Allocation of the proceeds:
After allocating $1,052,000 to the initial fair value of warrants derivative liabilities, and agent fee of $730,187, the remaining proceeds received from the convertible note of $3,409,813 were allocated to placement agent common stock and convertible note payable based on their relative fair value. This results in a debt discount of $2,439,743 from the face amount of the convertible note payable, accordingly, the discount is being amortized over the life of the note to accrete the note to its redemption value. The proceeds allocation is as follows:
| February 12, 2010 convertible note finance | | | |
| Gross proceeds | | $ | 4,140,000 | |
| Less cash fee paid to placement agent | | | 730,187 | |
| Net proceeds | | $ | 3,409,813 | |
| | | | | |
| Record warrant as derivative liability | | $ | 1,052,000 | |
| Allocated remaining proceeds to : | | | | |
| Common stock issued to placement agents | | | 657,556 | |
| Convertible Note | | | 1,700,257 | |
| | | $ | 3,409,813 | |
13. Receivable from Related Party:
As of June 30, 2010, receivable from related party in the amount of $1,111 was an advance to shareholders for travel related expenses occurring in normal course of business.
14. Subsequent Events
.
On July 26, 2010, the Company repaid outstanding term loan in amount of $2,927,961 (20,000,000 in RMB) to Agricultural Bank of China, Foshan Branch. On July 27, 2010, the Company entered into an agreement with the same branch office to borrow $2,927,961 (20,000,000 in RMB) with a term of 5 months. Interest on the new loan is payable on monthly basis at rates ranging from 5.85% to 7.75% per annum.
On August 4, 2010, the Company appointed Eric Gan as Chief Financial Officer. The compensation package included an annual salary of $120,000 and grant of non-statutory stock options to acquire 400,000 shares of the Company’s common stock. The options vest over a period of three years.
15. Earnings per Share
Basic earnings per share is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding during the year. Diluted earnings per share is calculated by dividing net income attributable to common shareholders as adjusted for the effect of dilutive common equivalent shares, if any, by the weighted average number of common and dilutive common equivalent shares outstanding during the year. Common equivalent shares consist of the common shares issuable upon the conversion of the convertible note (using the if-converted method) and common shares issuable upon the exercise of outstanding warrants (using the treasury stock method). Diluted EPS excludes all dilutive potential shares if their effect is anti dilutive.
| | | For the three months ended | |
| | | June 30, 2010 | | | | June 30, 2009 | |
| Net Income | | | | | | | |
| (numerator for basic income per share) | | $ | 429,768 | | | | $ | 357,462 | |
| Plus interest on convertible note | | | 697,811 | | | | | - | |
| Net Income - assumed conversions | | | | | | | | | |
| (numerator for diluted income per share) | | $ | 1,127,579 | | | | $ | 357,462 | |
| | | | | | | | | | |
| Weighted average common shares | | | | | | | | | |
| (denominator for basic income per share) | | | 15,245,604 | | | | | 14,510,204 | |
| | | | | | | | | | |
| Effect of Dilutive Securities: | | | | | | | | | |
| Warrants - treasury stock method | | | - | | | | | - | |
| Convertible note as if-converted method | | | 1,971,429 | | | | | - | |
| Weighted average common shares | | | | | | | | | |
| (denominator for diluted income per share) | | | 17,217,033 | | | | | 14,510,204 | |
| | | | | | | | | | |
| Basic net income per share | | $ | 0.03 | | | | $ | 0.02 | |
| Diluted net income per share | | $ | 0.07 | | Antidilutive | | $ | 0.02 | |
China Filtration Technology, Inc.
Notes to Consolidated Financial Statements for the six months ended March 31, 2010(Unaudited - - Expressed in US dollars)| | | For the nine months ended | |
| | | June 30, 2010 | | | | June 30, 2009 | |
| Net Income | | | | | | | |
| (numerator for basic income per share) | | $ | 2,169,448 | | | | $ | 1,089,208 | |
| Plus interest on convertible note | | | 1,114,535 | | | | | - | |
| Net Income - assumed conversions | | | | | | | | | |
| (numerator for diluted income per share) | | $ | 3,283,983 | | | | $ | 1,089,208 | |
| | | | | | | | | | |
| Weighted average common shares | | | | | | | | | |
| (denominator for basic income per share) | | | 14,879,603 | | | | | 14,510,204 | |
| | | | | | | | | | |
| Effect of Dilutive Securities: | | | | | | | | | |
| Warrants - treasury stock method | | | - | | | | | - | |
| Convertible note as if-converted method | | | 1,007,064 | | | | | - | |
| Weighted average common shares | | | | | | | | | |
| (denominator for diluted income per share) | | | 15,886,667 | | | | | 14,510,204 | |
| | | | | | | | | | |
| Basic net income per share | | $ | 0.15 | | | | $ | 0.08 | |
| Diluted net income per share | | $ | 0.21 | | Antidilutive | | $ | 0.08 | |
15. | 16. Accounting for Warrants |
The warrants issued in conjuctionconjunction with the convertible notes have the following material terms:
The warrants are exercisable at any time during a five-year period commencing on the closing of a “financing,” which means the first sale (or series of related sales) by us of stock (or debt or equity securities convertible into stock), in a capital raising transaction, occurring after the maturity date (or the date the notes become due pursuant to a default, if earlier) with aggregate gross proceeds of at least $2,000,000. The warrants cannotcan not be exercised if no financing is consummated within five-year period after the issue date and become void if the notes automatically convert into common stock.
Number of Shares: The warrants represent the right to purchase 8% of the total shares of common stock outstanding (on a fully-diluted basis) immediately after the closing of the financing.
Exercise Price: The warrants are exercisable at the price for which the shares of common stock (or common stock equivalent if derivative securities are sold) are sold in the financing. If the financing includes more than one type of security, the exercise price shall equal the lowest price per share of common stock or common stock equivalent included in the financing.
The Company analyzed the warrants and the conversion features in the notes to assess whether they meet the definition of a derivative under the guidance set forth by ASC Topic 815 (SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”) and, thereof, the applicability of the accounting rules in accordance to ASC Topic 815 to treat the warrants as derivative liabilities. Management also evaluated whether the warrants meet the scope exception set forth by ASC Topic 815-40 (“Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”), which is that contracts issued or held by the reporting entity that are both (1) indexed to its own stock and (2) classified in stockholders’ equity shall not be considered to be derivative instruments for purposes of ASC Topic 815. The provisions in ASC Topic 815-40 apply to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by ASC Topic 815 and to any freestanding financial instruments that are potentially settled in an entity’s own common stock.
Management concluded that the warrants issued in conjunction with the private placement of convertible notes in February 2010 to certain accredited investors should be treated as a derivative liabilityliability. Derivative instruments are recorded at fair value and the derivative accounting rules under ASC Topic 815-40 were adopted to record the warrants. Fair market value of the warrants were measured using the Black-Scholes pricing model at the issuance date and recorded as warrants liabilities. Changemarked-to-market each period until they are exercised or expire, with any change in the fair value of the warrants is recorded in othercharged or credited to income or loss in the statement of operations in the future reporting periods. Change in warrant value from February 2010 to March 31, 2010 were not material.each period.
As a result of adopting accounting treatment of ASC Topic 815-40, $1,052,000 waswarrants are recorded as warrantsderivative liabilities and valued at $1,052,000 based on 1,218,857 shares entitled underusing the Black-Scholes pricing model on the date of issuance and as of March 31, 2010. Because there was no trade market for the Company’s stock, management used substitute volatility in the initial and subsequent measuring of the fair market value of the warrants issued. Management re-measured the fair market value based on the adjusted volatility of publicly traded stock of a company with similar business and the remaining term of the warrants. As of June 30, 2010, these warrants were valued at$690,000. The valuation inputs asare provided in the table as follows.
| February 2010 Financing Warrants - Valuation Inputs | | |
| | | February 12 and March 31, | | | At date of issuance | | As of | |
| Attribute | | 2010 | | | February 12, 2010 | | June 30, 2010 | |
| Stock Price | | $ | 2.45 | | |
| | | | | | | |
| Warrants outstanding | | | 1,218,857 | (*) | | 1,218,857 | (*) |
| Exercise Price | | | $ | 2.45 | | $ | 2.45 | |
| Risk Free Interest Rate | | | 2.25 | % | | 2.25 | % | | 0.32 | % |
| Volatility | | | 90.00 | % | | 90 | % | | 70 | % |
| Exercise Price | | $ | 2.45 | | |
| Dividend Yield | | | 0 | % | | 0 | % | | 0 | % |
| Contractual Life (Years) | | | 1 | | |
| Contractual Life (years) | | | 1 | | 0.7 | |
(*) Warrants outstanding is based on 8% of the total outstanding common shares
China Filtration Technology, Inc.
Notes to Consolidated Financial Statements for the six months ended March 31, 2010
(Unaudited - - Expressed in US dollars)
16. | Recent accounting pronouncements |
17. Income Taxes
In June 2009USA
The Company and its subsidiary and branch divisions are subject to income taxes on an entity basis on income arising in, or derived, from the FASB establishedtax jurisdiction in which they operate. As the Accounting Standards Codification (“Codification” or “ASC”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with generally accepted accounting principlesCompany had no income generated in the United States, (“GAAP”). Rules and interpretive releasesthere was no tax expense or tax liability due to the Internal Revenue Service of the SecuritiesUnited States as of June 30, 2010 and Exchange Commission (“SEC”) issuedSeptember 30, 2009.
BVI
Hong Hui is incorporated under authority of federal securities laws are also sources of GAAP for SEC registrants. Existing GAAP was not intended to be changed as a resultthe International Business Companies Act of the Codification,British Virgin Islands and accordingly, the change did not impact our financial statements. The ASC does change the way the guidance is organized and presented.exempted from payment of British Virgin Island’s income taxes.
Statement of Financial Accounting Standards (“SFAS”) SFAS No. 165 (ASC Topic 855), “Subsequent Events”, SFAS No. 166 (ASC Topic 810), “Accounting for Transfers of Financial Assets – an Amendment of FASB Statement No. 140”, SFAS No. 167 (ASC Topic 810), “Amendments to FASB Interpretation No. 46(R)”, and SFAS No. 168 (ASC Topic 105), “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement No. 162” were recently issued. SFAS No. 165, 166, 167, and 168 have no current applicabilityPRC
Pursuant to the Company or their effectPRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for Foshan. For 2008 and 2009 Foshan enjoys tax free holiday for two years. From January 2010 onwards, Foshan is taxed at 25% of net income except for the 2010 and 2011years where there is 50% discount on the financial statements would not have been significant.income tax.
Accounting Standards Update (“ASU”) ASU No. 2009-05 (ASC Topic 820), which amends Fair Value MeasurementsThe current year tax provision was $6,328 and Disclosures – Overall, ASU No. 2009-13 (ASC Topic 605), Multiple Deliverable Revenue Arrangements, ASU No. 2009-14 (ASC Topic 985), Certain Revenue Arrangements that include Software Elements,$6,328 for the three and Variousnine months ended June 30, 2010, respectively. The Company has recorded zero deferred tax assets or liabilities as of June 30, 2010 and September 30, 2009 net of tax allowance because all other ASU’s No. 2009-2 through ASU No. 2010-19 which contain technical corrections to existing guidance or affect guidance to specialized industries or entities were recently issued. These updates have no current applicability to the Company or their effect on thesignificant difference in tax basis and financial statements would not have been significant.statement amounts are permanent differences.
| | | For the three months ended | | | For the nine months ended | |
| | | June 30, | | | June 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| | | | | | | | | | | | | |
| Income Tax Expense: | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Current tax | | $ | 6,328 | | | $ | 0 | | | $ | 6,328 | | | $ | 0 | |
| Change in deferred tax assets – Net operating loss | | | 46,911 | | | | 76,959 | | | | 285,019 | | | | 199,513 | |
| | | | | | | | | | | | | | | | | |
| Change in valuation allowance | | | (46,911 | ) | | | (76,959 | ) | | | (285,019 | ) | | | (199,513 | ) |
| | | | | | | | | | | | | | | | | |
| Total | | $ | 6,328 | | | $ | 0 | | | $ | 6,328 | | | $ | 0 | |
We follow the guidance in FASB ASC 740 Accounting for Uncertainty in Income Taxes . We have not taken any uncertain tax positions on any of our open income tax returns filed through the period ended June 30, 2010. Our methods of accounting are based on established income tax principles and are properly calculated and reflected within our income tax returns. In addition, we have timely filed extension of income tax returns in all applicable jurisdictions in which we believe we are required to make an income tax return filing.
We re-assess the validity of our conclusions regarding uncertain tax positions on a quarterly basis to determine if facts or circumstances have arisen that might cause us to change our judgment regarding the likelihood of a tax position’s sustainability under audit. We have determined that there were no uncertain tax positions for the nine months ended June 30, 2010 and 2009.
All of the Company’s income before income taxes is from PRC sources. Actual income tax expense reported in the consolidated statements of operations and comprehensive income differ from the amounts computed by applying the PRC statutory income tax rate of 12.5% (50% discount of 25%) to income before income taxes for the three and nine months ended June 30, 2010 for the followings reasons:
| | | For the three months ended | | | For the nine months ended | |
| | | June 30, | | | June 30, | |
| | | 2010 | | | 2009 | | | 2010 | | | 2009 | |
| | | | | | | | | | | | | |
| Income before income taxes | | $ | 436,096 | | | $ | 357,462 | | | $ | 2,175,776 | | | $ | 1,089,208 | |
| | | | | | | | | | | | | | | | | |
| Computed “expected” income tax expense at 12.5% and zero in 2010 and 2009 | | $ | 142,363 | | | $ | - | | | $ | 411,914 | | | $ | - | |
| Tax effect of net taxable permanent differences | | | (89,124 | ) | | | - | | | | (120,567 | ) | | | - | |
| | | | | | | | | | | | | | | | | |
| Effect of cumulative tax losses | | | (46,911 | ) | | | - | | | | (285,019 | ) | | | - | |
| | | | | | | | | | | | | | | | | |
| | | $ | 6,328 | | | $ | - | | | $ | 6,328 | | | $ | - | |
Our policy for recording interest and penalties associated with audits is to record such items as a component of income tax expense. There were no interest and penalties recorded for the nine months ended June 30, 2010 and 2009.
18. Accounting for stock-based compensation
The Company accounts for stock-based compensation under ASC 718 - Stock Compensation which establishes standards for the accounting for equity instruments exchanged for employee services. Under the provisions of ASC 718, share-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as an expense over the employee's requisite service period (generally the vesting period of the equity grant), net of estimated forfeitures. In May 2010, pursuant to the company’s 2010 stock incentive plan, 30,000 shares of restricted common stock were granted to an independent director with a vesting period of three years. Vested portion is recognized in the restated financial statements.
19. Recent Accounting Pronouncements
Fair Value Measurements
In January 2010, the FASB issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires disclosure of transfers of assets and liabilities between Level 1 and Level 2 of the fair value measurement hierarchy, including the reasons and the timing of the transfers and information on purchases, sales, issuance, and settlements on a gross basis in the reconciliation of the assets and liabilities measured under Level 3 of the fair value measurement hierarchy. The guidance is effective for annual and interim reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual and interim periods beginning after December 15, 2010. The Company adopted this guidance at January 1, 2010, except for the Level 3 reconciliation disclosures on the roll-forward activities, which it will adopt at the beginning of January 1, 2011. Adoption did not have a material impact on our consolidated financial statements.
Receivables
In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310), Effect of a Loan Modification When the Loan is Part of A Pool That Is Accounted for as a Single Asset . ASU 2010-18 provides that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loans are included is impaired if expected cash flows for the pool change. This guidance is effective prospectively for the first interim and annual period ending on or after July 15, 2010. Early adoption is permitted. The Company adopted this guidance without a material impact on its consolidated financial statements.
Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying financial statements.
20. Restatements of Previously Issued Financial Statements
Subsequent to the issuance of our consolidated financial statements for the three and nine months ended June 30, 2010, included in our Quarterly Report on Form 10-Q for the period ended June 30, 2010, filed with the United States Securities and Exchange Commission on August 16, 2010, and in connection with the SEC’s review of our registration statement on Form S-1 (File No. 333-168028), originally filed on July 8, 2010, as amended on September 7, 2010 and October 15, 2010, it was identified that (i) we failed to record a liability of $75,000 owed to each of United Best and Primary Capital (totaling $150,000) for advisory services rendered in connection with our private placement of convertible notes which closed on February 12, 2010, and (ii) we failed to record a grant of 30,000 shares of common stock in June 2010 to a director of the Company.
Accordingly, we have revised the previously issued consolidated financial statements to include the unpaid $150,000 advisory service fees and $5,000 as stock-based compensation expense in our consolidated balance sheet, consolidated statements of operations, consolidated statement of changes in stockholders’ equity and consolidated statements of cash flows for the periods affected. The following tables highlight changes to specific accounts affected:
| | | As reported | | | As restated | |
| | | June 30, 2010 | | | June 30, 2010 | |
| | | | | | | |
| Accounts payable and accrued liabilities | | $ | 696,703 | | | $ | 846,703 | |
| Total Current Liabilities | | $ | 7,845,182 | | | $ | 7,995,182 | |
| Common stock, $0.001 par value | | $ | 15,236 | | | $ | 15,266 | |
| Additional paid-in capital | | $ | 8,205,582 | | | $ | 8,210,552 | |
| Retained earnings | | $ | 6,824,980 | | | $ | 6,669,980 | |
| Total Stockholders’ equity | | $ | 16,728,172 | | | $ | 16,578,172 | |
A restatement of the consolidated statements of operations and comprehensive income affected the three month and nine month periods ended June 30, 2010 in general and administrative expenses as follows:
| | | Three months ended | | | Nine months ended | |
| | | 30-Jun-10 | | | 30-Jun-10 | |
| | | As reported | | | As restated | | | As reported | | | As restated | |
| Selling, General and Administrative Expenses | | $ | 701,436 | | | $ | 706,436 | | | $ | 1,363,574 | | | $ | 1,518,574 | |
| Income from Operations | | $ | 833,784 | | | $ | 828,784 | | | $ | 3,174,838 | | | $ | 3,019,838 | |
| Income before Income Taxes | | $ | 441,096 | | | $ | 436,096 | | | $ | 2,330,776 | | | $ | 2,175,776 | |
| Net Income | | $ | 434,768 | | | $ | 429,768 | | | $ | 2,324,448 | | | $ | 2,169,448 | |
| Earings per share – basic and diluted | | $ | 0.03 | | | $ | 0.03 | | | $ | 0.15 | | | $ | 0.15 | |
| Weighted-average Common Stock Shares Outstanding | | | | | | | | | | | | | | | | |
| Basic | | | 15,235,714 | | | | 15,245,604 | | | | 14,879,603 | | | | 14,879,603 | |
| Diluted | | | 16,925,510 | | | | 17,217,033 | | | | 15,739,975 | | | | 15,886,667 | |
Statements of Cash Flows for the nine months ended June 30, 2010 are restated under net income and accounts payable and accrued liabilities as follows:
| | | As reported | | | As restated | |
| | | June 30, 2010 | | | June 30, 2010 | |
| | | | | | | |
| Net income | | $ | 2,324,448 | | | $ | 2,169,448 | |
| Stock based Compensation | | $ | 0 | | | $ | 5,000 | |
| Accounts payable and accrued liabilities | | $ | 282,009 | | | $ | 432,009 | |
The net cash provided by the operating activities, the net cash used in investing activities, and the net cash provided by financing activities are not affected by the restatements.
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Special Note Regarding Forward LookingForward-Looking Statements
This Quarterly Reportreport contains some forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements give our current expectations or forecasts of future events. Forward-looking statements involve risks and uncertainties. You can identify these statements by the fact that they do not relate strictly to historical or current facts. In some cases they are identifiable by use of the words “may,” “will,” “should,” “anticipate,” “estimate,” “plan,” “potential,” “projects,” “continuing,” “ongoing,” “expects,” “management believes,” “we believe,” “we intend” or the negative of these words or other variations on Form 10-Q, including the followingthese words or comparable terminology. These statements may be found under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,Operations.” containsIn particular, these include statements relating to future actions, future performance, sales efforts, expenses, the outcome of contingencies such as legal proceedings, and financial results.
Any or all of our forward-looking statements that are basedin this report may turn out to be inaccurate. They can be affected by inaccurate assumptions we might make or by known or unknown risks or uncertainties. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially as a result of various factors, including, without limitation, the risks outlined under "Risk Factors" in our registration statement of Form S-1 (File No. 333-168028), originally filed on the beliefsJuly 8, 2010, as amended on September 7, 2010 and October 15, 2010 (the “S-1”). In light of our management, and involvethese risks and uncertainties, as well as assumptions,there can be no assurance that if they ever materialize or prove incorrect, could cause actual results to differ materially from those expressed or implied by such forward-looking statements. The words “believe,” “expect,” “anticipate,” “project,” “targets,” “optimistic,” “intend,” “aim,” “will” or similar expressions are intended to identify forward-looking statements. All statements, other than statements of historical fact, are statements that could be deemedthe forward-looking statements including statements regarding new and existing products, technologies and opportunities; statements regarding market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; uncertainties related to conducting business in China; any statements of belief or intention; any of the factors and risks mentioned in the “Risk Factors” sections of our Current Report on Form 8-K filed with the Securities and Exchange Commission on February 12, 2010, and any statements of assumptions underlying any of the foregoing. All forward-looking statements includedcontained in this report are basedfiling will in fact occur and you should not place undue reliance on information available to us on the date of this report. We assume no obligation and do not intend to update these forward-looking statements, except as required by law.statements.
INTRODUCTIONIntroduction
This section discusses and analyzes the results of operations and financial condition of China SLP Filtration Technology, Inc., formerly known as Perpetual Technologies, Inc., (“we,” “us,” or the “Company”) which is the ultimate parent company of Foshan S.L.P. Special Materials Co., Ltd. (“Foshan”), a PRC-basedChina-based operating company located in Foshan, Guangdong Province in the PRC.
People’s Republic of China. On February 12, 2010, we acquired control of Foshan in a share exchange transaction which closed on that date.
In the share exchange or “reverse merger” we acquired control of Hong Hui Holdings Limited (“Hong Hui”), a British Virgin Islands company and the owner of all of the stock of Technic International Limited (“Technic”), a Hong Kong holding company which in turn is the owner of all of the equity of Foshan, by issuing to the Hong Hui stockholders an aggregate of 14,510,204 shares of our common stock in exchange for all of the outstanding capital stock of Hong Hui.
The transaction is accounted for as a reverse acquisition, except that no goodwill or other intangible has been recorded. The recapitalization is considered to be a capital transaction in substance, rather than a business combination. Beginning with the quarter ended March 31, 2010 the operating results of Foshan are consolidated in the Company’s financials results for that period.
Foshan is engaged in the manufacture, sale, and research and development of advanced spun-bond PET, or polyester, non-wovens.
Nonwoven fabrics are broadly defined as sheet or web structures bonded together by entangling fiber or filaments (and by perforating films) mechanically, thermally or chemically. They are flat, porous sheets that are made directly from separate fibers or from molten plastic or plastic film. They are not made by weaving or knitting and do not require converting the fibers to yarn.
Our major market is the Chinese market. In recent years, our products have been successfully launched in the European, North American and South East Asian markets.
Currently, our major products are spun-bond, thermal calendaring and needle-punched industrial non-woven PET (polyester) and PP (polypropylene) fabrics. These products are used as filtration media and infrastructure engineering material, among other uses.
We currently operate three spun-bond production lines. Two lines are spun-bond, thermal calendaring production lines with a total annual capacity of 4,000 tons of spun-bond polyester filament thermal calendaring nonwoven. In February 2009, we added the third line, spun-bond needle-punching production line with an annual capacity of 4,000 tons of spun-bond polyester filament, needle-punched nonwoven fabric.
We recently developed a continuous filament, spun-bond, needle-punched manufacturing process to manufacture polyphenylene sulfide fiber, or PPS, a specialized type of high temperature resistant nonwoven fabric and intend to begin commercial production of PPS using our proprietary manufacturing process in 2010. We have applied for a process patent in the PRC for this process (Patent No. PRC: 201010102660.2) and we intend to apply for a process patent in North America and Europe. In comparison to other filtering materials currently available, we believe that our nonwoven fabric will be stronger, have lower production and operating costs, and will have higher filtration efficiency. We have tested our PPS material nonwoven fabric internally and, although a prototype using our material has not yet been deployed by any industrial end user, we believe that our material has the potential to replace the filtration materials and products currently available and become the most popular filtration material in high temperature environments such as coal-fired power plants, garbage incinerators and cement factories.
On March 24, 2010 the Company effected a 1 for 5 reverse stock split of its outstanding common stock. The effect of the reverse split is retrospectively showed in all periods presented.
Overview
This section discusses and analyses our results of operations and financial condition, including the results and condition of our operating company, Foshan, which have been consolidated with our own results for all periods presented. This discussion is intended to help you understand our financial results and the current facts and trends that may cause them to change, so that you may make informed judgments about our likely financial results in the future and, insofar as those results may affect our stock price and informed investment decisions.
GeneralOn February 12, 2010, immediately following
We are a PRC based manufacturer of nonwoven fabrics. We currently manufacture two types of PET nonwoven fabrics which are used in a wide range of products, including filtration products, road construction materials, home furnishings, automobile interior insulation and industrial packaging.
Our current PET products are sold primarily to PRC-based manufacturers which use our products as raw material components for end-products they sell to their customers. We recently developed a manufacturing process to manufacture polyphenylene-sulfide fiber, or PPS nonwoven fabric, which is the reverse merger,key product line around which our long-term growth strategy is centered.
Based on lab tests which we conducted internally we believe that our PPS nonwoven fabric is superior to other currently available high temperature filtration material because it is lighter, thicker, stronger, has higher air permeability and filtration efficiency and significantly cheaper to produce. Due to the Company entered intosuperior characteristics of our PPS product coupled with the demand created by these new regulations, we believe that our PPS material will become a note purchase agreement with certain accredited investorsmarket leader for the salehigh temperature filtration applications. We expect to sell our PPS nonwoven products to operators of convertible notes in the aggregate principal amount of $4,140,000coal fired power plants, garbage incinerators and warrants (which are exercisable only in certain circumstances), with net proceeds of $3.2 million after finance costs. The notes require quarterly interest payments at a rate of 10% per annum.other heavy industrial plants.
We intend for this discussion to providecontinue to manufacture PET nonwovens but we expect that the reader with information thatsales of our PPS nonwoven fabrics will assist in understandingultimately eclipse the sales of our financial statements, the changes in certain key items in those financial statements from year to year,existing PET nonwoven products and the primary factors that accounted for those changes, as well as how certain accounting principles affectbecome our financial statements. This discussion should be read in conjunction with our audited financial statements and accompanying notes as of September 30, 2009, and for the year then ended and the unaudited condensed consolidated interim financial statements for the six monhts ended March 31, 2010.main product offering.
Our manufacturing facility, which is located in Foshan City, Guangdong Province, PRC, currently has three production lines for PET nonwovens with annual product capacity of 8,000 tons. We plan to begin commercial production of our PPS nonwoven fabric in the latter part of 2010 with the addition of three high tech production lines with annual production capacity of 3,600 tons, which will bring our total overall production capacity to 11,600 tons per year.
Results of Operations
Three Month PeriodMonths Ended March 31,June 30, 2010 comparedCompared to Three Month PeriodMonths Ended March 31, 2009
The following table shows, for the periods indicated, information derived from our consolidated statements of income in US dollars and as a percentage of net sales (percentages may not add due to rounding). See the financial statements of the Company and the related notes thereto and other financial information included elsewhere in this report.
| | | Three months ended March 31 | |
| | | 2010 | | | 2009 | |
| | | Amount | | | % | | | Amount | | | % | |
| Sales | | | 4,628,671 | | | | 100 | % | | | 2,214,940 | | | | 100 | % |
| Cost of Sales | | | 3,237,311 | | | | 70 | % | | | 1,373,921 | | | | 62 | % |
| Gross Profit | | | 1,391,360 | | | | 30 | % | | | 841,019 | | | | 38 | % |
| SG&A expense | | | 407,461 | | | | 9 | % | | | 275,526 | | | | 12 | % |
| Operating Income | | | 983,899 | | | | 21 | % | | | 565,493 | | | | 26 | % |
| Interest Income | | | 292 | | | | 0 | % | | | - | | | | 0 | % |
| Interest Expenses | | | (390,355 | ) | | | 8 | % | | | (76,286 | ) | | | 3 | % |
| Gain on disposal of fixed assets | | | 496 | | | | 0 | % | | | 0 | | | | 0 | % |
| Net Income before taxes | | | 594,332 | | | | 13 | % | | | 489,207 | | | | 22 | % |
| Net Income | | | 594,332 | | | | 13 | % | | | 489,207 | | | | 22 | % |
Sales
Net sales revenue consists of revenue from sales of needle punched non woven fabric and thermal calendared product. Net sales for three month period ended March 31, 2010 were $4,628,671, an increase of $2,413,731, or 109%, from $2,214,940 for the same period of prior year. In February 2009, we installed a new production line to manufacture needle punched non woven fabric. Sales of needle-punched products for the three month period ended March31, 2010 were $1,942,811 compared to $220,718 for the same period of the prior year. In addition, sales of thermal calendared materials for the three month period ended March 31, 2010 $2,308,801, as increase of $569,189 compared to $1,739,612 for the same period of the prior year.
Cost of Goods Sold
Cost of goods sold principally consists of the cost of raw materials, labor, and manufacturing overhead expenses.
Cost of goods sold for the three month period ended March 31, 2010 was $3,237,311, an increase of $1,863,390, or 136%, from $1,373,921 for the same period in 2009.
Raw material expenses increased to 52% of the sales for the three month period ended March 31, 2010, compared to 41% of sales for the same period of the prior year, reflecting a mix of more expensive raw materials associated with 2010 sales. 98.7 % of our raw materials consists of polyester the price of which fluctuates with the price of oil
Labor expenses were 6% of sales for the three month period ended March 31, 2010 compared to 2% for the same period of year 2009. Beginning in February 2009 we hired 17 additional employees to work the new production line. Labor costs also increased due to increased demand for labor.
Overhead expenses were 11% of net sales for the three month period ended March 31, 2010, compared to 19% of net sales for 2009 due to the increase of manufacturing capacity of the Company with the addition of the new production line in February 2009.
Gross Profit
Gross profits represents net sales less cost of goods sold. Gross profit for the three month period ended March 31, 2010 was $1,391,360, an increase of $550,341, or 65%, from $841,019 for the same period in 2009. As a percentage of net sales, gross profit was 30% for the three month period ended March 31, 2010, compared to 38% for the same period last year. This was primarily due to increase of purchase of price of the raw materials associated with 2010 sales, which price increase was caused by fluctuations in the price of oil.
Selling, Marketing and Administrative Expenses
Selling expenses include salaries, advertising expenses, cost of manufacturing, rent, and all expenses dirirectly related to producing and selling product. General expenses include general operating expenses that are directly related to the general operation of the company but excluding selling and administrative expenses. Administrative expense includes executive salaries and other expenses related to the overall administration of the company.
Selling, general and administrative expenses for the three month period ended March 31, 2010 were $407,461, an increase of $131,935 compared to $275,526 for the same period 1n 2009. The increase was primarily due to increase of $25,524 in export delivery expenses and $83,286 additional professional expenses incurred in connection with the company’s planned financing.
Other Expenses
Other expenses solely consist of interest expense.
Interest expense for the three month period ended March 31, 2010 was $390,355 compared to $76,286 for the same period in 2009. Interest expense as a percentage of sales increased to 8% for the three month period ended March 31, 2010 from 3% for the same period of last year. The increase in interest expense was principally due to interest on the convertible notes in the aggregate principal amount of $4,140,000. We accreted non-cash related interest expense in the amount of $304,950. Excluding the accretion of interest, our interest expense for this three-month period was the same as for the same period in 2009.Net Income
Net income for the three months ended March 31, 2010 increased by $105,125, from net income of $489,207 for the three month period ended March 31, 2009 to net income of $594,332. The increase was largely due to an increase in net sales due to the sales generated from new needle-punch products.
Six Month Period Ended March 31, 2010 compared to Six Month Period Ended March 31,June 30, 2009
The following table shows, for the periods indicated, information derived from our consolidated statements of income in US dollars and as a percentage of net sales (percentages may not add due to rounding). See the financial statements of the Company and the related notes thereto and other financial information included elsewhere in this report.
| | | Six months ended March 31 | |
| | | 2010 | | | 2009 | |
| | | Amount | | | % | | | Amount | | | % | |
| Sales | | | 9,847,025 | | | | 100 | % | | | 4,540,833 | | | | 100 | % |
| Cost of Sales | | | 6,843,833 | | | | 70 | % | | | 2,906,402 | | | | 64 | % |
| Gross Profit | | | 3,003,192 | | | | 30 | % | | | 1,634,431 | | | | 36 | % |
| SG&A expense | | | 662,138 | | | | 7 | % | | | 758,442 | | | | 17 | % |
| Operating Income | | | 2,341,054 | | | | 24 | % | | | 875,989 | | | | 19 | % |
| Interest income | | | 517 | | | | 0 | % | | | - | | | | 0 | % |
| Interest Expenses | | | (452,387 | ) | | | 5 | % | | | (160,506 | ) | | | 4 | % |
| Gain on disposal of fixed assets | | | 496 | | | | 0 | % | | | 16,263 | | | | 0 | % |
| Net Income before taxes | | | 1,889,680 | | | | 19 | % | | | 731,746 | | | | 16 | % |
| Net Income | | | 1,889,680 | | | | 19 | % | | | 731,746 | | | | 16 | % |
| | | Three Months Ended June 30 | |
| | | 2010 (unaudited) | | | 2009 (unaudited) | |
| | | Amount | | | % | | | Amount | | | % | |
| Net sales | | $ | 5,072,791 | | | | 100 | % | | $ | 2,482,212 | | | | 100 | % |
| Cost of sales | | | 3,537,571 | | | | 70 | % | | | 1,779,328 | | | | 72 | % |
| Gross profit | | | 1,535,220 | | | | 30 | % | | | 702,884 | | | | 28 | % |
| Selling, general and administrative expense | | | 706,436 | | | | 14 | % | | | 266,101 | | | | 11 | % |
| Operating income | | | 828,784 | | | | 16 | % | | | 436,783 | | | | 18 | % |
| Interest income | | | 10,106 | | | | 0.2 | % | | | 2,104 | | | | 0 | % |
| Interest expense | | | (764,794 | ) | | | 15 | % | | | (65,162 | ) | | | 3 | % |
| Loss on disposition of fixed assets | | | - | | | | | | | | (16,263 | ) | | | 1 | % |
| Changes in fair value of warrants | | | 362,000 | | | | 7 | % | | | - | | | | 0 | % |
| Net income before taxes | | | 436,096 | | | | 9 | % | | | 357,462 | | | | 14 | % |
| Income tax provision | | | 6,328 | | | | 0 | % | | | - | | | | 0 | % |
| Net income | | $ | 429,768 | | | | 8 | % | | $ | 357,462 | | | | 14 | % |
SalesNet sales
Net sales revenue consistsconsisted of revenue from sales of needle punched non wovenPET nonwoven fabric and thermal calendared product. Netproducts. Our net sales for sixthe three month period ended March 31,June 30, 2010 were $9.85 million,$5,072,791, an increase of $5.30 million$2,590,579, or 116 %,104%, from $4.55 million for the same period of prior year. In February 2009, we installed a new production line to manufacture needle punched non woven fabric. Sales of needle-punched products for the six month period ended March 31, 2010 were $[4,300,022] compared to $220,718$2,482,212 for the same period of the prior year. The increase in net sales was largely attributable to higher sales volume after a new production line used to manufacture needle-punched nonwoven fabric was installed in February 2009. Sales of needle-punched PET products for the three month period ended June 30, 2010 were $2,054,318, an increase of $1,535,566, or 296%, over the prior year. In addition, sales of thermalthermal calendared PET materials for the sixthree month period ended March 31,June 30, 2010 were $[5,559,365], aswere $3,018,473, an increase of $[1,228,361] compared to $[4,331,204]$1,062,855, or 59%, from $1,955,618 for the same period of the prior year.
Cost of Goods Sold
Cost of goods soldSales
Cost of sales principally consists of the cost of raw materials, labor and manufacturing overhead expenses.
CostOur cost of goods soldsales for the sixthree month period ended March 31,June 30, 2010 was $6,843,833,$3,537,571, an increased $3,937,431,increase of $1,758,243, or 135%99%, from $2,906,402$1,779,328 for the same period in the prior year. The primary reason for the increase in cost of sales was an increase in our raw materials costs, which we believe was in line with our increased sales volume. 98.7% of our raw material costs consist of polyester, the cost of which increased with the price of oil.
Our raw material cost as a percentage of net sales increased to 56% for the three month period ended June 30, 2010, compared to 51% for the same period of the prior year, due to the raw materials associated with 2010 sales being more expensive than in the prior year. As a component of the cost of sales, raw material expense increased to $2,833,820 for the three months ended June 30, 2010 from $1,261,928 for the same period in the prior year. The $1,571,892 increase was due to higher pricing and increases in raw material usage. The change in material pricing contributed approximately 22% and the higher volume contributed approximately 78% of the total increase in raw material cost.
Labor cost accounted for 1% of net sales for the three month period ended June 30, 2010, the same level for the same period of the prior year.
Overhead expenses were 13% of net sales for the three month period ended June 30, 2010, compared to 18% of net sales for the same period of the prior year due to greater capacity utilization rates with the addition of our new production line in February 2009.
Gross Profit
Our gross profit for the three month period ended June 30, 2010 was $1,535,220, an increase of $832,336, or 118%, from $702,884 for the same period in the prior year. The increase in gross profit resulted primarily from the increase in our net sales. As a percentage of net sales, gross profit was 30% for the three month period ended June 30, 2010, compared to 28% for the same period last year. The improved gross profit margin was primarily attributed to lowered overhead cost as a percentage of the net sales.
Selling, General and Administrative Expenses
Selling expenses include salaries, advertising expenses, rent, cost of manufacturing and all expenses directly related to producing and selling our products. General expenses include general operating expenses that are directly related to the general operation of the company, but excluding selling and administrative expenses. Administrative expenses include executive salaries and other expenses related to the overall administration of the company.
Selling, general and administrative expenses for the three month period ended June 30, 2010 were $706,436, an increase of $440,335, or 166%, compared to $266,101 for the same period in the prior year. The increase was primarily due to increase of $47,219 in delivery charges related to overseas sales and $309,040 in legal fees related to the financing transaction which closed in February 2010.
Other Income and Expenses
Interest expense for the three month period ended June 30, 2010 was $764,791, compared to $65,162 for the same period in the prior year. Interest expense as a percentage of sales increased to 15% for the three month period ended June 30, 2010 from 3% for the same period of the prior. The increase in interest expense was mainly attributed to our adoption of derivative accounting rules under ASC 815-40 to record $4,140,000 of convertible loan notes. These accounting rules require us to accrete interest expense, in an amount of $609,900 quarterly, based on the term of the notes and note discount. Excluding the derivative-accounting-driven interest expense, our interest expense for this three month period remained the same level as for the same period of last year. The accreted interest expense was partially offset by the fair value change of the warrants after re-measurement at this reporting period.
Income Tax
USA
The Company and its subsidiary and branch divisions are subject to income taxes on an entity basis on income arising in, or derived from, the tax jurisdiction in which they operate. Since the Company had no income generated in the United States, there was no tax expense or tax liability due to the Internal Revenue Service of the United States as of June 30, 2010 and September 30, 2009.
BVI
Hong Hui is incorporated under the International Business Companies Act of the British Virgin Islands and accordingly, is exempted from payment of British Virgin Island’s income taxes.
PRC
Pursuant to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for Foshan SLP. For 2008 and 2009 Foshan SLP enjoys tax free holidays. From January 2010 onwards, Foshan SLP is taxed at 25% of net income except for the 2010, 2011 and 2012 in which we receive a 50% discount on income tax.
The current year tax provision was $6,328 and $6,328 for the three and nine months ended June 30, 2010, respectively. The company has recorded zero deferred tax assets or liabilities as of June 30, 2010 and September 30, 2009, net of tax allowance, because all other significant difference in tax basis and financial statement amounts are permanent differences.
Net Income
Net income for the three months ended June 30, 2010 was $429,768, an increase of $72,306, or 20%, from net income of $357,462 for the same period in the prior year. Excluding accretion of interest expense discussed above and the gains on change in warrant value, net income rose to $522,668, an increase of $165,206, or 46%, over the same period of the prior year. The increase was largely due to an increase in sales of our new needle-punched products.
Comparison of Nine Months Ended June 30, 2010 and June 30, 2009
The following table shows, for the periods indicated, information derived from our consolidated statements of income in US dollars and as a percentage of net sales (percentages may not add due to rounding). See our financial statements and the related notes thereto and other financial information included elsewhere in this report.
| | | Nine Months Ended June 30 | |
| | | 2010 (unaudited0) | | | 2009 (unaudited) | |
| | | Amount | | | % | | | Amount | | | % | |
| Net sales | | $ | 14,919,816 | | | | 100 | % | | $ | 7,023,045 | | | | 100 | % |
| Cost of sales | | | 10,381,404 | | | | 70 | % | | | 4,685,730 | | | | 67 | % |
| Gross profit | | | 4,538,412 | | | | 30 | % | | | 2,337,315 | | | | 33 | % |
| SG&A expense | | | 1,518,,574 | | | | 10 | % | | | 1,024,543 | | | | 15 | % |
| Operating income | | | 3,019,838 | | | | 20 | % | | | 1,312,772 | | | | 19 | % |
| | | | | | | | | | | | | | | | | |
| Interest income | | | 10,623 | | | | 0 | % | | | 2,104 | | | | 0 | % |
| | | | | | | | | | | | | | | | | |
| Interest expense | | | (1,216,685 | ) | | | 8 | % | | | (225,668 | ) | | | 3 | % |
| Changes in Fair value of warrants | | | 362,000 | | | | 2 | % | | | - | | | | 0 | % |
| Net income before taxes | | | 2,175,776 | | | | 15 | % | | | 1,089,208 | | | | 16 | % |
| Income tax provision | | | 6,328 | | | | 0 | % | | | - | | | | 0 | % |
| Net income | | $ | 2,169,448 | | | | 15 | % | | $ | 1,089,208 | | | | 16 | % |
Net Sales
Net sales for the nine month period ended June 30, 2010 were $14,919,816, an increase of $7,896,771, or 112%, from $7,023,045 for the same period of the prior year. The increase is mainly attributable to sales of needle punched nonwoven fabric products which were launched during the second quarter of 2010. Sales of needle-punched products for the nine month period ended June 30, 2010 were $6,342,001 compared to $739,097 for the same period of the prior year. In addition, sales of thermal calendared materials for the nine month period ended June 30, 2010 were $8,577,815, an increase of $2,293,867 compared to $6,283,948 for the same period of the prior year.
During the nine month period ended June 30, 2010, approximately 75% and 25% of our sales revenues were generated from sales made in the PRC and internationally, respectively, compared to approximately 83% and 17%, respectively, for the same period in prior year.
Cost of Sales
Cost of sales for the nine month period ended June 30, 2010 was $10,381,404, an increase of $5,695,674, or 122%, from $4,685,730 for the same period of the prior year. As a percentage of net sales cost of good sold sales was 70 %70% for the sixnine month period ended March 31, 2001June 30, 2010 compared to 64%67% for the same period in 2009.prior year.
Raw material expensescosts increased to 56%55% of thenet sales for the sixnine month period ended March 31,June 30, 2010, compared to 40%44% of net sales for the same period in 2009,the prior year, reflecting a mix of more expensive raw materials associated with 2010 sales. 98.7%Approximately 98% of our raw materials consistsconsist of polyester, the price of which fluctuates with the price of oil.
As a component of the cost of sales, raw material expense increased to $8,201,053 for the nine months ended June 30, 2010, from $3,090,140 for the same period of prior year. The increase of $5,115,749 was caused by an increase in material purchase price and higher volume of material usage due to an increase in production output. The rise in material purchase price and volume accounted for approximately 29% and approximately 71% of the total raw material cost increase, respectively.
Labor expenses were 6%cost was 1% of sales for the sixnine month period ended March 31,June 30, 2010 compared to 2% for the same period in 2009. Beginning in February 2009 we hired 17 additional employees to work the new production line. Labor costs also increased due to increased demand for labor.prior year.
Overhead expenses were 12%13% of net sales for the sixnine month period ended March 31,June 30, 2010, compared to 19%20% of net sales for the same period lastin the prior year due to greater capacity utilization rates with the increaseaddition of manufacturing capacity of the Company.our new production line in February 2010.
Gross Profit
Gross profits represents net sales less cost of goods sold. Gross profit for the sixnine month period ended March 31,June 30, 2010 was $3,003,192 and$4,538,412, an increase of $1,368,761$2,201,097, or 83%94%, from $1,634,431$2,337,315 for the same period lastof the prior year. As a percentage of net sales, gross profit was 30% for the sixnine month period ended March 31,June 30, 2010, compared to 36%33% for the same period lastof the prior year. This decrease was primarily due to the increase in the purchase price of the raw materials associated with 2010 sales. This was primarily due to increase of purchase of price of the raw materials associated with 2010 sales, which price increase was caused by fluctuations in the price of oil.
Selling, Marketing and AdministrativeSG&A Expenses
Selling, general and administrative expenses for the sixnine month period ended March 31,June 30, 2010 were $662,138,$1,518,574, an decreaseincrease of $96,304$494,031, or 48%, compared to $758,442$1,024,543 for the same period lastof the prior year. This is mainly due to decreased stamp duty $18,394 from $21,301increased legal and other expenses related to convertible note financing completed in 2009 compareFebruary 2010, including fees totaling $554,000 paid or payable to $2,907Primary and United Best, and the intended public offering and shipping expenses associated with overseas sales, offset by a decrease in other general expenses.
Other Income and Expenses
Interest expense for the nine month period ended June 30, 2010 was $1,216,685 compared to $225,668 for the same period this year. Office expense also decreased $77,327 from $147,221 in 2009 compared to $69,894 forof the same period 2010.
Other Expenses
Other expenses consist solely of interest expenses.
Interest expense for the six month period ended March 31, 2010 was $452,387 compared to $160,506 for the same period lastprior year. Interest expense as a percentage of net sales increased to 5%8% for the sixnine month period ended March 31,June 30, 2010 from 4%3% for the same period of lastthe prior year. The cause for the increase in interest expense for the nine month period was principally due to record $4,140,000the same as for the three month period. Excluding the accretion of convertible notes. We accreted non-cash related interest, expense, in the amount of $304,950. Excluding accretion on non-cash interest expense, interest expense for this sixnine month period remainedincreased by $76,000 over the same asperiod of last year, and, as a percentage of net sales, decreased to 1%2% from 4%3%.
Net Income
Net income for the sixnine months ended March 31,June 30, 2010 increased by $1,157,934was $2,169,448, or 99%, an increase of $1,080,240 from net income of $731,746$1,089,208 for the same period in 2009 to net income of $1,889,680.the prior year. The increase was mainly dueattributed to the increase in sales due to theincreased net sales generated from our new needle-punch products.needle-punched products and lower selling, general and administrative expenses relative to net sales. Excluding IPO related expenses and accretion of interest expense from convertible notes sold, net income increased by approximately $2,100,000 from net income for the same period in the prior year.
On February 12, 2010, we completed a financing transaction in which we raised gross proceeds of $4,140,000 through a private placement of convertible notes and warrants to certain accredited investors.
Management's discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. Our financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. See Note 2 to our consolidated financial statements, “Summary of Significant Accounting Policies.” We believe that the following paragraphs reflect the more critical accounting policies that currently affect our financial condition and results of operations:
The preparation of the financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ materially from those estimates.