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Sunday, September 25, 2005

Eternal Technologies (ETLT) comments etc.

The company also re-issued 10-Q statements from last year.

Q3 2004 re-issued on 8/19/2005
Q2 2003 re-issued on 8/29/2005
Q3 2003 re-issued on 8/29/2005
Q2 2003 re-issued on 8/29/2005 again

Doing a "diff" between originals and these, nearly all of the changes are cosmetic, which is really frickin odd. These people seem to have no idea how paranoid investors are about restatements. However, some of the changes are material.

In Q2 2003, the original had shown $91K sales for Q2 2003 and $119K sales for H1 2003, with no cost of sales. This was changed in the restatement to sales of zero for Q2 2003 and $28K for H1 2003. This then affects all the numbers below them. Actually, the changes below the sales and gross margins are not material based on what I read in Wiley GAAP (but the sales figures themselves are material and thus the other numbers must change also). I've seen this kind of confusion before in a Chinese reverse merger.

The second restatement of Q3 2003 was amazingly trivial
pink-sheets-prompt> diff -u Q2_03 Q2_03_again
--- Q2_03 2005-09-25 10:33:34.743945056 -0400
+++ Q2_03_again 2005-09-25 10:32:58.477458400 -0400
@@ -1,7 +1,7 @@


The filename. D'oh!

Q3 2003 has some more interesting differences from the original, such as this minor change:
-TOTAL ASSETS $ 29,322,381 $127,843,422
+TOTAL ASSETS $ 29,322,381 $ 27,843,422
Ok, so they were off by $100 million. Big deal!

Also, prepayments of $1,060,241 changed to deferred revenue of $1,151,325.

Later on, a Notes payable moves from operations cash flow to finance (duh!), again the prepayment changes to deferred revenue, etc.

The prepayment was from the sale of a sheep embryo transfer contract. The customer pre-paid 70% of the total with expected conclusion within the same fiscal year.

Other than the signature dates, here's the only remotely significant difference between the original Q3 2004 and the restated version (there were lots of tab changes, blank lines added/removed, etc.).
Item 3. Controls and Procedures
+As of the end of the period covered by this report, we have evaluated the
+effectiveness of the design and operation of our disclosure controls and
+procedures under the supervision of and with the participation of our Chief
+Executive Officer ("CEO") and our Chief Financial Officer ("CFO"). Based on this
+evaluation, our management, including our CFO and CEO, concluded that our
+disclosure controls and procedures were effective, and that there have been no
+significant changes in our internal controls or in other factors that could
+significantly affect internal controls subsequent to the evaluation.

- (a) Evaluation of disclosure controls and procedures. Our chief executive
-officer and our chief financial officer, after evaluating the effectiveness of
-the Company's "disclosure controls and procedures" (as defined in the Securities
-Exchange Act of 1934 Rules 13a-14(c) and 15-d-14(c)) as of a date (the
-"Evaluation Date") within 90 days before the filing date of this quarterly
-report, have concluded that as of the Evaluation Date, our disclosure controls
-and procedures were adequate and designed to ensure that material information
-relating to us and our consolidated subsidiaries would be made known to them by
-others within those entities.
- (b) Changes in internal controls. There were no significant changes in our
-internal controls or to our knowledge, in other factors that could significantly
-affect our disclosure controls and procedures subsequent to the Evaluation Date.
Here's a press release from Monday, Sept 19.
They hired Ms. Zheng Shen as CFO.
Ms. Shen is a graduate of Tianjin Finance and Economics University where she received a doctorate degree in 2002. Previously she had received her certification from the ACCA of the UK and her certificate as an International Certified Internal Auditor. She is an associated professor of accounting and a Chinese CPA. In joining the Company, Ms. Shen will play a significant role in the anticipated Chinese acquisition and the operations to be established in the US.
Red flag patterns
When we step back and look at all the red flags, do they form any pattern? What do they imply?
British Virgin Islands
peritoneal endoscopic technique doesn't seem to make sense [other techniques did make sense]
grazing rights on a very large farm, larger than Rhode Island, for a quarter million dollars a year [it's crappy land]
issues with grazing in Inner Mongolia [company addresses those same issues]
board of directors elected to default on some notes
tax holiday boosts apparent earnings [adjust for them]
two suppliers provide 65% of supplies, another 16% [a 53% supplier disappeared and a 35% supplier appeared in 2004, so it doesn't seem to be as dramatic as expected]
major customers: 39%, 24%, 20%, 16%, that is 99%! [a 13% customer went away and a 20% customer appeared in 2004, again, this seems less critical than expected]
two directors may have come from the same company and the statement may be hiding it
a director was supposedly installed on the board after the E-Sea acquisition which never occurred [of course this director is one of the three gone now]
why didn't the 8-K or the proxy mention the stock option plan?
auditors were dismissed
error in translation greatly exagerating revenues [I've seen similar errors in Chinese reverse mergers]
errors in re-issued quarterly reports [similar errors in Chinese reverse mergers]
three directors not up for re-election [one was the E-Sea guy above, one was an internal manager, one was a very outside director]
no audit committee ["the entire board is considered the audit committee", XingJian Ma is determined to be the audit financial expert according to 10-K]
huge increase in AR without answers [but it has jumped up and down by equivalent amounts in the past]
$6 million used in cash flow in H1 2005 [caused by huge increase in AR]

As far as a pattern goes, most of this seems to be a pattern of Chinese reverse mergers: errors in SEC docs, troubles with US stragglers after merger, auditors changing. The only red flag that sticks out in my mind is the one about the embryo procedure.

So what's the stock worth?
In 2004, they would have earned 9 cents if they paid taxes. They will begin paying taxes in Q3 2008. There's a large liquidity advantage to the tax holiday that adds some value beyond just the tax benefit, but I'll ignore that for valuation purposes. I believe it's reasonable to expect that 9 cents of earnings to increase to at least 11 cents within the next few years. Assuming a P/E of 15, the stock would be worth $1.65. I'd discount that to about $1.50 to the present. Given various uncertainties, I'd add in a margin of safety of perhaps 40 cents and assume the stock is worth $1.10. Considering that it's selling for something like 45 cents, I'd call this an acceptable investment.

I un-hid these posts before I finished buying because I'm starting to find more ideas than money to invest. It's been, what, 4 years since I've been able to say that? I have another potential investment in the pipeline and a few other possibilities to boot. But it really pissed me off that someone else found ETLT before I did and drove the price up. And the other investment in the pipeline is the same thing.

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