- The claim that the new business of resale of EV parts is a management tactic to pump up the top-line figure could be inappropriate.
- Queries over the sales, government grants and R&D expenses of the joint venture.
- Looking for clearer disclosures on the accounting of the joint venture.
Kandi (NASDAQ:KNDI) has been a stock with heated arguments between bulls and bears since last week. The bears thought the sales growth of last quarter was an illusion created by the management, while the bulls insisted on the sales number of electric vehicles, the actual demand and the growth story of the EV industry in China. First of all, let me emphasize again that I do not have any position in the stock, and I am not going to initiate any before the release of next quarterly results. In this writing, I would like to give the readers some different insights through my findings in 10K and 10Q, which I hope could serve as a basis for constructive discussions. Furthermore, I am looking for positive responses from the management to my points in the article in the upcoming results announcement.
About the $25 million sales of EV parts
In my opinion, the claim that the new business of resale of EV parts is a management tactic to pump up the top-line figure could be inappropriate, due to the following reasons:
1. This stock is an EV play and what investors should be most concerned about is the business performance of the joint venture established to sell EVs to end-users i.e. car sharing project. Since the company adopts the equity method to account for the joint venture, the sales of EVs to end-users are not included in the top line of the accounts. Instead, the sales amount can only be found in the notes to the financial statements, and only the amount of the share of profit/loss of the joint venture is shown in the income statement. With superior results of the joint venture, investors would still buy the stock even if the top line remains flat or declines. The management can always draw the attention of investors to the sales growth of the joint venture that have been disclosed in the notes. Therefore, I doubt whether there is any sufficient intention for the management to pump up the top line.
2. According to the page 38 of 10Q, the company explained the low margin of the new business as follows,
"We only recently commenced our business of selling EV parts, and related components are relatively expensive at the starting phase, therefore, sales of EV parts have a lower gross margin compared to other products."
Hence, the margin of the new business could be expected to be higher in the coming quarters. It is just too premature to jump to the short side after seeing only the first-quarter results of a new business.
Of course, it would be better if the company could give a more detailed explanation on this new business in the next results announcement, such as the rationale for such indirect purchases, the basis for the mark-up on this business, etc.
Joint venture business
As mentioned above, the key of the financial statements is the business performance of the joint venture. Unfortunately, I am convinced that there are rooms for improvements in the disclosure on this area. Before elaborating my concerns over the figures and presentations of the joint venture business, let us first take a look at the results I extracted from the notes to the financial statements in 10K and 10Q.
Concern 1: Sales of EVs
The first figure I come across that is difficult to understand is the net sales for the quarter ended 31 March 2014. Based on my own analysis as shown below, the unit price of EVs for each period (derived by dividing the net sales by the numbers of EVs sold during each period) shows a large fluctuation.
2013 full year
Condensed income statement information:
Number of EVs sold
3,000 (note 1)
Price per unit
Note 1: Based on my understanding, 4,694 units of EVs sold disclosed in the 10K represented the number of units of EV products that the company sold to the joint venture and other third parties. A more conservative figure shown in the press release about the receipt of subsidies is therefore used.
I cannot find any reason throughout the 10Q/10K filings to explain such fluctuation. I GUESS this could be due to any of the following reasons,
(1) the sales of the joint venture in 2013 might mainly constitute the sales of older and cheaper models. The new EV models (Kandi Brand SMA7000BEV and SMA7001BEV) which the company sold to the joint venture in 2013 were processed and sold to the car-sharing project in 2014 Q1.
(2) there might be sales of auto parts by the joint venture to the third party during 2014 Q1. In the press release about the establishment of the joint venture, the company stated that "the business scope of the joint venture is to develop, manufacture and sell electric vehicles and to develop, purchase, manufacture and sell auto parts, and invest in other companies which engage in such businesses."
(3) the net sales figure for 2014 Q1 might include items such as discounts, government grants or sales transactions to related parties within the joint venture group which should not be recognised in the sales. This could happen especially when the quarterly results were unaudited.
Concern 2: Recognition of government grants
There was no clue in the filings about whether there was any recognition of government grants in the income statement of the joint venture in 2013 and 2014 Q1. According to the accounting principles, government grants are usually recognised where there is a reasonable assurance that the grants will be received. The company received a national subsidy of RMB197 million (approximately US$31.8 million) in July 2014 for sales of over 3,000 EVs between June and December in 2013 and sales of over 1,000 EVs during the first quarter of 2014. The following table illustrates what the accounts of the joint venture would be if the grants have already been recognised,
2013 full year
Condensed income statement information:
- Net income/(loss)
+ Estimated government grants recognised
= Sales expenses, administrative and other expenses
Based on the above analysis, I cannot conclude whether the grants have already been accrued in the accounts of respective periods, or will be recognised in the next quarterly accounts on cash basis. Since the grants are significant to the company's accounts, it adds to the difficulty in estimating the results of the next quarters.
Concern 3: Research and development expenses
I am also concerned with the amount of research and development expenses recognised in the joint venture, if any. Excluding the joint venture, Kandi recognised only $1.2 million and $3.7 million on R&D respectively for Q1 2014 and 2013. In my opinion, the amount of research and development expenses in the joint venture is substantial for investors to evaluate the sustainability and the competitive advantage of its EV business.
To conclude, I sincerely hope the company would provide clearer disclosures on the accounting of the joint venture, particularly about its sales breakdown, the accounting policy on recognition of government grants, the amount of recognised government grants and the amount of research and development expenses. Alternatively, proportionate consolidation method, which combines the company's share of each of income, expenses, assets and liabilities LINE BY LINE with the company's accounts, can also be considered to account for the joint venture.