Item 1. DESCRIPTION OF BUSINESS
Background of Zhongchai
Reincorporation of Equicap
Equicap, Inc. (“Equicap”) was incorporated in the State of Nevada on March 13, 2002, for the purpose of entering into a merger with and re-domiciling its predecessor, Equicap, Inc., a California corporation ("Equicap California"). Effective January 25, 2005, Equicap California was merged with and into Equicap in a statutory merger based on management's belief that Nevada law is more advantageous to a corporation than California law. Equicap was considered a blank check company until its March 2007 acquisition of Usunco Automotive Limited, a British Virgin Islands company (“Usunco”). Equicap, Inc. changed its name to Zhongchai Machinery, Inc. (“Zhongchai” or the “Company”) on May 21, 2010.
Share Exchange
Equicap and Usunco entered a Share Exchange Agreement on March 7, 2007, which was consummated on March 9, 2007. Under the Exchange Agreement, Equicap acquired all the outstanding equity securities of Usunco in exchange for 18,323,944 shares of common stock of Equicap, and thereby Equicap acquired Usunco as a wholly owned subsidiary. Usunco was deemed to have been the acquiring company in the Share Exchange, and for accounting purposes, the Share Exchange transaction was treated as a reverse acquisition with Usunco as the acquirer and Equicap as the acquired party.
Private Placement Offering in Connection with Share Exchange
As a condition to the Share Exchange, Equicap conducted a private placement offering of its common stock to accredited and institutional investors in which it raised gross proceeds of $12 million (“Offering”). After commissions and expenses related to the Offering and the $450,000 advisory fee payable to Fountainhead, Equicap received net proceeds of approximately $10 million in the Offering. The investors were issued an aggregate of 8,450,704 shares of common stock, then representing approximately 30% of the issued and outstanding common stock of Equicap. The price per share of common stock was $1.42. vFinance was the exclusive placement agent for the Offering.
Share Transfer between Usunco and Zhongchai Holding (Hong Kong) Limited
On December 16, 2009, Equicap, Inc., its wholly owned subsidiary, Usunco, and its wholly owned subsidiary Zhongchai Holding (Hong Kong) Limited, a Hong Kong company (Zhongchai Holding”), took action to approve a transfer of the shares of Zhejiang Zhongchai Machinery Co., from Usunco to Zhongchai Holding. The transfer was completed on December 23, 2009. The purpose of the transfer was to take advantage of the tax treaty between the People’s Republic of China and the Special Administrative Region of Hong Kong, which reduces the withholding tax rate of the PRC on payments to entities outside of China. Usunco then discontinued all its business activities
Usunco Automotive Limited
Usunco was organized in the British Virgin Islands as a limited liability company on April 24, 2006. Until December 23, 2009, Usunco owned 75% of the equity interest of Zhejiang ZhongChai Machinery Co., Ltd. (“ZhongChai China”), which in turn owns all of Zhejiang Shengte Transmission Co., Ltd., that makes gears and gearboxes (transmissions) in China. Until June 15, 2009, Usunco also owned 100% of the equity interest of IBC Automotive Products, Inc. (“IBC”), which distributed automotive parts in North America. Until June 2009 Usunco operated with two business segments of the Company, represented by the China/Gear Segment of ZhongChai China and its subsidiary, which focuses on manufacturing and distribution of gears and gearboxes in China and by the North America/Auto Parts Segment of IBC, which focused on sourcing automotive parts and products from China and distributing them in North America and other regions. Pursuant to the share transfer described above, Unsunco discontinued all of its business activities.
Zhongchai Holding (Hong Kong) Limited
Zhongchai Holding was incorporated in the Special Administrative Region of Hong Kong on April 24, 2009. On December 23, 2009, Zhongchai Holding acquired the 75% equity interest of ZhongChai China from Usunco, and on April 26, 2010, Zhongchai Holding acquired the remaining 25% of the equity interest of Zhongchai China from Xinchang Keyi Machinery Co., Ltd.. After the acquisition, Zhongchai China became a Wholly Owned Foreign Enterprises and wholly owned subsidiary of Zhongchai Holding.
Zhejiang Zhongchai Machinery Co., Ltd.
ZhongChai China was a Sino-foreign equity joint venture established in the People’s Republic of China (the “PRC”) by Usunco, and a local party in China, Xinchang Keyi Machinery Co., Ltd. (“Keyi”), the successor in interest to Xinchai Holding Group Co., Ltd. with respect to the 25% joint venture interest. ZhongChai China manufacturers and sells drivetrain products consisting mainly of gears, transmission gearboxes, and transaxles in China. The products are sold to engine, gearbox, and equipment manufacturers for their engine, gearbox, and equipment products. ZhongChai China was approved by local authorities in the PRC as a Sino-foreign joint venture company with limited liability to be operated for a term of 25 years, with $10.6 million in registered capital. The registered capital may be used as general working capital for it operations and other corporate purposes.
On July 6, 2007, ZhongChai China completed the acquisition of all the outstanding equity of Zhejiang Shengte Transmission Co., Ltd. (“Shengte”). Shengte is a company organized under the laws of the PRC. The equity interest was acquired for approximately $3,700,000 in cash. Shengte manufactures and distributes gears and gearboxes mainly used in or together with diesel engines for industrial and agricultural machinery. Shengte was founded in 2006.
Products
The Company, through its wholly owned subsidiaries, is focused on the manufacturing and distribution of drivetrain products, mainly transmission gearboxes, gears, and transaxles. These products are primarily used for making industrial, agricultural, and construction machinery, such as forklift trucks, excavators, tractors, diesel engines, and other machines.
The gears produced by the Company are used for internal production of transmission gearboxes and sold mainly to Chinese diesel engine manufacturers. In order to meet market and internal demand, the Company gradually increases its gear production capacity and upgrades the production facilities to improve the overall quality of the production and product.
The Company started to produce and deliver transmission gearboxes in 2008. Since then it has sold 92 sets, 1767 sets, and 9,924 sets of transmission gearboxes during the fiscal years in 2008, 2009, and 2010 respectively. The Company expects the sales of the transmission gearboxes will continue to grow in the fiscal year of 2011. Zhongchai China produces two series of transmission gearboxes, JDS for mechanical shift control and YQX for hydraulic shift control with three classes for 1 ton, 2 ton, and 3 ton internal combusting forklift trucks. Zhongchai has finished the development of a 1-ton class transmission gearbox for electrical forklift trucks and will start to deliver to customers before the end of 2010.
The Company has started to deliver its first transaxle product, PSD-331, to its customers in fiscal year 2010. This new product will be produced in Zhongchai, China under a technology license from Wooyoung Hydraulic Corporation. This product integrates the functions of transmission and drive axle using a new hydrodynamic design concept.
Market Overview
The Company is primarily focused on the domestic market in China. As a result of the continued expansion of the Chinese economy and various government initiatives, the Company believes its best opportunity at this time is to concentrate its commercial efforts in that market. The domestic market in China for drivetrain products has grown in recent years because of the increase in domestic demand driven by countrywide economic growth and urban expansion. In addition, beginning in 2005, because of the favorable government policies towards farmers, the Chinese agricultural equipment market has experienced growth for the kinds of products that the Company produces and sells. As a result, the Company has seen growth of the gear and gearbox business in recent years, and it expects it to continue.
The main customers of the Company are manufacturers of engines and industrial equipment. The Company’s products are used as components in its customers’ final products. Typically the gears are used in diesel engines, and transmission gearboxes and transaxles that are incorporated into equipment and machinery for the industrial and agricultural markets, such as forklift trucks, excavators, construction equipment, and agricultural machinery.
Principal Customers
The Company’s main customers in its drivetrain business are both Chinese and global diesel engine and forklift truck manufacturers. The Company has business relations with more than thirty diesel engine and equipment manufacturers, including the two top Chinese diesel engine manufacturers and the five top Chinese forklift truck manufacturers.
The customers of the Company were more concentrated in the last fiscal year when two customers accounted for 69% and 17%, respectively, of the net revenue in China.
The Company performs appropriate credit checks before orders are accepted and invoices are issued. Most accounts are collected within 120 days. Customers generally do not provide long-term volume purchase commitments. Rather, transactions are based on non-binding purchase plans that provide only purchase forecasts and state basis terms. Sales are based on purchase orders.
Product Returns and Warranties
The Company provides only a limited right of return for non-conforming products if returned in a timely fashion. The Company generally provides a one-year limited warranty covering manufacturing defects and functional failures of its transmission gearbox products. After evaluation and confirmation, the Company will either replace the defective product or accept returns by crediting the customer account. The Company, thus, becomes responsible for the costs and expenses of the returns.
Sales and Marketing
Because the principal market for the Company is for equipment manufacturers, the Company undertakes sales and marketing principally designed to acquaint those types of enterprises with its products. Therefore, the Company focuses on direct sales on a business-to-business basis, by developing contacts with engine and gearbox producers and original equipment manufacturers. These contacts are developed through direct relationships, referrals and trade shows. One of the principal aspects of its marketing strategy is to focus customers on the Company’s commitment to quality products, customer service and after sales support.
Once a sale is developed, the customer typically will provide the Company with a forecast and a desired shipment schedule up to one year in advance, which are reviewed quarterly, and in some cases monthly. These forecasts and schedules are dependent on the demand for the Company’s products and the delivery schedules developed with the ultimate finished goods buyer. The Company’s customers usually will issue to the Company an irrevocable purchase order combined with the firm shipment schedule three months prior to shipment.
Principal Suppliers
The Company sources parts and components and semi-finished products mainly from Zhejiang Yuyang Machinery Co., Ltd., Zhongqing Shenjian Auto Transmission Co., Ltd., Hangzhou Qianjin General Machinery Co., Ltd., Changzhou No. 2 Gears Co., Ltd., and Wuxi Hydraulic Machinery Co., Ltd. for Zhongchai’s for further fine processing and assembly.
Five major suppliers, Zhejiang Yuyang Machinery Co.,Ltd, Chongqing Shenjian Auto Transmission Parts Co.,Ltd., Zhejiang Hengchun Machinery Co., Ltd., Hangzhou Qianjin General Machinery Co., Ltd., and Xinchang Liyuan Foundry Co., Ltd., accounted for approximately 18%, 7%, 5%, 5%, and 4%, respectively, of the Company’s total purchases for the years ended June 30, 2010. The Company’s sources for parts and components and semi-finished products were less concentrated in fiscal year 2010 compare to fiscal year 2009 when four main suppliers provided 32%, 13%, 5%, and 4%, respectively, of the Company’s consolidated purchases for the fiscal year.
The Company does not have any long term supply agreements with any of these companies, and it purchases products on the basis of purchase orders. None of our suppliers have any ownership in the Company or any relationship with the insiders of the Company.
Distribution
For our drivetrain business, currently the Company ships finished products directly to its customers from the factory warehouse in Zhejiang, China, or customers pick up finished products from our factory warehouse.
Competition
As the demand for drivetrain products has grown in China, the competition within that market has also grown and has become intense. There are many local manufacturers making gears, transmission gearboxes, and transaxles, and most of them are willing to compete for customers and market share through low pricing. These producers typically offer small production and their products vary greatly in quality. There are also many global manufacturers interested in the large Chinese market that are entering the market and selling gear and gearbox products having better quality and design than many Chinese suppliers. Zhongchai China faces the many challenges of being a new entrant to compete for new and existing customers. Management believes it will take Zhongchai China a few years to establish a solid customer base for itself. Zhongchai China competes on the basis of its quality and sales support, and as the Company develops, it will increasingly compete on the basis of diversified products and larger production capabilities.
Employees
As of June 30, 2010, the Company employed directly and through its subsidiaries approximately 151 individuals in the United States and China, consisting of 4 executives and managers, 15 technical personnel, 6 sales and marketing personnel, and 21 administrative and support personnel, and 105 production personnel. The largest increase in the number of the employees was for production personnel due the increase of production capacity. Employees are not represented by any labor union or similar collective bargaining group.
Item 1A.
Item 1A. RISK FACTORS
An investment in our common stock is speculative and involves a high degree of risk and uncertainty. You should carefully consider the risks described below, together with the other information contained in this Annual Report on Form 10-K, including the consolidated financial statements and notes thereto, when evaluating our Company and our business before deciding to invest in our common stock. The risks described below are not the only ones facing us. Additional risks not presently known to us or that we presently consider immaterial may also harm us. If any of the following risks occur, our business, financial condition and results of operations and the value of our common stock could be materially harmed.
Risks Related to Our Business
We anticipate that a significant portion of our revenue will be from the sale of gears and transmission gearboxes to a few customers. We have considerable risk related to the reliance on those few customers, which could have a detrimental consequence to our long-term viability.
We anticipate that a significant portion of our revenues will be from the sale of gear and transmission gearbox products to Zhejiang Xinchai Co., Ltd., Lonking (Shanghai) Forklift Co., Ltd., Hangcha Forklift Co., Ltd., Xiamen Xiagong Machinery co., Ltd., and Hunan Sunway Machinery Co., Ltd., which represents about 39.5%, 25.2%, 6.3%, 5%, and 4.1% of our sales respectively. If any of our significant customers experiences any events that affect their purchases of our products, there could be considerable detrimental consequences to our financial results and long term viability.
Our revenues will decrease if there is less demand for the kinds of products in which our products are component parts.
Our principal customers are manufacturers of engines, gearboxes and industrial equipment. Our products are part of the larger end product of these manufacturers, including things such as forklifts, excavators, construction equipment, tractors, and other machinery. If sales of these kinds of end products decrease, then the demand for our products and our revenues would likewise decrease. Therefore, we are dependent on a limited market segment.
Because of competition, we could experience downward pricing pressure on our products from our customers, which may adversely affect our growth, profit margins and net income.
We could face downward pricing pressure from our customers as a result of the intense competition in our industry. To retain our existing customers and gain new ones, we will have to continue to keep our unit prices competitive and possibly improve or expand our product offerings. In view of our need to maintain competitive prices on our products, our growth, profit margins and net income will be affected if we cannot effectively continue to control our sourcing and other costs.
We receive a significant portion of our revenues from a small number of customers which may make it difficult to negotiate price increases for our products.
A significant portion of our revenues depends on a small number of customers. Dependence on a few major customers could make it difficult to negotiate price increases for our products. Therefore, in addition to competitive pressures, we may face limitations on our ability to increase our prices to account for raw material price increases, increases in wages and production costs and other expenses of production. In such event, our profit margins may be reduced and our overall profitability reduced.
Our contracts with our customers generally are short-term and do not require the purchase of a minimum amount, which may result in periods of time during which we have limited orders for our products.
Our customers generally do not provide long-term volume purchase commitments. Although we anticipate receiving non-binding purchase plans from significant customers who will have continuing demand for certain products, these plans provide only purchase forecasts and state terms such as price, payment method, payment period, quality standards and inspection and similar matters rather than provide firm, long-term commitments to purchase products. As we are not likely to have many long term contracts for the majority of our sales, we could have periods during which we have no or only limited orders for our products, but will continue to have to pay the costs of maintaining our work force and our operating facilities and to service our indebtedness without the benefit of current revenues.
We face short lead-times for delivery of products to customers. Failure to meet delivery deadlines could result in the loss of customers and damage to our reputation and goodwill.
Our customers’ purchase agreements typically contain short lead-times for the delivery of products, leading to production and manufacturer supply schedules that can reduce our profit margins on the products procured from our suppliers. Our suppliers may lack sufficient capacity at any given time to meet all of our customers’ demands if orders exceed their production capacity. We will strive for rapid response to customer demand which can lead to reduced purchasing efficiency and increased procurement costs, therefore reducing margins. If we are unable to sufficiently meet our customers’ demands, we may lose our customers. Moreover, failure to meet customer demands may damage our reputation and goodwill.
If our selling efforts generate growth in demand, we may not be able to respond effectively if our capacity or sources of supply or capital are not adequate, resulting in lost business opportunity.
If our marketing plans result in market growth and demand for our products, we will be required to deliver larger volumes of products to our customers. Meeting customer order demand will require us to increase our capacity to produce, or ability to source quality products. Such demand would require us to expand our current production capacities, or it will necessitate our securing additional qualified suppliers. In addition, we may require more working capital than we currently have available to support new supply arrangements or additional inventory. The failure to meet demand for our products may result in customers seeking other sources of supply and may adversely affect our reputation as a ready and consistent supplier.
Because of market conditions, we will have to grant relatively long payment terms for accounts receivable which can adversely affect our cash flow.
As is customary in China, for competitive reasons, we grant relatively long payment terms to most of our customers. As a result of the size of many of our orders, these payment terms may adversely affect our cash flow and our ability to fund our operations out of our operating cash flow. In addition, the reserves we establish for our receivables may not prove to be adequate in view of an actual experience of bad debts. The failure of our customers to pay us timely would negatively affect our working capital, which could in turn adversely affect our cash flow.
Because our customers are likely to be large manufacturers, they generally will be placing large orders for our products and require their prompt delivery which will impact our working capital. If our customers do not use our products and sell the final end products in a timely fashion to generate their income, they, in turn may not pay us in a timely fashion. This failure to pay our invoices in a timely manner may defer or delay further product orders from us, which may adversely affect our cash flows, sales or income in subsequent periods.
We may not be able to finance the development of new products, which could negatively impact our competitiveness.
Our future operating results will depend, to some extent, on our ability to continue to provide new products that compare favorably on the basis of cost and performance with the products of our competitors. Some of our competitors have design and manufacturing capabilities and technologies that compete well with our products, particularly in markets outside of China. To remain competitive, we believe that in the future we will have to incur product development expense and invest in research for new products. These costs could result in greater operating expenses. All of these factors will create demands on our working capital and our ability to fund our current and future marketing and distribution activities and the expansion of our business.
Our ability to effectively implement our business strategy depends upon, among other factors, the successful recruitment and retention of additional skilled and experienced management and other key personnel, and we cannot assure that we will be able to hire or retain such employees.
We must attract, recruit and retain a sizeable workforce of technically competent management and employees, particularly in the areas of marketing and sales, production and technical personnel. These individuals can be difficult to find in China, and as the economy in China expands, there is increasing competition for these types of educated and trained workers. We cannot give assurance that we will be able to find, hire or retain such management persons and employees, or even if we are able to so hire such persons, that the financial costs associated with such persons may have an adverse effect on our net income.
It may be difficult to find or integrate acquisitions which could have an adverse effect on our expansion plans.
Although we have no commitments or agreements for any acquisitions at this time, a component of our growth strategy is to invest in or establish strategic alliances such as joint ventures with other companies, or acquire companies or divisions of companies that design, manufacture or distribute complementary products such as other sizes or designs of diesel engines, gearboxes or parts. We may be unable to identify suitable investments or acquisition candidates or to make these investments, alliances or acquisitions on a commercially reasonable basis, if at all. If we complete an investment, alliance or acquisition, we may not realize the anticipated benefits from the transaction.
Integrating an acquired company, division or product line is complex, distracting and time consuming, as well as a potentially expensive process. The successful integration of an acquisition would require us to:
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integrate and retain key management, sales, research and development, and other personnel;
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incorporate the acquired products or capabilities into our offerings both from an engineering and sales and marketing perspective;
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coordinate research and development efforts;
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integrate and support pre-existing supplier, distribution and customer relationships; and
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consolidate duplicate facilities and functions and combine back office accounting, order processing and support functions.
The geographic distance between the companies, the complexity of the technologies and operations being integrated and the disparate corporate cultures being combined may increase the difficulties of combining an acquired company. Acquired businesses are likely to have different standards, controls, contracts, procedures and policies, making it more difficult to implement and harmonize company-wide financial, accounting, billing, information and other systems. Management’s focus on integrating operations may distract attention from our day-to-day business and may disrupt key research and development, marketing or sales efforts.
The cyclical nature of industrial and agricultural equipment and medium and light duty commercial vehicle production and sales could result in a reduction in gears and gearboxes sales, which could adversely affect our financial condition.
Our sales to manufacturers rely on industrial and agricultural equipment and medium and light duty commercial vehicle production and sales by our customers, which are cyclical and depend on general economic conditions and other factors, including consumer spending and preferences. They also can be affected by government policies, labor relations issues, regulatory requirements, and other factors. All or any one of these factors may result in fluctuations in the demand for our products with an impact on our financial condition.
Increasing costs of goods from our suppliers as a result of increasing costs for manufactured components and raw materials may adversely affect our profitability.
A broad range of manufactured components and raw materials are used in the production of gears and gearboxes. The prices of these products are increasing as a result of the growth of the Chinese economy. Our suppliers may further increase the price of raw materials and components we use in our production. Because it may be difficult for us to pass increased costs on to our customers, any significant increase in the prices of our purchased goods could materially increase our operating costs and adversely affect our profit margins and profitability.
We may be subject to product liability and warranty and recall claims, which may increase the costs of doing business and adversely affect our reputation, financial condition and liquidity.
We face an inherent business risk of exposure to product liability and warranty claims if our products actually or allegedly fail to perform as expected or the use of our products results, or are alleged to result, in bodily injury and/or property damage. We may be exposed to potential liability even if we have product liability insurance. We cannot give any assurance that we will not incur significant costs to defend these claims or that we will not experience any product liability losses in the future. In addition, if any of our designed products are or are alleged to be defective; we may be required to participate in a recall of such products. We cannot assure you that the future costs associated with providing product warranties and/or bearing the cost of repair or replacement of our products will not have an adverse effect on our financial condition and liquidity.
We are subject to environmental and safety regulations, which may increase our compliance costs.
We are subject to the requirements of environmental and occupational safety and health laws and regulations in China. To the extent that we expect to expand our operations into other geographic areas, we will become subject to such laws and regulations of those countries as well. We cannot provide assurance that at all times we have been or will be in full compliance with all of these requirements, or that we will not incur material costs or liabilities in connection with these requirements. The capital requirements and other expenditures that may be necessary to comply with environmental requirements could increase and become a material expense of doing business.
Our business depends on our ability to protect and enforce our intellectual property effectively which may be difficult particularly in China.
The success of our business depends in some measure on the legal protection of proprietary rights in the technology we hold. We will protect our proprietary rights in our products and operations through contractual obligations, including nondisclosure agreements. If these contractual measures fail to protect our proprietary rights, any advantage those proprietary rights provide us would be negated.
Monitoring infringement of intellectual property rights is difficult, and we cannot be certain that the steps we have taken will prevent unauthorized use of our intellectual property and know-how, particularly in China and other countries in which the laws may not protect our proprietary rights as fully as the laws of the United States. Accordingly, other parties, including competitors, may duplicate our products using our proprietary technologies. Pursuing legal remedies against persons infringing our patents or otherwise improperly using our proprietary information is a costly and time consuming process that would divert management’s attention and other resources from the conduct of our other business, and could cause delays and other problems with the marketing and sales of our products, as well as delays in deliveries.
Our commercial viability depends significantly on our ability to operate without infringing the patents and other proprietary rights of third parties.
In the event that our technologies infringe or violate the patent or other proprietary rights of third parties, we may be prevented from pursuing product development, commercialization or distribution of our products that utilize such technologies. There may be patents held by others of which we are unaware that contain claims that our products or operations infringe. In addition, given the complexities and uncertainties of patent laws, there may be patents of which we know that we may ultimately be held to infringe, particularly if the claims of the patent are determined to be broader than we believe them to be. As a result, avoiding patent infringement may be difficult.
If a third party claims that we infringe its patents, any of the following may occur:
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we may become liable for substantial damages for past infringement if a court decides that our technologies infringe upon a competitor’s patent;
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a court may prohibit us from selling or licensing our product without a license from the patent holder, which may not be available on commercially acceptable terms or at all, or which may require us to pay substantial royalties or grant cross-licenses to our patents; and
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we may have to redesign our product so that it does not infringe upon others’ patent rights, which may not be possible or could require substantial funds or time.
In addition, employees, consultants, contractors, suppliers and others may use the trade secret information of others in their work for us or disclose our trade secret information to others. Either of these events could lead to disputes over the ownership of inventions derived from that information or expose us to potential damages or other penalties. If any of these events occurs, our business will suffer and the market price of our common stock will likely decline.
International expansion may subject us to risks inherent in doing business internationally, such as protectionist limitations, higher sales costs and additional importation taxes, all of which could affect our profitability.
Our long-term business strategy includes plans to expand sales outside China by targeting markets, such as Europe and the United States. Risks affecting international expansion include challenges caused by distance, language and cultural differences, conflicting and changing laws and regulations, international import and export legislation, trading and investment policies, foreign currency fluctuations, the burdens of complying with a wide variety of laws and regulations, protectionist laws and business practices that favor local businesses, foreign tax consequences, higher costs associated with doing business internationally, restrictions on the export or import of technology, difficulties in staffing and managing international operations, trade and tariff restrictions, and variations in tariffs, quotas, taxes and other market barriers. These risks could restrain international expansion, which in turn could limit our opportunities and the sought benefits of international sales. Such expansion may require us to incur additional expenses, which are not recovered through improved sales.
We do not intend to pay dividends on shares of our common stock in the foreseeable future.
We have never paid cash dividends on our common stock. Our current board of directors does not anticipate that we will pay cash dividends in the foreseeable future. Instead, we intend to retain future earnings for reinvestment in our business and/or to fund future acquisitions. Determination of net income under PRC accounting standards and regulations may differ from determination under U.S. GAAP in significant aspects, such as the use of different principles for recognition of revenues and expenses. Under PRC law, our PRC subsidiary is required to set aside a portion of its net income each year to fund designated statutory reserve funds. Therefore, there may be limitations on the availability of cash for the payment of dividends.
Risks Related to Doing Business in China
We are subject to the risks associated with doing business in the People’s Republic of China.
Our operations, assets and sales are located in China. Therefore, we are subject to special considerations and significant risks not typically associated with companies operating in North America and Western Europe. These include risks associated with, among other things, the political, economic and legal environment of China which is a partially controlled economy. Our results may be adversely affected by changes in the political and social conditions in China and by changes in governmental policies with respect to social and commercial laws and regulations, anti-inflationary measures, currency controls, conversion restrictions and remittances abroad. The recent changes in the tax laws will also have an impact on the operations of the Company.
Although a large portion of the productive assets in China are owned by the Chinese government, in the past years the government has implemented economic reform measures that emphasize decentralization and encourage private economic activity. Because these economic reform measures may be inconsistent or ineffectual, there are no assurances that:
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We will be able to capitalize on economic reforms;
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The Chinese government will continue its pursuit of economic reform policies;
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The economic policies, even if pursued, will be successful;
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Economic policies will not be significantly altered from time to time; and
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Business operations in China will not become subject to the risk of nationalization.
Economic reform policies or nationalization could result in a total loss of investment in our common stock.
Since 1979, the Chinese government has implemented policies to reform its economic system, which reforms have accelerated in the last 15 years. Because many reforms are unprecedented or experimental in the China context, they are expected to be changed over time. Other political, economic and social factors, such as political changes, changes in the rates of economic growth, unemployment or inflation, or in the disparities in per capita wealth between regions within China, could lead to readjustment of the reform measures so far taken. Any refining and readjustment may negatively affect our operations or our profits.
Over the last few years, China’s economy has registered a particularly high growth rate. Recently, there have been indications that rates of inflation have increased. For example, employee costs are increasing as are the costs of raw materials. In response, the Chinese government has taken some measures to regulate the growth of the economy. These measures include restrictions on the availability of domestic credit, monitoring international currency transactions, reducing the purchasing capability of certain of its customers, and limited re-centralization of the approval process for purchases of some foreign products. There has been some revaluation of the currency which has increased the costs of imported products. The Chinese government may adopt additional measures to further combat inflation, including the establishment of freezes or restraints on certain projects or markets. These measures may adversely affect our manufacturing operations and margins.
To date, the basic reforms to China’s economic system have not adversely impacted our operations and are not expected to adversely impact operations in the foreseeable future. We, however, will be affected by the change in the tax structure and rising costs of an expanding and increasingly sophisticated economy. We cannot assure you that the reforms to China’s economic system will continue or that we will not be adversely affected by changes in China’s political, economic, and social conditions and by changes in policies of the Chinese government, such as changes in laws and regulations, measures which may be introduced to control inflation and changes in the rate or method of taxation.
On November 11, 2001, China signed an agreement to become a member of the World Trade Organization, sometimes referred to as the WTO, the international body that sets most trade rules, further integrating China into the global economy and significantly reducing the barriers to international commerce. China’s membership in the WTO was effective on December 11, 2001. China has agreed upon its accession to the WTO to reduce tariffs and non-tariff barriers, remove investment restrictions and provide trading and distribution rights for foreign firms. The tariff rate reductions and other enhancements will enable us to develop better investment strategies. In addition, the WTO’s dispute settlement mechanism provides a credible and effective tool to enforce members’ commercial rights. Also, with China’s entry to the WTO, it is believed that the relevant laws on foreign investment in China will be amplified and will follow common practices.
The legal authorities in China are in the process of changing heretofore tax and fee benefits provided to foreign investors and companies to encourage development within the country such that these benefits will be lessened or removed with the consequence that expenses may rise and adversely impact margins and net income.
The legal authorities are in the process of changing business income tax and fee benefits that have been available to foreign investors and foreign companies operating in China and reducing the availability of tax holidays for new enterprises. In the near term, there will be changes that reduce or eliminate many, if not all, the tax and other governmental fee advantages that heretofore have been available to foreign entities and newly created entities whether or not such new entities are foreign. The goal is to institute greater equalization of tax and government fee treatment of all corporate and similar entities organized and operating in China. China is being encouraged to create this more equal treatment because of its WTO obligations and public opinion within China. There may be phase-ins of various taxes and fees for entities that currently benefit from either no or lower tax rates and fees compared to wholly Chinese companies and entities, but there can be no assurance of this. Even if there are phase-in periods, the length of such periods is not known. Some tax benefits may also be extended for certain industries. Overall, it is expected that the cost of operating in China will increase for those companies and entities that have had various tax and fee advantages in the past. As a result, Zhongchai Holding, a company which has had and expected to have benefits from some forms of preferential tax and fee rates, expects that in the near term certain of its costs will increase which may have an adverse impact on operating margins and will have an impact on net income.
The Chinese legal system is not fully developed and has inherent uncertainties that could limit the legal protections available to investors.
The Chinese legal system is a system based on written statutes and their interpretation by the Supreme People’s Court. Prior court decisions may be cited for reference but have limited legal precedents. Since 1979, the Chinese government has been developing a comprehensive system of commercial laws, and considerable progress has been made in introducing laws and regulations dealing with economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade. Two examples are the promulgation of the Contract Law of the People’s Republic of China to unify the various economic contract laws into a single code, which went into effect on October 1, 1999, and the Securities Law of the People’s Republic of China, which went into effect on July 1, 1999. However, because these laws and regulations are relatively new, and because of the limited volume of published cases and their non-binding nature, interpretation and enforcement of these laws and regulations involve uncertainties. In addition, as the Chinese legal system develops, changes in such laws and regulations, their interpretation or their enforcement may have a material adverse effect on our business operations.
Enforcement of regulations in China may be inconsistent.
Although the Chinese government has introduced new laws and regulations to modernize its securities and tax systems, China does not yet possess a comprehensive body of business law. As a result, the enforcement, interpretation and implementation of regulations may prove to be inconsistent and it may be difficult to enforce contracts.
We may experience lengthy delays in resolution of legal disputes.
As China has not developed a dispute resolution mechanism similar to the Western court system, dispute resolution over Chinese projects and joint ventures can be difficult and we cannot assure you that any dispute involving our business in China can be resolved expeditiously and satisfactorily.
Impact of the United States Foreign Corrupt Practices Act on our business.
We are subject to the United States Foreign Corrupt Practices Act, which generally prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some that may compete with us, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in mainland China. We have attempted to implement safeguards to prevent and discourage such practices by our employees and agents. We cannot assure you, however, that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations.
It may be difficult to serve us with legal process or enforce judgments against our management or us.
Most of our assets are located in China. In addition, some of our directors and officers are non-residents of the United States, and all, or substantial portions of the assets of such non-residents, are located outside the United States. As a result, it may not be possible to effect service of process within the United States upon such persons. Moreover, there is doubt as to whether the courts of China would enforce:
l
Judgments of United States courts against us, our directors or our officers based on the civil liability provisions of the securities laws of the United States or any state; or
l
Original actions brought in China relating to liabilities against non-residents or us based upon the securities laws of the United States or any state.
The Chinese government could change its policies toward private enterprise or even nationalize or expropriate it, which could result in the total loss of your investment.
Our business may be adversely affected by political, economic and social developments in China. Over the past several years, the Chinese government has pursued economic reform policies including the encouragement of private economic activity and greater economic decentralization. The Chinese government may not continue to pursue these policies or may significantly alter them to our detriment from time to time with little, if any, prior notice. Changes in policies, laws and regulations or in their interpretation or the imposition of confiscatory taxation, restrictions on currency conversion, restrictions or prohibitions on dividend payments to stockholders, devaluations of currency or the nationalization or other expropriation of private enterprises could have a material adverse effect on our business. Nationalization or expropriation could even result in the total loss of our investment in China and in the total loss of your investment.
The source of funds for any dividend and other equity based distributions will be from our operating subsidiary in China, which is subject to various legal and contractual restrictions.
We conduct our business operations through our wholly owned Chinese subsidiaries. As a result, our profits available for distribution to our shareholders are dependent on the profits available for distribution from our subsidiary. Under current PRC law, our PRC subsidiary is regarded as a foreign-invested enterprise in China. PRC law permits payment of dividends only out of net income as determined in accordance with PRC accounting standards and regulations. Determination of net income under PRC accounting standards and regulations may differ from determination under U.S. generally accepted accounting principles in significant aspects, such as the use of different principles for recognition of revenues and expenses. Under PRC law, our PRC subsidiary is required to set aside 10% of its net income each year to fund a designated statutory reserve fund until such funds reach 50% of registered share capital. These reserves are not distributable as cash dividends. As a result, our primary internal source of funds for dividend payments is subject to these and other legal and contractual restrictions, which may limit or impair our ability to pay dividends to our shareholders although we do not presently anticipate paying any dividends. Moreover, any transfer of funds from us to our PRC subsidiary, either as a shareholder loan or as an increase in registered capital, is subject to registration with or approval by PRC governmental authorities. These limitations on the flow of funds between us and our PRC subsidiary could restrict our ability to act in response to changing market conditions. Distributions will also be subject to taxation and withholding requirements, imposed by the PRC and under United States tax law.
Foreign Exchange Control Risks
Fluctuations in the value of the Chinese Renminbi relative to foreign currencies could affect our operating results.
Our revenues and expenses are China based, whose currency is the Chinese Renminbi. However, we use the United States dollar for financial reporting purposes. The value of Chinese Renminbi against the United States dollar and other currencies may fluctuate. The Chinese government is valuing the exchange rate of the Chinese Renminbi against a number of currencies, rather than just exclusively to the United States dollar. Although the Chinese government has stated its intention to support the current international value range of the Chinese Renminbi, we cannot assure you that the government will not take steps to revalue it. As our operations are in China, any significant revaluation of the Chinese Renminbi may materially and adversely affect our cash flows, revenues and financial condition. To date, we have not engaged in any hedging transactions in connection with our operations.
The PRC government imposes control over the conversion of the Chinese Renminbi into foreign currencies. Under the current unified floating exchange rate system, the People’s Bank of China publishes an exchange rate, which we refer to as the PBOC exchange rate, based on the previous day’s dealings in the inter-bank foreign exchange market. Financial institutions authorized to deal in foreign currency may enter into foreign exchange transactions at exchange rates within an authorized range above or below the PBOC exchange rate according to market conditions.
Pursuant to the Foreign Exchange Control Regulations of the PRC issued by the State Council which came into effect on April 1, 1996, and the Regulations on the Administration of Foreign Exchange Settlement, Sale and Payment of the PRC which came into effect on July 1, 1996, regarding foreign exchange control, conversion of Renminbi into foreign exchange by Foreign Investment Enterprises, or FIEs, for use on current account items, including the distribution of dividends and profits to foreign investors, is permissible. FIEs are permitted to convert their after-tax dividends and profits to foreign exchange and remit such foreign exchange to their foreign exchange bank accounts in the PRC.
Conversion of Renminbi into foreign currencies for capital account items, including direct investment, loans, and security investment, is still subject to certain restrictions. On January 14, 1997, the State Council amended the Foreign Exchange Control Regulations and added, among other things, an important provision, which provides that the PRC government shall not impose restrictions on recurring international payments and transfers under current account items.
Enterprises in the PRC (including FIEs) which require foreign exchange for transactions relating to current account items, may, without approval of the State Administration of Foreign Exchange, or SAFE, effect payment from their foreign exchange account or convert and pay at the designated foreign exchange banks by providing valid receipts and proofs.
Convertibility of foreign exchange in respect of capital account items, such as direct investment and capital contribution, is still subject to certain restrictions, and prior approval from the SAFE or its relevant branches must be sought.
Risks Related to Our Common Stock
An active trading market for Zhongchai’s common stock may not develop or be sustained.
Currently, there is very limited trading in our common stock. There can be no assurance that an active trading market will develop for such shares. If an active public trading market does not develop or continue, you may have limited liquidity and may be forced to hold your investment in the Company for an indefinite period of time. Further, the prices and volume of trading in the common stock may be adversely affected if its securities are not listed or quoted.
There may be substantial sales of the common stock by stockholders, which could cause the price of the stock to fall.
Future sales of substantial amounts of the common stock in the public market, if one develops, or the perception that such sales might occur, could cause the market price for our common stock to decline and could prevent an active market developing. Such “overhang” could impair the value of an investment in the common stock. These factors could also restrict the Company’s ability to raise equity capital in the future. A relatively small proportion of the outstanding shares are free trading. All the shares that were issued as restricted stock and the shares held by our affiliates, which represent the majority of our outstanding shares of common stock, may be sold pursuant to Rule 144 as applicable to former shell companies, subject to the limitations on the number of shares held by affiliates that can be sold from time to time. The sales of common stock by the stockholders able to sell under Rule 144 may depress any trading market that develops.
The common stock of Zhongchai will be subject to the “penny stock” rules for the foreseeable future.
Zhongchai is subject now and expects in the future to be subject to the SEC’s “penny stock” rules if its common stock sells below $5.00 per share. Penny stocks generally are equity securities with a price of less than $5.00. The penny stock rules require broker-dealers to deliver a standardized risk disclosure document prepared by the SEC that provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer must also provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson, and monthly account statements showing the market value of each penny stock held in the customer’s account. The bid and offer quotations, and the broker-dealer and salesperson compensation information must be given to the customer orally or in writing prior to completing the transaction and must be given to the customer in writing before or with the customer’s confirmation.
In addition, the penny stock rules require that prior to a transaction, the broker and/or dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. The penny stock rules are burdensome and may reduce purchases of any offerings and reduce the trading activity for the common stock. As long as the common stock is subject to the penny stock rules, the holders of its shares may find it more difficult to sell their securities.
Zhongchai’s articles of incorporation authorize the issuance of shares of preferred stock, the rights, preferences, designations and limitations of which may be set by the board of directors.
Zhongchai’s articles of incorporation have authorized the issuance of up to 10,000,000 shares of preferred stock in the discretion of its board of directors. Any undesignated shares of preferred stock may be issued by the Zhongchai board of directors; no further shareholder action is required. If issued, the rights, preferences, designations and limitations of such preferred stock would be set by the board of directors and could operate to the disadvantage of the holders of outstanding common stock. Such terms could include, among others, preferences as to dividends and distributions on liquidation, or could be used to prevent possible corporate takeovers.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2.
Item 2. DESCRIPTION OF PROPERTIES
The Company has an office in China and one operating facility in China.
The principal executive office of the Company is located in the city of Hangzhou in China, where the Company leases an aggregate of approximately 1,400 square feet at an approximate, aggregate annual rental of $6,160. The lease has term of one year, which can be renewed at similar rates. This office mainly handles general corporate affairs, administrative matters, accounting activities and other supporting functions.
The ZhongChai China and Shengte conduct operations from a facility in Xinchang County, Zhejiang Province in China, with an aggregate leased space of approximately 32,000 square feet, for an annual rental of approximately $38,633. The Company has reached an agreement to purchase the land with the building and some utility facility from Xinchai Holding Group. The Company has paid the deposit and is currently waiting for the value appraisal, government approval, and title transfer.
Item 3.
Item 3. LEGAL PROCEEDINGS
The Company is not currently a party to any material legal proceeding.
Item 4.
Item 4.
[RESERVED]
PART II
Item 5.
Item 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock price is quoted on the OTC Bulletin Board, or OTCBB, under the symbol “EQPI.OB”. There is a very limited trading market for our stock. There can be no assurance that a liquid market for our securities will ever develop. The following table sets forth for the periods indicated the high and low prices per share traded for our common stock as reported on the OTCBB.
The quotations shown above reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
Our common stock is designated as “penny stock” and thus may be illiquid for that reason. The SEC has adopted rules (Rules 15g-2 through l5g-6 of the Exchange Act), which regulate broker-dealer practices in connection with transactions in “penny stocks.” Penny stocks generally are any non-NASDAQ equity securities with a price of less than $5.00, subject to certain exceptions. The penny stock rules require a broker-dealer to deliver a standardized risk disclosure document to provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, monthly account statements showing the market value of each penny stock held in the customer’s account, to make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity, if any, in the secondary market for a stock that is subject to the penny stock rules. Since our common shares are subject to the penny stock rules, persons holding or receiving such shares may find it more difficult to sell their shares. The market liquidity for the shares could be severely and adversely affected by limiting the ability of broker-dealers to sell the shares and the ability of stockholders to sell their stock in any secondary market.
The trading volume in our common stock has been and is extremely limited. The limited nature of the trading market can create the potential for significant changes in the trading price for the common stock as a result of relatively minor changes in the supply and demand for our common stock and perhaps without regard to our business activities.
The market price of our common stock may be subject to significant fluctuations in response to numerous factors, including: variations in our annual or quarterly financial results or those of our competitors; conditions in the economy in general; announcements of key developments by competitors; loss of key personnel; unfavorable publicity affecting our industry or us; adverse legal events affecting us; and sales of our common stock by existing stockholders.
Holders
We have approximately 426 record holders of our common stock. In addition to the record ownership, there are additional beneficial owners who hold their shares in street name or through other nominees, but we have not ascertained the number of such persons.
Dividend Policy
We plan to retain all earnings generated by our operations, if any, for use in our business. We do not anticipate paying any cash dividends to our stockholders in the foreseeable future. The payment of future dividends on the common stock and the rate of such dividends, if any, and when not restricted, will be determined by our board of directors in light of our earnings, financial condition, capital requirements, the requirements of PRC law and other factors.
Recent Sales of Unregistered Securities
None.
Transfer Agent
The transfer agent and registrar for our common stock is Olde Monmouth Stock Transfer Co., Inc., 200 Memorial Parkway, Atlantic Highlands, NJ 07716.
Equity Compensation Plan Information
The following table gives information about our common stock that may be issued upon the exercise of options, warrants or rights under our existing equity compensation plans. The information in this table is as of June 30, 2010.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data for the four years ended June 30 are derived from the audited consolidated financial statements of Zhongchai Machinery, Inc. after the Share Exchange between Equicap and Usunco in March 2007. Prior to the Share Exchange, Equicap was a shell company with nominal assets and operations and with a different fiscal year end. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information.
SELECTED FINANCIAL DATA
QUARTERLY FINANCIAL DATA
Unaudited quarterly results of operations for the fiscal years ended June 30, 2010 and 2009 should be read in conjunction with the consolidated financial statements, related notes and other financial information and the Company's quarterly reports on Forms 10-Q, for the fiscal years 2010 and 2009.
Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS
The following is management’s discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements, as well as information relating to the plans of our current management. This report includes forward-looking statements. Generally, the words “believes,” “anticipates,” “may,” “will,” “should,” “expect,” “intend,” “estimate,” “continue,” and similar expressions or the negative thereof or comparable terminology are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, including, but not limited to, those described in the “Risk Factors” set forth in Item 1A - Risk Factors and the matters set forth in other reports or documents we file with the Securities and Exchange Commission from time to time, which could cause actual results or outcomes to differ materially from those projected. Undue reliance should not be placed on these forward-looking statements that speak only as of the date hereof. We undertake no obligation to update these forward-looking statements.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included in this report.
Overview
The Company does business through its wholly owned subsidiary, Zhongchai China, a Wholly Foreign Owned Enterprise established under the laws of the People’s Republic of China and Zhejiang Shengte Transmission Co., Ltd. (“Shengte”) a company established under the laws of the PRC and wholly owned by Zhongchai China. Through its operating subsidiaries, the Company is currently engaged in manufacturing and sale of drivetrain products, mainly gears, transmission gearboxes, and transaxles in China.
The Company owns the following interests in four entities organized in the PRC and Hong Kong as of June 30, 2010 and June 30, 2009.
Critical Accounting Policies and Estimates
Below is a description of accounting policies that we consider critical to the preparation and understanding of our financial statements. In addition, certain amounts included in or affecting our financial statements and related disclosure must be estimated, which requires us to make assumptions with respect to values or conditions which cannot be known with certainty at the time the financial statements are prepared. Actual results may differ from these estimates under different assumptions or conditions. The selection of critical accounting policies, the judgments and other uncertainties affecting the application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors to be considered when reviewing our consolidated financial statements.
We believe that the critical accounting policies set forth below involve the most significant judgments and estimates used in the preparation of our consolidated financial statements. We regularly evaluate these policies, in light of historical results and experience, consultation with experts, trends and other methods we consider reasonable in the particular circumstances, as well as our forecasts as to how these might change in the future.
Principles of Consolidation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United Stated of America. The consolidated financial statements include the accounts of Zhongchai Machinery, Inc. and its wholly and majority owned subsidiaries. All inter-company transactions and balances have been eliminated in consolidation.
Accounts Receivable and Bad Debt Reserves
Trade accounts receivable are stated at the amount management expects to collect from balances outstanding at the end of the period. Based on its assessment of the credit history with customers having outstanding balances and current relationships with them, management makes conclusions whether any realization of losses on balances outstanding at the end of the period will be deemed uncollectible based on the age of the receivables. The Company reserves 0.5% of accounts receivable balances that have been outstanding below three months, 5% of accounts receivable balances that have been outstanding between three months and six months, 20% of receivable balances that have been outstanding within one year, 50% of receivable balances that have been outstanding for between one year and two years, and 100% of receivable balances that have been outstanding more than two years. The balance of allowance for doubtful accounts amounted to $37,670 and $7,732 as of June 30, 2010 and 2009, respectively.
Inventory
Inventories are stated at the lower of cost or net realizable value. Cost is calculated on the weighted-average basis and includes all costs to acquire and other costs incurred in bringing the inventories to their present location and condition. The Company evaluates the net realizable value of its inventories on a regular basis and records a provision for loss to reduce the computed weighted-average cost if it exceeds the net realizable value. The Company did not record any provision for slow-moving and obsolete inventory as of June 30, 2010 and 2009.
Property and Equipment
Property and equipment is recorded at cost. Depreciation is provided on the straight-line method over the estimated useful lives of the assets. Repairs and maintenance expenditures, which do not extend the useful lives of the related assets, are expensed as incurred.
Under SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets", the Company's long-lived assets are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. The Company also assesses these assets for impairment based on their estimated future cash flows. The Company has not incurred any losses in connection with the adoption of this statement.
Goodwill and Other Intangible Assets
Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired businesses. Goodwill and intangible assets deemed to have indefinite lives are not amortized. All other intangible assets are amortized over their estimated useful lives. Goodwill and indefinite-lived intangible assets are subject to annual impairment testing using the guidance and criteria described in Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets”. This testing compares carrying values to fair values and, when appropriate, the carrying value of these assets is reduced to fair value. As of June 30, 2010, the Company concluded that there were no impairments on goodwill or indefinite-lived intangibles. The carrying value of goodwill increased from $3,407,262 for the year ended June 30, 2009, to $3,425,868 for the year ended June 30, 2010, which was attribute to the effect of foreign currency translation $18,606.
Revenue Recognition
Revenue consists of sales of automotive parts, gears and gearboxes. In accordance with the provisions of Staff Accounting Bulletin No. 103, revenue is recognized when merchandise is shipped, title and risk of loss pass to the customer and collectability is reasonably assured. Revenue is recorded as the sales price of goods and services, net of rebates and discounts and is reported on a gross basis. The gross basis is used mainly due to the fact that the Company acts as principal in each transaction and is responsible for fulfillment and acceptability of the products purchased, the Company takes title to its products before the products are ordered by its customers, the Company has risk of inventory loss as title of the products is transferred to the Company, the Company is responsible for collection of sales and delivery of products, and the Company does not act as an agent or broker and is not compensated on a commission or fee basis.
Research and Development Costs
Research and development ("R&D) costs are classified as general and administrative expenses and are expensed as incurred.
Comprehensive Income (Loss)
The Company has adopted SFAS No. 130, Reporting Comprehensive Income, which establishes rules for the reporting and display of comprehensive income, its components and accumulated balances. SFAS No. 130 defines comprehensive income (loss) to include all changes in equity, including adjustments to minimum pension liabilities, accumulated foreign currency translation, and unrealized gains or losses on available-for-sale marketable securities, except those resulting from investments by owners and distributions to owners.
Foreign Currency Translation
A significant portion of the Company's operations are conducted in China and the financial statements are translated from Chinese RMB, the functional currency, into U.S. Dollars in accordance with SFAS No. 52, "Foreign Currency Translation." Accordingly, all foreign currency assets and liabilities are translated at the period-end exchange rate and all revenues and expenses are translated at the average exchange rate for the period. The effects of translating the financial statements of foreign subsidiaries into U.S. Dollars are reported as a cumulative translation adjustment, a separate component of comprehensive income in stockholder's equity.
Fair Value of Financial Instruments
The Company considers the carrying amounts reported in the consolidated balance sheet for current assets and current liabilities qualifying as financial instruments and approximating fair value.
Income Taxes
Deferred income taxes are computed using the asset and liability method, such that deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between financial reporting amounts and the tax basis of existing assets and liabilities based on currently enacted tax laws and tax rates in effect in the United States of America for the periods in which the differences are expected to reverse. Income tax expense is the tax payable for the period plus the change during the period in deferred income taxes. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. No differences were noted between the book and tax bases of the Company’s assets and liabilities, respectively. Therefore, there are no deferred tax assets or liabilities for the year ended June 30, 2010. For the China/Gear segment, the Zhongchai China is located in the PRC, and is therefore subject to central government and provincial and local income taxes within the PRC at the applicable tax rate on the taxable income as reported in the PRC statutory financial statements in accordance with relevant income tax laws.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from those estimates.
Operating Results
The Fiscal Year Ended June 30, 2010 Compared to the Fiscal Year Ended June 30,
Revenue
Revenue increased by $6,059,882 or 123% to $10,983,800 for the year ended June 30, 2010 compared with $4,923,918 for the year ended June 30, 2009. Revenue for the year ended June 30, 2010 consists of sales of gears and transmission gearboxes in China, for $5,061,608 and $5,922,192, respectively. The increase in gears and gearboxes sales in fiscal 2010 compared to last year was attributed to the Company’s expansion in production capacity and continuous marketing efforts, and taking advantage of the recovery of the domestic market in China for gear and gearbox products as a result of Chinese government’s economic stimulus plan.
Cost of Sales and Gross Margin
Cost of sales was $8,359,486 for the year ended June 30, 2010, increasing by $4,519,997 or 118%, from $3,839,489 for the year ended June 30, 2009. The increased cost of sales was a reflection of the increased sales. The gross margin was approximately 24% for the year ended June 30, 2010 compared to approximately 22% for the year ended June 30, 2009. The 2% increase in gross margin is mainly attributed to the Company’s achievement of a larger economy of scale, despite the introduction of new gearbox products which bear a relatively low margin.
Selling, General and Administrative Expenses
Selling, general and administrative (“SG&A”) expenses consisted primarily of labor cost and related overhead costs for sales, marketing, finance, legal, human resources and general management. Such costs also include the expenses recognized for stock-based compensation pursuant to FAS 123(R).
SG&A expenses decreased by $760,796 to $1,287,359 in the year ended June 30, 2010 from $2,048,155 in year ended June 30, 2009. SG&A expenses for fiscal years 2010 and 2009 mainly consist of selling expenses, and costs related to being a public company including professional services related to auditing, legal and other services, costs associated with the operating expenses in China, and non-cash expenses amounting to $63,606 recognized for stock based compensation related to stock options and warrants granted in the period pursuant to SFAS 123(R). The decrease of SG&A in fiscal year 2010 is mainly attributed to less professional expenses as the Company moves forwards with more stable operations; and Zhongchai China’s decrease in R&D expenses of approximately $44,377 and in rental expense of approximately $16,214 in the fiscal 2010.
Income Tax
The income tax expense was $264,418 for the year ended June 30, 2010, compared to $57,246 for the year ended June 30, 2009, an increase of $207,172, due mainly to increased sales volume and operating profit.
Net Income
Net Income was $1,072,405 in the year ended June 30, 2010 compared with net loss of $1,132,190 in the year ended June 30, 2009. The net loss for fiscal year of 2009 was mainly attributed to the increase in SG&A related to a lawsuit, increase in R&D expenses, and the loss on disposal of IBC. Net profit for the fiscal year of 2010 was mainly attributed to the increase in production and sales.
Accounts Receivable
Accounts receivable was $3,618,030 after reduction of $37,670 for doubtful accounts at June 30, 2010, compared to accounts receivable of $1,540,402 after reduction of $7,732 for doubtful accounts at June 30, 2009. The increase in the amount of accounts receivable is mainly attributable to the increased operations of the Company during the period reported upon. The payment term for sold products usually is 60-90 days, and, to date, accounts receivable are generally within the payment terms.
Notes Receivable
Notes receivable was $463,465 at June 30, 2010, compared to $448,655 at June 30, 2009. The increase in the amount was minimal. Of the total amount, $22,500 was an unpaid balance of promissory notes due from two individuals, and $440,965 was from product sales to customers using bank accepted forward notes. Even though the notes receivable amount is almost the same compared to the amount at June 30, 2009, the situation has improved significantly since sales have increased by 123%.
Liquidity and Capital Resources
As of June 30, 2010, Zhongchai China had assets equal to $19,896,194 that primarily was comprised of cash and cash equivalents and restricted cash of $1,586,407, net account receivables, note receivable and other receivables of $4,191,626, inventory of $2,680,666, and an advance payment of $4,993,607. The advance payment represented an advance payment made by the Zhongchai China to Zhejiang Xinchai Holdings Co., Ltd. ("Xinchai Holdings"), for purchase of the land use right and plant building for Zhongchai China’s future production expansion. Zhongchai’s current liabilities as of June 30, 2010 were $9,003,684, which primarily were comprised of trade accounts payable and accrued expenses, notes payable, short-term loan and other payable. At June 30, 2010, Zhongchai had working capital of $4,448,622. ,Zhongchai believes that it has sufficient operating capital for its current operations.
Consolidated Statements of Cash Flows
Net cash provided by operating activities increased by $1,595,833 or 90.94% to $3,350,611 for the year ended June 30, 2010 compared with $1,754,778 for the year ended June 30, 2009. The increase mainly because the Company gained more in the achievement of a larger economy of scale, at the same time, accounts payable and accrued expenses, accounts receivable, and inventory also increased. Advance payments were divided into two parts, one is advance payments for trade which was listed in this part, the other is advance payments for purchase of land use rights and building which was listed in the following part: investing activities. Thirdly, the Company had to pay Keyi $2,600,000 for the purchase of the residual 25% equity of Zhejiang Zhongchai.
Net cash used in investing activities increased by $4,699,703 to $5,304,480 for the year ended June 30, 2010, compared with $604,777 for the year ended June 30, 2009. This was attribute to advance payment about $2.2 million for purchase of land use rights and building, and the payment about $2.5 million to noncontrolling interest for ownership buyback.
The change in net cash provided by (used in) financing activities was mainly because the Company had sufficient money to repay the loan from Agricultural Bank of China which was due on August 26, 2009.
Through the fiscal year ended June 30, 2010, Zhongchai has funded its operations from income generated by its PRC subsidiaries and loans for working capital.
We expect that future cash flows generated from the operation of gear, transmission gearbox, and transaxle business will be sufficient to cover the Company’s working capital requirements for its business.
As Zhongchai expands its operations and considers additional acquisitions of private companies, divisions or product lines, it may require additional capital for its business development and operations. Zhongchai does not have any specific sources of capital at this time; therefore, it would need to find additional funding for its capitalization needs. Such capital may be in the form of either debt or equity or a combination. To the extent that financing is in the form of debt, it is anticipated that the terms will include various restrictive covenants, affirmative covenants and credit enhancements such as guarantees or security interests. The terms of any proposed financing may not be acceptable to Zhongchai. There is no assurance that funding will be identified or accepted by Zhongchai or, that if offered, it will be concluded.
Off-Balance Sheet Arrangements
The Company does not have off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities” (SPEs).
Item 7A.
Item 7A. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
Item 8.
Item 8. FINANCIAL STATEMENTS
The information required by this Item is incorporated herein by reference to the financial statements beginning on page.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A.
Item 9A. CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and acting Chief Financial Officer (“Certifying Officers”), has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the fiscal period covered by this Annual Report on Form 10-K. Based upon such evaluation, the Certifying Officers have concluded that, as of the end of such period, June 30, 2010, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is made known to management, including our Certifying Officers, and that such information is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
In designing and evaluating our disclosure controls and procedures, our 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 our management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2010. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on our assessment, we believe that, as of June 30, 2010, the Company’s internal control over financial reporting is effective based on those criteria.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Item 9B.
Item 9B. OTHER INFORMATION
None.
PART III
Item 10.
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth certain information about each of the members of the Board of Directors and each executive officer:
Mr. Peter Wang has been the Chairman of the board of directors and President since the inception of Usunco in April 2006, and acting Chief Financial Officer since February 2010. He has more than 20 years of experience in technology and service area with strong background in research and development, operations and corporate management. Mr. Wang successfully co-founded a telecom venture in China, Unitech Telecom (now named UTStarcom, NASDAQ: UTSI) in 1990 and was the Executive Vice President until August 30, 1995. From August 1995 to December 2000, Mr. Wang was the Chairman and CEO of World Communication Group. From December 2000 to 2009, Mr. Wang was Chairman and CEO of China Quantum Communication Limited (later changed to Techedge, Inc. and then to China Biopharma, Inc.) Before forming his own companies, Mr. Wang worked at AT&T Bell Labs during 1987-1990 and Racal-Milgo Information System during 1983-1987. Mr. Wang was also a co-chairman of Business Advisory Council of the National Republican Congressional Committee during the period 1994-1995. In 2004, Mr. Wang received Outstanding 50 Asian Americans in Business Award. Mr. Wang earned his BS in Math & Computer Science and MS in Electrical Engineering from University of Illinois in 1983, as well as MBA in Marketing from Southeast-Nova University in 1986. We believe Mr. Wang’s qualifications to serve on our Board of Directors include his intimate knowledge of our operations as a result of his day to day leadership as our President.
Mr. Rong Shi has been Chairman and founder of Zhejiang Shengte Investment Co., Ltd. since August 2004. Mr. Shi founded and worked as General Manager of Zhejiang Bokai Auto A/C Compressor Co., Ltd. between March 2003 and October 2005. He was member of Oversight Committee of Rongda Trading Company during 2005 and 2006. Mr. Shi earned his MBA degree from Macao University of Science and Technology in 2003 and his BA degree from Shaoxin Liberal Arts College in 1997. We believe Mr. Shi’s qualifications to serve on our Board of Directors include his knowledge of compliance matters as evidenced by his Certificate for Sarbanes Oxley Training Program from Shanghai Financing University and Certificate for Compliance Officer for Public Company from China Stock Exchanges.
Mr. Chris Chen has been the General Manager of Manheim China, since February of 2007, where he manages Manheim’s overall business operation in China. From April 2005 to January of 2007, Mr. Chen worked as Principal, Director, and Marketing Manager of SAP AG for its global business operations in Germany, Singapore, and Canada, from January, 2001 to August, 2003, as a Project Manager of IBM Global Service in Canada, and from 1995 to 1999, as a Sales Industry Manager of Oracle Corporation, in China. Mr. Chen earned his MBA from INSEAD in France in 2004 and MS in Software Engineering from McMaster University in Canada in 2001, as well as his Bachelor of Engineering from Jiaotong University in China in 1992. We believe Mr. Chen’s qualifications to serve on our Board of Directors include his knowledge and expertise in the global and Chinese market for mechanical and computer engineering.
All directors are elected to annual terms by the holders of common stock. All directors hold office until the next annual meeting of shareholders and the election and qualification of their successors. Officers are elected annually by the board of directors and serve at the discretion of the Board.
There are no family relationships (whether by blood, marriage or adoption) among the Zhongchai directors or executive officers.
The business address of the directors is: 224 Tianmushan Road, Zhongrong Chengshi Huayuan 5-1-602, Hangzhou 310007, P.R. China.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires Zhongchai’s officers and directors, and persons who own more than ten percent of a registered class of Zhongchai’s equity securities, to file reports of ownership and changes in ownership with the Securities and Exchange Commission (the “Commission”). Officers, directors and greater than ten percent beneficial owners are required by Commission regulations to furnish the Company with copies of all forms they file pursuant to Section 16(a). Based solely on the Company’s review of the copies of such forms it received and written representations from reporting persons required to file reports under Section 16(a), to Zhongchai’s knowledge, all of the Section 16(a) filing requirements applicable to such persons with respect to fiscal 2010 were complied with.
Board Committees
The board of directors considers all major decisions. The board has established an operations committee and a compensation committee. The operations committee consists of three members and they are Mr. Xianwei Zhu who is Chairman of the committee and is Company’s senior advisor, Mr. Mengxing who is president of Zhongchai China, and Mr. Rong Shi who is independent director. The Compensation Committee consists of three members and they are Mr. Peter Wang who is Chairman of the committee and is director, Mr. Rong Shi who is independent director, and Mr. Harry Zhu who is director of Zhonchai China. The Company plans to establish an audit committee by March, 2011. The board has affirmatively determined that Messrs. Rong Shi and Chris Chen are independent directors as defined by applicable securities law and corporate governance guidelines.
The board of directors does not have a nominations committee because there are a limited number of directors, and the board believes that shareholder suggestions would be known to the entire board if and when communicated to the Company. As such, the board of directors believes there will be sufficient communication by shareholders with the board about matters and nominees to be brought to its attention.
Currently the board of directors functions as an audit committee and performs some of the same functions as an audit committee including: (1) selection and oversight of our independent accountant; (2) establishing procedures for the receipt, retention and treatment of complaints regarding accounting, internal controls and auditing matters; and (3) engaging outside advisors. The Company is not a "listed company" under SEC rules and is therefore not required to have an audit committee comprised of independent directors. The board has determined that its members do not include a person who is an "audit committee financial expert" within the meaning of the rules and regulations of the SEC. The board has determined, however, that each of its members is able to read and understand fundamental financial statements and has substantial business experience that results in that member's financial sophistication. Accordingly, the board believes that each of its members have the sufficient knowledge and experience necessary to fulfill the duties and obligations that an audit committee would have.
Code of Ethics
A code of ethics relates to written standards that are reasonably designed to deter wrongdoing and to promote:
1) Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;
2) Full, fair, accurate, timely and understandable disclosure in reports and documents that are filed with, or submitted to the Securities and Exchange Commission and in other public communications made by Zhongchai;
3) Compliance with applicable government laws, rules and regulations;
4) The prompt internal reporting of violations of the code to an appropriate person or persons identified in the code; and
5) Accountability for adherence to the code.
Zhongchai adopted a formal code of ethics statement that is designed to deter wrong doing and to promote ethical conduct and full, fair, accurate, timely and understandable reports that Zhongchai files or submits to the SEC and others. A copy of the form of Zhongchai’s code of ethics is filed as an exhibit to a Report on Form 8-K dated March 9, 2007. Requests for copies of Zhongchai’s code of ethics should be sent in writing to 224 Tianmushan Road, Zhongrong Chengshi Huayuan 5-1-602, Hangzhou 310007, P.R. China, Attention: Secretary.
Limitation of Director Liability; Indemnification
Under its bylaws, the Company is required to indemnify its officers, directors, employees and agents in certain situations. In some instances, a court must approve such indemnification. As permitted by Nevada statutes, the articles of incorporation eliminate in certain circumstances the monetary liability of its directors for a breach of their fiduciary duties. These provisions do not eliminate a director’s liability for:
l
a willful failure to deal fairly with us or our shareholders in connection with a matter in which the director has a material conflict of interest,
l
a violation of criminal law unless the director had reasonable cause to believe that his or her conduct was lawful or no reasonable cause to believe that his or her conduct was unlawful,
l
a transaction from which the director derived an improper personal profit, and
l
willful misconduct.
As to indemnification for liabilities arising under the Securities Act of 1933 for directors, officers or persons controlling the Company, we have been informed that, in the opinion of the Securities and Exchange Commission, such indemnification is against public policy and therefore unenforceable.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The table below sets forth for the fiscal year ended June 30, 2010, the compensation of the President and the three other most highly compensated executive officers of Zhongchai.
SUMMARY COMPENSATION TABLE
(1)
Mr. David He resigned from the position of chief financial officer of the Company on February 28, 2010.
The following table sets forth information concerning the other compensation granted to the named executive officers for the fiscal year ended June 30, 2010.
Employment Agreements
Currently, all employees of Zhongchai are employed on “at will” employment agreements. The Company intends to establish formal employment contracts for certain other key employees in the future.
Performance Equity Plan
Zhongchai adopted its 2010 Performance Equity Plan (“Option Plan”) on April 16, 2010 by the board of directors, and the Option Plan was approved by the shareholders on May 21, 2010.
Under the Option Plan, the Compensation Committee in its sole discretion may grant stock options, restricted stock and deferred stock, among other forms of awards, to the Company's employees, directors and consultants (or those of the Company's affiliates). The Company has reserved a total of 3,750,000 shares of common stock for issuance under the Option Plan.
The Compensation Committee may grant two types of options under the Option Plan: (a) options qualifying as "incentive stock options" under the requirements of Section 422 of the Internal Revenue Code of 1986, as amended (the "IRC"), or any successor provision, and designated as such ("ISOs"), and (b) non-qualified stock options ("Non-Qualified").
The Compensation Committee determines the vesting schedule, the exercise price per share and other terms and conditions for each option. In the case of options intended to constitute ISOs or performance-based compensation within the meaning of Section 162(m) of the IRC, the exercise price may not be less than the fair market value of the Company's common stock on the date of grant. The Compensation Committee will determine the term of each option, which may not exceed ten years and is subject to further limitations as described herein.
ISOs may be granted only to employees. To the extent required by Section 422(d) of the IRC, the aggregate fair market value of shares of common stock with respect to which ISOs are exercisable for the first time by any individual during any calendar year may not exceed $100,000. ISOs granted to a person considered to own more than 10% of the total combined voting power of all classes of the Company's outstanding stock, or the stock of any subsidiary or affiliate, may not be exercisable after the expiration of five years from the grant date and the option exercise price must be at least 110% of the fair market value of the common stock subject to the option.
Each option shall be evidenced by an option agreement. An option agreement may provide for the payment of the exercise price, in whole or in part, by the delivery of a number of shares of the Company's common stock (plus cash if necessary) having a fair market value equal to such exercise price. Moreover, an option agreement may provide for a "cashless exercise" of the option by establishing procedures whereby the holder, by a properly-executed written notice, directs (a) an immediate market sale or margin loan respecting all or a part of the shares of common stock to which he or she is entitled upon exercise pursuant to an extension of credit by the Company to the holder equal to the exercise price, (b) the delivery of shares of the Company's common stock from the Company directly to a brokerage firm, and (c) the delivery of the exercise price from sale or margin loan proceeds from the brokerage firm directly to the Company.
No stock options were awarded during the fiscal year ended June 30, 2010. Currently, there are 183,275 shares, which Usunco has issued as incentive stock option grants under the 2006 Option Plan at exercise of $1.065 per share. On July 7, 2010, the compensation committee and the board of directors have approved the issuance of options to purchase 1,300,000 shares of the Company’s common stock, of which 500,000 options were granted to one of the Company’s directors, at exercise price of $0.20 per share.
Executive Compensation Determination
It is the intention of Zhongchai to determine executive compensation by a decision of the majority of the members of compensation committee, at a meeting at which the chief executive officer will not be present.
From time to time key employees may receive a cash bonus as rewards for their job performance that meet or exceed the operation goals and results set up by the board of directors or high-level management. The Company will also consider other employee benefits for which it will assume the cost, such as health and dental insurance benefits. The Company also will reimburse employees for their travel expenses.
Director Compensation
The board of directors will consider granting stock options or additional equity compensation to outside directors as it determines from time to time, but there is no established plan at this time for such awards. Zhongchai Machinery does not provide cash compensation to directors for attending meetings, but it does reimburse them for their out-of-pocket expenses for attending meetings.
The following Director Compensation Table summarizes the compensation of our non-employee directors for services rendered by Zhongchai during the fiscal year ended June 30, 2010.
NON-EMPLOYEE DIRECTOR COMPENSATION TABLE
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information regarding common stock beneficially owned on August 31, 2010, for (i) each stockholder known to be the beneficial owner of 5% or more of the outstanding common stock, (ii) each current executive officer and director, and (iii) all executive officers and directors as a group. The table is based on a total of 27,613,019 shares of common stock outstanding.
* Less than 1%
(1)
Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission, which include holding voting and investment power with respect to the securities. Shares of common stock subject to options or warrants currently exercisable, or exercisable within 60 days, are deemed outstanding for computing the percentage of the total number of shares beneficially owned by the designated person, but are not deemed outstanding for computing the percentage for any other person.
(2)
Peter Wang has a 47.5% beneficial ownership in Sinoquest Management Limited.
(3)
Rong Shi was granted 500,000 shares of options on July 7, 2010. 200,000 of 500,000 were vested on July 7, 2010.
(4)
Ruihua International Limited ("Ruihua") has an address at 11/F Front Block, Hang Lok Building, 130 Wing Lok Street, Sheung Wan, Hong Kong. The officer and director of Ruihua who has the right to vote and dispose of the shares is Mr. Yang Yong HU. The foregoing information is derived from an amended 13D filed by Ruihua with the SEC on August 4, 2009.
(5)
Consists of Peter Wang, Rong Shi and Chris Chen.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
During the fiscal year ended June 30, 2010, the Company did not enter into any related party transactions with any director, officer, nominee for director, beneficial owner of 5% or more of the equity securities of the Company, or their family members.
Director Independence
We undertook a review of the independence of our directors and, using the definitions and independence standards for directors provided in the rules of The NASDAQ Stock Market, although not required as the standard for the Company as its stock is traded on the Over-the-Counter Bulletin Board, considered whether any director has a material relationship with us that could interfere with his or her ability to exercise independent judgment in carrying out their responsibilities. As a result of this review, we determined that Rong Shi and Chris Chen were "independent directors" as defined under the rules of The NASDAQ Stock Market.
Item 14.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table shows the fees paid or accrued for the audit and other services provided by Patrizio & Zhao for the fiscal years ended June 30, 2009 and June 30, 2010:
Audit services of Patrizio & Zhao for the fiscal years 2009 and 2010 consisted of the audit of the yearend financial statements and the review of the quarterly financial statements of Zhongchai and registration statements and other SEC filings.
Because the board of directors of Zhongchai does not have an audit committee, the above services and engagements were approved by the board of directors.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
Exhibits
Exhibit No.
Description
3.1
Certificate of Incorporation - (Incorporated by reference from Form 10-KSB for fiscal year ended December 31, 2004, Exhibit 3.1)
3.2
By-laws (Incorporated by reference from Form 10-KSB for fiscal year ended December 31, 2004, Exhibit 3.2)
3.3
Amendment to Certificate of Incorporation - Change of Name(Incorporated by reference from Form 8-K, Current Report, Event dated May 21, 2010, Exhibit 3.1)
4.1
Form of Common Stock Purchase Warrant Agreement issued to vFinance Investments, Inc. dated March 7, 2007 (Incorporated by reference from Form 8-K, Current Report, Event dated March 9, 2007, Exhibit 4.1)
10.1
Form of Securities Purchase Agreement with investor in March 2007 private placement. (Incorporated by reference from Form 8-K, Current Report, Event dated March 9, 2007, Exhibit 10.1)
10.2
Form of Registration Rights Agreement with investors and others dated March 7, 2007 (Incorporated by reference from Form 8-K, Current Report, Event dated March 9, 2007, Exhibit 10.4)
10.3
Joint Venture Agreement dated July 4, 2007 2006 between Xinchai Holding Group Co., Ltd and Usunco Automotive Limited in respect of Zhejiang Zhongchai Machinery Co., Ltd. (Incorporated by reference from Form 8-K, Current Report, Event dated March 9, 2007, Exhibit 10.1)
10.4
Exclusive Distribution Agreement between Xinchai Holding Group C., Ltd and Zhejiang Zhongchai Machinery Co., Ltd., Dated as of January 28, 2007 (Incorporated by reference from Form 8-K, Current Report, Event dated March 9, 2007, Exhibit 10.6)
10.5
Share Exchange Agreement dated March 7, 2007, among Usunco Automotive Limited and Equicap, Inc. (Incorporated by reference from Form 8-K, Current Report, Event dated March 9, 2007, Exhibit 10.7)
10.6
Convertible Note Conversion Agreement dated March 7, 2007 with Fountainhead Capital Partners Limited (Incorporated by reference from Form 8-K, Current Report, Event dated March 9, 2007, Exhibit 10.8)
10.7
Consulting Agreement with Fountainhead Capital Partners Limited dated March 7, 2007 (Incorporated by reference from Form 8-K, Current Report, Event dated March 9, 2007, Exhibit 10.9)
10.8
Share Exchange Agreement dated June 15, 2009, among Usunco Automotive Limited and IBC Automotive Products, Inc. and Equicap, Inc. (Incorporated by reference from Form 8-K, Current Report, Event dated June 15, 2009, Exhibit 10.1)
10.9
Form of Acquisition Agreement for 25% Interest in ZhongChai JV.( Incorporated by reference from Form 8-K, Current Report, Event dated June 7, 2010, Exhibit 10.1)
14.1
Code of Ethics (Incorporated by reference from Form 8-K, Current Report, Event dated March 9, 2007, Exhibit 14.1)
21.1
Subsidiaries of the Registrant*
31.1
Certificate pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 - Peter Wang*
32.1
Certificate pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 - Peter Wang*
* Filed herewith
ZHONGCHAI MACHINERY, INC.
Consolidated Financial Statements
June 30, 2010 and 2009
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Zhongchai Machinery, Inc.
We have audited the accompanying consolidated balance sheets of Zhongchai Machinery, Inc. (the “Company”) as of June 30, 2010 and 2009, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ equity and cash flows for the years then ended. These 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 audits 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 its 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Zhongchai Machinery, Inc. as of June 30, 2010 and 2009, and the consolidated results of their operations and their consolidated cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
/s/ Patrizio & Zhao, LLC
Parsippany, New Jersey
September 07, 2010
ZHONGCHAI MACHINERY, INC.
Consolidated Balance Sheets
ZHONGCHAI MACHINERY, INC.
Consolidated Statements of Operations and Comprehensive Income (Loss)
ZHONGCHAI MACHINERY, INC.
Consolidated Statements of Stockholders’ Equity
ZHONGCHAI MACHINERY, INC.
Consolidated Statements of Cash Flows
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 1 - Organization and Nature of Business
Zhongchai Machinery, Inc. (“Zhongchai Machinery” or “the Company”) (Formerly “Equicap, Inc.”), a Nevada corporation, is a manufacturer and distributor of gears and gearboxes and drive axles which are marketed and sold to equipment manufacturers in China.
On July 6, 2007, the Board of Directors of Zhejiang Zhongchai Machinery Co., Ltd. (“Zhejiang Zhongchai”), the China based and 75% owned subsidiary of the Company, approved and finalized a Share Purchase Agreement (“Share Purchase Agreement”) with Xinchang Keyi Machinery Co., Ltd., (“Keyi”) a corporation incorporated in the People’s Republic of China. Pursuant to the Share Purchase Agreement, Zhejiang Zhongchai purchased all the outstanding equity of Zhejiang Shengte Transmission Co., Ltd. (“Shengte”) from Keyi, the sole owner of Shengte for approximately $3.7 million.
On March 7, 2007, the Company and Usunco Automotive, Ltd. (“Usunco”), a British Virgin Islands company, entered into a Share Exchange Agreement (“Exchange Agreement”) which was consummated on March 9, 2007. Under the terms of the Exchange Agreement, the Company acquired all of the outstanding equity securities of Usunco in exchange for 18,323,944 shares of the Company’s common stock.
For accounting purposes, because the Company had been a public shell company prior to the share exchange, the share exchange was treated as a recapitalization of the Company. As such, the historical financial information prior to the share exchange is that of Usunco and its subsidiaries. Historical share amounts have been restated to reflect the effect of the share exchange.
On June 18, 2006, Usunco acquired 100% of IBC Automotive Products Inc (“IBC”), a California Corporation as of May 14, 2004 (date of inception), through a Share Exchange Agreement of 28% of Usunco’s shares. IBC was considered a “predecessor” business to Usunco as its operations constituted the business activities of Usunco formed to consummate the acquisition of IBC. The consolidated financial statements reflect all predecessor statements of income and cash flow activities from the inception of IBC in May 2004.
On June 15, 2009, IBC was sold to certain of the management persons of IBC in exchange for the following: (i) the cancellation of an aggregate of 555,994 shares of common stock of the Company which those individuals owned, and (ii) the payment of $60,000 in installments pursuant to the terms of an unsecured promissory note, the final payment of which will be November 15, 2010. As part of the transaction, the Company cancelled $428,261 through the closing date, of inter-company debt which funds had been used in the business of IBC prior to the transaction.
On September 22, 2009, Xinchang Xian Lisheng Machinery Co., Ltd. (“Lisheng”) was incorporated by Zhejiang Zhongchai and two individual investors. Total registered capital of Lisheng is RMB 5 million, of which Zhejiang Zhongchai accounts for 60%. The Company plans to start production of die casting products in 2010 for use in gearboxes, diesel engines and other machinery products.
On December 16, 2009, Zhongchai Machinery and its wholly owned subsidiaries, Usunco and Zhongchai Holding (Hong Kong) Limited, a Hong Kong company (“Zhongchai Holding”), took action to approve transfer of the shares of Zhejiang Zhongchai Machinery Co., from Usunco to Zhongchai Holding. The transfer was completed on December 23, 2009. The purpose of the transfer was to take advantage of the tax treaty between the People’s Republic of China and the Special Administrative Region of Hong Kong which reduces the withholding tax rate of the PRC on payments to entities outside of China. Usunco, which no longer had any assets after transferring all of them to Zhongchai Holding, was subsequently dissolved. The consolidated financial statements will continue to account for Zhejiang Zhongchai Machinery Co., in the same manner as before the transfer of the ownership. Shareholder approval by the shareholders of Zhongchai Machinery was not required under Nevada law, as there was no sale of all or substantially all the assets of the Company. The shareholder ownership and shareholder rights of Zhongchai Machinery remain the same as before the transaction.
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 1 - Organization and Nature of Business (continued)
On April 26, 2010, Zhongchai Holding (Hong Kong) Limited. (“Zhongchai Holding”), which owned 75% of the equity in Zhejiang Zhongchai Machinery Co., Ltd. (“Zhejiang Zhongchai”), executed a Share Purchase Agreement (“Share Purchase Agreement”) with Xinchang Keyi Machinery Co., Ltd., (“Keyi”) a corporation incorporated in the People’s Republic of China. Pursuant to the Share Purchase Agreement, Zhongchai Holding purchased the residual 25% equity of Zhejiang Zhongchai Machinery Co., Ltd. (“Zhejiang Zhongchai”) from Keyi at $2.6 million. The agreement has been approved by the local government agency and a new business license has been issued as Wholly Foreign Owned Enterprise.
Note 2 - Summary of Significant Accounting Policies
Basis Of Presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United Stated of America. The consolidated financial statements include the accounts of Zhongchai Machinery, Inc. and its controlling subsidiaries. All inter-company transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include valuation reserves for accounts receivable, inventory and income taxes and valuation of goodwill. Actual results could differ from those estimates
Cash And Cash Equivalents
In accordance with ASC Topic 230, “Statement of Cash Flows,” the Company considers all highly liquid instruments with original maturities of three months or less to be “cash equivalents”.
Accounts Receivable and Allowance for Doubtful Accounts
Trade accounts receivable are stated at the amount management expects to collect from balances outstanding at the end of the period. Based on its assessment of the credit history with customers having outstanding balances and current relationships with them, management makes conclusions whether any realization of losses on balances outstanding at the end of the period will be deemed uncollectible based on the age of the receivables. The Company reserves 0.5% of accounts receivable balances that have been outstanding less than three months, 5% of accounts receivable balances that have been outstanding between three months and six months, 20% of accounts receivable balances that have been outstanding within one year, 50% of accounts receivable balances that have been outstanding for between one year and two years, and 100% of accounts receivable balances that have been outstanding more than two years. The balance of allowance for doubtful accounts amounted to $37,670 and $7,732 as of June 30, 2010 and 2009, respectively.
Inventory
Inventory is stated at the lower of cost or net realizable value. Cost is calculated on the weighted-average basis and includes all costs to acquire and other costs incurred in bringing the inventory to their present location and condition. The Company evaluates the net realizable value of its inventory on a regular basis and records a provision for loss to reduce the computed weighted-average cost if it exceeds the net realizable value. The Company did not record any provision for slow-moving and obsolete inventory as of June 30, 2010 and 2009.
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 2 - Summary of Significant Accounting Policies (continued)
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated based on the straight-line method over the estimated useful lives of the assets as follows:
Construction in progress primarily represents the renovation costs of plant, machinery and equipment. Costs incurred are capitalized and transferred to property and equipment upon completion, at which time depreciation commences.
Cost of repairs and maintenance is expensed as incurred. Gain or loss on disposal of property and equipment, if any, is recognized in the consolidated statements of operations.
Long-Lived Assets
In accordance with ASC Topic 360-10-35, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company reviews the recoverability of its long-lived assets on a periodic basis in order to identify business conditions, which may indicate a possible impairment. The assessment for potential impairment is based primarily on the Company’s ability to recover the carrying value of its long-lived assets from expected future discounted cash flows. If the total of the expected future discounted cash flows is less than the total carrying value of the assets, a loss is recognized for the difference between the fair value (computed based upon the expected future discounted cash flows) and the carrying value of the assets.
Goodwill and Other Intangible Assets
Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired businesses. Goodwill and intangible assets deemed to have indefinite lives are not amortized. All other intangible assets are amortized over their estimated useful lives. Goodwill and intangible assets with indefinite lives are subject to annual impairment test using the guidance and criteria described in ASC Topic 350, “Goodwill and Other Intangible Assets”. This test compares carrying values to fair values and, when appropriate, the carrying value of these assets is reduced to fair value. As of June 30, 2010, the Company concluded that there were no impairments of goodwill or intangible assets with indefinite lives.
Revenue Recognition
Revenue consists of sales of automotive parts, gears and gearboxes. In accordance with the provisions of ASC Topic 605-10, revenue is recognized when merchandise is shipped, title and risk of loss are passed to the customers and the collectability is reasonably assured. Revenue is recorded as the sales price of goods and services, net of rebates and discounts and is reported on a gross basis. The gross basis is used mainly due to the fact that the Company acts as principal in each transaction and is responsible for fulfillment and acceptability of the products purchased, the Company takes title to its products before the products are ordered by its customers, the Company has risk of inventory loss as title of the products is transferred to the Company, the Company is responsible for collection of sales and delivery of products, and the Company does not act as an agent or broker and is not compensated on a commission or fee basis.
Sales Returns and Warranties
Generally the Company does not accept the return of products once sold to customers. The Company generally provides a one-year limited warranty covering manufacturing defects and/or product functional failures. After evaluation and confirmation of customer complaints, the Company either replaces the defective products or accepts returns by crediting the customer's account, and is responsible for the costs and expenses thus incurred. For auto parts distribution business, replacements and returns, and handling costs are passed through to supplying manufacturers.
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 2 - Summary of Significant Accounting Policies (continued)
Advertising Costs
The Company expenses the cost of advertising as incurred. Advertising costs for the years ended June 30, 2009 and 2008 were insignificant.
Research and Development Costs
Research and development ("R&D”) costs are classified as general and administrative expenses and are expensed as incurred. R&D costs amounted to $163,504 and $207,881, respectively, for the years ended June 30, 2010 and 2009.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. No differences were noted between the book and tax bases of the Company’s assets and liabilities, respectively. Therefore, there are no deferred tax assets or liabilities for the year ended June 30, 2010. For the China/Gear segment, the Zhongchai JV is located in the PRC, and is therefore subject to central government and provincial and local income taxes within the PRC at the applicable tax rate on the taxable income as reported in the PRC statutory financial statements in accordance with relevant income tax laws. The standard corporate income tax rate is 25%.
Fair Value of Financial Instruments
The carrying amounts of the Company’s financial instruments, which include cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and other obligations, approximate their fair value due to the short-term maturities of the related instruments.
Foreign Currency Translation and Transactions
The financial position and results of operations of the Company is determined using local currency (Chinese Yuan) as the functional currency. In accordance with ASC Topic 830-10, Foreign Currency Translation, assets and liabilities are translated at the prevailing exchange rate in effect at each year end. Contributed capital accounts are translated using the historical rate of exchange when capital is contributed. Income statement accounts are translated at the average rate of exchange during the year. Currency translation adjustments arising from the use of different exchange rates are included in accumulated other comprehensive income (loss) in shareholders' equity. Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations.
Comprehensive Income (Loss)
The Company has adopted ASC Topic 220-10, Reporting Comprehensive Income, which establishes rules for the reporting and display of comprehensive income, its components and accumulated balances. ASC 220-10 defines comprehensive income (loss) to include all changes in equity, including adjustments to minimum pension liabilities, accumulated foreign currency translation, and unrealized gains or losses on available-for-sale marketable securities, except those resulting from investments by owners and distributions to owners.
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 2 - Summary of Significant Accounting Policies (continued)
Earnings Per Share
In accordance with ASC Topic 260-10, “Computation of Earnings Per Share” and EITF No. 03-6, “Participating Securities and the Two-Class Method”, basic earnings per share is computed by dividing net income attributable to ordinary shareholders by the weighted average number of ordinary shares outstanding during the year using the two-class method. Under the two class method, net income is allocated between ordinary shares and other participating securities based on their respective participating rights. Diluted earnings per share is calculated by dividing net income attributable to ordinary shareholders as adjusted for the effect of dilutive ordinary equivalent shares, if any, by the weighted average number of ordinary and dilutive ordinary equivalent shares outstanding during the year. Ordinary equivalent shares consist of the ordinary shares issuable upon the conversion of the convertible preferred shares (using the if-converted method) and ordinary shares issuable upon the exercise of outstanding share options (using the treasury stock method).
Recent Accounting Pronouncements
In April 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-17, Revenue Recognition-Milestone Method (Topic 605) - Revenue Recognition (ASU 2010-17). ASU 2010-17 provides guidance on defining the milestone and determining when the use of the milestone method of revenue recognition for research or development transactions is appropriate. It provides criteria for evaluating if the milestone is substantive and clarifies that a vendor can recognize consideration that is contingent upon achievement of a milestone as revenue in the period in which the milestone is achieved, if the milestone meets all the criteria to be considered substantive. ASU 2010-17 is effective for us in fiscal 2012 and should be applied prospectively. The adoption of this ASU will not have a material impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued the following ASC Updates:
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ASU No. 2010-01- Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash. This Update clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in EPS prospectively and is not a stock dividend for purposes of applying Topics 505 and 260 (Equity and Earnings Per Share). The amendments in this Update are effective for interim and annual periods ending on or after December 15, 2009 with retrospective application.
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ASU No. 2010-02- Consolidation (Topic 505): Accounting and Reporting for Decreases in Ownership of a Subsidiary. This Update amends Subtopic 810-10 and related guidance to clarify that the scope of the decrease in ownership provisions of the Subtopic and related guidance applies to (i) a subsidiary or group of assets that is a business or nonprofit activity; (ii) a subsidiary that is a business or nonprofit activity that is transferred to an equity method investee or joint venture; and (iii) an exchange of a group of assets that constitutes a business or nonprofit activity for a noncontrolling interest in an entity, but does not apply to: (i) sales of in substance real estate; and (ii) conveyances of oil and gas mineral rights. The amendments in this Update are effective beginning in the period that an entity adopts FAS 160 (now included in Subtopic 810-10).
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ASU No. 2010-06- Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This Update amends Subtopic 820-10 that require new disclosures about transfers in and out of Levels 1 and 2 and activity in Level 3 fair value measurements. This Update also amends Subtopic 820-10 to clarify certain existing disclosures. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010.
The Company expects that the adoption of the above Updates issued in January 2010 did not and will not have any significant impact on its financial position and results of operations.
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 2 - Summary of Significant Accounting Policies (continued)
In October 2009, the FASB issued an ASU regarding accounting for own-share lending arrangements in contemplation of convertible debt issuance or other financing. This ASU requires that at the date of issuance of the shares in a share-lending arrangement entered into in contemplation of a convertible debt offering or other financing, the shares issued shall be measured at fair value and be recognized as an issuance cost, with an offset to additional paid-in capital. Further, loaned shares are excluded from basic and diluted earnings per share unless default of the share-lending arrangement occurs, at which time the loaned shares would be included in the basic and diluted earnings-per-share calculation. This ASU is effective for fiscal years beginning on or after December 15, 2009, and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. It is expected the adoption of this ASC Update will have no material impact on the Company’s consolidated financial statements.
In October 2009, the FASB concurrently issued the following ASC Updates:
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ASU No. 2009-14 - Software (Topic 985): Certain Revenue Arrangements That Include Software Elements (formerly EITF Issue No. 09-3). This standard removes tangible products from the scope of software revenue recognition guidance and also provides guidance on determining whether software deliverables in an arrangement that includes a tangible product, such as embedded software, are within the scope of the software revenue guidance.
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ASU No. 2009-13 - Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (formerly EITF Issue No. 08-1). This standard modifies the revenue recognition guidance for arrangements that involve the delivery of multiple elements, such as product, software, services or support, to a customer at different times as part of a single revenue generating transaction. This standard provides principles and application guidance to determine whether multiple deliverables exist, how the individual deliverables should be separated and how to allocate the revenue in the arrangement among those separate deliverables. The standard also expands the disclosure requirements for multiple deliverable revenue arrangements.
ASU No. 2009-13 and 2009-14 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. Alternatively, an entity can elect to adopt these standards on a retrospective basis, but both these standards must be adopted in the same period using the same transition method. The Company expects to apply this standard on a prospective basis for revenue arrangements entered into or materially modified beginning July 1, 2010. It is expected the adoption of these ASC Updates will not have a material impact on the Company’s Consolidated Financial Statements.
In August 2009, the FASB issued an ASU regarding measuring liabilities at fair value. This ASU provides additional guidance clarifying the measurement of liabilities at fair value in circumstances in which a quoted price in an active market for the identical liability is not available; under those circumstances, a reporting entity is required to measure fair value using one or more of valuation techniques, as defined. This ASU is effective for the first reporting period, including interim periods, beginning after the issuance of this ASU. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.
On July 1, 2009, the FASB officially launched the FASB Accounting Standards Codification (“ASC”), which has become the single official source of authoritative nongovernmental U.S. GAAP, in addition to guidance issued by the Securities and Exchange Commission. The ASC is designed to simplify U.S. GAAP into a single, topically ordered structure. All guidance contained in the ASC carries an equal level of authority. The ASC is effective for all interim and annual periods ending after September 15, 2009. The Company’s implementation of this guidance effective July 1, 2009 did not have a material effect on the Company’s condensed consolidated financial statements.
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 2 - Summary of Significant Accounting Policies (continued)
On July 1, 2009, the Company adopted the accounting and disclosure requirements of Statement of Financial Accounting Standard (“SFAS”) No. 160, Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51, which is now included with ASC Topic 810 Consolidation. This standard establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation. On a prospective basis, any changes in ownership will be accounted for as equity transactions with no gain or loss recognized on the transactions unless there is a change in control.
Note 3 - Restricted Cash
As of June 30, 2010 and June 30, 2009, the Company had restricted cash of $90,810, and $315,151, respectively. These restricted cash balances are reserved for settlement of trade notes payable in connection with inventory purchases. The cash held in custody by bank issuing the trade notes payable is restricted as to withdrawal or use, and is currently earning interest.
Note 4 - Inventory
Inventory consisting of material, labor and manufacturing overhead at June 30, 2010 and June 30, 2009 consists of the following:
Note 5 - Advance Payments
Advance payments amounted to approximately $5 million as of June 30, 2010, approximately $4.6 million of which represented an advance payment made by the Zhongchai JV to Zhejiang Xinchai Holdings Co., Ltd. ("Xinchai Holdings"), a corporation in China, for the purchase of land use rights and building for Zhongchai JV’s future expansion of its production capabilities. Zhongchai JV is currently leasing a portion of the land and building to be purchased. The total land area to be purchased is approximately 250,000 square feet. The total contract price for the land use rights, building and fixtures is approximately $4.6 million. The Company is currently in the process of transferring title.
Note 6 - Property and Equipment
Property and equipment at June 30, 2010 and June 30, 2009 consists of the following:
Depreciation expense for the years ended June 30, 2010 and 2009 was $322,658 and $214,770, respectively.
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 7 - Intangible Assets
Intangible assets at June 30, 2010 and June 30, 2009 consist of the following:
Amortization expenses for the years ended June 30, 2010 and 2009 were $1,076 and $1,074, respectively.
Note 8 - Goodwill
The following table provides information related to the carrying value of goodwill:
Note 9 - Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following:
The carrying value of accounts payable and accrued expenses approximates their fair value due to the short-term nature of these obligations.
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 10 - Short Term Bank Loans
Short-term bank loans consist of the following:
Note 11 - Other Current Liabilities
Other current liabilities amounted to $3,322,277 and $635,408 as of June 30, 2010 and 2009, respectively, approximately $425,588 and $424,854 of which represents the last payment due to Keyi from Shengte acquisition in July 2007 for both of the above periods. Also included in the balance of $3,322,277 as of June 30, 2010 was $2,600,000 due to Keyi for the purchase of the residual 25% equity of Zhejiang Zhongchai.
Note 12 - Risk Factors
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 environments in the PRC as well as by the general state of the PRC’s economy. The Company’s business may be influenced 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.
Note 13 - Risk of Concentrations in Sales and Purchases
Two customers accounted for 39% and 25%, respectively, of the Company’s sales for the years ended June 30, 2010.
One supplier, Zhejiang Yuyang Machinery Co., Ltd, accounted for approximately 18% of the Company’s total purchases for the year ended June 30, 2010.
Note 14 - Supplemental Disclosure of Cash Flow Information
Note 15 - Earnings (Loss) Per Share
The Company presents earnings (loss) per share on a basic and diluted basis. Basic earnings (loss) per share have been computed by dividing net earnings by the weighted average number of shares outstanding. Diluted earnings (loss) per share has been computed by dividing net earnings by the weighted average number of shares outstanding including the dilutive effect of equity securities. All share and per share data have been adjusted to reflect the recapitalization of the Company after the share exchange agreement with Usunco. The weighted average number of shares calculated for Diluted EPS excludes the potential common stock that would be exercised under the options granted to employees and warrants granted to agents because of their anti-dilutive effect.
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 15 - Earnings (Loss) Per Share (continued)
Note 16 - Share-Based Payments
As of June 30, 2010, there were 366,550 outstanding options to employees (“Employee Options”) and 422,535 outstanding warrants to the private placement agent (“Agent Warrants”). Both the Employee Options and Agent Warrants vest over three years and have a life of five years. For the years ended June 30, 2010 and 2009, the Company recorded approximately $63,606 and $108,789, respectively, of stock-based compensation based on the fair value method of ASC Topic 718 using the following assumptions: volatility of 34.94%, risk free interest rate of 4.63%, dividend yield of 0%, and expected life of 5 years. No estimate of forfeitures was made as the Company has a short history of granting options and warrants.
The fair value of the options and warrants was determined based on the number of shares granted and the quoted price of the Company’s common stock on the grant. The fair value of stock-based compensation was determined using the Black-Scholes model.
Note 17 - Stock Authorization and Issuance
On March 9, 2007, the Company completed the sale of an aggregate of 8,450,704 shares of its common stock to a limited number of institutional investors in a private placement transaction pursuant to offering exemptions under the Securities Act of 1933. The shares, which represented approximately 30% of the outstanding common stock on an after-issued basis, were sold at a price of $1.42 per share, for net proceeds of approximately $10 million.
The Company has a registration payment arrangement with regard to the common stock issued in the private offering. The Company was required to file a registration statement within 45 days of closing and cause the registration statement to become effective on or prior to 150 days after the closing date. The registration statement was filed within the 45 day limit thus fulfilling part of this obligation. In addition, the Company is required to use reasonable commercial efforts to maintain the registration statement’s effectiveness and file additional registration statements in the future, to continue to provide to the stockholders the opportunity to sell the shares of restricted stock that they hold. This obligation ends if the shares can be sold pursuant to Rule 144.
In the event the Company does not satisfy the registration obligations of the registration rights agreement, (“Registration Default”), the Company shall pay the investors an amount in cash equal to 1% of the aggregate investment amount for each 30-day period of a Registration Default. The maximum penalty that the Company may incur under this registration payment arrangement is 10% of the aggregate investment amount, or $1,200,000. Any payments made are to be prorated for the portion of a 30-day period of a Registration Default.
ZHONGCHAI MACHINERY, INC.
Notes to Consolidated Financial Statements
Note 17 - Stock Authorization and Issuance (continued)
Although the Company has the obligation to register shares of common stock for other persons under the above described registration rights agreement, the Company is not obligated to pay liquidated damages in the event that their shares are not registered or the registration statement is not available for their sale.
Note 18 - Employee Welfare Plan
The Company has established an employee welfare plan in accordance with Chinese laws and regulations. Full-time employees of the Company in the PRC participate in a government-mandated multi-employer defined contribution plan pursuant to which certain pension benefits, medical care, unemployment insurance, employee housing fund and other welfare benefits are provided to employees. PRC labor regulations require the Company to accrue for these benefits based on a certain percentage of the employees’ salaries.
NOTE 19 - Subsequent Events
On July 7, 2010, Compensation Committee and Board of Directors have granted 1,300,000 shares of stock options to one director and four employees.
These stock options will be expired on July 6, 2015. 40% of these options were vested on July 7, 2010 and the remaining 60% of the options will be vested 20% each year for next three years. Note: The closing price of the stock was $0.15 and the biding price was $0.05 as of July 6, 2010.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused this Report to be signed on its behalf by the undersigned thereunto duly authorized on September 21 2010.
In accordance with the Exchange Act, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated.