Tuesday, June 06, 2006

Turbochef Technologies- What's Cooking?

Turbochef Technologies (OVEN) seems to be the king of high speed-cooking. The company's ovens significantly reduce cooking times by combining microwave, convection, and air impingement technologies at the food preparation process but, unlike pure microwave, maintain the product quality. The company has focused primarily on the commercial customer but has just introduced its first residential oven.

Tasting "experts" who have extensive restaurant experience tell me the results are terrific. Wall Street analysts, and there appear to be 8 of them following this $300 million company, tell me that the company is being tested by more restaurant chains (at least 30 of them) than ever in its history. But I'd sure like to see evidence of this in the numbers.

This company was valued at $16 million back in 2001 with much of its revolutionary technology. There was a small acquisition of Enersyst in 2004 for $13.6 million in an equity
swap plus assumption of debt that provided brought in some additional innovation in food service in its 150 patents.The company does have a portfolio of over 200 patents.

Back in 2001, the company was held back by poor access to funding, and what seemed to be mediocre management at that time. A one for three reverse stock split was implemented in December of 2004.

In February of 2005, the company completed a 5 million share offering (including 2,075,000 shares sold by selling shareholders) raising about $56 million for the company and about $40 million for themselves. The deal was done at $20.50 per share.

The company does have a strong relationship with Subway and is the exclusive supplier of speed cook ovens to all Subway franchise restaurants, a majority of which, as of last year's prospectus, had already purchased the oven.In the first quarter of 2006, Subway ordered an additional 2,000 ovens in addition to an original 3,000 to place into Subway's expansion into Wal-Mart stores. Other orders have come from small chains in Brazil and an 800 store chain in Spain. Starbucks and Dunkin Donuts are testing the ovens as well with trials for Starbucks in locations in Washington, Portland, Chicago, and San Francisco.Dunkin Donuts trial is much smaller by comparison consisting of only two stores.

Despite an initial cost that is about three times that of a conventional oven, lower operating costs and lower installation costs (no vent is required) make the economics of this oven very attractive to the restaurant owner.

Now to the stock owner! In the last 8 years, the company has lost money on the operating line in 7 of them. The year 2005 demonstrated sales of $50 million plus another $2 million in licensing revenue for total revenues of $52 million. But the operating loss was also significant at $29.4 million. Cash flow from operations for the year was also negative at $20 million. The first quarter of 2006 also showed a loss on CFFO of about $6 million, compared to the comparable quarter in 2005 of a loss of $1.5 million.

At the end of the first quarter, the retained earnings, well err..., the accumulated deficit was $85 million. So much for all of the "success" in penetrating these various chains. As the prospectus points out:

" The market for our commercial ovens is a nascent sector of the commercial cooking equipment market. As is typical with new products based on innovative technologies, demand for and market acceptance of our commercial ovens are subject to a high level of uncertainty. Achieving market acceptance for our commercial ovens will require substantial marketing efforts and the expenditure of significant funds to increase public awareness of our brand and our products, and to educate potential customers as to the distinctive characteristics and benefits of our products and our technologies. There can be no assurance that our marketing efforts will result in significant market acceptance of our commercial ovens."

The prospectus also addresses the company's potential entry into the residential consumer market.

" An important part of our growth strategy includes the research, development and introduction of residential speed cook ovens. Historically, our expertise has been in the speed cook sector of the commercial cooking equipment market, and although we have developed technologies that currently are being licensed for use in certain existing residential ovens, we have no prior experience in the production, marketing and sale of products in the residential oven market."

I certainly agree that the company has very unique technology and has made significant inroads into commercial ovens. The cost savings afforded its customers provides a reasonable basis for success. In other words, not a half-baked idea ( I couldn't resist.) The selling cycle for commercial ovens is a long one requiring extensive testing in beta sites. Decisions by customers seemingly take at least two years.

But it comes down to finances. Commercial acceptance has not translated into financial success. The valuation on an EV/EBIT basis is negative 8.5 times. Profitability is non-existent, free cash flow is negative. Cash which post offering was at $65 million a year ago is now $33 million. Gross margins declined in the first quarter to 30.4% versus the comparable quarter's 38.8%.

This is an early stage company that should carry venture capital kinds of risks and rewards. Management continues to hold a significant amount of stock at about 40% and close to 45% with executive stock options considered. After the offering last year, very little follow-up selling has occured, only 29,000 shares sold by the chief operating officer.

Bottom line, too much risk for my blood. Fundamentals have yet to catch up with the valuation.

Disclaimer: Neither I, my family, nor clients have a current position in OVEN.


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