Azure upgraded

With Azure (AZV) trading at $0.105 the company has certainly copped its punishment for the poor FY15 earnings result, and the lack of respect by senior management towards ASX listing requirements – specifically continuous disclosure requirements. 

Net profit came in at $1.082 million, vs the guidance range of $0.8m to $1m from June 26. But before giving credit for the slight profit beat, it needs to be considered that the tax gain (partly R D) contributed to the group's profit and was well ahead of expectations at $0.96m vs $0.54m last year. EBIT of $0.2m is a very weak result in comparison to the $3.41m last year. But there was also $0.99m of “one-off” impairment write-downs and warranty expenses.

On the positive side, operating cashflow was strong at $1.5m vs $0.577m last year. As previously mentioned the company expenses all R D costs, and this year those costs increased from $2.6m to $5.1m.

The final cash balance of $3.16m is a good result. The company has forecast a similar level of R D for FY16, and no decline in the working capital position. What this means is that there will be no funding issues, which is the only real risk of further share price declines from the current depressed levels. The net tangible asset position has increased to 6.5 cents, which should also provide support – especially considering all R D costs are expensed.

Of the R D costs, $2.9m was incurred in Melbourne to develop the existing product. The $2.2m that was expensed in the US was towards new software related products which will expand the company's healthcare and clinical workflow solutions.

Restructuring the management/board

After recent events, usually senior management would have been shown the exit. CEO Robert Grey has lost his managing director position but remains on the board as an executive director. His 20 per cent shareholder position and strong industry knowledge have probably prevented more severe action. Jason Darcy the CFO is at this stage a lucky survivor of the debacle that was FY15.

Greg Lewis has been appointed as independent non-executive chairman, replacing Robert Grey. This would appear on the surface as a positive move, but the fact that Lewis is a neighbour of Grey's obviously raises concerns as to his level of independence.

Clayton Astles has been appointed as director and CEO. Astles has been leading the US business in recent times and with the transition towards the US this appears to be an appropriate appointment. What is not appropriate is the overly generous performance options that have been granted. The requirement of a 50 per cent increase in profit is normally a fair benchmark, but not when coming in after a depressed year that included significant R D costs that can be removed down the track.

Where to from here?

If we assume no cashflow issues, the main risk from here is that the new chairman Greg Lewis is just a puppet for Robert Grey and he will continue on with the ridiculous behaviour displayed over the past 12 months. To be more specific, Grey happily talked up the company's prospects of significant earnings growth with a share price around 40 cents. Although he mentioned expansion costs would be worn for the transition to the US, it was certainly not disclosed that profit would drop from $3.8m to $1m. Not long after providing the market with this guidance of strong earnings growth, Grey happily sold about one-third of his at the time 30 per cent stake in the company.

Grey's sale netted him approximately $9m. With the share price down approximately 75 per cent since this sale the market is most likely wondering why there haven't been any director purchases in recent times.

Maybe the new chairman Greg Lewis has closed the trading window for directors until the AGM? If this is the case it would be a small improvement on the company's terrible track record of corporate governance.

However, we don't expect any rapid improvement in FY16 due to the continued high R D costs. The fact is the company is towards the end of a significant transition to become a US business with a new improved range of healthcare software products. As such, if this opportunity is appropriately explained at the AGM along with the restructure of management and board, then it would suggest the chances of an initial share price recovery.

A further question for the AGM is how the company is handling the significant conflict of interests arising from Robert Grey's various related party ownerships – for example, he currently owns the Perth manufacturing facility that some would argue should be shut down given the transition to the states.

Why transition to the US?

The reason the second R D facility was opened in the US was because technology trends tend to originate in the US and are gradually adopted internationally. It enables access to a larger pool of talented software engineers that improve innovation and reduce time to market. There is a broader range of clinical, facility management and wireless telephony suppliers based in the US.

With this in mind the strategic decision has been made that the US presents the company with the greatest opportunity to develop and market its fourth generation Tacera platform. We will be looking towards the AGM for further guidance around the timelines for new product releases and the benefit for the company.

Valuation

At 10.5 cents the $20m market cap is pricing in very little chance of an earnings recovery. That will provide no comfort for those investors that bought at significantly higher prices last year. But as discussed the AGM will provide the company and new management/board an opportunity to present to the market a more realistic roadmap for the next three years. Our expectations are that FY16 will be flat and then FY17/FY18 will achieve strong earnings and share price recovery.

We upgrade our sell recommendation to a hold with an 18 cent valuation.