Taoping Inc. annual report, Q4 FY2013

Business context and reporting period

This is China Information Technology, Inc.’s (NASDAQ: CNIT) Form 20-F annual report for the fiscal year ended December 31, 2013, filed April 15, 2014—not a quarterly report. The filing identifies the registrant as China Information Technology, Inc.; the supplied company metadata says Taoping Inc., so the issuer identity should be verified.

CNIT provided software, hardware, systems integration and related services in China, including GIS, public-security, hospital-information and display technology solutions. It said it was shifting toward internet-related products and services and Smart City solutions. A material part of its business was conducted through iASPEC, a variable interest entity (VIE) owned by CEO Jiang Huai Lin.

Key financial metrics

Amounts are U.S. dollars unless stated otherwise. Audited statements and MD&A report losses for 2013; a selected-financial-data table elsewhere in the filing appears to show those results with incorrect positive signs, as noted below.

At December 31, 2013, short-term bank loans were $58.95 million and long-term bank loans were $0.31 million. Restricted cash was an additional $10.35 million, principally collateral for bank facilities. Interest expense was $5.55 million, up from $4.65 million in 2012. Cash provided by financing activities was $14.72 million, including $9.0 million from common-stock issuance; investing activities used $3.23 million.

Material changes versus the prior comparable period

• Revenue fell 11.85%. Product revenue rose 2.1%, but software revenue declined 13.0% and system-integration revenue declined 44.0%, reflecting the company’s decision to exit or reduce selected traditional display, government-related and lower-margin projects.
• Gross margin slipped to 22.69% from 23.73%. Management attributed this to a lower contribution from higher-margin government work and software, partly offset by improved margins on internet-enabled display products.
• Administrative expenses rose to $92.93 million from $52.80 million. The filing cites a $40.33 million increase in the provision for accounts receivable and $6.9 million of stock-based compensation.
• The allowance for doubtful accounts increased to $60.70 million from $29.52 million. Gross receivables were $83.41 million and net receivables $22.72 million at year-end 2013, versus $115.48 million and $85.96 million, respectively, in 2012. The filing reports $35.23 million of receivables written off in 2013.
• Impairment charges included $29.98 million for property, plant and equipment and $2.01 million for identifiable intangible assets in 2013. No goodwill impairment was recorded in 2013; $26.83 million of goodwill impairment was recorded in 2012.
• Operating cash use increased, and the balance sheet moved from positive working capital to a $46.78 million deficit. Total assets and stockholders’ equity also declined substantially year over year.

Outlook, risks and unusual items

Management said its 2014 plan emphasized internet-related products and services, cash flow and cost reductions. It believed cash, expected 2014 operating cash flows and borrowing availability would cover operating and financial obligations for the remainder of 2014. As of March 31, 2014, it reported approximately $17.8 million of additional borrowing availability. This outlook is management’s assessment, not a guarantee; the filing also warns that future financing may be needed and may not be available on acceptable terms.

• Receivables and liquidity: Government customers accounted for 74% of receivables at year-end, and 45% of receivables were more than one year outstanding. Collection delays, the large allowance and the working-capital deficit are key risks.
• VIE and related-party dependence: iASPEC generated 42.1% of 2013 revenue under contractual arrangements, and the CEO owns iASPEC. The filing describes risks around enforcement, renewal, licensing and potential conflicts. The CEO also provided a $900,350 loan at 6% interest, due December 26, 2014, and the company paid him $166,638 in rent in 2013.
• Capital and compensation: In November 2013, CNIT issued 3 million shares to employees for $9.0 million; it recorded $6.9 million as compensation expense and classified $2.175 million as temporary equity because it guaranteed bank loans used to purchase some shares. The company also repurchased 641,080 shares for approximately $3.8 million during 2013.
• Other exposures: Risks include PRC regulation and currency controls, dependence on government licensing through iASPEC, customer concentration, competitive and technology-change pressures, limited insurance, and potential difficulties enforcing U.S. judgments in China. Management reported no material legal proceedings and no material off-balance-sheet arrangements. No cash dividends were anticipated for the foreseeable future.
• Controls and audit: Management assessed disclosure controls and internal control over financial reporting as effective at December 31, 2013. The independent auditor issued an unqualified opinion on the financial statements; no auditor attestation on internal controls was included because CNIT was a non-accelerated filer.

Important facts for investors to verify

1. Confirm the issuer and reporting period: the filing is for China Information Technology, Inc. (CNIT), fiscal 2013, while the request metadata names Taoping Inc. and 2013 Q4.
2. Reconcile the selected-financial-data table, which appears to show 2013 operating income and net income as positive, against the audited statements and MD&A, which report an operating loss of $119.38 million and CNIT-attributable net loss of $119.24 million.
3. Assess the collectability, aging and subsequent receipts of receivables, including the $60.70 million allowance, 2013 write-offs and government-customer concentration.
4. Evaluate liquidity and near-term refinancing needs in light of the $46.78 million working-capital deficit, short-term bank borrowings, restricted cash and management’s stated credit availability.
5. Review the VIE arrangements, iASPEC revenue contribution, contract terms and related-party relationships, including the CEO’s ownership and the company’s ability to enforce or renew the agreements.
6. Check the assumptions and valuation methods supporting the large asset impairments and the employee share issuance, related bank-loan guarantees and temporary-equity classification.