Yuhe Intl (PINK:YUII)

Added to the GeoSpecial list on August 17, 2009 @ $5.10.
 
Catalyst: see original note 
Peak performance: Reached a high of $12.43 on March 9, 2010
Current Price: $7.60
 
Current road block:  In early March, YUII ran into some accounting obstacles; Debt to equity is around 20% which is right on the edge of where we prefer to see this ratio. (we prefer less than 20% and consider both long and short term debt).  YUII has reported two consecutive of quarters of subpar EPS growth;

• Fourth quarter 2009 vs 2008: $0.23 vs. $0.48
• First Quarter 2010 vs 2009:    $0.18 vs. $0.19

Remains on the GeoSpecial list.  With $15.7 million in cash and annualized cash flow from operations tracking at $8.0 million, YUII appears in good position to satisfy its $14.0 million debt obligations. Also, in April 2010, the company renegotiated approximately $8.2 million of its long-term bank loans at a more favorable fixed interest rate of 7.56%. The terms of these loans were extended to the first quarter of 2013. The lull in EPS growth was preceded by several above average growth periods and appears to be temporary as the company has recently increased capacity. Analyst estimates have the company’s next three quarters of EPS growing over 30%, followed by 44.5% for all of 2011.  Managements outlook is also positive:

"The Company's management expects sales volume and net income to rise throughout the remainder of 2010. Therefore, management re-affirms its previously issued guidance for 2010 of production totaling 150 million day-old broilers and net income of approximately $17 million." 

The company has, with the aid of a top ten accounting firm, addressed its accounting issues:

In May 2010, Ernst & Young (China) Advisory Limited completed its review of the Company's payment procedures at the request of Yuhe's Audit Committee. The review concluded the following: 

• Yuhe International has cleared all the inter-company balances with related parties.
• There were no payments between Yuhe International and its related parties in the period of March 1, 2010 to March 31, 2010.
• No material exceptions were noted during the review of the payment procedures.
• The Board of Directors and Audit Committee have initiated more stringent internal controls over payment procedures. Additional information is available in the Company's Form 10-Q filed with the SEC on May 14, 2010.

Even though YUII remains in the GeoSpecial list, short term is no slam dunk. Despite commentary in its 2010 first quarter 10Q indicating that its liquidity situation is sufficient for ongoing operations... 

"The Company expects that its strong positive working capital of $11.09 million as of March 31, 2010 and positive cash flow provided by operating activities of $1.99 million will meet its foreseeable working capital needs for the next 12 months from the date of this report. In the first quarter of year 2010, the Company renewed 7 bank loans for a total of $8.19 million with local banks, these loans will expire in year 2013."

On June 2, 2010 YUII snuck in an S-3 filing opening the door for more dilution.

This development is somewhat perplexing. As it stands, estimates are bullish and the balance sheet is solid.

Our suggestion:  Let the stock reflect the good news and consider an offering at a later time.  For the time being, we will give the company the benefit of the doubt, as a raise could be used for an accretive acquisition:

"Unless otherwise indicated in a prospectus supplement, we intend to use the net proceeds from the sale of shares of our common stock under this prospectus for capital expenditures, possible future acquisitions, and general corporate and working capital purposes. We have no current plans, commitments or agreements with respect to any acquisitions as of the date of this prospectus."

The most discouraging aspect regarding this ordeal is that we can't even trust what we read in SEC filings. We were just about to praise YUII as a company that appeared in a good position to avoid tapping the equity markets.  YUII joins Universal Travel (NYSE:UTA), Yongye Intl (NASDAQ:YONG), Shengkai Innovations Inc (NASDAQ:VALV)  as firms that we believe are doing shareholders an injustice by still tapping the equity markets when their stock valuations are low and balance sheets seem healthy enough to finance near-term growth.  Investors may want to wait for more clarity in the likelihood of YUII executing an offering before making a serious investing commitment.

YUII is down sharply this morning on details in an 8K mentioning that its independent registered public accounting firm, that Grant Thornton is resigning as the Company’s independent registered public accounting firm effective immediately.

Details:

• In the Company’s Annual Report on Form 10-K/A filed on June 3, 2009, the Company has concluded that certain related party loans between the Company and Shandong Yuhe Food Group Co., Ltd. have constituted prohibited transactions under Section 402 of the Sarbanes-Oxley Act of 2002.
  
• Although all such related party loans had been repaid as of the end of 2009, because the Company continues to make payments under certain arrangements to Yuhe Food, such payments have resulted in related party loans in January and February 2010.
  
• Grant Thornton noted during its audit procedures that the Company has been unable to eliminate the occurrence of related party loans between the Company and Yuhe Food, and the Company concluded that a material weakness continues to exist with respect to the Company’s compliance with Section 402 of the Sarbanes-Oxley Act of 2002.
  
• Grant Thornton also has communicated to the Company certain audit adjustments related to the Company’s financial statements for the year ended December 31, 2009, which indicated a material weakness of the Company’s internal control over financial reporting. The Company agrees with such assessment.

It's odd that YUII continues to make prohibited loans after acknowledgment of similar violations in June of 2009. But, we are more concerned about the "audit adjustments related to the Company’s financials for the year ended December 31, 2009."  Will this result in a restatement of financials? We are postulating that it will not as the statement likely refers to loan issue.

Normally, such news would prompt a removal of YUII from the GeoSpecial list, but we will let this play out for the moment until we receive more details.  Negative perception will certainly persist as the company seeks a new accounting firm and performs  damage control.  Some investors may assume that where there is smoke there is fire. We are actually making a bold move and initiating a trading position in YUII @ $9.50.  Most investors would likely require more clarity on the situation, but our risk tolerance is a 100 on a scale of one to ten.

Maj