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Saturday, September 24, 2005

Eternal Technologies (ETLT) 10-K

Eternal Technologies (obsolete website) is...
an agricultural genetics company operating in China and focused on the development and application of advanced animal husbandry techniques to produce improved food products.
Before diving into the details, consider some amazing things about this stock. It currently sells for about 45 cents. In early August it was selling for 20 cents. In 2004, it generated about 33 cents of free cash flow. In the last 6 months they earned 6 cents a share. So let's start with the most recent 10-K, Small Business version of form (10-KSB).

Full year ending Dec 31, 2004. Incorporated in Nevada. Offices in Suite D 5/F, Block A, Innotec Tower, 235 Nanjing Rd, Heping District, Tianjin, People's Republic of China 300052. Filed all reports required during last 12 months and been required to file such reports for at least 90 days.

They are an agricultural genetics company operating in China. Focus on development and application of advanced animal husbandry, especially embryonic techniques to shorten time for animals to reach maturity. Working on breeding sheep since 2000. Began selling lamb meat in 2003. Started on cattle in Q4 2003.

Pharm ops focus on gene engineering for biological drugs. Ceased operations in Sept 2004.

Reverse merger in Dec 2002 from Waterford Sterling Corp to Eternal Group. May 2000, acquired 100% of Willsley Company Ltd, a holding company incorporated in British Virgin Islands which owns 100% of Inner Mongolia Aershan Agriculture & Husbandry Technology Ltd. They operating a breeding center for sheep and livestock in Inner Mongolia.

Jan 2003, established relationship with Beijing AnBo Embryo Biotech Center. Originally a joint venture, but failed to agree on terms, so it's just a "close partnership".

Originally imported embryos from Australia and US. Currently producing a herd of "carrier animals" to produce domestic supply of embroys, removing dependency on 3rd party foreign embryo suppliers, reducing cost. Sell pregnant animals to customers. Offspring are breeding stock or commercial stock.

Government regulations related to plowing in Inner Mongolia may cause impediments to use of the farm for grazing. Final determination is pending. The sheep farm future is uncertain and it may be sold and the Company would rely on purchasing sheep from clients to support mutton production.

Very seasonal: nearly all revenue generated in Q4. Becoming less seasonal with the sale of lamb meat and embryo transfers to dairy cattle.

After WTO entry, China gov identified improved animal husbandry and key for China growth.
The Chinese agricultural industry has historically lagged behind Western
countries in the adoption of advanced breeding techniques. As a result, by world standards, Chinese breeding rates, size, health and meat yield have all been low and growing periods have been high. These factors have made quality meat difficult to supply within China without relying on imports, resulted in higher feed costs and waste production as a result of longer growing cycles and adversely impacted the competitive position of Chinese producers.
The Chinese government is trying to bring China up to world standards which will improve the lives of Chinese people [and presumably limit the chances of violent revolution against the current dynasty]. Improving standards also minimizes environmental impact.

Despite it's low productivity, China ranks first in the world for production and consumption of mutton. 2.55 million tons in 2001. China hopes to be a leading exporter in the future.

Milk consumption is increases (we saw this in a previous investment analysis of a Chinese agricultural company). Dairy productivity is about 50% of the US levels.

In 2000, the Company imported 10,000 breeding animal embryos out of a total of 13,000 embryos permitted to be imported by the Chinese government. These embryos were utilized to produce a herd of high-quality breeding sheep and supply of embroys for sale.

Company supplies large commercial and government farms in China with breeding stock, embryos, semen, and related technology and services. This was expanded to cattle in Q4 2003.
In our dairy cattle breeding and embryo transfer operations, we purchase
relatively high yielding dairy cattle in China, produce embryo's from these
cattle with advanced biotechnology and provide commercial dairy cattle through embryo transfer. After birth, retain the offspring to serve as breeder stock and sell the "host animal" back to the original owner.
Primary methods used:
peritoneal endoscopic technique: collection of sheep embryos by peritoneal endoscopes without surgery. Can be done about 10 times. This doesn't seem to make any sense from a medical point of view. Googling for it finds only the 10-K in question.
Peritoneal endoscope technique involves the collection of sheep embryo by means of peritoneal endoscopes without surgical operations. Traditional embryo collection and transfer techniques, using surgical procedures, have generally limited to four operations after which the provider is rendered useless as a result of adhesions left by the surgical procedures. We believe that the peritoneal endoscope technique, a less invasive procedure, may be used ten or more times, increasing the utilization of providers. Additionally, we believe that use of endoscopic techniques combined with deep semen deposition and frozen semen mating can markedly increase conception rates.
vitrificational freezing technique: They claim to be able to do this at room-temperature. Nothing I googled showed anything like this. Did this company discover Kurt Vonnegut's Ice Nine?
We have developed an anti-freezing protectant that
enables the freezing process to be carried out at room temperature without a cooling system, increasing the efficiency of the process. Livestock implanted with a frozen fertilized ovum have been shown to produce increased pregnancy and farrowing rates.
embryo splitting and cleavage ball techniques: This does make sense and is used in cloning. It's illegal to embryo split humans in certain countries.

external fertilization technique: cheap but only about 20% effective in China. The company has been able to reach 40% success which is approx the world standard.

The company has 2.8 million acres of farmland in Wulagai Development Area in Inner Mongolia (purchased from Chinese government for $6 million, the rights extend through 2025), an embryo transfer center, and a reception center, also the AnBo Biotech Center in Beijing (reminds me of Jurrasic Park?). 2.8 million acres is a square 60 miles on each side. This seems very large. Here's an interesting web page that raises some red flags about grazing land ownership in Inner Mongolia. Some maps. Wulagai seems to be located around 45.6 degrees north, 118.5 degrees east, which is just below the easternmost part of Mongolia, a few hundred miles northwest of the company's headquarters in Tianjin.
The farm is equipped with a 60-kilovolt electric transmission line, telephone
and transportation facilities, including a 200 kilometer road system connecting all sub-pastures. A railway station is located 80 kilometers [50 miles] south of the farm, facilitating distribution of products throughout China.

Also located on the farm is a 35,000 square foot embryo transfer center
including operating rooms, equipment rooms, offices, conference rooms, lecture halls and guest rooms. Substantially all research and embryo transfer operations occur in our embryo transfer center.
Sandstorms have been getting worse over the years and are even approaching Beijing (see the red flag web page above). They will probably be prohibited from plowing on the farm, which would be needed to support a large number of animals. They claim the land is still valuable because it hasn't been plowed, but who would want it and for what use?

The Biotech center is in Beijing.

Wulagai Development Area
China Continental purchased water rights by buying 2.6 square kilometers of land for their bottled water business in the Wulagai Development area.

They're looking to acquire companies or facilities for feedlot, dairy processing, slaughterhouse, and meat processing. Nothing current.

Competitors: Smithfield Foods from the US is in China. Also Sumitomo Corp of Japan. They both have a size advantage and name recognition.

Company applied for 3 Chinese patents.

There are extensive government regulations with a lot not-well-defined, possibly requiring future expenditures.

26 full-time employees. HQ is about 1,000 commercial square feet in Tianjin, $964 per month. 2.9 million acre farm purchased in April 2000.

2 legal proceedings: 1) Western Securities Corp. seeking $500K on 2 promissory notes, filed in Eastern Louisiana. Company filed to have it moved somewhere relevant. 2) Bristol Investments filed in NYC for failure to have a registration effective within stated period of time. Seeking $53,000. Company will settle, offering a convertable (at 20% discount to market price) debenture, 2 year maturity, unconverted amounts paid in cash.

979K shares of stock issued in 2003 to non-US investors for $277K. Later in 2003, issued 1.7 million shares and 1.2 million warrants (expire 2008) to 7 accredited investors for $1.3 million.

They started to purchase E-Sea earlier this year, but backed out successfully because they weren't able to audit E-Sea's financials.

Increase in 2004 sales was due to increase in sales of rolled mutton of $3.4 million, dairy cattle embryo transfers of $3 million, partially offset by decreases of $669K sale of lamb meat, $4.5 million in sheep embryo transfers.

Decrease in gross margins (to 38.7%) is due to loss of higher margin sheep embryo sales (down from gross margin of 57.7% in 2003).

Depreciation costs down due to some fully depreciated equipment.

SG&A increased due to accrued penalties associated with legal issue 2 above, and costs incurred in registration, increase in salaries, decrease in marketing expense.

Audit opinion includes a qualification about the prior operations of Waterford.
Auditors are Thomas Leger & Co. LLP, Houston, TX. Opinion on May 6, 2005. Karen (Ruikun) Tao is on their Chinese audit staff, the only one listed.

Balance sheet assets:
68% cash ($27 million)
15% fixed assets, net ($8.3 million cost, $2.4 million deprec)
12% land use rights
everything else is down in the noise
current ratio is greater than 10.

Liabilities and equity:
4% AP
94% equity

Income statement:
sales ($16.8 million) up 8% over prior year.
cost of sales: $10.3 million
depreciation: $760K
expenses: $1.58 million
taxes: 0
net income: $4.2 million (14 cents per diluted share)
30.7 million shares Dec 31, 2004. They issued 1.3 million shares during 2004 for employee compensation, plus 100K-ish amounts for various purposes.
1.29 million stock options issued in 2004 (strike 40 cents). Max allowed is currently 1.3 million. A new plan allows up to 500K shares. Assume about 34 million totally diluted shares.

Cash Flow:
operations produced $10.5 million (aided by drop in inventories and receivables)
capex: 0
nothing else significant

They sold property and received $1.5 million in inventory in exchange.
Inventory depreciation schedule is normal, includes $6 million land use depreciating over 25 years.

No allowances for doubtful accounts (none deemed needed).

Livestock inventory recorded at historical cost. Estimated costs are accumulated and capitalized as inventory. Embryo inventories recorded at cost. FIFO used.

Inventory: $621K
sheep and cows: $231K (up from $76K in 2003)
sheep and cow embryos: $364K (down from $1.1 million)
other raw materials: $25K (up from zero)

Dairy cow purchase agreement: Aug 2003, entered into contract to buy 2000 dairy cows at $2,750 each, total $5.5 million. Also agreement to sell them back during 2004. The cows were used for embryo production in Q4 2003. Buy-back for at least $1,700 per cow. Was completed. Total cost allocated to embryos was $2.1 million.

Company was trying to sell reception center in Q4 2003 (held as "construction in prog"). Impairment of $300K and shifted to property held for sale during Dec 2003 snapshot of balance sheet. Sold for even less and company took an impairment loss of $53K. Terms: cash of $620K, remainder paid in livestock worth $1.5 million. All received in 2004, noncash part in accordance with APB Opinion 29.

No material US dollar amounts (of anything) held.

The restatement for 2002 was based on Waterford's negative equity at the time of reverse merger. Impact was minor.

Two notes payable:
1) $402K to Market Management LLC, due Dec 11, 2005, 8%.
2) $41K to Thomas Tedrow, due Dec 11, 2005, 8%.
Company's board of directors elected to default on the notes (see legal proceedings above).

Income tax:
US NOLs of $1.76 million expiring in 2022 which is useless and is effectively written off (probably as a contra-asset).
Dividends and capital gains are not subject to tax in British Virgin Islands.
Aershan's current operations are exempt from PRC taxes, granted by Xilingol League (local government) and central PRC gov effective July 2000. This extends through July 2008. Savings so far have been $1.7 million in 2004 and $2.3 million in 2003. This boosted net income per share by 5 cents in 2004 and 9 cents in 2003. Don't forget to account for this.

China Continental (CHCL) is a related company. One of this company's former officers, directors, and current major shareholder (Shang Jia Ji) owns more than 10% of CCI and owned this company before the reverse merger.

Stoneside Development Limited, controlled by Thomas Tedrow (former principal shareholder and former officer of this company) contracted to do investor relations for $10,000 per month starting in June 2002. This was cancelled in 2004. Now it's a legal proceeding.

There was one majority supplier in 2003 (53%) and some major suppliers. In 2004, the majority supplier is gone, but there are suppliers of 30%, 16%, and 35% of purchases.

There are some major customers: 39%, 24%, 20%, and 16%.

Jijun Wu, 68, Chairman
Was president before the reverse merger. Was Accountant General for a large state-owned electronics enterprise in PRC. Also a consultant to foreign companies entering the PRC market. CPA.

Jiansheng Wei, 52, CEO
was COO. was VP-GM of Towering Industrial Group (had interactions with this company). 30 years in animal husbandry. Ran several operations in Inner Mongolia and Hebei province. MBA from Tianhin Finance and Economics College.

XignJian Ma, 58, CFO and director
was Chief of Financial Dept of Tianjin Electronic Instrument Corp (possibly same company as Chairman was in, why hide it?)

Garfield W. Hu, 30, Secretary
was instructor at Tianjin Normal University and Nankai University and translator and advisor for largest Chinese IT website, yesky.com.

6 other directors.
One of them, Tielan Liu, was supposedly installed on the board after the E-Sea acquisition, but that never occured.

This one is interesting:
He [Shien Zhu] invented a system of freezing and preservation, not aided by a cooling frigorimeter, which is characterized by low cost, simple operation and a high embryo survival rate. In recent years, he has written more than 40 articles that were published in international and domestic periodicals. Currently, he is undertaking vital projects for China and scientific research projects under the "Ninth Five-Year Plan" period.
Some webpages related to this guy: here
And this one:
Instead of using expensive embryo freezing humor, the vitreous humor is able to complete the freezing preservation of bovine embryo in a few minutes, which changed the traditional freezing method that may take several hours to complete the process. Started from last October, they have worked on excessive ovulation of eight imported cows. Seven days after being inseminated, embryos were collected non-surgically from cows' uteri. 12 healthy embryos were selected and preserved in vitreous humor. All 12 defrozen embryos that had been kept in liquid nitrogen for 1 to 13 days have been proven usable. The embryos were then transplanted non-surgically into 9 cows with five of them getting pregnant.
Executive compensation is embarassingly low. The highest salary is $27,299.

Shang Jiaji owns 14.67% of the company.
Jijun Wu owns 7.84%
James Q. Wang owns 3.59%
Tieliang Jiu 2.28%
Jiansheng Wei 2.37%.
All officers and directors: 31.9%

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