Yongye: Still a Risky Business?
Board: Value Hounds
The highlight of Q2 has to be this exchange from the conference call.
Anson Beard – Private Investor—Advisory Director of Morgan Stanley
Sam, you're not answering the question. Did you write off last year $9 million? Is that a correct end of the year? You set a preserve for $15 million. You're reversing $6 million. Did you write off $9 million? Just yes or no.
I'm sorry (inaudible).
Right here in your cash flow statement for the six months ended, you show a negative $6 million because you put money back in from your reserve (inaudible) double accounts so I assume that the $15 million reserve – what?
It's 15 minus six.
Inaudible) first quarter, yes.
The conversation encapsulates the problems investors have trying to make sense of this company and management’s inability to comprehend what they want.
The reversal of the reserve is interesting. They collected all overdue accounts and at the same time implemented a conservative revenue recognition policy whereby they do not recognize revenue from questionable accounts until some cash is received or the account has a history of reliable payments. It does not take the place of a reserve for doubtful accounts. They have historically managed to avoid having a reserve until the end of 2011, when they were castigated by the press and investors for allowing receivables to increase 471% year-over-year and days sales outstanding reached 10 months. Three months after creating the reserve, they reversed the %15.2 million by $6.3 million. That $6.3 million goes back on the profit and loss statement as a reduction in SG&A and lifts operating and net profits. The reserve still has $9 million. They did not take a charge of $9 million – it’s still there.
The reserve is a buffer to absorb defaults. If the reserve allowance is judged to be too high, part of the allowance can be reversed and the reserve gets smaller. The reversal of the non-cash charge is seen on the income statement as an expense decreases by the amount reversed.
[See Post for Tables]
Yongye’s receivables have improved significantly, but do continue to out pace revenue growth. Days sales outstanding (DSO) are higher than June 2011 even with the improved collections.
Businesses commonly increase the reserves over the years to match the increases in accounts receivables to ensure the buffer is adequate.
Since reserves decreased by 40%, the company must believe the ratio of reserve to receivables was too high. They do not have a history of reserves and normalized ratios for comparison. Every business is different. Yongye appears to believe they will have little trouble with collections.
The impact of the reversal was seen on operating income and net in Q1 2012. With the extra $6 million added back, operating growth was 94%. If we don’t allow it back (it is non-cash) growth drops to 38% and that is without the new revenue recognition policy. It gives an idea of “real” growth.
*Q1 results were adjusted for the reversal of reserves. It decreased operating and net income and slowed stated growth.
The new wrinkle to revenue recognition instituted in the second quarter is to not recognize a portion of revenue on shipment as they normally did. The company now identifies at risk and questionable accounts and will not put that revenue on the income statement until there is evidence the accounts will be paid.
… a significant amount of profit associated with this unrecognized revenue was not booked, either. We estimate that without the revenue recognition issue our revenue and profit would have increased the profit 41% and 59% respectively year-over-year.
Instead of a 41% increase over the Q2 2011 revenue of $154.7 million, Yongye Q2 2012 revenue increased only 14.8%. That means $40 million was not recognized or 19% of Q2 2012 revenue is on hold. Whether or not this will be collected in a timely fashion if ever will not be clear for three to six months. This is a substantial amount of revenue. If they are forced to write off more than 20%, the reserves will be inadequate. A more conservative revenue recognition policy is likely to negatively impact their historic growth based on recognizing revenue on all product as soon as it shipped.
Sales increased by $22.9 million or 14.8% to $177.6 million in the second quarter of 2012 from $154.7 million for the same period of 2011. In the second quarter of 2012, $176.3 million or 99.3% of the total sales were from the liquid crop nutrient and $1.3 million crop nutrients.
The original crop nutrient contributed $155.6 million or 88.2% of total liquid sales and the new products for crop seeds and roots contributed $20.7 million -- 11.8% of sales. Sales in Q2 2011 were $154.7 for the original formula with no new product -- nearly flat. Flat sales of their flagship product may foreshadow slower growth that will not return to historical norms that were often in excess of 100%.
Q2 operating margins and net margins are contracting year-over-year as expenses increase.
Selling expenses increased 32.2% to $38.6 million in the second quarter from $29.2 million for the same period in 2011. The increase in selling expenses was primarily due to an increase in advertising and promotion and distributors' seminar expenditures of $9.3 million. Yongye spent around $6.2 on similar activities in Q1. The amount seems excessive at 24% of selling expenses. Like the cars, it appears to be a perk for distributors. General and administrative expenses increased by 54.8% to $8.6 million in the second quarter of 2012 from $5.6 million for the same period of 2011. The higher G&A expense was mainly due to an increase in management equity compensation.
Sales price per ton remains high and has in the past been sustainable even as competitors like China Green Agriculture (NYSE:CGA) sell similar product much cheaper. In Q2 2012, the Shengmingsu sales were nearly flat and it may be that the price is beginning to slow sales. In the March Q the average selling price was $11,883 compared to $11,318 in 2011. In June a ton sold for $11,808 compared to $11,617 in 2011.
Finally, they continue to spend a lot on providing free cars to distributors. This debt obligation was up 32% in March and 64% for the first six months of 2012. The loan amount now stands $18.4 million. If we use $15,000 as an average economy car price that’s 1,226 cars. There are 25 provincial distributors and 810 county-level distributors. Maybe provincial distributors get luxury cars.
Q2 2012 does little to answer questions about Yongye’s stability. While the more conservative revenue recognition policy gives better transparency into the business and its relationship with the distributors, the reserve reversal and the $40 million in potentially bad accounts do not mesh. It should have been increased as receivables grew faster than revenue in Q2.
The company is instituting revenue and accounting changes that tend to make it difficult to estimate growth or understand historic growth rates. The 14.8% top line growth is believable, but was the result of a changed revenue recognition policy. How much of that is in the wind forever? How much will be collected? If they don’t know and don’t guide towards a percentage of ultimate collectability, U.S. shareholders will have no idea what level of growth is realistic and sustainable. That makes YONG a continuing high risk story whose phenomenal past growth rate may not be all it seemed and may never come again.