The accompanying notes are an integral part of these statements.
China
Valves Technology, Inc., (the “Company”), is incorporated in Nevada in August
1997. Through its direct and indirect subsidiaries, 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 Company’s Chief
Executive Officer and President, sold 12,150,000 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) 6,075,000 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) 2,025,000
shares upon the declaration of effectiveness of a registration statement filed
by the Company under the Securities Act of 1933, as amended; (3) 2,025,000
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) 2,025,000 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).
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 June 30, 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. The Company has performed an evaluation of subsequent events
through August 14, 2008, which is the date the financial statements were
issued.
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.
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 $103,545 and $50,411 for the three
months ended June 30, 2009, and 2008, respectively. Shipping and
handling costs amounted to $212,639 and $78,855 for the six months ended June
30, 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 $1,379 and $1,780 for the three
months ended June 30, 2009, and 2008, respectively and $7,884 and $15,535 for
the six months ended June 30, 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 June 30, 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 June 30, 2009 and 2008 were 6.83 RMB and 6.97 RMB to
$1.00, respectively, and for the six months ended June 30, 2009 and 2008 were
6.82 RMB and 7.05 RMB to $1.00, respectively.
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 June 30, 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 June 30, 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.
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 $2,562,307 and $3,191,237 as of June 30,
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 June 30, 2009 and December 31, 2008, the
Company’s cash and restricted cash balances, totaling $20,727,084 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 22% and 44% of the Company’s total
purchases for the three months ended June 30, 2009 and 2008, respectively. For
the six months ended June 30, 2009 and 2008, five major suppliers represented
approximately 20% and 37%, respectively of the Company’s total purchases. Five
major customers represented approximately 15% and 23% of the Company’s total
sales for the three months ended June 30, 2009 and 2008. For the six months
ended June 30, 2009 and 2008, five major customers represented approximately 14%
and 21%, respectively of the Company’s total sales.
FAIR
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:
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
June
30, 2009
|
|
Fair
Value Measurements at June 30, 2009
using
Fair Value Hierarchy
|
|
|
|
|
|
Level
1
|
Level
2
|
|
Level
3
|
|
Investments
|
|
$
|
763,472
|
|
|
|
|
$
|
763,472
|
|
Warrant
liabilities
|
|
$
|
568,913
|
|
|
|
|
$
|
568,913
|
|
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.
As
described in Notes 11 and 12, on August 26, 2008, the Company issued 2,750,000
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 2,750,000 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 2,750,000 shares have been included in basic and diluted
earnings per share for the period ended June 30, 2009.
As
described in Note 12, the placement agent, Brean Murray, Carret & Co., LLC
converted 352,349 warrant shares to 201,149 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 periods ended June 30, 2009.
All share and per share amounts used in
the Company's consolidated financial statements and notes thereto have been
retroactively restated to reflect the 1-for-2 reverse stock split, which are
effective on July 30, 2009. Although this reverse stock split has
already occurred under Nevada corporate law, the Company advises that as of
August 13, 2009, the Company’s common stock on the OTC Bulletin Board (“OTCBB”)
does not yet reflect this stock split. The Company’s common stock
trades under the OTCBB ticker symbol, “CVVT” on a pre 1-for-2 reverse stock
split basis.
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 $763,472 and $764,515 as of June
30, 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 June 30, 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 June 30, 2009 and December 31, 2008, customer deposits
amounted to $3,723,925 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.
BUSINESS
COMBINATIONS
Effective
January 1, 2009, the Company adopted FAS 141R, “Business Combinations” to
replace FAS 141, “Business Combinations”. FAS 141R retains the fundamental
requirements in FAS 141 that the acquisition method of accounting (which FAS 141
called the purchase method) be used for all business combinations and for an
acquirer to be identified for each business combination. FAS 141R requires an
acquirer to recognize the assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree at the acquisition date, measured at
their fair values as of that date, with limited exceptions. This replaces FAS
141’s cost-allocation process, which required the cost of an acquisition to be
allocated to the individual assets acquired and liabilities assumed based on
their estimated fair values.
On April
17, 2009, a subsidiary of the Company acquired 100% of the tangible assets
of Taizhou Wote Valve Co., Ltd. for a total cash consideration of $3
million. The acquisition was accounted as a business combination in
accordance to the terms of the purchase agreement. Assets acquired
included inventories of $1.0 million, buildings of $1.4 million, equipments of
$0.4 million, and land use rights of $0.4 million. The Company allocated
the purchase price based on the fair value of the assets acquired and recorded a
gain of approximately $252,000.
RECENTLY
ISSUED ACCOUNTING PRONOUNCEMENTS
In
January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment
Guidance of EITF Issue No. 99-20, and EITF Issue No. 99-20, Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets” (“FSP EITF 99-20-1”). FSP EITF 99-20-1 changes the
impairment model included within EITF 99-20 to be more consistent with the
impairment model of SFAS No. 115. FSP EITF 99-20-1 achieves this by amending the
impairment model in EITF 99-20 to remove its exclusive reliance on “market
participant” estimates of future cash flows used in determining fair value.
Changing the cash flows used to analyze other-than-temporary impairment from the
“market participant” view to a holder’s estimate of whether there has been a
“probable” adverse change in estimated cash flows allows companies to apply
reasonable judgment in assessing whether an other-than-temporary impairment has
occurred. The adoption of FSP EITF 99-20-1 did not have a material impact on the
consolidated financial statements because all of the investments in debt
securities are classified as trading securities.
In April
2009, the FASB issued three related FASB Staff Positions: (i) FSP FAS No. 115-2
and FAS No. 124-2, Recognition of Presentation of Other-Than-Temporary
Impairments (“FSP FAS 115-2 and FAS 124-2”), (ii) FSP FAS No. 107-1 and APB No.
28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP FAS
107-1 and APB 28-1”), and (iii) FSP FAS No. 157-4, Determining the 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”), which are effective for interim and annual reporting periods ending
after June 15, 2009. FSP FAS 115-2 and FAS 124-2 modifies the requirement for
recognizing other-than-temporary impairments, changes the existing impairment
model, and modifies the presentation and frequency of related disclosures. FSP
FAS 107-1 and APB 28-1 require disclosures about fair value of financial
instruments for interim reporting periods as well as in annual financial
statements. FSP 157-4 requires new disclosures
regarding the categories of fair value instruments, as well as the inputs and
valuation techniques utilized to determine fair value and any changes to
the inputs
and valuation techniques during the period. The adoption of these FASB
Staff Positions did not have a material impact the Company’s consolidated
financial statements.
In
May 2009, the FASB issued SFAS No. 165, “Subsequent Events.” SFAS
No. 165 establishes the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements; the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements; and the
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. We adopted this standard during the
second quarter of 2009. FAS 165 requires that public entities
evaluate subsequent through the date that the financial statements are issued.
We have evaluated subsequent events through the date the financial statements
were issued.
In
June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of
Financial Assets—an amendment of FASB Statement No. 140.” SFAS No. 166
eliminates the concept of a “qualifying special-purpose entity” and clarifies
the determination of whether a transferor and all of the entities included in
the transferor’s financial statements being presented have surrendered control
over transferred financial assets. SFAS No. 166 requires that a transferor
recognize and initially measure at fair value all assets obtained (including a
transferor’s beneficial interest) and liabilities incurred as a result of a
transfer of financial assets accounted for as a sale. Enhanced disclosures are
required to provide financial statement users with greater transparency about
transfers of financial assets and a transferor’s continuing involvement
with transferred financial assets. This statement will not have an impact on the
Company’s financial statements.
In
June 2009, the FASB issued SFAS No. 167, “Amendments to FASB
Interpretation No. 46(R)” (“SFAS No. 167”). SFAS No. 167 amends
FIN 46(R), “Consolidation of Variable Interest Entities (revised
December 2003)—an interpretation of ARB No. 51” (“FIN 46(R)”) to
require an enterprise to perform a qualitative assessment of whether the
enterprise’s variable interest or interests give it a controlling financial
interest in a variable interest entity. This assessment identifies the primary
beneficiary of a variable interest entity as one with the power to direct the
activities of a variable interest entity that most significantly impact the
entity’s economic performance and the obligation to absorb losses of the entity
that could potentially be significant to the variable interest. SFAS
No. 167 will be effective as of the beginning of the annual reporting
period commencing after November 15, 2009 and will be adopted by the
Company in the first quarter of 2010. The Company is assessing the potential
impact, if any, of the adoption of SFAS No. 167 on its consolidated
financial statements
In June,
2009 the FASB issued FAS No. 168, The FASB Accounting Standards
Codification TM and the Hierarchy of Generally Accepted Accounting Principles, a
replacement of FASB Statement No. 162 (FAS 168), which establishes the FASB
Accounting Standards Codification as the source of authoritative accounting
principles recognized by the FASB to be applied in the preparation of financial
statements in conformity with generally accepted accounting principles. FAS 168
explicitly recognizes rules and interpretive releases of the Securities and
Exchange Commission (SEC) under federal securities laws as authoritative
GAAP for SEC registrants. FAS 168 is effective for financial statements issued
for interim and annual periods ending after September 15, 2009. Our
Quarterly Report on Form 10-Q for the quarter ending September 26, 2009 and all
subsequent public filings will reference the Codification as the sole source of
authoritative literature.
Note
3 - Plant and equipment
Plant and
equipment consist of the following:
|
|
June
30, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Buildings
and improvements
|
|
$
|
5,077,833
|
|
|
$
|
3,291,978
|
|
Machinery
|
|
|
18,186,475
|
|
|
|
13,569,698
|
|
Motor
vehicles
|
|
|
1,873,250
|
|
|
|
1,638,036
|
|
Office
equipment
|
|
|
529,840
|
|
|
|
465,922
|
|
Construction
in progress
|
|
|
8,123,603
|
|
|
|
5,600,335
|
|
|
|
|
33,791,001
|
|
|
|
24,565,969
|
|
Less:
Accumulated depreciation
|
|
|
(8,970,741)
|
|
|
|
(8,381,075)
|
|
|
|
$
|
24,820,260
|
|
|
$
|
16,184,894
|
|
The
Company expects to complete the construction in the third quarter of 2009 and
has no major capital commitment as of June 30, 2009. Depreciation
expense was $390,048 and $246,263 for the three months ended June 30, 2009 and
2008, respectively. For the six months ended June 30, 2009 an 2008, depreciation
expense was $698,114 and $440,655.
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:
|
|
June
30, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Patents
|
|
$
|
763,792
|
|
|
$
|
191,088
|
|
Software
|
|
|
149,097
|
|
|
|
723,038
|
|
Land
use rights*
|
|
|
7,991,426
|
|
|
|
-
|
|
|
|
|
8,904,315
|
|
|
|
914,126
|
|
Less:
Accumulated amortization
|
|
|
(192,270)
|
|
|
|
(90,795
|
)
|
|
|
$
|
8,712,045
|
|
|
$
|
823,331
|
|
* Land
use rights were transferred from the Casting Company under escrow agreement by
issuing 2,750,000 shares of common stock. See Note 11 and 12 for
details.
Amortization
expense was $81,847 and $15,512 for the three months ended June 30, 2009 and
2008, respectively. Amortization expense was $105,081 and $30,577 for the
six months ended June 30, 2009 and 2008, respectively.
Note
5 - Inventories
|
|
June
30, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Raw
materials
|
|
$
|
2,245,673
|
|
|
$
|
2,451,477
|
|
Work-in-progress
|
|
|
2,175,416
|
|
|
|
1,853,317
|
|
Finished
goods
|
|
|
7,008,128
|
|
|
|
6,939,648
|
|
|
|
$
|
11,429,217
|
|
|
$
|
11,244,442
|
|
Note
6 – Accounts receivable
Accounts
receivable consists of the following:
|
|
June
30, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Total
accounts receivable
|
|
|
29,350,546
|
|
|
|
29,824,322
|
|
Allowance
for bad debts
|
|
|
(1,161,871)
|
|
|
|
(1,163,457
|
)
|
Accounts
receivable, net
|
|
|
28,188,675
|
|
|
|
28,660,865
|
|
Accounts
receivable – non-current retainage
|
|
|
(1,718,440)
|
|
|
|
(2,541,418
|
)
|
Accounts
receivable – current
|
|
$
|
26,470,235
|
|
|
$
|
26,119,447
|
|
Retainage
represents portions held for payment by customers pending quality inspection
ranging from 12-18 months after shipment of products. At June 30,
2009 and December 31, 2008, retainage held by customers included in the
Company’s accounts receivable is as follows:
|
|
June
30, 2009
|
|
|
December
31, 2008
|
|
|
|
(unaudited)
|
|
|
|
|
Retainage
|
|
|
|
|
|
|
Current
|
|
$
|
2,960,959
|
|
|
$
|
1,194,025
|
|
Non-current
|
|
|
1,718,440
|
|
|
|
2,541,418
|
|
Total
retainage
|
|
$
|
4,679,399
|
|
|
$
|
3,735,443
|
|
The
following represents the changes in the allowance for doubtful
accounts:
|
|
June
30, 2009
|
|
|
December
31,2008
|
|
|
|
(unaudited)
|
|
|
|
|
Balance,
beginning of the period
|
|
$
|
1,163,457
|
|
|
$
|
274,167
|
|
Additions
to the reserve
|
|
|
-
|
|
|
|
819,711
|
|
Write-off
charged against the allowance
|
|
|
-
|
|
|
|
-
|
|
Recovery
of amounts previously reserved
|
|
|
-
|
|
|
|
-
|
|
Foreign
currency translation adjustment
|
|
|
(1,586)
|
|
|
|
69,579
|
|
Balance,
end of the period
|
|
$
|
1,161,871
|
|
|
$
|
1,163,457
|
|
Note 7 –
Loans
SHORT
TERM LOANS:
|
|
June
30, 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
|
|
$
|
-
|
|
|
$
|
1,863,090
|
|
|
|
|
|
|
|
|
|
|
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.
|
|
|
-
|
|
|
|
2,934,000
|
|
|
|
|
|
|
|
|
|
|
Unrelated
third parties, non-secured, ranging from non-interest
|
|
|
|
|
|
|
|
|
Bearing
to annual interest at 10.00%, due on demand
|
|
|
1,179,433
|
|
|
|
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
|
|
$
|
3,161,578
|
|
|
$
|
7,839,960
|
|
|
|
|
|
|
|
|
|
|
Total
interest incurred for the three months ended June 30, 2009 and 2008 amounted to
$175,073 and $139,095 respectively and for the six months ended June 30, 2009
and 2008 amounted to $268,922 and $283,767, respectively. Capitalized interest
amounted to $35,068 and $0 for the three months ended June 30, 2009 and 2008,
respectively; and amounted to $100,186 and $0 for the six months ended June 30,
2009 and 2008, respectively.
As of
June 30, 2009, there are no restrictive covenants related to the loans stated
above.
Note
8 - Taxes
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, Zhengdie Valve and
Taizhou Wote, are all 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 months ended, June 30
|
|
|
|
|
2009
|
|
|
2008
|
|
U.S.
Statutory rate
|
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
Foreign
income not recognized in USA
|
|
|
|
(34.0
|
)
|
|
|
(34.0
|
)
|
Non-deductible
expenses (1)
|
|
|
|
67.4
|
|
|
|
2.0
|
|
China
income taxes
|
|
|
|
25.0
|
|
|
|
25.0
|
|
China
income tax exemption
|
|
|
|
-
|
|
|
|
-
|
|
Total
provision for income taxes
|
|
|
|
92.4
|
%
|
|
|
27.0
|
%
|
|
|
|
|
|
|
|
|
|
|
(1) The
67.4% represents the $10,757 and $62,951 general expenses incurred by Henan
Tonghai Fluid, and China Valve Fluid, Hongkong and $7,499,487 noncash
compensation expense related to the Make Good Escrow Agreement (see Note 12 for
detail), which are not deductible in PRC for the three months ended June 30,
2009.
|
|
|
For
the six months ended, June 30
|
|
|
|
|
2009
|
|
|
2008
|
|
U.S.
Statutory rate
|
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
Foreign
income not recognized in USA
|
|
|
|
(34.0
|
)
|
|
|
(34.0
|
)
|
Non-deductible
expenses (1)
|
|
|
|
30.0
|
|
|
|
2.0
|
|
China
income taxes
|
|
|
|
25.0
|
|
|
|
25.0
|
|
China
income tax exemption
|
|
|
|
-
|
|
|
|
-
|
|
Total
provision for income taxes
|
|
|
|
55.0
|
%
|
|
|
27.0
|
%
|
(1) The
30% represents the $10,757 and $544,496 general expenses incurred by Henan
Tonghai Fluid and China Valve Fluid, Hongkong, $7,499,487 noncash compensation
expense and $400,634 loss due to change in fair value of warrant liabilities,
which are not deductible in PRC for the six months ended June 30,
2009.
The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $34,507,000 as of June 30, 2009, is included in consolidated
retained earnings and will continue to be indefinitely reinvested in
international operations. According, no provision has been made for U.S.
deferred taxes related to future repatriation of these earnings, nor is it
practicable to estimate the amount of income taxes that would have to be
provided if we concluded that such earnings will be remitted in the
future.
Value Added
Tax
VAT on
sales and VAT on purchases in China amounted to $5,609,401 and $2,546,856 for
the three months ended June 30, 2009 and $2,084,447 and $990,525 for the three
months ended June 30, 2008, respectively. VAT on sales and VAT on purchases in
China amounted to $7,261,870 and $3,480,594 for the six months ended June 30,
2009 and $4,047,985 and $1,692,359 for the six months ended June 30, 2008,
respectively. 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
impacted by the income tax holiday.
Taxes
payable consisted of the following:
|
|
June
30,2009
|
|
|
December
31,2008
|
|
|
|
|
(unaudited)
|
|
|
|
|
|
VAT
|
|
$
|
734,664
|
|
|
$
|
167,500
|
|
Income
tax
|
|
|
2,069,565
|
|
|
|
924,291
|
|
Other
taxes
|
|
|
127,858
|
|
|
|
135,547
|
|
Total
taxes payable
|
|
$
|
2,932,087
|
|
|
$
|
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.
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 $15.0 million and $15.9 million as of
June 30, 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.
For the
three months ended June 30, 2009 and 2008, total lease expense, including
amounts included in cost of sales, was $85,779 and $139,201, respectively. Total
lease expense, including amounts included cost of sales, for the six months
ended June 30, 2009 and 2008 was $171,487 and $268,054,
respectively.
The
future minimum lease payments at June 30, 2009, are as follows:
|
|
Amount
|
|
Year
ending December 31, 2009
|
|
$
|
171,405
|
|
Year
ending December 31, 2010
|
|
|
342,810
|
|
Year
ending December 31, 2011
|
|
|
342,810
|
|
Year
ending December 31, 2012
|
|
|
342,810
|
|
Thereafter
|
|
|
-
|
|
|
|
|
|
|
As of
June 30, 2009, the Company has a capital commitment of approximately $230,000
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 as of June 30,
2007 and December 31, 2008:
The
Company received advances from Mr. Siping, Fang, our Chief Executive Officer,
and Mr. Bin Li, its shareholder, for cash flow purposes. As of June 30, 2009 and
December 31, 2008, the outstanding amount due to Mr. Fang was $114,721 and
$658,367, respectively, and the amount due to Mr. Li was $160,000, and $0,
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. During the second quarter
of 2009, Mr. Fang personally guaranteed and paid off certain receivables due to
the Company using the aforementioned working capital advances. As of June 30,
2009 and December 31, 2008, total outstanding other payables amounted to
$274,721 and $1,975,462, 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
$163,103 and $131,263 as of June 30, 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 $360,603 and $465,528 as of June 30, 2009, and December
31, 2008, respectively.
As
discussed in Note 12, 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 2,750,000 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 2,750,000 shares of common
stock issued under the Real Estate Transfer Agreement were valued at $9,834,000
or $3.576 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 $10.00 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
2,750,000 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 June 30, 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 June
30, 2009 and December 31, 2008, advances on inventory purchases to the Casting
Company amounted to $891,991 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 8,389,302 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
$3.576 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.
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 June 30, 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 12,583,032 shares of the Company’s common stock held by him, to be
held for the benefit of the Investors. Of these shares, 12,150,000 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, 4,194,344
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 $0.738 and for calendar 2010 the target is net income of $31,000,000
and fully diluted earnings per share of $0.994. 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
12,150,000 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 4,194,344 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 $3.576 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 4,194,344 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.
Based on
the Company’s current performance and other factors, the Company determines that
it is probable that the earnings target for 2009 will be achieved. Accordingly,
the Company recorded non-cash compensation of $7,499,487 in the second quarter
of 2009. The Company’s common stock continues to be thinly traded and therefore
the Company has used the cash price of $3.576 paid by the Investors in the
private placement to measure the compensation charge recorded. The Company will
reassess the probability at each reporting period based on its probability
assessment.
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 587,248 shares of common
stock. The warrants have a strike price equal to $4.2912 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 $3.576 on the date the warrants were issued. The warrants were
valued at $959,196 when they were issued on August 26, 2008.
On
February 18, 2009, the placement agent, Brean Murray, Carret & Co., LLC
performed a cashless exercise of 352,349 warrant shares; which were converted to
201,149 shares of common stock. The Company valued the conversion on exercise
date, and recorded $229,673 loss 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 June 30, 2009, the estimated fair value of the
remaining warrants was $495,714. The Company recorded a loss of $3,545 and
$144,830 for the three and six months ended June 30, 2009, respectively, related
to these warrants. These losses were recorded in the Company’s income
statement.
The
Company issued warrants to purchase 50,000 shares at $6.00 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 June 30, 2009, these warrants were valued at $73,199. The Company
recorded a gain of $2,911 and a loss of $26,131 for the three and six months
ended June 30, 2009, respectively, related to these warrants. These losses were
recorded in the Company’s income statement.
Warrants
issued and outstanding, all of which are exercisable at June 30,
2009
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
|
Warrants
|
|
|
Average
Exercise
|
|
|
Remaining
Contractual
|
|
|
|
Outstanding
|
|
|
Price
|
|
|
Life
|
|
Balance,
January 1, 2008
|
|
|
50,000
|
|
|
|
6.00
|
|
|
|
2.95
|
|
Granted
|
|
|
587,248
|
|
|
|
4.30
|
|
|
|
3.00
|
|
Forfeited
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Balance,
December 31, 2008
|
|
|
637,248
|
|
|
$
|
4.42
|
|
|
|
2.60
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(352,349)
|
|
|
|
4.29
|
|
|
|
|
|
Balance,
June 30, 2009 (Unaudited)
|
|
|
284,899
|
|
|
|
4.60
|
|
|
|
2.04
|
|
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:
|
|
Three
months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
Power
Supply
|
|
$
|
7,969
|
|
|
$
|
1,597
|
|
Petrochemical
and Oil
|
|
|
4,070
|
|
|
|
3,239
|
|
Water
Supply
|
|
|
8,807
|
|
|
|
1,893
|
|
Metallurgy
|
|
|
1,632
|
|
|
|
1,219
|
|
Other
areas
|
|
|
2,397
|
|
|
|
3,835
|
|
Total
sales revenue
|
|
$
|
24,875
|
|
|
$
|
11,783
|
|
|
|
Six
months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
|
(in
thousands)
|
|
Power
Supply
|
|
$
|
12,890
|
|
|
$
|
4,444
|
|
Petrochemical
and Oil
|
|
|
6,220
|
|
|
|
5,162
|
|
Water
Supply
|
|
|
13,935
|
|
|
|
4,852
|
|
Metallurgy
|
|
|
2,817
|
|
|
|
2,117
|
|
Other
areas
|
|
|
6,256
|
|
|
|
8,191
|
|
Total
sales revenue
|
|
$
|
42,118
|
|
|
$
|
24,766
|
|
|
|
Three
months ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
|
(in
thousands)
|
|
China
|
|
$ |
23,065 |
|
|
$ |
10,955 |
|
International
|
|
|
1,810 |
|
|
|
828 |
|
Total
sales revenue
|
|
$ |
24,875 |
|
|
$ |
11,783 |
|
|
|
Six
months ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
|
(in
thousands)
|
|
China
|
|
$ |
38,519 |
|
|
$ |
23,456 |
|
International
|
|
|
3,599 |
|
|
|
1,310 |
|
Total
sales revenue
|
|
$ |
42,118 |
|
|
$ |
24,766 |
|
Note
14 – Subsequent event
STOCK
REVERSE SPLIT
MAKE GOOD
ESCROW AGREEMENT AMENDMENT
The Make
Good Escrow Agreement was amended and became effective on August 14,
2009. The specified earnings targets were modified. For
2009, the net income target was decreased from $23,000,000 to $21,000,000 and
the fully diluted earnings per share were changed from $0.738 to
$0.668. For 2010, the net income target was increased from
$31,000,000 to $34,000,000 and the fully diluted earnings per share were changed
from $0.994 to $1.082.
Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Forward-Looking
Statements
This
Quarterly Report on Form 10-Q contains statements that constitute “forward
looking statements” within the meaning of Section 21E of the Securities
Exchange Act of 1934, as amended, and Section 27A of the Securities Act of
1933, as amended. The words “may,” “will,” “expect,” “anticipate,” “continue,”
“estimate,” “project,” “intend,” and similar expressions are intended to
identify forward-looking statements. These statements appear in a number of
places in this document and include statements regarding the intent, belief or
expectation of the Company, its directors or its officers with respect to
events, conditions, and financial trends that may affect the Company’s future
plans of operations, business strategy, operating results, and financial
position. Persons reviewing this Quarterly Report on Form 10-Q are
cautioned that any forward-looking statements are not guarantees of future
performance and are subject to risks and uncertainties and that actual results
may differ materially from those included within the forward-looking statements
as a result of various factors. These risks and uncertainties include, but are
not limited to, the factors mentioned in the “Risk Factors” section of our
Annual Report on Form 10-K for the year ended December 31, 2008, and other risks
mentioned in this Form 10-Q or in our other reports filed with the Securities
and Exchange Commission (the “SEC”) since the filing date of our Annual Report
on Form 10-K for the year ended December 31, 2008.
Although
these forward-looking statements, and any assumptions upon which they are based,
are made in good faith and reflect the Company’s current judgment regarding the
direction of its business, actual results will almost always vary, sometimes
materially, from any estimates, predictions, projections, assumptions or other
future performance suggested herein. The Company undertakes no responsibility or
obligation to update publicly these forward-looking statements, but may do so in
the future in written or oral statements. Investors should take note of any
future statements made by or on behalf of the Company.
The
following discussion should be read in conjunction with our unaudited
consolidated financial statements and the related notes that appear in
Part I, Item 1, “Financial Statements,” of this Quarterly Report. Our
unaudited consolidated financial statements are stated in United States Dollars
and are prepared in accordance with United States Generally Accepted Accounting
Principles. The following discussion and analysis covers the Company’s unaudited
consolidated results of operations for the three month periods ended June
30, 2009 and 2008.
Use
of Defined Terms
Except as
otherwise indicated by the context, references to:
·
|
“China
Fluid Equipment” are references to “China Fluid Equipment Holdings
Limited” incorporated in Hong Kong;
|
·
|
“China
Valves,” the “Company,” “we,” “us” and “our” are references to the
combined business of China Valves Technology, Inc. and its subsidiaries,
China Fluid Equipment, Henan Tonghai Fluid, High Pressure Valve, Zhendie
Valve and Taizhou Taide Valve;
|
·
|
“China
Valve Hong Kong” are references to “China Valve Holdings Limited”
incorporated in Hong Kong;
|
·
|
“China
Valve Samoa” are references to “China Valve Holdings Limited” incorporated
in Samoa;
|
·
|
“China
” and “PRC” are references to the People’s Republic of
China;
|
·
|
“$”
are references to the legal currency of the United
States.
|
·
|
“Henan
Tonghai Fluid” are references to Henan Tonghai Fluid Equipment Co.,
Ltd.;
|
·
|
“Henan
Tonghai Valve” are references to Henan Tonghai Valve Technology Co.,
Ltd.;
|
·
|
“HKD”
are references to the Hong Kong Dollar;
|
·
|
“High
Pressure Valve” are references to Henan Kaifeng High Pressure Valve Co.,
Ltd.;
|
·
|
“Operating
Subsidiaries” are references to Zhengdie Valve and High Pressure
Valve;
|
·
|
“RMB”
are references to Renminbi, the legal currency of
China;
|
·
|
“Taizhou
Taide Valve” are references to Taizhou Taide Valve Co.,
Ltd.;
|
|
“Taizhou
Wote” are references to Taizhou Wote Valve Co., Ltd.;
|
·
|
“The
Casting Company” are references to Kaifeng High Pressure Valve Steel
Casting Limited Liabilities Company;
|
·
|
“Zhengdie
Valve” are references to Zhengzhou City Zhengdie Valve Co.,
Ltd.;
|
Our
Company History
We were originally incorporated
on August 1, 1997 in the State of Nevada. Our name has changed
several times over the years and on December 18, 2007, we amended our articles
of incorporation to change our name to China Valves Technology,
Inc. We had no active business operations from 2001 until December
18, 2007, when we completed a share exchange transaction with China Valve Samoa,
a company incorporated under the laws of Samoa, and its sole shareholder Mr.
Siping Fang. In the share exchange transaction, we acquired all of
the outstanding capital stock of China Valve Samoa from its sole shareholder in
exchange for 20,000,000 shares, or 99.8%, of our common stock and a cash payment
by China Valve Samoa of $490,000. Our acquisition of China Valves
Samoa was accounted for as a reverse acquisition and recapitalization of our
Company in which China Valve Samoa was deemed to be the accounting
acquirer. Accordingly, the historical financial statements for
periods prior to December 18, 2007 are the financial statements of China Valve
Samoa, including Zhengdie Valve and High Pressure Valve, except that the equity
section and earnings per share data have been retroactively adjusted
to reflect the reverse acquisition.
At the time of the share exchange
transaction, China Valve Samoa was the holding company which indirectly owned
both of our Operating Subsidiaries. Following our acquisition of China Valves
Samoa (and indirectly, the Operating Subsidiaries) and in anticipation of our
August 2008 private placement transaction, we developed a group reorganization
plan to ensure that the manner in which we acquired our Operating Subsidiaries
complied with PRC merger and acquisition related regulations. The
group reorganization plan involved modifying our acquisition of our Operating
Subsidiaries previously acquired as a result of our acquisition of China Valves
Samoa and the concurrent re-acquisition of the Operating Subsidiaries through
newly established entities incorporated by Bin Li (a Canadian citizen then
unaffiliated with the Company, but who is the cousin of our Chairman Siping
Fang).
As part
of the reorganization, on April 10, 2008, Mr. Fang sold 12,150,000 shares of the
Company’s common stock beneficially owned by him (the “Shares”) and which he had
received in the exchange transaction involving China Valves Samoa described
above, to Mr. Li. In connection with Mr. Li’s acquisition of the
Shares from Mr. Fang, 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 from Mr. Li, subject to the satisfaction of
certain conditions. When all the conditions have been satisfied, Mr.
Fang will be able to regain ownership of all the shares in the Company that he
originally acquired when he transferred to the Company his interest in the
Operating Subsidiaries, subject to their release from the Make Good Escrow
Agreement described below.
In
connection with the Company’s private placement on August 26, 2008, the Company
entered into a Make Good Escrow Agreement, under which the 12,583,032 shares of
the Company’s common stock held by Bin Li, the Company’s major shareholder, were
placed in escrow for the benefit of the investors in the private placement. This
Make Good Escrow Agreement was amended on August 14, 2009. Of these shares,
12,150,000 are the subject of the Earn-In Agreement between Bin Li and Siping
Fang as described above 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,
4,194,344 shares will be released to the investors or returned to Bin Li,
depending on the fulfillment of specified earnings targets. The specified
earnings targets (before any charges related to the release of any shares from
escrow and after giving effect to the amendment to the Make Good Escrow
Agreement that became effective on August 14, 2009) are (a) for calendar 2008,
net income of $10,500,000, (b) for calendar 2009, net income of $21,000,000 and
fully diluted earnings per share of $0.668 and (c) for calendar 2010, net income
of $34,000,000 and fully diluted earnings per share of $1.082. If the earnings
target for any year is not met and 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. If the
earnings target for any year is met, the return to Bin Li of any of the
12,150,000 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 a non-cash
compensation charge at that time equal to the then fair value of the shares
returned (up to a total of 12,150,000 shares). For the year ended December 31,
2008, the earnings target was met and accordingly, the Company recorded a
non-cash charge to compensation cost of $14,998,974 in the fourth quarter of
2008 related to the release from escrow to Bin Li of 4,194,344
shares.
Based on
the Company’s current performance and other factors, the Company determines that
it is probable that the earnings target for 2009 will be achieved. Accordingly,
the Company recorded non-cash compensation of $7,499,487 in the second quarter
of 2009. The Company’s common stock continues to be thinly traded and therefore
the Company has used the cash price of $3.576 paid by the investors in the
private placement to measure the compensation charge recorded. The Company will
reassess the probability at each reporting period based on its probability
assessment
The above
acquisition and reorganization transactions, and the related Earn-In and Make
Good Escrow Agreements are more fully described in our Annual Report on Form
10-K for the year ended December 31, 2008, to which reference should be made for
further information.
Recent
Developments
The
Company completed the construction of the new production facility at High
Pressure Valve in the first quarter of 2009. The new 13,000 square meter
(approximately 140,000 square feet) facility will focus mainly on producing
high-end large diameter metal valves used in the oil and petrochemical, thermal
and nuclear power, and water supply and drainage industries. The new
production facility is also capable of producing high-quality forged steel
valves for use in supercritical thermal power generating units. The
new facility is designed to have an approximately $30 million production
capacity.
The
Company began trial production at the beginning of June 2009 and expects to
start commercial production at this new production facility in late August
2009.
On July
24, 2009, the Company amended its articles of incorporation with the State of
Nevada to effect a one-for-two reverse stock split. The reverse stock split
affects all issued and outstanding shares of the Company's common stock
immediately prior to the effectiveness of the reverse stock split with any
fractional shares rounded up to the next highest whole share. As a result of the
reverse split, the Company has approximately 31,393,701 shares issued and
outstanding. The reverse split took effect on August 13, 2009. All share
and per share amounts used in this report, including the Company's consolidated
financial statements and notes have been retroactively restated to reflect the
1-for-2 reverse stock split.
Overview
of Our Business
Through our subsidiaries and certain
commercial and contractual relationships and arrangements with other Chinese
companies, we operate companies in China that develop, manufacture and
distribute high quality metal valves for a variety of different
industries. We are located in Kaifeng, Henan Province and conduct
business throughout China, Southeast Asia, the Middle-East and Europe. Our
production facility in Kaifeng has an area of approximately 110,000 square
meters. We produce over 700 models of valves and service numerous
industries, including the thermal power, water supply, municipal construction,
sewage disposal, oil and chemical, metallurgy, heat power, and nuclear power
industries. We are the leader in valve sales for the thermal power
and water supply industries, according to the China Valves
Industry Association.
Although the United States and Europe
have been most affected by the recent financial crisis, governments
throughout the Asia-Pacific region have also taken steps to stabilize their
markets. To offset slowing global growth, on November 5, 2008, at the State
Council meeting, Premier Wen Jiabao offered a RMB4 trillion ($586 billion)
stimulus package for the next two years and announced the government would move
to a proactive fiscal and a moderately relaxed monetary policy.
Pursuant to the stimulus package, the
Chinese government has committed to launch more projects related to people’s
livelihood and infrastructure and decided to invest RMB100 billion ($14.49
billion) in these projects, starting in the fourth quarter of 2008. (Source:
China Daily). The actions taken by the Chinese government should significantly
increase the demand for valve products which are essential for infrastructure
construction and will provide market opportunities for the Company.
In addition,
although the financial crisis has affected Chinese enterprises that rely on
overseas markets, China Valves has not been materially affected as less than 10%
of our revenue is generated from exports and the relatively strong domestic
market demand has positioned us to continue to grow notwithstanding the current
financial crisis.
Management believes that the recent financial crisis in the US and Europe should
not have any materially negative impact on our business, and management believes
we will benefit from the stimulus plan of the central government of
China.
Industry
Wide Trends that are Relevant to Our Business
The valve industry in China is large
and growing as a result of growth in urbanization and heavy industrialization
throughout all of China. Our industry is usually categorized into
the following five major segments depending on the end user of the particular
valve products: (1) oil; (2) power; (3) water supply; (4) petrochemical; and (5)
metallurgy. The oil segment and the power segment rank as the largest segments
accounting for 25% and 21%, respectively, followed by the water supply,
petrochemical and metallurgy segments with 14%, 12%, and 8% market share,
respectively. Miscellaneous and varied end users of valve products account for
the remaining 20% market share.
Sales of valve products in the Chinese
domestic market reached $7.08 billion in 2007, an increase of 32% from the
previous year, and the Chinese market is expected to increase at an annual rate
of more than 30% for the next 5 years according to the China Valve Industry
Association’s research. We believe that total domestic demand for
valves will reach $12 billion by 2010 and will be driven primarily by the energy
and water treatment segments with operations and projects in urban
centers. The stimulus package being implemented by the Chinese
government in response to the global economic crisis is expected to emphasize
basic infrastructure construction projects for water, electricity, gas and heat
in order to ensure continuous economic development and meet the requirement of
improving people’s living standard. We believe that these initiatives
should generate strong demand for valves and promising business prospects for
the valve industry and our Company, especially as China’s valve market keeps
growing and developing. We intend to focus our efforts on utilizing our tangible
and intangible resources to expand and strengthen our products and increase our
market share in response to industry demands.
Second
quarter Financial Performance Highlights
During
the second quarter of 2009, we focused primarily on developing, manufacturing
and selling high-quality metal valves for the electricity, petroleum, chemical,
water, gas and metallurgy industries in the PRC.
The
following are some financial highlights for the second quarter of
2009:
·
|
Sales Revenue: Sales
revenue increased $13.1 million, or 111.1%, to $24.9 million for the
second quarter of 2009 from $11.8 million for the same period last
year.
|
·
|
Gross Profit: Gross
profit was 49.9% for the second quarter of 2009, compared with 41.1%
for the same period in 2008.
|
·
|
Net Income: Net income decreased
$1.5 million, or 87.3%, to $212,711 for the second quarter of 2009,
from $1.7 million for the same period of last year. Our net
income decreased as a result of a non-cash charge for stock compensation
expense of $7.5 million.
|
·
|
Fully diluted net income per
share: Fully diluted net income per share was $0.01 for the second
quarter of 2009, compared with $0.08 for the same period last
year.
|
Results
of Operations
Results
of operations for the three months ended June 30, 2009 as compared with the
three months ended June 30, 2008.
The
following table sets forth key components of our results of operations for the
periods indicated, in dollars and as a percentage of sales revenue.
|
|
Three Months Ended
June
30,
(unaudited)
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
$
Change
|
|
|
%
Change
|
|
|
|
(In
thousands, except percentages)
|
|
Statement
of Operations data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24,875
|
|
|
|
11,783
|
|
|
|
13,092
|
|
|
|
111.1
|
|
|
|
|
12,452
|
|
|
|
6,939
|
|
|
|
5,513
|
|
|
|
79.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12,423
|
|
|
|
4,844
|
|
|
|
7,579
|
|
|
|
156.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development costs
|
|
|
17
|
|
|
|
46
|
|
|
|
(29)
|
|
|
|
(63.0)
|
|
Sales
and marketing expenses
|
|
|
1,800
|
|
|
|
856
|
|
|
|
944
|
|
|
|
110.3
|
|
General
and administrative expenses (including non-cash stock compensation
expenses of $7.5 million in the second quarter of
2009)
|
|
|
8,697
|
|
|
|
1,690
|
|
|
|
7,007
|
|
|
|
414.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,514
|
|
|
|
2,591
|
|
|
|
7,923
|
|
|
|
305.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,909
|
|
|
|
2,253
|
|
|
|
(344)
|
|
|
|
(15.3)
|
|
|
|
|
54
|
|
|
|
158
|
|
|
|
(104)
|
|
|
|
(65.8)
|
|
|
|
|
(950)
|
|
|
|
(195
|
)
|
|
|
(755)
|
|
|
|
387.2
|
|
Change
in fair value of warrant liabilities
|
|
|
1
|
|
|
|
-
|
|
|
|
1
|
|
|
|
-
|
|
|
|
|
2,592
|
|
|
|
620
|
|
|
|
1,972
|
|
|
|
318.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
212
|
|
|
|
1,670
|
|
|
|
(1,458)
|
|
|
|
(87.3)
|
|
The
following tables set forth our sales by valve type, in terms of volume and
revenues for the periods indicated.
|
|
Three
Months Ended
June
30,
|
|
Volume,
in tons
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
Gate
valves
|
|
|
1,285
|
|
|
|
615
|
|
Check
valves
|
|
|
184
|
|
|
|
106
|
|
Global
valves
|
|
|
516
|
|
|
|
178
|
|
Safety
valves
|
|
|
108
|
|
|
|
83
|
|
Butterfly
valves
|
|
|
4,307
|
|
|
|
2,039
|
|
Ball
valves
|
|
|
544
|
|
|
|
324
|
|
Vent
valves
|
|
|
7
|
|
|
|
71
|
|
Other
valves and accessories
|
|
|
1,372
|
|
|
|
652
|
|
Total,
in tons
|
|
|
8,323
|
|
|
|
4,068
|
|
|
|
Three
Months Ended
June
30,
|
|
|
|
2009
|
|
|
2008
|
|
Sales
revenue
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
Gate
valves
|
|
$ |
7,442 |
|
|
$ |
3,352 |
|
Check
valves
|
|
|
941 |
|
|
|
495 |
|
Global
valves
|
|
|
2,055 |
|
|
|
821 |
|
Safety
valves
|
|
|
547 |
|
|
|
196 |
|
Butterfly
valves
|
|
|
9,643 |
|
|
|
4,391 |
|
Ball
valves
|
|
|
1,409 |
|
|
|
784 |
|
Vent
valves
|
|
|
19 |
|
|
|
201 |
|
Other
valves and accessories
|
|
|
2,819 |
|
|
|
1,543 |
|
Total
sales revenue
|
|
$ |
24,875 |
|
|
$ |
11,783 |
|
The China Valve Industry Association
divides the valve market into five primary segments; (i) power; (ii)
petrochemical; (iii) oil; (iv) water supply; and (v) metallurgy. Our revenues in
these markets are as follows:
|
|
Three
Months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
Power
Supply
|
|
$
|
7,969
|
|
|
$
|
1,597
|
|
Petrochemical
and Oil
|
|
|
4,070
|
|
|
|
3,239
|
|
Water
Supply
|
|
|
8,807
|
|
|
|
1,893
|
|
Metallurgy
|
|
|
1,632
|
|
|
|
1,219
|
|
Other
areas
|
|
|
2,397
|
|
|
|
3,835
|
|
Total
sales revenue
|
|
$
|
24,875
|
|
|
$
|
11,783
|
|
|
|
|
|
|
|
|
|
|
Our sales
revenue for the three months ended June 30, 2009 amounted to $24.9 million,
which is approximately $13.1 million or 111.1% more than that of the
same period in 2008, where we had revenue of $11.8 million. The
increased sales revenue was attributable to (1) increased demand for our
products fueled by rapid industrialization and manufacturing development in
China, (2) our successful marketing efforts, (3) retaining our existing
customers and adding additional large customers, (4) our expansion into the
nuclear power station valve market segment, and (5) volume increased for our
innovations on high temperature high pressure power station gate valves and
two-way metal sealing butterfly valves because the Company has established its
brand in China
Cost of
Sales
Cost of
sales, which consist of raw materials, direct labor and manufacturing overhead
expenses, was $12.5 million for the three month period ended June 30, 2009, an
increase of $5.5 million or 79.4%, as compared with $6.9 million for the three
month period ended June 30, 2008. Cost of sales as a percentage of total
revenues were 50.0% and 58.8% for the three month periods ended on June 30, 2009
and 2008, respectively, with a decrease of approximately 8.8%. The
decrease was a result of lower production costs caused by decreased cost of raw
materials and strengthened production cost control. Since the fourth
quarter of 2008, the prices of raw materials went down as a result of the global
financial crisis. The purchasing prices of our major raw materials, including
the prices of casting steel, weld puddle, disc and rotor decreased 18% on
average in the second quarter of 2009 as compared to the same period in
2008.
Sales and Marketing
Expenses
Sales and
marketing expenses, which consist primarily of sales commission, advertising and
promotion expenses, freight charges and related compensation, were $1.8 million
for the three month period ended June 30, 2009, compared with $856,034 for the
period ended June 30, 2008, an increase of $943,885 or approximately 110.3%
due to the increase of sales volume in the period. In addition, with the
implementation of the strengthened cost control policy in 2009, the percentage
increase of sales and marketing expenses was less than that of
sales.
General and Administrative
Expenses
Our
general and administrative expenses, which consist primarily of related salaries
and benefits, business development, traveling expenses, legal and professional
expenses and depreciation, and bad debt expenses, were $8.7 million for the
three month period ended June 30, 2009, compared with $1.7 million for the
period ended June 30, 2008, a increase of $7.0 million or approximately
414.7%. Included in these expenses is a non-cash stock compensation charge
of $7.5 million, as discussed below. The remaining increase was primarily
attributable to increases in our auditing, accounting and legal fees
related to our status as a public reporting company.
As
described in Note 12 to the Company’s June 30, 2009 consolidated financial
statements, in connection with the Company’s private placement on August 26,
2008, the Company entered into a Make Good Escrow Agreement which was amended on
August 14, 2009, under which 12,583,032 shares of the Company’s common stock
held by Bin Li, the Company’s major shareholder, were placed in escrow. These
shares are the subject of an Earn-In Agreement between Bin Li and Siping Fang as
described in Note 1 to the consolidated financial statements 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, 4,194,344 shares will be released to the
investors or returned to the shareholder, depending on the fulfillment of
specified earnings targets after giving effect to the amendment to the Make Good
Escrow Agreement. The specified earnings target for calendar 2008 was net income
of $10,500,000, for calendar 2009 the target is net income of $21,000,000 and
fully diluted earnings per share of $ 0.668 and for calendar 2010 the target is
net income of $34,000,000 and fully diluted earnings per share of $1.082. 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 a non-cash
compensation cost at that time equal to the then fair value of the shares
returned. For 2009, the earnings target of net income is $21,000,000 and fully
diluted earnings per share of $0.668 (before any charges related to the release
of any shares from escrow). As it is probable that the Company will meet the
earning target of 2009, the Company recorded a non-cash charge to compensation
cost of $7.5 million in the second quarter of 2009 related to the pledged shares
in the escrow account of Bin Li.
Income
from operations was $1.9 million for the three month period ended June 30, 2009,
compared with $2.3 million for the period ended June 30, 2008, a decrease
of $0.4 million or approximately 15.2%. The decrease was
primarily attributable to the increase in sales and gross margin in the current
quarter after deducting a $7.5 million non-cash compensation expenses in the
second quarter. Income from operations excluding the non-cash compensation
expense for the three month period ended June 30, 2009 was $9.4 million,
compared with $2.3 million for the period ended June 30, 2008, an increase of
$7.1 million or approximately 308.7%.
Other income
(expenses)
Total
other income was $895,053 for the three month period ended June 30, 2009,
compared with $37,670 for the period ended June 30, 2008. The
financial expenses for the three month period ended on June 30, 2009 and 2008
were $54,703 and $157,766, respectively.
Income
taxes
We
incurred income taxes of $2.6 million for the three month period ended June 30,
2009. This is an increase of $2.0 million or 318.1% from the
taxes we incurred in the 2008 period, which were $0.62 million. We
incurred more taxes in the three months ended June 30, 2009 mostly because of
the higher taxable income in the three month period ended on June 30, 2009
compared to 2008.
Provision
for Income Taxes
United
States
We are
subject to United States tax at a tax rate of 34%. No provision for US federal
income taxes has been made as we had no taxable income in the United States for
the reporting period.
Hong
Kong
China
Fluid Equipment was incorporated in Hong Kong and is not subject to income taxes
under the current laws of Hong Kong.
PRC
A company
registered in China is subject to national and local income taxes within China
at the applicable tax rate on the taxable income as reported in its PRC
statutory financial statements in accordance with relevant income tax
laws. Under the Provisional Taxation Regulation of the People’s
Republic of China effective before January 1, 2008, income tax was generally
payable by enterprises at a rate of 33% of their taxable income.
In 2007,
China passed the New EIT Law and its implementing rules, both of which became
effective on January 1, 2008. The New EIT Law significantly curtails
tax incentives granted to foreign-invested enterprises under the previous
law. The New EIT Law, however, (i) reduces the statutory rate of
enterprise income tax from 33% to 25%, (ii) permits companies to continue to
enjoy their existing tax incentives, adjusted by certain transitional phase-out
rules, and (iii) introduces new tax incentives, subject to various qualification
criteria.
Substantially
all of our income may be derived from dividends we receive from our PRC
operating subsidiaries described above. The New EIT Law and its
implementing rules generally provide that a 10% withholding tax applies to
China-sourced income derived by non-resident enterprises for PRC enterprise
income tax purposes. We expect that such 10% withholding tax will
apply to dividends paid to us by our PRC subsidiaries, but this treatment will
depend on our status as a non-resident enterprise. For detailed
discussion of PRC tax issues related to resident enterprise status, see “Risk
Factors — Risks Related to Doing Business in China — Under the New EIT Law, we
may be classified as a “resident enterprise” of China. Such
classification will likely result in unfavorable tax consequences to us and our
non-PRC shareholders.”
Net
Income
We earned
net income of $212,711 for the three month period ended June 30,
2009. This is a decrease of $1.5 million or approximately 87% from
the period ended June 30, 2008 which had a net income of $1.7
million. The primary factor for the
decrease is a non-cash compensation expense of $7.5 million in the current
quarter.
The
Company’s management uses non-GAAP adjusted net income to measure the
performance of the Company’s business internally by excluding non-cash expenses
related to the Make Good Escrow Agreement and change in fair value of warrant
liabilities. The Company’s management believes that the non-GAAP
adjusted financial measures allow the management to focus on managing business
operating performance because the measures reflect the essential operating
activities of the Company and provide a consistent method of comparison to
historical periods. The Company believes that providing the non-GAAP measures
that management uses internally to its investors is useful to investors for a
number of reasons. The non-GAAP measures provide a consistent basis for
investors to understand the Company's financial performance in comparison to
historical periods without variation of non-recurring items and non-operating
related charges. In addition, it allows investors to evaluate the Company's
performance using the same methodology and information as that used by the
management. Non-GAAP measures are subject to inherent limitations because they
do not include all of the expenses included under GAAP and because they involve
the exercise of judgment of which charges are excluded from the non-GAAP
financial measure. However, the management compensates for these limitations by
providing the relevant disclosure of the items excluded.
The
following table provides the non-GAAP financial measure and a reconciliation of
the non-GAAP measure to the GAAP income from operations and net
income.
|
|
Three
Months Ended
|
|
|
|
June
30
|
|
|
|
2009
|
|
|
2008
|
|
Income
From Operations
|
|
$
|
1,909,435
|
|
|
|
2,252,689
|
|
Add
back (Deduct):
|
|
|
|
|
|
|
|
|
Non-Cash
Compensation Expenses
|
|
|
7,499,487
|
|
|
|
-
|
|
Adjusted
Income From Operations
|
|
$
|
9,408,922
|
|
|
$
|
2,252,689
|
|
|
|
|
|
|
|
|
|
|
Net
Income (Loss)
|
|
$
|
212,711
|
|
|
$
|
1,670,038
|
|
Add
back (Deduct):
|
|
|
|
|
|
|
|
|
Non-Cash
Change in Warrant Liabilites
|
|
|
634
|
|
|
|
-
|
|
Non-Cash
Compensation Expenses
|
|
$
|
7,499,487
|
|
|
$
|
-
|
|
Adjusted
Net Income
|
|
$
|
7,712,832
|
|
|
$
|
1,670,038
|
|
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
$
|
0.01
|
|
|
$
|
0.08
|
|
Add
back (Deduct):
|
|
|
|
|
|
|
|
|
Non-Cash
Change in Warrant Liabilities
|
|
|
0.00
|
|
|
|
0.00
|
|
Non-Cash
Compensation Expenses
|
|
$
|
0.24
|
|
|
$
|
0.00
|
|
Adjusted
EPS
|
|
$
|
0.25
|
|
|
$
|
0.08
|
|
Results
of operations for the six months ended June 30, 2009 as compared with the six
months ended June 30, 2008.
The
following table sets forth key components of our results of operations for the
periods indicated, in dollars and as a percentage of sales revenue.
|
|
Six Months Ended
June
30,
(unaudited)
|
|
|
|
|
|
|
|
|
2009
|
|
2008
|
|
$
Change
|
|
|
%
Change
|
|
|
|
(In
thousands, except percentages)
|
|
Statement
of Operations data
|
|
|
|
|
|
|
|
|
|
|
|
|
|
42,118
|
|
24,766
|
|
|
17,352
|
|
|
|
70.1
|
|
|
|
|
21,374
|
|
14,818
|
|
|
6,556
|
|
|
|
44.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,744
|
|
9,948
|
|
|
10,796
|
|
|
|
108.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development costs
|
|
|
23
|
|
99
|
|
|
76
|
|
|
|
(76.8)
|
|
Sales
and marketing expenses
|
|
|
2,
915
|
|
1,863
|
|
|
1,052
|
|
|
|
56.5
|
|
General
and administrative expenses (including non-cash stock compensation
expenses of $7.5 million in the second quarter of
2009)
|
|
|
11,258
|
|
3,270
|
|
|
7,988
|
|
|
|
244.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14,196
|
|
5,232
|
|
|
8,964
|
|
|
|
171.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,548
|
|
4,716
|
|
|
1,832
|
|
|
|
38.8
|
|
|
|
|
126
|
|
292
|
|
|
(166)
|
|
|
|
(56.8)
|
|
|
|
|
(1,037)
|
|
(287)
|
|
|
(750)
|
|
|
|
261.3
|
|
Change
in fair value of warrant liabilities
|
|
|
401
|
|
-
|
|
|
401
|
|
|
|
-
|
|
|
|
|
3,878
|
|
1,281
|
|
|
2,597
|
|
|
|
202.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,180
|
|
3,430
|
|
|
(250)
|
|
|
|
(7.3)
|
|
The
following tables set forth our sales by valve type, in terms of volume and
revenues for the periods indicated.
|
|
Six
Months Ended
June
30,
|
|
Volume,
in tons
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
Gate
valves
|
|
|
1,959
|
|
|
|
1,289
|
|
Check
valves
|
|
|
307
|
|
|
|
189
|
|
Global
valves
|
|
|
723
|
|
|
|
473
|
|
Safety
valves
|
|
|
200
|
|
|
|
129
|
|
Butterfly
valves
|
|
|
6,613
|
|
|
|
3,635
|
|
Ball
valves
|
|
|
935
|
|
|
|
486
|
|
Vent
valves
|
|
|
8
|
|
|
|
204
|
|
Other
valves and accessories
|
|
|
2,096
|
|
|
|
1,898
|
|
Total,
in tons
|
|
|
12,843
|
|
|
|
8,303
|
|
|
|
Six
Months Ended June 30 ,
|
|
|
|
2009
|
|
|
2008
|
|
Sales
revenue
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
Gate
valves
|
|
$ |
12,708 |
|
|
$ |
6,790 |
|
Check
valves
|
|
|
1,722 |
|
|
|
898 |
|
Global
valves
|
|
|
3,325 |
|
|
|
1,747 |
|
Safety
valves
|
|
|
1,109 |
|
|
|
326 |
|
Butterfly
valves
|
|
|
15,709 |
|
|
|
7,752 |
|
Ball
valves
|
|
|
2,606 |
|
|
|
1,180 |
|
Vent
valves
|
|
|
26 |
|
|
|
582 |
|
Other
valves and accessories
|
|
|
4,913 |
|
|
|
5,491 |
|
Total
sales revenue
|
|
$ |
42,118 |
|
|
$ |
24,766 |
|
The China Valve Industry Association
divides the valve market into five primary segments; (i) power; (ii)
petrochemical; (iii) oil; (iv) water supply; and (v) metallurgy. Our revenues in
these markets are as follows:
|
|
Six
Months Ended June 30,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
Power
Supply
|
|
$
|
12,890
|
|
|
$
|
4,444
|
|
Petrochemical
and Oil
|
|
|
6,220
|
|
|
|
5,162
|
|
Water
Supply
|
|
|
13,935
|
|
|
|
4,852
|
|
Metallurgy
|
|
|
2,817
|
|
|
|
2,117
|
|
Other
areas
|
|
|
6,256
|
|
|
|
8,191
|
|
Total
sales revenue
|
|
$
|
42,118
|
|
|
$
|
24,766
|
|
|
|
|
|
|
|
|
|
|
Sales
Revenue
Our sales
revenue for the six months ended June 30, 2009 amounted to $42.1 million, which
is approximately $17.4 million or 70% more than that of the same
period in 2008, where we had revenue of $24.8 million. The increase
was primarily attributed to (1) increased demand for our products fueled by
rapid industrialization and manufacturing development in China, (2) our
successful marketing efforts, (3) retaining our existing customers and adding
additional large customers, (4) our expansion into the nuclear power station
valve market segment, and (5) volume increased for our innovations on high
temperature high pressure power station gate valves and two-way metal sealing
butterfly valves because the Company has established its brand in
China.
Cost of
sales was $21.4 million for the six month period ended June 30, 2009, an
increase of $6.6 million or 44.2%, as compared with $14.8 million for the six
month period ended June 30, 2008. Cost of sales as a percentage of total
revenues were 50.7% and 59.8% for the six month periods ended on June 30,
2009 and 2008, respectively, with a decrease of approximately
9.1%. The decrease was a result of lower production costs caused by
decreased cost of raw materials and strengthened production cost
control. Since the fourth quarter of 2008, the prices of raw
materials went down as a result of the global financial crisis. The purchasing
prices of our major raw materials, including the prices of casting steel, weld
puddle, disc and rotor decreased 18% on average in the second half of 2009 as
compared to the same period in 2008.
Sales and Marketing
Expenses
Sales and
marketing expenses were $2.9 million for the six month period ended June 30,
2009, compared with $1.9 million for the period ended June 30, 2008, an increase
of $1.0 million or approximately 56.5% due to the increase of sales
performance in the period. In addition, with the implementation of the
strengthened cost control policy in 2009, the percentage increase of sales and
marketing expenses was less than that of sales.
General and Administrative
Expenses
Our
general and administrative expenses were $11.3 million for the six month period
ended June 30, 2009, compared with $3.3 million for the period ended June 30,
2008, an increase of $8.0 million or approximately 244.3%. Included
in these expenses is a non-cash compensation charge of $7.5 million, as
discussed above. The remaining increase was primarily attributable to an
increases in our auditing, accounting and legal fees related to our status as a
public reporting company.
Income
from operations was $6.5 million for the six month period ended June 30, 2009,
compared with $4.7 million for the period ended June 30, 2008, a increase
of $1.8 million or approximately 38.8%. The increase was primarily
attributable to the increase in sales and gross margin in the current quarter
after deducting a $7.5 million non-cash compensation expenses in the second
quarter. Income from operations excluding the non-cash compensation expense for
the six month period ended June 30, 2009 was $14.0 million, compared with $4.7
million for the period ended June 30, 2008, an increase of $9.3 million or
approximately 197.8%.
Total
other income was $1.0 million for the six month period ended June 30, 2009,
compared with $286,984 for the period ended June 30, 2008. The
financial expenses for the six month period ended on June 30, 2009 and 2008 were
$126,152 and $291,594, respectively.
We
incurred income taxes of $3.9 million for the six month period ended June 30,
2009. This is an increase of $2.6 million or 202.7% from the
taxes we incurred in the 2008 period, which were $1.3 million. We
incurred more taxes in the six months ended June 30, 2009 mostly because of the
higher taxable income in the six month period ended on June 30, 2009 compared to
2008.
We had
net income of $3.2 million for the six month period ended June 30,
2009. This is a decrease of $250,306 or approximately 7.3% from the
period ended June 30, 2008 which had a net income of $3.4
million. The primary factor for the
decrease is a non-cash compensation expense of $7.5 million in the second
quarter.
The
Company’s management uses non-GAAP adjusted net income to measure the
performance of the Company’s business internally by excluding a non-cash
compensation expense related to the Make Good Escrow Agreement. The
Company’s management believes that the non-GAAP adjusted financial measure
allows the management to focus on managing business operating performance
because the measure reflect the essential operating activities of the Company
and provide a consistent method of comparison to historical periods. The Company
believes that providing the non-GAAP measures that management uses internally to
its investors is useful to investors for a number of reasons. The non-GAAP
measures provide a consistent basis for investors to understand the Company's
financial performance in comparison to historical periods without variation of
non-recurring items and non-operating related charges. In addition, it allows
investors to evaluate the Company's performance using the same methodology and
information as that used by the management. Non-GAAP measures are subject to
inherent limitations because they do not include all of the expenses included
under GAAP and because they involve the exercise of judgment of which charges
are excluded from the non-GAAP financial measure. However, the management
compensates for these limitations by providing the relevant disclosure of the
items excluded.
.
The
following table provides the non-GAAP financial measure and a reconciliation of
the non-GAAP measure to the GAAP income from operations and net
income.
|
|
Six
Months Ended
|
|
|
|
June
30
|
|
|
|
2009
|
|
|
2008
|
|
Income
From Operations
|
|
$
|
6,547,945
|
|
|
|
4,716,252
|
|
Add
back (Deduct):
|
|
|
|
|
|
|
|
|
Non-Cash
Compensation Expenses
|
|
|
7,499,487
|
|
|
$
|
0
|
|
Adjusted
Income From Operations
|
|
$
|
14,047,432
|
|
|
$
|
4,716,252
|
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
$
|
3,180,062
|
|
|
$
|
3,430,368
|
|
Add
back (Deduct):
|
|
|
|
|
|
|
|
|
Non-Cash
Change in Warrant
|
|
|
400,634 |
|
|
|
0 |
|
Non-Cash
Compensation Expenses
|
|
|
7,499,487
|
|
|
|
0
|
|
Adjusted
Net Income
|
|
$
|
11,080,183
|
|
|
$
|
3,430,368
|
|
|
|
|
|
|
|
|
|
|
Diluted
EPS
|
|
$
|
0.11
|
|
|
$
|
0.17
|
|
Add
back (Deduct):
|
|
|
|
|
|
|
|
|
Non-Cash
Change in Warrant Liabilities
|
|
|
0.02 |
|
|
|
0 |
|
Non-Cash
Compensation Expenses
|
|
$
|
0.24
|
|
|
$
|
0.00
|
|
Adjusted
EPS
|
|
$
|
0.35
|
|
|
$
|
0.17
|
|
Liquidity and Capital
Resources
As of
June 30, 2009, we had cash and cash equivalents of $19.7 million. The
following table sets forth a summary of our cash flows for the periods
indicated:
|
Six
months Ended June 30,
|
|
|
2009
|
|
|
2008
|
|
|
(in
thousands)
|
|
Net
cash (used in) / provided by operating activities
|
15,317
|
|
|
47
|
|
Net
cash used in investing activities
|
(7,249)
|
|
|
(1,729)
|
|
Net
cash (used in) / provided by financing activities
|
(4,703)
|
|
|
3,162
|
|
Effect
of exchange rate changes on cash and cash
equivalents
|
(97)
|
|
|
239
|
|
Net
Increase in cash and cash equivalent
|
3,268
|
|
|
1,719
|
|
Cash
and cash equivalents at the beginning of period
|
16,428
|
|
|
2,773
|
|
Cash
and cash equivalents at the end of period
|
19,696
|
|
|
4,492
|
|
The
Company currently generates its cash flow through operations which it believes
will be sufficient to sustain the current level of operations for at least the
next twelve months. In 2009, we continue to work to develop new
valves and expand our presence as the leader in the development and manufacture
of various valves.
Operating
Activities
Net cash
provided by operating activities was $15.3 million in the six months ended June
30, 2009, compared with net cash provided by operating activities of $46,743 in
the same period in fiscal year 2008. The change of $15.3 million in operating
activities was primarily attributable to a $7.5 million non-cash compensation
expense accrual, increases in customer deposit and tax payable for the six
months ended June 30, 2009. The Company has improved the collection
of accounts receivables by implementing new sales commission policies and
strengthening the collection efforts through compensating sales agents on timely
collection.
Investing
Activities
Net cash
used in investing activities increased to $7.2 million in the six months ended
June 30, 2009, compared with $1.7 million in the same period in fiscal year
2008.
Financing
Activities
Net cash
used by financing activities was $4.7 million in the six months ended June 30,
2009, compared with net cash obtained from financing activities of $3.2 million
in the same period in fiscal year 2008. The decrease in net cash is attributable
to the repayment of $4.8 million of short term loan.
As of
June 30, 2009, there was no principal outstanding under our credit facilities
and lines of credit.
Capital
Expenditures
The
capital expenditures in the six months ended June 30, 2009 and 2008 are set out
as below. Our capital expenditures were used primarily for plant construction
and purchase of equipment to expand our production capacity. The table below
sets forth the breakdown of our capital expenditures by use for the periods
indicated.
|
Six
months Ended June 30,
|
|
|
2009
|
|
2008
|
|
|
(in
thousands)
|
|
|
|
2,552
|
|
|
375
|
|
|
|
4,233
|
|
|
564
|
|
|
|
|
|
|
|
|
Total
capital expenditures
|
|
|
|
|
|
|
We
estimate that our total capital expenditures in fiscal year 2009 will reach
approximately $10 million: $6.8 million of which has been used to
complete construction of the new plant in Kaifeng and equipment purchase in
other two subsidiaries, Zhengdie and Taizhou Taide. $1 million of which
will be used to upgrade Taizhou Taide’s production technology and equipment,
which we expect will increase Taizhou Taide’s existing production capacity by
50%, and the $2.0 million be used for purchase of new equipment (e.g., equipment
for ultra-supercritical thermal power projects) and production line upgrades for
companies we plan to acquire in 2009.
Obligations
Under Material Contracts
The
following table sets forth our contractual obligations and commercial
commitments as of June 30, 2009:
|
|
Payment
Due by Period
|
|
|
|
Total
|
|
|
Less than
1 Year
|
|
|
1-3
Years
|
|
|
3-5
Years
|
|
|
More than
5 Years
|
|
|
|
(in
thousands)
|
|
Short-term
loans
|
|
|
3,685
|
|
|
|
3,685
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Bills
payable
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Long-term
bank loans
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
Minimum
Lease payments
|
|
|
1,199
|
|
|
|
171
|
|
|
|
1,028
|
|
|
|
|
|
|
|
-
|
|
Capital
commitments
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Future
interest payment on short-term bank loans
|
|
|
36
|
|
|
|
36
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Future
interest payment on long-term bank loans
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
4,920
|
|
|
|
3,892
|
|
|
|
1,028
|
|
|
|
|
|
|
|
-
|
|
Make
Good Escrow Agreement
In
connection with the private placement, our major stockholder Bin Li entered into
an escrow agreement with the private placement investors. Pursuant to the escrow
agreement which was amended on August 14, 2009, Bin Li agreed to certain “make
good” provisions. In the escrow agreement, we established minimum net income
thresholds of $10,500,000 for the fiscal year ended December 31, 2008,
$21,000,000 for the fiscal year ended December 31, 2009 and $34,000,000 for the
fiscal year ended December 31, 2010. Bin Li deposited a total of 12,583,032
shares into escrow with Escrow LLC under the escrow agreement. If the 2008 net
income threshold is not achieved, then the escrow agent must deliver the first
tranche of 4,194,344 shares to the investors on a pro rata basis (based upon the
total number of shares purchased by the investors in connection with the private
placement transaction), If the 2009 net income threshold is not achieved, then
the escrow agent must deliver the second tranche of 4,194,344 shares to the
investors on a pro rata basis and if the 2010 net income threshold is not
achieved, the escrow agent must deliver the second tranche of 4,194,344 shares
to the investors on a pro rata basis. However, only those private placement
investors who remain our stockholders at the time the escrow shares become
deliverable are entitled to their pro rata portion of such escrowed
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 released 4,194,344 shares from the escrow to Bin
Li.
Other
than the contractual obligations and commercial commitments set forth above, we
did not have any other long-term debt obligations, capital commitments, purchase
obligations or other long-term liabilities as of June 30, 2009.
Critical
Accounting Policies
Our
consolidated financial information has been prepared in accordance with U.S.
GAAP, which requires us to make judgments, estimates and assumptions that affect
(1) the reported amounts of our assets and liabilities, (2) the disclosure of
our contingent assets and liabilities at the end of each fiscal period and (3)
the reported amounts of revenues and expenses during each fiscal period. We
continually evaluate these estimates based on our own historical experience,
knowledge and assessment of current business and other conditions, our
expectations regarding the future based on available information and reasonable
assumptions, which together form our basis for making judgments about matters
that are not readily apparent from other sources. Since the use of estimates is
an integral component of the financial reporting process, our actual results
could differ from those estimates. Some of our accounting policies require a
higher degree of judgment than others in their application.
When
reviewing our financial statements, the following should also be considered: (1)
our selection of critical accounting policies, (2) the judgment and other
uncertainties affecting the application of those policies, and (3) the
sensitivity of reported results to changes in conditions and assumptions. We
believe the following accounting policies involve the most significant judgment
and estimates used in the preparation of our financial statements.
Revenue
Recognition
The
Company’s revenue recognition policies are in compliance 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.
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 the finished product.
Foreign
Currency Translation and Other Comprehensive Income
The
reporting currency of the Company is the US dollar. The functional currency of
our Chinese operating entities High Pressure Valve and Zhengdie Valve is the
Renminbi (RMB).
For the
subsidiaries whose functional currencies are other than the US dollar, all
assets and liabilities accounts were translated at the exchange rate on the
balance sheet date; shareholders’ equity is translated at the historical rates
and items in the income and cash flow statements are translated at the average
rate for the year. Because cash flows are calculated based using the average
translation rate, amounts related to assets and liabilities reported on the
statement of cash flows will not necessarily agree with changes in the
corresponding balances on the balance sheet. Translation adjustments resulting
from this process are included in accumulated other comprehensive income in the
statement of shareholders’ equity. The resulting translation 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.
Accumulated
other comprehensive income in the consolidated statement of shareholders’ equity
amounted to $6,077,912 and $6,158,977 as of June 30, 2009 and December 31, 2008,
respectively. The balance sheet amounts with the exception of equity at June 30,
2009 and December 31, 2008 were translated at 6.83 RMB and 6.82 RMB to $1.00
USD, respectively. The average translation rates applied to income and cash flow
statement amounts for the six months ended June 30, 2009 and 2008 were 6.82 RMB
and 7.05 RMB to $1.00, respectively.
Income
Taxes
The
Company follows Statement of Financial Accounting Standards No. 109, “Accounting
for Income Taxes” (SFAS 109) that 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 consists of taxes currently due plus
deferred taxes. Because the Company had no operations within the United States
there is no provision for US income taxes and there are no deferred tax amounts
as of June 30, 2009 and 2008.
The
charge for taxation is based on the results for the year as adjusted for items
which are non-assessable or disallowed. It is calculated using tax rates that
have been enacted or substantively enacted by the balance sheet date. Deferred
tax is accounted for using the balance sheet liability method in respect of
temporary differences arising from differences between the carrying amount of
assets and liabilities in the financial statements and the corresponding tax
basis used in the computation of assessable tax profit. In principle, deferred
tax liabilities are recognized for all taxable temporary differences, and
deferred tax assets are recognized to the extent that it is probable that
taxable profit will be available against which deductible temporary differences
can be utilized.
Deferred
tax is calculated at the tax rates that are expected to apply to the period when
the asset is realized or the liability is settled. Deferred tax is charged or
credited in the income statement, except when it relates to items credited or
charged directly to equity, in which case the deferred tax is 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.
The
Company adopted FASB Interpretation 48, “Accounting for Uncertainty in Income
Taxes” (“FIN 48”), as of January 1, 2007. 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. The adoption of FIN 48
had no affect on the Company’s financial statements.
Warranties
We
typically warranty all of our products. It is the Company’s policy to replace
parts if they become defective within one year after deployment at no additional
charge. Historically, failure of product parts due to materials or
workmanship is rare. Therefore, at June 30, 2009 and June 30, 2008, the Company
made no provision for warranty claims for our products. Management
continuously evaluates the potential warranty obligation. Management will record
the expenses related to the warranty obligation if the estimated amount becomes
material at the time revenue is recorded.
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, 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 June 30, 2009 and December 31, 2008, the
Company’s cash and restricted cash balances, totaling $20,727,084 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 22% and 44% of the Company’s total
purchases for the three months ended June 30, 2009 and 2008,
respectively. For the six months ended June 30, 2009 and 2008, five
major suppliers represented approximately 20% and 37% respectively of the
Company’s total purchases. Five major customers represented approximately 14%
and 21% of the Company’s total sales for the three months ended June 30, 2009
and 2008, respectively. For the six months ended June 30, 2009 and
2008, five major customers represented approximately 14% and 21%, respectively
of the Company’s total sales.
Accounts
Receivable and Allowance For Doubtful Accounts
The
Company’s business operations are conducted in the PRC. During the normal course
of business, the Company extends unsecured credit to its customers by selling on
various credit terms. Management reviews its accounts receivable 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. The Company’s existing reserve is consistent with its
historical experience and considered adequate by the management.
Fair
Value of Financial Instruments
The
Company adopted SFAS No. 157, “Fair Value Measurements” on January 1, 2008. SFAS
No. 157 defines fair value, establishes a three-level valuation hierarchy for
disclosures of fair value measurement and enhances disclosure requirements for
fair value measures. The carrying amounts reported in the balance sheets for
receivables and payables qualify as financial instruments and are a reasonable
estimate of fair value because of the short period of time between the
origination of such instruments and their expected realization and their current
market rate of interest. The three levels are defined as
follows:
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.
|
Carrying
Value as of
June
30, 2009
|
|
Fair
Value Measurements at June 30, 2009
using
Fair Value Hierarchy
|
|
|
|
|
|
Level
1
|
Level
2
|
|
Level
3
|
|
Investments
|
|
$
|
763,472
|
|
|
|
|
$
|
763,472
|
|
Warrant
liabilities
|
|
$
|
568,913
|
|
|
|
|
$
|
568,913
|
|
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.
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.
The
Company periodically 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
of long term investments in the event that the carrying value of the investment
exceeds our proportionate share of the net book value of the investee. As of
June 30, 2009, management believes no impairment charge is
necessary.
Goodwill
We test
goodwill for impairment annually and whenever events or circumstances make it
more likely than not that impairment may have occurred, such as a significant
adverse change in the business climate or a decision to sell or dispose of all
or a portion of a reporting unit. Our operating subsidiaries are considered
separate reporting units for purposes of this evaluation. Determining whether an
impairment has occurred requires valuation of the respective reporting unit,
which we estimate using a discounted cash flow method. In applying this
methodology, we rely on a number of factors, including actual operating results,
future business plans, economic projections and market data.
We test
other identified intangible assets with defined useful lives and subject to
amortization by comparing the carrying amount to the sum of undiscounted cash
flows expected to be generated by the asset. We test any other intangible assets
with indefinite lives annually for impairment using a fair value method such as
discounted cash flows.
Stock
Based Compensation
The
Company applies Statement of Financial Accounting Standards No. 123R “Accounting
for Stock-Based Compensation” (“SFAS 123R”), 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 the Emerging Issues Task
Force consensus in Issue No. 96-18, "Accounting for Equity Instruments that are
issued to Other than Employees for Acquiring, or in Conjunction with Selling
Goods or Services" ("EITF 96-18"), as the fair value of the consideration
received or the fair value of equity instruments issued, whichever is more
reliably measured. SFAS 123R allows the “simplified” method to determine the
term of employee options when other information is not available.
Changes
in Accounting Standards
In
January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment
Guidance of EITF Issue No. 99-20, and EITF Issue No. 99-20, Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets” (“FSP EITF 99-20-1”). FSP EITF 99-20-1 changes the
impairment model included within EITF 99-20 to be more consistent with the
impairment model of SFAS No. 115. FSP EITF 99-20-1 achieves this by amending the
impairment model in EITF 99-20 to remove its exclusive reliance on “market
participant” estimates of future cash flows used in determining fair value.
Changing the cash flows used to analyze other-than-temporary impairment from the
“market participant” view to a holder’s estimate of whether there has been a
“probable” adverse change in estimated cash flows allows companies to apply
reasonable judgment in assessing whether an other-than-temporary impairment has
occurred. The adoption of FSP EITF 99-20-1 did not have a material impact on the
consolidated financial statements because all of the investments in debt
securities are classified as trading securities.
In April
2009, the FASB issued three related FASB Staff Positions: (i) FSP FAS No. 115-2
and FAS No. 124-2, Recognition of Presentation of Other-Than-Temporary
Impairments (“FSP FAS 115-2 and FAS 124-2”), (ii) FSP FAS No. 107-1 and APB No.
28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP FAS
107-1 and APB 28-1”), and (iii) FSP FAS No. 157-4, Determining the 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”), which are effective for interim and annual reporting periods ending
after June 15, 2009. FSP FAS 115-2 and FAS 124-2 modifies the requirement for
recognizing other-than-temporary impairments, changes the existing impairment
model, and modifies the presentation and frequency of related disclosures. FSP
FAS 107-1 and APB 28-1 require disclosures about fair value of financial
instruments for interim reporting periods as well as in annual financial
statements. FSP 157-4 requires new disclosures regarding the
categories of fair value instruments, as well as the inputs and valuation
techniques utilized to determine fair value and any changes to the inputs and
valuation techniques during the period. The adoption of these FASB Staff
Positions did not have a material impact the Company’s consolidated financial
statements.
In
May 2009, the FASB issued SFAS No. 165, “Subsequent Events.” SFAS
No. 165 establishes the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements; the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements; and the
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. We adopted this standard during the
second quarter of 2009. FAS 165 requires that public entities
evaluate subsequent through the date that the financial statements are
issued. We have evaluated subsequent events through the date the
financial statements were issued.
In
June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of
Financial Assets—an amendment of FASB Statement No. 140.” SFAS No. 166
eliminates the concept of a “qualifying special-purpose entity” and clarifies
the determination of whether a transferor and all of the entities included
in the transferor’s financial statements being presented have surrendered
control over transferred financial assets. SFAS No. 166 requires that a
transferor recognize and initially measure at fair value all assets obtained
(including a transferor’s beneficial interest) and liabilities incurred as a
result of a transfer of financial assets accounted for as a sale. Enhanced
disclosures are required to provide financial statement users with greater
transparency about transfers of financial assets and a transferor’s continuing
involvement with transferred financial assets. This statement will not have an
impact on the Company’s financial statements.
In
June 2009, the FASB issued SFAS No. 167, “Amendments to FASB
Interpretation No. 46(R)” (“SFAS No. 167”). SFAS No. 167 amends
FIN 46(R), “Consolidation of Variable Interest Entities (revised
December 2003)—an interpretation of ARB No. 51” (“FIN 46(R)”) to
require an enterprise to perform a qualitative assessment of whether the
enterprise’s variable interest or interests give it a controlling financial
interest in a variable interest entity. This assessment identifies the primary
beneficiary of a variable interest entity as one with the power to direct the
activities of a variable interest entity that most significantly impact the
entity’s economic performance and the obligation to absorb losses of the entity
that could potentially be significant to the variable interest. SFAS
No. 167 will be effective as of the beginning of the annual reporting
period commencing after November 15, 2009 and will be adopted by the
Company in the first quarter of 2010. The Company is assessing the potential
impact, if any, of the adoption of SFAS No. 167 on its consolidated
financial statements
In June,
2009 the FASB issued FAS No. 168, The FASB Accounting Standards
Codification TM and the Hierarchy of Generally Accepted Accounting Principles, a
replacement of FASB Statement No. 162 (FAS 168), which establishes the FASB
Accounting Standards Codification as the source of authoritative accounting
principles recognized by the FASB to be applied in the preparation of financial
statements in conformity with generally accepted accounting principles. FAS 168
explicitly recognizes rules and interpretive releases of the Securities and
Exchange Commission (SEC) under federal securities laws as authoritative
GAAP for SEC registrants. FAS 168 is effective for financial statements issued
for interim and annual periods ending after September 15, 2009. Our
Quarterly Report on Form 10-Q for the quarter ending September 26, 2009 and all
subsequent public filings will reference the Codification as the sole source of
authoritative literature.
Off-Balance
Sheet Transactions
We do not
have any off-balance sheet arrangements.
Seasonality
Our
operating results and operating cash flows historically have not been subject to
seasonal variations. This pattern may change, however, as a result of new market
opportunities or new product introductions.
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
Not
applicable.
Item 4. Controls and
Procedures.
Evaluation
of Disclosure Controls and Procedures
Our
management, with the participation of our chief executive officer and chief
financial officer, Messrs. Siping Fang and Ms. Ichi Shih
respectively, evaluated the effectiveness of our disclosure controls and
procedures. The term “disclosure controls and procedures,” as defined in Rules
13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other
procedures of a company that are designed to ensure that information required to
be disclosed by a company in the reports, such as this report, that it files or
submits under the Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the SEC’s rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by a company in the
reports that it files or submits under the Exchange Act is accumulated and
communicated to the company’s management, including its principal executive and
principal financial officers, as appropriate to allow timely decisions regarding
required disclosure. Management recognizes that any controls and procedures, no
matter how well designed and operated, can provide only reasonable assurance of
achieving their objectives and management necessarily applies its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
Based on that evaluation, Mr. Fang and Ms. Shih concluded that despite
improvements in areas of previously identified weakness in internal control over
financial reporting identified (described below), our disclosure controls and
procedures were not effective as of June 30, 2009.
Changes
in Internal Control over Financial Reporting
The
Company’s management is focused on compliance with the requirements under
Section 404 of the Sarbanes-Oxley Act. The relevant section of the Act requires
the management of smaller reporting companies with equity securities listing in
the U.S. securities market to issue report and representations as to the
internal control over financial reporting. The Company anticipates that it will
be fully compliant with Section 404 of the Sarbanes-Oxley Act of 2002 by the
required date for smaller reporting companies and it is currently in the process
of improving and rectifying its internal control systems in order to be
compliant with Section 404 of the Sarbanes-Oxley Act.
The
Company has continuously refined the policies and standards for the control
environment based on the risk control framework established in the Internal
Control Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission (the “COSO”). In the past few months, the Company
has: standardized control procedures for monitoring the financial reporting and
period end financial closing procedures at the subsidiary and group level and
upgraded the business performance review processes and controls; expanded
accounting manuals to clearly document key controls and processes for preparing
consolidated financial statements in accordance with applicable accounting
standards; hired additional accounting professionals with experience in
financial reporting and familiarity with international accounting practices and
increased technical training for the finance and accounting personnel in respect
of relevant accounting standards; established and implemented the code of ethics
for senior officers and employees, company-wide anti-fraud policies and whistle
blowing mechanisms; enhanced internal controls over subsidiaries by assessing
the effectiveness of internal controls at subsidiary-level based on our
enterprise risk assessment results and preliminarily formulated long term
implementation plan on internal control.
The
Company had completed the documentation and implementation of internal control
framework in June 2009.
PART
II — OTHER INFORMATION
Item
1. Legal Proceedings.
From time
to time, we may become involved in various lawsuits and legal proceedings which
arise in the ordinary course of business. However, litigation is subject to
inherent uncertainties, and an adverse result in these or other matters may
arise from time to time that may harm our business. We are currently not aware
of any such legal proceedings or claims that we believe will have a material
adverse affect on our business, financial condition or operating
results.
Item
1A. Risk Factors
Under
the New EIT Law, we may be classified as a “resident enterprise” of China. Such
classification will likely result in unfavorable tax consequences to us and our
non-PRC shareholders.
China
passed a new Enterprise Income Tax Law, or the New EIT Law, and its implementing
rules, both of which became effective on January 1, 2008. Under the New EIT Law,
an enterprise established outside of China with “de facto management bodies”
within China is considered a “resident enterprise,” meaning that it can be
treated in a manner similar to a Chinese enterprise for enterprise income tax
purposes. The implementing rules of the New EIT Law define de facto
management as “substantial and overall management and control over the
production and operations, personnel, accounting, and properties” of the
enterprise.
On April
22, 2009, the State Administration of Taxation issued the Notice Concerning
Relevant Issues Regarding Cognizance of Chinese Investment Controlled
Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria
of de facto Management Bodies, or the Notice, further interpreting the
application of the New EIT Law and its implementation non-Chinese enterprise or
group controlled offshore entities. Pursuant to the Notice, an
enterprise incorporated in an offshore jurisdiction and controlled by a Chinese
enterprise or group will be classified as a “non-domestically incorporated
resident enterprise” if (i) its senior management in charge of daily operation
reside or perform their duties mainly in China; (ii) its financial or personnel
decisions are made or approved by bodies or persons in China; (iii) its
substantial properties, accounting books, corporate chops, board and shareholder
minutes are kept in China; and (iv) ½ directors with voting rights or senior
management often resident in China. Such resident enterprise would be
subject to an enterprise income tax rate of 25% on its worldwide income and must
pay a withholding tax at a rate of 10% when paying dividends to its non-PRC
shareholders. However, it remains unclear as to whether the Notice is
applicable to an offshore enterprise incorporated by a Chinese natural
person. Nor are detailed measures on imposition of tax from
non-domestically incorporated resident enterprises are
available. Therefore, it is unclear how tax authorities will determine tax
residency based on the facts of each case.
However,
as our case substantially meets the foregoing criteria, there is a likelihood
that we are deemed to be a resident enterprise by Chinese tax
authorities. If the PRC tax authorities determine that we are a “resident
enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC
tax consequences could follow. First, we may be subject to the enterprise income
tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise
income tax reporting obligations. In our case, this would mean that income such
as interest on financing proceeds and non-China source income would be subject
to PRC enterprise income tax at a rate of 25%. Second, although under the New
EIT Law and its implementing rules dividends paid to us from our PRC
subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such
dividends will not be subject to a 10% withholding tax, as the PRC foreign
exchange control authorities, which enforce the withholding tax, have not yet
issued guidance with respect to the processing of outbound remittances to
entities that are treated as resident enterprises for PRC enterprise income tax
purposes. Finally, it is possible that future guidance issued with
respect to the new “resident enterprise” classification could result in a
situation in which a 10% withholding tax is imposed on dividends we pay to our
non-PRC shareholders and with respect to gains derived by our non-PRC
shareholders from transferring our shares. We are actively monitoring
the possibility of “resident enterprise” treatment for the 2008 tax year and are
evaluating appropriate organizational changes to avoid this treatment, to the
extent possible.
If we
were treated as a “resident enterprise” by PRC tax authorities, we would be
subject to taxation in both the U.S. and China, and our PRC tax may not be
creditable against our U.S. tax.
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
None.
Item
3. Defaults Upon Senior Securities
None.
Item
4. Submission of Matters to a Vote of Security Holders.
None.
Item
5. Other Information.
On August
14, 2009, the Company entered into an amendment (the “Amendment”) to the Make
Good Escrow Agreement (the “Make Good Agreement”), dated as of August 26, 2008,
among the Company, Bin Li, Brean Murray Carret & Co., LLC as investor agent
and Escrow, LLC, as escrow agent. The Amendment revised the
2009 guaranteed after tax net income the Company was obligated to achieve under
the Make Good Agreement from $23 million to $21 million and the earnings per
share for 2009 was revised from $0.738 to $0.668. The Amendment also revised the
2010 guaranteed after tax net income the Company was obligated to achieve from
$31 million to $34 million and the earnings per share for 2010 was revised from
$0.994 to $1.082.
Item
6. Exhibits.
EXHIBITS.
10.1
*
|
Form
of Amendment Number 1 to Make Good Escrow Agreement, dated August 14,
2009, among China Valves Technology, Inc. Bin Li, Brean Murray Carret
& Co., LLC, Investors identified therein and Escrow,
LLC.
|
|
|
31.1*
|
Certification
of Principal Executive Officer filed pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
31.2*
|
Certification
of Principal Financial Officer filed pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
32.1*
|
Certification
of Principal Executive Officer furnished pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
|
32.2*
|
Certification
of Principal Financial Officer furnished pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
DATED:
August 14, 2009
CHINA
VALVES TECHNOLOGY, INC.
|
|
|
/s/
Ichi Shih
|
Ichi
Shih
|
Chief
Financial Officer (Principal Financial
Officer)
|
EXHIBIT
INDEX
10.1
*
|
Form
of Amendment Number 1 to Make Good Escrow Agreement, dated August 14,
2009, among China Valves Technology, Inc. Bin Li, Brean Murray Carret
& Co., LLC, Investors identified therein and Escrow,
LLC.
|
|
|
31.1*
|
Certification
of Principal Executive Officer filed pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
31.2*
|
Certification
of Principal Financial Officer filed pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
32.1*
|
Certification
of Principal Executive Officer furnished pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
|
32.2*
|
Certification
of Principal Financial Officer furnished pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|