Kandi 2012 Earnings Report

It looks like China is going to adopt battery powered vehicles despite all the obstacles. China has two powerful motivations: hazardous levels of pollution in the cities, reminiscent of the storied London Fog, and the lack of local hydrocarbon fuels. Serendipity is giving a helping hand. Just at the right time Kandi came up with a new paradigm for city electric cars consisting of two major innovations:

Don't sell the battery with the car, lease it, and
Don't recharge the battery, swap it with a fully charged one.

I wrote about this paradigm shift back in October 2010, two and a half years ago. Adoption has been slow but 2013 seems to be the definite take-off year.

Yesterday Kandi released the 4th quarter and full year 2012 earnings report. It is somewhat difficult to analyze because the geniuses at FASB have made GAAP practically useless as a tool to manage a business. But since that's what we have to work with, we'll have to do our best to gain understanding. The Profit and Loss Statement has the following major parts:

Revenue: The dollar amount sold
Less Cost of Revenue: The direct cost of product and services sold
Gross Profit: The profit made on the sale before all the expenses

SG&A: The expenses incurred in operating the business
Operating Profit: The profit made after the expenses of running the business but before a whole bunch of other stuff like interest and taxes

Up to this point there is not too much that GAAP can screw up but below Operating Profit, accounts can become quite meaningless. Kandi, in 2011, produced $3,035,959 in Operating Profit. GAAP shenanigans added $8,446,510 in "other stuff." GAAP shenanigans accounted for over 75% of the reported Net Income. Plainly absurd. As the warrants and other transactions wound down in 2012, most of these accounting shenanigans were reversed. In 2012, despite Revenue rising by over 60% and Operating Profit rising by 75%, Net Profit is down by over 40%. How this helps investors is really beyond me to understand.

The bottom part of the Income Statement includes:

Other Stuff: Income, expenses and adjustments incidental to the business
Taxes: Big Brother's cut of the business
Net Profit: The actual profit or loss of the shareholders also called "The Bottom Line" for obvious reasons.

Trying to understand the "Other Stuff" in detail is mostly a waste of time for individual investors and I have lumped it all together in a single row to make it easier to understand Kandi's P&L Statement for 2012:

Kandi Technologies Group, Inc. and Subsidiaries
Consolidated Statements Of Income And Comprehensive Income
For The Years Ended December 31, 2012 And 2011

                         ------ 2012 ------  ------ 2011 ------  Growth
                             Amount  Margin      Amount  Margin
Revenues, Net            64,513,670  100.0%  40,177,148  100.0%   60.6%
Cost Of Goods Sold      -51,620,280         -30,964,173           66.7%
Gross Profit             12,893,390   20.0%   9,212,975   22.9%   39.9%

Research & Development   -2,877,283          -2,304,373           24.9%
Selling & Marketing        -455,983            -414,255           10.1%
General & Administrative -4,250,832          -3,458,388           22.9%
Income From Operations    5,309,292    8.2%   3,035,959    7.6%   74.9%

Other stuff, net          2,688,545           8,446,510
Income tax               -1,523,735            -551,060
Net Income                6,474,102   10.0%  10,931,409   27.2%  -40.8%

Shares Outstand Basic    29,439,328          27,438,725            7.3%
Shares Outstand Diluted  29,677,325          28,735,748            3.3%
EPS, Basic                     0.21                0.33          -36.4%
EPS, Diluted                   0.20                0.32          -37.5%

A quick overview reveals the following:

Revenue growth: up 60.6%. Great!

Cost of goods sold: up 66.7% shrinking the gross margin from 22.9% to 20.0%. As volume ramps up, gross margin should expand again.

Income from operations: up 74.9%, terrific! They contained expenses very well.

Below this line things become difficult to quantify. In 2011 all the "other stuff" added $8,446,510 in paper gains to the bottom line while it only added $2,688,545 this year. This includes the valuation of the warrants. Normally all the other stuff should subtract from the bottom line. Assuming zero, the net margin for 2011 was 7.6% and for 2012 it was 8.2% (same as operating margin). Unfortunately this shatters the optimistic 20% net margin some people think is likely. This is the car business, margins are lowish. I would be more than happy with 10% net margin (a dime for every dollar sold).

Since net earnings is what counts in EPS and P/E, there will continue to be pressure on the stock price until this "other stuff" gets washed out, probably this year. Then the full weight of the fast growing revenues should kick in. Compared to 4000 EVs sold in 2012 we have some mega-projects in the oven.

Business Projection

Forecasting is fraught with error because the future, by its very nature, in unknowable. With this caveat, here is what I see. Pure EVs have a lot of hurdles to overcome including a lack of supporting infrastructure, inadequate energy density of the batteries, fast deterioration/depreciation of the batteries and their high cost. Clearly the problem are the batteries. At the same time, competing technologies including hybrids and start/stop are easier for car makers to adopt. Left to its own devices, the market is not likely to vote for pure EVs. For a disruptive technology to catch on it needs a new, under-served market.

The market that can best deal with the shortcomings of the batteries are fleets like taxis, busses, postal service and other delivery fleets as well as car rentals. Compared to private ownership, these are relatively small potatoes, niche markets. In China the national and provincial governments have decided to create rental and leasing programs to promote the usage of pure EVs as an extension of "public" transportation. The fleets required by these programs are much larger than the fleets mentioned above. Kandi is the car company best positioned to supply this market at this time. Kandi has lost no time in bulking up by acquiring production facilities and by joining up with private car maker Geely to take advantage of these opportunities.

After several false starts, 2013 looks like the year when pure EVs will come into their own.

Denny Schlesinger

Investing: Kandi Technologies, Corp. (KNDI) Software Times, October 31, 2010
4Q and Full Year 2012 Earnings Report Kandi Technologies Achieved Significant Gains in EV Sales
FORM 10-K For the fiscal year ended December 31, 2012
Kandi Technologies Private Yahoo! Group
Kandi Technolgies Group, Inc.Ý(KNDI) The Motley Fool discussion board

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