Monday, April 06, 2009

Is CSKI’s Late Filing of 10-K a Warning Sign?

As one of the success stories among Chinese reverse-merger stocks, CSKI ascended from OTC BB to AMEX and then all the way to Nasdaq Global Market all in last year. Until last week, the stock has been one of the better-performing small-caps in the present market turmoil. Then the music stopped last week when the company was unable to file its 2008 annual report with SEC on time.

To some, the stock’s recent retreat means an opportunity to buy into a growth story at bargain prices. To some others, however, there are ominous signs that cannot be ignored. Can the company’s 10-K filing extension be a warning sign of something deeper in its business practices? Here are a few things to consider.

1. Management has been eager to please the market with great news since it was admitted to Nasdaq last September. Management has not even failed to “schedule” (and then “un-schedule”) an earnings conference call just two business days prior to announcing the filing extension. The fact that such an eager management was no longer able to please the investment community is particularly disturbing.

2. Chairman and CEO Mr. Yan-qing Liu’s wife transferred 526,170 shares of common stock to an undisclosed third party as a “bona fide gift” as of February 12, 2009. That was worth $7.4 M (RMB 50.6M) using February 12’s closing price of $14.05, or $5.4 M (RMB 37.2M) using Monday’s market close of $10.34. Regardless of whether this level of gifting is out of the ordinary outside of family context, these shares have since been able to be sold freely without Mr. Liu having to file a Form 4.

3. Company changed auditors three times in the past two years. Before April 2007, company’s auditor was e-Fang Accountancy. In April 2007 the company replaced e-Fang with Murrell, Hall, McIntosh & Co., PLLP. In December 2007 the company changed heart again and engaged Sherb & Co., LLP instead. Then on May 21, 2008 the company dismissed Sherb & co. and replaced it with MSPC (“Moore Stephens”).

Notably CSKI’s 2007 annual report was signed off by Sherb & Co. According to a 2008 report by Barron’s, Sherb & Co. once signed off alleged revenue fabrication by a Florida financial company and has a record of deficiencies in PCAOB’s (Public Company Accounting Oversight Board) database.

It would be quite interesting to observe how long MSPC will be able to maintain relationship with CSKI going forward.

4. Accounting irregularity is nothing new with CSKI. Company’s 2006 annual report (audited by e-Fang Accountancy) was restated twice. After the restatements, company’s net income decreased from $4,300,401 to $624,415 (an 85% correction), and EPS (diluted) dropped from $0.31 to $0.05 (a 84% correction).

5. Mr. Jiang Qi Feng, a 25-year-old recent Master’s degree (in Computer Science) recipient (and possibly current graduate student as of March 2008) who does not have any financial background, was elected to CSKI’s board as an “independent” director on February 22, 2008. He serves on company’s Audit Committee, Compensation Committee, Executive Committee, and Finance Committee. In particular, per company's 10-K filing for FY 2007, management believes that Mr. Jiang qualifies as an “audit committee financial expert” as defined under Item 401(c) of Regulation S-B.

Here is Mr. Jiang’s qualification as given in company’s 2007 10-K:

"Jiang Qi Feng, joined our board of directors on February 22, 2008. From September 2006 to the present, Jiang Qi Feng has served as a Teaching Assistant and a Research Assistant at Simon Fraser University in Canada, where he specializes in biology statistics, biology research and probability. Jiang Qi Feng received a Masters Degree in Computer Science from Simon Fraser University in 2006, and Bachelor’s Degrees in Bio-Statistics and Mathematics from the University of British Columbia in 2005."

Mr. Jiang apparently was still a graduate student on teaching/research assistantship with Simon Fraser University, as of the 10-K filing date March 31, 2008. Fact is, it does not take a Ph.D. to figure out how “independent” and “qualified” a non-financial graduate graduate student (even with a non-financial Master's degree) can be on a company’s board and in particular as an “audit committee financial expert”. Management’s selection of Mr. Jiang as a director and “audit committee financial expert” seems to have sent a clear signal to the market. It does not take financial control and reporting seriously. Period.

All told, it is not quite clear to me if management is genuinely motivated to achieve the strict financial control commensurate with a public company listed on Nasdaq GM, or is it just interested in reporting “great numbers” and news stories to the investing public. There is a fundamental difference between a team only interested in reaping short-term profit for themselves and one that is committed to growing with investors over the long haul.

Disclosure: Author does not have a position on CSKI as of this writing.


Anonymous said...

CSKI -- Improper Accounting for Stock-Based Compensation -- Make Good Escrow Agreement
First, have a look at CRTP's (China Ritar Power Corporation) filings. When the net income threshold was met, the company treated the shares as an expense equal to the amount of the market value of the shares for the amount of the grant-date value of the shares as of the date that the Make Good Agreement was signed. CSKI should have done the same thing. Of course, that would have wiped out the company's earnings on a GAAP basis. In its press release, the company never said that its earnings were on a non-GAAP basis.

I sent an email to IR on April 8. They never replied to me.

Anonymous said...

CSKI -- This is a copy of an email I just sent to the CFO

I believe that you should have recorded a non-cash compensation expense for 2008 because the 3,000,000 shares that were deposited under the Make Good Escrow Agreement have been returned to the company's CEO. I think that the 2008 results should have been presented on a GAAP and on a non-GAAP basis. Unless you give us a resonable explanation, your annual report will have to be restated.

You are in the same situation as China Ritar Power Corporation and several other Chinese companies. You should read their filings. Normallly, when the net income threshold is met, the company is supposed to treat the shares as an expense equal to the amount of the market value of the shares for the amount of the grant-date value of the shares as of the date that the Make Good Agreement was signed.

You should have done the same thing. Obviously, that would have wiped out your company's earnings on a GAAP basis and would have scared a lot of investors. Why is it that in your press release your never said that your earnings were presented on a non-GAAP basis?

You never addressed this issue during your last conference call. I find this situation totally unacceptable, specially given the fact that the answer to this problem is very simple. You have to record a non-cash compensation expense. Contrary to what the company said in one of its press releases, this is not a complex issue.

The company lost a lot of credibility by reason of the manner in which it handled the whole situation.

I already sent an email to IR on April 8. I never received a reply. I expect that some people will file formal complaints with the SEC very shortly.

Anonymous said...

CSKI -- According to Statement of Financial Accounting Standards 123R, Accounting for Stock-Based Compensation, if the net income threshold is met, the shares that have been deposited under the Make Good Agreement are released back to the make good pledger and treated as an expense equal the grant date fair value of the shares. Can CSKI explain why it did not recognize an expense equal to the grant date fair value of the 3,000,000 shares?

Anonymous said...

Here is a copy of the email I got from the CFO. This is a satisfactory answer.

The reason CSKI filed 2008 10k extention on April 1, 2009 was because of the non-cash issue regarding the 3,000,000 escrow shares.

In our previous press release, we had disclosed CSKI management decision to carry this non-cash expense issue to the SEC Chief Account Office for final ruling.

As CFO of CSKI, I flied to New York to handle this situation in person, together with auditor and legal counsel. We strongly believe that to expense the escrow shares is because the company involved in the event of an IPO or a reverse merger in its early stage from private to public, in either case, the shares are newly issued and escrow agreement was signed.

We addressed our Correspondence Letter and sent to the to SEC Chief Account Office on April 8, 2009

After 2 major conferences with four SEC Chief Account Officers, the final ruling was reached at 16:35 on April 14, 2009. It is the SEC officers collective decision that CSKI was not in its early stage as to record the escrow expense, thus all this escrow related financials was deemed immaterial.

We have been adhering strictly with the GAAP and sent to the SEC our request in a discretional manner, most of all, CSKI management's position is absolutly correct in this matter. If any of our investors (I am not sure if you are), followed the track of what we have been dealing with regardingn this issue, and the result was that we still "lost a lot of credibility by reason of the manner in which it handled the whole situation", you get me lost of what you are expecting.

Stanley Hao