China Armco Metals, Inc. and Subsidiaries
June 30, 2011 and 2010
Notes to the Consolidated Financial Statements
(Unaudited)
NOTE 1 – ORGANIZATION AND OPERATIONS
Cox Distributing was founded as an unincorporated business in January 1984 and was incorporated as Cox Distributing, Inc., a C corporation in the State of Nevada on April 6, 2007 at which time 9,100,000 shares of common stock were issued to the founder in exchange for the existing unincorporated business. No value was given to the stock issued by the newly formed corporation. Therefore, the shares were recorded to reflect the $.001 par value and paid in capital was recorded as a negative amount ($9,100). On June 27, 2008, the Company amended its Articles of Incorporation, and changed its name to China Armco Metals, Inc. (“Armco Metals” or the “Company”) upon the acquisition of Armco Metals International Limited (formerly “Armco HK (H.K) Limited” or “Armco HK”) and Subsidiaries. The Company engages in, through its wholly owned subsidiaries in China, and Armco HK, import, export and distribution of ferrous and non-ferrous ores and metals, and processing and distribution of scrap steel.
Merger of Armco Metal International Limited and Subsidiaries (“Armco HK”)
On June 27, 2008, the Company entered into a share purchase agreement (the “Share Purchase Agreement”) and consummated a share purchase (the “Share Purchase”) with Armco HK and Feng Gao, who owned 100% of the issued and outstanding shares of Armco HK. In connection with the acquisition, the Company purchased from the Armco HK Shareholder 100% of the issued and outstanding shares of Armco HK’s capital stock for $6,890,000 by delivery of the Company’s purchase money promissory note. In addition, the Company issued to Ms. Gao a stock option entitling Ms. Gao to purchase a total of 5,300,000 shares of the Company’s common stock, par value $.001 per share (the “Common Stock”) at $1.30 per share expiring on September 30, 2008 and 2,000,000 shares at $5.00 per share expiring on September 30, 2010 (the “Gao Option”). On August 12, 2008, Ms. Gao exercised her option to purchase and the Company issued 5,300,000 shares of its common stock in exchange for the $6,890,000 note owed to Ms. Gao. The shares issued represented approximately 69.7% of the issued and outstanding common stock immediately after the consummation of the Share Purchase and exercise of the option to purchase 5,300,000 shares of the Company’s common stock at $1.30 per share. As a result of the ownership interests of the former shareholders of Armco HK, for financial statement reporting purposes, the merger between the Company and Armco HK has been treated as a reverse acquisition with Armco HK deemed the accounting acquirer and the Company deemed the accounting acquiree under the purchase method of accounting in accordance with section 805-10-55 of the FASB Accounting Standards Codification. The reverse merger is deemed a capital transaction and the net assets of Armco HK (the accounting acquirer) are carried forward to the Company (the legal acquirer and the reporting entity) at their carrying value before the combination. The acquisition process utilizes the capital structure of the Company and the assets and liabilities of Armco HK which are recorded at historical cost. The equity of the Company is the historical equity of Armco HK retroactively restated to reflect the number of shares issued by the Company in the transaction.
Armco & Metawise (H.K) Limited was incorporated on July 13, 2001 under the laws of the Hong Kong Special Administrative Region (“HK SAR”) of the People’s Republic of China (“PRC”). On March 22, 2011, Armco & Metawise (H.K) Limited amended its Memorandum and Articles of Association, and changed its name to Armco Metal International Limited (“Armco HK”). Armco HK engages in the import, export and distribution of ferrous and non-ferrous ore and metals.
On January 9, 2007, Armco HK formed Armet (Lianyungang) Renewable Resources Co, Ltd. (“Armet”), a wholly-owned foreign enterprise (“WOFE”) subsidiary in the City of Lianyungang, Jiangsu Province, PRC. On December 1, 2008, Armco HK transferred its 100% equity interest in Armet to China Armco Metals, Inc. Armet engages in the processing and distribution of scrap metal.
Henan Armco and Metawise Trading Co., Ltd. (“Henan”) was incorporated on June 6, 2002 in the City of Zhengzhou, Henan Province, PRC. Henan engages in the import, export and distribution of ferrous and non-ferrous ores and metals.
Merger of Henan with Armet, Companies under Common Control
On December 28, 2007, Armco HK entered into a Share Transfer Agreement with Armet, whereby Amrco HK transferred to Armet all of its equity interest in Henan, a company under common control of Armco HK. The acquisition of Henan has been recorded on the purchase method of accounting at historical amounts as Armet and Henan were under common control since June 2002. The consolidated financial statements have been presented as if the acquisition of Henan had occurred as of the first date of the first period presented.
Formation of Armco (Lianyungang) Holdings, Inc.
On June 4, 2009, the Company formed Armco (Lianyungang) Holdings, Inc. (“Lianyungang Armco”), a WOFE subsidiary in the City of Lianyungang, Jiangsu Province, PRC. Lianyungang intends to engage in marketing and distribution of the recycled scrap steel.
Formation of Armco Metals (Shanghai) Holdings, Ltd.
On July 16, 2010, the Company formed Armco Metals (Shanghai) Holdings. Ltd. (“Armco Shanghai”) as a WOFE subsidiary in Shanghai, China. Armco Shanghai serves as the headquarters for the Company’s China operations and oversees the activities of the Company in financing and international trading.
NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation - unaudited interim financial information
The accompanying unaudited interim consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information, and with the rules and regulations of the United States Securities and Exchange Commission (“SEC”) to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The unaudited interim financial statements furnished reflect all adjustments (consisting of normal recurring accruals) which are, in the opinion of management, necessary to a fair statement of the results for the interim periods presented. Interim results are not necessarily indicative of the results for the full year. These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements of the Company for the year ended December 31, 2010 and notes thereto contained in the Company’s Annual Report on Form 10-K filed with the SEC on March 31, 2011.
Principles of consolidation
The consolidated financial statements include all accounts of Armco Metals, Armco HK, Armet, Henan Armco and Lianyungang Armco as of June 30, 2011 and 2010 and for the interim periods then ended; all accounts of Armco Shanghai as of June 30, 2011 and 2010, for the interim period ended June 30, 2011 and for the period from June 16, 2010 (inception) through June 30, 2010. All inter-company balances and transactions have been eliminated.
Reclassification
Certain amounts in the prior period financial statements have been reclassified to conform to the current period presentation. These reclassifications had no effect on reported losses.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 revenues and expenses during the reported period. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
The Company’s significant estimates include allowance for doubtful accounts; foreign currency; the fair value of financial instruments; normal production capacity, inventory valuation and obsolescence; the carrying value and recoverability of long-lived assets, including the values assigned to and estimated useful lives of property, plant and equipment, and land use rights; revenue recognized or recognizable; sales returns and allowances; valued added tax and income tax provision. Those significant accounting estimates or assumptions bear the risk of change due to the fact that there are uncertainties attached to those estimates or assumptions, and certain estimates or assumptions are difficult to measure or value.
Management regularly reviews its estimates utilizing currently available information, changes in facts and circumstances, historical experience and reasonable assumptions. After such reviews, and if deemed appropriate, those estimates are adjusted accordingly. Actual results could differ from those estimates.
Fair value of financial instruments
The Company follows paragraph 825-10-50-10 of the FASB Accounting Standards Codification for disclosures about fair value of its financial instruments and has adopted paragraph 820-10-35-37 of the FASB Accounting Standards Codification (“Paragraph 820-10-35-37”) to measure the fair value of its financial instruments. Paragraph 820-10-35-37 establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America (U.S. GAAP), and expands disclosures about fair value measurements. To increase consistency and comparability in fair value measurements and related disclosures, Paragraph 820-10-35-37 establishes a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three (3) broad levels. The three (3) levels of fair value hierarchy defined by Paragraph 820-10-35-37 are described below:
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| Level 1 | | Quoted market prices available in active markets for identical assets or liabilities as of the reporting date. |
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| Level 2 | | Pricing inputs other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. |
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| Level 3 | | Pricing inputs that are generally observable inputs and not corroborated by market data. |
Financial assets are considered Level 3 when their fair values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial liabilities consist of the derivative warrant issued in July 2008 for which there is no current market for these securities such that the determination of fair value requires significant judgment or estimation. The Company valued the automatic conditional conversion, re-pricing/down-round, change of control; default and follow-on offering provisions using a lattice model, with the assistance of a valuation specialist, for which management understands the methodologies. These models incorporate transaction details such as Company stock price, contractual terms, maturity, risk free rates, as well as assumptions about future financings, volatility, and holder behavior as of the date of issuance and each balance sheet date.
The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.
The carrying amounts of the Company’s financial assets and liabilities, such as cash, pledged deposits, accounts receivable, advance on purchases, prepayments and other current assets, accounts payable, customer deposits, corporate income tax payable, accrued expenses and other current liabilities approximate their fair values because of the short maturity of these instruments.
The Company’s loans payable, banker’s acceptance notes payable, capital lease obligation, and long-term debt approximate the fair value of such instruments based upon management’s best estimate of interest rates that would be available to the Company for similar financial arrangements at June 30, 2011 and 2010.
Transactions involving related parties cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings may not exist. Representations about transactions with related parties, if made, shall not imply that the related party transactions were consummated on terms equivalent to those that prevail in arm's-length transactions unless such representations can be substantiated.
It is not however, practical to determine the fair value of advances from stockholders due to their related party nature.
Fair value of financial assets and liabilities measured on a recurring basis
The Company uses Level 1 of the fair value hierarchy to measure the fair value of the marketable securities and marks the available for sale marketable securities at fair value in the statement of financial position at each balance sheet date and reports the unrealized holding gains and losses for available-for-sale securities in other comprehensive income (loss) until realized.
The Company uses Level 3 of the fair value hierarchy to measure the fair value of the derivative liabilities and revalues its derivative warrant liability at every reporting period and recognizes gains or losses in the consolidated statements of operations and comprehensive income (loss) that are attributable to the change in the fair value of the derivative warrant liability.
Financial assets and liabilities measured at fair value on a recurring basis are summarized below and disclosed on the consolidated balance sheets:
| | | | | | Fair Value Measurement Using | |
| | | Carrying Value | | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| | | | | | | | | | | | | | | | |
| Marketable securities, available for sale | | $ | 1,380,015 | | | $ | 1,380,015 | | | $ | - | | | $ | - | | | $ | 1,380,015 | |
| | | | | | | | | | | | | | | | | | | | | |
| Derivative warrant liabilities | | $ | 10,023 | | | $ | - | | | $ | - | | | $ | 10,023 | | | $ | 10,023 | |
The table below provides a summary of the changes in fair value, including net transfers in and/or out, of all financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the interim period ended June 30, 2011:
| | Fair Value Measurement Using Level 3 Inputs | |
| | | | Derivative warrants | | | Total | |
| | | | | | | | |
| Balance, December 31, 2010 | | | $ | 138,143 | | | $ | 138,143 | |
| Total gains or losses (realized/unrealized) | | | | | | | | | |
| included in net loss | | | | (128,120 | ) | | | (128,120 | ) |
| Included in other comprehensive income | | | | - | | | | - | |
| Purchases, issuances and settlements | | | | - | | | | - | |
| Transfers in and/or out of Level 3 | | | | - | | | | - | |
| Balance, June 30, 2011 | | | $ | 10,023 | | | $ | 10,023 | |
The Company has no other assets or liabilities measured at fair value on a recurring basis or a non-recurring basis; consequently, the Company did not have any fair value adjustments for assets and liabilities measured at fair value at June 30, 2011 or December 31, 2010; no gains or losses are reported in the consolidated statement of income and comprehensive income (loss) that are attributable to the change in unrealized gains or losses relating to those assets and liabilities still held at the reporting date for the interim period ended June 30, 2011 or 2010.
Fair value of non-financial assets or liabilities measured on a recurring basis
The Company identifies potentially excess and slow-moving inventories by evaluating turn rates, inventory levels and other factors. Excess quantities are identified through evaluation of inventory aging, review of inventory turns and historical sales experiences. The Company provides lower of cost or market reserves for such identified excess and slow-moving inventories. The Company establishes a reserve for inventory shrinkage, if any, based on the historical results of physical inventory cycle counts.
Carrying value, recoverability and impairment of long-lived assets
The Company has adopted paragraph 360-10-35-17 of the FASB Accounting Standards Codification for its long-lived assets. The Company’s long-lived assets, which include property, plant and equipment and land use rights are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
The Company assesses the recoverability of its long-lived assets by comparing the projected undiscounted net cash flows associated with the related long-lived asset or group of long-lived assets over their remaining estimated useful lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable. If long-lived assets are determined to be recoverable, but the newly determined remaining estimated useful lives are shorter than originally estimated, the net book values of the long-lived assets are depreciated over the newly determined remaining estimated useful lives.
The Company considers the following to be some examples of important indicators that may trigger an impairment review: (i) significant under-performance or losses of assets relative to expected historical or projected future operating results; (ii) significant changes in the manner or use of assets or in the Company’s overall strategy with respect to the manner or use of the acquired assets or changes in the Company’s overall business strategy; (iii) significant negative industry or economic trends; (iv) increased competitive pressures; (v) a significant decline in the Company’s stock price for a sustained period of time; and (vi) regulatory changes. The Company evaluates acquired assets for potential impairment indicators at least annually and more frequently upon the occurrence of such events.
The key assumptions used in management’s estimates of projected cash flow deal largely with forecasts of sales levels, gross margins, and operating costs of the manufacturing facilities. These forecasts are typically based on historical trends and take into account recent developments as well as management’s plans and intentions. Any difficulty in manufacturing or sourcing raw materials on a cost effective basis would significantly impact the projected future cash flows of the Company’s manufacturing facilities and potentially lead to an impairment charge for long-lived assets. Other factors, such as increased competition or a decrease in the desirability of the Company’s products, could lead to lower projected sales levels, which would adversely impact cash flows. A significant change in cash flows in the future could result in an impairment of long lived assets.
The impairment charges, if any, is included in operating expenses in the accompanying consolidated statements of income and comprehensive income (loss).
Cash equivalents
The Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents.
Pledged deposits
Pledged deposits consist of amounts held in financial institutions for (i) outstanding letters of credit and (ii) open banker’s acceptance notes payable maturing between three (3) to nine (9) months from the date of issuance.
The Company uses letters of credit in connection with its purchases of ferrous and non-ferrous ores and metals, and scrap metal for processing and distribution. The issuing financial institutions of those letters of credit require the Company to deposit and pledge certain percentage of the maximum amount stipulated under those letters of the credit as collateral. The pledged deposits are either released to the Company in the event of vendors' non-performance or to be released to the Company as part of the payment toward the letters of credit when vendors delivers the goods under those letters of credit on or before maturity date.
The Company satisfies certain accounts payable, through banker’s acceptance notes issued by financial institutions to certain of the Company’s vendors. The issuing financial institutions of those banker’s acceptance notes require the Company to deposit and pledge certain percentage of the amount stipulated under those banker’s acceptance notes as collateral. The pledged deposits are released to the Company as part of the payment toward banker’s acceptance notes upon maturity.
The Management of the Company believes it is appropriate to classify such amounts as current assets as those letters of credit are of a short term nature, three (3) to nine (9) months in length from the date of issuance.
Marketable securities, available for sale
The Company accounts for marketable securities, available for sale, in accordance with sub-topic 320-10 of the FASB Accounting Standards Codification (“Sub-topic 320-10”).
Pursuant to Paragraph 320-10-35-1, investments in debt securities that are classified as available for sale and equity securities that have readily determinable fair values that are classified as available for sale shall be measured subsequently at fair value in the consolidated balance sheets at each balance sheet date. Unrealized holding gains and losses for available-for-sale securities (including those classified as current assets) shall be excluded from earnings and reported in other comprehensive income until realized except an available-for-sale security that is designated as being hedged in a fair value hedge, from which all or a portion of the unrealized holding gain and loss of shall be recognized in earnings during the period of the hedge, pursuant to paragraphs 815-25-35-1 through 35-4.
The Company follows Paragraphs 320-10-35-18 through 33 and assess whether an investment is impaired in each reporting period. An investment is impaired if the fair value of the investment is less than its cost. Impairment indicators include, but are not limited to the following: a. a significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee; b. a significant adverse change in the regulatory, economic, or technological environment of the investee; c. a significant adverse change in the general market condition of either the geographic area or the industry in which the investee operates; d. a bona fide offer to purchase (whether solicited or unsolicited), an offer by the investee to sell, or a completed auction process for the same or similar security for an amount less than the cost of the investment; e. factors that raise significant concerns about the investee's ability to continue as a going concern, such as negative cash flows from operations, working capital deficiencies, or noncompliance with statutory capital requirements or debt covenants. If the fair value of an investment is less than its cost basis at the balance sheet date of the reporting period for which impairment is assessed, the impairment is either temporary or other than temporary. Pursuant to Paragraph 320-10-45-8A, in periods in which an entity determines that a security’s decline in fair value below its cost basis is other than temporary, the entity shall recognize and present the total other-than-temporary impairment in the statement of earnings with an offset for the amount of the total other-than-temporary impairment that is recognized in other comprehensive income, in accordance with paragraph 320-10-35-34D, if any. Pursuant to Paragraph 320-10-45-9A, An entity shall separately present, in the financial statement in which the components of accumulated other comprehensive income are reported, amounts recognized therein related to held-to-maturity and available-for-sale debt securities for which a portion of an other-than-temporary impairment has been recognized in earnings.
Accounts receivable
Accounts receivable are recorded at the invoiced amount, net of an allowance for doubtful accounts. The Company follows paragraph 310-10-50-9 of the FASB Accounting Standards Codification to estimate the allowance for doubtful accounts. The Company performs on-going credit evaluations of its customers and adjusts credit limits based upon payment history and the customer’s current credit worthiness, as determined by the review of their current credit information; and determines the allowance for doubtful accounts based on historical write-off experience, customer specific facts and economic conditions.
Outstanding account balances are reviewed individually for collectability. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. Bad debt expense is included in general and administrative expenses, if any. Pursuant to paragraph 310-10-50-2 of the FASB Accounting Standards Codification account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company has adopted paragraph 310-10-50-6 of the FASB Accounting Standards Codification and determine when receivables are past due or delinquent based on how recently payments have been received.
The Company does not have any off-balance-sheet credit exposure to its customers.
Advance on purchases
Advance on purchases primarily represent amounts paid to vendors for future delivery of products ranging from three (3) months to nine (9) months, all of which were fully or partially refundable depending upon the terms and conditions of the purchase agreements.
Inventories
The Company values inventories, consisting of raw materials, packaging material and finished goods, at the lower of cost or market. Cost is determined on the first-in and first-out (“FIFO”) method for raw materials and packaging materials and the weighted average cost method for finished goods. Cost of finished goods comprises direct labor, direct materials, direct production cost and an allocated portion of production overhead. The Company reduces inventories for the diminution of value, resulting from product obsolescence, damage or other issues affecting marketability, equal to the difference between the cost of the inventory and its estimated market value. Factors utilized in the determination of estimated market value include (i) current sales data and historical return rates, (ii) estimates of future demand, (iii) competitive pricing pressures, (iv) new product introductions, (v) product expiration dates, and (vi) component and packaging obsolescence.
The Company follows paragraph 330-10-30-3 of the FASB Accounting Standards Codification for the allocation of production costs and charges to inventories. The Company allocates fixed production overhead to inventories based on the normal capacity of the production facilities expected to be achieved over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance. Judgment is required to determine when a production level is abnormally low (that is, outside the range of expected variation in production). Factors that might be anticipated to cause an abnormally low production level include significantly reduced demand, labor and materials shortages, and unplanned facility or equipment down time. The actual level of production may be used if it approximates normal capacity. In periods of abnormally high production, the amount of fixed overhead allocated to each unit of production is decreased so that inventories are not measured above cost. The amount of fixed overhead allocated to each unit of production is not increased as a consequence of abnormally low production or idle plant and unallocated overheads of underutilized or idle capacity of the production facilities are recognized as period costs in the period in which they are incurred rather than as a portion of the inventory cost.
The Company evaluates its current level of inventories considering historical sales and other factors and, based on this evaluation, classify inventory markdowns in the income statement as a component of cost of goods sold pursuant to Paragraph 420-10-S99 of the FASB Accounting Standards Codification to adjust inventories to net realizable value. These markdowns are estimates, which could vary significantly from actual requirements if future economic conditions, customer demand or competition differ from expectations. Other significant estimates include the allocation of variable and fixed production overheads. While variable production overheads are allocated to each unit of production on the basis of actual use of production facilities, the allocation of fixed production overhead to the costs of conversion is based on the normal capacity of the Company’s production facilities, and recognizes abnormal idle facility expenses as current period charges. Certain costs, including categories of indirect materials, indirect labor and other indirect manufacturing costs which are included in the overhead pools are estimated. The management of the Company determines its normal capacity based upon the amount of operating hours of the manufacturing machinery and equipment in a reporting period.
Property, plant and equipment
Property, plant and equipment are recorded at cost. Expenditures for major additions and betterments are capitalized. Maintenance and repairs are charged to operations as incurred. Depreciation of property, plant and equipment is computed by the straight-line method (after taking into account their respective estimated residual values) over the assets estimated useful lives ranging from five (5) years to twenty (20) years. Upon sale or retirement of property, plant and equipment, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in the consolidated statements of income and comprehensive income. Leasehold improvements, if any, are amortized on a straight-line basis over the term of the lease or the estimated useful lives, whichever is shorter. Upon becoming fully amortized, the related cost and accumulated amortization are removed from the accounts.
Land use right
Land use right represents the cost to obtain the right to use a 32 acre parcel of land in the City of Lianyungang, Jiangsu Province, PRC. Land use right is carried at cost and amortized on a straight-line basis over the life of the right of fifty (50) years. Upon becoming fully amortized, the related cost and accumulated amortization are removed from the accounts.
Banker’s acceptance notes payable
The Company satisfies certain accounts payable, through the issuance of banker’s acceptance notes issued by financial institutions to certain of the Company’s vendors. These notes are usually of a short term nature, three (3) to nine (9) months in length. They are non-interest bearing, are due upon maturity, and are paid by the Company’s banks directly to the vendors upon presentation on the date of maturity and the Company is obliged to repay the note in full to the financial institutions. In the event of insufficient funds to repay these notes, the Company's bank will convert them to loans on demand with interest at a predetermined rate per annum payable monthly.
Customer deposits
Customer deposits primarily represent amounts received from customers for future delivery of products, all of which were fully or partially refundable depending upon the terms and conditions of the sales agreements.
Leases
Lease agreements are evaluated to determine whether they are capital leases or operating leases in accordance with paragraph 840-10-25-1 of the FASB Accounting Standards Codification (“Paragraph 840-10-25-1”). When substantially all of the risks and benefits of property ownership have been transferred to the Company, as determined by the test criteria in Paragraph 840-10-25-1, the lease then qualifies as a capital lease. Capital lease assets are depreciated on a straight line method, over the capital lease assets estimated useful lives consistent with the Company’s normal depreciation policy for tangible fixed assets. Interest charges are expensed over the period of the lease in relation to the carrying value of the capital lease obligation.
Rent expense for operating leases, which may include free rent or fixed escalation amounts in addition to minimum lease payments, is recognized on a straight-line basis over the duration of each lease term.
Derivative instruments and hedging activities
The Company accounts for derivative instruments and hedging activities in accordance with paragraph 810-10-05-4 of the FASB Accounting Standards Codification (“Paragraph 810-10-05-4”). Paragraph 810-10-05-4 requires companies to recognize all derivative instruments as either assets or liabilities in the balance sheet at fair value. The accounting for changes in the fair value of a derivative instrument depends upon: (i) whether the derivative has been designated and qualifies as part of a hedging relationship, and (ii) the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument based upon the exposure being hedged as either a fair value hedge, cash flow hedge or hedge of a net investment in a foreign operation.
From time to time, the Company employs foreign currency forward contracts to convert unforeseeable foreign currency exchange rates to fixed foreign currency exchange rates. The Company does not use derivatives for speculation or trading purposes. Changes in the fair value of derivatives are recorded each period in current earnings or through other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and the type of hedge transaction. The ineffective portion of all hedges is recognized in current earnings. The Company has sales and purchase commitments denominated in foreign currencies. Foreign currency forward contracts are used to hedge against the risk of change in the fair value of these commitments attributable to fluctuations in exchange rates (“Fair Value Hedges”). Changes in the fair value of the derivative instrument are generally offset in the income statement by changes in the fair value of the item being hedged.
The Company did not employ foreign currency forward contracts to convert unforeseeable foreign currency exchange rates to fixed foreign currency exchange rates in 2011 or 2010.
Derivative warrant liability
The Company evaluates its convertible debt, options, warrants or other contracts, if any, to determine if those contracts or embedded components of those contracts qualify as derivatives to be separately accounted for in accordance with paragraph 810-10-05-4 and paragraph 815-40-25 of the FASB Accounting Standards Codification. The result of this accounting treatment is that the fair value of the embedded derivative is marked-to-market each balance sheet date and recorded as either an asset or a liability. In the event that the fair value is recorded as a liability, the change in fair value is recorded in the Statement of Operations and Comprehensive Income (loss) as other income or expense. Upon conversion, exercise or cancellation of a derivative instrument, the instrument is marked to fair value at the date of conversion, exercise or cancellation and then that the related fair value is reclassified to equity.
In circumstances where the embedded conversion option in a convertible instrument is required to be bifurcated and there are also other embedded derivative instruments in the convertible instrument that are required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument.
The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period. Equity instruments that are initially classified as equity that become subject to reclassification are reclassified to liability at the fair value of the instrument on the reclassification date. Derivative instrument liabilities will be classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument is expected within 12 months of the balance sheet date.
On January 1, 2009, the Company adopted Section 815-40-15 of the FASB Accounting Standards Codification (“Section 815-40-15”) to determine whether an instrument (or an embedded feature) is indexed to the Company’s own stock. Section 815-40-15 provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. The adoption of Section 815-40-15 has affected the accounting for (i) certain freestanding warrants that contain exercise price adjustment features and (ii) convertible bonds issued by foreign subsidiaries with a strike price denominated in a foreign currency.
The Company initially classified the warrants to purchase 2,728,913 shares of its common stock issued in connection with its July 2008 offering of common stock as additional paid-in capital upon issuance of the warrants. Upon the adoption of Section 815-40-15 on January 1, 2009, these warrants are no longer deemed to be indexed to the Company’s own stock and were reclassified from equity to a derivative liability with a fair value of $3,251,949 effective as of January 1, 2009. The reclassification entry included a cumulative adjustment to retained earnings of $1,845,455 and a reduction of additional paid-in capital of $5,097,404, the amount originally classified as additional paid-in capital upon issuance of the warrants on July 31, 2008.
On January 30, 2009, the Company issued 5,000 shares of its common stock for cash at $5.00 per share and received a cash payment of $25,000 in connection with the exercise of the warrant to purchase 5,000 shares with an exercise price of $5.00 per share by one investor and warrant holder.
During the three months ended March 31, 2010, warrants to purchase 1,324,346 shares of the Company’s common stock were exercised for cash at $5.00 per share and warrants to purchase 167,740 shares of the Company’s common stock were exercised on a cashless basis, for which the Company issued 1,324,346 and 78,217 shares of its common stock to the warrant holders and reclassified $1,665,011 and $210,095 of the derivative liability to additional paid-in capital, respectively. In addition, during the three months ended March 31, 2010, certain holders of warrants to purchase 1,031,715 shares of its common stock reached agreements with the Company, effective as of January 1, 2010, whereby the Company waived its right to offer or sell additional shares of its common stock below $5.00 per share in the future and the warrant holders waived their anti-dilution or commonly known as a most favored nation clause, for which the Company reclassified $1,292,227 of the derivative liability to additional paid-in capital.
During April 2010, four (4) warrant holders exercised their warrants to purchase 13,806 shares of Company common stock at $5.00 per share resulting in cash proceeds of $69,030 to the Company, for which the Company issued 13,806 shares of its common stock to the warrant holders and reclassified $21,229 of the derivative liability to additional paid-in capital.
The Company valued the fair value of the remaining derivative warrant liability at $10,023 at June 30, 2011 and recognized a gain of $128,120 on change in the fair value of the derivative warrants to purchase 186,306 shares of Company common stock for the six months then ended.
Related parties
The Company follows subtopic 850-10 of the FASB Accounting Standards Codification for the identification of related parties and disclosure of related party transactions.
Pursuant to Section 850-10-20 the related parties include a. affiliates of the Company; b. entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section 825–10–15, to be accounted for by the equity method by the investing entity; c. trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management; d. principal owners of the Company; e. management of the Company; f. other parties with which the Company may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests; and g. other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.
The financial statements shall include disclosures of material related party transactions, other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business. However, disclosure of transactions that are eliminated in the preparation of consolidated or combined financial statements is not required in those statements. The disclosures shall include: a. the nature of the relationship(s) involved ; b. a description of the transactions, including transactions to which no amounts or nominal amounts were ascribed, for each of the periods for which income statements are presented, and such other information deemed necessary to an understanding of the effects of the transactions on the financial statements; c. the dollar amounts of transactions for each of the periods for which income statements are presented and the effects of any change in the method of establishing the terms from that used in the preceding period; and d. amounts due from or to related parties as of the date of each balance sheet presented and, if not otherwise apparent, the terms and manner of settlement.
Commitment and contingencies
The Company follows subtopic 450-20 of the FASB Accounting Standards Codification to report accounting for contingencies. Certain conditions may exist as of the date the consolidated financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company assesses such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought therein.
If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s consolidated financial statements. If the assessment indicates that a potential material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, and an estimate of the range of possible losses, if determinable and material, would be disclosed.
Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the guarantees would be disclosed. Management does not believe, based upon information available at this time, that these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows. However, there is no assurance that such matters will not materially and adversely affect the Company’s business, financial position, and results of operations or cash flows.
Revenue recognition
The Company applies paragraph 605-10-S99-1 of the FASB Accounting Standards Codification for revenue recognition. The Company recognizes revenue when it is realized or realizable and earned. The Company considers revenue realized or realizable and earned when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the product has been shipped or the services have been rendered to the customer, (iii) the sales price is fixed or determinable, and (iv) collectability is reasonably assured. In addition to the aforementioned general policy, the following are the specific revenue recognition policies for each major category of revenue:
(i) Import, export and distribution of ferrous and non-ferrous ore, metals and processed scrap metal: The Company derives its revenues from sales contracts with customers with revenues being generated upon the shipment of metal ore pursuant to. Persuasive evidence of an arrangement is demonstrated via sales invoice or contract; product delivery is evidenced by warehouse shipping log as well as a signed bill of lading from the vessel or rail company and title transfers upon shipment, based on free on board (“FOB”) warehouse terms; the sales price to the customer is fixed upon acceptance of the signed purchase order or contract and there is no separate sales rebate, discount, or volume incentive. When the Company recognizes revenue, no provisions are made for returns because, historically, there have been very few sales returns and adjustments that have impacted the ultimate collection of revenues.
(ii) Import and export agent services: Form time to time, the Company provides import and export agent services to certain of its customers. Revenue from import and export agent services is recognized as the services are provided. The import and export agent services are considered provided when the goods to be imported or exported by the customer are delivered to the designated port specified by the service contract. The Company follows paragraph 605-45-45-15 to paragraph 605-45-45-18 of the FASB Accounting Standards Codification for revenue recognition to report revenue net for its import and export agent services since (1) the Company’s supplier is the primary obligor in the arrangement, (2) the amount the Company earns is fixed, and (3) the Company’s supplier has credit risk. The Company did not provide any import and export agent services for the interim period ended March 31, 2011 or 2010.
Net sales of products represent the invoiced value of goods, net of value added taxes (“VAT”). The Company is subject to VAT which is levied on the majority of the Company’s products at the rate of 13% on the invoiced value of sales prior to December 31, 2008 and 17% on the invoiced value of sales as of January 1, 2009 and forward. Sales or Output VAT is borne by customers in addition to the invoiced value of sales and Purchase or Input VAT is borne by the Company in addition to the invoiced value of purchases to the extent not refunded for export sales.
Shipping and handling costs
The Company accounts for shipping and handling fees in accordance with paragraph 605-45-45-19 of the FASB Accounting Standards Codification. While amounts charged to customers for shipping products are included in revenues, the related costs are classified in cost of goods sold as incurred.
Foreign currency transactions
The Company applies the guidelines as set out in Section 830-20-35 of the FASB Accounting Standards Codification (“Section 830-20-35”) for foreign currency transactions. Pursuant to Section 830-20-35 of the FASB Accounting Standards Codification, foreign currency transactions are transactions denominated in currencies other than U.S. Dollar, the Company’s reporting currency or Chinese Yuan or Reminbi, the Company’s Chinese operating subsidiaries' functional currency. Foreign currency transactions may produce receivables or payables that are fixed in terms of the amount of foreign currency that will be received or paid. A change in exchange rates between the functional currency and the currency in which a transaction is denominated increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction. That increase or decrease in expected functional currency cash flows is a foreign currency transaction gain or loss that generally shall be included in determining net income for the period in which the exchange rate changes. Likewise, a transaction gain or loss (measured from the transaction date or the most recent intervening balance sheet date, whichever is later) realized upon settlement of a foreign currency transaction generally shall be included in determining net income for the period in which the transaction is settled. The exceptions to this requirement for inclusion in net income of transaction gains and losses pertain to certain intercompany transactions and to transactions that are designated as, and effective as, economic hedges of net investments and foreign currency commitments. Pursuant to Section 830-20-25 of the FASB Accounting Standards Codification, the following shall apply to all foreign currency transactions of an enterprise and its investees: (a) at the date the transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from the transaction shall be measured and recorded in the functional currency of the recording entity by use of the exchange rate in effect at that date as defined in section 830-10-20 of the FASB Accounting Standards Codification; and (b) at each balance sheet date, recorded balances that are denominated in currencies other than the functional currency or reporting currency of the recording entity shall be adjusted to reflect the current exchange rate.
Stock-based compensation for obtaining employee services
The Company accounts for its stock based compensation in which the Company obtains employee services in share-based payment transactions under the recognition and measurement principles of the fair value recognition provisions of section 718-10-30 of the FASB Accounting Standards Codification. Pursuant to paragraph 718-10-30-6 of the FASB Accounting Standards Codification, all transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date used to determine the fair value of the equity instrument issued is the earlier of the date on which the performance is complete or the date on which it is probable that performance will occur.
The fair value of each option award is estimated on the date of grant using a Black-Scholes option-pricing valuation model. The ranges of assumptions for inputs are as follows:
| ● | The Company uses historical data to estimate employee termination behavior. The expected life of options granted is derived from paragraph 718-10-S99-1 of the FASB Accounting Standards Codification and represents the period of time the options are expected to be outstanding. |
| ● | The expected volatility is based on a combination of the historical volatility of the comparable companies’ stock over the contractual life of the options. |
| ● | The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods within the contractual life of the option. |
| ● | The expected dividend yield is based on the Company’s current dividend yield as the best estimate of projected dividend yield for periods within the contractual life of the option. |
The Company’s policy is to recognize compensation cost for awards with only service conditions and a graded vesting schedule on a straight-line basis over the requisite service period for the entire award.
Equity instruments issued to parties other than employees for acquiring goods or services
The Company accounts for equity instruments issued to parties other than employees for acquiring goods or services under guidance of section 505-50-30 of the FASB Accounting Standards Codification (“Section 505-50-30”).
Pursuant to Section 505-50-30, all transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date used to determine the fair value of the equity instrument issued is the earlier of the date on which the performance is complete or the date on which it is probable that performance will occur.
Pursuant to Paragraph 505-50-30-S99-1, if the Company receives a right to receive future services in exchange for unvested, forfeitable equity instruments, those equity instruments are treated as unissued for accounting purposes until the future services are received (that is, the instruments are not considered issued until they vest). Consequently, there would be no recognition at the measurement date and no entry should be recorded.
The Company accounts for income taxes under Section 740-10-30 of the FASB Accounting Standards Codification, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the Consolidated Statements of Income and Comprehensive Income in the period that includes the enactment date.
The Company adopted section 740-10-25 of the FASB Accounting Standards Codification (“Section 740-10-25”). Section 740-10-25 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under Section 740-10-25, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty (50) percent likelihood of being realized upon ultimate settlement. Section 740-10-25 also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.
The estimated future tax effects of temporary differences between the tax basis of assets and liabilities are reported in the accompanying consolidated balance sheets, as well as tax credit carry-backs and carry-forwards. The Company periodically reviews the recoverability of deferred tax assets recorded on its consolidated balance sheets and provides valuation allowances as management deems necessary.
Management makes judgments as to the interpretation of the tax laws that might be challenged upon an audit and cause changes to previous estimates of tax liability. In addition, the Company operates within multiple taxing jurisdictions and is subject to audit in these jurisdictions. In management’s opinion, adequate provisions for income taxes have been made for all years. If actual taxable income by tax jurisdiction varies from estimates, additional allowances or reversals of reserves may be necessary.
Foreign currency translation
The Company follows Section 830-10-45 of the FASB Accounting Standards Codification (“Section 830-10-45”) for foreign currency translation to translate the financial statements of the foreign subsidiary from the functional currency, generally the local currency, into U.S. Dollars. Section 830-10-45 sets out the guidance relating to how a reporting entity determines the functional currency of a foreign entity (including of a foreign entity in a highly inflationary economy), re-measures the books of record (if necessary), and characterizes transaction gains and losses. Pursuant to Section 830-10-45, The assets, liabilities, and operations of a foreign entity shall be measured using the functional currency of that entity. An entity’s functional currency is the currency of the primary economic environment in which the entity operates; normally, that is the currency of the environment, or local currency, in which an entity primarily generates and expends cash.
The functional currency of each foreign subsidiary is determined based on management’s judgment and involves consideration of all relevant economic facts and circumstances affecting the subsidiary. Generally, the currency in which the subsidiary transacts a majority of its transactions, including billings, financing, payroll and other expenditures, would be considered the functional currency, but any dependency upon the parent and the nature of the subsidiary’s operations must also be considered. If a subsidiary’s functional currency is deemed to be the local currency, then any gain or loss associated with the translation of that subsidiary’s financial statements is included in accumulated other comprehensive income. However, if the functional currency is deemed to be the U.S. Dollar, then any gain or loss associated with the re-measurement of these financial statements from the local currency to the functional currency would be included in the consolidated statements of income and comprehensive income (loss). If the Company disposes of foreign subsidiaries, then any cumulative translation gains or losses would be recorded into the consolidated statements of income and comprehensive income (loss). If the Company determines that there has been a change in the functional currency of a subsidiary to the U.S. Dollar, any translation gains or losses arising after the date of change would be included within the statement of income and comprehensive income (loss).
Based on an assessment of the factors discussed above, the management of the Company determined the relevant subsidiary’s local currency to be the functional currency for its foreign subsidiary.
The financial records of the Company's Chinese operating subsidiaries are maintained in their local currency, the Renminbi (“RMB”), which is the functional currency. Assets and liabilities are translated from the local currency into the reporting currency, U.S. dollars, at the exchange rate prevailing at the balance sheet date. Revenues and expenses are translated at weighted average exchange rates for the period to approximate translation at the exchange rates prevailing at the dates those elements are recognized in the consolidated financial statements. Foreign currency translation gain (loss) resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining accumulated other comprehensive income in the consolidated statement of stockholders’ equity.
RMB is not a fully convertible currency. All foreign exchange transactions involving RMB must take place either through the People’s Bank of China (the “PBOC”) or other institutions authorized to buy and sell foreign exchange. The exchange rate adopted for the foreign exchange transactions are the rates of exchange quoted by the PBOC. Commencing July 21, 2005, China adopted a managed floating exchange rate regime based on market demand and supply with reference to a basket of currencies. The exchange rate of the US dollar against the RMB was adjusted from approximately RMB 8.28 per U.S. dollar to approximately RMB 8.11 per U.S. dollar on July 21, 2005. Since then, the PBOC administers and regulates the exchange rate of the U.S. dollar against the RMB taking into account demand and supply of RMB, as well as domestic and foreign economic and financial conditions.
Unless otherwise noted, the rate presented below per U.S. $1.00 was the midpoint of the interbank rate as quoted by OANDA Corporation (www.oanda.com) contained in its consolidated financial statements. Management believes that the difference between RMB vs. U.S. dollar exchange rate quoted by the PBOC and RMB vs. U.S. dollar exchange rate reported by OANDA Corporation were immaterial. Translations do not imply that the RMB amounts actually represent, or have been or could be converted into, equivalent amounts in U.S. dollars. Translation of amounts from RMB into U.S. dollars has been made at the following exchange rates for the respective periods:
| | | June 30, 2011 | | | December 31, 2010 | | | June 30, 2010 | | | December 31, 2009 | |
| | | | | | | | | | | | | | | | |
| Balance sheet | | 6.4635 | | | | 6.6118 | | | | 6.8086 | | | | 6.8372 | |
| | | | | | | | | | | | | | | | | |
| Statement of income and comprehensive income (loss) | | 6.5399 | | | | 6.7788 | | | | 6.8347 | | | | 6.8409 | |
Net gains and losses resulting from foreign exchange transactions, if any, are included in the Company’s Consolidated Statements of Operations and Comprehensive Income (Loss).
The foreign currency translation gain (loss) was $886,612 and $103,048 and the effect of exchange rate changes on cash flows were ($17,356) and $17,899 for the interim period ended June 30, 2011 and 2010, respectively.
Comprehensive income (loss)
The Company has applied section 220-10-45 of the FASB Accounting Standards Codification. This statement establishes rules for the reporting of comprehensive income and its components. Comprehensive income (loss), for the Company, consists of net income, change in unrealized loss of marketable securities and foreign currency translation adjustments and is presented in the Company’s Consolidated Statements of Operations and Comprehensive Income (Loss) and Stockholders’ Equity.
Net income (loss) per common share
Net income (loss) per common share is computed pursuant to section 260-10-45 of the FASB Accounting Standards Codification. Basic net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock and potentially outstanding shares of common stock during the period to reflect the potential dilution that could occur from common shares issuable through stock options and warrants.
The following table shows the potentially outstanding dilutive common shares excluded from the diluted net income (loss) per common share calculation for the interim period ended June 30, 2011 and 2010 as they were anti-dilutive:
| | | | | Number of potentially outstanding dilutive common shares | |
| | | | | | |
| | | | | | | | For the Interim Period Ended June 30, 2011 | | | For the Interim Period Ended June 30, 2010 | |
| | | | | | | | | | | | | | | | |
| Warrants issued on August 1, 2008 in connection with the Company’s August 1, 2008 equity financing inclusive of non-derivative warrants to purchase 1,031,715 shares and derivative warrants to purchase 186,306 shares at $5.00 per share expiring five (5) years from date of issuance | | | | | | | | | | 1,218,021 | | | | 1,218,021 | |
| | | | | | | | | | | | | | | | |
| Warrants issued on April 20, 2010 in connection with the Company’s April 20, 2010 equity financing inclusive of warrants to purchase 1,538,464 shares to the investors and warrants to purchase 76,923 shares to the placement agent at $7.50 per share expiring five (5) years from date of issuance | | | | | | | | | | 1,615,387 | | | | 1,615,387 | |
| | | | | | | | | | | | | | | | |
| Options issued on October 5, 2010 to an employee to purchase 40,000 common shares exercisable at $5.00 per share expiring five (5) years from the date of issuance | | | | | | | | | | 40,000 | | | | - | |
| | | | | | | | | | | | | | | | |
| Total potentially outstanding dilutive common shares | | | | | | | | | | 2,873,408 | | | | 2,843,408 | |
Cash flows reporting
The Company adopted paragraph 230-10-45-24 of the FASB Accounting Standards Codification for cash flows reporting, classifies cash receipts and payments according to whether they stem from operating, investing, or financing activities and provides definitions of each category, and uses the indirect or reconciliation method (“Indirect method”) as defined by paragraph 230-10-45-25 of the FASB Accounting Standards Codification to report net cash flow from operating activities by adjusting net income to reconcile it to net cash flow from operating activities by removing the effects of (a) all deferrals of past operating cash receipts and payments and all accruals of expected future operating cash receipts and payments and (b) all items that are included in net income that do not affect operating cash receipts and payments. The Company reports the reporting currency equivalent of foreign currency cash flows, using the current exchange rate at the time of the cash flows and the effect of exchange rate changes on cash held in foreign currencies is reported as a separate item in the reconciliation of beginning and ending balances of cash and cash equivalents and separately provides information about investing and financing activities not resulting in cash receipts or payments in the period pursuant to paragraph 830-230-45-1 of the FASB Accounting Standards Codification.
Subsequent events
The Company follows the guidance in Section 855-10-50 of the FASB Accounting Standards Codification for the disclosure of subsequent events. The Company will evaluate subsequent events through the date when the financial statements are issued. Pursuant to ASU 2010-09 of the FASB Accounting Standards Codification, the Company as an SEC filer considers its financial statements issued when they are widely distributed to users, such as through filing them on EDGAR.
Recently issued accounting pronouncements
In January 2010, the FASB issued the FASB Accounting Standards Update No. 2010-06 “Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements”, which provides amendments to Subtopic 820-10 that requires new disclosures as follows:
| | 1. | Transfers in and out of Levels 1 and 2. A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. |
| | 2. | Activity in Level 3 fair value measurements. In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuances, and settlements (that is, on a gross basis rather than as one net number). |
This Update provides amendments to Subtopic 820-10 that clarifies existing disclosures as follows:
| | 1. | Level of disaggregation. A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities. A class is often a subset of assets or liabilities within a line item in the statement of financial position. A reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities. |
| | 2. | Disclosures about inputs and valuation techniques. A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3. |
This Update also includes conforming amendments to the guidance on employers' disclosures about postretirement benefit plan assets (Subtopic 715-20). The conforming amendments to Subtopic 715-20 change the terminology from major categories of assets to classes of assets and provide a cross reference to the guidance in Subtopic 820-10 on how to determine appropriate classes to present fair value disclosures. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.
In December 2010, the FASB issued the FASB Accounting Standards Update No. 2010-28 “Intangibles—Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts” (“ASU 2010-28”).Under ASU 2010-28, if the carrying amount of a reporting unit is zero or negative, an entity must assess whether it is more likely than not that goodwill impairment exists. To make that determination, an entity should consider whether there are adverse qualitative factors that could impact the amount of goodwill, including those listed in ASC 350-20-35-30. As a result of the new guidance, an entity can no longer assert that a reporting unit is not required to perform the second step of the goodwill impairment test because the carrying amount of the reporting unit is zero or negative, despite the existence of qualitative factors that indicate goodwill is more likely than not impaired. ASU 2010-28 is effective for public entities for fiscal years, and for interim periods within those years, beginning after December 15, 2010, with early adoption prohibited.
In December 2010, the FASB issued the FASB Accounting Standards Update No. 2010-29 “Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations” (“ASU 2010-29”). ASU 2010-29 specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments in this Update also expand the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amended guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted.
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 consolidated financial statements.
NOTE 3 – PLEDGED DEPOSITS
Pledged deposits consist of amounts held in financial institutions for (i) outstanding letters of credit and (ii) open banker’s acceptance notes payable maturing between three (3) to nine (9) months from the date of issuance. Pledged deposits at June 30, 2011 and December 31, 2010 consisted of the following:
| | | June 30, 2011 | | | December 31, 2010 | |
Armco HK | | | | | | | | |
| Letters of credit (i) | | $ | 1,048,402 | | | $ | 427,553 | |
| Armet | | | | | | | | |
| Bank acceptance notes payable (ii) | | | 3,867,873 | | | | 1,906,684 | |
| | | | | | | | | |
| Deposit for release of collateralized finished goods for shipment (iii) | | | 4,771,409 | | | | 7,135,727 | |
| Henan Armco | | | | | | | | |
| Letters of credit (iv) | | | 2,426,597 | | | | 3,174,70769 | |
| | | | | | | |
| | | $ | 12,114,281 | | | $ | 12,643,671 | |
| | (i) | $824,578 has been released to ArmcoHK and the remaining balance of $223,824 is to be released to the Company as part of the payment toward outstanding letters of credit when those letters of credit mature, ranging from August 19, 2011 through September 28, 2011. |
| | (ii) | $2,320,724 is to be released to the Company when the related banker’s acceptance note payable matures on September 17, 2011, $1,547,179 is to be released to the Company when the related banker’s acceptance note payable matures on November 3, 2011. |
| | (iii) | $632,784 is to be released to the Company for release of collateralized finished goods for shipment and future payment of loan; $773,575 is to be released to the Company for release of collateralized finished goods for shipment and payment of loan on August 15, 2011; $1,547,149 is to be released to the Company for release of collateralized finished goods for shipment and payment of loan on September 15, 2011; $1,817,901 is to be released to the Company for release of collateralized finished goods for shipment and payment of loan on September 30, 2011 |
| | (iv) | $635,603 was released to the Company as part of the payment toward fulfilled letters of credit and the remaining balance of $1,790,995 is to be released to the Company as part of the payment toward outstanding letters of credit when those letters of credit mature, ranging from May 10, 2011 through October 10, 2011. |
NOTE 4 – MARKETABLE SECURITIES, AVAILABLE FOR SALE
On June 8, 2010, China Armco Metals, Inc. (the “Company”) entered into a Subscription Agreement (the “Subscription Agreement”) with Apollo Minerals Limited (“Apollo Minerals”), an Australian iron ore exploration company listed on the Australian Securities Exchange (ASX: AON). Under the terms of the Subscription Agreement, the Company agreed to acquire up to a 19.9% stake in Apollo for US $3,396,658 in cash. On July 19, 2010 Apollo Minerals issued 29,250,000 shares of its common stock to the Company. Pursuant to the Subscription Agreement, the Company received a seat on Apollo Minerals’ Board of Directors in July 2010. The board representation continues as long as the Company maintains a minimum 12% stake in Apollo Minerals.
The Company will have the right to name one member to Apollo Mineral’s board of directors for as long as it maintains at least a 12% stake in Apollo Minerals. Apollo Minerals intends to use the cash infusion to advance its exploration activities, to carry out processing option studies and to evaluate opportunities to access local infrastructure and other project opportunities.
Apollo Minerals also issued to the Company, five (5) year options to purchase an additional 5 million shares of common stock at $0.25 (approximately $0.20) per share, half of which will vest on the first anniversary of the initial issuance with the balance vesting on the second anniversary of the initial issuance. The options may only be exercised in order for the Company to maintain its 19.9% stake should Apollo Minerals issue additional common shares in the future.
The Company values marketable securities using Australia quoted market prices on Apollo Mineral stock. At June 30, 2011, the estimated fair value of investment in Apollo Minerals was $2 million less than its original costs. The Company intends to hold these shares and the management of the Company concluded the decline in the fair value was temporary and recorded the unrealized loss of marketable securities of $2,109,512 to other comprehensive income (loss) on the accompanying consolidated balance sheet at June 30, 2011 and a gain from foreign exchange rate change of $92,869 in other income for the interim period then ended.
NOTE 5 – ACCOUNTS RECEIVABLE
Accounts receivable at June 30, 2011 and December 31, 2010 consisted of the following:
| | | June 30, 2011 | | | December 31, 2010 | |
| | | | | | | | | |
| Accounts receivable | | $ | 337,302 | | | $ | 19,115,019 | |
| | | | | | | | | |
| Allowance for doubtful accounts | | | (- | ) | | | (- | ) |
| | | | | | | | | |
| | | $ | 337,302 | | | $ | 19,115,019 | |
NOTE 6 – INVENTORIES
Inventories at June 30, 2011 and December 31, 2010 consisted of the following:
| | | June 30, 2011 | | | December 31, 2010 | |
| | | | | | | | | |
| Raw materials | | $ | 4,784,903 | * | | $ | 1,925,159 | * |
| | | | | | | | | |
| Finished goods | | | 8,884,370 | * | | | 4,719,339 | * |
| | | | | | | | | |
| Purchased merchandise for resale | | | - | | | | 3,795,333 | |
| | | | | | | | | |
| | | $ | 13,669,273 | | | $ | 10,439,831 | |
* Armet’s raw materials and finished goods are collateralized for loans from the Bank of Communications Lianyungang Branch.
Raw materials consisted of scrap metals to be processed and finished goods are comprised of all of the processed scrap metal at Armet. Due to the short duration time for the processing of its scrap metal, there was no material work-in-process inventory at June 30, 2011 or December 31, 2010. Armet’s raw materials at June 30, 2011 represented approximately one month production usage.
Purchased merchandise for sale is comprised of all of the metal ores to be resold through the distribution business at Armco HK and Henan, all of which were sold and delivered to the customers. There was no balance of purchased merchandise for sale as of June 30, 2011.
NOTE 7 – PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, stated at cost, less accumulated depreciation at June 30, 2011 and December 31, 2010 consisted of the following:
| | Estimated Useful Life (Years) | | June 30, 2011 | | | December 31, 2010 | |
| | | | | | | | | | |
| Buildings and leasehold improvements (i) | 20 | | $ | 21,979,895 | | | $ | 21,426,672 | |
| Construction in progress | | | | - | | | | 32,682 | |
| Machinery and equipment | 7 | | | 13,299,762 | | | | 11,954,005 | |
| Vehicles | 5 | | | 1,146,937 | | | | 1,034,961 | |
| Office equipment | 5-8 | | | 247,156 | | | | 185,319 | |
| | | | | | | | | | |
| | | | | 36,673,750 | | | | 34,633,339 | |
| | | | | | | | | | |
| Less accumulated depreciation (ii) | | | | (2,099,639 | ) | | | (761,515 | ) |
| | | | | | | | | | |
| | | | $ | 34,574,111 | | | $ | 33,872,124 | |
(i) Capitalized interest
For the interim periods ended June 30, 2011 and 2010, the Company capitalized $0 and $257,020 of interest to fixed assets, respectively.
(ii) Depreciation and amortization expense
Depreciation and amortization expense for the interim periods ended June 30, 2011 and 2010 was $1,322,537, and $ 60,757 respectively.
NOTE 8 – LAND USE RIGHT
Land use right, stated at cost, less accumulated amortization at June 30, 2011 and December 31, 2010, consisted of the following:
| | | June 30, 2011 | | | December 31, 2010 | |
| | | | | | | | | |
| Land use right | | $ | 2,391,940 | | | $ | 2,338,289 | |
| | | | | | | | | |
| Accumulated amortization | | | (181,784 | ) | | | (153,965 | ) |
| | | | | | | | | |
| | | $ | 2,210,156 | | | $ | 2,184,324 | |
Amortization expense
Amortization expense for the interim periods ended June 30, 2011 and 2010 was $24,287 and $23,056 respectively.
NOTE 9 – LOANS PAYABLE
Loans payable at June 30, 2011 and December 31, 2010 consisted of the following:
| | | June 30, 2011 | | | December 31, 2010 | |
| Armco HK | | | | | | |
| | | | | | | |
| Loan payable to RZB Austria Finance (Hong Kong) Limited, collateralized by certain of the Company’s inventory, guaranteed by the Company’s Chairman and Chief Executive Officer, with interest at the bank’s cost of funds plus 200 basis points, per annum, payable monthly, with principal due and paid on January 26, 2011. | | | - | | | | 2,145,246 | |
| | | | | | | | | |
| Loan payable to ING Bank, Hong Kong Branch, in the form of letters of credits, secured by (i) pledged deposits equal to 5% of the letters of credits, (ii) guarantee from China Armco Metals, Inc., (iii) guarantee by the Company’s Chairman and Chief Executive Officer, and (iv) assignment of specific receivables, with interest at the bank’s cost of funds plus 250 basis points, per annum, payable monthly with principal due and paid on January 3, 2011. | | | - | | | | 11,198,830 | |
| | | | | | | | | |
| Unsecured loan payable to Fremery Holdings, Ltd., with interest at 15% per annum, with principal and interest due March 26, 2011 and paid in full by March 23, 2011. | | | - | | | | 1,500,000 | |
| | | | | | | | | |
| Armet | | | | | | | | |
| | | | | | | | | |
| Loan payable to Bank of Communications, Lianyungang Branch, under trade credit facilities, collateralized by Armet inventories and guaranteed by the Company’s Chairman and Chief Executive Officer, with interest at 110% of the bank’s benchmark rate, per annum (5.3631%), payable monthly, with principal due through August 15, 2011. | | | 5,105,593 | | | | 9,074,685 | |
| | | | | | | | | |
| Loan payable to Bank of China, Lianyungang Branch, under trade credit facilities, guaranteed by the Company’s Chairman and Chief Executive Officer, with interest at 5.838%, per annum, payable monthly, with principal due October 28, 2011. | | | 773,575 | | | | 756,224 | |
| | | | | | | | | |
| Henan Armco | | | | | | | | |
| | | | | | | | | |
| Loan payable to Guangdong Development Bank Zhengzhou Branch, with interest at 4.5%, per annum, payable monthly, with principal due and paid March 21, 2011 | | | - | | | | 90,835 | |
| | | | | | | | | |
| Loan payable to Guangdong Development Bank Zhengzhou Branch, with interest at 5.8%, per annum, payable monthly, with principal due and paid July 27, 2011 | | | 1,799,373 | | | | - | |
| | | | | | | | | |
| Loan payable to Minsheng Bank, Zhengzhou Branch,, with interest at 3.92% per annum, with principal and interest due and paid July 26, 2011 | | | 1,149,174 | | | | - | |
| | | | | | | | | |
| | | $ | 8,827,715 | | | $ | 24,765,820 | |
NOTE 10 – BANKER’S ACCEPTANCE NOTES PAYABLE
Banker’s acceptance notes payable at June 30, 2011 and December 31, 2010, consisted of the following:
| | | June 30, 2011 | | | December 31, 2010 | |
| | | | | | | | | |
| Armet | | | | | | | | |
| | | | | | | | | |
| Banker’s acceptance notes payable maturing and payable from September 17, 2011 through November 3, 2011 | | $ | 6,188,598 | | | $ | 4,174,355 | |
| | | $ | 6,188,598 | | | $ | 4,174,355 | |
NOTE 11 – RELATED PARTY TRANSACTIONS
Advances from stockholder
Advances from stockholder at June 30, 2011 and December 31, 2010 consisted of the following:
| | | June 30, 2011 | | | December 31, 2010 | |
| | | | | | | | | |
| Advances from chairman, chief executive officer and stockholder | | $ | 726,634 | | | $ | 799,394 | |
| | | | | | | | | |
| | | $ | 726,634 | | | $ | 799,394 | |
The advances bear no interest and are due on demand.
Operating lease from Chairman, CEO and Stockholder
On January 1, 2006, Henan entered into a non-cancellable operating lease for its 176.37 square meter commercial office space in the City of Zhengzhou, Henan Province, PRC from the Chairman, Chief Executive Officer and significant stockholder of the Company for RMB10,000 per month, which expired on December 31, 2008 and has been extended through December 31, 2011. Total lease payments for the interim periods ended June 30, 2011 and 2010 amounted to RMB60,000 (equivalent to $9,174 and $8,779). Future minimum lease payments required under the non-cancelable operating lease are RMB60,000 per year (equivalent to $9,283) for 2011.
NOTE 12 – CAPITAL LEASE OBLIGATION
Capital lease obligation at June 30, 2011 and December 31, 2010 consisted of the following:
| | | June 30, 2011 | | | December 31, 2010 | |
| Armet | | | | | | |
| | | | | | | |
Capital lease obligation to a financing company for a term of three (3) years, collateralized by all of Armet’s machinery and equipment, with interest at 11.8% per annum, with principal and interest due and payable in monthly installment of RMB497,897 (approximately $75,304) on the 23rd of each month. | | $ | 1,932,539 | | | $ | 2,268,671 | |
| | | | | | | | | |
| Less current maturities | | | (730,334 | ) | | | (727,756 | ) |
| | | | | | | | | |
| CAPITAL LEASE OBLIGATION, net of current maturities | | $ | 1,202,205 | | | $ | 1,540,915 | |
The future minimum payments under this capital lease obligation at June 30, 2011 were as follows:
| Year ending December 31: | | | | |
| | | | | |
| 2011 (remainder of the year) | | $ | 464,953 | |
| | | | | |
| 2012 | | | 929,476 | |
| | | | | |
| 2013 | | | 852,020 | |
| | | | | |
| Total capital lease obligation payments | | | 2,246,449 | |
| | | | | |
| Less amounts representing interest | | | (313,910 | ) |
| | | | | |
| Present value of total future capital lease obligation payments | | | 1,932,539 | |
| | | | | |
| Less current maturities of capital lease obligation | | | (730,334 | ) |
| | | | | |
| Capital lease obligation, net of current maturities | | $ | 1,202,205 | |
NOTE 13 – LONG-TERM DEBT
Long-term debt at June 30, 2011 and December 31, 2010 consisted of the following:
| | | June 30, 2011 | | | December 31, 2010 | |
| Armet | | | | | | |
| | | | | | | |
| Long-term debt due to Bank of China, Lianyungang Branch, collateralized by all of Armet’s building and land use right, with interest at 5.40% per annum payable monthly, with principal of RMB30,000,000 ($4,641,443), and RMB25,000,000 ($3,867,873) due August 25, 2011 and August 25, 2012, respectively. | | $ | 8,509,321 | | | $ | 8,318,461 | |
| | | | | | | | | |
| Less current maturities | | | (4,641,448 | ) | | | (4,537,342 | ) |
| | | | | | | | | |
| LONG-TERM DEBT, net of current maturities | | $ | 3,867,873 | | | $ | 3,781,119 | |
NOTE 14 – DERIVATIVE INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS
(i) Warrants issued in 2008
Description of warrants
In connection with the four (4) rounds of private placements from July 25, 2008 through August 8, 2008 (the “2008 Unit Offering”), the Company issued (i) warrants for 2,486,649 shares to the investors and (ii) warrants for 242,264 shares to the brokers, or 2,728,913 shares in aggregate (“2008 Warrants”) with an exercise price of $5.00 per share and an expiration date of August 31, 2013, all of which have been earned upon issuance. The fair value of 2008 warrants, estimated on the date of grant, was $5,097,404, which was originally recorded as additional paid-in capital, using the Black-Scholes option-pricing model with the following weighted-average assumptions:
| Expected option life (year) | | | 5.00 | |
| | | | | |
| Expected volatility | | | 89.00% | |
| | | | | |
| Risk-free interest rate | | | 3.23% | |
| | | | | |
| Dividend yield | | | 0.00% | |
The remaining balance of the net proceeds of $1,523,277 has been assigned to Common stock.
Derivative analysis
The exercise price of 2008 warrants and the number of shares issuable upon exercise is subject to reset adjustment in the event of stock splits, stock dividends, recapitalization, most favored nation clause and similar corporate events. Pursuant to the most favored nation provision of the 2008 Unit Offering, if the Company issues any common stock or securities other than the excepted issuances, to any person or entity at a purchase or exercise price per share less than the share purchase price of the 2008 Unit Offering without the consent of the subscriber holding purchased shares, warrants or warrant shares of the 2008 Unit Offering, then the subscriber shall have the right to apply the lowest such purchase price or exercise price of the offering or sale of such new securities to the purchase price of the purchased shares then held by the subscriber (and, if necessary, the Company will issue additional shares), the reset adjustments are also referred to as full reset adjustments.
Because these warrants have full reset adjustments tied to future issuances of equity securities by the Company, they are subject to derivative liability treatment under Section 815-40-15 of the FASB Accounting Standard Codification (“Section 815-40-15”) (formerly FASB Emerging Issues Task Force (“EITF”) 07-5). Section 815-40-15 became effective for the Company on January 1, 2009 and as of that date the Warrants issued in the 2008 Unit Offering have been measured at fair value using a lattice model at each reporting period with gains and losses from the change in fair value of derivative liabilities recognized on the consolidated statement of income and comprehensive income.
Valuation of derivative liability
The Company’s 2008 warrants do not trade in an active securities market, as such, the Company developed a lattice model that values the derivative liability of the warrants based on a probability weighted discounted cash flow model. This model is based on future projections of the various potential outcomes. The features that were analyzed and incorporated into the model included the exercise feature and the full ratchet reset.
The fair value of the 2008 warrants treated as derivatives were computed using the following assumptions:
| | | December 31, 2010 | | December 31, 2009 | |
| | | | | | | |
| Expected option life (year) | | 2.50 | | | 3.50 | |
| | | | | | | |
| Expected volatility | | 159% | | | 169% | |
| | | | | | | |
| Risk-free interest rate | | 1.02% | | | 2.61% | |
| | | | | | | |
| Dividend yield | | 0.00% | | | 0.00% | |
The risk-free interest rate is based on a yield curve of U.S treasury interest rates on the date of valuation based on the contractual life of the warrant remaining. Expected dividend yield is based on our dividend history and anticipated dividend policy. Expected volatility is based on historical volatility for our common stock. The Company currently has no reason to believe future volatility over the expected remaining life of these warrants is likely to differ materially from historical volatility. The expected life is based on the remaining term of the warrants.
Extinguishment of derivative warrant liability
During the three months ended March 31, 2010, certain holders of 2008 warrants to purchase 1,031,715 shares of the Company’s common stock reached agreements with the Company effective as of January 1, 2010, whereby the Company waived its right to offer or sell additional shares of its common stock below $5.00 per share in the future and the 2008 warrant holders waived their anti-dilution or commonly known as most favored nation clause, for which the Company reclassified $1,292,227 of the derivative warrant liability to additional paid-in capital.
Exercise of warrants
On January 30, 2009, the Company issued 5,000 shares of its common stock for cash at $5.00 per share and received a cash payment of $25,000 in connection with the exercise of the 2008 warrants for 5,000 shares with an exercise price of $5.00 per share by one (1) investor and 2008 warrants holder.
During the first quarter of 2010, the Company issued 1,324,346 shares of its common stock for cash at $5.00 per share and received cash of $6,621,730 in connection with the exercise of the warrants to purchase 1,324,346 shares with an exercise price of $5.00 per share to 50, 2008 warrant holders. In addition, the Company issued 78,217 shares of its common stock in connection with the exercise of the 2008 warrants to purchase 167,740 shares with an exercise price of $5.00 per share on a cashless basis to 13, 2008 warrant holders.
During April 2010, four (4) 2008 warrant holders exercised their warrants to purchase 13,806 shares of the Company’s common stock at an exercise price of $5.00 per share resulting in cash proceeds of $69,030 to the Company.
Warrants outstanding
As of June 30, 2011 warrants to purchase 1,218,021 shares of Company common stock remain outstanding.
The table below summarizes the Company’s derivative warrant activity through June 30, 2011:
| | | 2008 Warrant Activities | | | APIC | | | (Gain) Loss | |
| | | Derivative Shares | | | Non-derivative Shares | | | Total Warrant Shares | | | Fair Value of Derivative Warrants | | | Reclassification of Derivative Liability | | | Change in Fair Value of Derivative Liability | |
| | | | | | | | | | | | | | | | | | | |
| Derivative warrant at 12/31/2009 | | | 2,728,913 | | | | - | | | | 2,728,913 | | | $ | (3,417,974 | ) | | $ | - | | | $ | 166,025 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Exercise of warrants | | | (5,000 | ) | | | - | | | | (5,000 | ) | | | 6,263 | | | | (6,263 | ) | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Exercise of warrants | | | (1,324,346 | ) | | | - | | | | (1,324,346 | ) | | | 1,658,748 | | | | (1,658,748 | ) | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Exercise of warrants – Cashless | | | (167,740 | ) | | | - | | | | (167,740 | ) | | | 210,095 | | | | (210,095 | ) | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total warrant exercised | | | (1,497,086 | ) | | | - | | | | (1,497,086 | ) | | | 1,875,106 | | | | (1,875,106 | ) | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Extinguishment of warrant liability resulting from waiver of anti-dilution | | | (1,031,715 | ) | | | 1,031,715 | | | | - | | | | 1,292,227 | | | | (1,292,227 | ) | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Derivative warrants remaining | | | 200,112 | | | | - | | | | - | | | | (250,641 | ) | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mark to market | | | - | | | | - | | | | | | | | (321,752 | ) | | | - | | | | 321,752 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Derivative warrant at March 31, 2010 | | | 200,112 | | | | 1,031,715 | | | | 1,231,827 | | | | (572,393 | ) | | | - | | | | 321,752 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Exercise of warrants in April 20, 2010 | | | (13,806 | ) | | | - | | | | (13,806 | ) | | | 21,229 | | | | (21,229 | ) | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Derivative warrants remaining | | | 186,306 | | | | - | | | | 186,306 | | | | (551,164 | ) | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mark to market | | | - | | | | - | | | | | | | | 427,875 | | | | - | | | | (427,875 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Derivative warrant at June 30, 2010 | | | 186,306 | | | | 1,031,715 | | | | 1,218,021 | | | | (123,289 | ) | | | - | | | | (106,123 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mark to market | | | - | | | | - | | | | | | | | (13,211 | ) | | | - | | | | 13,211 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Derivative warrant at September 30, 2010 | | | 186,306 | | | | 1,031,715 | | | | 1,218,021 | | | | (136,500 | ) | | | - | | | | (92,912 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mark to market | | | - | | | | - | | | | | | | | (1643 | ) | | | - | | | | 1643 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Derivative warrant at December 31, 2010 | | | 186,306 | | | | 1,031,715 | | | | 1,218,021 | | | | (138,143 | ) | | | - | | | | (91,269 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mark to market | | | - | | | | - | | | | | | | | 51,223 | | | | - | | | | (51,223 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Derivative warrant at March 31, 2011 | | | 186,306 | | | | 1,031,715 | | | | 1,218,021 | | | | (86,920 | ) | | | - | | | | (51,223 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mark to market | | | | | | | | | | | | | | | 76,897 | | | | | | | | (76,897 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Derivative warrant at June 30, 2011 | | | 186,306 | | | | 1,031,715 | | | | 1,218,021 | | | | (10,023 | ) | | | | | | | (128,120 | ) |
(ii) Warrants issued in April 2010
Description of warrants
In connection with the sale of 1,538,464 shares of its common stock at $6.50 per share or $10,000,016 in gross proceeds to nine (9) accredited and institutional investors on April 20, 2010, the Company issued five (5) year common stock purchase warrants to purchase an additional 1,538,464 shares of its common stock at $7.50 per share (“2010 Warrants”) exercisable commencing 181 days following the date of issuance. At the closing of the private offering, the Company paid Rodman & Renshaw, LLC, a FINRA member firm that served as placement agent for the Company in the offering, (i) a fee of $500,000 as compensation for their services and (ii) five-year common stock purchase warrants to purchase 76,923 shares of the Company’s common stock at $7.50 per share exercisable commencing 181 days following the date of issuance, as well as a $15,000 non-accountable expense allowance to one of the nine (9) investors in the offering.
Warrants valuation and related assumptions
The 2010 warrants were valued with the following assumptions:
| - | The underlying NYSEAmex stock price $6.95 was used as the fair value of the common stock as of 4/20/10; |
| - | The Company’s stock price would fluctuate with its projected volatility. The projected volatility curve for each valuation period was based on the historical volatility of 14 comparable companies in the metal/industrial metals industries:At April 20, 2010 one (1) through five (5) years were 76%, 134%, 155%, 167% and 182%, respectively. |
| - | The Holder would exercise the warrants at maturity if the stock price was above the exercise price. |
| - | Dilutive reset events projected to occur are based on no future projected capital needs; |
| - | The Holder would exercise the warrants as they become exercisable at target prices of $11.25 for the 2010 Offering, and lowering such target as the warrants approaches maturity. |
| - | 1,615,387 warrants have been issued on 4/20/10. |
The fair value of the 2010 warrants, estimated on the date of issuance, was $2,483,938.
Derivative analysis
The warrants issued as part of the April 20, 2010 private placement were analyzed to determine the appropriate treatment under ASC 815-40. The warrants meet the provisions of EITF 07-5 (ASC 815-40) to be considered indexed to the Company’s own stock. In addition, the warrants meet all the criteria in EITF 00-19 (ASC 815-40) to be accounted for as equity.
Warrants outstanding
As of June 30, 2011 warrants to purchase 1,615,387 shares of its common stock remain outstanding.
(iii) Warrant activities
The table below summarizes the Company’s derivative warrant activities through June 30, 2011:
| | | Number of Warrant Shares | | | Exercise Price Range Per Share | | | Weighted Average Exercise Price | | | Fair Value at Date of Issuance | | | Aggregate Intrinsic Value | |
| | | | | | | | | | | | | | | | |
| Balance, December 31, 2009 | | | 2,723,913 | | | $ | 5.00 | | | $ | 5.00 | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Granted | | | 1,615,387 | | | | 7.50 | | | | - | | | | 2,483,938 | | | | - | |
| Canceled for cashless exercise | | | (89,523 | ) | | | - - | | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Exercised (Cashless) | | | (78,217 | ) | | | - | | | | - | | | | - | | | | - | |
| Exercised | | | (1,338,152 | ) | | | 5.00 | | | | 5.00 | | | | - | | | | - | |
| Expired | | | - | | | | - | | | | - | | | | - | | | | - | |
| Balance, December 31, 2010 | | | 2,833,408 | | | $ | 6.43 | | | $ | 4.14 | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Granted | | | - | | | | - | | | | - | | | | - | | | | - | |
| Canceled for cashless exercise | | | (- | ) | | | - - | | | | - | | | | - | | | | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Exercised (Cashless) | | | (- | ) | | | - | | | | - | | | | - | | | | - | |
| Exercised | | | (- | ) | | | - | | | | - | | | | - | | | | - | |
| Expired | | | - | | | | - | | | | - | | | | - | | | | - | |
| Balance, June 30, 2011 | | | 2,833,408 | | | $ | 6.43 | | | $ | 4.14 | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Earned and exercisable, June 30, 2011 | | | 2,833,408 | | | $ | 6.43 | | | $ | 4.14 | | | $ | - | | | $ | - | |
| | | | | | | | | | | | | | | | | | | | | |
| Unvested, June 30, 2011 | | | - | | | $ | - | | | $ | - | | | $ | - | | | $ | - | |
The following table summarizes information concerning outstanding and exercisable warrants as of June 30, 2011:
| | | | Warrants Outstanding | | | | Warrants Exercisable | |
| Range of Exercise Prices | | | Number Outstanding | | | | Average Remaining Contractual Life (in years) | | | | Weighted Average Exercise Price | | | | Number Exercisable | | | | Average Remaining Contractual Life (in years) | | | | Weighted Average Exercise Price | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| $5.00 | | | 1,218,021 | | | | 2.34 | | | $ | 5.00 | | | | 1,218,021 | | | | 2.34 | | | $ | 5.00 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| $7.50 | | | 1,615,387 | | | | 4.06 | | | $ | 7.50 | | | | 1,615,387 | | | | 4.06 | | | $ | 7.50 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| $5.00 - $7.50 | | | 2,833,408 | | | | 3.32 | | | $ | 6.43 | | | | 2,833,408 | | | | 3.32 | | | $ | 6.43 | |
NOTE 15 – STOCKHOLDERS’ EQUITY
Sale of common stock
On April 20, 2010, the Company entered into a Securities Purchase Agreement with nine (9) accredited and institutional investors for the sale of 1,538,464 shares of its common stock at an offering price of $6.50 per share resulting in gross proceeds to the Company of $10,000,016. At closing the Company issued the investors five (5) year common stock purchase warrants to purchase an additional 1,538,464 shares of its common stock at an exercise price of $7.50 per share. The warrants are exercisable commencing 181 days after the date of issuance. The private offering, which was made under an exemption from the registration requirements of the Securities Act of 1933 in reliance on exemptions provided by Section 4(2) of that act and Rule 506 of Regulation D. At closing, the Company paid Rodman & Renshaw, LLC, a FINRA member firm that served as placement agent for the Company in the offering, (i) a fee of $500,000 as compensation for its services and (ii) issued the firm five (5) year common stock purchase warrants exercisable for 76,923 shares of the Company’s common stock at an exercise price of $7.50 per share which are exercisable commencing 181 days after the date of issuance, as well as a $15,000 non-accountable expense allowance to one (1) of the investors in the offering. The Company intends to use the net proceeds from this offering for its working capital.
Issuance of common stock for services
On May 7, 2009, the Company issued 7,000 shares of its common stock to Hayden Communications as consideration for canceling an agreement to provide IR services. These shares were valued at $1.50 per share for total consideration of $10,500 (the estimated fair value on the date of grant).
On February 5, 2010, the Company issued 80,000 shares of its common stock to China Direct Investments, Inc. as consideration for management and accounting consulting services for the period beginning January 1, 2010 through December 31, 2010. There is no performance commitment at the date of the agreement therefore the company will use the date(s) at which performance is complete as the measurement date(s). The services are earned and forfeitable on a ratable basis throughout each quarter during the year. The 20,000 shares each earned for each quarter in 2010 were valued at $9.39, $2.90, $3.47 and $3.88 per share, or $187,800, $58,000, $69,400 and $77,600 in aggregate, which was recorded as consulting fees for the relevant quarter. In aggregate, $392,800 was recorded as consulting fee for the year ended December 31, 2010.
On April 30 and July 9, 2010, the Company issued 12,500 shares and 10,000 shares, or 22,500 shares in aggregate to Bespoke Growth Partners, Inc. as consulting fees for investor relations services rendered, valued at $3.49 per share for $78,525.
On June 11, 2010 the Company entered into a Guaranty Cooperation Agreement with Henan Chaoyang Steel Co., Ltd. (“Henan Chaoyang”), a Chinese limited liability company that was 85% owned by the Company’s then member of the Board of Director, Mr. Heping Ma. Under the terms of the guaranty, Henan Chaoyang agreed to provide loan guarantees to Armet existing and pending bank lines of credit of up to 300 million RMB in aggregate (approximately $45,400,000) for five (5) years expiring June 30, 2016. On September 16, 2010 Mr. Ma resigned from the Company’s Board of Directors. As consideration for the guaranty, the Company issued a designee of Henan Chaoyang 500,000 shares of its common stock, which are earned and forfeitable on a ratable basis during the term of the agreement.
33,333 shares each earned for quarters ended September 30, 2010 and December 31, 2010 were valued at $3.47 and $3.88 per share, or $115,666 and $129,332 in aggregate, which was recorded as loan guarantee expense and included in the consolidated statements of operations and comprehensive income (loss) for the relevant periods. In aggregate, $244,998 was recorded as loan guarantee expense for the year ended December 31, 2010.
33,333 common shares each earned for quarter ended March 31, 2011 and June 30, 2011 were valued at $2.61 and $1.36 per share, or $86,996 and $45,333 in aggregate, which was recorded as loan guarantee expense and included in the consolidated statements of operations and comprehensive income (loss) for the relevant periods.
On November 19, 2010, the Company entered into an investor relations consulting agreement with HCI International Inc. expiring December 31, 2011. Either party may terminate the agreement any time during the term of the contract. Pursuant to the agreement the Company is required to pay the investor relation firm 3,600 shares of the Company’s restricted stock per month payable at the first of each month for the 12 month service period, or 43,200 shares in aggregate for 2011 investor relations services. 10,800 shares per quarter were valued at $1.36 per share, or $14,688 in aggregate and $2.69 per share, or $29,051 in aggregate and recorded as investor relations expense for the quarterly period ended March 31, 2011 and June 30, 2011, respectively.
Stock options
On June 27, 2008, the Company entered into a share purchase agreement (the “Share Purchase Agreement”) and consummated a share purchase (the “Share Purchase”) with Armco HK and Feng Gao, who owned 100% of the outstanding shares of Armco HK. Under the Share Purchase Agreement, the Company purchased from Ms. Gao, the sole shareholder of Armco HK, 100% of the issued and outstanding shares of Armco HK capital stock for $6,890,000 by delivery of the Company’s purchase money promissory note (the “Share Purchase”). In addition, the Company issued to Ms. Gao a stock option entitling Ms. Gao to purchase 5,300,000 shares of our common stock, par value $.001 per share (the “Common Stock”) at $1.30 per share expiring on December 31, 2008 and 2,000,000 shares at $5.00 per share expiring on June 27, 2010, vested immediately (the “Gao Option”). On August 12, 2008, Ms. Gao exercised her option to purchase and the Company issued 5,300,000 Shares in exchange for the $6,890,000 note owed to Ms. Gao. Accordingly, the 5,300,000 Shares issued to Ms. Gao represented approximately 69.7% of the issued and outstanding Shares of the Company giving effect to the cancellation of 7,694,000 Shares owned by Mr. Cox.
The fair value of the stock options issued in June 2008 under Share Purchase Agreement using the Black-Scholes Option Pricing Model was $0 at the date of grant. For the interim periods ended March 31, 2010 and 2009, the Company did not grant any stock options.
On April 12, 2010, Mr. Kexuan Yao purchased the stock option to purchase 2,000,000 shares of the Company’s common stock at $5.00 per share on June 27, 2008 originally granted to and owned by Ms. Feng Gao pursuant to a share purchase agreement to consummate the reverse merger capital transaction with Armco HK. In addition, on April 12, 2010 and June 25, 2010, Mr. Yao exercised part of the option and purchased 1,000,000 and 400,000 shares of the Company’s common stock at $5.00 per share resulting in net proceeds of $4,500,000, forgiveness of debt of $500,000 and $2,000,000 to the Company, respectively. The balance of the stock option to purchase the remaining 600,000 common shares expired at June 27, 2010.
Stock incentive plan
On October 26, 2009, the Board of Directors of the Company adopted the 2009 Stock Incentive Plan, whereby the Board of Directors authorized 1,200,000 shares of the Company’s common stock to be reserved for issuance (the “2009 Stock Incentive Plan”). The purpose of the 2009 Stock Incentive Plan is to advance the interests of the Company’s company by providing an incentive to attract, retain and motivate highly qualified and competent persons who are important to us and upon whose efforts and judgment the success of the company is largely dependent. Grants to be made under the Plan will be limited to the Company’s employees, including employees of the Company’s subsidiaries, the Company’s directors and consultants to the Company. The recipient of any grant under the Plan, and the amount and terms of a specific grant, will be determined by the board of directors. Should any option granted or stock awarded under the Plan expire or become un-exercisable for any reason without having been exercised in full or fail to vest, the shares subject to the portion of the option not so exercised or lapsed will become available for subsequent stock or option grants.
On May 19, 2011, the Company’s Board of Directors adopted and approved the Amended and Restated 2009 Stock Incentive Plan, subject to stockholder approval at the Annual Meeting. At the 2011 Annual Meeting of Stockholders (the “Annual Meeting”) of the Company held on July 9, 2011, the Company’s stockholders approved an amendment and restatement of the Company’s 2009 Stock Incentive Plan (the “Amended and Restated 2009 Stock Incentive Plan”). The primary purpose for the Amended and Restated 2009 Stock Incentive Plan was to increase the number of shares of the Company’s common stock available for issuance thereunder by 1,000,000 shares to 2.200,000 shares of the Company’s common stock.
On October 26, 2009, the Company awarded 200,000 shares of its restricted common stock, par value $.001 per share, pursuant to the 2009 Stock Incentive Plan, to Mr. Kexuan Yao, the Company’s Chief Executive Officer. The shares awarded to Mr. Yao will vest 66,667 shares on December 15, 2010, 66,667 shares on December 15, 2011 and 66,666 shares on December 15, 2012. These shares were valued at $3.28 per share or $656,000 on the date of grant and were amortized over the vesting period. In aggregate, $54,667 was recorded as stock based compensation for the interim period ended March 31, 2011 each.
On October 26, 2009, the Company agreed to pay Mr. William Thomson the sum of $20,000 and awarded 6,250 shares of the Company’s restricted common stock to Mr. William Thomson in conjunction with his appointment to the Company's board of directors. The shares awarded to Mr. Thompson will vest 25% on March 31, 2010, 25% on June 30, 2010, 25% on September 30, 2010 and 25% on December 31, 2010. The restricted stock vests only if Mr. Thomson is still a director of the Company on the vesting date (with limited exceptions), and the shares are eligible for the payment of dividends, if the Board of Directors was to declare dividends on the Company’s common stock. These shares were valued at $3.28 per share or $20,500 on the date of grant and were amortized over the vesting period. In aggregate, all of the $20,500 was earned and recorded as stock based compensation for the year ended December 31, 2010. The Company and Mr. William Thomson are in the process of entry into the new director service agreement for 2011.
On September 16, 2010, the Company agreed to pay Mr. Jinping Chan the sum of $20,000 and awarded 6,250 shares of the Company’s restricted common stock to Mr. Chan in conjunction with his appointment to the Company's board of directors. The shares awarded to Mr. Chan will vest 50% on March 10, 2011 and 50% on September 10, 2011. The restricted stock vests only if Mr. Chan is still a director of the Company on the vesting date (with limited exceptions), and the shares are eligible for the payment of dividends, if the Board of Directors was to declare dividends on the Company’s common stock. These shares were valued at $3.12 per share or $19,500 on the date of grant and were amortized over the vesting period. In aggregate, $4,875 was recorded as stock based compensation for the three months ended March 31, 2011.
On October 5, 2010, the Company awarded a stock option to purchase 40,000 shares of the Company’s common stock exercisable at $5.00 per share to an employee in conjunction with his employment agreement as the Company's Director of Administration, vested upon grant. The fair value of option granted, estimated on the date of grant, was $138,000, using the Black-Scholes option-pricing model with the following weighted-average assumptions:
| Expected option life (year) | | | 5.00 | |
| | | | | |
| Expected volatility | | | 187% | |
| | | | | |
| Risk-free interest rate | | | 1.21% | |
| | | | | |
| Dividend yield | | | 0.00% | |
The Company recorded the entire amount of $138,000 as stock based compensation expense on the date of grant.
On January 25, 2011, the Company issued 55,378 shares of its common shares to certain of its employees for their 2010 services of approximately $187,100 in lieu of cash, which was recorded as compensation expenses in 2010 and credited the same to the accrued expenses at December 31, 2010.
On March 29, 2011, the Company awarded 10,000 shares of the Company’s common stock to an employee for his 2011 employment service vesting on July 1, 2011. These shares were valued at $2.74 per share or $27,400 on the date of grant and are being amortized over the service period of one year in 2011. $6,850 was recorded as stock based compensation expense for the six months ended June 30, 2011.
The table below summarizes the Company’s Amended and Restated 2009 Stock Incentive Plan activities as of June 30, 2011:
| | | Number of Shares or Options | | | Fair Value at Date of Grant | |
| | | | | | | | | |
| Balance, December 31, 2009 | | | 206,250 | | | $ | 676,500 | |
| | | | | | | | | |
| Granted – shares | | | 6,250 | | | | 19,500 | |
| Canceled – shares | | | - | | | | - | |
| Granted – options | | | 40,000 | | | | 138,000 | |
| Canceled – options | | | - | | | | - | |
| Balance, December 31, 2010 | | | 252,500 | | | | 834,000 | |
| | | | | | | | | |
| Granted – shares | | | 65,378 | | | | 214,580 | |
| Canceled – shares | | | - | | | | - | |
| Granted – options | | | - | | | | - | |
| Canceled – options | | | - | | | | - | |
| Balance, June 30, 2011 | | | 317,878 | | | $ | 1,048,580 | |
| | | | | | | | | |
| Vested, June 30, 2011 | | | 211,319 | | | | 605,365 | |
| | | | | | | | | |
| Unvested, June 30, 2011 | | | 106,559 | | | $ | 403,215 | |
As of June 30, 2011, there were 1,882,122 shares of common stock remaining available for issuance under the Amended and Restated 2009 Stock Inceptive Plan.
NOTE 16 – OPERATING COST OF IDLE MANUFACTURING FACILITY
Armet’s manufacturing facility is idle from time to time depending upon market conditions. Total operating costs of the idle manufacturing facility, including salary and wages, payroll tax and benefits, materials, depreciation and other operating costs of maintaining the manufacturing facility, were $899,786 for the interim period ended June 30, 2011. There were no operating costs of the idle manufacturing facility for the interim period ended June 30, 2010 as Armet did not complete the construction of its manufacturing facility and commence operations until the end of September 2010.
NOTE 17 – COMMITMENTS AND CONTINGENCIES
Uncommitted trade credit facilities
The Company entered into uncommitted trade credit facilities with certain financial institutions. Substantially all of the uncommitted trade credit facilities were guaranteed by Mr. Yao, the Company’s chairman, Chief Executive Officer and principal stockholder. The uncommitted trade credit facilities at June 30, 2011 were as follows:
| | Date of Expiration | | Total Facilities | | | Facilities Used | | | Facilities Available | |
| Armco HK | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| DBS (Hong Kong) Limited (i) | August 26, 2011 | | $ | 20,000,000 | | | $ | 0.00 | | | $ | 20,000,000 | |
| | | | | | | | | | | | | | |
| ING Bank, N.V. Hong Kong Branch (ii) | August 12, 2011 | | | 20,000,000 | | | | 26,740,000 | | | | - | |
| | | | | | | | | | | | | | |
| RZB (Beijing) Branch (iii) | October 31, 2011 | | | 15,000,000 | | | | 765,000 | | | | 14,235,000 | |
| | | | | | | | | | | | | | |
| Henan Armco | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| Guangdong Development Bank Zhengzhou Branch (iv) | June 17, 2012 | | | 10,830,046 | | | | 2,936,768 | | | | 7,893,278 | |
| | | | | | | | | | | | | | |
| China CITIC Bank Zhengzhou Branch (v) | March 15, 2012 | | | 7,735,747 | | | | 0.00 | | | | 7,735,747 | |
| | | | | | | | | | | | | | |
| China Minsheng Bank Zhengzhou Branch (vi) | October 13, 2011 | | | 3,094,299 | | | | 2,128,364 | | | | 965,935 | |
| | | | | | | | | | | | | | |
| Armet | | | | | | | | | | | | | |
| | | | | | | | | | | | | | |
| Bank of China Lianyungang Branch (vii) | September 3, 2012 | | | 10,830,046 | | | | 8,509,322 | | | | 2,320,724 | |
| | | | | | | | | | | | | | |
| Bank of China Lianyungang Branch (viii) | October 29, 2011 | | | 3,094,299 | | | | 773,575 | | | | 2,320,724 | |
| | | | | | | | | | | | | | |
| Bank of Communications Lianyungang Branch (ix) | June 30, 2013 | | | 11,139,476 | | | | 5,105,593 | | | | 6,033,883 | |
| | | | | | | | | | | | | | |
| | | | $ | 101,723,913 | | | $ | 51,710,602 | | | $ | 61,505,291 | |
(i) On August 6, 2010, Armco HK entered into a Banking Facilities Agreement with DBS Bank (Hong Kong) Limited of $20,000,000 for issuance of commercial letters of credit in connection with the Company’s purchase of metal ore. The Company pays interest at LIBOR or DBS Bank’s cost of funds plus 2.50% per annum on issued letters of credit in addition to an export bill collection commission equal to 1/8% of the first $50,000 and 1/16% of the balance and an opening commission of 1/4% on the first $50,000 and 1/16% of the balance for each issuance. Amounts advanced under this facility are repaid from the proceeds of the sale of metal ore. The lender may terminate the facility at anytime at its sole discretion. The facility is secured by the charge on cash deposit of the borrower, the borrower’s restricted pledged deposit in the minimum amount of 3% of the letter of credit amount, the Company’s letter of comfort and the guarantee of Mr. Kexuan Yao.
(ii) On August 12, 2010, Armco HK obtained a $20,000,000 line of credit from ING Bank Hong Kong Branch for issuance of letters of credit to finance the purchase of metal ore along with a sub-limit facility for freight advance of $3,000,000. The letters of credit require the Company to pledge cash equal to 5% of the letter of credit, subject to increase by the lender in the event of price fluctuations and market demand while the letter of credit remains open. The Company pays interest at the lender’s cost of funds plus 250 basis points per annum on issued letters of credit in addition to an export bill collection commission equal to 1/4% of the first $50,000 and 1/16% of the balance for each issuance. Amounts advanced under this line of credit are repaid from the proceeds of the sale of metal ore. The lender may terminate the facility at anytime at its sole discretion. The facility is secured by the Company’s restricted cash deposit in the minimum amount of 5% of the letter of credit amount, the Company’s guarantee, the guarantee of Mr. Kexuan Yao and a security interest in the contract for the purchase of the ore for which the letter of credit has been issued and the contract for the sale of the ore. ING verbally approved the increase of trade credit facilities to $26,740,000 to facilitate one purchase on a temporary basis.
(iii) On July 23, 2010, Armco HK entered into Amendment No. 1 to the March 25, 2010 uncommitted Trade Finance Facility with RZB Austria Finance (Hong Kong) Limited. The amendment provides for the issuance of $15,000,000 of commercial letters of credit in connection with the purchase of metal ore, an increase of $5,000,000 over the amounts provided for in the March 25, 2010 facility. The Company pays interest at 200 basis points per annum plus the lender’s cost of funds per annum on issued letters of credit in addition to fees upon issuance of the letter of credit of 1/16% for issuance commissions, negotiation commissions, commission-in-lieu and collection commissions. Amounts advanced under this facility are repaid from the proceeds of the sale of metal ore. The lender may, however, terminate the facility at anytime or at its sole discretion upon the occurrence of any event which causes a material market disruption in respect of unusual movement in the level of funding costs to the lender or the unusual loss of liquidity in the funding market. The lender has the sole discretion to decide whether or not such event has occurred. The facility is secured by restricted cash deposits held by the lender, the personal guarantee of Mr. Kexuan Yao, the Company’s guarantee, and a security interest in the contract for the purchase of the ore for which the letter of credit has been issued and the contract for the sale of the ore.
(iv) On June 18, 2011, Henan Armco obtained a RMB 70,000,000 (approximately $10,800,000) line of credit from Guangdong Development Bank Zhengzhou Branch for issuance of letters of credit to finance the purchase of metal ore. The Company pays interest at 120% of the applicable base rate for lending published by the People’s Bank of China (“PBC”) at the time the loan is made on issued letters of credit. The facility is secured by the guarantee provided by Mr. Kexuan Yao and Armet jointly and the pledge of movable assets provided by the borrower. Amounts advanced under this line of credit are repaid from the proceeds of the sale of metal ore. The term of the facility is one year.
(v) On April 27, 2011, Henan Armco obtained a RMB 50,000,000 (approximately $7,700,000) line of credit from China CITIC Bank, Zhengzhou Branch, for issuance of letters of credit to finance the purchase of metal ore and scrap metal expiring one (1) year from the date of issuance. The letters of credit require the Company to pledge cash deposits equal to 20% of the letter of credit for letters of credit at sight, or 30% for term letters of credit. Term letters of credit are limited to no more than 90 days. The interest rates are variable depending on the lender’s cost of funds at the time when the letter of credit is issued. The facility is guaranteed by Armet and Mr. Kexuan Yao, the Company’s Chairman and Chief Executive Officer.
(vi) On October 13, 2010, Henan Armco obtained a RMB 20,000,000 (approximately $3,000,000) line of credit from China Minsheng Bank, Zhengzhou Branch, for issuance of letters of credit to finance the purchase of metal ore and scrap metal expiring one (1) year from the date of issuance. The facility is guaranteed by Armet and Mr. Kexuan Yao, the Company’s Chairman and Chief Executive Officer.
(vii) On September 4, 2009, Armet entered into a line of credit facility (“Line of Credit”) in the amount of RMB 70,000,000 (approximately $10.7 million) from Bank of China, Lianyungang Branch expiring September 3, 2012, which can be drawn in the form of long-term debt or a bank acceptance payable. The facility is to finance the construction of Armet’s metal recycling facility. Armet pays interest at 105% of the applicable base rate for lending published by the People’s Bank of China (“PBOC”) at the time the loan is drawn down, as adjusted annually. The line of credit facility is collateralized by Armet’s building, equipment and land use right and the guarantees provided by Mr. Kexuan Yao, Mr. Yi Chu, Henan Armco and Henan Chaoyang, respectively.
(viii) On October 29, 2010, Armet entered into a line of facility in the amount of RMB20,000,000 (approximately $3.0 million) from Bank of China, Lianyungang Branch for the purchase of raw materials. The term of the facility is 12 months with interest at 5.838% per annum. The facility is secured by the guarantees provided by Mr. Kexuan Yao, Mr. Yi Chu, Henan Armco and Henan Chaoyang, respectively.
(ix) On July 1, 2011, Armet obtained a RMB 72,000,000 (approximately $11.1 million) line of credit from Bank of Communications, Lianyungang Branch expiring two years from the date of issuance, for issuance of letters of credit in connection with the purchase of scrap metal. The letters of credit require Armet to pledge cash deposit equal to 20% of the letter of credit for letters of credit at sight, or 30% for other domestic letters of credit and for extended domestic letters of credit, the collateral of inventory equal to 166% of the letter of credit. The facility is secured by Armet inventories and guarantee provided by Mr. Kexuan Yao, the Company’s Chairman and Chief Executive Officer.
Loan guarantee
On June 11, 2010 the Company entered into a Guaranty Cooperation Agreement with Henan Chaoyang to provide additional liquidity to meet anticipated capital requirements of the recently launched Armet scrap metal recycling facility and the expansion of its metal ore trading business in the coming years. Under the terms of this guaranty, Henan Chaoyang agreed to provide up to RMB 300 million (approximately $46,400,000) loan guarantees to the Company’s subsidiary, Armet, for five (5) years for the following approved bank loans and credit lines and pending application of bank loans and line of credits:
| | ● | Bank of China Lianyungang Branch’s project loan in the amount of RMB 90 million (approximately $13.4 million) which was guaranteed in 2009, |
| | ● | Bank of Communications Lianyungang Branch loan in the amount of RMB 50 million (approximately $7.5 million) which was approved on June 10, 2010 and is in the process of closing, |
| | ● | Bank of Jiangsu loan in the amount of RMB 30 million (approximately $4.5 million) which is pending lender approval, and |
| | ● | Bank of China’s additional loan for working capital of RMB 130 million (approximately $19.4 million) which is pending lender approval. |
Under the terms of the Guaranty Cooperation Agreement, the Company has the right to apply to other banks for credit lines at the same or lesser amounts if the pending applications are not approved, but the Company needs the consent of Henan Chaoyang to apply to other banks for credit lines.
As consideration for the guaranty, the Company issued to Xianjun Ma, a designee of Henan Chaoyang, 500,000 shares of its common stock. The shares are earned ratably over the term of the agreement, and the unearned shares are forfeitable in the event of nonperformance by the guarantor.
Mr. Heping Ma, a former member of the Company’s Board of Directors, is the founder, Chairman and owns 85% equity interest of Henan Chaoyang. On September 16, 2010, Mr. Ma resigned from the Company’s Board of Directors. This transaction was approved by the members of Board of Directors of the Company who were independent in the matter in accordance with the Company’s Related Persons Transaction Policy.
Legal proceedings
The Company and certain of its officers and directors were named as parties to a lawsuit filed on September 16, 2010 in the U.S. District Court, District of Nevada (Case No.: 2:10-cv-01581-JCM-RJJ). The complaint, brought by Crawford Shaw, an alleged shareholder of the Company, sought unspecified money damages, against the Company and certain officers and directors of the Company relating primarily to an alleged omission regarding Mr. Kexuan Yao’s pledge of his personal stock.
On October 12, 2010, the Company filed a motion to dismiss the complaint filed by Mr. Shaw on grounds that, among other things, the Complaint failed to state a claim for relief. On January 24, 2011, United States District Judge Mahan granted the Company’s motion to dismiss the complaint against the Company without prejudice. On March 8, 2011, the Court dismissed the law suit against the Company’s officers and directors without prejudice on grounds that the plaintiff failed to serve the complaint.
Operating leases
(i) Operating lease for San Mateo office
On December 17, 2010, China Armco entered into a non-cancelable operating lease for office space that will expire on December 31, 2013. Future minimum payments required under this non-cancelable operating lease were as follows:
| Year ending December 31: | | | | |
| | | | | |
| 2011 | | $ | 21,867 | |
| | | | | |
| 2012 | | | 44,916 | |
| | | | | |
| 2013 | | | 46,098 | |
| | | | | |
| | | $ | 112,881 | |
(ii) Operating lease for Armco Shanghai office
On July 16, 2010, Armco Shanghai entered into a non-cancelable operating lease for office space that will expire on July 15, 2012. Future minimum payments required under this non-cancelable operating lease were as follows:
| Year ending December 31: | | | | |
| | | | | |
| 2011 | | $ | 45,984 | |
| | | | | |
| 2012 | | | 48,698 | |
| | | | | |
| | | $ | 94,682 | |
(iii) Operating lease of property, plant and equipment and facilities
On June 24, 2011, Armet entered into a non-cancelable operating lease agreement with an independent third party for property, plant, equipment and facilities that will expire one year from date of signing. Armet is required to pay RMB 30 (equivalent to $4.64) per metric ton of scrap metal processed at this facility over the term of the lease. The fee will be paid annually and necessary adjustment will be made at the end of term.
NOTE 18 – CONCENTRATIONS AND CREDIT RISK
Customers and credit concentrations
Customer concentrations for the interim periods ended June 30, 2011 and 2010 and credit concentrations at June 30, 2011 and 2010 are as follows:
| | Net Sales for the Interim Period Ended | | | Accounts Receivable At | |
| | June 30, 2011 | | | June 30, 2010 | | | June 30, 2011 | | | June 30, 2010 | |
| | | | | | | | | | | | | | | | |
| Customer #206010 Lianyungang Jiaxin | | - | % | | | 32.1 | % | | | - | % | | | 61.0 | % |
| | | | | | | | | | | | | | | | |
| Customer #113102 Taicangtaike | | - | % | | | 14.7 | % | | | - | % | | | 36.6 | % |
| | | | | | | | | | | | | | | | |
| Customer #122023 Granton | | - | % | | | 10.4 | % | | | - | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Customer #1122024 Derby Materials | | 27.6 | % | | | - | % | | | - | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Customer #1122014 Citic Metal | | - | % | | | 10.2 | % | | | 15.5 | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Customer #1122028 Qingdao BaoSong Resources | | | % | | | - | % | | | 21.7 | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Customer #302023Shangdong Yongjia | | 13.6 | % | | | - | % | | | - | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Customer #122002 Zhongji NingBo | | | % | | | - | % | | | 39.8 | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Customer #102003 ZhongJin Renewable Resources | | 7.8 | % | | | - | % | | | - | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Customer 0101009 NingBo HangGang | | 16.4 | % | | | - | % | | | - | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Customer #122003 ZhongJi NingBo | | 8.3 | % | | | - | % | | | - | % | | | - | % |
| | | | | | | | | | | % | | | |
| | | 73.7 | % | | | 67.4 | % | | | 77.0 | % | | | 97.6 | % |
A reduction in sales from or loss of such customers would have a material adverse effect on the Company’s results of operations and financial condition.
Vendor concentrations
Vendor purchase concentrations for the interim periods ended June 30, 2011 and 2010 and accounts payable concentration at June 30, 2011 and 2010 are as follows:
| | Net Purchases for the Interim Period Ended | | | Accounts Payable At | |
| | June 30, 2011 | | | June 30, 2010 | | | June 30, 2011 | | | June 30, 2010 | |
| | | | | | | | | | | | | | | | |
| Vendor #302006 Anhuihuatai | | - | % | | | 27.8 | % | | | - | % | | | 46.10 | % |
| | | | | | | | | | | | | | | | |
| Vendor #121015 Suizhou Huiyang | | - | % | | | 13.4 | % | | | - | % | | | 43.4 | % |
| | | | | | | | | | | | | | | | |
| Vendor #010032 LianYunGang TongKe Trade | | - | % | | | - | % | | | 14.6 | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Vendor #010030 LinYi LiYuan | | - | % | | | - | % | | | 6.3 | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Vendor #204014 Mineracao | | 25.5 | % | | | - | % | | | 30.4 | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Vendor 202019 Bridge Group Finance | | - | % | | | - | % | | | 12.3 | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Vendor #301009 XinJiang BaGang | | 14.2 | % | | | - | % | | | - | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Vendor #204033 Oversea Enterprise Pte, Ltd. | | - | % | | | 26.0 | % | | | - | % | | | | % |
| | | | | | | | | | | | | | | | |
| Vendor #010001 Xie HongJian | | 8.0 | % | | | - | % | | | - | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Vendor #99081 Liang XiaoLei | | 7.7 | % | | | - | % | | | - | % | | | - | % |
| | | | | | | | | | | | | | | | |
| Vendor #2202019 Smart Trading LLP | | 8.6 | % | | | - | % | | | 6.2 | % | | | - | % |
| | | | | | | | | | | | | | | | |
| | | 64.0 | % | | | 67.2 | % | | | 69.8 | % | | | 89.5 | % |
Credit risk
Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents.
As of June 30, 2011, substantially all of the Company’s cash and cash equivalents were held by major financial institutions located in the PRC, none of which are insured. However, the Company has not experienced losses on these accounts and management believes that the Company is not exposed to significant risks on such accounts.
Foreign currency risk
The Company is exposed to fluctuations in foreign currencies for transactions denominated in currencies other than RMB, the functional currency due to the fact the majority of the Company’s purchasing activities are transacted in foreign currencies.
The Company had no foreign currency hedges in place at June 30, 2011 or 2010 to reduce such exposure.
Interest risk
Substantially all of the Company’s operations are carried out in the PRC. The tight monetary policy currently instituted by the PRC government and increases in interest rate would have a material adverse effect on the Company’s results of operations and financial condition.
NOTE 19 - FOREIGN OPERATIONS
Operations
Substantially all of the Company’s operations are carried out and all of its assets are located in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC. The Company’s business may be influenced by changes in governmental policies with respect to laws and regulations, monetary policies, anti-inflationary measures, currency fluctuation and remittances and methods of taxation, among other things.
Dividends and Reserves
Under the laws of the PRC, net income after taxation can only be distributed as dividends after appropriation has been made for the following: (i) cumulative prior years’ losses, if any; (ii) allocations to the “Statutory Surplus Reserve” of at least 10% of net income after tax, as determined under PRC accounting rules and regulations, until the fund amounts to 50% of the Company’s registered capital; (iii) allocations of 5-10% of income after tax, as determined under PRC accounting rules and regulations, to the Company’s “Statutory Common Welfare Fund”, which is established for the purpose of providing employee facilities and other collective benefits to employees in PRC; and (iv) allocations to any discretionary surplus reserve, if approved by stockholders.
As of June 30, 2011, the Company had no Statutory Surplus Reserve and the Statutory Common Welfare Fund established and segregated in retained earnings.
NOTE 20 – SUBSEQUENT EVENTS
The Company has evaluated all events that occurred after the balance sheet date through the date when the financial statements were issued. The Management of the Company determined that there were no reportable subsequent events to be disclosed.
