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CHINA CARBON GRAPHITE GROUP, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge)
The following discussion of the results of our operations and financial
condition should be read in conjunction with our financial statements and the
related notes, which appear elsewhere in this report. The following discussion
includes forward-looking statements. For a discussion of important factors that
could cause actual results to differ from our forward-looking statements, see
the sections entitled "Risk Factors" and "Cautionary Note Regarding Forward
Looking Statements" above.
In some cases, you can identify forward-looking statements by terms such as
"anticipates," " believes," "could," "estimates," "expects," "intends," "may,"
"plans," "potential," "predicts," "projects," "should," "would" and similar
expressions intended to identify forward-looking statements. Forward-looking
statements reflect our current views with respect to future events and are based
on assumptions and subject to risks and uncertainties. Given these
uncertainties, undue reliance should not be placed on these forward-looking
statements.
Also, forward-looking statements represent our estimates and assumptions only as
of the date of this report. This Annual Report should be read in its entirety
and with the understanding that our actual future results may be materially
different from what we expect.
Except as required by law, we assume no obligation to update any forward-looking
statements publicly, or to update the reasons actual results could differ
materially from those anticipated in any forward-looking statements, even if new
information becomes available in the future.
Overview
We are engaged in the manufacture of graphite-based products in the PRC. Our
products are used in the manufacturing process of other products, particularly
non-ferrous metals and steel, and are incorporated in various types of products
or processes, such as atomic reactors. We currently manufacture and sell
primarily the following types of graphite products:
· graphite electrodes;
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· fine grain graphite; and
· high purity graphite.
Based on information we receive about our industry in the course of our
business, we believe that we are the largest wholesale supplier of fine grain
graphite and high purity graphite in China and one of China's largest producers
and suppliers of graphite products overall. Approximately 40% of our products
are sold directly to end users in China, primarily consisting of steel
manufacturers. All other sales are made to over 200 distributors located
throughout 22 provinces in China. Our distributors then sell our products to end
users both in China and in foreign countries, including, among others, Japan,
the United States, Spain, England, South Korea and India. In 2011, our revenues
and profits improved from 2010 due to an increase in demand for our products,
which resulted from improved market conditions, increased sales prices and an
increase in our production capacity, as discussed in greater detail below under
the heading "Results of Operations."
From the fourth quarter of 2008 until the end of 2009, however, as a result of
the global economic crisis, the steel industry in general slowed, which caused
our revenues and gross margin to decline significantly. The industry started to
recover in 2010, in particular since the third quarter of 2010. This recovery
and development continued during 2011 and the first quarter of 2012. Our
revenues, gross profits and gross margins improved significantly during the
second half of 2010, which continued in 2011. Our gross margin for the year
ended December 31, 2011 was 23.2%, compared to 22.4% for the year ended December
31, 2010. We believe that our gross margin will be approximately 23% during the
next twelve months.
Our cash and receivables increased during the year ended December 31, 2011
compared to the year ended December 31, 2010, while collectability of our
receivables remained highly probable. We believe that our allowance for doubtful
accounts as of December 31, 2011 was adequate. We expect the recovery and
increasing demand in the fine grain, high purity and ultra-high power graphite
electrode markets to continue in 2012, primarily due to anticipated growth in
the iron, steel, automobile, aerospace and defense industries in the PRC.
Currently, steel plants in China have been upgrading their furnace facilities,
which created a high demand for large size ultra-high power graphite electrodes.
The margin for large size ultra-high power graphite electrodes is high due to
the shortage of supply compared to demand. We estimate that this trend will
continue for the near future. Our new production plant will specialize in
manufacturing high margin products including large size ultra-high power
graphite electrodes, high purity graphite and fine gain graphite.
In order to address this demand, we installed a 4200-ton compressor and 36
annular kilns, which we have completed testing. The 4200-ton compressor began
trial production in October 2011, and the 36 annular kilns began trial
production in August 2011. In addition, the new baking plant will have 36
furnaces, totaling 160 meters in length. The new plant will be used to
manufacture a new product, ultra-high power graphite electrodes with a diameter
ranging from 600 to 800 millimeters, along with existing fine grain and high
purity graphite products. The industrial applications of the products to be
manufactured in the new facility include aerospace, defense, automotive and
clean tech end products, which currently carries the greatest demand for all
forms of graphite. We believe that this expansion will make us China's first
domestic producer of 800 millimeter diameter ultra-high power electrodes and
will further strengthen the Company's leading position in China's fine grain
graphite market. After completion of the expansion, our annual production
capacity increased to 60,000 tons. The Company is currently operating at 75%
production capacity of 30,000 tons annually.
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The initial budgeted investment for the construction of our new facility was
approximately $13.5 million in the aggregate, $9 million of which had been spent
as of December 31, 2011.
Some of our expansion plans, including the expansion of our product offerings to
include nuclear, solar and semiconductor products and pursuing an acquisition,
would likely require us to obtain additional financing from equity or debt
markets, or borrow additional funds from local banks. We currently have no
commitments from any financing sources. There is no assurance that we will be
able to raise any funds on terms favorable to us, or at all. In the event that
we issue shares of equity or convertible securities, holdings of our existing
stockholders would be diluted. In addition, there is no assurance that we will
successfully manage and integrate the production and sale of new products.
At December 31, 2011, we had short-term bank loans of approximately $45.5
million. These bank loans, which are secured by liens on our fixed assets and
land use rights, are due between August 2012 and January 2013, including
approximately $32 million owed to the Construction Bank of China. During the
year ended December 31, 2011 and the first quarter of 2012, the Company rolled
over all of its short-term bank loans from the China Construction Bank,
including a loan for $4.72 million that was originally due on January 11, 2012,
and a short-term bank loan from Credit Union that was originally due in February
2012. Historically, we have rolled over our short-term loans when they became
due. However, we cannot assure investors that our lenders, including the
Construction Bank of China, will not demand repayment when these loans mature.
If our lenders demand repayment when due, we may be unable to obtain the
necessary funds to pay off these loans, which could result in the imposition of
penalties, including a 50% increase in interest rates and a request from the
banks for additional security for the loans. At December 31, 2011, our cash
reserves, including restricted cash, were $12.2 million and are insufficient to
pay off all of our loans when due.
We purchase all of our raw materials from domestic Chinese suppliers. Because we
do not have any long-term contracts with our suppliers, any increase in the
prices of our raw materials would affect the price at which we can sell our
products. If we are unable to pass on increased costs to our customers, we may
be unable to maintain our profit margins. Raw material prices increased
significantly in 2010 and continued to increase during the year ended December
31, 2011. While we anticipate this trend to continue in 2012, decreases in our
gross margin have been offset by increasing sales prices. To offset increasing
prices, we make advance deposits to suppliers with available cash to lock in
prices. As of December 31, 2011 and 2010, we advanced to suppliers $5,921,970
and $10,198,602, respectively. The average prices for our products have been
increasing since January 2011, and have continued to increase through the date
of this Annual Report. In particular, prices for high purity graphite products
have notably increased.
In times of decreasing prices, we may have to sell our products at prices, which
are lower than the prices at which we purchased our raw materials. Furthermore,
PRC regulations grant broad powers to the government to adjust the price of raw
materials and manufactured products. Although the government has not imposed
price controls on our raw materials or our products, it is possible that price
controls may be implemented in the future, thereby affecting our results of
operations and financial condition.
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--------------------------------------------------------------------------------Results of Operations
Fiscal Years Ended December 31, 2011 and 2010
The following table sets forth the results of our operations for the periods
indicated in U.S. dollars and as a percentage of net sales (dollars in
thousands):
Results of Operations
Fiscal Years Ended December 31, 2011 and 2010
The following table sets forth the results of our operations for the periods
indicated in U.S. dollars and as a percentage of net sales (dollars in
thousands):
Year ended December 31,
2011 2010
Sales $ 49,847 100.0 % $ 30,994 100.0 %
Cost of goods sold 38,262 76.8 % 24,062 77.6 %
Gross profit 11,585 23.2 % 6,932 22.4 %
Operating expenses
Selling expenses 598 1.2 % 187 0.6 %
General and administrative 5,420 10.9 % 4,156 13.4 %
Depreciation and amortization 224 0.4 % 163 0.5 %
Income from operations 5,343 10.7 % 2,426 7.8 %
Other income 1,167 2.3 % 25 0.1 %
Other expense - - (87 ) (0.3 )%
Change in fair value of warrants (87 ) (0.2 )% 386 (1.2 )%
Interest expense (3,451 ) (6.9 )% (1,366 ) (4.4 )%
Income before income tax expense 2,972 6.0 % 1,384 4.5 %
Net income 2,972 6.0 % 1,384 4.5 %
Preferred stock deemed dividend - - (133 ) (0.4 )%
Dividend (28 ) (0.1 )% (101 ) (0.3 )%
Net income available to common shareholders 2,944 5.9 % 1,150 3.7 %
Foreign currency translation adjustment 1,599 3.2 % 1,307 4.2 %
Total comprehensive income $ 4,571 9.2 % $ 2,691 8.7 %
27--------------------------------------------------------------------------------Sales.
During the year ended December 31, 2011, we had sales of $49,846,744, compared
to sales of $30,994,150 for the year ended December 31, 2010, an increase of
$18,852,594, or approximately 60.8%. Sales increase was mainly attributable to a
significant increase in the demand for our products during the year ended
December 31, 2011, which resulted from the market recovery, new customer
developments and changes to our product mix to include more high purity graphite
products. The average unit selling price of our products increased 24% and the
average unit selling price of high purity graphite products increased 58% during
the year ended December 31, 2011, compared to the same period for the year ended
December 31, 2010. The manufacturing of solar and mold products increased the
demand for our products as raw materials. Increased production capacity and
increased unit prices also contributed to an increase in total sales. The
increase in the average unit selling price of high purity graphite is due to a
large demand for such products in the market as well an increase in the cost for
raw materials. We experienced a decrease in the demand for high purity graphite
during the first quarter of 2010. Since then, the company has been successful in
improving its product mix to achieve higher profit through increasing sales of
fine grain graphite and high purity graphite products, which generate a better
margin.
The breakdown of revenues for each of graphite electrodes, fine grain graphite
and high purity graphite, in 2011 and 2010, respectively, was as follows:
December 31, % of Total December 31, % of Total
2011 Sales Sales 2010 Sales Sales
Graphite Electrodes $ 6,396,600 12.8 % $ 9,263,690 29.9 %
Fine Grain Graphite 21,787,763 43.7 % 12,977,109 41.9 %
High Purity Graphite 20,692,796 41.5 % 6,663,847 21.5 %
Others (1) 969,585 2.0 % 2,089,504 6.7 %
Total $ 49,846,744 100.0% $ 30,994,150 100.0%
(1) "Other" sales represent revenue generated by sales of semi-processed
products and other types of products.
Cost of sales; gross margin.
Our cost of goods sold consists of the cost of raw materials, utilities, labor,
and depreciation expenses in our manufacturing facilities. During the year ended
December 31, 2011, our cost of goods sold was $38,261,812, compared to
$24,062,354 for the cost of goods sold for the year ended December 31, 2010, an
increase of $14,199,458, or approximately 59.0%. The increase in the cost of
sales was directly associated with an increase in in the cost of raw materials
due to our increase in sales and an increase in the unit selling price of our
products. Our gross margin increased from 22.4% for the year ended December 31,
2010 to 23.2% for the year ended December 31, 2011. This increase reflects the
variance in our product mix, which is attributable to an increase in our sales
of high purity graphite products (a higher margin product compared to graphite
electrodes). There was a decrease in the margin for fine grain graphite products
due to a shift in demand for high purity graphite electrodes during the year
ended December 31, 2011. The increased sales and increased margin for high
purity graphite products offset the decreased margin and unit price for fine
grain graphite products.
28--------------------------------------------------------------------------------Operating expenses.
Operating expenses totaled $6,242,033 for the year ended December 31, 2011,
compared to $4,505,584 for the year ended December 31, 2010, an increase of
$1,736,449, or approximately 38.5%.
Selling, general and administrative expenses
Selling expenses increased from $186,693 for the year ended December 31, 2010 to
$597,802 for the year ended December 31, 2011, an increase of $411,109, or
220.2%. The increase was due to higher shipping and handling expenses during the
year ended December 31, 2011 as compared to the year ended December 31, 2010,
which resulted from higher sales and increased shipping and handling costs due
to the increased cost of fuel.
Our general and administrative expenses consist of salaries, office expenses,
utilities, business travel, amortization expenses, public company expenses
(including legal expenses, accounting expenses and investor relations expenses)
and stock compensation. General and administrative expenses were $5,420,157 for
the year ended December 31, 2011, compared to $4,155,581 for the year ended
December 31, 2010, an increase of $1,264,576, or 30.4%. The increase in general
and administrative expenses was due primarily to increased taxes and
professional expenses as a public company. The Company incurred $1,440,750 for
consulting expenses and the compensation of directors and an employee through
stock issuances during the year ended December 31, 2011. The increased land use
tax of approximately $1,292,464 for the year ended December 31, 2011 is
attributable to our payment of land use tax for the land use right we acquired
in 2010, which became subject to land use tax during the year ended December 31,
2011.
Depreciation and amortization expenses
Depreciation and amortization expenses totaled $1,803,770 for the year ended
December 31, 2011, compared to $1,752,232 for the year ended December 31, 2010,
an increase of $51,538, or approximately 2.9%. For the year ended December 31,
2011, depreciation and amortization was allocated between costs of goods sold
and selling, general and administrative expenses in the amounts $1,579,696 and
$224,074, respectively. For the year ended December 31, 2010, depreciation and
amortization was allocated between costs of goods sold and selling, general and
administrative expenses in the amounts $1,588,922 and $163,310, respectively The
slight increase in depreciation and amortization expenses is a result of
additional fixed assets placed in service during 2011
Income from operations.
As a result of the factors described above, operating income was $5,342,899 for
the year ended December 31, 2011, compared to $2,426,212 for the year ended
December 31, 2010, an increase of approximately $2,916,687, or 120.2%.
Other income and expenses.
Our interest expense was $3,451,037 for the year ended December 31, 2011,
compared to $1,366,104 for the year ended December 31, 2010, reflecting
increased interest payments on loans from banks. We used the additional bank
loans to secure additional inventory and to make advanced payments to our
suppliers because raw material prices are rising and we anticipate increased
production levels due to the construction of our new facility. Other income,
which consisted of government grants, was $1,167,077 for the year ended December
31, 2011, compared to $24,589 for the year ended December 31, 2010. Expenses
from changes in the fair value of our warrants as a result of adopting ASC
820-10 was $86,691 for the year ended December 31, 2011, compared to $385,661
for the year ended December 31, 2010.
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--------------------------------------------------------------------------------Income tax.
During the years ended December 31, 2011 and 2010, we benefited from a 100% tax
holiday from the PRC enterprise tax. As a result, we had no income tax due for
these periods. The enterprise income tax at the statutory rates would have been
approximately $833,119 and $424,549, respectively, for 2011 and 2010 without
consideration of adjustments on taxable income. The tax holiday is from 2008
through 2017.
Net income.
As a result of the factors described above, our net income for the year ended
December 31, 2011 was $2,972,251, compared to $1,383,391 for the year ended
December 31, 2010, an increase of $1,588,860, or 114.9%.
Foreign currency translation.
Our financial statements are expressed in U.S. dollars but the functional
currency of our operating subsidiary is RMB. Results of operations and cash
flows are translated at average exchange rates during the period, assets and
liabilities are translated at the unified exchange rate at the end of the period
and equity is translated at historical exchange rates. Translation adjustments
resulting from the process of translating the financial statements denominated
in RMB into U.S. dollars are included in determining comprehensive income. Our
foreign currency translation gain for the year ended December 31, 2011 was
$1,599,128, compared to $1,307,351 for the year ended December 31, 2010, an
increase of $291,777, or 22.3%.
Preferred stock deemed dividend.
As a result of the private placement that was completed on January 13, 2010, we
incurred a preferred stock deemed dividend of $132,778, of which $86,221
represented the intrinsic value of the conversion feature of the warrants issued
with the preferred stock and $46,557 represented the allocated value of the
warrants. The preferred stock deemed dividend is a non-cash charge which did not
affect our operations or cash flow for the year ended December 31, 2010, and for
which there was no comparable charge for the year ended December 31, 2011.
Dividend expense.
Pursuant to the terms of a private placement that closed on December 22, 2009
and January 13, 2010, the Series B Preferred Stock offers a 6% dividend. The
preferred stock dividend is payable quarterly commencing April 1, 2010. As a
result, we incurred dividend expenses of $28,099 and $101,043 for the years
ended December 31, 2011 and 2010, respectively.
Net income available to common stockholders.
Net income available to our common stockholders was $2,944,152, or $0.13 and
$0.13 per share (basic and diluted), for the year ended December 31, 2011,
compared to $1,149,570, or $0.07 and $0.06 per share (basic and diluted), for
the year ended December 31, 2010.
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--------------------------------------------------------------------------------Liquidity and Capital Resources
Our primary capital needs have been to fund our working capital requirements.
Our primary sources of financing have been cash generated from short-term and
long-term loans from banks in China and loans from a related party. In addition,
in December 2009 and January 2010, we raised an aggregate of approximately $3
million in a private placement transaction. In 2011, we raised an aggregate of
$160,000.
At December 31, 2011, we had short-term loans in the aggregate amount of $45.5
million outstanding, as described below.
We have a short-term bank loan from Huaxia Bank for $5.5 million bearing
interest at 8.203% annually and due in June 2012. The short-term bank loan is
secured by a security interest in certain equipment, property and land use
rights.
We entered into five short-term bank loans with China Construction Bank for a
total of $32 million between August 6, 2010 and February 28, 2011. The first of
these loans was made on August 6, 2010 for $6.3 million with an interest rate of
6.56% per year and a maturity date of August 27, 2012. The second loan was made
on August 23, 2010 for $6.3 million with an interest rate of 6.56% per year and
a maturity date of August 14, 2012. The third loan was made on September 6, 2010
for $6.3 million with an interest rate of 6.56% per year and a maturity date of
August 28, 2012. The fourth loan was made on September 16, 2010 for $8.8 million
with an interest rate of 6.56% per year and a maturity date of September 27,
2012. The fifth loan was made on February 28, 2011 for $4.7 million with an
interest rate of 5.81% per year and a maturity date of January 11, 2012. In
January 2012, this loan was rolled over by the Company and renewed for the same
amount with an interest rate of 6.56% per year and a maturity date of January
2013. The loan is secured by property and equipment and land use rights. Each of
the loans made on August 6, 2010, August 23, 2010, September 6, 2010 and
September 16, 2010 were originally due between August 5, 2011 and September 15,
2011 but were rolled over and renewed by the Company during the year ended
December 31, 2011. Interest on each loan is payable quarterly. All of the loans
with China Construction Bank are renewable at the lender's discretion. The loan
agreements provide for events of default and operating and financial covenants
typical for loan transactions of this type. As of December 31, 2011, the balance
for these sixshort-term bank loans was $32 million.
We have a short-term bank loan from Credit Union for $1.3 million bearing
interest at 13.66% annually and due in February 2012. In January 2012, this loan
was rolled over by the Company and renewed for the same amount with an interest
rate of 13.66% per year and a maturity date of August 2012. The loan is secured
by property and equipment and land use rights.
We have a short-term bank loan from China Everbright Bank for $6.3 million
bearing interest at 8.528% annually and due in July 2012. The short-term bank
loan is secured by equipment and property and land use rights.
Historically we have rolled over our short-term loans on an annual basis.
Although we believe that we will be able to obtain extensions of these loans
when they mature, we cannot assure investors that such extensions will be
granted. In the event repayment of the loans is not extended and we default on
our obligations, the lenders could call the loans, foreclose on the collateral
securing the loans or seek other remedies. In such an event, our operations and
financial conditions would be materially adversely affected and we would be
forced to cease operations if alternative funding is not obtained.
Despite a low amount of working capital, we are able to operate our business
through bank financing, loans from related parties and issuing equity in
exchange for certain services provided. Our long-term goal is to continue to
roll over short-term loans and obtain positive cash flows from our outstanding
accounts receivable and sales of inventory until our new facility is operating
at full capacity. We believe that increased market demand for our products and
the increased production capacity, together with management of our accounts
receivable, will produce a positive cash flow in future years. We expect that
anticipated cash flows from future operations, short-term and long-term bank
loans and loans from a related party will be sufficient to fund our operations
through at least the next twelve months, provided that:
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· we generate sufficient business so that we are able to
generate substantial profits, which cannot be assured;
· our banks continue to provide us with the necessary
working capital financing; and
· we are able to generate savings by improving the efficiency of our operations.
In December 2009 and January 2010, we raised an aggregate of approximately $3
million in a private placement transaction. We may require additional equity,
debt or bank funding to finance acquisitions or to allow us to produce graphite
for the nuclear industry, which are our primary growth strategies. We can
provide no assurances that we will be able to enter into any financing
agreements on terms favorable to us, if at all, especially considering the
current global instability of the capital markets. In addition, although we
expect to refinance our bank loans when they mature, we can provide no
assurances that we will be able to refinance such loans on terms favorable to
us, if at all.
At December 31, 2011, cash and cash equivalents were $521,450, compared to
$296,312 at December 31, 2010, an increase of $225,138. Restricted cash
increased to $11,516,500 as of December 31, 2011 from nil as of December 31,
2010, which was restricted as a requirement by our lenders. Our working capital
decreased by $1,034,489 to $1,056,065 at December 31, 2011 from $2,090,554 at
December 31, 2010. Our cash position slightly increased due to the increased
sales and less cash used in operating activities for the year ended December 31,
2011 compared to use of cash from operations during the year ended December 31,
2010.
As of December 31, 2011, accounts receivable, net of allowance, was $12,541,321,
compared to $6,222,112 at December 31, 2010, an increase of $6,319,209, or
101.56%. The increase was consistent with an increase in our sales. Accounts
receivable are recorded at the invoiced amount and do not bear interest. Our
management reviews the adequacy of our allowance for doubtful accounts on an
ongoing basis, using historical collection trends and the aging of receivables.
Management also periodically evaluates individual customer's financial
condition, credit history, and the current economic conditions to make
adjustments in the allowance when it is considered necessary. The Company
believes its allowance was sufficient as of December 31, 2011.
As of December 31, 2011, inventories were $37,430,248, compared to $26,432,217
at December 31, 2010, an increase of $10,998,031, or 41.61%. The increase in
inventories is due to an increase in the cost of raw materials and an increase
in the production capacity of our facilities.
As of December 31, 2011, prepaid expenses were $452,730, compared to $573,094 at
December 31, 2010, a decrease of $120,364, or 21.00%. The decrease in prepaid
expenses is attributable to the amortization of various prepaid consulting fees
paid with stock issuances.
Advances to suppliers decreased from $10,198,602 at December 31, 2010 to
$5,921,970 at December 31, 2011, a decrease of $4,276,632. The decrease is due
to the Company advancing more money to suppliers to acquire raw materials during
the year ended December 31, 2010. No allowance for doubtful accounts was
necessary for the balance of advances to suppliers.
Notes payable reflect our obligations to bank lenders who have guaranteed our
future payment obligations as requested by certain of our suppliers. Notes
payable increased from $0 to $16,763,100 from December 31, 2010 to December 31,
2011. The increase is attributable to an increase in the purchase of inventory.
The notes payable were secured by $11,694,820 of restricted cash at December 31,
2011. Notes payable allow the Company to reserve more cash resources for other
operating expenses. Restricted cash represents amounts held by a bank as
security for bank acceptance notes and is subject to withdrawal restrictions.
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Accounts payable decreased from $5,452,743 at December 31, 2010 to $1,340,498 at
December 31, 2011, a decrease of $4,112,245. The decrease in accounts payable
resulted from an increase in the number of payments the Company was able to make
to vendors during the year ended December 31, 2011 because of an increase in
production.
Fiscal Year Ended December 31, 2011 Compared to Fiscal Year Ended December 31,
2010
The following table sets forth information about our net cash flow for the years
indicated:
Cash Flows Data:
For Year Ended
December 31
2011 2010
Net cash flows used in operating activities $ (8,256,429 ) $ (13,508,155 )
Net cash flows used in investing activities $ (8,562,060 ) $ (13,285,972 )
Net cash flows provided by financing activities $ 17,032,709 $ 24,374,521
33--------------------------------------------------------------------------------
Net cash flow used in operating activities was $8,256,429 for the year ended
December 31, 2011, compared to $13,508,155 for the year ended December 31, 2010,
a decrease of $5,251,726, or 38.9%. The decrease in net cash flow used in
operating activities was mainly due to less payments for advances to suppliers
of $13.6 million and less payments made for taxes payable of $2.2 million, which
was offset by increased accounts receivable of $3.7 million, increased payments
for accounts payable and accrued liabilities of $5.2 million and increased
payments for inventory of $1.02 million. During the year ended December 31,
2011, an increase in our sales increased the Company's accounts receivable.
Net cash flow used in investing activities was $8,562,060 for the year ended
December 31, 2011, compared to $13,285,972 for the year ended December 31, 2010,
a decrease of $4,723,912, or 35.6%. The decrease in net cash flow used in
investing activities is attributable to the Company spending $6.8 million during
the year ended December 31, 2010 to acquire land use rights for which there was
no comparable expense for the year ended December 31, 2011. Approximately $2.8
million was spent on construction costs and $5.8 million was spent for property
and equipment for our new factory during the year ended December 31, 2011,
including the installation of a 4200-ton compressor and 36 annular kilns. For
the year ended December 31, 2010, $5.5 million was spent on construction costs
and $1.0 million was spent on property and equipment.
Net cash flow provided by financing activities was $17,032,709 for the year
ended December 31, 2011, compared to $24,374,521 for the year ended December 31,
2010, a decrease of $7,341,812, or 31.1%. The decrease in net cash flow provided
by financing activities was due to an increase in the amount of restricted cash
of $11.5 million required to secure our notes payable, which offset the increase
in additional notes payable and short-term loans entered into during the year
ended December 31, 2011. The Company had approximately $16.5 million of notes
payable for the year ended December 31, 2011, compared to $1.6 million for the
year ended December 31, 2010. In addition, the aggregate amount of outstanding
short-term loans borrowed and repaid increased for the year ended December 31,
2011. The Company borrowed $45.5 million in short-term bank loans and repaid
$34.0 million during the year ended December 31, 2011, while the Company
borrowed $33.3 million in short-term bank loans and repaid $5.1 million for the
year ended December 31, 2010.
Off-Balance Sheet Arrangements
We have not entered into any off-balance sheet arrangements.
Significant Accounting Estimates and Policies
The discussion and analysis of our financial condition and results of operations
is based upon our financial statements that have been prepared in accordance
with accounting principles generally accepted in the United States. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets and liabilities. On an
ongoing basis, we evaluate our estimates including the allowance for doubtful
accounts, the salability and recoverability of our products, income taxes and
contingencies. We base our estimates on historical experience and on other
assumptions that we believe to be reasonable under the circumstances, the
results of which form our basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
Revenue Recognition
We recognize revenue in accordance with ASC 605-25, Revenue Recognition, which
states that revenue should be recognized when the following criteria are met:
(1) persuasive evidence of an arrangement exists; (2) the service has been
rendered; (3) the selling price is fixed or determinable; and (4) collection of
the resulting receivable is reasonably assured. Sales represent the invoiced
value of goods, net of value added tax ("VAT"), if any, and are recognized upon
delivery of goods and passage of title.
34
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In accordance with ASC 605-25, the Company recognizes revenue when persuasive
evidence of an arrangement exists, transfer of title has occurred or services
have been rendered, the selling price is fixed or determinable and
collectability is reasonably assured.
The Company derives revenues from the manufacturing and distribution of graphite
based products. The Company recognizes its revenues net of VAT. The Company is
subject to VAT, which is levied on a majority of the products, at a rate ranging
from 13% to 17% on the invoiced value of sales. Output VAT is borne by customers
in addition to the invoiced value of sales and input VAT is borne by the Company
in addition to the invoiced value of purchases to the extent not refunded for
export sales.
The Company recognizes revenue upon receipt of the delivery confirmation
provided by the customer or distributor. The Company does not provide chargeback
or price protection rights to the distributors. The distributor only places
purchase orders with the Company once it has confirmed the sale with a third
party because this is a specialized business, which dictates that the Company
will not manufacture the products until the purchase order is received. The
Company allows its customers to return products only if its products are later
determined by the Company to be defective. Based on the Company's historical
experience, product returns have been insignificant throughout all of its
product lines. Therefore, the Company does not estimate deductions or allowances
for sales returns. If sales returns occur, they are taken against revenue when
products are returned from customers. Sales are presented net of any discounts
given to customers. Interest income is recognized when earned. The Company
experienced no returns for the years ended December 31, 2011 and 2010.
Comprehensive Income
We have adopted ASC 220, Comprehensive Income, formerly known as SFAS No. 130,
Reporting Comprehensive Income, which establishes standards for reporting and
presentation of comprehensive income (loss) and its components in a full set of
general purpose financial statements. We have chosen to report comprehensive
income (loss) in the statements of operations and comprehensive income.
Income Taxes
We account for income taxes under the provisions of ASC 740, Income Tax,
formerly known as SFAS No. 109, Accounting for Income Taxes, which requires
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been included in the consolidated financial
statements or tax returns. Deferred tax assets and liabilities are recognized
for the future tax consequence attributable to the difference between the tax
bases of assets and liabilities and their reported amounts in the financial
statements. Deferred tax assets and liabilities are measured using the enacted
tax rate expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
Effective January 1, 2008, the new Chinese income tax law sets unified income
tax rates for domestic and foreign companies at 25%, except for a 15% corporate
income tax rate for qualified high technology and science enterprises. In
accordance with this new income tax law, low preferential tax rates in
accordance with both the tax laws and administrative regulations prior to the
promulgation of this law gradually become subject to the new tax rate within
five years after the implementation of this law.
We have been recognized as a high technology and science company by the Ministry
of Science and Technology of the PRC. The Xing He District Local Tax Authority
in the Nei Mongol province granted us a 100% tax holiday with respect to
enterprise income tax for ten years from 2008 through 2017. Afterwards, based on
the present tax law and our status as a qualified high technology and science
company, we will be subject to a corporate income tax rate of 15% effective in
2018.
Accounts Receivable and Allowance For Doubtful Accounts
Accounts receivables are recognized and carried at the original invoice amount
less allowance for any uncollectible amounts. An estimate for allowance for
doubtful accounts is made when collection of the full amount is no longer
probable. Bad debts are written off as incurred. Accounts receivable are
recorded at the invoiced amount and do not bear interest. Management reviews the
adequacy of the allowance for doubtful accounts on an ongoing basis, using
historical collection trends and aging of receivables. Management also
periodically evaluates individual customer's financial condition, credit
history, and the current economic conditions to make adjustments in the
allowance when it is considered necessary. The allowance for doubtful accounts
amounted to $2,790,662 for the year ended December 31, 2011. Management believes
that this allowance is sufficient based on a review of customer credit history,
historic payment records, aging, the market and other factors.
35
--------------------------------------------------------------------------------Inventories
Inventories are stated at the lower of cost, determined on a weighted average
basis, and net realizable value. Work in progress and finished goods are
composed of direct material, direct labor and a portion of manufacturing
overhead. Net realizable value is the estimated selling price, in the ordinary
course of business, less estimated costs to complete and dispose. Management
believes that there was no obsolete inventory as of December 31, 2011 or
December 31, 2010 and therefore, no allowance for inventory was necessary.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Major expenditures for
betterments and renewals are capitalized while ordinary repairs and maintenance
costs are expensed as incurred. Depreciation and amortization is provided using
the straight-line method over the estimated useful life of the assets after
taking into account the estimated residual value. The Company reviews the
carrying value of property, plant, and equipment for impairment whenever events
and circumstances indicate that the carrying value of an asset may not be
recoverable from the estimated future cash flows expected to result from its use
and eventual disposition. In cases where undiscounted expected future cash flows
are less than the carrying value, an impairment loss is recognized equal to an
amount by which the carrying value exceeds the fair value of assets. The factors
considered by management in performing this assessment include current operating
results, trends and prospects, the manner in which the property is used, and the
effects of obsolescence, demand, competition, and other economic factors. Based
on this assessment, there was no impairment recorded during the years ended at
December 31, 2011 and 2010.
Land Use Rights
There is no private ownership of land in China. All land ownership is held by
the government, its agencies and collectives. Land use rights are obtained from
the government, and are typically renewable. Land use rights can be transferred
upon approval by State Land Administration Bureau and payment of the required
transfer fee. We record the property subject to land use rights as intangible
asset.
The Company has land use rights of 386,853 square meters used for operations in
Xinghe County, Inner Mongolia, China. The land use rights have terms of 50
years, with the land use right relating to 130,220 square meters expiring in
2052 and the land use right with respect to 256,633 square meters expiring in
2053. In addition, in 2011, the local Chinese government and the Company agreed
on terms for the land use rights of 387,838 square meters of land located
adjacent to the Company's facilities. The Company was not required to sign a
land use right agreement or pay a fee. In exchange, the Company will allow
public use of this 387,838 square meters of land and keep the land in good
condition. The land use right has a term of 50 years, with such term expiring
in January 2060. The value of the land is estimated to be $14,000,000. The
Company has not accrued the liability or recorded the land use right asset for
this property in accordance with ASC 450, Contingencies. Because of our current
relationship and agreement with the local government to keep the land in good
condition, we believe that it is unlikely that we will have to pay for the land
use right. The bank allows, and the Company uses, this land use right as
collateral for its short-term bank loans. We believe that our facilities are
sufficient to meet our current and near future requirements and that any
additional space that we may require would be available on commercially
reasonable terms.
Each intangible asset is reviewed periodically or more often if circumstances
dictate, to determine whether its carrying value has become impaired. We
consider assets to be impaired if the carrying value exceeds the future
projected cash flows from related operations. We also re-evaluate the
amortization periods to determine whether subsequent events and circumstances
warrant revised estimates of useful lives.
36
--------------------------------------------------------------------------------Research and Development
Research and development costs are expensed as incurred, and are included in
general and administrative expenses. These costs primarily consist of the cost
of material used and salaries paid for the development of our products and fees
paid to third parties. Our research and development expense for the years ended
December 31, 2011 and 2010 has not been significant.
Value Added Tax
Pursuant to China's VAT rules and regulations, as an ordinary VAT taxpayer we
are subject to a tax rate of 17% ("output VAT"). The output VAT is payable after
offsetting VAT paid by us on purchases ("input VAT"). Under the commercial
practice of the PRC, the Company paid VAT and business tax based on tax invoices
issued.
The tax invoices may be issued subsequent to the date on which revenue is
recognized, and there may be a considerable delay between the date on which the
revenue is recognized and the date on which the tax invoice is issued. In the
event that the PRC tax authorities dispute the date on which revenue is
recognized for tax purposes, the PRC tax office has the right to assess a
penalty, which can range from zero to five times the amount of the taxes that
are determined to be late or deficient. In the event that a tax penalty is
assessed on late or deficient payments, the penalty will be expensed as a period
expense if and when a determination has been made by the taxing authorities that
a penalty is due.
Fair Value of Financial Instruments
On January 1, 2008, the Company began recording financial assets and liabilities
subject to recurring fair value measurement at the price that would be received
to sell an asset or paid to transfer a liability in an orderly transaction
between market participants. On January 1, 2009, the Company began recording
non-recurring financial as well as all non-financial assets and liabilities
subject to fair value measurement under the same principles. These fair value
principles prioritize valuation inputs across three broad levels. The three
levels are defined as follows:
? Level 1 inputs to the valuation methodology are quoted
prices (unadjusted) for identical assets or liabilities in
active markets.
? Level 2 inputs to the valuation methodology include
quoted prices for similar assets and liabilities in
active markets, and inputs that are observable for the
assets or liabilities, either directly or indirectly, for
substantially the full term of the financial instruments.
? Level 3 inputs to the valuation methodology are
unobservable and significant to the fair value.
The carrying amounts of financial assets and liabilities, including cash and
cash equivalents, accounts receivable, notes receivable, advances to suppliers,
other receivables, short-term bank loans, notes payable, accounts payable,
advances from customers and other payables, approximate their fair values
because of the short maturity period for these instruments.
The following table sets forth by level within the fair value hierarchy of the
Company's financial assets and liabilities that was used to calculate fair value
on a recurring basis as of December 31, 2011:
Carrying Value at Fair Value Measurement at
December 31, December 31, 2011
2011 Level 1 Level 2 Level 3
Warrant liability $ 174,805 - - $ 174,805
37--------------------------------------------------------------------------------
The following table sets forth by level within the fair value hierarchy of the
Company's financial assets and liabilities that was used to calculate fair value
on a recurring basis as of December 31, 2010:
Carrying Value at Fair Value Measurement at
December 31, December 31, 2010
2010 Level 1 Level 2 Level 3
Warrant liability $ 73,121 - - $ 73,121
Please see Note 3 contained in the Notes to the Consolidated Financial
Statements for a description of our warrant liability for the years ended
December 31, 2011 and 2010.
The Company did not identify any other non-recurring assets and liabilities that
are required to be presented on the balance sheet at fair value.
Stock-based Compensation
Stock-based compensation includes (i) common stock awards granted to employees
and directors for services which are accounted for under FASB ASC 718,
Compensation-Stock Compensation, and (ii) common stock awards granted to
consultants which are accounted for under FASB ASC 505-50, Equity-Equity-Based
Payments to Non-Employees.
All grants of common stock awards and stock options to employees and directors
are recognized in the financial statements based on their grant date fair
values. The Company has elected to recognize compensation expense using the
straight-line method for all common stock awards and stock options granted with
service conditions that have a graded vesting schedule, with a corresponding
charge to additional paid-in capital.
Common stock awards are granted to directors for services provided.
Common stock awards issued to consultants represent common stock granted to
non-employees in exchange for services at fair value. The measurement dates for
such awards are set at the dates that the contracts are entered into as the
awards are non-forfeitable and vest immediately. The measurement date fair value
is then recognized over the service period as if the Company has paid cash for
such service. The Company did not make significant grants to consultants for any
of the periods presented.
The Company estimates fair value of common stock awards based on the number of
shares granted and the quoted price of the Company's common stock on the date of
grant.
$1,336,150 and $130,000 of stock compensation expenses were amortized and
recognized as general and administrative expenses for the years ended December
31, 2011 and 2010, respectively.
38
--------------------------------------------------------------------------------Recent Accounting Pronouncements
The Company has reviewed all recently issued, but not yet effective, accounting
pronouncements and does not believe the future adoption of any such
pronouncements will have a material impact on its financial condition or the
results of its operations.
In May 2011, the Financial Accounting Standards Board ("FASB") issued ASU No.
2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure
Requirements in U.S. GAAP and International Financial Reporting Standards
("IFRS"). This pronouncement was issued to provide a consistent definition of
fair value and ensure that the fair value measurement and disclosure
requirements are similar between U.S. GAAP and IFRS. ASU 2011-04 changes certain
fair value measurement principles and enhances the disclosure requirements
particularly for level 3 fair value measurements. This pronouncement is
effective for reporting periods beginning on or after December 15, 2011. The
adoption of ASU 2011-04 is not expected to have a significant impact on our
consolidated financial position or results of operations.
In June 2011, FASB issued new guidance on the presentation of comprehensive
income. The new guidance allows an entity to present components of net income
and other comprehensive income in one continuous statement, referred to as the
statement of comprehensive income, or in two separate, but consecutive
statements. The new guidance eliminates the current option to report other
comprehensive income and its components in the statement of changes in
stockholders' equity. While the new guidance changes the presentation of
comprehensive income, there are no changes to the components that are recognized
in net income or other comprehensive income from that of current accounting
guidance. This new guidance is effective for fiscal years and interim periods
beginning after December 15, 2011. The Company elected to adopt this accounting
guidance and it did not have a material impact on its consolidated financial
statements and related disclosures.
In December 2011, FASB issued ASU 2011-11, Disclosures about Offsetting Assets
and Liabilities. The amendments contained in ASU 2011-11 require an entity to
disclose information about offsetting and related arrangements to enable users
of its financial statements to understand the effect of those arrangements on
its financial position. The adoption of ASU 2011-11 results in changes to
presentation and disclosure only and is not expected to have an impact on our
consolidated results of operations and financial condition.
During December 2011, FASB issued ASU 2011-12, Deferral of the Effective Date
for Amendments to the Presentation of Reclassifications of Items out of
Accumulated Other Comprehensive Income in Accounting Standards Update No.
2011-05. The amendments contained in ASU 2011-12 supersede changes to those
paragraphs in ASU 2011-05 that pertain to how, when and where reclassification
adjustments are presented. The adoption of ASU 2011-12 will result in changes to
presentation and disclosure only, and is not expected to have an impact on our
consolidated results of operations and financial condition.
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