Can Spectra Systems continue to milk the cash cow?

Spectra Systems Corporation is a UK-listed USA-based business that provides banknote authentication technologies, brand protection technologies (for consumer branded products such as energy drinks, shampoo, wine, spirits and tobacco) and gaming security software. Spectra also provides security software, which is used by US and international lotteries in Norway, Malaysia and Puerto Rico.

Spectra’s largest income stream comes from providing covert security technologies to authenticate banknotes to 20 central banks throughout the world. All of Spectra’s technologies were developed by the current management team under CEO Dr Nabil Lawandy, who founded Spectra in 1998 after developing the initial technology while a professor at Brown University.

With a company like Spectra, the immediate assumption may be that the changing payments landscape, moving from cash to digital, creates risk for shareholders. However, as detailed in this Research Note by Ennismore and explored further in the article below, the use of physical cash as a means of payment is not declining as much as we may expect. This article aims to evaluate the investment case for Spectra Systems, and see whether there is a growing future for this company.

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Business Model

Spectra’s business is in authentication and protection technologies. Its business can be broadly split into two divisions: banknotes and outside of banknotes. Within banknotes, Spectra specialises in sensor development programmes and covert technologies, making banknotes difficult to forge and also helping banks to detect counterfeits. Spectra’s banknote authentication technologies account for roughly half of its revenues, and are its largest income stream.

Outside of banknotes, Spectra has product lines in brand protection technologies, working in smartphone authentication and innovative products such as branded coffee machine protectors, limiting the use of coffee pods to the branded parent machine.

Also, more recently, Spectra has invested in the medical and biotech markets, with its investment in Solaris BioSciences.

Recent Financials

The image shows a table, which contains Spectra Systems' half year report for the half year ended 30 June 2021. Key takeaways from this table are explained and explored in the paragraph underneath the image.
Source: Spectra's Half Year 2021 Interim Report

In the company’s financial statements, Spectra’s revenues are split into three sections:

  • Product revenue, (representing approximately 57% of total revenue) which includes sales of pigments, security taggants and equipment.

  • Service revenue, (representing approximately 32% of total revenue) which includes:

  • Secure Transactions software licensing and support;

  • Maintenance and repair services related to manufactured equipment;

  • Research and development services.

  • License and royalties, (representing approximately 11% of total revenue) for the use of Spectra’s know-how and technology.

As seen in the table above, taken from Spectra’s most recent interim report for the half year ended 30 June 2021, product revenues increased from H1’20 by roughly 4% to H1’21, from $4.4m to $4.6m. Service revenues also increased greatly from H1’20 by 114%, from $1.2m to $2.5m. License and royalty revenues dropped slightly, by 2.7% from $0.89m to $0.87m. This resulted in a total increase in revenue of 23% from $6.5m to $8m.

Gross profit increased by 25% in H1’21, from $4.4m (H1’20) to $5.4m, and operating profits also increased by 59%, from $1.9m to $3m.

Business Divisions and Future Growth Potential

The image shows a pie graph. At the centre of the pie graph is a circle with the title 'core strengths'. The pie chart then has four segments. The first segment reads 'future growth outside banknotes'. The second segment reads 'future growth within banknotes'. The third segments reads 'secure financial base'. And the fourth segment reads 'technical advantages'.
Source: Spectra Systems' Website


In its most recent interim report, Spectra remarked on three current opportunities for growth in its banknotes division:

  • Sensor development programmes;

  • The introduction of machine-readable polymer substrate;

  • Aeris banknote cleaning process for deactivating SARS-2.

Sensor Development Programmes

Spectra is currently working with an undisclosed central bank, providing sensors for its banknotes, in order to protect them against counterfeits. This contract began in October 2020, and included $1.9m in Phase 1 development work, $5.6m in Phase 2 development through 2023, up to $34m for the delivery of an as yet unspecified number of sensors, and finally a service component worth approximately $7.5m. Spectra is now in Phase 2 with this customer, and in April 2021, a new component was also added to this contract, which now includes the capability incorporated into these sensors to detect “exotic counterfeits”. This will result in an additional $1.2m of developmental funding, increasing the total development funding to $8.7m, and increasing the overall sensor sales revenue by a potential $7.5m to $41.5m.

Machine-Readable Polymer Substrate

Secondly, Spectra sees potential future growth within banknotes in its newly developed machine-readable polymer substrate. This substrate, named Fusion, contains covert taggants invisible to the naked eye, which makes the polymer notes very difficult to forge but easy for banks to quickly identify. CEO Dr Nabil Lawandy stated that where Spectra is currently paid ‘$1 to $2 per 1,000 banknotes...the polymer itself is worth $20 per 1,000”, meaning that Spectra will be able to charge more money for this service, increasing Spectra’s potential revenues if banks decide to adopt this technology.

Aeries Banknote Cleaning Process

Finally, Spectra has pioneered its Aeris banknote cleaning process for deactivating SARS-2. Due to Covid-19, casinos and central banks now require technology to disinfect banknotes. Spectra has positioned itself ‘deliberately and successfully’ to be the world’s only provider of this technology for disinfecting banknotes from SARS-2 on a large scale.

The Aeris banknote cleaning system, launched in 2014, lifts sebum and other substances from the banknote through a dry process that is based on CO2 cleaning, where the gas is heated and placed under pressure and takes on some liquid-like qualities.

The image shows the Aeris banknote cleaning system. It is a large blew box with a circular opening at one end for the banknotes to be placed into.
The Aeris Banknote Cleaning System. Source: Spectra Systems' Website

Unlike traditional cleaning fluids that can damage the material they clean due to their harsh chemical properties, supercritical CO2 penetrates the banknote substrate, leaving the banknotes clean and dry without damaging the substrate, inks or security features.

Outside of Banknotes

Outside of banknotes, Spectra is pioneering a smartphone authentication technology named Trubrand. This technology enables a customer to scan a product with their phone to identify the authenticity of the product, and can also inform the brand owner of the time and place where counterfeits are found. The technology is being ‘aggressively promoted’ by Spectra for use with tobacco products in China, a huge potential market, and was recently tested by some Chinese Tobacco manufacturers. In December 2020, Spectra issued a patent for its Trubrand technology in China, which will be for 20 years from the filing date of July 2016.

Spectra expects that Trubrand technology will have a multitude of applications, and is expecting it to be a transformative source of revenue for the company.

Spectra is also expanding its K-cup technology to new customers. One key takeaway from Spectra’s most recent interim results (and a recent trading update released in December) was the outperformance from a newly acquired customer for Spectra’s K-cup authentication technology for use in Keurig brewers. This authentication technology means that Keurig’s coffee machine hardware only works when paired with a Keurig-authenticated K-cup.

The image shows a rack of branded K-Cups.
Branded K-Cups

Spectra began its K-cup authentication journey in October 2017, with a partnership with LMI Packaging Solutions. Spectra signed a five year agreement with LMI (with an 18-month exclusivity clause) to provide an authentication coating on the K-cup lids LMI produces.

Most recently, Spectra’s newest customer for the production of K-cup lids has placed three orders since September 2021, totalling $394,000. The orders from this customer were above Spectra’s expectations, with these orders representing 93% of Spectra’s 2021 expected revenues from this product, and 46% higher than the product’s total orders in 2020. CEO Dr Nabil Lawandy stated that off the back of this performance, Spectra expects that the new and existing customer will result in over $1 million of high margin revenue in 2022. Spectra has also stated that many more products in the consumer products market are using sensors to lock hardware with associated consumables, indicating there could be a greater market for this authentication software.

Further Business Opportunities

Outside of Spectra’s core business, Spectra is also branching out into the medical and biotech markets. In December 2020, Spectra made a $702,000 investment in Solaris BioSciences, a company also led by Spectra’s Dr Nabil Lawandy. This investment increased Spectra’s equity interest in Solaris from 4.79% to 48.65%. Prior to this, Dr Nabil Lawandy owned 84.54% of Solaris, which declined to 46.01% after this transaction. Solaris BioSciences is a development stage company that currently does not generate revenue, generating an EBITDA loss of $60,000 in H121.

Solaris is currently undertaking the creation of a two-minute, pinprick volume, blood plasma viscosity test — a technology that was explained as being ‘well understood’ by Spectra. This understanding appears to be due to CEO Dr Nabil Lawandy’s association with Brown University, where a parallel effort to create a paper-based laboratory level test strip is also proceeding at a fast pace. Spectra believes that the market opportunity for this two-minute test is similar to the market for blood oximeters, currently a $2.1 billion dollar market. The measurement of blood plasma viscosity has received a significant resurgence as an important diagnostic, since a number of institutions in the USA and the UK have made direct connections with the progression of Covid-19 disease. Solaris BioSciences is in the early stages of a Series C financing and currently has approximately $180,000 of cash to fund its operations.


Outside of the potential threat from the rise of digital payments (more on that below), I foresee one particular risk with an investment in Spectra — 63% of revenues come from 2 key customers.

The image shows the number of significant customers for Spectra Systems in 2019 and 2020, and the percentage of total revenue these customers made up. In 2019, Spectra Systems had 2 significant customers that accounted for 52% of revenue. In 2020, Spectra Systems had 2 significant customers that accounted for 63% of total revenue.
Source: Spectra Systems' FY'20 Report

In FY’20, 63% of Spectra’s revenues came from only 2 customers, up from 52% of revenue in 2019. This certainly adds risk to Spectra’s revenue profile. For those of you in the market in 2017, we only have to reference Imagination Technologies (the Apple Iphone chip supplier) for what can happen in the event a core customer pulls the plug.

Imagination was listed on the UK stock market and had 50% of revenues sourced from sales to Apple Inc. In 2017, Apple alluded to its intentions to stop using Imagination’s graphics processors, which wiped 70% off the stock price in a couple of trading sessions.

However, there are reasons to believe key customer risk could be reduced in the case of Spectra.

Firstly, given Spectra works with central banks for authentication, Spectra has already built a large installed base in the number of banknotes in circulation with Spectra’s embedded technology. The cost therefore of switching to another provider could prove insurmountable to replace the existing float of cash in circulation with Spectra’s technology.

Spectra have noted that it is difficult for them to initially acquire customers — due to the high level of trust that is required in performing covert level accreditations for bank notes. This provides a big barrier to entry for others looking to enter the market. Once with Spectra, customers tend to remain with them for a long time. Spectra’s CEO stated that some of Spectra’s relationships span decades: “We're going past 20 years with some of them.”

Lastly, Spectra may have just a handful of key customers, however, revenue streams are split into products and services. 32% of revenues are currently derived from servicing the customer base, reducing risk further.

Is Cash Still King?

As stated above, Spectra’s largest income stream is derived from its banknotes business division. This begs the question, how much are digital transactions affecting the use of cash, particularly in Spectra’s biggest market the US, which represents roughly 72% of the company’s revenues?

The image shows a chart, on the vertical axis is the Total Number of Banknotes in Circulation (in billions) and on the horizontal axis are the years 2010 to 2020. The graph shows that the total number of banknotes in circulation has been steadily increasing across this time period.
Source: Numbers Taken from the US Federal Reserve

In the graph above, you can see the volume of currency in circulation in billions of notes as of 31 December each year, with figures taken from the US Federal Reserve. As you can see, despite the rise in digital payments, the number of bank notes in the US has in fact grown steadily YoY, at a roughly 6% average rate over the past 22 years, showing that, largely, the fears over declining levels of cash in circulation are overblown.

In further evidence of these fears being overblown, this year, the European Central Bank (ECB) announced plans to redesign euro banknotes and present the final new designs by 2024. “Euro bank notes are here to stay,” said ECB President, Christine Lagarde. “They are a tangible and visible symbol that we stand together in Europe, particularly in times of crisis, and there is still a strong demand for them.”

Long-Term Financials

The image shows a table from the years 2013-2020. The table shows Spectra Systems' revenue, revenue growth, gross profit, gross margin, operating profit, operating margin, debt to equity ratio and ROCE across this timeframe. Key takeaways from this table are explained underneath the image.
Source: The Twenties Trader, numbers taken from Spectra's full year reports

Looking at Spectra’s long-term financials, we can see that the business has experienced some revenue volatility over the past 8 years. Revenues grew rapidly in 2013 & 2014 before seeing a steep drop in revenue growth in 2015 and 2016, declining by 16.6% and 21.2% respectively from the prior year.

This decline in 2015 was explained by Spectra as due to an exceptional year in 2014 of materials and phosphor sales, which acted as a tough comparator and thus affected 2015 revenue growth. In 2016, the decline was due to the final delivery of sensors to a G7 central bank in 2015. An unfortunate result of Spectra’s business model, where two key customers make up 63% of revenues, can create some volatility in order volume and revenues.

Since 2017, growth has been much smoother, at roughly 7.5% through to the end of 2020. As Spectra’s business has grown, so has the number of applications for Spectra’s technology and the number of products it offers, creating a more robust revenue profile that may reduce volatility.

One thing that is immediately noticeable in Spectra’s financials, however, is the distinguished jump in profitability from 2017 onwards, where operating margins surged to 25% and leapt higher sequentially each year to result in operating margins of 36% in 2020. Alongside increasing operating margins, return on capital (ROCE) also jumped in 2017 and has ended up at a highly respectable level of 18% in 2020.

Interestingly, comparing Spectra's revenue results in 2020 with 2014, where Spectra’s revenues have recovered to £14.68m in 2020 (still some £2m shy of 2014) Spectra is a fundamentally better business, able to return nearly 5x the profit for shareholders from a lower revenue base.

Lastly, the balance sheet for Spectra also looks in great shape, with a very low debt to equity ratio of 0.17.

Summary and Valuation

Spectra Systems looks like a unique business with a positive growth trajectory that is clearly improving given its latest interim result showed growth of 23%, well above the 7.5% average over the 2017-20 period. With cash payments seemingly not quite as threatened as previously anticipated, and with long-standing relationships with large and loyal customers (20 central banks including two G7 central banks and the governments of Turkey, India, Malaysia, the Netherlands and Norway), Spectra’s banknotes division looks like it could be in good standing in the next few years, particularly considering the introduction of Spectra’s Aeris cleaning system.

Spectra also beholds some fantastic qualities when looking at the financial metrics. The business has been transformed in recent years to deliver very high levels of operating profit (36% operating margins) and robust rates of return on capital. Combined with a healthy balance sheet and investments in other businesses (Solaris), Spectra’s financials are very high quality and are far superior to many businesses found on the AIM market in the UK.

My main concern for Spectra would be the high level of revenues that relies on so few customers. Whilst I expect Spectra will indeed hold onto these customers, it could cause revenue volatility in the future, like we have seen in 2015-16. However, the diversification of the business into other avenues (K-cups, Trubrand and Solaris Biosciences) indicates a company that is aware of this potential downside, and the growing portion of service revenues indicates Spectra is generating cash from its installed base of technology with its customers, not solely reliant upon the sale of new equipment.

A further hint of quality can also be found looking at Spectra’s shareholder ownership structure, which shows the equity is held between directors, family members and a handful of investment firms. CEO Dr Lawandy owns 4.93% of the business. I like investing in businesses with this sort of ownership structure as it suggests that company owners act as long-term stewards of the business.

The image shows a table, which shows the substantial shareholders of Spectra Systems. Key takeaways from this table are explained underneath the image.
Source: Spectra's FY'20 Annual Report

Lastly, looking at valuation, Spectra’s appointed research provider Allenby Capital estimates Spectra will earn EPS of 11p in 2021 followed by 12p in 2022, giving Spectra a price to earnings multiple of 14.5x and 13.3x earnings in 2021 and 2022 respectively. I think this is a very reasonable price to pay for a business with good prospects and certainly some quality features to the business. Should Spectra start to see further momentum in its business outside the predictable banknote applications, the company could top expectations and drive a re-rating for the stock.


At the time of writing, The Twenties Trader did not own shares in Spectra Systems.

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