THE MORE THINGS CHANGE, THE MORE THINGS STAY THE SAME AT LIHUA INTERNATIONAL

It has been over 6 months since we last wrote about Lihua International, Inc. (LIWA) (and 2 years since our first instablog on LIWA). Since our last instablog on May 31, 2011, the following events have taken place regarding LIWA:

1. Cash Verification? On August 4, 2011, LIWA announced that John Lees Associates had confirmed LIWA’s cash balances as of December 31, 2010 and March 31, 2011.¹ However, John Lees Associates did not confirm the bank borrowings. On May 22, 2011, Deloitte Touche Tohmatsu CPA Ltd. (China) (Deloitte) formally resigned as auditor of Longtop Financial Technologies Limited. In its resignation notice, Deloitte stated that there was “significant bank borrowings reported by bank staff not identified in previously received confirmations (and not recorded in the books and records of the Group).”² By not confirming bank borrowings, LIWA’s cash verification was incomplete.

2. Due Diligence? China 360^o Solutions prepared a due diligence report dated August 9, 2011 to identify any unusual accounting or business practices. China 360^o Solutions concluded that “it is unlikely that the Company has filed incorrect SAT or SAIC reports.”³ We disagree with their conclusion. In December 2009, we obtained the 2008 SAICs for Lihua Copper and Lihua Electron, LIWA’s 2 subsidiaries. For Lihua Copper, the 2008 SAICs we obtained matched the 2008 SAICs obtained by China 360^o Solutions. In their report, China 360^o Solutions even stated that the “Lihua Copper 2008 SAIC report varied materially in certain respects from the management accounts.”

For Lihua Electron, the 2008 SAICs that we obtained were different from the 2008 SAICs obtained by China 360^o Solutions. The 2008 Lihua Electron SAICs changed from the time that Qingdao Inter-Credit Services provided them to us on December 9, 2009 to the time China 360^o Solutions printed them on July 14, 2011. According to Lihua Electron’s Amendment Application, this change occurred on June 2, 2011, a month and a half before China 360^o Solutions printed the 2008 Lihua Electron SAICs. Since the 2008 SAICs that we obtained and the 2008 SAICs obtained by China 360^o Solutions are so different, one set must be incorrect. In other words, the company has filed an incorrect SAIC report.

Proof that the 2008 Lihua Electron SAICs we obtained were legitimate are as follows:

• Qingdao Inter-Credit Services provided the 2008 SAICs for both Lihua Copper and Lihua Electron to us in December 2009. China 360^o Solutions has verified that the 2008 SAICs for Lihua Copper that we obtained were legitimate.
• The paid-up capital from the 2008 SAICs for Lihua Electron obtained by us matched the common stock-par value from the 2008 SAICs for Lihua Electron obtained by China 360^o Solutions.
• On September 15, 2011, Qingdao Inter-Credit Services provided to us the full 2007 SAICs for Lihua Electron. Note that the 2007 SAICs closely resembles the numbers from the 2008 SAICs obtained by us rather than the 2008 SAICs obtained by China 360^o Solutions.

So why is LIWA changing their 2008 Lihua Electron SAICs? Because the 2008 Lihua Electron SAICs that we obtained prove that their SEC financial statements are incorrect. In order for their SEC financial statements to be correct, Lihua paid the Chinese government $1.8 million for income taxes during 2008 yet reported zero in profit tax for 2008 to the same Chinese government through June 2, 2011. This anomaly regarding the profit tax continues to be irreconcilable and continues to lead us to conclude that the 2008 SEC financial statements are incorrect. If the 2008 SEC financial statements are incorrect, then future financial statements are also incorrect due to the carryover effect of the balance sheet.

3. CFO Turnover/Auditor Upgrade? On October 24, 2011, LIWA announced that Yang Yu had been replaced as Chief Financial Officer.⁴ Although Mr. Yu was appointed Executive Vice President of Finance at the time, he has since sold two-thirds of his LIWA stock, or 300,000 shares, for $1.57 million.⁵ Even though there has been turnover at the CFO position, there has not been any turnover in auditors. Crowe Horwath continues to be the auditor despite LIWA’s “discussions with a Big Four audit firm” declared during their first investor and analyst day on May 24, 2011.⁶

4. Stock Buyback/Cash Dividends? On January 26, 2011, LIWA authorized the repurchase of up to $15 million of its shares over the next 12 months.⁷ LIWA only repurchased $2.1 million through September 30, 2011, despite having $102 million of cash on hand.⁸ At the time they announced their September 30, 2011 results, November 9, 2011, LIWA announced 2 special cash dividends of 3 cents each.⁹ Magnify Wealth Enterprise Ltd., LIWA’s largest shareholder and an affiliate of Jianhua Zhu, LIWA’s founder, Chairman, and CEO, agreed to waive their payment of the dividends. Accordingly, the dividends would be distributed among approximately 16.8 million shares and, therefore, cost approximately $1 million. If LIWA truly has $102 million of cash on hand as of September 30, 2011, why would the dividends be so low and why would the largest shareholder waive its dividends?

The investing community has seemed to caught on. The stock price has gone from 9.30 on December 21, 2009 (the date of our first instablog on LIWA) to 7.46 on May 31, 2011 (the date of our last instablog on LIWA) to 4.93 on December 15, 2011.

Disclosure: Author is short LIWA.

Sources:

¹ Lihua International’s Cash Balances Confirmed Through Independent Forensic Accounting Review (http://www.lihuaintl.com/PDF/pdfurl/LIWA 08 04 11 Cash Balances Final.pdf)

² Deloitte Notice of Resignation to Longtop Financial Technologies Limited

³ China 360^o Solutions Due Diligence Report

⁴ Lihua International Appoints Daphe Huang as Chief Financial Officer

⁵ Yahoo! Insider Filings

⁶ Lihua International Recaps First Investor and Analyst Day (http://www.lihuaintl.com/PDF/pdfurl/LIWA 05.26.11 Mr Zhu Purchase Final2.pdf)

⁷ Lihua International Announces Approval of $15 Million Share Repurchase Program (http://www.lihuaintl.com/PDF/pdfurl/01.26.11 LIWA Buyback Release - Final.pdf)

⁸ LIWA September 30, 2011 Form 10-Q

⁹ Lihua International Announces Special Cash Dividends