SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
1.
ORGANIZATION AND DESCRIPTION OF BUSINESS
SmartHeat
Inc., formerly known as Pacific Goldrim Resources, Inc. (the “Company” or
“SmartHeat”), was incorporated on August 4, 2006 in the State of Nevada. The
Company is engaged in the manufacturing and sale of plate heat exchangers and
various packages, thermometer testing devices and heat usage calculators through
its wholly owned operating subsidiaries in China.
On April
14, 2008, the Company entered into a Share Exchange Agreement with Shenyang
Taiyu Machinery and Electronic Equipment Co., Ltd. ("Taiyu") and the Taiyu
Shareholders. The Company issued 18,500,000 shares of its common stock to the
shareholder of Taiyu in exchange for all of the equitable and legal rights,
title and interests in and to Taiyu's share capital of RMB 25,000,000.
Concurrent with the share exchange, one of SmartHeat’s shareholders cancelled
2,500,000 shares out of 6,549,900 of total issued and outstanding shares of
SmartHeat pursuant to the Split-Off Agreement dated April 14, 2008. As a result
of the share exchange and the cancellation of the 2,500,000 shares of the
Company's common stock, there were 22,549,900 shares of the Company's common
stock issued and outstanding, 82.04% of which was held by the former Taiyu
Shareholders. The shareholders of the Company immediately prior to
the completion of these transactions held the remaining 17.96% of the issued and
outstanding share capital of SmartHeat. Taiyu became a wholly-owned subsidiary
of SmartHeat.
Prior to
the acquisition of Taiyu, the Company was a non-operating public shell. Pursuant
to Securities and Exchange Commission ("SEC") rules, the merger or acquisition
of a private operating company into a non-operating public shell with nominal
net assets is considered a capital transaction, rather than a business
combination. Accordingly, for accounting purposes, the transaction was treated
as a reverse acquisition and a recapitalization, and pro-forma information is
not presented. Transaction costs incurred in the reverse acquisition were
charged to expense.
Taiyu was
incorporated in the Liaoning Province, People’s Republic of China (“PRC” or
"China") in July, 2002. Taiyu is engaged in manufacturing and sale of plate heat
exchangers and various packages, thermo meter testing devices and heat usage
calculators. The Company is an authorized dealer of the SONDEX brand; SONDEX is
the second largest plate heat exchanger manufacturer in the world.
On
September 25, 2008, the Company entered into a Share Exchange Agreement (the
"Agreement") between Asialink (Far East) Limited ("Asialink") and the Company
providing for the acquisition by the Company from Asialink of all of the
outstanding capital stock of SanDeKe Co., Ltd., a Shanghai based manufacturer of
heat plate exchangers ("SanDeKe"). The purchase price for the SanDeKe shares was
$741,516. Under the terms of the Agreement, two of the shareholders of SanDeKe
agreed not to compete with the business of SanDeKe for four years after the
completion of the purchase.
On June
12, 2009, the Company incorporated a new subsidiary SmartHeat Siping Beifang
Energy Technology Co., Ltd (“SmartHeat Siping”) for the manufacturing of heat
exchangers.
On June
16, 2009, Taiyu closed an asset purchase transaction with Siping Beifang Heat
Exchanger Manufacture Co., Ltd (“Siping”), a
company organized under the laws of the PRC, to purchase certain assets
consisting of the plant and equipment and certain land use rights for a purchase
price of 54,000,000 RMB, or USD 7,906,296. Taiyu then
transferred all the assets acquired to SmartHeat Siping, the newly incorporated
subsidiary. The purchase consideration is non-interest bearing and
payable according to the following schedule:
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
Payment
in RMB
|
|
Payment
in USD
|
|
Payment
Date
|
RMB
3,000,000
|
|
$ |
439,239 |
|
May
27, 2009
|
RMB
10,250,000
|
|
$ |
1,500,732 |
|
June
30, 2009
|
RMB 13,000,000
|
|
$ |
1,903,367 |
|
September
30, 2009
|
RMB
12,300,000
|
|
$ |
1,800,878 |
|
March
1, 2010
|
RMB
8,200,000
|
|
$ |
1,200,586 |
|
September
30, 2010
|
At June
30, 2009, the Company paid RMB 10,250,000 or $1,500,732. This payment includes
the first payment of RMB 3,000,000 or $439,239 and the balance of RMB 7,250,000
or $1,061,500 is applied towards the second payment. The Company recorded RMB
8,200,000 or $1,200,586 as part of other payable - non current. The payment
terms does not include any default provision.
The
unaudited financial statements have been prepared by the Company,
pursuant to the rules and regulations of the SEC. The information
furnished herein reflects all adjustments (consisting of normal recurring
accruals and adjustments) which are, in the opinion of management, necessary to
fairly present the operating results for the respective periods. Certain
information and footnote disclosures normally present in annual financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America (“US GAAP”) have been omitted pursuant to such
rules and regulations. These financial statements should be read in
conjunction with the 2008 audited financial statements and footnotes
included in the Company’s audited financial statements. The results
for the six months ended June 30, 2009 are not necessarily indicative of the
results to be expected for the full year ending December 31,
2009.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation
The
accompanying consolidated financial statements include the accounts of
SmartHeat, Taiyu, SanDeKe and SmartHeat Siping, a newly incorporated subsidiary
in June, 2009. For purposes of this Quarterly Report, the "Company" refers
collectively to SmartHeat, Taiyu, SanDeKe and Siping. All significant
inter-company accounts and transactions have been eliminated in
consolidation.
Use
of Estimates
In
preparing the financial statements in conformity with US GAAP, management makes
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the dates of
the financial statements, as well as the reported amounts of revenues and
expenses during the reporting year. Significant estimates, required by
management, include the recoverability of long-lived assets, allowance for
doubtful accounts, and the reserve for obsolete and slow-moving inventories.
Actual results could differ from those estimates.
Cash and Cash
Equivalents
For
purposes of the statement of cash flows, the Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents. As of June 30, 2009, the Company maintained total restricted cash
of $956,657 in several bank accounts, $580,369 representing cash deposits from
customers for securing payment from customers that occurs no later than the
warranty period expires, and $376,288 representing the deposits the Company paid
to a commercial bank for the bank issuing the bank acceptance to its vendors
(see Note 10); of the total restricted cash, $933,312 was cash that
will be released to the Company within one year. As of December 31, 2008, the
Company maintained total restricted cash of $681,520, of which, $462,048 was the
cash that will be released to the Company within one year. Restricted cash is
held in the interest bearing bank accounts.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
Accounts
and Retentions Receivable
The
Company’s policy is to maintain reserves for potential credit losses on accounts
receivable. Management reviews the composition of accounts receivable and
analyzes historical bad debts, customer concentrations, customer credit
worthiness, current economic trends and changes in customer payment patterns to
evaluate the adequacy of these reserves. Based on historical collection
activity, the Company had allowances of $629,936 and $629,687 at June 30, 2009
and December 31, 2008, respectively.
At June
30, 2009 and December 31, 2008, the Company had retentions receivable from
customers for product quality assurance of $1,778,513 and $457,764,
respectively. The retention rate varies from 5% to 20% of the sales price with
variable terms from three months to two years depending on the shipping date of
the products and the number of heating seasons that the warranty period
covers.
Accounts
receivable is net of unearned interest of $96,838 and $28,526 at June 30, 2009
and December 31, 2008, respectively. Unearned interest represents imputed
interest on accounts receivable with due dates over one year from the invoice
date discounted at the Company's borrowing rate, currently 7.16%, and it was
7.04% in 2008.
Inventories
Inventories
are valued at the lower of cost or market with cost determined on a moving
weighted average basis. Cost of work in progress and finished goods comprises
direct material, direct production cost and an allocated portion of production
overheads.
Property
and Equipment
Property
and equipment are stated at cost, net of accumulated depreciation. Expenditures
for maintenance and repairs are expensed as incurred; additions, renewals and
betterments are capitalized. When property and equipment are retired or
otherwise disposed of, the related cost and accumulated depreciation are removed
from the respective accounts, and any gain or loss is included in operations.
Depreciation of property and equipment is provided using the straight-line
method with a 10% salvage value and estimated lives ranging from 5 to 20 years
as follows:
Building
|
20
years
|
Vehicles
|
5
years
|
Office
Equipment
|
5
years
|
Production
Equipment
|
5-10
years
|
Land
Use Rights
Right to
use land is stated at cost less accumulated amortization. Amortization is
provided using the straight-line method over 50 years.
Impairment
of Long-Lived Assets
Long-lived
assets, which include property, plant and equipment and intangible assets, are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable.
Recoverability
of long-lived assets to be held and used is measured by a comparison of the
carrying amount of an asset to the estimated undiscounted future cash flows
expected to be generated by the asset. If the carrying amount of an asset
exceeds its estimated undiscounted future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the assets. Fair value is generally determined using the asset’s
expected future discounted cash flows or market value, if readily determinable.
Based on its review, the Company believes that, as of June 30, 2009 and December
31, 2008, there were no significant impairments of its long-lived
assets.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
Warranties
The
Company offers warranties to all customers on its products for one or two
heating seasons depending on the terms negotiated with the customers. The
Company accrues for warranty costs based on estimates of the costs that may be
incurred under its warranty obligations. The warranty expense and related
accrual is included in the Company's selling expenses and other payable
respectively, and is recorded at the time revenue is recognized. Factors that
affect the Company's warranty liability include the number of sold units, its
estimates of anticipated rates of warranty claims, costs per claim and estimated
support labor costs and the associated overhead. The Company
periodically assesses the adequacy of its recorded warranty liabilities and
adjusts the amounts as necessary.
The
Company's warranty reserve at June 30, 2009 and December 31, 2008 is as
follows:
|
|
For the Six Months Ended June 30, 2009
|
|
|
For the Year Ended December 31, 2008
|
|
Beginning
balance
|
|
$
|
-
|
|
|
$
|
-
|
|
Provisions
made
|
|
|
219,893
|
|
|
|
95,000
|
|
Actual
costs incurred
|
|
|
(31,743
|
)
|
|
|
(95,000
|
)
|
Ending
balance in current liabilities
|
|
$
|
188,150
|
|
|
$
|
-
|
|
Income
Taxes
The
Company utilizes Statement of Financial Accounting Standards ("SFAS") No. 109,
“Accounting for Income Taxes,” which requires the recognition of deferred tax
assets and liabilities for the expected future tax consequences of events that
have been included in the financial statements or tax returns. Under this
method, deferred income taxes are recognized for the tax consequences in future
years of differences between the tax bases of assets and liabilities and their
financial reporting amounts at each period end based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be
realized.
The
Company adopted the provisions of the Financial Accounting Standards Board's
("FASB") Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on
January 1, 2007. As a result of the implementation of FIN 48, the Company made a
comprehensive review of its portfolio of tax positions in accordance with
recognition standards established by FIN 48. As a result of the implementation
of Interpretation 48, the Company recognized no material adjustments to
liabilities or shareholders’ equity. When tax returns are filed, it is highly
certain that some positions taken would be sustained upon examination by the
taxing authorities, while others are subject to uncertainty about the merits of
the position taken or the amount of the position that would be ultimately
sustained. The benefit of a tax position is recognized in the financial
statements in the period during which, based on all available evidence,
management believes it is more likely than not that the position will be
sustained upon examination, including the resolution of appeals or litigation
processes, if any. Tax positions taken are not offset or aggregated with other
positions. Tax positions that meet the more-likely-than-not recognition
threshold are measured as the largest amount of tax benefit that is more than 50
percent likely of being realized upon settlement with the applicable taxing
authority. The portion of the benefits associated with tax positions taken that
exceeds the amount measured as described above is reflected as a liability for
unrecognized tax benefits in the accompanying balance sheets along with any
associated interest and penalties that would be payable to the taxing
authorities upon examination.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
Interest
associated with unrecognized tax benefits is classified as interest expense and
penalties are classified as selling, general and administrative expense in the
statements of income. The adoption of FIN 48 did not have a material impact on
the Company’s financial statements.
Revenue
Recognition
The
Company's revenue recognition policies are in compliance with SEC Staff
Accounting Bulletin (“SAB”) 104. Sales revenue is recognized when products are
delivered and for PHE and PHE units, when customer acceptance occurs, the price
is fixed or determinable, no other significant obligations of the Company exist
and collectibility is reasonably assured. Payments received before all of the
relevant criteria for revenue recognition are recorded as unearned
revenue.
The
Company’s sales contracts with the customers generally provide that 30% of the
purchase price is due upon the placement of an order, 30% is due on delivery,
30% is due upon installation and acceptance of the equipment after customer
testing, the final 10% of the purchase price is due on a date that is no later
than the termination date of the standard warranty period.
Sales
revenue represents the invoiced value of goods, net of value-added tax ("VAT").
All of the Company’s products that are sold in the PRC are subject to Chinese
value-added tax of 17% of the gross sales price. This VAT may be offset by VAT
paid by the Company on raw materials and other materials included in the cost of
producing their finished product. The Company recorded VAT payable and VAT
receivable net of payments in the financial statements. The VAT tax return is
filed offsetting the payables against the receivables.
Sales and
purchases are recorded net of VAT collected and paid as the Company acts as an
agent for the government. VAT taxes are not affected by the income tax
holiday.
Sales
returns and allowances were $0 for both the six months ended June 30, 2009 and
2008. The Company does not provide right of return, price protection or any
other concessions to its customers.
The
standard warranty of the Company is provided to all customers and is not
considered an additional service; rather it is considered an integral part of
the product’s sale. The Company believes that the existence of its standard
product warranty in a sales contract does not constitute a deliverable in the
arrangement and thus there is no need to apply the EITF 00-21 separation
and allocation model for a multiple deliverable arrangement. SFAS 5 specifically
address the accounting for standard warranties and neither SAB 104 nor EITF
00-21 supersedes SFAS 5. The Company believes that accounting for its standard
warranty pursuant to SFAS 5 does not impact revenue recognition because the cost
of honoring the warranty can be reliably estimated.
The
Company provides after sales services at a charge after expiration of the
warranty period, with after sales services mainly consisting of cleaning plate
heat exchangers and repairing and exchanging parts. The Company recognizes such
revenue when service is provided. For the six months ended June 30, 2009 and
2008, revenue from after sales services after expiration of the warranty period
was approximately $3,700 and $21,000. For the three months ended June 30, 2009
and 2008, revenue from after sales services after expiration of the warranty
period was approximately $1,500 and $16,000, respectively.
Cost
of Goods Sold
Cost of
goods sold consists primarily of material costs, direct labor, and manufacturing
overhead which are directly attributable to the production of products.
Write-down of inventories to lower of cost or market is also recorded in cost of
goods sold.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
Concentration
of Credit Risk
Financial
instruments that potentially subject the Company to credit risk consist
primarily of accounts receivable and other receivables. The Company does not
require collateral or other security to support these receivables. The Company
conducts periodic reviews of its clients' financial condition and customer
payment practices to minimize collection risk on accounts
receivable.
The
operations of the Company are located 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 economy.
Statement
of Cash Flows
In
accordance with SFAS No. 95, “Statement of Cash Flows,” cash flows from the
Company's operations are calculated based upon the local currencies. As a
result, amounts related to assets and liabilities reported on the statement of
cash flows may not necessarily agree with changes in the corresponding balances
on the balance sheet. The cash flows from operating, investing and
financing activities exclude the effect of conversion from accounts payable to
notes payable – bank acceptance in the amount of $762,621and assets purchased
from Siping Manufacture in the amount of $7,906,296 for the six months ended
June 30, 2009.
Basic
and Diluted Earnings per Share (EPS)
Basic EPS
is computed by dividing income available to common shareholders by the weighted
average number of common shares outstanding for the period. Diluted EPS is
similarly computed, except that the denominator is increased to include the
number of additional common shares that would have been outstanding if the
potential common shares had been issued and if the additional common shares were
dilutive. Diluted net earnings per share are based on the assumption that all
dilutive convertible shares and stock options were converted or exercised.
Dilution is computed by applying the treasury stock method. Under this method,
options and warrants are assumed to have been exercised at the beginning of the
period (or at the time of issuance, if later), and as if funds obtained
thereby were used to purchase common stock at the average market price during
the period.
The
following table presents a reconciliation of basic and diluted earnings per
share:
|
|
For the Six
Months Ended June 30,
(Unaudited)
|
|
|
For the Three Months
Ended June 30,
(Unaudited)
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Net
income
|
|
$ |
3,638,818 |
|
|
$ |
1,203,675 |
|
|
$ |
2,617,549 |
|
|
$ |
732,412 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding - basic
|
|
|
24,179,900 |
|
|
|
20,213,419 |
|
|
|
24,179,900 |
|
|
|
21,926,838 |
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unexercised
warrants and options
|
|
|
11,163 |
|
|
|
— |
|
|
|
26,199 |
|
|
|
— |
|
Weighted
average shares outstanding - diluted
|
|
|
24,191,063 |
|
|
|
20,213,419 |
|
|
|
24,206,099 |
|
|
|
21,926,838 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share - basic
|
|
$ |
0.15 |
|
|
$ |
0.06 |
|
|
$ |
0.11 |
|
|
$ |
0.03 |
|
Earnings
per share - diluted
|
|
$ |
0.15 |
|
|
$ |
0.06 |
|
|
$ |
0.11 |
|
|
$ |
0.03 |
|
Fair
Value of Financial Instruments
SFAS No.
107, “Disclosures about Fair Value of Financial Instruments,” requires the
Company disclose estimated fair values of financial instruments. The carrying
amounts reported in the statements of financial position for current assets and
current liabilities qualifying as financial instruments are a reasonable
estimate of fair value.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
Foreign
Currency Translation and Comprehensive Income (Loss)
The
accounts of the Company’s Chinese subsidiaries are maintained in the Chinese
Yuan Renminbi (RMB) and the accounts of the U.S. parent company are maintained
in the U.S. Dollar (USD). The accounts of the Chinese subsidiaries were
translated into USD in accordance with SFAS No. 52, "Foreign Currency
Translation," with the RMB as the functional currency for the Chinese
subsidiaries. According to the Statement, all assets and liabilities were
translated at the exchange rate on the balance sheet date, stockholders’ equity
are translated at the historical rates and statement of operations items are
translated at the weighted average exchange rate for the year. The resulting
translation adjustments are reported under other comprehensive income in
accordance with SFAS No. 130, "Reporting Comprehensive Income”.
Stock-Based
Compensation
The
Company accounts for its stock-based compensation in accordance with SFAS No.
123R, “Share-Based Payment, an Amendment of FASB Statement No. 123.” The
Company recognizes in the income statement the grant-date fair value of stock
options and other equity-based compensation issued to employees and
non-employees.
Segment
Reporting
SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information"
requires use of the “management approach” model for segment reporting. The
management approach model is based on the way a company's management organizes
segments within the company for making operating decisions and assessing
performance. Reportable segments are based on products and services, geography,
legal structure, management structure, or any other manner in which management
disaggregates a company.
SFAS 131 has no effect on
the Company's financial statements as substantially all of the Company's
operations are conducted in one industry segment. All of the Company's assets
are located in the PRC.
Registration
Rights Agreement
The
Company accounts for payment arrangements under registration rights agreement in
accordance with FASB Staff Position EITF 00-19-2, which requires that the
contingent obligation to make future payments or otherwise transfer
consideration under a registration payment arrangement, whether issued as a
separate agreement or included as a provision of a financial instrument or other
agreement, be separately recognized and measured in accordance with FASB
Statement No. 5, Accounting for Contingencies.
The
Company is required to file the Registration Statement with the SEC within 60
days of the closing of the private placement offering. The Registration
Statement must be declared effective by the SEC within 180 days of the final
closing of the offering. Subject to certain grace periods, the Registration
Statement must remain effective and available for use until the Investors can
sell all of the securities covered by the Registration Statement without
restriction pursuant to Rule 144. If the Company fails to meet the filing or
effectiveness requirements of the Registration Statement, the Company is
required to pay liquidated damages of 2% of the aggregate purchase price paid by
such Investor for any Registrable Securities then held by such Investor on the
date of such failure and on each anniversary of the date of such failure until
such failure is cured. The last closing under the private
placement occurred on September 24, 2008 and the 180 day period for
effectiveness of the registration statement under the Registration Rights
Agreement ended on March 23, 2009. At March 31, 2009, the Company became
liable to pay approximately $110,000 liquidated damages to our investors as a
result of failure to declare the effectiveness of the Registration Statement
within 180 days of the final closing of the offering. The liquidated
damage was recorded as the Company’s G&A expense with charging corresponding
account to accrued liabilities. The Registration Statement became
effective on June 23, 2009.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
New
Accounting Pronouncements
The FASB Accounting
Standards Codifications
In June
2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification
and the Hierarchy of Generally Accepted Accounting. SFAS 168 represents the last
numbered standard to be issued by FASB under the old (pre-Codification)
numbering system, and amends the GAAP hierarchy. On July 1, FASB will launch new
FASB’s Codification (full name: the FASB Accounting Standards Codification TM.)
The Codification will supersede existing GAAP for nongovernmental entities;
governmental entities will continue to follow standards issued by FASB's sister
organization, the Governmental Accounting Standards Board (GASB). This
pronouncement has no effect on the Company’s financial statements.
Consolidation of Variable
Interest Entities
In June
2009, the FASB issued SFAS No. 167, a revision to FASB Interpretation No. 46(R),
Consolidation of Variable Interest Entities, and will change how a company
determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. Under SFAS
No. 167, determining whether a company is required to consolidate an entity will
be based on, among other things, an entity's purpose and design and a company's
ability to direct the activities of the entity that most significantly impact
the entity's economic performance. SFAS 167 is effective at the start of a
company’s first fiscal year beginning after November 15, 2009, or January 1,
2010 for companies reporting earnings on a calendar-year basis.
Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of
Liabilities
In June
2009, the FASB issued SFAS No. 166, a revision to SFAS No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
and will require more information about transferred of financial assets and
where companies have continuing exposure to the risks related to transferred
financial assets. SFAS 166 is effective at the start of a company’s first fiscal
year beginning after November 15, 2009, or January 1, 2010 for companies
reporting earnings on a calendar-year basis.
Subsequent
Events
In May
2009, the FASB issued SFAS No. 165, "Subsequent Events" ("SFAS 165"). SFAS 165
is intended to establish general standards of accounting for and disclosures of
events that occur after the balance sheet date but before financial statements
are issued or are available to be issued. It requires the disclosure of the date
through which an entity has evaluated subsequent events and the basis for
selecting that date, that is, whether that date represents the date the
financial statements were issued or were available to be issued. SFAS 165 is
effective for interim or annual financial periods ending after June 15,
2009.
The Hierarchy of Generally
Accepted Accounting Principles
In May
2008, FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting
Principles.” SFAS 162 identifies the sources of accounting principles and
the framework for selecting the principles to be used in the preparation of
financial statements of nongovernmental entities that are presented in
conformity with generally accepted accounting principles (GAAP) in the United
States (the GAAP hierarchy). SFAS 162 adoption did not have an impact on
the Company’s financial statements.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
Determination of the Useful
Life of Intangible Assets
In
April 2008, the FASB issued FASB Staff Position FAS 142-3, “Determination
of the Useful Life of Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends
the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset
under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”),
and requires additional disclosures. The objective of FSP FAS 142-3 is to
improve the consistency between the useful life of a recognized intangible asset
under SFAS 142 and the period of expected cash flows used to measure the fair
value of the asset under SFAS No. 141 (R), “Business Combinations” (“SFAS
141(R)”), and other accounting principles generally accepted in the USA. FSP FAS
142-3 applies to all intangible assets, whether acquired in a business
combination or otherwise and shall be effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. The guidance for determining the useful life of
intangible assets shall be applied prospectively to intangible assets acquired
after the effective date. The disclosure requirements apply prospectively to all
intangible assets recognized as of, and subsequent to, the effective date.
Early adoption is prohibited. The adoption of FSP FAS 142-3 did not have a
material impact on the Company’s financial statements.
Disclosures about Derivative
Instruments and Hedging Activities
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities an amendment of FASB Statement No. 133.” This
Statement changes the disclosure requirements for derivative instruments and
hedging activities. Entities are required to provide enhanced disclosures about
(a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under
Statement 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance, and cash flows. SFAS 161 is effective for fiscal
years, and interim periods within those fiscal years, beginning on or
after November 15, 2008. The adoption of SFAS 161 did not have a
material impact on the Company’s financial statements.
Fair value of
measurements
On
January 1, 2008, the Company adopted SFAS No. 157, “Fair Value
Measurements,” SFAS 157 defines fair value, establishes a three-level
valuation hierarchy for disclosures of fair value measurement and enhances
disclosures requirements for fair value measurements. The three levels are
defined as follow:
|
·
|
Level 1 inputs to the valuation
methodology are quoted prices (unadjusted) for identical assets or
liabilities in active
markets.
|
|
·
|
Level 2 inputs to the valuation
methodology include quoted prices for similar assets and liabilities in
active markets, and inputs that are observable for the asset or liability,
either directly or indirectly, for substantially the full term of the
financial instrument.
|
|
·
|
Level 3 inputs to the valuation
methodology are unobservable and significant to the fair value
measurement.
|
As of
June 30, 2009, the Company did not identify any assets and liabilities that are
required to be presented on the balance sheet at fair value.
Non-Controlling Interests in
Consolidated Financial Statements - An Amendment of ARB No. 51
In
December 2007, FASB issued SFAS No. 160, "Non-controlling Interests in
Consolidated Financial Statements - An Amendment of ARB No. 51." SFAS 160
establishes new accounting and reporting standards for the non-controlling
interest in a subsidiary and for the deconsolidation of a subsidiary.
Specifically, this statement requires the recognition of a non-controlling
interest (minority interest) as equity in the consolidated financial statements
and separate from the parent’s equity. The amount of net income attributable to
the non-controlling interest will be included in consolidated net income on the
face of the income statement. SFAS 160 clarifies that changes in a parent’s
ownership interest in a subsidiary that do not result in deconsolidation are
equity transactions if the parent retains its controlling financial interest. In
addition, this statement requires that a parent recognize a gain or loss in net
income when a subsidiary is deconsolidated. Such gain or loss will be measured
using the fair value of the non-controlling equity investment on the
deconsolidation date. SFAS 160 also includes expanded disclosure requirements
regarding the interests of the parent and its non-controlling interest. SFAS 160
is effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. The Company expects SFAS 160 will
have an impact on accounting for business combinations, but the effect is
dependent upon acquisitions at that time. The Company adopted the
provisions of SFAS 160 on January 1, 2009.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
Business
Combinations
SFAS 141
(Revised 2007), Business Combinations (SFAS 141(R)), is effective for the
Company for business combinations for which the acquisition date is on or after
January 1, 2009. SFAS 141(R) changes how the acquisition method is applied in
accordance with SFAS 141. The primary revisions to this Statement require an
acquirer in a business combination to measure assets acquired, liabilities
assumed, and any noncontrolling interest in the acquiree at the acquisition
date, at their fair values as of that date, with limited exceptions specified in
the Statement. This Statement also requires the acquirer in a business
combination achieved in stages to recognize the identifiable assets and
liabilities, as well as the noncontrolling interest in the acquiree, at the full
amounts of their fair values (or other amounts determined in accordance with the
Statement). Assets acquired and liabilities assumed arising from contractual
contingencies as of the acquisition date are to be measured at their
acquisition-date fair values, and assets or liabilities arising from all other
contingencies as of the acquisition date are to be measured at their
acquisition-date fair value, only if it is more likely than not that they meet
the definition of an asset or a liability in FASB Concepts Statement No. 6,
Elements of Financial Statements. This Statement significantly amends other
Statements and authoritative guidance, including FASB Interpretation No. 4,
Applicability of FASB Statement No. 2 to Business Combinations Accounted for by
the Purchase Method, and now requires the capitalization of research and
development assets acquired in a business combination at their acquisition-date
fair values, separately from goodwill. FASB Statement No. 109, Accounting for
Income Taxes, was also amended by this Statement to require the acquirer to
recognize changes in the amount of its deferred tax benefits that are
recognizable because of a business combination either in income from continuing
operations in the period of the combination or directly in contributed capital,
depending on the circumstances. The Company expects SFAS 141R will have a
significant impact on accounting for business combinations, but the effect is
dependent upon acquisitions at that time. The Company adopted the
provisions of SFAS 160 on January 1, 2009.
Accounting for
Non-Refundable Advance Payments for Goods or Services Received for Use in Future
Research and Development Activities
In June
2007, FASB issued FASB Staff Position No. EITF 07-3, “Accounting for
Nonrefundable Advance Payments for Goods or Services Received for use in Future
Research and Development Activities,” which addresses whether non-refundable
advance payments for goods or services that used or rendered for research and
development activities should be expensed when the advance payment is made or
when the research and development activity has been performed. EITF 07-03
is effective for fiscal years beginning after December 15, 2008. The
adoption of EITF 07-03 did not have a significant impact on the Company’s
financial statements.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
3.
INVENTORIES
Inventories
at June 30, 2009 and December 31, 2008 were as follows:
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2009
|
|
|
2008
|
|
Raw
materials
|
|
$
|
4,760,139
|
|
|
$
|
4,411,298
|
|
Work
in process
|
|
|
1,601,767
|
|
|
|
652,472
|
|
Finished
Goods
|
|
|
1,858,275
|
|
|
|
1,043,813
|
|
Total
|
|
$
|
8,220,181
|
|
|
$
|
6,107,583
|
|
4.
PROPERTY AND EQUIPMENT, NET
Property
and equipment consisted of the following at June 30, 2009 and December
31, 2008:
|
|
June 30,
2009
|
|
|
December 31,
2008
|
|
|
|
|
|
|
Building
|
|
$
|
4,324,667
|
|
|
$
|
1,818,827
|
|
Production
equipment
|
|
|
2,666,584
|
|
|
|
441,065
|
|
Office
equipment
|
|
|
306,717
|
|
|
|
231,975
|
|
Vehicles
|
|
|
577,368
|
|
|
|
300,956
|
|
|
|
|
7,875,336
|
|
|
|
2,792,823
|
|
Less:
Accumulated depreciation
|
|
|
(512,296
|
)
|
|
|
(356,270
|
)
|
|
|
$
|
7,363,041
|
|
|
$
|
2,436,553
|
|
Depreciation
expense for the six months ended June 30, 2009 and 2008 was approximately
$111,000 and $77,000, respectively. Depreciation expense for the
three months ended June 30, 2009 and 2008 was approximately $55,000 and $39,000,
respectively.
5.
OTHER RECEIVABLES, PREPAYMENTS AND DEPOSITS
Other
receivables, prepayments and deposits consisted of the following at June 30,
2009 and December 31, 2008, respectively:
|
|
June 30,
2009
|
|
|
December 31,
2008
|
|
|
|
|
|
|
Cash
advance to third parties
|
|
$
|
407,866
|
|
|
$
|
89,628
|
|
Deposit
for public bids of sales contracts
|
|
|
603,540
|
|
|
|
353,399
|
|
Prepayment
for freight and related insurance expenses
|
|
|
102,082
|
|
|
|
95,888
|
|
Deposits
|
|
|
71,373
|
|
|
|
42,783
|
|
Advance
to employees
|
|
|
182,104
|
|
|
|
117,136
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,366,965
|
|
|
$
|
698,834
|
|
Cash
advance to third parties was the short term cash advances to customers and
vendors with repayment usually within three to six months. Deposits
for public bidding represented the deposits for bidding expected contracts,
which will be returned to the Company after the bidding process is completed
unusually within three to four months from the payment
date. Prepayment for freight and /or related insurance expenses
represented prepaid shipping and freight insurance expenses for customers and is
generally repaid upon customer receipt of products. Deposits mainly
consisted of deposits for rents and utilities. Cash advance to employees
represented short term loan to employees and advance to employees for business
trip and related expenses. Other receivables, prepayments and deposits are
reimbursed or settled within 12 months.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
6.
INTANGIBLE ASSETS
Intangible
assets mainly consisted of land use rights, computer software, know-how
technology, customer list and covenant not to compete. All land in the PRC is
government owned and cannot be sold to any individual or company. However, the
government grants the user a “land use right” to use the land. The Company
acquired land use right during 2005 for approximately $440,000 (RMB 3,549,682).
The Company has the right to use the land for 50 years and is amortizing such
rights on a straight-line basis for 50 years. The Company acquired
another land use right of $3,106,676 from Siping on June 16, 2009.
Intangible
assets consisted of the following at June 30, 2009 and December 31, 2008,
respectively:
|
|
June 30,
2009
|
|
|
December 31,
2008
|
|
|
|
|
|
|
Land
use rights
|
|
$
|
3,626,252
|
|
|
$
|
519,369
|
|
Know-how
technology
|
|
|
266,913
|
|
|
|
266,808
|
|
Customer
list
|
|
|
191,728
|
|
|
|
191,652
|
|
Covenant
not to compete
|
|
|
104,299
|
|
|
|
104,258
|
|
Software
|
|
|
190,242
|
|
|
|
190,166
|
|
|
|
|
4,379,433
|
|
|
|
1,272,253
|
|
Less:
accumulated amortization
|
|
|
(200,290
|
)
|
|
|
(117,122
|
)
|
|
|
$
|
4,179,143
|
|
|
$
|
1,155,131
|
|
Amortization
expense of intangible assets for the six months ended June 30, 2009 and 2008 was
approximately $83,000 and $26,000, respectively. Amortization expense for the
three months ended June 30, 2009 and 2008 was approximately $42,000 and $15,000,
respectively. Annual amortization expense for the next five years from June 30,
2009 is expected to be: $242,000, $242,000, $242,000, $242,000 and
$202,000.
7.
MAJOR CUSTOMERS AND VENDORS
Three
customers accounted for 21%, 14% and 10% of the Company’s net revenue for the
six months ended June 30, 2009 while one customer accounted for 19% of the
Company’s net revenue for the six months ended June 30, 2008. For the three
months ended June 30, 2009, three customers accounted for about 32%, 21%, and
15% of the sales. For the three months ended June 30, 2008, one
customer accounted for about 12% of the sales. At June 30, 2009 the total
receivable balance due from these customers was approximately
$3,597,230.
There is
no major vendor provided of the Company’s purchases of raw materials for the six
months and three months ended June 30, 2009 while two major vendors provided 44%
and 27% of the Company’s purchases of raw materials for the six months and three
months ended June 30, 2008, respectively. The Company had
approximately $690,395 in accounts payable to these vendors at June 30,
2008.
8.
TAXES PAYABLE
Taxes
payable consisted of the following at June 30, 2009 and December 31,
2008:
|
|
June 30,
2009
|
|
|
December 31,
2008
|
|
|
|
|
|
|
Income
tax payable
|
|
$
|
424,234
|
|
|
$
|
723,958
|
|
Value
added tax payable
|
|
|
131,204
|
|
|
|
597,676
|
|
Other
taxes payable
|
|
|
3,647
|
|
|
|
6,141
|
|
|
|
$
|
559,085
|
|
|
$
|
1,327,775
|
|
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
9.
ACCRUED LIABILITIES AND OTHER PAYABLES
Accrued
liabilities and other payables consisted of the following at June 30, 2009 and
December 31, 2008:
|
|
June 30,
2009
|
|
|
December 31,
2008
|
|
|
|
|
|
|
Advance
from third parties
|
|
$
|
88,000
|
|
|
$
|
453,625
|
|
Payable
for purchase of SanDeKe
|
|
|
-
|
|
|
|
741,516
|
|
Payable
for purchase of assets from SiPing – current portion
|
|
|
5,203,196
|
|
|
|
-
|
|
Other
payables
|
|
|
322,020
|
|
|
|
99,418
|
|
Warranty
reserve
|
|
|
188,151
|
|
|
|
-
|
|
Accrued
liabilities
|
|
|
167,342
|
|
|
|
36,253
|
|
Total
|
|
$
|
5,968,709
|
|
|
$
|
1,330,812
|
|
Advance
from third parties represented short term, non interest bearing advances from
third parties. Other payables consisted of payables for the Company’s
miscellaneous expenses including postage, business insurance, employee benefits,
bidding fee, etc. Accrued liabilities mainly consisted of accrued interest,
payroll, utility, and liquidated damages for failure to declare the
effectiveness of the Registration Statement within 180 days of the final closing
of the offering.
10.
NOTES PAYABLE – BANK ACCEPTANCE
Notes
payable represented accounts payable to vendors that were converted to notes
payable accepted by the bank. The Company deposited a portion of the acceptance
amount into the bank. The bank charged 2.5% of the face value of the note which
is amortized over the term of the acceptance.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
11.
LOANS PAYABLE
The
Company was obligated for the following short term loans payable as of June 30,
2009 and December 31, 2008:
|
|
June
30, 2009
|
|
|
December 31, 2008
|
|
Loans
from a commercial bank in the PRC for 30,000,000 RMB. Of which, 17,000,000
RMB was entered into on April 22, 2009 and is due on April 22, 2010.
13,000,000 RMB was entered into on June 12, 2009 and is due on June 12,
2010. These loans currently bear interest at 5.576%. The
Company pledged its building in the value of approximately RMB 12,430,950
or approximately $1,818,000 for this loan.
|
|
$ |
4,391,165
|
|
|
$ |
-
|
|
|
|
|
|
|
|
|
|
|
Loan
from a commercial bank in the PRC for 6,000,000 RMB. This loan was entered
into on Apr 28, 2007 and was due on Apr 12, 2008. This loan was renewed on
Apr 12, 2008. The Company repaid loan in April, 2009.
|
|
|
-
|
|
|
|
877,886
|
|
|
|
|
|
|
|
|
|
|
The
Company entered into a series of short term loans during 2006 and 2007
with a third party company in the PRC for total of 10, 300,000 RMB. Some
of the loans matured on various dates in 2008 and some of the loans are
payable on demand. These loans bear variable interest at 8.591% for 2009
and 2008. The Company repaid RMB 2,600,000 in 2008, RMB
2,700,000 in April, 2009, and had RMB 5,000,000 outstanding as of June 30,
2009, due on December 31, 2009 with interest of 8.591%.
|
|
|
731,861
|
|
|
|
1,126,621
|
|
|
|
|
|
|
|
|
|
|
The
Company entered into a one year loan on July 1, 2008 with another third
party company in the PRC for total of 3,000,000 RMB. This loan is renewed
and due on December 31, 2009 with interest of 8.591%.
|
|
|
439,116
|
|
|
|
438,943
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
5,562,142
|
|
|
$
|
2,443,450
|
|
12.
DEFERRED TAX LIABILITY
Deferred
tax liability represented differences between the tax bases and book bases of
property and equipment and intangible assets arising from the acquisition of
SanDeKe.
13.
INCOME TAXES
The
Company is subject to income taxes by entity on income arising in or derived
from the tax jurisdiction in which each entity is domiciled.
SmartHeat
was incorporated in the United States and has incurred net operating loss for
income tax purposes. SmartHeat has net operating loss carry forwards
for income taxes of approximately $230,000 at June 30, 2009 which may be
available to reduce future years’ taxable income as NOL can be carried
forward up to 20 years from the year the loss is incurred. Management believes
that the realization of the benefits from these losses appears uncertain due to
the Company’s limited operating history and continuing losses. Accordingly, a
100% deferred tax asset valuation allowance has been provided.
Taiyu and
SanDeKe are governed by the Income Tax Law of the PRC concerning privately-run
enterprises, which are generally subject to tax at a statutory rate of 25% on
income reported in the statutory financial statements after appropriated tax
adjustments.
Taiyu, as
a manufacturing business, is subject to 18% income tax rate for 2008 and 20%
income tax rate for 2009. According to the new income tax law that became
effective January 1, 2008, new high-tech enterprises that government gives
special support are subject to income tax rate of 15%. Taiyu was
recognized as a new high-tech enterprise and registered the status with tax
bureau, therefore, enjoys the income tax rate of 15% from 2009 through
2010.
SanDeKe
is subject to an 18% income tax rate after 7% reduction in federal income tax
rate given by federal government. SanDeKe, is also exempt from income tax for
two years starting from the 1st profitable year, and is entitled to a 50%
discount on the 18% income tax rate for 2010 through 2012.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
The
Company's net income for the six and three months ended June 30, 2009 would be
lower by approximately $191,000 or $0.01 earnings per common share, and $130,000
or $0.0053 earnings per common share had Taiyu not enjoyed lower income tax rate
and SanDeKe not been exempted from income tax for the six and three months ended
June 30, 2009.
Foreign
pretax earnings approximated $4,436,000 and $1,469,000 for the six months ended
June 30, 2009 and 2008 respectively. Pretax earnings of a foreign subsidiary are
subject to U.S. taxation when effectively repatriated. The Company provides
income taxes on the undistributed earnings of non-U.S. subsidiaries except to
the extent that such earnings are indefinitely invested outside the United
States. At June 30, 2009, $10,998,000 of accumulated undistributed earnings of
non-U.S. subsidiaries was indefinitely invested. At the existing U.S. federal
income tax rate, additional taxes of $990,000 would have to be provided if such
earnings were remitted currently.
The
following table reconciles the U.S. statutory rates to the Company’s effective
tax rate for the six and three months ended June 30, 2009 and 2008:
|
|
For the Six Months Ended June 30,
|
|
|
For the Three Months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
US
statutory rates
|
|
|
34.0 |
% |
|
|
34.0 |
% |
|
|
34.0 |
% |
|
|
34.0 |
% |
Tax
rate difference
|
|
|
(14.0 |
)% |
|
|
(16.0 |
)% |
|
|
(14.0 |
)% |
|
|
(16.0 |
)% |
Effect
of tax holiday
|
|
|
(5.1 |
)% |
|
|
- |
|
|
|
(5.0 |
)% |
|
|
- |
|
Valuation
allowance
|
|
|
0.9 |
% |
|
|
- |
|
|
|
0.0 |
% |
|
|
- |
|
Tax
per financial statements
|
|
|
15.8 |
% |
|
|
18.0 |
% |
|
|
15.0 |
% |
|
|
18.0 |
% |
14.
STATUTORY RESERVES
Pursuant
to the new corporate law of the PRC effective January 1, 2006, the Company is
now only required to maintain one statutory reserve by appropriating from its
after-tax profit before declaration or payment of dividends. The statutory
reserve represents restricted retained earnings.
Surplus
Reserve Fund
The
Company is now only required to transfer 10% of its net income, as determined
under PRC accounting rules and regulations, to a statutory surplus reserve fund
until such reserve balance reaches 50% of the Company’s registered
capital.
The
surplus reserve fund is non-distributable other than during liquidation and can
be used to fund previous years’ losses, if any, and may be utilized for business
expansion or converted into share capital by issuing new shares to existing
shareholders in proportion to their shareholding or by increasing the par value
of the shares currently held by them, provided that the remaining reserve
balance after such issue is not less than 25% of the registered
capital.
Common
Welfare Fund
The
common welfare fund is a voluntary fund that provides that the Company can elect
to transfer 5% to 10% of its net income to this fund. This fund can only be
utilized on capital items for the collective benefit of the Company’s employees,
such as construction of dormitories, cafeteria facilities, and other staff
welfare facilities. This fund is non-distributable other than upon
liquidation.
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
15.
STOCKHOLDERS’ EQUITY
Common
Stock with Warrants Issued for Cash
In August
2008, the Company closed a private placement offering of Units pursuant to which
SmartHeat sold 1,630,000 Units at $3.50 per Unit for aggregate gross proceeds of
approximately $5.7 million. Each "Unit" consists of one share of SmartHeat
common stock and a three year warrant to purchase 15% of one share of common
stock at an exercise price of $6.00 per share. The Units sold represent an
aggregate of 1,630,000 million shares of common stock and warrants to purchase
244,500 shares of Common Stock. In connection with the private placement
offering, the Company paid commission of approximately $340,000 and issued
warrants to purchase 148,500 shares of common stock to its placement agents. The
warrants are immediately exercisable and expire on the third anniversary of
their issuance. The warrants require the Company to settle in its own
shares. There is no provision for cash settlement, except in lieu of
fractional shares. Net proceeds of approximately $5.1 million were
received by the Company. The value of warrants was determined by using the
Black-Scholes pricing model with the following assumptions: discount
rate – 2.76%;
dividend yield – 0%; expected
volatility – 15% and term of 3
years. The value of the Warrants was $70,246. There were no warrants
exercised from the grant date to June 30, 2009.
Stock
Options to Independent Directors
On July
17, 2008, the Company granted non-statutory stock options to each of its two
independent US directors. The terms of each option are: 10,000 shares at an
exercise price per share of $4.60, with a life of five years and vesting over
three years as follows: 3,333 shares vest on July 17, 2009; 3,333 shares vest on
July 17, 2010; and 3,334 shares vest on July 17, 2011, subject in each case to
the director continuing to be associated with the Company as a
director.
Based on
the fair value method under SFAS No. 123 (Revised) “Share Based Payment” (“SFAS
123(R)”), the fair value of each stock option granted is estimated on the date
of the grant using the Black-Scholes option pricing model. The Black-Scholes
option pricing model has assumptions for risk free interest rates, dividends,
stock volatility and expected life of an option grant. The risk free interest
rate is based upon market yields for United States Treasury debt securities at a
maturity near the term remaining on the option. Dividend rates are based on the
Company’s dividend history. The stock volatility factor is based on the
historical volatility of the Company’s stock price. The expected life of an
option grant is based on management’s estimate. The fair value of each option
grant to independent directors is calculated by the Black-Scholes method and is
recognized as compensation expense over the vesting period of each stock option
award. For stock options issued, the fair value was estimated at the date of
grant using the following range of assumptions:
The
options vest over three years and have a life of 5 years, volatility of 15%,
risk free interest rate of 2.76%, and dividend yield of 0%. No estimate of
forfeitures was made as the Company has a short history of granting options.
There were no options exercised during the six months ended June 30,
2009.
Following is a summary of the warrant
activity:
|
|
Number of
Shares
|
|
|
Average
Exercise
Price per Share
|
|
|
Weighed
Average
Remaining
Contractual
Term in Years
|
|
Outstanding
at December 31, 2007
|
|
|
-
|
|
|
|
|
|
|
|
Exercisable
at December 31, 2007
|
|
|
-
|
|
|
|
|
|
|
|
Granted
|
|
|
393,000
|
|
|
$ |
6.00
|
|
|
|
3.00
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2008
|
|
|
393,000
|
|
|
|
6.00
|
|
|
|
2.51
|
|
Exercisable
at December 31, 2008
|
|
|
393,000
|
|
|
|
6.00
|
|
|
|
2.51
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at June 30, 2009
|
|
|
393,000
|
|
|
$ |
6.00
|
|
|
|
2.02
|
|
Exercisable
at June 30, 2009
|
|
|
393,000
|
|
|
$ |
6.00
|
|
|
|
2.02
|
|
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
Following
is a summary of the option activity:
|
|
Number of
Shares
|
|
|
Average
Exercise
Price per Share
|
|
|
Weighed
Average
Remaining
Contractual
Term in Years
|
|
Outstanding
at December 31, 2007
|
|
|
-
|
|
|
|
|
|
|
|
Exercisable
at December 31, 2007
|
|
|
-
|
|
|
|
|
|
|
|
Granted
|
|
|
20,000
|
|
|
$ |
4.60
|
|
|
|
5.00
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at December 31, 2008
|
|
|
20,000
|
|
|
|
4.60
|
|
|
|
4.54
|
|
Exercisable
at December 31, 2008
|
|
|
20,000
|
|
|
|
4.60
|
|
|
|
4.54
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
at June 30, 2009
|
|
|
20,000
|
|
|
$ |
4.60
|
|
|
|
4.04
|
|
Exercisable
at June 30, 2009
|
|
|
20,000
|
|
|
$ |
4.60
|
|
|
|
4.04
|
|
16.
COMMITMENTS
Employment
Agreements
On
January 1, 2008, the Company entered into a three year employment agreement with
Mr. Jun Wang, which agreement may be renewed at the end of the initial term upon
mutual agreement between Mr. Jun Wang and the Company. Either party
shall give written notice to the other party of its intention not to renew
the agreement at least 30 days prior to the end of the initial
term. Pursuant to the terms of the employment agreement, Mr. Jun Wang
shall receive a salary in an amount that is not less than the lowest minimum
wage per month paid in Shenyang and shall be based on the uniform wage and
incentive system in Shenyang, currently $18,000 per annum. In addition, Mr. Jun
Wang shall be entitled to overtime pay in accordance with the applicable
law.
On
January 1, 2008, The Company entered into a three year employment agreement with
Ms. Zhijuan Guo, at terms identical to the terms of the employment agreement
with Mr. Jun Wang with current salary of $10,684 per annum.
Lease
agreements
The
Company leased several offices for its sales representative in different cities
under various one-year, non-cancellable, and renewable operating lease
agreements. At June 30, 2009, future minimum rental payments required
under these operating leases are as follows:
Year
Ending June 30,
|
|
Amount
|
|
2010
|
|
$
|
87,000
|
|
2011
|
|
|
87,000
|
|
Total
|
|
$
|
174,000
|
|
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
17.
CONTINGENCIES
The
Company sold goods to its customers and received Commercial Notes from the
customers in lieu of accounts receivable. The Company discounts the
Notes with the bank or endorses the Notes to vendors, which could be for payment
of their own obligations or get cash from the third parties. Most of
the Commercial Notes have maturity of less than six months.
At June
30, 2009 and December 31, 2008, the Company is contingently liable to vendors
for endorsed notes receivable of $14,637 and $14,631, respectively.
The
Company’s operations in the PRC are subject to specific considerations and
significant risks not typically associated with companies in North America and
Western Europe. These include risks associated with, among others, the
political, economic and legal environments and foreign currency exchange.
The Company’ s results may be adversely affected by changes in governmental
policies with respect to laws and regulations, anti-inflationary measures,
currency conversion and remittance abroad, and rates and methods of taxation,
among other things.
The
Company’s sales, purchases and expense transactions are denominated in RMB and
all of the Company’s assets and liabilities are also denominated in RMB. The RMB
is not freely convertible into foreign currencies under the current law. In
China, foreign exchange transactions are required by law to be transacted only
by authorized financial institutions. Remittances in currencies other than RMB
may require certain supporting documentation in order to affect the
remittance.
18.
ACQUISITION OF SANDEKE CO., LTD.
On
September 25, 2008, the Company entered into an Agreement for the acquisition of
all the outstanding capital stock of SanDeKe. The purchase price for the SanDeKe
shares was $741,516. Under the terms of the Agreement, two of the shareholders
of SanDeKe have agreed not to compete with the business of SanDeKe for a period
of four years after the completion of the purchase. At June 30, 2009,
the Company paid the purchase consideration for SanDeKe.
For
convenience of reporting the acquisition for accounting purposes, September 1,
2008 was designated as the acquisition date.
The
following table summarizes the fair values of the assets acquired and
liabilities assumed at the date of acquisition. The fair value of
the net assets acquired exceeded the total consideration for the acquisition by
approximately $117,000 (RMB 800,000). The excess (negative goodwill) was
allocated on a pro rata basis to long-lived assets.
Cash
|
|
$
|
59,245
|
|
Accounts
receivable
|
|
|
489,527
|
|
Advance
to suppliers
|
|
|
329,951
|
|
Other
receivables
|
|
|
128,646
|
|
Inventory
|
|
|
92,370
|
|
Property
and equipment
|
|
|
73,324
|
|
Intangible
assets
|
|
|
563,567
|
|
Accounts
payable
|
|
|
(332,276
|
)
|
Advance
from customers
|
|
|
(557,216
|
)
|
Deferred
tax liability
|
|
|
(39,076
|
)
|
Other
current liabilities
|
|
|
(66,546
|
)
|
Purchase
price
|
|
$
|
741,516
|
|
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
The
intangible asset consisted of know-how technology is amortized over 5 years, the
customer list is amortized over 5 years and covenants not to compete, is
amortized over 4 years.
The
following unaudited pro forma consolidated results of operations of the Company
for the six months ended June 30, 2008 presents the operations of the Company
and SanDeKe as if the acquisition of SanDeKe occurred on January 1,
2008. The pro forma results are not necessarily indicative of the
actual results that would have occurred had the acquisitions been completed as
of the beginning of the periods presented, nor are they necessarily indicative
of future consolidated results.
|
|
Pro forma
Consolidated
|
|
Net
revenue
|
|
$
|
9,980,244
|
|
Cost
of revenue
|
|
|
7,341,630
|
|
Gross
profit
|
|
|
2,638,614
|
|
Selling
expense
|
|
|
608,028
|
|
General
& administrative expense
|
|
|
759,989
|
|
Total
operating expenses
|
|
|
1,368,017
|
|
Income
from operations
|
|
|
1,270,597
|
|
Non-operating
income, net
|
|
|
113,572
|
|
Income
before income tax
|
|
|
1,384,169
|
|
Income
tax
|
|
|
266,028
|
|
Net
income
|
|
$
|
1,118,141
|
|
Basic
and diluted weighted average shares outstanding
|
|
|
20,213,419
|
|
Basic
and diluted net earnings per share
|
|
$
|
0.06
|
|
19. SUBSEQUENT
EVENTS
On July
3, 2009, the “Company entered into a Senior Loan Agreement with an institutional
investor to obtain a loan of US $9,000,000.00.
Under the
terms of the Agreement, the Company agreed to a simple interest rate of 10% per
annum payable quarterly beginning on September 30, 2009. The principal amount
and any unpaid interest accrued thereon are due six (6) months from the date of
the Agreement.
The
Lender may demand payment of principal and interest three (3) months from the
date of the Note, in the event of a change of control or upon material organic
changes to the Company. The terms of any subsequent financing must meet with
Lender’s consent.
Without
the prior written consent of the Lender, from the date hereof until the date the
Senior Note is repaid in full, the Company and its Subsidiary shall be
prohibited from
(A)
Effecting or entering into an agreement or to affect any subsequent financing
which shall be senior to the Senior Notes, or any other financing;
(B)
Selling, leasing, or otherwise disposing of their respective
assets;
(C) Dissolving,
liquidating, or winding up their respective businesses;
(D)
Conducting their respective businesses other than in their ordinary and usual
course;
(E) Paying
any dividend or make any other distributions of cash or property;
SMARTHEAT
INC. AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE
30, 2009 (UNAUDITED) AND DECEMBER 31, 2008
(F) Merging
or consolidating with another entity;
(G) Issuing
any shares of Company capital stock or Company debt securities.