The Street Sweeper

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Sonya Colberg joined TheStreetSweeper in early 2012 as a senior investigative reporter after racking up an impressive pile of journalism awards for her past work at two major daily newspapers. For example, Colberg recently won top honors – recognized by the Society of Professional Journalists and the Associated Press alike – for her performance in the tough investigative reporting field. During her long and decorated career, she has walked away with major prizes for her in-depth coverage of business and healthcare as well. A fearless reporter with incredible writing skills, Colberg has now teamed up with Melissa Davis – another award-winning journalist who serves as senior editor of TheStreetSweeper – to deliver hard-hitting coverage of risky stocks to the investment community.

Hydrogenics: Margin Drop, Cash-Poor, Insider Sell-Out And Enough Malfunctions to Make Janet Jackson Swoon


Hydrogenics Corporation (USA) (NASDAQ:HYGS) suffers an unfortunate link to Janet Jackson – sort of a “wardrobe malfunction.”

The fuel cell company is now dealing with a “parts malfunction” in which it revealed two multi-million-dollar shipments were delayed because Hydrogenics’ supplier had built defective equipment. This mistake by the fuel cell technology company electrified listeners almost as much as the singer’s caper. Oddly, much as that other malfunction ignited fleeting promotion for a fading star, Hydrogenics’ malfunction may have sparked an unexpected boost for the company, too. We’ll explain that below.

We’ll also look more closely at various big issues threatening Hydrogenics’ business:

  • The reputation-damaging parts malfunction.
  • Big shareholder sells off stock.
  • Gross margin drops heavily.
  • Backlog drops – indicating shrinkage of future potential sales – even as some analysts expect 50 percent year-over-year growth.
  • Hydrogenics execs back off from 30 percent growth projection – a figure also unlikely to materialize given backlog numbers.
  • Burning cash. Company’s shelf prospectus allows up to $100 million worth of banknotes, common stock, etc. We expect an equity raise.

Hydrogenics did not return our requests for an interview for this article.

With a tip of the hat to some old Janet Jackson tunes, we’ll review Hydrogenics’ positives, as well as the negatives that we believe make this stock scarier than any future outrageous attempts by Ms. Jackson to remain relevant.

Whoops Now,” Here’s The Bull Case

Canada-based Hydrogenics provides hydrogen fuel cells for stationary and mobile uses, and hydrogen-generating products for industrial applications as well as for energy storage. The bull argument includes a belief Hydrogenics can sell more products as California, Canada, European Union and Germany develop policies to encourage alternative energy uses. Additionally, backlogged inventory still appears significant, and bulls add this suggests the pipeline will lead to a positive adjusted EBITDA for 2015. The maturing and expanding order pipeline should drive more news flow, which analysts believe would be a strong positive catalyst, pointing to growth and stability assuming hydrogen fuel cells become a more common power source.

 “Can’t B Good,” Or Why Did Hydrogenics Have To Blow This Delivery?

The stock has zig-zagged over the past year like a pop musician drunk on fuel cell bubbly.  The stock swooned again in December when the company updated investors with the news that delayed shipments would squash 2014 targets.

Then came the day for Hydrogenics to sing out those sour notes in the earnings call. In light of the delays, EBITDA remained negative and the targeted $50 million revenue turned out to be just $45.5 million.

“Let me assure our investors that it was very unusual for these particular parts in question to be defective,” CEO Daryl Wilson said early in the call on March 4.

Those parts were critical. One shipment was destined as a second energy storage system for E.ON, an important German energy and gas customer.

Mr. Wilson said the supplier had simply provided inferior parts for this “OnSite Generation” project and another project that he didn’t name.

E.ON’s Falkenhagen project currently uses Hydrogenics’ 2 megawatt electrolyzer. The system allows the combination of water with excess energy from wind turbines to create hydrogen that is stored and moved into the natural gas pipeline. A big portion of a $5 million sale and Hydrogenics’ reputation hinged on delivering a second electrolyzer to E.ON. This was to be installed in the Hamburg project that E.ON folks enthusiastically referred to as “the first prototype operating in the 1MW range.” But Hydrogenics executives indicated the company will recover from this blunder and get paid this first quarter.

We hope so. But we can’t overemphasize the significance of messing up these OnSite Generation orders. Consider this customer concentration issue: E.ON and the other unnamed important customer are among just four big customers that delivered 39 percent of Hydrogenics’ sales last year.

“You Want This,” or Darn Right We Want Good Gross Margins. Ahhh, Those Twisty Low Margins

The parts problems went hand-in-hand with another blow-up mentioned gently by analysts in the earnings call. Gross margins fell both sequentially and the same quarter prior year. In fact, margins are by far the lowest since the first quarter of 2013, as shown below:

Yet, this disappointment apparently handed Hydrogenics the oddest twist.

OnSite Generation sales are lower-margin at under 15 percent (10 percent below the other division, Power Systems). An analyst who requested anonymity pointed out that if the shipments had actually occurred, more low-margin product revenues would have diluted the higher-margin revenues. “If those sales had been in there,” the analyst said, “Hydrogenics might not have been profitable because of those crummy gross margins.” And though the company reported its first quarterly profit of $612,000 on revenue of $15.7 million, that doesn’t dampen our concerns about the low margins that the CFO referred to as “a new normal.”

“Even Backlog “Doesn’t Really Matter;” Next Rev Hit Unlikely

Backlog, which is sometimes crafted in the fuel cell business as a measure of future revenues (though it is subject to customer cancellation), decreased by 7 percent to $62.2 million:

But let’s say Hydrogenics converted most backlog to revenue, as executives said most inventory will be delivered in 12 months. And let’s add the roughly $5 million revenue from the delayed shipments hoped to be realized in the first quarter.

Though 23 is the highest percentage converted from backlog in any quarter so far this year, let’s go ahead and assume Hydrogenics converts a crazy-optimistic 95 percent of that backlog by year’s end.

2015 Revenue Estimate/Bloomberg      $ 68.5 million
95% Backlog Converted       $ 59   million
Q4 Rev. To Be Recognized in Q1 2015   +  $   5   million
Estimate Miss
  • $ 9   million

 

Our calculations suggest that unless Hydrogenics can charge substantially more for each system sold, it’s impossible to hit those analyst estimates. “There’s no way Hydrogenics can hit 2015 revenue,” an analyst told TheStreetSweeper.

In fact, in the earnings call, executives seemed to have their own doubts about lofty revenue guesses. They refused to be pinned down on speculating (as they did in 3Q and earlier) that Hydrogenics could even hit 30 percent additional revenue – which would be $59 million – and our example above shows even that much would require 95 percent of backlog to be converted to revenue.

Major Shareholder Sings Along With Janet, “You Want This?” And Just Keeps Selling Shares. More To Come.

Customer and major shareholder CommScope sold HYGS shares last week. And the week before … and twice the week before … and so on. Just since last May, it has sold nearly 1 million shares or nearly half its entire stake. CommScope bought about 2.2 million shares in 2011 and records show it now holds only 1.3 million shares after kicking off its selling spree last May.

Mr. Wilson explained during the earnings call that CommScope’s CFO has just decided to monetize the investment: Daryl Wilson, CEO: “We believe there will be demand in the stock to buy out that relatively slow dribble out that’s coming from CommScope. And again, they are limited by regulations on trading those shares in each three month period, no greater than the weekly average trading volume. So it’s a pretty severe limitation on their ability to sell.” CommScope has a unique perspective on Hydrogenics business because CommScope is not just an investor but also a customer.

If you’re wondering if you should be worried, you’re not alone. After confirming that CommScope owns about 14 percent of the company, Tendercapital analyst Marco Sirugo raised that very question. Marco Sirugo: “Okay. So should I not be worried by this data?” Bob Motz, CFO: “No, I don’t think at all. It’s not germane to our business directly, because as Daryl has indicated, it really doesn’t affect in my view the value proposition for the company.”

We’re still worried. And curious. If CommScope actually believed in Hydrogenics technology, why sell now?

Judging by the current trend, investors will likely have a few white-knuckle weeks to watch the remaining 1.4 million shares hit the market. The last time 1.5 million shares of Hydrogenics hit the market, shareholders probably weren’t in the mood for humming along with Ms. Jackson’s song, “The Best Things in Life Are Free.” In fact, Hydrogenics announced a public offering on May 13, 2014 of 1 million shares in the treasury – plus 500,000 shares owned by CommScope. In reaction, the stock took a freefall to a new normal that persists today. The price flittered 30 percent virtually overnight from ~$20 to ~$14.

Here’s that Hydrogenics stock chart:

“Hold Back The Tears.” That Cash Burn’s Hurting

We, too, could barely hold back the tears when we spotted Hydrogenics available cash in 2014 and noted it dropped below 2013. Yet its cash burn grew.   Cash burn leaped 62 percent to about $3.9 million per quarter. At the same time, available cash slumped to $6.6 million. With little more than one quarter’s worth of cash available – even less if the company hopes to sell improved products – it makes sense that it would put its stock on the auction block this year.

So we’re expecting a cash raise in the second quarter – or the third quarter at the latest. After all, the company’s shelf prospectus allows up to $100 million worth of banknotes, common stock, etc. So why not an equity raise soon?

“Son Of A Gun (I Betcha Think This Song Is About You)” Indeed, This Material Weakness Alert is About Your Stock

If all that’s not enough to make you want to change your playlist and portfolio, Hydrogenics’ material weakness warning tucked away in Exhibit 99.1 may do the trick. It trills out bad news uncovered by PricewaterhouseCoopers accountants, dated March 3, 2015:

Inherent limitations

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

Opinion

In our opinion, Hydrogenics Corporation and its subsidiaries did not maintain, in all material respects, effective internal control over financial reporting as at December 31, 2014, based on criteria established in Internal Control – Integrated Framework (2013) issued by COSO because of a material weakness in internal control over financial reporting related to the incorrect recording of non-monetary assets denominated in foreign currency in the German subsidiary.

Hydrogenics’ execs added:

Our disclosure controls and procedures were not effective as of December 31, 2014. 

We identified a material weakness in our Internal Controls over Financial Reporting in our 2014 financial statements related to the translation of non-monetary assets in our German subsidiary.   A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.  The material weakness resulted in errors in the measurement of non-monetary assets in the German subsidiary that were corrected in the Company’s consolidated financial statements for the year ended December 31, 2014 prior to their release. We are committed to remediating the material weakness in internal control over financial reporting by enhancing existing controls and introducing new controls over the use of appropriate exchange rates in the recording and translation of foreign currency transactions and balances in our foreign subsidiaries. We are committed to implementing its remediation plan as soon as practicable.

A Bill Gates quote may apply to Hydrogenics: “In this business, by the time you realize you’re in trouble, it’s too late to save yourself.”

Executive compensation gets fired up and just goes “On And On.”

Mr. Wilson’s annual salary and stock value exceeded $1.5 million.  And compensation for all seven top officers in the most recently disclosed year of 2012 reached $4.1 million – in just one year. All on the backs of shareholders, many of whom have watched their shares fall apart over the past year. How badly? Here’s the 1-year chart showing Hydrogenics stock (down 55%) compared with the NASDAQ (up 13%). And, though the company has plugged along for years, handing many shareholders diminished share value, the trend for executive compensation is rising… and just goes on and on.

Conclusion: “Sad

Janet Jackson might agree that a face-full of spider-leg eyelashes, a truckload of spooky-high heels or even a closetful of red bustiers set to malfunction at just the right moment could never erase the sad issues surrounding Hydrogenics.

We believe Hydrogenics will ultimately get pummeled even worse than other former high-flying alternative energy stocks such as Plug Power Inc (NASDAQ:PLUG) $7.99 on 3/16/14 now $2.75, along with others that TheStreetSweeper has warned investors of, including Ballard Power Systems Inc. (USA) (NASDAQ:BLDP) $2.60 on 2/19/15 pub date, now $2.09 and FuelCell Energy Inc (NASDAQ:FCEL) $2.84 on 8/19/14 pub date, now $1.28.

The combined chart for those stocks over the past year shows the downward trend:

Much as many people would prefer otherwise, these alternative energy-related stocks are likely decades ahead of the infrastructure, compelling uses and wide market acceptance needed to become really profitable.

It looks like investing in Hydrogenics is just about as pointless as Janet Jackson and Justin Timberlake replaying that wardrobe malfunction at the old folks’ home. And consider this: After 20 years of trying, Hydrogenics is still making big mistakes within the slow-moving fuel cell field and has only just eked out $612,000 profit. Yet the market has placed the company’s value at $134 million.

So, if the company continued to make $612,000 every quarter, it would take a while for profits to add up to Hydrogenics’ current value – well, quite a while! About 55 years.

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