UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________________ to __________________________
Commission File Number: 001-34631
CHINA ARMCO METALS, INC.
(Exact name of registrant as specified in its charter)
Nevada | 26-0491904 |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) |
incorporation or organization) | |
One Waters Park Drive, Suite 98, San Mateo, CA | 94403 |
(Address of principal executive offices) | (Zip Code) |
(650) 212-7620
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer (Do not check if a smaller reporting company) [ ] Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
As of May 11, 2012, 17,137,087 shares of common stock, par value $0.001, are issued and outstanding.
TABLE OF CONTENTS
Page No. |
PART I - FINANCIAL INFORMATION
Item 1. | Financial Statements. | F-1 |
Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations. | 5 |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk. | 22 |
Item 4. | Controls and Procedures. | 22 |
PART II - OTHER INFORMATION
Item 1. | Legal Proceedings. | 25 |
Item 1A. | Risk Factors. | 25 |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. | 26 |
Item 3. | Defaults Upon Senior Securities. | 26 |
Item 4. | Mine Safety Disclosures. | 26 |
Item 5. | Other Information. | 26 |
Item 6. | Exhibits. | 26 |
2
Cautionary Note Regarding Forward-Looking Information and Factors That May Affect Future Results
This Report contains forward-looking statements. The Securities and Exchange Commission encourages companies to disclose forward-looking information so that investors can better understand a company’s future prospects and make informed investment decisions. This Quarterly Report on Form 10-Q and other written and oral statements that we make from time to time contain such forward-looking statements that set out anticipated results based on management’s plans and assumptions regarding future events or performance. We have tried, wherever possible, to identify such statements by using words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “will” and similar expressions in connection with any discussion of future operating or financial performance. In particular, these include statements relating to future actions, future performance or results of current and anticipated sales efforts, expenses, the outcome of contingencies, such as legal proceedings, and financial results. A list of factors that could cause our actual results of operations and financial condition to differ materially is set forth below, and these factors are discussed in greater detail under Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011:
● | We operate in cyclical industries and we experience volatile demand for our products. |
● | Our ability to operate our scrap metal recycling facility efficiently and profitably. |
● | Our ability to obtain sufficient capital to fund a potential expansion of our scrap metal recycling facility. |
● | Our ability to establish adequate management, legal and financial controls in the United States and the PRC. |
● | The availability to us of supplies of metal ore and scrap metal upon favorable terms. |
● | The availability of electricity to operate our scrap metal recycling facility. |
● | Fluctuations in raw material prices may affect our operating results as we may not be able to pass on cost increases to customers. |
● | The lack of various legal protections in certain agreements to which we are a party which are customarily contained in similar contracts prepared in the United States and which are material to our operations. |
● | Our dependence on our key management personnel. |
● | Our potential inability to meet the filing and internal control reporting requirements imposed by the SEC. |
● | The effect of changes resulting from the political and economic policies of the Chinese government on our assets and operations located in the PRC. |
● | The limitation on our ability to receive and use our revenues effectively as a result of restrictions on currency exchange in the PRC. |
● | The impact on future inflation in China on economic activity in China. |
● | Our ability to enforce our rights due to policies regarding the regulation of foreign investments in the PRC. |
● | The restrictions imposed under regulations relating to offshore investment activities by Chinese residents and the increased administrative burden we face and the creation of regulatory uncertainties that may limit or adversely affect our ability to complete any business combinations with our PRC-based subsidiaries. |
● | Our ability to comply with the United States Foreign Corrupt Practices Act which could subject us to penalties and other adverse consequences. |
● | The provisions of our articles of incorporation and bylaws which may delay or prevent a takeover which may not be in the best interests of our shareholders. |
● | Our controlling stockholders may take actions that conflict with your interests. |
We caution that the factors described herein and other factors could cause our actual results of operations and financial condition to differ materially from those expressed in any forward-looking statements we make and that investors should not place undue reliance on any such forward-looking statements. Further, any forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of anticipated or unanticipated events or circumstances. New factors emerge from time to time, and it is not possible for us to predict all of such factors. Further, we cannot assess the impact of each such factor on our results of operations or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
3
INDEX OF CERTAIN DEFINED TERMS USED IN THIS REPORT
When used in this report the terms:
– | “Armco HK” or “Armco & Metawise” refers to Armco Metals International Limited, a limited liability company established under the laws of Hong Kong. |
– | “Armco Shanghai” refers to Armco Metals (Shanghai) Holdings. Ltd., a wholly-owned foreign enterprise and limited liability company established under the laws of the People’s Republic of China. | |
– | “China Armco Metals,” “we,” “us” or “our” refers to China Armco Metals, Inc., a Nevada corporation, and its subsidiaries. |
– | “Exchange Act” refers to the Securities Exchange Act of 1934, as amended. |
– | “Henan Armco” refers to Henan Armco & Metawise Trading Co., Ltd., a limited liability company established under the laws of the People’s Republic of China. |
– | “Lianyungang Armco” refers to Armco (Lianyungang) Holdings, Ltd., a wholly-owned foreign enterprise and limited liability company established under the laws of the People’s Republic of China. |
– | “PRC”, “China”, and “Chinese” refer to the People’s Republic of China. |
– | “Renewable Metals” refers to Armco (Lianyungang) Renewable Resources Co., Ltd. (formerly known as Armet (Lianyungang) Scraps Co., Ltd.), a limited liability company established under the laws of the People’s Republic of China. |
– | “SEC” refers to the United States Securities and Exchange Commission; |
4
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements.
China Armco Metals, Inc. and Subsidiaries
March 31, 2012 and 2011
Index to the Consolidated Financial Statements
Contents | Page(s) |
Consolidated Balance Sheets at March 31, 2012 (Unaudited) and December 31,2011 | F-2 |
Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three Months Ended March 31, 2012 and 2011 (Unaudited) | F-3 |
Consolidated Statement of Stockholders’ Equity for the Three Months Ended March 31, 2012 (Unaudited) | F-4 |
Consolidated Statements of Cash Flows for the Three Months Ended March 31,2012 and 2011 (Unaudited) | F-5 |
Notes to the Consolidated Financial Statements (Unaudited) | F-6 |
F-1
CHINA ARMCO METALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, 2012 | December 31, 2011 | |||||||
(Unaudited) | ||||||||
ASSETS | ||||||||
CURRENT ASSETS: | ||||||||
Cash | $ | 981,863 | $ | 1,042,591 | ||||
Pledged deposits | 9,518,173 | 8,357,670 | ||||||
Marketable securities | 1,215,045 | 1,636,742 | ||||||
Bank acceptance notes receivable | 158,265 | - | ||||||
Accounts receivable | 28,243,055 | 758,500 | ||||||
Inventories | 11,214,554 | 33,344,547 | ||||||
Advance on purchases | 6,237,242 | 3,079,684 | ||||||
Prepaid corp income taxes - Renewable Metals | 470,505 | 467,546 | ||||||
Prepayments and other current assets | 1,392,465 | 1,744,047 | ||||||
Total Current Assets | 59,431,167 | 50,431,327 | ||||||
PROPERTY, PLANT AND EQUIPMENT | ||||||||
Property, plant and equipment | 43,724,618 | 42,165,437 | ||||||
Accumulated depreciation | (4,240,863 | ) | (3,514,893 | ) | ||||
PROPERTY, PLANT AND EQUIPMENT, net | 39,483,755 | 38,650,544 | ||||||
LAND USE RIGHT | ||||||||
Land use right | 6,463,618 | 6,422,956 | ||||||
Accumulated amortization | (223,222 | ) | (209,474 | ) | ||||
LAND USE RIGHT, net | 6,240,396 | 6,213,482 | ||||||
Total Assets | $ | 105,155,318 | $ | 95,295,353 |
F-2
CHINA ARMCO METALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
CURRENT LIABILITIES: | ||||||||
Loans payable | $ | 33,779,054 | $ | 6,711,898 | ||||
Banker's acceptance notes payable and letters of credit | 10,128,986 | 8,178,029 | ||||||
Current maturities of capital lease obligation | 2,272,864 | 2,195,177 | ||||||
Current maturities of long-term debt | 3,956,635 | 3,931,745 | ||||||
Accounts payable | 3,333,452 | 18,543,129 | ||||||
Advances received from Chairman and CEO | 626,032 | 607,009 | ||||||
Customer deposits | 2,501,826 | 5,851,769 | ||||||
Corporate income tax payable | 186,445 | 99,042 | ||||||
Value added tax and other taxes payable | 191,514 | 1,150 | ||||||
Accrued expenses and other current liabilities | 3,532,639 | 2,713,532 | ||||||
Total Current Liabilities | 60,509,447 | 48,832,480 | ||||||
CAPITAL LEASE OBLIGATION, net of current maturities | 3,560,776 | 4,127,354 | ||||||
DERIVATIVE LIABILITY | 752 | 203 | ||||||
Total Liabilities | 64,070,975 | 52,960,037 | ||||||
STOCKHOLDERS' EQUITY: | ||||||||
Preferred stock, $0.001 par value; 1,000,000 shares authorized; none issued or outstanding | - | - | ||||||
Common stock, $0.001 par value, 74,000,000 shares authorized, 17,068,334 and 15,421,008 shares issued and outstanding, respectively | 17,068 | 15,421 | ||||||
Additional paid-in capital | 29,902,944 | 29,733,619 | ||||||
Retained earnings | 7,705,827 | 9,366,035 | ||||||
Accumulated other comprehensive income (loss): | ||||||||
Change in unrealized loss on marketable securities | (797 | ) | ||||||
Foreign currency translation gain | 3,458,504 | 3,221,038 | ||||||
Total Stockholders' Equity | 41,084,343 | 42,335,316 | ||||||
Total Liabilities and Stockholders' Equity | $ | 105,155,318 | $ | 95,295,353 |
See accompanying notes to the consolidated financial statements.
F-3
CHINA ARMCO METALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
For the three Months Ended March 31, 2012 | For the three Months EndedMarch 31, 2011 | |||||||
(Unaudited) | (Unaudited) | |||||||
NET REVENUES | $ | 49,284,191 | $ | 49,684,652 | ||||
�� | ||||||||
COST OF GOODS SOLD | 47,824,094 | 46,515,883 | ||||||
GROSS PROFIT | 1,460,097 | 3,168,769 | ||||||
OPERATING EXPENSES: | ||||||||
Selling expenses | 130,523 | 271,524 | ||||||
Professional fees | 16,712 | 128,165 | ||||||
General and administrative expenses | 1,043,466 | 895,409 | ||||||
Operating cost of idle manufacturing facility | 497,224 | 471,350 | ||||||
Total operating expenses | 1,687,925 | 1,766,448 | ||||||
INCOME (LOSS) FROM OPERATIONS | (227,828 | ) | 1,402,321 | |||||
OTHER (INCOME) EXPENSE: | ||||||||
Interest income | (1,052 | ) | (4,334 | ) | ||||
Interest expense | 786,512 | 554,253 | ||||||
Foreign currency transaction (gain) loss - marketable securities | 35,553 | (183,866 | ) | |||||
Impairment other than temporary - marketable securities | 386,941 | - | ||||||
Change in fair value of derivative liability | 549 | (51,223 | ) | |||||
Loan guarantee expense | 16,667 | 89,666 | ||||||
Other (income) expense | 119,807 | 256,492 | ||||||
Total other (income) expense | 1,344,977 | 660,988 | ||||||
INCOME (LOSS) BEFORE INCOME TAXES | (1,572,805 | ) | 741,333 | |||||
INCOME TAX PROVISION | 87,403 | 175,163 | ||||||
NET INCOME (LOSS) | (1,660,208 | ) | 566,170 | |||||
OTHER COMPREHENSIVE INCOME (LOSS): | ||||||||
Change in unrealized loss of marketable securities | 797 | (1,594,654 | ) | |||||
Foreign currency translation gain | 237,466 | 298,598 | ||||||
COMPREHENSIVE INCOME (LOSS) | $ | (1,421,945 | ) | $ | (729,886 | ) | ||
NET (INCOME) LOSS PER COMMON SHARE - BASIC AND DILUTED: | ||||||||
Net income (loss) per common share - basic and diluted | $ | (0.10 | ) | $ | 0.04 | |||
Weighted Average Common Shares Outstanding - basic and diluted | 16,668,006 | 15,320,498 |
See accompanying notes to the consolidated financial statements.
F-4
CHINA ARMCO METALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the Year Ended December 31, 2011 and for the Interim Period Ended March 31, 2012
(Unaudited)
Common Stock, $0.001 Par Value | Accumulated Other Comprehensive Income (Loss) | |||||||||||||||||||||||||||
Number of Shares | Amount | Additional Paid-in Capital | Retained Earnings | Change in Unrealized Loss on Marketable Securities | Foreign Currency Translation Gain | Total Stockholders' Equity | ||||||||||||||||||||||
Balance, December 31, 2010 | 14,840,948 | $ | 14,841 | $ | 28,966,596 | $ | 12,711,039 | $ | (506,278 | ) | $ | 1,643,567 | $ | 42,829,765 | ||||||||||||||
Loan guarantee services received and shares vested from common shares issued to Chaoyang Steel on June 11, 2010 for 5 year loan guarantee services expiring June 30, 2016 | 33,333 | 33 | 89,633 | 89,666 | ||||||||||||||||||||||||
Issuance of common stock to an employee pursuant to 2009 Stock Incentive Plan for services valued at $3.38 per share granted on October 6, 2010 | 55,378 | 55 | 187,125 | 187,180 | ||||||||||||||||||||||||
Issuance of common stock to HCI for public relation services for first quarter 2011 | 10,800 | 11 | 29,040 | 29,051 | ||||||||||||||||||||||||
Issuance of common shares to an employee for future services | 10,000 | 10 | 27,390 | 27,400 | ||||||||||||||||||||||||
Issuance of common shares to an employee for future services | - | (27,400 | ) | (27,400 | ) | |||||||||||||||||||||||
Amortization of deferred employee services | 260,693 | 260,693 | ||||||||||||||||||||||||||
Loan guarantee services received and shares vested from common shares issued to Chaoyang Steel on June 11, 2010 for 5 year loan guarantee services expiring June 30, 2016 | 33,333 | 34 | 45,299 | 45,333 | ||||||||||||||||||||||||
Issuance of common stock to HCI for public relation services for second quarter 2011 | 10,800 | 10 | 14,678 | 14,688 | ||||||||||||||||||||||||
Loan guarantee services received and shares vested from common shares issued to Chaoyang Steel on June 11, 2010 for 5 year loan guarantee services expiring June 30, 2016 | 33,333 | 33 | 13,634 | 13,667 | ||||||||||||||||||||||||
Issuance of common shares for conversion of accrued expenses-Director cash compensation | 17,371 | 18 | 23,742 | 23,760 | ||||||||||||||||||||||||
Issuance of common stock to HCI for public relation services for 3rd quarter 2011 | 10,800 | 10 | 4,418 | 4,428 | ||||||||||||||||||||||||
Loan guarantee services received and shares vested from common shares issued to Chaoyang Steel on June 11, 2010 for 5 year loan guarantee services expiring June 30, 2016 | 33,333 | 34 | 9,366 | 9,400 | ||||||||||||||||||||||||
Issuance of common stock to HCI for public relation services for 4th quarter 2011 | 7,200 | 7 | 2,146 | 2,153 | ||||||||||||||||||||||||
Issuance of common stock to an employee pursuant to 2009 Stock Incentive Plan for services valued at $0.27 per share granted on December 15, 2011 | 264,379 | 265 | 71,119 | 71,384 | ||||||||||||||||||||||||
Issuance of common stock to Directors for 2011 services | 60,000 | 60 | 16,140 | 16,200 | ||||||||||||||||||||||||
Comprehensive income (loss) | ||||||||||||||||||||||||||||
Net Loss | (3,345,004 | ) | (3,345,004 | ) | ||||||||||||||||||||||||
Change in unrealized loss on marketable securities | 505,481 | 505,481 | ||||||||||||||||||||||||||
Foreign currency translation gain | 1,577,471 | 1,577,471 | ||||||||||||||||||||||||||
Total comprehensive income (loss) | (1,262,052 | ) | ||||||||||||||||||||||||||
Appropriation to statutory reserves | - | |||||||||||||||||||||||||||
Appropriation to employee welfare funds | - | |||||||||||||||||||||||||||
Dividends paid | - | |||||||||||||||||||||||||||
Dividends declared | - | |||||||||||||||||||||||||||
Balance, December 31, 2011 | 15,421,008 | 15,421 | 29,733,619 | 9,366,035 | (797 | ) | 3,221,038 | 42,335,316 | ||||||||||||||||||||
Loan guarantee services received and shares vested from common shares issued to Chaoyang Steel on June 11, 2010 for 5 year loan guarantee services expiring June 30, 2016 | 33,333 | 33 | 16,634 | 16,667 | ||||||||||||||||||||||||
Issuance of restricted stock to a Director pursuant to the 2009 Stock Incentive Plan for future services valued at $0.2851 per share granted on December 19, 2011 | 6,250 | 6 | 1,776 | 1,782 | ||||||||||||||||||||||||
Issuance of restricted stock to a Director pursuant to the 2009 Stock Incentive Plan for future services valued at $0.2851 per share granted on December 19, 2011 | (1,782 | ) | (1,782 | ) | ||||||||||||||||||||||||
Issuance of restricted stock to a Director pursuant to the 2009 Stock Incentive Plan for future services valued at $0.28 per share granted on December 20, 2011 | 50,000 | 50 | 13,950 | 14,000 | ||||||||||||||||||||||||
Issuance of restricted stock to a Director pursuant to the 2009 Stock Incentive Plan for future services valued at $0.28 per share granted on December 20, 2011 | (14,000 | ) | (14,000 | ) | ||||||||||||||||||||||||
Issuance of common stock to an employee pursuant to the 2009 Stock Incentive Plan for services valued at $0.57 per share granted on February 6, 2012 | 57,743 | 58 | 33,260 | 33,318 | ||||||||||||||||||||||||
Issuance of restricted stock to CEO pursuant to an employment agreement for future services valued at $0.499 per share granted on February 8, 2012 | 1,500,000 | 1,500 | 747,000 | 748,500 | ||||||||||||||||||||||||
Issuance of restricted stock to CEO pursuant to the 2009 Stock Incentive Plan for future services valued at $0.499 per share granted on February 8, 2012 | (748,500 | ) | (748,500 | ) | ||||||||||||||||||||||||
Amortization of deferred employee services | 120,987 | 120,987 | ||||||||||||||||||||||||||
Comprehensive income (loss) | ||||||||||||||||||||||||||||
Net Loss | (1,660,208 | ) | (1,660,208 | ) | ||||||||||||||||||||||||
Change in unrealized loss on marketable securities | 797 | 797 | ||||||||||||||||||||||||||
Foreign currency translation gain | 237,466 | 237,466 | ||||||||||||||||||||||||||
Total comprehensive income (loss) | (1,421,945 | ) | ||||||||||||||||||||||||||
Balance, March 31, 2012 | 17,068,334 | $ | 17,068 | $ | 29,902,944 | $ | 7,705,827 | $ | - | $ | 3,458,504 | $ | 41,084,343 |
See accompanying notes to the consolidated financial statements.
F-5
CHINA ARMCO METALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three Months Ended | For the three Months Ended | |||||||
(Unaudited) | (Unaudited) | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
Net Income (loss) | $ | (1,660,208 | ) | $ | 566,170 | |||
Adjustments to reconcile net income (loss) to net cash used in operating activities | ||||||||
Depreciation expense | 704,941 | 640,225 | ||||||
Amortization expense | 12,422 | 11,965 | ||||||
Change in fair value of derivative liability | 549 | (51,223 | ) | |||||
(Gain) loss from foreign currency exchange rate change on marketable securities | 35,553 | (183,866 | ) | |||||
Impairment other than temporary - marketable securities | 386,941 | - | ||||||
Stock based compensation | 155,382 | 185,110 | ||||||
Changes in operating assets and liabilities: | ||||||||
Bank acceptance notes receivable | (158,265 | ) | - | |||||
Accounts receivable | (27,480,173 | ) | (11,345,619 | ) | ||||
Inventories | 22,233,344 | (8,481,017 | ) | |||||
Advance on purchases | (3,138,063 | ) | (746,901 | ) | ||||
Prepayments and other current assets | 362,154 | (529,792 | ) | |||||
Accounts payable | (15,217,453 | ) | 9,477,183 | |||||
Customer deposits | (3,386,988 | ) | 1,979,848 | |||||
Taxes payable | 277,761 | (272,380 | ) | |||||
Accrued expenses and other current liabilities | 820,715 | (417,695 | ) | |||||
NET CASH USED IN OPERATING ACTIVITIES | (26,051,388 | ) | (9,167,992 | ) | ||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
Proceeds from release of pledged deposits | 8,413,409 | 15,252,670 | ||||||
Payment made towards pledged deposits | (9,534,359 | ) | (12,504,818 | ) | ||||
Purchases of property and equipment | (1,297,120 | ) | (366,554 | ) | ||||
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES | (2,418,070 | ) | 2,381,298 | |||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
Proceeds from loans payable | 43,404,164 | 26,882,112 | ||||||
Repayment of loans payable | (16,372,992 | ) | (23,375,825 | ) | ||||
Banker's acceptance notes payable | 1,899,185 | 6,097,468 | ||||||
Repayment of capital lease obligation | (528,916 | ) | (215,933 | ) | ||||
Advances from (repayment to) Chairman and CEO | 19,016 | (20,000 | ) | |||||
NET CASH PROVIDED BY FINANCING ACTIVITIES | 28,420,457 | 9,367,822 | ||||||
EFFECT OF EXCHANGE RATE CHANGES ON CASH | (11,727 | ) | (11,902 | ) | ||||
NET CHANGE IN CASH | (60,728 | ) | 2,569,226 | |||||
Cash at beginning of period | 1,042,591 | 3,097,917 | ||||||
Cash at end of period | $ | 981,863 | $ | 5,667,143 | ||||
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION: | ||||||||
Interest paid | $ | 786,512 | $ | 554,253 | ||||
Income tax paid | $ | - | $ | 449,071 | ||||
NON CASH FINANCING AND INVESTING ACTIVITIES: | ||||||||
Accrued compensation paid in common shares in lieu of cash | $ | 15,591 | $ | 187,180 |
See accompanying notes to the consolidated financial statements.
F-6
China Armco Metals, Inc. and Subsidiaries
March 31, 2012 and 2011
Notes to the Consolidated Financial Statements
(Unaudited)
Note 1 – Organization and Operations
China Armco Metals, Inc. (formerly Cox Distributing, Inc.)
Cox Distributing was founded as an unincorporated business in January 1984 and was incorporated as Cox Distributing, Inc. (“Cox Distributing”), a C corporation under the laws of 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). Cox Distributing engaged in the distribution of organic fertilizer products used to improve soil and growing conditions for the potato farmers of eastern Idaho (“Legacy Business”).
On June 27, 2008, Cox Distributing 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 & Metawise (H.K) Limited” or “Armco HK”) and Subsidiaries to better identify the Company with the business conducted, through its wholly owned subsidiaries in China, import, export and distribution of ferrous and non-ferrous ores and metals, and processing and distribution of scrap steel.
Cox Distributing conducted nominal organic fertilizer distribution business post the acquisition of Armco HK. On December 30, 2008, the Company entered into an Agreement of Assumption and Release and Bill of Sale (“Spin-Out Agreement”) with its former Chairman and Chief Executive Officer, Stephen E. Cox, with respect to its Legacy Business of fertilizer distribution business. Pursuant to the terms of the Spin-Out Agreement, Mr. Cox assumed all of the assets and liabilities of the Legacy Business and surrendered 6,200 shares of the Company’s common stock he owned for cancellation. As a result of the consummation of the Spin-Out Agreement, the Company discontinued its Legacy Business of distribution of organic fertilizer products.
Armco Metal International Limited (formerly Armco & Metawise (H.K) Limited) and Subsidiaries
Armco Metal International Limited (formerly Armco & Metawise (H.K) Limited)
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”). Armco HK engages in the import, export and distribution of ferrous and non-ferrous ore and metals.
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”).
Formation of Henan Armco and Metawise Trading Co., Ltd.
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.
Formation of Armco (Lianyungang) Renewable Metals, Inc.
On January 9, 2007, Armco HK formed Armco (Lianyungang) Renewable Metals, Inc. (“Renewable Metals”), a wholly-owned foreign enterprise (“WOFE”) subsidiary in the City of Lianyungang, Jiangsu Province, PRC. Renewable Metals engages in the processing and distribution of scrap metal.
On December 1, 2008, Armco HK transferred its 100% equity interest in Renewable Metals to Armco Metals.
Merger of Henan with Renewable Metals, Companies under Common Control
On December 28, 2007, Armco HK entered into a Share Transfer Agreement with Renewable Metals, whereby Armco HK transferred to Renewable Metals 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 Renewable Metals 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.
F-7
Acquisition of Armco Metal International Limited and Subsidiaries (“Armco HK”) Recognized as a Reverse Acquisition
On June 27, 2008, the Company entered into and consummated a share purchase agreement (the “Share Purchase Agreement”) with Armco HK and Feng Gao, who owned 100% of the issued and outstanding shares of Armco HK. In connection with the consummation of the Share Purchase Agreement, (i) Stephen Cox surrendered 7,694,000 common shares, representing his controlling interest in the Company for cancellation and resigned as an officer and director; (ii) 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; (iii) issued to Ms. Gao (a) a stock option entitling Ms. Gao to purchase 5,300,000 shares of the Company’s common stock, par value $.001 per share (the “Common Stock”) with an exercise price of $1.30 per share expiring on September 30, 2008 and (b) a stock option entitling Ms. Gao to purchase 2,000,000 shares of the Company’s common stock with an exercise price of $5.00 per share expiring two (2) years from the date of issuance on June 27, 2010 (the “Gao Options”). 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 stockholder 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.
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 Armco 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, 2011 and notes thereto contained in the Company’s Annual Report on Form 10-K filed with the SEC on March 30, 2012.
F-8
Principles of Consolidation
The consolidated financial statements include all accounts of the entities as of March 31, 2012 and 2011 and for the interim period then ended as follows:
Entity | Jurisdiction or Place of Incorporation | Attributable Interest |
Armco HK | Hong Kong SAR | 100% |
Henan Armco | PRC | 100% |
Renewable Metals | PRC | 100% |
Lianyungang Armco | PRC | 100% |
Armco Shanghai | PRC | 100% |
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 and Assumptions
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 reporting period.
The Company’s significant estimates and assumptions include the fair value of financial instruments; allowance for doubtful accounts; normal production capacity, inventory valuation and obsolescence; the carrying value, recoverability and impairment, if any, of long-lived assets, including the values assigned to and the estimated useful lives of property, plant and equipment, and land use rights; interest rate; revenue recognized or recognizable, sales returns and allowances; valued added tax rate; expected term of share options and similar instruments, expected volatility of the entity’s shares and the method used to estimate it, expected annual rate of quarterly dividends, and risk free rate(s); income tax rate and related income tax provision; reporting currency, functional currency of the PRC subsidiaries and foreign currency exchange rate. 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 bases its estimates on historical experience and on various assumptions that are believed to be reasonable in relation to the financial statements taken as a whole 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.
Management regularly evaluates the key factors and assumptions used to develop the estimates utilizing currently available information, changes in facts and circumstances, historical experience and reasonable assumptions. After such evaluations, 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:
Level 1 | Quoted market prices available in active markets for identical assets or liabilities as of the reporting date. | |
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. | |
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.
F-9
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 March 31, 201 2and 2011.
The Company’s 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.
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 significant stockholder and lease arrangement with the significant stockholder due to their related party nature.
Fair Value of Financial Assets and Liabilities Measured on a Recurring Basis
Level 1 Financial Assets – Marketable Securities
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 provided the unrealized holding gains and losses is temporary. 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, and it is determined that the impairment is other than temporary, then an impairment loss is recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date of the reporting period.
Level 3 Financial Liabilities – Derivative Warrant Liabilities
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.
Fair Value of Non-Financial Assets or Liabilities Measured on a Recurring Basis
The Company’s non-financial assets include inventories. 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.
F-10
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. When 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) and 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 Debt and Equity Securities, Available for Sale
The Company accounts for marketable debt and equity 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 815-25-35-4.
F-11
The Company follows Paragraphs 320-10-35-17 through 34E 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 320-10-35-34, if it is determined that the impairment is other than temporary, then an impairment loss shall be recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made. The measurement of the impairment shall not include partial recoveries after the balance sheet date. The fair value of the investment would then become the new basis of the investment and shall not be adjusted for subsequent recoveries in fair value. For presentation purpose, 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 320-10-45-8A; and 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 pursuant to Paragraph 320-10-45-9A. Pursuant to Paragraphs 320-10-35-36 and 37 the entire change in the fair value of foreign-currency-denominated available-for-sale debt securities shall be reported in other comprehensive income and An entity holding a foreign-currency-denominated available-for-sale debt security is required to consider, among other things, changes in market interest rates and foreign exchange rates since acquisition in determining whether an other-than-temporary impairment has occurred.
Accounts Receivable and Allowance for Doubtful Accounts
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
Inventory Valuation
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.
F-12
Normal Capacity and Period Costs of Underutilized or Idle Capacity of the Production Facilities
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.
Inventory Obsolescence and Markdowns
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.
Construction in progress represents direct costs of construction or the acquisition cost of long-lived assets. Under U.S. GAAP, all costs associated with construction of long-lived assets should be reflected as long-term as part of construction-in-progress. Capitalization of these costs ceases and the construction in progress is transferred to property, plant and equipment when substantially all of the activities necessary to prepare the long-lived assets for their intended use are completed. No depreciation is provided until the construction of the long-lived assets is complete and ready for their intended use.
Land Use Rights
Land use rights represent the cost to obtain the right to use certain parcels of land in the City of Lianyungang, Jiangsu Province, PRC. Land use rights are carried at cost and amortized on a straight-line basis over the lives of the rights 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, which are fully or partially refundable depending upon the terms and conditions of the sales agreements.
F-13
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 for the interim period ended March 31, 2012 or 2011.
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 Section 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 consolidated 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.
F-14
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.
The Company marks to market the fair value of the remaining embedded derivative warrants at each balance sheet date and records the change in the fair value of the remaining embedded derivative warrants as other income or expense in the consolidated statements of operations and comprehensive income (loss).
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.
F-15
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.
The Company derives its revenues from sales contracts with customers with revenues being generated upon the shipment of merchandise. 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.
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 Renminbi, 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.
F-16
The fair value of share options and similar instruments is estimated on the date of grant using a Black-Scholes option-pricing valuation model. The ranges of assumptions for inputs are as follows:
· | Expected term of share options and similar instruments: The expected life of options and similar instruments represents the period of time the option and/or warrant are expected to be outstanding. Pursuant to Paragraph 718-10-50-2(f)(2)(i) of the FASB Accounting Standards Codification the expected term of share options and similar instruments represents the period of time the options and similar instruments are expected to be outstanding taking into consideration of the contractual term of the instruments and employees’ expected exercise and post-vesting employment termination behavior into the fair value (or calculated value) of the instruments. Pursuant to paragraph 718-50-S99-1, it may be appropriate to use the simplified method, if (i) A company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its equity shares have been publicly traded; (ii) A company significantly changes the terms of its share option grants or the types of employees that receive share option grants such that its historical exercise data may no longer provide a reasonable basis upon which to estimate expected term; or (iii) A company has or expects to have significant structural changes in its business such that its historical exercise data may no longer provide a reasonable basis upon which to estimate expected term. The Company uses the simplified method to calculate expected term of share options and similar instruments as the company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term. |
· | Expected volatility of the entity’s shares and the method used to estimate it. Pursuant to ASC Paragraph 718-10-50-2(f)(2)(ii) a thinly-traded or nonpublic entity that uses the calculated value method shall disclose the reasons why it is not practicable for the Company to estimate the expected volatility of its share price, the appropriate industry sector index that it has selected, the reasons for selecting that particular index, and how it has calculated historical volatility using that index. The Company uses the average historical volatility of the comparable companies over the expected contractual life of the share options or similar instruments as its expected volatility. If shares of a company are thinly traded the use of weekly or monthly price observations would generally be more appropriate than the use of daily price observations as the volatility calculation using daily observations for such shares could be artificially inflated due to a larger spread between the bid and asked quotes and lack of consistent trading in the market. |
· | Expected annual rate of quarterly dividends. An entity that uses a method that employs different dividend rates during the contractual term shall disclose the range of expected dividends used and the weighted-average expected dividends. 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 expected term of the share options and similar instruments. |
· | Risk-free rate(s). An entity that uses a method that employs different risk-free rates shall disclose the range of risk-free rates used. 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 expected term of the share options and similar instruments. |
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 Sub-topic 505-50 of the FASB Accounting Standards Codification (“Sub-topic 505-50”).
Pursuant to ASC 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.
F-17
The fair value of share options and similar instruments is estimated on the date of grant using a Black-Scholes option-pricing valuation model. The ranges of assumptions for inputs are as follows:
· | Expected term of share options and similar instruments: Pursuant to Paragraph 718-10-50-2(f)(2)(i) of the FASB Accounting Standards Codification the expected term of share options and similar instruments represents the period of time the options and similar instruments are expected to be outstanding taking into consideration of the contractual term of the instruments and holder’s expected exercise behavior into the fair value (or calculated value) of the instruments. Pursuant to paragraph 718-50-S99-1, it may be appropriate to use the simplified method, if (i) A company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its equity shares have been publicly traded; (ii) A company significantly changes the terms of its share option grants or the types of employees that receive share option grants such that its historical exercise data may no longer provide a reasonable basis upon which to estimate expected term; or (iii) A company has or expects to have significant structural changes in its business such that its historical exercise data may no longer provide a reasonable basis upon which to estimate expected term. The Company uses the simplified method to calculate expected term of share options and similar instruments as the company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term. |
· | Expected volatility of the entity’s shares and the method used to estimate it. Pursuant to ASC Paragraph 718-10-50-2(f)(2)(ii) a thinly-traded or nonpublic entity that uses the calculated value method shall disclose the reasons why it is not practicable for the Company to estimate the expected volatility of its share price, the appropriate industry sector index that it has selected, the reasons for selecting that particular index, and how it has calculated historical volatility using that index. The Company uses the average historical volatility of the comparable companies over the expected contractual life of the share options or similar instruments as its expected volatility. If shares of a company are thinly traded the use of weekly or monthly price observations would generally be more appropriate than the use of daily price observations as the volatility calculation using daily observations for such shares could be artificially inflated due to a larger spread between the bid and asked quotes and lack of consistent trading in the market. |
· | Expected annual rate of quarterly dividends. An entity that uses a method that employs different dividend rates during the contractual term shall disclose the range of expected dividends used and the weighted-average expected dividends. 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 expected term of the share options and similar instruments. |
· | Risk-free rate(s). An entity that uses a method that employs different risk-free rates shall disclose the range of risk-free rates used. 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 expected term of the share options and similar instruments. |
Pursuant to ASC paragraph 505-50-25-7, if fully vested, nonforfeitable equity instruments are issued at the date the grantor and grantee enter into an agreement for goods or services (no specific performance is required by the grantee to retain those equity instruments), then, because of the elimination of any obligation on the part of the counterparty to earn the equity instruments, a measurement date has been reached. A grantor shall recognize the equity instruments when they are issued (in most cases, when the agreement is entered into). Whether the corresponding cost is an immediate expense or a prepaid asset (or whether the debit should be characterized as contra-equity under the requirements of paragraph 505-50-45-1) depends on the specific facts and circumstances. Pursuant to ASC paragraph 505-50-45-1, a grantor may conclude that an asset (other than a note or a receivable) has been received in return for fully vested, nonforfeitable equity instruments that are issued at the date the grantor and grantee enter into an agreement for goods or services (and no specific performance is required by the grantee in order to retain those equity instruments). Such an asset shall not be displayed as contra-equity by the grantor of the equity instruments. The transferability (or lack thereof) of the equity instruments shall not affect the balance sheet display of the asset. This guidance is limited to transactions in which equity instruments are transferred to other than employees in exchange for goods or services. Section 505-50-30 provides guidance on the determination of the measurement date for transactions that are within the scope of this Subtopic.
Pursuant to Paragraphs 505-50-25-8 and 505-50-25-9, an entity may grant fully vested, nonforfeitable equity instruments that are exercisable by the grantee only after a specified period of time if the terms of the agreement provide for earlier exercisability if the grantee achieves specified performance conditions. Any measured cost of the transaction shall be recognized in the same period(s) and in the same manner as if the entity had paid cash for the goods or services or used cash rebates as a sales discount instead of paying with, or using, the equity instruments. A recognized asset, expense, or sales discount shall not be reversed if a stock option that the counterparty has the right to exercise expires unexercised.
Pursuant to ASC 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.
F-18
Investment Credit - Government
Certain Chinese local government provides investment credit to encourage enterprises to invest in local communities which are non-refundable. Investment credits from local government are credited to other income – investment credit - government upon receipt.
Renewable Metals was granted RMB10,000,000 in investment credit from Lianyungang Economic and Technology Development Zone on November 25, 2011, which was received on November 30, 2011.
Income Tax Provision
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.
Uncertain Tax Positions
The Company did not take any uncertain tax positions and had no adjustments to its income tax liabilities or benefits pursuant to the provisions of Section 740-10-25 for the interim period ended March 31, 2012 or 2011.
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).
F-19
Based on an assessment of the factors discussed above, the management of the Company determined the relevant subsidiaries’ local currencies to be their respective functional currencies.
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:
March 31, 2012 | December 31, 2011 | March 31, 2011 | December 31,2010 | ||||||||||
Balance sheet | 6.3185 | 6.3585 | 6.5601 | 6.6118 | |||||||||
Statement of operations and comprehensive income (loss) | 6.3089 | 6.4640 | 6.5804 | 6.7788 |
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 (loss), 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 contingent share arrangements, stock options and warrants.
F-20
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 March 31, 2012 and 2011 as they were anti-dilutive:
Potentially Outstanding Dilutive Common Shares | ||||||||
For the Interim Period Ended March 31, 2012 | For the Interim Period Ended March 31, 2011 | |||||||
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 | ||||||
Sub-total - Warrants | 2,833,408 | 2,833,408 | ||||||
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 | 40,000 | ||||||
Sub-total - Options | 40,000 | 40,000 | ||||||
Total potentially outstanding dilutive common shares | 2,873,408 | 2,873,408 |
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
FASB Accounting Standards Update No. 2011-05
In June 2011, the FASB issued the FASB Accounting Standards Update No. 2011-05 “Comprehensive Income” (“ASU 2011-05”), which was the result of a joint project with the IASB and amends the guidance in ASC 220, Comprehensive Income, by eliminating the option to present components of other comprehensive income (OCI) in the statement of stockholders’ equity. Instead, the new guidance now gives entities the option to present all non-owner changes in stockholders’ equity either as a single continuous statement of comprehensive income or as two separate but consecutive statements. Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the amendments require entities to present all reclassification adjustments from OCI to net income on the face of the statement of comprehensive income.
F-21
The amendments in this Update should be applied retrospectively and are effective for public entity for fiscal years, and interim periods within those years, beginning after December 15, 2011.
FASB Accounting Standards Update No. 2011-08
In September 2011, the FASB issued the FASB Accounting Standards Update No. 2011-08 “Intangibles—Goodwill and Other: Testing Goodwill for Impairment” (“ASU 2011-08”). This Update is to simplify how public and nonpublic entities test goodwill for impairment. The amendments permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350. Under the amendments in this Update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount.
The guidance is effective for interim and annual periods beginning on or after December 15, 2011. Early adoption is permitted.
FASB Accounting Standards Update No. 2011-10
In December 2011, the FASB issued the FASB Accounting Standards Update No. 2011-10 “Property, Plant and Equipment: Derecognition of in Substance Real Estate-a Scope Clarification” (“ASU 2011-09”). This Update is to resolve the diversity in practice as to how financial statements have been reflecting circumstances when parent company reporting entities cease to have controlling financial interests in subsidiaries that are in substance real estate, where the situation arises as a result of default on nonrecourse debt of the subsidiaries.
The amended guidance is effective for annual reporting periods ending after June 15, 2012 for public entities. Early adoption is permitted.
FASB Accounting Standards Update No. 2011-11
In December 2011, the FASB issued the FASB Accounting Standards Update No. 2011-11 “Balance Sheet: Disclosures about Offsetting Assets and Liabilities” (“ASU 2011-11”). This Update requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of U.S. GAAP and those entities that prepare their financial statements on the basis of IFRS.
The amended guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods.
FASB Accounting Standards Update No. 2011-12
In December 2011, the FASB issued the FASB Accounting Standards Update No. 2011-12 “Comprehensive Income: Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011-12”). This Update is a deferral of the effective date pertaining to reclassification adjustments out of accumulated other comprehensive income in ASU 2011-05. FASB is to going to reassess the costs and benefits of those provisions in ASU 2011-05 related to reclassifications out of accumulated other comprehensive income. Due to the time required to properly make such a reassessment and to evaluate alternative presentation formats, the FASB decided that it is necessary to reinstate the requirements for the presentation of reclassifications out of accumulated other comprehensive income that were in place before the issuance of Update 2011-05.
All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011.
Other Recently Issued, but Not Yet Effective Accounting Pronouncements
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.
F-22
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 March 31, 2012 and December 31, 2011 consisted of the following:
March 31, 2012 | December 31, 2011 | |||||||
Armco HK | ||||||||
Letters of credit (i) | $ | 1,392,673 | $ | 2,109,832 | ||||
Sub-total – Armco HK | 1,392,673 | 2,109,832 | ||||||
Renewable Metals | ||||||||
Bank acceptance notes payable (ii) | 5,381,024 | 1,100,889 | ||||||
Letters of credit (iii) | 1,424,389 | 3,774,475 | ||||||
Deposit for capital lease obligation (iv) | 474,796 | 417,809 | ||||||
Sub-total – Renewable Metals | 7,280,209 | 5,347,173 | ||||||
Henan Armco | ||||||||
Letters of credit (v) | 845,291 | 900,665 | ||||||
Sub-total – Henan Armco | 845,291 | 900,665 | ||||||
$ | 9,518,173 | $ | 8,357,670 |
(i) | $1,392,673 is to be released to the Company as part of the payment toward outstanding letters of credit when those letters of credit mature on May 20, 2012. |
(ii) | $1,107, 858 is to be released to the Company when the related banker’s acceptance notes payable mature on May 25, 2012 and $4,273,166 is to be released to the Company when the related banker’s acceptance notes payable mature on September 28, 2012. |
(iii) | $1,424,389 is to be released to the Company for payment toward fulfilled letters of credit when those letters of credit matured on June 23, 2012. |
(iv) | $474,796 is to be released to the Company as part of the payment towards capital lease installment payment when the capital lease agreement mature on December 15, 2014. |
(v) | $845,291 is to be released to the Company as part of the payment toward fulfilled letters of credit t when those letters of credit mature ranging from May 15, 2012 through June 10, 2012. |
Note 4 – Marketable Equity 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 has 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.,
F-23
Apollo Minerals also issued to the Company, five (5) year options to purchase an additional 5 million shares of common stock at AUD0.25 (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 at the lower of its original cost, Private Place of Memorandum ("PPM") or market using Australia quoted market prices on Apollo Minerals stock, whichever is more reliably measurable.
At December 31, 2011, the estimated fair value of the investment in Apollo Minerals was approximately ($1.76) million less than its original costs inclusive of ($1.98) million in impairment and $0.22 million of foreign currency transaction gain based on the most recent PPM price of AUD0.055 per common share whereby Apollo Minerals sold 23,545,454 common shares for AUD1,295,000 on November 15, 2011. Even though the Company intends to hold these shares the management of the Company concluded that the decline in the fair value was other than temporary and recorded the unrealized loss of marketable securities to (i) impairment – other than temporary of ($1.98) million in other income (loss) and (ii) foreign currency transaction gain in other income (loss) in the accompanying consolidated statements of operations and comprehensive income (loss) for the year ended December 31, 2011.
At March 31, 2012, the estimated fair value of the investment in Apollo Minerals was approximately ($2.18) million less than its original costs based on most recent PPM price of AUD0.04 per common share whereby Apollo Minerals sold 89,550,000 common shares for AUD3,600,000 on May 8, 2012. Even though the Company intends to hold these shares the management of the Company concluded that the decline in the fair value was other than temporary and recorded the unrealized loss of marketable securities to (i) impairment – other than temporary of ($0.38) million in other income (loss) and (ii) foreign currency transaction gain in other income (loss) in the accompanying consolidated statements of operations and comprehensive income (loss) for the quarter ended March 31, 2012.
The table below provides a summary of the changes in the fair value of marketable securities, available for sale measured at fair value on a recurring basis using Level 1 of the fair value hierarchy to measure the fair value during the interim period ended March 31, 2012:
Fair Value Measurement Using Level 1 Inputs | ||||||||||||||||||||
Original cost | Impairment – Other Than Temporary | Accumulated Foreign Currency Transaction Gain (Loss) | Other Comp. Loss - Change in Unrealized Loss | Fair Value | ||||||||||||||||
Balance, December 31, 2010 | $ | 3,396,658 | $ | - | $ | - | $ | (506,278 | ) | $ | 2,890,380 | |||||||||
Purchases, issuances and settlements | ||||||||||||||||||||
Total gains or losses (realized/unrealized) included in: | ||||||||||||||||||||
Net Loss: Impairment – other than temporary | (1,980,000 | ) | (1,980,000 | ) | ||||||||||||||||
Net Loss: Gain (loss) on foreign currency rate change | 220,881 | 220,881 | ||||||||||||||||||
Other comprehensive income (loss): Changes in unrealized loss | - | 505,481 | 505,481 | |||||||||||||||||
Balance, December 31, 2011 | 3,396,658 | (1,980,000 | ) | 220,881 | (797 | ) | 1,636,742 | |||||||||||||
Purchases, issuances and settlements | ||||||||||||||||||||
Total gains or losses (realized/unrealized) included in: | ||||||||||||||||||||
Net Loss: Impairment – other than temporary | (386,941 | ) | (386,941 | ) | ||||||||||||||||
Net Loss: Gain (loss) on foreign currency rate change | (35,553 | ) | - | (35,553 | ) | |||||||||||||||
Other comprehensive income (loss): Changes in unrealized loss | - | 797 | 797 | |||||||||||||||||
Balance, March 31, 2012 | $ | 3,396,658 | $ | (2,366,941 | ) | $ | 185,328 | $ | (- | ) | $ | 1,215,045 |
F-24
Note 5 – Accounts Receivable
Accounts receivable at March 31, 201 2 and December 31, 2011 consisted of the following:
March 31, 2012 | December 31, 2011 | |||||||
Accounts receivable | $ | 28,243,055 | * | $ | 758,500 | |||
Allowance for doubtful accounts | (- | ) | (- | ) | ||||
$ | 28,243,055 | $ | 758,500 |
* The Company collected $18,281,872 on May 11, 2012, expects to collect $8,851,687 from a letter of credit on May 30, 2012 and the remaining balance of the accounts receivable of $1,109,496 is within the normal credit terms granted to the customers and expected to be collected when due.
Note 6 – Inventories
Inventories at March 31, 2012 and December 31, 2011 consisted of the following:
March 31, 2012 | December 31, 2011 | |||||||
Raw materials – scrap metal | $ | 3,775,204 | * | $ | 10,031,185 | |||
Finished goods – processed scrap metal | 6,433,438 | * | 3,833,910 | |||||
Purchased merchandise for resale | 1,005,912 | 19,479,451 | ||||||
$ | 11,214,554 | $ | 33,344,547 |
* Renewable Metals raw materials and finished goods are collateralized for loans from the Bank of Communications Limited Lianyungang Branch. Raw materials consisted of scrap metals to be processed and finished goods were comprised of all of the processed scrap metal at Renewable Metals. Due to the short duration time for the processing of its scrap metal, there was no material work-in-process inventory at March 31, 2012 or December 31, 2011.
Slow-Moving or Obsolescence Markdowns
The Company recorded no inventory obsolescence adjustments for the interim period ended March 31, 2012 or 2011.
Lower of Cost or Market Adjustments
There was no lower of cost or market adjustments for the interim period ended March 31, 2012 or 2011.
F-25
Note 7 – Property, Plant and Equipment
Property, plant and equipment, stated at cost, less accumulated depreciation at March 31, 2012 and December 31, 2011 consisted of the following:
Estimated Useful Life (Years) | March 31, 2012 | December 31, 2011 | |||||||
Buildings and leasehold improvements (i) | 20 | $ | 24,074,609 | $ | 23,923,160 | ||||
Construction in progress | 4,551,612 | 3,251,525 | |||||||
Machinery and equipment | 7 | 13,634,010 | 13,536,934 | ||||||
Vehicles | 5 | 1,211,312 | 1,203,692 | ||||||
Office equipment | 5-8 | 253,075 | 250,126 | ||||||
43,724,618 | 42,165,437 | ||||||||
Less accumulated depreciation (ii) | (4,240,863 | ) | (3,514,893 | ) | |||||
$ | 39,483,755 | $ | 38,650,544 |
(i) Capitalized Interest
The Company did not capitalize any of interest to fixed assets for the interim period ended March 31, 2012 or 2011.
(ii) Depreciation and Amortization Expense
Depreciation and amortization expense for the interim period ended March 31, 2012 and 2011 was $704,941 and $640,225, respectively.
(iii) Collateralization of Property, Plant and Equipment
Both Renewable Metals and Lianyungang Armco’s property, plant and equipment representing substantially all of the Company’s property, plant and equipment are collateralized for loans from the Bank of China Lianyungang Branch.
Note 8 – Land Use Rights
Renewable Metals
On September 28, 2007, Renewable Metals entered into an agreement with the Chinese government, whereby the Company paid RMB 14,384,002 to acquire the right to use 129,585.60 square meter of land for approximate 50 years. In November 2007, the Company expended additional RMB 1,076,300 in aggregate in land survey, transfer agent fees and land use right transfer tax in connection with the acquisition of the land use right and obtained the land use right certificate (Certificate No. 017158277) expiring December 30, 2058 on November 20, 2007. The purchase price and related acquisition costs are being amortized over the term of the right of approximately fifty (50) years.
Lianyungang Armco
On September 2, 2010, the Company entered into an agreement with the Chinese government, whereby the Company made a deposit of RMB8,160,000 in aggregate towards the acquisition of the right to use 199,999 square meter of land for RMB40,800,000. On April 13, 2011, the Company paid an additional RMB16,320,000 to acquire the land use right to use 100,045 square meter of land and obtained the related certificate of the land use right (Certificate No. (L) LUR (2011) Y003218) expiring September 9, 2060 on October 25, 2011. The Company expended an additional RMB 900,067 in aggregate in land survey, transfer agent fees and land use right transfer tax in connection with the acquisition of the land use right. In addition, Lianyungang Armco expended an additional RMB20,674,830 to level the land as of December 31, 2011, which was recorded as construction in progress included in consolidated balance sheets. The purchase price and related acquisition costs shall be amortized over the term of the right of approximately fifty (50) years when the land is ready to use in the intended purpose.
The Company needs to pay an additional RMB16,320,000 (equivalent to $2,566,643 using U.S. Dollar to RMB at 6.3585 exchange rate) to acquire the land use right to use the remaining 100,045 square meter of land.
F-26
The short term plan for this parcel of land is for warehouse of raw materials and products when Renewable Metals’ space becomes scarce for future expansion and the long term plan for the land is to construct automobile dismantling production line or build a scrap metal trading market center, depending on the Company’s progress on obtaining necessary license and permits and market conditions.
Land use rights, stated at cost, less accumulated amortization at March 31, 2012 and December 31, 2011, consisted of the following:
March 31, 2012 | December 31, 2011 | |||||||
Renewable Metals | ||||||||
Land use right | $ | 2,446,831 | $ | 2,431,438 | ||||
Accumulated amortization | (223,222 | ) | (209,474 | ) | ||||
2,223,609 | 2,221,964 | |||||||
Lianyungang Armco | ||||||||
Land use right | 4,016,787 | 3,991,518 | ||||||
Accumulated amortization | (- | ) | (- | ) | ||||
4,016,787 | 3,991,518- | |||||||
Total | ||||||||
Land use right | 6,463,618 | 6,422,956 | ||||||
Accumulated amortization | (223,222 | ) | (209,474 | ) | ||||
$ | 6,240,396 | $ | 6,213,482 |
(i) Amortization Expense
Amortization expense for the interim period ended March 31, 2012and 2011 was $12,422 and $11,965, respectively.
(ii) Collateralization of Land Use Rights
Both Renewable Metals and Lianyungang Armco’s land use rights representing all of the Company’s land use rights are collateralized for loans from the Bank of China Lianyungang Branch.
F-27
Note 9 – Loans Payable
Loans payable at March 31, 2012 and December 31, 2011 consisted of the following:
March 31, 2012 | December 31, 2011 | |||||||
Armco HK | ||||||||
Loan payable to DBS, collateralized by certain of the Company’s inventory, guaranteed by the Company’s Chairman and Chief Executive Officer, with interest at 3.3% , per annum, payable monthly, with principal due and repaid in full on April 22, 2012. | 512,846 | - | ||||||
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, with principal and interest due and repaid in full on January 12, 2012. | - | 325,196 | ||||||
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 of $17,916,234 due and repaid on May 14, 2012 and $8,674,654 due May 30, 2012. | 26,590,888 | - | ||||||
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 (3.63%) per annum, payable monthly with principal due December 7, 2011 and repaid in full on January 9, 2012. | - | 702,250 | ||||||
Sub-total - Armco HK | 27,103,734 | 1,027,446 | ||||||
Renewable Metals | ||||||||
Loan payable to Bank of Communications, Lianyungang Branch, under trade credit facilities, collateralized by Renewable Metals inventories and guaranteed by the Company’s Chairman and Chief Executive Officer, with interest at 120% of the bank’s benchmark rate, per annum (average 7.194%), payable monthly, with principal due from May 25, 2012 through August 21, 2012 | 3,165,308 | 5,504,443 | ||||||
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 7.216%, per annum, payable monthly, with principal due on March 27, 2013. | 3,165,308 | - | ||||||
Sub-total – Renewable Metals | 6,330,616 | 5,504,443 | ||||||
Henan Armco | ||||||||
Loan payable to Guangdong Development Bank Zhengzhou Branch, collateralized by certain of Henan’s inventory, with interest at 6.5%, per annum, payable monthly, with principal due May 21, 2012 | 344,704 | 180,009 | ||||||
Sub-total – Henan Armco | 344,704 | 180,009 | ||||||
$ | 33,779,054 | $ | 6,711,898 |
Note 10 – Banker’s Acceptance Notes Payable and Letters of Credit
Banker’s acceptance notes payable at March 31, 2012 and December 31, 2011, consisted of the following:
March 31, 2012 | December 31, 2011 | |||||||
Renewable Metals | ||||||||
Banker’s acceptance notes payable maturing May 25, 2012 | $ | 10,128,986 | $ | 1,100,889 | ||||
Letters of credit maturing and repaid in full on March 21, 2012 | - | 7,077,141 | ||||||
$ | 10,128,986 | $ | 8,178,029 |
F-28
Note 11 – Related Party Transactions
Advances from Stockholder
From time to time, the Chairman, CEO and significant stockholder of the Company advance funds to the Company for working capital purpose. Those advances are unsecured, non-interest bearing and due on demand.
Advances from stockholder at March 31, 2012 and December 31, 2011 consisted of the following:
March 31, 2012 | December 31, 2011 | |||||||
Advances from chairman, chief executive officer and stockholder | $ | 626,032 | $ | 607,009 | ||||
$ | 626,032 | $ | 607,009 |
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, 2012. Total lease payments for the interim periods ended March 31, 2012 and 2011 amounted to RMB30,000 (equivalent to $4,755 and $4,559). Future minimum lease payments required under the non-cancelable operating lease are RMB90, 000 per year (equivalent to $14,244) for the remainder of 2012.
Note 12 – Capital Lease Obligation
Capital lease obligation at March 31, 201 2 and December 31, 2011 consisted of the following:
March 31, 2012 | December 31, 2011 | ||||||
Renewable Metals | |||||||
(i) Capital lease obligation to a financing company for a term of three (3) years, collateralized by certain of Renewable Metals machinery and equipment, with interest at 11.8% per annum, with principal and interest due and payable in monthly installments of RMB497, 897 on the 23rd of each month. | $ | 1,425,007 | $ | 1,604,437 | |||
Less current maturities | (819,628 | ) | (789,733 | ) | |||
Capital lease obligation, net of current maturities | 605,379 | 814,704 | |||||
(ii) Capital lease obligation to a financing company for a term of three (3) years, collateralized by certain of Renewable Metals machinery and equipment, with interest at 11% per annum, with principal and interest due and payable in quarterly installments of RMB2,969,054 on the 15th of each quarter. | 4,408,633 | 4,718,094 | |||||
Less current maturities | (1,453,236 | ) | (1,405,444) | ||||
Capital lease obligation, net of current maturities | 2,955,397 | 3,312,650 | |||||
Total capital lease obligation | 5,833,640 | 6,322,531 | |||||
Less current maturities | (2,272,864 | ) | (2,195,177) | ||||
TOTAL CAPITAL LEASE OBLIGATION, net of current maturities | $ | 3,560,776 | $ | 4,127,354 |
F-29
The future minimum payments under this capital lease obligation at March 31, 2012 were as follows:
Year ending December 31: | ||||
2012 | $ | 2,122,801 | ||
2013 | 2,751,166 | |||
2014 | 1,879,594 | |||
Total capital lease obligation payments | 6,753,561 | |||
Less amounts representing interest | (919,921 | ) | ||
Present value of total future capital lease obligation payments | $ | 5,833,640 |
Note 13 – Long-Term Debt
Long-term debt at March 31, 2012 and December 31, 2011 consisted of the following:
March 31, 2012 | December 31, 2011 | |||||||
Renewable Metals | ||||||||
Long-term debt due to Bank of China, Lianyungang Branch, collateralized by all of Renewable Metals’s building and land use rights, with interest at 5.40% per annum payable monthly, with the remaining principal of RMB25,000,000 due August 25, 2012. | $ | 3,956,635 | $ | 3,931,745 | ||||
Less current maturities | (3,956,635 | ) | (3,931,745 | ) | ||||
LONG-TERM DEBT, net of current maturities | $ | - | $ | - |
Note 14 – Derivative Instruments and the Fair Value of Financial Instruments
(i) Warrants Issued in 2008
Description of Warrants and Fair Value on Date of Grant
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 to purchase 2,486,649 common shares of the Company to the investors and (ii) warrants t purchase 242,264 common shares of the Company to the brokers, or 2,728,913 common shares in aggregate (“2008 Warrants”) with an exercise price of $5.00 per share expiring on August 31, 2013, all of which have been earned upon issuance.
The Company estimated the fair value of 2008 warrants on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
Expected life (year) | 5.00 | |||||||
Expected volatility | 89.00 | % | ||||||
Risk-free interest rate | 3.23 | % | ||||||
Expected annual rate of quarterly dividends | 0.00 | % |
Expected volatility is based on historical volatility of the Company’s common stock. The Company currently has no reason to believe future volatility over the expected life of these warrants is likely to differ materially from its historical volatility. The risk-free interest rate is based on a yield curve of U.S. treasury interest rates on the date of grant based on the expected term of the warrant. Expected annual rate of quarterly dividends is based on the Company’s dividend history and anticipated dividend policy.
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 and the remaining balance of the net proceeds of $1,523,277 has been assigned to common stock.
F-30
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”) Issue No. 07-5: Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity's Own Stock (“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
(a) | Valuation Methodology |
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.
Based on these features, there are two primary events that can occur; the Holder exercises the Warrants or the Warrants are held to expiration. The model analyzed the underlying economic factors that influenced which of these events would occur, when they were likely to occur, and the specific terms that would be in effect at the time (i.e. stock price, exercise price, volatility, etc.). Projections were then made on these underlying factors which led to a set of potential scenarios. As the result of the large Warrant overhang we accounted for the dilution affects, volatility and market cap to adjust the projections.
Probabilities were assigned to each of these scenarios based on management projections. This led to a cash flow projection and a probability associated with that cash flow. A discounted weighted average cash flow over the various scenarios was completed to determine the value of the derivative warrant liability.
(b) | Valuation Assumptions |
The Company’s 2008 derivative warrants were valued at each period ending date with the following assumptions:
· | The underlying stock price was used as the fair value of the common stock on period end date; |
· | The stock price would fluctuate with the CNAM 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; |
· | The Holder would exercise the warrant at maturity if the stock price was above the exercise price; |
· | Reset events projected to occur are based on no future projected capital needs; |
· | The Holder would exercise the warrant as they become exercisable at target prices of $7.50 for the 2008 Offering, and lowering such target as the warrants approached maturity; |
· | The probability weighted cash flows are discounted using the risk free interest rates. |
· | 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 warrants |
· | Expected annual rate of quarterly dividends is based on the Company’s dividend history and anticipated dividend policy. |
F-31
(c) | Fair Value of Derivative Warrants |
The fair value of the 2008 derivative warrants were computed using the lattice model with the following assumptions at March 31, 2012 and December 31, 2011:
March 31, 2012 | December 31, 2011 | |||||
Expected life (year) | 1.25 | 1.50 | ||||
Expected volatility | 70.00 | % | 69.00 | % | ||
Risk-free interest rate | 0.33 | % | 0.25 | % | ||
Expected annual rate of quarterly dividends | 0.00 | % | 0.00 | % |
The fair value of the embedded derivative warrants is marked-to-market at each balance sheet date and the change in the fair value of the embedded derivative warrants is recorded in the consolidated statements of operations and comprehensive income (loss) as other income or expense.
The table below provides a summary of the fair value of the remaining derivative warrant liability and the changes in the fair value of the remaining derivative warrants to purchase 186,306 shares of the Company’s common stock, including net transfers in and/or out, of derivative warrants measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at March 31, 2012 and for the interim period then ended:
Fair Value Measurement Using Level 3 Inputs | |||||||
Derivative warrants Assets (Liability) | Total | ||||||
Balance, December 31, 2011 | $ | (203 | ) | $ | (203 | ) | |
Total gains or losses (realized/unrealized) included in: | |||||||
Net income (loss) | (549 | ) | (549 | ) | |||
Other comprehensive income (loss) | - | - | |||||
Purchases, issuances and settlements | - | - | |||||
Transfers in and/or out of Level 3 | - | - | |||||
Balance, March 31, 2012 | $ | (752 | ) | $ | (752 | ) |
Exercise and Extinguishment 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 three months ended March 31, 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 fifty (50) of the 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 thirteen (13) of the 2008 warrant holders. The Company 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 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 certain 2008 warrant holders waived their anti-dilution or commonly known as a most favored nation clause thus making those warrants no longer derivative warrant, for which the Company reclassified $1,292,227 of the derivative liability to additional paid-in capital.
F-32
During April 2010, four (4) of the 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, for which the Company issued 13,806 shares of its common stock to the 2008 warrant holders and reclassified $21,229 of the derivative liability to additional paid-in capital.
Warrants Outstanding
As of March 31, 2012 warrants to purchase 1,218,021 shares of Company common stock remain outstanding.
The table below summarizes the Company’s derivative warrant activity through March 31, 2012:
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 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 | ) | |||||||||||
Mark to market | 8,688 | (8,688) | ||||||||||||||||
Derivative warrant at September 30, 2011 | 186,306 | 1,031,715 | 1,218,021 | (1,335 | ) | (136,808 | ) | |||||||||||
Mark to market | 1,132 | (1,132 | ) | |||||||||||||||
Derivative warrant at December 31, 2011 | 186,306 | 1,031,715 | 1,218,021 | (203 | ) | (137,940 | ) | |||||||||||
Mark to market | (549 | ) | 549 | |||||||||||||||
Derivative warrant at March 31, 2012 | 186,306 | 1,031,715 | 1,218,021 | (752 | ) | 549 |
(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 warrants to purchase an additional 1,538,464 shares of its common stock with an exercise price of $7.50 per share (“2010 Warrants”) expiring five (5) years from date of grant 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) a warrant to purchase 76,923 shares of the Company’s common stock with an exercise price of $7.50 per share expiring five (5) years from date of grant 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.
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Warrants Valuation and Related Assumptions
The 2010 warrants were valued on the date of grant with the following assumptions:
· | The underlying NYSEAmex stock price $6.95 was used as the fair value of the common stock on April 20, 2010; |
· | The stock price would fluctuate with the CNAM 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 warrant at maturity if the stock price was above the exercise price; |
· | 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; |
· | The probability weighted cash flows are discounted using the risk free interest rates. |
· | 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 expected term of the warrants |
· | Expected annual rate of quarterly dividends is based on the Company’s dividend history and anticipated dividend policy. |
The Company estimated the fair value of 2010 warrants on the date of grant using the lattice model with the Black-Scholes option-pricing model with the following weighted-average assumptions:
April 20, 2010 | |||||
Expected life (year) | 5.00 | ||||
Expected volatility | 182.00 | % | |||
Risk-free interest rate | 2.56 | % | |||
Expected annual rate of quarterly dividends | 0.00 | % |
The fair value of the 2010 warrants, estimated on the date of issuance, was $2,483,938, which was recorded as additional paid-in capital and the remaining balance of the net proceeds of $6,629,036, net of issuance cost, has been assigned to common stock.
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 Section 815-40-15 of the FASB Accounting Standard Codification (“Section 815-40-15”) (formerly FASB Emerging Issues Task Force (“EITF”) Issue No. 07-5: Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity's Own Stock (“EITF 07-5”)) to be considered indexed to the Company’s own stock. In addition, the warrants meet all the criteria in Section 815-40-55 of the FASB Accounting Standard Codification (“Section 815-40-55”) (formerly FASB EITF Issue No. 00-19: Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (“EITF 00-19”)) to be accounted for as equity.
Warrants Outstanding
As of March 31, 2012 warrants to purchase 1,615,387 shares of its common stock remain outstanding.
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(iii) Warrant Activities
The table below summarizes the Company’s non-derivative warrant activities through March 31, 2012:
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, 2010 | 2,833,408 | $ | 5.00 - 7.50 | $ | 6.43 | $ | - | $ | - | |||||||||||
Granted | - | - | - | - | - | |||||||||||||||
Canceled for cashless exercise | (- | ) | - | - | - | - | ||||||||||||||
Exercised (Cashless) | (- | ) | - | - | - | - | ||||||||||||||
Exercised | (- | ) | - | - | - | - | ||||||||||||||
Expired | - | - | - | - | - | |||||||||||||||
Balance, December 31, 2011 | 2,833,408 | $ | 5.00 - 7.50 | $ | 6.43 | $ | - | $ | - | |||||||||||
Granted | - | - | - | - | - | |||||||||||||||
Canceled for cashless exercise | (- | ) | - | - | - | - | ||||||||||||||
Exercised (Cashless) | (- | ) | - | - | - | - | ||||||||||||||
Exercised | (- | ) | - | - | - | - | ||||||||||||||
Expired | - | - | - | - | - | |||||||||||||||
Balance, March 31, 2012 | 2,833,408 | $ | 5.00 - 7.50 | $ | 6.43 | $ | - | $ | - | |||||||||||
Earned and exercisable, March 31, 2012 | 2,833,408 | $ | 5.00 - 7.50 | $ | 6.43 | $ | - | $ | - | |||||||||||
Unvested, December 31, 2011 | - | $ | - | $ | - | $ | - | $ | - |
The following table summarizes information concerning outstanding and exercisable warrants as of March 31, 2012:
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 | 1.33 | $ | 5.00 | 1,218,021 | 1.33 | $ | 5.00 | |||||||||
$ | 7.50 | 1,615,387 | 3.05 | $ | 7.50 | 1,615,387 | 3.05 | $ | 7.50 | |||||||||
$ | 5.00 - $7.50 | 2,833,408 | 2.31 | $ | 6.43 | 2,833,408 | 2.31 | $ | 6.43 |
Note 15 – 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.
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The uncommitted trade credit facilities at March 31, 2012 were as follows:
Date of Expiration | Total Facilities | Facilities Used | Facilities Available | |||||||||||
Armco HK | ||||||||||||||
DBS (Hong Kong) Limited (i) | December 20, 2012 | $ | 20,000,000 | $ | 1,501,800 | $ | 18,498,200 | |||||||
ING Bank, N.V. Hong Kong Branch (ii) | July 28, 2012 | 30,000,000 | 30,000,000 | - | ||||||||||
RZB (Beijing) Branch (iii) | February 28, 2013 | 15,000,000 | - | 15,000,000 | ||||||||||
Sub-total - Armco HK | 65,000,000 | 31,501,800 | 33,498,200 | |||||||||||
Henan Armco | ||||||||||||||
China Minsheng Bank Zhengzhou Branch (iv) | November 26, 2012 | 3,165,308 | 1,294,141 | 1,871,167 | ||||||||||
Guangdong Development Bank Zhengzhou Branch (v) | June 17, 2012 | 11,078,579 | 1,728,000 | 9,350,579 | ||||||||||
Sub-total – Henan Armco | 14,243,887 | 3,022,141 | 11,241,746 | |||||||||||
Renewable Metals | ||||||||||||||
Bank of China Lianyungang Branch (vi) | January 29, 2013 | 11,869,906 | 3,165,308 | 8,704,598 | ||||||||||
Bank of Communications Lianyungang Branch (vii) | June 30, 2013 | 11,395,110 | 6,488,882 | 2,373,981 | ||||||||||
Sub-total – Renewable Metals | 23,265,016 | 9,654,190 | 11,078,579 | |||||||||||
$ | 102,508,903 | $ | 44,178,131 | $ | 58,330,772 |
(i) On December 20, 2011, 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 July 29, 2011, Armco HK obtained a $30,000,000 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 any time 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.
(iii) On September 30, 2011, Armco HK entered into Amendment No. 2 to the March 25, 2009 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 any time 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.
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(iv) On November 26, 2011, Henan Armco obtained a RMB 20,000,000 (approximately $3,1 million) 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 Renewable Metals and Mr. Kexuan Yao, the Company’s Chairman and Chief Executive Officer.
(v) On June 18, 2011, Henan Armco obtained a RMB 70,000,000 (approximately $11.0 million) 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 Renewable Metals 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.
(vi) On January 30, 2012, Renewable Metals entered into a line of credit facility in the amount of RMB75, 000,000 (approximately $11.8 million) from Bank of China, Lianyungang Branch for the purchase of raw materials. The term of the facility is 12 months with interest at 120% of the applicable base rate for lending published by the People’s Bank of China (“PBOC”) at the time the loan is drawn down per annum. The facility is secured by the guarantees provided by Mr. Kexuan Yao, Mr. Yi Chu, Henan Armco and Henan Chaoyang, respectively.
(vii) On July 1, 2011, Renewable Metals obtained a RMB 72,000,000 (approximately $11.3 million) line of credit from Bank of Communications, Lianyungang Branch expiring two (2) 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 Renewable Metals 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 Renewable Metals inventories and guarantee provided by Mr. Kexuan Yao, the Company’s Chairman and Chief Executive Officer.
Employment with the Chairman and CEO
On February 8, 2012, the Company and the CEO, Mr. Yao, entered into an Employment Agreement (the “Employment Agreement”), to employ Mr. Yao as the Company’s Chairman of the Board of Directors, President, and Chief Executive Officer. The initial term of employment under the agreement is from January 1, 2012 (the “Effective Date”) until December 31, 2014, unless sooner terminated in accordance with the terms of the Employment Agreement. Pursuant to the Employment Agreement, Mr. Yao is entitled to, among others, the following compensation and benefits:
a. | Base Salary. The Company shall pay the Executive a salary at a minimum rate of (i) $250,000 per annum for the period beginning on the Effective Date through December 31, 2012; (ii) $275,000 per annum for the period beginning on January 1, 2013 through December 31, 2013; and (iii) $300,000 per annum for the period beginning on January 1, 2014 through December 31, 2014 (the “Base Salary”). Base Salary shall be payable in accordance with the customary payroll practices of the Company applicable to senior executives. |
b. | Bonus. Each year during the Term, in addition to Base Salary, the Executive shall be entitled to an annual cash bonus in an amount equal to 50% of the Executive’s Base Salary for such year. Any such bonus shall be payable no later 2 ½ months following the year with respect to which the Base Salary is payable. |
c. | Restricted Shares. On the Effective Date, Executive shall receive 1,500,000 shares of the Company’s common stock (“Restricted Shares”) subject to the terms and conditions of the Amended and Restated China Armco Metals, Inc. 2009 Stock Incentive Plan (the "Incentive Plan"). The Restricted Shares shall vest according to Vesting Schedule attached the Employment Agreement as Exhibit A; provided, however, if the Executive is terminated pursuant to Section 5 of this Agreement, the Executive shall forfeit all the unvested Restricted Shares as of such termination. |
d. | Equity Incentive Compensation. The Executive shall be entitled to participate in any equity compensation plan of the Company in which he is eligible to participate, and may, without limitation, be granted in accordance with any such plan options to purchase shares of Company’s common stock, shares of restricted stock and other equity awards in the discretion of the Board or the Committee. Any equity incentive compensation shall be payable no later than 2 ½ months of the following tax year in which such compensation is granted |
e. | Eligibility to participate in the Company’s benefit plans that are generally provided for executive employees. |
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Operating Leases
(i) Operating Lease - 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: | ||||
2012 (remainder of the year) | 33,687 | |||
2013 | 46,104 | |||
$ | 79,791 |
(ii) Operating Lease - 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: | ||||
2012 (remainder of the year) | 27,439 | |||
$ | 27,439 |
(iii) Operating Lease of Property, Plant and Equipment and Facilities
Initial Lease signed on June 24, 2010
On June 24, 2011, Renewable Metals entered into a non-cancelable operating lease agreement with an independent third party for property, plant, equipment and facilities expiring one (1) year from date of signing. Renewable Metals 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.
First Renewal on April 13, 2012
On April 13, 2012, Renewable Metals renewed the aforementioned non-cancelable operating lease agreement for property, plant, equipment and facilities for another two-year term commencing on June 25, 2012, in consideration for the issuance of one million shares of the Company’s common stock and the payment of RMB1,000,000 (approximately $159,000) in cash. Pursuant to the lease agreement, the Company issued one million shares to the third party on April 13, 2012. The cash amount is to be paid during the second year of the lease term.
For the interim period ended March 31, 2012, 3,498 tons of scrap metal had been processed at this facility and RMB104,940 (equivalent to $16,608 using U.S. Dollar to RMB exchange rate of $1=RMB6.3185 at March 31, 2012) were accrued and included in the inventory of finished goods – processed scrap metal which will be transferred to cost of goods sold upon shipment of processed scrap metal.
Note 16 – Stockholders’ Equity
Shares Authorized
Upon formation the aggregate number of shares which the Corporation shall have authority to issue is seventy five million (75,000,000) shares, consisting of two classes to be designated, respectively, “Common Stock” and “Preferred Stock,” with all of such shares having a par value of $.001 per share. The total number of shares of Preferred Stock that the Corporation shall have authority to issue is one million (1,000,000) shares. The total number of shares of Common Stock that the Corporation shall have authority to issue is seventy four million (74,000,000) shares.
Common Stock
Immediately prior to the consummation of the Share Purchase Agreement on July 27, 2008, the Company had 10,000,000 common shares issued and outstanding.
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On July 27, 2008, upon the consummation of the Share Purchase Agreement, (i) Stephen Cox surrendered 7,694,000 common shares, representing his controlling interest in the Company for cancellation and resigned as an officer and director; (ii) the Company issued a promissory note of $6,890,000 (the “Share Purchase Note”) to purchase from Ms. Gao, the sole stockholder of Armco HK, the 100% of the issued and outstanding capital stock of Armco HK; and (iii) (a) a stock option entitling Ms. Gao to purchase 5,300,000 shares of its common stock, par value $.001 per share (the “Common Stock”) with an exercise price of $1.30 per share expiring on September 30, 2008 and (b) a stock option entitling Ms. Gao to purchase 2,000,000 shares of its common stock with an exercise price of $5.00 per share expiring two (2) years from the date of issuance on June 27, 2010, vested immediately (the “Gao Options”). The Company did not record the fair value of the Gao Options as the options were included as part of the reverse acquisition and recapitalization.
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.
On April 12, 2010, Mr. Kexuan Yao purchased the Gao option to purchase 2,000,000 shares of the Company’s common stock with an exercise price of $5.00 per share 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 on June 27, 2008. 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 on June 27, 2010.
Sale of Equity Unit Inclusive of Common Stock and Warrants
July and August 2008 Issuances
On July 25, 2008 and July 31, 2008, the Company closed the first and second rounds of a private placement by raising $6,896,229 from eighty-two (82) investors through the sale of 22.9 units of its securities at an offering price of $300,000 per unit in a private placement. Each unit sold in the offering consisted of 100,000 shares of the Company’s common stock, $.001 par value per share at a per share purchase price of $3.00, and five (5) year warrants to purchase 100,000 shares of common stock with an exercise price of $5.00 per share (the “Warrants“).
On August 8, 2008 the Company closed the third round of the offering by raising $523,500 from ten (10) investors through the sale of 1.745 units of its securities at an offering price of $300,000 per unit.
On August 11, 2008 the Company closed the fourth round of the offering by raising $40,200 from five (5) investors through the sale of 0.134 units of its securities at an offering price of $300,000 per unit.
The Company paid (i) FINRA member broker-dealers cash commissions of $162,660 and issued those firms five (5) year warrants to purchase a total of 99,650 shares of its common stock at $5.00 per share as compensation for services to the Company, (ii) due diligence fees to certain investors or their advisors in connection with the Offering aggregating $579,316 in cash and issued those firms five (5) year warrants to purchase a total of 142,614 shares of its common stock at $5.00 per share as compensation for services to the Company, and (iii) professional fees in the amount of $97,689 paid in cash in connection with the Offering. The recipients of these fees included China Direct Investments, Inc., a subsidiary of China Direct, Inc. and a principal stockholder of the company.
In aggregate, the Company raised $7,459,929 in the offering from ninety-seven (97) investors through the sale of 24.87 units and after payment of cash commissions, broker dealer fee, due diligence fees and other costs associated with the Offering, the Company received net proceeds of $6,620,681, all of which will be used for construction of a scrap steel recycling facility in China as previously disclosed by the Company and general corporate working capital purposes.
April 2010 Issuance
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 warrants to purchase an additional 1,538,464 shares of its common stock at an exercise price of $7.50 per share expiring five (5) years from the date of grant. 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) a warrant to purchase 76,923 shares of the Company’s common stock at an exercise price of $7.50 per share expiring five (5) years from the date of issuance 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.
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Issuance of Common Stock to Parties Other Than Employees for Acquiring Goods or Services
Loan Guarantee - Henan Chaoyang Steel Co., Ltd.
On June 11, 2010 the Company entered into a Guaranty Cooperation Agreement with Henan Chaoyang Steel Co., Ltd. (“Henan Chaoyang”) to provide additional liquidity to meet anticipated working capital requirements of Renewable Metals’ scrap metal recycling facility. Under the terms of the guaranty, Henan Chaoyang agreed to provide loan guarantees to Renewable Metals’ existing and pending bank lines of credit of up to 300 million RMB in the aggregate (approximately $45,400,000) for five (5) years expiring June 30, 2015. As consideration for the guaranty, the Company issued 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 a founder, Chairman and owns an 85% equity interest of Henan Chaoyang Steel Co., Ltd. Co, a corporation incorporated under the laws of the PRC. This transaction was approved by the members of the Board of Directors of the Company who were independent in the matter in accordance with the Company’s Related Persons Transaction Policy. On September 16, 2010, Mr. Ma resigned from the Company’s Board of Directors.
33,333 shares each earned for the 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, 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 the quarters ended March 31, 2011, June 30, 2011, September 30, 2011 and December 31, 2011 were valued at $2.61, $1.36, $0.41 and $0.282 per share, or $86,996, $45,333, $13,667 and $9,400, which was recorded as loan guarantee expense and included in the consolidated statements of operations and comprehensive income (loss) for the relevant periods.
33,333 common shares earned for the quarter ended March 31, 2012 were valued at $0.50 per share, or $16,667, which was recorded as loan guarantee expense and included in the consolidated statements of operations and comprehensive income (loss) for the relevant periods.
2009 Stock Incentive Plan as Amended
Adoption of 2009 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 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.
2011 Amendment to the 2009 Stock Incentive Plan
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.
Shares Awarded during 2009
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, or $54,667 per quarter.
F-40
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. Thomson 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, all of which was earned and recorded as stock based compensation for the year ended December 31, 2010.
Shares and Options Awarded during 2010
On September 16, 2010, the Company agreed to pay Mr. J.P. 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, or $4,875 per quarter.
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 expiring five (5) years from the date of grant to an employee in conjunction with his employment agreement as the Company's Director of Administration, vested upon grant. The Company estimated the fair value of option granted, estimated on the date of grant, using the Black-Scholes option-pricing model with the following weighted-average assumptions:
October 5, 2010 | |||||
Expected life (year) | 5.00 | ||||
Expected volatility | 187.00 | % | |||
Risk-free interest rate | 1.21 | % | |||
Expected annual rate of quarterly dividends | 0.00 | % |
Expected volatility is based on historical volatility for the Company’s common stock. The Company currently has no reason to believe future volatility over the expected life of the option is likely to differ materially from its historical volatility. 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 expected term of the share options or equity instruments. Expected dividend yield is based on our dividend history and anticipated dividend policy.
The fair value of share options or equity instruments granted, estimated on the date of grant, using the Black-Scholes option-pricing model, was $138,000. The Company recorded the entire amount as stock based compensation expense on the date of grant.
Shares Awarded during 2011
On January 25, 2011, the Company issued 55,378 shares of its common stock to certain of its employees for their 2010 services of approximately $187,180 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.
On December 15, 2011, the Company issued 60,000 shares of its common stock to its directors for their 2011 services. These shares were valued at $0.27 per share, or $16,200 on the date of grant, which was recorded as stock based compensation.
On December 15, 2011, the Company issued 264,379 shares of its common stock to certain of its employees for their 2011 services of approximately $71,383, in lieu of cash, which was recorded as compensation expense in 2011.
Shares Awarded during 2012
On February 6, 2012, the Company issued 57,743 shares of its common stock to certain of its employees for their 2011 services of approximately $33,318, in lieu of cash, which was recorded as compensation expense in 2012
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On February 8, 2012, the Company awarded 1,500,000 shares of its restricted common stock, par value $.001 per share, pursuant to the Amended and Restated 2009 Stock Incentive Plan, to Mr. Kexuan Yao, the Company’s Chief Executive Officer. Mr. Yao is to receive 1,500,000 shares of the Company’s common stock (the “Restricted Shares”), subject to the terms and conditions of the Amended and Restated China Armco Metals, Inc. 2009 Stock Incentive Plan. The Restricted Shares will vest according to the following schedule: 125,000 shares of Restricted Shares to vest on the first day of each quarter over a three (3) year period commencing on April 1, 2012 and terminating on December 31, 2014. These shares were valued at $0.499 per share or $748,500 on the date of grant and are amortized over the vesting period, or $62,375 per quarter
Summary of the Company’s Amended and Restated 2009 Stock Incentive Plan Activities
The table below summarizes the Company’s Amended and Restated 2009 Stock Incentive Plan activities as of March 31, 2012:
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 | 389,757 | 302,163 | ||||||
Canceled – shares | - | - | ||||||
Granted – options | - | - | ||||||
Canceled – options | - | - | ||||||
Balance, December 31, 2011 | 642,257 | 1,136,163 | ||||||
Granted – shares | 1,557,743 | 781,818 | ||||||
Canceled – shares | - | - | ||||||
Granted – options | - | - | ||||||
Canceled – options | - | - | ||||||
Balance, March 31, 2012 | 22,000,000 | $ | 1,917,981 | |||||
Vested, March 31, 2012 | 650,000 | 1,005,481 | ||||||
Unvested, March 31, 2012 | 1,550,000 | $ | 912,500 |
As of March 31, 2012, there were no shares of common stock remaining available for issuance under the Amended and Restated 2009 Stock Incentive Plan.
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Note 17 – Concentrations and Credit Risk
Customers and Credit Concentrations
Customer concentrations for the interim period ended March 31, 2012 and 2011 and credit concentrations at March 31, 2012 and 2011 are as follows:
Net Sales for the Interim Period Ended | Accounts Receivable at | |||||||||||||
March 31, 2012 | March 31, 2011 | March 31, 2012 | March 31, 2011 | |||||||||||
Customer #1122028 QingDao Baosong Resources | 18.0 | % | - | % | 31.3 | % | - | % | ||||||
Customer #1122031 Shandong Huaxin Industry Co | 16.3 | % | - | % | - | % | - | % | ||||||
Customer #1122024 Derby Materials | - | % | 45.1 | % | - | % | 73.5 | % | ||||||
Customer #302023 Shangdong Yongjia | - | % | 22.0 | % | - | % | - | % | ||||||
Customer #101009 NingBo HanGang | - | % | 8.6 | % | - | % | - | % | ||||||
Customer # 1122002 ZhongJi NingBo | 37.1 | % | 13.5 | % | 64.7 | % | 22.0 | % | ||||||
71.4 | % | 89.2 | % | 96.0 | % | 95.5 | % |
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 period ended March 31, 2012and 2011 and accounts payable concentration at March 31, 2012 and 2011 are as follows:
Net Purchases for the Interim Period Ended | Accounts Payable at | |||||||||||||
March 31, 2012 | March 31 , 2011 | March 31 , 2012 | March 31, 2011 | |||||||||||
Vendor #2202-024 Mineracao | 80.3 | % | 36.5 | % | 50.5 | % | 7.6 | % | ||||||
Vendor #301009 XinJiang BaGang | - | % | 19.8 | % | - | % | - | % | ||||||
Vendor #1123-990006 LianYunGang DiShang | - | % | - | % | 12.5 | % | - | % | ||||||
Vendor #2202019 Smart Trading LLP | - | % | 12.1 | % | - | % | 50.7 | % | ||||||
Vendor #399081 Lian, XiaoLei | - | % | 10.6 | % | - | % | % | |||||||
Vendor #2010001 Xie Hong Jian | - | % | 9.5 | % | - | % | 8.8 | % | ||||||
80.3 | % | 88.5 | % | 63 | % | 67.1 | % |
Credit Risk Arising from Financial Instruments
Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents.
As of March 31, 2012, 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.
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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 for the interim period ended March 31, 2012 or 2011 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 18 - 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 March 31, 2012, the Company had no Statutory Surplus Reserve and the Statutory Common Welfare Fund established and segregated in retained earnings.
Note 19 – 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.
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the information contained in our unaudited consolidated financial statements and the notes thereto appearing elsewhere herein and in conjunction with the Management’s Discussion and Analysis set forth in our Annual Report on Form 10-K for the year ended December 31, 2011 (the "Form 10-K").
We are on a calendar year; as such the three month period ended March 31, is referred to as our “first quarter”. The past year ended December 31, 2011 is referred to as “2011”, the current year ending December 31, 2012 is referred to as “2012”, and the coming year ended December 31, 2013 is referred to as “2013”.
The unaudited interim consolidated financial statements furnished in this report 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, 2011and notes thereto contained in the Company’s Annual Report on Form 10-K filed with the SEC on March 31, 2012.
OVERVIEW OF OUR PERFORMANCE AND OPERATIONS
Our Business and Recent Developments
We import, sell and distribute to the metal refinery industry in the People’s Republic of China a variety of metal ore, including iron, chrome, nickel, copper and manganese ore as well as non-ferrous metals and coal. We obtain these raw materials from global suppliers in Brazil, India, South America, Oman, Turkey, Nigeria, Indonesia, and the Philippines and distribute them in the PRC. We also recycle scrap metal to steel mills for their use in the production of recycled steel.
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Chinese steel industry slowed down and suffered quarterly losses first time in ten years during the first quarter of 2012. The domestic steel production continued to increase while the steel consumption in the PRC saw the first time decline for the past three years in the first quarter of 2012 compared to the same period of last year. The main reasons of the fall in the domestic demand of steel were the adverse impact on steel consumption by restrictions on the real estate industry implemented by the PRC government, the first drop in spending on infrastructure constructions in recent years, and also the slowdown of steel consumption from other big steel consumers, including the automotive, ship and equipment manufacturing industries. The increased production and declined demand exacerbated the oversupply and inventory backlog which depressed steel and metal ore prices in the first quarter of 2012. Moreover, starting on February 1, 2012, the government increased the resources tax imposed on iron ore mines by approximately $0.5 per metric ton and further increased the industry’s costs. As a consequent, both our metal ore trading and recycling businesses in the first quarter of 2012 have been adversely affected by the factors described above.
We continue to refine our business model in response to fluctuations in market prices. We seek to secure longer term supply contracts in response to known opportunities rather than sell goods purchased in the spot market. Where possible, we structure transaction-specific terms with our customers in order to better manage risk and ensure an acceptable profit margin. While this process can limit certain trading opportunities, we believe that it will enhance our competitive position as the market for ore prices recover. We are also evaluating other methods to manage market risks in the future, such as hedging.
We formally commenced the operation of our scrap metal recycling facility in the Banqiao Industrial Zone of Lianyungang Economic Development Zone in the Jiangsu province of the PRC (the “Facility”) in the third late quarter of 2010. This facility recycles automobiles, machinery, building materials, dismantled ships and various other scrap metals. We sell and distribute the recycled scrap metal to the metal refinery industry in the PRC utilizing our existing network of metal ore customers. During the first quarter of 2012, the scrap metals recycled at our recycling facility increased by 103% to 25,071 MT compared to 12,373 MT in the same period of last year. Despite of the increase in output of recycled scrap metals, production of our recycling facility still operated significantly below capacity due to seasonal factors and to certain other factors described below. Traditionally the first quarter of each year sees the lowest production for Chinese scrap metal recyclers due to the Chinese New Year holiday, which can last for as long as three or four weeks, when facilities are shut down and stricter restrictions are enforced on the transportation of scrap metals materials. In addition, due to the market downturn, our recycling business customers and other steel mills had sluggish sales and excess inventory with tight cash position, which resulted in lower demand and purchases in the first quarter of 2012. Consequently, for the first quarter of 2012, our scrap metal business sold approximately 16,753 MT of scrap metals, generating approximately $8.7 million of revenue and $0.14 million of gross profit. By comparison, for the first quarter of 2011, our scrap metal business sold approximately 14,435 MT of scrap metals, generating approximately $6.3 million of revenue and $0.4 million of gross profit.
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We continue to believe that our recycling business will become a strong growth driver for our Company as natural resources continue to be depleted and larger amounts of unprocessed scrap metal become available as a result of increases in consumer demand for products made from steel that eventually are recycled. We also believe the profit margin of our recycling business will gradually stabilize and could further increase as we gain more experience in operating our Facility, marketing our products and establishing our reputation and presence in the recycled scrap metal industry. We have conducted a series of cost testing and variance analysis to improve our cost control and implement precise management in our recycling operations. We also developed a strategy to expand our sources of raw material and to establish a supply chain network locally to increase and stabilize the availability of raw materials near and for our recycling operation. We expect to continue to expend our overseas supply channels and recent development included negotiations on business cooperation with U.S. and Japan suppliers.
We invested a total of approximately $50.2 million in the aggregate to acquire land use rights and to construct and purchase equipment for the Facility. These capital expenditures were funded from a portion of the net proceeds we received from sales of securities and debt and vendor financing. In 2012, we continued to secure financing for our business. We maintain seven bank facilities, which provide for the issuance of commercial lines of credit for letters of credit in the aggregate amount of $102 million with approximately $ 58 million available to us at March 31, 2012. These bank facilities improve our ability to finance our continued business expansion and help us develop our brand in the industries we operate in.
7
Our Performance
During the first quarter of 2012, our net revenues remained at $49 million compared to the same period in 2011. Due to the deteriorating of the market situation, our gross profit margin decreased drastically during the current period to 3%, compared to 6% during the same period in 2011. Our trading business and recycling business gross profit margins were 3% and 2%, respectively. Our trading business has historically experienced fluctuations in gross profit as a result of fluctuations in the market prices of ore and metals that we sell. In this regard, gross profit margins ranged from 6 % for the first quarter of 2011, to 4 % for the second quarter of 2011, to 2% for the third quarter of 2011, and to -23% for the fourth quarter of 2011.
As noted above, our recycling business generated a gross profit margin of 2% for the first quarter of 2012, which represents a sharp decrease from the 6% gross profit margin in this business for same period in 2011. We believe this decrease in gross profit margin for the first quarter of 2012 is primarily due to the deteriorated market condition in the period, which was the most difficult quarter for the industry in the PRC for recent years and was the first time in 10 years Chinese steel industry suffered quarterly losses. .
We had a net loss of $1.66 million during the first quarter of 2012 due to significant decreases in gross margins on both our trading business and recycling business, compared to same period in 2011. Our total assets at March 31, 2012 increased $10 million, or 10%, compared to December 31, 2011, which was mainly due to an $27.5 million increase in accounts receivable resulting from the sale of 230,000 MT iron ore against L/C (generating an accounts receivable of $26.85 million) , an $3.2 million increase in advance on purchases for our recycling production, and a $1.2 million increase in pledged deposits, offset by a $22.1 million decrease in inventories due to the sales of iron ore. We expect to collect the payments for the sales of iron ore within the second quarter of 2012.
We have a capital lease obligation of $3.56 million (net of current maturities) with current maturities of such capital lease of $2.3 million for our recycling operation, and a current maturities of long-term debt of 3.96 million related to our investment in the Facility. Loans payable increased $27 million, Banker’s acceptance notes payable increased by $1.95 million, accounts payable decreased by $15 million, and customers deposits decreased $3.3 million, while inventories decreased $22 million, accounts receivable increased $27 million, advances on purchases increased $3.2 million and pledged deposits increased $1.2 million at March 31, 2012 from December 31, 2011.
Our Outlook
Although the industry experienced difficult time during the first quarter of 2012, we believe the low-income housing construction, on-going urbanization and increasing domestic consumption in the PRC will continue to support the growth of the steel industry, evidencing a higher demand for our products with an associated revenue growth. We also expect our recycling business to benefit substantially from the measures and policies to be implemented gradually by the Chinese government according to its 12th Five Year Plan (2011-2015). Under this plan, China intends to restructure its iron and steel industry to be more energy efficient and have increased environmental protection by adopting and developing the most advanced technology in the world.
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Metal Ore Trading. The metal ore prices decreased overall in the first quarter of 2012 compared same period of 2011. The price decreases were due to a sluggish steel market, as the steel sector posted widespread losses in the first quarter. We believe steel companies are likely to further tighten purchases of raw materials and the price of imported iron ore is likely to trend downward in the short-term. We expect the price of iron ore may stabilize at its current level in a longer term which is supported by the growth of demand in the PRC. Our trading business remained at approximately $40 million in net revenues during the first quarter of 2012 compared to the same period in 2011. In the first quarter of 2012, we completed large order sales of iron ores quickly and lowered our inventory level substantially to control market risks. We continued to firm our business relationship with large suppliers and stabilize our supply capacity .We believe our effort to build our supply capacity will benefit us in the long term and strengthen our market position in the industry in the PRC.
Scrap Metal Recycling. The gross profit margin for our recycling business decreased significantly to 2% for the first quarter in 2012 compared to 6 % for same period of 2011 due to the factors described above, although the net revenue generating in first quarter increased approximately 30% compared to first quarter of 2011. We believe that our recycling operations will generate greater revenue growth in the remaining quarters of 2012 as we gain more operational experience and create efficiencies at the Facility. Moreover, with the increase in our sales force, we have commenced a concerted effort to increase our brand name in the market, establishing our reputation on the recycling business. We believe that we will benefit from the PRC governmental mandates to increase the use of scrap metal steel as it encourages the use of scrap as opposed to the use of iron ore to satisfy the demand for steel products per China’s Five Year Plan and related national policies. We have concentrated our efforts on streamlining our production and operations by developing standardized production processes, improving cost controls with greater precision and efficiencies. With the expected improvement of our supply chain management, we anticipate that our recycling operation will be the largest drive of revenues for the foreseeable future. We intend to devote a significant amount of our resources towards the improvement of our operations and if appropriate, its expansion. At the same time, we will continue to pursue our strategy to create a local network of raw material suppliers for our Facility and expand our oversea supply channels.
While we believe our business is well positioned to grow in the coming years, we will need to continue our efforts to provide capital liquidity to support that growth, although we can offer no assurances that we can acquire such capital on terms acceptable to us.
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RESULTS OF OPERATIONS
The table below summarizes the consolidated operating results for the three months ended March 31, 2012 and 2011. The percentages represent each line item as an approximate percentage of net revenues unless otherwise noted.
For the Three Months Ended March 31, | ||||||||||||||||||||||||
2012 | 2011 | $ Change | % Change | |||||||||||||||||||||
Net revenues | $ | 49,284,191 | 100.0 | % | $ | 49,684,652 | 100.0 | % | $ | (400,461) | -0.8 | % | ||||||||||||
Cost of goods sold | 47,824,094 | 97.0 | % | 46,515,883 | 93.6 | % | 1,308,211 | 2.8 | % | |||||||||||||||
Gross profit | 1,460,097 | 3.0 | % | 3,168,769 | 6.4 | % | (1,708,672) | -53.9 | % | |||||||||||||||
Total operating expenses | 1,687,925 | 3.4 | % | 1,766,448 | 3.6 | % | (78,523) | -4.4 | % | |||||||||||||||
Operating income (loss) | (227,828) | -0.5 | % | 1,402,321 | 2.8 | % | (1,529,151) | -109.0 | % |
Net Revenues
Net revenues of $49.3 million in the first quarter of 2012 slightly decreased $0.4 million compared to the same period in 2011, primarily due to a decrease of $11 million in the sales of pellets, partially offset by an increase of $5.5 million in the sales of iron ore, an increase of $3.0 million in sales of chrome ore, and an increase of $1.7 million in the sales of scrap metals.
Cost of Goods Sold
Cost of goods sold includes the cost of the products we purchase from our vendors and shipping and handling costs on shipments from such vendors. Cost of goods sold in the first quarter of 2012 was $47.8 million, representing a gross profit margin of 3%, compared to a gross profit margin of 6% in the same period in 2011. The gross profit margin of 3% in the first quarter of 2012 represents a compound margin for our trading and recycling businesses, which generated gross profit margins of 3% and 2% for the period, respectively. Our trading business and recycling business each generated a gross profit margin of 6% for the same period of 2011.
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Total Operating Expenses
Operating expenses of $1.69 million in the first quarter of 2012 decreased by $78,000, or 4% compared to the same period in 2011, resulted from a decrease of $141,000 in selling expenses and a decrease of $111,000 in professional fees. Such decrease was partially offset by an increase of $148,000 in general and administrative expenses and an increase of $26,000 in operating cost of idle manufacturing facility.
General and administrative expenses include salaries and office expenses. Our general and administrative costs increased by $148,000, or 17%, in the first quarter of 2012 as compared to the same period in 2011 primarily due to an increase of $73,000 in stock based compensation to our Chairman and CEO as well as other employees and Written off uncollectible prepayments of $72,000 .
Professional fees include legal, accounting, SEC filing consultant, investor relation and public relation consultant fees. Our professional fees decreased by $111,000, or 87% in the first quarter compared to same period of 2011as we used less expensive but cost-effective services and also took some outsourced job in-house to save cost.
Operating costs of idle facility remained approximately $0.5 million of costs that were mainly depreciation expenses of idle manufacturing facilities due to under utilization of the production facility in the first quarter of 2012 compared to same period of 2011..
Selling expenses include commissions, salaries, and travel for our sales agents. Selling expenses as a percentage of net revenues were 0.26% in the first quarter of 2012 as compared to 1% in the first quarter of 2011. Selling expenses decreased by $141,000 mainly due to decreases in port charges and lower warehousing expenses as a result of faster sales of inventory in the first quarter of 2012 as compared to the same period of 2011.
Total Other (Income) Expense
Total other expense of $1.3 million in the first quarter of 2012 increased $0.7 million from the comparable period in 2011, during which we had total other expense of $0.7million. The increase in total other expense was primarily due to an increase of $386,000 in impairment other than temporary-marketable securities from our investment in Apollo minerals, an increase of $232,000 in interest expense, an increase of $ 219,000 in foreign currency transaction (gain) loss – marketable securities , and an increase of $52,000 in change in fair value of derivative liability. These increases were partially offset by a decrease of $137,000 in other expense and a decrease of $73,000 in loan guarantee expense. Interest expense increased $232,000 as a result of increased short term borrowings of $29 million incurred inour business operation.
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Income Tax Expense
Income tax expense of $87,000 in the first quarter of 2012 were decreased by $88,000, compared to the same period in 2011, primarily due to a decrease in net income tax accrual for income taxes on the operations of our Hong Kong subsidiary during 2012 (using an effective tax rate of 16.5%).
Net Income (Loss)
Net income (loss) of ($1.66 million) in the first quarter of 2012 decreased $2.2 million compared to the same period in 2011, primarily due to a significantly decreased gross margin (reflecting a decrease of $1.7 million in gross profit) and the increase of $0.7million in total other expense.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is the ability of a company to generate adequate amounts of cash to meet its cash needs.
At March 31, 2012 and December 31, 2011, we had cash and cash equivalents of approximately $ 1 million. At March 31, 2012, our working capital was ($1million) as compared to $1.6 million at December 31, 2011.
As of March 31, 2012, we had invested a total of approximately $50.2 million for the acquisition of land use rights, construction and equipment purchases for the facilities we operate. We expect to expand the production capacity at the facilities in the future and to build or acquire additional facilities in the future, depending on market conditions. We have not set a timeframe for this expansion.
Moreover, we have not yet determined how we plan to finance this future expansion if we determine to proceed with it. Unless we can obtain additional financing on terms we deem favorable to us, we will be unable to complete any such expansion or construct additional facilities in the future, and there can be no assurance that we will be successful in obtaining any such additional financing, or that such financing would be on terms deemed to be desirable or favorable to our management. Furthermore, in the event we do obtain such financing, there can be no assurance that such investment will result in enhanced operating performance or produce significant revenues and related profits in the future.
In addition, we will continue to need to fund future capital expenditures for our existing operations, to service our debt and to purchase the raw materials required in our recycling operations. We have historically financed our cash needs primarily through the sales of our common stock and warrants, internally generated funds and debt financing. We collect cash from our customers based on our sales to them and their respective payment terms.
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We believe we can get sufficient working capital for our operations for at least the next 12 months. We have bank facilities which provide for cash borrowings or the issuance of commercial letters of credit that we require in our metal ore trading business in the aggregate amount of $102 million. Approximately $58 million was available under these facilities at March 31, 2012.
Substantially all of our cash reserves are held in the form of RMB in bank accounts at financial institutions located in the PRC. Cash held in banks in the PRC is not insured. As described above under "Risk Factors," the Chinese regulatory authorities impose a number of restrictions regarding RMB conversions and restrictions on foreign investments. Accordingly, our cash on deposit in banks in the PRC is not readily deployable by us for purposes outside of China.
On December 20, 2011, 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. At March 31, 2012, the balance outstanding under this facility was $1,501,800.
On July 29, 2011, Armco HK obtained a $30,000,000 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. At March 31, 2012, the balance outstanding under this facility was $33 million.
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On September 30, 2011, Armco HK, entered into Amendment No. 2 to the March 25, 2009 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. At March 31, 2012, no balance was outstanding under this facility.
On June 18, 2011, Henan Armco obtained a RMB 70,000,000 (approximately $11 million) line of credit from Guangdong Development Bank Zhengzhou Branch for issuance of letters of credit to finance the purchase of metal ore. The term of this facility is one year. 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 credit facility is secured by the guarantee provided by Mr. Kexuan Yao and Renewable Metals jointly and the pledge of moveable assets provided by the borrower. Amounts advanced under this line of credit are repaid from the proceeds of the sale of metal ore. At March 31, 2012, the balance outstanding under this facility was $1,728,000.
On November 26, 2011, Henan Armco obtained a RMB 20,000,000 (approximately U.S. $3.2 million) 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 year from the date of issuance. The facility is guaranteed by Renewable Metals and Mr. Kexuan Yao, the Company’s Chairman and Chief Executive Officer. At March 31, 2012, the outstanding under this facility was $1,294,141.
On January 30, 2012, Renewable Metals entered into a line of credit facility in the amount of RMB75, 000,000 (approximately $11.8 million) from Bank of China, Lianyungang Branch for the purchase of raw materials. The term of the facility is 12 months with interest at 120% of the applicable base rate for lending published by the People’s Bank of China (“PBOC”) at the time the loan is drawn down per annum. The facility is secured by the guarantees provided by Mr. Kexuan Yao, Mr. Yi Chu, Henan Armco and Henan Chaoyang, respectively. At March 31, 2012, the balance outstanding under this facility was $3,165,308.
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On July 1, 2011, Renewable Metals obtained a RMB 72,000,000 (approximately $11.4 million) line of credit from Bank of Communications, Lianyungang Branch expiring two (2) 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 Renewable Metals 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 Renewable Metals inventories and the guarantee provided by Mr. Kexuan Yao, the Company’s Chairman and Chief Executive Officer. At March 31, 2012, $6,488,882 was outstanding under this facility.
Our current assets at March 31, 2012 were $59.4 million, an increase of 18% from December 31, 2011. This overall increase reflects increases primarily in accounts receivable of $27.4 million, advance on purchases of $3.2 million, and pledged deposits of $1.2 million. These increases were partially offset by decreases of $22 million in inventories.
Pledged deposits at March 31, 2012 of $9.5 million represent deposits with financial institutions as collateral to letters of credit and bank acceptable notes payable we provide to suppliers for the purchase of inventories. The amounts will be released to pay vendors upon acceptance of goods.
Marketable securities at March 31, 2012 of $1.2 million represent the estimated value of our investment in Appollo Mineral calculated based on most recent private placement price of AUD0.04 per common share whereby Apollo Minerals sold 89,550,000 for AUD3,600,000 on May 8, 2012.
Our accounts receivable increased $27.5 million at March 31, 2012 from December 31, 2011 mainly due to the timing difference between the sales and collections of sales for a $230,000 MT iron ore transaction that generated an account receivable of $26.5 million. We expect to collect full payment of this account receivable within second quarter of 2012.
Inventories decreased $22 million at March 31, 2012 from December 31, 2011, primarily due to our completion of sales of iron ores of approximately 300,000 MT during the first quarter 2012, some of which were inventories at year end 2011.
Advances on purchases increased $3.2 million at March 31, 2012 from December 31, 2011, and consisted of prepayments to vendors for merchandise and deposits on pending purchases. These advances on purchases are customary in our business and help us secure inventory below prevailing market prices, thereby providing us with a better opportunity to increase our gross profit margins.
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Our prepayments and other current assets decreased $0.35 million at March 31, 2012 compared to December 31, 2011, primarily due to the decreases in prepayments and deposits for our metal ore trading business and deposits related to our scrap metal recycling operations.
Our current liabilities increased $11.7 million at March 31, 2012 from December 31, 2011, which is mainly attributable to an increase in loans payable of $27.1 million, an increase in banker's acceptance notes payable of $2.0 million and accrued expenses and other current liabilities of $0.8 million. These increases were partially offset by decreases in accounts payable of $15.2 million and customer deposits of $3.3 million.
Loans payable increased $27 million at March 31, 2012, compared to December 31, 2011, primarily due to a short-term borrowing under our letter of credit facilities in the first quarter of 2012 used to finance the payment of iron ore purchases. The short-term borrowing will be paid when we collected the payment from our customer within the second quarter of 2012. We used collections of accounts receivable to repay these short-term borrowings.
Accounts payable decreased $15.2 million at March 31, 2012 compared to December 31, 2011 mainly due to our repayment paid in the first quarter of 2012 to accounts payable for iron ore purchases made in 2011.
Banker's acceptance notes payable increased $1.9 million at March 31, 2012 compared to December 31, 2011 primarily due to short-term borrowings used to purchase of scrap metals raw materials for our recycling production in the first quarter, and reflects the increase in our inventory in the current quarter.
At March 31, 2012, we owed our Chairman and CEO, Mr. Kexuan Yao, $0.62 million for funds he advanced to us for working capital purposes, a net increase of $20,000 from December 31, 2011.
Customer deposits decreased $3.3 million at March 31, 2012, compared to December 31, 2011. This decrease is due to timing of customer orders and amounts that we require for deposits and the orders we delivered against the customer deposits. We recognize customer deposits as revenue when the goods have been delivered and the risk of loss has transferred to the customer either at the port of origin or port of destination based on the shipping terms we agree to with our customer.
Accrued expenses and other current liabilities increased $0. 8 million at March 31, 2012 from December 31, 2011. Accrued expenses consist of accrued expenses and other payables related to shipping fees. These expenses are due to timing differences of shipments and payments of our payables as compared to 2011.
We do not have any commitments for capital expenditures at March 31, 2012.
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Statements of Cash Flows
Our cash decreased $61,000 during the first quarter of 2012 as compared to an increase of $2.6 million during the comparable period in 2011. During the current quarter we were provided $28.4 million of cash from financing activities, and we used cash of $26.1 million in operating activities and $2.4 million of cash in investing activities. In comparable period in 2011 we were provided $9.4 million of cash from financing activities and $2.4 million of cash in investing activities, and we used cash of $9.2 million in operating activities.
Net Cash Provided by (Used in) Operating Activities
In the first quarter of 2012, net cash used in operating activities of $26 million was mainly comprised outflows related to an increase in accounts receivable of $27.5 million, a decrease in accounts payable of $15.2 million and a decreases in customer deposits of $3.3 million. These outflows were partially offset by cash provided by a decrease in inventory of $22.2 million, an increase in advance on purchases of $3.1 million and an increase in accrued expenses and other current liabilities of $0.8 million.
In the comparable quarter of 2011, net cash used in operating activities of $9.2 million was mainly comprised outflows related to an increase in accounts receivable of $11.3 million, an increase in inventory of $8.5 million, an increase in advance of purchases of $0.75 million and increases in prepayments and other current assets of $0.53 million. These outflows were partially offset by cash provided by an increase in accounts payable of $9.5 million and an increase in customer deposits of $2.0 million.
Cash Used in Investing Activities
In the first quarter of 2012 cash used in investing activities of $2.4 million was due to payment made towards pledged deposits of $9.5 million and purchase of property and equipment of $1.3 million, offset by proceeds from release of pledged deposits of $8.4 million.
In the first quarter of 2011 cash provided by investing activities of $2.4 million was due to proceeds from release of pledged deposits of $15.3 million, offset by proceeds made towards pledged deposits of $12.5 million and purchase of property and equipment of $0.37 million associated with the Facility.
Cash Provided by Financing Activities
In the first quarter of 2012 cash provided by financing activities of $28.4 million consisted of proceeds from loans payable of $43.4 million and Banker's acceptance notes payable of $1.9 million, which was partially offset by repayment of loans payable of $16.4 million and repayment of capital lease obligation of $0.53 million.
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In the first quarter of 2011 cash provided by financing activities of $9.4 million consisted of proceeds [from loans payable of $26.9 million and Banker's acceptance notes payable of $6.1 million, which was partially offset by repayment of loans payable of $23.4 million, repayment of mortgage payable of $0.22 million and repayment of $20,000 to Mr. Kexuam Yao of a loan he previously made to us.
Off Balance Sheet Arrangements
Under SEC regulations, we are required to disclose our off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, such as changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. An off-balance sheet arrangement means a transaction, agreement or contractual arrangement to which any entity that is not consolidated with us is a party, under which we have:
● | Any obligation under certain guarantee contracts; | |
● | Any retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets; | |
● | Any obligation under a contract that would be accounted for as a derivative instrument, except that it is both indexed to our stock and classified in stockholder’s equity in our statement of financial position; and | |
● | Any obligation arising out of a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to us, or engages in leasing, hedging or research and development services with us. |
We do not have any off-balance sheet arrangements that we are required to disclose pursuant to these regulations. In the ordinary course of business, we enter into operating lease commitments, purchase commitments and other contractual obligations. These transactions are recognized in our financial statements in accordance with generally accepted accounting principles in the United States.
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Contractual Obligations and Commitments.
At March 31, 2012, our long-term debt and financial obligations and commitments by due dates were as follows:
Payments due by period | ||||||||||||||||||||
Contractual obligations | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||||||
Banker's acceptance notes payable and letters of credit (1) | 10,128,986 | 10,128,986 | ||||||||||||||||||
Current portion of Long-Term Debt Obligations(2) | 3,956,635 | 3,956,635 | - | |||||||||||||||||
Short-Term Loans Payable (3) | 33,779,054 | 33,779,054 | ||||||||||||||||||
Capital Lease Obligations (4) | 5,833,640 | 2,272,864 | 3,560,776 | - | - | |||||||||||||||
Operating Lease Obligations (5) | 282,838 | 77,734 | 205,104 | - | - | |||||||||||||||
Purchase Obligations | - | |||||||||||||||||||
Other Long-Term Liabilities Reflected on the Registrant's Balance Sheet under GAAP | - | - | - | - | - | |||||||||||||||
Total | 53,981,153 | 50,215,273 | 3,765,880 | - |
(1) | See Note 10 – Banker's acceptance notes payable and letters of credit in our audited consolidated financial statements included in this Report. | |
(2) | See Note 13 – Long-Term Debt in our audited consolidated financial statements included in this report. | |
(3) | See Note 9 – Loans Payable in our audited consolidated financial statements included in this Report. | |
(4) | See Note 12 – Capital lease obligation in our audited consolidated financial statements included in this Report. | |
(5) | See Note 15 – Operating lease in our audited consolidated financial statements included in this Report. |
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below.
Use of Estimates and Assumptions
Our Company’s significant estimates and assumptions include the fair value of financial instruments; allowance for doubtful accounts; normal production capacity, inventory valuation and obsolescence; the carrying value, recoverability and impairment, if any, of long-lived assets, including the values assigned to and the estimated useful lives of property, plant and equipment, and land use rights; interest rate; revenue recognized or recognizable, sales returns and allowances; valued added tax rate; expected term of share options and similar instruments, expected volatility of the entity’s shares and the method used to estimate it, expected annual rate of quarterly dividends, and risk free rate(s); income tax rate and related income tax provision; reporting currency, functional currency of the PRC subsidiaries and foreign currency exchange rate. 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.
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We bases our estimates on historical experience and on various assumptions that are believed to be reasonable in relation to the financial statements taken as a whole 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.
Our management team regularly evaluates the key factors and assumptions used to develop the estimates utilizing currently available information, changes in facts and circumstances, historical experience and reasonable assumptions. After such evaluations, if deemed appropriate, those estimates are adjusted accordingly. Actual results could differ from those estimates.
Fair Value of Financial Instruments
We follow applicable accounting guidance for disclosures about fair value of its financial instruments. The U.S.GAAP establishes a framework for measuring fair value, and requires disclosures about fair value measurements. To provide consistency and comparability in fair value measurements and related disclosures, U.S. GAAP establishes a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. 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. The three levels of fair value hierarchy are described below:
Level 1 | Quoted market prices available in active markets for identical assets or liabilities as of the reporting date. | |
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. | |
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.
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 our 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.
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Our 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 our company for similar financial arrangements at March 31, 2012 and 2011.
Our company’s 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. We 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.
Marketable Debt and Equity Securities, Available for Sale
We account for marketable debt and equity 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 815-25-35-4.
We follow Paragraphs 320-10-35-17 through 34E 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 320-10-35-34, if it is determined that the impairment is other than temporary, then an impairment loss shall be recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made. The measurement of the impairment shall not include partial recoveries after the balance sheet date. The fair value of the investment would then become the new basis of the investment and shall not be adjusted for subsequent recoveries in fair value. For presentation purpose, 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 320-10-45-8A; and 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 pursuant to Paragraph 320-10-45-9A. Pursuant to Paragraphs 320-10-35-36 and 37 the entire change in the fair value of foreign-currency-denominated available-for-sale debt securities shall be reported in other comprehensive income and An entity holding a foreign-currency-denominated available-for-sale debt security is required to consider, among other things, changes in market interest rates and foreign exchange rates since acquisition in determining whether an other-than-temporary impairment has occurred.
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Revenue Recognition
We apply paragraph 605-10-S99-1 of the FASB Accounting Standards Codification for revenue recognition. We recognize revenue when it is realized or realizable and earned. We consider 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.
We derive our revenues from sales contracts with customers with revenues being generated upon the shipment of merchandise. 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 we recognize 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.
Stock-Based Compensation for Obtaining Employee Services
We account for our stock based compensation in which we obtain employee services in share-based payment transactions according to the fair value method. 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 third-party performance is complete or the date on which it is probable that performance will occur.
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The fair value of share options and similar instruments is estimated on the date of grant using a Black-Scholes option-pricing valuation model. The ranges of assumptions for inputs are as follows:
● | Expected term of share options and similar instruments: The expected life of options and similar instruments represents the period of time the option and/or warrant are expected to be outstanding. |
● | Expected volatility of the entity’s shares and the method used to estimate it. Pursuant to ASC Paragraph 718-10-50-2(f)(2)(ii) a thinly-traded or nonpublic entity that uses the calculated value method shall disclose the reasons why it is not practicable for the Company to estimate the expected volatility of its share price, the appropriate industry sector index that it has selected, the reasons for selecting that particular index, and how it has calculated historical volatility using that index. We use the average historical volatility of the comparable companies over the expected contractual life of the share options or similar instruments as our expected volatility. |
● | Expected annual rate of quarterly dividends. We have not declared any dividends since inception. |
● | Risk-free rate(s). 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 expected term of the share options and similar instruments. |
Our 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
We account for equity instruments issued to parties other than employees for acquiring goods or services under applicable accounting guidance. 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 option or warrant award is estimated on the date of grant using a Black-Scholes option-pricing valuation model.
We may grant fully vested, non-forfeitable equity instruments that are exercisable by the grantee only after a specified period of time if the terms of the agreement provide for earlier exercisability if the grantee achieves specified performance conditions. Any measured cost of the transaction is recognized in the same period(s) and in the same manner as if the entity had paid cash for the goods or services or used cash rebates as a sales discount instead of paying with, or using, the equity instruments. A recognized asset, expense, or sales discount is not to be reversed if a stock option that the counterparty has the right to exercise expires unexercised.
If we 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, in such cases, there is no recognition at the measurement date and no entry is to be recorded
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
As a smaller reporting company, we are not required to provide the information required by this item.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed by us in reports that we file under the Exchange Act is recorded, processed, summarized and reported as specified in the SEC’s rules and forms and that such information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer, or CEO, and our Chief Financial Officer, or CFO, to allow timely decisions regarding required disclosure. Management, with the participation of our CEO and CFO, performed an evaluation of the effectiveness of our disclosure controls and procedures as of March 31, 2012. Based on that evaluation, we have identified material weaknesses in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f)). These weaknesses include a lack of sufficiently qualified accounting and other finance personnel with appropriate U.S. GAAP knowledge and experience. Solely as a result of these material weaknesses, our management, including our CEO and CFO, concluded that our disclosure controls and procedures were not effective as of March 31, 2012. The general experience of our accounting and finance personnel and the qualifications of our audit committee financial expert are described in more detail below.
General Experience of Company Accounting and Finance Personnel
The people who are primarily responsible for preparing and supervising the preparation of the Company’s financial statements and evaluating the effectiveness of internal controls, all of whom are our employees, have responsibilities and qualifications as set forth below:
● | The CFO, who has served in this role since 2008, and is responsible for overseeing all of our accounting, financial reporting and internal control functions. From 2005 through 2008, he served as the accounting manager of Armco & Metawise and Henan & Armco. From 1996 to 2005, our CFO worked in the accounting department of Zhengzhou Forging Co., Ltd. Our CFO obtained a bachelors degree in accounting from Zhengzhou University in 1996. |
● | The Chief Accountant, who has served in this role since 2009, and obtained a bachelors degree in accounting from Henan Institute of Finance in 2005. The Chief Accountant supervises the accounting, financial reporting and internal control functions. Prior to joining our Company, the Chief Accountant spent eleven years as the financial manager of another PRC industrial company. |
● | The Henan Armco Finance Manager is responsible for the accounting and internal control functions for Henan Armco. This individual served as an accountant for Henan Armco from 2003 to 2010 prior to being named the Finance Manager, and studied accounting at Henan Taxation Advanced Vocational College from 1999 to 2001. Prior to joining our Company, this individual was responsible for financial accounting and reporting at another Chinese industrial company from 2001 to 2003. |
● | The Armet Finance Manager has been responsible for the accounting and internal control functions for our Armet subsidiary since 2007, and obtained an associates degree in accounting from Suzhou University in 1996. |
The above-mentioned individuals supervise an additional seven accounting staff members who are responsible for recording our business and financial transactions in our accounting records and ensure that all disbursements are properly authorized, as well as performing other tasks normally associated with accounting and financial controls.
Experience of Audit Committee Financial Expert
As previously disclosed, William Thomson serves as our audit committee financial expert. Through Mr. Thomson’s experience as a chief financial officer, audit committee member in a number of public companies, auditor for Peat Marwick Mitchell & Co. and educational background, he has acquired an understanding of U.S. GAAP and internal control over financial reporting that we believe meets the standards of an “audit committee financial expert.”
Mr. Thomson received his Bachelor of Commerce from Dalhousie University in 1961 and received his Chartered Accountant designation from the Institute of Chartered Accountants of Nova Scotia in 1963. He was a supervising auditor at Peat Marwick Mitchell & Co. from 1961 to 1966. Mr. Thomson served as vice president of finance for Clairtone Sound Corp. Ltd. from 1968 to 1970. He served as chief financial officer of Gage Educational Publishing Ltd. from 1971 to 1973, of Upper Lakes Shipping Ltd. from 1973 to 1981, and of Bendinat Inc. (Spain) from 1985 to 1988.
Mr. Thomson currently serves on the boards of directors of Score Media, Inc., Asia Bio-Chem Group Co. and Chile mining Technologies, Inc., in addition to our company. He has served on a total of 13 boards of public companies, beginning in 1983. Of these 13 companies, Mr. Thomson has served on the audit committee for six and was the audit committee chair of each of these six companies. He is currently the audit committee chair of each of the four boards on which he serves.
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Remediation Plan
As a result of management’s evaluation of our internal controls, we are considering the costs and benefits associated with remediating our control deficiencies. We are devoting significant resources to remediate, improve and document our disclosure controls and procedures, including our recent engagement of a CPA consultant who has U.S. GAAP knowledge to assist in the preparation of our financial statements. We continue to consider the following remediation options, or some combination thereof: (i) hiring additional personnel with sufficient U.S. GAAP experience and (ii) implementing ongoing training in U.S. GAAP requirements for our CFO and accounting and other finance personnel. Our Audit Committee and Board of Directors recently approved the hiring of a professional services firm that has expertise in accounting and U.S. GAAP matters with publicly-traded companies. No such firm has been engaged at this time, but we have identified several potential candidates and are in the process of interviewing them.
Changes in Internal Control
There were no changes in our internal control over financial reporting identified in connection with the evaluation of our controls performed during the quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 1A. Risk Factors
AS A COMPANY ACTIVE IN THE U.S. SECURITIES MARKET AND WITH OPERATIONS BASED IN CHINA, WE MAY BE SUBJECT TO HEIGHTENED SCRUITINY BY THE U.S. SECURITIES AND EXCHANGE COMMISSION RELATING TO OUR SECURITIES LAW COMPLIANCE, OUR FINANCIAL REPORTING AND/OR OUR COMPLIANCE WITH THE FCPA.
In the past year, the Securities and Exchange Commission has investigated several Chinese companies that have entered the U.S. securities market through reverse mergers into publicly traded U.S. companies for, among other things, accounting irregularities in financial reporting and compliance with the FCPA. Given this heightened scrutiny of Chinese companies with a presence in the U.S. securities market that the Securities and Exchange Commission appears to have implemented, we may also be subject to such heightened scrutiny, including formal investigation by the U.S. Securities and Exchange Commission or other regulatory authority. While we have not received any notice that we are under investigation for our U.S. securities law compliance, financial reporting or FCPA compliance, there can be no assurance that we will not be under such investigation in the future. Any such investigation could divert substantial time and focus of our management team from operating our business, which could materially adversely affect our business, financial condition and results of operations. If any investigation results were to result in a finding that we are not in compliance with the U.S. securities laws or the FCPA, or that our financial reporting lacks sufficient internal controls, our business, financial condition and results of operations would likely be materially adversely affected, and we may also be subject to significant penalties, which could include the delisting of our common stock from the NYSE Amex Stock Exchange.
Additional risk factors describing the major risks to our business can be found under Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011. Other than the risk factor included above, there has been no material change in our risk factors from those previously discussed in the Annual Report on Form 10-K.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
The Company is not required to provide disclosures required by this Item.
Item 5. Other Information.
None.
Item 6. Exhibits
No. Description
31.1* | Rule 13a-14(a)/ 15d-14(a) Certification of Chief Executive Officer |
31.2* | Rule 13a-14(a)/ 15d-14(a) Certification of Chief Financial Officer |
32.1+ | Section 1350 Certification of Chief Executive Officer and Chief Financial Officer |
101** | Financial statements from the quarterly report on Form 10-Q of China Armco, Inc. for the quarter ended March 31, 2012, formatted in XBRL: (i) the Unaudited Condensed Consolidated Balance Sheets, (ii) the Unaudited Condensed Consolidated Statements of Income, (iii) the Unaudited Condensed Consolidated Statements of Cash Flows and (iv) the Notes to Unaudited Condensed Consolidated Financial Statements tagged as blocks of text. |
* Filed herewith
+In accordance with the SEC Release 33-8238, deemed being furnished and not filed.
**Furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise not subject to liability under these sections.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
China Armco Metals, Inc. | |||
Date: May 15, 2012 | By: | /s/ Kexuan Yao | |
Kexuan Yao | |||
Chief Executive Officer | |||
(Duly authorized officer and principal executive officer) |
Date: May 15, 2012 | By: | /s/ Fengtao Wen | |
Fengtao Wen | |||
Chief Financial Officer | |||
(Duly authorized officer and principal financial and accounting officer) |
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