With a Rare Earnings Miss, CSKI Is Looking Rather Sick

The Chinese pharmaceutical company -- long known for its blowout quarters -- fell well short of Wall Street targets for the latest period and issued disappointing guidance for the upcoming year. The big earnings miss represents the latest in a series of a recent challenges for the company, which has been accused of selling "counterfeit" drugs in China and filing inaccurate financial statements here in the U.S. 

CSKI's stock, which peaked above $25 late last year, tumbled 8.2% to $15.75 a share on Wednesday following news of the fresh setback. The stock has now fallen almost 15% since TheStreetSweeper first launched coverage of the company -- courtesy of reports supplied by longtime bear Manuel Asensio -- less than a month ago. 

For CSKI investors, by now accustomed to generous upside, the company's latest results came as a serious blow. CSKI missed analyst estimates for both the top line and the bottom line, while reporting plenty of troubling figures in between. 

Although revenue climbed 15% to $29.9 million for the fourth quarter, it failed to grow at its traditional pace and disappointed Wall Street analysts -- looking for quarterly sales of $34.33 million -- as a result. Moreover, sales of some particularly important products flattened or even declined. Excluding special items, earnings per share of 47 cents fell well short of the 57-cent consensus estimate as well. 

Net income of $5.3 million, hurt by stock-based compensation expense and liabilities associated with delayed warrant registrations, actually plummeted 23.6% from a year ago. Operating expenses jumped 32.9%, due to higher overhead costs, while days sales outstanding and income taxes both climbed. 

Worst of all, perhaps, CSKI saw rising demand for some of its most popular products start to decline. Sales of medical patches, which provide roughly one-third of the company's revenue, remained essentially flat in the fourth quarter. Sales of ointments, another major source of revenue, actually slid during the recent period. Sales of diagnostic testing kits, while a much smaller revenue driver, suffered declines as well. 

Indeed, CSKI posted sales growth for only two product categories. Revenue from "other" products, boosted by recent acquisitions, more than doubled for the quarter. Meanwhile, sales of spray treatments jumped 56% due primarily to rising demand for sprays targeting the H1N1 virus -- viewed by some as a unique seasonal event -- during the same period. 

Going forward, CSKI could face new challenges when selling its medical sprays. According to a recent report published by Asensio, an accomplished investor known for his early calls on troubled stocks, six of the eight CSKI products appearing on a government list of counterfeit drugs fall into the spray category. Notably, Asensio reported, the Chinese government has ordered pharmacies to "immediately stop the sale" of products included on that list. 

Since the list reportedly surfaced in November -- near the end of the latest quarter -- CSKI could still be facing any major fallout during the quarters that lie ahead. 

Meanwhile, CSKI has already issued weak sales guidance for the entire year. The company expects revenue to grow by 20% -- or at half the clip seen last year -- to $156 million in 2010. Analysts, on average, were projecting 2010 revenue of $166.46 million instead. 

To its credit, CSKI did manage to convince its auditors to sign off on its latest financial statements. CSKI's independent auditing firm, Moore Stephens, faces a new lawsuit for allegedly blessing overstated patent values recorded in the company's past regulatory filings. 

"The CSKI financial statements were inaccurate in several material respects, including the fact that they reported that CSKI or its subsidiaries owned seven patents in China supposedly worth $15,093,718, when in fact it did not own any patents," the lawsuit claims. "As a result of this material misstatement, the assets of CSKI were substantially overstated." 

As Asensio noted in a follow-up report on that lawsuit, the line item covering CSKI's patents represented 15% of the company's total assets at the end of 2008. 

Interestingly, CSKI adopted a new accounting treatment for those assets in its latest annual report. In fact, the company has apparently done away with the "patent" category under its intangible assets altogether. 

"Historically, we have included our proprietary technologies and ... licenses for drug batch numbers under the category of patents," CSKI's new 10-K filing states. However, "we now believe it is more accurate to categorize such IP (intellectual property) in separate categories" without the patent label. 

Previously, Asensio noted in one of his recent reports, CSKI's auditor -- a past target of securities regulators -- had failed to respond to issues raised in the lawsuit about the company's treatment of those assets.