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.$20,000,000. The warrants cannot be exercised if no financing is consummated within a five-year period after the issue date and become void if the notes automatically convert into common stock.
Management also evaluated whether the warrants meet the scope exception set forth by FASB 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 FASB ASC Topic 815. The provisions in FASB ASC Topic 815-40 apply to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by FASB ASC Topic 815 and to any freestanding financial instruments that are potentially settled in an entity’s own common stock.
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 based on the beliefs of our management, and involve risks and uncertainties, as well as assumptions, 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 deemed 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 included in this report are basedmay 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. There can be no assurance that the forward-looking statements contained in this filing 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”“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,from February 12, 2010, the operating results of Foshan are consolidated in the Company’s financialsfinancial results for that period.
Foshan is engaged in the manufacture and sale and research and development of advanced spun-bond PET, or polyester, non-wovens.nonwovens.
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. We sell products to industrial customers in China. 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 PPPPS (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.non-woven. 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 nonwovennon-woven fabric.
We recently developed a continuous filament, spun-bond, needle-punched manufacturing process to manufacture polyphenylenepolyphenylene sulfide fiber, or PPS, a specialized type of high temperature resistant nonwovennon-woven fabric and intend to begin commercial production of PPS using our proprietary manufacturing process in 2010. 2011.
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 filteringfiltration materials currently available, we believe that our nonwovennon-woven fabric will be stronger, have lower production and operating costs, and will have higher filtration efficiency. We have testedAlthough our PPS materialproduct has been tested in laboratories, prototype bag filters made of our product have not been tested on site by any potential end user and we do not expect to develop prototype products for testing by any potential end user prior to commencing commercial production of PPS products. Our new PPS nonwoven fabric internallymay never achieve broad market acceptance, due to any number of factors, including that the product may not be as effective as our initial testing indicates and although a prototype usingcompetitive material may be introduced which renders 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. PPS product too expensive or obsolete.
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 shown in all periods presented.
On February 12, 2010, immediately following the reverse merger, the Company entered into a note purchase agreement with certain accredited investors for the sale of convertible notes in the aggregate principal amount of $4,140,000 and warrants (which are exercisable only in certain circumstances), with net proceeds of $3.2$3.4 million after finance costs. The notes require quarterly interest payments at a rate of 10% per annum.
Recent Development
On January 31, 2011, we entered into note extension agreements with each holder of our outstanding convertible notes (except for Lumen Capital LP who holds a convertible note in the principal amount of $100,000) to extend the maturity date of the notes from February 12, 2011 to June 30, 2011. We repaid Lumen Capital the principal amount of $100,000 on February 11, 2011.
We intend for this discussion to provide the reader with information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our financial statements. This discussion should be read in conjunction with our audited financial statements and accompanying notes as of September 30, 2009,2010, and for the year then ended, and the unaudited condensed consolidated interim financial statements for the three months and six monhtsmonths ended March 31, 2010.2011.
Results of Operations
Three Month PeriodMonths Ended March 31, 2010 compared2011 Compared to Three Month PeriodMonths Ended March 31, 20092010
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 | |
| | 2011 | | | 2010 | |
Net Sales | | $ | 4,895,596 | | | | 100 | % | | $ | 4,628,671 | | | | 100 | % |
Cost of Sales | | | 3,911,768 | | | | 80 | % | | | 3,237,311 | | | | 70 | % |
Gross Profit | | | 983,828 | | | | 20 | % | | | 1,391,360 | | | | 30 | % |
Selling, General and Administration expenses | | | 989,685 | | | | 20 | % | | | 557,461 | | | | 12 | % |
Income (Loss) from Operations | | | (5,857 | ) | | | 0 | % | | | 833,899 | | | | 18 | % |
| | | | | | | | | | | | | | | | |
Other income (expense) | | | | | | | | | | | | | | | | |
Interest Income | | | 7,658 | | | | 0 | % | | | 292 | | | | 0 | % |
Interest Expense | | | (326,235 | ) | | | -7 | % | | | (390,355 | ) | | | -8 | % |
Gain (Loss) from Disposal of Fixed Assets | | | - | | | | - | | | | 496 | | | | - | |
Changes in Fair Value of Warrants | | | (44,276 | ) | | | -1 | % | | | - | | | | 0 | % |
Total other income (expenses) | | | (362,853 | ) | | | -7 | % | | | (389,567 | ) | | | -8 | % |
Income (Loss) before Income Taxes | | | (368,710 | ) | | | -8 | % | | | 444,332 | | | | 10 | % |
Income tax provision | | | 3,398 | | | | | | | | - | | | | | |
Net Income (Loss) | | $ | (372,108 | ) | | | -8 | % | | $ | 444,332 | | | | 10 | % |
| | 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 | % |
Net Sales
Net sales revenue consistsconsisted of revenue from sales of needle punched non woven fabricnonwoven product and thermal calendared product. Netproducts. Our net sales for the three month period ended March 31, 20102011 were $4,628,671,$4,895,596, an increase of $2,413,731,$266,925, or 109%6%, 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$4,628,671 for the same period of the prior year. In addition,The increase in revenue was primarily attributable to the appreciation of Renminbi, our transaction currency against the US dollars, our reporting currency. Reflected in the transaction currency, our net sales of thermal calendared materials forincreased by 2% from the quarter ended March 31, 2010.
For the three month period ended March 31, 2010 $2,308,801, as increase2011, sales of $569,189 compared to $1,739,612 forthermal calendared products increased by $112,482, or 4%, from the same period of the prior year. An increase of $403,038 in thermal calendared products in domestic market was offset by a decrease of $290,556 in international sales.
CostInternational sales of Goods Soldneedle-punched products increased by $156,673 and domestic sales slightly decreased by $2,230.
Cost of goods soldSales
Cost of sales 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, 2010,2011 was $3,911,768, an increase of $674,457, or 21%, from $3,237,311 for the same period in 2010.
Raw material cost increased to 70% of net sales for the three month period ended March 31, 2011, compared to 41%52% of net sales for the same period of the prior year, reflecting a mix of more expensive raw materials associated with 2010 sales. 98.7 %Over 98% percent of our raw materials consistsconsist of polyester, the price of which fluctuates with the price of oil
Labor expenses were 6%oil. Recent surge in the price of sales forcrude oil adversely affected the purchase price of polyester resin chips, our main raw material. During the three month period ended March 31, 2010 compared to 2% for2011, our cost of raw materials increased 20% from the same period of year 2009. Beginningthe prior year. The increase of our cost of sales was due principally from the increase in February 2009 we hired 17 additional employees to work the new production line. cost of raw materials.
Labor costs also increased due to increased demandcost accounted for labor.
Overhead expenses were 11%1% of net sales for the three month period ended March 31, 2010, compared to 19%2011, the same level as the same period in 2009.
Overhead expenses were 14% of net sales for 2009the three month period ended March 31, 2011, compared to 11% of net sales for the same period in 2010. As a percentage of net sales, overhead expenses increased due to lower capacity utilization and lower production volume, compared to the increase of manufacturing capacity of the Company with the addition of the new production linesame period in February 2009.2010.
Gross Profit
Gross profitsprofit represents net sales less cost of goods sold.sales. Gross profit for the three month period ended March 31, 20102011 was $1,391,360, an increase$983,828, a decrease of $550,341,$407,532, or 65%29%, from $841,019$1,391,360 for the same period in 2009.2010. As a percentage of net sales, gross profit was 30%20% for the three month period ended March 31, 2010,2011, compared to 38%30% for the same period last year. This was primarily due to increase of purchase of price of the prior year. The decrease in our gross profit was due primarily to the increase in cost of raw materials associated with 2010 sales, which price increase was caused by fluctuations in the priceas a percentage of oil. net sales.
Selling, MarketingGeneral and Administrative Expenses
Selling expenses include salaries, advertising expenses, cost of manufacturing, rent, and all expenses dirirectlydirectly 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.Company. Administrative expense includesexpenses 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 March 31, 20102011 were $407,461,$989,685, an increase of $131,935$432,224, or 78%, compared to $275,526$557,461 for the same period 1n 2009.in 2010. The increase was primarily dueconsisted of $132,120 in legal counsel and documentation fees related to increasethe Company’s intended initial public offering, investor relation consulting fees of $25,524$70,500, fees paid to our auditors of $89,545, and $151,329 in export delivery expenses and $83,286 additional professional expenses incurredstock-based employee compensation, offset by a decrease in connection with the company’s planned financing.
Other Income and Expenses
Other expenses solely consistprimarily consisted of interest expense.expense while other income was primarily interest income and change in fair value of warrants.
Interest expense for the three month period ended March 31, 20102011 was $390,355$326,235 compared to $76,286$390,355 for the same period in 2009. Interest expense as a percentage of sales increaseddecreased to 8%7% for the three month period ended March 31, 20102011, from 3%8% for the same period of lastthe prior year. The increase in interest expense was principally due to interest onextension of the maturity date of the convertible notes inhelped reduce interest expense by decreasing accretion of the aggregatenotes discount to the principal amount at the notes maturity date.
At March 31, 2011, under the requirements of $4,140,000. We accreted non-cash related interestFASB ASC 815, management re-measured the fair value of the warrants issued in connection with the sale of convertible notes to bridge loan creditors on February 12, 2010. This re-measurement resulted in an increase of the fair value of the warrants from December 31, 2010 and accordingly an increase of the value of the warrants liabilities and reported as other 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.$44,276.
Income Tax
NetUSA
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. As 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 March 31, 2011 and September 30, 2010.
BVI
Hong Hui is incorporated under the International Business Companies Act of the British Virgin Islands and accordingly is exempt 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 enjoyed a tax free holiday for two years. From January 2010 onwards, Foshan SLP is taxed at 25% of net income except for the 2010 and 2011 years where there is a 50% discount on income tax.
The current year tax provision was $3,398 for the three months ended March 31, 2011. The Company has recorded zero deferred tax assets or liabilities as of March 31, 2011 and September 30, 2010 increased by $105,125,net of tax allowance because all other significant difference in tax basis and financial statement amounts are permanent differences. Valuation allowance is applied to deferred tax assets derived from immaterial temporary difference in tax and financial basis financial statements.
Net (Loss) Income
Our operations resulted in net loss for the three months ended March 31, 2011 in amount of $372,108, compared with a net income of $489,207$444,332 for the three month periodmonths ended March 31, 20092010. The net loss was attributable to net incomea combination of $594,332. The increase was largely due to an increasedeclining gross margin, high general and administrative expenses and high finance cost in net sales due toconnection with the sales generated from new needle-punch products.Company’s intended initial public offering and bridge financing.
Six Month Period Ended March 31, 20102011 compared to Six Month Period Ended March 31, 20092010
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 | % |
| | Six Months Ended | |
| | March 31 | |
| | 2011 | | | 2010 | |
Net Sales | | $ | 10,676,569 | | | | 100 | % | | $ | 9,847,025 | | | | 100 | % |
Cost of Sales | | | 8,135,330 | | | | 76 | % | | | 6,843,833 | | | | 70 | % |
Gross Profit | | | 2,541,239 | | | | 24 | % | | | 3,003,192 | | | | 30 | % |
Selling, General and Administration expenses | | | 1,802,321 | | | | 17 | % | | | 812,138 | | | | 8 | % |
Income from Operations | | | 738,918 | | | | 7 | % | | | 2,191,054 | | | | 22 | % |
| | | | | | | | | | | | | | | | |
Other income (expense) | | | | | | | | | | | | | | | | |
Interest Income | | | 12,988 | | | | 0 | % | | | 517 | | | | 0 | % |
Interest Expense | | | (1,103,932 | ) | | | -10 | % | | | (452,387 | ) | | | -5 | % |
Gain (Loss) from Disposal of Fixed Assets | | | (23,575 | ) | | | 0 | % | | | 496 | | | | 0 | % |
Government subsidy | | | 6,133 | | | | - | | | | - | | | | - | |
Changes in Fair Value of Warrants | | | 146,724 | | | | 1 | % | | | - | | | | 0 | % |
Total other income (expenses) | | | (961,662 | ) | | | -9 | % | | | (451,374 | ) | | | -5 | % |
Income (Loss) before Income Taxes | | | (222,744 | ) | | | -2 | % | | | 1,739,680 | | | | 18 | % |
Income tax provision | | | 92,001 | | | | | | | | - | | | | | |
Net Income (Loss) | | $ | (314,745 | ) | | | -3 | % | | $ | 1,739,680 | | | | 18 | % |
Net Sales
Net sales revenue consists of revenue from sales of needle punched non woven fabric and thermal calendared product. Net sales for the six month period ended March 31, 20102011 were $9.85 million,$10,676,569, an increase of $5.30 million$829,544 or 116 %,8%, from $4.55 million$9,847,025 for the same period of prior year. In February 2009, we installed a new production lineSales of thermal calendared products for the six month period ended March 31, 2011 were $6,202,228, an increase of $642,863 compared to manufacture needle punched non woven fabric.$5,559,365 for the same period of the prior year. Sales of needle-punched products for the six month period ended March 31, 20102011 were $4,300,022$4,474,341 compared to $220,718$4,300,022 for the same period of the prior year. In addition,Appreciation of Renminbi, our transaction currency, against the US dollars, contributed 3% of the increase in net sales revenue for the six months ended March 31, 2011.
Cost of thermal calendared materialsSales
Cost of sales for the six month period ended March 31, 2010 were $5,559,365, as2011 was $8,135,330, an increase of $1,228,361 compared to $4,331,204 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 six month period ended March 31, 2010 was $6,843,833, an increased $3,937,431,$1,291,497, or 135%19%, from $2,906,402$6,843,833 for the same period of the prior year. As a percentage of net sales, cost of good sold sales was 70 %76% for the six month period ended March 31, 20012011 compared to 64%70% for the same period in 2009.
Raw material expensescosts increased to 56%64% of the sales for the six month period ended March 31, 2010,2011, compared to 40%56% of sales for the same period in 2009,2010, reflecting a mix of more expensive raw materials associated with 20102011 sales. 98.7%Over 98% of our raw materials consistsconsist of polyester, the price of which fluctuates with the price of oil.
Labor costs were 1% of net sales for the six month period ended March 31, 2011, and remained the same percentage when compared to the percentage for the same period in 2010.
Overhead expenses were 6%14% of net sales for the six month period ended March 31, 2011, compared to 12% of net sales for the same period last year due to increase in utility cost and depreciation expense.
Gross Profit
Gross profit for the six month period ended March 31, 2011 was $2,541,239, a decrease of $461,953, or 15%, from $3,003,192 for the same period of the prior year. As a percentage of net sales, gross profit was 24% for the six month period ended March 31, 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.
Overhead expenses were 12% of net sales for the six month period ended March 31, 2010, compared to 19% of net sales for the same period last year due to the increase of manufacturing capacity of the Company.
Gross Profit
Gross profits represents net sales less cost of goods sold. Gross profit for the six month period ended March 31, 2010 was $3,003,192 and increase of $1,368,761 or 83%, from $1,634,431 for the same period last year. As a percentage of net sales, gross profit was 30% for the six month period ended March 31, 2010, compared to 36% for the same period last year. This decrease was primarily due to the increase in the purchase price of the raw materials associated with 20102011 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, MarketingGeneral and Administrative Expenses
Selling, general and administrative expenses for the six month period ended March 31, 20102011 were $662,138,$1,802,321, an decreaseincrease of $96,304$990,183, or 122%, compared to $758,442$812,138 for the same period lastof the prior year. This isincrease was mainly due to decreased stamp duty $18,394 from $21,301an increase in 2009 compare to $2,907 for the same period this year. Officeaudit fees of $115,824, legal counsel fees of $177,096, investor relation consulting fees of $141,000, $350,398 in equity-based compensation expense, also decreased $77,327 from $147,221 in 2009 compared to $69,894 for the same period 2010.$18,449 SEC filing related expenses, and foreign currency exchange loss of $103,029.
Other Expenses
Other expenses consist solely of interest expenses.
Interest expense for the six month period ended March 31, 2010 was $452,387$1,103,932 compared to $160,506$452,387 for the same period lastof the prior year. Interest expense as a percentage of net sales increased to 5%10% for the six month period ended March 31, 20102011 from 4%5% for the same period of lastthe prior year. The increase in interest expense was principally due to record $4,140,000 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 six month period remained the same as last year, and, as a percentage of net sales, decreased to 1% from 4%.
Net Income
Net income for the six months ended March 31, 2010 increased by $1,157,934 from2011 was principally due to the amortization of the convertible note discount.
Net (Loss) Income
Our operations resulted in net loss for the six months ended March 31, 2011 in amount of $314,745, compared with a net income of $731,746$1,739,680 for the same periodsix months ended March 31, 2010. The net loss was attributable to a combination of declining gross margin, high general and administrative expenses and high finance cost in 2009 to net income of $1,889,680. The increase was mainly due toconnection with the increase in sales due to the sales generated from new needle-punch products.Company’s intended initial public offering and bridge borrowings.
Liquidity and Capital Resources
The following table sets forth a summary of our net cash flow information for the periods indicated:
| | Three Month Periods Ended December 31, | |
| | 2011 | | | 2010 | |
| | (Consolidated) | | | (Consolidated) | |
Net cash provided by (used in) operating activities | | $ | (126,527 | ) | | $ | 1,553,423 | |
Net cash (used in) investing activities | | $ | (1,250,614 | ) | | $ | (1,389,582 | ) |
Net cash provided by (used in) financing activities | | $ | (362,554 | ) | | $ | 2,636,263 | |
Effect of currency exchange rate | | $ | (6,659 | ) | | $ | (5,418 | ) |
Net cash inflow (outflow) | | $ | (1,746,354 | ) | | $ | 2,794,686 | |
We finance our legacy business with cash flowsgenerated from operations and use short-term bank loans and we use shareholders’ equity investment and retained earnings to fund capital expenditures.
Working capital consists mainly of cash, accounts receivable, advances to suppliers and inventory. Cash, inventory and accounts receivable account for the majority of our working capital.
Our working capital requirements may be influenced by many factors, including cash flow, competition, relationships with suppliers, and the availability of credit facilities and financing alternatives, none of which can be predicted with certainty.
Our investment in new production facilities to manufacture PPS filtration products consumed a large amount of the proceeds obtained from bank loans and the issuance of convertible notes. This capital expenditure to a large extent affected our liquidity.
The planned production of our new PPS products will require a large amount of working capital to purchase expensive raw materials from foreign suppliers. Our operating cash inflow will not be adequate to meet the new working capital needs. Therefore, we are actively seeking public and private financing to acquire additional capital in order to expand our business.
At March 31, 2010,2011, we had severaloutstanding bank loans forin the total amount of $3.8$3.5 million (RMB26(RMB 23 million) with AgricultureIndustrial and Commercial Bank of China, Foshan Branch and these loans arebranch office. The loan is repayable in December 2010. We have the highest credit rating for that bank.on February 14, 2012.
On January 31, 2011, we entered into a note extension agreement with each holder (except for Lumen Capital LP who held a convertible note in the principal amount of $100,000) of our outstanding convertible notes to extend the maturity date of the notes from February 12, 20102011 to June 30, 2011. On February 11, 2011, we completed a financing transactionrepaid the note held by Lumen Capital. The proceeds received from the sale of the notes were invested in which we raised gross proceeds of $4,140,000 through a private placement of convertible notes and warrantsthe manufacturing facility to certain accredited investors.make our new products.
Cash Flow from Operating Activities
Six month period ended March 31, 2010 compared with six month period ended March 31, 2009
Net cash proved byused in operating activities for the six months ended March 31, 20102011 was approximately $1.55 million,$126,527, compared to a cash flow of $3.59$1.5 million provided by operating activities for the same period of the prior year. The operating cash outflow resulted primarily from a decrease was due primarily toin net income and an increase in Non-cash interest charges, decreaseaccounts receivable, advances to suppliers, and inventory, which were offset by an increase in advance to suppliers.accounts payable and accrued liabilities.
Cash inFlow from Investing Activities
Six month period ended March 31, 2010 compared with six month period ended March 31, 2009
Net cash providedused by investing activities for the six months ended March 31, 2010 was negative cash flow $1.392011was $1.25 million, compared to a negative cash flow of $4.93$1.4 million used for the same period of the prior year. The increased cash used fromby investing activities because there were no large capital expenditures during the first six months of the year. Only deposits were made a new product assembly line project. The net cash used in investing activities for the same period of last year was due to the deposits for purchases of equipment and expenses relating to outfitting our facilities.
We satisfied this cash expenditure with cash reserves and cash generated from 2009 and 2010 operations.
Cash in Financing Activities
Six month period ended March 31, 2010 compared with six month period ended March 31, 2009
Net cash provided by financing activities for the six month period ended March 31, 20102011 was approximately $2.64primarily for the capital project to build up a new PPS manufacturing facility.
Cash Flow from Financing Activities
Net cash used in financing activities for the six months ended March 31, 2011was $0.36 million, compared to $0.19$2.64 million of net cash provided by financing activities for the same period of the prior year. The increase wasDuring the result of cash received from the sale of the convertible notes.
Loans
The balance of our outstanding short-term bank loans onsix months ended March 31, 20102011, the Company repaid more than borrowed from banks. The new loan obtained from Industrial and Commercial Bank of China was approximately $3.8 million, compared with $4.6 million on March 31, 2009
On February 12, 2010, immediately followingmainly used to pay off the reverse merger, we entered into a note purchase agreement with certain accredited investors for the saleloan from Agriculture Bank of convertible notes in the aggregate principal amount of $4,140,000 and warrants (which are exercisable only in certain circumstances), with net proceeds for $3.4 million after finance costs. The notes require quarterly interest payments at a rate of 10% per annum and interest for six month in amount of $204,464 to be held in an escrow account.
The warrants become void if the notes automatically convert into common stock.
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 $20,000,000. The warrants cannot be exercised if no financing is consummated within the five-year period after the issue date.China.
Future Cash Commitments
We have an ambitious capital investment plansbusiness expansion plan for our PPS products. The PPS projects in 2010require significant capital expenditures. We financed the capital expenditures with short-term loans from banks and whichintended public equity offerings to raise additional capital to fund our capital projects. In addition, the planned launch of sales of PPS products will require a significant investment capital. This demand for investmentamount of working capital to purchase expensive raw materials. The new need of additional working capital will be met by the proceeds from the Februarythrough private placement, and by outside financing (including the public offering) that we intend to raise as needed to continue our expansion.equity financing.
Critical Accounting Policies and Estimates
Management'sManagement’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 23 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:
Method of Accounting
We maintain our general ledger and journals with the accrual method of accounting for financial reporting purposes. Accounting policies adopted by us conform to generally accepted accounting principles in the United States and have been consistently applied in the presentation of financial statements, which are compiled on the accrual basis of accounting.
Use of estimates
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.
Economic and political risks
Our operations are conducted in the PRC. Accordingly, our 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 economy.
Our operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. Our results may be adversely affected by changes in political and social conditions in the PRC and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.
Revenue recognition
Revenue represents the invoiced value of goods sold recognized upon the delivery of goods to customers. Revenue is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, and the seller’s price to the buyer is fixed or determinable and collectible.
Land use rights
Land use rights are stated at cost less accumulated amortization. Amortization is provided over the respective useful lives,a lease term of 50 years using the straight-line method. Estimated useful lives range from 20 to 50 years.
Property, plant and equipment
Plant and equipment are carried at cost less accumulated depreciation. Depreciation is provided over their estimated useful lives, using the straight-line method. Estimated useful lives of plant and equipment are as follows:
Buildings | | | 15-3520 years | |
Machinery and equipment | | | 10 years | |
Office equipment | | | 6-105 years | |
Motor vehicles | | | 6-810 years | |
Other assets | | | 6-10 years | |
The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statement of income. The cost of maintenance and repairs is charged to income as incurred, whereas significant renewals and betterments are capitalized.
Accounting for the Impairment of Long-Lived Assets
The long-lived assets held and used by us are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. It is reasonably possible that these assets could become impaired as a result of technology or other industry changes. Determination of recoverability of assets to be held and used is by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the assets.
If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonable likely to have a current or future effect on our financial condition.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
Not Applicable.Increases in the price of crude oil have a negative impact on the cost of our raw materials. Given the recent rise in the price of crude oil and the fact that the global economy is recovering, we expect that the price of our raw materials will stay at relatively high levels due to the relatively high price of crude oil which will adversely affect our gross margin for our PET products as our ability to pass on the increased material costs to customers is limited.
During 2010, all of our raw materials were purchased from suppliers located in the PRC. Because the raw materials for our new PPS products are expected to be sourced from the United States and Japan, we anticipate that, after introduction of our PPS products, a significant amount of our raw materials will be purchased from suppliers in the United States and Japan through their distributors in China. Accordingly, changes in the value of the RMB relative to the dollar and yen will affect our production costs and gross profit in 2011. However, we believe the RMB will continue to appreciate against the dollar based on the increasing pressure from the US government and so the impact of foreign currency conversion will be favorable to us.
ITEM 4. | CONTROLS AND PROCEDURES. |
Evaluation of Disclosure Controls and Procedures.
We maintain “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to ensure that information that would beis required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including to our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Rule 13a-15 under the Exchange Act, our management, including Mr. Jie Li, our Chief Executive Officer and Ms. Sabrina Liang,Mr. Eric Gan our Controller,Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2010.2011. Based on that evaluation, Mr. LieLi and Ms. LiangMr. Gan concluded that as of March 31, 2010,2011, and as of the date that the evaluation of the effectiveness of our disclosure controls and procedures was completed, our disclosure controls and procedures were not effective in that certain “significant deficiencies” existed related to (i) the U.S. GAAP expertise of our internal accounting staff, and (ii) our internal audit function.
ChangesChanges in Internal Control over Financial Reporting.
Under the supervision and with the participation of our management, including our chief executive officer and controller,our chief financial officer, we identified a number of “significant deficiencies” in the process of preparing our financial statements for the quarter ended March 31, 20102011 as described above.
During the quarter ended March 31, 2010, we began to take certain remedial measures as described below that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Because our current accounting department is relatively new to U.S. GAAP and the related internal control procedures required of U.S. public companies, our management has determined that they require additional training and assistance in U.S. GAAP matters.matters and the SEC regulations. Management has determined that our internal audit function is also significantly deficient due to insufficient qualified resources to perform internal audit functions.
In order to correct the foregoing significant deficiencies, we are takinghave taken the following remediation measures:
| · | We are arranginghave arranged for necessary training for our accounting department staff; |
| · | We plan to engage external professional accounting orand consultancy firms to assist us in the preparation of the US GAAP accounts; and |
| · | We do not currently have a chief financial officer but are currently searching for a qualified candidiate. We remain committed to the establishment of effective internal audit functions; however, due to the scarcity of qualified candidates with extensive experience in U.S. GAAP reporting and accounting in the region, we were not able to hire sufficient internal audit resources before the end of our reporting period. However, we will increase our search for qualified candidates with assistance from recruiters and through referrals; |
| · | In addition, we have allocated significant financial and human resources to strengthen the internal control structure and we have been actively working with external consultants to assess our data collection, financial reporting, and control procedures and to strengthen our internal controls over financial reporting.functions. |
We believe that the foregoing steps will remediate the significant deficiencies identified above, and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate.
PART II
OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS. |
We are not aware of any legal proceedings or claims that we expect will have a material adverse affect on our business, financial condition or operating results.
The following exhibits are filed as part of this report or incorporated by reference:
Exhibit No. | | Description |
| | |
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 | | Certification of Principal Executive Officer and 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
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: May 26, 2010
| CHINA SLP FILTRATION TECHNOLOGY, INC. | |
| | | |
Dated: May 18, 2011 | By: | /s/ Jie Li | |
| | Jie Li | |
| | Chief Executive Officer | |
| | (Principal Executive Officer) | |
| | | |
| By: | /s/ Jie LiEric Gan | |
| | Jie LiEric Gan | |
| | Chief ExecutiveFinancial Officer |
| | (Principal Executive Officer) |
| | |
| By: | /s/ Sabrina Liang |
| | Sabrina Liang |
| | Controller |
| | (Principal Financial and Accounting Officer) | |
EXHIBIT INDEX
Exhibit No. | | Description |
| | |
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 | | Certifications of Principal Executive Officer and Principal Accounting Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |