ITEM 1. BUSINESS
We are engaged in two business segments - the forged rolled rings and related components segment, in which we manufacture and sell high precision forged rolled rings, shafts, flanges, and other forged components for the energy industry including wind power and other industries, and the dyeing and finishing equipment segment, in which we manufacture and sell textile dyeing and finishing machines.
Forged rolled rings and related components segment
Through our forged rolled rings and other related products division, we produce precision forged rolled rings and other forged components to the energy industry including wind power and other industries. Our forged rolled rings and other related products are sold for use by manufacturers of industrial equipment for the various industries. Forged rolled rings and other forged components for the wind industry are used in wind turbines, which are used to generate wind power.
The demand for products used in manufacturing in general, and the wind power industries, in particular, is uncertain. Although we believe that over the long term, the forged rolled rings and related components segment will expand, and the government of the PRC has announced its desire to increase the use of wind power and other alternative energy such as solar as an energy source, in the short term, other factors such as economic factors and the fluctuations in the price of oil and coal, may affect the requirements by our customers and potential customers for our products. To the extent that the demand for our forged rolled rings and related components declines, our revenue and net income will be affected.
Among all the renewable energies, we believe that wind power is at a mature stage in terms of the technology and possesses the best prospects for large-scale commercial development. We believe that wind power is becoming competitive with traditional energy sources as the industry continues to grow and production costs continue to fall. We believe that wind power will see its share of China’s national energy mix gradually increase.
We are also marketing our products to other industries. In the fourth quarter of 2014, we received purchase orders for products from our forged rolled rings and related components segments from two customers in industries from which we had not previously received orders. In November 2014, we received a purchase order for a total purchase price of RMB13.3 million (approximately $2.2 million) from a subsidiary of China Petroleum and Chemical Corporation. The purchase order covers parts and equipment including heat exchangers, coolers, reboilers, condensers and prefractionating columns used in offshore oil refineries.
In December 2014, we received a purchase order for a purchase price of RMB80.5 million (approximately $13.0 million) from a large state-owned enterprise based in Xinjiang, China. The purchase order covers parts and equipment including washing, distillation, purifying, dehydration, refining and other columns, along with storage containers, heat exchangers and carbonation reactors that will be used in a large scale project that transforms glycol calcium carbide furnace tail gas into ethylene glycol.
Dyeing and finishing equipment segment
Through our dyeing and finishing segment, we design, manufacture and distribute a line of proprietary high and low temperature dyeing and finishing machinery to the textile industry. Our products feature a high degree of both automation and mechanical-electrical integration. Our products are used in dyeing yarns such as pure cotton, cotton-polyester, terylene, polyester wool, poly-acrylic fiber, nylon, cotton ramie, and wool yarn. We are continuing to seek to utilize our expertise in manufacturing precision products to meet demand in new and existing end markets.
Our airflow dyeing units use air instead of water. Water is used in the traditional dyeing process. We believe that our air-flow technology, which is designed to enable users to meet the stricter environmental standards, results in reduced input costs, fewer wrinkles, less damage to the textile, and reduced emissions. With the growing acceptance of our new dyeing technology and the China government’s mandate to phase out older machinery in China’s textile industry that does not meet the new environmental standards, we expect our revenue from this segment will continue to increase in the near future.
Recently, we have developed a new air-fluid, dual-use dyeing machine which uses both air flow and fluid flow in the dyeing process. It allows users to customize the dyeing process according to the specific type of textile. It is equipped with a series of specialized and patented components, including nozzles, cloth wheels and cloth spreaders, which are designed to permit greater color evenness and reduce defects. It can be used on a wider range of textiles and uses 60% to 70% less water, about 30% less power and 40% to 50% less steam than traditional models of high-temperature, high-pressure dyeing machines and reduces the use of additives by about 50% while shortening dyeing time by 1 to 2 hours.
Organization
We are a Nevada corporation. We were incorporated in Delaware on June 24, 1987 under the name Malex, Inc. We changed our corporate name to China Wind Systems, Inc. on December 18, 2007. On June 13, 2011, we changed our corporate name to Cleantech Solutions International, Inc. On August 7, 2012, we were converted into a Nevada corporation.
We are the sole stockholder of Fulland Limited, a Cayman Islands limited liability company organized on May 9, 2007. Fulland owns 100% of the capital stock of Green Power Environment Technology (Shanghai) Co., Ltd. (“Green Power”) and Wuxi Fulland Wind Energy Equipment Co., Ltd. (“Fulland Wind Energy”), which are wholly foreign-owned enterprises organized under the laws of the PRC. We formed Fulland Wind Energy in August 2008. We currently manufacture our forged products, which are sold for use in the wind, steel and other industries through Fulland Wind Energy.
Green Power is a party to a series of contractual arrangements dated October 12, 2007 with the Huayang Companies, both of which are limited liability companies organized under the laws of, and based in, the PRC, and their stockholders, who are our chief executive officer, Jianhua Wu, and his wife, Lihua Tang. Our corporate organizational structure, including the contractual arrangements with the Huayang Companies, is designed to comply with certain laws and regulations of the PRC which restrict the manner in which Chinese companies, particularly companies owned by Chinese residents, may raise funds from non-Chinese sources.
The following table sets forth our relationship our subsidiaries and the variable interest entities whose financial statements are consolidated with ours.
Our executive offices are located No. 9 Yanyu Middle Road, Qianzhou Village, Huishan District, Wuxi City, Jiangsu Province, China 214181, telephone (86)51083397559.
Our website is www.cleantechsolutionsinternational.com. Information on our website or any other website does not constitute a part of this annual report.
Contractual arrangements with the Huayang Companies and their stockholders
We have contractual arrangements with the Huayang Companies and their stockholders, who are our chief executive officer, Jianhua Wu, and his wife, Lihua Tang, pursuant to which we provide these companies with technology consulting and other general business operation services. Through these contractual arrangements, we also have the ability to substantially influence these companies’ daily operations and financial affairs, appoint their senior executives and approve all matters requiring stockholder approval. As a result of these contractual arrangements, which enable us to control the Huayang Companies, we are considered the primary beneficiary of the Huayang Companies. Accordingly, we consolidate the results, assets and liabilities of the Huayang Companies in our financial statements.
Our relationships with the Huayang Companies and their stockholders are governed by a series of contractual arrangements between Green Power, our wholly foreign owned enterprise in the PRC, and each of the Huayang Companies, which are our operating companies in the PRC. Under PRC laws, each of Green Power, Fulland Wind Energy, Dyeing and Heavy Industries is an independent legal person and none of them is exposed to liabilities incurred by the other parties. Other than pursuant to the contractual arrangements between Green Power and the Huayang Companies described below, generally, neither of the Huayang Companies transfers any other funds generated from its operations to the other Huayang Company. On October 12, 2007, we entered into the following contractual arrangements with each of the Huayang Companies.
Consulting Services Agreement. Pursuant to the exclusive consulting services agreements between Green Power and each of the Huayang Companies, Green Power has the exclusive right to provide to the Huayang Companies general business operation services, including advice and strategic planning, as well as consulting services related to the technological research and development of dye and finishing machines, electrical equipment and related products. Under this agreement, Green Power owns the intellectual property rights developed or discovered through research and development, in the course of providing its services under the agreement, or derived from the provision of the services. The Huayang Companies shall pay a quarterly consulting service fees to Green Power that is equal to all of the Huayang Companies’ profits for such quarter. The term of this agreement, as amended on November 1, 2008, is 20 years from October 12, 2007 and may be extended only upon Green Power’s written confirmation prior to the expiration of the agreement, with the extended term to be mutually agreed upon by the parties.
Operating Agreement. Pursuant to the operating agreement among Green Power, the Huayang Companies and all stockholders of the Huayang Companies, Green Power provides guidance and instruction on the Huayang Companies’ daily operations, financial management and employment issues. The Huayang Companies stockholders must designate the candidates recommended by Green Power as their representatives on the boards of directors of each of the Huayang Companies. Green Power has the right to appoint senior executives of the Huayang Companies. In addition, Green Power agrees to guarantee the Huayang Companies’ performance under any agreements or arrangements relating to the Huayang Companies’ business arrangements with any third party. The Huayang Companies, in return, agrees to pledge their accounts receivable and all of their assets to Green Power. Moreover, the Huayang Companies agree that without the prior consent of Green Power, the Huayang Companies will not engage in any transactions that could materially affect their respective assets, liabilities, rights or operations, including, without limitation, incurrence or assumption of any indebtedness, sale or purchase of any assets or rights, incurrence of any encumbrance on any of their assets or intellectual property rights in favor of a third party or transfer of any agreements relating to their business operation to any third party. The term of this agreement, as amended on November 1, 2008, is 20 years from October 12, 2007 and may be extended only upon Green Power’s written confirmation prior to the expiration of the this agreement, with the extended term to be mutually agreed upon by the parties.
Equity Pledge Agreement. Under the equity pledge agreement between the Huayang Companies stockholders and Green Power, the Huayang Companies’ stockholders pledged all of their equity interests in the Huayang Companies to Green Power to guarantee the Huayang Companies’ performance of their obligations under the consulting services agreement. If the Huayang Companies or the Huayang Companies’ stockholders breach their respective contractual obligations, Green Power, as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests. The Huayang Companies stockholders also agreed that upon occurrence of any event of default, Green Power shall be granted an exclusive, irrevocable power of attorney to take actions in the place and stead of the Huayang Companies stockholders to carry out the security provisions of the equity pledge agreement and take any action and execute any instrument that Green Power may deem necessary or advisable to accomplish the purposes of the equity pledge agreement. The Huayang Companies’ stockholders agreed not to dispose of the pledged equity interests or take any actions that would prejudice Green Power’s interest. The equity pledge agreement will expire two years after the Huayang Companies’ obligations under the consulting services agreements have been fulfilled.
Option Agreement. Under the option agreement between the Huayang Companies’ stockholders and Green Power, the Huayang Companies’ stockholders irrevocably granted Green Power or its designated person an exclusive option to purchase, to the extent permitted under PRC law, all or part of the equity interests in the Huayang Companies for the cost of the initial contributions to the registered capital or the minimum amount of consideration permitted by applicable PRC law. Green Power or its designated person has sole discretion to decide when to exercise the option, whether in part or in full. The term of this agreement, as amended, is 20 years from October 12, 2007 and may be extended prior to its expiration by written agreement of the parties.
The Forged Rolled Rings and Related Components Segment
We manufacture rolled rings and other related components designed to be used for issue in the wind power industry as well as other uses. We employ axial close-die forging technology in producing precision forgings, a technology for producing rotary precision forgings. We made the forging machine, which we believe provides us with an advantage in machine maintenance and cost compared with other companies using foreign equipment. Our rolled rings are essentially hollow cylindrical sections forged from a stainless steel stock of varying thickness and height. The rings are called rolled rings because of the nature of the forging process. Forging is a manufacturing process where metal is pressed, pounded or squeezed under great pressure to create high strength parts. Rolled ring forging turns a hollow round piece of metal under extreme pressure against a rotating roller, thereby squeezing out a single-piece ring without any welding required.
Rings can also be manufactured through machining or casting. We believe that forging provides increased strength and flexibility for the finished product. A ring’s strength affects its fatigue resistance, and is determined by the orientation of the grain flow of the ring’s metal material. Unlike the machining process, which creates a unidirectional grain flow, or the casting process, which creates no grain flow, the forging process is designed to cause alignment and orientation of the grain flow in a direction creating maximum strength, thereby providing maximum fatigue resistance. This high strength property also reduces sectional thickness and overall weight of the ring without compromising the overall integrity of the finished product.
High tangential strength and ductility make forged rings well-suited for torque- and pressure-resistant components, such as gears, engine bearings for aircraft, wheel bearings, couplings, rotor spacers, sealed discs and cases, flanges, pressure vessels and valve bodies. As such, rolled rings have a wide variety of applications. Presently, the majority of Chinese rolled ring producers rely on technologies such as the steam hammer and friction press, which consume large amounts of energy and cause pollution, and which, we believe, result in a less desirable product.
Yaw bearings, which are found in every wind turbine, are made from rolled rings. Essentially, a yaw bearing is a large ring with teeth, all of which are either pointing outward or inward. The teeth allow the yaw bearing to engage with a smaller wheel attached to the yaw motor. The yaw motor turns the wind turbine so that the rotor (to which blades are attached) faces the wind in order to optimize electricity generation. The yaw bearing is used by the yaw motor to turn the wind turbine.
Manufacturing
In 2009, we opened our state-of-the-art forging facility. Our operations feature a 4,500-ton press and a ring-rolling mill, employing our advanced axial close-die forging technology, to manufacture rolled rings measuring up to 6.3 meters in diameter and a cross section up to 700mm and shafts used in wind turbine units that are designed to generate wind power in the range of 1MW-3MW. We also have a series of workshops dedicated for fabrication, welding, machining and assembly of high strength materials.
We believe that our forging facility, which is able to meet the quality requirements of our most demanding customers, has an annual capacity of 50,000 tons.
The melting, forging, heat-treating and machining capability at our facility allows for the manufacturing of a wide range of custom-forged products. Multi-diameter shafts, gear blanks, mandrel-forged rings and specialized shapes, are available in a wide range of sizes and weights ranging from a few hundred pounds to over 25,000 pounds. Most popular carbon and alloy AISI/SAE grades such as 1026, 1045, 4140, 4150F, 4340, and 8620 are readily available. We also have experience with the melting and forming of specialized alloys. We believe that we are capable of producing components that meet various industry specifications as well as product-specific specifications.
Our manufacturing site covers over 1.1 million square feet. In addition to our forging operation we have established state-of-the-art fabrication, machining, assembly and finishing workshops to meet the manufacturing needs of our clean technology focused customer base.
We believe that we are a major Chinese manufacturer of:
● Large forged rolled rings, yaw bearings, tower flanges and shafts used in large-scale windmills;
● Stainless steel pressure vessel/chambers used in the manufacturing of multi-crystalline solar wafers;
● Specialty, high tolerance, fabricated components and assemblies used in various clean technology industries;
● Other fabricated and machined components, assemblies and equipment requiring high precision manufacturing.
During the years ended December 31, 2011 and 2010, we generated revenue from one customer for products which required the use of our electro-slag remelted (“ESR”) equipment. We had purchased the equipment in anticipation of a demand for ESR products which did not materialize. On March 3, 2014, we entered into an equipment operating lease with Shanghai Liangting Metallurgy Roll Manufacture Co., Ltd. pursuant to which we leased the ESR equipment to for a quarterly rate of RMB 1,450,000, which, at the present exchange rate is approximately $236,000. The lease has an eight-year term commencing April 1, 2014. The equipment remains on our premises, and the lease gives the lessee a right of access to our premises for the purpose of using the equipment. The equipment is shown on our consolidated balance sheet at December 31, 2014 as equipment held for sale and at December 31, 2013 as equipment held for operating lease. In early 2015, the lessee stopped using the equipment and stopped paying rent to us on the equipment. As a result, we incurred an impairment loss on the ESR equipment in the amount of approximately $3.8 million during the fourth quarter of 2014. For the year ended December 31, 2013, we recorded an impairment loss of $2,573,256 related to the ESR equipment.
Marketing and Distribution
Based at our facilities in Wuxi, we have a sales team of five employees for our forged rolled rings and shafts. Our marketing efforts include participation at industrial conferences and trade fairs, sales training, and advertising. Our sales team works closely with our product development and manufacturing teams to coordinate our product development activities, product launches and ongoing demand and supply planning. Our rolled rings, flanges and other forged products are currently sold to companies in cities and provinces throughout China including Luoyang, Shenyang, Zhenjiang province, Jiangsu province, Qingdao, Jinan, Shanghai, Chongqing, Beijing, Xinjiang, and Zhengzhou. We are an ISO9001:2000 certified supplier.
Competition
The markets for products in our forged rolled rings and related products are intensely competitive. Many of our competitors have established more prominent market positions, and if we fail to attract and retain customers and establish successful distribution networks in our target markets for our products, we will be unable to increase our sales. Many of our existing and potential competitors have substantially greater financial, technical, manufacturing and other resources than we do. Our competitors’ greater size in some cases provides them with a competitive advantage with respect to manufacturing costs because of their economies of scale and their ability to purchase raw materials at lower prices, as well as securing supplies at times of shortages. Many of our competitors also have greater brand name recognition, more established distribution networks and larger customer bases. In addition, many of our competitors have well-established relationships with our current and potential distributors and have extensive knowledge of our target markets. As a result, they may be able to devote greater resources to the research, development, promotion and sale of their products or respond more quickly to evolving industry standards and changes in market conditions than we can. Our failure to adapt to changing market conditions and to compete successfully with existing or new competitors may materially and adversely affect our financial condition and results of operations.
We believe there has been an increase in overall competition in the forged product market as industry capacity has increased and the market for the product has slowed. Additionally, we believe some turbine manufacturers that use forged products and are not our customers or potential customers, have built their own forging capacity to save costs by vertical integration and to have better leverage when negotiating with the component suppliers. This resulted in downward pressure on our pricing and may indirectly affect our sales as a result of increased competition for a smaller number of potential customers. Our products are sold for use by manufacturers of industrial equipment. The demand for products such as ours which are used both for manufacturing in general and for wind power specifically is uncertain. Although we believe that over the long term, our forged rolled rings and related components segment will expand and the government of the PRC has announced its desire to increase the use of wind power as an energy source, in the short term other factors have affected the requirements of our wind power customers and potential customers for our products which has had an effect of lessening the demand for wind power products such as ours. To the extent that the demand for our forged rolled rings and related components for both wind power and other industries declines, our revenue and net income will continue to be affected.
We believe that we are well positioned to capitalize on the opportunities provided by the demand for products by the wind power industry and other industries in China by supplying superior quality, high performance forged products. We believe that we offer:
●High quality manufacturing facilities and production quality;
●A prime location in Jiangsu province near major transportation routes which can provide shipping cost savings and a good response time;
●Strong management, engineering and technical capabilities;
●ISO9001 certification, which covers machining and related service of shaft-shaped forging, ring forging, tubular forging and component assembly.
The Dyeing and Finishing Segment
In recent years, China has been one of the world’s leading textile producers, and the textile industry has been a pillar in the Chinese national economy, experiencing generally steady growth over the last few decades. We believe that the textile business has continued to improve due to the tax reimbursement for export incentive given by the PRC government and we believe that the market for dyeing and finishing equipment is improving, in large part because of the environmental policies of the Chinese government which are resulting in an increased market for equipment designed to enable dyeing companies to comply with the environmental standards.
In our dyeing and finishing segment, we design, manufacture and distribute a line of proprietary high and low temperature dyeing and finishing machinery. We believe that we are one of the leading domestic Chinese manufacturers of textile dyeing machines, and our Huayang brand is nationally recognized. We currently have the capacity to manufacture and assemble approximately 600 textile-dyeing machines annually. Our state-of-the-art and automated production line enables us to manufacture our products efficiently, with lower labor and energy costs compared to traditional manufacturing methods. As part of our manufacturing process, we make corrosion-resistant stainless steel pumps and pressure vessels, which are not only critical components for our dyeing and finishing products but have other industrial applications as well.
We have received the “Advanced Enterprise for Progress in Science and Technology Award” from Wuxi City in 1999, and the “Star of Brilliance Medal” from the Wuxi City Bureau of Industrial and Commercial Administration in the same year. In 2002, we were recognized as an “Advanced Enterprise for Technical Reform Input” by Qianzhou, a municipality within Wuxi City for our dyeing products.
We hold eight Chinese patents (Patent Nos. ZL 2012 2 0165878.7, ZL 2012 2 0752919. 2, ZL 2012 2 0752924. 3, ZL 2012 2 0752922. 4, ZL 2012 2 0752921. X, ZL 2012 2 0752917. 3, ZL 2013 1 0004772.8 and ZL 2013 1 0004736.1). These patents cover an innovative production technique enabling more-effective cloth washing in dyeing machines under high temperature and pressure, the dyeing liquid mixing device, dyeing liquid atomizing device, horizontal manipulated devices, mechanical seal and atomizer of its airflow dyeing machine and cover components of the hot air circulation system of low emission air flow dyeing machines. The patents were issued by the State Intellectual Property Office of the People’s Republic of China in November 2012, as to the first patent, and June 2013 as to the other five, and September 2014 as to the last two. Under the PRC patent laws, the patents give us the exclusive right to use the patented process or product for a period of ten years for the first six patents and give us the exclusive use of the system components in dyeing equipment for a period of 20 years for the last two patents.
Our dyeing and finishing products are generally compact in design compared with alternatives on the market and feature a high degree of both automation and mechanical-electrical integration. Our products are used in dyeing a wide variety of yarns such as pure cotton, cotton-polyester, terylene, polyester wool, poly-acrylic fiber, nylon, cotton ramie, and wool yarn. In 2010, we introduced an advanced dyeing technology enabling a quick, economic and environment-friendly operation designed for optimal performance. The liquid pressure and quantity are adjusted to the respective type and quantity of fabric. The special layout of the pressure pump circuit is designed to provide constant and safe operations of the machine reducing resources wastage and enhancing performance.
We developed a new model of dyeing machine - high (low) temperature airflow dyeing machine. We believe that this new model of dyeing machine is efficient and cost effective and meets the requisite Chinese environmental standards. In September 2014, we received two patents which cover components of the hot air circulation system of our low emission air flow dyeing machines. We believe that the hot air circulation system helps to enhance the machines’ ability to produce higher quality textiles with a better look and feel.
Recently, we have developed a new air-fluid, dual-use dyeing machine which uses both air flow and fluid flow in the dyeing process. It allows users to customize the dyeing process according to the specific type of textile. It is equipped with a series of specialized and patented components, including nozzles, cloth wheels and cloth spreaders, which are designed to permit greater color evenness and reduce defects. It can be used on a wider range of textiles and uses 60% to 70% less water, about 30% less power and 40% to 50% less steam than traditional models of high-temperature, high-pressure dyeing machines and reduces the use of additives by about 50% while shortening dyeing time by 1 to 2 hours.
Marketing and Distribution
All of our revenue from the textile dyeing machine segment is derived from sales in China. We presently sell our products in Jiangsu and Zhejiang Provinces, both regions with significant textile production, as well as in many of the coastal regions of China such as Shandong and Guangdong provinces.
We market and sell our products through our internal sales force, which is based in our facilities in Wuxi. Our marketing programs include industrial conferences, trade fairs, sales training and advertising. Our sales and marketing groups work closely with our manufacturing groups to coordinate our product development activities, product launches and ongoing demand and supply planning. We sell our products directly to many of China’s largest textile producers. During the year ended December 31, 2014, no customer accounted for 10% or more of our sales.
Growth Strategies
According to China’s National Development and Reform Commission, the main focus of the country’s textile industry has shifted from gaining competitive advantages based on labor costs toward the objectives of developing scientific and technological innovation as well as brand creation. Under the auspices of China’s Twelfth Five Year Plan, which was implemented in 2011, the next stage for the textile and dyeing industries in China is to strengthen pollution control, according to the Bureau of Economic Operation under the National Development and Reform Commission.
In support of this objective, we are continuing our efforts to develop and implement next-generation low energy consumption and high heating efficiency features to our machines. The current emphasis of our efforts continues to be on increasing automation features in our existing products and implementing power line communication technology throughout our production facilities to enable our customers to reduce their use of electricity and water.
Competition
Because of the importance of the Chinese textile industry in the world market, we face competition from both domestic and foreign suppliers. However, we believe that, due to the high quality of our products, our principal competition is from suppliers based in foreign countries, including Japan, Germany, Italy and France. Domestically, our chief competitor is Fong’s National Engineering (Shenzhen) Co., Ltd., a subsidiary of Fong’s Industries Company Ltd., a Hong-Kong based conglomerate.
We believe that we can effectively compete with these companies on the basis of the quality and performance of our products, our after-sales service, and cost. We provide one year of maintenance and repair services for all of our products and based on historical we experience, maintenance and repair service calls have been minimal. Moreover, we provide customers in the Jiangsu and Zhejiang Provinces, our top markets, with on-site support which is generally provided within 24 hours of receiving a request. However, many of our competitors have longer operating histories and significantly greater financial or technological resources than we do and presently enjoy greater brand recognition.
Source of Supply
Stainless steel is the principal raw material for the manufacture of all of our products. We purchase stainless steel tubes from Wuxi City Zhongtian Stainless Steel Co., Ltd. and stainless steel plates from Wuxi City Fanshun Materials Co., Ltd. In 2014 and 2013, our purchases of steel from Wuxi City Fanshun Materials Co., Ltd accounted for approximately 20% and 27%, respectively, of our total purchases. While we do not have long-term contracts with these suppliers, we have long-term business relationship with them, and these companies have generally met our supply requirements. For the textile machinery business, the price of steel can have more significant impact. Any significant rise in the price of or demand for stainless steel could have an adverse effect on our results of operations. Inflation has recently affected raw materials generally, and inflationary pressures could have a significant effect on our business, particularly on our dyeing and finishing segment. To the extent that we are not able to pass along price increases for stainless steel to our forging customers, these factors will affect this segment as well.
Other raw materials, such as stainless steel planks and transducers, are readily available from a number of suppliers on commercially reasonable terms.
Research and Development
We incurred research and development expense in the amount of $116,061 and $92,803 related to the development and improvement of our new dyeing machinery in 2014 and 2013, respectively. In our forged rolled rings and related product segment, we plan to concentrate our product development efforts on developing enhancement of rolled rings and related products principally for the wind power and other industries.
Government Regulations
Environmental Regulations
Our manufacturing processes generate noise, waste water, gaseous and other industrial wastes, and we use, generate and discharge toxic, volatile and otherwise hazardous chemicals and wastes in our operations. As a result, we are required to comply with all national and local regulations regarding protection of the environment. Our operations are subject to regulations promulgated by China’s Environmental Protection Administration, Jiangsu Province Environmental Protection Administration and the Wuxi City Environmental Administration. We are also subject to periodic monitoring by local environmental protection authorities in Wuxi. We have installed various types of anti-pollution equipment in our facilities to reduce, treat, and, where feasible, recycle the wastes generated in our manufacturing processes. We believe that our manufacturing facilities and equipment are in substantial compliance with all applicable environmental regulations. Based on the requirement of present law, we do not expect that any additional measures that may be required to maintain compliance will materially affect our capital expenditures, competitive position, financial position or results of operations.
The Chinese government has expressed a concern about pollution and other environmental hazards. Although we believe that we comply with current national and local government regulations, if it is determined that we are in violation of these regulations, we can be subject to financial penalties as well as the loss of our business license, in which event we would be unable to continue in business. Further, if the national or local government adopts more stringent regulations, we may incur significant costs in complying with such regulations. If we fail to comply with present or future environmental regulations, we may be required to pay substantial fines, suspend production or cease operations. Any failure by us to control the use of or to restrict adequately the discharge of, hazardous substances could subject us to potentially significant monetary damages and fines or suspensions in our business operations.
Our products must also comply with applicable environmental regulations, and we believe we are in material compliance with all applicable environmental laws and regulations applicable to our products.
Business License
Green Power, Fulland Wind Energy and both of the Huayang Companies have been issued business licenses with the appropriate municipal and provincial governments which specifically authorize the companies to operate their respective businesses. All of these business licenses, which are subject to annual review by the issuing agencies, are current as of the date of this annual report. No additional approval or license is required for the manufacturing and sale of the textile dyeing and finishing machines or the rolled rings.
ISO Certification
We received the International Organization for Standardization (ISO) certificate for our new facility in Wuxi City on July 15, 2009. The certificate accredits our quality management system as compliant with ISO9001:2008 and covers machining and related service of shaft-shaped forging, ring forging, tubular forging and component assembly. The certification was renewed in August 2012 and expires on August 12, 2015. We also received the certificate of Level A Pressure Vessel from the General Administration of Quality Supervision, Inspection and Quarantine of the People’s Republic China on August 18, 2009 and covers the manufacturing of pressure vessel pipelines. This certificate was renewed in 2013 and expires on December 6, 2015.
Our Dyeing segment also has received the certificate to manufacture D1 and D2 levels of pressure vessels, which includes our current line of dyeing machines, from the Quality and Technical Supervision Bureau of Jiangsu Province. We received the certificate on December 7, 2007 and renewed it on November 11, 2011. This certificate expires on December 6, 2015.
Since our ISO certifications expire in 2015, in connection with the renewal process, we will be subject to inspection of our facilities by Beijing Zhen Xing Industry Management System Certification Ltd., an independent inspection company, before the expiration dates. If any violation is found, the inspection company will recommend appropriate corrections and issue the renewed certifications once the related corrections are made and our facilities pass inspection to confirm compliance.
Circular 106 Compliance and Approval
On May 31, 2007, the State Administration of Foreign Exchange, or SAFE, issued an official notice known as “Circular 106,” which requires the owners of any Chinese companies to obtain SAFE’s approval before establishing any offshore holding company structure for foreign financing as well as subsequent acquisition matters in China. Accordingly, in early September 2007, the owners of 100% of the equity in the Huayang Companies, namely Jianhua Wu and Lihua Tang, submitted their application to SAFE. On October 11, 2007, SAFE approved their application, permitting them to establish an offshore company, Fulland, as a “special purpose vehicle” for any foreign ownership and capital raising activities by the Huayang Companies. After SAFE’s approval, Mr. Wu and Ms. Tang became the majority owners of Fulland on October 11, 2007. Fulland was acquired by us in November 2007.
Draft Foreign Investment Law
On January 19, 2015, the Ministry of Commerce of China (“MOFCOM”) published a draft version of a proposed Foreign Investment Law with an explanatory note. The draft Foreign Investment Law, if and when promulgated, will replace and integrate the three existing laws over foreign investment, the Law of the PRC on Chinese-Foreign Equity Joint Ventures, the Wholly Foreign-owned Enterprise Law and the Law of the PRC on Sino-foreign Cooperative Enterprises. The draft Foreign Investment Law was formulated with a view to opening wider to the outside, promoting and regulating foreign investment, protecting the legitimate rights and interests of foreign investors, safeguarding national security and public interests, and facilitating the healthy development of the socialist market economy. MOFCOM has requested comments from the public on the draft Law by February 17, 2015.
Some of the more significant concepts in the draft Foreign Investment Law include the following:
Effective Control
The proposed law has adopted the concept of effective control in the foreign investment area. The draft Foreign Investment Law notes that a company established in China but controlled by foreign investors shall be deemed a foreign investor and foreign entities controlled by Chinese investors can, in some circumstances, be deemed Chinese domestic investors. According to the draft Foreign Investment Law, “control” refers to several circumstances including the contractual control by imposing decisive influences on the operation, finance, personnel or technology of the enterprise by contract, trust or other means.
Negative List Management
Most foreign investments will not need pre-approval as was previously required. It means that the Chinese market could be more open and efficient in some sectors to set up foreign invested companies. However, the draft Foreign Investment Law sets out a Negative List, or Catalogue of Prohibitions. Foreign investors are not allowed to invest in any sector set out in the Catalogue of Prohibitions. Further, a Catalogue of Restrictions will note those sectors with restrictions imposed on foreign investors. The use of Negative lists represents a method of management or administration of foreign investments.
How domestic VIEs, potentially deemed to be foreign enterprises under the draft Foreign Investment Law and currently operating in Negative List sectors, will be treated is unclear.
National Security Reviews
The draft Foreign Investment Law also establishes a united foreign investment national security review system which will conduct examinations on the foreign investments that endangers or may endanger the national security.
Information Reporting System
The draft Foreign Investment Law establishes a foreign investment information reporting system. The new rules include submission of a foreign investment report (such as when setting up a company), a report of any Changes of Foreign Investment (any adjustments of investment) and an annual report. Generally, reporting obligations arise when a foreign investor purchases not less than 10% of the stock of a domestic entity, or less than 10% but the purchase results in a change of control of the domestic entity.
Supervision and Inspection
The draft Foreign Investment Law establishes a mechanism for the supervision and inspection of foreign investors and foreign invested enterprises from industrial and commercial, taxation, foreign exchange, auditing and other administrative departments. The government’s eye on foreign investments and foreign investment management has shifted from the approval prior to a foreign invested company being established to the supervision and inspection after it is set up.
PRC laws and regulations governing the validity of these contractual arrangements are uncertain and the relevant government authorities have broad discretion in interpreting these laws and regulations. If the PRC government determines that our contractual arrangements do not comply with applicable laws and regulations, it could revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, block our website, require us to restructure our operations, impose additional conditions or requirements with which we may not be able to comply, or take other regulatory or enforcement actions against us that could be harmful to our business. The imposition of any of these penalties would result in a material and adverse effect on our ability to conduct our business.
Intellectual Property Rights
We rely on a combination of trademark, copyright and trade secret protection laws in China and other jurisdictions, as well as confidentiality procedures and contractual provisions to protect our intellectual property and our brand. We hold eight Chinese patents, all of which relate to our dyeing products. The patents were issued by the State Intellectual Property Office of the People’s Republic of China in November 2012, as to the first patent, and June 2013 as to the other five and September 2014 as to the last two. Under the PRC patent laws, the first six patents and the last two patents give us the exclusive right to use the patented process or product for a period of ten years and twenty years, respectively.
The following table sets forth information concerning our patents.
We intend to apply for more patents to protect our core technologies. We also have confidentiality and non-competition policies in place as part of our company employment guideline which is given to each employee, and we enter into nondisclosure agreements with third parties. However, we cannot assure you that we will be able to protect or enforce our intellectual property rights.
Employees
As of March 30, 2015, we had 174 full time employees. Of these, 128 employees are in the dyeing and finishing segment (ten executives, managers and administrative staff, four accounting staff, three quality control staff, three engineers and technicians, six marketing and salespeople, three purchasing staff and 99 manufacturing staff) and 46 employees are with our forged rolled rings and related products segment (seven executive, managers and administrative staff, two accounting staff, three salespeople, one purchasing staff, and 33 manufacturing staff.).
Our manufacturing employees usually work in two shifts, based upon our manufacturing requirements. We may also send our engineers and technicians to our customers’ work sites to provide after-sale customer service for them.
All of these employees are members of a union, organized by the Union for Huishan District, Wuxi City, as mandated by the PRC Union Law. We have not experienced a work strike. We believe that our relations with our employees are good.
ITEM 1A.
ITEM 1A. RISK FACTORS
An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this report, before making an investment decision, and you should only consider an investment in our common stock if you can afford to sustain the loss of your entire investment. You should carefully consider the risks described below together with all of the other information included in this report before making an investment decision with regard to our securities. If any of the following risks occurs, our business, financial condition or results of operations could be harmed. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Business
We are incurring significant obligations in developing the manufacture of forged rolled rings for use in the wind power industry and other industries with no assurance that we can or will be successful in this business.
Wind power account for a small percentage of the power generated in the PRC, and our ability to market to this segment is dependent upon both an increased acceptance of wind power as an energy source in the PRC and the acceptance of our products. We are making the financial and manpower commitment in our belief that there will be an increased demand for wind power in China and elsewhere and that the companies that manufacture wind power generation equipment and other equipment that uses our products will purchase our products. We cannot assure you that we will be able to successfully develop this business, and our failure to develop the business will have a material adverse effect on our overall financial condition and the results of our operations.
We will require additional funds to expand our operations.
In connection with any expansion projects for our business, we will incur significant capital and operational expenses. We do not presently have any funding commitments other than our present credit arrangements which we do not believe are sufficient to enable us to expand our business. If we are unable to generate cash flow from operations and obtain necessary bank or other financing to pay for significant capital or operational expenses, we may be unable to finance the growth of our existing business, which may impair our ability to operate profitably. Because of our stock price and the worldwide economic situation, we may not be able to raise any additional funds that we require on favorable terms, if any. The failure to obtain necessary financing may impair our ability to expanse or business and remain profitable.
We rely on short term financing to fund our operations.
We have historically financed our operations through short-term bank loans, which have been refinanced upon maturity. At December 31, 2014, we had outstanding short-term bank loans of approximately $3.1 million. We cannot assure you that we would be able to obtain alternative financing in the event that our lenders did not renew our short-term loans. Our failure to have the bank loans refinanced could materially impair our ability to operate our business.
A decrease in supply or increase in cost of the materials used in our products could harm our profitability.
Any restrictions on the supply or the increase in the cost of the materials used by us in manufacturing our products, especially steel, could significantly reduce our profit margins. Efforts to mitigate restrictions on the supply or price increases of materials by entering into long-term purchase agreements, by implementing productivity improvements or by passing cost increases on to our customers may not be successful. Increased competition may affect our ability to pass on to our customers’ price increases in raw materials, particularly, stainless steel, which is our principal raw material for all of our products. Our profitability depends largely on the price and continuity of supply of the materials used in the manufacture of our products, which in many instances are supplied by a limited number of sources.
Inflationary and competitive pressures may affect our ability to maintain our margins.
In recent years, raw materials, including steel, which is our principal raw material, have been subject to significant price increases. The Chinese government has expressed concern about inflation in certain segments of the economy. We cannot predict the extent or effect of inflationary pressures with respect to steel and steel products. To the extent that we have to raise our prices to maintain our margins, our sales may suffer. If we are unable to raise prices, either because of competitive factors or customer resistance, our margins and net income may suffer. We cannot assure you that our business will not be impaired by inflation.
The nature of our products creates the possibility of significant product liability and warranty claims, which could harm our business.
Customers use some of our products in potentially hazardous applications that can cause injury or loss of life and damage to property, equipment or the environment. In addition, some of our products are integral to the production process for some end-users and any failure of our products could result in a suspension of operations. We cannot be certain that our products will be completely free from defects. Moreover, we do not have any product liability insurance and may not have adequate resources to satisfy a judgment in the event of a successful claim against us. The successful assertion of product liability claims against us could result in potentially significant monetary damages and require us to make significant payments.
If we fail to introduce enhancements to our existing products or to keep abreast of technological changes in our markets, our business and results of operations could be adversely affected.
Although certain technologies in the industries that we occupy are well established, we believe our future success depends in part on our ability to enhance our existing products and develop new products in order to continue to meet customer demands. In particular, the next generation of wind turbines requires components that are stronger than the present generation. Although we are seeking to address these requirements with our forged products, our failure to introduce and develop a market for these and any other new or enhanced products on a timely and cost-competitive basis, as well as the development of processes that make our existing technologies or products obsolete, could harm our business and results of operations.
Because we face intense competition from other companies for both of our operating segments, many of which have greater resources than we do, we may not be able to compete successfully and we may lose or be unable to gain market share.
The markets for products in both of our business segments are intensely competitive. Many of our competitors have established more prominent market positions, and if we fail to attract and retain customers and establish successful distribution networks in our target markets for our products, we will be unable to increase our sales. Many of our existing and potential competitors have substantially greater financial, technical, manufacturing and other resources than we do. Our competitors’ greater size in some cases provides them with a competitive advantage with respect to manufacturing costs because of their economies of scale and their ability to purchase raw materials at lower prices, as well as securing supplies at times of shortages. Many of our competitors also have greater brand name recognition, more established distribution networks and larger customer bases. In addition, many of our competitors have well-established relationships with our current and potential distributors and have extensive knowledge of our target markets. As a result, they may be able to devote greater resources to the research, development, promotion and sale of their products or respond more quickly to evolving industry standards and changes in market conditions than we can. Our failure to adapt to changing market conditions and to compete successfully with existing or new competitors may materially and adversely affect our financial condition and results of operations. Further, from time to time, we have had to adjust the prices of our products to remain competitive.
Compliance with environmental regulations can be expensive, and noncompliance with these regulations may result in adverse publicity and potentially significant monetary damages and fines.
As our manufacturing processes generate noise, wastewater, gaseous and other industrial wastes, we are required to comply with all national and local regulations regarding protection of the environment. If we fail to comply with present or future environmental regulations, we may be required to pay substantial fines, suspend production or cease operations. We use, generate and discharge toxic, volatile and otherwise hazardous chemicals and wastes in our activities. Any failure by us to control the use of or to restrict adequately, the discharge of hazardous substances could subject us to potentially significant monetary damages and fines or suspensions in our business operations. We do not have insurance to cover any liability which we may incur as a result of personal injury or property damages resulting from emissions of toxic material into the environment.
Our ISO certifications expire in 2015, and our failure to maintain these certifications could impair our ability to obtain customers for our products.
Since our ISO certifications expire in 2015, we need to complete the renewal process in order to continue to maintain these certifications. The renewal process requires an inspection of our facilities by an independent inspection company. Our failure to maintain, or any delay in obtaining, a continuation of our ISO certification could impair our ability to attract business which could affect both our revenue and our gross margin.
Our products are subject to PRC regulations, which may materially adversely affect our business.
Government regulations influence the design, components or operation of our products. New regulations and changes to current regulations are always possible and, in some jurisdictions, regulations may be introduced with little or no time to bring related products into compliance with these regulations. Our failure to comply with these regulations may restrict our ability to sell our products in the PRC. In addition, these regulations may increase our cost of supplying the products by forcing us to redesign existing products or to use more expensive designs or components. In these cases, we may experience unexpected disruptions in our ability to supply customers with products, or we may incur unexpected costs or operational complexities to bring products into compliance. This could have an adverse effect on our revenues, gross profit margins and results of operations and increase the volatility of our financial results.
The success of our businesses will depend on our ability to effectively develop and implement strategic business initiatives.
In connection with the development and implementation of our growth plans, we will incur additional operating expenses and capital expenditures. The development and implementation of these plans also requires management to divert a portion of its time from day-to-day operations. These expenses and diversions could have a significant impact on our operations and profitability, particularly if our plans for any new initiative prove to be unsuccessful. Moreover, if we are unable to implement any of our plans in a timely manner, or if those plans turn out to be ineffective or are executed improperly, our business and operating results would be adversely affected.
Failure to successfully reduce our production costs may adversely affect our financial results.
A significant portion of our strategy relies upon our ability to successfully rationalize and improve the efficiency of our operations. If we are not able to implement cost reduction measures, especially in times of either an economic downturn or inflationary pressures, or if these efforts do not generate the level of cost savings that we expect going forward or result in higher than expected costs, there could be a material adverse effect on our business, financial condition, results of operations or cash flows.
If we are unable to make necessary capital investments or respond to pricing pressures, our business may be harmed.
In order to remain competitive, we need to invest in product development, manufacturing, customer service and support, and marketing. We do not have any significant research and development activities. We may not have available sufficient financial or other resources to continue to make investments necessary to maintain our competitive position. Currently, our research and development is not significant.
Unforeseen or recurring operational problems at our facilities may cause significant lost production, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our manufacturing processes could be affected by operational problems that could impair our production capability. Our facilities contain complex and sophisticated machines that are used in our manufacturing process. Disruptions at our facilities could be caused by maintenance outages; prolonged power failures or reductions; a breakdown, failure or substandard performance of any of our machines; the effect of noncompliance with material environmental requirements or permits; disruptions in the transportation infrastructure, including railroad tracks, bridges, tunnels or roads; fires, floods, earthquakes or other catastrophic disasters; labor difficulties; or other operational problems. Any prolonged disruption in operations at our facilities could cause significant lost production, which would have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our officers and directors own a substantial portion of our outstanding common stock, which will enable them to influence many significant corporate actions and in certain circumstances may prevent a change in control that would otherwise be beneficial to our shareholders.
As of March 30, 2015, our officers and directors and members of their families beneficially owned approximately 38.1% of our outstanding voting shares. Our by-laws provide that a quorum for action by stockholders is one-third of the outstanding shares. Consequently, these stockholders, acting together, could have a substantial impact on matters requiring the vote of the shareholders, including the election of our directors and most of our corporate actions. This control could delay, defer or prevent others from initiating a potential merger, takeover or other change in our control, even if these actions would benefit our shareholders and us. This control could adversely affect the voting and other rights of our other shareholders and could depress the market price of our common stock.
Our business depends substantially on the continuing efforts of our executive officers and our ability to maintain a skilled labor force, and our business may be severely disrupted if we lose their services.
Our future success depends substantially on the continued services of our executive officers, especially Mr. Jianhua Wu, our chief executive officer and the chairman of our board of directors. We do not maintain key man life insurance on any of our executive officers. If one or more of our executive officers are unable or unwilling to continue in their present positions, we may not be able to replace them readily, if at all. Therefore, our business may be severely disrupted, and we may incur additional expenses to recruit and retain new officers. In addition, if any of our executives joins a competitor or forms a competing company, we may lose some of our customers. Our chief executive officer is a party to contractual agreements as described elsewhere in our annual report.
A significant portion of our business is conducted through the Huayang Companies, which are owned by our chief executive officer and his wife.
Approximately 11.5% of our forged rolled rings and related products revenue and all of our dyeing and finishing equipment business is conducted by the Huayang Companies, which are variable interest entities that are owned by our chief executive officer and his wife and whose financial results are included with ours because the Huayang Companies are deemed as variable interest entities and we are the sole beneficiary of their operations. The variable interest entity relationship is derived from a series of agreements between us and our chief executive officer and his wife, as the sole stockholders of the Huayang Companies. Pursuant to these agreements, we are responsible for the operations of the Huayang Companies and receive the benefits of those operations. However, in the event that we have to seek to enforce these agreements, such enforcement would be sought in Chinese courts, and we cannot assure you that we will prevail or that we will be able to obtain the benefits intended by these agreement. Any inability to enforce our rights under these agreements would materially impair our operations, financial position and cash flows.
If we are unable to attract, train and retain technical and financial personnel, our business may be materially and adversely affected.
Our future success depends, to a significant extent, on our ability to attract, train and retain technical and financial personnel. Recruiting and retaining capable personnel, particularly those with expertise in our industries and in the industries to which we market, are vital to our success. There is substantial competition for qualified technical and financial personnel, and there can be no assurance that we will be able to attract or retain our technical and financial personnel. If we are unable to attract and retain qualified employees, our business may be materially and adversely affected.
Because our chief financial officer is not a full-time employee, we do not have the same level of financial control which we would have if we had a full-time chief financial officer at our facilities.
Our chief financial officer does not work for us on a full-time basis and also serves as chief financial officer of other companies. His primary office is in the United States rather than in China, where our facilities are located. As a result, we do not have the same controls that we would have if our chief financial officer were located at our offices in China and was employed by us on a full-time basis, and our chief executive’s services for other companies may detract from his services for us.
Our failure to protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights or defend against third-party allegations of infringement may be costly.
We rely primarily on trade secret and contractual restrictions to protect our intellectual property. Nevertheless, these afford only limited protection and the actions we take to protect our intellectual property rights may not be adequate and we may not be able to protect our intellectual property under Chinese laws. As a result, third parties may infringe or misappropriate our proprietary technologies or other intellectual property rights, which could have a material adverse effect on our business, financial condition or operating results. In addition, policing unauthorized use of proprietary technology can be difficult and expensive. Litigation may be necessary to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of the proprietary rights of others and the enforcement of intellectual property rights in China may be difficult. We cannot assure you that the outcome of any litigation will be in our favor. Intellectual property litigation may be costly and may divert management attention as well as expend our other resources away from our business. An adverse determination in any such litigation will impair our intellectual property rights and may harm our business, prospects and reputation. In addition, we have no insurance coverage against litigation costs and would have to bear all costs arising from such litigation to the extent we are unable to recover them from other parties. The occurrence of any of the foregoing could have a material adverse effect on our business, results of operations and financial condition.
Implementation of China’s intellectual property-related laws has historically been lacking, primarily because of ambiguities in China’s laws and difficulties in enforcement. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries. Although we have received patents for our new dyeing machines, we cannot assure you that there patents will provide us with adequate protection against infringers or other parties who design around our patents.
We do not have business liability or disruption insurance coverage.
The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited business insurance products. We do not have any business liability or disruption insurance coverage for our operations in China. Any business disruption, litigation or natural disaster may result in our incurring substantial costs and the diversion of our resources.
You may suffer significant dilution if we raise additional capital.
If we need to raise additional capital to expand or continue operations, it may be necessary for us to issue additional equity or convertible debt securities. If we issue equity or convertible debt securities, our net tangible book value per share may decrease, and the percentage ownership of our current stockholders would be diluted, and any equity securities we may issue may have rights, preferences or privileges senior or more advantageous to our common stockholders.
We may experience major accidents in the course of our operations, which may cause significant property damage and personal injuries.
We may experience major accidents in the course of our operations, which may cause significant property damage and personal injuries. Significant industry-related accidents and disasters may cause interruptions to various parts of our operations, or could result in property or environmental damage, increase in operating expenses or loss of revenue. We do not carry any insurance policy covering our capital assets. In accordance with customary practice in China, we do not carry any business interruption insurance or third party liability insurance for personal injury or environmental damage arising from accidents on our property or relating to our operations other than our automobiles. Losses or payments incurred may have a material adverse effect on our operating performance if such losses or payments are not fully insured.
Our status as an emerging growth company may result in reduced disclosure obligations.
We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act (which we refer to as the “JOBS Act”), and we are eligible to take advantage of certain exemptions from various reporting and financial disclosure requirements that are applicable to other public companies, that are not emerging growth companies, including, but not limited to, (1) not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), (2) reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and (3) exemptions from the requirements of holding a non-binding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We intend to take advantage of these exemptions. Because of the reduced disclosure and because our business is conducted in the PRC, investors may find investing in our common shares less attractive as a result, which could have an adverse effect on our stock price.
In addition, Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, for complying with new or revised accounting standards. As a result, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We elected to opt out of such extended transition period and acknowledge such election is irrevocable pursuant to Section 107 of the JOBS Act.
We could remain an emerging growth company for up to five years, or until the earliest of (1) the last day of the first fiscal year in which our annual gross revenues exceed $1 billion, (2) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our ordinary shares that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter and we have been publicly reporting for at least 12 months, or (3) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three-year period.
Risks Related to Conducting Business in the PRC
PRC laws and regulations governing our businesses and the validity of certain of our contractual arrangements are uncertain. If we are found to be in violation, we could be subject to sanctions. In addition, changes in such PRC laws and regulations may materially and adversely affect our business.
There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including, but not limited to, the laws and regulations governing our business, or the enforcement and performance of our contractual arrangements with our affiliated Chinese entities, the Huayang Companies, and its shareholders. We are considered a foreign person or foreign invested enterprise under PRC law. As a result, we are subject to PRC law limitations on foreign ownership of Chinese companies. These laws and regulations are relatively new and may be subject to change, and their official interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively.
The PRC government has broad discretion in dealing with violations of laws and regulations, including levying fines, revoking business and other licenses and requiring actions necessary for compliance. In particular, licenses and permits issued or granted to us by relevant governmental bodies may be revoked at a later time by higher regulatory bodies. We cannot predict the effect of the interpretation of existing or new PRC laws or regulations on our businesses. We cannot assure you that our current ownership and operating structure would not be found in violation of any current or future PRC laws or regulations. As a result, we may be subject to sanctions, including fines, and could be required to restructure our operations or cease to provide certain services. Any of these or similar actions could significantly disrupt our business operations or restrict us from conducting a substantial portion of our business operations, which could materially and adversely affect our business, financial condition and results of operations.
The PRC government restricts foreign investment in businesses in China. Accordingly, we operate our business in China through the Huayang Companies and, recently through a wholly-owned subsidiary which is a wholly foreign owned entity known as a WFOE. The Huayang Companies and the subsidiary hold the licenses and approvals necessary to operate our businesses in China. We have contractual arrangements with the Huayang Companies and its shareholders that allow us to substantially control the Huayang Companies. We cannot assure you, however, that we will be able to enforce these contracts.
Although we believe we comply with current PRC regulations, we cannot assure you that the PRC government would agree that these operating arrangements comply with PRC licensing, registration or other regulatory requirements, with existing policies or with requirements or policies that may be adopted in the future. If the PRC government determines that we do not comply with applicable law, it could revoke our business and operating licenses, require us to discontinue or restrict our operations, restrict our right to collect revenues, require us to restructure our operations, impose additional conditions or requirements with which we may not be able to comply, impose restrictions on our business operations or on our customers, or take other regulatory or enforcement actions against us that could be harmful to our business.
There are significant uncertainties under the Draft Foreign Investment Law relating to the status of businesses in China controlled by foreign invested enterprises primarily through contractual arrangements, such as our business.
On January 19, 2015, MOFCOM published a draft of the PRC Law on Foreign Investment (Draft for Comment), or the Draft Foreign Investment Law, which is open for public comments until February 17, 2015. At the same time, MOFCOM published an accompanying explanatory note of the Draft Foreign Investment Law, or the Explanatory Note, which contains important information about the Draft Foreign Investment Law, including its drafting philosophy and principles, main content, plans to transition to the new legal regime and treatment of business in China controlled by foreign invested enterprises, or FIEs, primarily through contractual arrangements. The draft Foreign Investment Law utilizes the concept of “actual control” for determining whether an entity is considered to be a foreign-invested enterprise, and defines “control” broadly to include, among other things, voting or board control through contractual arrangements.
The draft Foreign Investment Law proposes significant changes to the PRC foreign investment legal regime and may have a material impact on Chinese companies listed or to be listed overseas. The proposed draft Foreign Investment Law is to regulate FIEs the same way as PRC domestic entities, except for those FIEs that operate in industries deemed to be either “restricted” or “prohibited” in a “Negative List.” Because the Negative List has yet to be published, it is unclear whether it will differ from the current list of industries subject to restrictions or prohibitions on foreign investment. The draft Foreign Investment Law also provides that only FIEs operating in industries on the Negative List will require entry clearance and other approvals that are not required of PRC domestic entities. As a result of the entry clearance and approvals, certain FIE’s operating in industries on the Negative List may not be able to continue to conduct their operations through contractual arrangements. It states that entities established in China but controlled by foreign investors will be treated as foreign-invested enterprises, while entities set up outside of China which are controlled by PRC persons or entities, would be treated as domestic enterprises after completion of market entry procedures.
There is substantial uncertainty regarding the draft Foreign Investment Law, including, among others, what the actual content of the law will be as well as the adoption and effective date of the final form of the law. While such uncertainty exists, we cannot assure you that the new foreign investment law, when it is adopted and becomes effective, will not have a material and adverse effect on our ability to conduct our business through our contractual arrangements.
If the draft Foreign Investment Law is enacted and goes into effect in its current form, if we are deemed to have a non-PRC entity as a controlling shareholder, the provisions regarding control through contractual arrangements could reach our VIE arrangements, and as a result our VIEs could become subject to restrictions on foreign investment, which may materially impact the viability of our current corporate structure and operations. Specifically, we may be required to modify our corporate structure, change our current scope of operations, obtain approvals or face penalties or other additional requirements, compared to entities which do have PRC controlling shareholders.
Regulations relating to offshore investment activities by PRC residents may limit our ability to acquire PRC companies and could adversely affect our business.
In July 2014, SAFE promulgated the Circular on Issues Concerning Foreign Exchange Administration Over the Overseas Investment and Financing and Roundtrip Investment by Domestic Residents Via Special Purpose Vehicles, or Circular 37, which replaced Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Corporate Financing and Roundtrip Investment through Offshore Special Purpose Vehicles, or Circular 75. Circular 37 requires PRC residents to register with local branches of SAFE in connection with their direct establishment or indirect control of an offshore entity, referred to in Circular 37 as a “special purpose vehicle” for the purpose of holding domestic or offshore assets or interests. Circular 37 further requires amendment to a PRC resident’s registration in the event of any significant changes with respect to the special purpose vehicle, such as an increase or decrease in the capital contributed by PRC individuals, share transfer or exchange, merger, division or other material event. Under these regulations, PRC residents’ failure to comply with specified registration procedures may result in restrictions being imposed on the foreign exchange activities of the relevant PRC entity, including the payment of dividends and other distributions to its offshore parent, as well as restrictions on capital inflows from the offshore entity to the PRC entity, including restrictions on its ability to contribute additional capital to its PRC subsidiaries. Further, failure to comply with the SAFE registration requirements could result in penalties under PRC law for evasion of foreign exchange regulations.
As Circular 37 is newly-issued, it is unclear how these regulations will be interpreted and implemented. In addition, different local SAFE branches may have different views and procedures as to the interpretation and implementation of the SAFE regulations, and it may be difficult for our ultimate shareholders or beneficial owners who are PRC residents to provide sufficient supporting documents required by the SAFE or to complete the required registration with the SAFE in a timely manner, or at all. Any failure by any of our shareholders who is a PRC resident, or is controlled by a PRC resident, to comply with relevant requirements under these regulations could subject us to fines or sanctions imposed by the PRC government, including restrictions on WFOE’s ability to pay dividends or make distributions to us and on our ability to increase our investment in the WFOE.
Although we believe that our agreements relating to our structure are in compliance with current PRC regulations, we cannot assure you that the PRC government would agree that these contractual arrangements comply with PRC licensing, registration or other regulatory requirements, with existing policies or with requirements or policies that may be adopted in the future.
If we become directly subject to the scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, stock price and reputation.
U.S. public companies that have substantially all of their operations in China, particularly companies like us that have completed so-called reverse acquisition transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered on financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits and SEC enforcement actions and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on us, our business and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our company. This situation will be costly and time consuming and distract our management from developing our growth. If such allegations are not proven to be groundless, we and our business operations will be severely affected and you could sustain a significant decline in the value of our stock.
The disclosures in our reports and other filings with the SEC and our other public pronouncements are not subject to the scrutiny of any regulatory bodies in the PRC.
We are regulated by the SEC and our reports and other filings with the SEC are subject to SEC review in accordance with the rules and regulations promulgated by the SEC under the Securities Act and the Exchange Act. Our SEC reports and other disclosure and public pronouncements are not subject to the review or scrutiny of any PRC regulatory authority. For example, the disclosure in our SEC reports and other filings are not subject to the review by China Securities Regulatory Commission, a PRC regulator that is responsible for oversight of the capital markets in China. Accordingly, you should review our SEC reports, filings and our other public pronouncements with the understanding that no local regulator has done any review of us, our SEC reports, other filings or any of our other public pronouncements.
Our contractual arrangements with the Huayang Companies and its shareholders may not be as effective in providing control over these entities as direct ownership.
Since the law of the PRC limits foreign equity ownership in companies in China, we operate a significant portion of our business through the Huayang Companies. The equity in these companies is owned by our chief executive officer and his wife, and we have no equity ownership interest in the Huayang Companies. We rely on contractual arrangements to control and operate such businesses. These contractual arrangements may not be effective in providing control over the Huayang Companies as direct ownership. For example, the Huayang Companies could fail to take actions required for our businesses despite its contractual obligation to do so. If the Huayang Companies fail to perform under their agreements with us, we may have to incur substantial costs and resources to enforce such arrangements and may have to rely on legal remedies under the law of the PRC, which may not be effective. In addition, we cannot assure you that the Huayang Companies’ shareholders would always act in our best interests.
Adverse changes in political and economic policies of the Chinese government could have a material adverse effect on the overall economic growth of China, which could reduce the demand for our products and materially and adversely affect our competitive position.
All of our business operations are conducted and all of our revenues are made in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including:
● the amount of government involvement;
● the level of development;
● the growth rate;
● the control of foreign exchange; and
● the allocation of resources.
While the Chinese economy has grown significantly in the past 20 years, the growth has been uneven, both geographically and among various sectors of the economy, and the worldwide economic downturn has affected China. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall Chinese economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.
The Chinese economy has been transitioning from a planned economy to a more market-oriented economy. Although in recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of the productive assets in China is still owned by the Chinese government. The continued control of these assets and other aspects of the national economy by the Chinese government could materially and adversely affect our business. The Chinese government also exercises significant control over Chinese economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. Efforts by the Chinese government to slow the pace of growth of the Chinese economy could result in decreased capital expenditure by our customers and potential customers, which in turn could reduce demand for our products. Furthermore, in response to the worldwide economic downturn, the Chinese government may seek to increase its control over businesses which could affect our business.
Any adverse change in the economic conditions or government policies in China could have a material adverse effect on the overall economic growth and the level of renewable energy investments and expenditures in China, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our businesses.
Uncertainties with respect to the Chinese legal system could have a material adverse effect on us.
We conduct substantially all of our business through our Chinese subsidiaries and affiliates, which are generally subject to laws and regulations applicable to foreign investment in China and, in particular, laws applicable to wholly foreign-owned enterprises. China’s legal system is based on written statutes. Prior court decisions may be cited for reference but have limited precedential value. Since 1979, Chinese legislation and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since these laws and regulations are relatively new and China’s legal system continues to rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws, regulations and rules involve uncertainties, which may limit legal protections available to us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention.
We rely on dividends and working capital advances paid by our subsidiaries and VIEs for our cash needs
We conduct substantially all of our operations through our subsidiaries and variable interest entities. We rely on dividends and working capital advances from our subsidiaries for our cash needs, including the funds necessary to pay any dividends which we may declare and other cash distributions to our shareholders, to service any debt we may incur and to pay our operating expenses. The payment of dividends and working capital advances by entities organized in China is subject to limitations. Regulations in China currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Each subsidiary and VIE entity is also required to set aside at least 10% of its after-tax profit based on China’s accounting standards each year to its general reserves until the accumulated amount of such reserves reach 50% of its registered capital. These reserves are not distributable as cash dividends. Our subsidiaries are also required to allocate a portion of their after-tax profits to their staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation. In addition, if our subsidiaries incur debt, the instruments governing the debt may restrict their ability to pay dividends or make other distributions to us.
China’s Unified Corporate Income Tax Law also imposes a withholding income tax of 10% on dividends distributed by a foreign invested enterprise to its immediate holding company outside of China, if such immediate holding company is considered as a non-resident enterprise without any establishment or place within China or if the received dividends have no connection with the establishment or place of such immediate holding company within China, unless such immediate holding company’s jurisdiction of incorporation has a tax treaty with China that provides for a different withholding arrangement.
Fluctuation in the value of the Renminbi may have a material adverse effect on your investment.
The change in value of the Renminbi against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. On July 21, 2005, the Chinese government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in appreciation of Renminbi against U.S. dollar. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the Chinese government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar. As a portion of our costs and expenses is denominated in Renminbi, the revaluation in July 2005 and potential future revaluation has and could further increase our costs. Any significant revaluation of the Renminbi may have a material adverse effect on our revenues and financial condition, and the value of, and any of our dividends payable on our ordinary shares in foreign currency terms.
Restrictions on currency exchange may limit our ability to receive and use our revenues effectively.
Under China’s existing foreign exchange regulations, our Chinese subsidiaries are able to pay dividends in foreign currencies without prior approval from SAFE by complying with certain procedural requirements. However, we cannot assure you that the Chinese government will not take further measures in the future to restrict access to foreign currencies for current account transactions. Foreign exchange transactions by our Chinese subsidiaries under the capital account continue to be subject to significant foreign exchange controls and require the approval of China’s governmental authorities, including the SAFE. In particular, if a subsidiary borrows foreign currency loans from us or other foreign lenders, these loans must be registered with the SAFE, and if we finance the subsidiary by means of additional capital contributions, these capital contributions must be approved by certain government authorities including the Ministry of Commerce or its local counterparts. These limitations could affect the ability of our subsidiaries to obtain foreign exchange through debt or equity financing.
Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise materially adversely affect us.
In October 2005, the PRC State Administration of Foreign Exchange, or SAFE, issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75, which required PRC residents to register with the competent local SAFE branch before establishing or acquiring control over an offshore special purpose company for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Internal implementing guidelines issued by SAFE, which became public in June 2007 (known as Notice 106), expanded the reach of Circular 75 by (i) purporting to cover the establishment or acquisition of control by PRC residents of offshore entities which merely acquire “control” over domestic companies or assets, even in the absence of legal ownership; (ii) adding requirements relating to the source of the PRC resident’s funds used to establish or acquire the offshore entity; (iii) covering the use of existing offshore entities for offshore financings; (iv) purporting to cover situations in which an offshore special purpose vehicle establishes a new subsidiary in China or acquires an unrelated company or unrelated assets in China; and (v) making the domestic affiliate of the special purpose vehicle responsible for the accuracy of certain documents which must be filed in connection with any such registration, notably, the business plan which describes the overseas financing and the use of proceeds. Amendments to registrations made under Circular 75 are required in connection with any increase or decrease of capital, transfer of shares, mergers and acquisitions, equity investment or creation of any security interest in any assets located in China to guarantee offshore obligations, and Notice 106 makes the offshore special purpose vehicle jointly responsible for these filings. In the case of an special purpose vehicle which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, a retroactive SAFE registration was required to have been completed before March 31, 2006; this date was subsequently extended indefinitely by Notice 106, which also required that the registrant establish that all foreign exchange transactions undertaken by the special purpose vehicle and its affiliates were in compliance with applicable laws and regulations. Failure to comply with the requirements of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the special purpose vehicle’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the special purpose vehicle, or from engaging in other transfers of funds into or out of China. We cannot provide any assurances that their existing registrations have fully complied with, and they have made all necessary amendments to their registration to fully comply with, all applicable registrations or approvals required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies.
Risks Related to our Common Stock
Our stock price has been and may continue to be volatile.
The trading price of our common stock has been and is expected to continue to be highly volatile as well as subject to wide fluctuations in price in response to various factors, some of which are beyond our control. These factors include:
● Quarterly variations in our results of operations.
● Announcements by us or our competitors of acquisitions, new products, significant contracts, commercial relationships or capital commitments.
● Our ability to develop and market new and enhanced products on a timely basis.
● Changes in governmental regulations or in the status of our regulatory approvals.
● Changes in earnings estimates or recommendations by securities analysts.
● Market reaction to problems encountered by other Chinese companies that became public companies in the United States through the reverse merger process.
● Market reaction to reports written by investors about us and about Chinese companies in general.
● Market reaction to the slowdown in the Chinese wind power industry.
● General economic conditions and slow or negative growth of related markets.
These broad market and industry factors may seriously affect the market price of our Common Stock, regardless of our actual operating performance.
Any failure to meet the Nasdaq continued listing requirements may result in our delisting.
During 2011, our stock failed to meet the Nasdaq continued listing requirement resulting from our failure to maintain a $1.00 bid price and our failure to maintain a minimum market value of publicly held common stock. In order to maintain our listing on Nasdaq we transferred our listing from the Nasdaq Global Market to the Nasdaq Capital Market, and we effected a one-for-ten reverse split. In the event that our stock price falls below $1.00 per share, we may not be able to maintain our Nasdaq listing, which could have a material adverse effect on the market for and the market price of our common stock.
If we fail to maintain the adequacy of our internal controls, our ability to provide accurate financial statements and comply with the requirements of the Sarbanes-Oxley Act of 2002 could be impaired, which could cause our stock price to decrease substantially.
Prior to November 2007, the Huayang Companies operated as private companies without public reporting obligations, and they committed limited personnel and resources to the development of the external reporting and compliance obligations that would be required of a public company. We are continuing to institute changes to satisfy our obligations in under the Sarbanes-Oxley Act. In Item 9A of this annual report, we report that our disclosure controls and procedures and our internal controls over financial reporting were not adequate at December 31, 2014. We are continuing to institute changes to satisfy our obligations under the Sarbanes-Oxley Act. Any failure of our internal controls or our ability to provide accurate financial statements could cause the trading price of our common stock to decrease substantially.
We do not anticipate paying any cash dividends.
We presently do not anticipate that we will pay any dividends on any of our capital stock in the foreseeable future. We presently intend to retain all earnings, if any, to implement our business plan; and we do not anticipate the declaration of any dividends in the foreseeable future.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
Our main office and our manufacturing facilities are located in Wuxi, China, in seven buildings with approximately 215,000 square feet. We have been issued a land use right certificate for the land until June 7, 2015 by the municipal government of Wuxi City, which may be renewed at our option with no expected capital requirement. We plan to begin the renewal process in May 2015. The seven buildings are an office building, warehouse, raw material processing hall, metal processing hall, assembling hall, laboratory and quality control, and guard house. We believe that our existing facilities are well maintained and in good operating condition.
In 2003, we acquired land use rights to a plot of land approximately 5.1 acres from the local government of the Town of Qianzhou in Wuxi City. This land, along with the land use rights acquired from a related party as discussed in the following paragraph, house our new factory and employee housing facilities. The land lease has a term of 50 years, expiring October 30, 2053.
During 2008, we completed the purchase of land use rights for an approximately 100,000 square foot factory, employee housing facilities and other leasehold improvements from a related party, Wuxi Huayang Boiler Company, Ltd. (“Huayang Boiler”) for approximately $10.9 million. The land use rights expire on January 1, 2053. In March 2009, we received the title to the buildings.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
There are no material legal proceedings pending against us.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information.
Our common stock has traded on The NASDAQ Capital Market under the symbol “CLNT” since December 29, 2011. Our stock was previously traded on The NASDAQ Global Market under the symbol “CLNT” from June 16, 2011 to December 28, 2011 and under the symbol “CWS” from December 24, 2009 until June 15, 2011. Prior to December 24, 2009, it was traded on the OTC Bulletin Board under the symbol “CHWY” from October 13, 2009 until December 23, 2009, and prior to October 13, 2009, it was traded under the symbol “CWSI.” The following table sets forth, for the periods indicated, the reported high and low closing bid quotations for our common stock by calendar quarters during 2013 and 2014. These prices reflect inter-dealer quotations, do not include retail markups, markdowns or commissions and do not necessarily reflect actual transactions.
On March 27, 2015, the last sale price of our common stock as reported by NASDAQ was $3.70 per share.
Shareholders
As of March 30, 2015, we had approximately 1,118 record holders of our common stock.
Transfer Agent
The transfer agent for the common stock is Empire Stock Transfer Inc. The transfer agent’s address is 1859 Whitney Mesa Dr., Henderson, Nevada 89014, and its telephone number is (702) 818-5898.
Dividend Policy
We have not paid cash dividends on our common stock since we became public through reverse acquisition. We intend to keep any future earnings to finance the expansion of our business, and we do not anticipate that any cash dividends will be paid in the foreseeable future.
In addition, due to various restrictions under PRC laws on the distribution of dividends by our PRC operating companies, we may not be able to pay dividends to our shareholders. The Wholly Foreign Owned Enterprise Law (1986), as amended and The Wholly Foreign Owned Enterprise Law Implementing Rules (1990), as amended and the Company Law of the PRC (2006) contain the principal regulations governing dividend distributions by wholly foreign owned enterprises. Under these regulations, wholly foreign owned enterprises may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. Additionally, such companies are required to set aside a certain amount of their accumulated profits each year, if any, to fund certain reserve funds. These reserves are not distributable as cash dividends except in the event of liquidation and cannot be used for working capital purposes.
The PRC government also imposes controls on the conversion of RMB into foreign currencies and the remittance of currencies out of the PRC. Therefore, we may experience difficulties in completing the administrative procedures necessary to obtain and remit foreign currency for the payment of dividends from the Company’s profits. Furthermore, if our subsidiaries and affiliates in China incur debt on their own in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments. If we or our subsidiaries and affiliates are unable to receive all of the revenues from our operations through the current contractual arrangements, we may be unable to pay dividends on our common stock.
Equity Compensation Plan Information
The following table summarizes the equity compensation plans under which our securities have been or may be issued as of December 31, 2014.
In January 2010, our board of directors adopted, and in March 2010, the stockholders approved, the 2010 long-term incentive plan (the “2010 plan”), covering 200,000 shares of common stock. In October 2013, the directors adopted and in December 2013, the stockholders approved, an amendment to the 2010 plan which increased the number of shares subject to the 2010 plan from 200,000 shares to 500,000 shares. As of December 31, 2014, there were 256,509 shares of common stock available for issuance pursuant to the 2010 plan.
We did not have any equity compensation plans that were not approved by stockholders.
Unregistered Sales of Equity Securities and Use of Proceeds
We had no sales of unregistered securities during the fourth quarter of 2014.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
As a smaller reporting company, we are not required to provide the information called for by Item 6 of Form 10-K.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Overview
We are engaged in two business segments - the forged rolled rings and related components segment, in which we manufacture and sell high precision forged rolled rings, shafts, flanges, and other forged components for the wind power and other industries, and the dyeing and finishing equipment segment, in which we manufacture and sell textile dyeing and finishing machines.
The following table sets forth information as to revenue of our forged rolled rings and related components and dyeing and finishing equipment segments in dollars and as a percent of revenue (dollars in thousands):
The factors that affected our revenue, gross margin and net income in both of our segments during the year ended December 31, 2014, which are described below, are likely to continue to affect our operations in the near future. Our ability to expand our operations and increase our revenue is largely affected by the PRC government’s policy on such matters as the availability of credit, which affects all of our operations, and its policies relating to alternative energy such as wind power, which affect our products for these industries. Our business is also affected by general economic conditions. Because of the nature of our products, our customers’ projection of future economic conditions are an integral part of their decisions as to whether to purchase capital equipment at this time or defer such purchases until a future date.
Forged Rolled Rings and Related Components Segment
Through our forged rolled rings and other related products division, we produce precision forged rolled rings and other forged components to the wind power and other industries. Our forged rolled rings and other related products are sold to manufacturers of industrial equipment. Forged rolled rings and other forged components for the wind industry are used in wind turbines, which are used to generate wind power.
Revenue from our forged rolled rings and related components segment for the year ended December 31, 2014 remained materially consistent as compared to the year ended December 31, 2013. The demand for products used in manufacturing in general, including wind power industry and other industries, is uncertain. Although we believe that over the long term, the forged rolled rings and related components segment will expand, and the government of the PRC has announced its desire to increase the use of wind power as an energy source, in the short term, other factors, such as economic factors and the fluctuations in the price of oil and coal and the availability of credit, may affect the requirements by our customers and potential customers for our products. To the extent that the demand for our forged rolled rings and related components declines, our revenue and net income will be affected. We believe that there is a degree of market saturation and we expect that our combined revenues from wind and non-wind customers of forged rolled rings and related components will continue at the current rate for the near future.
Among all the renewable energies, we believe that wind power is at a mature stage in terms of the technology and represents the best prospect for large-scale commercial development. We believe that it is becoming more competitive against traditional energy sources as the industry continues to grow and production costs continue to fall, although difficulties in transmission of electricity generated by wind power continues to affect and the recent decline in oil prices is affecting the market for wind power energy and other sources of renewable energy. We believe that wind power will see its share of China’s national energy mix gradually increase. While interest in wind power is increasing in many countries, we do not have the infrastructure and personnel to market our products in countries other than China, we are continuing to limit our sales and marketing efforts to China to wind power customers and increased our sales and marketing efforts to the oil and gas industry.
Dyeing and Finishing Equipment Segment
Revenue from our dyeing segment increased $3.9 million, or 10.1%, for the year ended December 31, 2014 as compared to the year ended December 31, 2013. We believe that the increase reflects both our marketing effort for our new airflow dyeing units, which use air instead of water which is used in the traditional dyeing process, and the response to China’s stricter environmental standards for the dyeing industry. We believe that our air-flow technology, which is designed to enable users to meet China’s stricter environmental standards, provides the customer with reduced input costs, fewer wrinkles, less damage to the textile and reduced emissions. With the growing acceptance of our new dyeing technology and the China government’s mandate to phase out obsolete machinery in China’s textile industry, we expect our revenue from this segment will continue to increase in the near future, and the expansion of our manufacturing facilities has been primarily for the dyeing and finishing equipment segment.
Inventory and Raw Materials
A major element of our cost of revenues is raw materials, principally steel as well as other metals. These metals are subject to price fluctuations, and recently these fluctuations have been significant. In times of increasing prices, we need to try to establish the price at which we purchase raw materials in order to avoid increases in costs which we cannot recoup through increases in sales prices. Similarly, in times of decreasing prices, we may have purchased metals at prices which are high in terms of the price at which we can sell our products, which also can impair our margins. Three major suppliers provided approximately 49% of our purchases of raw materials for the year ended December 31, 2014. No other supplier accounted for 10% or more of our purchases during the year ended December 31, 2014.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our estimates, including those related to bad debts, inventories, recovery of long-lived assets, income taxes, and the valuation of equity transactions. We base our estimates on historical experience and on various other assumptions that we believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Any future changes to these estimates and assumptions could cause a material change to our reported amounts of revenues, expenses, assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the consolidated financial statements.
Variable Interest Entities
Pursuant to ASC Topic 810 and related subtopics related to the consolidation of variable interest entities, we are required to include in our consolidated financial statements the financial statements of variable interest entities (“VIEs”). The accounting standards require a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss for the VIE or is entitled to receive a majority of the VIE’s residual returns. VIEs are those entities in which we, through contractual arrangements, bear the risk of, and enjoy the rewards normally associated with ownership of the entity, and therefore we are the primary beneficiary of the entity.
The Huayang Companies are considered VIEs, and we are the primary beneficiary. On November 13, 2007, we entered into agreements with the Huayang Companies pursuant to which we shall receive 100% of the Huayang Companies’ net income. In accordance with these agreements, the Huayang Companies shall pay consulting fees equal to 100% of its net income to our wholly-owned subsidiary, Green Power, and Green Power shall supply the technology and administrative services needed to service the Huayang Companies.
The accounts of the Huayang Companies are consolidated in the accompanying financial statements. As VIEs, the Huayang Companies sales are included in our total sales, their income from operations is consolidated with ours, and our net income includes all of the Huayang Companies’ net income, and their assets and liabilities are included in our consolidated balance sheets. The VIEs do not have any non-controlling interest and, accordingly, we did not subtract any net income in calculating the net income attributable to us. Because of the contractual arrangements, we have pecuniary interest in the Huayang Companies that require consolidation of the Huayang Companies financial statements with our financial statements.
Accounts Receivable
We have a policy of reserving for uncollectible accounts based on our best estimate of the amount of probable credit losses in our existing accounts receivable. We periodically review our accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
As a basis for estimating the likelihood of collection has been established, we consider a number of factors when determining reserves for uncollectable accounts. We believe that we use a reasonably reliable methodology to estimate the collectability of our accounts receivable. We review our allowances for doubtful accounts on at least a quarterly basis. We also consider whether the historical economic conditions are comparable to current economic conditions. If the financial condition of our customers or other parties that we have business relations with were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Inventories
Inventories, consisting of raw materials, work-in-process and finished goods, are stated at the lower of cost or market utilizing the weighted average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, we will record additional reserves for the difference between the cost and the market value. These reserves are recorded based on estimates. We review inventory quantities on hand and on order and record, on a quarterly basis, a provision for excess and obsolete inventory, if necessary. If the results of the review determine that a write-down is necessary, we recognize a loss in the period in which the loss is identified, whether or not the inventory is retained. Our inventory reserves establish a new cost basis for inventory and are not reversed until we sell or dispose of the related inventory. Such provisions are established based on historical usage, adjusted for known changes in demands for such products, or the estimated forecast of product demand and production requirements.
Advances to Suppliers
Advances to suppliers represent the advance payments for the purchase of raw material from suppliers. The advance payments are intended to ensure preferential pricing and delivery.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets are as follows:
The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in disposition.
Included in property and equipment is construction-in-progress which consists of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use.
We examine the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. We recognize an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value.
Equipment Held for Operating Lease and Rental Revenue; Equipment Held for Sale
At December 31, 2013, we reflected ESR equipment that was used in 2010 and 2011 to produce forged products for the high performance components market as equipment held for operating lease on our consolidated balance sheet based on an operating lease that was signed in March 2014. We made a determination with respect to the lease whether it should be accounted for as operating lease or financing lease. The classification criteria is based on estimates regarding the fair value of the leased ESR equipment, minimum lease payments, the economic life of the equipment, the existence of a bargain purchase option, and certain other terms in the lease agreement. We believe the lease should be accounted for as operating lease and that, at December 31, 2013, the equipment should be accounted for as equipment held for operating lease. We measure long-lived assets being leased at the lower of carrying amount or fair value, less associated costs to lease.
In March 2014, we signed an operating lease agreement related to the lease of such equipment for a period of eight years. Equipment held for operating lease is depreciated over its estimated useful life starting from the operating lease commencement date, April 1, 2014. Rental payments are recorded as rental income over the lease term as earned. The related depreciation on the equipment held for operating lease is recognized as a reduction of rental income on a straight-line basis. For the year ended December 31, 2014, the rental income was $605,214 and the related depreciation on the equipment held for operating lease was $503,675, respectively. The lessee stopped using the equipment and stopped paying its lease payments in early 2015 and we have not found and do not expect to find other potential lessees in 2015. Therefore, we reclassified the equipment held for operating lease to equipment held for sale at December 31, 2014.
Land Use Rights
There is no private ownership of land in the PRC. All land in the PRC is owned by the government and cannot be sold to any individual or company. The government grants a land use right that permits the holder of the land use right to use the land for a specified period. Our land use rights were granted with a term of 45 or 50 years. Any transfer of the land use right requires government approval. We have recorded as an intangible asset the costs paid to acquire a land use right. The land use rights are amortized on the straight-line method over the land use right terms.
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the purchase price is fixed or determinable and collectability is reasonably assured.
We recognize revenues from the sale of dyeing and finishing equipment, forged rolled rings and other components upon shipment and transfer of title. The other elements may include installation and, generally, a one-year warranty. Equipment installation revenue is valued based on estimated service person hours to complete installation and is recognized when the labor has been completed and the equipment has been accepted by the customer, which is generally within a couple days of the delivery of the equipment. Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the years ended December 31, 2014 and 2013, amounts allocated to installation and warranty revenues were minimal. Based on historical experience, warranty service calls and any related labor costs have been minimal.
Rental income is recognized on a straight-line basis over the term of the operating lease and is presented net of depreciation
All other product sales with customer specific acceptance provisions, including the forged rolled rings, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.
Income Taxes
We are governed by the income tax laws of the PRC and the United States. Income taxes are accounted for pursuant to ASC 740 “Accounting for Income Taxes”, which is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. The charge for taxes is based on the results for the period as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.
Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probably that taxable profit will be available against which deductible temporary differences can be utilized.
Deferred tax is calculated using tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it is related to items credited or charged directly to equity, in which case the deferred tax is changed to equity. Deferred tax assets and liabilities are offset when they related to income taxes levied by the same taxation authority and we intend to settle its current tax assets and liabilities on a net basis.
Stock-based Compensation
Stock based compensation is accounted for based on the requirements of the Share-Based Payment topic of ASC 718 which requires recognition in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments over the period the employee or director is required to perform the services in exchange for the award. The Accounting Standards Codification also requires measurement of the cost of employee and director services received in exchange for an award based on the grant-date fair value of the award.
Pursuant to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the “measurement date.” The expense is recognized over the period of services or the vesting period, whichever is applicable. Until the measurement date is reached, the total amount of compensation expense remains uncertain. We record compensation expense based on the fair value of the award at the reporting date. The awards to consultants and other third-parties are then revalued, or the total compensation is recalculated based on the then current fair value, at each subsequent reporting date.
Currency Exchange Rates
Our functional currency is the U.S. dollar, and the functional currency of our operating subsidiaries and VIEs is the RMB. All of our sales are denominated in RMB. As a result, changes in the relative values of U.S. dollars and RMB affect our reported levels of revenues and profitability as the results of our operations are translated into U.S. dollars for reporting purposes. In particular, fluctuations in currency exchange rates could have a significant impact on our financial stability due to a mismatch among various foreign currency-denominated sales and costs. Fluctuations in exchange rates between the U.S. dollar and RMB affect our gross and net profit margins and could result in foreign exchange and operating losses.
Our exposure to foreign exchange risk primarily relates to currency gains or losses resulting from timing differences between signing of sales contracts and settling of these contracts. Furthermore, we translate monetary assets and liabilities denominated in other currencies into RMB, the functional currency of our operating subsidiaries. Our results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in our statement of shareholders’ equity. We have not used any forward contracts, currency options or borrowings to hedge our exposure to foreign currency exchange risk. We cannot predict the impact of future exchange rate fluctuations on our results of operations and may incur net foreign currency losses in the future.
Our financial statements are expressed in U.S. dollars, which is the functional currency of our parent company. The functional currency of our operating subsidiaries and affiliates is RMB. To the extent we hold assets denominated in U.S. dollars, any appreciation of the RMB against the U.S. dollar could result in a charge in our statement of operations and a reduction in the value of our U.S. dollar denominated assets. On the other hand, a decline in the value of RMB against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results.
Recent Accounting Pronouncements
Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. We do not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to our financial condition, results of operations, cash flows, or disclosures.
RESULTS OF OPERATIONS
Comparison of Results of Operations for the Years Ended December 31, 2014 and 2013
The following table sets forth the results of our operations for the years ended December 31, 2014 and 2013 indicated as a percentage of net revenues (dollars in thousands):
The following table sets forth information as to the revenues, gross profit and gross margin for our two business segments for the years ended December 31, 2014 and 2013 (dollars in thousands).
Revenues. For the year ended December 31, 2014, we had revenues of $75,959,000, as compared to revenues of $72,113,000 for the year ended December 31, 2013, an increase of $3,846,000 or approximately 5.3%. The increase in revenue for the year ended December 31, 2014 was primarily attributable to an increase in revenue from our dyeing segment. Our revenues from forged rolled rings and related products were substantially the same as for 2013. The change in revenues is summarized as follows (dollars in thousands):
Forged rolled rings and related products segment
For the year ended December 31, 2014, revenue from the sale of forged rolled rings and related products to wind power industry and other industries remained materially constant as compared to the year ended December 31, 2013. We anticipate sales volumes of forged rolled rings and related products to customers in the wind power industry and other industries will remain around their current level for the near future.
Dyeing and finishing equipment segment
For the year ended December 31, 2014, revenues from the sale of dyeing and finishing equipment increased by approximately $3,872,000 or 10.1% as compared to the year ended December 31, 2013. The increase in revenue from the sale of dyeing and finishing equipment for the year ended December 31, 2014 was primarily attributable to our marketing efforts and the effects of the policies of the PRC local governments to encourage the purchase of low-emission airflow dyeing machine which are intended to reduce pollution from the dyeing process and the increase of a new style of dyeing machinery to meet our customers’ demand. With the growing acceptance of our new dyeing technology and the Chinese government’s mandate to phase out obsolete machinery in China’s textile industry, we expect our revenue from this segment will continue to increase in the near future, although at a lower rate than in previous periods. We continue to develop new styles of dyeing machines such as a new air-fluid, dual-use dyeing machine which uses both air flow and fluid flow in the dyeing process. It allows users to customize the dyeing process according to the specific type of textile. It is equipped with a series of specialized and patented components, including nozzles, cloth wheels and cloth spreaders, which are designed to permit greater color evenness and reduce defects. It can be used on a wider range of textiles and uses 60% to 70% less water, about 30% less power and 40% to 50% less steam than traditional models of high-temperature, high-pressure dyeing machines and reduces the use of additives by about 50% while shortening dyeing time by 1 to 2 hours.
Cost of revenues. Cost of revenues includes the cost of raw materials, labor, depreciation and other overhead costs.
For the year ended December 31, 2014, cost of revenues was $58,218,000 as compared to $54,447,000 for the year ended December 31, 2013, an increase of $3,771,000, or 6.9%. Cost of revenues related to the manufacture of forged rolled rings and related products was $25,768,000 for the year ended December 31, 2014 as compared to $25,598,000 for the year ended December 31, 2013. Cost of revenues for the dyeing and finishing equipment segment was $32,450,000 for the year ended December 31, 2014, as compared to $28,849,000 for the year ended December 31, 2013.
Gross profit and gross margin. Our gross profit was $17,741,000 for the year ended December 31, 2014 as compared to $17,666,000 for the year ended December 31, 2013, representing gross margins of 23.4% and 24.5%, respectively.
Gross profit from forged rolled rings and related products segment was $7,982,000 for the year ended December 31, 2014 as compared to $8,178,000 for the year ended December 31, 2013, representing gross margins of approximately 23.6% and 24.2%, respectively. The decrease in our gross margin for the forged rolled rings and related products segment for the year ended December 31, 2014 as compared to the year ended December 31, 2013 was primarily attributed to the decline in sales prices, which was necessary to meet competition. Continued competition will continue to affect our margins as we may have difficulty increasing or maintaining prices.
Gross profit for the dyeing and finishing equipment segment was $9,759,000 for the year ended December 31, 2014 as compared to $9,488,000 for the year ended December 31, 2013, representing gross margins of approximately 23.1% and 24.7%, respectively. The decrease in our gross margin for the dyeing and finishing equipment for the year ended December 31, 2014 as compared to the year ended December 31, 2013 was primarily attributed to the low gross margin from a new style of dyeing machine which we introduced in the fourth quarter of 2013. For the new style dyeing machines, we operated at low production level. Therefore, there is a decline in operational and cost efficiencies, including the allocation of fixed costs primarily consisting of depreciation, to cost of revenues. We expect that we can improve our gross margin from dyeing and finishing equipment segment in the near future since we anticipate we will become more efficient and be able to produce this new machine and other new machines in larger quantities.
Depreciation. Depreciation was $8,470,000 and $6,704,000 for the year ended December 31, 2014 and 2013, respectively. Depreciation for the year ended December 31, 2014 and 2013 was included in the following categories (dollars in thousands):
The increase in depreciation expense for cost of revenues for the year ended December 31, 2014 as compared to the year ended December 31, 2013 is attributable to the increase in our depreciable production equipment in our dyeing and finishing equipment segment.
The increase in depreciation expense for operating expenses for the year ended December 31, 2014 as compared to the year ended December 31, 2013 is attributable to the increased depreciation from our newly purchased office equipment and furniture and from our office building and other improvements in the years ended December 31, 2014 and 2013.
Equipment held for sale, which was treated as equipment held for operating lease during 2014, was depreciated over its estimated useful life starting from the operating lease commencement date, April 1, 2014 through December 31, 2014. Rental payments are recorded as rental income over the lease term as earned. The related depreciation on the equipment held for operating lease was recognized as a reduction of rental income on a straight-line basis and is reflected in rental income, net. The lessee stopped using the equipment and stopped paying its lease payments in early 2015 and we have not found and do not expect to find other potential lessees in 2015. Therefore, we reclassified the equipment held for operating lease to equipment held for sale at December 31, 2014.
Impairment loss. For the years ended December 31, 2014 and 2013, we incurred impairment charge in operations of approximately $3,800,000 and $2,573,000, respectively, on the ESR equipment. The valuations of the ESR equipment which, at December 31, 2013 was reflected as equipment held for operating lease and as equipment held for sale at December 31, 2014 on the accompanying balance sheets, and the amounts of the impairment charge, were based on the impairment assessments conducted on ESR equipment at December 31, 2014 and 2013. At December 31, 2014, the estimated fair value of the ESR equipment which is reflected as equipment held for sale was $422,500 and we do not expect any material impairment charges in the future on this ESR equipment.
Selling, general and administrative expenses. Selling, general and administrative expenses totaled $4,194,000 for the year ended December 31, 2014, as compared to $3,034,000 for the year ended December 31, 2013, an increase of $1,160,000 or approximately 38.2%. Selling, general and administrative expenses for the years ended December 31, 2014 and 2013 consisted of the following (dollars in thousands):
●Professional fees for the year ended December 31, 2014 increased by $15,000, or 4.6%, as compared to the year ended December 31, 2013. The increase was primarily attributable to an increase in accounting fees of approximately $11,000 and an increase in investor relations service fees of approximately $4,000.
●For the year ended December 31, 2014, we recorded bad debt expense of $522,000 and accounts with the amount of approximately $27,000 were written off after exhaustive efforts at collection. For the year ended December 31, 2013, we decreased the allowance for doubtful accounts of approximately $628,000 (net of approximately $1,200,000 write-offs). During the years ended December 31, 2014 and 2013, we collected approximately $354,000 and $857,000, respectively, of accounts receivable for which we have previously reserved at December 31, 2013 and 2012, respectively. Based on our periodic review of accounts receivable balances, we adjusted the allowance for doubtful accounts after considering management’s evaluation of the collectability of individual receivable balances, including the analysis of subsequent collections, the customers’ collection history, the write off of uncollectible receivables against the existing reserve, and recent economic events.
●Payroll and related benefits for the year ended December 31, 2014 decreased by $81,000, or 7.5%, as compared to the year ended December 31, 2013. The decrease was mainly attributable to a decrease in stock-based compensation of approximately $47,000 which reflected the decrease in stock-based bonuses incurred and paid to our management in 2014, and a decrease in employee salaries and related benefits of approximately $34,000 due to the stricter control in general and administrative personnel. We expect that payroll and related benefits will remain in its current level with minimal increase in the near future.
●Travel and entertainment expense for the year ended December 31, 2014 increased by $109,000, or 29.5%, as compared to the year ended December 31, 2013. The increase was primarily attributable to the increased spending of approximately $55,000 in our travel due to increased on-site communication and discussion with our customers in order to more efficiently manage our business and compete with our competitors and the increase of approximately $54,000 in our entertainment spending in order to enhance our visibility.
●Shipping expense for the year ended December 31, 2014 increased by $82,000, or 6.4%, as compared to the year ended December 31, 2013. The increase mainly reflects the increase in our revenues during the year ended December 31, 2014 as compared to the year ended December 31, 2013.
●Other selling, general and administrative expenses for the year ended December 31, 2014 decreased by $115,000, or 19.2%, as compared to the year ended December 31, 2013. The decrease was primarily attributable to a decrease in vehicle expenses of approximately $23,000, and a decrease in expense related to a one-time write-off of advances to suppliers of approximately $98,000 in 2013, offset by an increase in other miscellaneous items of approximately $6,000.
Research and development expenses. Research and development expenses was $116,000 for the year ended December 31, 2014, as compared to $93,000 for the year ended December 31, 2013, an increase of $23,000 or approximately 25.1%. We did not have any research and development activity and did not incur any research and development expense in the first quarter of 2013. Research and development expense related to the development of new dyeing and finishing products.
Income from operations. As a result of the factors described above, for the year ended December 31, 2014, income from operations amounted to $8,910,000, as compared to $11,393,000 for the year ended December 31, 2013, a decrease of $2,483,000 or 21.8%.
Other income (expense). Other income (expense) includes interest income, grant income, foreign currency transaction gain, rental income, other income and interest expense. For the year ended December 31, 2014, total other expense amounted to $83,000 as compared to total other expense $208,000 for the year ended December 31, 2013, a decrease of $125,000 or 60.3%. The decrease in other expense, net, was primarily attributable to the decrease in interest expense of approximately $62,000, due to the decrease in interest-bearing short-term bank borrowings in 2014, an increase in grant income of approximately $35,000, and an increase in rental income, net, of approximately $102,000, related to our equipment held for operating lease during 2014, offset by a decrease in foreign currency transaction gain of approximately $26,000 and a decrease in other income of approximately $43,000. Grant income represents incentives granted and received from the Chinese government to encourage technology innovation and related to the patents we received in 2013 and 2014 for devices and parts of our airflow dyeing machine. Other income includes the net amount of rental income and related depreciation which is recognized as a reduction of rental income from our equipment held for operating lease.
Income tax expense. Income tax expense was $4,561,000 for the year ended December 31, 2014, as compared to $3,000,000 for the year ended December 31, 2013, an increase of $1,561,000, or 52.0%. The increase in income tax expense was primarily attributable to an increase in income tax expense of approximately $2,166,000 resulting from the increase in allowance to reduce deferred tax asset for ESR equipment’s impairment loss to expected realizable value since we determined that it was more likely than not that the deferred tax asset related to the deductibility for PRC tax purposes of impairment losses on equipment held for sale/operating lease would not be realized, offset by a decrease in income tax expense of approximately $605,000 which reflected the decrease in taxable income generated by our operating entities in the year ended December 31, 2014.
Net income. As a result of the foregoing, our net income was $4,266,000, or $1.15 per share (basic and diluted), for the year ended December 31, 2014, as compared with $8,186,000, or $2.55 per share (basic and diluted), for the year ended December 31, 2013, a decrease of $3,919,000, or 47.9%.
Foreign currency translation gain. The functional currency of our subsidiaries and variable interest entities operating in the PRC is the Chinese Yuan or Renminbi (“RMB”). The financial statements of our subsidiaries are translated to U.S. dollars using period end rates of exchange for assets and liabilities, and average rates of exchange (for the period) for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations. As a result of foreign currency translations, which are a non-cash adjustment, we reported a foreign currency translation loss of $408,000 for the year ended December 31, 2014, as compared to a foreign currency translation gain of $2,752,000 for the year ended December 31, 2013. This non-cash gain/loss had the effect of increasing/decreasing our reported comprehensive income.
Comprehensive income. As a result of our foreign currency translation gain/loss, we had comprehensive income for the year ended December 31, 2014 of $3,858,000, compared to $10,937,000 for the year ended December 31, 2013.
Liquidity and Capital Resources
Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis. At December 31, 2014 and 2013, we had cash balances of approximately $7,836,000 and $1,115,000, respectively. These funds are located in financial institutions located as follows (dollars in thousands):
The following table sets forth a summary of changes in our working capital from December 31, 2013 to December 31, 2014 (dollars in thousands):
Our working capital increased $12,475,000 to $23,597,000 at December 31, 2014 from $11,122,000 at December 31, 2013. This increase in working capital is primarily attributable to an increase in cash and cash equivalents of approximately $6,721,000, an increase in accounts receivable, net of allowance for doubtful accounts, of approximately $5,081,000, mainly due to the increase in credit periods for our customers in order to compete with our competitors and certain of our accounts receivable are from sales generated in the second half of 2014, an increase in deferred tax assets - current portion of approximately $123,000, an increase in prepaid expenses and other current assets of approximately $79,000, a decrease in bank acceptance notes payable of approximately $199,000, a decrease in accounts payable of approximately $639,000, a decrease in advances from customers of approximately $960,000 and a decrease in income taxes payable of approximately $1,092,000 due to the payments made to China tax authority in year 2014, offset by a decrease in restricted cash of approximately $199,000, a decrease in notes receivable of approximately $590,000, a decrease in inventories, net of reserve for obsolete inventories, of approximately $493,000, a decrease in advances to suppliers of approximately $130,000, a decrease in prepaid VAT on purchases of approximately $489,000, an increase in accrued expenses of approximately $160,000 and an increase in VAT and service taxes payable of approximately $374,000.
Because the exchange rate conversion is different for the consolidated balance sheets and the consolidated statements of cash flows, the changes in assets and liabilities reflected on the consolidated statements of cash flows are not necessarily identical with the comparable changes reflected on the consolidated balance sheets.
Net cash flow provided by operating activities was $12,158,000 for the year ended December 31, 2014 as compared to $11,469,000 for the year ended December 31, 2013, an increase of $689,000.
● Net cash flow provided by operating activities for the year ended December 31, 2014 primarily reflected net income of $4,266,000 and the add-back of non-cash items primarily consisting of depreciation of $8,470,000, amortization of land use rights of $96,000, an increase in allowance for doubtful accounts of $522,000, an increase in allowance for deferred tax assets of $2,166,000, a loss on impairment of equipment held for operating lease of $3,800,000 and stock-based compensation of $376,000, and changes in operating assets and liabilities primarily consisting of a decrease in notes receivable of $586,000, a decrease in inventories of $471,000, a decrease in prepaid value-added taxes on purchases of $487,000, a decrease in advances to suppliers of $126,000, an increase in accrued expenses of $164,000, an increase in VAT and service taxes payable of $375,000, offset primarily by an increase in accounts receivable of $5,669,000, an increase in deferred tax assets of $1,080,000, a decrease in accounts payable of $872,000, a decrease in income taxes payable of $1,077,000, and a decrease in advances from customers of $953,000.
● Net cash flow provided by operating activities for the year ended December 31, 2013 primarily reflected net income of $8,186,000 and the add-back of non-cash items primarily consisting of depreciation of $6,704,000, amortization of land use rights of $95,000, an increase in inventory reserve of $41,000, a loss on impairment of equipment held for lease of $2,573,000, and stock-based compensation of $423,000, which was offset by a decrease in allowance for doubtful accounts of $628,000 mainly due to the collection of approximately $857,000 accounts receivable for which we have previously reserved for at December 31, 2012, and changes in operating assets and liabilities primarily consisting of a decrease in inventories of $1,304,000, offset primarily by an increase in notes receivable of $605,000, an increase in accounts receivable of $4,126,000, a decrease in accounts payable of $1,810,000, a decrease in accrued expenses of $113,000, a decrease in income taxes payable of $129,000, and a decrease in advances from customers of $453,000.
For the year ended December 31, 2014, net cash flow used in investing activities reflects the purchase of property and equipment of $11,059,000, offset by refunds of payments of approximately $3,991,000 made by us with respect to purchase orders we had cancelled. We examined and found some faults on the machinery delivered to us in the fourth quarter of 2014. Therefore, we cancelled the purchase order and we returned the machinery to the supplier and received a refund of approximately $2,000,000, representing the payment which we had made. In addition, in the fourth quarter of 2014, a supplier did not deliver equipment because the supplier advised us that it could not import an important component necessary to complete our order on time. We cancelled the order and received refund of approximately $1,500,000, representing our advance payment for the equipment. Also, in the fourth quarter of 2014, we cancelled a purchase order and received a refund of approximately $491,000, representing the payment we had made with respect to the order. For the year ended December 31, 2013, net cash flow used in investing activities reflects the purchase of property and equipment of $14,634,000.
Net cash flow provided by financing activities was $1,624,000 for the year ended December 31, 2014 as compared to net cash flow provided by financing activities of $2,804,000 for the year ended December 31, 2013. During the year ended December 31, 2014, we received proceeds from bank loans of $3,907,000, proceeds from the decrease in restricted cash of $195,000 and net proceeds from sale of common stock of approximately $1,624,000 to our chief executive officer and his wife, offset by the repayments of bank loans of $3,907,000 and the decrease in bank acceptance notes payable of $195,000. During the year ended December 31, 2013, we received proceeds from bank loans of $5,654,000, proceeds from an increase in bank acceptance notes payable of $678,000, and net proceeds from sale of common stock of $2,389,000, offset by the repayments of bank loans of $4,846,000, repayments of principal on capital lease obligations of $392,000 and the increase in restricted cash of $678,000.
Our capital requirements for the next twelve months relate to purchasing machinery for the manufacture of products in our forged rolled rings division and for our dyeing business. We believe that our cash flow from operations will be sufficient to meet our anticipated cash requirements for the next twelve months.
We generally finance our operations through short term loans from our banks, which we refinance upon expiration. We do not have any long-term financing arrangements.
Contractual Obligations and Off-Balance Sheet Arrangements
Contractual Obligations
We have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant assumptions used in our determination of amounts presented in the tables, in order to assist in the review of this information within the context of our consolidated financial position, results of operations, and cash flows. The following tables summarize our contractual obligations as of December 31, 2014 (dollars in thousands), and the effect these obligations are expected to have on our liquidity and cash flows in future periods.
(1)Bank loans consisted of short term bank loans. Historically, we have refinanced these bank loans for an additional term of six months to one year and we expect to continue to refinance these loans upon expiration.
Off-balance Sheet Arrangements
We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
Foreign Currency Exchange Rate Risk
We produce and sell almost all of our products in China. Thus, most of our revenues and operating results may be impacted by exchange rate fluctuations between RMB and US dollars. For the year ended December 31, 2014, we had unrealized foreign currency translation loss of $408,386, because of changes in the exchange rate.
Inflation
The effect of inflation on our revenue and operating results was not significant.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable for smaller reporting companies
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements begin on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not Applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures
As required by Rule 13a-15 under the Exchange Act, our management, including Jianhua Wu, our chief executive officer, and Adam Wasserman, our chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2014.
Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating and implementing possible controls and procedures.
Management conducted its evaluation of disclosure controls and procedures under the supervision of our chief executive officer and our chief financial officer. Based on that evaluation, Mr. Wu and Mr. Wasserman concluded that our disclosure controls and procedures were not effective as of December 31, 2014.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act. Our management is also required to assess and report on the effectiveness of our internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”). Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. During our assessment of the effectiveness of internal control over financial reporting as of December 31, 2014, management identified significant deficiencies related to (i) the U.S. GAAP expertise of our internal accounting staff, (ii) our internal audit functions and (iii) a lack of segregation of duties within accounting functions. Although management believes that these deficiencies do not amount to a material weakness, our internal controls over financial reporting were not effective at December 31, 2014.
A major hurdle of our internal control efforts was the segregation of duties and installation of a company-wide Enterprise Resource Planning (“ERP”) system which are important parts of a good internal control system. During the year ended December 31, 2014, due to our working capital requirements and the lack of local professionals with the necessary experience in implementing the ERP system, we postponed the hiring of professional staff to implement ERP system. We have found that engaging professionals who are based outside of Wuxi is very costly and we have not been able to find qualified personnel in the Wuxi area.
We currently have no plans to expand our ERP system during 2015 and have not implemented further ERP modules to manage inventory and to expand existing ERP systems to other areas of our factory.
Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. As a result, we have not been able to take steps to improve our internal controls over financial reporting during the year ended December 31, 2014. However, to the extent possible, we are implementing procedures to assure that the initiation of transactions, the custody of assets and the recording of transactions will be performed by separate individuals.
A material weakness (within the meaning of PCAOB Auditing Standard No. 5) is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company’s financial reporting.
In light of this significant deficiency, we performed additional analyses and procedures in order to conclude that our consolidated financial statements for the year ended December 31, 2014 included in this Annual Report on Form 10-K were fairly stated in accordance with GAAP. Accordingly, management believes that despite our significant deficiency, our consolidated financial statements for the year ended December 31, 2014 are fairly stated, in all material respects, in accordance with GAAP.
Auditor Attestation
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
Changes in Internal Controls over Financial Reporting
There were no changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCES
Our current directors and executive officers are:
Member of the audit committee.
Member of the compensation committee.
Member of the corporate governance/ nominating committee.
Jianhua Wu has been our chief executive officer, chairman and a director since the completion of the reverse acquisition in November 2007. Mr. Wu founded our predecessor companies, the Huayang Companies, Dyeing and Heavy Industries in 1995 and 2004, respectively, and was executive director and general manager of these companies prior to becoming our chief executive officer. Mr. Wu is a certified mechanical engineer. Mr. Wu is qualified to serve as a director because of his experience with us as our chief executive officer.
Adam Wasserman has been our chief financial officer since December 10, 2012. Mr. Wasserman served as our vice president of financial reporting from 2008 until his appointment as chief financial officer in December 2012. Mr. Wasserman is chief executive officer for CFO Oncall, Inc. and CFO Oncall Asia, Inc. (collectively “CFO Oncall”), in both of which he is the controlling stockholder. CFO Oncall provides chief financial officer services to various companies. Currently, Mr. Wasserman also serves as the chief financial officer of Oriental Dragon Corp, a position he has held since June 2010, FAL Explorations Corp, (formerly Apps Genius Corp) since January 2011, and Wally World Media, Inc. since November 2012. Mr. Wasserman also served as chief financial officer of other companies all under the terms of consulting agreements with CFO Oncall. Mr. Wasserman holds a bachelor of science in accounting from the State University of New York at Albany. He is a member of The American Institute of Certified Public Accountants and is a director and an executive board member of Gold Coast Venture Capital Association.
Tianxiang Zhou has been a director since July 2010. Mr. Zhou served as lead engineer in Wuxi Angyida Mechanism Limited Company since 2004. From 1998 to 2004, he was general engineer in Wuxi Huayang Dye Machinery Equipment Limited. From 1994 to 1998 Mr. Zhou worked for Wuxi Chemicals Holdings as chief engineer of its design division. Mr. Zhou received his bachelor degree in engineering from Nanjing Institute of Chemical Technology in August 1961. Mr. Zhou’s engineering background and his experience in the manufacturing business are important qualifications for his service as a director.
Xi Liu has been a director since November 2007. Mr. Liu has an extensive background in material engineering, being a 1989 graduate of Jiangsu University of Technology with a degree in metal material and heat treatment, and having been trained at the Volvo facilities in Penta, Sweden in 1999. Immediately after graduating from university, Mr. Liu worked at China FAW Group Corporation, the oldest and one of largest Chinese automakers, as an engineer, before leaving in 2005 as an assistant manager in the purchasing department of the Wuxi Diesel Engine Works plant. He then joined WAM Bulk Handling Machinery (Shanghai) Co., Ltd., part of the Italian industrial giant WAMGROUP, as a purchasing and sourcing manager, which is his current position. Mr. Liu’s background in engineering and his practical industrial experience is important to us as we plan and develop our business.
Frank Zhao, who is also known as Ming Zhao, has been a director since April 2014. Mr. Zhao has been chief financial officer of China Jo-Jo Drugstores, Inc. since August 2011, having served as executive assistant to the chief executive officer and chief financial officer from September 2010 until July 2011. From July 2006 until August 2010, Mr. Zhao was a senior auditor with Sherb & Co., LLP. While at Sherb, Mr. Zhao was a senior auditor who worked on the audit of the Company’s financial statements. From December 2002 to July 2003, Mr. Zhao worked as financial analyst at Microsoft Corporation. Mr. Zhao received a bachelor of accounting degree from Central University of Finance and Economics in Beijing, China, and his master of Professional Accounting from the University of Washington. Mr. Zhao completed the course work for a PhD in accounting from Florida Atlantic University, but did not complete his dissertation. Mr. Zhao’s accounting and auditing experience background is important to us as we improve our financial accounting controls.
Furen Chen has been a director since July 2012. Mr. Chen is general manger and chairman of the board of Wuxi City ZhengCheng Accounting Services, Ltd., a position he has held since February 2000. From 1990 until February 2000, Mr. Chen was accounting manager at Qian Zhou Agricultural Financial Co., Ltd. Mr. Chen is a certified public accountant in China. Mr. Chen’s finance and accounting experience background is important to us as we improve our financial accounting controls.
Committees
Our business, property and affairs are managed by or under the direction of the board of directors. Members of the board are kept informed of our business through discussion with the chief executive and financial officers and other officers, by reviewing materials provided to them and by participating at meetings of the board and its committees.
Our board of directors has three committees - the audit committee, the compensation committee and the corporate governance/nominating committee. The audit committee is comprised of Frank Zhao, Xi Liu and Furen Chen, with Mr. Frank Zhao serving as chairman. The compensation committee is comprised of Tianxiang Zhou, Xi Liu and Furen Chen, with Mr. Tianxiang Zhou as chairman. The corporate governance/nominating committee is comprised of Xi Liu, Furen Chen, and Tianxiang Zhou, with Mr. Xi Liu as chairman.
Our audit committee is involved in discussions with our independent auditor with respect to the scope and results of our year-end audit, our quarterly results of operations, our internal accounting controls and the professional services furnished by the independent auditor. Our board of directors has adopted a written charter for the audit committee which the audit committee reviews and reassesses for adequacy on an annual basis.
The compensation committee oversees the compensation of our chief executive officer and our other executive officers and reviews our overall compensation policies for employees generally. If so authorized by the board of directors, the committee may also serve as the granting and administrative committee under any option or other equity-based compensation plans which we may adopt. The compensation committee does not delegate its authority to fix compensation; however, as to officers who report to the chief executive officer, the compensation committee consults with the chief executive officer, who may make recommendations to the compensation committee. Any recommendations by the chief executive officer are accompanied by an analysis of the basis for the recommendations. The committee will also discuss compensation policies for employees who are not officers with the chief executive officer and other responsible officers. We are in the process of amending our compensation committee charter to meet the requirements of Nasdaq. The compensation committee has the responsibilities and authority relating to the retention, compensation, oversight and funding of compensation consultants, legal counsel and other compensation advisers, as well as the requirement to consider six independence factors before selecting, or receiving advice from, such advisers.
The corporate governance/nominating committee is involved in evaluating the desirability of and recommending to the board any changes in the size and composition of the board, evaluation of and successor planning for the chief executive officer and other executive officers. The qualifications of any candidate for director will be subject to the same extensive general and specific criteria applicable to director candidates generally.
The board and its committees held the following number of meetings during 2014:
The meetings include meetings that were held by means of a conference telephone call, but do not include actions taken by unanimous written consent.
Each director attended at least 75% of the total number of meetings of the board and those committees on which he served during the year.
Our non-management directors did not meet in executive session during 2014.
Compensation Committee Interlocks and Insider Participation
Aside from his service as director, no member of our compensation committee had any relationship with us as of December 31, 2014.
Section 16(a) Compliance
Section 16(a) of the Securities Exchange Act of 1934, requires our directors, executive officers and persons who own more than 10% of our common stock to file with the SEC initial reports of ownership and reports of changes in ownership of common stock and other of our equity securities. During the year ended December 31, 2014, Mr. Wu and Mr. Wasserman and Mr. Zhao were late in the filing of one or more Form 4 or Form 3 filings.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The following summary compensation table indicates the cash and non-cash compensation earned during the years ended December 31, 2014 and 2013 by each person who served as chief executive officer and chief financial officer during the year ended December 31, 2014. No other executive officer received compensation equal or exceeding $100,000.
Summary Annual Compensation Table
(1)Mr. Wu’s 2014 compensation consisted of salary of $32,556 and 20,000 shares of common stock, valued at $110,600. Mr. Wu’s 2013 compensation consisted of salary of $28,241and 25,000 shares of common stock, valued at $102,250.
(2)Mr. Wasserman has been our chief financial officer since December 2012. Mr. Wasserman’s compensation is paid to CFO Oncall Inc. where he serves as chief executive officer. Mr. Wasserman’s 2014 compensation included salary of $52,000 and 15,000 shares of common stock, valued at $98,303. Mr. Wasserman’s 2013 compensation included salary of $52,000 and 23,015 shares of common stock, valued at $103,332.
Employment Agreement
Pursuant to an employment agreement dated December 10, 2012, Adam Wasserman receives compensation at the annual rate of $52,000. In addition, Mr. Wasserman was granted 19,603 shares of common stock pursuant to our long-term incentive plan. The agreement had a term commencing December 10, 2012 through March 31, 2014 and continues on a month-to-month basis thereafter unless terminated by either party.
Compensation of Directors
We do not have any agreements or formal plan for compensating our current directors for their service in their capacity as directors, although our board may, in the future, award stock options to purchase shares of common stock to our current directors.
The following table provides information concerning the compensation of each member of our board of directors whose compensation is not included in the Summary Compensation Table for his or her services as a director and committee member for 2014. The value attributable to any stock grants is computed in accordance with ASC Topic 718.
(1) Baowen Wang resigned as a director of us on April 24, 2014.
(2) Frank Zhao has been our director since April 2014.
Long-Term Incentive Plan
In January 2010, the board of directors adopted, and in March 2010, the stockholders approved the 2010 long-term incentive plan, covering 200,000 shares of common stock. In October 2013, the board of directors adopted and in December 2013, the stockholders approved, an amendment to the 2010 plan which increased the number of shares subject to the 2010 plan from 200,000 shares to 500,000 shares. The 2010 plan provides for the grant of incentive and non-qualified options and stock grants to employees, including officers, directors and consultants. The 2010 plan is to be administered by a committee of not less than three directors, each of whom is to be an independent director. In the absence of a committee, the plan is administered by the board of directors. The board has granted the compensation committee the authority to administer the 2010 plan. Members of the committee are not eligible for stock options or stock grants pursuant to the 2010 plan unless such stock options or stock grant are granted by a majority of our independent directors other than the proposed grantee. As of December 31, 2014, we had issued a total of 243,491 shares of common stock pursuant to this plan.
The following table sets forth information as options outstanding on December 31, 2014.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The following table provides information as to shares of common stock beneficially owned as of the filing date of this report, by:
● each current director;
● each current officer named in the summary compensation table;
● each person owning of record or known by us, based on information provided to us by the persons named below, to own beneficially at least 5% of our common stock; and
● all current directors and executive officers as a group.
* less than 1%.
(1) Jianhua Wu and Lihua Tang, who are husband and wife, are majority stockholders of Maxworthy International Ltd. Mr. Wu is also managing director of Maxworthy. The shares reflected as being owned by Mr. Wu and Ms. Tang represent (i) 544,267 shares owned by Maxworthy (ii) 340,917 shares owned by Mr. Wu and (iii) 244,475 shares owned by Ms. Tang. Each of Mr. Wu and Ms. Tang disclaims beneficial ownership in the shares of beneficially owned by the other. The address for Maxworthy is P.O. Box 957, Offshore Incorporations Centre, Road Town, Tortola, British Virgin Islands.
(2) Yunxia Ren and Haoyang Wu are the daughter-in-law and son of Jianhua Wu and Lihua Tang. Ms. Ren owns 259,022 shares of common stock and Mr. Wu owns 68,252 shares of common stock. Each of Ms. Ren and Mr. Wu disclaims ownership of the shares owned by the other.
(3) Address is No. 9 Yanyu Middle Road, Qianzhou Village, Huishan District, Wuxi City, Jiangsu Province, P.R.C.
(4)
Address is No. 25 Jin Xiu Second Village, Qianzhou Town Huishan District, Wuxi City, Jiangsu Province, P.R.C.
(5) 41,000 shares are held by Adam Wasserman and 286 shares are held in the name of CFO Oncall Asia, Inc. of which Mr. Wasserman is chief executive officer.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.
Director Independence
Four of our directors, Furen Chen, Frank Zhao, Xi Liu, and Tianxiang Zhou, are independent directors, using the Nasdaq definition of independence. Except for Frank Zhao, Each of these directors serves on at least two of our board committees. The audit committee is comprised of Frank Zhao (chair), Xi Liu and Furen Chen, the compensation committee is comprised of Tianxiang Zhou (chair), Xi Liu, and Furen Chen, and the corporate governance/nominating committee is comprised of Xi Liu (chair), Furen Chen, and Tianxiang Zhou. Our board has determined that Mr. Zhao is an audit committee financial expert.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The following table sets forth the fees billed by our principal independent accountants, RBSM LLP, for each of our last two fiscal years for the categories of services indicated.
Audit fees. Consists of fees billed for the audit of our annual financial statements, review of our Form 10-K, review of our interim financial statements included in our Form 10-Q and services that are normally provided by the accountant in connection with year-end statutory and regulatory filings or engagements.
Audit-related fees. Consists of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements and are not reported under “Audit Fees”, review of our Forms 8-K filings and services that are normally provided by the accountant in connection with non-year-end statutory and regulatory filings or engagements.
Tax fees. Consists of professional services rendered by a company aligned with our principal accountant for tax compliance, tax advice and tax planning.
Other fees. The services provided by our accountants within this category consisted of advice and other services relating to SEC matters, registration statement review, accounting issues and client conferences.
Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors
The audit committee’s policy is to pre-approve all audit and permissible non-audit services provided by the independent registered public accounting firm. These services may include audit services, audit-related services, tax services and other services. The independent registered public accounting firm and management are required to periodically report to the audit committee regarding the extent of services provided by the independent registered public accounting firm in accordance with this pre-approval, and the fees for the services performed to date. The audit committee may also pre-approve particular services on a case-by-case basis. All services since October 1, 2008 were pre-approved by the audit committee.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(1) Incorporated by reference to the Form 10-K filed by the Company on April 11, 2013.
(2) Incorporated by reference to the Form 8-K filed by the Company on August 9, 2012.
(3) Incorporated by reference to the Form 10-K filed by the Company on March 31, 2010.
(4) Incorporated by reference to the Company’s definitive proxy statement for the 2013 annual meeting of shareholders, which was filed by the Company on October 30, 2013.
(5)
Incorporated by reference to the Form 10-K filed by the Company on March 31, 2009.
(6) Incorporated by reference to the Company’s Form 10-K filed by the Company on March 28, 2014.
* filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities on the dates indicated. Each person whose signature appears below hereby authorizes Jianhua Wu as his or her true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution for him or her and in his or her name, place and stead, in any and all capacities to sign any and all amendments to this report, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
CONTENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Cleantech Solutions International, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Cleantech Solutions International, Inc. and Subsidiaries (the "Company") as of December 31, 2014 and 2013 and the related consolidated statements of operations and comprehensive income, changes in stockholders' equity and cash flows for each of the two years in the period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cleantech Solutions International, Inc. and Subsidiaries as of December 31, 2014 and 2013 and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.
/s/ RBSM LLP
New York, New York
March 30, 2015
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
See notes to consolidated financial statements
See notes to consolidated financial statements
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Cleantech Solutions International, Inc. (the “Company”) was incorporated in Delaware on June 24, 1987 under the name of Malex, Inc. On December 18, 2007, the Company’s corporate name was changed to China Wind Systems, Inc., and on June 13, 2011, the Company’s corporate name was changed to Cleantech Solutions International, Inc. On August 7, 2012, the Company was converted into a Nevada corporation.
Through its affiliated companies and subsidiaries, the Company manufactures and sells forged products and fabricated products to a range of clean technology customers including high precision forged rolled rings and related products for the wind power industry and other industries and manufactures and sells textile dyeing and finishing machines. The Company is the sole owner of Fulland Limited (“Fulland”), a Cayman Island limited liability company, which was organized on May 9, 2007. Fulland owns 100% of the capital stock of Green Power Environment Technology (Shanghai) Co., Ltd. (“Green Power”) and Wuxi Fulland Wind Energy Equipment Co., Ltd. (“Fulland Wind Energy”), which are wholly foreign-owned enterprises (“WFOE”) organized under the laws of the People’s Republic of China (“PRC” or “China”). Green Power is a party to a series of contractual arrangements, as fully described below, dated October 12, 2007 with Wuxi Huayang Heavy Industries, Co., Ltd. ("Heavy Industries"), formerly known as Wuxi Huayang Electrical Power Equipment Co., Ltd. and Wuxi Huayang Dyeing Machinery Co., Ltd. (“Dyeing”), both of which are limited liability companies organized under the laws of, and based in, the PRC. Heavy Industries and Dyeing are sometimes collectively referred to as the “Huayang Companies.”
Fulland was organized by the owners of the Huayang Companies as a special purpose vehicle for purposes of raising capital, in accordance with requirements of the PRC State Administration of Foreign Exchange (“SAFE”). On May 31, 2007, SAFE issued an official notice known as Hui Zong Fa [2007] No. 106 (“Circular 106”), which requires the owners of any Chinese company to obtain SAFE’s approval before establishing any offshore holding company structure for foreign financing as well as subsequent acquisition matters in China. Accordingly, the owners of the Huayang Companies, Mr. Jianhua Wu and Ms. Lihua Tang, submitted their application to SAFE in early September 2007. On October 11, 2007, SAFE approved their application, permitting these Chinese citizens to establish Fulland as a special purpose vehicle for any foreign ownership and capital raising activities by the Huayang Companies.
Heavy Industries was formed on May 21, 2004, and Fulland Wind Energy was formed on August 27, 2008. Beginning in April 2007, Heavy Industries began to produce large-scaled forged rolled rings that are up to three meters in diameter for the wind-power and other industries. In 2009, the Company began to produce and sell forged products through Fulland Wind Energy. Through Heavy Industries and Fulland Wind Energy, the Company manufactures and machines all forged products, including wind products such as shafts, rolled rings, gear rims, gearboxes, bearings and other components and finished products and assemblies for the wind power and other industries, including large-scale equipment used in the manufacturing process for the various industries. The Company refers to this segment of its business as the forged rolled rings and related components segment.
Dyeing, which was formed on August 17, 1995, produces and sells a variety of high and low temperature dyeing and finishing machinery for the textile industry. The Company refers to this segment as the dyeing and finishing equipment segment.
Basis of presentation
The Company’s consolidated financial statements include the financial statements of its wholly-owned subsidiaries, Fulland, Green Power and Fulland Wind Energy, as well as the financial statements of Huayang Companies, Dyeing and Heavy Industries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Pursuant to Accounting Standards Codification (“ASC”) Topic 810, the Huayang Companies are considered variable interest entities (“VIE”), and the Company is the primary beneficiary. The Company’s relationships with the Huayang Companies and their shareholders are governed by a series of contractual arrangements between Green Power, the Company’s wholly foreign-owned enterprise in the PRC, and each of the Huayang Companies, which are the operating companies of the Company in the PRC. Under PRC laws, each of Green Power, Dyeing and Heavy Industries is an independent legal entity and none of them is exposed to liabilities incurred by the other parties. The contractual arrangements constitute valid and binding obligations of the parties of such agreements. Each of the contractual arrangements and the rights and obligations of the parties thereto are enforceable and valid in accordance with the laws of the PRC. On October 12, 2007, the Company entered into the following contractual arrangements with each of Dyeing and Heavy Industries:
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Basis of presentation (continued)
Consulting Services Agreement. Pursuant to the exclusive consulting services agreements between Green Power and the Huayang Companies, Green Power has the exclusive right to provide to the Huayang Companies general business operation services, including advice and strategic planning, as well as consulting services related to the technological research and development of dyeing and finishing machines, electrical equipment and related products (the “ Services ”). Under this agreement, Green Power owns the intellectual property rights developed or discovered through research and development, in the course of providing the Services, or derived from the provision of the Services. The Huayang Companies shall pay a quarterly consulting service fees in Renminbi (“RMB”) to Fulland that is equal to all of the Huayang Companies’ profits for such quarter.
Operating Agreement. Pursuant to the operating agreement among Green Power, the Huayang Companies and all shareholders of the Huayang Companies, Green Power provides guidance and instructions on the Huayang Companies’ daily operations, financial management and employment issues. The Huayang Companies shareholders must designate the candidates recommended by Green Power as their representatives on the boards of directors of each of the Huayang Companies. Green Power has the right to appoint senior executives of the Huayang Companies. In addition, Green Power agrees to guarantee the Huayang Companies’ performance under any agreements or arrangements relating to the Huayang Companies’ business arrangements with any third party. The Huayang Companies, in return, agree to pledge their accounts receivable and all of their assets to Green Power. Moreover, each of the Huayang Companies agrees that, without the prior consent of Green Power, it will not engage in any transactions that could materially affect its assets, liabilities, rights or operations, including, without limitation, incurrence or assumption of any indebtedness, sale or purchase of any assets or rights, incurrence of any encumbrance on any of their assets or intellectual property rights in favor of a third party or transfer of any agreements relating to their business operation to any third party. The term of this agreement, as amended on November 1, 2008, is 20 years from October 12, 2007 and may be extended only upon Green Power’s written confirmation prior to the expiration of the this agreement, with the extended term to be mutually agreed upon by the parties.
Equity Pledge Agreement. Under the equity pledge agreement between the Huayang Companies’ shareholders and Green Power, the Huayang Companies’ shareholders pledged all of their equity interests in the Huayang Companies to Green Power to guarantee the Huayang Companies’ performance of their respective obligations under the consulting services agreement. If the Huayang Companies or the Huayang Companies’ shareholders breach their respective contractual obligations, Green Power, as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests. The Huayang Companies’ shareholders also agreed that, upon occurrence of any event of default, Green Power shall be granted an exclusive, irrevocable power of attorney to take actions in the place and stead of the Huayang Companies’ shareholders to carry out the security provisions of the equity pledge agreement and take any action and execute any instrument that Green Power may deem necessary or advisable to accomplish the purposes of the equity pledge agreement. The Huayang Companies’ shareholders agreed not to dispose of the pledged equity interests or take any actions that would prejudice Green Power’s interest. The equity pledge agreement will expire two years after the Huayang Companies’ obligations under the consulting services agreements have been fulfilled.
Option Agreement. Under the option agreement between the Huayang Companies’ shareholders and Green Power, the Huayang Companies’ shareholders irrevocably granted Green Power or its designated person an exclusive option to purchase, to the extent permitted under PRC law, all or part of the equity interests in the Huayang Companies for the cost of the initial contributions to the registered capital or the minimum amount of consideration permitted by applicable PRC law. Green Power or its designated person has sole discretion to decide when to exercise the option, whether in part or in full. The term of this agreement, as amended on November 1, 2008, is 20 years from October 12, 2007 and may be extended prior to its expiration by written agreement of the parties.
Pursuant to ASC Topic 810 and related subtopics related to the consolidation of variable interest entities, the accounts of the Huayang Companies are consolidated in the accompanying financial statements. As VIEs, the Huayang Companies’ sales are included in the Company’s total sales, its income from operations is consolidated with the Company’s, and the Company’s net income includes all of the Huayang Companies net income. The Company does not have any non-controlling interest and, accordingly, did not subtract any net income in calculating the net income of the VIEs that is attributable to the Company. Because of the contractual arrangements, the Company has a pecuniary interest in the Huayang Companies that requires consolidation of the Company’s and the Huayang Companies’ financial statements.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Use of estimates
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Actual results could materially differ from these estimates. Significant estimates in 2014 and 2013 include the allowance for doubtful accounts, the allowance for obsolete inventory, the useful life of property and equipment and intangible assets, assumptions used in assessing impairment of long-term assets and valuation of deferred tax assets, accruals for taxes due, and the value of stock-based compensation.
Cash and cash equivalents
For purposes of the consolidated statements of cash flows, the Company considers all highly liquid instruments purchased with a maturity of three months or less and money market accounts to be cash equivalents. The Company maintains with various financial institutions mainly in the PRC and the U.S. As of December 31, 2014 and 2013, cash balances in banks in the PRC of $7,792,993 and $704,391, respectively, are uninsured.
Fair value of financial instruments
The Company adopted the guidance of ASC Topic 820 for fair value measurements which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:
Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.
Level 2-Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.
Level 3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.
At December 31, 2013, the following table presents information about equipment held for operating lease measured at fair value on a nonrecurring basis. At December 31, 2014, equipment held for operating lease was reclassified to equipment held for sale and is measured at fair value on a nonrecurring basis as shown in the following table.
The Company conducted an impairment assessment on the equipment held for sale and equipment held for operating lease based on the guidelines established in ASC Topic 360 to determine the estimated fair market value of the equipment as of December 31, 2014 and 2013, respectively. Upon completion of its 2014 and 2013 impairment analysis, the Company determined that the carrying value exceeded the fair market value on this equipment. Accordingly, for the years ended December 31, 2014 and 2013, the Company recorded an impairment loss of $3,799,947 and $2,573,256, respectively.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Fair value of financial instruments (continued)
The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, restricted cash, notes receivable, accounts receivable, inventories, advances to suppliers, prepaid VAT on purchases, deferred tax assets, prepaid expenses and other, short-term bank loans, bank acceptance notes payable, accounts payable, accrued expenses, advances from customers, VAT and service taxes payable and income taxes payable approximate their fair market value based on the short-term maturity of these instruments.
ASC Topic 825-10 “Financial Instruments” allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. The Company did not elect to apply the fair value option to any outstanding instruments.
Concentrations of credit risk
The Company’s operations are carried out in the PRC. Accordingly, the Company’s 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’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. Substantially all of the Company’s cash is maintained with state-owned banks within the PRC, and none of these deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts. A significant portion of the Company’s sales are credit sales which are primarily to customers whose ability to pay is dependent upon the industry economics prevailing in these areas; however, concentrations of credit risk with respect to trade accounts receivables is limited due to generally short payment terms. The Company also performs ongoing credit evaluations of its customers to help further reduce credit risk.
At December 31, 2014 and 2013, the Company’s cash balances by geographic area were as follows:
Restricted cash
Restricted cash consists of cash deposits held by a bank to secure bank acceptance notes payable.
Notes receivable
Notes receivable represents trade accounts receivable due from customers where the customers’ bank has guaranteed the payment of the receivable. This amount is non-interest bearing and is normally paid within six months. Historically, the Company has experienced no losses on notes receivable. The Company’s notes receivable totaled $114,034 and $703,718 at December 31, 2014 and 2013, respectively.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Accounts receivable
Accounts receivable are presented net of an allowance for doubtful accounts. The Company maintains allowances for doubtful accounts for estimated losses. The Company reviews the accounts receivable on a periodic basis and makes general and specific allowances when there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, the Company considers many factors, including the age of the balance, a customer’s historical payment history, its current credit-worthiness and current economic trends. Accounts are written off after exhaustive efforts at collection. During the years ended December 31, 2014 and 2013, accounts with the amount of approximately $27,000 and $1,200,000, respectively, were written off after exhaustive efforts at collection with a corresponding debit to the allowance for doubtful account. The writes-offs of accounts receivable against the allowance for doubtful accounts only impact the balance sheet accounts. During the years ended December 31, 2014 and 2013, the Company has recovered and collected approximately $354,000 and $857,000, respectively, of accounts receivable for which the Company has previously reserved for as of December 31, 2013 and 2012, respectively. At December 31, 2014 and 2013, the Company has established, based on a review of its outstanding balances, an allowance for doubtful accounts in the amounts of $1,321,328 and $830,211, respectively.
Inventories
Inventories, consisting of raw materials, work in process and finished goods related to the Company’s products are stated at the lower of cost or market utilizing the weighted average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, the Company will record reserves for the difference between the cost and the market value. These reserves are recorded based on estimates. The Company recorded an inventory reserve of $181,646 and $182,482 at December 31, 2014 and 2013, respectively.
Advance to suppliers
Advance to suppliers represents the cash paid in advance for the purchase of raw material from suppliers. The advance payments are intended to ensure preferential pricing and delivery. The amounts advanced under such arrangements totaled $565,581 and $695,254 as of December 31, 2014 and 2013, respectively.
Property and equipment
Property and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. The Company examines the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.
Included in property and equipment is construction-in-progress which consisted of factory improvements and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation of the assets. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use.
Equipment held for operating lease and related rental revenue
At December 31, 2013, the Company reflected electro-slag re-melted (“ESR”) equipment that was used in 2010 and 2011 to produce forged products for the high performance components market as equipment held for operating lease on the accompanying consolidated balance sheets. The Company made a determination with respect to the lease whether it should be accounted for as operating lease or financing lease. The classification criteria is based on estimates regarding the fair value of the leased ESR equipment, minimum lease payments, the economic life of the equipment, the existence of a bargain purchase option, and certain other terms in the lease agreement. The Company believes the lease should be accounted for as operating lease. The Company measures long-lived assets being leased at the lower of carrying amount or fair value, less associated costs to lease.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Equipment held for operating lease and related rental revenue (continued)
In March 2014, the Company signed an operating lease agreement related to the lease of such equipment for a period of eight years. Equipment held for operating lease is depreciated over its estimated useful life starting from the operating lease commencement date, April 1, 2014. Rental payments are recorded as rental income over the lease term as earned. The related depreciation on the equipment held for operating lease is recognized as a reduction of rental income on a straight-line basis. For the year ended December 31, 2014, the rental income was $605,214 and the related depreciation on the equipment held for operating lease was $503,675, respectively. The lessee stopped using the equipment and stopped paying its lease payments in early 2015 and the Company has not found and does not expect to find other potential lessees in 2015. Therefore, the Company reclassified the equipment held for operating lease to equipment held for sale at December 31, 2014.
Impairment of long-lived assets
In accordance with ASC Topic 360, the Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable, or at least annually. The Company recognizes an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value. For the years ended December 31, 2014 and 2013, the Company incurred impairment charge in operations of $3,799,947 and $2,573,256, respectively, on the electro-slag re-melted equipment. The valuations of the ESR equipment which, at December 31, 2013 was reflected as equipment held for operating lease and as equipment held for sale at December 31, 2014 on the accompanying balance sheets, and the amounts of the impairment charge, were based on the impairment assessments conducted on ESR equipment at December 31, 2014 and 2013.
Advance from customers
Advance from customers at December 31, 2014 and 2013 amounted to $495,461 and $1,455,740, respectively, and consist of prepayments from customers for merchandise that had not yet been shipped. The Company will recognize the deposits as revenue as customers take delivery of the goods and title to the assets is transferred to customers in accordance with the Company’s revenue recognition policy.
Revenue recognition
Pursuant to the guidance of ASC Topic 605 and ASC Topic 360, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the purchase price is fixed or determinable and collectability is reasonably assured.
The Company recognizes revenues from the sale of dyeing and finishing equipment, forged rolled rings and other components upon shipment and transfer of title. The other elements may include installation and, generally, a one-year warranty. Equipment installation revenue is valued based on estimated service person hours to complete installation and is recognized when the labor has been completed and the equipment has been accepted by the customer, which is generally within a couple days of the delivery of the equipment. Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the years ended December 31, 2014 and 2013, amounts allocated to installation and warranty revenues were $130,565 and $125,970, respectively. Based on historical experience, warranty service calls and any related labor costs have been minimal.
Rental income is recognized on a straight-line basis over the term of the operating lease.
All other product sales with customer specific acceptance provisions, including the forged rolled rings, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Income taxes
The Company is governed by the Income Tax Law of the PRC and the U.S. Internal Revenue Code of 1986, as amended. The Company accounts for income taxes using the asset/liability method prescribed by ASC 740, “Accounting for Income Taxes.” Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the period in which the differences are expected to reverse. The Company records a valuation allowance to offset deferred tax assets if based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized as income or loss in the period that includes the enactment date.
The Company applied the provisions of ASC 740-10-50, “Accounting for Uncertainty in Income Taxes,” which provides clarification related to the process associated with accounting for uncertain tax positions recognized in our financial statements. Audit periods remain open for review until the statute of limitations has passed. The completion of review or the expiration of the statute of limitations for a given audit period could result in an adjustment to the Company’s liability for income taxes. Any such adjustment could be material to the Company’s results of operations for any given quarterly or annual period based, in part, upon the results of operations for the given period. As of December 31, 2014 and 2013, the Company had no uncertain tax positions, and will continue to evaluate for uncertain positions in the future.
Stock-based compensation
Stock-based compensation is accounted for based on the requirements of the Share-Based Payment topic of ASC Topic 718 which requires recognition in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments over the period the employee or director is required to perform the services in exchange for the award (presumptively, the vesting period). The Financial Accounting Standards Board (“FASB”) also requires measurement of the cost of employee and director services received in exchange for an award based on the grant-date fair value of the award.
Pursuant to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the “measurement date.” The expense is recognized over the vesting period of the award. Until the measurement date is reached, the total amount of compensation expense remains uncertain. The Company records compensation expense based on the fair value of the award at the reporting date. The awards to consultants and other third-parties are then revalued, or the total compensation is recalculated, based on the then current fair value, at each subsequent reporting date.
Shipping costs
Shipping costs are included in selling expenses and totaled $1,372,724 and $1,291,197 for the years ended December 31, 2014 and 2013, respectively.
Employee benefits
The Company’s operations and employees are all located in the PRC. The Company makes mandatory contributions to the PRC government’s health, retirement benefit and unemployment funds in accordance with the relevant Chinese social security laws. The costs of these payments are charged to the same accounts as the related salary costs in the same period as the related salary costs incurred. Employee benefit costs totaled $245,267 and $217,513 for the years ended December 31, 2014 and 2013, respectively.
Advertising
Advertising is expensed as incurred and is included in selling, general and administrative expenses on the accompanying consolidated statements of income and comprehensive income and totaled $24,175 and $18,352 for the years ended December 31, 2014 and 2013, respectively.
Research and development
Research and development costs are expensed as incurred. The costs primarily consist of raw materials and salaries incurred for the development and improvement of the Company’s new dyeing machinery. Research and development costs totaled $116,061 and $92,803 for the years ended December 31, 2014 and 2013, respectively.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Foreign currency translation
The reporting currency of the Company is the U.S. dollar. The functional currency of the parent company is the U.S. dollar and the functional currency of the Company’s operating subsidiaries is the Chinese Renminbi (“RMB”). For the subsidiaries and affiliates, whose functional currencies are the RMB, results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate at the end of the period, and equity is translated at historical exchange rates. As a result, amounts relating to assets and liabilities reported on the statements of cash flows may not necessarily agree with the changes in the corresponding balances on the balance sheets. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income. The cumulative translation adjustment and effect of exchange rate changes on cash for the years ended December 31, 2014 and 2013 was $6,338 and $30,034, respectively. Transactions denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing on the transaction dates. Assets and liabilities denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing at the balance sheet date with any 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.
All of the Company’s revenue transactions are transacted in the functional currency of the operating subsidiaries and affiliates. Other than for the purchase of equipment from non-Chinese suppliers, the Company does not enter into any material transaction in foreign currencies. Transaction gains or losses have not had, and are not expected to have, a material effect on the results of operations of the Company.
Asset and liability accounts at December 31, 2014 and 2013 were translated at 6.1385 RMB to $1.00 and at 6.1104 RMB to $1.00, respectively, which were the exchange rates on the balance sheet dates. Equity accounts were stated at their historical rate. The average translation rates applied to the statements of income for the years ended December 31, 2014 and 2013 were 6.1432 RMB and 6.1905 RMB to $1.00, respectively. Cash flows from the Company’s operations are calculated based upon the local currencies using the average translation rate.
Income per share of common stock
ASC Topic 260 “Earnings per Share,” requires presentation of both basic and diluted earnings per share (“EPS”) with a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
Basic net income per share is computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. The Company did not have any potentially dilutive common stock outstanding during the years ended December 31, 2014 and 2013.
The following table presents a reconciliation of basic and diluted net income per share:
The Company did not have any common stock equivalents at December 31, 2014 and 2013.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Related parties
Parties are considered to be related to the Company if the parties, 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 with 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. The Company discloses all related party transactions. All transactions are recorded at fair value of the goods or services exchanged.
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 years ended December 31, 2014 and 2013 included net income and unrealized gains (losses) from foreign currency translation adjustments.
Recent accounting pronouncements
In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). Early adoption is not permitted. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.
In June 2014, the FASB issued Accounting Standards Update No. 2014-12, Compensation - Stock Compensation (Topic 718), Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force) (ASU 2014-12). The guidance applies to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. The amendments require that a performance target that affects vesting and that could be achieved after the requisite service period is treated as a performance condition. For all entities, the amendments in this Update are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The effective date is the same for both public business entities and all other entities. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.
In August 2014, the FASB issued Accounting Standards Update No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40), Disclosure of Uncertainties about an Entities Ability to Continue as a Going Concern (ASU 2014-15). The guidance in ASU 2014-15 sets forth management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern as well as required disclosures. ASU 2014-15 indicates that, when preparing financial statements for interim and annual financial statements, management should evaluate whether conditions or events, in the aggregate, raise substantial doubt about the entity's ability to continue as a going concern for one year from the date the financial statements are issued or are available to be issued. This evaluation should include consideration of conditions and events that are either known or are reasonably knowable at the date the financial statements are issued or are available to be issued, as well as whether it is probable that management's plans to address the substantial doubt will be implemented and, if so, whether it is probable that the plans will alleviate the substantial doubt. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods and annual periods thereafter. Early application is permitted. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.
Other accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its consolidated financial condition, results of operations, cash flows or disclosures.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 2 - ACCOUNTS RECEIVABLE
At December 31, 2014 and 2013, accounts receivable consisted of the following:
The Company reviews the accounts receivable on a periodic basis and makes general and specific allowances when there is doubt as to the collectability of individual balances. After evaluating the collectability of individual receivable balances, the Company increased the allowance for doubtful accounts in the amount of $521,928 for the year ended December 31, 2014 and decreased the allowance for doubtful accounts in the amount of $628,188 for the year ended December 31, 2013.
During the years ended December 31, 2014 and 2013, accounts with the amount of approximately $27,000 and $1,200,000, respectively, were written off after exhaustive efforts at collection with a corresponding debit to the allowance for doubtful account. The writes-offs of accounts receivable against the allowance for doubtful accounts only impact the balance sheet accounts. During the years ended December 31, 2014 and 2013, the Company has recovered and collected approximately $354,000 and $857,000, respectively, accounts receivable for which the Company has previously reserved for at December 31, 2013 and 2012, respectively.
NOTE 3 - INVENTORIES
At December 31, 2014 and 2013, inventories consisted of the following:
For the year ended December 31, 2014, the Company did not make any change for reserve for obsolete inventories. For the year ended December 31, 2013, the Company increased reserve for obsolete inventories in the amount of $41,381.
NOTE 4 - PROPERTY AND EQUIPMENT
At December 31, 2014 and 2013, property and equipment consisted of the following:
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 4 - PROPERTY AND EQUIPMENT (continued)
For the years ended December 31, 2014 and 2013, depreciation expense amounted to $8,469,771 and $6,704,386, respectively, of which $7,244,647 and $6,131,296, respectively, was included in cost of revenues, $503,675 and $0 which was related to the ESR equipment held for operating lease (see note 6), respectively, was included in rental income, net, and the remainder was included in operating expenses.
Depreciation is not taken during the period of construction or equipment installation. Upon completion of the installation of manufacturing equipment or any construction in progress, construction in progress balances will be classified to their respective property and equipment category.
NOTE 5 - LAND USE RIGHTS
There is no private ownership of land in China. Land is owned by the government and the government grants land use rights for specified terms. The Company’s land use rights have terms of 45 and 50 years and expire on January 1, 2053 and October 30, 2053. The Company amortizes the land use rights over the term of the respective land use right. For the years ended December 31, 2014 and 2013, amortization of land use rights amounted to $96,226 and $95,491, respectively. At December 31, 2014 and 2013, land use rights consisted of the following:
Amortization of land use rights attributable to future periods is as follows:
NOTE 6 - EQUIPMENT HELD FOR OPERATING LEASE/HELD FOR SALE
The Company measures long-lived assets to be leased at the lower of carrying amount or fair value, less associated costs to lease these assets. During the last quarter of 2013, the Company decided to lease the ESR equipment to a third party and negotiations took place last quarter of 2013 through March 2014. In March 2014, the Company entered into an operating lease agreement with an eight-year term commencing April 1, 2014, with a third party, whereby the lessee leases the ESR equipment from the Company for quarterly lease payments of 1,450,000 RMB (including value-added tax, approximately $236,000 per quarter). Accordingly, at December 31, 2013, the ESR equipment has been reflected as equipment held for operating lease on the accompanying consolidated balance sheets. The lessee stopped using the equipment and stopped paying rent in early 2015. Therefore, the Company reclassified the equipment held for operating lease to equipment held for sale at December 31, 2014. At December 31, 2014 and 2013, the Company evaluated the ESR equipment for impairment. The Company compared the estimated fair values of the equipment to its carrying value with impairment indicators and recorded an impairment charge for the excess of carrying value over fair value. For the years ended December 31, 2014 and 2013, the Company recorded an impairment loss on ESR equipment in the amount of $3,799,947 and $2,573,256, respectively.
Equipment held for operating lease was depreciated over its estimated useful life starting from the operating lease commencement date, April 1, 2014 through December 31, 2014. Rental payments were recorded as rental income over the lease term as earned. The related depreciation on the equipment held for operating lease was recognized as a reduction of rental income on a straight-line basis. For the year ended December 31, 2014, the Company recorded rental income of $605,214 and recorded related depreciation on the equipment held for operating lease of $503,675, respectively, which were included in rental income, net, on the accompanying consolidated statements of income and comprehensive income.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 7 - SHORT-TERM BANK LOANS
Short-term bank loans represent amounts due to various banks that are due within one year. These loans can be renewed with these banks upon maturity. At December 31, 2014 and 2013, short-term bank loans consisted of the following:
For the years ended December 31, 2014 and 2013, interest expense related to short-term bank loans amounted to $238,226 and $300,381, respectively, which were included in interest expense on the accompanying consolidated statements of income and comprehensive income.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 8 - BANK ACCEPTANCE NOTES PAYABLE
Bank acceptance notes payable represent amounts due to banks which are collateralized. All bank acceptance notes payable are secured by the Company’s restricted cash which is on deposit with the lender. At December 31, 2014 and 2013, the Company’s bank acceptance notes payables consisted of the following:
NOTE 9 - ACCURED EXPENSES
At December 31, 2014 and 2013, accrued expenses consisted of the following:
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 10 - INCOME TAXES
The Company accounts for income taxes pursuant to ASC 740 “Accounting for Income Taxes” that requires the recognition of deferred tax assets and liabilities for the differences between the financial statements and the tax basis of assets and liabilities, and for the expected future tax benefit to be derived from tax losses and tax credit carry forwards. Additionally, the accounting standards require the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Realization of deferred tax assets, including those related to the U.S. net operating loss carry forwards and to the temporary differences related to the deduction of impairment losses in PRC for income tax purposes as compared to financial statement purposes, are dependent upon future taxable income and timing of reversals of future taxable differences along with any other positive and negative evidence during the periods in which those temporary differences become deductible or are utilized.
Net deferred tax assets related to the U.S. net operating loss carry forward and impairment loss on equipment held for sale/operating lease have been fully offset by a valuation allowance. The Company is governed by the Income Tax Law of the PRC and the U.S. Internal Revenue Code of 1986, as amended. Under the Income Tax Laws of PRC, Chinese companies are generally subject to an income tax at an effective rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments. The Company’s VIEs (Dyeing and Heavy Industries) and the Company’s subsidiary, Fulland Wind Energy, are subject to these statutory rates. The Company’s wholly-owned subsidiary, Fulland Limited was incorporated in the Cayman Islands. Under the current laws of the Cayman Islands, this entity is not subject to income taxes.
Cleantech Solutions International, Inc. was incorporated in the United States and has incurred an aggregate net operating loss of approximately $6,172,000 for income tax purposes through December 31, 2014, subject to the Internal Revenue Code Section 382, which places a limitation on the amount of taxable income that can be offset by net operating losses after a change in ownership. The net operating loss carries forward for United States income taxes and may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, through 2034. Management believes that it appears more likely than not that the Company will not realize these tax benefits due to the Company’s limited operating history and continuing losses for United States income tax purposes. Accordingly, the Company has provided a 100% valuation allowance on the deferred tax asset benefit related to the U.S. net operating loss carry forward to reduce the asset to zero. Management will review this valuation allowance periodically and make adjustments as necessary.
The Company has cumulative undistributed earnings from its foreign subsidiaries of approximately $64 million and $60 million as of December 31, 2014 and 2013, respectively, which is included in the consolidated retained earnings and will continue to be indefinitely reinvested in the Company’s PRC operations. Accordingly, no provision has been made for any deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if we concluded that such earnings will be remitted in the future.
The Company reviews the realization of its deferred tax asset related to the deduction of impairment loss on equipment held for sale/operating lease on a quarterly basis, or whenever events or changes in circumstances indicate that a review is required. In determining the requirement for a valuation allowance, the timing of reversals of future taxable differences along with any other positive and negative evidence is considered. In the fourth quarter of fiscal 2014, the Company performed an analysis related to the realization of the deferred tax asset related to the deduction of impairment loss on equipment held for sale/operating lease. As a result, the Company determined that it was more likely than not that the deferred tax asset related to the deductibility for PRC tax purposes of impairment losses on equipment held for sale/operating lease would not be realized. Therefore, the Company recorded a $2,165,677 valuation allowance related to the impairment losses as income tax expense in the year ended December 31, 2014.
The table below summarizes the Company’s income tax provision:
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 10 - INCOME TAXES (continued)
The table below summarizes the differences between the U.S. statutory federal rate and the Company’s effective tax rate for the years ended December 31, 2014 and 2013:
For the years ended December 31, 2014 and 2013, income tax expense related to our operations in the PRC and amounted to $4,561,030 and $2,999,795, respectively.
The tax effects of temporary differences under ASC 740 “Accounting for Income Taxes” that give rise to significant portions of deferred tax assets and liabilities as of December 31, 2014 and 2013 were as follows:
The valuation allowance at December 31, 2014 and 2013 were $2,098,420 and $1,844,921, respectively, related to the U.S. net operating loss carry forward and $2,167,335 and $0, respectively, related to the impairment loss on equipment held for sale/operating lease. During the years ended December 31, 2014 and 2013, the valuation allowance was increased by approximately $2,421,000 and $274,000, respectively.
NOTE 11 - STOCKHOLDERS’ EQUITY
Common stock issued for services
On July 29, 2013, the Company issued a total of 30,000 shares of common stock pursuant to its 2010 long-term incentive plan, of which 8,000 shares were issued to the chief executive officer’s wife, who the Company employs in its sales department, 8,000 shares were issued to the chief financial officer and 14,000 shares were issued to other employees. The shares were valued at the fair market value on the grant date, and the Company recorded stock-based compensation of $157,200 in 2013.
On May 12, 2014, the Company issued 65,500 shares of common stock pursuant to its 2010 long-term incentive plan, including 20,000 shares to the chief executive officer, 15,000 shares to the chief financial officer and 3,500 shares to an independent director. The shares were valued at the fair market value on the grant date, and the Company recorded stock-based compensation of $362,215 in 2014.
Common stock sold for cash
On June 18, 2013, the Company sold 428,398 shares of common stock at a purchase price of $4.50 per share. The shares were sold pursuant to a prospectus supplement dated June 18, 2013 to the Company’s registration statement on Form S-3. The Company did not engage a placement agent with respect to the sale. The Company paid a fee of 10% and a non-accountable expense allowance of 2%, for a total of $154,745, to an individual in connection with sales made to investors introduced to the Company by this individual who is not a U.S. citizen or resident. The net proceeds received by the Company from the sale of the shares were approximately $1,768,000.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 11 - STOCKHOLDERS’ EQUITY (continued)
Common stock sold for cash (continued)
On July 10, 2013, the Company sold a total of 150,518 shares of common stock at a price of $4.70 per share to an investor. The shares were issued pursuant to a prospectus supplement for the Company’s registration statement on Form S-3. The Company paid a fee of 10% and a non-accountable expense allowance of 2%, for a total of $84,892, to an individual in connection with sales made to investors introduced to the Company by this individual who is not a U.S. citizen or resident. The net proceeds received by the Company from the sale of the shares were approximately $620,000.
On June 2, 2014, the Company sold 290,984 shares of its common stock to its chief executive officer and his wife for $1,623,691. The purchase price per share was the highest closing price per share during the period from the date of the chief executive officer advised the board of his proposal to advance the funds, which was May 2, 2014, until June 2, 2014, when the Company’s independent directors approved the terms of the stock sale.
2010 long-term incentive plan
In January 2010, the Company’s board of directors adopted, and in March 2010, the stockholders approved the Company’s 2010 long-term incentive plan, which initially covered 200,000 shares of common stock. In October 2013, the Company’s board of directors adopted, and in December 2013, the stockholders approved, an amendment to the 2010 long-term incentive plan to increase the number of shares of common stock subject to the plan, to 500,000 shares. The plan provides for the grant of incentive and non-qualified options and stock grants to employees, including officers, directors and consultants. The plan is to be administered by a committee of not less than three directors, each of whom is to be an independent director. In the absence of a committee, the plan is administered by the board of directors. Members of the committee are not eligible for stock options or stock grants pursuant to the plan unless such stock options or stock grant are granted by a majority of the Company’s independent directors other than the proposed grantee. As of December 31, 2014, the Company had issued a total of 243,491 shares of common stock under the plan.
NOTE 12- STATUTORY RESERVE
The Company is required to make appropriations to statutory reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (the “PRC GAAP”). Appropriation to the statutory reserve should be at least 10% of the after tax net income determined in accordance with the PRC GAAP until the reserve is equal to 50% of the entities’ registered capital or members’ equity. As of December 31, 2013, the Company appropriated the required maximum 50% of its registered capital to statutory reserve for Heavy Industries; accordingly, no additional statutory reserve is required for the year ended December 31, 2014. As of December 31, 2014, the Company had not appropriated the required maximum 50% of its registered capital to statutory reserve for Dyeing and Fulland Wind Energy.
For the years ended December 31, 2014 and 2013, statutory reserve activities were as follows:
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 13 - SEGMENT INFORMATION
For the years ended December 31, 2014 and 2013, the Company operated in two reportable business segments - (1) the manufacture of forged rolled rings and related components for the wind power and other industries segment, which also includes the manufacture of the Company’s solar industry products, and (2) the manufacture of textile dyeing and finishing equipment segment. The Company’s reportable segments are strategic business units that offer different products. They are managed separately based on the fundamental differences in their operations. All of the Company’s operations are conducted in the PRC. Information with respect to these reportable business segments for the years ended December 31, 2014 and 2013 was as follows:
(a)The Company does not allocate the depreciation for equipment held for sale/operating lease to any operating segment.
(b)The Company does not allocate any general and administrative expense of its U.S. activities to its reportable segments, because these activities are managed at a corporate level.
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2014 and 2013
NOTE 14 - CONCENTRATIONS
Customers
No customer accounted for 10% or more of the Company’s revenues during the years ended December 31, 2014 and 2013.
Suppliers
The following table sets forth information as to each supplier that accounted for 10% or more of the Company’s purchases for the years ended December 31, 2014 and 2013.
* Less than 10%.
The three largest suppliers accounted for 30.4% of the Company’s total outstanding accounts payable at December 31, 2014. The largest supplier accounted for 10.2% of the Company’s total outstanding accounts payable at December 31, 2013.
NOTE 15 - RESTRICTED NET ASSETS
Regulations in the PRC permit payments of dividends by the Company’s PRC VIEs only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Subject to certain cumulative limit, a statutory reserve fund requires annual appropriations of at least 10% of after-tax profit, if any, of the relevant PRC VIE’s and subsidiary. Heavy Industries had reached the cumulative limit as of December 31, 2014 and 2013, respectively. The statutory reserve funds are not distributable as cash dividends. As a result of these PRC laws and regulations, the Company’s PRC VIE’s and its subsidiary are restricted in their abilities to transfer a portion of their net assets to the Company. Foreign exchange and other regulations in PRC may further restrict the Company’s PRC VIEs and its subsidiary from transferring funds to the Company in the form of loans and/or advances.
As of December 31, 2014 and 2013, substantially all of the Company’s net assets are attributable to the PRC VIE’s and its subsidiary located in the PRC. Accordingly, the Company’s restricted net assets at December 31, 2014 and 2013 were approximately $96,519,000 and $90,291,000, respectively.
NOTE 16 - SUBSEQUENT EVENTS
On January 7, 2015, the Company issued 80,000 shares of common stock pursuant to its 2010 long-term incentive plan, including 20,000 shares to the chief executive officer, 12,000 shares to the chief executive officer’s wife, who the Company employs in its sales department, 18,000 shares to the chief financial officer and 30,000 shares to other employees. The shares were valued at the fair market value on the grant date, and the Company recorded stock-based compensation of $274,400 in 2015.
In January 2015, the Company repaid short-term loan from Bank of China in the principal amount of $488,719, and borrowed $407,266 from the same bank. The new loan bears interest rate at 7.2% per annum and is due on January 12, 2016.
In January 2015, the Company repaid short-term loan from Bank of China in the principal amount of $488,719, and borrowed the same amount from the same bank. The new loan bears interest rate at 7.2% per annum and is due on January 25, 2016.
In March 2015, the Company repaid short-term loan from Agricultural and Commercial Bank in the principal amount of $488,719, and borrowed the same amount from the same bank. The new loan bears interest rate at 6.72% per annum and is due on June 7, 2015.