Last October I was working through a spreadsheet of dark unlisted companies and happened across Kyzen Corporation, which deregistered its shares in 2004. Kyzen got its start manufacturing alternative cleaning agents for industrial processes. Many solvents used in these processes once contained CFCs, which were discovered to be wreaking havoc on the ozone layer. When CFCs were banned by the Montreal Protocol, Kyzen stepped in with more environmentally friendly products. Kyzen also engineers cleaning processes and provides contract cleaning services. Two thirds of Kyzen’s sales are to customers outside the US.

Though I was able to learn about Kyzen’s products and history, I could not locate any recent financial statements. I spent $12 to buy ten shares, hoping I would eventually receive an annual report.

That report arrived last week in the form of a sparse-looking black and white printed booklet. I paged through it, taking note of Kyzen’s operating results and financial position. What I found was encouraging, but I had a problem at hand.

When I look at a company’s results, I rarely focus solely on the most recent period. I like to compare recent results to the past five years or so. Doing so tells me a lot. First, I can get an idea of normalized profitability. If this year’s margins were unusually high or low, that may suggest that future periods will see a reversion to the mean. It could also mean the company has undertaken a strategy shift that will permanently change margins, or that general industry conditions have changed. Regardless, it is easier to assess the meaning of these data points by comparing them with previous periods. Once I have an idea of normalized earnings power, I can see if the current market value is justified.

Examining results over multiple periods also helps me assess management skill. If management continually reinvests earnings back into operations, I had better see growth! There’s not much worse than a company that consistently reports profits only to squander them due to bad capital allocation. In the long run, management skill shows up as growth in book value per share, adjusted for dividends.

Finally, I examine the company’s balance sheet for trends in leverage and liquidity. I care very little about the absolute amount of debt on a company’s balance sheet. Rather, I care about the debt relative to debt capacity, and the trend of that capacity. If a company is suffering from stagnant or declining revenues and margins, if had better not be taking on more debt and should probably be reducing the existing balance.

With Kyzen, much of the information I desired was missing. The 2012 annual report I received had figures for 2012 and 2011, but everything from 2004 to 2010 was a mystery. Luckily, Kyzen’s business is little-changed from a decade ago. The company is still manufacturing the same products and providing the same services, so looking at such old data can still be useful.

Normalized Profits

For 2012, Kyzen earned $1.07 million on revenue of $19.83 million. EBITDA was $2.14 million and operating income was $1.71 million. Here are the company’s results for 2012 and 2011, compared with figures from the company’s last five publicly filed 10-ks.

What a difference! 2012’s revenues are 3.4 times higher than the 1999-2003 average. Kyzen’s operating margins have reached the high single digits, no longer languishing below zero.

But is it sustainable? Kyzen’s 2012 profits were four times higher than 2011. Which is the anomaly?

First, gross margins. From 1999-2003, Kyzen’s average gross margin was 54.26%. 2012’s gross margin of 52.73% is much more in line with the average than 2011’s 44.89%. At the current revenue level, normalized gross profits of $10.45 million or a little higher seem sustainable.

Operating expenses ate up 44.12% of revenues in 2011 and 42.19% in 2011. By comparison, operating expenses averaged 55.85% of revenues from 1999-2003. Before concluding that operating expenses are due for a dramatic increase, remember that Kyzen’s revenues are more than triple what they were a decade ago. Positive operating leverage tends to increase operatings margins as revenues increase, because many operating expenses do not scale linearly with sales growth. In absolute terms, 2012 operating expenses are 2.7 times what they were in 2003. I view the 42-44% operating costs as normal and sustainable.

Since Kyzen’s margins seem sustainable, so do its profits. Barring a decrease in demand for Kyzen’s cleaning products, the company should be able to produce a repeat peformance in 2013.

Management

Kyzen Corporation pays no dividends, retaining all profits for growth. Because they receive no income from their investment, shareholders should look to management to growth book value per share at an acceptable rate. Kyzen’s management has lived up to that expectation.

When Kyzen went dark in 2004, it had a book value per share of $0.40 with 4.69 million shares outstanding. Nine years later, book value has risen to $1.73 per share and shares outstanding have been reduced to 4.08 million. That’s an annualized increase in book value per share of 17.5%, excellent by any standards. From 2011 to 2012, book value per share increased by 14.88% as shares oustanding declined by 2%.

Management has shown great skill in capital allocation. For as long as management can continue to find worthwhile investments, they are justified in retaining and reinvesting profits.

Balance Sheet

Kyzen maintains a strong balance sheet with $0.65 million in net cash. The company is slightly more levered than it was in 2003, but remains conservatively financed.

As Kyzen’s revenue and profitability has grown, so has its debt capacity. If management saw fit, Kyzen’s balance sheet could bear additional debt for continued share repurchases or capital projects.

Valuation

Shares are bid at $1.21 and offered at $1.38. Kyzen is cheap at either price.

Kyzen is quoted at a P/E of 4.6 to 5.3, an EV/EBITDA of 2.0 to 2.3 and an EV/EBIT of 2.5 to 2.9. Kyzen is in great shape, with strong profits, capable management and a sound balance sheet. A P/E of 10 would yield a share price of $2.62. At an EV/EBITDA of 5, the company would be worth $2.78 per share.

If the next nine years are anything like the last, Kyzen shareholders will do exceptionally well. But don’t expect to hear about Kyzen’s results in the news! Kyzen sends out only one report per year, and only to shareholders. Would-be investors must be content to be left in the dark. Investors should also remember that Kyzen is extremely tiny, and illiquid.

I own shares in Kyzen Corporation.