## Saturday, April 28, 2007

### Jones Soda Co, Breaking Down the Growth

When I look at a stock I always look at the fully diluted market cap and the P/E first. As of March 6, 2007 Jones Soda, JSDA, gives 25,667,491 shares, Stock Option 1,424,025 (2006 annual report), for a total 27,091,516. Additionally, it appears they have another 1,930,975 options they can issue. Current price as of Apr 28, 2007 is \$23.02. That gives a fully diluted market cap of \$623.6 million and if you include the options that can be issued, you get \$628 million. I get two different P/E's, depending on which site I look at, 124 on Yahoo, and 99 on The Motley Fool Caps, neither of which looks good.

What do I calculate as a fully diluted P/E based on the 2006 income of \$4.574 million and the fully diluted market cap? \$623.6/\$4.574 = 136.

If I use the 19c eps with the \$23.02 price, I get a P/E of 121. If divide the 19c into the \$4.574 million of earnings I get 24 million shares, so clearly the P/E of 121 is a understatement. I get a P/E more than 12% greater.

It is absurd to truncate eps calculations when they are mere pennies as from 18c to 19c is 5.6% difference in earnings. At 5c to 6c, you get 20% difference in earning. They ought to have 3 significant figures.

There is no question there is an awesome growth story here in terms of the business, but at the same time, from December 2000 with a share price of 41c to \$23.02 today is 5,500% growth in share price, and because of increased shares, the growth in the market cap would be 7600%, yet revenue in 2000 was \$19 million and in 2006 it was \$39 million, only double.

What is striking about Jones Soda is that eps went from 6c/share to 19c/share, a stellar 217% improvement considering revenue only increased by 16.5%.

Where did the growth come from?

Breaking down Jones Soda's growth numbers show that actual sales revenue went up 16.5%, yet their cost of goods only went up 8.3%. This change enabled them to increase their gross margin by 30%, from \$12.3 million to \$16 million.

Thirty percent growth in gross margin is great, but, keep in mind that \$16 million is only 2.5% of the market cap. They still have to pay promotion, selling, general and administrative expenses from this.

The promotion and selling expenses increased by 10.6%, and as an expense that accounts for more than half the gross margin, keeping this expense down relative to the gross margin is very good. The one place where they did not do so well is the general and administrative expenses which increased by 42%. Combined these expenses actually went up 20%, which exceeds the increase in sales revenue, but, because the margin was up 30%, it further leverage earnings.

The licensing part of gross margin declined by 6%. Overall the licensing revenue accounted for 2.67c/share of the income.

Earning before interest and taxes increased by a whopping 111%. This kind of number sounds great, but it means that earnings increased from \$1.3 million to \$2.7 million, or from 2/10ths of one percent of the market cap to 4/10th of one percent of the market cap. This is so far behind the rate of inflation, it is effectively a negative earning rate. It makes up for about 11 of the 19c eps, or 60% of the eps, before taxes.

What made up the other 40% of the EPS?

Taking a closer look at the earning for the year you find that the revenue was way more consistent than the earnings:

 2006 Q1 Q2 Q3 Q4 TOTAL Revenue 8,760,380 10,025,978 10,200,843 10,047,925 39,035,125 Earnings 2,542 2,313,795 194,774 2,063,328 4,574,439 EPS \$0.00 \$0.10 \$0.01 \$0.08 \$0.19 Using 3 s.f. \$0.000123 \$0.0964 \$0.00741 \$0.0787 \$0.183 Interest 12,710 100,637 438,958 360,252 912,557

What has happened in Q2 is a deferred income tax credit of \$1,482,934, or \$0.0618 per share, fully 34% of the earnings. This had come from a new equity issue, which leads to another significant portion of the earnings, interest!

The company issued new equity, and much of that was invested and has given interest income. Fully, 20% of the earnings is from interest, or \$0.0371 per share.

Together the interest and the deferred taxes make up 52.4% of the earnings.

The are separate adjustment where taxes are paid and the deferred taxes are reduced, leaving \$1,144,491 still outstanding, or \$0.0465/share.

What would the growth look like without the equity offering?

Without the equity offering there would not be this enormous increase in interest. Based on Q1, there might have \$50k of interest income for the year. There would also not be the enormous deferred tax item, and the eps would be less than the 11c eps without taxes calculated above.

I have no idea what taxes would be without the interest income and and with the increased earnings. Taxes paid were \$50k in 2005. There is \$150k payable liability on the 2006 balance sheet. It would be fair to expect earning to be \$100k less due to taxes if the equity offering had not happened, or eps of about \$0.10, or a 69% increase, still stellar, but about 1/3rd of the 217% growth.

The earnings per share from actual operations is about 4/10ths of one percent of the market cap. They rest is from a tax thing that can not be repeated, and interest.

The interest component is especially interesting to think about. They have gotten \$28,113,000 from an equity offering which has enabled them to earn about \$900,000 in interest, or perhaps 5-6%. Investors in the stock then essentially buy these earnings in the form of at a P/E of 136, or 0.7% eps or they are paying a 1200% premium for these earnings.

I repeat, Jones Soda made about \$900k of interest, and investors have created \$900*136 = \$122 million of market cap for it!

Alternatively, say the allocation of market cap to the interest is at 6%, or \$15 million of market cap. The deferred tax thing is not worth any market cap, so that leaves about \$610 million of market cap for the \$2.6 million of business earnings. It gives a P/E of 235. They need to increase the real earnings of the business at least 10-fold to catch up with the market cap.

What is the company doing with all that equity?

It appears that they are preparing to expand directly into business rather than using their licensing option. There agreement with Target ended December 31, 2006, and with it goes some of that licensing revenue. They need to build replacement business for that revenue, and they have raised enough equity to expect to do that.

It took them about 6 years to double their revenue, excluding licensing. This stock is going to crash.

Attention getters for me:

As of December 31, 2006 we had 67 full-time employees.

Ok, so a lot of the business is through distribution, etc., but \$623 million of market cap for 67 employees? To me it simply points to the degree to which the business is over valued. That's about \$9 million of market cap per employee. It just gets my attention.

Net income for 2005 was \$1,285,000 compared to net income of #1,330,000 for 2004. The decrease ... was primarily due to an increase in income tax expense (tax espense increased by 37k) and a smaller contribution from other income (interest income declined by 25k).

These same items are going to murder earnings in the future and if you've understood this post, you'll understand why.

Deborah said...

I made a spreadsheet with some of their financial data going back to 1998.

IIO said...

I wish I had spent more time reading this post a couple days ago. Nice job.

Deborah said...

Thanks for dropping by. I took a peek at your blog and see that you share my sentiment that there is a lot of over priced stocks out there.

Chris Perruna said...

This is an excellent breakdown of JSDA!

Deborah said...

Thanks Chris.