Tom Konrad CFA
When Maxwell Technologies (NASD:MXWL)
problems with its revenue accounting on March 7h, I took a
look at the company’s reported Accounts Receivable (where early
revenue recognition usually shows up) and concluded
that management had underestimated the scope of the accounting
problems. Convinced that there was more to come, I not only
sold the stock, but took a short position.
On August 1st, Maxwell filed its restated annual reports for 2012
(including restatements of 2011), as well as statements for
the first two quarters of 2013.
The Bad News: Revenue mis-statements were much larger
than previously announced
The bad news for Maxwell investors was that I was right about the
revenue mis-statement. The initial press release put the
overstated revenues for 2011 and the first three quarters of 2012
at $6.5 million and $5.5 million ($11 million total,) while the
actual restatement was $10 million and $9.2 million, respectively
($19.2 million total.)
To be fair, $2.5 million of the 2011 restatement involved
replacing a reported general and administrative (G&A)
expense with a contra-revenue account, which has no net effect on
earnings. What apparently happened was that some returns or
warranty costs were charged to overhead, rather than decreasing
revenue as accounting rules say they should. This type of
misreporting makes revenue growth look faster than in reality it
should, but does not increase earnings. While it is a
problem, it has less of an effect on company valuation than early
reporting of revenue.
Because the effect of the $2.5 million re-categorization of
G&A expense as contra-revenue has no effect on Maxwell’s
earnings, the rest of this article does not include the
re-categorized $2.5 million from 2011 as restated revenue.
Even excluding this $2.5 million, the total revenue restatement
of $16.7 million was significantly greater ($5.7 million, or 52%)
than the $11 million restatement the company’s initial press
release told us to expect. If the $2.5 million
re-categorization is included, the initial announcement
understated the problem by $8.2 million, or 75%.
Still More To Come?
I initially predicted these
larger revenue restatements by observing that Maxwell’s Accounts
Receivable (AR) had been growing much more quickly than they
should have in order to keep up with the company’s sluggish sales
growth at the time. This can be seen in the chart above,
where orange bars and dark blue line show what AR and revenue
looked like before the restatement, the red lines (“adjusted AR”)
and light blue line show what the restatement would have looked
like if the initial press release had been accurate, and the brown
bars and green line show AR and revenue as the company reported
them on August 1st.
As you can see, recent growth in AR has been much lower than
revenue growth (green line.) If anything, Maxwell management
is now being extremely cautious about revenue recognition.
This is unsurprising, as the company is currently being
investigated by both the Department of Justice (DOJ) and Securities
and Exchange Commission (SEC) in because of the previously
misreported revenue: The company has every incentive to err on the
side of caution.
I think it’s very unlikely the DOJ or SEC will find any more
skeletons to be hiding in Maxwell’s accounting closet. With
luck, the investigations (which have not yet involved company
management) will not lead to significant expenses or management
time going forward. While it’s appropriate for the DOJ and
SEC to look into the particulars, it seems as if Maxwell has done
a good job cleaning up the books and putting better controls in
place, and it would be unfortunate if past problems were to
interfere with a promising business.
Despite the worse-than-forecast revenue restatement, the market
reacted euphorically to Maxwell’s filings. MXWL stock soared
$1.47 to $9.43 (18%) in the first day of trading after the
announcement. I ascribe this euphoria to three factors, in
decreasing order of importance.
- Maxwell’s revenues and earnings grew strongly over the past
three quarters, flattered in part by the restatement itself.
- Many traders had sold the company’s stock short, and the
strong results created a short squeeze.
- Investors were paying more attention to recent growth (which
management highlighted) than previous disappointments.
The Good News: Recent Growth
As Maxwell’s CEO David Schramm stated in the conference call,
year-on-year revenue growth has been 54% and 33% over the last two
quarters (Q2 2013 and Q1 2013, respectively). Fourth quarter
(Q4 2012) growth was 19% over the previous year.
The restatement contributed to this recent growth both by
reducing reported revenue in the first two quarters of 2012, and
increasing revenue in those quarters of 2013. Without the
restatement, Q2 2013, Q1 2013, and Q4 2013 sales growth would have
been 28% and 14% growth, and a 2% decline respectively compared to
the previous years’ results.
Nonetheless, no matter how you slice it, revenue and earnings
have been growing strongly over the last two quarters. The
following chart show’s Maxwell’s earnings per share (EPS), before and after
the effect of the restatement:
While the restatement has the effect of making recent results
look stronger as compared to results from the previous year, it’s
important to keep in mind that the restated results were restated
to correct real accounting errors, not just to make Maxwell’s
recent growth look good.
I was not the only analyst, trader or hedge fund manager to be
surprised by the strength of Maxwell’s recent results. As of
June 15th, 2.91 million shares were held short. That is 11%
of the company’s float, or over seven days’ trading volume.
Unlike myself, many shorts use significant margin, and a
share price spike like the one yesterday can lead to margin calls
which force them to cover, buying even as the stock is rising, and
accelerating the ascent. I keep my short positions
relatively small to avoid being caught in such a short squeeze,
and was not forced to cover.
I plan to cover my short position in the next few days, assuming
the stock declines to something closer to what I consider
Maxwell’s actual value. If it declines far enough, I may
even go long again: I like the company’s business. Since I
have yet to make these trades, I won’t reveal my current valuation
of the company here, although I will give you much of the
information which led to that valuation.
To determine what Maxwell is worth, we have to determine our
expectations for Maxwell’s future earnings. Growth of
ultracapacitor sales for automotive stop-start applications has
been flat, but this has been driven by poor car sales in Europe,
which are at a 20 year low. Stop-start idle elimination
systems using Maxwell’s ultracapacitors are now available in more
models, and their wider availability has offset the decline in
overall auto sales.
The main source of Maxwell’s recent growth has been the hybrid
bus business in China. accounting for 80% of sales in Q1 2013, and
65% in Q2 2013. We can expect softness in this segment as
Maxwell’s Chinese customers await the release of new subsidies fro
hybrid buses. These subsidies are widely expected, but have
yet to be finalized, and it is anyone’s guess when that will
happen. With the third quarter almost half over without an
announcement, we can expect far fewer sales of ultracapacitors for
Chinese buses in the third quarter than in the second.
The other major end market for ultracapacitors has been the wind
market, which in the past has exceeded sales for hybrid buses.
Global wind installation in 2013 are
not expected to grow over 2012, but growth is expected to
resume in 2014. Hence, while wind should be a source of long
term growth in for Maxwell, it is unlikely to be a source of
growth in the near term.
With hybrid bus demand falling in Q3 and stable wind sales, we
can expect Maxwell’s third quarter revenues to be down from the
second quarter, with earnings following suit. The fourth
quarter could see growth resume once Chinese bus subsidies are in
Maxwell’s inventory levels at the end of the second quarter seem
to echo my expectation of lower sales in Q3: they were down from
the second quarter, and Maxwell’s CEO David Schramm forecast
inventory levels to remain flat in Q3 during the recent conference
call. Further, Q2 inventory was down from Q1 levels.
Since every future sale has to pass through inventory,
Maxwell’s management would be increasing inventory to meet this
anticipated demand if they expected growth in Q3.
As you can see in the chart above, quarterly revenues have been
growing much more quickly than quickly than accounts receivable or
inventory. While increasing revenues relative to working
capital items such as these can be a sign of increased efficiency,
such efficiency gains are seldom this rapid. Most likely, Q2
(and possibly Q1) represented a short term revenue spike which will
be reversed in Q3. The fact that Q2 revenues rose above their
trend line just as Q2 inventory dipped below it increases my
confidence that Q2 revenue growth represents a short term blip.
Longer term, Maxwell’s growth prospects are bright, as wind and
bus markets return to growth, while Maxwell also begins to see
significant sales in new markets such as their Engine Starting
Module (ESM) for trucks, where the company has been making
progress by getting the ESM adopted by two truck fleets.
Over the next two quarters, straight-line projections of revenue
and earnings are likely to significantly overestimate Maxwell’s
As I said above, I’m not ready to reveal my own valuation of the
company. I will say that the recent results are better than
I expected, and I plan to cover my short position at a loss
reflecting my higher current valuation of the company.
Analysts at Roth Capital were pleasantly surprised by Maxwell’s
reported results. They raised
their price target to $8.50, from $7, keeping their rating at
neutral. I have not yet seen how other analysts have
reacted, although average estimates for Maxwell’s 2014 EPS have
dropped from $0.59 to $0.45 per share over the last week.
Disclosure: Short MXWL
This article was first
published on the author's Forbes.com blog, Green
Stocks on August 6th.
DISCLAIMER: Past performance
is not a guarantee or a reliable indicator of future
results. This article contains the current opinions of the
author and such opinions are subject to change without
notice. This article has been distributed for
informational purposes only. Forecasts, estimates, and certain
information contained herein should not be considered as
investment advice or a recommendation of any particular
security, strategy or investment product. Information
contained herein has been obtained from sources believed to be
reliable, but not guaranteed.