"Off-the-books procurement financing" Over a span of one and a half years, Zhejiang Tony Electronic Co.,Ltd. (603595) overstated its total profits by more than 110 million yuan. Additionally, the company failed to promptly disclose foreseeable delays in fulfilling a major contract. On October 29, a regulatory pre-penalty notice exposed these two significant violations.
According to the "Administrative Penalty Prior Notice" issued by the Zhejiang Securities Regulatory Bureau, the company was found guilty of two major violations. First, it failed to disclose in a timely manner the severe underperformance of a 675 million yuan silicon carbide substrate procurement contract with key customer Guangdong Tianyu Semiconductor. More seriously, the company inflated its total profits by 111 million yuan in its 2022 annual report and 2023 interim report by underreporting R&D expenses, operating costs, and asset impairment losses.
Part of the fraudulent activities stemmed from undisclosed procurement financing provided by Tony Industrial Group, a wholly-owned subsidiary of controlling shareholder Shen Xinfang. These violations occurred during a period when the company's stock price was plummeting, and Shen Xinfang faced margin call risks on multiple pledged shares.
**Overstating Profits by Over 100 Million Yuan in 1.5 Years** The first violation cited in the notice was the delayed disclosure of major contract fulfillment progress. In early 2023, Tony Semiconductor, a subsidiary of Zhejiang Tony Electronic, signed a procurement contract with Guangdong Tianyu, agreeing to deliver 135,000 6-inch silicon carbide substrates monthly from May to December 2023, totaling 675 million yuan—51.84% of the company’s audited annual revenue. However, monthly deliveries consistently fell short of targets. By October 2023, only 6.74% of the contract had been fulfilled, yet the company delayed disclosing this risk until January 6, 2024.
The second violation involved false records in the 2022 annual report and 2023 interim report. Investigations revealed overstated profits of 38.78 million yuan and 72.28 million yuan, accounting for 38.63% and 70.95% of the disclosed amounts, respectively. Cumulatively, profits were inflated by 111 million yuan.
The fabricated profits were achieved through three methods: underreporting R&D expenses, underreporting operating costs, and underreporting asset impairment losses. Specifically: 1. Tony Semiconductor misclassified defective crystals as inventory instead of R&D expenses, underreporting 56.81 million yuan in R&D costs and inflating profits by the same amount. 2. Tony Industrial funded material procurement for Tony Semiconductor without proper accounting, leading to underreported R&D expenses (6.74 million yuan) and operating costs (20.72 million yuan), totaling 27.46 million yuan in overstated profits. 3. In 2022, the company failed to fully provision for impairment on undisclosed materials, underreporting asset impairment losses by 10.24 million yuan. In 2023, it further underreported losses by 16.54 million yuan due to inadequate impairment testing.
As a result, Zhejiang Tony Electronic faces a 7 million yuan fine, while Chairman Shen Xinfang, CEO Shen Xiaoyu, and four other responsible individuals were warned and fined a combined 8.7 million yuan.
**Controlling Shareholder’s High-Risk Pledges** Tony Industrial, owned by Shen Xinfang, played a key role in the profit overstatement by funding undisclosed procurement, leading to underreported costs and impairment losses.
Shen Xinfang and Shen Xiaoyu, acting in concert, hold 32.25% and 16.65% stakes, respectively, in Zhejiang Tony Electronic. From 2022 to 2023, they pledged shares seven times for personal financing or guarantees, with liquidation prices ranging from 20 to 45 yuan per share. Several pledges neared or breached liquidation thresholds.
For example, in October 2023, Shen Xinfang pledged 8.36 million shares to Guojin Securities, with warning and liquidation prices at 24.48 yuan and 21.4 yuan, respectively. By December 2023, another 3.92 million shares pledged to ICBC faced liquidation at 23 yuan per share.
These risks coincided with Zhejiang Tony Electronic’s stock decline from a January 2023 high of 85.86 yuan to below 40 yuan by year-end, hitting a low of 15.53 yuan in February 2024. Had the downtrend continued, massive liquidations could have ensued.
As of Q3 2024, 59.8 million of Shen Xinfang’s 74.97 million shares were pledged, with 8.4 million frozen. Similarly, 30.4 million of Shen Xiaoyu’s 38.7 million shares were pledged, and 5.4 million were frozen.
**Guangdong Tianyu’s IPO Timing** Guangdong Tianyu, central to both violations, is currently pursuing a Hong Kong IPO. On October 22, it passed the HKEX hearing, with CITIC Securities as sole sponsor. Founded in 2009, it was among China’s first to industrialize third-gen semiconductor silicon carbide epitaxial wafers.
Shareholding disclosures show no direct ties between Zhejiang Tony Electronic and Guangdong Tianyu. Li Xiguang holds 29.05% directly, with additional indirect control via investment vehicles, while Ouyang Zhong holds 18.21% directly.
