| | | For the three months ended | |
| | | June 30, 2010 | | | | June 30, 2010 | |
| Net Income | | | | | | | |
| (numerator for basic income per share) | | $ | 434,768 | | | | $ | 357,462 | |
| Plus interest on convertible note | | | 697,811 | | | | | - | |
| Net Income - assumed conversions | | | | | | | | | |
| (numerator for diluted income per share) | | $ | 1,132,579 | | | | $ | 357,462 | |
| | | | | | | | | | |
| | | | | | | | | | |
| Weighted average common shares | | | | | | | | | |
| (denominator for basic income per share) | | | 15,235,714 | | | | | 14,510,204 | |
| | | | | | | | | | |
| Effect of Dilutive Securities: | | | | | | | | | |
| Warrants - treasury stock method | | | - | | | | | - | |
| Convertible note as if-converted method | | | 1,689,796 | | | | | - | |
| Weighted average common shares | | | | | | | | | |
| (denominator for diluted income per share) | | | 16,925,510 | | | | | 14,510,204 | |
| | | | | | | | | | |
| Basic net income per share | | $ | 0.03 | | | | $ | 0.02 | |
| Diluted net income per share | | $ | 0.07 | | Antidilutive | | $ | 0.02 | |
China Filtration Technology, Inc.
Notes to Consolidated Financial Statements for the six months ended March 31, 2010(Unaudited - - Expressed in US dollars)| | | For the nine months ended | |
| | | June 30, 2010 | | | | June 30, 2010 | |
| Net Income | | | | | | | |
| (numerator for basic income per share) | | $ | 2,324,448 | | | | $ | 1,089,208 | |
| Plus interest on convertible note | | | 1,114,535 | | | | | - | |
| Net Income - assumed conversions | | | | | | | | | |
| (numerator for diluted income per share) | | $ | 3,438,983 | | | | $ | 1,089,208 | |
| | | | | | | | | | |
| | | | | | | | | | |
| Weighted average common shares | | | | | | | | | |
| (denominator for basic income per share) | | | 14,879,603 | | | | | 14,510,204 | |
| | | | | | | | | | |
| Effect of Dilutive Securities: | | | | | | | | | |
| Warrants - treasury stock method | | | - | | | | | - | |
| Convertible note as if-converted method | | | 860,372 | | | | | - | |
| Weighted average common shares | | | | | | | | | |
| (denominator for diluted income per share) | | | 15,739,975 | | | | | 14,510,204 | |
| | | | | | | | | | |
| Basic net income per share | | $ | 0.16 | | | | $ | 0.08 | |
| Diluted net income per share | | $ | 0.22 | | Antidilutive | | $ | 0.08 | |
| 15. | Accounting for Warrants |
The warrants issued in conjuctionconjunction with the convertible notes have the following material terms:
The warrants are exercisable at any time during a five-year period commencing on the closing of a “financing,” which means the first sale (or series of related sales) by us of stock (or debt or equity securities convertible into stock), in a capital raising transaction, occurring after the maturity date (or the date the notes become due pursuant to a default, if earlier) with aggregate gross proceeds of at least $2,000,000. The warrants cannotcan not be exercised if no financing is consummated within five-year period after the issue date and become void if the notes automatically convert into common stock.
Number of Shares: The warrants represent the right to purchase 8% of the total shares of common stock outstanding (on a fully-diluted basis) immediately after the closing of the financing.
Exercise Price: The warrants are exercisable at the price for which the shares of common stock (or common stock equivalent if derivative securities are sold) are sold in the financing. If the financing includes more than one type of security, the exercise price shall equal the lowest price per share of common stock or common stock equivalent included in the financing.
The Company analyzed the warrants and the conversion features in the notes to assess whether they meet the definition of a derivative under the guidance set forth by ASC Topic 815 (SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”) and, thereof, the applicability of the accounting rules in accordance to ASC Topic 815 to treat the warrants as derivative liabilities. Management also evaluated whether the warrants meet the scope exception set forth by ASC Topic 815-40 (“Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”), which is that contracts issued or held by the reporting entity that are both (1) indexed to its own stock and (2) classified in stockholders’ equity shall not be considered to be derivative instruments for purposes of ASC Topic 815. The provisions in ASC Topic 815-40 apply to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by ASC Topic 815 and to any freestanding financial instruments that are potentially settled in an entity’s own common stock.
Management concluded that the warrants issued in conjunction with the private placement of convertible notes in February 2010 to certain accredited investors should be treated as a derivative liabilityliability. Derivative instruments are recorded at fair value and the derivative accounting rules under ASC Topic 815-40 were adopted to record the warrants. Fair market value of the warrants were measured using the Black-Scholes pricing model at the issuance date and recorded as warrants liabilities. Changemarked-to-market each period until they are exercised or expire, with any change in the fair value of the warrants is recorded in othercharged or credited to income or loss in the statement of operations in the future reporting periods. Change in warrant value from February 2010 to March 31, 2010 were not material.each period.
As a result of adopting accounting treatment of ASC Topic 815-40, $1,052,000 waswarrants are recorded as warrantsderivative liabilities and valued at $1,052,000 based on 1,218,857 shares entitled underusing the Black-Scholes pricing model on the date of issuance and as of March 31, 2010. Because there was no trade market for the Company’s stock, management used substitute volatility in the initial and subsequent measuring of the fair market value of the warrants issued. Management re-measured the fair market value based on the adjusted volatility of publicly traded stock of a company with similar business and the remaining term of the warrants. As of June 30, 2010, these warrants were valued at$690,000. The valuation inputs asare provided in the table as follows.
| | | At date of issuance | | | As of | |
| Attribute | | February 12, 2010 | | | June 30, 2010 | |
| | | | | | | |
| Warrants outstanding | | | 1,218,857 | (*) | | | 1,218,857 | (*) |
| Exercise Price | | $ | 2.45 | | | $ | 2.45 | |
| Risk Free Interst Rate | | | 2.25 | % | | | 0.32 | % |
| Volatility | | | 90 | % | | | 70 | % |
| Dividend Yield | | | 0 | % | | | 0 | % |
| Contractual Life (years) | | | 1 | | | | 0.7 | |
(*) Warrants outstanding is based on 8% of the total outstanding common shares
USA
The Company and its subsidiary and branch divisions are subject to income taxes on an entity basis on income arising in, or derived, from the tax jurisdiction in which they operate. As the Company had no income generated in the United States, there was no tax expense or tax liability due to the Internal Revenue Service of the United States as of June 30, 2010 and September 30, 2009.
BVI
Hong Hui is incorporated under the International Business Companies Act of the British Virgin Islands and accordingly, is exempted from payment of British Virgin Island’s income taxes.
PRC
Pursuant to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for Foshan. For 2008 and 2009 Foshan enjoys tax free holiday for two years. From January 2010 onwards, Foshan is taxed at 25% of net income except for the 2010 and 2011years where there is 50% discount on income tax.
The current year tax provision was $6,328 and $6,328 for the three and nine months ended June 30, 2010, respectively. The Company has recorded zero deferred tax assets or liabilities as of June 30, 2010 and September 30, 2009 net of tax allowance because all other significant difference in tax basis and financial statement amounts are permanent differences.
| | | For the three months ended | | | For the nine months ended | |
| | | June 30, | | | June 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| | | | | | | | | | | | | |
| Income Tax Expense: | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Current tax | | $ | 6,328 | | | $ | 0 | | | $ | 6,328 | | | $ | 0 | |
| Change in deferred tax assets – Net operating loss | | | 46,911 | | | | 76,959 | | | | 285,019 | | | | 199,513 | |
| | | | | | | | | | | | | | | | | |
| Change in valuation allowance | | | (46,911 | ) | | | (76,959 | ) | | | (285,019 | ) | | | (199,513 | ) |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 6,328 | | | $ | 0 | | | $ | 6,328 | | | $ | 0 | |
We follow the guidance in FASB ASC 740 Accounting for Uncertainty in Income Taxes. We have not taken any uncertain tax positions on any of our open income tax returns filed through the period ended June 30, 2010. Our methods of accounting are based on established income tax principles and are properly calculated and reflected within our income tax returns. In addition, we have timely filed extension of income tax returns in all applicable jurisdictions in which we believe we are required to make an income tax return filing.
We re-assess the validity of our conclusions regarding uncertain tax positions on a quarterly basis to determine if facts or circumstances have arisen that might cause us to change our judgment regarding the likelihood of a tax position’s sustainability under audit. We have determined that there were no uncertain tax positions for the nine months ended June 30, 2010 and 2009.
All of the Company’s income before income taxes is from PRC sources. Actual income tax expense reported in the consolidated statements of operations and comprehensive income differ from the amounts computed by applying the PRC statutory income tax rate of 12.5% (50% discount of 25%) to income before income taxes for the three and nine months ended June 30, 2010 for the followings reasons:
| February 2010 Financing Warrants - Valuation Inputs | |
| | | February 12 and March 31, | |
| Attribute | | 2010 | |
| Stock Price | | $ | 2.45 | |
| Risk Free Interest Rate | | | 2.25 | % |
| Volatility | | | 90.00 | % |
| Exercise Price | | $ | 2.45 | |
| Dividend Yield | | | 0 | % |
| Contractual Life (Years) | | | 1 | |
13| | | For the three months ended | | | For the nine months ended | |
| | | June 30, | | | June 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Income before income taxes | | $ | 441,096 | | | $ | 357,462 | | | $ | 2,330,776 | | | $ | 1,089,208 | |
| | | | | | | | | | | | | | | | | |
| Computed “expected” income tax expense at 12.5% and zero in 2010 and 2009 | | $ | 142,363 | | | $ | - | | | $ | 430,664 | | | $ | - | |
| Tax effect of net taxable permanent differences | | | (89,124 | ) | | | - | | | | (139,317 | ) | | | - | |
| | | | | | | | | | | | | | | | | |
| Effect of cumulative tax losses | | | (46,911 | ) | | | - | | | | (285,019 | ) | | | - | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | $ | 6,328 | | | $ | - | | | $ | 6,328 | | | $ | - | |
China Filtration Technology, Inc.
NotesOur policy for recording interest and penalties associated with audits is to Consolidated Financial Statementsrecord such items as a component of income tax expense. There were no interest and penalties recorded for the sixnine months ended March 31,June 30, 2010
and 2009.(Unaudited - - Expressed in US dollars)
17. Recent Accounting Pronouncements16. | Recent accounting pronouncements |
Fair Value Measurements
In June 2009January 2010, the FASB establishedissued guidance to amend the Accounting Standards Codification (“Codification” or “ASC”) asdisclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires disclosure of transfers of assets and liabilities between Level 1 and Level 2 of the sourcefair value measurement hierarchy, including the reasons and the timing of authoritative accounting principles recognized bythe transfers and information on purchases, sales, issuance, and settlements on a gross basis in the reconciliation of the assets and liabilities measured under Level 3 of the fair value measurement hierarchy. The guidance is effective for annual and interim reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual and interim periods beginning after December 15, 2010. The Company adopted this guidance at January 1, 2010, except for the Level 3 reconciliation disclosures on the rollforward activities, which it will adopt at the beginning of January 1, 2011. Adoption did not have a material impact on our consolidated financial statements.
Receivables
In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310), Effect of a Loan Modification When the Loan is Part of A Pool That Is Accounted for as a Single Asset. ASU 2010-18 provides that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be applied by nongovernmental entitiesrequired to consider whether the pool of assets in which the preparation of financial statements in accordance with generally accepted accounting principles inloans are included is impaired if expected cash flows for the United States (“GAAP”). Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) issued under authority of federal securities laws are also sources of GAAP for SEC registrants. Existing GAAP was not intended to be changed as a result of the Codification, and accordingly the change did not impact our financial statements. The ASC does change the way thepool change. This guidance is organizedeffective prospectively for the first interim and presented.annual period ending on or after July 15, 2010. Early adoption is permitted. The Company adopted this guidance without a material impact on its consolidated financial statements.
Statement of Financial Accounting Standards (“SFAS”) SFAS No. 165 (ASC Topic 855), “Subsequent Events”, SFAS No. 166 (ASC Topic 810), “Accounting for Transfers of Financial Assets – an Amendment of FASB Statement No. 140”, SFAS No. 167 (ASC Topic 810), “Amendments to FASB Interpretation No. 46(R)”, and SFAS No. 168 (ASC Topic 105), “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement No. 162” were recently issued. SFAS No. 165, 166, 167, and 168 have no current applicability to the Company or their effect on the financial statements would not have been significant.
Accounting Standards Update (“ASU”) ASU No. 2009-05 (ASC Topic 820), which amends Fair Value Measurements and Disclosures – Overall, ASU No. 2009-13 (ASC Topic 605), Multiple Deliverable Revenue Arrangements, ASU No. 2009-14 (ASC Topic 985), Certain Revenue Arrangements that include Software Elements, and Various other ASU’s No. 2009-2 through ASU No. 2010-19 which contain technical corrections to existing guidance or affect guidance to specialized industries or entities were recently issued. These updates have no current applicability to the Company or their effect on the financial statements would not have been significant.
Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying financial statements.
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Special Note Regarding Forward LookingForward-Looking Statements
This Quarterly Report on Form 10-Q, including the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements that are based on the beliefs of our management, and involve risks and uncertainties, as well as assumptions, that, if they ever materialize or prove incorrect, could cause actual results to differ materially from those expressed or implied by such forward-looking statements. The words “believe,” “expect,” “anticipate,” “project,” “targets,” “optimistic,” “intend,” “aim,” “will” or similar expressions are intended to identify forward-looking statements. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements, including statements regarding new and existing products, technologies and opportunities; statements regarding market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; uncertainties related to conducting business in China; any statements of belief or intention; any of the factors and risks mentioned in the “Risk Factors” sections of our Current Report on Form 8-K filed with the Securities and Exchange Commission on February 12, 2010, and any statements of assumptions underlying any of the foregoing. All forward-looking statements included in this report are based on information available to us on the date of this report. We assume no obligation and do not intend to update these forward-looking statements, except as required by law.
INTRODUCTIONIntroduction
This section discusses and analyzes the results of operations and financial condition of China SLP Filtration Technology, Inc., formerly known as Perpetual Technologies, Inc., (“we,” “us,” or the “Company”) which is the ultimate parent company of Foshan S.L.P. Special Materials Co., Ltd. (“Foshan”), a PRC-basedChina-based operating company located in Foshan, Guangdong Province in the PRC.People’s Republic of China.
On February 12, 2010, we acquired control of Foshan in a share exchange transaction which closed on that date.
In the share exchange or “reverse merger” we acquired control of Hong Hui Holdings Limited (“Hong Hui”), a British Virgin Islands company and the owner of all of the stock of Technic International Limited (“Technic”), a Hong Kong holding company which in turn is the owner of all of the equity of Foshan, by issuing to the Hong Hui stockholders an aggregate of 14,510,204 shares of our common stock in exchange for all of the outstanding capital stock of Hong Hui.
The transaction is accounted for as a reverse acquisition, except that no goodwill or other intangible has been recorded. The recapitalization is considered to be a capital transaction in substance, rather than a business combination. Beginning with the quarter ended March 31,from February 12, 2010 the operating results of Foshan are consolidated in the Company’s financialsfinancial results for that period.
Foshan is engaged in the manufacture, sale, and research and development of advanced spun-bond PET, or polyester, non-wovens.
NonwovenNon-woven fabrics are broadly defined as sheet or web structures bonded together by entangling fiber or filaments (and by perforating films) mechanically, thermally or chemically. They are flat, porous sheets that are made directly from separate fibers or from molten plastic or plastic film. They are not made by weaving or knitting and do not require converting the fibers to yarn.
Our major market is the Chinese market. We sell products to industrial customers in China. In recent years, our products have been successfully launched in the European, North American and South East Asian markets.
Currently, our major products are spun-bond, thermal calendaring and needle-punched industrial non-woven PET (polyester) and PP (polypropylene) fabrics. These products are used as filtration media and infrastructure engineering material, among other uses.
We currently operate three spun-bond production lines. Two lines are spun-bond, thermal calendaring production lines with a total annual capacity of 4,000 tons of spun-bond polyester filament thermal calendaring nonwoven.non-woven. In February 2009, we added the third line, spun-bond needle-punching production line with an annual capacity of 4,000 tons of spun-bond polyester filament, needle-punched nonwovennon-woven fabric.
We recently developed a continuous filament, spun-bond, needle-punched manufacturing process to manufacture polyphenylenepolyphenylene sulfide fiber, or PPS, a specialized type of high temperature resistant nonwovennon-woven fabric and intend to begin commercial production of PPS using our proprietary manufacturing process in 2010. We have applied for a process patent in the PRC for this process (Patent No. PRC: 201010102660.2) and we intend to apply for a process patent in North America and Europe. In comparison to other filtering materials currently available, we believe that our nonwovennon-woven fabric will be stronger, have lower production and operating costs, and will have higher filtration efficiency. We have tested our PPS material nonwovennon-woven fabric internally and, although a prototype using our material has not yet been deployed by any industrial end user, we believe that our material has the potential to replace the filtration materials and products currently available and become the most popular filtration material in high temperature environments such as coal-fired power plants, garbage incinerators and cement factories.
On March 24, 2010 the Company effected a 1 for 5 reverse stock split of its outstanding common stock. The effect of the reverse split is retrospectively showed in all periods presented.
On February 12, 2010, immediately following the reverse merger, the Company entered into a note purchase agreement with certain accredited investors for the sale of convertible notes in the aggregate principal amount of $4,140,000 and warrants (which are exercisable only in certain circumstances), with net proceeds of $3.2$3.4 million after finance costs. The notes require quarterly interest payments at a rate of 10% per annum.
We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements. This discussion should be read in conjunction with our audited financial statements and accompanying notes as of September 30, 2009, and for the year then ended and the unaudited condensed consolidated interim financial statements for the six monhtsnine months ended March 31,June 30, 2010.
Results of Operations
Three Month PeriodMonths Ended March 31,June 30, 2010 comparedCompared to Three Month PeriodMonths Ended March 31, 2009
The following table shows, for the periods indicated, information derived from our consolidated statements of income in US dollars and as a percentage of net sales (percentages may not add due to rounding). See the financial statements of the Company and the related notes thereto and other financial information included elsewhere in this report.
| | | Three months ended March 31 | |
| | | 2010 | | | 2009 | |
| | | Amount | | | % | | | Amount | | | % | |
| Sales | | | 4,628,671 | | | | 100 | % | | | 2,214,940 | | | | 100 | % |
| Cost of Sales | | | 3,237,311 | | | | 70 | % | | | 1,373,921 | | | | 62 | % |
| Gross Profit | | | 1,391,360 | | | | 30 | % | | | 841,019 | | | | 38 | % |
| SG&A expense | | | 407,461 | | | | 9 | % | | | 275,526 | | | | 12 | % |
| Operating Income | | | 983,899 | | | | 21 | % | | | 565,493 | | | | 26 | % |
| Interest Income | | | 292 | | | | 0 | % | | | - | | | | 0 | % |
| Interest Expenses | | | (390,355 | ) | | | 8 | % | | | (76,286 | ) | | | 3 | % |
| Gain on disposal of fixed assets | | | 496 | | | | 0 | % | | | 0 | | | | 0 | % |
| Net Income before taxes | | | 594,332 | | | | 13 | % | | | 489,207 | | | | 22 | % |
| Net Income | | | 594,332 | | | | 13 | % | | | 489,207 | | | | 22 | % |
Sales
Net sales revenue consists of revenue from sales of needle punched non woven fabric and thermal calendared product. Net sales for three month period ended March 31, 2010 were $4,628,671, an increase of $2,413,731, or 109%, from $2,214,940 for the same period of prior year. In February 2009, we installed a new production line to manufacture needle punched non woven fabric. Sales of needle-punched products for the three month period ended March31, 2010 were $1,942,811 compared to $220,718 for the same period of the prior year. In addition, sales of thermal calendared materials for the three month period ended March 31, 2010 $2,308,801, as increase of $569,189 compared to $1,739,612 for the same period of the prior year.
Cost of Goods Sold
Cost of goods sold principally consists of the cost of raw materials, labor, and manufacturing overhead expenses.
Cost of goods sold for the three month period ended March 31, 2010 was $3,237,311, an increase of $1,863,390, or 136%, from $1,373,921 for the same period in 2009.
Raw material expenses increased to 52% of the sales for the three month period ended March 31, 2010, compared to 41% of sales for the same period of the prior year, reflecting a mix of more expensive raw materials associated with 2010 sales. 98.7 % of our raw materials consists of polyester the price of which fluctuates with the price of oil
Labor expenses were 6% of sales for the three month period ended March 31, 2010 compared to 2% for the same period of year 2009. Beginning in February 2009 we hired 17 additional employees to work the new production line. Labor costs also increased due to increased demand for labor.
Overhead expenses were 11% of net sales for the three month period ended March 31, 2010, compared to 19% of net sales for 2009 due to the increase of manufacturing capacity of the Company with the addition of the new production line in February 2009.
Gross Profit
Gross profits represents net sales less cost of goods sold. Gross profit for the three month period ended March 31, 2010 was $1,391,360, an increase of $550,341, or 65%, from $841,019 for the same period in 2009. As a percentage of net sales, gross profit was 30% for the three month period ended March 31, 2010, compared to 38% for the same period last year. This was primarily due to increase of purchase of price of the raw materials associated with 2010 sales, which price increase was caused by fluctuations in the price of oil.
Selling, Marketing and Administrative Expenses
Selling expenses include salaries, advertising expenses, cost of manufacturing, rent, and all expenses dirirectly related to producing and selling product. General expenses include general operating expenses that are directly related to the general operation of the company but excluding selling and administrative expenses. Administrative expense includes executive salaries and other expenses related to the overall administration of the company.
Selling, general and administrative expenses for the three month period ended March 31, 2010 were $407,461, an increase of $131,935 compared to $275,526 for the same period 1n 2009. The increase was primarily due to increase of $25,524 in export delivery expenses and $83,286 additional professional expenses incurred in connection with the company’s planned financing.
Other Expenses
Other expenses solely consist of interest expense.
Interest expense for the three month period ended March 31, 2010 was $390,355 compared to $76,286 for the same period in 2009. Interest expense as a percentage of sales increased to 8% for the three month period ended March 31, 2010 from 3% for the same period of last year. The increase in interest expense was principally due to interest on the convertible notes in the aggregate principal amount of $4,140,000. We accreted non-cash related interest expense in the amount of $304,950. Excluding the accretion of interest, our interest expense for this three-month period was the same as for the same period in 2009.Net Income
Net income for the three months ended March 31, 2010 increased by $105,125, from net income of $489,207 for the three month period ended March 31, 2009 to net income of $594,332. The increase was largely due to an increase in net sales due to the sales generated from new needle-punch products.
Six Month Period Ended March 31, 2010 compared to Six Month Period Ended March 31,June 30, 2009
The following table shows, for the periods indicated, information derived from our consolidated statements of income in US dollars and as a percentage of net sales (percentages may not add due to rounding). See the financial statements of the Company and the related notes thereto and other financial information included elsewhere in this report.
| | | Six months ended March 31 | | | Three Months Ended June 30 | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | |
| Sales | | | 9,847,025 | | | | 100 | % | | | 4,540,833 | | | | 100 | % | | $ | 5,072,791 | | | | 100 | % | | $ | 2,482,212 | | | | 100 | % |
| Cost of Sales | | | 6,843,833 | | | | 70 | % | | | 2,906,402 | | | | 64 | % | | | 3,537,571 | | | | 70 | % | | | 1,779,328 | | | | 72 | % |
| Gross Profit | | | 3,003,192 | | | | 30 | % | | | 1,634,431 | | | | 36 | % | | | 1,535,220 | | | | 30 | % | | | 702,884 | | | | 28 | % |
| SG&A expense | | | 662,138 | | | | 7 | % | | | 758,442 | | | | 17 | % | |
| Selling, General and Administrative Expense | | | | 701,436 | | | | 14 | % | | | 266,101 | | | | 11 | % |
| Operating Income | | | 2,341,054 | | | | 24 | % | | | 875,989 | | | | 19 | % | | | 833,784 | | | | 16 | % | | | 436,783 | | | | 18 | % |
| Interest income | | | 517 | | | | 0 | % | | | - | | | | 0 | % | |
| Interest Expenses | | | (452,387 | ) | | | 5 | % | | | (160,506 | ) | | | 4 | % | |
| Gain on disposal of fixed assets | | | 496 | | | | 0 | % | | | 16,263 | | | | 0 | % | |
| Interest Income | | | | 10,106 | | | | 0.2 | % | | | 2,104 | | | | 0 | % |
| Interest Expense | | | | (764,794 | ) | | | 15 | % | | | (65,162 | ) | | | 3 | % |
| Loss on disposition of fixed assets | | | | - | | | | | | | | (16,263 | ) | | | 1 | % |
| Changes in Fair Value of Warrants | | | | 362,000 | | | | 7 | % | | | - | | | | 0 | % |
| Net Income before taxes | | | 1,889,680 | | | | 19 | % | | | 731,746 | | | | 16 | % | | | 441,096 | | | | 9 | % | | | 357,462 | | | | 14 | % |
| Income tax provision | | | | 6,328 | | | | | | | | - | | | | | |
| Net Income | | | 1,889,680 | | | | 19 | % | | | 731,746 | | | | 16 | % | | $ | 434,768 | | | | 9 | % | | $ | 357,462 | | | | 14 | % |
Net Sales
Net sales revenue consistsconsisted of revenue from sales of needle punched non wovennon-woven fabric and thermal calendared product. Netproducts. Our net sales for sixthree month period ended March 31,June 30, 2010 were $9.85 million,$5,072,791, an increase of $5.30 million$2,590,579, or 116 %,104%, from $4.55 million$2,482,212 for the same period of the prior year. In February 2009,2010, we installed a new production line to manufacture needle punched non woven fabric.non-woven fabric and start sales of the new products. Sales of needle-punched products for the sixthree month period ended March 31,June 30, 2010 were $[4,300,022]$2,054,318 compared to $220,718$518,752 for the same period of the prior year. In addition, sales of thermalthermal calendared materials for the sixthree month period ended March 31,June 30, 2010 were $[5,559,365], aswere $3,018,473, an increase of $[1,228,361]$1,062,855 compared to $[4,331,204]$1,955,618 for the same period of the prior year.
Cost of Goods Sold
Cost of goods soldSales
Cost of sales principally consists of the cost of raw materials, labor, and manufacturing overhead expenses.
Cost of goods soldsales for the sixthree month period ended March 31,June 30, 2010 was $6,843,833,$3,537,571, an increased $3,937,431,increase of $1,758,243, or 135%99%, from $2,906,402 for the same period of the prior year. As a percentage of net sales cost of good sold was 70 % for the six month period ended March 31, 2001 compared to 64%$1,779,328 for the same period in 2009.
Raw material expensescost increased to 56% of the sales for the sixthree month period ended March 31,June 30, 2010, compared to 40%51% of sales for the same period in 2009,of the prior year, reflecting a mix of more expensive raw materials associated with 2010 sales. 98.7% of our raw materials consists of polyester the price of which fluctuates with the price of oil.oil
Labor cost accounted for 1% of net sales for the three month period ended June 30, 2010, the same level for the same period of year 2009.
Overhead expenses were 6%13% of net sales for the three month period ended June 30, 2010, compared to 18% of net sales for 2009. As a percentage of net sales, overhead expenses decreased due to production capacity expansion and volume increase.
Gross Profit
Gross profit represents net sales less cost of sales. Gross profit for the three month period ended June 30, 2010 was $1,535,220, an increase of $832,336, or 118%, from $702,884 for the same period in 2009. As a percentage of net sales, gross profit was 30% for the three month period ended June 30, 2010, compared to 28% for the same period last year. The improved gross profit was primarily attributed to lowered overhead cost as a percentage of the net sales.
Selling, General and Administrative Expenses
Selling expenses include salaries, advertising expenses, rent, and all expenses directly related to selling product. General expenses include general operating expenses that are directly related to the general operation of the company. Administrative expenses include executive salaries and other expenses related to the overall administration of the company.
Selling, general and administrative expenses for the three month period ended June 30, 2010 were $701,436, an increase of $435,335 compared to $266,101 for the same period in 2009. The increase was primarily due to increase of $47,219 in delivery charges related to overseas sales and $309,040 in the Company’s IPO related legal fees and other expenses.
Other Income and Expenses
Other expenses primarily consisted of interest expense while other income was primarily interest income and change in fair value of warrants.
Interest expense for the three month period ended June 30, 2010 was $764,791 compared to $65,162 for the same period in 2009. Interest expense as a percentage of sales increased to 15% for the three month period ended June 30, 2010 from 3% for the same period of last year. The increase in interest expense was mainly attributed to adoption of derivative accounting rules under ASC 815-40 to record $4,140,000 of convertible loan notes. These accounting rules require us to accrete interest expense, in amount of $609,900, based on the term of the notes and note discount. Excluding the derivative-accounting-driven interest expense, our interest expense for this three month period remained the same level as for the same period of last year. The accreted interest expense was partially offset by the fair value change of the warrants after re-measurement at this reporting period.
Income Tax
USA
The Company and its subsidiary and branch divisions are subject to income taxes on an entity basis on income arising in, or derived, from the tax jurisdiction in which they operate. As the Company had no income generated in the United States, there was no tax expense or tax liability due to the Internal Revenue Service of the United States as of June 30, 2010 and September 30, 2009.
BVI
Hong Hui is incorporated under the International Business Companies Act of the British Virgin Islands and accordingly, is exempted from payment of British Virgin Island’s income taxes.
PRC
Pursuant to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for Foshan SLP. For 2008 and 2009 Foshan SLP enjoys tax free holiday for two years. From January 2010 onwards, Foshan SLP is taxed at 25% of net income except for the 2010 and 2011 years where there are 50% discount on income tax.
The current year tax provision was $6,328 and $6,328 for the three and nine months ended June 30, 2010, respectively. The Company has recorded zero deferred tax assets or liabilities as of June 30, 2010 and September 30, 2009 net of tax allowance because all other significant difference in tax basis and financial statement amounts are permanent differences.
Net Income
Net income for the three months ended June 30, 2010 increased by $77,306 from net income of $357,462 for the same period ended June 30, 2009 to net income of $434,768. Excluding accretion of interest expense discussed above and the gains on change in warrant value, net income rose to $682,668, an increase of $325,206 over the same period of last year.
Nine Month Period Ended June 30, 2010 compared to Nine Month Period Ended June 30, 2009
The following table shows, for the periods indicated, information derived from our consolidated statements of income in US dollars and as a percentage of net sales (percentages may not add due to rounding). See the financial statements of the Company and the related notes thereto and other financial information included elsewhere in this report.
| | | Nine Months Ended June 30 | |
| | | 2010 | | | 2009 | |
| | | Amount | | | % | | | Amount | | | % | |
| Sales | | $ | 14,919,816 | | | | 100 | % | | $ | 7,023,045 | | | | 100 | % |
| Cost of Sales | | | 10,381,404 | | | | 70 | % | | | 4,685,730 | | | | 67 | % |
| Gross Profit | | | 4,538,412 | | | | 30 | % | | | 2,337,315 | | | | 33 | % |
| Selling, General and Administrative Expense | | | 1,363,574 | | | | 9 | % | | | 1,024,543 | | | | 15 | % |
| Operating Income | | | 3,174,838 | | | | 21 | % | | | 1,312,772 | | | | 19 | % |
| | | | | | | | | | | | | | | | | |
| Interest Income | | | 10,623 | | | | 0 | % | | | 2,104 | | | | 0 | % |
| | | | | | | | | | | | | | | | | |
| Interest Expense | | | (1,216,685 | ) | | | 8 | % | | | (225,668 | ) | | | 3 | % |
| Changes in Fair Value of Warrants | | | 362,000 | | | | 2 | % | | | - | | | | 0 | % |
| Net Income before taxes | | | 2,330,776 | | | | 16 | % | | | 1,089,208 | | | | 16 | % |
| Income tax provision | | | 6,328 | | | | | | | | - | | | | | |
| Net Income | | $ | 2,324,448 | | | | 16 | % | | $ | 1,089,208 | | | | 16 | % |
Sales
Net sales revenue consisted of revenue from sales of needle punched non-woven fabric and thermal calendared products. Net sales for the nine month period ended June 30, 2010 were $14,919,816, an increase of $7,896,771 or 112 %, from $7,023,045 for the same period of the prior year. The increase is mainly attributable to sales of the needle punched non-woven fabric products we launched during the second quarter of 2010. Sales of needle-punched products for the nine month period ended June 30, 2010 were $6,342,001 compared to $739,097 for the same period of the prior year. In addition, sales of thermal calendared materials for the nine month period ended June 30, 2010 were $8,577,815, an increase of $2,293,867 compared to $6,283,948 for the same period of the prior year.
Cost of Sales
Cost of sales principally consisted of the cost of raw materials, labor, and manufacturing overhead expenses.
Cost of sales for the sixnine month period ended March 31,June 30, 2010 was $10,381,404, an increase of $5,695,674, or 122%, from $4,685,730 for the same period of the prior year. As a percentage of net sales cost of sales was 70% for the nine month period ended June 30, 2010 compared to 67% for the same period in 2009.
Raw material cost increased to 55% of the sales for the nine month period ended June 30, 2010, compared to 44% of sales for the same period in 2009, reflecting a mix of more expensive raw materials associated with 2010 sales. Approximately 98% of our raw materials consists of polyester, the price of which fluctuates with the price of oil.
Labor cost was 1% of sales for the nine month period ended June 30, 2010 compared to 2% for the same period in 2009.Beginning in February 2009 we hired 17 additional employees to work the new production line. Labor costs also increased due to increased demand for labor.
Overhead expenses were 12%13% of net sales for the sixnine month period ended March 31,June 30, 2010, compared to 19%20% of net sales for the same period last year due to the increase of manufacturing capacity of the Company.reflecting operation efficiency achieved by increased production volume.
Gross Profit
Gross profitsprofit represents net sales less costCost of goods sold.sales. Gross profit for the sixnine month period ended March 31,June 30, 2010 was $3,003,192 and$4,538,412, an increase of $1,368,761$2,201,097 or 83%94%, from $1,634,431$2,337,315 for the same period last year. As a percentage of net sales, gross profit was 30% for the sixnine month period ended March 31,June 30, 2010, compared to 36%33% for the same period last year. This decrease was primarily due to the increase in the purchase price of the raw materials associated with 2010 sales. This was primarily due to increase of purchase of price of the raw materials associated with 2010 sales, which price increase was caused by fluctuations in the price of oil.
Selling, MarketingGeneral and Administrative Expenses
Selling, general and administrative expenses for the sixnine month period ended March 31,June 30, 2010 were $662,138,$1,363,574, an decreaseincrease of $96,304$339,031, compared to $758,442$1,024,543 for the same period last year. This is mainlyprimarily due to decreased stamp duty $18,394 from $21,301increase in 2009 compare to $2,907 for the same period this year. OfficeIPO related legal and other expenses and shipping expense also decreased $77,327 from $147,221associated with overseas sales, offset by decrease in 2009 compared to $69,894 for the same period 2010.other general expenses.
Other Income and Expenses
Other expenses consistconsisted solely of interest expenses.expenses and change in fair value of warrants.
Interest expense for the sixnine month period ended March 31,June 30, 2010 was $452,387$1,216,685 compared to $160,506$225,668 for the same period of last year. Interest expense as a percentage of net sales increased to 5%8% for the sixnine month period ended March 31,June 30, 2010 from 4%3% for the same period of last year. The cause for the increase in interest expense for the nine month period was principally due to record $4,140,000the same as for the three month period. Excluding the accretion of convertible notes. We accreted non-cash related interest expense, in the amount of $304,950. Excluding accretion on non-cash interest expense, interest expense for this sixnine month period remainedincreased by $76,000 over the same asperiod of last year, and, as a percentage of net sales, decreased to 1%2% from 4%3%.
Net Income
Net income for the sixnine months ended March 31,June 30, 2010 increased by $1,157,934$1,235,240 from net income of $731,746$1,089,208 for the same period in 2009 to net income of $1,889,680.$2,324,448. The increase was mainly dueattributed to the increase in sales due to theincreased net sales generated from our new needle-punch products.needle-punched products and the lower selling, general and administrative expenses relative to net sales. Excluding IPO related expenses and accretion of interest expense from convertible notes sold, net income increased by $2.1 million for the nine month period.
Liquidity and Capital Resources
We finance our business with cash flowsgenerated from operations and use short-term bank loans and we use shareholders’ equity investment and retained earnings to fund capital expenditures.
Working capital consists mainly of cash, accounts receivable, advances to suppliers and inventory. Cash, inventory and accounts receivable account for the majority of our working capital.
Our working capital requirements may be influenced by many factors, including cash flow, competition, relationships with suppliers, and the availability of credit facilities and financing alternatives, none of which can be predicted with certainty.
At March 31,June 30, 2010, we had several bank loans for the total amount of $3.8 million (RMB26 million) with Agriculture Bank of China, Foshan Branch and these loans are repayable in December 2010. We have the highest credit rating for that bank.
On February 12, 2010 we completed a financing transaction in which we raised gross proceeds of $4,140,000$4.14 million through a private placement of convertible notes and warrants to certain accredited investors.
Cash Flow from Operating Activities
SixNine month period ended March 31,June 30, 2010 compared with sixnine month period ended March 31, 2009June 30, 2009.
Net cash provedprovided by operating activities for the sixnine months ended March 31,June 30, 2010 was approximately $1.55$2.86 million, compared to a cash flowused of $3.59$0.25 million for the same period of the prior year. The decrease was dueincreased operating cash inflow resulted primarily tofrom increase in Non-cash interest charges, decreasenet income and favorable changes in advance to suppliers.suppliers, accounts payable and accrued expenses offset by unfavorable changes in accounts receivable, inventory and prepaid expenses.
Cash inFlow from Investing Activities
SixNine month period ended March 31,June 30, 2010 compared with sixnine month period ended March 31,June 30, 2009
Net cash providedused by investing activities for sixnine months ended March 31,June 30, 2010 was negative cash flow $1.39$2.51 million, compared to a negative cash flowused of $4.93$0.09 million for the same period of the prior year. The increased cash used from investing activities because there were no largeduring the nine month period of the year was primarily attributed to capital expenditures during the first six months of the year. Only deposits were madeon building up a PPS, a new product, assembly line project. The net cash used in investing activities for the same period of last year was due to the deposits for purchases of equipment and expenses relating to outfitting our facilities.production line.
22
We satisfied this cash expenditure with cash reserves and cash generated from 2009 and 2010 operations.
Cash inFlow from Financing Activities
SixNine month period ended March 31,June 30, 2010 compared with sixnine month period ended March 31,June 30, 2009
Net cash provided by financing activities for the sixnine month period ended March 31,June 30, 2010 was approximately $2.64 million, compared to $0.19$0.20 million of net cash used in financing activities for the same period of the prior year. The increase was from the result of cash received from the sale of the convertible notes.
Loans
The balance of our outstanding short-term bank loans on March 31, 2010 was approximately $3.8 million, compared with $4.6 million on March 31, 2009
On February 12, 2010, immediately following the reverse merger, we entered into a note purchase agreement with certain accredited investors for the sale of convertible notes in the aggregate principal amount of $4,140,000 and warrants (which are exercisable only in certain circumstances), with net proceeds for $3.4 million after finance costs. The notes require quarterly interest payments at a rate of 10% per annum and interest for six month in amount of $204,464 to be held in an escrow account.
The warrants become void if the notes automatically convert into common stock.
The warrants are exercisable at any time during a five-year period commencing on the closing of a “financing,” which means the first sale (or series of related sales) by us of stock (or debt or equity securities convertible into stock), in a capital raising transaction, occurring after the maturity date (or the date the notes become due pursuant to a default, if earlier) with aggregate gross proceeds of at least $20,000,000. The warrants cannot be exercised if no financing is consummated within the five-year period after the issue date.
Future Cash Commitments
We have an ambitious capital investment plansbusiness expansion plan for our PPS products. The PPS projects in 2010 and which will require significant investment capital. This demand for investment capital willexpenditures. We plan to finance the capital expenditures with short term loans from banks and public equity offerings. We expect our working capital needs can be met by the proceedscash generated from the February private placement, and by outside financing (including the public offering) that we intend to raise as needed to continue our expansion.operations.
Critical Accounting Policies and Estimates
Management's discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. Our financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. See Note 2 to our consolidated financial statements “Summary of Significant Accounting Policies.” We believe that the following paragraphs reflect the more critical accounting policies that currently affect our financial condition and results of operations:
Method of Accounting
We maintain our general ledger and journals with the accrual method of accounting for financial reporting purposes. Accounting policies adopted by us conform to generally accepted accounting principles in the United States and have been consistently applied in the presentation of financial statements, which are compiled on the accrual basis of accounting.
Use of estimates
The preparation of the financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ materially from those estimates.
Economic and political risks
Our operations are conducted in the PRC. Accordingly, our business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.
Our operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. Our results may be adversely affected by changes in political and social conditions in the PRC and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.
Revenue recognition
Revenue represents the invoiced value of goods sold recognized upon the delivery of goods to customers. Revenue is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, and the seller’s price to the buyer is fixed or determinable and collectible.
Land use rights
Land use rights are stated at cost less accumulated amortization. Amortization is provided over the respective useful lives,a lease term of 50 years using the straight-line method. Estimated useful lives range from 20 to 50 years.
Property, plant and equipment
Plant and equipment are carried at cost less accumulated depreciation. Depreciation is provided over their estimated useful lives, using the straight-line method. Estimated useful lives of plant and equipment are as follows:
| Buildings | | | 15-3520 years | |
| Machinery and equipment | | | 10 years | |
| Office equipment | | | 6-105 years | |
| Motor vehicles | | | 6-810 years | |
| Other assets | | | 6-10 years | |
The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statement of income. The cost of maintenance and repairs is charged to income as incurred, whereas significant renewals and betterments are capitalized.
Accounting for the Impairment of Long-Lived Assets
The long-lived assets held and used by us are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. It is reasonably possible that these assets could become impaired as a result of technology or other industry changes. Determination of recoverability of assets to be held and used is by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the assets.
If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
Not Applicable.
We maintain “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including to our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Rule 13a-15 under the Exchange Act, our management, including Mr. Jie Li, our Chief Executive Officer and Ms. Sabrina Liang,Mr. Eric Gan our Controller,Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31,June 30, 2010. Based on that evaluation, Mr. LieLi and Ms. LiangMr., Gan concluded that as of March 31,June 30, 2010, and as of the date that the evaluation of the effectiveness of our disclosure controls and procedures was completed, our disclosure controls and procedures were not effective in that certain “significant deficiencies” existed related to (i) the U.S. GAAP expertise of our internal accounting staff, and (ii) our internal audit function.
Because our current accounting department is relatively new to U.S. GAAP and the related internal control procedures required of U.S. public companies, our management has determined that they require additional training and assistance in U.S. GAAP matters. Management has determined that our internal audit function is also significantly deficient due to insufficient qualified resources to perform internal audit functions.
In order to correct the foregoing significant deficiencies, we are taking the following remediation measures: