Eastern Environment Sols (PINK:EESC)

The agreements we made with Harbin Dongxin Group and Harbin Bin County Welfare Plastic Products Co. in 2010 marked the expansion of our business from waste storage toward the efficient recycling of waste into value-added products.  The use of polyethylene terephthalate (“PET”) by the bottling industry has increased dramatically in the past decade, as has the demand for recycled PET for a variety of industrial purposes, especially as a component of solar-heating installations.  With both supply and demand for PET established, the logic of positioning ourselves as middleman became evident.  Since January 2010, we have been removing the PET bottles from waste deposited in the Harbin landfill and delivering the bottles to Harbin Dongxin Group on a consignment basis.  During this period, we were also purchasing PET bottles from third parties and consigning them to Harbin Dongxin Group.  We pay Harbin Dongxin Group a per-ton fee for processing the bottles into usable PET, and then we consign the resulting PET to Harbin Dongxin Group for resale to industry.  We fix a minimum resale price, which Harbin Dongxin Group must collect and remit to us upon sale of the recycled PET.  Harbin Dongxin Group is entitled to retain any revenue it obtains from the resale in excess of the fixed minimum price.

The terms of our agreement with Harbin Bin County Welfare Plastic Products Co. mimic the agreement with Harbin Dongxin Group.  Since we re-started operations at the Harbin landfill in November 2009, we have been removing plastic bottle caps from the waste deposited there.  In March 2010, we engaged Harbin Bin County Welfare Plastic Products Co. to accept the bottle caps on a consignment basis.  We pay Harbin Bin County Welfare Plastic Products Co. a per-ton fee for grinding the bottle caps into plastic granules, and then we consign the resulting granules to Harbin Bin County Welfare Plastic Products Co. for resale to industry.  We fix a minimum resale price, which Harbin Bin County Welfare Plastic Products Co. must collect and remit to us upon sale of the granules.  Harbin Bin County Welfare Plastic Products Co. is entitled to retain any revenue it obtains from the resale in excess of the fixed minimum price.

The sale of recovered materials quickly became our leading source of revenue, as we marketed both PET recovered from our Landfill and PET purchased from outside sources.  Recently, however, the wholesale market price for recovered PET has increased significantly, sharply reducing the profitability of our resale operations.  In the first quarter of 2011 the sale of recovered PET bottles and bottle caps produced 73% of our revenue ($3,304,608), but yielded a gross margin of only 19% - i.e. $613,253 in gross profit.  This represented a marked reduction from the 41% gross margin we achieve on PET operations in 2010 (79% in the first quarter of 2010).  The reason for the reduction in profitability was a marked increase in the wholesale price of PET available from third party providers.  In addition, the value added tax was imposed on sales in 2011 at a rate of 17%, compared to a 3% value added tax on sales in the first quarter of 2010.   For this reason, since the beginning of the second quarter of 2011  we have limited our sale of PET to bottles and caps salvaged from our Landfill, and have not purchased any PET from third party providers.  The result was that revenue from our PET bottle sales fell to $830,798 in the recent quarter.  However, our gross profit on sales of PET in the recent quarter, $614,155, represented a margin of 74% and exceeded gross profit from PET sales in the first quarter of 2011.  The high gross profit on PET sales in the recent quarter is attributable to the fact that our only direct cost in obtaining the PET from our landfill is labor.  Since we can achieve the same profits with only the bottles in our Landfill as we did when we functioned as a reseller (and with significantly less administrative effort), our plan is to continue at the present level of PET operations until market conditions make an expansion attractive.

The reduction in our PET resale operations has resulted in a reduction in our overall revenues from 2010 to 2011, as revenue contributed by HMUAB reimbursements for our landfill operations remains relatively static.  Revenue for the three months ended September 30, 2011 fell by 53% to $2,173,807, and revenue for the nine months ended September 30, 2011 fell by 24% to $8,736,150.  At September 30, 2011 we had no PET in inventory, as a result of which PET sales during the remainder of 2011 will continue to significantly lag PET sales in 2010.  Over the long term, however, we expect our Company to grow.  We plan to expand our waste processing operations by (a) pursuing strategic acquisitions, (b) developing additional landfills, and (c) implementing additional recycling technologies that will provide additional revenue sources, such as the sale of methane to the electric power industry.  Given China’s continuing growth, we believe there will be numerous market opportunities.

GeoTeam Note: Adjusted Year end 2010 vs. 2009 was $0.46 vs. $0.08, while fourth quarter 2010 vs 2009 EPS was $0.11 vs. $0.01

The sale of recovered materials has quickly become our leading source of revenue. In 2010 the sale of recovered PET bottles and bottle caps produced 72% of our revenue ($12,054,911). With the $4,767,111 contributed by HMUAB reimbursements for our landfill operations, we increased revenue from $1,881,302 in 2009 to $16,822,022 in 2010. For the future we expect growth to continue. We plan to expand our waste processing operations by (a) pursuing strategic acquisitions, (b) developing additional landfills, and (c) implementing additional recycling technologies that will provide additional revenue sources, such as the sale of methane to the electric power industry. Given China’s continuing growth, we believe there will be numerous market opportunities. 

The largest component of our working capital at December 31, 2010 consisted of $5,445,418 in accounts receivable. This represents an increase of $1,192,215 from our accounts receivable at December 31, 2009. However, at December 31, 2009 the entirety of our accounts receivable was owed to us by HMUAB. The receivable from HMUAB had grown over $4.0 million during the suspension of operations. Although under the BOT agreement, payments were due thirty days after each month, during the suspension of Landfill operations between June 2007 and October 2009, HMUAB made few payments. However, when the Landfill re-opened in November 2009, HMUAB began to pay both current accounts and portions of the past due account. As a result, at December 31, 2010 our receivable from HMUAB was $1,246,873, no portion of which was more than three months old. Accordingly, we do not consider the receivable to be at risk. The remainder of our receivables is owed to us by the two companies to which we sell PET bottles and caps, which have paid on time throughout the year. For these reasons, we have made no provision for doubtful accounts as of December 31, 2010.

We would like some color on the following:

The next largest component of working capital at December 31, 2010 was a loan to unrelated party of $4,543,864. This loan was made in November 2010 to the Heilongjiang Guoan Real Estate Development Corp., and is secured by a pledge of real estate by an unrelated party. Half of the principal of the loan is due on September 30, 2011, the remainder on November 29, 2011. Interest is payable quarterly at 6.372% per annum. Harbin Yifeng made the loan in order to obtain a better return on its cash reserves than can be obtained from bank deposits in China. The borrower is a well-established entity, and management does not believe that there is an unreasonable risk of default.

Capital Commitments:

If we are able to maintain our recent level of cash flow from the Harbin Landfill operation, we should be able to fund the completion of Phase II and Phase III from our internal capital resources. However, if we are to achieve critical mass in our industry by developing or acquiring new landfills, we will require substantial infusions of capital

EESC Restates 2009 and 2008 year end financial statements:

EXPLANATORY NOTE

This Form 10-K/A (“Amendment No.1”) is being filed by Eastern Environmental Solutions Corp. (the “Company”) to amend the Company’s Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission (“SEC”) on March 18, 2010 (“Initial 10-K”).  This Amendment No.1 is filed to

(i) amend the Company’s consolidated financial statements,

(ii) amend the disclosures in the Company’s Management’s Discussion and Analysis of Financial Condition and Results of Operations and

(iii) amend disclosures in “Management’s Annual Report on Internal Controls over Financial Reporting” section under Item 9A.  These changes were made as a result of a review by the Company of its policies regarding recognition of revenue and expenses associated with waste disposal operations at the landfill it operates in Harbin, China.  The Company’s revised  accounting policies and the changes to its historical financial statements that have resulted from implementation of the revised policies are set forth in Note 2 to the Consolidated Financial Statements.

Additionally, the text of the Initial 10-K had been modified to:

(a) clarify in Item 1, “Business” the terms of the B-O-T Agreement between the Company and HMUAB,

(b) modify the definitions in Item 1, “Business” of the “Phases” of construction of the Harbin landfill project

(c) add disclosure in Item 7, “Management’s Discussion” regarding the Company’s receivable from HMUAB.  Finally, Item 4, which was omitted from the Initial 10-K, has been re-inserted as a reserved item, and all subsequent Items have been renumbered: and (d) update the disclosure in item 13: Certain Relationships and Related Transactions.

Sales for the third quarter increased to $4,659,194 from $452,533.

In the first quarter of 2010, our business prospects brightened considerably. The most significant events that occurred in that quarter were:

• In January 2010 we executed an agreement with the HMUAB that increased the fee payable to us for waste disposal from 42 RMB ($6.28) per ton to 60 RMB ($8.97) per ton, based on current exchange rates.
• In February 2010 the HMUAB increased the limits on our operations from 1,200 tons of waste per day to 1,500 tons per day.
• In January 2010 we took the first major step towards implementing our plan to commercialize the resources available in the waste deposited in the landfill, as we engaged Harbin Dongxin Group as our agent to process and distribute the polyethylene terephthalate (“PET”) bottles that we remove from the landfill.
• In March 2010 we signed a plastic bottle cap processing and consignment sales agreement with Harbin Bin County Welfare Plastic Products Co., Ltd., under which we engaged Harbin Bin County Welfare Plastic Products Co. as our agent to process the bottle caps that we remove from the landfill and resell the granules

Although our revenue in the first nine months of 2009 was achieved without any production on our part, we incurred $185,630 expenses. These costs were attributable to the fact that we retained our core employees on salary during the suspension period. These costs have classified as Administrative expenses. Management determined that eliminating the Company’s employee base during the landfill suspension would make it very difficult to return the landfill to full operations when the suspension ended. This decision proved advantageous as in 2010, as we were able to return promptly to full-scale operation without significant start-up costs or inefficiencies. During the nine months ended September 30, 2010 the expenses attributable to our landfill operations increased to $5.3 million, compared to no landfill operating costs in 2009, except the payroll costs for retaining our labor force.

Our agreements with Harbin Dongxin Group and Harbin Bin County Welfare Plastic Products Co. mark the expansion of our business from waste storage toward the efficient recycling of waste into value-added products.  The use of PET by the bottling industry has increased dramatically in the past decade, as has the demand for recycled PET for a variety of industrial purposes, especially as a component of solar-heating installations.  With both supply and demand for PET established, the logic of positioning ourselves as middleman becomes evident.  Since January 2010, we have been removing the PET bottles from waste deposited in the Harbin landfill and delivering the bottles to Harbin Dongxin Group on a consignment basis.  We pay Harbin Dongxin Group a per-ton fee for processing the bottles into usable PET, and then we consign the resulting PET to Harbin Dongxin Group for resale to industry.  We fix a minimum resale price, which Harbin Dongxin Group must collect and remit to us upon sale of the recycled PET.  Harbin Dongxin Group is entitled to retain any revenue it obtains from the resale in excess of the fixed minimum price.

The terms of our agreement with Harbin Bin County Welfare Plastic Products Co. mimic the agreement with Harbin Dongxin Group.    Since we re-started operations at the Harbin landfill in November 2009, we have been removing plastic bottle caps from the waste deposited there.  In March 2010 we engaged Harbin Bin County Welfare Plastic Products Co. to accept the bottle caps on a consignment basis.  We pay Harbin Bin County Welfare Plastic Products Co. a per-ton fee for grinding the bottle caps into plastic granules, and then we consign the resulting granules to Harbin Bin County Welfare Plastic Products Co. for resale to industry.  We fix a minimum resale price, which Harbin Bin County Welfare Plastic Products Co. must collect and remit to us upon sale of the granules.  Harbin Bin County Welfare Plastic Products Co. is entitled to retain any revenue it obtains from the resale in excess of the fixed minimum price.

The sale of recovered PET bottles and bottle caps produced 69% of our revenue ($7,959,964) in the first nine months of 2010.  With the $3,530,736 contributed by HMUAB reimbursements for our landfill operations, we increased revenue from $1,342,554 in the first nine months of 2009 to $11,490,700 in the first nine months of 2010, during which we accrued only the minimum fee guaranteed by HMUAB in our agreement.  In the third quarter, revenue increased from $452,533 to $4,659,194.  For the future we expect growth to continue.  Having now returned to operations, we will endeavor to expand our waste processing operations by (a) pursuing strategic acquisitions, (b) developing additional landfills, and (c) implementing additional recycling technologies that will provide additional revenue sources, such as the sale of methane to the electric power industry.  Given China’s continuing growth, we believe  there will be numerous market opportunities.

Our operating subsidiary, Yifeng, has sufficient liquidity to fund its near-term operations and to fund the working capital demands of a modest expansion of its operations. In order to complete Phase II and Phase III of the Landfill project within the next six years, it will be necessary for us to obtain additional debt or equity financing. In addition, if we are to achieve critical mass in our industry by developing new landfills, we will require substantial infusions of capital. We do not know at this time whether we will be able to secure such financing, or on what terms it might be available.

Based upon the financial resources available to Yifeng, management believes that it has sufficient capital and liquidity to sustain operations for at least the next twelve months.

On October 6, 2010 the Registrant’s Chief Executive Officer, pursuant to authority from the Board of Directors, concluded that the following financial statements should not be relied upon:

• The financial statements included by the Registrant in its Annual Reports on Form 10-K or 10-KSB for the years ended December 31, 2009, 2008, 2007 and 2006.
  
• The financial statements included by the Registrant in its Quarterly Reports on Form 10-Q or Form 10-QSB filed during 2010, 2009, 2008, 2007 and for the quarter ended September 30, 2006.
  
• The financial statements of its subsidiary, Harbin Yifeng Eco-Environment Co., Ltd. included in the Current Report on Form 8-K filed on September 12, 2006.

"The determination was based on her conclusion that the policies applied by the Registrant in amortizing the construction cost of the landfill operated by the Registrant’s subsidiary were not in conformity with generally accepted accounting principles.  The Chief Executive Officer has discussed this determination with the Registrant’s independent accountant."  

Some Insight from GeoInvesting Contributor Dan France:

Hopefully they will file restated financials in the next month. They might have understated amortization if they only amortized the cost of capacity utilized as opposed to what was placed in service. Depreciation and amortization for the first six months of 2010 was around $130,000 or $260,000 annualized and close to the same amount in 2009. Just a wild guess, but we might be looking at a $200,000 hit to 2009 if they amortized only ½ of the capacity (880,000 of 160,000 tons) placed in service. YTD 2010 might be another $50,000 (1.3 million of 1.6 million utilized) but not material relative to 2010 net income. This is embarrassing for the company, but not a killer.

In an other development, we recently informed the company that its SAIC filings did not match SEC files for 2007 and 2008.   We are speculating that the non-reliance findings may have something to do with our conversations with management and/or its recent efforts to up-list its stock.

We believe that much of the SAIC inconsistencies, which are significant, deal with with U.S. GAAP vs. China reporting differences as it relates to:

• Accounts receivable
  
• Expense recognition

"EESC landfill was shut down for maintenance from about mid 2007 to late 2009. Over that time EESC built up an account receivables with its local government.  Under PRC accounting rules these AR may have not been permitted to be realized. In the SEC filings, it appears that some of the AR were realized, applying U.S. GAAP rules."

(Please note that we had obtained EESC documents after our  August 24, 2010 research note. We had maintained the GeoBargain code due to a belief that the company would work with us to reconcile filings). 

We are currently long a small position in EESC as we wait for developments to unfold.

On October 6, 2010 the Registrant’s Chief Executive Officer, pursuant to authority from the Board of Directors, concluded that the following financial statements should not be relied upon:

• The financial statements included by the Registrant in its Annual Reports on Form 10-K or 10-KSB for the years ended December 31, 2009, 2008, 2007 and 2006.
  
• The financial statements included by the Registrant in its Quarterly Reports on Form 10-Q or Form 10-QSB filed during 2010, 2009, 2008, 2007 and for the quarter ended September 30, 2006.
  
• The financial statements of its subsidiary, Harbin Yifeng Eco-Environment Co., Ltd. included in the Current Report on Form 8-K filed on September 12, 2006.

The determination was based on her conclusion that the policies applied by the Registrant in amortizing the construction cost of the landfill operated by the Registrant’s subsidiary were not in conformity with generally accepted accounting principles.  The Chief Executive Officer has discussed this determination with the Registrant’s independent accountant.     

On August 16, 2010, we coded EESC as a GeoBargain. Recall, that we have been tracking this story since March 10, 2010. In its March 2010 first quarter the company reported net income of $1.2 million or $0.07 ($0.06 taxed). While not overly undervalued at the time , aided by capacity expansion and a resumption of operations in late 2009^a, we surmised that the company might be able to exceed its $4 million 2010 net income run rate and report sequentially higher EPS for its 2010 second quarter.

On August 16, 2010, the company filed its 2010 second quarter 10Q which highlighted the results of what could be a break out quarter. The related press release shed some more light on the quarter:

• Revenue increased 1071% to $5.2 million.
  
• Gross profit increased 706% to $2.9 million Income from operations increased 1173% to $2.8 million.
  
• Operating margin increased 385 basis points to 53.3% from 49.5%.
  
• Net income increased to $2.4 million from $180,511 in 2009 $7.2 million of working capital.
  
• Diluted EPS increased to $0.24 ($0.21 fully taxed)  from $$0.02.
  
• Shareholders' equity of $16.7 million.

Ms. Feng continued, "The major factor contributing to our strong sequential revenue growth was the shift in our strategy to include recycling polyethylene terephthalate (PET) plastic bottles and plastic bottle caps, which we implemented in the first quarter of this year and began generating substantial revenue in the second quarter. In addition to separating plastic bottles and plastic bottle caps from our own landfill, we have established relationship with local collection points which provide us with much larger and more stable supplies of plastic bottle waste than we had previously collected on our own."

Ms. Feng says, "In addition to providing a valuable new revenue stream, our PET recycling removes waste from our landfill and, in turn, increases our overall disposal capacity at the landfill. Looking ahead, we are focused on further expanding our waste processing operations by implementing additional recycling technologies that will provide new revenue streams from our landfill. At the same time, we are actively seeking new landfills we can either develop or acquire. Given the overwhelming growth of Harbin and other cities within Heilongjiang Province, there is enormous demand and government support for new landfills and recycling technologies."

Simply put, what we have here is a company with:

• An annuity type revenue stream (via landfill business with the government) that found a way, through its recycling business strategy, to tap into an environmentally friendly growth market.
  
• A break out quarter that is likely sustainable.
  
• Pre-tax margins of over 50.0%.
  
• Cash flow from operations that has turned positive and is tracking at a $2.0 to $3.0 million annual run rate.
  
• A Current ratio of  5.24 to 1
  
• A top tier auditor (Friedman LLP)
  
• Sufficient liquidity to maintain its current business levels. However, at some point, EESC will likely need to raise capital to fully implement its growth strategy, but we are currently not overly concerned about this issue in the near term. 
  
• A clear intent to up-list to a senior exchange as indicated in our August 9, 2010 research note and by company comments in yesterday's press release:

"During the quarter, we also enhanced our leadership team with the addition of three new independent directors. These three new board members bring a wealth of industry experience as well as financing and accounting experience that will be instrumental as we prepare for the next phase of our growth. As a result of these board appointments, we believe we meet most of the qualifications to list on a senior exchange."

At near $3.00, EESC is trading at 2.7 times its book value per share of $1.12 and a meager 7.3 P/E times our annualized tax adjusted 2010 EPS expectation of $0.41. If the market sentiment for ChinaHybrids abates and SAIC not matching SEC filings issues fade away, we think investors could flock to EESC shares. Short-term investors may have to exercise patience as EESC is trading at trailing tax adjusted P/E of around 14. (Although a P/E of 25 may be warranted).

^a On June 13, 2007, the company filed a Form 8-K with the SEC, announcing that in accordance with the PRC National Environment Protection Bureau’s request in relation to landfills and adjustments to their peripheral inhabitants’ well-being, the Harbin municipal government city administrative bureau was carrying out certain adjustments to the original landfill plans of our subsidiary, Harbin Yifeng Eco-environment Co. Ltd. (“Harbin Yifeng”). Such adjustments resulted in the relocation of some peripheral inhabitants of the landfill and its waste water disposal plant. The costs of such adjustments will be borne by the Harbin municipal government city administrative bureau. These measures disrupted Harbin Yifeng’s normal operations. After careful consideration, our Board of Directors decided to temporarily suspend Harbin Yifeng’s operations while the measures were being carried out. However, Harbin Yifeng was still entitled to collect the minimum fixed fees for the Suspension Period as per the “Special Permission Operation Rights Contract”, which Harbin Yifeng had signed with the Harbin municipal government city administrative bureau on September 1, 2003. The bureau was required to compensate and pay Harbin Yifeng a sum equivalent to the fee for disposing 800 tons of waste per day during the Suspension Period.

GeoTeam note®: We have not obtained EESC SAIC filings. We will continue to highlight companies on the basis of fundamentals in SEC filings.  Investors need to formulate their own opinion on the severity of this issue. We may soon publish an extensive article on the topic of SAIC filings not matching SEC filings. 

Disclosure at time of this update: Long EESC.  Please see information on the GeoTeam note® sell discipline principals  that we generally consider.

Eastern Envtl Solutions takes a step closer to a potential uplisting:

On August 3, 2010 the Board of Directors increased the number of members of the Board to five, and elected Shiping Wang to serve as a member of the Board of Directors.

First Quarter 2010 Financial Highlights: (from May 18, 2010)

• Revenue increased 259% to $1.6 million
• Gross profit increased 306% to $1.4 million
• Gross margin increased to 86.8% from 76.7%
• Income from operations increased 511% to $1.2 million
• Operating margin increased to 77.6% from 45.6%
• Net income increased 536% to $1.1 million
• $1.3 million of cash, $4.9 million of working capital and shareholders' equity of $14.1 million

Ms. Feng Yan, Chairman and Chief Executive Officer, stated, "We are quite pleased with our performance now that we have resumed full operations at the landfill. We generated a record $1.1 million of net income, or $0.07 per diluted share, for the first quarter. As a result, we are now on pace to achieve in excess of $4 million of annualized net income, based on our first quarter 2010 results. Looking ahead, we expect to see strong sequential revenue growth for the second quarter and balance of this year as we implement our strategic expansion plans."

Ms. Feng Yan continued: "As one of the largest landfill companies in Heilongjiang Province, Eastern Environment is extremely well positioned to capture market share in this highly fragmented market. We believe we can organically grow the business by bidding on new BOT contracts due to our long and successful track record. Additionally, we remain alert for accretive acquisition opportunities that leverage our core waste expertise and geographic focus. We believe the combination of increased landfill capacity, PET recycling, and our recent agreement with Veolia to convert the landfill gases into green energy and carbon credits will all translate into improved profitability for our shareholders."

We will follow the Eastern Envtl Solutions more closely due to the following events:

• Announced that it will increase its disposal capacity by 25% in the first quarter of 2010 at its Harbin municipal solid waste (MSW) landfill.  GlobeNewswire (March 1, 2010)
  
• Entered into a letter of intent with Veolia Environment, one of the world's leading environmental services firms, on a project to establish a power plant that would utilize recaptured landfill gas from Eastern Environment's Harbin landfill to power turbines and generate electricity.  Marketwire (February 9, 2010)
   
• After two and half years of suspended operations in it Land Fill Company was notified by the Harbin Municipal Urban Administrative Bureau (HMUAB) that it could recommence operations at the landfill as of October 30, 2009.  PR Newswire (November 16, 2009)

"Among our planned initiatives, we are implementing new recycling technologies that will provide additional revenue streams from our existing landfill. These new revenue streams will likely include the sale of methane to the electric power industry, as well as implementing waste-to-energy and waste-to-fertilizer processes.

This was a special situation that slipped through the GeoTeam's cracks. We will monitor events and their impact on EPS.

The growth of our business was delayed in June 2007, when the Harbin Municipal Urban Administrative Bureau (“HMUAB”), which is our only customer, was mandated by the PRC National Environment Protection Bureau to carry out certain modifications to the development of its landfill for the protection of local residents. The modifications involve the relocation of some of the neighboring residents, as well as the relocation of our wastewater disposal plant. The cost of the modifications is being born entirely by the HMUAB. Nevertheless, while the modifications are ongoing, we have suspended our operations at the Landfill, which are currently our only source of revenue. We expect to recommence operations at the Landfill in the near future, although the date will depend on the efficiency with which HMUAB completes the modifications. As of June 30, 2009, Harbin Yifeng has not yet resumed the landfill operations.

Source: SEC Filing 10Q (For the quarterly period ended June 30, 2009, page 18)