2023 07 28 - Response to June 26 Press Release [PDF]

Zitiervorschau

GOTHAM CITY RESEARCH LLC

Response to the SES Imagotag June 26 Press Release

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Response to the SES-Imagotag June 26, 2023 Press Release On June 22, we published Part I of our report, and the Company provided their detailed response to Part I on June 26. We would like to share a few important observations regarding their response: 

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Since the publication of our first report, SES-imagotag has issued several press releases that initially appear to strongly deny our assertions. For example, the company “refutes in the strongest possible terms each of the allegations made against it in the report produced by Gotham City Research on Thursday, June 22, 2023”. However, the actual details in the press release contradict this strongly worded denial, as we discuss in this report. SES Imagotag defends against allegations we never made and attempts to discredit us on that basis. For example, we see this in the revenue reconciliation and double-counting points below. The company effectively acknowledges most of our core points or does not deny them.

Gotham City Research presents the following clarifications and responses set out in this document which address in detail the topics listed below: 1. SESL claims that their consolidated revenue does reconcile. However, they do not provide the information to reconcile the revenues, as we explained in our report, nor does their response provide the required information. The core question remains unanswered. 2. BOE is a related party, NOT a subsidiary of SESL, therefore SESL’s explanations regarding its round-trip transactions with BOE – “neutralized in consolidation” & “no round-trip doublecounting” – make no sense. These are irrelevant between a company and related parties. 3. The company’s response validates our concern that JV’s revenues are suspect. Rather than disclosing the breakdown of ESL vs digital signage sales, SESL provides a lengthy non-answer. 4. It is impressive that SES’s cash flows deteriorate while revenue and EBITDA expand. SES Imagotag does not deny that it capitalizes expenses excessively relative to its peers. 5. We believe the company has admitted in their response to our Part II report that their financial statements contain accounting irregularities, which contradicts their claim that “financial statements are not misstated.” 6. Every company we know with a related-party problem has stated that their related party relationships are subject to rules. Nothing has been refuted. 7. Every company we know with a related party problem has said they follow strict policies. We doubt that BOE is the best EMS provider for 70% of all tenders under fair competition. Regarding COGS per unit calculations, while SES states we are wrong they notably do not provide alternative metrics, and as such nothing has been refuted. 8. SES has presented itself as a SaaS company and was in the process of changing its name to Vusion – its SaaS platform. SES confesses that SaaS revenues are a “minor fraction” of revenue. 9. Regarding the Walmart contract’s profitability, we note again SES says we are wrong without providing any data to refute our calculations. They state that the Walmart contract is in line with the Vusion ’27 plan. The problem is that SES failed miserably to meet its Vusion ’22 targets. 10. SESL is required to disclose related party payables and receivables balances – disclosures currently absent in its historical financial reports – based on our review of IAS 24. Page 3 of 12

1. We note SESL’s claim that their consolidated revenue does reconcile. However, they do not provide the information to reconcile the revenues, as we explained in our report, nor does their response provide the required information. The core question remains unanswered. SESL claims the following (p. 2): “When the revenue from SES-imagotag as an operating company and the revenue for the first nine months of 2022 from the Chinese JV are taken into account, and after elimination of inter-company accounts, the Group’s consolidated net revenue totals €620.9m for FY 2022, as reported.”

The company’s response regarding the Consolidation of the revenues is misleading. Firstly, in its press release dated June 26, 2023, SES Imagotag mischaracterizes one of our statements of fact as an allegation:

The above is a statement of fact, not a “claim”. Worse, they twist the original intent of our sentence, by removing the accompanying question that was originally included in our report: “why?”

The company also fails to mention the critical context we provide in our report, which made abundantly clear the methodologies we used and why:  

We have successfully detected material fraud in past cases, Quindell plc and Aurelius AG, by comparing consolidated financial results with the sum of their subsidiaries’ results. We made no allegations, instead we clearly raised two possible explanations.

Thus, we believe this section, as originally presented, was both accurate and not misleading. Page 4 of 12

What’s even more revealing here is, SES Imagotag refuses to disclose the intercompany eliminations necessary to reconcile these figures. The company falsely implies that had we only accounted for the parent company’s revenue, the numbers would reconcile. In its press release dated June 26, 2023, SES Imagotag writes: “However, this amount does not constitute SES-imagotag’s consolidated revenue because it does not include the revenue generated by SES-imagotag as an operating company, a crucial fact that Gotham City omitted to take into account in its assumptions.”

This claim is false. If you add the subsidiaries’ EUR 501 million revenue to the parents’ 2022 EUR 596 million revenue (both from the 2022 Annual Report), the resulting figure makes no sense without mentioning the amount of intercompany transactions. The fact remains that, despite SES-Imagotag’s vigorous explanation, it is still not possible to reconcile the consolidated financial results with the sum of their subsidiaries’ results, because the company refuses to disclose these intercompany transactions. 2. BOE is a related party, NOT subsidiary of SESL, therefore SESL’s explanations regarding its roundtrip transactions with BOE – “neutralized in consolidation” & “no round-trip double-counting” – make no sense. These concepts are irrelevant between a company and its related parties. SESL claims the following (p. 2): “Sales of components to BOE are neutralized in consolidation and do not enter into the revenues of the Group. Therefore, there is no round-trip double-counting between SES-imagotag and BOE.”

BOE is a related party, not subsidiary, of SESL, thus “consolidation” and “double-counting” are irrelevant SESL’s explanation regarding its related party sales to BOE makes no sense to us: BOE is a related party, not subsidiary of SESL, yet SESL uses words such as “consolidation” and “double-counting” in their explanation to describe the related party transactions between SESL and BOE. These words “consolidation” and “double-counting” are relevant for transactions between subsidiaries, but they are irrelevant for related party transactions. This raises the question: why is SESL using these words that are irrelevant for related party transactions, in their explanation? The company also defends against a claim we never made: "there is no round-trip double-counting between SES-imagotag and BOE”. We never discussed nor alleged “double counting” related to round trip revenues in Part I of our report. Our focus was regarding related party revenues between SESL and BOE. Again, since BOE is a related party, not a subsidiary, their denial makes no sense.

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SESL should NOT eliminate sales derived from a related party, per IAS 24 According to IFRS, IAS 24 is the standard relevant to related party disclosures. SES Imagotag follows IFRS, according to its 2022 Annual Report. The title of IAS 24 is "Related party disclosures" and not "Related party accounting" or "elimination". The text to the standard is interesting because it defines the concept of related party. The standard requires disclosures, not "recording" and/or "eliminating" of related party transactions. Therefore, SESL should NOT eliminate sales derived from a related party, in this case, from BOE. See here for IAS 24: https://www.iasplus.com/en/standards/ias/ias24 SESL uses the word “neutralize”, not “eliminate” to describe these related party transactions The company states “sales of components to BOE are neutralized in consolidation”. However, we find the use of the word “neutralized” unusual and notable for a few different reasons:   

SESL uses the word ‘neutralized’, instead of ‘eliminated’ in their explanation regarding related party transactions between SESL and BOE. SESL used the word ‘eliminated’ elsewhere within the same press release, which we see as evidence that the company is not using these two words interchangeably. Among the 40 constituents of the CAC 40, we found ZERO instances whereby “neutralize” was used in a similar context.

In our experience analyzing publicly traded companies, we’ve never seen any company use the word “neutralized” in the context of consolidation. We have, however, seen the word “eliminated” used. Perhaps there is a linguistic issue here, and SES Imagotag meant to use “neutralized” and “eliminated” interchangeably. The problem we see with this explanation is that SESL actually does use the word “eliminated” within the same press release dated June 26 2023 (pg 2), suggesting that neutralize differs from eliminate: “When the revenue from SES-imagotag as an operating company and the revenue for the first nine months of 2022 from the Chinese JV are taken into account, and after elimination of intercompany accounts, the Group’s consolidated net revenue totals €620.9m for FY 2022, as reported. This revenue is generated in its entirety by sales to external clients.” Finally, given that we have never seen the term “neutralize” in the context SESL uses it, we examined if there were any similar instances contained within the financial reports of the CAC-40 constituent companies. We found that “Neutralize” and its variations do not appear in any of the CAC 40 company’s annual reports that we all reviewed, used within similar contexts.

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SESL’s related party 2021 and 2022 disclosures are incorrect or management’s explanation is incorrect SES Imagotag provides related party disclosures in Note 29 to their consolidated financial statements. As these disclosures are post-consolidation, and as there is no explanation regarding netting of these transactions, it is correct to interpret these transactions with BOE as part of SESL’s consolidated figures:

Very simply put, either the related party disclosure in the 2021 and 2022 annual reports (the 2022 Note 29 is shown above) are incorrect, or management’s explanation in their June 29 press release is incorrect – both cannot be true at the same time. 3. The company’s response validates our concern that JV’s revenues are suspect. Rather than disclosing the breakdown of ESL vs digital signage sales, SESL provides a lengthy non-answer. SESL claims the following (p. 4): “As in all other countries where the Group is active, the range of products includes Electronic Shelf Labels as well as other products and services including digital signage solutions. This last is a specialty of BOE and constitutes one of the synergies between the two groups. Low ESL market prices and margins in China led the company to slow down efforts on ESL, and to focus more on digital signage.

In Part I of our report, we explained why we believed that the China JV’s revenue may consist of de minimis ESL sales (see Part I report), thus raising the question: what does the China JV’s revenue consist of? The issue is the company does not say. SESL acknowledges that we were correct: that the digital signage explains a portion of the JV’s revenues. How much? The company doesn’t disclose, even after our report. In fact, the company does not even explicitly deny that portions of the JV’s revenues come from unexplained, possibly suspect sources, akin to roundtrip revenue between it and BOE. As discussed in Part I and Part II, we believe these transactions are highly suspect and await clarification. Nothing has been refuted, Instead, SESL focuses on a non-issue: SESL claims the following (p. 3): “The consolidation of the subsidiary in China (the “JV”), which was majority-owned and controlled by the Group until September 2022, is compliant with IFRS accounting standards”

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We did not opine on whether the consolidation was proper or not according to IFRS. In fact, we raised the possibility that it may or may not. We merely pointed out that its importance to SESL’s overall results was non-obvious and could easily be misunderstood by investors, whether intended to or not by the company. With that said, the JV’s governance was clearly designed with deliberation by BOE and SES, and the full consolidation of the JV’s revenues, did flatter SES’s reported revenue. 4. It is impressive that SES’s cash flows deteriorate while revenue and EBITDA expand. We believe that the company has been capitalizing expenses excessively relative to peers, and SES Imagotag does not deny this, completely ignoring our analysis from Part I. SESL claims the following (p. 5): “Capitalized expenses are consistent with R&D and IP investments and compliant with IFRS accounting standards”

SESL does not address our core focus in Part I: SESL capitalizes expenses far more aggressively relative to its peers. Their approach may or may not be compliant with IFRS accounting standards. But the company’s refusal to address our analysis directly appears to be a tacit admission we are correct. And this would not be the first time, as we have successfully detected aggressive expense capitalization before (i.e., previous Gotham City Research reports on other issuers correctly identified aggressive and/or improper expense capitalization issues). 5. We believe the company has admitted in their response to our Part II report that their financial statements contain accounting irregularities. SESL claims the following (p. 6): “Financial statements are not misstated. Revenue and EBITDA are not overstated.”

We believe the company foolishly made a broad sweeping statement such as shown above. Based on our review of the company’s response to our Part II report, as we discuss further in our response to the Company’s press release addressing the report Part II, this claim is demonstrably false. 6. Every company we know with a related-party problem has stated that their relationship with related parties are subject to rules. Nothing has been refuted. SESL claims the following (p. 6): “The relationship with BOE is subject to strict governance and supervision rules”

SESL and BOE can be subject to strict governance and supervision rules, yet still succumb to impropriety. The mere presence of rules does not prevent malfeasance. Thus, this is a non-statement. 7. Every company we know with a related party problem has said they follow strict policies. We doubt that BOE is the best EMS provider for 70% of all tenders under fair competition. Page 8 of 12

Regarding COGS per unit calculations, while SES states we are wrong they notably do not provide alternative metrics, and as such nothing has been refuted. SESL claims the following (p. 7): “SES-imagotag follows a strict multi-sourcing policy. Purchase prices from BOE have not evolved differently than from other EMS. The conclusions of the report on COGS are therefore totally wrong.”

SESL finds our COGs per unit analysis faulty yet fails to identify any specific calculation errors. Nor does SESL provide additional metrics necessary to analyze the COGs per unit in a more detailed manner. 8. SES has presented itself as a SaaS company and was in the process of changing its name to Vusion – its SaaS platform. SES confesses that SaaS revenues are a “minor fraction” of revenue. SESL claims the following (p. 7): “SES-imagotag does never present itself as « SaaS company » but as the leading Retail IoT platform, with a large majority (85%) of its revenues coming from ESL hardware, and 15% of our revenues come from “Software, services and non-ESL solutions (VAS)”

The company’s response does not actually dispute our specific observations. As shown in our Part I report, the company presents itself as a SaaS concern (please refer back to our Part I report and see for yourself). Even worse, the company confesses (for the first time, anywhere) that SaaS revenue is: “SAAS revenues are still a minor fraction of the total VAS revenue” – that is exactly what we estimate in our Part I report! Yet even then, the company refuses to provide exact figures! We apologize for getting the spelling of the website incorrect – that was a typo, and we thank the company for the opportunity to provide clarification. That said, our analysis used the correct domain, thus the analysis remains correct. The correct domain that our analysis was based on: https://cloud.vusion.io/ Thus the company is incorrect in asserting that the statistics were based on vusion.cloud.io. False. They were based on the URL http://cloud.vusion.io

Regarding employees, our underlying assertion stands: We find no mention of software engineers/developers/programmers, neither in the examples we cited in our report Part I, nor in page 119 as the company pointed out. Yes, there are “200+ Engineers” according to page 119, but the company conflates its disclosure of “engineers” with our more nuanced and specific point: an engineer is not necessarily a software engineer/developer/programmer. The latter is more specifically necessary for SaaS and other software needs. For example, a civil engineer is not the same as a software engineer/developer/programmer. In fact, the company’s own risk factor disclosure appears to support our specific point, as page 57 of the 2022 Annual Report specifically identifies software engineering, not engineering in general:

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“Regarding the presentation of our business to the investors, SES-imagotag has never mentioned or presented the VAS as an operating segment” We agree with management (in fact, that is exactly what we assert in our Part I report): VAS is not an operating segment. Instead, it is a management construct to make the business appear more attractive than it actually is. We wholeheartedly agree with SES’s response: their response is a confirmation, not refutation, of our assertion. 9. Regarding the Walmart contract’s profitability, we note again SES says we are wrong without providing any data to refute our calculations. They state that the Walmart contract is in line with the Vusion ’27 plan. The problem is that SES failed miserably to meet its Vusion ’22 targets. SESL claims the following (p. 10): “Walmart contract is profitable and consistent with the Vusion’27 plan.”

Reality can diverge from plan. For example, SESL revealed its Vusion 2022 Strategic Plan on 23 May 2018:

Yet actual 2022 results fell well short of the 2022 plan:   

ESL installed (actual 350 million vs original target estimate of 500 million) Sales (actual €620.9mln vs original target of €800mln) EBITDA margin (actual 9.4% vs original target estimate 20%)

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SESL claims the following (p. 10): In addition to the errors on COGS pointed out in section 7, the allegations made by the Gotham City Research are wrong and rely on easily debunked shallow analysis work.”

The Company says we are either making errors or gross misrepresenting, but the Company does not reveal specific information that is necessary for us or other public investors to come to the correct conclusion. We acknowledge that Walmart is not the customer representing 34% of 2022 revenue and thank the company for the enhanced disclosure. We note that a business with a customer accounting for 34% of revenue leads risk of significant volatility of results. As such, our overall observation remains relevant: because their business is project-oriented, and not necessarily recurring, future Walmart revenues growth must be sufficiently large simply to maintain current revenue levels. We would also note we never claimed the 2023 contract had anything to do with sales to Walmart before 2023, though Walmart sales did occur – for clarification.

Appendix: 

The limited royalties earned from IP agreement imply de minimis ESL revenue from China JV

SESL claims the following (p. 12): “it was decided to not charge the first two years, and then to charge gradually over time an incremental fee (starting at 1%) to move up to the standard Group fee (3%) the following years”

The divergence between the JV’s revenue growth and the above claims, give us more conviction that JV revenues consisted of de minimis revenue originating from ESL sales. Which increases our belief the JV revenues are suspect.

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

SESL is required to disclose related party payables and receivables, based on our review of IAS 24:

SESL claims the following (p. 12): “This information is not required. The information required in the annual report is related to the purchases and the sales made with related parties.”

However, management held a conference call the same day. In it, management claims they have disclosed related party “receivables on a regular basis”: “Well, actually we disclosed that, but not on ½ year basis. So and not they are comparing. The figure was disclosed by BOE at the end of September, with the figures that will close at the end of June. So no surprise, they are not totally matching and we report some information on the receivables on a regular basis, but only on a semester basis. There is nothing to hide.” Management’s written response, and conference call conference, do not seem quite consistent. A quick examination of IAS 24, the IFRS standard regarding related party transactions, reveals that SESL should disclosure the amount of outstanding related party transaction balances, and their terms/conditions:

Concluding remarks:  

We encourage investors to do their own homework. As part of that process, investors should read our reports, the company’s financial reports, and responses to our reports, line by line. Consider that the company uses some clever methods in their responses, that may muddy the picture, including but not limited to:  Reframe our questions, selectively cite our words but without the appropriate context.  Defend against allegations we never make.  State that we are wrong about something, but fail to provide necessary information to corroborate their claims. In essence, “trust us” at our word, is their position.

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