China Carbon Graphite Group, Inc. - Quarter Report: 2009 March (Form 10-Q)

---

---

 

Copies to:

Asher S. Levitsky PC

Sichenzia Ross Friedman Ference LLP

61 Broadway, 32nd Floor

New York, New York 10006

Phone: (212) 981-6767

Fax: (212) 930 - 9725

E-mail: alevitsky@srff.com

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 [√] 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 smaller reporting company)	[  ]	Smaller reporting company	[√]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes [ ] No [√]

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.  13,785,470 shares of common stock are issued and outstanding as of May 12, 2009.

 

---

CHINA CARBON GRAPHITE GROUP, INC. AND SUBSIDIARIES

FORM 10-Q

March 31, 2009

TABLE OF CONTENTS

 

 

		Page No.
PART I. - FINANCIAL INFORMATION
Item 1.	Financial Statements:	3
	Condensed Consolidated Balance Sheets at March 31, 2009 (unaudited) and December 31, 2008	3
	Condensed Consolidated Statements of Income and Comprehensive Income for the three months ended March 31, 2009 and 2008 (unaudited)	4
	Condensed Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2009 (unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2009 and 2008 (unaudited)	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations.	21
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	30
Item 4	Controls and Procedures.	30
PART II - OTHER INFORMATION
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	32
Item 6.	Exhibits.	32

 

 

 

1

---

 

FORWARD LOOKING STATEMENTS

 

This report contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this report. Additionally, statements concerning future matters are forward-looking statements.

 

Although forward-looking statements in this report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the headings “Risks Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our annual report on Form 10-K, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q and in other reports that we file with the SEC.   You are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We file reports with the SEC. The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

 

We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report, except as required by law. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this quarterly report, which are designed to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

 

 

2

---

 

 

PART 1 - FINANCIAL INFORMATION

Item 1.  Financial Statements.

China Carbon Graphite Group, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
		March 31, 2009				December 31, 2008
		(Unaudited)				(Audited)
ASSETS
Current Assets
Cash and cash equivalents		$	243,697			$	51,799
Trade accounts receivable, net			4,020,953				4,224,410
Notes receivable			65,736				27,720
Other receivables			233,228				150,694
Advance to related party			290,774				290,409
Advance to suppliers, net			543,573				1,017,088
Inventories			16,011,638				15,889,549
Prepaid expenses			85,133				-
Total current assets			21,494,732				21,651,669
Property and equipment, net			22,199,061				21,003,607
Construction in progress			854,115				2,029,777
Land use rights, net			3,589,770				3,604,324
		$	48,137,678			$	48,289,377
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued expenses		$	808,392			$	1,253,265
Advance from customers			786,957				640,346
Taxes payable			236,940				362,298
Short term bank loans			4,893,654				4,887,514
Long term bank loan - current portion			1,460,792				1,896,647
Loan from shareholder			30,337				-
Other payables			544,507				551,096
Total current liabilities			8,761,579				9,591,166
Long Term Liabilities
Long term bank loan - non-current portion			3,213,744				3,209,711
Total liabilities			11,975,323				12,800,877
Contingencies and Commitments (Note 16)
Stockholders' Equity
Convertible preferred stock, par value $0.001 per share,
authorized 20,000,000 shares, issued and outstanding 453,411 and 1,200,499
shares at March 31,2009 and December 31, 2008, respectively		$	453			$	1,200
Common stock, $0.001 par value,  authorized 100,000,000 shares,
issued and outstanding 13,785,470 and 12,218,412 shares
at March 31, 2009 and December 31, 2008, respectively			13,785				12,218
Additional paid-in capital			8,847,506				8,690,426
Accumulated other comprehensive income			5,036,027				4,991,113
Retained earnings			22,264,584				21,793,543
Total stockholders' equity			36,162,355				35,488,500
		$	48,137,678			$	48,289,377

 

The accompanying notes are an integral part of these financial statements

 

3

---

 

China Carbon Graphite Group, Inc and subsidiaries
Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited)
		Three months ended March 31,
		2009				2008
Sales		$	2,893,647			$	5,728,002
Cost of Goods Sold			2,052,752				4,366,293
Gross Profit			840,895				1,361,709
Operating Expenses
Selling expenses			308,645				20,334
General and administrative			135,995				149,204
Depreciation and amortization			19,080				15,140
			463,720				184,678
Operating Income Before Other Income (Expense)
and Income Tax Expense			377,175				1,177,030
Other Income (Expense)
Other income			292,116				199,196
Interest income			94				178
Interest expense			(198,345	)			(133,223	)
			93,865				66,151
Income Before Income Tax Expense			471,040				1,243,181
Income tax expense			-				-
Net income			471,040				1,243,181
Deemed preferred stock dividend			-				(854,300	)
Net income available to common shareholders		$	471,040			$	388,881
Comprehensive income
Net income		$	471,040			$	1,243,181
Other comprehensive income
Foreign currency translation gain			44,914				1,252,143
Total Comprehensive Income		$	515,954			$	2,495,324
Share data
Basic earnings per share		$	0.04			$	0.03
Diluted earnings per share		$	0.04			$	0.02
Weighted average common shares outstanding,
basic			12,768,144				13,218,412
Weighted average common shares outstanding,
diluted			13,847,244				18,757,257

The accompanying notes are an integral part of these financial statements

 

4

---

 

China Carbon Graphite Group, Inc and subsidiaries
Condensed Consolidated Statements of Changes in Stockholders' Equity
For the three months ended March 31,2009 (Unaudited)
		Common Stock								Convertible preferred Stock																Accumulated
																		Additional								Other			Total
		Number				Amount				Number				Amount				Paid-In				Retained				Comprehensive			Stockholders'
																		Capital				Earnings				Income			Equity
Balance at December 31, 2008			12,218,412			$	12,218				1,200,499			$	1,200			$	8,690,426			$	21,793,543			$	4,991,113		$	35,488,500
Foreign currency translation adjustment			-				-				-				-				-				-				44,914			44,914
Net income for the period
ended March 31, 2009			-				-				-				-				-				471,040				-			471,040
Issuance of common stock for consulting fee			750,000				750												89,250											90,000
Issuance of common stock for cash			70,000				70				-				-				67,830				-				-			67,900
Conversion of preferred stock to common stock			747,058				747				(747,058	)			(747	)			-				-				-			-
Balance at March 31, 2009			13,785,470			$	13,785				453,441			$	453			$	8,847,506			$	22,264,583			$	5,036,027		$	36,162,355

 

The accompanying notes are an integral part of these financial statements

 

5

---

 

China Carbon Graphite Group, Inc and Subsidiaries
Condensed Consolidated Statements of Cash Flows(Unaudited)
		Three months ended March 31,
		2009				2008
Cash flows from operating activities
Net Income		$	471,040			$	1,243,181
Adjustments to reconcile net cash provided by
operating activities
Depreciation and amortization			328,355				309,846
Share based compensation			25,220				-
Change in operating assets and liabilities
Accounts receivable			208,734				1,392,595
Notes receivable			(37,975	)			83,307
Other receivables			(82,334	)			372,245
Advance to suppliers			474,723				(301,925	)
Inventories			(102,113	)			(1,159,142	)
Prepaid expenses			(20,350	)			(29,761	)
Accounts payable and accrued expenses			(446,134	)			(592,042	)
Advance from customers			145,785				(1,718,299	)
Taxes payable			(125,795	)			(14,766	)
Other payables			(7,280	)			509,862
Net cash provided by operating activities			831,876				95,102
Cash flows from investing activities
Acquisition of property and equipment			(1,478,173	)			(13,073	)
Construction in progress			1,178,041				-
Net cash used in investing activities			(300,132	)			(13,073	)
Cash flows from financing activities
Issuance of preferred stock			-				400,000
Issuance of common stock			67,900				-
Repayment of bank loans			(438,174	)			(379,097	)
Advance from related party			30,333				160,921
Net cash used in financing activities			(339,941	)			181,824
Effect of exchange rate fluctuation			95				60,847
Net increase in cash			191,898				324,700
Cash and cash equivalents at beginning of period			51,799				4,497
Cash and cash equivalents at end of period		$	243,697			$	329,197
Supplemental disclosure of cash flow information
Interest paid		$	198,345			$	133,223
Income taxes paid		$	-			$	-
Non-cash financing and investing activities:
Deemed preferred stock dividend		$	-			$	854,300
Issuance of common stock for consulting fee		$	90,000			$	-

 

The accompanying notes are an integral part of these financial statements

 

6

---

 

China Carbon Graphite Group, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

For the three months ended March 31, 2009

 

1.	Organization and Business

 

China Carbon Graphite Group, Inc. (the “Company”), is a Nevada corporation, incorporated on February 13, 2003 under the name Achievers Magazine Inc.  The Company’s corporate name was changed to China Carbon Graphite Group, Inc. on January 30, 2008.

The Company is the sole stockholder of Talent International Investment Limited (“Talent”), a British Virgin Islands corporation, which is the sole stockholder of Xinghe Yongle Carbon Co., Ltd. (“Yongle”), a company organized under the laws of the People’s Republic of China (the “PRC”).

 

Yongle is a party to a series of contractual arrangements with Xinghe Xingyong Carbon Co., Ltd. (“Xingyong”), a corporation organized under the laws of the PRC.  These agreements give the Company the ability to operate and manage the business of Xingyong and to derive the profit (or sustain the loss) from Xingyong’s business. As a result, the operations of Xingyong are consolidated with those of the Company for financial reporting purposes. The relationship among the above companies as follows:

 

 

The Company, through its subsidiaries and affiliates, manufactures graphite electrodes, fine grain graphite, high purity graphite and other carbon derived products.

Stock distribution

On January 22, 2008, the Company effected a 1.6-for-one stock distribution whereby each share of common stock became converted into 1.6 shares of common stock. All references to share and per share information in these financial statements reflect this stock distribution.

2.	Basis of Preparation of Financial Statements

Management acknowledges its responsibility for the preparation of the accompanying interim condensed consolidated financial statements which reflect all adjustments, consisting of normal recurring adjustments, considered necessary in its opinion for a fair statement of its condensed consolidated financial position and the results of its operations for the interim period presented. These condensed consolidated financial statements should be read in conjunction with the summary of significant accounting policies and notes to condensed consolidated financial statements included in the Company’s Form 10-K annual report for the year ended December 31, 2008. 

 

7

---

 

The accompanying unaudited condensed consolidated financial statements for China Carbon Graphite Group, Inc., its subsidiaries and variable interest entity, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 8-03 of Regulation S-X. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole.

The Company maintains its books and accounting records in Renminbi (“RMB”), and its reporting currency is United States dollars.

The financial statements have been prepared in order to present the financial position and results of operations of the Company, its subsidiaries and Xingyong, which is an affiliated company whose financial condition is consolidated with the Company pursuant to FIN 46R, in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).

FIN 46R requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss for the variable interest entity or is entitled to receive a majority of the variable interest entity’s residual returns. Variable interest entities are those entities in which the Company, through contractual arrangements, bears the risks of, and enjoys the rewards normally associated with ownership of the entities, and therefore the Company is the primary beneficiary of these entities.

Yongle is a party to a series of contractual arrangements with Xingyong. These agreements include a management agreement pursuant to which 80% to 100% of Xingyong’s net income after deduction of necessary expenses, if any, is paid to Yongle and Yongle is responsible for paying Xingyong’s obligations incurred in connection with its business. For the years ended December 31, 2008 and 2007, Xingyong paid 100% of net income to Yongle. In addition, Yongle manages and controls all of the funds of Xingyong. Yongle also has the right to purchase Xingyong’s equipment and patents and lease its manufacturing plants, land and remaining equipment. This agreement is designed so that Yongle can conduct its business in China. Pursuant to two other agreements, the sole stockholder of Xingyong, who was, at the time of the transaction, the Company’s chief executive officer, has pledged all of his equity in Xingyong as security for performance of Xingyong’s obligations to Yongle. As a result, Xingyong is considered a variable interest entity.

According to PRC rules and regulations, Talent is required to pay 20% of its capital investment in Yongle, or $800,000, within three months and the remaining 80%, or $3,200,000, within two years from the date of issuance of business license.  Business license was issued on September 13, 2007 and accordingly, Talent was required to pay $800,000 on or before December 12, 2007 and is required to pay $3,200,000 on or before September 12, 2009.  Talent can apply for extension of time to pay up its investments with reasons acceptable to the Government.  Failing this, Talent has to apply for the investment to be cancelled and business license to be revoked.  The Government can, if ever Talent does not apply for cancellation, give notice to Talent and revoke the business license and thus cancel the investment. 

Talent has not paid the initial 20% or $800,000 nor applied for an extension of time to effect this payment.  However, the Government issued a new business license for Yongle expiring December 31, 2009.  Management assumes that the Government will take no action and the investment can be paid up on or before December 31, 2009, the expiration date of the new business license.  Management is seeking capital to enable it to make this payment, and it believes that the investment can be fully paid up on time. However, the Company has no commitment from any party to make this payment, and failure to make payment by December 31, 2009 could result in the loss its investment in Yongle.  In this event, the Company would no longer be able to conduct business through Yongle, and Yongle would no longer be in business.

 

3.	Summary of Significant Accounting Policies

 

Use of estimates - The preparation of these financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affected the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net sales and expenses during the reported periods.

Significant estimates included values and lives assigned to acquired property, equipment and intangible assets, reserves for customer returns and allowances, uncollectible accounts receivable, slow moving, obsolete and/or damaged inventory and stock warrant valuation. Actual results may differ from these estimates.

 

8

---

 

Cash and cash equivalents - The Company considers all highly liquid debt instruments purchased with maturity period of three months or less to be cash equivalents. The carrying amounts reported in the accompanying balance sheet for cash and cash equivalents approximate their fair value. Substantially all of the Company’s cash is held in bank accounts in the PRC and is not protected by FDIC insurance or any other similar insurance.

Inventory - Inventory is stated at the lower of cost or market. Cost is determined using the weighted average method. Market value represents the estimated selling price in the ordinary course of business less the estimated costs necessary to complete the sale.

The cost of inventories comprises all costs of purchases, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. The costs of conversion of inventories include fixed and variable production overhead, taking into account the stage of completion.

Accounts receivable - Trade receivables are recognized and carried at the original invoice amount less allowance for any uncollectible amounts. An estimate for doubtful accounts is made when collection of the full amount is no longer probable. Bad debts are written off as incurred.

 

Property and equipment - Property and equipment is stated at the historical cost, less accumulated depreciation. Land use rights are being amortized to expense on a straight line basis over the life of the rights. Depreciation on property, plant and equipment is provided using the straight-line method over the estimated useful lives of the assets for both financial and income tax reporting purposes as follows:

  

Buildings			25 - 40 years
Machinery and equipment			10 - 20 years
Motor vehicles			5 years

Expenditures for renewals and betterments were capitalized while repairs and maintenance costs are normally charged to the statement of operations in the year in which they are incurred. In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the asset, the expenditure is capitalized as an additional cost of the asset.

Upon sale or disposal of an asset, the historical cost and related accumulated depreciation or amortization of such asset were removed from their respective accounts and any gain or loss is recorded in the Statements of Income.

The Company reviews the carrying value of property, plant, and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of assets. The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the property is used, and the effects of obsolescence, demand, competition, and other economic factors. Based on this assessment there was no impairment recorded during the three months ended at March 31, 2009 and 2008.

Construction in progress - Construction in progress represents the costs incurred in connection with the construction of buildings or additions to the Company’s plant facilities. No depreciation is provided for construction in progress until such time as the assets are completed and placed into service.

Land use rights - There is no private ownership of land in the PRC. The Company has acquired land use rights to a total of 2,356,209 square feet, on which a 290,626 square feet facility is located. The land use rights have terms of 50 years, with the land use right relating to 1,207,388 square feet expiring in 2050 and the land use right with respect to 1,148,821 square feet expiring in 2057. The cost of the land use rights is amortized over the 50-year term of the land use right. The Company evaluates the carrying value of intangible assets during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the intangible asset below its carrying amount.

Income recognition - Revenue is recognized in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition, which states that revenue should be recognized when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) the service has been rendered; (3) the selling price is fixed or determinable; and (4) collection of the resulting receivable is reasonably assured. The Company believes that these criteria are satisfied when the goods are shipped pursuant to a purchase order.

 

9

---

 

Interest income is recognized when earned.

Advertising - The Company expenses all advertising costs as incurred. There was no advertising expense for the three months ended March 31, 2009.

Shipping and handling costs - The Company follows Emerging Issues Task Force (“EITF”) No. 00-10, Accounting for Shipping and Handling Fees and Costs.  The Company does not charge its customers for shipping and handling. The Company classifies shipping and handling costs as part of the operating expenses. For the three months ended March 31, 2009 and 2008, shipping and handling costs were $300,787 and $12,967, respectively.

 

Segment reporting - Statement of Financial Accounting Standards No 131 (“SFAS 131”), “Disclosure about Segments of an Enterprise and Related Information,” requires use of the “management approach” model for segment reporting. Under this model, segment reporting is consistent with the manner that the Company’s management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company.

The Company only sells carbon graphite products and sells only to Chinese distributors and end users and is in only one business segment.

Taxation - Taxation on profits earned in the PRC has been calculated on the estimated assessable profits for the year at the rates of taxation prevailing in the PRC where the Company operates after taking into effect the benefits from any special tax credits or “tax holidays” allowed in the county of operations.

  

The Company does not accrue United States income tax since it has no significant operating income in the United States. Its operating subsidiaries are organized and located in the PRC and do not conduct any business in the United States.

In 2006, the Financial Accounting Standards Board (FASB) issued FIN 48, which clarifies the application of SFAS 109 by defining a criterion that an individual income tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements and provides guidance on measurement, recognition, classification, accounting for interest and penalties, accounting in interim periods, disclosure and transition. In accordance with the transition provisions, the Company adopted FIN 48 effective January 1, 2007.

The Company recognizes that virtually all tax positions in the PRC are not free of some degree of uncertainty due to tax law and policy changes by the state. However, the Company cannot reasonably quantify political risk factors and thus must depend on guidance issued by current government officials.

Based on all known facts and circumstances and current tax law, the Company believes that the total amount of unrecognized tax benefits as of December 31, 2008 is not material to its results of operations, financial condition or cash flows. The Company also believes that the total amount of unrecognized tax benefits as of December 31, 2008, if recognized, would not have a material effect on its effective tax rate. The Company further believes that there are no tax positions for which it is reasonably possible, based on current Chinese tax law and policy, that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on the Company’s results of operations, financial condition or cash flows.

Enterprise income tax - On March 16, 2007, the PRC’s parliament, the National People’s Congress, adopted the Enterprise Income Tax Law, which took effect on January 1, 2008. The new income tax law sets unified income tax rate for domestic and foreign companies at 25% except a 15% corporation income tax rate for qualified high technology and science enterprises. In accordance with this new income tax law, low preferential tax rate in accordance with both the tax laws and administrative regulations prior to the promulgation of this law shall gradually transit to the new tax rate within five years after the implementation of this law.

The Company has been recognized as a high technology and science company by the Ministry of Science and Technology of the PRC. Therefore, Xing He District Local Tax Authority in the Nei Mongol province granted tax holiday from 100% of enterprises income tax for 10 years from 2008 through 2018. Afterwards, based on the present tax law and the Company’s status as a high technology and science company, the Company will be subject to a corporation income tax rate of 15% effective in 2019.

The enterprise income tax is calculated on the basis of the statutory profit as defined in the PRC tax laws. This statutory profit computed differently from the Company’s net income under U.S. GAAP.

 

10

---

 

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets, including tax loss and credit carry forwards, 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 of deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Value added tax  - The Provisional Regulations of the PRC Concerning Value Added Tax promulgated by the State Council came into effect on January 1, 1994. Under these regulations and the Implementing Rules of the Provisional Regulations of the PRC Concerning Value Added Tax, value added tax (“VAT”) is imposed on goods sold in or imported into the PRC and on processing, repair and replacement services provided within the PRC.

 

VAT payable in the PRC is charged on an aggregated basis at a rate of 13% or 17% (depending on the type of goods involved) on the full price collected for the goods sold or, in the case of taxable services provided, at a rate of 17% on the charges for the taxable services provided, but excluding, in respect of both goods and services, any amount paid in respect of VAT included in the price or charges, and less any deductible value added tax already paid by the taxpayer on purchases of goods and services in the same financial year.

The Company has been granted an exemption from VAT by the Xing He County People’s Government and Xing He Tax Authority on some products in which an exchange agreement is in place for raw materials and fuel.

Contingent liabilities and contingent assets - A contingent liability is a possible obligation that arises from past events and whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the Company. It can also be a present obligation arising from past events that is not recognized because it is not probable that the Company will incur a liability or obligations as a result. A contingent liability, which might occur but is not probable, is not recorded but is disclosed in the notes to the financial statements. The Company will recognize a liability or obligation when it is probable that the Company will incur it.

A contingent asset is an asset, which could possibly arise from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain events not wholly within the control of the Company. Contingent assets are not recorded but are disclosed in the notes to the financial statements when it is likely that the Company will recognize an economic benefit. When the benefit is virtually certain, the asset is recognized.

Retirement benefit costs - According to PRC regulations on pensions, the Company contributes to a defined contribution retirement program organized by the municipal government in the province in which the Company was registered and all qualified employees are eligible to participate in the program. Contributions to the program are calculated at 23.5% of the employees’ salaries above a fixed threshold amount and the employees contribute 2% to 8% while the Company contributes the balance contribution of 15.5% to 21.5%. The Company has no other material obligation for the payment of retirement benefits beyond the annual contributions under this program.

In addition, we are required by Chinese laws to cover employees in China with various types of social insurance. We believe that we are in material compliance with the relevant PRC laws.

 

Fair value of financial instruments - In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements. The provisions of this statement are to be applied prospectively as of the beginning of the fiscal year in which this statement is initially applied, with any transition adjustment recognized as a cumulative-effect adjustment to the opening balance of retained earnings. The provisions of SFAS 157 are effective for the fiscal years beginning after November 15, 2007.

Effective January 1, 2008, the Company adopted SFAS 157, Fair Value Measurements (SFAS 157). The adoption of SFAS No. 157 did not have a material impact on the Company’s fair value measurements. The carrying amounts of certain financial instruments, including cash, accounts receivable, notes receivable, other receivables, accounts payable, commercial notes payable, accrued expenses, and other payables approximate their fair values as of March 31, 2009 and December 31, 2008 because of the relatively short-term maturity of these instruments.

 

11

---

 

Foreign currency translation - The reporting currency of the Company is the U.S. dollar. The functional currency of the Company is the local currency, the Chinese Renminbi (“RMB”). Results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate at the end of the period, and equity is translated at historical exchange rates. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income. Translation adjustments for the three months ended March 31, 2009 and 2008 are $44,914 and $1,252,143, respectively. The cumulative translation adjustment and effect of exchange rate changes on cash for the three months ended March 31, 2009 and 2008 was $95 and $60,847, respectively. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

Asset and liability accounts at March 31, 2009 and December 31, 2008 were translated at 6.8456 RMB to $1.00 and at 6.8542 RMB to $1.00, respectively. Equity accounts were stated at their historical rate. The average translation rates applied to income statements for the three months ended March 31, 2009 and 2008 were 6.84659 RMB and 7.177 RMB to $1.00, respectively. In accordance with Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows," cash flows from the Company's operations are calculated based upon the local currencies using the average translation rate. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet.

Earnings per share - Basic earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income available to common shareholders by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. Potentially dilutive shares of common stock consist of the common stock issuable upon the conversion of convertible debt, preferred stock and warrants. The Company has outstanding warrants to purchase 3,000,000 shares of common stock at an exercise price of $1.20 per share and 3,000,000 shares of common stock at an exercise price of $2.00 per share. The Company uses if-converted method to calculate the dilutive preferred stock and treasury stock method to calculate the dilutive shares issuable upon exercise of warrants.

The following table sets forth the computation of the number of net income per share for the three months ended March 31, 2009 and 2008.

		Three Months Ended March 31,
		2009				2008
Weighted average shares of common stock outstanding (basic)			12,768,144				13,218,412
Shares issuable upon conversion of series A preferred stock			453,441				923,460
Shares issuable upon exercise of warrants			0				4,615,385
Weighted average shares of common stock outstanding (diluted)			13,221,585				18,757,257
Net income available to common shareholders		$	471,040			$	388,881
Net income per shares of common stock (diluted)		$	.04			$	.02

For the three months ended March 31, 2009, the Company did not include any shares of common stock issuable upon exercise of warrants, since such issuance would be antidilutive.

Accumulated other comprehensive income - The Company follows Statement of Financial Accounting Standards No. 130 (SFAS 130) "Reporting Comprehensive Income" to recognize the elements of comprehensive income. Comprehensive income is comprised of net income and all changes to the statements of stockholders' equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. For the Company, comprehensive income for the three months ended March 31, 2009 and 2008 included net income and foreign currency translation adjustments.

Related parties - Parties are considered to be related to the Company if the parties that, directly or indirectly, through one or more intermediaries, control, are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management and 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. Transactions with related parties are disclosed in the financial statements.

 

12

---

 

Recent accounting pronouncements

 

In December, 2007, the FASB issued SFAS No. 141(R), “Business Combinations”, and SFAS No. 160, “Accounting and Reporting of Noncontrolling interest in Consolidated Financial Statements, an amendment of ARB No. 51” (SFAS No. 160). These new standards will significantly change the financial accounting and reporting of business combination transactions and noncontrolling (or minority) interests in consolidated financial statements. SFAS No. 141(R) and SFAS No. 160 are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (that is, the year ended December 31, 2009 for the Company). The adoption of SFAS 141(R) and 160 does not have a material effect on the Company’s condensed consolidated financial statements.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51” (“SFAS No. 160”), which establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, this statement requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 (that is, the year ended December 31, 2009 for the Company). This Statement does not have an effect on the Company’s condensed consolidated financial statements.

 

 In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – An Amendment of FASB Statement No. 133” (“SFAS No. 161”), which changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. This statement will be effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 (that is, the year ended December 31, 2009 for the Company). This Statement does not have an effect on the Company’s condensed consolidated financial statements.

 

In May 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement). FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon either mandatory or optional conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants. Additionally, FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s non-convertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company adopted FSP APB 14-1 beginning in the first quarter of 2009, and this standard must be applied on a retroactive basis. This Statement does not have an effect on the Company’s condensed consolidated financial statements.

 

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”. This Statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). This Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. Management does not expect that this Statement will have an effect on the Company’s condensed consolidated financial statements.

 

In May 2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts—an interpretation of FASB Statement No. 60”. This Statement interprets Statement 60, “Accounting and Reporting by Insurance Enterprises” and amends existing accounting pronouncements to clarify their application to the financial guarantee insurance contracts included within the scope of this Statement. This Statement requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. This Statement also clarifies how Statement 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. This Statement is effective for financial statements issued for fiscal years beginning after December 15, 2008 (that is, fiscal 2009 for the Company), and all interim periods within those fiscal years. This Statement does not have an effect on the Company’s condensed consolidated financial statements.

 

On June 16, 2008, the FASB issued final Staff Position (FSP) No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” to address the question of whether instruments granted in share-based payment transactions are participating securities prior to vesting. As provided in the FSP, unvested share-based payment awards that contain rights to dividend payments should be included in earnings per share calculations. The guidance will be effective commencing in the year ended December 31, 2009. We are currently evaluating the requirements of EITF 03-6-1 as well as the impact of the adoption on our condensed consolidated financial statements.

 

 

13

---

 

In June 2008, the FASB issued EITF 08-4, “Transition Guidance for Conforming Changes to Issue No. 98-5.” The objective of EITF 08-4 is to provide transition guidance for conforming changes made to EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”, that result from EITF 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments”, and SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This Issue is effective for financial statements issued for fiscal years ending after December 15, 2008 and has no effect on the Company’s financial statements.

 

In June 2008, the FASB ratified Emerging Issues Task Force Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5 mandates a two-step process for evaluating whether an equity-linked financial instrument or embedded feature is indexed to the entity’s own stock.  Warrants that a company issues that contain a strike price adjustment feature, upon the adoption of EITF 07-5, are no longer being considered indexed to the company’s own stock. Accordingly, adoption of EITF 07-5 will change the current classification (from equity to liability) and the related accounting for such warrants outstanding at that date. EITF 07-5 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The adoption of EITF 07-5 as of January 1, 2009 did not have any material effect on the Company’s consolidated financial position, results of operations or cash flows.

 

In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset in a Market That Is Not Active” (FSP 157-3), which clarifies the application of SFAS 157 when the market for a financial asset is inactive. Specifically, FSP 157-3 clarifies how (1) management’s internal assumptions should be considered in measuring fair value when observable data are not present, (2) observable market information from an inactive market should be taken into account, and (3) the use of broker quotes or pricing services should be considered in assessing the relevance of observable and unobservable data to measure fair value. The Company adopted the provisions of FSP 157-3, which did not impact the Company’s financial position or results of operations.

 

 

In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities” (“FSP FAS 140-4 and FIN 46(R)-8”). FSP FAS 140-4 and FIN 46(R)-8 amends FAS 140 and FIN 46(R) to require additional disclosures regarding transfers of financial assets and interest in variable interest entities. FSP FAS 140-4 and FIN 46(R)-8 is effective for interim or annual reporting periods ending after December 15, 2008. FSP FAS 140-4 and FIN 46(R)-8 did not have any impact on the Company’s financial statements.

 

 

In January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20, and EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets”. FSP EITF 99-20-1 changes the impairment model included within EITF 99-20 to be more consistent with the impairment model of SFAS 115. FSP EITF 99-20-1 achieves this by amending the impairment model in EITF 99-20 to remove its exclusive reliance on “market participant” estimates of future cash flows used in determining fair value. Changing the cash flows used to analyze other-than-temporary impairment from the “market participant” view to a holder’s estimate of whether there has been a “probable” adverse change in estimated cash flows allows companies to apply reasonable judgment in assessing whether an other-than-temporary impairment has occurred. The adoption of FSP EITF 99-20-1, which is effective for annual reporting periods ending after December 15, 2008, does not have a material impact on the Company’s financial statements.

 

4.	Concentrations of Business and Credit Risk

Substantially all of the Company’s bank accounts are in banks located in the PRC and are not covered by any type of protection similar to that provided by the FDIC on funds held in U.S. banks.

 

The Company is operating in the PRC, which may give rise to significant foreign currency risks from fluctuations and the degree of volatility of foreign exchange rates between U.S. dollars and the Chinese RMB.

Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash, trade accounts receivables and inventories, the balances of which are stated on the balance sheet. The Company places its cash in banks located in China. Concentration of credit risk with respect to trade accounts receivables is limited due to the Company's large number of diverse customers in different locations in China. The Company does not require collateral or other security to support financial instruments subject to credit risk.

For the three months ended March 31, 2009, two customers accounted for 10% or more of sales revenues, representing 27% and 26%, respectively of the total sales. No customer accounted for 10% or more of the Company’s revenue during the three months ended March 31, 2008.

For the three months ended March 31, 2009 and 2008, the Company had insurance expense of $0 and $5,281 respectively. Accrual for losses is not recognized until such time a loss has occurred.

 

14

---

 

5.	Income Taxes

Under the Provisional Regulations of The People’s Republic of China Concerning Income Tax on Enterprises promulgated by the PRC, which took effect on January 1, 2008, domestic and foreign companies pay a unified corporate income tax of 25% except a 15% corporation income tax rate for qualified high technology and science enterprises.

The Company has been granted a 100% tax holiday from enterprises income tax from the Xing He District Local Tax Authority for the ten years 2008 through 2018. This tax holiday could be challenged by higher taxing authorities in the PRC, which could result in taxes and penalties owed for those years. For the three months ended March 31, 2009 and 2008, the enterprise income tax at the statutory rates would have been approximately $70,656 and $186,477, respectively.

 

A reconciliation of the provision for income taxes with amounts determined by the PRC statutory income tax rate to income before income taxes is as follows:

 

		Three months ended March 31,
		2009				2008
Computed tax at the PRC statutory rate of 15%		$	70,656			$	186,477
Benefit of tax holiday			(70,656	)			(186,477	)
Income tax expenses per books		$	-			$	-

6.	Trade Accounts Receivable - net

As of March 31, 2009 and December 31, 2008, trade accounts receivable consisted of the following:

 

		March 31, 2009				December 31, 2008
Amount outstanding		$	4,631,577			$	4,928,354
Bad debt provision			(610,624	)			(703,944	)
Net amount		$	4,020,953			$	4,224,410

7.	Advance to suppliers, net

As of March 31, 2009 and December 31, 2008, advance to suppliers consisted of the following:

 

 

		March 31, 2009				December 31, 2008
Amount outstanding		$	718,284			$	1,186,640
Bad debt provision			(174,711	)			(169,552	)
Net amount		$	543,573			$	1,017,088

 

For the three months ended March 31, 2009 and 2008, the reserve on advance to suppliers was charged to expenses for $5,159 and $0, respectively.

8.	Inventories

 

As of March 31, 2009 and December 31, 2008, inventories consisted of the following:

 

15

---

 

		March 31, 2009				December 31, 2008
Raw materials		$	994,136			$	820,250
Work in process			13,670,537				13,193,750
Finished goods			1,293,068				1,821,719
Repair Parts			53,897				53,830
		$	16,011,638			$	15,889,549

 

Raw materials consist primarily of asphalt, petroleum coke, needle coke and other materials used in production. Finished goods consist of graphite electrodes, fine grain graphite and high purity graphite. The costs of finished goods include direct costs of raw materials as well as direct labor used in production. Indirect production costs such as utilities and indirect labor related to production are also included in the cost of inventory.

9.	Property and Equipment, net

As of March 31, 2009 and December 31, 2008, property and equipment consist of the following:

		March 31, 2009				December 31, 2008
Building		$	8,118,267			$	7,956,770
Machinery and equipment			20,867,087				19,515,684
Motor vehicles			40,902				40,851
			29,026,256				27,513,305
Less: Accumulated depreciation			6,827,195				6,509,698
		$	22,199,061			$	21,003,607

For the three months ended March 31, 2009 and 2008, depreciation expense amounted to $309,275 and $294,373 was charged to cost of goods sold.

10.	Land Use Right

As of March 31, 2009 and December 31, 2008, land use rights consist of the following:

		March 31, 2009				December 31, 2008
Land Use Right		$	3,811,539			$	3,811,539
Less: Accumulated amortization			221,769				207,214
		$	3,589,770			$	3,604,325

 

For the three months ended March 31, 2009 and 2008, amortization expenses were $19,080 and $15,474 respectively.

Future amortization of the land use rights is as follows:

Year ended December 31,
2009		$	76,320
2010			76,320
2011			76,320
2012			76,320
2013			76,320
2014 and thereafter			3,222,725
Total		$	3,604,325

11.	Stockholders’ equity

 

(a)	Restated Articles of Incorporation

 

 

16

---

 

On January 22, 2008, the Company changed its authorized capital stock to 120,000,000 shares of capital stock, of which 20,000,000 shares are shares of preferred stock, par value $0.001 per share, and 100,000,000 shares are shares of common stock, par value $0.001 per share. The restated articles of incorporation give the directors the authority to issue one or more series of preferred stock and to designate the rights, preferences, privileges and limitation of the holders of each set. The board of directors has designated the rights, preferences, privileges and limitation of one series of preferred stock -- the series A convertible preferred stock (“series A preferred stock”).

On December 17, 2007, the Company issued its 3% promissory note in the amount of $1,200,000. Pursuant to the agreement pursuant to which the note was issued, upon the filing of a restated certificate of incorporation which provided for the creation of a series of preferred stock and the filing of a certificate of designation which created the series A preferred stock, the note would automatically be converted into 1,200,499 shares of series A preferred stock and warrants to purchase 3,000,00 shares of common stock at $1.20 per shares and 3,000,00 shares of common stock at $2.00 per share. On January 22, 2008, upon the filing of a restated articles of incorporation and a statement of designation for the series A convertible preferred stock, and the outstanding convertible note was converted into such shares of series A preferred stock and warrants.

The statement of designation for the series A preferred stock provides the following:

•	Each share of series A preferred stock is convertible into one share of common stock, at a conversion price of $1.00, subject to adjustment.

 

•

While the series A preferred stock is outstanding, with certain exceptions, if the Company issues common stock at a price or warrants or other convertible securities at a conversion or exercise price which is less than the conversion price then in effect, the conversion price shall be adjusted on a formula basis.

 

•	While the Series A Preferred Stock is outstanding, without the approval of the holders of 75% of the outstanding shares of Series A Preferred Stock, the Company may not pay cash dividends or other distributions of cash, property or evidences of indebtedness, nor redeem any shares of Common Stock.

 

•	No dividends are payable with respect to the series A preferred stock.

 

•

Upon any voluntary or involuntary liquidation, dissolution or winding-up, the holders of the series A preferred stock are entitled to a preference of $1.00 per share before any distributions or payments may be made with respect to the common stock or any other class or series of capital stock which is junior to the series A preferred stock upon voluntary or involuntary liquidation, dissolution or winding-up.

 

•

The holders of the series A preferred stock have no voting rights. However, so long as any shares of series A preferred stock are outstanding, the Company shall not, without the affirmative approval of the holders of 75% of the outstanding shares of series A preferred stock then outstanding, (a) alter or change adversely the powers, preferences or rights given to the series A preferred stock or alter or amend the certificate of designation, (b) authorize or create any class of stock ranking as to dividends or distribution of assets upon liquidation senior to or otherwise pari passu with the series A preferred stock, or any of preferred stock possessing greater voting rights or the right to convert at a more favorable price than the series A preferred stock, (c) amend our articles of incorporation or other charter documents in breach of any of the provisions thereof, (d) increase the authorized number of shares of series A preferred stock, or (e) enter into any agreement with respect to the foregoing.

 

(b)

Warrants

The warrants have terms of five years, and expire December 3, 2012. The warrants provide a cashless exercise feature; however, the holders of the warrants may not make a cashless exercise only if the underlying shares are not covered by an effective registration statement.  As of March 31, 2009, the underlying shares were not covered by a registration statement.

 

(c)	Securities Purchase Agreement

Pursuant to the securities purchase agreement, as amended (see Note 16), relating to the Company’s December 2007 private placement:

•

On January 22, 2008, the Company filed a restated certificate of incorporation which changed the Company’s authorized capital stock to 120,000,000 shares of capital stock, of which 20,000,000 shares would be shares of preferred stock, par value $.001 per share, and 100,000,000 shares would be shares of common stock, par value $.001 per share, and included a statement of designations of the rights of the holders of the series A preferred stock.

 

 

17

---

 

•

The Company and the investor entered into a registration rights agreement pursuant to which we are required to have a registration statement filed with the SEC by December 31, 2010.  The Company is required to pay liquidated damages at the rate of 200 shares of series A preferred stock for each day after December 31, 2010 that the registration statement is not declared effective or for any period that we fail to keep the registration statement effective, up to a maximum of 100,000 shares. The number of shares of series A preferred stock issuable pursuant to the liquidated damages provision is subject to reduction based on the maximum number of shares that can be registered under the applicable SEC guidelines. The registration obligation does not apply to shares that can be sold pursuant to Rule 144 of the Securities and Exchange Commission.

 

•	The investor has a right of first refusal on future financings until December 2010.

 

(d)	Cancellation of common stock

In connection with the acquisition of Talent, the Company purchased 1,000,000 shares of common stock from the then principal shareholder. The purchase price was paid in installments, with the final installment being due and paid on June 30, 2008. The Company placed 1,000,000 of the shares of common stock in escrow, and the shares were released from escrow and cancelled. 

(e)	Deemed Preferred Stock Dividend

 

Upon filing of the Company’s amended and restated articles of incorporation on January 22, 2008, $1,200,000 of convertible notes were automatically converted into (i) 1,200,499 shares of preferred stock, with each share of series A preferred stock being convertible into one share of common stock (subject to adjustment) and (ii) warrants to purchase 3,000,000 shares of the common stock at $1.20 and 3,000,000 shares at $2.00 per share. At December 17, 2007, the fair value of the warrants used to calculate the intrinsic value of the conversion option was estimated at $3,831,900 and was computed using the Black-Scholes option-pricing model based on the assumed issuance of the warrants on the date the notes were issued. Variables used in the option-pricing model include (1) risk-free interest rate at the date of grant (3.5%), (2) expected warrant life of 5 years, (3) expected volatility of 100%, and (4) 0% expected dividend.   The Company used the market price of its common stock at December 17, 2007, $0.95 per share, and computed the effective preferred stock conversion price to be $0.24 per share. The resulting intrinsic value of the conversion feature was $854,300 reported as a deemed dividend to the holder of the series A preferred stock. 

 

As the series A preferred stock does not provide for redemption by the Company or have a finite life, upon the conversion to preferred stock, a one-time preferred stock deemed dividend of $854,300 was recognized immediately as a non-cash charge. The deemed preferred stock dividend of $854,300 has been recorded as additional paid-in capital and a reduction to retained earnings in 2008.

(f)	Issuance of restricted common stock

Liquidity and Capital Resources

Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations and otherwise operate on an ongoing basis.  At March 31, 2009, we had a cash balance of $244,000, of which $241,000 was located in banks in China.

The following table sets forth information as to the principal changes in the components of our working capital from December 31, 2008 to March 31, 2009 

All amounts, other than percentages, in thousands of U.S. dollars 

 

 

27

---

 

Category		March 31, 2009				December 31, 2008				Change				Percent Change
Current assets:
Cash and cash equivalents		$	244			$	52			$	192				369.2	%
Trade accounts receivable			4,021				4,224				(203	)			(4.8	)%
Notes receivable			66				28				38				135.7	%
Other receivables			233				151				82				54.3	%
Advances to suppliers			544				1,017				(473	)			(46.5	)%
Advances to related party			291				291				--				--
Prepaid expenses			85				--				85				100.0	%
Inventories			16,012				15,890				122				0.8	%
Current liabilities:
Accounts payable and accrued expenses			808				1,253				(445	)			35.5	%
Advances from customers			787				640				147				23.0	%
Taxes payable			237				362				(125	)			(34.5	)%
Short term bank loan			4,894				4,888				6				0.1	%
Long term bank loan – current portion			1,461				1,897				(436	)			(23.0	)%
Loan from shareholder			30				--				30				100.0	%
Other payables			545				551				(6	)			(1.1	)%
Working capital:
Total current assets			21,495				21,652				(157	)			(0.7	)%
Total current liabilities			8,762				9,591				(829	)			(8.6	%)
Working capital			12,733				12,061				672				5.6	%

Our working capital position increased $672,000 to $12,733,000 at March 31, 2009 from a working capital of $12,061,000 at December 31, 2008.

We have financed our operations principally through bank loans. At March 31, 2009, we have bank loans totaling $9,568,000 outstanding.  Short term bank loans in the total amount of $4,894,000 are due in May 2009 through July 2009, bear interest at 9.711% per annum and are secured by a security interest on our fixed assets and land use rights.  A long-term note, in the amount of $4,675,000 is due October 9, 2011, and bears interest at 6.75% per annum. The current portion of the long term bank loan is $1,461,000. Although we believe that we will be able to obtain extensions of these loans when they mature, we cannot assure you that such extensions will be granted.  

 

We are required to make payments totaling $4,000,000 as part of the capital of Yongle.  We did not make the first payment, in the amount of $800,000, which was due by December 13, 2007.  The second payment, in the amount of $3,200,000 is due by September 13, 2009.  The government issued to Yongle a new business license expiring December 31, 2009 and management assumes that the Government will take no action before December 31, 2009, the expiration date of the new business license.  However, we cannot assure you that the government will not take action prior to December 31, 2009, that we will be able to make that payment before December 31, 2009, that we will receive any further extensions or that we will be able to reduce the capitalization which would reduce the amount of our payment.   Although we expect that we will be able to make these payments, we have no commitment from any funding source to provide us with the necessary funds.  Because of our stock price and the lack of any active trading in our stock, it may be difficult for us to raise the necessary funds through the sale of equity securities, and the terms of any equity securities which we may issue may results in significant dilution to our stockholders.  Our failure to make the payments on time may subject Talent subject of fines or penalties by the PRC business bureau,   In addition, Talent may not be permitted to exercise any decision-making rights as a shareholder in Yongle, which may prevent us from consolidating Yongle’s financial results with our financial statements. If Yongle loses its business license it would no longer be permitted to continue in business and it would have to terminate its operations.  In such event, we would be unable to continue in business.  Further, our banks’ perception of our ability to make the capital contribution may affect both the willingness of the banks to make or extend loans to us as well as the terms of any loans that they are willing to make.

At March 31, 2009 and 2008, we owed Mr.  Dengyong Jin $30,000 and $4,893,000, respectively.  These loans bear no interest and are due on demand.

 

We believe that our working capital, together with the cash flow from our ongoing business and our bank financing will be sufficient to enable us to meet our normal cash requirements for the next twelve months provided that:

 

•	We generate sufficient business so that we are able to generate a profit, which cannot be assured;

 

 

28

---

 

•	We are able to generate or obtain from third parties funding to enable us to make the $4,000,000 capital contribution to Yongle in a timely manner;

 

•	Our banks continue to provide us with the necessary working capital financing;

 

•	We are able to generate savings by improving the efficiency of our operations.

 

We will require additional working capital if we are going to make any acquisitions or to purchase equipment to expand our production capacity. Further, we expect that both revenue and the results of our operations will decline as a result of the effects of the global economic downturn.  We cannot assure you that funding will be available if and when we require funding. Further, in the event that any of our lenders demand payment at the time the loans are due in May 2009 through July 2009, we would require additional financing in order to repay those loans, and we cannot assure you that we will be able to obtain the necessary funding either from another bank or from other sources.

Net cash flow provided by operating activities was $832,000 for the three months ended March 31, 2009 as compared to $95,000 for the three months ended March 31, 2008, an increase of $737,000 . Net cash flow provided by operating activities in the three months ended March 31, 2009 was mainly due to our net income of $471,000, a decrease in account receivable of $209,000, a decrease in advance to suppliers of $475,000 and the add-back of non-cash items of depreciation and amortization of $328,000, offset by a decrease in accounts payable and accrued expenses of $446,000 and a decrease in taxes payable of $126,000 .

 

Net cash flow used in investing activities was $300,000 for the three months ended March 31, 2009 to purchase properties and equipments.   Cash flow use in investing activities for the three months ended March 31, 2008, was not significant.

Net cash flow used in financing activities was $340,000 for the three months ended March 31, 2009. We received $68,000 from investor by issuing 70,000 shares of restricted common stocks pursuant to a share purchase agreement. We received $30,000 proceeds from related party and repaid $438,000 bank loan.

Contractual Obligations and Off-Balance Sheet Arrangements

 

Contractual Obligations

 

We have certain fixed contractual obligations and commitments that include future estimated payments. Changes in our business needs, cancellation provisions, changing interest rates, and other factors may result in actual payments differing from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most significant assumptions used in our determination of amounts presented in the tables, in order to assist in the review of this information within the context of our consolidated financial position, results of operations, and cash flows.

The following tables summarize our contractual obligations as of March 31, 2009, and the effect these obligations are expected to have on our liquidity and cash flows in future periods.

	Payments Due by Period
	Total				Less than 1 year				1-3 Years				3-5 Years				5 Years +
Contractual Obligations :
Bank indebtedness (1)		$	9,568,190			$	6,354,446			$	3,213,7431			$	-			$	-
Total Contractual Obligations:		$	9,568,190			$	6,354,446			$	3,213,7431			$	-			$	-

 

(1)

A bank loan in the amount of  $4,893,654, of which $657,357  is due on May 6, 2009, three installments of $1,168,634 are due on May 25, 2009, June 15, 2009 and July 1, 2009 and $730,395 due on July 13, 2009. The bank loans bore interest at 9.711% per annum and were secured by a security interest on our fixed assets and land use rights. Another loan, in the amount of $4,674,536 is due October 9, 2011, and bears interest at 6.75% per annum. The current portion of this bank loan is $ 1,460,792.

 

29

---

 

Off-balance Sheet Arrangements

 

We have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder’s equity or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

We do not use derivative financial instruments in our investment portfolio and we have no foreign exchange contracts. Our financial instruments consist of cash and cash equivalents, trade accounts receivable, accounts payable and long-term obligations. We consider investments in highly liquid instruments purchased with a remaining maturity of 90 days or less at the date of purchase to be cash equivalents. However, in order to manage the foreign exchange risks, we may engage in hedging activities to manage our financial exposure related to currency exchange fluctuation. In these hedging activities, we might use fixed-price, forward, futures, financial swaps and option contracts traded in the over-the-counter markets or on exchanges, as well as long-term structured transactions when feasible.

 

Interest Rates. Our exposure to market risk for changes in interest rates relates primarily to our short-term investments and short-term obligations; thus, fluctuations in interest rates would not have a material impact on the fair value of these securities. At March 31, 2009, we had $243,697 in cash and cash equivalents. A hypothetical 2% increase or decrease in interest rates would not have a material impact on our earnings or loss, or the fair market value or cash flows of these instruments.

 

Foreign Exchange Rates. All of our sales are denominated in Renminbi (“RMB”). As a result, changes in the relative values of U.S. Dollars and RMB affect our reported levels of revenues and profitability as the results are translated into U.S. Dollars for reporting purposes. In particular, fluctuations in currency exchange rates could have a significant impact on our financial stability due to a mismatch among various foreign currency-denominated sales and costs. Fluctuations in exchange rates between the U.S. dollar and RMB affect our gross and net profit margins and could result in foreign exchange and operating losses.

Our exposure to foreign exchange risk primarily relates to currency gains or losses resulting from timing differences between signing of sales contracts and settling of these contracts. Furthermore, we translate monetary assets and liabilities denominated in other currencies into RMB, the functional currency of our operating business. Our results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in our statement of shareholders’ equity. We have not used any forward contracts, currency options or borrowings to hedge our exposure to foreign currency exchange risk. We cannot predict the impact of future exchange rate fluctuations on our results of operations and may incur net foreign currency losses in the future. As our sales denominated in foreign currencies, such as RMB and Euros, continue to grow, we will consider using arrangements to hedge our exposure to foreign currency exchange risk.

Our financial statements are expressed in U.S. dollars but the functional currency of our operating subsidiary is RMB. The value of your investment in our stock will be affected by the foreign exchange rate between U.S. dollars and RMB. To the extent we hold assets denominated in U.S. dollars, including the net proceeds to us from this offering, any appreciation of the RMB against the U.S. dollar could result in a change to our statement of operations and a reduction in the value of our U.S. dollar denominated assets. On the other hand, a decline in the value of RMB against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results, the value of your investment in our company and the dividends we may pay in the future, if any, all of which may have a material adverse effect on the price of our stock.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Not applicable to smaller reporting companies.

Item 4.  Controls and Procedures

Evaluation of Disclosure Controls and Procedures

 

30

---