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Sunday, November 19, 2006

HQ Sustainable Maritime Industries (HQSM) Quick Update

I had looked at HQSM (sec, website) here and here and here (where I said that I still believed it was worth 50 about cents) and finally here in March 2006 (where I didn't say much except that it would probably be worth more than 50 cents).

Ok, so I'll look at the most recent 10-Q:
Period ending Sept 30, 2006.
123 million shares on Sept 30, 2006.

Comparing to Dec 31, 2005, cash is up. Trade receivables are way up. Inventory is up. Net PP&E is down.
519K intangibles.
Loan from related party.
They have a slight amount of net cash, which is a sign of a strong balance sheet.

Revenues are up over 23% from prior year and up over 10% from the prior quarter.

Ok, so why did they need to restate the quarter ending June 30, 2006?
The financial statements for the six months and the three months periods ended June 30, 2006 have been restated to reflect the methodology correction for the embedded conversion option of the convertible promissory notes that the Company issued in January 2006. The effective conversion price has been used to measure the intrinsic value of the embedded conversion option under EITF 00-27, the issue 98-5 model.
Ok, so it's the same thing that clobbered a lot of Chinese reverse mergers. I've been very happy with how a number of them have been overcoming the accounting issues that were so rampant a year ago. If HQSM can do the same for all the red flags I had about them, then that would make me a lot more comfortable about owning the stock.

Ok, back to the numbers...
Gross margins are 44% (48% in Q2, 42% in 2005).
Operating margins are 21% (25% in Q2, 16% in 2005).
Net margins are 5.6% due to big finance costs (6.7% in Q2, 12% in 2005 which doesn't have the big finance costs). My first thought is whether these are cash charges or non-cash charges due to changes in stock price and warrants/options.

Cash flow shows the rest of the story.
First of all, the 9 month earnings are a slight loss. Why? In Q1, they said it was due to increased financing costs and bad debt.
Operating cash flow in full year 2005 was negative, despite big earnings due to trade receivables and AP. And that's with a nearly $1 million tailwind from depreciation. In the first 9 months of 2005, it was far worse due to the lack of the $1 million tailwind. Also, in 2005 financing, they issued a lot of stock and paid off bank loans.

Operating cash flow for the first 9 months of 2006 burned up $647K. Again, trade receivables is the big culprit. That's in spite of $3.8 million of non-cash financial and other charges. So in fact, operations have been a big cash drain.

The cash story for 2006 has been that they sell a lot of stuff in exchange for promises. They buy some stuff, including intangibles. And they issue convertible notes to raise $4.2 million to keep the cash flowing.

That story doesn't make me want to buy the stock. Maybe there's something happening in the future that will turn this into a cash generating machine.

Looking at the segment info, I see the same thing I saw before: the fish business still stinks. The other segment is quite profitable. And finance charges are killing the overall bottom line. When you look at the margins and the return on assets in the segments, that's the real story.

In the discussion, they talk about how the net income was greatly affected by non-cash charges, but that's not what I see in the cash flow. How long are those trade receivables going to continue expanding without converting into cash? That's an important factor.


The fish business seems lousy in terms of margins and in terms of return on assets. The company overall currently has a problem generating cash from actual operations rather than financing. Perhaps I'm missing something because this was a quick look. Why did I ever like this stock?

Ok, so now I'll look at the stock price, but it almost doesn't matter. Would I buy it for 10 cents? 5 cents?

Ok, so the ask is under 24 cents. Chart. I'll pass.

UPDATE same day:
I quickly read this this transcript of a conference call from Feb 26, 2006. Lots of happy talk. Lots of "you guys are just so great" questions. The word "cash" occurs exactly twice and both are associated with the same quote:
You have good cash on hand. You reported that revenues for the nine months ending September 2005, which is your last quarter report, rose by 115% from 2004, the period before, and that third quarter profit from operations was up 22%. Now that you've just passed your year-end. Do you care to comment on what we might see in that last quarter and could you possibly give us some guidance for 2006?
The first sentence is oddly unrelated to the rest of the question. This isn't someone seeking information for making [possible] future investment decisions, it's someone looking for confirmation of a previous investment decision.

UPDATE: Nov 23, 2006
I just wanted to make a note for current HQSM investors. I've seen some bashing going on at the Raging Bulls message board. When I toss out a stock as something I won't invest in, that definitely does not mean that I think it's a bad investment, even when I say a lot of bad stuff about it. Many of them are going to be bad, but some of them will probably be outstanding investments, and usually I get a rough sense of how likely that is. The way I filter out stocks, I can guarantee that I'll throw out good investments. I just want to be as sure as I can not to put money into bad investments.

My sense about HQSM is that I don't find it meets my criteria for investing. I think I mentioned elsewhere that if specialty (zero toxin) fish end up being sold in large amounts in the US with reasonably high margins, then HQSM could end up being a good investment. The problem is my confidence level of that happening. When I say that I'd pay X dollars for stock, my intent is to pay a lot less than what I'm confident that it's worth.

Also, other people might have better knowledge than I do about whether it's a good investment or not.

However, cod fish egg pasta sauce, that's a different story. Tarako!


Do you think they are not getting paid?

365/(Revs $27 mil/Trade Receivables $14.7 mil)= 195 days
"Do you think they are not getting paid?"

Yes. Is it more than they are provisioning for doubtful accounts? I don't know. If your margins are thin already and you allow receivables to build up fast, then you don't bring in cash. If you're wrong enough about your collection rate, then you don't make any money (without realizing it for a long time), regardless of DSO rate.

From Dec 2004 to Sept 2006, AR increased by $9 million with total sales of about %54 million and operations used up about $1.1 million across 7 quarters.

2004 itself was a bit complicated (transition year starting May 1). They show operations burning up about $18 million due to a goodwill adjustment. But ignoring that, they decreased the provisions for doubtful accounts by $2.5 million but the net value still climbed from $2.4 million to $5.4 million.

Now I understand that sales have increased by 36% over a period of two years (Q3 2004 sales were $7.7 million and Q3 2006 sales were $10.5 million), but I'd still expect some cash generated over that time.

I suppose the root cause is the low margins on the fish business (and possibly lax collection), which is really the problem I have with the company, considering how much they're itching to expand the fish part of the business.

Maybe the margins will improve. I don't know.
Damn HQSM,

These guys keep talking and talking and talking, but they never sem to deliver any results. I've been in it since last summer, and still have a few shares left. When are they going to build this feedmill, they keep talking about it and raising money saying that it will go towards the feedmil, this recent financing as usual stinks.

But aren't they going to the Amex? Yeah right, I bet they will just dangle this in front of investors eyes for the next year and do nothing about it, just like the feedmill. The only thing that can pull this stock out of the dumpster is if they can actually start to get some higher margin sales of Tilapia in the US.

As always Bruce, a great blog, it's too bad that I can't write updates to mine anymore because of my job.


Actually, I wouldn't worry so much about how long things take. I view it as one of those universal things that progress always takes longer than expected. If they can somehow sell large amounts of specialty fish in the US for high margins, then I'd end up being wrong about them.


You know it isn't the time period that I am worried about, it is the fact that they keep doing excessively dilutive financings that they have been doing. You know this company lists major financing costs needs as a 1 time expense, but for HQSM is it more of a Quarterly event! Paying a ton of consultants to run this business in warrants.
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