ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
(Unaudited)
Note 15 – Earnings Per Share (continued)
| | Three Months Ended March 31, | |
| | 2011 | | | 2010 | |
| | | | | | |
Net income attributable to Zhongchai | | $ | 1,451,738 | | | $ | 263,861 | |
Machinery, Inc. | | | | | | | | |
| | | | | | | | |
Weighted average common shares | | | 27,613,019 | | | | 27,613,019 | |
(denominator for basic income per share) | | | | | | | | |
| | | | | | | | |
Effect of dilutive securities: | | | 291,873 | | | | - | |
| | | | | | | | |
Weighted average common shares | | | 27,904,892 | | | | 27,613,019 | |
(denominator for diluted income per share) | | | | | | | | |
| | | | | | | | |
Basic net income per share | | $ | 0.05 | | | $ | 0.01 | |
Diluted net income per share | | $ | 0.05 | | | $ | 0.01 | |
| | Nine Months Ended March 31, | |
| | 2011 | | | 2010 | |
| | | | | | |
Net income attributable to Zhongchai | | $ | 2,522,507 | | | $ | 281,838 | |
Machinery, Inc. | | | | | | | | |
| | | | | | | | |
Weighted average common shares | | | 27,613,019 | | | | 27,613,019 | |
(denominator for basic income per share) | | | | | | | | |
| | | | | | | | |
Effect of dilutive securities: | | | 287,990 | | | | - | |
| | | | | | | | |
Weighted average common shares | | | | | | | | |
(denominator for diluted income per share) | | | 27,901,009 | | | | 27,613,019 | |
| | | | | | | | |
Basic net income per share | | $ | 0.09 | | | $ | 0.01 | |
Diluted net income per share | | $ | 0.09 | | | $ | 0.01 | |
Note 16 – Share-Based Payments
On July 7, 2010, the Company issued 1,300,000 options to its employees that shall vest over three years with a life of five years. The grant date fair value was $0.003729 based on the following assumptions: volatility of 10%, risk free interest rate of 1.76%, dividend yield of 0%, and expected life of 5 years. On November 1, 2010, the Company issued 8,333 options to its consultant, Mr. Larry Chinemployee with a life of five years and strike price of $0.50.years. The grant date fair value was $0.070585 based on the following assumptions: volatility of 12.81%, risk free interest rate of 1.17%, dividend yield of 0%, and expected life of 5 years. No estimate of forfeitures was made as the Company has a short history of granting options. For the sixnine months ended DecemberMarch 31, 2010,2011, the Company recorded approximately $3,389$3,827 of stock-based compensation cost.
The fair value of the options was determined based on the number of shares granted and the quoted price of the Company’s common stock on the grant. The fair value of stock-based compensation was determined using the Black-Scholes model.
Item 22. Management’s Discussion and Analysis of Financial Condition and Results of Operations or Plan of Operations.
Zhongchai Machinery, Inc. (“Zhongchai”), a Nevada corporation, does business through its subsidiary, Zhongchai Holding (Hong Kong) Limited, a Hong Kong company (“Zhongchai Holding”), which in turn operates through Zhejiang ZhongChai Machinery Co., Ltd. (the “Zhongchai China”), a wholly owned subsidiary established under the laws of the People’s Republic of China (the “PRC” or “China”), Zhejiang Shengte Transmission Co., Ltd. (“Shengte”) a company established under the laws of the PRC and wholly owned by Zhongchai China, and Xinchang Xian Lisheng Machinery Co., Ltd. (“Lisheng”), a company established under the laws of the PRC and 60% owned by Zhongchai China. Through its wholly and partially owned operating subsidiaries, Zhongchai is currently engaged in the manufacturing and sale of drivetrain products, such as gears, transmission gearboxes, and drive axels in China.
Results of Operations
Three Months Ended DecemberMarch 31, 20102011 Compared to Three Months Ended DecemberMarch 31, 20092010
Sales
Sales increased by $2,861,036$3,841,717 or 151%120% to $4,750,859$7,044,067 for the three months ended DecemberMarch 31, 20102011 compared to $1,889,823$3,202,350 for the three months ended DecemberMarch 31, 2009.2010. Sales for the three months ended DecemberMarch 31, 20102011 consisted mainly the sales of gears and transmission gearboxes in China. The increase in gear and transmission gearbox sales was attributable to the continued increasing of the Company’s production capabilities, increase sales and an increased share of the market due to the recognition of the Company and its products.
Cost of Sales and Gross Profit Margin
Cost of sales was $3,497,710$5,128,888 for the three months ended DecemberMarch 31, 2010,2011, increasing by $2,014,357,$2,673,935, or 136%109%, from $1,483,353$2,454,953 for the three months ended DecemberMarch 31, 2009.2010. The gross profit margin was approximately 27% for the three months ended March 31, 2011, compared to approximately 23% for the three months ended March 31, 2010. The increase in gross profit margin in this quarter as compared to the same period in the prior fiscal year was attributable mainly to the decrease in transmission gearbox unit cost and therefore the increase in transmission gearbox margin after the expansion in transmission gearbox production capacity and sales.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) expenses consisted primarily of labor costs and overhead costs for sales, marketing, finance, legal, human resources and general management. Such costs also include the expenses recognized for stock-based compensation pursuant to SFAS 123R (ASC 718).
SG&A expenses decreased by $19,320 to $265,020 in the three months ended March 31, 2011, from $284,340 in three months ended March 31, 2010. The change of SG&A was minimal. Even though the sales have increased 120%, SG&A expenses are almost remained the same compared to the amount at March 31, 2010. There were no significant cost decreases in administration, sales, and professional services.
Net Income (Loss)
Net income was $1,451,738 in three months ended March 31, 2011, compared to a net income of $263,861 in the three months ended March 31, 2010. The increase of net income in the quarter is mainly attributable to increased sales and gross profit.
Nine Months Ended March 31, 2011 Compared to Nine Months Ended March 31, 2010
Sales
Sales increased by $8,737,892 or 124% to $15,778,471 for the nine months ended March 31, 2011 compared to $7,040,579 for the nine months ended March 31, 2010. Sales for the nine months ended March 31, 2011 consisted mainly the sales of gears and transmission gearboxes in China. The increase in gear and transmission gearbox sales was attributable to the continued increasing of the Company’s production capabilities, increase sales and an increased share of the market due to the recognition of the Company and its products.
Cost of Sales and Gross Profit Margin
Cost of sales was $11,599,149 for the nine months ended March 31, 2011, increasing by $6,117,669, or 112%, from $5,481,480 for the nine months ended March 31, 2010. The gross profit margin was approximately 26% for the threenine months ended DecemberMarch 31, 2010,2011, compared to approximately 22% for the threenine months ended DecemberMarch 31, 2009.2010. The increase in gross profit margin in this quarter as compared to the same period in the prior fiscal year was attributable mainly to the decrease in transmission gearbox unit cost and therefore the increase in transmission gearbox margin after the expansion in transmission gearbox production capacity and sales.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) expenses consisted primarily of labor costs and overhead costs for sales, marketing, finance, legal, human resources and general management. Such costs also include the expenses recognized for stock-based compensation pursuant to SFAS 123R (ASC 718).
SG&A expenses increased by $316,461$297,345 to $604,411$1,213,875 in the threenine months ended DecemberMarch 31, 2010,2011, from $287,950$916,530 in threenine months ended DecemberMarch 31, 2009. As the sales increased significantly, the company spent more resources in administration, sales, and professional services.
Net Income (Loss)
Net income was $559,559 in three months ended December 31, 2010, compared to a net income of $46,332 in the three months ended December 31, 2009. The increase of net income in the quarter is mainly attributable to increased sales and gross profit.
Six Months Ended December 31, 2010 Compared to Six Months Ended December 31, 2009
Sales
Sales increased by $4,896,175 or 128% to $8,734,404 for the six months ended December 31, 2010 compared to $3,838,229 for the six months ended December 31, 2009. Sales for the six months ended December 31, 2010 consisted mainly the sales of gears and transmission gearboxes in China. The increase in gear and transmission gearbox sales was attributable to the continued increasing of the Company’s production capabilities, increase sales and an increased share of the market due to the recognition of the Company and its products.
Cost of Sales and Gross Profit Margin
Cost of sales was $6,470,261 for the six months ended December 31, 2010, increasing by $3,443,734, or 114%, from $3,026,527 for the six months ended December 31, 2009. The gross profit margin was approximately 26% for the six months ended December 31, 2010, compared to approximately 21% for the six months ended December 31, 2009. The increase in gross profit margin in this quarter as compared to the same period in the prior fiscal year was attributable mainly to the decrease in transmission gearbox unit cost and therefore the increase in transmission gearbox margin after the expansion in transmission gearbox production capacity and sales.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) expenses consisted primarily of labor costs and overhead costs for sales, marketing, finance, legal, human resources and general management. Such costs also include the expenses recognized for stock-based compensation pursuant to SFAS 123R (ASC 718).
SG&A expenses increased by $316,665 to $948,855 in the six months ended December 31, 2010, from $632,190 in six months ended December 31, 2009.2010. As the sales increased significantly, the company spent more resources in administration, sales, and professional services.
Net Income (Loss)
Net income was $1,070,769$2,522,507 in sixnine months ended DecemberMarch 31, 2010,2011, compared to a net income of $17,977$281,838 in the sixnine months ended DecemberMarch 31, 2009.2010. The increase of net income for the period is mainly attributable to increased sales and gross profit.
Accounts Receivable
Accounts receivable were $2,751,677$6,222,150 after a reduction of $17,297$35,053 for doubtful accounts at DecemberMarch 31, 2010,2011, compared to accounts receivable of $3,618,030 after a reduction of $37,670 for doubtful accounts at June 30, 2010. The decreaseincrease in the amount of accounts receivable is mainly attributable to the increased sales of the Company enforcing a strict payment policy on its customers.during the period reported upon. The payment term for sold products usually is 60-90 days, and, to date, the Company’s experience is that the accounts receivable are within the payment terms.
Note Receivable
Notes receivable were $3,772,549$2,761,806 at DecemberMarch 31, 2010,2011, compared to $463,465 at June 30, 2010. All the current note receivables are from the trade accounts. Many of the principal customers of the Company use bank accepted forward drafts to pay for their purchases. As the sales increased during the reported period, the amount of bank accepted forward drafts also increased somewhat in line with the sales increase.
Foreign Currency Translation
All foreign currency assets and liabilities are translated at the period-end exchange rate and all revenues and expenses are translated at the average exchange rate for the period. The effects of translating the financial statements of foreign subsidiaries into U.S. Dollars are reported as a cumulative translation adjustment, a separate component of comprehensive income in stockholder's equity. As the exchange rate between CNY to USD is significantly increased during the sixnine months ended DecemberMarch 31, 2010,2011, the Company recorded a comprehensive income $420,655.
Liquidity and Capital Resources
As of DecemberMarch 31, 2010, Zhongchai had current assets equal to $16,404,613,$19,415,402, current liabilities equal to $15,658,452$17,987,706 and working capital of $746,161.$1,427,696. Zhongchai believes that if there is no sufficient operating capital for its current operations, it will seek an increase in its credit available under current bank loans.
Operating Activities
Net cash used in operating activities was approximately $1.7$0.38 million for the sixnine months ended DecemberMarch 31, 2010,2011, as compared to $0.31$0.25 million net cash used in operating activities for the same period in the prior fiscal year. The change was due to the increase of $3.3$1.54 million in accounts receivable, $1.64 million in trade related notes receivables,receivable, and $2.3$2.77 million in other current liabilities, the decrease of $1.59 million in accounts payable, and $3.45 million in trade related notes payable during the six-monthnine-month period.
Investing Activities
Net cash used in investing activities was $0.44$0.96 million for the six-monthnine-month period ended DecemberMarch 31, 2010,2011, a decrease from $2.11$2.72 million for the same period in fiscal year 2009.2010. The decrease was mainly due to the $2.3 million advance payment being returned to the Company in December 2010. The advance payment was originally made by the Zhongchai China to Xinchai Holdings in 2009, for the purchase of land use rights and building for Zhongchai China’s future expansion of its production capabilities. Because there were several legal issues regarding the transferring of title of ownership, the deposit was returned; however, the Company believes that the issues shall be solved in the future and the Company will pursue title ownership.
Financing Activities
Net cash provided by financing activities was $4.5$4.4 million for the six-monthnine-month period ended DecemberMarch 31, 2010,2011, which consisted of the following: a loan from a bank with an annual fixed interest rate of 5.31% which is due on September 20, 2011; a loan from a bank with an annual fixed interest rate of 5.56% which is due on November 7, 2011; a loan from a bank with an annual fixed interest rate of 5.56% which is due on November 28, 2011; and a loan from a bank with an annual fixed interest rate of 1.98% which is due on December 20, 2011. These loans aggregated a total outstanding loan from a bank in principal amount of $5,876,710.$5,893,510.
Other Current Liabilities
On DecemberMarch 31, 2010,2011, the other current liabilities of the Company were $1,269,054,$1,047,833, which included $438,301$440,612 due to Keyi from the Shengte acquisition in July 2007, there is no any interest charge or penalty due in respect of this liability. The remaining other current liabilities of $830,753$607,221 are as follows:
Professional Fees | | $ | 124,820 | | | $ | 94,524 | |
Accrued Consulting Fees | | $ | 171,950 | | | $ | 123,601 | |
Tax Payment | | $ | 83,794 | | | $ | 84,236 | |
Pre-allocated Warranty Expenses | | $ | 151,700 | | |
Pension Payment | | $ | 3,533 | | | $ | 3,832 | |
Employee Rent Withhold | | $ | 4,334 | | | $ | 5,767 | |
Rent Payment | | | $ | 9,471 | |
Working Meal Payment | | $ | 713 | | | $ | 993 | |
Working Cloth Deposit | | $ | 2,048 | | | $ | 2,333 | |
Other Trade Related Payments | | $ | 287,861 | | | $ | 282,464 | |
Total | | $ | 830,753 | | | $ | 607,221 | |
As Zhongchai expands its operations and considers additional acquisitions of private companies, divisions or product lines, it may require additional capital for its business development and operations. Zhongchai does not have any specific sources of capital at this time; therefore, it would need to find additional funding for its capitalization needs. Such capital may be in the form of either debt or equity or a combination. To the extent that financing is in the form of debt, it is anticipated that the terms will include various restrictive covenants, affirmative covenants and credit enhancements such as guarantees or security interests. The terms of any proposed financing may not be acceptable to Zhongchai. There is no assurance that funding will be identified or accepted by Zhongchai or, that if offered, it will be concluded.
The Company does not have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities” (SPEs).
Please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended June 30, 2010, for disclosures regarding Zhongchai Machinery, Inc.’s critical accounting policies and estimates. The interim financial statements follow the same accounting policies and methods of computations as those for the year ended June 30, 2009. There were no new accounting policies and estimates during the period ended DecemberMarch 31, 20102011 which affects the Company.
Not applicable.
Item 4. Controls and Procedures.
As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, the Chief Executive Officer and Acting Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. There was no change in the Company’s internal control over financial reporting during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 5. Exhibits.