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Sunday, October 30, 2005


See the next post for summary and details (and Q2 results).
see here for a Nov 2006 update.

I keep trying to figure out what to tackle and how to tackle it with HQSM. Every time I look at a company that's not really simple, I run into the same problem. I need to get a better understanding of the business and there are two major directions that could be taken.
  1. Walk the process. In other words, simply go through all the documents in some rational order, taking notes. At the end, hopefully I'll have the understanding I'm looking for. If this is going to become an investment, this is definitely the quickest and most effective direction to take because I need to go through all the stuff anyway. The downside is that I might not find an obvious showstopper until nearly all the work is done. And it could be something that would be easy to find (and quickly found) using method #2
  2. Search through the documents looking for answers to specific questions. This is good for weeding out bad investments quickly. However, at the end of the process, I still have to do method #1 anyway.
I use method #2 for the earlier phases of analysis and method #1 for the later phases. So I guess in this case, I'm just concerned that there's some fairly blatant showstopper here. Usually when I start the final phase, I already have a good mental picture of the business. Right now, I can't say that for HQSM. I've tried looking for obvious ways to find "the big problem" without much luck. So I'm just going to dive in to method #1.

Incorporated in Delaware. Executive offices in NYC.
NOTE: Transitional Report for May 1, 2004 to Dec 31, 2004.
Incorporated as Sharon Capital Corporation in 1989 (Nevada) as a blank check company. 1990 changed to PEI, Inc. Then changed to Process Equipment Acquisition Corp (Nevada) (PEQM.OB). March 17, 2004, the Company merged with British Virgin Islands company Jade Profit Investment Limited. Company thus ended up with an 84.42% ownership in the subsidiary Hainan Quebec Ocean Fishing Company Ltd, a PRC llc ("HQOF") also here. April 2004, Company changed its name to HQ Sustainable Maritime Industries, Inc. and incorporated in Delaware, all effective in May 2004.

August 17, 2004, HQSM acquired Sealink Wealth Limited, which was a subsidiary of Sino-Sult Canada Ltd. Sealink was incorporated in British Virg. Isl. Sealink is sole owner of Hainan Jiahua Marine Bio-Products Co ("Jiahua") a limited liability company in PRC. They sell stuff like seal genitals (mmmm... seeeaaal genitals).

This purchase of Sealink (contract contract) was a related party deal (same people involved in both HQOF and SSC):
SSC [was] owned by Harry Wang Hua (51%), Lillian Wang Li (25%), and Norbert Sporns (24%) (collectively, the "SSC Owners"). Lillian Wang Li [Chairman of HQSM] and Harry Wang Hua [COO of HQSM] are brother and sister. Lillian Wang Li is married to Norbert Sporns [CEO of HQSM]. The SSC Owners are current directors and executive officers of HQSM, as well as, collectively, indirect beneficial owners of the majority of its capital stock.
The terms of the deal were:
The consideration of the acquisition is $20 million in terms of 12,698,078 shares (equivalent to $8,888,655), $11,011,345 promissory note convertible to 15,732,493 Class A shares and $100,000 promissory note convertible to 100,000 Series A preferred stock with par value at $0.001 per share. Both promissory notes accrue interest at the rate of 5% per annum. 12,698,078 shares were issued to SSC on August 17, 2004 after the Purchase Agreement was signed. And $11,011,345 of promissory notes were converted to 15,732,493 Class A shares on November 18, 2004.
Also on August 17, 2004, they bought out the rest of HQOF, with appropriate PRC government approvals. Cost was $5,695,145 cash paid on Halloween 2004.

Analysis: HQSM paid a total of $26 million for Jiahua. In the first half of 2005, Jiahua earned perhaps $1.2 million. If this can be extrapolated, then Jiahua would be worth $36 million. Jiahua requires less capital, has higher margins, and is a more profitable business. So why screw around with HQOF?

In April 2004, HQSM US was formed and registered, but was dormant. In June 2004, HQSM Canada was formed and started business development operations (sales and mktng).

Main business is
The Hainan aquatic products processing plant was designed in Canada. The plant had 2 production lines, but that was expanded to 6: 2 filleting lines (3,000 tons/year), 2 hole fish lines of tilapia gutting, scaling, gilling (10,000 tons/year), 2 shrimp lines (3,000 tons/year). The plant has 2 shifts. They are HACCP certified for export to the US and Japan (but some other Hainan producers also have these certs*). They also have an EU Code for exporting to the EU. Only two Hainan Province producers have a code, which are supposedly difficult to get. Restricted trade is good for business insiders while free trade is good for consumers. Thank you, EU. Also acknowledged as "eco-friendly" by the Canadian International Development Agency (CIDA) which provides government-to-government aid for developing countries like China. They provided technology transfer to the business in Hainan (this one?) in exchange for "detailed environmental and social (gender) impact studies." [yeah, sure, we'll tap dance for you evangelists in exchange for your technology]

* HQSM claims that they know of no other competitor in Hainan that has a similar scale and production capacity or that has the vertical business model. Note that Hainan is the best place in China to farm tilapia because of the year-round climate.

Jiahua Marine subsidiary provides capacity to make nutraceuticals to enrich feed for tilapia and shrimp in Hainan. They're working with the US to improve the feed (health, feed conversion, meat quality, and boost their immunity to disease).

Jiahua marine bioproducts factory. Located in Wenchang City of Hainan. 180K sq ft and a construction area of about half that size. Two production lines: powder line, oil line. Jaihua has HACCP ceritification from China Entry-Exit Inspection and Quarantine Bureau.

Jiahua sales in 2003 were over $7 million, $2.7 million net profit. Sales in 2004 were higher (unspecified). Looks like only $3.2 million of the 2004 Jiahua sales were to external customers.

Jiahua research and development: Marine Organism Research Institute. Clinical trials, lab testing have resulted in National Certification for "various healthcare products". Won some awards in China. This group has a long-term relationship with Qingdao University of Oceanography (intro) (enterprises) (alumni for searching).

Chinese patents:
460000X340-2001: shark cartilage health benefits (suspicously high number of unrelated benefits).
460000x131-2001: more shark catilage stuff (same red flag)
460000x338-2001: shark liver oil
460000x342-2001: shark liver oil for nursing mothers
"The above products have been shown to be effective."

Jiahua has adopted a sales strategy of large scale tours in popular tourist areas. Products started selling in Hualian Supermarket Co. (1200 outlets, $2 billion in sales)

March 2005, Jiahua finalized an agreement with American River Nutrition providing HQSM with technology (for boosting immune system of shrimp). ARN is also into stuff like this (which, in March 2005, is HQSM's entry into the North American market for voodoo medicines... that's just what I call it)
DeltaGold® is a registered trademark of American River Nutrition, Inc. and is protected by US Patent no: 6,350,453 and patent pending application No: US 2005037102.
Nine people in Jiahua sales and marketing, led by Harry Wang, COO [you were thinking of some culturally insensitive snide joke, weren't you?].

There are some barriers to competition due to the high cost of infrastructure (but it's clearly not all that high).

In 2001, HQOF was recognized as a "Leading Agriculture Enterprise" by Hainan Provincial Government, which helps at trade shows such as the Boston Seafood Show (which I just missed, it was in October).

There are "significant" economies of scale with HQSM. R&D and QA can monitor larger operations without new hiring. Larger buy orders can be made with long term supply orders. They made an odd statement: "Large buyers are able to sole source instead of having to group supply from various producers...."

April 2001, they received the "New/high tech Enterprise of Hainan Province" award by Hainan Provincial Technology Authorities.

Jan 2003, they received the "Industrial Enterprise of the Province"

2002, they were named "Leading Agriculture Enterprise" for both Hainan and Wenchang provinces.
[Googling these things only shows HQSM's statements]

March 2005, they received the "prestigious China Excellence Award" for health product excellence and advancement of of China business practices, by the China Association of Entrepreneur Foreign Investment (CAEFI), can't verify.

HQOF and Jiahua together have 434 employees, all full-time, mostly in Haikou, PRC. The rest are in Wenchang, PRC.

The land is rented from PLA Haijun No. 4802. Lease expires in 2009. Rent in $26K per year. The health and bio-product processing factory costs $81K for 50 years (from 2000). There's a coconut producer on the same road as the factory.

No material legal proceedings.

Stock transactions:
The fiscal year has been changed from April 30 to Dec 31 (reason for the transitional report).

8 Month Results

Jiahua contributed $3.2 million to sales. Gross margins were 83%. Advertising costs were 52% of sales. Net income was $1 million. This was August 17, 2004 to Dec 31, 2004. This would annualize to sales of $8.5 million.

The original fish farming sales were $17.5 million for the 8 months of 2004 (was $10.8 million during the same 8 months in 2003). Gross margins were 14% during 2004, but 31% during 2003. They intentionally pushed gross margins down in 2004 to attract customers and make up for lost revenue, also the supply from local fishermen dropped significantly due to frequent bad weather in Hainan causing higher supply costs. Net profits were $2.8 million in 2004 ($490K in 2003). Um, where's the SG&A? Why are(n't?) gross profits higher than net profits?

Selling and distribution costs were $331K or 1.6% ($474K or 4.4% in 2003).
Advertising costs were $1.7 million or 8% (zero in 2003).
G&A was $1.9 million or 9% ($672K or 6% in 2003).
Depreciation $509K ($210K in 2003).

Provision for bad and doubtful receivables zero ($800K in 2003). Debts were slowly recovered during the shutdown but all debts were collected afterward, and all receivables are now current so they used zero provisions here. NOTE 3P boilerplate really contradicts what they're saying. Not to mention...

From Wiley GAAP 2002:
The recording of a valuation allowance for anticipated uncollectable amounts is almost always neccessary. The direct writeoff method, in which a receivable is charged off only when it is clear that it cannot be collected, is unsatisfactory since it overstates assets and results in a mismatching of revenues and expenses. Proper matching can only be achieved if bad debts are recorded in the same fiscal period as the revenues to which they are related. Since the amount of uncollectable accounts is not known with certainty, an estimate must be made.
There are two estimate techniques:
The direct writeoff method is used for income taxes, but not for GAAP accounting.

The giant increase in "other income" is due to large bad debt recovery. I'm not sure if such as large percentage should still go on other income or if it's an extraordinary event. I treat it as extraordinary, myself.

No income taxes. Deferred tax for the period was $194K (vs $120K), the increase due to timing of provision for bad debt being eliminated and recovery of bad debt.

Liquidity: financing has normally been done via operations. This should be sufficient, except for temporary periods of rapid growth. The decrease in the current ratio is mainly due to buying out the minority interest in HQOF.

Most important of the risks, in my view:
It's worth noting there that HQOF and Jiahua are Foreign Investment Entities (FIEs) and subject to restrictions in foreign exchange. They are permitted to exchange current account items and after-tax dividends. But things are never without exceptions.

Auditor Report
Auditors are Rotenberg & Co of Rochester, NY. The report is dated March 16, 2005. There are no qualifications. These auditors are not on the list of top auditors of SEC clients. They audited or are auditing CHFI (which I looked at earlier, can't find them elsewhere other than the FAQ), OZLU (OTC BB, seems ok), ZEOM (OTC BB), Epsey Manufacturing & Electronics Corp (ESP), Contact Capital Group (which seems kind of scummy).

Rotenberg & Co replaced Baum & Co who resigned. Baum had their own issues with the Public Company Accounting Oversight Board. Numerous infractions.

Balance Sheet
Current assets are half trade receivables and nearly half cash. Very low inventories. $389K due from related parties (net of provision???) So they have a provision for a related party but not for customers? You'd think that you'd know which related parties were trustworthy/solvent and which ones aren't. Another $27K advanced to an employee.

Current assets: $4.6 million
Trade receivables: $5.4 million
Deferred taxes: $1.2 million
Total assets: $21 million

Current liabilities: $9.2 million (about half accrued expenses, half bank loans)
Total liabilities: $9.3 million
Equity: $11.6 million

Income Statement
The "8 Month Results" above are really better than looking at the consolidated results. And 2004 was a weird year for them. Can't really compare 2004 with 2003 (and 2005 won't be very comparable to 2004).

Sales: $21 million
Gross profit: $5 million
Selling: $331K
Advertising: $1.7 million
G&A: $1.9 million
Deprec: $509K
Finance costs: $400K
Other income (recovery of bad debt): $2.6 million
Deferred tax: $194K
Minority interest: $235K (goes away in 2005)

Share count at end of year is 95 million (it's now over 100 million).
25 million on April 30, 2004
Issued 70 million during 2004 (plus warrants, see Stock Transactions above)

A realistic bottom line would be to add at least $400K for provision for doubtful accounts, remove the $2.3 million of other income and put it into some extraordinary category. This would give them a net loss from operations of about $182K. This isn't so bad because they had shut down for part of the year.

I truly don't understand one part of the financial statements. On the equity statement, they issued 70 million shares which raised the paid-in capital by $22.5 million. Then they subtracted the exact same amount as "Adjustment from acquisition of Assets under cost basis", which essentially means they paid $22.5 million for something worth zero? It was all goodwill, but that goodwill doesn't show up on the balance sheet.

If we look at the cash flow statement for 2004, everything in operating activities looks normal except for a $22.5 million negative which results in about $18 million used in operating activities. Wait a minute, that wasn't operating activities, it was investment or at least finance.

Finance produced $20,755,288 as "proceeds from common stock". But this was wiped way by "Goodwill adjusted for reorganization process" of $22.5 million. I don't understand how operations destroyed $22.5 million. If you flush $22.5 million down the toilet, isn't that investing activities?

Capex was $6 million. But there's an entry outside of capex called Acquisition of PP&E. How is that not "capital expenditure"?

They received $1.2 million in cash from an acquisition along with $409K in PP&E.

Trade receivables on the balance sheet increased from $2.4 million to $5.4 million. In cash flow from operations, they subtracted $2.54 million as a decrease in provision for doubtful account. But there's also an entry for "trade receivables, net of provisions" of $3.8 million. I hope the "net of provisions" really applies to 2003 and that it's zero for 2004. But there's something really, really weird: the decrease in provision for doubtful account in 2004 is $2,535,047. There's also a decrease in provision for doubtful account in 2003 for $2,535,047, the exact same amount!! This is Fouled Up Beyond All Repair: FUBAR.

I can't understand this financial statement. Maybe it's just me, but how could they possibly have a change in provisions two years in a row of exactly the same amount down to 1 part per 2.5 million?

The $100,000 promissory note (which is also listed in the supplemental disclosure of non-cash investing and financing activities) is listed in the cash flow from operations. This seems like it's definitely finance. Didn't I cover something exactly like this recently? Another Chinese reverse merger had an issued note payable under operations.

I suspect it's very difficult to put together an 8-month transitional financial statement. You have to compare two different 8-month periods with a gap of 4 months in-between that you must somehow deal with. I don't see how this could pass an audit. Rotenberg & Co expressed their opinion for both periods of the cash flow statement. And NOTE 2 states that the statements are prepared according to US GAAP.

Depreciation schedules (straight line)
Taxes accounted for by liability method.
8.3 renminbi to the dollar.
revenue recognition is when merchandise is shipped, title passes, and collectability is reasonably assured.
$175K shipping and handling in 2004 ($290K in 2003), included in selling and admin expenses.

Fish farmings sales in 2004: $17.5 million
Selling: $303K
Advertising: $0
Finance costs: $156K
Profit before tax: $3.24 million
Tax: $194K
Net Profit not including G&A: $2.8 million

Health and bio-products sales in 2004: $3.24 million
Selling: $28K
Advertising: $1.7 million
Finance costs: $50K
Profit before tax: $1 million
Tax: $0
Net Profit not including G&A: $1 million

G&A: $1.9 million
Finance costs not associated with segments: $194K

Note 3Q: They mention SFAS 149 which makes changes for derivatives and hedgding. They aren't using any of this, so they should make a statement saying this has no material impact on financial statements [of the future]. But they say nothing: not even that it's being evaluated. They do say the right thing about SFAS 150 and derivatives. Also for the other accounting pronouncements.

NOTE 4: Trade Receivable
Jan 2004 starts off with $829K allowance for doubtful accounts.
$1.5 million is added to this during the first 4 months of 2004.
April 30, 2004: allowance = $2.35 million
This is entirely written off during the last 8 months of 2004.

This makes the duplicate numbers for 2003 and 2004 in the cash flows even more bogus.

Dec 2004 PP&E is mostly plant and machinery ($8.5 million) with some buildings and leasehold improvements ($2.8 million).
April 2004 PP&E is nearly all plant and machinery ($3 million).

Gross PP&E increased by $8.2 million during the last 8 months of 2004 to $11.5 million.

Depreciation is nearly all plant and machinery.

Three expired bank loans (all secured by fixed assets):
  1. $1.8 million (6.588% interest)
  2. $964K (6.588% interest)
  3. $1.7 million (5.04% interest)
Currently negotiating with bankers to extend these loans.

PRC Taxes (no tax benefit or burden for US):
Statutory rate: 15%
Tax holidays and concessions: (7.5%)
Effective rate: 7.5%

Deferred tax asset (liability method):
Jan 2004: $1.426 million
April 2004: $1.403 million
Dec 2004: $1.209 million

PRC reserves: $1.1 million (vs $957K in April 2004). Can't make any cash distributions until these are satisfied at the discretion of the board of directors as per PRC GAAP. If the statutory reserve reaches 50% of the registered capital of the company, then the reserve doesn't increase any more.

Stock option plan:
Dec 2, 2004 non-qual plan approved
$0.28 strike price, 10 year expiration, immediate full vesting
Norbert Sporns: 500K
Lillian Wang: 500K
Harry Wang: 500K
Fusheng Wang: 1 million
CFO Dallaire: 200K, 1/3 vested per year
5 million more reserved
Total dilution from stock options is 7.5 million

Credit Risk:
Top 5 customers accounted for 57% of AR (15.9% of sales, 12% of sales, 10% of sales), aggregate of 38.5% of sales.

No legal proceedings

Executives and Directors
Norbert Sporns <== married ==> Lillian Wang Li <== sister/brother ==> Harry Wang Hua
Fusheng Wang == father ==> Lillian and Harry Wang

Fusheng Wang is Honorary Chairman and received 1 million options

Lillian Wang Li, 47, Chairman of the Board ($187K) owns 18.3% of the company via Red Coral Group Ltd. (no website)
HQSM founder. 25 years in management of Chinese and Canadian businesses. Graduated Beijing Univerisity (Euro and Chinese lit), Certificate of BA Concordia University in Canada.

Harry Wang Hua, 41, COO, Director ($150K) owns 37.3% of the company
HQSM founder (esp operations). Civil engineer, Beijing University. 15 years in startup company management in China and Canada. Also many years training Chinese middle managers in Western standards.

Norbert Sporns, 50, CEO, Director ($150K) owns 17.6% of the company
HQSM founder (from 1997). University of British Columbia (philosophy), bachelor of civil law degree and bachelor of English common law from McGill. Certificate of Tax Law, Certificate of Condominium Law, Diploma of Notarial Law from University of Montreal.

Jean-Pierre Dallaire, 53, CFO, Director
Fusheng Wang, 71, Honorary Chairman, Director
Jacques Vallee, 52, indpendent Director
In charge of business development and financing with Altitude Consulting Group (no website). MBA Sherbrooke. Advanced Certificate in BA from University de Quebec a Trois Rivieres. Post-grad level Advertising Mgmt Diploma from Ecole des Hautes Etudes Commercialese (Montreal). 30 years mgmt experience. Bank of Montreal and other places.

Fred Bild, 67, independent Director
Visiting professor at University of Montreal's Centre of East Asian Studies. Private consultant on political and economic relations with China and East Asia. Has been Ambassador to various countries from Canada.

Daniel Too, 52, independent Director
Grad of Hong Kong University and Polytechnic. Managing Director of Delta Elevator Far East. Director of Voker Chemical Paint Ltd. (no website)

He Jian Bo, 37, Manager Finance Dept.
Bachelor's and Masters in economics from Southwestern University of Finance and Economics, PRC. Joined HQSM in 1999.

Liam Haniffy, 37, Sales and Quality Production Mgr

Wang Fu Hai, 60, Chief Production Controller
Chief Production Controller and Engineer at HQSM. Joined HQSM in 1997.

Barron Partners LP owns 3.6% of the company.

All executives and directors own 73.28%.

UPDATE: Rotenberg and Co. gave an unqualified audit opinion on what seems like either outright fraud or else extremely unethical.

UPDATE Dec 21, 2005: There's just too much red here, too many red flags.

HQ Sustainable Maritime Industries (HQSM)


HQSM (yahoo, website) is involved in ocean fishing, fish farming, and fish processing. They have 4 ships. They also have a deep sea duty-free port (the only foreign joint venture in China to have one). They continually pass USFDA inspections. Sales and marketing covers the US, Canada, Japan, Korea, China, and Southeast Asia (offices in NYC, Montreal, Beijing, Shanghai, and Haikou). They participate in international seafood shows in Boston (I didn't see them on the list of exhibitors), LA (they're on the list), and Shanghai.

Chinese language website
(not linked by the English website). Some various seafood companies.

The Market

A NOAA presentation on The Aquaculture Revolution, very good stuff. It has a great chart showing Chinese dominance of the tilapia aquaculture market. And the next chart shows the amazing growth of the market itself. Very exciting stuff.
Many aquaculture species, such as catfish and tilapia, are grown almost entirely on vegetable-based feeds....
They warn that just because people aren't eating a particular fish today, doesn't mean they won't be eating it tomorrow. They give tilapia as one example of that.

Here's a presentation by Kevin Fitzsimmons; President, World Aquaculture Society; Professor, University of Arizona; Sec./Tres., American Tilapia Association. Consumption of talapia just continues to climb. At least $317 million of sales in 2004. It claims prices have been stable for several years (and will continue to be stable) but will not go up with inflation.

They have 10% of the market for Chinese tilapia fish sold in the US (the US is the largest market for tilapia). The market for tilapia in the US has grown from $20 million in 1992 to $173 million in 2002. China produces 47% of the world's tilapia. HQSM said that in 2004, demand for their product was 4 times greater than capacity. So they're trying to rapidly increase capacity. They're creating a fish feed plant to control quality of food to fish suppliers in Hainan and consolidate the relationships. Also developing "organic" products for certification and a price premium. They're doing mergers and acquisitions, claiming to choose carefully.
Our main marketing offices are currently in Beijing and Shanghai. More than half our products are exported to the U.S., Australia, South Korea, Japan and other Asian countries. Some of these exports are sold under the buyers' brand names. In addition, we have long-term business relationships in Canada, Germany, France, Belgium, and Spain. We regularly attend major International Food Shows in Boston, Los Angeles, Shanghai, Beijing, Singapore and Brussels. I believe we are the only PRC based integrated producers present at these shows. We also work with such leading U.S. distributors as Beaver Street Fisheries (they carry tilapia), Slade Gorton (tilapia), Paragon Seafood Company tilapia, Crocker & Winsor Seafoods (tilapia), Mareida Trading Co., and Tomich Brother Fish Co.
From Slade Gorton:
Tilapia has a long shelf life when fresh, as a result of tightly regulated harvesting, processing and shipping processes. Water quality and high-grade feed are the keys to raising premium tilapia. Tilapia act like sponges, taking on the flavor of the environment they are harvested in. As such, tilapia raised in cement tanks are generally better tasting than those raised in ponds which may take on a muddy or gritty flavor.
They're located Haikou, the chief city in the province of Hainan, which is an island in the extreme southern part of China (which forms part of the Gulf of Tonkin with Vietnam).

AmeriCulture is a fish farm for tilapia. They're not a public company, unfortunately.

FDA fish finder.

The Numbers
Looking at the 10-K (See 10-K posting for better details)
US Dollars
In the 8 months from May 1, 2004 to Dec 31, 2004 (audited US GAAP)...
Aquatic activities nearly stopped during 2004 due to renovations. The health and bio-product segment was acquired in August 2004. So these numbers are fairly meaningless.
Sales: $20.8 million
Gross margins: $5.1 million (24.7%)
Large advertising and G&A costs
Operational income: $758K (3.6%)
Net income is greatly distorted by a one-time other income
Removing the one-time income but keeping all taxes (which actually seems correct based on a sanity test), net income is $564K
Outstanding shares: 95,055,123 on Dec 31, 2003 (which is WAY more than the weighted ave given due to 70 million shares issued to raise $22.5 million dollars)
(there's something funky going on with a gigantic writedown of assets related to goodwill but not really showing up normally on the balance sheet)
Net income per share for last 8 months of 2004: 0.6 cents per share (i.e. a bit over half a cent)
This would correspond to little less than a cent per for a year.

The cash flow is also very odd due to the funky issue above. Without it, cash flow would look good, with a significant investment going on.

Let's jump ahead to Q2 of 2005, ending June 30, 2005.
100,261,523 shares outstanding on that date.
For three months:
Sales: $6.5 million
Gross margins: $2.8 million (43%) Warning: Jiahua Marine had 82% gross margins while "aquatic products" had only 18% gross margins (and gross loss during the same time in 2004).
Operational income: $1.3 million (17%) with no provision for doubtful accounts
Taxes are only $97K (special economic zone, which is not guaranteed in the future)
Net income: $1 million (1 cent per share) However, with a normal provision it would be closer to $750K, so earnings per share are probably something like 0.75 cent (three quarters of a cent). This is with a low tax rate. There's also $200K of other income.

But the cash flow is destroyed by increase in AR ($1.5 million!), decreases in AP ($626K). Operations burned $1.2 million in cash!

More financing by issue of stock: $619K
There's now just over 100 million shares.

  1. The seafood business is definitely low margin. Don't expect any operational leverage as it scales. Every dollar of revenue gain will probably only fetch 16 cents? Are there efficiencies to be gained? That's the real question to be answered when I do the detailed work. [answer: some, but not a lot]
  2. The fish market looks like it will definitely expand as the US and probably other countries continue eating more of this fish I had never heard of before (but then I hate seafood).
  3. They seem to be in a fairly dominant position in the market and that is very likely to continue.
  4. They seem to have big accounting issues.
  5. Based on $750K earnings per quarter and 100 million shares, I'd say it's worth about 50 cents.

Saturday, October 29, 2005

Man Sang Holdings (MHJ)

Q1 10-Q
8/5/2005 8-K increased authorized share count (for split), also ameded by-laws for AMEX rule
7/25/2005 8-K moving to AMEX
7/22/2005 8-K insanely confusing 5-for-4 stock split (why frickin bother?)
2004 proxy
2004 10-K

Get a load of the ownership chart near the beginning of the 10-K. Zillions of subsidiaries within subsidiaries.

1996 reverse merger.
The foundation of the group of companies... was laid in the early 1980's when Cheng Chung Hing, Ricky formed Man Sang Trading Hong, a freshwater pearl trading company, and Cheng Tai Po formed Peking Pearls Company, a Japanese cultured pearl trading company. As the business of the Group developed, Man Sang Jewellery Company Limited ("MSJ") and Peking Pearls Company Limited were formed in Hong Kong in 1988 and 1991, respectively, to continue the trading operations of the Group.

Subsequently, the Group expanded its operations to include pearl processing with the establishment of Man Hing Industry Development (Shenzhen) Co., Ltd. ("Man Hing") in 1992 to process and assemble freshwater pearls and Chinese cultured pearls, and Damei Pearls Jewellery Goods (Shenzhen) Co., Ltd. ("Damei") in 1995 to assume and expand the Chinese cultured pearl processing operations of Man Hing. In view of the continuous expansion of Chinese cultured pearls business, in December 1996 the Group set up a subsidiary, Tangzhu Jewellery Goods (Shenzhen) Co., Ltd. ("Tangzhu") in the PRC to specialize in purchasing and processing Chinese cultured pearls of larger sizes with diameter from 6mm and above and, to a lesser extent, in processing other cultured pearls. As a result, Damei started to concentrate on the purchasing and processing of cultured pearls of smaller size with diameter below 6mm. The business of purchasing and processing of Chinese freshwater pearls was also transferred from Man Hing to Tangzhu whilst Man Hing started to concentrate on the pearl jewelry assembling business.
Ya got that?

An insane number of changes happened over the years. But let's skip to the pearl industry discussion.

Seven product lines:
  1. Freshwater (US$2 to US$1,000 per 16 inch strand)
  2. Chinese cultured (US$10 to US$400)
  3. Japanese cultured (US$100 to US$2,000)
  4. South Sea (US$300 to US$70,000)
  5. Tahitian (US$150 to $15,000)
  6. Pearl jewelry
  7. Other jewelry products
Company buys pearls from pearl farms with full-time staff working with farms. No long term purchase contracts. Top 5 suppliers accounted for 53.5% of sales, largest is 14%.

Let's stop here and look ahead at the rough numbers....

They earned about US$0.38 in 2005 (excluding a huge gain on sale of real estate), making them perhaps worth $5.70. The stock is selling for $5.60 Yahoo lists them as having a P/E of 10, although it's really probably closer to 15. But I don't know about the weird stock split.

Looking at their Q1 balance sheet, it's very strong. They earned 9 cents diluted in Q1, but cash flow from ops is terrible due to the usual suspects.

This one is worth following.

HIA, Inc. (HIAI)

Back in 1984, HIA acquired CPS, which is now a hundred-year-old company selling well water equipment in Colorado.

Revenues have been remarkably stable between $31 and $33 million going back to 2000. Net income has steadily increased from $378K to $809K in 2004. Per share earnings went from 4 cents in 2000 to 8 cents fully diluted in 2004.

Directors and officers own 77.6% of the business.
Carl J. Bently, 71, (Chairman since 1996) owns 25%
Alan C. Bergold, 56, (President since 1996) owns 30.1%
Donald L. Champlin, 53 (Executive VP since 1996) owns 25.8%
these include only a small proportion of stock options.

Unqualified auditor opinion from Hein & Associates of Denver.

Current assets are inventories and AR, steady from the year earlier.
$8 million current assets, $1.4 million net PP&E, $1.2 million goodwill.
Current liabilities are mostly line-of-credit, accrued payroll, AP, construction loan, etc.
Current ratio is a little less than 2.
Very little long term debt.
$5.9 million equity, $11 million assets.

Gross margins are consistently around 30%.
Operating margins are consistently around 4%.
Income taxes consistently between $400K and $500K.
Net income was $809K (vs $720K in 2003, $696K in 2002)
The increase from 2003 was due to a number of ordinary factors.

Share count has decreased over the years from treasury stock purchases.

Cash flow from operations shows lots of cash produced in 2002 and a big investment of $1.3 million in 2004. From 2002 to end of 2004, cash flow from ops matches earnings with the exception of the large investment.

Lots of flow out-of and into the line-of-credit, roughly $9 million to $10 million per year.
Long term debt interest rate is 8% and 8.125%.
Maturities are well staggered so that no year has more than $158K maturing.
Operating lease obligations are $939K in 2005 and decreasing significantly from there.

Tax benefit of $26K in 2004 and $36K in 2002.

750K options outstanding end of year 2004.
9,273,435 shares outstanding end of year 2004.
Total diluted shares is around 10 million

In Q2, both inventories and AR increased dramatically over 80%!
net PP&E jumped from $1.3 million to $4.4 million (goodwill remained unchanged)

Sales increased slightly in Q2, but more in Q1. Gross profit is down. Operating income is down. Net income is down. All of this is both for 1st half and Q2. This is all due to competitive pricing pressures from national distributors. The increase is sales is due to general economic conditions in the region.

The company is doing a reverse stock split in order to go dark. Here's their discussion of it.
we anticipate that there will be eight remaining owners of HIA stock, consisting of HIA’s three directors and principal shareholders, Carl. J. Bentley, Alan C. Bergold and Donald L. Champlin, as well as five other HIA employees. The remainder of the shareholders, including all of the public shareholders of HIA, will own fractional shares for which they will be entitled to receive cash at the rate of $0.60 per pre-split share....
In order to free HIA from the obligation of public reporting, we only need to reduce the number of shareholders to less than 300. However, we thought it would be unfair to the public shareholders to leave some of them in the position of holding stock in a private company which had no obligation to make information publicly available and no semblance of a public market. Accordingly, we concluded that it was preferable to do the reverse split on a basis that cashed out all of the public shareholders.
Decent people, right to the end.

The latest ask on the stock is 60 cents, so no chance of arbitrage. This one is truly going private. Adios.

Miller Industries (MLR)

Year ending: Dec 31, 2004
11.2 million shares at March 9, 2005
incorporated: Tennessee
offices located: Ooltewah, Tennessee (outside Chattanooga)
Was on the NYSE.

World's largest manufacturer of vehicle towing and recovery equipment (which is installed on 3rd party truck chasis). Disposed of all towing services business around 1997. Sold via 120 independent distributors for US, Canada, and Mex. and 50 distributors covering other countries. Jige subsidiary in France. Beniface subsidiary in UK. 65% of distributors sell MLLS on an exclusive basis. MLLS has some independent commission-based sales reps covering specific territories. They have demo units available.

No single distributor accounted for more than 5% of sales.

Wreckers: from conventional tow trucks to large recovery vehicles with 70-ton lifting. Various special features available ("Express" automatic wheellift allows operators to get a vehicle without leaving the truck cab.

Car Carriers: flat bed trucks.

Multi-Vehicle Transport Trailers: those open air trailers with upper and lower decks. 6-7 cars (can get up to 8 with speical cab rack).

Century: top of the line. started in 1974. 8-70 ton.
Vulcan: light and heavy duty wreckers, sold via distributors
Challenger: 8-70 ton wreckers, car carriers. started in 1975.
Holmes: mid-priced wreckers 8-16 ton. car carriers. started in 1916. well recognized brand.
Champion: started in 1991. Low priced car carriers. Expanded in 1993 to include cheap tow trucks.
Chevron: car carriers, light duty wreckers. Operated autonomously with its own distribution network in the salvage industry.
Eagle: light duty wreckers, acquired, "Eagle Claw" express hook-up system, patented in 1984. Designed for the repo market. Upgraded and expanded after acquisition.
Jige: light and heavy wreckers and car carriers for Europe.
Boniface: heavy duty wreckers in Europe. Long underlift technology for European tour buses.

Four major innovations in the industry (associated with Holmes and Century).
  1. Rapid reverse winch
  2. Tow sling
  3. Hydraulic lifting mechanism
  4. Underlift with parallel linkage and L-arms
Much of the patent IP has expired and the rest will expire within the next few years. They've successfully defended their IP in the past.

Six manufacturing plants in US, France, and UK.
Oolteway, Tenn (242K sq ft)
Hermitage, PA (95K sq ft)
Mercer, PA (110K sq ft)
Greeneville, TN (112K sq ft)
Lorraine region of France (180K sq ft)
Norfolk, England (30K sq ft)

They purchase components such as hydraulic cylinders, winches, valves, pumps. Either MLLS installs it on the truck chassis, or it's shipped and installed on-site. MLLS only applies primer coat so the buyer can paint is as desired. Painting before delivery is done by outside paint shops.

No supply issues.

In 2002, the board decided to sell the distribution group. Only one remained (in BC Canada) at year end 2004. It will be sold quickly. Accounted as a discontinued business.

Barriers to entry into the business are actually low (which is bad). Technologicial capabilities are becoming more important (which is good).

840 employees. No unions (except for the usual nasty governmental stuff in Europe).

30,000 towing operators
80,000 service station, repair shop, salvage operators.

MLLS is the official recovery vehicle for: Daytona, Talledega, Atlanta, and Darlington NASCAR. Grand Prix Miami, Suzuka in Japan, Rolex Daytona 24 Hour Race, Molson Indy, Brickyard, and the Indianapolis 500 (and others).

Virtually all products are based on orders, not for general inventory.

Expiring IP (I expect profits to drop by some unknown amount, depends on their current margins and whether they're gouging for profits today).

Large debt, credit facility expired in July 2005, but they entered into another one with Wachovia: $20 million revolver at LIBOR+(1.75 to 2.5), plus a term loan of $7 million at same rate. Revolver expires June 08, term loan expires June 2010. Junior term loan by William G. Miller (owns 20% of the business) of $5.7 million, matures Sept 2008, rate of 9%.

Retaining some liabilities in tow services businesses sold off.

Officers and Board:
William G. Miller, 58, Chairman since 1994 and co-CEO since 2003 and from 1994 to present (as co-CEO with two others including Badgley), owns 20%, (Team Sports Entertainment CEO only during 2002). Was also head of Miller Group in early 1990s.

Jeffrey Badgley, 52, President and co-CEO since 2003, president since 1996, director since 1996. Various titles. President of Miller Industries Towing Equipment since 1996. VP of sales and marketing for Challenger Wrecker Corp from 1982 until joining Miller Industries Towing Equip Inc.

Frank Madonia, 56, Exec VP, general counsel since 1998. Was also general counsel at Miller Industry Towing Equip Inc. Was general counsel at Flow Measurement from 1987 to 1994. Before 1987, he was in various legal and mgmt positions for US Steel, Neptune International, Wheelabrator-Frye, and Signal Companies (Note: Miller was also at those same companies).

J. Vincent Mish, 54, Exec VP, CFO since 1999 and 94-96, president of Financial Services Group. Also a VP of Miller Industries and Miller Industries Towing Equip. Also at Flow Measurement. Worked at Touche Ross & Co for 10 years, CFO of DNE Corp 1982 to 1987. Member of AICPA.

Ownership from proxy statement:
William G. Miller: 17.9%
Ashford Capital Mgmt: 12.7%
Various interlinked investment firms: 7.9%

Miller: $180K no options or bonuses, total options=0 (wow!)
Badgley: $276K plus 100K options, total options=155K
Madonia: $196K plus 30K options, total options=70K
Mish: $176K plus 30K options, total options=54K

No significant legal proceedings.

De-listed from NYSE due to a lack of sufficient equity and low market cap. Company restructured, converted debt into equity with shareholder approval, disposed of towing services. December 2004, NYSE moved MLLS into a company in good standing. Need 12 months of good standing to return to NYSE.

Revenues have been fairly steady around $200 million. Was $192 million in 2003 and $236 million in 2004. The increase was due to increased demand due to market conditions.
Operating margins excluding SG&A are low at around 13%.
Net margins are 3.2%. Earned 64 cents from continuing operations in 2004, 22 cents in 2003, 34 cents in 2002. In 2004 the tax rate was only 9.3%.

This is already not a particularly strong business. If Korea or China jump into this business, it's all over for MLLS.

Auditor is Joseph Decosimo and Co in Chattanooga. Audit opinion contains a qualification that they changed their accounting for intangibles in 2002 (was that the discontinuation of goodwill amortization? If so, that's a strange qualification to add)

Balance sheet current ratio is close to 2, but it's still fairly weak. Current assets are mostly AR which incrased in 2004. So did inventories. PP&E is fairly small.

Cash flow from operations is terrible due to AR and inventory increase.

I'm scaling back on detail now because this is looking fairly bad, but mostly because of the reason listed at the bottom of the post. But let's see what Q2 looks like.

Q2 results

Holy cow, AR climbed by 31% from year end 2004! Inventories went up a bit, too. However, AP went up 29%. So I'm expecting significantly higher revenues.
Yes, revenues went up 56%! Net margins are up to 5.5%. They earned 46 cents diluted in Q2 vs 19 cents prior year.

Increase in sales was due to general market conditions and to delivery to the Australian military and production of mobile communications trailers for DataPath. Also helped by price increases in 2004 (good sign of pricing power).

Results were better during Q1 (revenues up 60%).

Cash flow from ops still stinks as they seem to be selling stuff for IOUs.

Ok, so do we value this business at $19 assuming the last 6 months is the reality of the future? What about Korean and Chinese entry into the market? Will that happen?

The stock price right now is around $18 so this was a waste of time. I had looked into it trying to figure out why it looked like two different companies. It was two different companies. MLLS is Miller Industries the Florida real estate business selling for around 12 cents. MLR is Miller Industries the Tennessee tow truck maker which is earning around 64 cents a share in the first half of 2005. Unfortunately, this isn't some deep discount business.

Friday, October 28, 2005

more for the "Worth Following" list

HOOB, Holobeam. Real estate and surgical staples. I believe I've looked at this business before, unless there are two companies dealing with real estate and surgical staples. They earn a pretty solid 60 cents a share. An OK balance sheet. Cash flow from ops is good. 2005 looks as good or better than 2004. It's selling for $41 per share which probably means that they have hidden value in the balance sheet.
possibly worth looking into further, but unlikely to be all that cheap

HYDI, polymer R&D for medical, commercial, cosmetics, and vet use. They license to 9 companies.

Solid balance sheet. Steady revenues. High gross margins (of course). Very low net margins. Some stock options. Earned 6 cents in 2005 (5 cents in 2004). Cash flow looks good.

So maybe they're worth 90 cents. They're selling for $1.15.

HWWI, A French company making breast implants and other implants(?). First to market with saline implants. Revenues increased over 15% in 2005. Gross margins are over 50%. Earned $881K in 2005 (lost a masive amount of money in 2004, looks like a doubtful account). Earned 5 cents for the year. Cash flow is ok.

Balance sheet is ok, but not much equity. So it might be worth 75 cents, maybe more. Selling for 80 cents.

MNRD, interesting, but they have 28 million shares priced at $1.80 for a
market cap of $50 million. Their annual revenues are only $8 million. So
the price already assumes a great deal of success.

DYSL, might be interesting

HRBN, they have amazingly high profit margins looking at the numbers in the latest quarter. Balance sheet is very PP&E heavy, but almost no liabilities. Cash flow isn't so great, but it's hard to tell with the weird ramping up in such little time. Oh goodie, another Chinese reverse merger. A linear motor company. Earned 17 cents in Q2. Maybe it's worth $1.80. It's selling for $4.60.

DWVS, The stock is probably priced about right, but I'll probably look into it some

DYHP, Not too interesting, but they're growing fast and I'm not sure what they're
worth yet.

DTGLF, not profitable lately, maybe worth 15 cents, selling for 21 cents.

FAME, seems like a good business, but it's selling for about what it's worth.

GACF, Reasonable company in the airplane repair business, rapidly growing, but
priced about right for its current business level.

GBEL, Real estate business, priced about right.

GARM, Struggling recycle business that could be a wildcard.

DAAT is good.
DAOU passes because they made money in 2003.
DDSI is not good because current liabilities are greater than total assets AND
there are no earnings in the annual AND there are no earnings in the most
recent quarter.
DEWY is good.
DFNS is good.

DNII, The company is a mess, but not that much of a mess. I can't tell what price
it's trading at, but it might be cheap (it's listed at 5 shares for a penny
in the database) but they did a 510-for-1 reverse merger so they could go
dark (I know you don't know what that means, but it's for my notes).

DSCI, Seems priced about right, but I need to look more carefully

DYNR, a mine, but possibly selling cheap. 2004 earnings of 9 cents diluted, stock is at 25 cents.

DRUG, This one is complicated and it's difficult to tell much about it. It could
end up as an investment, but it might not be cheap enough. A quick check
puts it as being worth $1.20 and it's selling for 82 cents.

EBHC: hey, it's Eddie Bauer!

EPLN, Solid business, but the price isn't cheap. I'll be picking it apart later.

ERIF, Another fairly good company which is not selling cheap. I'll look at this in
more detail later.

ERIF, has good disclosure and provides good visibility into their operations over the years. They clearly don't have a Warren Buffett at the helm or else they'd be making a lot more money. Their investment results are not very good (not terrible).

EZEN, don't remember but I think it's worth following

EVDR, just finished an audit in mid-July and should be releasing the results
some time soon, once the SEC approves it. I checked the SEC website and
their submissed was made Sept 14, 2005, but it was in paper form so I can't
read it. They had "planned" to be registered in Q1 of 2005 but apparently
that didn't work out.

Need to sift through these:
DNII, a mess, but maybe still ok. no clear trading prices.

ERMS, not very stable, but cheap.
ETEC, suspicious lack of operational cash flow, but might be ok.
EVDR, scooter company. expecting release of audited results soon.

FATS, revenues up, earnings down, stock overpriced.

GBCS, casino
GBEL, real estate business, priced about right
GARM, struggling recycle business that could be a wildcard.
GECO, minor league hockey, overpriced

Check back on Carnegie Cooke and Company (CGKY), they should have financial results by mid-sept latest. UPDATE: Nothing by Oct 7.

CTIG, no details

Eat at Joes (JOES) (Philidelphia single restaurant). Selling for $1million market cap. Crossed over cash flow break even. Doing better. Still a big long shot.

RZPK is a pachinko strategy company (that's pretty funny). Worth looking at if they start auditing their results.

MLTO, With all that manure, maybe there's a pony in there somewhere
MOBK (no financial details yet)
MRFD (improving?)


SMID, Smith Midland Corp is fully priced, but maybe not depending on growth.

SPOP is interesting. Natural food stuff. At break even. Selling for .6 times sales.

SPSC: What's up with these guys? Can't tell easily.

SCIE: medical mousetrap, laser cancer detection, just started revenues

SCSG: yet another bank.

SOTK is growing and profitable but overpriced?

SPND: oil and gas producer is priced about right.

other Chinese reverse mergers:
TBV might be cheap.
KMGB might be priced about right.
SZI is a money loser
TLF is probably priced about right
DXPE is probably priced about right (they're on NASDAQ)

China Expert Technology (CXTI) private placement

On Oct 21, 2005, CXTI (yahoo, website) signed this roughly 184 page agreement (don't bother looking for the actual numbers in that document because they're left blank) with a number of investment groups. This 8-K filing explains the terms of the agreement (if it takes 184 pages to say it precisely, you have to wonder how it can be condensed into a few pages without losing something).

$6 million of 7% convertable debentues (1 year maturity!) which are sort of like call options with a strike price of 75% of the recent stock price, but limited to no more than $1.80 (which for 1 year, the limit is probably not worth all that much). But in addition to these convertables, you also get 3.9 million handsome Short Term Warrants with a strike price of $1.53 and 18 months before expiration. But wait! You also get 1.96 million Long Term Warrants with a strike price of $3.06 and 5 years before expiration. These can all be yours if the Price Is Right (and you're one of the acredited participating investors).

So what is the value of what these investors are getting? The market says, "Way More Than Six Million Dollars!" because it drove the price of CXTI down by 20% after the announcement (or the market might be saying this is a sign of trouble).

Here's my extremely rough and possibly error-prone estimate of the value of what CXTI gave up in exchange for six million dollars. Well, I consider it extremely likely that CXTI will be able to repay the principal after 1 year (their current ratio is greater than 3). So I'd say the bonds might be [originally I said "probably" but I think that's definitely an overstatement] worth a premium, but we'll ignore that for now because the conversion itself is worth more. You might convert these shares at 75% of the recent stock price, but you'd push the price down quite a bit in selling them off. Let's say the conversion is worth 15% of the $6 million, or $900K, but let's round that up to a million. Using my great skill at valuing warrants (hah), I'll say the Short Term Warrants are worth $500K and the Long Term Warrants are also worth $500K. That's really close to my best guess and I've spent many hours trying to value LEAPs of various companies and comparing that to market prices. But the downside is that I spent almost no time trying to figure out the value of these CXTI securities.

So by my far-from-expert valuation and the back of a napkin-shaped envelope, I figure the company paid out $8 million in stuff for $6 million in cash. Is this a good deal? It depends on the opportunities for that cash. If I had a magic genie who could send me back in time by 3 hours and it was just after a big jackpot lottery event turned up no winners, if I didn't have any money at that time, I'd gladly write a check for $10,000 in exchange for a single dollar in cash. It's all about the cost of the money and the value of the opportunity. It could be that CXTI landed some big deal, but they needed X amount of cash on their balance sheet (the one year maturity sort of indicates something like this). But who knows? Maybe there was some huge shortfall in cash and the "opportunity" is simply not going bankrupt (like I said, far from being likely).

Without any more information, I have no idea whether this is a good deal or a bad deal. But given the cost of the six million dollars, they're going to need a very good opportunity to make it worth while.

UPDATE 20 minutes later: I just realized that the value of the convertables shouldn't be discounted because if you were to buy the same number of shares, you'd end up with an even higher cost basis than the recent stock price. I priced them assuming you'd want to dump them immediately. So I should probably add $600K to the number. Later on in the day I made more changes [with notes].

UPDATE Halloween: Well, I bought more shares (I had a very small investment in CXTI already). It's clearly worth 85 cents, in my opinion

Sarbanes-Oxley Act discussion

An interesting blog thread on SOX and federalization of state law.

One of the major debates in corporate law has been over to what extent laws should be determined by the federal government rather than by the states. Since “state corporate laws” is nearly synonymous with “Delaware’s corporate law,” a major portion of the debate was over whether Delaware was “racing to the top” in order to provide regulation superior to that of other states, or “racing to the bottom” in order to accomodate managerial interests at the expense of shareholders.
Panelist bloggers

Intro. Opening statements 1, 2, 3, 4, 5, 6, 7

The SEC is shareholder biased, albeit in its view in a positive way. The shareholder of today is not Ma and Pa Kettle holding 100 shares of AT&T for retirement earnings. Increasingly institutional shareholders dominate the market. Do they need an advocate in DC wedded to prescriptive regulation or can their complaints, if any, be as readily and more equitably addressed by private ordering in State civil law litigation on a case by case contextual environment? Moving corporate governance to DC means increased costs with little effort to determine benefit, an arena for dispute resolution decision making that is not unbiased and portends no guarantee that the guidelines, regs or pronouncements from the banks of the Potomac will enhance long term shareholder value. Those who advocate a drift from the common law resolution of disputes by a highly trained and experienced cadre of jurists to the bureaucracy in DC should be careful what they wish for.

Chief Justice Steele kicks ass. I haven't read all of the posts, but it seems like Steele is the only one who really gets it.

It's one thing to ponder legal issues in abstract, but as an investor, what I care about most is having some auditor's neck on the line, having officers of the company personally liable for their actions, and directors with fiduciary responsibility that can be enforced. I want people with significant reputations and money and personal liberty directly at risk. If they make mistakes, that's fine, we all suffer. If they purposefully defraud investors, I want the long arm of the law to grab them by the scruff of the neck and drag them into a fair and just legal system.

If you're going to try to make the investment world better, then setting up the right incentives is what's important. Rather than independent directors, it's more important to have directors with serious money at risk in the company.

But if you're trying to correct a situation where lots of people broke the law and you want to avoid it in the future, don't change the law, just start enforcing it better.

Some discarded companies

These are companies which were discarded during phase 2 of sifting. I put them here for the record.

, residential real estate home builder (in California, Florida, and Texas!) If I wanted that, I'd buy Lennar or even their spinoff LNR... oh wait, I did buy LNR, which was then acquired by someone or other and I made lots of money on it (same with Crossman Communities).

HSPR, in the pre-fab residential construction business (oh boy, wrong time for that kind of thing). And they're new. So they jumped into the housing construction business during a manic period. Those are the kind of people who go bankrupt.

Their balance sheet isn't all that strong (current ratio close to 1). They have an equity deficit.

They just started making a profit (earning 1 cent in Q2). Gross margins are ok. It's selling for 17 cents, which I guess is about the same P/E as homebuilders.

HRBGF, Harbor Global, Russian real estate management, earnings all over the map, cash distribution dividends also all over the map. Seems Ponzi-like. Selling for $8.80.

HTDS, gone.

HTLJ, steel fab, property management (resid and commercial), idle agribusiness, manufacturing. 10-K wording contains great quantities of manure language. Losing money.

HTVL, Cayman Island reinsurance business.

HVYB, bank

HMWS, home warranty (i.e. maintanence) in Arizona. No financials.

NMXS cik# 1101865, New Mexico Software, web and database
unqualified audit opinion (2 auditors), horrible balance sheet, losing money on decreasing revenues.

NNBP cik# 925894, pharm, losing money, restatement, horrible balance sheet

website - click on investor relationsions) click on SEC filings -
cik #1030065, went dark in 2003.
Once successfully accomplished, this has the potentiality for solving the world energy crisis
As Instapundit would say, "Heh".

NPDI cik# 1138659, sustainable seafood (aka fish farming)
going concern qualification, stable balance sheet perhaps, negative gross margins. SG&A greater than revenues.

NMSCA institutional food and food service
steadily declining revenues, lawsuit against customer, earned 27 cents in 2005 but it was due to non-operational stuff, would have lost money without it. Low margins for food. Balance sheet acceptable. Huge payroll and other costs.

NPFV - (perfromance improvement to industries) may be good
check annual and latest quarter
a mine with terrible balance sheet in pre-exploration.

HDRX, water filtration business, new reverse merger. Lots of weirdness with this one.

HGIIA, 12 franchised liquor licensed "half-a-car-sticking-out-of-a-wall" restaurants (up from 9 last year). 1950s 1960s themed. Only 1 full time employee (an admin). Very straight forward 10-K. Auditors quit.

Balance sheet is strong, but not much equity.
Thin margins. Results are worse than they look. They earned 1 cent in 2004, but a lot of that was from one-time stuff. More like half a cent. Some dilution. Cash flow was good in 2004, not good in 2005. 2005 is pretty much still looking like half a cent.
Figure the business is worth maybe 7 cents. Stock price hovers around 7 cents.

HICKA, electronics corporation from 1915, now they make electronic diagnostic equipment for car mechanics. Minor qualification to audit opinion.

Strong balance sheet, nearly all equity.
Widely varying revenues, $15.7 million in 2004. Gross margins about 50%. Very high marketing and admin expenses (about 25%). 4.2% net margins in 2004. Earnings are all over the map in the last 3 years. 54 cents, -60 cent loss, 20 cents.
Cash flow is a bit better. Free cash flow is about $1.4 million, $0.1 million, $1.7 million. Consistent 1.2 million shares.

2005 results are way lower. Revenues for first 9 months down to $6.9 million from $12 million with net loss and negative cash flow from ops. The cause was simply lumpiness in revenues, apparently.

Company made a tender offer for small shareholders in order to go dark.

Shares sell for $4.50. I have no idea what the business is worth.

HISC, homeland security integrated something or other.
Assets are spread out. Balance sheet is ok. $1.2 million equity. $2.1 million assets.
They just reached profitability in Q2 on $237K sales earning six thousand dollars. There are over 700 million shares. Revenues haven't been growing all that fast.
This could very well be the most worthless genuinely profitable company I've ever seen on a per-share basis.

HCFB - this company passes and isn't really a bank, it's only a holding
company for a bank. Ok, let's look at HORRY COUNTY STATE BANK.
Earnings were level at around 75 cents, then went up to 92 cents in 2003 and $1.20 in 2004. They earned 62 cents [diluted! a bank with stock options?] in the first half of 2005. Now let's see how much higher than $18 the stock is selling for... $29.50.

NIMU, cik number, the business itself is still in development stage, pretty much.

NEXH, real estate (mostly commercial) in Utah and Kansas. They do a lot of leasing. There might be a foreclosure risk.

36K sq ft old building in Salt Lake City. Only the 7,816sqft ground floor was renting out [as retail] which rents out at $15/sq ft [per year]. Renovations being done on 2nd floor which will lease out at $12/sq ft, 4,700 sq ft. Total monthly receipts are $5,682. Loan payments are $8,875, interest.

One storey retail building in Salt Lake City, cost $535K. 7Ksq-ft, late 1960s building. Much is not occupied.
Another building in a suburb of SLC, $750K cost. 100% occupied. $11K monthly rents (twice the monthly loan payments). $11.45/sq-ft.
Another shopping plaza in SLC. 72K sq ft. 60% leased. One tenant. Sounds crappy. $20K/month rent payments. Loan is $12K/month.
Also a ski condo... unit. Just one condo unit. For sale. Potential fraud.
40 acres ugly industrial land in West Virginia. Unused, bad future outlook. Cost is impaired now. WV EPA looking for cleanup. Ugh. Property dumped for $1,816 in unpaid property taxes due to clerical oversight. Oh geez.
Also some undeveloped land in Kansas.

Assets mostly PP&E and land. Very weak balance sheet.
Losing money.
Big gain from disposal of assets in 2005, but still losing money all over the place.

NLEQ, industrial equipment leasing consolidators. Bankrupt, but emerged on Feb 2004. All stock was wiped out. They merged with NES Rentals which survived the merger. Audit opinion qualified by a change to how the company accounts for goodwill.

Assets are mostly rental equipment and some AR. Liabilities are nearly all debt. 15% equity to assets. About 20% gross margins. Losing money in 2004. Operational cash flow is positive due to depreciation but free cash flow negative with normal capex.

NMKT, voice over IP telecom business. Ugh. There also in other areas of telecom. It looks like there might be some interesting stuff. Let's do the numbers:

Balance sheet isn't too bad, but lots of goodwill and intangibles. They have an unconsolidated subsidiary to watch out for.

Revenues went from $2.3 million in 2003 to $14.6 million in 2004, presumably due to acquisitions (assets jumped from $9.5 million to $25 million). Gross margins are about 40%. Operating margins are thin, so the big question is capacity and market growth. They earned about half a million in 2004, 1 cent diluted. Share count went from 51 million to 82 million during 2004 (mostly stock for debt). Cash flow is kind of ugly, but probably too much stuff in flux to really know what's going on.

In Q2 05, assets had jumped again up to $44 million. Bulemia is a terrible thing. The incremental sales were much lower margin. There are all sorts of one-time things going on in 2005: bad debt expense recovery, lawsuit settlement, gain on forgiveness of debt.

I can't tell what this business is worth. There could be a pony hidden in all that manure. Or maybe not. Maybe it's worth 10 cents? Now let's look at the stock price: 38 cents.

This is one of those companies with a high degree of difficulty.

MLOG, These people have gone REALLY dark. No news, no updates, nothing.

MLTO, All their financial numbers are estimates. Their balance sheet is fairly
frightening, although they could survive without dilution if everything were
to fall into place well. They might be worth 4 dollars a share, maybe more.
But the stock is selling for 4 dollars a share. I'll put this on the list to
look at... on second thought, no. If they get audited results that will help. But I just passed on FPGR which also has unaudited results and some weirdness that made me not invest... and they are way cheap.

MOBK, they don't provide any information about their financials, so I can't invest
in them.

MODM, losing money, they're late filing quarterlies.

MCAM, In the most recent quarter, they actually started making money again, but the balance sheet is already so weak that the value of equity is doubtful. I don't see how the future of the business can be predictable.

MCET, would also pass the criteria since they didn't have declining revenues
and the cash flow statement for the most recent year is positive, especially
since they started making money in the 2005-07-15 quarter report. UPDATE: what was I looking at? They're losing money like crazy.

MRCR, might be worth $6 and they're selling for 87 cents, but cash flow is bad
(need to find out why). UPDATE: losing too much money.

MRGN, movies on demand, horrible industry, no good.

MRFD, Yum! Brands franchisee. They haven't made money since 2002, and that was only a small amount for 1 year. However, they seem to be improving during 2005. The stock has gone up quite a bit because of it. But if they were going to be consistently making about a dollar a year per share, then it would be worth $15: 3 times as much as the current price. Worth looking to see why they're improving and whether it's sustainable (probably not, I discarded it).

MSITF, They have no recent financial statements, but they're making lots of hype-ridden claims. They're based out of the Caribbean and they're in an industry that itself is somewhat of a red flag. They have very little of what I would consider normal disclosure, but lots of hype. And about 90% of their balance sheet assets are hidden in an investment in another company. This one definitely doesn't pass the smell test, as they say.

UPDATE Sept 7, 2006: I posted this stuff to the MSITF message board (Raging Bulls)
I wrote that stuff about MSITF (I run that blog). As you can see from that page, I've looked at a huge number of companies. Many of the companies I pass up will end up going up in price (for example, I knew about PTSC when it was 20 cents but passed it up because I didn't have confidence about the total size of their eventual patent infringement awards), and some of those will be companies that I could have understood if I worked hard enough at it. What I do is attempt to identify a very small number of investments that I have strong reason to believe are worth a lot more than their current price. I intentionally filter out a lot of good investments because it's a lot more important to me not to make a bad investment than to pass up a good investment.

I've learned from experience to rely heavily on red flags. I basically go through a company and collect the things that are fishy or are commonly associated with bad things. When I looked at MSITF, it was rife with them and doing a quick check now doesn't look any different.

If you look at the top of that page you linked, you'll see a lot of work I did on HQSM, but at the end of it, I still chose not to invest in it. And believe me, HQSM looked a great deal better than MSITF!

I figure you can do investing or you can do gambling. The fact that MSITF *might* be ok is not enough for me to put even a dollar into it.

FCPG, face recognition database stuff. Losing money badly but the future could be
very good. Unlikely to ever be a good investment because it's a glamorous
technology among investors.

FIND, a bible studies software maker that sells directly to customers.
They lose money in normal operations but they've sometimes been able to be
profitable by various other items. I don't see this as being a good business
to own.

FTPI, startup.

FRMO, an interesting company which does investment analysis and has some stocks.
I'm not sure I'd ever be able to know what the company is worth.

FSCR, Federal Screw Works... I didn't know the IRS was a public company.
They're barely eeking out a living, but paying way too much in a regular
dividend. Not very interesting other than the funny name.

FULO, these people are in a terrible business, eeking out a living.

MDVN, "medical mousetrap" losing money

MDTA, software, bad

DVID, These guys are headed off a cliff.

DYTM, not too interesting

DOWJB, Wow, I didn't know Dow Jones was on the pink sheets. They seem to be priced about right.

DSSI, It would be nice if they could have made money in *this* millenium.

DXXFF, composite patio decks. No financials.

DTIX, money loser

DTTO, money loser

FBGO, looking at the SEC docs, it's not a good business

FATS, revenues have gone up while earnings have gone down, but cash flow has been
going up. The stock is probably overpriced.

GBCS, Casino, might be a bit cheap, but casinos can be bad business. Prior fraud.

GBIR, Transports goods from Western Europe to Eastern Europe. Bad business.

GAXC, Overpriced ATM machine operator.

GECO, minor league hockey, overpriced

DMEC, This one's no good. They simply have too many shares (639 million) for them
to ever be worth anything. The stock is cheap at 1 cent, but not cheap
enough given their unstable situation.

DRMS, Doesn't seem very interesting

DNAG, They have essentially 841 million shares. In 6 months they did half a
million dollars in business, which cost them nearly that much to produce,
plus they had nearly another $2 million in expenses. Even at 2 cents a
share, I can't see it as an investment.

EBLC, Terra Block scares me because they seem more driven by the technology
than by solving their customers' problems/needs. Why would customers use
their product rather than bricks? The burden of proof is clearly on EBLC to
gain new customers. They would need to be far better than bricks to overcome
doubts about unforseen issues.

SEHI, manufactured homes. Crappy results over time. Overpriced.

Thursday, October 27, 2005

more businesses

HCAR, new and used car dealerships in the Northeast (some nearby). The income story is that SG&A has steadily been driving downwards. Interest income dropped after 2001. The combination of these two made them profitable (lost money in 2000 and 2001). They ramped up the business in 1998 and took a loss that year. But otherwise they've been profitable. Some stock options. Cash flow is kind of crappy. Recent results have been very good. That's going to change with SUVs probably decreasing, interest rates going up. Depending on the stock price, this might be a short candidate. They earned 50 cents in 2004, but long term I'd price it as if they earned about 15 cents. They beat 2004 numbers in Q1 05 (on lower revenues). The stock is trading at $1.40, so the market isn't fooled by this one.
low priority pile

HEMA, It's the only for-profit blood donation company. There's a nursing shortage which makes expansion very difficult. In Southern Calif, a major company switched to 24-hour frozen plasma from 8-hour. If enough companies switch, HEMA might have to reduce prices. A new therapeutic apheresis company stole some of HEMA's employees, causing a recruiting hit and a salary hit to keep nurses from leaving.

HEMA has been restructuring, closing some centers.

Only one large 10% customer. No legal matters.

Revenues are fairly constant at around $26 million for 4 years. Gross margins declined for years, but then went back up to 21% in 2004 (restructuring). Gross margins in continuing operations increased from 7% to 17% and 22% in Q2 05. They earned 17 cents diluted in 2004. Equity took a big hit in 2003, probably due to restructuring. Unqualified audit opinion. Q2 earnings were 5 cents diluted (vs 6), 8 cents diluted for the half vs 9.

I'd expect some deterioration in earnings due to the issues above. Also some stock option dilution.

Cash flow is great. Earnings is probably fairly close to free cash flow. But cash flow in 2005 has been lower due to various balance sheet movements that would indicate a slowing business.

Balance sheet is AR, PP&E, and cash. Current ratio is about 2. Lots of equity. This only improved in Q2.Ok, so based on all of this, a rough guess of value would be $1.95. Recent stock price is $1.56.
worth following

HFIT, fitness and health management services to corporations and hospitals and universities. They bought Johnson & Johnson Health Care Systems, Inc. at the end of 2003.

Unqualified audit, with an extra paragraph about extra auditing done.Assets are mostly goodwill and AR (AR is mostly unchanged by Q2 05). The next highest is an order of magnitude lower. Yuk. And that's an intangible. Double yuk. Otherwise the balance sheet looks stable. Half equity.

25% gross margins. 6.7% operating margins. Earned 10 cents diluted (7 cents in first half 2005), but watch out for deferred tax assets. Some dilution.

Cash flow looks ok through Q2 05. Free cash flow probably matches earnings, but it's not easy to tell quickly. There's lots of stuff like amortized intangibles, deferred taxes, etc.

Quick valuation guess: $1.80. Stock price is $2.10.
worth following

HNNA, investment advisor/broker. They ran a "Dogs of the Dow" fund. Didn't Motley Fool come up with that idea? HNNA has been buying up mutual fund management companies. Revenues went way up in 2004. 50% operating margins (up from 37%). Wow. 29% net margins (up from 22%). Double wow.

Unqualified audit opinion. Balance sheet is odd, as expected for this kind of company, but it's good. $1.63 diluted earnings (vs 65 cents in 2003). Cash flow is good, as you'd expect.

Results leveled off in 2005. 93 cents earning in 9 months (vs 78 cents). Doesn't seem like a lot of dilution on quick glance.probably worth about $18 per share. Selling for $26
worth following

MKRS, It's difficult to know what the business is worth. It might be worth 10cents, maybe more. It's selling for 22 cents. But still it's...
worth watching (update: stop following)

MPAA, worth about $10 and they're selling for $10.20.
low priority pile

MPAD, they earned 55 cents, but the actualcash flow has been terrible for 4 years (was better before that). Based onearnings, they'd be worth about $7, perhaps more. They're selling for $8.00.
low priority pile

MRPT, they made money in 2004. But more importantly their website contains valuable info about other companies that I've looked at, such as Bulldog Technologies and Billy Martin's!

MEK, Moved to AMEX. Results improving dramatically in Q2, earned 7 cents. Priced for Q2. Some Katrina damage. New revolver at prime + 1.5, secured by "security agreements". Seems fully valued, but...
worth putting on the good list (update: stop following)

MTWD, overpriced based on current results, but unknown future growth is a wild card.
Worth tracking

MHCO, (plumbing & electrical supplies) seems like an OK company but priced about right. Someone "found" it in September.
worth following

MIOK, they're making a cheap GPS system, which is good, but I fear that the big
companies will duplicate what they're doing and do it even cheaper with large
worth following

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