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Monday, May 15, 2006

China Expert Technology (CXTI) Q1

Q1 10-Q

Quarter ending March 31, 2006
27,945,837 shares on April 24, 2006 (31K shares issued on April 19). 6.6 million warrants plus the toxic convertables. For right now, I'm assuming 45 million totally diluted shares.

Balance Sheet
Comparing to Dec 31, 2006
Cash is roughly the same, AR is about $3 million higher (no allowance), cost and est earnings in excess of billings is about $4.8 million higher.
Current ratio is very solid.
Current payables are down.
Embedded derivatives (toxic convertables) and warrants are huge current liabilities of $9.5 million total.

Equity is up by $6 million (only $1.7 million due to increased retained earnings).
Total assets are up to $41 million, nearly all current.

Ok, so interpreting the balance sheet is a bit tough due to the warrants and toxic convertables as liabilities. The main thing I want to see from the balance sheet is whether the company has enough cash going forward. They claim they have enough in the statement. It's difficult to read much into the details because of the coarse nature of the business. I don't see anything frightening.

Income Statement
It really doesn't make a lot of sense to compare Q1 results to anything else. The business is lumpy.
Revenue is $15 million, up from $8.7 million in Q1 2005, up from $9 million in Q3 2005, up from around $9 million in Q4 2005.
Gross margin is 51%, up from 47% in Q1 2005, 45% in Q3 2005.

The real killer here is the $2.5 million "advertising and marketing" charge (non-cash), which is new. It's essentially payment to a 3rd party for landing a big contract.

Another killer was G&A at $2 million in Q1 (we'll get into all this stuff below). G&A was $1.2 million in Q3 2005, $1.7 million for the first 9 months, but yet only $1.6 million for the full year 2005 (huh? I just noticed that, probably due to fair value estimates).

And we have the unpredictably volatile changes in fair value of derivatives.

Net income was $1.7 million. There was icing (currency translation benefit) of $215K. If I'm going to use my totally diluted share count, then I need to back out dilution based charges against earnings.

What about the advertising charges?

According to AICPA Statement of Position 93-7, advertising costs should be expensed either as incurred or the first time the advertising takes place with two exceptions. The first exception is direct response advertising where the primary purpose is to elicit sales to customers who could be shown to have responded specifically to the advertising and which results in probable future economic benefits. The second exception is when the expense occurs after the revenue generated by the advertising. However, this isn't really advertising, it's more like a finder's fee.

But all of this all doesn't matter. From the perspective of "how much would I pay for this entire business", what I care about is total free cash flow and when it happens. Since the payment is in shares and since the company won't be paying dividends anytime soon, the timing of payment makes no difference to me. Therefore the accounting of the costs doesn't matter so long as I correctly subtract the real costs from the real free cash flow estimate. I plan to throw all these costs into the totally diluted share count, so I shouldn't include it in my earnings estimate: earnings in this case being a [potentially flawed!] proxy for free cash flow.

I'm guessing about $3.2 million in adjusted earnings for Q1 or about 7 cents per totally diluted share. But in terms of "what's the business worth?", this isn't all that helpful. My estimate is fuzzy and based on 1) the amount of business they will dredge up over time, 2) the cost of doing that business, 3) the final diluted share count. 1 is looking great, 2 is getting uglier, 3 was always pretty ugly.

Cash Flow Statement
Operations burned up $4 million in cash. The reason is simple: CXTI had to front a huge amount of expenses while having to wait a long time before being paid. See the Shishi contract post.

Investing activities provided $3.7 million, but that was a refund from a non-acquisition.

Financing was pretty quiet.

Notes etc.

Cost + estimated earnings so far are $87 million ($15.1 million from Q1). Billings are $81 million, leaving $5.9 million in excess as a current asset on the balance sheet.

We've got the usual related party stuff.

The PP&E is almost entirely depreciated.

Management Tap Dancing

$121 million outstanding in contracts.
The increase in revenue is attributable to the commencement of several new projects, namely Jinjiang (4th Phase), Dehua (3rd and 4th Phases), Nan’an and Huian.
Better gross margins were claimed to be due to better control over subcontracting costs and reduced proportion of subcontract work.

The increase in G&A expense was nearly all stock based compensation ($1.67 million out of $1.76 million).

And to go along with what I said about cash flow from operations...
We required additional working capital in terms of accounts receivable and cost and estimated earnings in excess of billings because of the commencement of several new projects during this period, namely Jinjiang (4th Phase), Dehua (3rd and 4th Phases), Nan’an and Huian, as revenue was recognized in excess of billings and majority of the billings was near the end of the period.
And they leave us with this...
The Company anticipates that the existing cash and cash equivalent on hand, together with the cash flow generated from the existing projects will be sufficient to meet the working capital requirements for the on-going projects and to sustain the business operations for the remainder of 2006. In the event that the Company signs up and commences new contracts, additional financing may be required....
Conclusion: Continue owning it

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