Recently, Jiangsu Jingchuang Electric Co., Ltdresponded to the second round of inquiry from the Beijing Stock Exchange (BSE) regarding its Initial Public Offering (IPO). Previously, Jingchuang Electric submitted its prospectus on June 24, seeking to raise a total of 250 million RMB (approximately 38 million USD), with Guotai Junan Securities as the sponsorThis endeavor, however, has not been smooth sailing, as the company faces a myriad of questions and scrutiny concerning its corporate governance, financial performance stability, and compliance practices.

Several key challenges have come to the forefront during the IPO processThe BSE raised concerns about matters pertaining to personnel turnover, the consistency of the company’s business performance, high levels of family ownership, and compliance management, leading to doubts about the viability of Jingchuang’s future prospects

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The company’s understanding of R&D expenditures and their implications on earnings insider has particularly caught the attention of regulators.

Delving into the company’s operational focus, Jingchuang Electric specializes in the development, production, and sale of advanced cold chain equipment, which includes intelligent controllers, pharmaceutical and food cold chain monitoring instruments, heat pump testing devices, and environmental particulate matter monitoring instrumentsThe company also offers Internet of Things (IoT) and cloud-based system solutions, positioning itself as a key player in the cold chain management industry.

Financially, Jingchuang Electric’s figures present a mixed picture over the past few yearsBetween 2021 and 2023, the company reported revenues of 402 million RMB, 396 million RMB, and 435 million RMB respectivelyTheir net profits also showed increasing trends: 28.55 million RMB in 2021, 48.74 million RMB in 2022, and 55.36 million RMB in 2023. The gross margin for core business activities improved from 39.26% to 42.65% over these years, despite the steady growth in revenue.

However, when we turn our gaze towards R&D investments, a concerning trend arises

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Jingchuang Electric invested 28.86 million RMB, 25 million RMB, and 26.2 million RMB respectively from 2021 to 2023 on R&D expenses, which translates to 7.11%, 6.31%, and 6.03% of their revenuesComparatively, industry peers’ average R&D expenditures have consistently outpaced Jingchuang’s, raising alarms to regulators regarding their commitment to ongoing innovationThe downturn in R&D expenditure coincides with apparent cost-cutting measures including reduced employee compensation and lowered material inputs, a decision that invites skepticism about future product development capabilities.

In more detail, the total salary for R&D personnel diminished from 22.97 million RMB in 2021 to 11.69 million RMB in the first half of 2024, alongside the average number of R&D employees declining from 145 to 147 across the same periodWhile management justifies these reductions as an optimization process of the R&D department, they have nonetheless pledged to increase the R&D workforce to meet upcoming strategic needs.

On the other hand, raw material investments dedicated to R&D reflected a drastic drop across these same periods, illustrated by figures of 3.49 million RMB, 1.29 million RMB, 1.06 million RMB, and 687,100 RMB

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These fluctuations have caused the BSE to demand clarity regarding the precipitous decline of investment in raw materials for R&D.

In their response, the company cited variations in the R&D projects undertaken at different phasesFor example, in 2021, Jingchuang emphasized hardware R&D projects leading to considerable use of raw materials, while shifting towards software and system engineering projects in 2022 and onwards, which intuitively requires fewer physical resourcesThe company's management decisions aimed at streamlining existing products and managing new project resource consumption have also influenced overall materials expenditure.

Moreover, the BSE expressed skepticism surrounding how the company categorizes executive compensation as part of R&D expensesThis became particularly evident when Zhang Lingchi was appointed as chairman of the supervisory board in June 2023, receiving a full salary from the R&D budget

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The BSE sought further clarification on the rationale behind solely allocating his salary to R&D expenses without partitioning it appropriately.

Interestingly, just a month prior to their IPO submission, Jingchuang Electric voluntarily terminated its planned dividend distributionInitially, the company proposed a cash dividend of 2 RMB per every 10 shares, which would have represented roughly 17% of the net profit for 2023. However, during a subsequent shareholders' meeting, the decision was reversed, cited as a strategic move to align with future business development needs and not significantly disrupt core operations.

The underlying rationale may be attributed to the ongoing cash flow challenges faced by the companyAs of 2021 to 2023, figures indicate that the company's cash and cash equivalent amounts were 68.51 million RMB, 68 million RMB, and 144 million RMB, significantly beneath their retained earnings which fluctuated between 144 million RMB and 226 million RMB

These financial pressures may have influenced Jingchuang’s decision to retract from profit-sharing in order to alleviate liquidity concerns, thus ensuring that the IPO process continues smoothly.

Jingchuang Electric also faces increasing challenges with accounts receivable, which exhibited a compound annual growth rate of 25.39%, consistently surpassing revenue growth rates and accounting for an alarming 16.88% of total revenues in 2023. This combination of cash flow instability and rising receivables raises additional flags about the company's financial health.

To further contextualize their future direction, Jingchuang Electric aims to gather 250 million RMB in this IPO, planing to allocate 130 million RMB toward core production line upgrades, 65 million RMB for R&D on smart instruments and establishing a cold cloud platform, and 55 million RMB for the expansion of their marketing network