China Sky Confusion: Management Is Flying in Circles

Yesterday, China Sky One Medical, Inc. (CSKI) issued a press release stating that it had engaged Pricewaterhouse Coopers to assist the company in complying with the financial reporting and control requirements of the Sarbanes-Oxley Act. Pricewaterhouse will not become the company's auditor. China Sky is only engaging the firm as a consultant.

If China Sky wanted to truly improve its financial reporting, why would it not just retain Pricewaterhouse as its external auditor? Does this mean that the company is admitting faults in its financial control?

Oddly, on May 15 China Sky's management stated that they would not retain a Big 4 firm as auditor. This statement was made in China Sky's first quarter earnings conference call. One analyst on the call asked specifically whether the company would consider hiring one of the Big Four accounting firms to conduct its audit, along with hiring more experienced directors. China Sky management stated in response that the company's chairman "doesn’t think it's appropriate to change auditing firms that often," and that the company will not be changing anytime soon.

Reports previously issued by asensio.com pointed out that China Sky had four auditors at different times in the past three years, with each auditor having a history of deficiencies, and that the company had appointed a 25 year-old graduate student to serve on its board and audit committee as a "financial expert."

Apparently the issue of appropriateness did not occur to CSKI management when it changed auditors three times in three years. Crocker Coulson, China Sky's outside investor relations representative, thereafter stated on the call that in his experience smaller auditing firms provided better "service" to companies like China Sky. Mr. Coulson did not specify what services CSKI's current auditor provides that are better than what could be done by a more reputable firm.

In the conference call China Sky management responded to many other questions on issues raised in asensio.com's reports on China Sky, including irregularities in inventory and gross margins. Though China Sky's management answered questions, their responses did not provide much clarity on the serious issues facing the company.

A report issued by asensio.com on May 15 pointed out the continuing inconsistency in China Sky's gross margins evident in the first quarter earnings. China Sky's sales of contract products, manufactured by other companies, decreased to 0% of sales in the first quarter of 2009 from more than 20% in the same period of 2008, while gross margin remained nearly constant. An analyst asked China Sky management about this directly. The company's explanation was that contract sales had gross margins that were only 2% lower than the company's own products.

Several people on the call asked China Sky management about the company's low inventory levels, what is perhaps the most clearly problematic issue in China Sky’s financial disclosures.

China Sky's management provided some long-winded, circular responses, but their basic claim was that China Sky can push its inventory off onto customers and suppliers. If the process of pushing inventory off onto customers and suppliers were indeed the case, it would mean that the company should be reporting deposits from customers and deposits to suppliers as separate line items on the balance sheet. The only comparable entry in CSKI's latest Form 10-Q is for "Prepaid and other current assets," totaling $77,726. The notes to the financial statements provide no explanation as to what these prepaid and other assets are precisely. However, if it represented prepayments for product, then $77,726 seems an especially small number for the type of prepayment system that CSKI management alluded to, especially given that the company reported more than $24 million in sales for the first quarter.

China Sky management made further puzzling statements concerning its customer and distributor relationships. Management referred to two of its three major customers as "sales agents." Sales agents are typically distinct from distributors. It would be highly irregular for a sales agent to maintain the type of relationship where products are pre-purchased, as CSKI management stated was the case in response to questions on inventory.

Trying to find logical explanations to reconcile China Sky's various disclosures and management statements can be like running around in circles. More explanation provided by the company only results in more confusion.

Disclosure: Short CSKI.

Comments

[balabanovj:]

Clearly another desperate attempt to drive down the price of CSKI. You are so very blind to all the positives this company has to offer. Your short position will either wind up being dead money for you, or you'll have to cover. For a short, your stock picking ability is abysmal!

JBB

May 20 05:46 AM

[Karl Francis:]

It's obvious that you are getting frustrated. In spite of your relentless smear attacks, the stock price isn't crashing.

It's revealing that you don't even try to contact the company and ask for clarification of the alleged issues. If others address those issues in the CC and if management tries to provide detailed answers, you qualify those answers as tortuous and report them in an intentionally distorted way. It should be clear that in CC's of Chinese companies, there is always some information loss in translation and misunderstandings occur. It's always advisable to contact management afterwards to check this out before basing arguments on what the interpreter has said.

In your eyes, the company is always at fault. If CSKI changes (and upgrades) to a better known auditor, you call that suspicious, if it doesn't, it's bad too. The current auditor, Moore Stephens, is a well regarded international accounting group with a good presence in China. Why should CSKI switch to another one? Management says that it has chosen Moore Stephens last year after consultation with its international institutional investors. What is bad with that? Management has said that it will stick with this auditor because it has learned that changing the auditor too often invites critique. Management has also explained that it is difficult for a Chinese micro cap to get full auditing services from one of the big four accounting firms. Those firms are more focussed on big companies. Now that CSKI has been able to contract one of this four as a second auditor for help in further enhancing internal auditing and accounting, you are not happy again. It's obvious that if the company can further enhance the credibility of its accounting, you are getting in serious trouble with your short position.

You allege that the company's business is less than reported. Because the company's reported earnings translate into fast growing piles of cash on the company's balance sheet, you insinuate that Moore Stephens has wrongly certified non existing cash. You avoid saying this directly because you know that this could invite lawsuits and that you could be proven wrong easily, leading to another conviction (see asensioexposed.com).

Regarding inventories, management has explained it's just in time inventory policies. Why should the company be obliged to pay deposits to suppliers for asking them keep enough inventories of raw materials, if those suppliers are eager to have CSKI as a customer? During the year, CSKI's inventories are low, but not unnaturally low. At year end, most finished good inventories are pushed into the sales channels, resulting in somewhat higher receivables. The reasons for this have been explained. If this hasn't satisfied you, you should try to clarify this with management. Many major investors regularly visit the company's facilities in China and ask detailed questions directly to management. You should do the same before drawing premature conclusions.

Based on your own web of very questionable allegations and wrong or distorted arguments, and mostly quoting yourself, you are spinning a rather absurd case.

May 20 08:29 AM

[Davis Freeberg:]

I'm not sure what Balabanovj is talking about. Asensio's record speaks for itself when it comes to his short selling. There are only a small handful of firms that I can think of, who've matched his consistency when it comes to unrooting fraud. To ignore the points he raises, just because he's bet on the do not pass line is a very dangerous game for investors to play.

I haven't listened in to any of the CSKI's conference calls yet, but I do find some of these numbers pretty unbelievable. It would be one thing if CSKI was doing less than a million in sales per year, but it seems highly unlikely (to me) that a business could generate CSKI numbers with such a consistently low inventory on hand.

Add to this the troubled history of auditors and the sketchy backgrounds of the people who created the company and I think that you have a compelling argument that they are cooking the books. Instead of seeing critics attack Asensio's credibility for being short, I'd like to see someone attack his argument and provide a rational explanation for how CSKI's accounting makes sense?

May 20 08:35 AM

[China Expert:]

Arsenio !

Is the cash flow from operations real ? Is the "cash" really in the bank ? If so, then you can bark all you want, no one will notice. Of the 20 Chinese companies at the recent China conf in NYC, none of them has a big 4 four auditor. Personally, I have seen larger auditing firms assign peons to their smaller clients and then the filings are notoriously late. And for this privlege, the client pays more. What's wrong with this picture ? Good luck Arsenio. I suggest you do more work and get some bigger bullets. Why don't you stop being an arm chair analyst and go to China and do some real due diligence. Air China is running a deal this month !

May 20 09:20 AM

[stocklad:]

I was going to write something to refute Mr/Ms Asensio's issues, but that's been done rather nicely above. All the anti-CSKI points have been addressed and what we are left with is just a little puff of smoke. The last one, hopefully.

Talk about picking the wrong company to short. Revenue has gone from $8Million to $92 Million in just 3 years. Earnings has gone from $2 Million to $29 Million in just 3 years. Very positive cash flow. No debt. $2.97/share in cash. $4.01/share in working capital. The company pays attention to its shareholders ... AND ... the best two quarters of the year are coming up.

This is such an impressive company.

May 20 09:46 AM

[stocklad:]

BTW, I think we're about due for another acquisition! No acquisitions are including in that rather lovely 2009 guidance ... AND ... there were three acquisitions last year.

Like I said, this is the wrong company to short.

May 20 09:50 AM

[notsosmart:]

i have no interest in this co.my question is"do you trust the chinese?i dont even trust our gov let alone communist dictatorships.not long,not short,no options or any other of the gaming paper trades.better time this well as these folks could be smarter than made-off.

May 20 10:46 AM

[Lookatvalue:]

finra.org/Newsroom...

one word for Asenio Hall confirmed criminal..

May 20 01:25 PM

[Lookatvalue:]

I'm sorry, that was 2 WORDS.hahahhahah

May 20 01:26 PM

[User 223026:]

I am ambivalent about short-sellers. There is a need to correct the hubris of those who tout stocks, but there is also a strong element of capriciousness for profit that artificially manipulates markets. If I believed in the tooth-fairy, I might think that Asenio has my interests at heart and is trying to help me make informed investment decisions. Clearly he knows when he will post his comments and can time his shorts accordingly. The bad news is that he has been able to make some money that way. The good news is that he has created buying opportunities for me when the stock dips (sorry the money goes into his pocket) and he is working through the weak holders of the stock who are influenced by his kind of biased statements.
I am a long-term holder of CSKI and made my investment after exhaustive review including meetings with Mr. Liu and other principals of the company, I was impressed by the vision, integrity, and business knowledge of this group. I expected them to deliver and they have significantly surpassed my expectations.It appears that many others who have posted comments hear share my enthusiasm for the company and regard the current pricing to be base-building for the next major move higher. So keep it up Asenio: build my position and enhance my profit.

May 20 04:23 PM

[Keep it Pos...:]

I think its more like Manuel Asensio Is flying in circles - What is this guy talking about? If the groundless spin was true, CSKI management and the board would be in jail. manuel, get your facts right, and do a little real research, before you use your journalism position to promote your own bottom line. I think most of us agree that we are getting tired of this guy's groundless and self serving negativity.

May 21 07:26 AM