Citron Research’s skepticism about the viability of Home Solutions of America (NASDAQ:HSOA) has only deepened over the recent weeks and we now believe that the company is on the brink of bankruptcy.
The company’s cash position, as reported in its June 30 10-Q, was down to $4.6 million. Meanwhile payables were at historic highs at $31.17 mil and that does not include the $40 million owed to the bank….tick tock tick tock. Receivables continue to expand, with a total lack of transparency as to their collectability. The situation has become so dire that the company admitted on the conference call that they will have to raise money to continue their operations.
Specifically, the auditor’s warning from the last 10-K, especially the parts about the inadequacy of corporate controls on accounts receivable accounting, quoted extensively in our last report, now looms large. Why?
The company’s primary resource in maintaining its liquidity is its line of credit. As of the last conference call, $40 million of a maximum limit of $60 million had been drawn down. The collateral for that receivable is primarily the company’s receivables.
The standing of that banking relationship remains unclear.
The company was required to get lender approval of its agreement with Brian Marshall regarding outstanding receivables. It failed to do so, and as of today, that approval is still not forthcoming.
Looming around the issue is that line-of-credit agreements are typically immediately revocable in circumstances of fraud….please read on.
Specifically, some of the numbers in the 10-Q are startling.
To generate $51 million in topline revenue in the face of eroding interiors and restoration business, on the conference call, CEO Fradella attributed the lion’s share to income from Fireline, although he was unable to name a single significantly sized project contributing to that revenue.
Fireline would have had to generate $35 million for the quarter. Fireline’s total revenue in the six months prior to the merger (as per 8k) was $18 million , so we are expected to believe that merging into HSOA resulted in a 400% growth spurt.
And its not just any business – its 50% gross margin business. In a world where the world’s top construction companies – top-flight firms such as Shaw Group – post margins of 10%, HSOA blithely racks up 50% margins quarter after quarter. And that is from a subsidiary growing 400% during a construction recession and no disasters to name of.
Say it isn’t So
Home Solutions is a company that puts out press releases about everything … without concerning itself much with the truth. Yet, a few months back a deal was hatched that Home Solutions attempted to hide from investors. They were transferred the assets of a now defunct restoration and construction company called RG America.
Disclosed in the RGMI (now RGMIE) filings but not identified in any HSOA disclosure, RGMI transferred nearly $13 million in “accounts receivable” to HSOA. http://www.sec.gov/Archives/edgar/data/1088401/000114420407027323/v075998_10ksb.htm
If Home Solutions recorded this as revenue, than it would explain how they could keep their margins breathtakingly high as these appear to have 0 cost to HSOA. More importantly, were these receivables booked as new or were they properly aged? On January 1, 2007 these receivables were over 200 days old, which makes them now close to 400 days old. But more importantly, this forces us to ask the following questions:
Why has the company failed to disclose or discuss this transaction anywhere? It has never been mentioned in a filing or a conference call.
Are they attempting to borrow against these RG America receivables?
Are these receivable part of the portfolio that is supposed to be collateralizing a $60 million line of credit?
Would any bank in the current market environment allow this to pass the smell test?
Beyond RG America, how much of the current work was done for related parties and not disclosed, as recently suggested by the NY Post entitled, “Builder May be Going Bust”
At what point does this extend from what we believe to be securities fraud to bank fraud as well?
Just for Yucks
The CEO of RG America is Bruce Hall (just left) is on the board of MBIF. Frank Fradella is an investor in mbif and provided initial seed money. CEO of MBIF is Patrick McGeeney who is also on the board of HSOA. RGMI was an investor in MBIF.
The Proof is in the Numbers
Citron finds it humorous that Home Solutions refers to themselves as a “mini Shaw Group”. Why would they stoop to that? If anything the Shaw Group should strive to be a big Home Solutions: Home Solutions has repeatedly demonstrated 50% margins in a space where 10% is the gold standard. Home Solutions is such a well oiled machine that they are 500% more profitable than their competition.
This is also evident in internal growth.
Whereas most companies have difficulty growing organically in this space, for Fireline it has been a rocket ship ride.
One of two things must be happening:
The company is amazingly efficient and they are able to buck all trends in construction spending and disaster work. Their revenues and margins cannot be compared to any of their competition as they are in a different class than anyone else.
They are lying.
The Nostradamus of business
The twin PR’s – two news releases in May and June proudly announcing “$100 million contracts” have turned into the icons of the company’s undoing. Neither deal has ever been able to identify a counterparty capable of buying $100 million in services – or paying for it. The one thing that both deals have in common is that they both have counterparties that were created after the press release was issued. These guys are so efficient that they are able to predict business with companies that have not even been created…..take that, Jack Welch.
Having a discussion on whether someone actually gave Fireline two $100 million contracts is like having a conversation on who is tougher, Batman or Spiderman … the whole thing is ludicrous and we will not dedicate any more space to this obviously moot point.
We believe the clock is ticking on a looming liquidity crisis for HSOA. Maybe it’s a day, maybe it’s a week, and maybe it’s a month, but the company cannot continue to operate like this. In fact, it is not impossible that it may be bankrupt as you read this.
Work like they announced in last week’s PR — 11 separate projects for $12 million total – for bottom-rung jobs like kitchen rebuilds in elementary schools – can’t possibly save it.
Who gets em’ first…the SEC, the Bank, or the Vendors?
Cautious investing to all ….. and tick, tick, tick.
PS. For those of you interested, here is a picture of the New Orleans
Headquarters of the $200 million construction services company.