireless connectivity will negatively impact our
revenue projections.
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Appendix
STATEMENTS OF OPERATIONS 2014 2015 2016 2017E 2018E
(in US$, 1000's) - YE Dec 31st 31-Dec 31-Dec 31-Dec 31-Dec 31-Dec
Revenues 8,047 14,306 10,045 9,534 11,500
Cost of Revenues 4,687 9,534 6,632 6,454 7,353
Gross Profit 3,360 4,772 3,413 3,080 4,147
Research and development 846 1,358 1,140 937 1,725
Selling, general and administrative 2,711 2,505 2,030 1,823 1,610
Stock based compensation 160 275 104 52 288
Total Operating Expenses 3,717 4,138 3,274 2,812 3,623
EBITDA (357) 634 139 268 525
Amortization and Depreciation 28 239 212 198 222
EBIT (385) 395 (73) 70 303
Share listing expense
Securities (25) 28 -30
Income from transfer of technology 2,250
Gain on bargain purchase 678
(Gain)/loss on conversion of debt 1,335
Other expense (234) 138 10
Interest expense (194) (145) -8
Income before Income Taxes 2,090 1,613 27 80 303
Provision for income tax 71 -7 20 38 0
Net Income 2,019 1,620 7 42 303
EPS 0.02 0.02 0.00 0.00 0.00
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
BALANCE SHEETS 2014 2015 2016 2017E 2018E
(in US$, 1000's) - YE Dec 31st 31-Dec 31-Dec 31-Dec 31-Dec 31-Dec
ASSETS
CURRENT
Cash 645 953 563 1,825 1,204
Restricted Cash 500 500 500
A/R 3,448 1,879 1,754 1,430 1,725
Prepaid expenses 256 270 286 236 284
Inventories 3,786 3,086 3,105 2,807 2,206
Other assets 119
Total Current Assets 8,254 6,188 6,208 6,798 5,919
Property and Equipment, Net 1,529 1,524 1,412 1,477 3,755
Total Assets 9,783 7,712 7,620 8,275 9,675
LIABILITIES
Current Liabilities
A/P 5,248 2,006 1,848 1,807 2,573
Deferred revenue 410 170 125 205 248
Bank borrowings
Note payable + Conv debenture + Others 2,926
Provision for income tax 71
Total Current Liabilities 8,655 2,176 1,973 2,012 2,821
Warrant liability
Total Liabilities 8,655 2,176 1,973 2,012 2,821
SHAREHOLDERS EQUITY
Common shares 25,824 28,317 28,317 28,839 28,839
Contributed surplus 3,384 3,679 3,783 3,835 4,123
Accumulated deficit (28,080) (26,460) (26,453) -26,411 -26,108
Total SE 1,128 5,536 5,647 6,263 6,854
Total Liabilities and SE 9,783 7,712 7,620 8,275 9,675
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
STATEMENTS OF CASH FLOWS 2014 2015 2016 2017E 2018E
(in US$, 1000's) - YE Dec 31st 31-Dec 31-Dec 31-Dec 31-Dec 31-Dec
OPERATING ACTIVITIES
Net income 2,019 1,620 7 42 303
Adjustments for non-cash items:
Depreciation and amortization 28 239 212 198 222
Gain on bargain purchase price (678)
Change in fair value of Legend shares 25 30
Foregin exchange (70) (50)
Forgiveness of Creditor Payables 57
Gain/loss on conversion of debt into equity 234 (1,335)
Share-based compensation 160 295 104 52 288
Share listing expense
Change in fair value of warrant liabilities
Amortization of warrants
Trademarks
Funds flow from operations 1,718 769 410 292 812
Changes in assets and liabilities:
A/R (1,501) 1,569 125 324 (295)
Inventories (615) 570 (38) 298 602
Deferred inventory costs (163) 130 19
Funds held on sale of Legend Oil and Gas shares 147
Prepaid expenses and other current assets 70 106 (46) 50 (49)
A/P (191) (1,269) (192) (41) 766
A/P to related parties (125)
Accrued liabilities 488 (1,021) (23)
Income taxes 71 (71)
Deferred revenue 343 (241) (45) 80 42
NET CASH USED IN OPERATING ACTIVITIES 242 542 210 1,003 1,879
Cash Flows from Investing Activities
Additions to property and equipment (52) (234) (100) (263) (2,500)
Proceeds from sale of Legend Oil and Gas shares 16
NET CASH USED IN INVESTING ACTIVITIES (36) (234) (100) (263) (2,500)
Cash Flows from Financing Activities
Proceeds from (repayment of) bank borrowins
Proceeds from (repayment of) bridge loans
Proceeds from note payable to ISE
Proceeds from note payable to related party (500)
Proceeds from note payable to Norton Rose
Proceeds from promissory notes 100
Repayment of promissory notes (150)
Collateral for Line of Credit (500)
Escrow receivable 500
Receipt of investor funds in advance of share issuance
Exercise of stock options
Issuance of common shares for cash 474 522
NET CASH FROM FINANCING ACTIVITIES 424 - (500) 522 -
Net Increase (Decrease) in Cash 630 308 (390) 1,262 (621)
Cash, beginning of period 15 645 953 563 1,825
Cash, at end of period 645 953 563 1,825 1,204
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2018 Fundamental Research Corp. “10+ Years of Bringing Undiscovered Investment Opportunities to the Forefront” www.researchfrc.com
PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT
Fundamental Research Corp. Equity Rating Scale:
Buy – Annual expected rate of return exceeds 12% or the expected return is commensurate with risk Hold – Annual expected rate of return is between 5% and 12% Sell – Annual expected rate of return is below 5% or the expected return is not commensurate with risk Suspended or Rating N/A— Coverage and ratings suspended until more information can be obtained from the company regarding recent events. Fundamental Research Corp. Risk Rating Scale:
1 (Low Risk) - The company operates in an industry where it has a strong position (for example a monopoly, high market share etc.) or operates in a regulated industry. The future outlook is stable or positive for the industry. The company generates positive free cash flow and has a history of profitability. The capital structure is conservative with little or no debt. 2 (Below Average Risk) - The company operates in an industry where the fundamentals and outlook are positive. The industry and company are relatively less sensitive to systematic risk than companies with a Risk Rating of 3. The company has a history of profitability and has demonstrated its ability to generate positive free cash flows (though current free cash flow may be negative due to capital investment). The company’s capital structure is conservative with little to modest use of debt. 3 (Average Risk) - The company operates in an industry that has average sensitivity to systematic risk. The industry may be cyclical. Profits and cash flow are sensitive to economic factors although the company has demonstrated its ability to generate positive earnings and cash flow. Debt use is in line with industry averages, and coverage ratios are sufficient. 4 (Speculative) - The company has little or no history of generating earnings or cash flow. Debt use is higher. These companies may be in start-up mode or in a turnaround situation. These companies should be considered speculative. 5 (Highly Speculative) - The company has no history of generating earnings or cash flow. They may operate in a new industry with new, and unproven products. Products may be at the development stage, testing, or seeking regulatory approval. These companies may run into liquidity issues, and may rely on external funding. These stocks are considered highly speculative.
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