Sunday, July 02, 2006
China Energy Savings Technology (CESV)
Trading in this stock was halted Feb 15, 2006.
As previously announced by Nasdaq, trading in shares of China Energy Savings Technology, Inc.'s (Nasdaq:They were de-listed from NASDAQ on May 10, 2006.
CESV) common stock was halted on February 15, 2006, and would remain halted until the Company had satisfied Nasdaq's request for additional information. At Nasdaq's request, China Energy Savings Technology is providing this update as to the status of Nasdaq's inquiry. Nasdaq's request for information involves the facts and circumstances regarding the underlying transactions related to the rescission of certain Rule 144 legal opinions by the Company's prior securities counsel who resigned in February 2006, as well as certain other matters related to the company's issuance of securities. The Company has retained new securities counsel and is cooperating with Nasdaq in an effort to resolve any questions or issues raised by Nasdaq in order to resume trading as soon as possible.
...due to public interest concerns under Marketplace Rule 4300 and that the Registrant may have violated Marketplace Rules 4330 and 4420Here are the Marketplace Rules.
Rule 4300: Qualification Requirements for Nasdaq Stock Market Securities. This says NASDAQ has broad discretionary powers to include or not include securities.
Rule 4330: Obligation to Provide Information. NASDAQ may request any information necessary in order to make a determination about including/rejecting a security.
Rule 4420: Quantitative Designation Criteria. There are several criteria spelled out. They basically set the bar for what is needed to retain NASDAQ listing. It spells out various types of securities such as stocks, ADRs, units, index fund shares, preferred stock, etc.
The "Conduct Rules" are in the range of 2000 and 3000, which are the rules I would most care about as a shareholder.
The stock had been trading above $6.00 until trading was halted in February. When it resumed trading in June, the stock plummeted to around 40 cents and it stayed down there.
Take a look at the list of executives and directors who have resigned this year. All directors except the last one who is also the CFO.
- Paul Risberg, resigned March 28 ("disagreed with the Registrant's approach in communicating with its shareholders during the current stock trading halt" among other things)
- Jing Wen Pang, resigned April 24
- Wing-Sze Yau, resigned April 26
- Shao Guang Tan, resigned April 26
- Kwun Luen Siu, resigned April 28
- Lai Fun Sim, resigned April 28
- Lawrence Lok, resigned April 28 (both as director and as CFO)
(also see farther below for more details on one lawsuit)
There are zillions of shareholder lawsuits outstanding, too numerous to link to. However, this one gives some good details:
...the complaint alleges that the defendants failed to disclose that: (a) the Company's insiders were engaging in self dealing involving the Company's January 2006 private placement; and (b) the Company was in violation of SEC Rules regarding limitations on sales of restricted stock that resulted in the stock being halted by Nasdaq.This one is also good:
On January 17, 2006, the Company announced an underwriting agreement to raise $50 million through a private placement of Company stock. The very same day, China Energy announced that Mr. Sun Li resigned as Chairman and CEO of the Company. Upon his resignation, the Company immediately appointed Kwun Luen Siu Chairman of the Board and CEO. On January 20, 2006, China Energy filed two registration statements indicating that the Company could offer up to ten million shares of its common stock and in addition the Company also indicated that selling stockholders could sell up to 6.05 million shares. Shortly thereafter, on February 9, 2006, China Energy announced that it was delaying the filing of its SEC Form 10-Q for the quarter ended December 31, 2005, due to the recent change in management. On February 14, 2006, the Company filed its delayed Form 10-Q, which revealed that the Company and its independent auditors were the subject of an informal SEC inquiry.Insiders dumped the stock knowing that an SEC investigation was underway, but didn't tell anyone else about it. That's way too far outside the strike zone.
So my big question is this: Did they look any different from ETLT or CXTI before that time?
10-K for the year ending Sept 30, 2005
25 million shares on Dec 19, 2005.
They now own 100% of Starway Management Ltd (British Virgin Isle Co) which owns 100% of Shenzhen Dicken Industrial Development Ltd (Taiwan aka ROC) which owns 100% of Shenzhen Dicken Technology Development Ltd. (Taiwan aka ROC). This company "develops, markets, distributes, and manufactures energy saving products for use in commercial and industrial settings." Later on, they say that the two Shenzhen Dicken companies are PRC companies! Which is it? ROC or PRC?
Later on they go into better detail. They're a wholely foreign owned enterprise, subject to the WFOE law. They have a great writeup on Chinese business law starting on page 9.
They make the "Light Saver" projects. These use switching systems to reduce electricity used by lighting systems. For many street lights and flourescent lights, the full voltage is only needed to turn the lights on. After that, a reduced voltage is good enough. There's some intelligence to the system. It retro-fits into existing lighting systems. Installation is quick and easy. Fully automated. 3-year warranty.
They also make a sewing machine electricity saver. They also have similar products for other industrial areas (injection molding, central air conditioning, etc.)
Sales are currently only in China, offices in Beijing, Shanghai, Chengdu, Xi'An, and provinces of Wu-Han, Guangzhou, Hunan, Ah-Hui. There's also qualified city level distributors (one-time up-front fee and pass qualification inspections).
Installations in approx 400 customers in 12 provinces and cities (later they claim 600 customers). Also installations on street lamps for cities in China.
Contracts are two types:
- savings sharing
- equipment sale
- Shenzhen Deqin Jilin Branch
- Zhuzhou Municipal Street Light Bureau
- Anqing Kuntai Decoration Co., Ltd
- Shenzhen E-store Market Co., Ltd
- Nanjing Langchi Group Co., Ltd
- Shenzhen Deqin Shenyang Branch
- Nanjing Giant Economic Co., Ltd
- Chongqing Baifuda Technology Development Co., Ltd (12% of total revenue... or maybe it's the other Chongqing company)
- Hunan Xuhua Economic trade Co., Ltd
- Wuhu United Technology Co., Ltd
- Kelamayi Jingying Co., Ltd
- Chong Qing Environmental Protection Energy Savings Development Co., Ltd
- Hangzhou Energy Savings Technology Co. Ltd (13% of total revenue)
- Xin Jiang Technology Co., Ltd (13% of total revenue)
- Shanghai Da Xiyi Electrical Appliances Co., Ltd (10% of total revenue)
Patents are obviously important here and a preliminary approval was granted by the Chinese intellectual property agency Sept 19, 2003. All rights were transferred to the Company. The company also has exclusive use of several patents from the founder for 10 years, expiring July 2012.
There are 50 competitors, but they generally use only transformers to step down the voltage while these guys use software switching and more intelligence in the system.
Dec 11, 2003, the China National Scientific Technology Products Committee issued a "Certificate of Approval" for the products stating that the average savings is 28% to 34% compared to competitors which range from 8% to 25%. There's another cert as well.
Management doesn't know of any competitor who uses an intelligent circuit board, but they could appear without warning.
No currency hedging, straight renminbi.
They expect to spend $2 million ($330K per year) on R&D from 2005 to 2010.
Parent company has no full-time employees. 11 part-timers. No long term consultants. 3 officers: CEO, CFO, Secretary.
Starway has 4 part-timers.
End business in PRC has 230 full-time employees, 2,300 part-timer sales consultants, 7 long-term consultants.
LIU TIAN FU
Age 40 C.F.O. (CHIEF FINANCIAL OFFICER) is an economist who received his Master degree from University of Xiang Tan, Hunan Province. Prior to joining Dicken Hi-Tech Development, he worked as a financial analyst and advisor for International Financial Venture Capital Committee. [VENTURE CAPITAL GUY]
YANG AN YONG
Age 42 C.T.O. (CHIEF TECHNICAL OFFICER) is a professional engineer, graduated from Electronics Science University of Chang [Cheng?] Du, Si-Chuang province. He has over 12 years R&D experience in high technology and in the energy saving industries. He joined Dicken Hi-Tech Development in September, 2002 as a Senior Software Engineering Manager. [TECHNICAL GURU]
Age 47 (OFFICE MANAGER) has over 20 years experience in Public Relations and Human Resources. Graduated from University of Lao-ning Province, worked as a professional TV reporter. She has successfully worked over 6 years for HR department of Shenzhen City Government. [HR]
Age 44 C.M.O. (CHIEF MARKETING OFFICER) is a highly motivated team player [oh please...] with 13 years experience in management and supervision for automotive, international sales and franchise industries in Europe and Canada. He has proven ability to increase profitability through contract negotiations, developing new partnerships, strategic planning, and innovative marketing strategies. Mr. Sizykh has a Bachelor of Arts Degree in Economics and Commerce. [MANAGER]
Executive officers and one shareholder own 63% of the company.
Obviously, a drop in the price of electricity would be bad for the company.
Rented office in Hong Kong, $8K per month. Old tiny factory (a square of about 60 feet on each side) is leased out to an unrelated party (outgrown the facilities). They own two apartments in Futian District of Shenzhen City, Guangdong. One is for the company's president "Mr Cheng" and the other for certain expat technicians. They lease out a real factory for $58K per year for 5 years.
No legal proceedings (just wait).
1.2 million options in compensation plan, all issued. The strike prices listed are more than 10 times the current stock price.
Feb 2004, they issued 2.5 million shares of restricted common to legal counsel for $50K of accrued legal services and future legal services. This is insane! It would have been something like $25 million!
Aug 2004, they issued 11.5 million shares to EuroFaith Holdings for convertable debt. Restricted shares. Exemption from Section 4(2) of Securities Act of 1933.
Nov 2004, they issued another 4,683 shares to legal counsel. I guess the 2.5 million shares just weren't quite enough.
Nov 2004, issued 3.3 million shares to EuroFaith Holdings as part of an additional 15% interest in the not-quite-fully-owned subsidiary Starway. Again, exempt from Section 4(2).
Feb 2005, 7.8 million shares issued to Sky Beyond for the remaining 35% of Starway.
Webb & Company of Boynton Beach, FL gave them an unqualified opinion, signed Jan 29, 2004.
They audited Direct Casket Delivery. Which registered securities in 2003 and then de-registered them less than a year later. Their financials were terrible. Webb gave them a going concern qualifier.
They also audited Webb Mortgage Depot (presumably no relation, now Medical Connections Holdings). Slammed them in their statement (page 23).
They audited others as well.
Ok, so here's the big thing about this company. For the full year ending Sept 30, 2005, they earned $22.4 million. In the prior year (2004), they earned around $17 million (before pulling out the minority interest at that time). But 2004 was really worse than that. In 2003, they earned around $1.7 million. Revenues increased from $31 million in 2004 to $48 million in 2005. Gross margins were 62% in 2004 and 59% in 2005. Net margin (note there's no taxes in 2005 and I've removed the tax benefit for 2004) was essentially 36% in 2004 and 53% in 2005, not counting minority interest, either.
Tax in 2005 would have been $4.7 million more. So I'd assume that, had they been taxed in 2005, they would have earned $12 million.
The balance sheet has $31 million cash. Total liabilities are less than $8.4 million. They have about $30 million in notes receivable (not counting ordinary AR), but we won't even count that. They have about 90 cents of net cash per share and the stock is selling for around 50 cents.
The big dilution is entirely due to acquiring the rest of the Starway subsidiary, plus 578K shares issued for services.
Cash flow from operations was only around $13 million since they took $20 million in notes receivable. In investing, debt increased by $1.9 million. Capex was a measley $22K. And that's about it for cash flow. Cash flow from operations in 2004 was just OK when you adjust for minority interest.
Scanning the Notes
They're in a special economic region of China and have a 2 year tax exemption and a 50% reduction for the next 3 years.
Allowance for doubtful accounts is around 10% of AR (and has hovered around there in the past).
Inventories are down.
Net PP&E is low at $444K, half depreciated (net PP&E is down from $528K in 2004 and $750K in 2003).
Some related party transactions as cash advances to shareholders for ordinary business expenses. Also shareholders collected payments on receivables which hadn't yet been turned over to the company (bad).
They carry some US NOLs, but I'd consider that worthless.
1.2 million stock options were registered on Sept 8, 2004. 10 million preferred shares authorized but not issued.
The 10-Q for Q1 is here. What I see is that the balance sheet is deteriorating (but they still have around $20 million net cash). Revenues are still largely promises (accounts receivable). Cash flow from operations is seriously negative for this quarter due to AR, inventories, loans to related parties, various receivables. Are things falling apart?
Earnings per share were 25 cents and you could probably squeeze a dollar per share of net cash out of the business in liquidation. But is this all real? Are there hidden liabilities beyond the lawsuits? Speaking of which...
Victor Reichenstein complaint. Against CEO (appointed Jan 17, 2006), CFO, prior CEO and Chairman. Paragaph 32 raises the issue about the prior auditor, Gary E. Hirth. When CESV dismissed Hirth, they said there was no disagreement on accounting issues nor on any other reportable occurrence relating to his departure. Then the complaint claims the transitional 10-K filed on Jan 13, 2005 had a going concern qualifier. That's nothing new and it covers the pre-reverse merger company. See here for the qualifier and see page 23 here for the supposedly false claim by CESV. Notice that the "false claim" actually contains the going concern qualifier itself.
We dismissed Gary E. Hirth CPA ("Hirth") as our auditors effective from August 19, 2004. Hirth served as our independent auditors for our former fiscal years ended September 30, 2003 and September 30, 2002. Hirth's report on our consolidated financial statements for our fiscal years ended September 30, 2003 and September 30, 2002 (the "Reports") did not contain an adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles except as follows: In Hirth's report dated December 29, 2003 and December 23, 2002 for financial statements for our fiscal years ended September 30, 2003 and September 30, 2002, respectively, Hirth indicated that: "The Company has negative working capital and a deficit stockholders' equity. These conditions raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty."Next, the complaint says the company released a 10-Q on Aug 24, 2004 showing earnings of 23 cents per share. Two days later, New Solomon Consultants Ltd purchased a controlling interest in CESV from Eurofaith on converting the promissory note that was issued to buy controlling interest in Starway. New Solomon is essentially controlled by the defendent Sun Li. After this whole deal, the original CEO resigned and Sun Li became Chairman and CEO.
On Nov 5, 2004, the auditors Webb & Co resigned after one of its affiliates was appointed CFO of CESV (to avoid conflict of interest as stated in the document). Nov 17, 2004, CESV acquired another 15% of Starway (to 65%).
On Dec 3, 2004, CESV announced it applied for listing on NASDAQ. They also reported 9-month revenues of $31 million and net profit of $22 million.
On Dec 9, 2004, CESV issued a press release touting a big increase in new contracts that Starway had entered into. The press release claims 50% market share and some real boasting. Other results and press releases followed.
On Feb 3, 2005, they issued a press release announcing they acquired the rest of Starway for 7.8 million shares.
On April 18, 2005, they announced NASDAQ approval.
On May 17, 2005, they filed yet another NT 10-Q (late extension). This was the 3rd quarter in a row. The 10-Q was filed May 23. Results were apparently good. Over $13 million in net cash (over 50 cents per share).
On June 27, 2005, they filed an 8-K announcing a restatement for the year ending Sept 30, 2004 and the quarter ending Dec 31, 2004. The restatement was for accounting for stock issued to consultants and other service providers. There were other issues as well: Chinese taxes, consideration for the Starway acquisition. They also said not to rely on the original 10-K for Sept 2004 and for the latest quarter March 29, 2005.
The complaint contains a funny error saying that on June 27, 2005 CESV amended the 10-K for the year ending Sept 31 [sic], 2005 and amended the 10-Q for Dec 31, 2005. Apparently they had a time machine. [Actually it was 2004]
Three directors and the CFO resigned July 1, 2005. No explanations were given. A new CFO was appointed.
July 12, 2005 CESV announced results for June 30, 2005. They also provided full year guidance projecting $27 million profits ($1.10 per share).
August 15, 2005 CESV filed yet another NT 10-Q for the quarter ending June 30, 2005. August 22, 2005 they filed the 10-Q and results weren't as good as projected (then management should stop projecting results and shut the hell up). Revenues and profits were down from a year earlier.
Dec 14, 2005. NT 10-K. Late again. Dec 20, 2005 they filed the 10-K. Results were good, but "only" $22.4 million profits ($1.04 per share).
Jan 17, 2006 CESV announced an underwriting agreement with a full service investment group to raise $50 million in a private placement. The proceeds would go to acquisitions and new infrastructure etc. The same day, the Chairman and CEO resigned as CEO (see same document).
Jan 20, CESV filed two registration statements. The first was for the sale of 6 million shares held by Chairman's company, New Solomon. The second was for 10 million company shares. The company did not announce that the private placement was "fraught with self dealing" (you can search the documents and you won't find "fraught with self dealing" anywhere in them!).
The company did not disclose that the new CEO had introduced an investment group to CESV which then did the underwriting for the $50 million placement.
On Feb 6, 2006, Dutton Associates downgraded the company due to the obvious reasons. But they also noted that upon Mr. Li's resignation The Board of Directors immediately appointed Kwun Luen Siu to the positions of Chairman and CEO. Mr Siu was referred by Sun Li and reviewed by the Board of CESV before being appointed. Mr Siu also served as the Responsible Director of Forex, Futures and Securities under the Securities and Futures Commission of Hong Kong, Chairman of Supervisory Committee of the Chinese Gold and Silver Exchange Society of HK, and Managing Director of Dashin Group in HK.
The Dutton downgrade notes that the press release says the new CFO is supposedly better at English. More importantly, they point to the large amount of revnue that is recognized in the form of receivables rather than cash. They also mention that the auditors (which they humorously label as MSFT) disclaimed an opinion about management's assessment of the effectiveness of internal controls... and all that SOX stuff.
So if I understand the issue correctly, the complaint is that the new CEO came on board presumably due to having a financial group lined up, "If you put me in charge of the company, I'll bring these guys in to raise $50 million, and I'll arrange for the CEO to be able to sell 6 million shares."
NASDAQ then halted trading. CESV's press release only said that "additional information" was requested.
March 22, 2006 CESV announced that the request for information involved the facts and circumstances regarding the "transactions related to the rescission of certain Rule 144 legal opinions by the Company's prior securities counsel who resigned in Feb 2006, as well as certain other matters related to the company's issuance of securities."
Dutton issued a report on March 13, 2006 with the opinion that the trading halt was related to issues surrounding the large sales of restricted stock by the former Chairman/CEO.
Dutton noted that there were several sales of stock by New Solomon (controlled by then Chairman and CEO):
Jan 3, 2006: 2.2 million shares sold in private sale at $8.00 (only 575K would be allowed by Rule 144, see below)
Jan 27, 2006: 1 million shares sold in private sale at $5.75 (only 448K would be allowed by Rule 144, see below)
Feb 3, 2006: 1.3 million shares sold in the market at $8.92 (slightly less would be allowed by Rule 144, see below)
When CESV filed the 10-Q for the quarter ending Dec 31, 2005, it said that the auditors and CESV management were advised by the SEC on Jan 31, 2006 and Feb 9, 2006 that the SEC was conducting an informal and non-public inquiry into CESV and the SEC requested certain documents.
The rule on restricted stock under Rule 144 is that after the one-year holding period, you can't sell more than 1% of the outstanding shares of that class of stock. If it's a publicly listed stock, then you can't sell more than 1% of the weekly volume (during the 4 weeks prior to filing a notice to sell on Form 144).
The former Chairman/CEO filed a Form 144 to sell 2.97 million shares when trading resumes (which it did).
The stock had been trading above $6.00 until trading was halted in February 2006. When it re-opened, the stock plummeted and it's been around 40 cents.
I won't be buying any shares of this company. It's tempting, yes. But a controlling interest is held by someone who is, at best, unethical and potentially not particularly accountable... and I know all about the worst. And there's enough funny business for me to avoid the shares, but even below net cash value with a P/E significantly less than 1? If the company is for real and everything goes back to normal, those holding the shares will see a huge increase going forward. The shareholder lawsuits don't scare me all that much (they should scare the defendents).
It's kind of frightening to see some similarities between this company and ETLT and CXTI. I can see the benefit of spending lots of time looking at lots of companies to get a sort of Blink sense.
I haven't looked this over as carefully as I normally would. I'd pessimistically assume about 30 million totally diluted shares. I'd also guess that the shareholder lawsuits could be a big downward hit. These energy savings products seem fairly good, but I'd expect significant competition in the future; not terrible slugfest competition, but enough to cut the net margins in half. I also have no idea how revenues will grow. So let's say they'll routinely earn around $12 million per year, or about 40 cents per totally diluted share. That would make the stock nominally worth about $6.00. However, there would need to be a significant margin of safety, given the shareholder lawsuits.
Too horrifying for anything except perhaps a tiny gamble.
UPDATE July 4, 2006:
ABH (in the comments) pointed me to this webb page which explains the real funny business. Yeah, it's horrible alright.
I think this link will fill you in on some of the issues that surrounded CESV:
this is the best information about CESV ever found on the internet. Do you have any idea when there will be a final judgment for the outstanding lawsuits?