China
Valves Technology, Inc., (the “Company”), is incorporated in Nevada in August
1997. Through its direct owned subsidiary China Valve Samoa, the Company focuses
primarily on the development, manufacture and sale of high-quality metal valves
for the electricity, petroleum, chemical, water, gas and metal industries in the
People’s Republic of China (“PRC”). Our operations are headquartered in Kaifeng,
Henan Province, PRC.
China
Valve Samoa was incorporated on June 6, 2007 in Samoa and its principle activity
was its investment in all of the outstanding capital stock of China Valve
Holding Limited, a corporation incorporated under the laws of Hong Kong (“China
Valve Hong Kong”). China Valve Hong Kong, in turn, was the owner of all of the
outstanding equity interests in Henan Tonghai Valve Technology Co., Ltd.,
(“Henan Tonghai Valve”), a corporation incorporated under the laws of the PRC
which in turn owned all of the outstanding equity interests in two entities (the
“Operating Subsidiaries”), namely, Henan Kaifeng High Pressure Valve Co., Ltd.,
(“High Pressure Valve”) and Zhengzhou City Zhengdie Valve Co., Ltd., (“Zhengdie
Valve”), both corporations incorporated under the laws of the PRC.
RESTRUCTURING
PLAN
The
Company undertook a restructuring plan intended to ensure compliance with
regulatory requirements of the PRC. Under that plan, on April 1 and 3, 2008, the
Company transferred 100% of the equity of the Operating Subsidiaries back to
Sipang Fang, the Company’s majority shareholder, Chief Executive Officer and
President and the other original owners, with the intention that
Sipang Fang would transfer the Operating Subsidiaries to a new entity controlled
by Mr. Bin Li (a Canadian citizen and Mr. Siping Fang’s cousin), and that Mr. Li
would then sell such entity to the Company, thereby allowing the Company to
reacquire legal ownership of the Operating Subsidiaries.
Under the
restructuring plan, on April 10, 2008, Mr. Sipang Fang, the, sold 24,300,000
shares of the Company’s common stock beneficially owned by him to Mr. Li for
HK$10,000 (approximately $1,281). In connection with his acquisition of the
Shares, Mr. Li issued to Mr. Fang a HK$10,000 note. The note, which does not
bear interest, is due sixty days after a written demand for payment is made by
Mr. Fang to Mr. Li, provided that such demand is made on or after October 15,
2008. The sale represented a change of control of the Company and the Shares
acquired by Mr. Li represented approximately 60.75% of the then issued and
outstanding capital stock of the Company calculated on a fully-diluted basis.
Prior to the acquisition, Mr. Li was not affiliated with the Company. However
following the acquisition, Mr. Li is deemed an affiliate of the Company as a
result of his stock ownership interest in the Company. In connection therewith,
Mr. Fang and Mr. Li entered into an Earn-In Agreement (the “Earn-In Agreement”)
pursuant to which Mr. Fang obtained the right and option to re-acquire the
shares of the Company from Mr. Li, subject to the satisfaction of four
conditions as set forth in the Earn-In Agreement, as follows: (1) 12,150,000
shares, upon the later occurrence of either (i) the date that is six months
after April 10, 2008 or (ii) the date upon which Mr. Fang and Henan Tonghai
Valve enter into a binding employment agreement for a term of not less than five
years for Mr. Fang to serve as Henan Tonghai Valve’s chief executive officer and
chairman of its board of directors; (2) 4,050,000 shares upon the declaration of
effectiveness of a registration statement filed by the Company under the
Securities Act of 1933, as amended; (3) 4,050,000 shares when the Operating
Subsidiaries achieve after-tax net income of not less than $3,000,000, as
determined under United States Generally Accepted Accounting Principles (“GAAP”)
consistently applied for six months ended June 30, 2008; and (4) 4,050,000 of
the Shares when the Operating Subsidiaries achieve not less than $7,232,500 in
pre tax profits, as determined under GAAP, for the fiscal year ended December
31, 2008. Conditions (3) and (4) have been met. The shares under the Earn-In
Agreement are also the subject of a Make-Good Escrow Agreement in connection
with the Company’s August 26, 2008 private placement (see Note 12).
In
accordance with the restructuring plan, Mr. Li established China Fluid Equipment
Holdings Limited (“China Fluid Equipment”) on April 18, 2008, to serve as the
100% owner of a new PRC subsidiary, Henan Tonghai Fluid Equipment Co., Ltd.
(“Henan Tonghai”). On June 30, 2008, Henan Tonghai acquired the Operating
Subsidiaries from Mr. Fang and the other original owners. The acquisitions were
consummated under the laws of the PRC. The former Hong Kong holding company,
China Valve Hong Kong and its subsidiary Henan Tonghai Valve, which no longer
hold any assets, are now dormant. On July 31, 2008, the Company and Mr. Li
completed the restructuring plan when Mr. Li transferred all of the capital
stock of China Fluid Equipment to the Company pursuant to an Instrument of
Transfer for a nominal consideration of HK$10,000. As a result of these
transactions, the Operating Subsidiaries are again the Company’s indirect
wholly-owned subsidiaries. During the time that the operating subsidiaries were
held by the original owners as part of the restructuring plan, Siping Fang made
an additional capital contribution of $1,317,095 to Zhengdie Valve which,
subsequent to the reacquisition of the subsidiaries, is to be returned to him
(see Note 11).
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
As part
of these restructuring transactions, no significant amounts were paid to or
received from Mr. Fang or Mr. Li. Mr. Li was not at risk during these
transactions and no new capital was introduced. As a result, no new basis in the
net assets of the Operating Subsidiaries was established. During this
restructuring, Mr. Fang continued to serve as Chairman and Chief Executive of
the Company and, together with other management of the Company, continued to
direct both the day-to-day operating and management of the Operating
Subsidiaries, as well as their strategic direction. Because of this operating
and management control and because the restructuring plan effectively resulted
in the Company continuing to bear the residual risks and rewards related to the
Operating Subsidiaries, the Company continued to consolidate the Operating
Subsidiaries during the restructuring. The acquisition by the Company on July
31, 2008 of the new holding company for the Operating Subsidiaries, which
represented the return to legal ownership of the Operating Subsidiaries by the
Company, represented a transaction between related parties under common control
and did not establish a new basis in the assets and liabilities of the Operating
Subsidiaries. The Earn-In Agreement will enable Mr. Fang to regain ownership of
the Company’s shares originally transferred by him to Mr. Li as part of the
restructuring arrangements and, accordingly, the Company does not consider his
re-acquisition of those shares to represent compensation cost to the Company.
However, those shares are also subject to a Make-Good Escrow Agreement in
connection with the Company’s August 26, 2008 private placement and their
release from that escrow may require us to recognize compensation cost – see
Note 12.On November 17, 2008, the Company’s subsidiary, China Fluid Equipment
established a new holding company, Tai Zhou Tai De Valve Co., Ltd. for the
purpose of acquiring new valve manufacturing companies. The newly established
company’s approved registered capital is $3,000,000 (RMB 20,468,819), which has
been received from China Fluid Equipment as of March 31, 2009.
Note
2 – Summary of significant accounting policies
THE
REPORTING ENTITIES
The
accompanying consolidated financial statements include the following
subsidiaries:
Name
of entity
|
Place
of
incorporation
|
Capital
|
Ownership
|
Principle
business
|
|
|
Local
currency
|
USD
|
|
|
Henan
Kai Feng High Pressure Valve Co., Ltd.
|
PRC
|
RMB
60,000,000
|
$7,260,000
|
100%
Indirectly
|
Manufacturing
|
Zhengzhou
City ZhengDie Valve., Ltd.
|
PRC
|
RMB
50,000,000
|
$6,454,174
|
100%
Indirectly
|
Manufacturing
|
Tai
Zhou Tai De Valve Co. , Ltd.
|
PRC
|
RMB
20,468,819
|
$3,000.000
|
100%
Indirectly
|
Holding
Company
|
Henan
Tonghai Fluid Equipment Co., Ltd.
|
PRC
|
RMB
146,793,400
|
$21,500,000
|
100%
Indirectly
|
Holding
Company
|
China
Fluid Equipment Holdings Limited
|
Hong
Kong
|
HKD
10,000
|
$1,282
|
100%
Directly
|
Holding
Company
|
BASIS OF
PRESENTATION
The
consolidated financial statements are prepared in accordance with generally
accepted accounting principles in the United States of America ("US
GAAP"). In the opinion of management, the accompanying balance
sheets, and statements of income, stockholders’ equity and cash flows include
all adjustments, consisting only of normal recurring items, considered necessary
to give a fair presentation of operating results for the periods
presented. All material inter-company transactions and balances have
been eliminated in consolidation.
Management
has included all adjustments, consisting only of normal recurring adjustments,
considered necessary to give a fair presentation of operating results for the
periods presented. Interim results are not necessarily indicative of results for
a full year. The information included in this Form 10-Q should be read in
conjunction with information included in the 2008 annual report filed on Form
10-K
USE OF
ESTIMATES
The
preparation of consolidated financial statements in conformity with US GAAP
requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosures of contingent assets and liabilities
at the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
REVENUE
RECOGNITION
The
Company’s revenue recognition policies are in accordance with Staff Accounting
Bulletin 104. Sales revenue is recognized when all of the following have
occurred: (i) persuasive evidence of an arrangement exists, (ii) delivery has
occurred or services have been rendered, (iii) the price is fixed or
determinable, and (iv) the ability to collect is reasonably assured. These
criteria are generally satisfied at the time of shipment when risk of loss and
title passes to the customer.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
The
Company recognizes revenue when the goods are delivered and title has passed.
Sales revenue represents the invoiced value of goods, net of a value-added tax
(“VAT”). All of the Company’s products that are sold in the PRC are subject to a
Chinese value-added tax at a rate of 17% of the gross sales price or at a rate
approved by the Chinese local government. This VAT may be offset by the VAT paid
by the Company on raw materials and other materials included in the cost of
producing their finished product.
The
Company allows its customers to retain 5% to 10% of the contract prices as
retainage during the warranty period, usually 12 or 18 months, to guarantee
product quality. Historically, the Company has experienced very few actual
warranty claims resulting in the Company having to repair or exchange a
defective product. Due to the infrequency and insignificant amount of warranty
claims, the ability to collect retainage is reasonably assured and is recognized
at the time of shipment.
COST OF
GOODS SOLD
Cost of
goods sold consists primarily of direct material costs, direct labor costs,
direct depreciation and related direct expenses attributable to the production
of the products. Inbound shipping and handling costs and purchasing are included
in direct material costs. Manufacturing overhead includes expenses such as
indirect labor, depreciation as it relates to the cost of production, rent,
utilities, receiving costs, and equipment maintenance and repairs.
SHIPPING
AND HANDLING
Shipping
and handling costs incurred for shipping of finished products to customers are
included in selling expense and totaled $109,094 and $28,444 for the three
months ended March 31, 2009, and 2008, respectively.
SELLING
EXPENSE
Selling
expense includes transportation expense, advertising, salaries, conference fees
and sales commissions.
GENERAL
AND ADMINSTRATIVE EXPENSE
General
and administrative expenses include insurance expense, administrative and
management salaries, bad debt expense, depreciation, rent, travel expense,
welfare expense, office expenses, meal and entertainment expense, conference
expense, and repairs and maintenance expense.
ADVERTISING
Advertising
costs are expensed as incurred and totaled $6,505 and $13,755 for the three
months ended March 31, 2009, and 2008, respectively.
FOREIGN
CURRENCY TRANSLATION AND OTHER COMPREHENSIVE INCOME
The
reporting currency of the Company is the US dollar. The functional currency of
the Company and the local currency of its operating subsidiaries, High Pressure
Valve and Zhengdie Valve, is the Chinese Renminbi (RMB).
For those
entities whose currency is other than the US dollar, all assets and liabilities
are translated into U.S. dollars at the exchange rate on the balance sheet date;
shareholders’ equity is translated at historical rates and items in the
statements of income and of cash flows are translated at the average rate for
the period. Because cash flows are translated based on the average translation
rate, amounts related to assets and liabilities reported in the statement of
cash flows will not necessarily agree with changes in the corresponding balances
in the balance sheet. Translation adjustments resulting from this process are
included in accumulated other comprehensive income in the statement of
shareholders’ equity. Transaction gains and losses that arise from exchange rate
fluctuations on transactions denominated in a currency other than the functional
currency are included in the results of operations as incurred.
The
balance sheet amounts with the exception of equity at March 31, 2009 and
December 31, 2008 were translated at 6.83 RMB and 6.82 RMB to $1.00,
respectively. The average translation rates applied to the statements of income
and of cash flows for the three months ended March 31, 2009 and 2008 were 6.83
RMB and 7.15 RMB to $1.00, respectively.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
PLANT AND
EQUIPMENT
Plant and
equipment are stated at cost less accumulated depreciation. Depreciation is
calculated using the straight-line method over the estimated life of the asset,
ranging from five to thirty years.
Construction
in progress represents direct costs of construction as well as acquisition and
design fees incurred. Capitalization of these costs ceases and the construction
in progress is transferred to plant and equipment when substantially all the
activities necessary to prepare the assets for their intended use are completed.
Interest incurred during construction is capitalized into construction in
progress. All other interest is expensed as incurred. No depreciation is
provided until construction is completed and the asset is ready for its intended
use. Maintenance, repairs and minor renewals are charged directly to expenses as
incurred. Major additions and betterments to property and equipment are
capitalized.
INTANGIBLE
ASSETS
Intangible
assets consist of goodwill, patents, software and land use right. The
Company records goodwill when the purchase price of the net assets acquired
exceeds their fair value. In accordance with SFAS 142, “Goodwill and Other
Intangible Assets,” goodwill has an indefinite life and therefore costs are not
amortized but reviewed for impairment. Patents and software are
subject to amortization. Patents, which have a legal life of 10 years in the
PRC, are being amortized over 5 years as management believes that five years is
the estimated useful life of the patents currently owned by the Company. Land
use rights are carried at cost and charged to expense on a straight-line basis
over the period the rights are granted, 46.4 years. Software is amortized over
10 years, its estimated useful life.
LONG-LIVED
ASSETS
The
Company reviews the carrying amount of its long-lived assets, including
intangibles, for impairment, each reporting period. An asset is considered
impaired when estimated future cash flows are less than the carrying amount of
the asset. In the event the carrying amount of such asset is considered not
recoverable, the asset is adjusted to its fair value. Fair value is generally
determined based on discounted future cash flow. As of March 31, 2009, the
Company determined no impairment charges were necessary.
INVENTORY
The
Company values its inventory at the lower of cost or market, determined on a
weighted average method, or net realizable value. The Company reviews its
inventories periodically to determine if any reserves are necessary for
potential obsolescence or if a write down is necessary because the carrying
value exceeds net realizable value.
RESEARCH
AND DEVELOPMENT COSTS
Research
and development costs are expensed as incurred. The costs of material and
equipment that are acquired or constructed for research and development
activities and which have alternative future uses, either in research and
development, marketing, or sales, are classified as property and equipment and
depreciated over their estimated useful lives.
RETIREMENT
BENEFIT COSTS
Amounts
payable for the PRC state managed retirement benefit programs are expensed in
the financial statements following the accrual basis of accounting.
INCOME
TAXES
The
Company applies SFAS 109, “Accounting for Income Taxes” and FASB Interpretation
48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) for accounting for
income taxes. SFAS 109 requires recognition of deferred income tax
liabilities and assets for the expected future tax consequences of temporary
differences between the income tax basis and financial reporting basis of assets
and liabilities. Provision for income taxes consist of taxes currently due plus
deferred taxes. Because the Company has no operations within the United States,
there is no provision for US income taxes and there are no deferred tax amounts
as of March 31 2009 and December 31, 2008.
The
charge for taxation is based on the results for the year as adjusted for items
that are non-assessable or disallowed. It is calculated using tax rates that
have been enacted or substantively enacted by the balance sheet date. Deferred
taxes are accounted for using the balance sheet liability method in respect of
temporary differences arising from differences between the carrying amount of
assets and liabilities in the financial statements and the corresponding tax
basis used in the computation of assessable tax profit. In principle,
deferred tax liabilities are recognized for all taxable temporary differences,
and deferred tax assets are recognized to the extent that it is probable that
taxable profit will be available against which deductible temporary differences
can be utilized.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
Deferred
taxes are calculated at the tax rates that are expected to apply to the period
when the asset is realized or the liability is settled. Deferred
taxes are charged or credited in the income statement, except when they relate
to items credited or charged directly to equity, in which case the deferred
taxes are also recorded in equity. Deferred tax assets and liabilities are
offset when they relate to income taxes levied by the same taxation authority
and the Company intends to settle its current tax assets and liabilities on a
net basis.
Under FIN
48, “Accounting for Uncertainty in Income Taxes,” a tax position is recognized
as a benefit only if it is “more likely than not” that the tax position would be
sustained in a tax examination, with a tax examination being presumed to occur.
The amount recognized is the largest amount of tax benefit that is greater than
50% likely of being realized on examination. For tax positions not meeting the
“more likely than not” test, no tax benefit is recorded.
CASH AND
CASH EQUIVALENTS
Cash and
cash equivalents comprise cash in banks and on hand, demand deposits with banks
and other financial institutions, and short-term, highly liquid investments
which are readily convertible into known amounts of cash and which are subject
to an insignificant risk of changes in value, having been within three months of
maturity at acquisition.
RESTRICTED
CASH
The Company’s restricted cash consists
of cash in the bank as security for its exported products, notes payable and
cash in held escrow pursuant to the Securities Purchase Agreement entered into
on August 26, 2008. For restricted cash held in bank, the restriction is
released after the customers have received and inspected the
products. The Company has notes payable
outstanding with various banks and is required to keep certain amounts on
deposit that are subject to withdrawal restrictions. Cash held in escrow
pursuant to the Securities Purchase Agreement is released after the Company
satisfies certain covenants as stated in the Securities Purchase Agreement, see
note 12. Restricted cash amounted to $3,907,304 and $3,191,237 as of March 31,
2009 and December 31, 2008, respectively.
CONCENTRATION
RISKS
The
Company's operations are carried out in the PRC. Accordingly, the Company's
business, financial condition and results of operations may be influenced by the
political, economic and legal environment in the PRC, and by the general state
of the PRC's economy. The Company's operations in the PRC are subject to
specific considerations and significant risks not typically associated with
companies in North America and Western Europe. The Company's results may be
adversely affected by changes in governmental policies with respect to laws and
regulations, anti-inflationary measures, restrictions on currency conversion and
remittance abroad, and rates and methods of taxation, among other
things.
Certain
financial instruments may subject the Company to concentration of credit risk.
The Company maintains bank deposits within state-owned banks within the PRC and
Hong Kong. Balances at financial institutions of state owned banks within the
PRC are not covered by insurance. As of March 31, 2009 and December 31, 2008,
the Company’s cash and restricted cash balances, totaling $18,594,233 and
$11,984,233 respectively at those dates, were not covered by insurance. The
Company has not experienced any losses in such accounts and believes it is not
exposed to any significant risks on its cash in bank accounts.
.
Five
major suppliers represented approximately 31% and 33% of the Company’s total
purchases for the three months ended March 31, 2009 and 2008, respectively. Five
major customers represented approximately 21% and 19% of the Company’s total
sales for the three months ended March 31, 2009 and 2008.
FAIE
VALUE OF FINANCIAL INSTRUMENTS
SFAS 107,
“Disclosures about Fair Value of Financial Instruments” defines financial
instruments and required fair value disclosure of those instruments. SFAS 157,
“Fair Value Measurements” adopted January 1, 2008, defines fair value,
establishes a three-level valuation hierarchy for disclosures of fair value
measurement and enhances disclosure requirements for fair value measures.
Receivables, investments, payables, short and long term debt and warrant
liabilities qualified as financial instruments. Management believes the carrying
amounts of receivables, payables and debt are a reasonable estimate of fair
value because of the short period of time between the origination of such
instruments, their expected realization, and if applicable, their stated
interest rate is equivalent to interest rates currently available. The three
levels are defined as follows:
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
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 assets or liability, either directly or indirectly, for substantially
the full term of the financial instruments.
Level
3 inputs to the valuation methodology are unobservable and
significant to the fair value.
The Company analyzes all
financial instruments with features of both liabilities and equity under SFAS
150, “Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity,” SFAS 133, “Accounting for Derivative Instruments and
Hedging Activities,” EITF 00-19, “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” and
EITF 07-5 “Determining Whether an Instrument (or Embedded Feature) Is Indexed to
an Entity’s Own Stock.” Paragraph 11(a) of SFAS 133 “Accounting for Derivatives
and Hedging Activities” specifies that a contract that would otherwise meet the
definition of a derivative but is both (a) indexed to the Company’s own
stock and (b) classified in stockholders’ equity in the statement of
financial position would not be considered a derivative financial instrument.
EITF 07-5 provides a two-step model to be applied in determining whether a
financial instrument or an embedded feature is indexed to an issuer’s own stock
and thus able to qualify for the SFAS 133 paragraph 11(a) scope exception. All
warrants issued by the Company are denominated in U.S. dollars; because the
Company’s functional currency is the Renminbi, the Company accounts for these
warrants as derivative instrument liabilities and marks them to market each
period. Because there is
no quoted or observable market price for the warrants, the Company used level 3
inputs for its valuation methodology.
The
Company invested in China Perfect Machinery Industry Co., Ltd. in 1996 and
Kaifeng Commercial Bank in 1997. There is no quoted or observable
market price for these investments; therefore, the Company used level 3 inputs
for its valuation methodology. Based on its proportionate share of the
underlying book value of the investees, the Company believes the fair value of
the investments is at least equal to the original cost. The determination of the
fair value was based on the capital investment that the Company
contributed. There has been no change in the carrying value since
inception, other than the effects of translating the balances to US
dollars.
A
discussion of the valuation technique used to measure the fair value of the
warrant liabilities is provided in Note 12.
|
Carrying
Value as of
March
31, 2009
(Unaudited)
|
|
Fair
Value Measurements at March 31, 2009
using
Fair Value Hierarchy
(Unaudited)
|
|
|
|
|
|
Level
1
|
Level
2
|
|
Level
3
|
|
Investments
|
|
$
|
763,473
|
|
|
|
|
$
|
763,473
|
|
Warrant
liabilities
|
|
$
|
568,279
|
|
|
|
|
$
|
568,279
|
|
Except
for the warrant liability and investments, the Company did not identify any
other asset and liability that are measured at fair value on a recurring basis
in accordance with SFAS 157.
RECEIVABLES
The
Company’s business operations are conducted in the PRC by selling on various
credit terms. Management reviews its receivables on a quarterly basis to
determine if the allowance for doubtful accounts is adequate. An estimate for
doubtful accounts is recorded when collection of the full amount is no longer
probable. Known bad debts are written off against the allowance for doubtful
accounts when identified. The Company’s existing reserve is consistent with its
historical experience and considered adequate by management.
EARNINGS
PER SHARE
The
Company reports earnings per share in accordance with the provisions of SFAS
128, "Earnings per Share." SFAS 128 requires presentation of basic and diluted
earnings per share in conjunction with the disclosure of the methodology used in
computing such earnings per share. Basic earnings per share excludes dilution
and is computed by dividing income available to common stockholders by the
weighted average common shares outstanding during the period. Diluted earnings
per share takes into account the potential dilution (using the treasury stock
method) that could occur if securities or other contracts to issue common stock
were exercised and converted into common stock.
For the
three months ended March 31, 2009 and 2008, basic and diluted earnings per share
amount to $0.05 and $0.04, respectively.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
As
described in Notes 10, 11 and 12, on August 26, 2008, the Company issued
5,500,000 shares as consideration for the transfer to the Company of certain
land use rights and property. The shares were in escrow, pending PRC
governmental approval of the transfer for the year ended December 31,
2008. In accordance with SFAS 128, outstanding common shares that are
contingently returnable (that is, subject to recall) are treated in the same
manner as contingently issuable shares. Therefore, the 5,500,000 shares were
excluded from diluted earnings per share for the year ended December 31,
2008. On March 6, 2009, the land use rights and property were transferred
to the Company and the shares were released from escrow, thus resolving the
contingency and the 5,500,000 shares have been included in basic and diluted
earnings per share for the period ended March 31, 2009.
As
described in Note 12, the placement agent, Brean Murray, Carret & Co., LLC
converted 704,698 warrant shares to 402,298 shares of common stock on February
18, 2009. A total of $756,012 of carrying value and warrant liability had been
reclassified into equity and have been included in basic and diluted earnings
per share for the period ended March 31, 2009.
At March
31, 2009, 569,799 warrants, whose weighted average exercise price is $2.15, are
excluded from the calculation of diluted earnings per share because of their
anti-dilutive nature.
LONG TERM
INVESTMENT
The
Company invested in China Perfect Machinery Industry Co., Ltd. in 1996 and
Kaifeng Commercial Bank in 1997. The Company owns approximately 0.14% of China
Perfect Machinery Industry Co. Ltd. and approximately 4.01% of Kaifeng
Commercial Bank. The Company does not have the ability to exercise control over
the investee companies and the investments have been recorded under the cost
method. These long term investments amounted to $763,473 and $764,515 as of
March 31, 2009 and December 31, 2008, respectively.
The
Company evaluates potential impairment whenever events or changes in
circumstances indicate that the carrying amount of the investments may not be
recoverable. For investments carried at cost, the Company recognizes impairment
in the event that the carrying value of the investment exceeds our proportionate
share of the net book value of the investee. As of March 31, 2009, management
believes no impairment charge is necessary.
CUSTOMER
DEPOSITS
Customer
deposits represent amounts advanced by customers on product orders. The product
normally is shipped within six months after receipt of the advance payment and
the related sale is recognized in accordance with the Company’s revenue
recognition policy. As of March 31, 2009 and December 31, 2008, customer
deposits amounted to $3,668,903 and $3,129,708, respectively.
STOCK
BASED COMPENSATION
The
Company applies SFAS 123R “Accounting for Stock-Based Compensation”, which
defines a fair-value-based method of accounting for stock based employee
compensation and transactions in which an entity issues its equity instruments
to acquire goods and services from non-employees. Stock compensation for stock
granted to non-employees has been determined in accordance with SFAS 123R
and EITF 96-18, "Accounting for Equity Instruments that are issued to Other than
Employees for Acquiring, or in Conjunction with Selling Goods or Services", as
the fair value of the consideration received or the fair value of equity
instruments issued, whichever is more reliably measured. SAB 107 allows the
“simplified” method to determine the term of employee options when other
information is not available.
RECENTLY
ISSUED ACCOUNTING PRONOUNCEMENTS
In April
2008, the FASB issued FSP FAS 142-3 “Determination of the useful life of
Intangible Assets”, which amends the factors a company should consider when
developing renewal assumptions used to determine the useful life of an
intangible asset under SFAS142. This FSP is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. SFAS 142 requires companies to consider whether
renewal can be completed without substantial cost or material modification of
the existing terms and conditions associated with the asset. FSP FAS 142-3
replaces the previous useful life criteria with a new requirement—that an entity
consider its own historical experience in renewing similar arrangements. If
historical experience does not exist, then the Company would consider market
participant assumptions regarding renewal including 1) highest and best use of
the asset by a market participant, and 2) adjustments for other entity-specific
factors included in SFAS 142. The adoption of FSP FAS 142-3 did not have a
material impact on the Company’s financial statements.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
In May
2008, the FASB issued SFAS 162, “The Hierarchy of Generally Accepted Accounting
Principles.” This Statement 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 did not have any effect on the Company’s
financial statements.
In
October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a
Financial Asset in a Market That Is Not Active” (FSP 157-3), which clarifies the
application of SFAS 157 when the market for a financial asset is inactive.
Specifically, FSP 157-3 clarifies how (1) management’s internal assumptions
should be considered in measuring fair value when observable data are not
present, (2) observable market information from an inactive market should be
taken into account, and (3) the use of broker quotes or pricing services should
be considered in assessing the relevance of observable and unobservable data to
measure fair value. The Company adopted the provisions of FSP 157-3, which did
not impact Company’s financial position or results of operations.
In April
2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and
Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly”. FSP FAS 157-4 amends SFAS 157
and provides additional guidance for estimating fair value in accordance with
SFAS 157 when the volume and level of activity for the asset or liability have
significantly decreased and also includes guidance on identifying circumstances
that indicate a transaction is not orderly for fair value measurements. This FSP
shall be applied prospectively with retrospective application not permitted.
This FSP shall be effective for interim and annual periods ending after
June 15, 2009, with early adoption permitted for periods ending after
March 15, 2009. An entity early adopting this FSP must also early
adopt FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of
Other-Than-Temporary Impairments”. Additionally, if an entity elects to early
adopt either FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value
of Financial Instruments” or FSP FAS 115-2 and FAS 124-2, it must also elect to
early adopt this FSP. We are currently evaluating this new FSP but do not
believe that it will have a significant impact on the determination or reporting
of our financial results.
In April
2009, the FASB issued FSP FAS 115-2 and FAS 124-2. This FSP amends SFAS 115,
“Accounting for Certain Investments in Debt and Equity Securities,” SFAS 124,
“Accounting for Certain Investments Held by Not-for-Profit Organizations,” and
EITF 99-20, “Recognition of Interest Income and Impairment on Purchased
Beneficial Interests and Beneficial Interests That Continue to Be Held by a
Transferor in Securitized Financial Assets,” to make the other-than-temporary
impairments guidance more operational and to improve the presentation of
other-than-temporary impairments in the financial statements. This FSP will
replace the existing requirement that the entity’s management assert it has both
the intent and ability to hold an impaired debt security until recovery with a
requirement that management assert it does not have the intent to sell the
security, and it is more likely than not it will not have to sell the security
before recovery of its cost basis. This FSP provides increased disclosure about
the credit and noncredit components of impaired debt securities that are not
expected to be sold and also requires increased and more frequent disclosures
regarding expected cash flows, credit losses, and an aging of securities with
unrealized losses. Although this FSP does not result in a change in the carrying
amount of debt securities, it does require that the portion of an
other-than-temporary impairment not related to a credit loss for a
held-to-maturity security be recognized in a new category of other comprehensive
income and be amortized over the remaining life of the debt security as an
increase in the carrying value of the security. This FSP shall be effective for
interim and annual periods ending after June 15, 2009, with early adoption
permitted for periods ending after March 15, 2009. An entity may early
adopt this FSP only if it also elects to early adopt FSP FAS 157-4. Also, if an
entity elects to early adopt either FSP FAS 157-4 or FSP FAS 107-1 and APB 28-1,
the entity also is required to early adopt this FSP. We are currently evaluating
this new FSP but do not believe that it will have a significant impact on the
determination or reporting of our financial results.
In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1. This FSP amends SFAS
No. 107, “Disclosures about Fair Value of Financial Instruments,” to
require disclosures about fair value of financial instruments not measured on
the balance sheet at fair value in interim financial statements as well as in
annual financial statements. Prior to this FSP, fair values for these assets and
liabilities were only disclosed annually. This FSP applies to all financial
instruments within the scope of SFAS 107 and requires all entities to disclose
the method(s) and significant assumptions used to estimate the fair value of
financial instruments. This FSP shall be effective for interim periods ending
after June 15, 2009, with early adoption permitted for periods ending after
March 15, 2009. An entity may early adopt this FSP only if it also elects
to early adopt FSP FAS 157-4 and FSP FAS 115-2 and FAS 124-2. This FSP does not
require disclosures for earlier periods presented for comparative purposes at
initial adoption. In periods after initial adoption, this FSP requires
comparative disclosures only for periods ending after initial adoption. We are
currently evaluating the disclosure requirements of this new FSP.
RECLASSIFICATIONS
Certain
prior period amounts have been reclassified to conform to the current period
presentation. These classifications have no effect on net income. The Company
has also reclassified repayment of other payable – related party, totaled
$650,465, from cash flows from operating activities to cash flows from financing
activities in the Statement of Cash Flows.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
Note
3 - Plant and equipment
Plant and
equipment consist of the following:
|
|
March
31, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Buildings
and improvements
|
|
$
|
6,832,920
|
|
|
$
|
3,291,978
|
|
Machinery
|
|
|
13,797,601
|
|
|
|
13,569,698
|
|
Motor
vehicles
|
|
|
1,687,902
|
|
|
|
1,638,036
|
|
Office
equipment
|
|
|
543,550
|
|
|
|
465,922
|
|
Construction
in progress
|
|
|
6,940,682
|
|
|
|
5,600,335
|
|
|
|
|
29,802,655
|
|
|
|
24,565,969
|
|
Less:
Accumulated depreciation
|
|
|
(8,576,850)
|
|
|
|
(8,381,075
|
)
|
|
|
$
|
21,225,805
|
|
|
$
|
16,184,894
|
|
Depreciation
expense was $308,066 and $194,392 for the three months ended March 31, 2009 and
2008, respectively.
Note
4 – Goodwill and intangible assets
In 2004,
the Company acquired two companies engaged in the production of
valves. As a result of these acquisitions the Company recorded
goodwill representing the fair value of the assets acquired in these
acquisitions over the cost of the assets acquired. The change in the carrying
value of goodwill is due solely to currency translation.
Intangible
assets consist of the following:
|
|
March
31, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Patents
|
|
$
|
190,828
|
|
|
$
|
191,088
|
|
Software
|
|
|
722,052
|
|
|
|
723,038
|
|
Land
use rights*
|
|
|
7,553,476
|
|
|
|
-
|
|
|
|
|
8,466,356
|
|
|
|
914,126
|
|
Less:
Accumulated amortization
|
|
|
(113,903
|
)
|
|
|
(90,795
|
)
|
|
|
$
|
8,352,453
|
|
|
$
|
823,331
|
|
* Land
use rights were transferred from the Casting Company under escrow agreement by
issuing 5,500,000 shares of common stock. See Note 11 and 12 for
details.
Amortization
expense was $23,234 and $15,065 for the three months ended March 31, 2009 and
2008, respectively.
Note
5 - Inventories
|
|
March
31, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Raw
materials
|
|
$
|
2,022,194
|
|
|
$
|
2,451,477
|
|
Work-in-progress
|
|
|
2,044,574
|
|
|
|
1,853,317
|
|
Finished
goods
|
|
|
6,501,717
|
|
|
|
6,939,648
|
|
|
|
$
|
10,568,485
|
|
|
$
|
11,244,442
|
|
There was
no inventory write-down for the three months ended March 31, 2009. As of
December 31, 2008, the Company determined the carrying amount of raw materials
exceeded net realized value; therefore, $159,078 was written off, and the amount
has been included in cost of goods sold for 2008.
Note
6 – Accounts receivable
Accounts
receivable consists of the following:
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
|
|
March
31, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Total
accounts receivable
|
|
|
32,483,407
|
|
|
|
29,824,322
|
|
Allowance
for bad debts
|
|
|
(1,722,542
|
)
|
|
|
(1,163,457
|
)
|
Accounts
receivable, net
|
|
|
30,760,865
|
|
|
|
28,660,865
|
|
Accounts
receivable – non-current retainage
|
|
|
(2,250,693
|
)
|
|
|
(2,541,418
|
)
|
Accounts
receivable – current
|
|
$
|
28,510,172
|
|
|
$
|
26,119,447
|
|
Retainage
represents portions held for payment by customers pending quality inspection
ranging from 12-18 months after shipment of products. At March 31,
2009 and December 31, 2008, retainage held by customers included in the
Company’s accounts receivable is as follows:
|
|
March
31, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Retainage
|
|
|
|
|
|
|
Current
|
|
$
|
1,559,948
|
|
|
$
|
1,194,025
|
|
Non-current
|
|
|
2,250,693
|
|
|
|
2,541,418
|
|
Total
retainage
|
|
$
|
3,810,641
|
|
|
$
|
3,735,443
|
|
The
following represents the changes in the allowance for doubtful
accounts:
|
|
March
31, 2009
|
|
|
December
31,2008
|
|
|
|
(unaudited)
|
|
|
|
|
Balance,
beginning of the period
|
|
$
|
1,163,457
|
|
|
$
|
274,167
|
|
Additions
to the reserve
|
|
|
560,709
|
|
|
|
819,711
|
|
Write-off
charged against the allowance
|
|
|
-
|
|
|
|
-
|
|
Recovery
of amounts previously reserved
|
|
|
-
|
|
|
|
-
|
|
Foreign
currency translation adjustment
|
|
|
(1,624
|
)
|
|
|
69,579
|
|
Balance,
end of the period
|
|
$
|
1,722,542
|
|
|
$
|
1,163,457
|
|
Note 7 –
Loans
SHORT
TERM LOANS:
|
|
March
31, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Short
term loans from Commercial Bank of Zhengzhou City
|
|
|
|
|
|
|
Due
May 2009, annual interest at 11.21%
|
|
|
|
|
|
|
guaranteed
by Zhengzhou Huazhong
|
|
|
|
|
|
|
Capital
Construction Co., Ltd
|
|
$
|
1,860,550
|
|
|
$
|
1,863,090
|
|
|
|
|
|
|
|
|
|
|
Zhengzhou
Shangjie Credit Union
|
|
|
|
|
|
|
|
|
Due
July 2009, annual interest at 10.13%
|
|
|
|
|
|
|
|
|
guaranteed
by Zhengzhou Huazhong
|
|
|
|
|
|
|
|
|
Capital
Construction Co., Ltd.
|
|
|
1,172,000
|
|
|
|
1,173,600
|
|
|
|
|
|
|
|
|
|
|
Citic
bank, Zhengzhou branch
|
|
|
|
|
|
|
|
|
Due
June 2009. annual interest at 8.22%,
|
|
|
|
|
|
|
|
|
guaranteed
by Kaifeng Cast Iron Co., Ltd.
|
|
|
2,930,000
|
|
|
|
2,934,000
|
|
|
|
|
|
|
|
|
|
|
Unrelated
third parties, non-secured, ranging from non-interest
|
|
|
|
|
|
|
|
|
Bearing
to annual interest at 10.00%, due on demand
|
|
|
1,228,390
|
|
|
|
1,058,061
|
|
|
|
|
|
|
|
|
|
|
Local
Bureau of Finance, Kaifeng City.
|
|
|
|
|
|
|
|
|
No
expiration date and non-interest bearing
|
|
|
546,445
|
|
|
|
547,191
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
No
expiration date, annual interest at 2.55% per annum
|
|
|
263,700
|
|
|
|
264,018
|
|
Total
short term loans
|
|
$
|
8,001,085
|
|
|
$
|
7,839,960
|
|
|
|
|
|
|
|
|
|
|
Total
interest incurred for the years ended March 31, 2009 and 2008 amounted to
$93,849 and $133,828 respectively.
Capitalized
interest amounted to $65,118 and $33,457 for the three months ended March 31,
2009 and 2008, respectively
As of
March 31, 2009, there are no restrictive covenants related to the loans stated
above.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
Note
8 - Income taxes
The
Company conducts all its operating business through its two subsidiaries in
China. The two subsidiaries are governed by the income tax laws of the PRC and
do not have any deferred tax assets or deferred tax liabilities under the income
tax laws of the PRC because there are no temporary differences between financial
statement carrying amounts and the tax bases of existing assets and liabilities.
The Company by itself does not have any business operating activities in the
United States and is therefore not subject to United States income
tax.
The
Company’s subsidiaries are governed by the Income Tax Law of the People’s
Republic of China (PRC) concerning Foreign Investment Enterprises and Foreign
Enterprises and various local income tax laws (the Income Tax Laws).
Beginning January 1, 2008, the new Enterprise Income Tax (“EIT”) law has
replaced the previous laws for Domestic Enterprises (“DEs”) and Foreign Invested
Enterprises (“FIEs”). The new standard EIT rate of 25% has replaced the 33% rate
previously applicable to both DEs and FIEs.
Prior to
2008, under the Chinese Income Tax Laws, FIEs generally were subject to an
income tax at an effective rate of 33% (30% state income taxes plus 3% local
income taxes) on income as reported in their statutory financial statements
after appropriate tax adjustments unless the enterprise was located in specially
designated regions for which more favorable effective tax rates
apply. Beginning January 1, 2008, China has unified the corporate
income tax rate on foreign invested enterprises and domestic enterprises. The
unified corporate income tax rate is 25%.
The
Company’s operating subsidiaries, High Pressure Valve and Zhengdie Valve, are
both subject to an income tax at an effective rate of 25%.
The
following table reconciles the U.S. statutory rate to the Company’s effective
tax rate:
|
|
For
the three month ended March 31
|
|
|
|
2009
|
|
|
2008
|
|
U.S.
Statutory rate
|
|
|
34
|
%
|
|
|
34
|
%
|
Foreign
income not recognized in USA
|
|
|
(34
|
)
|
|
|
(34
|
)
|
Non-deductible
expenses (1)
|
|
|
5
|
|
|
|
-
|
|
China
income taxes
|
|
|
25
|
|
|
|
25
|
|
China
income tax exemption
|
|
|
-
|
|
|
|
-
|
|
Total
provision for income taxes
|
|
|
30
|
%
|
|
|
25
|
%
|
|
|
|
|
|
|
|
|
|
(1) The
5% represents the $481,545 general expenses incurred by China Valve Fluid, Hong
Kong and $400,000 loss due to change in fair value of warrant liabilities, which
are not deductible in PRC for the three months ended March 31,
2009.
VAT on
sales and VAT on purchases in China amounted to $1,652,469 and $933,738,
respectively, for the year ended March 31, 2009 and $1,963,538 and $701,834,
respectively, for the year ended March 31, 2008. Sales and purchases are
recorded net of VAT collected and paid as the Company acts as an agent for the
government.
Taxes
payable consisted of the following:
|
March
31, 2009
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
VAT
|
$
|
718,731
|
|
$
|
167,500
|
|
Income
tax
|
|
930,168
|
|
|
924,291
|
|
Other
taxes
|
|
82,110
|
|
|
135,547
|
|
Total
taxes payable
|
$
|
1,731,009
|
|
$
|
1,227,338
|
|
Note
9 – Statutory reserves
The laws
and regulations of the People’s Republic of China require that before a foreign
invested enterprise can legally distribute profits, it must first satisfy all
tax liabilities, provide for losses in previous years, and make allocations, in
proportions determined at the discretion of the board of directors, to the
statutory reserve. The statutory reserves include the surplus reserve fund and
the common welfare fund.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
The
Company is required to transfer 10% of its net income, as determined in
accordance with PRC accounting rules and regulations, to a statutory surplus
reserve fund until such reserve balance reaches 50% of the Company’s registered
capital. The transfer to this reserve must be made before distribution of any
dividends to shareholders. The remaining reserve to fulfill the 50% registered
capital requirement amounted approximately $16.7 million and $15.9 million as of
March 31, 2009 and December 31, 2008, respectively.
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 50% of the registered
capital.
Note
10 - Commitments and contingencies
The
Company’s subsidiary, ZhengDie Valve entered into a lease agreement for a
manufacturing plant and office space with ZhengZhou Cheng Long Corporation, an
unrelated party, from January 1, 2008 to December 31, 2008. The lease agreement
was subsequently extended to December 31, 2012.
The
Company’s subsidiary, High Pressure Valve, previously leased factory facilities
from Kaifeng High Pressure Valve Steel Casting Limited Liabilities Company (the
“Casting Company”) under a month-to-month arrangement. On March 6,
2009, the transfer of the real estate title from the Casting Company to High
pressure Valve was completed and the Company has released the shares
in escrow to Mr., Bin Fang, the Casting Company’s owner. As a result, High
Pressure Valve no longer has rental expenses in 2009. See Note 11 for detailed
discussion of the real estate transfer.
For the
three months ended March 31, 2009 and 2008, total lease expense, including
amounts included in cost of sales, was $85,708 and $128,853,
respectively.
The
future minimum lease payments at March 31, 2009, are as follows:
|
|
Amount
|
|
Year
ending December 31, 2009
|
|
$
|
257,102
|
|
Year
ending December 31, 2010
|
|
|
342,810
|
|
Year
ending December 31, 2011
|
|
|
342,810
|
|
Year
ending December 31, 2012
|
|
|
342,810
|
|
Thereafter
|
|
|
-
|
|
|
|
|
|
|
The
Company has a capital commitment of approximately $2.4 million for
the construction of the new facility and acquisition of machinery in
connection with the new plant.
Note
11 – Related party transactions
The
Company had the following significant related party transactions during the
three months ended March 31, 2009 and 2008:
The
Company received advances from Mr. Siping, Fang, our Chief Executive Officer,
for cash flow purposes. As of March 31, 2009 and December 31, 2008, the
outstanding amount due to Mr. Fang was $188,103 and $658,367, respectively. The
advances are unsecured, interest-free and have no fixed terms of repayment, but
are expected to be repaid in cash upon demand. In 2008, during the
reorganization of the ownership of the Operating Subsidiaries (see Note 1 –
Restructuring Plan), Siping Fang contributed $1,317,095 to Zhengdie Valve to
enable them to meet their approved PRC registered capital requirements.
Following our re-acquisition of the legal ownership of the Operating
Subsidiaries and the subsequent consummation of the Securities Purchase
Agreement related to the private placement of our common stock, this
contribution is to be returned to Mr. Fang. The $1,317,095 due to Mr. Fang,
together with the $188,103 and $658,367 due to Mr. Fang for working capital
advances as described above, totaled $1,505,198 and $1,975,462 as of March 31,
2009 and December 31, 2008, respectively.
The
Company borrowed money from certain employees for cash flow purposes. The loans
bear interest at 10% per annum due on demand. Loans from employees amounted to
$198,177 and $131,263 as of March 31, 2009 and December 31, 2008, respectively.
The Company borrowed money from various family members of Mr. Siping Fang for
working capital purposes. The loans are unsecured, interest free and have no
fixed terms of repayment, but are expected to be repaid in cash upon request.
These loans amounted to $666,229 and $465,528 as of March 31, 2009, and December
31, 2008, respectively.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
As
discussed in Note 10, on August 26, 2008, the Company’s wholly owned subsidiary
High Pressure Valve and Kaifeng High-Pressure Valve Steel Casting Limited
Liabilities Company (the “Casting Company”) entered into an Agreement for
Transfer of Land Use Right and Housing for the transfer of certain real estate
to High Pressure Valve. Mr. Bin Fang is not related to either Mr. Siping Fang,
our Chief Executive Officer and Chairman or Mr. Binjie Fang, our Chief Operating
Officer and a director. Under the Real Estate Transfer Agreement, the Company
purchased from the Casting Company the land use rights and factory facilities
that it currently leases. The Company placed 5,500,000 shares of
common stock in escrow, to be released to Mr. Bin Fang when the Real Estate
Transfer is completed, in consideration for his agreement to have the Casting
Company transfer the land use rights and facilities to the
Company. Because the transfer of the land use rights and facilities
requires governmental approval in the PRC, which it was expected could take up
to ten months to obtain, the Company entered into a new lease agreement with the
Casting Company, effective August 26, 2008 until High-Pressure Valve acquires
title to the Real Estate from the Casting Company in accordance with the Real
Estate Transfer agreement. The Real Estate Transfer Agreement was negotiated
contemporaneously with the Securities Purchase Agreement described above and was
a condition precedent to the consummation of the transactions contemplated by
the Securities Purchase Agreement. Accordingly, the 5,500,000 shares of common
stock issued under the Real Estate Transfer Agreement were valued at $9,834,000
or $1.788 per share, the same price paid on August 26, 2008 by the accredited
investors under the Securities Purchase Agreement described
above. The market price of the Company’s common stock on August 26,
2008 was $5.00 per share. However, the Company’s common stock is
currently thinly traded and the Company believes that the cash price paid on
that date by the accredited investors for their shares is a better indicator of
the fair value of the shares issued under the Real Estate Transfer
Agreement.
The
transfer of the title to the Real Estate was completed on March 6, 2009, and
with effect from that date, it is accounted for as fixed assets and intangible
assets and depreciated over its estimated useful lives. As a result of the
transfer of the Real Estate on March 6, 2009, the Company has also released the
5,500,000 shares of the Company’s common stock from escrow to Mr. Bin Fang. The
release of escrow shares to Bin Fang had no impact on the consolidated financial
statements. In addition, High Pressure Valve and the Casting Company entered
into a Leaseback Agreement (the “Leaseback Agreement”) pursuant to which High
Pressure Valve agreed to lease back the portion of the Real Estate used by the
Casting Company at an annual rental of $80,000 for a period of one
year starting on the date of the acquisition of title to the Real Estate by
High Pressure Valve. The Company has not leased-back the real estate
to the Casting Company as of March 31, 2009.
As a
result of the Company’s issuance of common shares to the Casting Company’s
shareholder, Mr. Bin Fang, the Casting Company became a related party. On August
26, 2008, High Pressure Valve and the Casting Company, which is our largest
supplier, entered into a Manufacturing and Supply Agreement pursuant to which
the Casting Company agreed to provide High Pressure Valve with molds, casts,
dies and other supplies and equipment for use in the manufacture of High
Pressure Valve’s products. The Casting Company also agreed to use its production
capacity to fulfill High Pressure Valve’s orders before it may take any orders
from third parties. The term of the agreement is five years. The
agreement does not require High Pressure Valve to purchase any minimum volume or
value of products. Prices will be determined at the time orders are
submitted to the Casting Company, based on prevailing market prices. As of March
31, 2009 and December 31, 2008, advances on inventory purchases to the Casting
Company amounted to $1,201,607 and $1,367,446, respectively.
Note
12 – Shareholders' equity
PRIVATE
PLACEMENT FINANCING
On August
26, 2008, the Company entered into a securities purchase agreement (the
“Securities Purchase Agreement”) with certain accredited
investors. Under the Securities Purchase Agreement, the Company
agreed to issue and sell to the Investors 16,778,523 shares of the Company’s
common stock, representing approximately 29.5% of the issued and outstanding
capital stock of the Company on a fully-diluted basis as of and immediately
after consummation of the transactions contemplated by the Securities Purchase
Agreement, for an aggregate purchase price of approximately $30 million, or
$1.788 per share.
As a
condition precedent to the private placement transaction contemplated by the
Securities Purchase Agreement, the Company and the Investors also entered into a
registration rights agreement (the “Registration Rights Agreement”), pursuant to
which the Company was obligated to file a registration statement under the
Securities Act of 1933 on Form S-1 covering the resale of the Shares and any
other shares of common stock issued to the Investors under the Securities
Purchase Agreement within 90 days of the closing. The Company also agreed to
make the registration statement effective no later than the 135th day following
the closing date or the fifth trading day following the date on which the
Company is notified by the Securities and Exchange Commission that such
registration statement will not be reviewed or is no longer subject to further
review and comments, whichever date is earlier. The Company later obtained an
extension from the investors providing that the registration agreement should be
effective no later than March 31, 2009, The registration statement was declared
effective on April 7th, 2009.
Subsequently, the investors have waived liquidated damages for the 7 day late
period.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
In
conjunction with the private placement, the Company entered into separate
lock-up agreements (the “Lock-up Agreements”) with each director and officer of
the Company, which precluded such individuals from selling or otherwise
disposing of any shares held by them for a period commencing from and after the
date of the Lock-up Agreement and through and including the one year anniversary
of the effective date of a registration statement resulting in all Shares being
registered for resale by the Investors.
In
conjunction with the private placement, the Company entered into a holdback
escrow agreement (the “Holdback Escrow Agreement”) with the Investors and
Escrow, LLC, as escrow agent pursuant to which the Company agreed that an
aggregate of $3,150,000 of the Purchase Price (the “Holdback Amount”) would be
deposited on the Closing Date with the Escrow Agent and be distributed upon the
satisfaction of certain covenants set forth in the Securities Purchase
Agreement. As of March 31, 2009 and December 31, 2008, $105,616 and $128,130 are
left in the escrow account related to investor relations expenses to be incurred
by the Company.
In
connection with the Securities Purchase Agreement, on August 26, 2008, the
Company also entered into a make good escrow agreement (the “Make Good Escrow
Agreement”) with Bin Li (the “Pledgor”), the Investors, Brean Murray, Carret
& Co., LLC and the Escrow Agent, pursuant to which the Pledgor agreed to
certain “make good” provisions in the event that the Company does not meet
certain income thresholds for fiscal years 2008, 2009 and/or
2010. Pursuant to the Make Good Escrow Agreement, the Pledgor placed
in escrow 25,166,064 shares of the Company’s common stock held by him, to be
held for the benefit of the Investors. Of these shares, 24,300,000 are the
subject of the Earn-In Agreement between Bin Li and Siping Fang, described in
Note 1, and Bin Li entered into the Make Good Escrow Agreement on behalf of
Siping Fang. For each of the calendar years 2008, 2009 and 2010, 8,388,688
shares will be released to the Investors or returned to the shareholder,
depending on the fulfillment of specified earnings targets, The specified
earnings target for calendar 2008 was net income of $10,500,000, for calendar
2009 the target is net income of $23,000,000 and fully diluted earnings per
share of $0.369 and for calendar 2010 the target is net income of $31,000,000
and fully diluted earnings per share of $0.497. In the event that
shares are required to be released from escrow to the Investors, such shares
will be recorded as a contribution to capital and a simultaneous issuance of
common shares to the Investors. The return to Bin Li of any of the shares placed
in escrow by him on behalf of Siping Fang is considered to be a separate
compensatory arrangement because Siping Fang is an officer and director of the
Company. Accordingly, if any of the required earnings targets are met and shares
are returned to Bin Li, the Company will recognize compensation cost at that
time equal to the then fair value of the shares returned, up to a total of
24,300,000 shares. For the year ended December 31, 2008, the Company’s net
income (prior to any compensation charge related to release of the shares from
escrow was $10,762,129 which met the earnings target for 2008 of net income
of $10,500,000. Accordingly, the Company recorded non-cash compensation of
$14,998,974 in the fourth quarter of 2008 related to the release from escrow to
Bin Li of 8,388,688 shares. The Company’s common stock is currently thinly
traded and therefore the Company does not believe that the prices at which such
trades of the Company’s common stock as have occurred are necessarily reflective
of the fair value of the shares released from escrow as of December 31, 2008.
Accordingly, the Company has used the cash price of $1.788 paid by the Investors
in the private placement to measure the compensation charge to be recorded as of
December 31, 2008 as a result of the release of 8,388,688 shares to Bin Li. If
the earnings targets for 2009 and 2010 are met and the Company is thus required
to record additional non-cash compensation charges for the release of shares
from escrow to Bin Li, the Company will make a determination of the appropriate
fair value of those shares at that time. No compensation charges will be
recorded if the earnings targets are not met and the shares are released from
escrow to the Investors. Compensation charges are measured annually, therefore,
no compensation charges relating to the Make Good Escrow Agreement is recorded
as of March 31, 2009.
WARRANTS
At the closing of the private
placement, as part of the compensation to the placement agent, the Company
issued warrants to the placement agent to acquire 1,174,497 shares of common
stock. The warrants have a strike price equal to $2.1456 and a term of 3 years.
The shares underlying the warrants will have registration rights. The warrants
contain a standard anti-dilution provision for stock dividends, stock
splits, stock combination, recapitalization and a change of control
transaction. Because the warrants are denominated in U.S. dollars and the
Company’s functional currency is the Renminbi, they do not meet the requirements
of EITF 07-5 to be indexed only to the Company’s stock. Accordingly,
they are accounted for at fair value as derivative liabilities and marked to
market each period
The
initial value of the warrants was determined using the Cox-Ross-Rubinstein
binomial model using the following assumptions: volatility of 75%;
risk free interest rate of 2.64%; dividend yield of 0% and expected term of 3
years. The volatility of the Company’s common stock was estimated by management,
the risk free interest rate was based on Treasury Constant Maturity Rates
published by the U.S. Federal Reserve for periods applicable to the life of the
warrants, the dividend yield was based on the Company’s current and expected
dividend policy and the expected term is equal to the contractual life of the
warrants. The value of the warrants was based on the Company’s common
stock price of $1.788 on the date the warrants were issued. The warrants were
valued at $959,196 when they were issued on August 26, 2008.
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
On
February 18, 2009, the placement agent, Brean Murray, Carret & Co., LLC
performed a cashless exercise of 704,698 warrant shares; which were converted to
402,298 shares of common stock. The Company valued the conversion on exercise
date, and recorded $10,604 gain from changes in fair value of derivative. A
total of $756,012 of carrying value and derivative liability had been
reclassified into equity. As of March 31, 2009, the estimated fair value of the
remaining warrants was $492,178, resulting in a loss of $141,285, which was
recorded in the Company’s income statement.
The
Company issued warrants to purchase 100,000 shares at $3.00 per share, to CCG
investors Relation Partners LLC on December 12, 2007 for one year of services to
be provided. The initial value of the warrants was determined using the
Cox-Ross-Rubinstein binomial model using the following assumptions: volatility
75%; risk free interest rate 3.12%; dividend yield of 0% and expected term of 3
years. The warrants were initially valued at $65,574, all of which was expensed
in 2008. At March 31, 2009, these warrants were valued at $76,110 and we
recorded a loss for the three months ended March 31, 2009 related to these
warrants of $29,042.
Warrants
issued and outstanding, all of which are exercisable at March 31,
2009
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
Warrants
|
|
|
Average
Exercise
|
|
|
Remaining
Contractual
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
Life
|
|
Balance,
January 1, 2008
|
|
|
100,000
|
|
|
|
3.00
|
|
|
|
2.95
|
|
Granted
|
|
|
1,174,497
|
|
|
|
2.15
|
|
|
|
3.00
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance,
December 31, 2008
|
|
|
1,274,497
|
|
|
$
|
2.21
|
|
|
|
2.60
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(704,698)
|
|
|
|
2.15
|
|
|
|
|
|
Balance,
March 31, 2009 (Unaudited)
|
|
|
569,799
|
|
|
|
2.30
|
|
|
|
2.29
|
|
STOCK
OPTIONS
On
November 4, 2008, the Company issued stock options to purchase 100,000 shares of
the Company’s common stock at the price of $3.50 per share upon the appointment
of Veronica Jing Chen as the Company’s CFO. Under the option agreement, the
options vested beginning one year after her employment date. However, effective
February 1, 2009, Ms. Chen resigned as the CFO of the Company and all of her
options are considered forfeited by the Company as of December 31,
2008.
REAL
ESTATE TRANSFER
As
discussed in Notes 10 and 11, on March 6, 2009, the transfer of the Real Estate
was completed and the Company has released the 5,500,000 shares of common stock,
issued under the Real Estate Transfer Agreement, from escrow to Mr. Bin Fang the
Casting Company’s owner. Accordingly, the fair value of the 5,500,000 shares,
amounted to $9,834,000 as of March 31, 2009, was reclassified from subscription
receivable to additional paid in capital.
Note
13 - Geographic and product lines:
The
Company sells valves, which are used by customers in various
industries. The production process, class of customer, selling practice and
distribution process are the same for all valves. The Company’s chief
operating decision-makers (i.e. chief executive officer and his direct reports)
review financial information presented on a consolidated basis, accompanied by
disaggregated information about revenues by product lines for purposes of
allocating resources and evaluating financial performance. There are no segment
managers who are held accountable for operations, operating results and plans
for levels or components below the consolidated unit level. Based on
qualitative and quantitative criteria established by SFAS 131, “Disclosures
about Segments of an Enterprise and Related Information”, the Company considers
itself to be operating within one reportable segment.
The
Company does not have long-lived assets located in foreign countries. In
accordance with the enterprise-wide disclosure requirements of SFAS 131, the
Company's net revenue from external customers by main product lines (based upon
primary markets defined by the Chinese Valve Industry Association) and by
geographic areas is as follows:
CHINA
VALVES TECHNOLOGY, INC AND SUBSIDIARIES
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
March
31, 2009
(Unaudited)
|
Three
months ended March 31,
|
|
|
2009
(Unaudited)
|
|
2008
(Unaudited)
|
|
|
(in
thousands)
|
|
|
|
|
|
|
Power
supply
|
|
$ |
4,921 |
|
|
$ |
2,847 |
|
Petrochemical
and oil
|
|
|
2,151 |
|
|
|
1,923 |
|
Water
supply
|
|
|
5,128 |
|
|
|
2,959 |
|
Metallurgy
|
|
|
1,185 |
|
|
|
898 |
|
Other
areas
|
|
|
3,858 |
|
|
|
4,356 |
|
Total
sales revenue
|
|
$ |
17,243 |
|
|
$ |
12,983 |
|
|
|
|
|
|
|
|
|
|
Net
revenues from external customers by geographic areas:
|
Three
months ended March 31,
|
|
|
2009
(Unaudited)
|
|
2008
(Unaudited)
|
|
|
(in
thousands)
|
|
|
|
|
|
|
China
|
|
$ |
15,454 |
|
|
$ |
12,501 |
|
International
|
|
|
1,789 |
|
|
|
482 |
|
Total
sales revenue
|
|
$ |
17,243 |
|
|
$ |
12,983 |
|
Note
14 – Subsequent event
On April
17, 2009, Taizhou Taide Valve Co., Ltd., a wholly-owned subsidiary of China
Valves Technology, Inc., acquired 100% tangible assets of Taizhou Wote Valve
Co., Ltd., for a total cash consideration of $3 million pursuant to an Asset
Purchase Agreement, dated February 15, 2009.