This AIM share's no-frills culture is a winner

Results are impressive, and our companies analyst thinks this small-cap is a good long-term investment.

Assessing Quartix (LSE:QTX) performance in the year to December 2018 is tricky. The company implemented a new financial reporting standard, IFRS 15, that changed how it accounts for revenue and profit.

Warning: Confounding accounting ahead!

Quartix restated its results for 2017 using the new standard, so we can compare the two years on the same basis. It did well. Revenue was 5% higher in 2018 than the previous year and adjusted profit was 22% higher. Cash conversion, the amount of profit earned in cash, was 80%, lower than average, but still pretty healthy.

All of these figures have been affected by the new policy though, which has changed the way Quartix accounts for insurance contracts.

To step back a moment, Quartix supplies tracking devices installed in vans that report on their location, and how they are being driven. The devices enable fleet owners, typically small businesses like builders and electricians, to ensure their vans are driven more efficiently and more safely. They are a cheap, generic, useful piece of kit.

This business is sticky. Customers do not pay anything up-front and are only tied into the service for the first year, but the vast majority stay with Quartix for much longer. 

Quartix also supplies insurers. Insurance contracts tend to last just one year, typically the first year a young driver is insured, and they're not as lucrative because the market is very competitive. Unlike fleet customers, Insurers pay up front, and this is where the new accounting standard comes in.

Under IAS 18 (the previous standard) Quartix recognised some of the revenue when it installed the device, and the rest as it delivered the tracking service over the year. Under IFRS 15, it spreads all the revenue over the subsequent year, effectively paying more revenue and profit forwards.

Quartix is reducing its business with insurers, and the new accounting standard delays the impact of a sharp reduction in new installations. While Quartix’s fleet business (responsible for 79% of revenue) grew quite strongly in 2018, it installed 29% fewer devices for insurers. Revenue from insurers only fell 7% though, because Quartix's revenue and profit in 2018 were buoyed by contracts agreed in 2017. The fact that it has installed far fewer devices for insurers has provided an additional boost to profit, as the cost of new installations, which is booked immediately, has fallen.

This means we have not yet experienced the full impact of falling installations, and though the headline figures indicate Quartix is growing again after a flat 2017, most of the increase in profit, £1.2m Quartix says, would not have occurred but for the "pay it forward" effect. 

The new accounting rule is smoothing but prolonging the drag on revenue and profit as Quartix shrinks its insurance business, and I do not think this year's results necessarily herald a return to clear-cut growth.

Long-term, though, it should come, both in the UK, and in much less mature, but faster-growing markets abroad. The insurance business is already much smaller and it can only shrink to zero. The fleet business has great potential.

High-value ecosystem

It is dispiriting to dwell on complex accounting when keeping things simple is one of Quartix's virtues. In 2018 the company revamped the tracking software interface to enable localisation and to match the product to the branding of its websites, which I think are designed rather well. It introduced the user-install option in the US and Europe, which has grown to 20% of all installations and reduces the cost of the service.

After the year-end, Quartix hired two salespeople each for Spain and Poland and launched Spanish and Polish versions of its website.

I have just read an article about manufacturing in the USA. It says "the knock-on-benefits of manufacturing come from creating high-value ecosystems," enabling companies to nurture talent and create valuable services.

Quartix isn't a manufacturer, the device itself is fairly simple and assembled by a contractor. But I think Quartix is a high-value ecosystem, and that is largely down to the fact that it is still run by its founder and majority shareholder, who has instilled a particular ethos.

Quartix's high-minded principles are explained in more detail on p.22 of the annual report, but basically it wants to build meaningful relationships with customers, partners investors and employees; keep processes, communication, hardware and software simple; treat everybody equally; share knowledge; and "do the right thing".

Scoring Quartix

As usual, I have scored Quartix to determine whether it is profitable, adaptable, resilient, equitable, and cheap. Each criterion can achieve a maximum score of 2, and a minimum score of zero except the last one. The lowest score for companies trading at very high valuations is -2.

Profitable: Does it make good money?

Quartix has been very profitable since it floated in 2014. It does not charge fleet customers upfront or tie them into long contracts so it's very easy for them to choose Quartix, even when they are uncertain about business prospects. This has enabled the company to grow its installed base every year since it was founded in 2001.

Score: 2

Adaptable: How will it make more money?

Quartix's strategy is to focus on a generic set of features that appeal to most fleet owners, especially a large number of small business but potentially larger fleets too. It keeps the cost of marketing and fulfilment low through automation and is expanding abroad. It is still growing in the UK, it is growing faster and profitably in France, and still faster in the USA, although it has yet to make a profit there. It has just opened websites targeting Spain and Portugal.

Score: 2

Resilient: What could go wrong?

The hardware is not sophisticated but it is bundled with proprietary software, a low-cost direct sales model and low-cost installation, a business model that has been refined over many years. It is so highly optimised I doubt Quartix could be disrupted by a rival doing a similar thing better. I wonder, though if its great strength is also a weakness in the very long term. Quartix is a one product company and that product will probably only be required as long as drivers are. 

Although Quartix is scaling back its business with insurers to ensure it earns good returns, one customer, Wunelli, still accounts for 21% of revenue, which would hurt Quartix if it were to lose it in one go.

A hard Brexit could also throw a spanner in the works. Quartix's operations are centralised in Newtown in Wales, where it achieves economies of scale managing UK and foreign operations together. European offices would add cost and complexity.

Score: 1

Equitable: Will we all benefit?

The company is still run by its founder, Andy Walters, who championed the clockwork efficiency of the business from the beginning. I really like the company's corporate principles, designed to "keep customers happy, impressed and reassured". Customers benefit from an efficient no-frills service, executive pay is restrained, employees get free share options, and the company treats shareholders well, publishing its annual report and related presentations on the day of the preliminary results announcement.

Score: 2

Cheap: Is the firm's valuation modest?

The valuation is not immodest. The shares trade on an adjusted multiple of 17 times post-tax profit.

Score: 0.8

A total score of 7.8 means I think Quartix is a good long-term investment. A word of warning though, with insurance installations falling sharply and the potential for a hard Brexit, shareholders may be in for a choppy short-term. 

They also need to keep an eye on attrition rates. They have risen from 10% to 11.9%, partly because of higher attrition rates in the USA. Quartix still does better than its estimate of the industry average (14-15%), but the fact that Quartix typically retains 90% of customer's business every year even though they are not tied in is a powerful indication that it is indeed "doing the right thing".

Contact Richard Beddard by email: richard@beddard.net or on Twitter: @RichardBeddard.

Richard Beddard is a freelance contributor and not a direct employee of interactive investor.