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Sunday, October 28, 2007

Jpak Group (JPAK)

My new approach is paying off. After hitting about 50 bad companies, I ran into something that may turn out to be an investment (not JPAK). That will probably take some time before it gets posted and I like to post stuff at least once a week, so I figured that I'd take another company and do a quick blurb on it. But that company also looked like it could be too good to post yet. So I tried a third company, Composite Technology (CPTC), which was really too much to attempt in a quick blurb. Some people might find it interesting but I threw it on the "too difficult" pile.

So let me try one more time to find something that I can pick apart quickly. So let's take a look at Jpak Group (JPAK).

The first interesting thing I see is that QVT Financial LP accidentally filed a statement of ownership and then withdrew it because the company itself wasn't reporting.
Because the Issuer does not have a class of equity securities registered under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”), the reporting persons do not have a reporting obligation under Section 13(d) of the Exchange Act.
In August they owned 15.9% of the stock.

JPAK filed a registration statement early in Oct.
The offices are in Shandong Province, China.
39 million shares (owned by existing stockholders) being registered.

They make aseptic cartons (aka juice boxes): milk, juices, soy milk, yogurt drinks, etc. They believe they're the largest domestic supplier in China. They plan to export to Southeast Asia.

They were a state owned business, started in 1958. Management bought out 88% of the company in 2004 and started development of aseptic liquid food and drink cartons, launched in 2005. Reverse merger in 2006.

I find this odd. The Asceptic Packaging Council claims that these packages have been in Asia for decades. JPAK just launched in 2005 and claim to be the biggest domestic supplier in China. Since they're a US company, they can't be excluding other US companies who make these things in China. I suppose this is possible, but seems very unlikely.

For the year ending June 30, 2007:
Revenue: $30 million, up from $22.6 million prior year due to new customers
gross margin: 20% (down from 23% prior year)
They have positive earnings of $1.5 million, which is actually down from $1.6 million prior year, largely due to minority interest in 2006 that became 100% owned in 2007.
Net margin: 5.6% (down from 6.9% prior year), killed by SG&A.

They added a sales force and related expenses. SG&A will increase in absolute terms going forward due to expansion efforts, public company expenses.

The China carton market is $1.4 billion and growing. Multinationals supply nearly 90% with the rest are domestic supplier like JPAK ($140 million). This would mean JPAK has 21% market share among domestic suppliers.

They believe they're the low cost provider, but don't provide any reasons why.

The officers have all sorts of experience and awards. Yijun Wang has been CEO since 1984. President has been with the company for 30+ years, starting as technical manager on a production line. CFO has Chinese experience only and has an engineering background.

Salaries are low, as usual for a Chinese company. CEO makes $55K, CFO makes $30K.

No stock options.

Joyrich Group Ltd (100% owned by Stewart Shiang Lor, one of the directors) owns 69.5% of the company. The same guy owns more stock through another fund, so it's massively controlled by one person. Executives and directors own 87.2%, much of it via preferred shares.

At the end of the offering, directors and executives will own a whole lot less of the company.

The preferred stock has some pretty serious dilution and may be toxic, I'm not sure. Each pfd share converts into a variable number of common shares, currently 11.2 million. Also three classes of warrants. 11 million dilutive shares for Series A and B, but Series J converts into preferred, so tack on another 11 million for this. Also about a million "placement" warrants.

The total registered accounts for all this for a grand total of 39 million shares.

Assets are mostly AR, PP&E, cash, and inventory. Current ratio is a bit over 1. 1/3 equity.

Ignoring currency translation, they've been earning about 3.8 cents per share.

Operating cash flow is seriously negative due to various payables and inventory. The prior year was very anemic due to a massive increase in AR.

Capex has been running very high. They acquired the remaining 11.77% portion of the subsidiary for $5.2 million (giving the business a value of $44 million or $1.13 per fully diluted share).

Bank loans, convertible notes, and capital contribution etc. added a net $12.3 million in cash.

In the notes, the advertising costs were claimed to be insignificant for the two prior years.

I'm not particularly interested in the company, but I'd guess it's probably worth a dollar or so. Now let's check the market price: the bid is $1.25 and the ask is $1.40. The price has ranged from 75 cents to $1.45.

Tuesday, October 23, 2007

Pink Sheets transforms

In Internet years (like dog years), this blog has been going for a very long time. I started it by doing things differently than I had in the past. Looking at the Pink Sheets nowadays, they've transformed the way they handle and present information so well that I no longer feel the need to add a layer of information processing on top of it to do investment work (which has been a real pain to do).

I'm very impressed with how they've created classes of companies and the little symbols associated with them: "Caveat Emptor", "Grey Market", "No Information", "Limited Information", "Current Information", OTCBB, Pink Sheets & OTCBB, PrimeQX, PrimeQX International, PremierQX, and PremierQX International. I'll bet Pink sheets has a shrine honoring SarBox and hoping it lives forever. Regardless, I believe there's a real need for this sort of private tiered certification.

I've started working more directly with the Pink Sheets website in searching for companies and info instead of using scripts and EDGAR directly. like this instead of this. Different location, same information. A lot of little improvements have made a very big difference.

In other news, given the search capability of Blogger, I've decided to stop maintaining an index of posts (Blogger should really do this automatically).

Sunday, October 21, 2007

Miller Industries (MLR)

Miller Industries (MLR, sec) They convert trucks into wreckers, tow trucks, recovery equipment, etc. They're the largest manufacturer. When they announced results for Q2 2007, they included this warning:

Mr. Badgley concluded, “With the completion of the most recent municipal and military orders and with no additional follow-on orders on these contracts to date, our order intake has moderated. We expect this to cause net sales for the remainder of 2007 to be lower than those achieved during the past several quarters. While we remain optimistic about our ability to secure additional follow-on orders, we cannot predict the success or the timing of any such orders under these contracts. We continue to be concerned about general economic conditions and the effect they could have on the towing and recovery industry, as well as the level of acceptance by our customers of the 2008 chassis with new engine emission requirements. Accordingly, we have taken appropriate steps to reduce our production levels and lower our costs for the remainder of the year in response to these uncertainties. We will continue to monitor our cost structure to ensure that it remains in line with business conditions.”
The results for Q2 were good, but this warning killed the stock. The price went from $25.50 down to $15.59. I had look at this two years ago at $18 and passed on it, figuring it might be worth $19, but feared potential competition from a lower cost manufacturer in Asia.

I looked at it a year ago (and here with a quick valuation of $22) at around $18 and passed again. Materials costs were rising, as one would expect nowadays.

Looking at Q2 results: The balance sheet has improved a bit (although it has the look of a business that's winding down somewhat). I see they expanded PP&E somewhat.

Once again, I see the same big issue of low margins and interest rate sensitivity. Q2 was a solid quarter revenue-wise. Gross margins were only 15.8%! SG&A ate up another 6.4%. Interest expense was only 0.8% of revenue so perhaps that's not going to be so much of an issue (if rates go up that much, I've got bigger problems to worry about). They earned 88 cents diluted in the first half.

I expect operating cash flow to be well above earnings, but it's not because of a huge drop in AP. Ok, fine. Operations produced a reasonable amount of cash, but capex was large: about half of the operating cash flow. That's not what you'd want to see if you suddenly worried about the business drying up. CVU had that same issue a couple years ago.

The other half of operating cash flow went into paying off debt, which has been cut in half since the end of last year. Good move. Senior debt is now lowered to LIBOR plus 0.75%-to-1.50% (100 basis points lower). Junior debt was with the CEO and was paid off.

Ok, so here's the question: If the company proved to be as solid and well run as they appear, where are they going to be 5 to 10 years from now in terms of free cash flow? Can potential Asian competition's low cost make up for a lack of industry experience, knowledge, and proximity to customers? I'm thinking that I overrated this somewhat. I wouldn't worry much if MLR's margins were higher and they could absorb some price reductions. But there's not a lot of freeboard above the waterline and if someone in Asia decided to make a lot of waves for a few years, MLR could be in trouble. But if I had to pick a valuation number, is $22 reasonable? I expect long term growth (even with Buffett betting on railroads). Heavy highway vehicles aren't going away. But I don't expect big growth. Let's call it $20.

In the short term, as far as military orders go, this blog post from the highly respected historian/observer VDH contains some interesting observations in Iraq:

The number of vehicles, arms, bases, and American infrastructure in Iraq is staggering. And the wear and tear on it all is evident everywhere. I wouldn’t be surprised that 30% of our equipment is worn out to the degree that it wouldn’t make sense hauling it back, and would be better off left to help transition the Iraqis. Humvees have sprung doors, broken glass, missing pieces, well in addition to the wear from sand and heat.
There's a lot of stuff that's going to need repair/replacement. I wonder if MLR might snag a big chunk of that business?

With the stock price at $15.59, I don't think it's cheap enough, unless I had to pick 50 stocks as a fund manager.

continue following

UPDATE Mon Oct 21, 2007:
Ok, perhaps because I'm bored and undisciplined, I bought back some shares of SDTH when it dropped this morning.

Thursday, October 11, 2007

China Education Alliance (CEDA) sold about half

I sold about half of my CEDA (combined links, sec) today at around $1.15. I started buying CEDA on Dec 11, 2006. Now is when I wish I had been doing more work in digging up new investments.

With CEDA and SDTH am I cutting off the possible long tail gains? Am I overreacting to CXTI?

I bought some NICK, CVU, and CFRI with the cash from this and SDTH. I still have a lot of cash.

UPDATE Tues Oct 16, 2007: Sold the rest this morning. I'm out completely at this point.

Wednesday, October 10, 2007

Shengda Tech (SDTH) sold it

I had looked at Shengda Tech here less than two weeks ago and bought some. I sold it today at around $7.95 for a 20% gain. It might go up, it might go down. But this was where my confidence of intrinsic value was getting a bit thin.

UPDATE same day: and of course the stock closes the day at $8.40. Oh well.

when men wore hats

Tuesday, October 09, 2007

LiveWorld (LVWD)

LiveWorld (LVWD, collected entries, sec): Still around 55 cents. I sold the last of my stock on Valentine's Day 2006.

They picked up BBC as a customer and the client list seems bigger. Same management team. They started filing with the SEC and got OTC:BB approval! They increased the team size to scale for future projects which killed operating income for the quarter.

Q2 results:
31 million shares on June 30, 2007.
22 million options outstanding.
10 million options available for granting.
Assume 60 million totally diluted shares. [update: that could be 80 million or effectively more, see comments]

Balance sheet
Cash *********************************
AR ************
misc *
PP&E, net ***********
joint venture **********

AP ***
Salaries *
Vacation ***
Total Curr Liab **************
Total Liabilities***************

Equity ***************************************************

Revenues are up 17%. 65% gross margin.
They ramped up product development, sales and marketing, and G&A. So operating expenses went up 54%.
Operating loss.

Free cash flow pretty much matches the net loss.

Backlog is $4.8 million.

Q2 2007:
Revenue $2.49 million
Gross margin $1.63 million (65.3%)
Operating expenses $2.25 million
other expenses are close to zero
Net loss $0.64 million

But here's the real story:
AOL revenues have been understandably dropping... a lot. It was 37% of their business in Q2 2006. It's 11% of their business in Q2 2007.
eBay has been fairly steady at about 34% of their business.
No other client was more than 9%

Q2 2007:
AOL was $270K revenue (down from $790K)
eBay was a steady $850K
Other business grew by $879K!

Sales and marketing probably scales quite a bit along with revenue. It's currently $605K in Q2 or 24% of revenue.

New clients in the last 6 months that launched services (could that mean existing clients with new services?):
AOL Europe
Digitas -- American Express
Wildfire -- Proctor and Gamble
Hillary Clinton Presidential Campaign
Wildfire -- Glaxo-Smith Klein

They filed with the SEC, but the SEC had some issues. The use of Adjusted EBITDA and the purpose of some warrants. This SEC comment is funny:
...please revise the disclosure to elaborate on why the reduction in adjusted EBITDA is "directly related to [your] investing in future growth."
Vague but enthusiatic.
Specifically, tell us why management believes that the fair market value [of issued warrants] should not be factored into your basis in your investment in the joint venture.
Jeff Easton owns 3.3 million shares as part of a hedge fund.
CEO owns $708K shares (options).
CFO owns 250K shares (options).
Jenna Woodul (the online relationship guru or something like that) owns a whole lot of options.
WPP (joint venture people) own 4.6 million.

Ok, what happens if they double their business? We'd be looking at $5 million in quarterly revenue and perhaps a net profit of one-to-two million or four-to-eight million per year, 6 to 11 cents per totally diluted share. At that point, they might be worth as much as $2.00 per share, depending on fast they got there.

I'd say the shares are probably a reasonable price for a gamble. When I had looked at them before (and invested in them), they were scaling up rapidly and consistently, but then hit a brick wall. Seems the wall is crumbling. These are some good people running the business with a lot of experience at what they're doing. But I don't see it being more compelling than what I have now unless the price drops a lot, which could happen.

Saturday, October 06, 2007

Two community banks (BOJF, SCCB)

Going back and looking at two community banks I had looked at in the past...

Bank of the James (BOJF, FDIC #35207, sec): $17 to $17.50 now down to $15.70 on the ask. They're repurchasing stock. The FDIC database now supports comparing 4 things (including 4 time periods of one institution). For BOJF, assets and earning assets have been steadily climbing each quarter to $246 million. Assets past due jumped in Q1 2007 much due to residential housing loans, however zero assets have been more than 90 days past due. Net interest margin is down slightly to 4.23%. ROA dipped to 0.64% and is back to 0.72% (was 0.85%). Efficiency ratio is 73.45%. Capitalization ratios are very solid and have actually improved. Net income dropped to $376K in Q1 from around $1.5 million in the prior two quarters, it's now back to $859K. I figure it's probably not worth more than $15 per share.

Seacoast Commerce Bank (SCCB, FDIC #57428): fell to $9.50. Assets steadily climbing. but equity has been dropping slightly so let's look at the losses: losses for Q1 and Q2, prior quarters were small profits. I'm thinking they've probably got crappy interest margins... nope, 4.96% net interest margin, so they probably have a high efficiency ratio, which they do at 112% (the ave small California bank has about the same ratio) and $2.64 million in assets per employee. Their total risk-based capital ratio is 27%, seems overcapitalized.

Looking at the peer group small banks in California, they've all been doing crappy for well over a year. A national peer group of small banks was doing just fine during the past two years. Interesting.

Thursday, October 04, 2007

China Education Alliance (CEDA) 1-for-3 reverse split

China Educational Alliance (combined links) announced a reverse stock split. This was in the brewing for a while in the SEC filings. The proxy had a vote for it. Since the CEO/Chairman owns 66% of the stock, it was a done deal.

It's worth noting that in the 10-K, Xiqun Yu owned 30,190,411 shares (page 26). In the proxy, he owns 38,050,000 shares. Yet in between, I don't see any forms filed with the SEC about acquiring more shares.

Getting back to the reverse split...
"We believe the reverse stock split will place our company in a position to apply for listing on a market or exchange if we can meet the applicable listing requirements. Our goal is to work towards meeting listing standards," said Mr. Yu, Chairman and CEO of China Education Alliance, Inc.
I don't know if this is what caused the stock to go up so much lately. If that was the case, it should have happened long before it did. The jump and very heavy volume started on Sept 26. The proxy was filed on Sept 9.
As a result of the amendment to the certificate of incorporation, the board of directors has the power to set the rights, preferences, privileges and limitations with respect to one or more series of preferred stock, and the directors approved a series of preferred stock, designated the Series A Convertible Preferred Stock. As a result, notes in the principal amount of $3,400,000 that were issued in the May 2007 private placement were automatically converted into shares of series A preferred stock and warrants as previously disclosed.
Ok, fine.

I continue to hold the stock.

UPDATE minutes later:
I just noticed that the post about Fission Energy (the Strathmore Minerals spinoff) seems to have disappeared. They had a trading halt at 3:08 PM on Wed pending news. The Blogger ate my post! [update: no, it was just an update and it's still there. Homer "D'oh!"s.]

Tuesday, October 02, 2007

China Expert Technologies (CXTI) trading suspended

I just noticed this over at Microcap Speculator. It seems the SEC has suspended trading in CXTI stock (combined links) due to "questions that have been raised about the accuracy and adequacy of publicly-disseminated information concerning, among other things, China Expert's: (1) financial performance and business prospects and (2) current financial condition."

Wow, that's serious stuff. I would NOT want to be holding onto any stock ("just about the finest outhouse wallpaper you've ever seen!") right now.

Strathmore Minerals (STHJF, STM.V) humorous press release

Strathmore Minerals (combined links) issued a press release stating that they have no exposure to sub-prime paper in its $19 million liquid portfolio. So if you call up their office and say that you heard that they invested in sea monkeys, will they issue a press release denying it? I guess it's good they err on the side of communication.

I haven't covered their annual report. After going past lots of pictures of mountain ranges and sunsets, we get to the substance: a cash and short term investment portfolio of roughly $33 million, presumably Canadian but by now it really doesn't matter, they're 1-for-1. (funny joke: Perhaps they no longer have any exposure to sub-prime stuff now that the value dropped by a third). And there's less than a million in liabilities.

In cash flow, here's how I see it. Garden variety operations burned up about $2 million. They invested around $18 million in short term investments. They spent around $8 million on exploration. They raised around $22 million in stock sales.

They had 70,631,548 shares at year end. If I recall, I'm assuming 77 million fully diluted shares. There are about 6 millon options and warrants outstanding, total. Ave strike prices are in the $2 range.

UPDATE Wed Oct 3, 2007:
There was a trading halt in Fission Energy stock today at 3:08 PM, the spinoff from Strathmore Minerals. The reason is pending news.

Here's what I want to see in the news: I want to see them drill 50 holes and have all 50 of them intercept 25+ feet of 10% uranium.

Monday, October 01, 2007

Shengda Tech (SDTH)

This was a suggestion from Alex Harbin in the notes of Faith Based Investing. If I had looked at it sooner, it would have been a lot cheaper.

ShengdaTech (SDTH, sec) I've never looked at this company before. Chinese reverse merger. They make "nano precipitated calcium carbonate": fancy pants lime. They also make other (coal based) chemicals. Q2 results: 54 million shares. Balance sheet is mostly PP&E and cash ($30 million net cash out of $82 million in assets).

Revenue increased 59% yoy, but was flat qoq (the Q1 10-Q says the big increase in NPCC in Q1 was due to capacity expansion, so I wonder if they're capacity limited). 34% gross margins (up from 28%). 29% operating margin. Very low taxes [tax holiday for 2 profitable years, 10-K Note 7] (avoid letting it distort your view of the bottom line). Earned 11 cents diluted for Q2.

Cash flow from operations was somewhat higher than earnings, but capex was larger than operating cash flow! Some cash went to a related party payable/receivable.

The yoy revenue increases were pretty much all due to nano-materials, which has better margins.

The SEC had something to say to them back in April. There are other SEC correspondences.

Ok, so what's the stock selling for? Less than $6? $6.03 (that was on Friday). Will the revenue growth continue into the future? Are they going to disappear [or seem to get in over their heads] like CXTI? Let's dive into this one....

2006 10-K
Period ending Dec 31, 2006. 54 million shares on Mar 15, 2007.

Two businesses:
  1. nano precipitated calcium carbonate ("NPCC")
  2. coal-based chemicals (ammonium bicarbonate, liquid ammonia, methanol, melamine)
Direct sales force. Geographical coverage is in northern China, including Shandong Province [an industrious province] where they have good market share.

NPCC is used in paper, paints, rubber, and plastic industries. SDTH sells mostly to tire and PVC industries.

Ammonium bicarbonate is used for fertilizers. Methanol is a common chemical raw material (I've known this since making good money on Methanex, MEOH, which I still consider a reasonable investment for commodities). Melamine is "the intermediate product of environment friendly resin."
We believe the fastest growing area for NPCC will be in the tire and PVC building material market. We believe that our NPCC products provide highly effective fillers and additives for tires and PVC building materials. NPCC products are ultra fine and pure, and its particle size and crystal shape can be controlled effectively in the production process.
They go into detail about how NPCC improves many qualities of PVCs and rubber.

One subject that I think about a lot is how things have changed in the last 100 years. One of the biggest group of changes that never seems to be discussed is the improved qualities of materials. Not that long ago, plastic was a derogatory term to mean phony and cheap. Compare the really awful qualities of 1960s plastic items with consumer products of today. Night and day. And you find big improvements in just about every material (not sure about steel and concrete, however).
According to a report by China Economic Daily dated October 10, 2005, China’s total tire output was 239,000,000 units in 2004 which represents a 18.7% increase from 2003. From 1999 to 2004 the average annual growth in tire output was 15%. Currently, we are the only Chinese manufacturer of NPCC that is able to supply the tire market.
The building boom has pushed the demand for PVC and oil based paints. I wonder if this is sustainable.

They're also targeting new market segments in the future. I have no idea what to think of this other than shooting enough arrows at random could result in hitting a target somewhere.
Our company owns the only exclusive [i.e. there may be others which are non-exclusive] NPCC development and research lab in China. It is located in Pudong, Shanghai and its excellent working environment will attract more intelligent and excellent NPCC researchers and scholars. Currently there are ten staff working in this lab, each having a masters degree in chemical related fields. They engaged primarily in furthering NPCC related technologies. We believe that our development and research team will enable us to obtain more technological improvements, which will allow us to offer cost-effective and high-quality NPCC products. We recently developed new NPCC products for paper, paints, coatings, polypropylene and polyethylene industries. We expect to ship these products to the market gradually in the second half of 2007.
The direct sales force is based in three main cities.
We will expand our sales network by setting new sales offices in Xian, Guangzhou and Dalian, in addition to our existing ones in Shanghai, Tsingdao and Beijing.
They only manufacture 10% of the total NPCC in China. However, they believe they're the only one selling to the tire industry which allows them to have high margins. It would be very bad if some aggressive player invaded that market.

They use a "high gravity precipitation" method [presumably centerfuge based] which has been licensed by Beijing University of Chemical Technology, apparently more correctly Nano Material Technology Pte. Ltd. Four others have a license, but none has "been successful in commercializing this technology."
However, among the five companies, we are the only one that has successfully integrated the ultra-gravity method with a distribution control system, which gives us the ability to maintain high quality NPCC products.
In new facilities in Shaanxi, they've developed another method, the membrane-dispersion technology which was co-developed with Qinghua University and exclusively owned by SDTH. This supposedly allows higher quality at lower cost.
...we jointly own a pending patent developed by Tsinghua University on next generation NPCC particle producing technology based on membrane-dispersion techniques. The pending patent is expected to be officially issued in November, 2007.
and also what is apparently trade secrets:
We also own a proprietary technique for NPCC chemical modification that is applicable to different types of end products critical to adding value to downstream industry plants.
Current NPCC capacity is 90,000 metric tons per year (one of the largest suppliers in China). Biggest customers seem to use 4,000 metric tons per year. They plan to add 40,000 tons capacity in May 2007 and 60,000 tons in Dec 2007 to reach 190,000 tons and be the largest manufacturer in China. Are any other companies planning to add capacity???

The Shaanxi facility is near a limestone mine with the highest quality limestone in China.
Our use of the membrane dispersion technology jointly developed with Tstinghua University has enabled us to save energy in the production process. In addition, we anticipate spending an average of approximately $2 million per year for the next three years to replace our existing chemical equipment in order to reduce energy consumption and pollution. We believe as a result of these and other factors our production costs will be significantly lower.
Despite their claims about the greatness of their research team, their experience seems somewhat short. The director of R&D has been in the NPCC research for "more than six years." However, he did head up the effort to develop proprietary methods for chemical modification of NPCC products for the tire, paint, and PVC industries. So Xukui Chen has done well so far.

In 2006, they completed samples testing of NPCC products with 22 companies in various industries: PVC, rubber, adhesive, latex, coating.

There's more joint development with universities going on. SDTH has exclusive ownership to the technology developed with Tsingdao. With Tsinghua, it's jointly owned but SDTH has exclusive rights to use it. Tsinghua has produced one patent application. The fee to Tsinghua is $130K per year.

There's also "micro-mix reactors" which reduce costs and enable other product lines.
We haven’t fully expensed our budget of $9 million for establishing research and development centers in Beijing, Shanghai and Tsingdao, mainly because we purchased a R&D building with a total investment of $2.5 million. This center is able to meet our current R&D demand.
I'm not sure I understand what that means.

They've completed sampling and testing with 4 foreign companies in the paints, PVC, polyethylene industries in Thailand, Indonesia, Malaysia, and Korea. Products are also being tested in Japan and Netherlands. Expansion is via trade shows and a Chinese B2B website (which doesn't seem very industrial).

Sales team of 41.

Raw materials are nearly 60% of production costs.

There's some significant vendor concentration, as much as 34% in NPCC and 13% in coal based chemicals.
14% customer concentration in tires (Triangle Tire), also a 12% (Zhaoyuan Liao).
20% customer concentration in PVC (Dalian Jinyuan), also a 17% (Qingdao Haiwei).
Not much customer concentration in coal based chemicals.

Competitors' NPCC prices are $161 per metric ton to $620 per metric ton. Perhaps the median might be $300? The segments of competitors is: electrical wire and cable, rubber, adhesive, paints, coatings, plastics, ink.

1,355 full-time employees: 433 in Shandong Haize Nano-materials, 346 in Shaanxi Haize Nano-materials, 576 in the chemical devision. 5% management, 3% sales.
45 day to 90 day AR

Notable Risks:
Exhaust gas and wastewater pollution
Raw materials price fluctuations (need moat), especially the price of coal (page 24)
Trade secrets (normal non-disclosure and 5-year non-compete contracts in place)
Possible future chemical supply glut
Potential future tire composition changes to exclude NPCC
Difficulty in attracting good technical people in small city (but this can be a definitely plus, which is why I'll be visiting Visakhapatnam and not Bangalore)
Possible foreign competition

No outstanding SEC issues.
No legal proceedings.

Pages 21 and 22 have excellent long term financial information for the company.

Revenues (each "*" = $1 million, green = gross profit):
2002 chemical *********
2002 NPCC ****

2003 chemical **********************
2003 NPCC ********

2004 chemical *************************************
2004 NPCC *************

2005 chemical *******************************************
2005 NPCC ***************

2006 chemical ***************************************************
2006 NPCC **********************

Income Before Taxes (the wild tax differences they had distort the picture, in my opinion)
2002: *
2003: ****
2004: ************
2005: ****************
2006: ******************

...return on beginning assets
2003: 17%
2004: 39%
2005: 45%
2006: 58% (26% return on ending assets, they're expanding fast)
Jumping ahead to Q2 of 2007: an equivalent of about 31% for the half
Looking ahead, depreciation for 2006 was $1.0 million, same as 2005 and similar to 2004. Gross PP&E is around $27 million. In reality, this is not a capital intensive business in the sense of low return on assets with an associated slow depreciation, but I suppose it could be if the competition was bad enough.

G&A way more than doubled in 2006. It had been fairly stable in prior years.
The main reasons were: (1) the $340,771 increase as R&D fee and (2) salary of the employees increased by $86,411 due to the expansion of the production capacity (3) the lease expense of new NPCC facility’s office building increased by $20,718 and (4) production and construction amortization expenses increased by $322,557 and (5) expenses of $750,041 related to becoming a public company and (6) value of warrant granted as the service compensation was $153,619.
Coal price increases: 2004 $70/ton, 2005 $80/ton, 2006 $90/ton.
Seasonality is a slowdown in Dec and Jan.
No allowance for doubtful receivables due to collecting them all before finalizing the report.
No capitalization of internally generated intangibles (e.g. patents).
Land use rights amortize over 50 years. Patents 20 years which is interesting.

Gross margins on chemincal decreased to 25% from 28% (due to mix and materials costs). 2004 was only 24%.
Gross margins on NPCC increased to 40% from 37% (due to increased revenues and lower materials costs at new plant). 2004 was 36%.

Reasons for chemical revenue increase:
(1) additional revenue from new products such as melamine for $3,914,827 and (2) technical improvement (the installation of decarbonators in our chemical plant enabled us to change our product mix to meet seasonal demand) increasing the sales of high profit products, which caused the increase of revenue by $5,811,350 which was offset by the decrease of sales from low profit products by $3,109,859
Reasons for NPCC revenue increase:
(1) additional revenue from new products for $419,075 due to the introduction of new NPCC pulp for tires and (2) revenue increase of $1,453,489 due to increased demand from our customers
Xiangzhi Chen, CEO, 44, owns 45% of the stock. Background is in construction and not the core business.
Anhui Gho, CFO, 36. Came from same background as CEO. Doesn't seem to have a particularly strong accounting background.

All officers and directors own 47% of the stock.

One outside director from Shandong Bangsheng Chemical Co.
One very new outside director from Shandong Chemistry and Chem Eng Assoc and other associations. Seems to have solid connections.
One foreign director, A. Carl Mudd, a financial person. This is good to see:
He has spent the past 14 years consulting with and mentoring CEOs and Boards of Directors major companies on global strategy, business processes and international operations and 27 years as CFO, COO and President of international companies. From 2003 to 2006, he was an advisory director at CIMIC Holdings, Ltd. From 1993 to 1996, he served as director and chairman of the Audit Committee at AM International, Inc. He is a Certified Public Accountant and holds a business degree from St. Edward's University.
Another foreign director, Sheldon Saidman, a marketing person.
From May 2001 to October 2005, he served as president and chief operating officer of Liberty Wire & Cable, Inc. He holds a bachelor’s degree in journalism and public relations from The University of Maryland.
Unlike so many Chinese reverse mergers, they have a true audit committee. Carl Mudd (chairman), Dongquan Zhang, and Sheldon Saidman.
The Audit Committee has established as a separately-designated standing committee in accordance with section 3(a)(58)(A) of the Exchange Act. The Audit Committee has at least one member, Mr. Carl Mudd, who meets the definition of an “audit committee financial expert” under SEC rulesand whom the Board has determined to be “independent”.
Compensation committee: Dongquan Zhang (chairman), Carl Mudd, Sheldon Saidman. The highest compensation is $250K total. CFO got $100K total.

No employee stock options granted in 2006. No options exercised, nothing vested in 2006.

Some related party stuff. March 2006, SDTH leases Shaanxi plant and land from Shangdon Shengda: the SDTH CEO is controlling shareholder of it.

Audit fees $165K for 2006, $84K for 2005. No other fees paid to auditors.

Hansen, Barnett & Maxwell
5 Triad Center, Suite 750
Salt Lake City, UT 84180
(801) 532-2200
40 years of experience. They audit 38 public companies.

Non-qualified opinion.

Equity statement:
In 2006, there were 5.8 million shares issued for cash at $2.29.
3.1 million shares issued "recorded as a purchase". What's up with that?
$971K was distributed to shareholders. What's up with that?
154K warrants issued
$907K of the net income for the year was recorded as statutory reserves. What's up with that?

Operating Cash Flow:
cash flow exceeded net income by $4 million due to $4 million receivables decrease, plus payables increase, and depreciation, partly offset by trade AR and advances and inventory.

Investing Cash Flow:
Capex was huge at $15 million, not surprising.

Financing Cash Flow:
$2.9 million cash added due to AP of related parties. $952K added due to AR of related parties.
$971K distributed to shareholders (no addition info here, wait for the notes).
$14 million cash generated from stock issue.

So the stock issue effectively financed the plant expansion while operations generated $21 million.

In 1998, 19 investors (with Chen Xiangzhi having a controlling interest) formed Shandong Shengda Nano Co. Ltd. ("Shengda Nano") in PRC, which makes NPCC for tires.

Nov 13, 2001, those same investors formed Shandong Shengda Chemical Co. Ltd ("Shengda Chemical") in PRC, which makes ammonium bicarbonate, liquid ammonia, and methanol in PRC.

Sept 2004, those same investors formed Dongfang Nano-Materials Pte Ltd, a Singapore private limited company. The name changed to Eastern Nano-Materials Holdings Pte. Ltd ("Eastern Nano"), and two subsidiaries of it: Shandong Haize Nano Co Ltd ("Haize Nano") and Shandong Bangsheng Chemical Co Ltd ("Bangsheng Chemical"), both in PRC: ("Eastern Nano Subsidiaries").

Nov 2004, the investors transferred all of Shengda Nano and Shengda Chemical, with the exception of $7.8 million in cash and $301K receivables, land, land use rights, buildings, to the Eastern Nano Subsidaries, which also assumed $1.3 million in liabilities from the investors.

June 2005, Eastern Nano Subsidiaries acquired this stuff for $5.2 million. Chen Xiangzhi, the controlling shareholder, personally borrowed $5.3 million and paid $5.2 to the investors as a capital distribution. The net assets transferred were also considered a capital distribution. This was done to follow PRC rules. After this, the investors repaid the loan which was considered a non-cash(?) investment into Eastern Nano parent by the investors. This also included a $3.4 million receivable from a shareholder. Wow, is that silly or what?

All those assets, including the stuff withheld, had a carrying value of $28.2 million.

The stuff that Shengda Nano and Shengda Chemical withheld was then leased to Eastern Nano Subsidiaries.

The stuff, excluding the stuff withheld, had a carrying value of $23 million.

Nov 15, 2005, the investors formed Faith Bloom Ltd in British Virgin Islands (you can see the reverse merger coming here). Dec 31, 2005, Eastern Nano parent transferred the Eastern Nano Subsidiaries to Faith Bloom in exchange for 10 million Faith Bloom common shares to the investors. This was considered a reorg into Faith Bloom.

March 31, 2006, Faith Bloom issued 1.3 million shares to some institutional investors and accredited investors for $15 million, less $1 million in costs. On the same day, Faith Bloom did a reverse merger into Zeolite Exploration Company (Nevada), exchanging all 11.3 million Faith Bloom shares for 50,957,603 shares of Zeolite common, giving Faith Bloom investors 94.2% of the company. In Jan 2007, the company name changed to Shengdatech, Inc.

All financial statements are stated as if this reorg had been in place the whole time.

By the way, if you ever wanted to learn how to master the 3 Card Monte, here's the book for you.

In Sept 2006, they realized that 2004 and 2005 needed to be restated: revenues were overstated due to incorrectly accounting for rebates to customers of $513K and $723K. It took 40% off the selling expenses and 1% off revenues of 2004.

Land use rights, buildings, and some equipment are not consolidated into the financials as SDTH is not the primary beneficiary due to significant other operations and equity of lessors. Remaining future leases are:
2007: $887K
2008: $277K
2009: $184K

In the agreement between Eastern Nano parent and Shengda Nano and Shengda Chemical in Nov 2004, some assets were deemed impaired by $231K.

Revenue recognition seems ok. No post-delivery obligations.

R&D costs:
2004: $2.4K (yes, you read that correctly)
2005: $104K
2006: $341K

The 2005 non-trade receivable as mostly an income tax refund of about $4 million.

PP&E is almost entirely plant, machinery, and eqipment of $25 million. The building is $1.9 million.
$3.7 million depreciation against $27 million in PP&E.

$818K of replacement equipment was purchased from a related party.

Depreciation schedule (straight line):
Building: 15-25 years
Plant, machinery, equipment: 10-17 years (is this too long?)
Motor Vehicle: 5-10 years (10 years is pushing it)
Office equipment: 3-5 years

Other Payables is mostly utilities payments, plus payroll and "other".

SDTH was granted a tax holiday for the first two profitable years.
Only 50% taxes during years 3 to 5, which is 15% federal and 1.5% for local.

Tax for 2006 would normally have been $5.78 million. This would have lowered net income to $11.75 million (from $17.53 million) resulting in 19.6 cents per currently fully diluted share (assuming 60 million shares).


Wendy Fu joins as VP of finance (press release).
2005-2007: worked in Deloitte & Touche as a SOX senior consultant.
1999-2004: assistant controller, Wal*Mart China
1997-1999: regional finance mgr at Asia Pulp & Paper
1995-1999: auditor with BDO Binder
licensed CPA and holds a masters in accountancy from U Texas, Austin.... a Longhorn!

Here's the Q2 press release which has a lot more good stuff. The coal based revenue dropped qoq due to a 15 day factory shutdown and upgrade in April. The equipment should reduce raw material cost. The NPCC production is at full capacity, as I had wondered above.
Moreover, we successfully added seven new domestic clients and one Malaysian client, which marks our expansion into the international markets for NPCC.
Latex and adhesives had strong growth, up 264% qoq to 8.5% of NPCC revenue.
The higher gross margins at the Xi’an factory were due to the use of the company’s proprietary membrane dispersion technology combined with lower raw materials and labor costs, which together lowered the overall cost of goods sold at the Xi’an factory by 30% compared to the original factory.
So the claims in the 10-K are being realized this year. That's good to see.
In July 2007, ShengdaTech completed the addition of 40,000 metric tons of NPCC capacity. The new lines are expected to be at full capacity by November, 2007. The Company also plans on completing instillation of an additional 60,000 metric tons of capacity by year end 2007. Total NPCC capacity, once all lines are completed, will be 190,000 metric tons.
Wonderful, they put the conference call transcript in the SEC filing.
...we have successfully won seven new domestic customers and one overseas customer in the past quarter, and we expect to add four or five new NPCC customers in the third quarter.
and the Q&A.
The ASP for NPCC is around $390/MT without VAT.
Our cash on hand and cash generated by operation activity can support the capacity expansion of 60,000 metric tons capacity.
The big players like Michelin use their own technologies. The 2nd tier players have shown interest. Their targets are Kumho tire (Korea) and Bridgestone in Japan.
NPCC is used in the coating for manufacturing coating paper which usually requires about 12 -15 parts of NPCC, equivalent 8-10% of total weight. For latex, NPCC is mainly filled into silicone adhesive, which has high demand of NPCC which usually requires 30% of total weight. Regarding paint, NPCC can partially replace titanium dioxide (20%) and other materials which usually require 5-8% of total weight. For PVC, the proportion is about 5% of total weight.
However, this statement seems odd given how incredibly common limestone is in the world
Limestone is the main raw material for producing NPCC. Because China has large reserves, we are able to produce NPCC at a reasonable cost while in many other countries where limestone is not widely available the cost is relatively higher.
Here's the 40K metric ton capacity completion press release. New membrane method lowers cost by 5-7%. Also better quality particles. Overall, production costs are lowered by 30%.

Carl Mudd acquired 5,000 shares at $5.40.

Modified articles of incorporation. 110 million authorized shares.

Q1 conference call
$460 per metric ton ASP before VAT.
In order to continue to consolidate our market share, we plan to begin adjusting our NPCC average selling prices in the second quarter. Given the strong cost efficiencies in our Xi’an facility, we have the ability to offer lower price to our customers without compromising our blended gross margin.
Going into detail about the Xi'an facility lower costs:
Our cost on the limestone is 14% lower, electricity is 7% lower and consumption of anthracite is 8% lower, soft coal is 45% lower.
Q1 results

SEC commenting on rebate issue and a purchase obligation issue

Q&A info
These are good questions and the answers seem fine. A $199K "other expense" was bank fees and disposing of equipment. Expect 60 sales people by the end of 2007.
Can you explain why purchases of property and equipment on the cash flow statement were negative in the fourth quarter?

A: As of September 30, 2006, the Company had recorded, as fixed asset additions, the construction of the new 60,000/mt plant. During the fourth quarter 2007, it was determined that a portion ($971,496) of the amount paid to related parties for the construction of the new plant was a capital distribution. During the 4th quarter, this amount was reclassified from fixed assets to a charge to stockholders equity and exceeded the amount of additions and advances paid for the 40,000/mt plant thereby resulting in a negative addition to fixed assets for the quarter.
I guess...

Carl Mudd buys 3,000 shares for $4.00 each.

Q4 results

Feb 23, 2007: A. Carl Mudd, Sheldon B. Saidman, Dongquan Zhang added to the board.


I like this company. The business seems to have very good characteristics. They seem serious about a good set of goals. They've demonstrated an ability to deliver by setting up the new factory and getting the anticipated results. They've brought in appropriate outsiders.

The price per shares is/was around $6.00. This is a case where it's worth asking whether this is something worth more than a cigar butt valuation.

I'm going to assume 60 million totally diluted shares. I think the stock is worth around ten dollars a share, which might be a bit high compared to my valuation of other stocks (the tax holiday for SDTH doesn't last forever). Maybe I'm relying too much on a gut feeling.

I bought some with some cash that I added into one of my accounts. It's not much. If some opportunity arises, I might buy some significant amount.

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