Quality Products ($QPDC) the Mysterious
…a tiny company that manages enormous gross and operating margins, high returns on capital and consistent free cash flow…to repurchase shares and pay large special dividends.
This got my attention. So, I went through the company’s filings. They are worth reading just for the story they tell – how from a whole bunch of lousy businesses, poor acquisitions, and numerous lawsuits emerged what OTC Adventures talks about.
The earliest annual report available on OTC Markets goes back to 1995. That’s just the time when Quality Products disposed of its losing subsidiaries acquired just 2-3 years earlier. There was a steel processor, a toy factory, a “foam recreational products” manufacturer, and, to top it off, claims on zinc deposits. After 1995, all this was gone (except the zinc claims). Quality Products went from 127 to 31 employees. The proceeds extinguished some of the bank debt that financed some of (the acquisitions of) these fine businesses after covering substantial litigation and severance payments (all the Directors and C-suit walked, the auditor too). The company was in default and was operating under a workout agreement with the bank. What was left was QPI Multipress – the manufacturer of hydraulic presses that is still the company’s main business today.
The stock price went from a high of $61 in December, 1993 to a low of $0.125 in December, 1995; holders – from 1210 to 320.
The strategy at the time was:
…to increase profitability of Multipress and continuing efforts to renegotiate and settle outstanding liabilities which are unrelated to Multipress’ operations. Once the Company is current with its filings with the Securities and Exchange Commission, it will review all refinancing possibilities including the issuance of securities. No assurance can be given that the Company will be able to continued as a going concern.
On April 26, 2001, Quality Products purchased Columbus Jack – a hydraulic jacks manufacturer located in the company’s hometown of Columbus, Ohio. CJ was in pretty bad shape. It was losing money and was technically bankrupt. Management was looking for options to save the company. Incidentally, CJ’s business was a good match for Quality Products – adjacent to the company’s hydraulics operations.
At the end of fiscal 2004 (9/30/2004), Quality Products went dark. It quoted the onerous Sarbanes-Oaxley regulations that were going into effect as the main reason for deregistering. Compliance would have cost the company $300,000 in the first year. At 16% of the year’s profit from operations, it was the reasonable thing to do.
After 2004, there are no filings by the company to be found anywhere, although, when going dark, it promised to issue quarterly press releases. If anyone has any filings issued by Quality Products since 2005, I would love to read them because there lies the mystery of how this company, which as late as 2002 was not sure whether it will continue as a going concern, became the amazing success story described by the numbers OTC Adventures was so kind to provide.
In short, over the 8 years between 2004-2012, Multipress grew sales at 5% annually, Columbus Jack – at 12%. The gross margin of the former stayed at 34% while of the latter it grew from 40% to 50%.
Below are some summary statistics for the whole company.
I use 5 year averages as a way to reduce the influence of starting and ending year on the compound annual growth rate computation, but also because I don’t like working with single year numbers when taking a broader look of a company’s financials.
In the 8 years between 2004 and 2012, Quality Products’ performance has been nothing short of astounding. It had its best year in 2009 and doesn’t seem to have been affected one bit by the crisis. The stock traded between $3.5-6 in fiscal 2009 and only crept up since – until March 2012 when it started coming down from the low twenties to the low teens.
The company ended 2004 with a deficit of over $21m. Five years later, it was down to $1m. How did a company with peak profit over the past 5-year period (2000-2004) of $1.9m and cumulative profit over the same period of $4m manage to whip up $20m in 5 short years? I don’t know. But, the numbers are there and they add up. I have the profits for 2007-2009. Only 2005 and 2006 are missing. Subtracting the $13.75m generated in 2007-2009 from the $20m reduction in deficit, leaves $6.25 of profits for 2005 and 2006 – $3.125m per year. As you can see from the table above, earnings have averaged $5.6m in the latest 5-year period. So, $3.125m is not a stretch at all. How this tiny, unspectacular company is managing to return 30% on its assets, remains a mystery.
Book value grew at a rate of 33% annually in the 2005-2009 period – from $4.8m to $19.8m. That was before Quality Products repurchased a large part of its shares. Speaking of repurchases, between 2007 and 2012 the company retired almost 40% of its shares. As if that were not enough, it paid out $8.5 per share in special dividends in the last three years, on a stock selling between $14 and $27 in this period (with the exception of two spikes).
Quality Products is now offering an earnings yield of 12.5%. Selling at 1.5 times book and 11 times net current asset value, it doesn’t have any asset protection. But, it has repurchased 40% of its shares in just 5 years and has paid substantial special dividends in the last 3. It has also worked a miracle with its hydraulic presses and hydraulic jacks businesses. There haven’t been any management changes since 2004 and the Drexler’s own 56% of the common, if they didn’t sell any shares in the repurchases.
The bottom line is that Quality Products managed an unbelievable turnaround in the years since it went dark. However, without access to the company’s annual reports, I have no idea what the sustainable level of the company’s earnings is and the valuation is entirely dependent on earnings in this case.
At the risk of appearing as if I am not buying any of the shares I am writing up here, I will pass on this one.
As for my buying, I do buy rarely. I am sure this is no surprise to other value investors. Yet somehow, as Nate from Oddball stocks observed recently, few people write about the companies they pass on. Maybe they don’t think passes are worth writing about. Maybe they are afraid of coming out as insincere or having weak stomachs – not being able to eat their own cooking.
I think writing about close passes is any bit as worth it as writing about (close) buys is. If it’s any good, the post tells just as much about the analytical process of the writer and about the company reviewed as a buy post does. Besides, I am writing infrequently as it is. If I wrote only about my buys, I’ll post 2-3 times a year (not that I am doing considerably better now).
In any case, if anyone has those missing Quality Products filings, do share.
After some searching, I found the missing press releases, save for 2005 and 2006. It was an unlikely place – the International Business Times appearing on the second page of search results. All the usual sources, such as Yahoo Finance, Google Finance, Bloomberg, WSJ, Morningstar, OTC Markets, don’t have these press releases.
Anyway, the press releases don’t give any details how the company did it but they support the numbers discussed above. Quality Products really turned around its two lines of business.
This is what management had to say about Multipress:
Historically, the visibility of future business for this segment has rarely exceeded six months, making it difficult to predict long-term trends.
…and about Columbus Jack:
A majority of this segment’s business is with the U.S. government from which we have experienced a reduction in orders. This may be a temporary slowdown until Congress resolves the budget issues, but we are unsure. However, if defense spending is reduced, which based on recent government discussions appears probable, it is likely this segment will continue to be unfavorably impacted. Historically, when equipment orders have declined, the impact has been somewhat muted by an increase in higher-margin parts orders as customers repair existing equipment instead of buying new equipment. However, we are unable to quantify this effect.
- The company benefited from a $3.2m tax benefit in 2006 (and probably also in 2005). As of the last 10-KSB, it had $25m tax loss carryforwards going to (and some past) 2010.
- The company has been using debt to finance (most of) the special dividends. This, combined with the controlling shareholder and the fact that the company was already returning the extra cash through buybacks, raises a red flag for me. This change in the capital structure increased return on equity from 35% to 50% even while return on assets dropped slightly – from 30% to 25%. A 50:50 debt-to-equity for a business that can’t be forecast more than half a year out and another business that’s highly dependent on the government is not good. One bad year can return the company back to the old days of pondering its existence as a going concern.
- Every year since 2010, management has considered doing a reverse stock split to reduce the burden of servicing the “large number of smaller shareholders.” I don’t know how much of a burden “servicing” 200 to 500 (my guess) shareholders is, but obviously not enough for management to pull the trigger on this one, although it makes perfect sense to take the company private.