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I am a former analyst, now full-time investor. I may take long or short positions in companies that I write about, although my focus is on uncovering what I believe to be questionable companies and transactions. I will always provide disclosure whenever I publish a blog post. I will never... More
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  • China Agritech: The Case of The Missing Receivables and Factory Space 0 comments
    Oct 11, 2010 4:17 AM | about stocks: CAGC
    China Agritech, a China-based manufacturer of organic fertilizers, has extremely high levels of accounts receivables (“AR”). In fact, based on the figures in their 2009 10-K, as of the end of 2009, accounts receivable represented almost 40% of their overall assets, while days of sales outstanding (“DSOs”) stood at 188 days, meaning that China Agritech had not received payment for over half of the revenue that they booked in 2009. While this should be viewed as a red flag itself, there is something that may be even more troubling to investors than the high DSOs. What I am referring to is the almost $1 million worth of receivables that simply vanished without explanation between the end of 2007 and the end of 2008.

    Inconsistent Numbers for Accounts Receivable From 2007 to 2008 – What Happened to Almost $1M in Accounts Receivable?

    Examining Note 2 (d) of the 2007 10-K, it is stated that the CAGC had AR of $22,695,039 net of allowance for doubtful accounts of $227,981. Moving on to 2008’s 10-K, Note 4 reports the number for 2008's accounts receivable $34,773,115 net an allowance of $448,606. But a taking a closer look at Note 4, one will also notice that there is also a figure given for 2007’s accounts receivable. Examination of this number and the number on the comparative balance sheet filed with the 2008 10-K reveals that this number has changed to $21,876,368, net of the same allowance of $227,981. This accounting inconsistency represents $818,671 worth of receivables, or about 4% of 2007's overall AR, and deserves further attention.
     
    There is no mention of any write-down of $818,671 in accounts receivable in the 2008 10-K. Had this been the case, CAGC's 2008 operating expenses would have increased by over 12% and net income would have decreased by approximately 10%. Such a large write-down of receivables should certainly have been noted in the 2008 10-K if it had occurred, especially since it would have represented 360% of 2007's stated allowance for doubtful accounts and almost 200% of 2008’s allowance. This would have been an indication that CAGC had been seriously mistaken in their estimate regarding bad debt expense. But again, based on the 2008 10-K, no such write-down occurred.
     
    No 10-K/A amendment was ever filed for the 2007 10-K to correct the original AR number, so this can also be ruled out as a possible explanation. Additionally, the allowance for doubtful accounts remained exactly the same in US dollar terms, which rules out that this adjustment is simply due to a change in the USD/RMB conversion rate.
     
    This begs the question, what exactly happened to the $818,671 worth of accounts receivable from 2007 that seems to have disappeared between 2008 and 2007? Is it just a coincidence that these receivables curiously went missing in 2008, the year that current CFO Yau Sing Tang was appointed to the position? Perhaps, but considering his past financial history, this incident deserves serious attention by CAGC investors.

    CAGC's Curiously Inconsistent Reporting of Factory Space  

    Accounts receivable isn't the only thing that has gone missing from CAGC’s financial statements. CAGC has also been remarkably inconsistent in the reporting of factory floor space at their Harbin facility, which is leased in a related-party transaction from CEO Yu Chang and director/former COO Xiao Reng Teng. 
    From the 2006 10-K:

    “We currently lease 9,878 square meters in the aggregate for office space and manufacturing facilities in Harbin, China where our subsidiary Pacific Dragon is located. The lease has a 10-year term which runs from January 1, 2004 to January 1, 2014. Our current rent due under this lease is approximately $450,000 (RMB 3,600,000) per year.”
     

    In the 2007 10-K, the floor space reported decreased to only 7,018 sq. M, while the rent paid to Mr. Chang and Ms. Teng has remained the same. What happened to the other 2,860 sq. M? No explanation is given.

    In the 2008 10-K, the number increases again to 9,878 sq. M, and again, no explanation is given for the increase.

    In the 2009 10-K, this number has decreased again to 7,018 sq. M. Yet again, no explanation is given for the inconsistency.

    As of the June 2010 10-Q, this number has remained at 7,018 sq. M, while there has still been no explanation offered as to what occurred to the other 2,860 sq. M that is presumably covered under the original lease mentioned in the 2006 10-K.

    My understanding of how industrial leases typically work is that the lessee pays the lessor based on the amount of space that they rent. Yet despite the factory footprint inexplicably shrinking by 29%, the rent has stayed consistent throughout the period of the lease from 2006-2010. This is also suspicious, especially due to the related-party nature of the lease itself.

    In conclusion, CAGC has been inconsistent in their reporting of both accounts receivable and factory floor space covered under their related-party lease with CEO Yu Chang and director/former COO Xiao Rong Teng. The case of the vanishing receivables should be particularly disconcerting to shareholders because receivables comprise such a large portion of CAGC’s asset base. These accounting inconsistencies represent further red flags that investors should consider carefully prior to investing in CAGC.
     



    Disclosure: short CAGC
    Themes: china, short ideas Stocks: CAGC
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