UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10−Q/A
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: June 30, 2010
¨ | 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: 000-53010
CHINA SLP FILTRATION TECHNOLOGY, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 90-0475058 | |
(State or other jurisdiction of | (I.R.S. Employer Identification No.) | |
incorporation or organization) |
Shishan Industrial Park
Nanhai District, Foshan City, Guangdong Province, PRC
(Address of principal executive offices, Zip Code)
(86 22) 757-86683197
(Registrant’s telephone number, including area code)
(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 Exchange Act during the past 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 ¨ 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
The number of shares outstanding of each of the issuer’s classes of common equity, as of November17, 2010 is as follows:
Class of Securities | Shares Outstanding | |
Common Stock, $0.001 par value | 15,265,714 |
Quarterly Report on FORM 10-Q/A
Three Months and Nine Months Ended June 30, 2010
Table of Contents
PART I FINANCIAL INFORMATION | ||
ITEM 1. | FINANCIAL STATEMENTS. | 4 |
ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. | 20 |
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. | |
ITEM 4. | CONTROLS AND PROCEDURES. | 29 |
PART II OTHER INFORMATION | ||
ITEM 1. | LEGAL PROCEEDINGS. | |
ITEM 6. | EXHIBITS. | 30 |
2
EXPLANATORY NOTE
China SLP Filtration Technology, Inc. (the “Company”) is filing this Amendment No. 1 to its Quarterly Report on Form 10-Q (“Form 10-Q/A”) to restate its consolidated financial statements for the three and nine months ended June 30, 2010. Subsequent to the issuance of the Company’s consolidated unaudited interim financial statements for the three and nine months ended June 30, 2010, included in its Quarterly Report on Form 10-Q for the period ended June 30, 2010, filed with the United States Securities and Exchange Commission (the “SEC”) on August 16, 2010 (the “Original Form 10-Q”), and in connection with the SEC’s review of our registration statement on Form S-1 (File No. 333-168028), originally filed on July 8, 2010, as amended on September 7, 2010 and October 15, 2010, it was identified that (i) the Company failed to record a liability of $75,000 owed to each of United Best and Primary Capital (totaling $150,000) for advisory services rendered in connection with our private placement of convertible notes which closed on February 12, 2010, and (ii) the Company failed to record a grant of 30,000 shares of common stock in June 2010 to a director of the Company. Accordingly, the Company is restating its unaudited interim financial statements for the three and nine month periods ended June 30, 2010 and 2009, as set forth in the Original Form 10-Q.
See Item 1 of Part I, “Financial Statements — Note 20 — Restatements of Previously Issued Financial Statements” for a detailed discussion of the effects of the restatement of our interim financial statements for the three and nine months ended June 30, 2010.
For purposes of this Form 10-Q/A, and in accordance with Rule 12b-15 under the Securities Exchange Act of 1934, as amended, each item of the Original Form 10-Q that was affected by the restatement has been amended and restated in its entirety. No material changes have been made in this Form 10-Q/A to update other disclosures presented in the Original Form 10-Q, except as required to reflect the effects of the restatement. This Form 10-Q/A does not reflect events occurring after the filing of the Original Form 10-Q or modify or update those disclosures, including the exhibits to the Original Form 10-Q affected by subsequent events. The following sections of this Form 10-Q/A have been amended to reflect the restatement:
· | Part I—Item 1—Financial Statements (Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Cash Flows), |
· | Part I—Item 2—Management's Discussion and Analysis of Financial Condition and Results of Operations (Liquidity and Capital Resources), and |
· | Part I—Item 4—Controls and Procedures |
This Form 10-Q/A is dated as of a current date and includes as exhibits 31.1, 31.2 and 32 new certifications by the Company’s Chief Executive Officer and Chief Financial Officer as required by Rule 12b-15 promulgated under the Securities Exchange Act of 1934, as amended. Accordingly, this Form 10-Q/A should be read in conjunction with our filings made with the SEC subsequent to the filing of the Original Form 10-Q for the fiscal quarter ended June 30, 2010.
3
PART I
FINANCIAL INFORMATION
ITEM 1. | FINANCIAL STATEMENTS. |
China SLP Filtration Technology, Inc.
Condensed Consolidated Financial Statements
Three and Nine Months ended June 30, 2010 and 2009
Index to Condensed Consolidated Financial Statements
Page | |
Unaudited Condensed Consolidated Balance Sheets (Restated) | 4 |
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss (Restated) | 5 |
Unaudited Condensed Consolidated Statements of Cash Flows (Restated) | 6 |
Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity (Restated) | 7 |
Notes to Unaudited Consolidated Financial Statements (Restated) | 8 |
4
CHINA SLP FILTRATION TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
Restated | ||||||||
June 30, | September 30, | |||||||
2010 | 2009 | |||||||
(Unaudited) | ||||||||
Current Assets | ||||||||
Cash and cash equivalents | $ | 6,333,417 | $ | 3,297,648 | ||||
Accounts receivable - Net | 2,258,662 | 1,424,835 | ||||||
Advance to suppliers | 453,174 | 685,551 | ||||||
Inventory | 1,490,078 | 1,197,289 | ||||||
Prepaid expenses and other current assets | 279,595 | 45,656 | ||||||
Total Current Assets | 10,814,926 | 6,650,979 | ||||||
Deposits | 2,193,202 | 0 | ||||||
Property and equipment - Net | 11,032,609 | 10,711,865 | ||||||
Receivable from related party | 1,111 | 773,672 | ||||||
Land use rights - Net | 531,506 | 537,350 | ||||||
Total Assets | $ | 24,573,354 | $ | 18,673,866 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
Current Liabilities | ||||||||
Short term loan | $ | 3,833,994 | $ | 4,578,409 | ||||
Accounts payable and accrued liabilities | 846,703 | 410,114 | ||||||
Client's deposits | - | 75,176.00 | ||||||
Taxes payable | 9,378 | 726 | ||||||
Warrants liabilities | 690,000 | - | ||||||
Convertible notes payable $4,140,000, net of discount | 2,615,107 | - | ||||||
Total Current Liabilities | 7,995,182 | 5,064,425 | ||||||
Total Liabilities | 7,995,182 | 5,064,425 | ||||||
Stockholders' Equity | ||||||||
Preferred stock, $0.001 par value, 10,000,000 shares authorized, 0 shares issued and outstanding | - | - | ||||||
Common stock, $0.001 par value, 40,000,000 shares authorized, 15,265,714 and 14,510,204 shares issued and outstanding at June 30, 2010 and September 30, 2009 | 15,266 | 14,510 | ||||||
Additional paid-in capital | 8,210,552 | 7,548,752 | ||||||
Retained earnings | 6,669,980 | 4,500,532 | ||||||
Accumulated other comprehensive income | 1,682,374 | 1,545,647 | ||||||
Total Stockholders' Equity | 16,578,172 | 13,609,441 | ||||||
Total Liabilities and Stockholders' Equity | $ | 24,573,354 | $ | 18,673,866 |
See accompanying notes to financial statements
5
CHINA SLP FILTRATION TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
June 30 | June 30 | |||||||||||||||
Restated 2010 | 2009 | Restated 2010 | 2009 | |||||||||||||
Net Sales | $ | 5,072,791 | $ | 2,482,212 | $ | 14,919,816 | $ | 7,023,045 | ||||||||
Cost of Sales | 3,537,571 | 1,779,328 | 10,381,404 | 4,685,730 | ||||||||||||
Gross Profit | 1,535,220 | 702,884 | 4,538,412 | 2,337,315 | ||||||||||||
Selling, General and Administrative Expenses | 706,436 | 266,101 | 1,518,574 | 1,024,543 | ||||||||||||
Income from Operations | 828,784 | 436,783 | 3,019,838 | 1,312,772 | ||||||||||||
Other Income (expense) | ||||||||||||||||
Interest Income | 10,106 | 2,104 | 10,623 | 2,104 | ||||||||||||
Interest Expense | (764,794 | ) | (65,162 | ) | (1,216,685 | ) | (225,668 | ) | ||||||||
Loss on disposal of fixed assets | - | (16,263 | ) | - | - | |||||||||||
Changes in Fair Value of Warrants | 362,000 | - | 362,000 | - | ||||||||||||
Total Other Income (expenses) | (392,688 | ) | (79,321 | ) | (844,062 | ) | (223,564 | ) | ||||||||
Income before Income Taxes | 436,096 | 357,462 | 2,175,776 | 1,089,208 | ||||||||||||
Income Tax Provision | 6,328 | - | 6,328 | - | ||||||||||||
Net Income | $ | 429,768 | $ | 357,462 | $ | 2,169,448 | $ | 1,089,208 | ||||||||
Other Comprehensive Income | ||||||||||||||||
Foreign Currency Translation Adjustments | 161,972 | 24,560 | 136,727 | (66,276 | ) | |||||||||||
Total Comprehensive Income | $ | 591,740 | $ | 382,022 | $ | 2,306,175 | $ | 1,022,932 | ||||||||
Net Income Per Common Shares: | ||||||||||||||||
Basic and Diluted | $ | 0.03 | $ | 0.02 | $ | 0.15 | $ | 0.08 | ||||||||
Weighted-Average Common Shares Outstanding: | ||||||||||||||||
Basic | 15,245,604 | 14,510,204 | 14,879,603 | 14,510,204 | ||||||||||||
Diluted | 17,217,033 | 14,510,204 | 15,886,667 | 14,510,204 |
See accompanying notes to financial statements
6
CHINA SLP FILTRATION TECHNOLOGY, INC.
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended June 30 | ||||||||
Restated 2010 | 2009 | |||||||
Cash Flow from Operating Activities: | ||||||||
Net income | $ | 2,169,448 | $ | 1,089,208 | ||||
Adjustments to reconcile net income to net cash | ||||||||
flow provided by (used in) operating activities: | ||||||||
Stock compensation | $ | 5,000 | - | |||||
Depreciation | 864,016 | 632,799 | ||||||
Amortization | 9,339 | 9,342 | ||||||
Changes in fair value of warrants | (362,000 | ) | - | |||||
Non-cash interest charges | 914,850 | |||||||
Change in operating assets and liabilities: | ||||||||
Accounts receivable | (832,721 | ) | (561,041 | ) | ||||
Allowance for doubtful accounts | 13,743 | |||||||
Advance to suppliers | 235,358 | (34,311 | ) | |||||
Inventory | (282,992 | ) | (525,210 | ) | ||||
Prepaid expenses and other current assets | (232,102 | ) | (131,539 | ) | ||||
Accounts payable & accrued liabilities | 432,009 | (610,775 | ) | |||||
Clients' deposits | (75,176 | ) | (93,457 | ) | ||||
Taxes payable | 1,357 | (8,949 | ) | |||||
Net cash provided by (used in) operating activities | 2,860,129 | (233,933 | ) | |||||
Cash Flow from Investing Activities: | ||||||||
Addition-property, equipment, and land use rights | (1,105,084 | ) | (844,747 | ) | ||||
Deposits for purchase of equipment | (2,178,792 | ) | - | |||||
Proceeds from related party receivable | 772,573 | 735,878 | ||||||
Net cash (used in) provided by investing activities | (2,511,303 | ) | (108,869 | ) | ||||
Cash Flow from Financing Activities: | ||||||||
Repayment of loans | (769,631 | ) | (5,172,817 | ) | ||||
Proceeds from loans | - | 4,974,197 | ||||||
Proceeds from notes issued | 3,404,798 | - | ||||||
Net cash provided by (used) in financing activities | 2,635,167 | (198,620 | ) | |||||
Effects of Exchange Rates on Cash | 51,776 | (14,504 | ) | |||||
Net increase (decrease) in cash and cash equivalents | 3,035,769 | (555,926 | ) | |||||
Cash and cash equivalents, beginning of year | 3,297,648 | 2,367,570 | ||||||
Cash and cash equivalents, end of year | $ | 6,333,417 | $ | 1,811,644 | ||||
Supplemental information of cash flows | ||||||||
Cash paid for interest | $ | 298,270 | $ | 216,705 | ||||
Cash paid for income taxes | $ | - | $ | - |
See accompanying notes to financial statements
7
CHINA SLP FILTRATION TECHNOLOGY, INC.
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(Restated)
Accumulated | ||||||||||||||||||||||||
Additional | Other | Total | ||||||||||||||||||||||
Common Stock | Paid-in | Retained | Comprehensive | Stockholders' | ||||||||||||||||||||
Shares | Amount | Capital | Earnings (Deficit) | Income | Equity | |||||||||||||||||||
BALANCE, September 30, 2008 | 14,510,204 | $ | 14,510 | $ | 7,548,752 | $ | 2,054,880 | $ | 1,602,725 | $ | 11,220,867 | |||||||||||||
Net Income | - | - | - | 2,445,652 | - | 2,445,652 | ||||||||||||||||||
Currency translation adjustment | - | - | - | (57,078 | ) | (57,078 | ) | |||||||||||||||||
BALANCE, September 30, 2009 | 14,510,204 | $ | 14,510 | $ | 7,548,752 | $ | 4,500,532 | $ | 1,545,647 | $ | 13,609,441 | |||||||||||||
Shares effectively issued to former shareholders – 2/12/2010 | 2,600,000 | 2,600 | (2,600 | ) | - | |||||||||||||||||||
Cancellation of stock in recapitalization | (2,528,000 | ) | (2,528 | ) | 2,528 | - | ||||||||||||||||||
Shares issued to placement agents in conjunction with convertible note | 653,510 | 654 | 656,902 | - | 657,556 | |||||||||||||||||||
Restricted shares issued – Restated | 3,000 | 30 | 4,970 | 5,000 | ||||||||||||||||||||
Net Income – Restated | - | - | - | 2,169,448 | 2,169,448 | |||||||||||||||||||
Currency translation adjustment | - | - | - | - | 136,727 | 136,727 | ||||||||||||||||||
BALANCE, June 30, 2010 - UNAUDITED Restated | 15,265,714 | $ | 15,266 | $ | 8,210,552 | $ | 6,669,980 | $ | 1,682,374 | $ | 16,578,172 |
See accompanying notes to financial statements
8
China Filtration Technology, Inc.
Notes to Consolidated Financial Statements for the nine months ended June 30, 2010
(Unaudited - - Expressed in US dollars)
1. Nature of Business and Organization History:
China SLP Filtration Technology, Inc., formerly named Perpetual Technologies, Inc. (the “Company”, or “we”) was incorporated under the laws of the State of Delaware in March 2007. Prior to a reverse merger completed on February 12, 2010, we had no operations or substantial assets.
Hong Hui Holdings Limited (“Hong Hui”) was formed in January 2010 in the territory of the British Virgin Islands as a holding company by the shareholders of Technic International Inc. (“Technic”). Upon the formation, each shareholder transferred their ownership of Technic to Hong Hui. As a result of this transaction, Technic became a wholly-foreign owned enterprise under PRC law. This acquisition was accounted for as a transfer of entities under common control.
Technic International Ltd. (“Technic”) was incorporated in September 2005 under the laws of Hong Kong as a holding company that owns 100% equity interest of Nanhai Jinlong Nonwoven Co. Ltd. (“Jin Long”) located in Foshan City, Guangdong Province, the People’s Republic of China (“China”). Jin Long was established in the year 2000 under the laws of China. In September 2005, Jin Long became the wholly-owned foreign enterprise (“WOFE). In April 2009, Jin Long changed its name to Foshan S.L.P. Special Materials Co., Ltd. (“Foshan”).
On February 12, 2010, we entered into a share exchange agreement with the owners of all of the outstanding shares of Hong Hui. Under the terms of the share exchange agreement we issued and delivered to the Hong Hui stockholders a total of 14,510,204 (72,551,020 pre-split) shares of our common stock in exchange for all of the outstanding shares of Hong Hui. As a result of the share exchange or reverse merger, Hong Hui became our wholly-owned subsidiary. The transaction is accounted for as a reverse acquisition, except that no goodwill or other intangible should be recorded. The recapitalization is considered to be a capital transaction in substance, rather than a business combination.
On March 24, 2010 the Company effected a 1 for 5 reverse stock split of its outstanding common stock. The effect of the reverse split is retrospectively showed in all periods presented.
We engage in manufacturing, marketing and sale, research and development of polyester spun-bonded nonwoven fabrics, polyester needle-punch nonwovens, spun-laced nonwovens, polylactic acid nonwovens, and special functions nonwovens ( flame retardant, anti-static, oil & water repellent, etc).
2. Basis of Presentation and Principles of Consolidation:
The accompanying condensed consolidated balance sheet as of June 30, 2010, the condensed consolidated statements of operations for the nine months ended June 30, 2010 and 2009, and the condensed consolidated statements of cash flow for the nine months ended June 30, 2010 and 2009 are unaudited. These unaudited interim condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). They do not include all the disclosures as required for annual financial statements under generally accepted accounting principles. However, these interim consolidated financial statements follow the same accounting policies and methods of application as the Company’s most recent annual financial statements. These interim consolidated financial statements should be read in conjunction with the Company’s annual consolidated financial statements for the year ended September 30, 2009.
9
Operating results for the nine month period ended June 30, 2010 are not necessarily indicative of the results that may be expected for the full year ending September 30, 2010 or for any other period.
3. Summary of Significant Accounting Policies:
These interim consolidated financial statements follow the same accounting policies and methods of application as the Company's most recent annual financial statements.
4. Accounts Receivable:
The Company maintains allowance for potential credit losses on accounts receivable. Management periodically analyzes the composition of the accounts receivable, aging of the receivables and historical bad debt to evaluate the adequacy of the reserve for uncollectible accounts.
June 30, | September 30, | |||||||
2010 | 2009 | |||||||
Accounts receivable | $ | 2,309,626 | $ | 1,461,721 | ||||
Less: Allowance for doubtful accounts | (50,964 | ) | (36,886 | ) | ||||
Accounts receivable – Net | $ | 2,258,662 | $ | 1,424,835 |
As of June 30, 2010 and September 30, 2009, customer accounts receivable balances exceeding 10% of the gross accounts receivable balance are as follows:
June 30, | September 30, | |||||||
2010 | 2009 | |||||||
Customers: | Percentage | Percentage | ||||||
A | 23 | % | 30 | % | ||||
B | 13 | % | 13 | % | ||||
C | 10 | % | 13 | % | ||||
Total | 46 | % | 56 | % |
Three customers individually accounted for 10% or more of the total gross accounts receivable and together accounted for 46% and 56% of the total gross accounts receivable at June 30, 2010 and 2009.
5. Advances to Suppliers:
As of June 30, 2010 and September 30, 2009, advances to suppliers consisted of deposits on account with several key raw materials suppliers to secure preferential pricing of raw materials. The deposits also are used to ensure timely delivery of materials purchased.
6. Inventories:
Inventory consisted of the following:
June 30, | September 30, | |||||||
2010 | 2009 | |||||||
Raw materials | $ | 281,146 | $ | 40,126 | ||||
Work in progress | 63,226 | 50,443 | ||||||
Finished goods | 1,145,706 | 1,106,720 | ||||||
$ | 1,490,078 | $ | 1,197,289 |
10
7. Property, plant and equipment:
Property, plant and equipment is recorded at cost. Expenditures incurred for repairs and maintenance are charged to earnings. Betterment, additions and renewals to property, plant and equipment are capitalized. When property, plant and equipment are retired or disposed of, associated cost and accumulated depreciation are removed, and gain or loss, if any, incurred from disposal is included under other income or expense in the statement of operations.
Property, plant and equipment consist of the following:
June 30, | September 30, | |||||||
2010 | 2010 | |||||||
Building and plant | $ | 2,716,302 | $ | 2,958,978 | ||||
Machinery | 11,542,131 | 11,174,517 | ||||||
Office equipment and other equipment | 776,760 | 771,829 | ||||||
Vehicles | 140,678 | 139,753 | ||||||
Construction in progress | 1,087,395 | - | ||||||
16,263,266 | 15,045,077 | |||||||
Less: | ||||||||
Accumulated depreciation | (5,230,657 | ) | (4,333,212 | ) | ||||
$ | 11,032,609 | $ | 10,711,865 |
Depreciation expense is computed using straight-line method with estimated useful lives as follows:
Building and plant | 20 years |
Machinery | 10 years |
Office equipment and other equipment | 5 years |
Vehicles | 10 years |
For the three month period ended June 30, 2010, depreciation expense of $276,661 was included in cost of sales and $16,222 was included in selling, marketing, and administrative expenses, for a total of $292,883
For the three month period ended June 30, 2009, depreciation expense of $263,724 was included in cost of sales and $16,250 was included in selling, general and administrative expenses, for a total of $279,974
For the nine month period ended June 30, 2010, depreciation expense of $815,191 was included in cost of sales and $48,825 was included in selling general and administrative expenses, for a total of $864,016
For the nine month period ended June 30, 2009, depreciation expense of $581,505 was included in cost of sales and $51,294 was included in selling, general and administrative expenses, for a total of $632,799.
11
8. Deposits:
As of June 30, 2010, we have deposits of $2,193,202 with equipment providers to ensure timely fulfillment of our purchase contracts to build up new production facilities.
9. Land Use Rights:
Land use rights is amortized over a lease term of 50 years.
June 30, 2010 | September 30, 2009 | |||||||
Land use rights | $ | 626,699 | $ | 622,578 | ||||
Less: | ||||||||
Accumulated amortization | (95,193 | ) | (85,228 | ) | ||||
$ | 531,506 | $ | 537,350 |
For the three month periods ended June 30, 2010 and 2009, amortization expense was $3,132 and $3,139, respectively.
For the nine month periods ended June 30, 2010 and 2009, amortization expense was $9,339 and $9,342, respectively.
Change in cost of land use rights from September 30, 2009 to June 30, 2010 was caused by effect of changes in currency exchange rate.
10. Accounts Payable and Accrued liabilities:
The restated accounts payable and accrued liabilities include fees of $75,000 ($150,000 in total) incurred and payable to each of Primary Capital and Unites Best for their advisory service provided in connection with the convertible note financing which closed on February 12, 2010.
11. Short-term Loans:
The Company has several loans with Agricultural Bank of China, Foshan Branch and these loans are due in September 2010. The interest on the outstanding balance is payable every month at rates ranging from 5.93% to 7.75% per annum.
12. Convertible Note Payable:
On February 12, 2010, immediately following the closing of a share exchange agreement, the Company entered into a note purchase agreement with certain accredited investors for the sale of convertible notes in the aggregate principal amount of $4,140,000 and warrants. In addition to the finance cost of approximately $730,000 which is accounted for as debt discount, 653,510 common shares were issued to placement agents. The notes have the following material terms:
Maturity: The notes mature in one year. If principal is not paid on maturity then 150% of the principal amount shall be payable.
Interest: 10% per annum payable quarterly increasing to 15% if there is a default. At close of the transaction, $204,464, out of the closing proceeds, was held in an escrow account to cover the first six months interest and it was included as prepaid expense. As of June 30, 2010, prepaid interest expense was $68,609.
Conversion: In the event of the closing of any equity or series of related financings resulting in aggregate gross proceeds to the Company of at least $20,000,000 (or such lesser amount as shall be approved in writing by the holder(s) of notes evidencing at least 50% of the principal amount of the notes then outstanding), a “qualified financing,” prior to the maturity date of the notes, the principal amount of the notes converts automatically into the securities sold in such financing at a 65% discount to the offering price of such securities.
Besides the stated interest expense at 10% per annum, interest expenses are recorded to accrete the note to its balance of $4,140,000 due on February 12, 2011. Accretion on interest expenses amounted to $609,900 and $914,850 for the three months and nine months ended June 30, 2010.
12
Allocation of the proceeds:
After allocating $1,052,000 to the initial fair value of warrants derivative liabilities, and agent fee of $730,187, the remaining proceeds received from the convertible note of $3,409,813 were allocated to placement agent common stock and convertible note payable based on their relative fair value. This results in a debt discount of $2,439,743 from the face amount of the convertible note payable, accordingly, the discount is being amortized over the life of the note to accrete the note to its redemption value. The proceeds allocation is as follows:
February 12, 2010 convertible note finance | ||||
Gross proceeds | $ | 4,140,000 | ||
Less cash fee paid to placement agent | 730,187 | |||
Net proceeds | $ | 3,409,813 | ||
Record warrant as derivative liability | $ | 1,052,000 | ||
Allocated remaining proceeds to : | ||||
Common stock issued to placement agents | 657,556 | |||
Convertible Note | 1,700,257 | |||
$ | 3,409,813 |
13. Receivable from Related Party:
As of June 30, 2010, receivable from related party in the amount of $1,111 was an advance to shareholders for travel related expenses occurring in normal course of business.
14. Subsequent Events
.
On July 26, 2010, the Company repaid outstanding term loan in amount of $2,927,961 (20,000,000 in RMB) to Agricultural Bank of China, Foshan Branch. On July 27, 2010, the Company entered into an agreement with the same branch office to borrow $2,927,961 (20,000,000 in RMB) with a term of 5 months. Interest on the new loan is payable on monthly basis at rates ranging from 5.85% to 7.75% per annum.
On August 4, 2010, the Company appointed Eric Gan as Chief Financial Officer. The compensation package included an annual salary of $120,000 and grant of non-statutory stock options to acquire 400,000 shares of the Company’s common stock. The options vest over a period of three years.
15. Earnings per Share
Basic earnings per share is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding during the year. Diluted earnings per share is calculated by dividing net income attributable to common shareholders as adjusted for the effect of dilutive common equivalent shares, if any, by the weighted average number of common and dilutive common equivalent shares outstanding during the year. Common equivalent shares consist of the common shares issuable upon the conversion of the convertible note (using the if-converted method) and common shares issuable upon the exercise of outstanding warrants (using the treasury stock method). Diluted EPS excludes all dilutive potential shares if their effect is anti dilutive.
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For the three months ended | |||||||||
June 30, 2010 | June 30, 2009 | ||||||||
Net Income | |||||||||
(numerator for basic income per share) | $ | 429,768 | $ | 357,462 | |||||
Plus interest on convertible note | 697,811 | - | |||||||
Net Income - assumed conversions | |||||||||
(numerator for diluted income per share) | $ | 1,127,579 | $ | 357,462 | |||||
Weighted average common shares | |||||||||
(denominator for basic income per share) | 15,245,604 | 14,510,204 | |||||||
Effect of Dilutive Securities: | |||||||||
Warrants - treasury stock method | - | - | |||||||
Convertible note as if-converted method | 1,971,429 | - | |||||||
Weighted average common shares | |||||||||
(denominator for diluted income per share) | 17,217,033 | 14,510,204 | |||||||
Basic net income per share | $ | 0.03 | $ | 0.02 | |||||
Diluted net income per share | $ | 0.07 | Antidilutive | $ | 0.02 |
For the nine months ended | |||||||||
June 30, 2010 | June 30, 2009 | ||||||||
Net Income | |||||||||
(numerator for basic income per share) | $ | 2,169,448 | $ | 1,089,208 | |||||
Plus interest on convertible note | 1,114,535 | - | |||||||
Net Income - assumed conversions | |||||||||
(numerator for diluted income per share) | $ | 3,283,983 | $ | 1,089,208 | |||||
Weighted average common shares | |||||||||
(denominator for basic income per share) | 14,879,603 | 14,510,204 | |||||||
Effect of Dilutive Securities: | |||||||||
Warrants - treasury stock method | - | - | |||||||
Convertible note as if-converted method | 1,007,064 | - | |||||||
Weighted average common shares | |||||||||
(denominator for diluted income per share) | 15,886,667 | 14,510,204 | |||||||
Basic net income per share | $ | 0.15 | $ | 0.08 | |||||
Diluted net income per share | $ | 0.21 | Antidilutive | $ | 0.08 |
16. Accounting for Warrants
The warrants issued in conjunction with the convertible notes have the following material terms:
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The warrants are exercisable at any time during a five-year period commencing on the closing of a “financing,” which means the first sale (or series of related sales) by us of stock (or debt or equity securities convertible into stock), in a capital raising transaction, occurring after the maturity date (or the date the notes become due pursuant to a default, if earlier) with aggregate gross proceeds of at least $2,000,000. The warrants can not be exercised if no financing is consummated within five-year period after the issue date and become void if the notes automatically convert into common stock.
Number of Shares: The warrants represent the right to purchase 8% of the total shares of common stock outstanding (on a fully-diluted basis) immediately after the closing of the financing.
Exercise Price: The warrants are exercisable at the price for which the shares of common stock (or common stock equivalent if derivative securities are sold) are sold in the financing. If the financing includes more than one type of security, the exercise price shall equal the lowest price per share of common stock or common stock equivalent included in the financing.
The Company analyzed the warrants and the conversion features in the notes to assess whether they meet the definition of a derivative under the guidance set forth by ASC Topic 815 (SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”) and, thereof, the applicability of the accounting rules in accordance to ASC Topic 815 to treat the warrants as derivative liabilities. Management also evaluated whether the warrants meet the scope exception set forth by ASC Topic 815-40 (“Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”), which is that contracts issued or held by the reporting entity that are both (1) indexed to its own stock and (2) classified in stockholders’ equity shall not be considered to be derivative instruments for purposes of ASC Topic 815. The provisions in ASC Topic 815-40 apply to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by ASC Topic 815 and to any freestanding financial instruments that are potentially settled in an entity’s own common stock.
Management concluded that the warrants issued in conjunction with the private placement of convertible notes in February 2010 to certain accredited investors should be treated as a derivative liability. Derivative instruments are recorded at fair value and marked-to-market each period until they are exercised or expire, with any change in the fair value charged or credited to income each period.
As a result of adopting accounting treatment of ASC Topic 815-40, warrants are recorded as derivative liabilities and valued at $1,052,000 based on 1,218,857 shares using the Black-Scholes pricing model on the date of issuance and as of March 31, 2010. Because there was no trade market for the Company’s stock, management used substitute volatility in the initial and subsequent measuring of the fair market value of the warrants issued. Management re-measured the fair market value based on the adjusted volatility of publicly traded stock of a company with similar business and the remaining term of the warrants. As of June 30, 2010, these warrants were valued at$690,000. The valuation inputs are provided in the table as follows.
At date of issuance | As of | |||||||
Attribute | February 12, 2010 | June 30, 2010 | ||||||
Warrants outstanding | 1,218,857 | (*) | 1,218,857 | (*) | ||||
Exercise Price | $ | 2.45 | $ | 2.45 | ||||
Risk Free Interest Rate | 2.25 | % | 0.32 | % | ||||
Volatility | 90 | % | 70 | % | ||||
Dividend Yield | 0 | % | 0 | % | ||||
Contractual Life (years) | 1 | 0.7 |
(*) Warrants outstanding is based on 8% of the total outstanding common shares
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17. Income Taxes
USA
The Company and its subsidiary and branch divisions are subject to income taxes on an entity basis on income arising in, or derived, from the tax jurisdiction in which they operate. As the Company had no income generated in the United States, there was no tax expense or tax liability due to the Internal Revenue Service of the United States as of June 30, 2010 and September 30, 2009.
BVI
Hong Hui is incorporated under the International Business Companies Act of the British Virgin Islands and accordingly, is exempted from payment of British Virgin Island’s income taxes.
PRC
Pursuant to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for Foshan. For 2008 and 2009 Foshan enjoys tax free holiday for two years. From January 2010 onwards, Foshan is taxed at 25% of net income except for the 2010 and 2011years where there is 50% discount on income tax.
The current year tax provision was $6,328 and $6,328 for the three and nine months ended June 30, 2010, respectively. The Company has recorded zero deferred tax assets or liabilities as of June 30, 2010 and September 30, 2009 net of tax allowance because all other significant difference in tax basis and financial statement amounts are permanent differences.
For the three months ended | For the nine months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Income Tax Expense: | ||||||||||||||||
Current tax | $ | 6,328 | $ | 0 | $ | 6,328 | $ | 0 | ||||||||
Change in deferred tax assets – Net operating loss | 46,911 | 76,959 | 285,019 | 199,513 | ||||||||||||
Change in valuation allowance | (46,911 | ) | (76,959 | ) | (285,019 | ) | (199,513 | ) | ||||||||
Total | $ | 6,328 | $ | 0 | $ | 6,328 | $ | 0 |
We follow the guidance in FASB ASC 740 Accounting for Uncertainty in Income Taxes . We have not taken any uncertain tax positions on any of our open income tax returns filed through the period ended June 30, 2010. Our methods of accounting are based on established income tax principles and are properly calculated and reflected within our income tax returns. In addition, we have timely filed extension of income tax returns in all applicable jurisdictions in which we believe we are required to make an income tax return filing.
We re-assess the validity of our conclusions regarding uncertain tax positions on a quarterly basis to determine if facts or circumstances have arisen that might cause us to change our judgment regarding the likelihood of a tax position’s sustainability under audit. We have determined that there were no uncertain tax positions for the nine months ended June 30, 2010 and 2009.
All of the Company’s income before income taxes is from PRC sources. Actual income tax expense reported in the consolidated statements of operations and comprehensive income differ from the amounts computed by applying the PRC statutory income tax rate of 12.5% (50% discount of 25%) to income before income taxes for the three and nine months ended June 30, 2010 for the followings reasons:
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For the three months ended | For the nine months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Income before income taxes | $ | 436,096 | $ | 357,462 | $ | 2,175,776 | $ | 1,089,208 | ||||||||
Computed “expected” income tax expense at 12.5% and zero in 2010 and 2009 | $ | 142,363 | $ | - | $ | 411,914 | $ | - | ||||||||
Tax effect of net taxable permanent differences | (89,124 | ) | - | (120,567 | ) | - | ||||||||||
Effect of cumulative tax losses | (46,911 | ) | - | (285,019 | ) | - | ||||||||||
$ | 6,328 | $ | - | $ | 6,328 | $ | - |
Our policy for recording interest and penalties associated with audits is to record such items as a component of income tax expense. There were no interest and penalties recorded for the nine months ended June 30, 2010 and 2009.
18. Accounting for stock-based compensation
The Company accounts for stock-based compensation under ASC 718 - Stock Compensation which establishes standards for the accounting for equity instruments exchanged for employee services. Under the provisions of ASC 718, share-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as an expense over the employee's requisite service period (generally the vesting period of the equity grant), net of estimated forfeitures. In May 2010, pursuant to the company’s 2010 stock incentive plan, 30,000 shares of restricted common stock were granted to an independent director with a vesting period of three years. Vested portion is recognized in the restated financial statements.
19. Recent Accounting Pronouncements
Fair Value Measurements
In January 2010, the FASB issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires disclosure of transfers of assets and liabilities between Level 1 and Level 2 of the fair value measurement hierarchy, including the reasons and the timing of the transfers and information on purchases, sales, issuance, and settlements on a gross basis in the reconciliation of the assets and liabilities measured under Level 3 of the fair value measurement hierarchy. The guidance is effective for annual and interim reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual and interim periods beginning after December 15, 2010. The Company adopted this guidance at January 1, 2010, except for the Level 3 reconciliation disclosures on the roll-forward activities, which it will adopt at the beginning of January 1, 2011. Adoption did not have a material impact on our consolidated financial statements.
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Receivables
In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310), Effect of a Loan Modification When the Loan is Part of A Pool That Is Accounted for as a Single Asset . ASU 2010-18 provides that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loans are included is impaired if expected cash flows for the pool change. This guidance is effective prospectively for the first interim and annual period ending on or after July 15, 2010. Early adoption is permitted. The Company adopted this guidance without a material impact on its consolidated financial statements.
Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying financial statements.
20. Restatements of Previously Issued Financial Statements
Subsequent to the issuance of our consolidated financial statements for the three and nine months ended June 30, 2010, included in our Quarterly Report on Form 10-Q for the period ended June 30, 2010, filed with the United States Securities and Exchange Commission on August 16, 2010, and in connection with the SEC’s review of our registration statement on Form S-1 (File No. 333-168028), originally filed on July 8, 2010, as amended on September 7, 2010 and October 15, 2010, it was identified that (i) we failed to record a liability of $75,000 owed to each of United Best and Primary Capital (totaling $150,000) for advisory services rendered in connection with our private placement of convertible notes which closed on February 12, 2010, and (ii) we failed to record a grant of 30,000 shares of common stock in June 2010 to a director of the Company.
Accordingly, we have revised the previously issued consolidated financial statements to include the unpaid $150,000 advisory service fees and $5,000 as stock-based compensation expense in our consolidated balance sheet, consolidated statements of operations, consolidated statement of changes in stockholders’ equity and consolidated statements of cash flows for the periods affected. The following tables highlight changes to specific accounts affected:
As reported | As restated | |||||||
June 30, 2010 | June 30, 2010 | |||||||
Accounts payable and accrued liabilities | $ | 696,703 | $ | 846,703 | ||||
Total Current Liabilities | $ | 7,845,182 | $ | 7,995,182 | ||||
Common stock, $0.001 par value | $ | 15,236 | $ | 15,266 | ||||
Additional paid-in capital | $ | 8,205,582 | $ | 8,210,552 | ||||
Retained earnings | $ | 6,824,980 | $ | 6,669,980 | ||||
Total Stockholders’ equity | $ | 16,728,172 | $ | 16,578,172 |
A restatement of the consolidated statements of operations and comprehensive income affected the three month and nine month periods ended June 30, 2010 in general and administrative expenses as follows:
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Three months ended | Nine months ended | |||||||||||||||
30-Jun-10 | 30-Jun-10 | |||||||||||||||
As reported | As restated | As reported | As restated | |||||||||||||
Selling, General and Administrative Expenses | $ | 701,436 | $ | 706,436 | $ | 1,363,574 | $ | 1,518,574 | ||||||||
Income from Operations | $ | 833,784 | $ | 828,784 | $ | 3,174,838 | $ | 3,019,838 | ||||||||
Income before Income Taxes | $ | 441,096 | $ | 436,096 | $ | 2,330,776 | $ | 2,175,776 | ||||||||
Net Income | $ | 434,768 | $ | 429,768 | $ | 2,324,448 | $ | 2,169,448 | ||||||||
Earings per share – basic and diluted | $ | 0.03 | $ | 0.03 | $ | 0.15 | $ | 0.15 | ||||||||
Weighted-average Common Stock Shares Outstanding | ||||||||||||||||
Basic | 15,235,714 | 15,245,604 | 14,879,603 | 14,879,603 | ||||||||||||
Diluted | 16,925,510 | 17,217,033 | 15,739,975 | 15,886,667 |
Statements of Cash Flows for the nine months ended June 30, 2010 are restated under net income and accounts payable and accrued liabilities as follows:
As reported | As restated | |||||||
June 30, 2010 | June 30, 2010 | |||||||
Net income | $ | 2,324,448 | $ | 2,169,448 | ||||
Stock based Compensation | $ | 0 | $ | 5,000 | ||||
Accounts payable and accrued liabilities | $ | 282,009 | $ | 432,009 |
The net cash provided by the operating activities, the net cash used in investing activities, and the net cash provided by financing activities are not affected by the restatements.
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ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
Special Note Regarding Forward-Looking Statements
This report contains some forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements give our current expectations or forecasts of future events. Forward-looking statements involve risks and uncertainties. You can identify these statements by the fact that they do not relate strictly to historical or current facts. In some cases they are identifiable by use of the words “may,” “will,” “should,” “anticipate,” “estimate,” “plan,” “potential,” “projects,” “continuing,” “ongoing,” “expects,” “management believes,” “we believe,” “we intend” or the negative of these words or other variations on these words or comparable terminology. These statements may be found under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” In particular, these include statements relating to future actions, future performance, sales efforts, expenses, the outcome of contingencies such as legal proceedings, and financial results.
Any or all of our forward-looking statements in this report may turn out to be inaccurate. They can be affected by inaccurate assumptions we might make or by known or unknown risks or uncertainties. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially as a result of various factors, including, without limitation, the risks outlined under "Risk Factors" in our registration statement of Form S-1 (File No. 333-168028), originally filed on July 8, 2010, as amended on September 7, 2010 and October 15, 2010 (the “S-1”). In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this filing will in fact occur and you should not place undue reliance on these forward-looking statements.
Introduction
This section discusses and analyzes the results of operations and financial condition of China SLP Filtration Technology, Inc. (“we,” “us,” or the “Company”) which is the ultimate parent company of Foshan S.L.P. Special Materials Co., Ltd. (“Foshan”), a China-based operating company located in Foshan, Guangdong Province in the People’s Republic of China. On February 12, 2010, we acquired control of Foshan in a share exchange transaction which closed on that date. In the share exchange or “reverse merger” we acquired control of Hong Hui Holdings Limited (“Hong Hui”), a British Virgin Islands company and the owner of all of the stock of Technic International Limited (“Technic”), a Hong Kong holding company which in turn is the owner of all of the equity of Foshan, by issuing to the Hong Hui stockholders an aggregate of 14,510,204 shares of our common stock in exchange for all of the outstanding capital stock of Hong Hui. The transaction is accounted for as a reverse acquisition, except that no goodwill or other intangible has been recorded. The recapitalization is considered to be a capital transaction in substance, rather than a business combination.
On March 24, 2010 the Company effected a 1 for 5 reverse stock split of its outstanding common stock. The effect of the reverse split is retrospectively showed in all periods presented.
Overview
This section discusses and analyses our results of operations and financial condition, including the results and condition of our operating company, Foshan, which have been consolidated with our own results for all periods presented. This discussion is intended to help you understand our financial results and the current facts and trends that may cause them to change, so that you may make informed judgments about our likely financial results in the future and, insofar as those results may affect our stock price and informed investment decisions.
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General
We are a PRC based manufacturer of nonwoven fabrics. We currently manufacture two types of PET nonwoven fabrics which are used in a wide range of products, including filtration products, road construction materials, home furnishings, automobile interior insulation and industrial packaging.
Our current PET products are sold primarily to PRC-based manufacturers which use our products as raw material components for end-products they sell to their customers. We recently developed a manufacturing process to manufacture polyphenylene-sulfide fiber, or PPS nonwoven fabric, which is the key product line around which our long-term growth strategy is centered.
Based on lab tests which we conducted internally we believe that our PPS nonwoven fabric is superior to other currently available high temperature filtration material because it is lighter, thicker, stronger, has higher air permeability and filtration efficiency and significantly cheaper to produce. Due to the superior characteristics of our PPS product coupled with the demand created by these new regulations, we believe that our PPS material will become a market leader for high temperature filtration applications. We expect to sell our PPS nonwoven products to operators of coal fired power plants, garbage incinerators and other heavy industrial plants.
We intend to continue to manufacture PET nonwovens but we expect that the sales of our PPS nonwoven fabrics will ultimately eclipse the sales of our existing PET nonwoven products and become our main product offering.
Our manufacturing facility, which is located in Foshan City, Guangdong Province, PRC, currently has three production lines for PET nonwovens with annual product capacity of 8,000 tons. We plan to begin commercial production of our PPS nonwoven fabric in the latter part of 2010 with the addition of three high tech production lines with annual production capacity of 3,600 tons, which will bring our total overall production capacity to 11,600 tons per year.
Results of Operations
Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009
The following table shows, for the periods indicated, information derived from our consolidated statements of income in US dollars and as a percentage of net sales (percentages may not add due to rounding). See the financial statements of the Company and the related notes thereto and other financial information included elsewhere in this report.
Three Months Ended June 30 | ||||||||||||||||
2010 (unaudited) | 2009 (unaudited) | |||||||||||||||
Amount | % | Amount | % | |||||||||||||
Net sales | $ | 5,072,791 | 100 | % | $ | 2,482,212 | 100 | % | ||||||||
Cost of sales | 3,537,571 | 70 | % | 1,779,328 | 72 | % | ||||||||||
Gross profit | 1,535,220 | 30 | % | 702,884 | 28 | % | ||||||||||
Selling, general and administrative expense | 706,436 | 14 | % | 266,101 | 11 | % | ||||||||||
Operating income | 828,784 | 16 | % | 436,783 | 18 | % | ||||||||||
Interest income | 10,106 | 0.2 | % | 2,104 | 0 | % | ||||||||||
Interest expense | (764,794 | ) | 15 | % | (65,162 | ) | 3 | % | ||||||||
Loss on disposition of fixed assets | - | (16,263 | ) | 1 | % | |||||||||||
Changes in fair value of warrants | 362,000 | 7 | % | - | 0 | % | ||||||||||
Net income before taxes | 436,096 | 9 | % | 357,462 | 14 | % | ||||||||||
Income tax provision | 6,328 | 0 | % | - | 0 | % | ||||||||||
Net income | $ | 429,768 | 8 | % | $ | 357,462 | 14 | % |
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Net sales
Net sales consisted of sales of needle punched PET nonwoven fabric and thermal calendared products. Our net sales for the three month period ended June 30, 2010 were $5,072,791, an increase of $2,590,579, or 104%, from $2,482,212 for the same period of the prior year. The increase in net sales was largely attributable to higher sales volume after a new production line used to manufacture needle-punched nonwoven fabric was installed in February 2009. Sales of needle-punched PET products for the three month period ended June 30, 2010 were $2,054,318, an increase of $1,535,566, or 296%, over the prior year. In addition, sales of thermal calendared PET materials for the three month period ended June 30, 2010 were $3,018,473, an increase of $1,062,855, or 59%, from $1,955,618 for the same period of the prior year.
Cost of Sales
Cost of sales principally consists of the cost of raw materials, labor and manufacturing overhead expenses.
Our cost of sales for the three month period ended June 30, 2010 was $3,537,571, an increase of $1,758,243, or 99%, from $1,779,328 for the same period in the prior year. The primary reason for the increase in cost of sales was an increase in our raw materials costs, which we believe was in line with our increased sales volume. 98.7% of our raw material costs consist of polyester, the cost of which increased with the price of oil.
Our raw material cost as a percentage of net sales increased to 56% for the three month period ended June 30, 2010, compared to 51% for the same period of the prior year, due to the raw materials associated with 2010 sales being more expensive than in the prior year. As a component of the cost of sales, raw material expense increased to $2,833,820 for the three months ended June 30, 2010 from $1,261,928 for the same period in the prior year. The $1,571,892 increase was due to higher pricing and increases in raw material usage. The change in material pricing contributed approximately 22% and the higher volume contributed approximately 78% of the total increase in raw material cost.
Labor cost accounted for 1% of net sales for the three month period ended June 30, 2010, the same level for the same period of the prior year.
Overhead expenses were 13% of net sales for the three month period ended June 30, 2010, compared to 18% of net sales for the same period of the prior year due to greater capacity utilization rates with the addition of our new production line in February 2009.
Gross Profit
Our gross profit for the three month period ended June 30, 2010 was $1,535,220, an increase of $832,336, or 118%, from $702,884 for the same period in the prior year. The increase in gross profit resulted primarily from the increase in our net sales. As a percentage of net sales, gross profit was 30% for the three month period ended June 30, 2010, compared to 28% for the same period last year. The improved gross profit margin was primarily attributed to lowered overhead cost as a percentage of the net sales.
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Selling, General and Administrative Expenses
Selling expenses include salaries, advertising expenses, rent, cost of manufacturing and all expenses directly related to producing and selling our products. General expenses include general operating expenses that are directly related to the general operation of the company, but excluding selling and administrative expenses. Administrative expenses include executive salaries and other expenses related to the overall administration of the company.
Selling, general and administrative expenses for the three month period ended June 30, 2010 were $706,436, an increase of $440,335, or 166%, compared to $266,101 for the same period in the prior year. The increase was primarily due to increase of $47,219 in delivery charges related to overseas sales and $309,040 in legal fees related to the financing transaction which closed in February 2010.
Other Income and Expenses
Interest expense for the three month period ended June 30, 2010 was $764,791, compared to $65,162 for the same period in the prior year. Interest expense as a percentage of sales increased to 15% for the three month period ended June 30, 2010 from 3% for the same period of the prior. The increase in interest expense was mainly attributed to our adoption of derivative accounting rules under ASC 815-40 to record $4,140,000 of convertible loan notes. These accounting rules require us to accrete interest expense, in an amount of $609,900 quarterly, based on the term of the notes and note discount. Excluding the derivative-accounting-driven interest expense, our interest expense for this three month period remained the same level as for the same period of last year. The accreted interest expense was partially offset by the fair value change of the warrants after re-measurement at this reporting period.
Income Tax
USA
The Company and its subsidiary and branch divisions are subject to income taxes on an entity basis on income arising in, or derived from, the tax jurisdiction in which they operate. Since the Company had no income generated in the United States, there was no tax expense or tax liability due to the Internal Revenue Service of the United States as of June 30, 2010 and September 30, 2009.
BVI
Hong Hui is incorporated under the International Business Companies Act of the British Virgin Islands and accordingly, is exempted from payment of British Virgin Island’s income taxes.
PRC
Pursuant to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for Foshan SLP. For 2008 and 2009 Foshan SLP enjoys tax free holidays. From January 2010 onwards, Foshan SLP is taxed at 25% of net income except for the 2010, 2011 and 2012 in which we receive a 50% discount on income tax.
The current year tax provision was $6,328 and $6,328 for the three and nine months ended June 30, 2010, respectively. The company has recorded zero deferred tax assets or liabilities as of June 30, 2010 and September 30, 2009, net of tax allowance, because all other significant difference in tax basis and financial statement amounts are permanent differences.
Net Income
Net income for the three months ended June 30, 2010 was $429,768, an increase of $72,306, or 20%, from net income of $357,462 for the same period in the prior year. Excluding accretion of interest expense discussed above and the gains on change in warrant value, net income rose to $522,668, an increase of $165,206, or 46%, over the same period of the prior year. The increase was largely due to an increase in sales of our new needle-punched products.
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Comparison of Nine Months Ended June 30, 2010 and June 30, 2009
The following table shows, for the periods indicated, information derived from our consolidated statements of income in US dollars and as a percentage of net sales (percentages may not add due to rounding). See our financial statements and the related notes thereto and other financial information included elsewhere in this report.
Nine Months Ended June 30 | ||||||||||||||||
2010 (unaudited0) | 2009 (unaudited) | |||||||||||||||
Amount | % | Amount | % | |||||||||||||
Net sales | $ | 14,919,816 | 100 | % | $ | 7,023,045 | 100 | % | ||||||||
Cost of sales | 10,381,404 | 70 | % | 4,685,730 | 67 | % | ||||||||||
Gross profit | 4,538,412 | 30 | % | 2,337,315 | 33 | % | ||||||||||
SG&A expense | 1,518,,574 | 10 | % | 1,024,543 | 15 | % | ||||||||||
Operating income | 3,019,838 | 20 | % | 1,312,772 | 19 | % | ||||||||||
Interest income | 10,623 | 0 | % | 2,104 | 0 | % | ||||||||||
Interest expense | (1,216,685 | ) | 8 | % | (225,668 | ) | 3 | % | ||||||||
Changes in Fair value of warrants | 362,000 | 2 | % | - | 0 | % | ||||||||||
Net income before taxes | 2,175,776 | 15 | % | 1,089,208 | 16 | % | ||||||||||
Income tax provision | 6,328 | 0 | % | - | 0 | % | ||||||||||
Net income | $ | 2,169,448 | 15 | % | $ | 1,089,208 | 16 | % |
Net Sales
Net sales for the nine month period ended June 30, 2010 were $14,919,816, an increase of $7,896,771, or 112%, from $7,023,045 for the same period of the prior year. The increase is mainly attributable to sales of needle punched nonwoven fabric products which were launched during the second quarter of 2010. Sales of needle-punched products for the nine month period ended June 30, 2010 were $6,342,001 compared to $739,097 for the same period of the prior year. In addition, sales of thermal calendared materials for the nine month period ended June 30, 2010 were $8,577,815, an increase of $2,293,867 compared to $6,283,948 for the same period of the prior year.
During the nine month period ended June 30, 2010, approximately 75% and 25% of our sales revenues were generated from sales made in the PRC and internationally, respectively, compared to approximately 83% and 17%, respectively, for the same period in prior year.
Cost of Sales
Cost of sales for the nine month period ended June 30, 2010 was $10,381,404, an increase of $5,695,674, or 122%, from $4,685,730 for the same period of the prior year. As a percentage of net sales cost of sales was 70% for the nine month period ended June 30, 2010 compared to 67% for the same period in prior year.
Raw material costs increased to 55% of net sales for the nine month period ended June 30, 2010, compared to 44% of net sales for the same period in the prior year, reflecting a mix of more expensive raw materials associated with 2010 sales. Approximately 98% of our raw materials consist of polyester, the price of which fluctuates with the price of oil.
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As a component of the cost of sales, raw material expense increased to $8,201,053 for the nine months ended June 30, 2010, from $3,090,140 for the same period of prior year. The increase of $5,115,749 was caused by an increase in material purchase price and higher volume of material usage due to an increase in production output. The rise in material purchase price and volume accounted for approximately 29% and approximately 71% of the total raw material cost increase, respectively.
Labor cost was 1% of sales for the nine month period ended June 30, 2010 compared to 2% for the same period in the prior year.
Overhead expenses were 13% of net sales for the nine month period ended June 30, 2010, compared to 20% of net sales for the same period in the prior year due to greater capacity utilization rates with the addition of our new production line in February 2010.
Gross Profit
Gross profit for the nine month period ended June 30, 2010 was $4,538,412, an increase of $2,201,097, or 94%, from $2,337,315 for the same period of the prior year. As a percentage of net sales, gross profit was 30% for the nine month period ended June 30, 2010, compared to 33% for the same period of the prior year. This decrease was primarily due to the increase in the purchase price of the raw materials associated with 2010 sales, which price increase was caused by fluctuations in the price of oil.
SG&A Expenses
Selling, general and administrative expenses for the nine month period ended June 30, 2010 were $1,518,574, an increase of $494,031, or 48%, compared to $1,024,543 for the same period of the prior year. This is mainly due to increased legal and other expenses related to convertible note financing completed in February 2010, including fees totaling $554,000 paid or payable to Primary and United Best, and the intended public offering and shipping expenses associated with overseas sales, offset by a decrease in other general expenses.
Other Income and Expenses
Interest expense for the nine month period ended June 30, 2010 was $1,216,685 compared to $225,668 for the same period of the prior year. Interest expense as a percentage of net sales increased to 8% for the nine month period ended June 30, 2010 from 3% for the same period of the prior year. The cause for the increase in interest expense for the nine month period was the same as for the three month period. Excluding the accretion of interest, interest expense for this nine month period increased by $76,000 over the same period of last year, and, as a percentage of net sales, decreased to 2% from 3%.
Net Income
Net income for the nine months ended June 30, 2010 was $2,169,448, or 99%, an increase of $1,080,240 from net income of $1,089,208 for the same period in the prior year. The increase was mainly attributed to increased net sales generated from our new needle-punched products and lower selling, general and administrative expenses relative to net sales. Excluding IPO related expenses and accretion of interest expense from convertible notes sold, net income increased by approximately $2,100,000 from net income for the same period in the prior year.
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Liquidity and Capital Resources
The following table sets forth a summary of our net cash flow information for the periods indicated:
Nine Months Ended June 30, | ||||||||
2010 | 2009 | |||||||
(Consolidated, unaudited) | (Consolidated, unaudited) | |||||||
Net cash provided by (used in) operating activities | $ | 2,860,129 | $ | (233,933 | ) | |||
Net cash (used in) investing activities | $ | (2,511,303 | ) | $ | (108,869 | ) | ||
Net cash provided by (used in) financing activities | $ | 2,635,167 | $ | (198,620 | ) | |||
Net cash inflow (outflow) | $ | 2,983,993 | $ | (541,422 | ) |
We finance our business with cash generated from operations and use short-term bank loans to fund capital expenditures.
Working capital consists mainly of cash and equivalents, accounts receivable, advances to suppliers and inventory. Cash and equivalents, inventory and accounts receivable account for the majority of our working capital.
Our working capital requirements may be influenced by many factors, including our cash flow, competition, relationships with suppliers, and the availability of credit facilities and financing alternatives, none of which can be predicted with certainty.
At June 30, 2010, we had several bank loans in the total amount of $3.8 million (RMB26 million) with Agriculture Bank of China, Foshan Branch. These loans are repayable in December 2010.
On February 12, 2010, we completed a financing transaction in which we raised gross proceeds of $4,140,000 through a private placement of convertible notes and warrants to certain accredited investors.
Operating Activities
Net cash provided by operating activities for the nine months ended June 30, 2010 was approximately $2,860,129, compared to cash used of $0.25 million for the same period of prior year. The increased operating cash inflow resulted primarily from an increase in net income and favorable changes in advances to suppliers, accounts payable and accrued expenses, offset by unfavorable changes in accounts receivable, inventory and prepaid expenses.
Investing Activities
Net cash used in investing activities was $2,511,303 for nine months ended June 30, 2010, compared to $108,869 for the same period of the prior year. The increased cash used in investing activities during the nine months ended June 30, 2010 was primarily attributable to capital expenditures on our new PPS production line.
Financing Activities
Net cash provided by financing activities for the nine month period ended June 30, 2010 was approximately $2.64 million, compared to $0.20 million of net cash used in financing activities for the same period of the prior year. The increase was from the cash received from the sale of the convertible notes.
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Loans and Credit Facilities
The balance of our outstanding short-term bank loans on June 30, 2010 was approximately $3,800,000, compared with approximately $4,600,000 on June 30, 2009. Other than disclosed in the financial statements, we had no long term debt, capital lease obligations, operating leases or any other long term obligations as of June 30, 2010.
On February 12, 2010, we entered into a note purchase agreement with certain accredited investors for the sale of convertible notes in the aggregate principal amount of $4,140,000 and warrants (which are exercisable only in certain circumstances), with net proceeds for $3.4 million after finance costs. The notes require quarterly interest payments at a rate of 10% per annum and interest for six months in amount of $204,464 to be held in an escrow account. The notes are convertible into shares of common stock at a 65% discount to the offering price upon consummation of a “qualified financing”. The offering contemplated by this prospectus is expected to be a “qualified financing.”
The warrants become void if the notes automatically convert into common stock which is expected to occur upon consummation of this offering. The warrants are exercisable at any time during a five-year period commencing on the closing of a “financing,” which means the first sale (or series of related sales) by us of stock (or debt or equity securities convertible into stock), in a capital raising transaction, occurring after the maturity date (or the date the notes become due pursuant to a default, if earlier) with aggregate gross proceeds of at least $20,000,000. The warrants cannot be exercised if no financing is consummated within the five-year period after the issue date.
Future Cash Commitments
Our planned expansion of our PPS manufacturing facilities in 2010 will require significant investment capital. We intend to use the net proceeds of the offering to purchase and install three new production lines to manufacture PPS materials which will increase our annual output to 11,600 tons of nonwoven material. The estimated cost of this equipment is approximately $20,000,000. In the future, we may need to raise additional capital if the proceeds from the two financings and our operating cash flows are inadequate to continue our capital expansion plans.
Critical Accounting Policies and Estimates
Management's discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. Our financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. See Note 2 to our consolidated financial statements, “Summary of Significant Accounting Policies.” We believe that the following paragraphs reflect the more critical accounting policies that currently affect our financial condition and results of operations:
Method of Accounting
We maintain our general ledger and journals with the accrual method accounting for financial reporting purposes. Accounting policies adopted by us conform to generally accepted accounting principles in the United States and have been consistently applied in the presentation of financial statements, which are compiled on the accrual basis of accounting.
Use of estimates
The preparation of the financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Management makes these estimates using the best information available at the time the estimates are made; however actual results could differ materially from those estimates.
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Economic and political risks
Our operations are conducted in the PRC. Accordingly, our business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.
Our operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. Our results may be adversely affected by changes in political and social conditions in the PRC and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things.
Revenue recognition
Revenue represents the invoiced value of goods sold recognized upon the delivery of goods to customers. Revenue is recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, and the seller’s price to the buyer is fixed or determinable and collectible.
Land use rights
Land use rights are stated at cost less accumulated amortization. Amortization is provided over the respective useful lives, using the straight-line method. Estimated useful lives range from 20 to 50 years.
Property, plant and equipment
Plant and equipment are carried at cost less accumulated depreciation. Depreciation is provided over their estimated useful lives, using the straight-line method. Estimated useful lives of plant and equipment are as follows:
Buildings | 15-35 years |
Machinery and equipment | 10 years |
Office equipment | 6-10 years |
Motor vehicles | 6-8 years |
Other assets | 6-10 years |
The cost and related accumulated depreciation of assets sold or otherwise retired are eliminated from the accounts and any gain or loss is included in the statement of income. The cost of maintenance and repairs is charged to income as incurred, whereas significant renewals and betterments are capitalized.
Accounting for the Impairment of Long-Lived Assets
The long-lived assets held and used by us are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of assets may not be recoverable. It is reasonably possible that these assets could become impaired as a result of technology or other industry changes. Determination of recoverability of assets to be held and used is by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the assets.
If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
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Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonable likely to have a current or future effect on our financial condition.
ITEM 4. | CONTROLS AND PROCEDURES. |
Evaluation of Disclosure Controls and Procedures.
We maintain “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to ensure that information that is required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including to our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Rule 13a-15 under the Exchange Act, our management, including Mr. Jie Li, our chief executive officer and Mr. Eric Gan, our chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures and internal controls as of June 30, 2010. Based on that evaluation, Mr. Lie and Mr. Gan concluded that as of June 30, 2010, and as of the date that the evaluation of the effectiveness of our disclosure controls and procedures and internal controls was completed, our disclosure controls and procedures and internal controls were not effective in that certain “material weaknesses” existed related to (i) the U.S. GAAP expertise of our internal accounting staff, and (ii) our internal audit function.
A material weakness is a control deficiency, or a combination of control deficiencies, that result in more than a remote likelihood that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected.
As more fully disclosed in a Current Report on Form 8-K filed on November 18, 2010, subsequent to the issuance of our consolidated financial statements for the three and nine months ended June 30, 2010, included in our Quarterly Report on Form 10-Q for the period ended June 30, 2010, filed with the United States Securities and Exchange Commission on August 16, 2010, and in connection with the SEC’s review of our registration statement on Form S-1 (File No. 333-168028), originally filed on July 8, 2010, as amended on September 7, 2010 and October 15, 2010, it was identified that (i) we failed to record a liability of $75,000 owed to each of United Best and Primary Capital (totaling $150,000) for advisory services rendered in connection with our private placement of convertible notes which closed on February 12, 2010, and (ii) we failed to record a grant of 30,000 shares of common stock in June 2010 to a director of the Company.
Our chief executive officer and chief financial officer and our Audit Committee determined , after discussions with Child, Van Wagoner & Bradshaw, PLLC, our independent registered public accounting firm, that (i) our unaudited interim financial statements for the three month and nine month periods ended June 30, 2010 and 2009, as set forth in the Quarterly Report on Form 10-Q for the quarter ended June 30, 2010 filed on August 16, 2010, and (ii) our unaudited interim financial statements for the three month and six month periods ended March 31, 2010 and 2009, as set forth in the Quarterly Report on Form 10-Q filed on May 24, 2010, as amended on May 26, 2010 should be restated and should not be relied on.
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Changes in Internal Control over Financial Reporting.
Because our current accounting department is relatively new to U.S. GAAP and the related internal control procedures required of U.S. public companies, our management has determined that they require additional training and assistance in U.S. GAAP matters. Management has determined that our internal audit function is also significantly deficient due to insufficient qualified resources to perform internal audit functions.
In order to correct the foregoing significant deficiencies, we are taking or have taken the following remediation measures:
· | In August 2010, we hired Eric Gan as our new chief financial officer; |
· | We are arranging necessary training for our accounting department staff; |
· | We plan to engage external professional accounting or consultancy firms to assist us in the preparation of the U.S. GAAP accounts; and |
· | We have allocated financial and human resources to strengthen the internal control structure and we have been actively working with external consultants to assess our data collection, financial reporting, and control procedures and to strengthen our internal controls over financial reporting. |
We believe that the foregoing steps will remediate the significant deficiencies identified above, and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate. However, there is no guarantee that these improvements will be adequate or successful or that such improvements will be carried out on a timely basis.
Other than described above, there was no change in our internal control over financial reporting during the fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II
OTHER INFORMATION
ITEM 6. | EXHIBITS. |
The following exhibits are filed as part of this report or incorporated by reference:
Exhibit No. | Description | |
31.1 | Certification of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32 | Certification of Principal Executive Officer and Principal Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: November 24, 2010
CHINA SLP FILTRATION TECHNOLOGY, INC. | ||
By: | /s/ Jie Li | |
Jie Li | ||
Chief Executive Officer | ||
(Principal Executive Officer) | ||
By: | /s/ Eric Gan | |
Eric Gan | ||
Chief Financial Officer | ||
(Principal Financial and Accounting Officer) |
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EXHIBIT INDEX
Exhibit No. | Description | |
31.1 | Certification of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32 | Certifications of Principal Executive Officer and Principal Accounting Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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