Notes to Consolidated Financial Statements
(Unaudited)
(1) Organization and Business
China Carbon Graphite Group, Inc. (the “Company”), through its subsidiaries, is engaged in the manufacture of graphite-based products in the People’s Republic of China (“China” or the “PRC”). The Company’s 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. The Company manufactures and sells three types of products throughout China and internationally: graphite electrodes; fine grain graphite; and high purity graphite.
The Company was incorporated on February 13, 2003 in Nevada under the name Achievers Magazine Inc. In connection with the reverse merger transaction described below, the Company’s corporate name was changed to China Carbon Graphite Group, Inc. on January 30, 2008.
On December 17, 2007, the Company completed a share exchange pursuant to a share exchange agreement with Sincere Investment (PTC), Ltd. (“Sincere”), a British Virgin Islands corporation. Sincere was the sole stockholder of Talent International Investment Limited (“Talent”), a British Virgin Islands corporation, which is the sole stockholder of XingheYongle Carbon Co., Ltd. (“Yongle”), a company organized under the laws of the PRC. Pursuant to the share exchange agreement, the Company issued 9,388,172 shares of common stock to Sincere in exchange for all of the outstanding on stock of Talent, and Talent became a wholly-owned subsidiary of the Company. Upon completion of the reverse merger, the Company’s business became the business of Talent, its subsidiaries and its affiliated variable interest entities.
Talent owns 100% of the stock of Yongle, which is a wholly foreign-owned enterprise organized under the laws of the PRC. Yongle is party to a series of contractual agreements with XingheXingyong Carbon Co., Ltd. (“Xingyong”), a corporation organized under the laws of the PRC. These agreements allow the Company to operate its business in the PRC and to control the management of Xingyong and receive economic remuneration from Xingyong’s business. Xingyong’s principal stockholder is Mr. Denyong Jin, the General Manager of the Company’s China operations. As a result, Xingyong is a variable interest entity and the operations of Xingyong are consolidated with those of the Company for financial reporting purposes.
Accounting Standard Codification (“ASC”) 810-10-45-25 calls for balance sheet disclosure of (a) assets of a consolidated variable interest entity (VIE) that can be used only to settle obligations of the consolidated VIE, and (b) liabilities of a consolidated VIE for which creditors (or beneficial interest owners) do not have recourse to the general credit of the primary beneficiary. The entire operating business of the Company is conducted by Xingyong and the consolidated balance sheet of the Company reflects Xingyong’s balance sheet. There are no such assets or liabilities on the balance sheet of Xingyong. The Operating Agreement dated December 7, 2007 provides that Yongle is a full-recourse guarantor of all obligations of Xingyong, and Xingyong has pledged all of its assets to Yongle. The Consulting Agreement of that date includes an assignment of all of the revenues of Xingyong to Yongle. Yongle is 100% owned by Talent and Talent is 100% owned by the Company. Accordingly, there are no assets or liabilities of Xingyong that in which the Company does not share.
The consolidated financial statements presented herein consolidate the financial statements of China Carbon Graphite, Inc. with the financial statements of its subsidiaries, Talent and Yongle. Also consolidated are the financial statements of Xingyong. The financial statements of Xingyong are consolidated with our financial statements because Xingyong is a variable interest entity. The entire operating business operations of the Company are located in Xingyong. Therefore the financial position and results of operations and cash flows of the Company are significantly influenced by the results of Xingyong, the VIE. Talent is party to four agreements dated December 7, 2007 with the owners of the registered equity of Xingyong. The agreements transfer to Talent benefits and all of the risk arising from the operations of Xingyong, as well as complete managerial authority over the operations of Xingyong.
The following paragraphs briefly describe the key provisions of each contractual agreement that prescribes the Company’s relationship with Xingyong:
Exclusive Technical Consulting and Services Agreement
. Technical consulting and services agreement entered into on December 7, 2007 between Yongle and Xingyong, pursuant to which Yongle has agreed to provide technical and consulting services related to the business operations of Xingyong. As consideration for such services, Xingyong has agreed to pay to Yongle a service fee equal to 80% to 100% of the profits of Xingyong. The exact fee is calculated and paid on a quarterly basis, and is determined based on a number of factors, including but not limited to the complexity of the services provided and the commercial value of the services provided. The exclusive technical consulting and services agreement has a 10 year term. Yongle may extend the term of such agreement. The parties may terminate the agreement, prior to its expiration, upon the mutual consent of Yongle and Xingyong.
Business Operations Agreement.
Pursuant to the business operations agreement entered into on December 7, 2007 between Yongle, Xingyong, and the shareholders of Xingyong, Xingyong has agreed not to conduct any material transaction or corporate action without obtaining the prior written consent of Yongle. Furthermore, Xingyong and its shareholders have agreed to implement proposals made by Yongle with respect to the operations of Xingyong’s business and the appointment of directors and officers of Xingyong. Yongle may terminate the business operations agreement at any time. The term of the business operations agreement is indefinite.
Option Agreement
. Yongle entered into an option agreement on December 7, 2007 with Xingyong and each of the shareholders of Xingyong, pursuant to which Yongle has an exclusive option to purchase, or to designate another qualified person to purchase, to the extent permitted by PRC law and foreign investment policies, part or all of the equity interests in Xingyong owned by the shareholders of Xingyong. To the extent permitted by the PRC laws, the purchase price for the entire equity interest shall equal the actual price designated by Yongle to the extent permitted by relevant laws and regulations. The option agreement has a 10 year term. Upon the request of Yongle, the parties shall extend the term of the option agreement.
Equity Pledge Agreement
. Pursuant to an equity pledge agreement, dated December 7, 2007, each of the shareholders of Xingyong pledged his equity interest in Xingyong to Yongle to secure Xingyong’s obligations under the VIE agreements described above. In addition, the shareholders of Xingyong agreed not to transfer, sell, pledge, dispose of or create any encumbrance on any equity interests in Xingyong that would affect Yongle’s interests. The equity pledge agreement will expire when Xingyong fully performs its obligations under the various VIE agreements described above.
Because the relationship between Xingyong and Yongle is entirely contractual, the Company’s interest in Xingyong depends on the enforceability of those agreements under the laws of the PRC. The Company is not aware of any judicial decision as to the enforceability of similar agreements under PRC law. However, since the owner of the registered equity of Xingyong is Mr. Jin, the Company’s major shareholder and General Manager, the Company does not believe that there is a significant risk that Xingyong will seek to terminate the relationship or otherwise breach the agreements. Accordingly, the Company believes that consolidation of the financial statements of Xingyong with those of the Company is appropriate. The shareholders of Xingyong do not have any kick-back rights.
Acquisition in December 2013
On December 23, 2013, we acquired Golden Ivy Limited, a British Virgin Island company (“BVI Co.,”). Pursuant to the terms of the acquisition, we will issue an aggregate of 5,000,000 shares of common stock, par value $0.001 per share, to the former shareholders of BVI Co. in exchange for 100% of the issued and outstanding equity of BVI Co.. BVI Co. then becomes a wholly owned subsidiary of the Company. The shares were issued on January 16, 2014.
BVI Co. currently has two business operations as follows (collectively the “Business”):
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Manufacture of Graphene Oxide and graphite bipolar plates. Graphene Oxide has wide applications as a conductive agent, such as in lithium ion batteries, super capacitors, rubber and plastic additives, conductive ink, special coating, transparent conductive thin films and chips. Graphite bipolar plates are primarily used in solar power storage.
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A business-to-business and business-to-consumers Internet portal (www.roycarbon.com) for graphite related products. Vendors can sell raw materials, industrial commodities and consumer (household) commodities to both business and consumers through the website by paying a fee for each transaction conducted through the website.
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The Business and the facilities related thereto are all located in the People’s Republic of China (“China”). The Business is conducted by Royal Elite New Energy Science and Technology (Shanghai) Co., Ltd. (“Royal Shanghai”), a wholly foreign owned enterprise under laws of China. Royal Shanghai is wholly owned by Royal Elite International Limited, a Hong Kong company, (“Royal HK”), which is wholly owned by BVI Co. The Business currently generates minimal sales.
Royal Shanghai was set up in Shanghai on June 9, 2010. Royal HK was set up in Hong Kong on January 8, 2010.
Organizational Structure Chart
The following chart sets forth our organizational structure:
Liquidity and Working Capital Deficit
As of March 31, 2014 and as of December 31, 2013, the Company managed to operate its business with a negative working capital. The Company has been able to operate with negative working capital primarily due to its ability to borrow substantial short-term and long-term bank loans and notes payables from banks with the support of the local government in lnner Mongolia.
The Company Law of the PRC applicable to Chinese companies provides that net after tax income should be allocated by the following rules:
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1.
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10% of after tax income to be allocated to a statutory surplus reserve until the reserve amounts to 50% of the company’s registered capital.
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If the cumulative balance of statutory surplus reserve is not enough to make up the Company’s cumulative prior years’ losses, the current year’s after tax income should be first used to make up the losses before the statutory surplus reverse is drawn.
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Allocation can be made to the discretionary surplus reserve, if such a reserve is approved at the meeting of the equity owners.
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Therefore, the Company is required to maintain a statutory reserve in China that limits any equity distributions to its shareholders. The maximum amount of the shareholders has not been reached. The Company has never distributed earnings to shareholders and has no intentions to do so.
(2) Going Concern
The Company’s consolidated financial statements are prepared using generally accepted accounting principles in the United States of America applicable to a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As of and for the period ended March 31, 2014, the Company has incurred significant operating losses, working capital deficit, and negative net cash flows from operating activities. While the Company’s sales revenue declined significantly for the period ended March 31, 2014 as compared to the same period prior year, the demand for the Company’s products remains highly uncertain. The ability of the Company to continue as a going concern is dependent on the Company obtaining adequate capital to fund operating losses until it becomes profitable. If the Company is unable to obtain adequate capital, it could be forced to cease operations. The accompanying consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
Management’s Plan to Continue as a Going Concern
In order to continue as a going concern, the Company will need, among other things, additional capital resources. Management’s plans to obtain such resources for the Company include (1) obtaining capital from the sale of its equity securities, (2) sales of its products, and (3) short-term or long-term borrowings from banks, stockholders or other party(ies) when needed. However, management cannot provide any assurance that the Company will be successful in accomplishing any of its plans.
The ability of the Company to continue as a going concern is dependent upon its ability to successfully accomplish the plans described in the preceding paragraph and eventually to secure other sources of financing and attain profitable operations.
(3) Basis for Preparation of the Financial Statements
Management acknowledges its responsibility for the preparation of the accompanying interim consolidated financial statements which reflect all adjustments, consisting of normal recurring adjustments, considered necessary in its opinion for a fair statement of its consolidated financial position and the results of its operations for the interim period presented. These consolidated financial statements should be read in conjunction with the summary of significant accounting policies and notes to consolidated financial statements included in the Company’s Form 10-K annual report for the year ended December 31, 2013. The consolidated balance sheet as of December 31, 2013 has been derived from the audited financial statements. The results of the three months ended March 31, 2014 are not necessarily indicative of the results to be expected for the full fiscal year ending December 31, 2014.
The accompanying unaudited consolidated financial statements for China Carbon Graphite Group, Inc. and its subsidiaries and variable interest entity, have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
The Company maintains its books and accounting records in Renminbi (“RMB”), but its reporting currency is U.S. dollars.
The financial statements have been prepared in order to present the financial position and results of operations of the Company, its subsidiaries and Xingyong, a variable interest entity whose financial condition is consolidated with the Company pursuant to ASC Topic 810-10, Consolidation, in accordance with U.S. GAAP. All significant intercompany accounts and transactions have been eliminated.
(4) Summary of Significant Accounting Policies
The accompanying consolidated financial statements reflect the application of certain significant accounting policies as described in this note and elsewhere in the accompanying consolidated financial statements and notes.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current period presentation. These reclassifications had no impact on net earnings and financial position.
The preparation of these financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net sales and expenses during the reporting period. Some of the significant estimates include values and lives assigned to acquired property, equipment and intangible assets, reserves for customer returns and allowances, uncollectible accounts receivable, slow moving, obsolete and/or damaged inventory and stock warrant valuation. Actual results may differ from these estimates.
Cash and cash equivalents
The Company considers all highly liquid debt instruments purchased with maturity periods of three months or less to be cash equivalents. The carrying amounts reported in the accompanying balance sheet for cash and cash equivalents approximate their fair value. Substantially all of the Company’s cash is held in bank accounts in the PRC and is not protected by FDIC insurance or any other similar insurance. The Company’s bank account in the United States is protected by FDIC insurance.
Restricted cash
Restricted cash represents amounts held by a bank as security for short-term bank notes payable and therefore is subject to withdrawal restrictions. As of March 31, 2014 and December 31, 2013, these amounts totaled $34,823,380 and $35,643,666, respectively. The restricted cash is expected to be released within the next twelve months after the bank notes have matured. Upon release the restricted cash will be used to repay the liabilities or as security for new debt.
Accounts receivable
Trade receivables are recognized and carried at the original invoice amount less allowance for any uncollectible amounts. An 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.
Inventory
Inventory is stated at the lower of cost or market. The cost of inventories comprises all costs of purchases, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. The costs of conversion of inventories include fixed and variable production overhead, taking into account the stage of completion. Cost is determined using the weighted average method. Market value represents the estimated selling price in the ordinary course of business less the estimated costs necessary to complete the sale. The Company periodically reviews historical sales activity to determine excess, slow moving items and potentially obsolete items and also evaluates the impact of any anticipated changes in future demand. The Company provides inventory allowances based on excess and obsolete inventories determined principally by customer demand. Impairment of inventories is recorded in cost of goods sold.
For the three months ended March 31, 2014 and 2013, the Company has provision for inventory in regards to slow moving or obsolete items of $0 and $0, respectively. As of March 31, 2014 and December 31, 2013, the Company has provision for inventory in regards to slow moving or obsolete items
of $20
,858,557
and $21,419,154, respectively.
Property, plant and equipment
Property, plant and equipment is stated at the historical cost, less accumulated depreciation. Depreciation on property, plant and equipment is provided using the straight-line method over the estimated useful lives of the assets for both financial and income tax reporting purposes as follows:
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Buildings
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25 - 40 years
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Machinery and equipment
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10 - 20 years
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Motor vehicles
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5 years
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Expenditures for renewals and betterments are capitalized while repairs and maintenance costs are normally charged to the statement of operations in the year in which they are incurred. In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the asset, the expenditure is capitalized as an additional cost of the asset.
Upon sale or disposal of an asset, the historical cost and related accumulated depreciation or amortization of such asset were removed from their respective accounts and any gain or loss is recorded in the statements of income.
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, $0 and $0 of impairment expenses for property, plant, and equipment recorded in operating expenses during the three months ended March 31, 2014 and 2013, respectively. As of March 31, 2014 and December 31, 2013, $19,214,221 and $19,730,625 were recorded as impairment for property, plant and equipment, respectively
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Construction in progress
Construction in progress represents the costs incurred in connection with the construction of buildings or additions to the Company’s plant facilities. No depreciation is provided for construction in progress until such time as the assets are completed and placed into service. The Company has capitalized interest expenses of $319,083 and $178,177 for the three months ended at March 31, 2014 and 2013, respectively.
The Company reviews the carrying value of construction in progress 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 for construction in progress during the three months ended March 31, 2014 and 2013. As of March 31, 2014 and December 31, 2013, $5,122,824 and $5,260,506 were recorded as impairment for construction in progress, respectively.
Land use rights
The Company has land use rights of 368,804 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 112,171 square meters expiring in 2052 and the land use right with respect to 256,634 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 but we have obtained its land use right certificate. In exchange, the Company will allow public use of this 387,838 square meters of land, provide improvements to the 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. We used level 1, the most observable market inputs, to arrive at fair market value. In particular, we used market price of land use right in the open market to determine the fair market value of the public use land. The land use right is about 387,838 square meters. The market price for each square meter for industrial use land use right in that area is about $41. 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 the relationship and agreement with the local government to keep provide improvements to the land and keep it in good condition, the Company believes that it is unlikely to 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.
The Company reviews the carrying value of land use rights 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, no impairment of land use rights was deemed necessary for the three months ended March 31, 2014 and 2013, respectively.
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. The vested portions of common stock awards granted but not yet issued are recorded in common stock to be issued.
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 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.
Foreign currency translation
The reporting currency of the Company is U.S. dollars. The Company uses RMB as its functional currency. The results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rates at the balance sheet dates, and equity is translated at the historical exchange rates. As a result, amounts related to assets and liabilities reported on the statements of cash flows will not necessarily agree with changes in the corresponding accounts on the balance sheets. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statements of stockholders’ equity. Translation adjustments for the three months ended March 31, 2014 and 2013 were $380,249 and $146,277, respectively. The cumulative translation adjustment and effect of exchange rate changes on cash for the three months ended March 31, 2014 and 2013 were $(8,868) and $3,283, respectively. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.
Assets and liabilities were translated at 6.22 RMB and 6.05 RMB to $1.00 at March 31, 2014 and December 31, 2013, respectively. The equity accounts were stated at their historical rates. The average translation rates applied to income statements for the three months ended March 31, 2014 and 2013 were 6.10 RMB and 6.22 RMB to $1.00, respectively. Cash flows are also translated at average translation rates for the period; therefore, amounts reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.
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.
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 three months ended March 31, 2014 and 2013.
Cost of goods sold
Cost of goods sold consists primarily of the costs of raw materials, freight charges, direct labor, depreciation of plants and machinery, warehousing and overhead associated with the manufacturing process and commission expenses. Cost of goods sold also includes impairment charge of inventories.
Shipping and handling costs
The Company follows ASC 605-45, Handling Costs, and Shipping Costs, formerly known as Emerging Issues Task Force No. 00-10, Accounting for Shipping and Handling Fees and Costs. The Company classifies shipping and handling costs paid on behalf of its customers in selling expenses. For the three months ended March 31, 2014 and 2013, shipping and handling costs were $8,424 and $3,877, respectively.
Segment reporting
ASC 280, Segment Reporting, formerly known as Statement of Financial Accounting Standards No. 131, Disclosure about Segments of an Enterprise and Related Information, requires use of the “management approach” model for segment reporting. Under this model, segment reporting is consistent with the manner that the Company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure or any other manner in which management disaggregates a company.
Because the Company sells only carbon graphite products to Chinese distributors and end users, it has only one business segment.
Taxation
Taxation on profits earned in the PRC has been calculated based on the estimated assessable profits for the year at the rates of taxation prevailing in the PRC after taking into account the benefits from any special tax credits or “tax holidays” allowed in the county of operations.
The Company does not accrue U.S. income tax since it has no operations in the United States. Its operating subsidiaries are organized and located in the PRC and do not conduct any business in the United States.
In 2006, the Financial Accounting Standards Board (“FASB”) issued ASC, 740 Income Tax, formerly known as FIN 48, which clarifies the application of SFAS 109 by defining a criterion that an individual income tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements and provides guidance on measurement, recognition, classification, accounting for interest and penalties, accounting in interim periods, disclosure and transition. In accordance with the transition provisions, the Company adopted FIN 48 effective January 1, 2007.
The Company recognizes that virtually all tax positions in the PRC are not free from some degree of uncertainty due to tax law and policy changes by the state. The Company cannot reasonably quantify political risk factors and thus must depend on guidance issued by current government officials.
Based on all known facts and circumstances and current tax law, the Company believes that the total amount of unrecognized tax benefits as of March 31, 2014 is not material to its results of operations, financial condition or cash flows. The Company also believes that the total amount of unrecognized tax benefits as of March 31, 2014, if recognized, would not have a material effect on its effective tax rate. The Company further believes that there are no tax positions, including the Enterprise Income Tax holiday from Xing He District Local Tax Authority, for which it is reasonably possible, based on current Chinese tax law and policy, that the unrecognized tax benefits will significantly increase or decrease over the next twelve months producing, individually or in the aggregate, a material effect on the Company’s results of operations, financial condition or cash flows.
Enterprise income tax
The Company has been recognized as a high technology and science company by the Ministry of Science and Technology of the PRC. Therefore, Xing He District Local Tax Authority in the Nei Mongol province granted the Company a 100% tax holiday from the enterprise income tax for 10 years from 2008 through 2017. When the tax holiday ends, based on the present tax law and the Company’s status as a high technology and science company, the Company will be subject to a corporate income tax rate of 15% effective in 2018.
The enterprise income tax is calculated on the basis of the statutory profit as defined in the PRC tax laws. This statutory profit is computed differently than the Company’s net income under U.S. GAAP.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets, including tax loss and credit carry forwards, and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of deferred tax assets and liabilities from a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Value added tax
The Provisional Regulations of the PRC Concerning Value Added Tax promulgated by the State Council came into effect on January 1, 1994. Under these regulations and the Implementing Rules of the Provisional Regulations of the PRC Concerning Value Added Tax, value added tax (“VAT”) is imposed on goods sold in or imported into the PRC and on processing, repair and replacement services provided within the PRC.
VAT payable in the PRC is charged on an aggregated basis at a rate of 13% or 17% (depending on the type of goods involved) on the full price collected for the goods sold or, in the case of taxable services provided, at a rate of 17% on the charges for the taxable services provided, but excluding, in respect of both goods and services, any amount paid in respect of VAT included in the price or charges, and less any deductible value added tax already paid by the taxpayer on purchases of goods and services in the same financial year. VAT payable (recoverable), which is included in other payables, was $171,329 and $(23,055) as of March 31, 2014 and December 31, 2013, respectively.
Contingent liabilities and contingent assets
A contingent liability is a possible obligation that arises from past events and whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the Company. It can also be a present obligation arising from past events that is not recognized because it is not probable that the Company will incur a liability or obligations as a result. A contingent liability, which might occur but is not probable, is not recorded but is disclosed in the notes to the financial statements. The Company will recognize a liability or obligation when it is probable that the Company will incur it.
A contingent asset is an asset, which could possibly arise from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain events not wholly within the control of the Company. Contingent assets are not recorded but are disclosed in the notes to the financial statements when it is likely that the Company will recognize an economic benefit. When the benefit is virtually certain, the asset is recognized.
Retirement benefit costs
According to PRC regulations on pensions, the Company contributes to a defined contribution retirement program organized by the municipal government in the province in which the Company is registered and all qualified employees are eligible to participate in the program. Contributions to the program are calculated at 23.5% of the employees’ salaries above a fixed threshold amount and the employees contribute 2% to 8% while the Company contributes the remaining 15.5% to 21.5%. The Company has no other material obligation for the payment of retirement benefits beyond the annual contributions under this program.
Fair value of financial instruments
The Company has adopted ASC Topic 820, Fair Value Measurement and Disclosure, which defines fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands disclosures about fair value measurements. It does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. It establishes a three-level valuation hierarchy of valuation techniques based on observable and unobservable inputs, which may be used to measure fair value and include the following:
|
●
|
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 liability, 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 fair value of the 2009 Warrants to purchase 200,000 shares of common stock was $390 and $808 at March 31, 2014 and December 31, 2013, respectively. The Company recognized a gain of $418 from the change in fair value of these warrants for the three months ended March 31, 204.
The fair value of the 2009 Series B Warrants to purchase 804,200 shares of common stock was $9,227 and $11,106 at March 31, 2014, and December 31, 2013, respectively. The Company recognized a gain of $1,879 from the change in fair value of these warrants for the three months ended March 31, 2014.
The fair value of 2010 Series B warrants to purchase 100,000 shares of common stock was $1,355 and $1,553 at March 31, 2014 and December 31, 2013, respectively. The Company recognized a gain of $198 from the change in fair value of these warrants for the three months ended March 31, 2014.
In summary, the Company recorded a total amount of $2,495 of changes in fair value of warrants in the Consolidate statement of income and comprehensive income for the three months ended March 31, 2014. Each reporting period, the change in fair value is recorded into other income (expense).
Warrants referred to in the preceding paragraphs do not trade in an active securities market, and as such, the Company estimates the fair value of these warrants using the Black-Scholes option pricing model using the following assumptions:
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
2007 Warrants
|
|
|
|
|
|
|
|
Annual dividend yield
|
|
|
-
|
|
|
|
-
|
|
|
Expected life (years)
|
|
|
-
|
|
|
|
-
|
|
|
Risk-free interest rate
|
|
|
0.18
|
%
|
|
|
0.18
|
%
|
|
Expected volatility
|
|
|
163
|
%
|
|
|
152
|
%
|
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
2009 Warrants
|
|
|
|
|
|
|
|
Annual dividend yield
|
|
|
-
|
|
|
|
-
|
|
|
Expected life (years)
|
|
|
0.46
|
|
|
|
0.71
|
|
|
Risk-free interest rate
|
|
|
0.18
|
%
|
|
|
0.18
|
%
|
|
Expected volatility
|
|
|
163
|
%
|
|
|
152
|
%
|
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
2009 Series B Warrants
|
|
|
|
|
|
|
|
Annual dividend yield
|
|
|
-
|
|
|
|
-
|
|
|
Expected life (years)
|
|
|
0.73
|
|
|
|
0.98
|
|
|
Risk-free interest rate
|
|
|
0.18
|
%
|
|
|
0.18
|
%
|
|
Expected volatility
|
|
|
163
|
%
|
|
|
152
|
%
|
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
2010 Series B Warrants
|
|
|
|
|
|
|
|
Annual dividend yield
|
|
|
-
|
|
|
|
-
|
|
|
Expected life (years)
|
|
|
0.78
|
|
|
|
1.03
|
|
|
Risk-free interest rate
|
|
|
0.18
|
%
|
|
|
0.18
|
%
|
|
Expected volatility
|
|
|
163
|
%
|
|
|
152
|
%
|
The carrying amount of restricted cash, other receivables, advance to vendors, advances from customers, other payables, accrued liabilities and short-term loans are reasonable estimates of their fair value because of the short-term nature of these items.
The following table sets forth by level within the fair value hierarchy of the Company’s financial assets and liabilities that was accounted for at fair value on a recurring basis or for purposes of disclosures as of March 31, 2014:
|
|
|
Carrying Value at
March 31,
|
|
|
Fair Value Measurement at
March 31, 2014
|
|
|
|
|
2014
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Warrant liability
|
|
$
|
10,972
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
10,972
|
|
|
Notes payable
|
|
$
|
59,841,709
|
|
|
|
-
|
|
|
$
|
59,841,709
|
|
|
|
-
|
|
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, 2013:
|
|
|
Carrying
Value at
December
|
|
|
Fair Value Measurement at
December 31, 2013
|
|
|
|
|
31, 2013
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Warrant liability
|
|
$
|
13,467
|
|
|
|
-
|
|
|
|
-
|
|
|
$
|
13,467
|
|
|
Notes payable
|
|
$
|
68,553,116
|
|
|
|
-
|
|
|
$
|
68,553,116
|
|
|
|
-
|
|
The Company uses the black-scholes valuation method approach when determining fair values of its Level 3 recurring fair value measurements. Certain unobservable units for these assets are offered quotes, lack of marketability and volatility. For Level 3 measurements, significant increases or decreases in either of those inputs in isolation could result in a significantly lower or higher fair value measurement. In general, a significant change in the calculated volatility of the Company’s stock price could negatively affect the fair value of the warrant liability.
Summary of warrants outstanding:
|
|
|
Warrants
|
|
|
Weighted
Average
Exercise Price
|
|
|
Outstanding as of December 31, 2013
|
|
|
1,229,200
|
|
|
$
|
1.51
|
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
Cancelled
|
|
|
-
|
|
|
|
-
|
|
|
Outstanding as of March 31, 2014
|
|
|
1,229,200
|
|
|
$
|
1.51
|
|
Earnings (loss) per share
Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. Potentially dilutive shares of common stock consist of the common stock issuable upon the conversion of convertible debt, preferred stock and warrants. The Company has outstanding warrants to purchase 1,229,200 shares of common stock at an exercise price in the range of $1.30 - $2.00 per share. The Company uses if-converted method to calculate the dilutive preferred stock and treasury stock method to calculate the dilutive shares issuable upon exercise of warrants.
The following table sets forth the computation of the number of net income per share for the three months ended March 31, 2014 and 2013:
|
|
|
March 31,
2014
|
|
|
March 31,
2013
|
|
|
Weighted average shares of common stock outstanding (basic)
|
|
|
30,602,251
|
|
|
|
25,103,518
|
|
|
Shares issuable upon conversion of Series B Preferred Stock
|
|
|
-
|
|
|
|
-
|
|
|
Weighted average shares of common stock outstanding (diluted)
|
|
|
30,602,251
|
|
|
|
25,103,518
|
|
|
Net (loss) available to common shareholders
|
|
$
|
(2,722,440
|
)
|
|
$
|
(1,506,805
|
)
|
|
Net (loss) per shares of common stock (basic)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.06
|
)
|
|
Net (loss) per shares of common stock (diluted)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.06
|
)
|
For the three months ended March 31, 2014, the Company excluded 300,000 shares of common stock issuable upon conversion of preferred
stock, because
such issuance would be anti-dilutive.
For the three months ended
March 31, 2014
, the Company excluded 1,229,200 shares of common stock issuable upon exercise of warrants, because such issuance would be anti-dilutive.
Accumulated other comprehensive income
The Company follows ASC 220, Comprehensive Income, formerly known as SFAS No. 130, Reporting Comprehensive Income, to recognize the elements of comprehensive income. Comprehensive income is comprised of net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. For the Company, comprehensive income for the three months ended March 31, 2014 and 2013 included net income and foreign currency translation adjustments.
Related parties
Parties are considered to be related to the Company if the parties that, directly or indirectly, through one or more intermediaries, control, are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management and other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. Transactions with related parties are disclosed in the financial statements.
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 April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”. The amendments in the ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. It also addresses sources of confusion and inconsistent application related to financial reporting of discontinued operations guidance in U.S. GAAP. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. In addition, the new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. The amendments in the ASU are effective in the first quarter of 2015 for public organizations with calendar year ends. Early adoption is permitted. The Company does not expect the adoption to have a significant impact on its consolidated financial statements.
(5) Concentration of Business and Credit Risk
Substantially all of the Company’s bank accounts are in banks located in the PRC and are not covered by any type of protection similar to that provided by the Federal Deposit Insurance Corporation (“FDIC”) on funds held in U.S. banks. The Company’s bank account in the United States is covered by FDIC insurance.
Because the Company’s operations are located in the PRC, this may give rise to significant foreign currency risks due to fluctuations in and the volatility of foreign exchange rates between U.S. dollars and RMB.
Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash, trade accounts receivables and inventories, the balances of which are stated on the balance sheet. The Company places its cash in banks located in China. Concentration of credit risk with respect to trade accounts receivables is limited due to the diversity of the Company’s customers who are located in different regions of China. The Company does not require collateral or other security to support financial instruments subject to credit risk.
For the three months ended March 31, 2014, three customers accounted for 10% or more of sales revenues, representing 36.3%, 29.5% and 14.8%, respectively of the total sales. For the three months ended March 31, 2013, three customers accounted for 10% or more of sales revenues, representing 36%, 23% and 23%, respectively of the total sales. As of March 31, 2014, there were two customers that constituted 41.7% and 11.5% of the accounts receivable. As of December 31, 2013, there were two customers that constituted 40.8% and 11.7% of the accounts receivable.
For the three months ended March 31, 2014, one supplier accounted for 10% or more of our total purchases, representing 94.1%. For the three months ended March 31, 2013, two suppliers accounted for 10% or more of our total purchases, representing 59.7% and 22.6%, respectively.
For the three months ended March 31, 2014 and 2013, the Company had insurance expense of $491 and $0 respectively. Accrual for losses is not recognized until such time as a loss has occurred.
(6) Income Taxes
Under the Provisional Regulations of The People’s Republic of China Concerning Income Tax on Enterprises promulgated by the PRC, which took effect on January 1, 2008, domestic and foreign companies pay a unified corporate income tax of 25%, except for a 15% corporate income tax rate for qualified high technology and science enterprises.
The Company has been granted a 100% tax holiday from enterprise income tax from the Xing He District Local Tax Authority for 10 years from 2008 through 2017.
A reconciliation of the provision for income taxes with amounts determined by the PRC statutory income tax rate to income before income taxes is as follows:
|
|
|
Three months ended
March 31,
|
|
|
|
|
2014
|
|
|
2013
|
|
|
Computed tax at the PRC statutory rate of 15%
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Benefit of tax holiday
|
|
|
-
|
|
|
|
-
|
|
|
Income tax expenses per books
|
|
$
|
-
|
|
|
$
|
-
|
|
(7) Accounts Receivable, net
The Company establishes an individualized credit and collection policy based on each individual customer’s credit history. The Company does not have a uniform policy that applies equally to all customers. The collection period usually ranges from three months to twelve months. The Company grants extended payment terms only when the Company believes that the payment will be collectible at the end of the term. The Company grants extended payment terms to customers if based on the following factors: (a) whether or not the Company views a real need, from the customer’s perspective, for the extension and (b) how critical the Company’s relationship with the customer and is the customer the Company’s long-term business. The Company grants extended payment terms only when the Company believes that the payment will be collectible at the end of the term. This meets the criteria of revenue recognition under U.S. GAAP, which requires that collection of the resulting receivable be reasonably assured.
As of March 31, 2014 and December 31, 2013, accounts receivable consisted of the following:
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
Amount outstanding
|
|
$
|
11,273,783
|
|
|
$
|
11,488,063
|
|
|
Less: Allowance for doubtful accounts, net
|
|
|
(7,195,656
|
)
|
|
|
(6,999,753
|
)
|
|
Net amount
|
|
$
|
4,078,127
|
|
|
$
|
4,488,310
|
|
As of March 31, 2014 and December 31, 2013, allowance for doubtful accounts consisted of the following:
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
Beginning balance
|
|
$
|
6,999,753
|
|
|
$
|
3,872,082
|
|
|
Provision for doubtful accounts
|
|
|
195,903
|
|
|
|
3,127,671
|
|
|
Ending balance
|
|
$
|
7,195,656
|
|
|
$
|
6,999,753
|
|
(8) Advances to Suppliers
As of March 31, 2014 and December 31, 2013, advance to suppliers consisted of the following:
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
Advances for raw material
|
|
$
|
3,081,793
|
|
|
$
|
4,080,246
|
|
|
Advances for construction
|
|
|
-
|
|
|
|
-
|
|
|
Allowance for advances
|
|
|
(3,017,113
|
)
|
|
|
(3,548,068
|
)
|
|
Advances to suppliers, net
|
|
$
|
64,680
|
|
|
$
|
532,178
|
|
(9) Inventories
As of March 31, 2014 and December 31, 2013, inventories consisted of the following:
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
Raw materials
|
|
$
|
6,541,290
|
|
|
$
|
6,801,043
|
|
|
Work in process
|
|
|
38,932,717
|
|
|
|
40,557,526
|
|
|
Finished goods
|
|
|
1,981,840
|
|
|
|
1,962,002
|
|
|
Reserve for slow moving and obsolete inventory
|
|
|
(20,858,557
|
)
|
|
|
(21,419,154
|
)
|
|
|
|
$
|
26,597,290
|
|
|
$
|
27,901,417
|
|
For the three months ended March 31, 2014 and 2013, the Company has provision for inventory in regards to slow moving or obsolete items of $0 and $0, respectively. As of March 31, 2014 and December 31, 2013, the Company has provision for inventory in regards to slow moving or obsolete items of
$20,858,557
and $21,419,154, respectively.
(10) Property, plant and Equipment, net
As of March 31, 2014 and December 31, 2013, property, plant and equipment consisted of the following:
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
Building
|
|
$
|
26,837,475
|
|
|
$
|
27,558,762
|
|
|
Machinery and equipment
|
|
|
28,826,591
|
|
|
|
29,600,169
|
|
|
Motor vehicles
|
|
|
78,720
|
|
|
|
80,836
|
|
|
Impairment of property, plant and equipment
|
|
|
(19,214,221
|
)
|
|
|
(19,730,625
|
)
|
|
|
|
|
36,528,565
|
|
|
|
37,509,142
|
|
|
Less: accumulated depreciation
|
|
|
(17,380,862
|
)
|
|
|
(17,482,059
|
)
|
|
|
|
$
|
19,147,703
|
|
|
$
|
20,027,083
|
|
For the three months ended March 31, 2014 and 2013, depreciation expenses amounted to $363,007 and $671,458, respectively. As of March 31, 2014 and December 31, 2013, a net book value of
$
16,389,872 and $17,148,452
of property, plant and equipment were pledged as collateral for the Company’s short-term loans, respectively.
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 $0 and $0 of impairment for property, plant, and equipment was recorded as for the three months ended March 31, 2014 and 2013, respectively. Impairment of property, plant, and equipment is recorded in operating expenses. As of March 31, 2014 and December 31, 2013, $19,214,221 and $19,730,625 were recorded as impairment for property, plant and equipment, respectively.
Construction in progress consists of two projects as follows:
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
Estimated
completion time
|
|
Expected
capital
needed to
complete
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Production facility
|
|
$
|
20,983,509
|
|
|
$
|
21,042,023
|
|
July 2014
|
|
$
|
1,608,648
|
|
|
Land improvements
|
|
|
10,500,576
|
|
|
|
10,704,987
|
|
June 2014
|
|
|
160,865
|
|
|
|
|
$
|
31,484,085
|
|
|
$
|
31,747,010
|
|
|
|
$
|
1,769,513
|
|
Construction in progress represents the costs incurred in connection with the construction of buildings or additions to the Company’s plant facilities and land improvements to the property adjacent to our plant. No depreciation is provided for construction in progress until such time as the assets are completed and placed into service. Construction in progress in the amount of $0 was transferred to fixed assets during the three months ended March 31, 2014.
Production facility refers to a new manufacturing facility that the Company started building in the first quarter of 2013. We expect the facility to be completed around the end of 2014. Addition of the project during the three months ended March 31, 2014 includes construction cost and machine and equipment used in the construction.
Land improvement refers to a project to improve the green coverage of a piece of land. We expect it to be completed around the end of 2013. Addition of the project during the three months ended March 31, 2014 includes construction cost and plants used in the construction.
The Company reviews the carrying value of construction in progress 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, $0 and $0 impairment losses were recorded for construction in progress during the three months ended March 31, 2014 and 2013. As of March 31, 2014 and December 31, 2013, $5,122,824 and $5,260,506 were recorded as impairment for construction in progress, respectively.
(11) Land Use Rights
As of March 31, 2014 and December 31, 2013, land use rights consisted of the following:
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
Land Use Rights
|
|
$
|
11,749,190
|
|
|
$
|
12,064,963
|
|
|
Less: Accumulated amortization
|
|
|
(2,489,538
|
)
|
|
|
(2,431,661
|
)
|
|
|
|
$
|
9,259,652
|
|
|
$
|
9,633,302
|
|
During the year ended December 31, 2013, the Company increased $116,974 to land use right by paying additional fee. During the three months ended March 31, 2014, the Company increased $117,516 to land use right by paying additional fee. For the three months ended March 31, 2014 and 2013, amortization expenses were $123,789 and $58,598, respectively.
Land use rights are amortized over 50 years. Future amortization of the land use rights is as follows:
|
Twelve-month period ended March 31,
|
|
|
|
|
|
|
|
$
|
241,663
|
|
|
2015
|
|
|
241,663
|
|
|
2016
|
|
|
241,663
|
|
|
2017
|
|
|
241,663
|
|
|
2018
|
|
|
241,663
|
|
|
2019 and thereafter
|
|
|
8,051,337
|
|
|
Total
|
|
$
|
9,259,652
|
|
As of March 31, 2014 and December 31, 2013, all land use rights were pledged as collateral for short-term bank loans.
(12) Stockholders’ equity
Restated Articles of Incorporation
On January 22, 2008, the Company changed its authorized capital stock to 120,000,000 shares of capital stock, of which 20,000,000 shares are shares of preferred stock, par value $0.001 per share, and 100,000,000 shares are shares of common stock, par value $0.001 per share. The restated articles of incorporation authorizes the board of directors of the Company to issue one or more series of preferred stock and to designate the rights, preferences, privileges and limitation of the holders of such preferred stock. The board of directors has authorized the issuance of two series of preferred stock, Series A Convertible Preferred Stock (“Series A Preferred Stock”) and Series B Convertible Preferred Stock (“Series B Preferred Stock”).
Issuance of Common Stock
(a)
Series A Preferred Stock
As of March 31, 2014 and December 31, 2013, no shares of Series A Preferred Stock are issued or outstanding.
(b)
Series B Preferred Stock
During the year ended December 31, 2012, the Company issued an aggregate of 126,110 shares of common stock to holders of Series B Preferred Stock upon the conversion of an aggregate of 126,110 shares of Series B Preferred Stock.
During the three months ended March 31, 2014, the Company issued an aggregate of 0 shares of common stock to holders of Series B Preferred Stock upon the conversion of an aggregate of 0 shares of Series B Preferred Stock. The remaining 300,000 shares of Series B Preferred Stock are redeemable by the holder as of March 31, 2014. The Company has reclassified these shares into Temporary Equity as of December 31, 2012 and were booked in Temporary Equity as of March 31, 2014.
In July 2013, CNH Diversified Opportunities Master Fund LP (“CNH”) filed a lawsuit against the Company in the Southern District of New York. CNH is the sole holder of the Company’s Series B Preferred Stock. In its pleadings, CNH has made a claim against the Company in the amount of approximately $400,000 in connection with the mandatory redemption of their Series B Preferred shares and the parties settled out of court for $320,000. As of December 31, 2013, the Company has paid $90,000 and accrued additional $230,000 in connection with the redemption of the Series B Preferred Stock. The $230,000 will be paid in installments payments of $40,000 per month for 5 months from January 2014 and $30,000 for the last month. The preferred stock will be canceled after all payments are made. The Company paid $120,000 during the three months ended March 31, 2014.
(c)
Exercise of Warrants
On January 19, 2011, the Company issued 45,833 shares of common stock to First Trust Group, Inc. upon the cashless exercise of 100,000 warrants at an exercise price of $2.34 per share. On January 24, 2011, the Company issued 124,025 shares of common stock to Maxim Group LLC upon exercise of warrants at an exercise price of $1.32 per share. On February 7, 2011, the Company issued 160,000 shares of common stock to Silver Rock II, Ltd. upon exercise of warrants at an exercise price of $1.30 per share.
As of March 31, 2014, there are total 1,229,200 shares warrants outstanding.
(d)
Stock Issuances for Cash
The Company did not issue any stock for cash during the years ended December 31, 2014 and 2013.
(e)
Stock Issuances to Consultants
In April 2012, the Company issued an aggregate of 110,000 shares of common stock pursuant to a consulting agreement in exchange for investor relations services. A fair value of $96,800 was recorded for the expenses and amortized over one year. The amount of $0 and $24,200 was amortized and recognized as a general and administrative expense for the three months ended March 31, 2014 and 2013, respectively. As of June 30, 2013, these consulting expenses were fully amortized.
In December 2012, the Company issued an aggregate of 65,000 shares of common stock pursuant to a consulting agreement in exchange for investor relations services. A fair value of $27,950 was recorded for the expenses and amortized over six months. The amount of $0 and $13,975 was amortized and recognized as a general and administrative expense for the three months March 31, 2014 and 2013, respectively. As of June 30, 2013, these consulting expenses were fully amortized.
In January 2013, the Company issued 30,000 shares of common stock pursuant to a consulting agreement in exchange for investor relation’s services. A fair value of $20,400 was recorded for the expenses and amortized over six months. The amount of $0 and $10,200 was amortized and recognized as a general and administrative expense for the three months ended March 31, 2014 and 2013, respectively. As of June 30, 2013, these consulting expenses were fully amortized.
On March 28, 2013, the Company issued 30,000 shares of common stock to a consultant for services provided. The issuance of these shares was recorded at fair market value, or $12,000 and fully amortized during the three months ended March 31, 2013.
In May 2013, the Company issued 120,000 shares of common stock pursuant to a consulting agreement in exchange for investor relations services. A fair value of $28,800 was recorded for the expenses and amortized over six months. The amount of $0 and $0 was amortized and recognized as a general and administrative expense for the three months ended March 31, 2014 and 2013, respectively. As of December 31, 2013, these consulting expenses were fully amortized.
In July 2013, the Company issued 60,000 shares of common stock pursuant to a consulting agreement in exchange for investor relations services. A fair value of $12,000 was recorded for the expenses and amortized over six months. The amount of $0 and $0 was amortized and recognized as a general and administrative expense for the three months ended March 31, 2014 and 2013, respectively. As of December 31, 2013, these consulting expenses were fully amortized.
(f)
Other Stock Issuances
On May 8, 2013, the Company issued 1,000,000 shares of restricted common stock to an employee for services provided in 2013. On May 8, 2013, the Company issued 25,000 shares of common stock to a director as compensation for services provided in 2013. The issuance of these shares was recorded at fair market value, or $256,250 and were recorded as general and administration expense.
On January 14, 2014, the Company issued an aggregate of 100,000 shares of common stock to four directors as compensation for services provided in 2013. The issuance of these shares was recorded at fair market value.
On January 14, 2014, the Company issued 76,000 shares of common stock to two employees for services provided in 2013. The issuance of these shares was recorded at fair market value.
(g)
Stock Issuances for acquisition
On January 16, 2014, the Company issued an aggregate of 5,000,000 shares of common stock, par value $0.001 per share, to the former shareholders of BVI Co. in exchange for 100% of the issued and outstanding equity of BVI Co. The issuance of these shares was recorded at fair market value.
(h)
Shares Held in Escrow
In a private placement that closed on December 22, 2009 and January 13, 2010, the Company sold an aggregate of 2,480,500 shares of Series B Preferred Stock and five-year warrants to purchase 992,000 shares of common stock at an exercise price of $1.30 per share, for an aggregate purchase price of $2,976,600. The Company also paid the private placement agent an aggregate of $298,000 and issued five-year warrants to purchase 124,025 shares of common stock at an exercise price of $1.32 per share. In connection with the private placement and pursuant to the transaction agreements, the Company deposited into escrow an aggregate of 1,240,250 shares of common stock, which are to be held in escrow to be returned to the Company or delivered to the investors, depending on whether the Company meets certain financial performance targets for the years ending December 31, 2010 and 2011.
The Company did not meet the financial targets. The number of Escrow Shares payable to each Investor shall be equal to a fraction of the total number of Escrow Shares potentially issuable pursuant to the terms hereof, the numerator of which shall be the amount by which (i) the number of Conversion Shares issued or issuable upon Preferred Shares which was initially issued to the Investor exceeds (ii) the sum of (x) the number of Conversion Shares sold or otherwise transferred by the Investor plus (y) the number of shares of Conversion Shares issued or issuable sold or otherwise transferred by the Investor, and the denominator of which is the number of Conversion Shares issued or issuable by the Company in the Offering. Any Escrow Shares for either Fiscal Year 2011 or Fiscal Year 2010 which are not transferred to the Investors pursuant to this paragraph shall be returned to the Company for cancellation. As of March 31, 2014, no Escrow shares have been transferred to investors or returned to the Company.
Dividend Distribution for Series B Preferred Stock
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 until December 31, 2011.
For the three months ended March 31, 2014 and 2013, no payment was made for dividends declared.
(13) Amount Due to Related Parties
As of March 31, 2014 and December 31, 2013, the Company had related parties payable in the amount of $5,026,626 and $5,157,112, respectively.
As of March 31, 2014 and December 31, 2013, $4,493,696 and $4,614,469 are due to Mr. Dengyong Jin, who is General Manager of the Company’s China operations and chief executive officer and principal shareholder of Xingyong. These amounts are due on December 31, 2014 and are made to the Company by Mr. Jin for business operating purposes. The advances are interest free.
As of March 31, 2014 and December 31, 2013, $394,119 and $404,711 are due to Inner Mongolia Xingyong Real Estate Development Ltd. Inc., which is owned by Dong Jin, the son of Mr. Dengyong Jin. These amounts are due on December 31, 2014 and are made to the Company by Inner Mongolia Xingyong Real Estate Development Ltd. for business operating purposes. The advances are interest free.
As of March 31, 2014 and December 31, 2013, $138,811 and $137,932 are due to Mr. Donghai Yu, who is CEO of the Company. These amounts are due on December 31, 2014 and are made to the Company by Mr. Yu for business operating purposes. The advances are interest free.
(14) Loan from Unrelated Parties
Short term borrowings of were $261,704 and $268,738 as of March 31, 2014 and December 31, 2013, respectively. The borrowings are from unrelated parties, interest free, and due on demand.
(15) Bank Loans
Short-term bank loans:
As of March 31, 2014 and December 31, 2013, short-term loans in the amount of $51,927,160 and $40,636,305, respectively, consisted of the following:
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
|
|
|
|
|
|
|
|
Bank loan from Credit Union, dated April, 2012, due in April 1, 2015, with an annual interest rate of 15.3% payable monthly, secured by machinery.
|
|
$
|
4,311,177
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank loan from China Construction Bank, dated January 15, 2014, due January 15, 2015 with an annual interest rate of 6.0% plus 12% floating rate and interest payable monthly, secured by property, equipment, building and land use rights.
|
|
$
|
8,043,240
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank loan from China Construction Bank, dated June 8, 2013, due June 8, 2014 with an annual interest rate of 6.6% payable monthly, secured by property, equipment, building and land use rights
|
|
$
|
6,434,592
|
|
|
$
|
6,607,529
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank loan from China Construction Bank, dated August 6, 2013, due August 5, 2014 with an annual interest rate of 6.0% plus 10% floating rate and interest payable monthly, secured by property, equipment, building and land use rights.
|
|
|
6,434,592
|
|
|
|
6,607,529
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank loan from China Construction Bank, dated August 22, 2013, due August 21, 2014 with an annual interest rate of 6.0%plus 10% floating rate and interest payable monthly, secured by property, equipment, building and land use rights.
|
|
|
6,434,592
|
|
|
|
6,607,529
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank loan from China Construction Bank, dated March 20, 2014, due March 20, 2015 with an annual interest rate of 6% plus 10% floating rate, payable monthly, secured by property, equipment, building and land use rights.
|
|
|
6,434,592
|
|
|
|
6,607,529
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank loan from China Construction Bank, dated September 10, 2013, due September 9, 2014 with an annual interest rate of 6.0% plus 10% floating rate and interest payable monthly, secured by property, equipment, building and land use rights.
|
|
|
4,825,944
|
|
|
|
4,955,647
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank loan from China Construction Bank, dated January 10, 2014, due January 10, 2015 with an annual interest rate of 6% plus 10% floating rate, payable monthly, secured by property, equipment, building and land use rights.
|
|
|
4,825,944
|
|
|
|
4,955,647
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank loan from China Construction Bank, dated September 17, 2013, due September 16, 2014, with an annual interest rate of 6.0% plus 10% floating rate and interest payable monthly, secured by property, equipment, building and land use rights.
|
|
|
4,182,485
|
|
|
|
4,294,894
|
|
|
|
|
$
|
51,927,160
|
|
|
$
|
40,636,305
|
|
In January 2012, the Company entered into a secured line of credit agreement with China Construction Bank for borrowings up to $71 million (or RMB 430 million) between January 10, 2012 and August 4, 2015, which is secured by liens on our fixed assets and land use rights. Under the secured line of credit, the Company is entitled to draw funds through sub-agreements of bank loans, foreign currency loans, bank acceptance notes, letter of credit, or bank guarantee letter. As of March 31, 2014, the unpaid principal balance drawn from the secured line of credit was $65.3 million, including $47.6 million of short-term bank loans as disclosed above and $17.7 million of long-term bank loans as disclosed below.
Each of these loans is renewable at the lender’s discretion. As of March 31, 2014, all land use rights and certain property, plant and equipment were pledged as collateral for our short-term bank loans.
Interest expenses were $1,123,916 and $862,448 for the three months ended March 31, 2014 and 2013, respectively.
The weighted average interest rates for these short-term loans were 7.57% and 6.79% as of March 31, 2014 and December 31, 2013, respectively.
Capitalized interest were $319,083 and $178,177 for the three months ended March 31, 2014 and 2013, respectively.
Long term bank loans:
|
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
|
|
|
|
|
|
|
|
|
Bank loan from China Construction Bank, dated January 22, 2013, due in January 21, 2016, with an annual interest rate of 6.15%, payable monthly, secured by machinery.
|
|
$
|
11,260,537
|
|
|
$
|
11,563,176
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank loan from China Construction Bank, dated July 2, 2013, due in July 1, 2016, with an annual interest rate of 6.0% plus 10% floating rate and interest payable monthly, secured by machinery.
|
|
|
6,434,592
|
|
|
|
6,607,529
|
|
|
|
|
|
|
|
|
|
|
|
|
Bank loan from Credit Union, dated April, 2012, due in April 2015, with an annual interest rate of 15.3% payable monthly, secured by machinery.
|
|
|
-
|
|
|
|
4,427,045
|
|
|
|
|
$
|
17,695,129
|
|
|
$
|
22,597,750
|
|
(16) Notes Payable
The Company’s notes payable represent payables vouchers in the form of notes issued by the Company with a term of 3 to 6 months. They are issued to suppliers in connection with their purchase contracts with the Company, and endorsed by banks to ensure that note holders will be paid upon maturity. Essentially, notes payable are the payables arising from transactions between the Company and suppliers in the normal course of business that are due within one year on customary trade terms. Therefore, the Company has determined that the notes payable meet the scope exception set forth in ASC 835-30-15-3a and the Company is not required to impute interest for the notes payable pursuant to ASC 835-30-25.
As of March 31, 2014 and December 31, 2013, notes payable consisted of the following:
|
|
|
March 31,
2014
|
|
|
|
|
|
|
|
Notes payable from China Everbright Bank Co., Ltd, dated January 14, 2014, due July 13, 2014, and restricted cash required 50% of loan amount
|
|
$
|
6,434,592
|
|
|
|
|
|
|
|
|
Notes payable from China Everbright Bank Co., Ltd, dated January 27, 2014, due July 26, 2014, and restricted cash required 50% of loan amount
|
|
|
6,434,592
|
|
|
|
|
|
|
|
|
Notes payable from China Everbright Bank Co., Ltd, dated November 14, 2013, due May 13, 2014, and restricted cash required 50% of loan amount.
This note payable is paid in full on May 13, 2014.
|
|
|
9,651,889
|
|
|
|
|
|
|
|
|
Notes payable from China Construction Bank, dated March 11, 2014, due September 10, 2014, and restricted cash required 50% of loan amount
|
|
|
4,825,944
|
|
|
|
|
|
|
|
|
Notes payable from Huaxia Bank, dated December 03, 2013, due June 03, 2014, and restricted cash required 60% of loan amount
|
|
|
8,364,970
|
|
|
|
|
|
|
|
|
Notes payable from Huaxia Bank, dated December 11, 2013, due June 11, 2014, and restricted cash required 0% of loan amount
|
|
|
4,021,620
|
|
|
|
|
|
|
|
|
Notes payable from Huaxia Bank, dated December 17, 2013, due June 17, 2014, and restricted cash required 60% of loan amount
|
|
|
4,021,620
|
|
|
|
|
|
|
|
|
Notes payable from Credit Union, dated December 27, 2013, due June 27, 2014, and restricted cash required 50% of loan amount
|
|
|
9,651,889
|
|
|
|
|
|
|
|
|
Notes payable from Bank of Inner Mongolia, dated Febuary 18, 2014, due August 17, 2014, and restricted cash required 50% of loan amount, paid back on February 16, 2014.
|
|
|
6,434,592
|
|
|
|
|
$
|
66,758,896
|
|
|
|
|
December 31,
2013
|
|
|
|
|
|
|
|
Notes payable from China Everbright Bank Co., Ltd, dated July 30, 2013, due January 30, 2014, and restricted cash required 50% of loan amount, paid back on January 30, 2014.
|
|
$
|
6,607,529
|
|
|
|
|
|
|
|
|
Notes payable from China Everbright Bank Co., Ltd, dated July 22, 2013, due January 22, 2014, and restricted cash required 50% of loan amount, paid back on January 22, 2014.
|
|
|
6,607,529
|
|
|
|
|
|
|
|
|
Notes payable from China Everbright Bank Co., Ltd, dated November 14, 2013, due May13, 2014, and restricted cash required 50% of loan amount
|
|
|
9,911,294
|
|
|
|
|
|
|
|
|
Notes payable from China Construction Bank, dated November 26, 2013, due May 26, 2014, and restricted cash required 50% of loan amount
|
|
|
7,103,094
|
|
|
|
|
|
|
|
|
Notes payable from China Construction Bank, dated September 03, 2013, due March 03, 2014, and restricted cash required 50% of loan amount, paid back on March 3, 2014.
|
|
|
4,955,647
|
|
|
|
|
|
|
|
|
Notes payable from Huaxia Bank, dated December 03, 2013, due June 03, 2014, and restricted cash required 60% of loan amount
|
|
|
8,589,788
|
|
|
|
|
|
|
|
|
Notes payable from Huaxia Bank, dated December 11, 2013, due June 11, 2014, and restricted cash required 0% of loan amount
|
|
|
4,129,706
|
|
|
|
|
|
|
|
|
Notes payable from Huaxia Bank, dated December 17, 2013, due June 17, 2014, and restricted cash required 60% of loan amount
|
|
|
4,129,706
|
|
|
|
|
|
|
|
|
Notes payable from Credit Union, dated December 27, 2013, due June 27, 2014, and restricted cash required 50% of loan amount
|
|
|
9,911,294
|
|
|
|
|
|
|
|
|
Notes payable from Bank of Inner Mongolia, dated August 16, 2013, due February 16, 2014, and restricted cash required 50% of loan amount, paid back on February 16, 2014.
|
|
|
6,607,529
|
|
|
|
|
$
|
68,553,116
|
|
The banks that issue notes payable to us charge a service fee in an amount 0.05% of the total outstanding notes payable amount for all the banks and additional 2.5% of the total outstanding notes payable amount minus security deposit. The service fee is recorded in general and administrative expense.
(17) Other Payable
Other payable amounted $2,762,605 and $2,755,529 as of March 31, 2014 and December 31, 2013, respectively. For the three months ended March 31, 2014, other payable mainly included amounts payables to the local bureau of finance of $1,013,770 for VAT. For the year ended December 31, 2013, other payable mainly included amounts payables to the local bureau of finance of $1,037,382 for VAT.
(18) Subsequent events
In accordance with ASC 855, Subsequent Events, which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before consolidated financial statements are issued, the Company has evaluated events and transactions for potential recognition or disclosure through the reporting date, the date the consolidated financial statements were available to be issued.