On July 16th, 2014, FAB Universal (NYSEMKT:FU) will make an oral appeal to the NYSE's April 28th, 2014, delisting decision. Presumably, FAB will try to explain how its secret $16.3 million Chinese bond offering was not a sufficiently bad corporate governance-lapse to merit a delisting. FAB will also have to explain how its decision to downgrade its auditor somehow made sense given its admitted lack of internal control over its Chinese subsidiaries. On top of all this, FAB will have to convince the NYSE that its contradictory disclosures in its belatedly filed 2013 10-K finally paint a true picture of FAB's Chinese business. In today's report, I analyze and expose contradictions in FAB's new description of its media kiosk business and question why FAB's former auditor was unable to perform cash balance confirmations
Is FAB a Provider and Operator of Media Kiosks or a Seller of Technology Licenses?
In Note 1 to FAB's 2012 audited financials in its 2012 10-K FAB described its core Chinese business as follows:
"[FAB]'s products and services are primarily distributed through its flagship stores, wholesale services, proprietary 'FAB' kiosks, and online virtual stores. FAB kiosks, located in high-traffic areas of office buildings, shopping malls, retail stores and airports, are self-service terminals that provide a range of entertainment and consumer applications."
"FAB Media was incorporated as a private enterprise in the PRC in April 2008 with a registered capital of RMB 1 million. FAB Media is primarily engaged in operating and providing proprietary multimedia kiosks for music downloads, information exchange and advertising." (Page 49)
FAB claimed to be responsible for the placement and location of the media kiosks, which FAB refers to as "our Kiosks" in the following risk factor related to FAB's business disclosed in the 2012 10-K:
"Our failure to maintain existing relationships or obtain new relationships that allow us to place our Kiosks in desirable locations would harm our business and prospects."
"Our ability to generate revenues from Kiosks depends largely upon our ability to provide licensees networks of Kiosks in desirable locations throughout major urban areas in China. This, in turn, requires that we develop and maintain business relationships with real estate developers, landlords, property managers, hypermarkets, retailers, and other businesses and locations in which we are provided space for our facilities. If we fail to maintain our relationships with landlords and property managers, or if a significant number of our existing Kiosks placement agreements are terminated or not renewed or if we fail to maintain our relationship with our location provider, licensees may find our networks unattractive and may not renew agreement after the termination of five years agreement, which would cause our revenues to decline and our business and prospects to deteriorate." (Page 13)
Recall that in my December 9th, 2013 report, I announced that I was only able to locate 20 of the 3,954 media kiosks FAB claimed to have installed in Beijing alone. All FAB had to do was publish a detailed list of its Beijing media kiosk locations. FAB did not do this and I believe FAB could not do this because the kiosks simply do not exist.
So rather than simply publishing the locations of the media kiosks, FAB revised its entire business model in its delinquently filed 2013 10-K (filed June 27th, 2014). FAB removed all the previous references to the number of media kiosks installed or deployed in China. Instead, FAB now states that the kiosk business merely involves the sale of "FAB brand licenses:"
"FAB has grown its business through its licensing and regional agent programs and has sold 17,944 brand licenses, which allows the licensees to use FAB's brand on the kiosks."
"FAB generates revenues from the sale of FAB Brand licenses, as well as advertising, and FAB membership card sales." (Page 32)
This seems to be a bold act of recanting the previously disclosed business model (in every single public announcement related to Wizzard's acquisition of FAB up until now) and recasting it in a new, albeit equally dubious direction. The first hint of this change in business description appeared in FAB's December 10th, 2013 announcement that its Board of Directors had taken the time to review thousands of "licenses to operate kiosks." In this same press release, FAB also reiterated that 3,954 media kiosks had been deployed in Beijing. With the absence of any mention of deployments in the new 10-K, FAB has taken an unconvincing but decisive step toward being able to disavow any knowledge of the location of the kiosks. The bottom line is that "FAB brand licenses" for kiosks that FAB cannot prove exist are simply meaningless. Where are the kiosks?
Turning back to FAB's historical filings, let's not forget that FAB in fact described its media kiosk licensing program in great detail in the June 1st, 2012 Proxy, which again showed that FAB was in complete control of the location and operation of all the media kiosks:
"FAB licensing program is a merchant program that binds the FAB and each small investor or vendor. Under this program and associated contract, both licensor and licensee take their joint-business obligations as follows:
- The licensee pays for FAB Kiosk and other equipment and fixtures while the licensor (FAB Media) is responsible for the complete set-up of each FAB outlet from the location selection to construction or conversion, remodeling and equipment installation.
- All FAB outlets will be owned by the licensee, but supervised by a designated management company - Beijing Huzhong Culture Co., Ltd ("Huzhong Culture") in accordance with FAB's distinctive business formats.
- FAB kiosks are linked to the server station through the internet to remain updated. Such maintenances are operated by Huzhong Culture." (Page 35)
The 2012 10-K also confirmed that the media kiosks are networked:
"The content is contained on internal hard drives within each terminal thereby eliminating bandwidth download problems associated with the internet and providing content owners with a secure closed system for digital file protection and accurate transparent accounting. The terminals are updated and monitored via web-linked electronic communications." (Page 29)
Based on these and other 2012 disclosures in its SEC filings, FAB explicitly portrayed as fact that it owns and/or operates a vast network of thousands of media kiosks. FAB's licensees invested in thousands of the media kiosks, which were located in places FAB selected, built out, and maintained. FAB (via a related party known as Huzhong) supervised the media kiosks in operation, and the media kiosks were networked to a central server.
However, in its delinquently filed 2013 10-K, FAB makes no mention of the kiosks being "networked" to a central server and even removes all mention of FAB's provision of "desirable locations" for kiosk placements "throughout major urban areas of China," as it repeatedly stated in the past filings and public announcements.
Further, FAB makes a deceitful attempt to "backdate" the 2013 10-K business description changes to 2010:
"Prior to 2010, the Company's business model consisted of brand licensing and agreements that allowed for the purchase and operation of kiosks under the FAB brand. After 2010, the Company only sold license agreements which were outside of Beijing." (Page 3)
FAB's purported 2010 change to its business model is contradicted by my research that found that as recently as late 2013, FAB's Beijing kiosk franchising sales office was still offering media kiosks to Chinese investors on a turnkey basis - whereby FAB was responsible for placing and operating the kiosks and guaranteed franchisees a positive return on their investments.
FAB also suspiciously discloses in the 2013 10-K that only "some kiosks" have media download capabilities:
"The Kiosks provide a variety of functions, and some provide multiple functions. The great majority of the kiosks generate revenue from the sale of advertising. Some kiosks are ATM style terminals where consumers can download content directly to their cell phones, memory sticks or other mobile storage devices. Others provide directions or other services or offer coupons or other goods for sale." (Page 3)
Contrast the 2013 10-K statement with FAB's June 1st, 2012 proxy that described the standard kiosk as having media download capabilities:
"The standard FAB kiosks have the following features:
· The user can review and select a variety of licensed music, movies, mobile phone ringtones and games from a touch screen.
· The user can stream the selected content or titles to different kinds of portable devices, such as, MP3, MP4, memory cards, hard disks, flash disks, mobile phones." (Page 35)
FAB's new claim that only "some kiosks" are media kiosks indicates to me that the true number of media kiosks in Beijing is not much more than the 20 I found in my investigation. This further explains FAB's reluctance to disclose the media kiosk locations.
The Auditor Downgrade - Why Did Management Not Let Friedman Verify $100 Million Purported Cash Balance?
Through April 30th, 2014, the date of FAB's dismissal of its auditor (Friedman):
"(A) due to the time requirements placed on management because of an internal investigation (the "Internal Investigation") being conducted by an outside independent consulting firm at the same time as the audit, Company personnel were not readily available to assist Friedman in completion of certain audit procedures, (B) certain requests for additional documentation and procedures were not complied with, and (C) Friedman was unwilling to express an opinion on the Company's financial statements prior to the completion of the Internal Investigation and prior to the confirmation of bank balances at certain depository institutions in China,…"
From this disclosure, it is apparent that as of April 30th, 2014, Friedman had not verified FAB's December 31st, 2013 bank balances of $99,077,811. The excuse that FAB's management personnel were unavailable to assist Friedman to verify bank balances is simply absurd and insulting to U.S. investors and regulators.
FAB has been given a full 8 months to disclose the locations of the media kiosks. Instead, FAB tossed aside the facts in its previous disclosures and overhauled its entire business description to focus on "FAB Brand licenses" that make the existence of the actual kiosks completely unverifiable. FAB further called its financials into question by downgrading its auditor, during a period of intense scrutiny of FAB's failed internal controls, and would not assist its former auditor to verify nearly $100 million of purported bank balances.
I continue to fully expect that FAB will be delisted immediately following the appeal hearing after which I will cover my short on the OTC exchange. Delisted Chinese companies typically have market capitalizations of well under $20 million, implying an OTC trading price target of less than $1 per share. If FAB's stock is somehow allowed to continue its NYSE listing, I will short more shares and of course continue my investigation to further expose the truth about FAB.
Disclosure: The author is short FU. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
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