Frank Voisin is the author of the popular value focused website Frankly Speaking, found at http://www.FrankVoisin.com.
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Last year I wrote about how Chinese firm,Wonder Auto Technology (NASDAQ: WATG), was going to restate its 2008 and 2009 annual reports. I quoted the following from its 8-K announcement:
Historically, the Company has disclosed in its Annual Report that “revenue from sales of its products is recognized when the significant risks and rewards of ownership have been transferred to the buyer at the time when the products are put into use by its customers, the sales price is fixed or determinable and collection is reasonably assured.” During 2008 and 2009, two of the company’s significant subsidiaries recorded period sales and cost of sales based on when usage reports were provided by the customers. The periods covered by the usage reports, however, did not always exactly correspond to the financial reporting periods. As a result of these cut-off errors, sales, cost of sales and net income for individual financial reporting periods (annually and quarterly) have been misstated.
A few people emailed saying that I was not presenting a fair picture because later in the 8-K the firm says that 2008 and 2009 income would increase, as revenues from 2009 would be shifted to 2008 and from 2010 to 2009. From my perspective, being forced to restate something as basic as revenues is indicative of greater problems related to internal controls that will inevitably come to light.
So, with a year’s worth of perspective, let’s see what’s happened with WATG.
First, there was a report written by Todor Mitev titled WATG: A Vehicle for Draining Money? which alleged, as I expected, significant problems with the company’s internal controls and corporate governance policies. I have been unable to find the original Mitev report, but the company tells us that it contained the following:
The Mitev Report asserted that the Company had failed to make required related party disclosures in connection with five transactions during the period 2006-2010, and that cash had been misappropriated from the Company.
In response to this report, the company’s Audit Committee began an investigation.
While the investigation was ongoing, the company’s CEO and CFO resigned:
“On and effective July 12, 2011, Qingjie Zhao resigned as Chief Executive Officer and President of Wonder Auto Technology, Inc. (the “Company”). Also on July 12, 2011, Meirong Yuan resigned as Chief Financial Officer of the Company.”
The simultaneous resignation of high level executives is never a good thing, and the fact that it occurred in the midst of an internal investigation into related party transactions and other nefarious deeds is an especially bad sign.
Finally, the investigation concluded with a blockbuster report on the corruption at the company (emphasis mine):
The Committee finds that each acquisition target identified in the Mitev Report had been owned in whole or part by Winning International Development, Ltd., a British Virgin Islands company, or its affiliates (“Winning”). The Committee notes that, Qingjie Zhao, in his personal capacity, held equity and control positions in two target companies, though these apparently were extinguished prior to the Company’s purchase of those companies. The Committee further notes that, before joining the Company, Qingdong Zeng held control positions at the selling party, its affiliate, or the target during three of these transactions. During that time, Mr. Zeng’s brother-in-law maintained significant shareholdings in the Company. The Committee finds that this relationship should be disclosed.
During the course of its review of an acquisition identified in the Mitev Report, the Committee noted the participation of an affiliate of Magic Era Group Ltd. (“Magic”), a British Virgin Islands company. The Committee identified a total of four acquisitions, dating from 2008-2010, in which Magic and/or suspected affiliates participated. In connection with three of these acquisitions, the Company provided at least $17.8 million in cash or value to these entities. These ostensibly were made for the purchase of equity, as remuneration for consulting services, or to facilitate the transfer of funds to counter-parties.
The Committee finds that the participation of Magic and its affiliates in these four acquisitionsserved no necessary business purpose. The Committee lacks sufficient basis definitively to determine who exerted actual control over Magic and its affiliates, the beneficiaries of that control, or the uses to which funds transferred to Magic and its affiliates ultimately were put. The Committee, however, discovered various connections between the Company and Magic, including:
- Current and former Company personnel have acted on behalf of or provided assistance to Magic and its affiliates, including applying to open brokerage accounts for a Magic affiliate and signing an agreement with a third party as Magic’s representative;
- A significant Company shareholder appears to have supplied consideration on behalf of Magic in connection with Magic’s acquisition of equity in an entity later acquired by the Company;
- Records obtained by the Committee state that a longtime associate of Company management served as the director and shareholder of Magic;
- The Company has provided at least one Magic affiliate with office space;
- A Magic affiliate purchased debts totaling more than $4.4 million owed by an acquisition target shortly before the acquisition; and
- According to records obtained by the Committee, at least one early Company investor served as the shareholder, Chairman, and director of a Magic affiliate.
The Committee finds that the Independent Directors were not informed of these relationships. The Committee also finds that the Company lacks a sufficient basis to rely on the authenticity or accuracy of certain related documents.
2. Compliance with Generally Accepted Accounting Principles and Company Policies
During the investigation, the Committee obtained information calling into question the accuracy of the Company’s reported financial results for the periods 2008-2010. …
a. Revenue Recognition and Returns
The Company’s stated policy is to recognize revenue when “the significant risks and rewards of ownership have been transferred to the buyer at the time when the products are put into use by its customers.” However, the Company’s Wanyou subsidiary recognizes revenue on export sales at the time of shipment of product. The Committee finds that the Company should reevaluate its revenue recognition disclosures to account for its differing revenue recognition treatments. The Committee further finds that the Company should review its revenue recognition practices at the Wanyou subsidiary to ensure the risks and benefits of ownership have transferred at the time of shipment.
Moreover, the Committee finds that the Company has engaged in consignment sales in which the revenue was recognized before the inventory was sold. The Committee finds that, in at least three sales in 2008 totaling more than RMB 3 million, and at least one sale in 2009 totaling RMB 2.7 million, the Company recognized revenue prior to the revenue recognition criteria being achieved.
The Committee finds that the Company failed properly to account for certain sales in which product was returned or deemed unusable. These transactions had the effect of overstating 2008 revenue by at least RMB 14.5 million.
The Committee finds that the Company lacks reliable systems and internal controls timely and properly to track and account for costs associated with inventory, including inventory obsolescence, defective product, and the reworking of inventory. These deficiencies call into question the Company’s ability properly to calculate its inventory valuation, cost of sales and gross margin.
d. Accounting Personnel and Internal Controls
The Committee finds that the Company lacks sufficient qualified and competent accounting personnel and internal controls.
As the company was continuously unable to restate its financials, it was delisted from the NASDAQ:
On October 11, 2011, Wonder Auto Technology, Inc. (the “Company”) received a letter from the Nasdaq Hearings Panel (the “Panel”) of The NASDAQ Stock Market LLC (“Nasdaq”) stating that the Panel has determined to deny the Company’s request for continued listing on Nasdaq, relying on Nasdaq Listing Rules 5101 and 5250(c)(1). Trading of the Company’s securities will remain suspended until a Form 25 Notification of Delisting is filed with the Securities and Exchange Commission after all appeal periods have expired.
To top it all off, the company’s auditor (PWC Zhong Tian) resigned, suggesting that the company’s problems have not yet been fully addressed:
Nevertheless, while PwC indicated in its letter of December 10, 2011 that it recognizes that the Company has taken certain remedial steps and is continuing to consider additional steps, PwC has informed the Company of its view that the issues raised by the Investigation have not been fully addressed by Company management as of December 6, 2011, and in order for PwC to complete its audit, it would, in the exercise of its professional judgment, have to satisfy itself that such issues have been fully addressed.
The WATG case seems to confirm the old adage “there is never just one cockroach in the kitchen.”
Author Disclosure: None