RED FLAG
PCCG's 10-K 1998 Filing
The purpose of this note is to alert prospective investors of several inappropriate and deceitful business transactions the Company has engaged in.
Background:
PCC Group, Inc. (PCCG - NASDAQ) is a distributor of microcomputer products. Until recently, the stock of the company had been thinly traded as a result of a reverse merger of PC Craft, Inc. with and into WMD Microdistributors, Inc. ("WMD"). Concurrently with the merger, WMD changed its name to PCC Group, Inc. The Company is controlled and managed by Chinese nationals. Common stock is held by approximately 3,100 public shareholders. The majority of public shareholders individually own less than 10 shares. Thus, public shareholders have little to say on how the Company is run.
NOTES RECEIVABLE - A PHANTOM ASSET OR THE VIRTUAL DEFERMENT OF AN INVESTMENT WRITE-OFF?
On September 29, 1998, the PCCG sold its investment and advances in Dalian Green Resource Co. Ltd. ("Dalian") to an unidentified third party in exchange for a three year, $3,700,000 promissory note. This transaction did not involve any cash consideration. Notwithstanding the materiality of the divestiture, the Company has chosen not to disclose essential transaction data. Based on the information appearing below, it appears that the Dalian plant divestiture, which took place one day before year-end closing, represents a Machiavellian scheme to virtually defer a significant investment write-off. A write-off that would have reduced PCCG's net worth by 58%, from $5.4 million to $2.3 million. More importantly, it would have led to NASDAQ de-listing since the Company's equity would have fallen under the $3 million small-cap threshold requirement. A brief history of the scrap tire recycling fiasco follows:
Per 10-K filing for fiscal year ended September 30, 1994, the Company's first recycling plant, which it began to build in 1993, in the municipality of Dalian, Liao Lin Province, Peoples Republic of China, was expected to become operational in early 1995. Since then, the Company repeatedly stated in subsequent Form 10-K and 10-Q filings that its plant would open soon. Five years transpired and the plant never commenced operations.
The Dalian facility was designed to function based on a process know as "pyrolysis". Pyrolysis is the thermal decomposition of tires under an oxygen-deprived environment. The typical products of scrap tire pyrolysis are: low grade carbon black, hydrocarbon gases and oils, and scrap steel. On March 25, 1994, the Company signed an agreement with Dr. Virgil Flanigan, a well-know scientist in the environmental field and University of Missouri professor. In this agreement, Dr. Flanigan licensed certain technology to the Company for use in the Dalian facility and throughout South East Asia. In May 1997, Dr. Flanigan filed a breach of contract lawsuit against the Company. Thus, the Dalian project has floundered without its inventor since 1996. The Company subsequently disclosed that it was receiving technological expertise from Laser Micro Systems, a related party. Laser Micro is an offshore company, owned by the Wen family. According to public records, this company is a manufacturer and distributor of microcomputer products. A consulting fee of $300,000.00 has been paid to this company.
In 1997, the Chinese government established strict import regulations which ban the importation of scarp materials, including used tires. Since then, any type of commercial recycling activity is prohibited in China.
Form S-3, filed by the Company on June 6, 1998, disclosed on page seven that "To date, neither of the plants owned by the two joint ventures have commenced operations and no assurances can be given that the plants will ever commence operations. If the joint ventures do not open for operations the Company's entire investment in the two joint ventures will be lost, which would materially and adversely affect the Company's earnings and financial condition. No assurances can be given that the two joint ventures will commence operations in the near future, or at all".
Taking into account the previously mentioned facts and chain of events, who in the world would embark in acquiring the Dalian facility? A non-functioning five-year old plant? An installation without key proprietary technology due to litigation? A commercial activity prohibited by the host government? An investment that elementary research reveals that nobody has been able to develop an economically viable pyrolysis process, after more than 30 years of extensive research conducted by large corporations, universities and scientists?
Because of the materiality of the Dalian investment, and its subsequent suspicious divestiture, the following remedies or disclosures have yet to be provided by Management: a) The obtainment of Shareholders' approval to validate the sale. b) Divestiture agreement disclosure. c) Identification of the buyers including business background, financial statements, credit ranking, national origin and business address. d) Financial guarantees from buyers. The existing Secured Note Receivable is worthless, unless backed by tangible, non-revocable guarantees. If appropriate guarantees cannot be obtained, the Note Receivable should be discounted based on the creditworthiness of the buyers; e) Asset valuation from a reputable independent party; f) Name of Broker/Finder along with amount of fees paid; g) Explanation why the sale did not include a cash consideration.
By failing to produce irrefutable evidence to validate the legitimacy of the sale, Management has tacitly accepted that the Dalian divestiture was a scheme. A scheme to deflect and prolong NASDAQ de-listing. Obviously, the Note Receivable will never be settled, therefore, it represents a phantom asset.
INVESTMENTS IN HIGHLY VOLATILE SECURITIES
During fiscal 1998 the Company invested its excess cash in highly volatile securities and incurred margin liability in such purchases. Securities purchased during the October 1997 through June 1998 period totaled a staggering $32.4 million, or 65% of its cash flow (Refer to Cash Flow Statement). As a result of this practice, the Company incurred losses in the aggregate of $742,153 ($557,438.00 resulting from the sale of investments and $184,715.00 in interest expenses ensuing from additional borrowings). Without this loss, net income for fiscal 1998 would have more than doubled, from $404,000.00 to approximately $916,000. In fiscal years 1996 and 1997, investments in securities totaled $12.6 million and $12 million respectively.
Is PCCG a grossly mismanaged Chinese investment house, or is it a NASDAQ-listed microcomputer products distribution company? During the past few years, the stock market has been a bonanza for most professional and individual investors. Fortunes have been made with relatively low investments. Regrettably, in this case the inappropriate use, and flagrant mismanagement of a $32.4 million cash fund produced a significant loss to PCCG's shareholders
ADVANCES TO VENDORS
Per its latest 10-K filing "The Company entered into an agreement with a related party in which the Company would acquire certain customized equipment on behalf of the Party. As of September 30, 1998, the Company made an advance to a vendor of $3,034,254 to manufacture equipment." The Company failed to disclose this significant activity, representing 30% of its assets, in it 10-K filing, under Item 1 - Business, pursuant to SEC regulations. In the "Discontinued Operations - Environmental Resources Division" paragraph appearing on page 7 of the 10-K, the Company states that it has "ceased all of its other environmental resources operations". If that statement is true, what does the acquisition of customized manufacturing equipment have to do with the Company's distribution business? Again, PCCG's filing shows a consistent pattern of deception. Furthermore, the related party story re-emerges.
For the sake of transparency, Management ought to file a 10-K amendment that would: a) Fully disclose the Company's "actual" business activities. b) Delineate the Company's and related parties involvement in the second scrap tire facility being built in Taiwan along with the disclosure of all related agreements and contracts from project inception to date. d) Disclose related financial commitments including the prospective use of a secured $5 million Import-Export Bank facility. e) Provide a copy of the agreement signed with customized manufacturing equipment vendor.
WHERE IS THE BOARD OF DIRECTORS?
Sadly, independent Board of Directors' members, Gary Blum and George Rodda Jr., seem to be either oblivious or supportive of the previously mentioned matters. One could call into question the appropriate exercise of their fiduciary responsibilities. |
