Alj Regional Hldg (OOTC:ALJJ) ($3.93) – ALJJ’s shares took a wild ride after the company’s annual report was released on December 31, 2014.  The release was accompanied by a press release that cited full year EPS of $.48 and $.20 for the three months ended December 31.  Initially the shares surged from $4.00 to $4.89 before quickly reversing and ending the day at $4.35.  The selling accelerated when trading resumed after the New Year’s holiday reaching a recent low of $3.57 on what was heavy volume for ALJJ.  The shares have since worked their way back to $3.93.

So what gives?  Why the surge, the plunge and quiet recovery in ALJJ?  We attribute the volatility to the following:

  • Deferred income tax benefit:  ALJJ recorded a deferred income tax benefit of $5.2 million in Q IV.  That represented around $.15 of EPS.  Some investors quickly discounted the tax benefit and focused instead on what EPS would have been without the benefit.  That was a reasonable reaction but investors should not lose sight of the fact that ALJJ has a $164 million NOL that could eventually translate to a $54 million tax benefit.  That’s an actual reduction of future income tax expense meaning that cash will be available in future years for purposes other than paying taxes.  That is a material asset that should not be disregarded by investors.
  • Q IV operating results disappointed:  Operating profits for ALJJ’s operating companies, Faneuil and Carpets, were sequentially down in Q IV from Q III, the first quarter to include the full operating results of both companies.  A quick glance at the accompanying chart reflecting Q III, Q IV and full year operating results for Faneuil and Carpets reveals issues that no doubt gave investors pause:
    • Revenues for Q III and Q IV were sequentially flat.
    • Total COGS as a % of revenue increased to 79% in Q IV vs. 76% in Q III with COGS for Carpets surging to 89.3% from 76%.
    • SG&A as a % of revenue increased from 13% in Q III to 16% Q IV with Carpets at 26% vs. 18% in Q III.
    •  Total operating profits for Faneuil and Carpets declined from $4.8 million Q III to $2.3 million in Q IV.   Most striking was that Carpets’ results swung from a $563,000 profit in Q III to a nearly $1.3 million loss in Q IV.

We believe Q IV’s operating results included factors that will not repeat in fiscal Q I 2015 when reported by February 15:

  • First year audits:  Faneuil and Carpets were both acquired in fiscal 2014 and were audited by ALJJ’s accounting firm for the first time.  First year audits always bring out unexpected adjustments that are catch-up in nature and should not be recurring in future periods.
  • Carpets had operating issues:  Management’s press release stated that Carpets had a difficult quarter and that corrective actions have been and are being taken to resolve operational issues.  One clear indication of a clean-up is the decline in Carpets’ inventory from $2.7 million at the end of Q III (June 30) to $2.0 million at the end of Q IV (September 30).  The decline in inventory despite sequentially flat quarterly sales tells us that when acquired effective April 1, 2014, Carpets was probably carrying too much inventory and/or aged inventory that had to be deeply discounted or liquidated leading to the spike in COGS to nearly 90% of revenue in Q IV.  If that’s the case, we can expect COGS to return to more normal levels in fiscal Q I.  Otherwise, we understand ALJ management is directly involved in managing carpets to resolve operational issues.  Those efforts should have begun to bear fruit during fiscal Q I ended December 31, 2014 and will certainly be fully reflected in future operating results.

Looking ahead to fiscal Q I when reported, we expect normalized operating results with COGS and SG&A as a % of revenues more in line with the results posted in Q III 2014.  We also expect Faneuil to show meaningful revenue growth in Q I as the company began providing services under a new health care contact services contract in California in early October.

We believe that once investors have the opportunity to compare what are likely to be strong fiscal Q I 2015 operating performance with Q IV 2014, and Q I 2015 to Q I 2014 for Faneuil, that ALJJ will respond favorably.  The future is bright for ALJJ so don’t get caught up looking in the rearview mirror.