KeyStone s Small-Cap Stock Report

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1 Industry: Technology - Semiconductor Tech Recommended: December 2014 Recommendation Price: $0.46 Current Price: $1.47 Market Cap: $145,982,367 Shares Outstanding: 105,023,286 Fully Diluted: 113,263,292 Focus BUY Portfolio EVENT On March 31, 2017, Photon Control both announced the resignation of 2 directors and the CEO and subsequently reported the appointments of a new CEO and Director, COO, and two other Directors. IMPACT Positive DISCUSSION The release of the director and CEO resignations, subsequent stock halt and release of the news regarding the new board and management appointments was a bit clunky. However, the resulting team will likely serve shareholder interests well. In the early morning, Photon Control announced certain changes to its Board of Directors and management team. Robert B. Breault and Joseph Litner each resigned from the Board of Photon Control, effective March 30, Mr. Michael W. Goldstein resigned from the Board of Photon Control and as acting CEO, effective as of April 1, Ronan McGrath, Neil McDonnell and Michael Torok remain directors of the Board of Photon Control and Mr. McDonnell remains Chair of the Board. The stock was then halted, given the near-term uncertainty, and quickly unhalted following the appointments of Chuck Cargile, Director, Scott Edmonds, President and CEO, and Director, Paul Hellebrekers, Chief Operating Officer, and Yuri Sikorski, VP Solutions Engineering to its Board of Directors and management team. The new team grows in depth and has good experience in the semiconductor space. Perhaps most importantly, the team will look to finalize a settlement in regard to Photon Control s litigation with Photon Control R&D and integrate their staff into its operations over the next few weeks. This type of agreement will likely provide certainty in terms IP ownership, lower royalty rates and a better working environment 1 Copyright 2017 KeyStone Financial Publishing Corp.

2 to grow moving forward. In fact, we got an overview of what the settlement to resolve all legal actions would look from a recent release that was likely put together by the Chairman who was negotiating the deal. The company recently released the following news which the previous board did not approve, but the new board will likely stand beside. On March 20th, Photon announced that it has signed a Letter of Intent which lays out the terms of a proposed settlement to resolve all legal actions commenced by the company against Photon Control R&D Ltd. and certain others, as well as the counter-claims filed by R&D against the company. The litigation primarily involved the question of ownership of certain intellectual property, the rates and terms of certain royalty agreements, control of Photon Control s research and development and other matters involving a historical relationship between the company and R&D. The settlement will enable Photon Control to focus its resources on serving the needs of its customers and it avoids an expensive and time consuming trial currently scheduled to be held in Most importantly, it provides stability for the company s customers and it adds a cohort of deeply talented industry experts to the company s research and development team. All legal actions currently underway between the Photon Control and R&D will be suspended pending preparation and execution of binding agreements which is targeted for the end of March with closing to occur by mid April. The binding agreements remain subject to approval by the board of directors of the Photon Control and the principals of R&D. Principal terms of the Settlement are as follows: Photon Control will acquire full ownership of all Intellectual Property, products, trademarks and other assets previously under dispute. R&D employees will be transferred to and hired by Photon Control. The company will pay a percentage of sales revenue to the current owners of R&D commencing January 1, 2017, for a period of 5 years, equal to 4.25% of revenues from sales of products currently under license from R&D pursuant to existing agreements and such additional products created by the company based on designs in development by R&D up to December 31, This reduces the royalty rate in the existing, disputed agreements by more than 50% (currently a sliding scale of 25% to 10%) and decreases the term of the disputed agreements by 5 years. The company will pay R&D in cash for all past due royalty amounts to December 2 Copyright 2017 KeyStone Financial Publishing Corp.

3 5. 31, 2016, and outstanding payables, the entire quantum of which has been fully accrued by the company in its accounts. R&D has agreed to non-competition arrangements with the company. CONCLUSION From a purely IP perspective it would be great to see Photon Control assert its right to its IP and pay zero royalty to Photon R&D given the nature of how the R&D business was spun out of Photon Control and the manner in which the subsequent amendments to the deal were made. However, we are pragmatists. In business, it is sometimes best not to litigate the proverbial hell out of a situation, paying millions of dollars in the processes and taking management s focus on the important task of growing a good business. Photon Control has been a good business and a great investment to date for KeyStone. In this case, we see a resolution of the litigation, the removal of any uncertainty regarding Photon Control s IP and a focus on growing the existing business with an experienced team as the best scenario. It certainly makes the company more attractive for any potential suitors. The outgoing management team, primarily the CEO, was light years ahead of the previous CEO in terms of market communication and we thank him for that. But the new CEO certainty has market experience and the team has strengthened broadly speaking. Most importantly, the business remains strong. Photon Control is a solid success story that has largely flown under the radar in Canada. The company has grown revenues from just over $1 million in 2004 to $21 million in 2014 and $27.6 million with excellent profitability in The company will once again post record revenues in Perhaps most importantly, we know Photon Control is entering 2017 with another record backlog. Due to its high exposure to the semiconductor industry, business has historically been cyclical and while we expect this to smooth out as the base of OEMs grows and via product diversification, there will likely be another downturn at some stage. The positive near term is that we expect an uptick in semiconductor sales in 2017 and that the company has experienced higher highs and lower lows in terms of sales and profitability overtime as it gains more customers. We expect the later to continue. Photon s trailing PE is in the range of 16 which remains below the market average multiple. The company boasts a very strong balance sheet with zero debt and a cash balance of $32.5 million, or $0.31 per share. If we strip this out of the company its price-to-earnings based on the core business is around 13 which remains a rea- 3 Copyright 2017 KeyStone Financial Publishing Corp.

4 sonable multiple. Given the current backlog, the near-term outlook is once again strong. The proposed settlement would remove significant uncertainty and distraction for Photon Control and its customers. Photon Control would acquire undisputed ownership of intellectual property and internalize R&D activities. The settlement would more than halve existing royalty rates and term of the disputed agreements. These are all positives. With the company s shares jumping over 200% since our original recommendation and over 75% since December, the stock is closer to fair value near term. We maintain our Near-Term rating at HOLD. Given the company s its strong backlog, balance sheet, history of profitability and relatively reasonable valuations, investors with a long-term outlook (2-5 years) should be rewarded over this time frame. As such we maintain our Long-Term ratings at BUY. OPERATIONAL SUMMARY Headquartered in an ISO 9001:2008 manufacturing facility in Burnaby, British Columbia, Photon Control Inc. designs, manufactures and distributes a wide range of optical sensors and instruments to measure temperature, pressure, position, and flow. Optical sensors are immune to electro-magnetic interference and operate robustly in harsh environments. These products are used by original equipment manufacturers (OEM) as well as end-users in the Semiconductor (90% of current business), Oil and Gas, Power, Life Science, and Manufacturing industries. Photon Control s products provide high accuracy and reliability in extreme conditions and are supported by a team of experts that offer onsite installation, training, and support. Photon Control also provides engineering services for customized optical measurement systems. From Smart homes to Smart phones, Photon products play a behind the scenes role in the everyday experience of technology consumers. The company s end market customers are semiconductor manufacturing companies and through them the company is part of the evolution of the smart world. Photon s customers end-users products fabricate ships that power computers, smart phones, wearable technology and even automotive sensors. 4 Copyright 2017 KeyStone Financial Publishing Corp.

5 Ratios and Ratings BV (BV/Share): Book value (book value per share) Book value per common share calculated as total shareholder s equity less preferred equity, and divided by the number of common shares outstanding. Should the company decide to dissolve, the book value per common share indicates the dollar value remaining for common shareholders after all assets are liquidated and all creditors are paid. D/E: Debt-to-equity ratio A measure of a company s financial leverage calculated by dividing long term debt by shareholders equity. It indicates what proportion of equity and debt the company is using to finance its assets. Current ratio One of many ratios designed to evaluate short-term liquidity of a company. Calculated as current assets divided by current liabilities, this ratio gauges the level of cash resources relative to current liabilities as a measure of cash obligations. EBITDA Earnings before interest, taxes, depreciation, and amortization. EBITDA is calculated as revenue minus expenses (excluding tax, interest, depreciation, and amortization). EPS: Earnings per share A company s earnings available to common shareholders, also known as net income or net profit, divided by the number of shares outstanding. EV: Enterprise value Enterprise value is calculated as market capitalization less cash and equivalents, plus debt. Evaluation of EV relative to the company s trailing EBITDA is used in identifying potential takeover targets. FCF: Free cash flow Capital expenditures are subtracted from cash flow from operating activities to arrive at free cash flow, which intends to measure the cash available to a company after making all cash outlays necessary to maintain existing productive capacity (as measured by capital expenditures on a company s cash flow statement). Net working capital A measure of the company s ability to carry on its normal business comfortably and without financial stringency, to expand its operations without the need of new financing, and to meet emergencies and losses. Calculated by deducting current liabilities from the current assets. P/B: Price-to-book ratio Calculated as a stock s market value (current closing price) divided by its latest quarter s book value. While a lower P/B ratio could mean that the stock is undervalued, it could also serve as a sign of weak fundamentals, and as with most ratios, this varies a fair amount by industry. PEG ratio The price/earnings to growth, or PEG ratio is calculated as P/E ratio divided by a company s annual EPS growth. The PEG ratio is used to determine a stock s value while taking into account earnings growth. P/FCF: Price-to-free cash flow ratio Calculated as a company s current share price divided by its free cash flow per share (i.e., free cash flow divided by the number of company s shares outstanding) over the last four quarters (called TTM, or trailing 12 months calculation). It is a measure of the market s expectations regarding a firm s future financial health. P/S: Price-to-sales ratio It is calculated as a stock s current market price divided by its sales (revenue) per share. When calculating this ratio, we use the company s revenue from its latest four quarters, or on a TTM basis. ROE: Return on equity A measure of a corporation s profitability, calculated as net income divided by shareholder s equity. ROE is often useful in comparing the profitability of a company to other firms in the same industry. Featured companies in are evaluated on a scale of 1 to 5 on each of the following criteria: Value: 1 - poor investment value 5 - excellent investment value Risk/Liquidity: 1 - high exposure to liquidity concerns 5 - low exposure to liquidity concerns Growth: 1 - poor growth potential 5 - excellent growth potential Overall: 1 - poor fundamental characteristics 5 - excellent fundamental characteristics Disclosure Stock Holding Companies KeyStone KeyStone Employees Related Companies Investment Banking Client Related Company Business Relationship Other 5 Copyright 2017 KeyStone Financial Publishing Corp.