SHARING ECONOMY INTERNATIONAL INC. - Quarter Report: 2015 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2015

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

COMMISSION FILE NUMBER: 001-34591

CLEANTECH SOLUTIONS INTERNATIONAL, INC.

(Exact name of Registrant as specified in its charter)

No. 9 Yanyu Middle Road

Qianzhou Village, Huishan District, Wuxi City

Jiangsu Province, China 214181

(Address of principal executive offices)

(86) 51083397559

(Registrant’s telephone number, including area code)

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.

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. 3,943,986 shares of common stock are issued and outstanding as of November 13, 2015.

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

FORM 10-Q

September 30, 2015

TABLE OF CONTENTS

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 information contained 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 FREE.

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.

PART 1 - FINANCIAL INFORMATION

Item 1.    Financial Statements.

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See condensed notes to unaudited consolidated financial statements

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE (LOSS)/INCOME

See condensed notes to unaudited consolidated financial statements

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

 See condensed notes to unaudited consolidated financial statements

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

Cleantech Solutions International, Inc. (the “Company”) was incorporated in Delaware on June 24, 1987 under the name of Malex, Inc. On December 18, 2007, the Company’s corporate name was changed to China Wind Systems, Inc., and on June 13, 2011, the Company’s corporate name was changed to Cleantech Solutions International, Inc. On August 7, 2012, the Company was converted into a Nevada corporation.

Through its affiliated companies and subsidiaries, the Company manufactures and sells forged products and fabricated products to a range of clean technology customers including high precision forged rolled rings and related components for the wind power industry and other industries and manufactures and sells textile dyeing and finishing machines. The Company is the sole owner of Fulland Limited (“Fulland”), a Cayman Island limited liability company, which was organized on May 9, 2007. Fulland owns 100% of the capital stock of Green Power Environment Technology (Shanghai) Co., Ltd. (“Green Power”) and Wuxi Fulland Wind Energy Equipment Co., Ltd. (“Fulland Wind Energy”), which are wholly foreign-owned enterprises (“WFOE”) organized under the laws of the People’s Republic of China (“PRC” or “China”). Green Power is a party to a series of contractual arrangements, as fully described below, dated October 12, 2007 with Wuxi Huayang Heavy Industries, Co., Ltd. ("Heavy Industries"), formerly known as Wuxi Huayang Electrical Power Equipment Co., Ltd., and Wuxi Huayang Dyeing Machinery Co., Ltd. (“Dyeing”), both of which are limited liability companies organized under the laws of, and based in, the PRC. Heavy Industries and Dyeing are sometimes collectively referred to as the “Huayang Companies.”

Fulland was organized by the owners of the Huayang Companies as a special purpose vehicle for purposes of raising capital, in accordance with requirements of the PRC State Administration of Foreign Exchange (“SAFE”). On May 31, 2007, SAFE issued an official notice known as Hui Zong Fa [2007] No. 106 (“Circular 106”), which requires the owners of any Chinese company to obtain SAFE’s approval before establishing any offshore holding company structure for foreign financing as well as subsequent acquisition matters in China. Accordingly, the owners of the Huayang Companies, Mr. Jianhua Wu and Ms. Lihua Tang, submitted their application to SAFE in early September 2007. On October 11, 2007, SAFE approved their application, permitting these Chinese citizens to establish Fulland as a special purpose vehicle for any foreign ownership and capital raising activities by the Huayang Companies.

Heavy Industries was formed on May 21, 2004. During the period from April 2007 until 2009, Heavy Industries produced large-scaled forged rolled rings that are up to three meters in diameter for the wind-power and other industries. Since 2009, the forged rolled rings were produced primarily by Fulland Wind Energy along with Heavy Industries. Beginning in February 2015, Heavy Industries began to produce equipment for the petroleum and chemical industries, and it produces and sells a variety heat exchangers, separators, tanks, towers, cryogenic equipment, and other products. The Company refers to this new segment of its business as the petroleum and chemical equipment segment.

Fulland Wind Energy was formed on August 27, 2008. In 2009, the Company began to produce and sell forged products through Fulland Wind Energy. Through Fulland Wind Energy, the Company manufactures and machines all forged products, including wind products such as shafts, rolled rings, gear rims, gearboxes, bearings and other components and finished products and assemblies for the wind power and other industries, including large-scale equipment used in the manufacturing process for the various industries. The Company refers to this segment of its business as the forged rolled rings and related components segment.

Dyeing, which was formed on August 17, 1995, produces and sells a variety of high and low temperature dyeing and finishing machinery for the textile industry. The Company refers to this segment as the dyeing and finishing equipment segment.

Basis of presentation; management’s responsibility for preparation of financial statements

The Company’s unaudited consolidated financial statements include the financial statements of its wholly-owned subsidiaries, Fulland, Green Power and Fulland Wind Energy, as well as the financial statements of Huayang Companies - Dyeing and Heavy Industries. All significant intercompany accounts and transactions have been eliminated in consolidation.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements as of and for the year ended December 31, 2014 and footnotes thereto included in the Company’s Annual Report on Form 10-K filed with the SEC on March 30, 2015. The consolidated balance sheet as of December 31, 2014 contained herein has been derived from the audited consolidated financial statements as of December 31, 2014, but do not include all disclosures required by the U.S. GAAP.

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Basis of presentation; management’s responsibility for preparation of financial statements (continued)

Pursuant to Accounting Standards Codification (“ASC”) Topic 810, the Huayang Companies are considered variable interest entities (“VIE”), and the Company is the primary beneficiary. The Company’s relationships with the Huayang Companies and their shareholders are governed by a series of contractual arrangements between Green Power, the Company’s wholly foreign-owned enterprise in the PRC, and each of the Huayang Companies, which are the operating companies of the Company in the PRC. Under PRC laws, each of Green Power, Dyeing and Heavy Industries is an independent legal entity and none of them is exposed to liabilities incurred by the other parties. The contractual arrangements constitute valid and binding obligations of the parties of such agreements. Each of the contractual arrangements and the rights and obligations of the parties thereto are enforceable and valid in accordance with the laws of the PRC. On October 12, 2007, the Company entered into the following contractual arrangements with each of Dyeing and Heavy Industries:

Consulting Services Agreement. Pursuant to the exclusive consulting services agreements between Green Power and the Huayang Companies, Green Power has the exclusive right to provide to the Huayang Companies general business operation services, including advice and strategic planning, as well as consulting services related to the technological research and development of dyeing and finishing machines, electrical equipment and related components (the “ Services ”). Under this agreement, Green Power owns the intellectual property rights developed or discovered through research and development, in the course of providing the Services, or derived from the provision of the Services. The Huayang Companies shall pay a quarterly consulting service fees in Renminbi (“RMB”) to Fulland that is equal to all of the Huayang Companies’ profits for such quarter.

Operating Agreement. Pursuant to the operating agreement among Green Power, the Huayang Companies and all shareholders of the Huayang Companies, Green Power provides guidance and instructions on the Huayang Companies’ daily operations, financial management and employment issues. The Huayang Companies’ shareholders must designate the candidates recommended by Green Power as their representatives on the boards of directors of each of the Huayang Companies. Green Power has the right to appoint senior executives of the Huayang Companies. In addition, Green Power agrees to guarantee the Huayang Companies’ performance under any agreements or arrangements relating to the Huayang Companies’ business arrangements with any third party. The Huayang Companies, in return, agree to pledge their accounts receivable and all of their assets to Green Power. Moreover, each of the Huayang Companies agrees that, without the prior consent of Green Power, it will not engage in any transactions that could materially affect its assets, liabilities, rights or operations, including, without limitation, incurrence or assumption of any indebtedness, sale or purchase of any assets or rights, incurrence of any encumbrance on any of their assets or intellectual property rights in favor of a third party or transfer of any agreements relating to their business operation to any third party. The term of this agreement, as amended on November 1, 2008, is 20 years from October 12, 2007 and may be extended only upon Green Power’s written confirmation prior to the expiration of the this agreement, with the extended term to be mutually agreed upon by the parties.

Equity Pledge Agreement. Under the equity pledge agreement between the Huayang Companies’ shareholders and Green Power, the Huayang Companies’ shareholders pledged all of their equity interests in the Huayang Companies to Green Power to guarantee the Huayang Companies’ performance of their respective obligations under the consulting services agreement. If the Huayang Companies or the Huayang Companies’ shareholders breach their respective contractual obligations, Green Power, as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests. The Huayang Companies’ shareholders also agreed that, upon occurrence of any event of default, Green Power shall be granted an exclusive, irrevocable power of attorney to take actions in the place and stead of the Huayang Companies’ shareholders to carry out the security provisions of the equity pledge agreement and take any action and execute any instrument that Green Power may deem necessary or advisable to accomplish the purposes of the equity pledge agreement. The Huayang Companies’ shareholders agreed not to dispose of the pledged equity interests or take any actions that would prejudice Green Power’s interest. The equity pledge agreement will expire two years after the Huayang Companies’ obligations under the consulting services agreements have been fulfilled.

Option Agreement. Under the option agreement between the Huayang Companies’ shareholders and Green Power, the Huayang Companies’ shareholders irrevocably granted Green Power or its designated person an exclusive option to purchase, to the extent permitted under PRC law, all or part of the equity interests in the Huayang Companies for the cost of the initial contributions to the registered capital or the minimum amount of consideration permitted by applicable PRC law. Green Power or its designated person has sole discretion to decide when to exercise the option, whether in part or in full. The term of this agreement, as amended on November 1, 2008, is 20 years from October 12, 2007 and may be extended prior to its expiration by written agreement of the parties.

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Basis of presentation; management’s responsibility for preparation of financial statements (continued)

Pursuant to ASC Topic 810 and related subtopics related to the consolidation of variable interest entities, the accounts of the Huayang Companies are consolidated in the accompanying financial statements. As VIEs, the Huayang Companies’ sales are included in the Company’s total sales, its income from operations is consolidated with the Company’s, and the Company’s net income includes all of the Huayang Companies net income. The Company does not have any non-controlling interest and, accordingly, did not subtract any net income in calculating the net income of the VIEs that is attributable to the Company. Because of the contractual arrangements, the Company has a pecuniary interest in the Huayang Companies that requires consolidation of the Company’s and the Huayang Companies’ financial statements.

Use of estimates

The preparation of the unaudited consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Actual results could materially differ from these estimates. Significant estimates in the three and nine months ended September 30, 2015 and 2014 include the allowance for doubtful accounts, the allowance for obsolete inventory, the useful life of property and equipment and intangible assets, assumptions used in assessing impairment of long-term assets and valuation of deferred tax assets, accruals for taxes due, and the value of stock-based compensation.

Cash and cash equivalents 

For purposes of the consolidated statements of cash flows, the Company considers all highly liquid instruments purchased with a maturity of three months or less and money market accounts to be cash equivalents. The Company maintains with various financial institutions mainly in the PRC and the U.S. As of September 30, 2015 and December 31, 2014, cash balances in banks in the PRC of $18,671,229 and $7,792,993, respectively, are uninsured.

Fair value of financial instruments and other assets

The Company adopted the guidance of ASC Topic 820 for fair value measurements which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

Level 2-Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.

Level 3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

At September 30, 2015 and December 31, 2014, equipment held for sale was measured at fair value on a nonrecurring basis as shown in the following table.

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Fair value of financial instruments and other assets (continued)

The Company conducted an impairment assessment on the equipment held for sale based on the guidelines established in ASC Topic 360 to determine the estimated fair market value of the equipment as of December 31, 2014. Upon completion of its 2014 impairment analysis, the Company determined that the carrying value exceeded the fair market value on this equipment. Accordingly, the Company recorded an impairment loss of $3,799,947 at December 31, 2014. The difference in the value of equipment held for sale at September 30, 2015 from December 31, 2014 reflects changes in the currency exchange rate.

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, restricted cash, notes receivable, accounts receivable, inventories, advances to suppliers, deferred tax assets, prepaid expenses and other, short-term bank loans, bank acceptance notes payable, accounts payable, accrued expenses, advances from customers, VAT and service taxes payable and income taxes payable approximate their fair market value based on the short-term maturity of these instruments.

ASC Topic 825-10 “Financial Instruments” allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. The Company did not elect to apply the fair value option to any outstanding instruments.

Concentrations of credit risk

The Company’s operations are carried out in the PRC. Accordingly, the Company’s 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’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. Substantially all of the Company’s cash is maintained with state-owned banks within the PRC, and none of these deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts. A significant portion of the Company’s sales are credit sales which are primarily to customers whose ability to pay is dependent upon the industry economics prevailing in these areas; however, concentrations of credit risk with respect to trade accounts receivables is limited due to generally short payment terms. The Company also performs ongoing credit evaluations of its customers to help further reduce credit risk.

At September 30, 2015 and December 31, 2014, the Company’s cash balances by geographic area were as follows:

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Restricted cash

Restricted cash consists of cash deposits held by a bank to secure bank acceptance notes payable.

Notes receivable

Notes receivable represents trade accounts receivable due from customers where the customers’ bank has guaranteed the payment of the receivable. This amount is non-interest bearing and is normally paid within six months. Historically, the Company has experienced no losses on notes receivable. The Company’s notes receivable totaled $248,670 and $114,034 at September 30, 2015 and December 31, 2014, respectively. 

Accounts receivable

Accounts receivable are presented net of an allowance for doubtful accounts. The Company maintains allowances for doubtful accounts for estimated losses. The Company reviews the accounts receivable on a periodic basis and makes general and specific allowances when there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, the Company considers many factors, including the age of the balance, a customer’s historical payment history, its current credit-worthiness and current economic trends. Accounts are written off after exhaustive efforts at collection. At September 30, 2015 and December 31, 2014, the Company has established, based on a review of its outstanding balances, an allowance for doubtful accounts in the amounts of $1,270,574 and $1,321,328, respectively. 

Inventories

Inventories, consisting of raw materials, work in process and finished goods related to the Company’s products are stated at the lower of cost or market utilizing the weighted average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, the Company will record reserves for the difference between the cost and the market value. These reserves are recorded based on estimates. The Company recorded an inventory reserve of $175,491 and $181,646 at September 30, 2015 and December 31, 2014, respectively.

Advance to suppliers

Advance to suppliers represents the cash paid in advance for the purchase of raw material from suppliers. The advance payments are intended to ensure preferential pricing and delivery. The amounts advanced under such arrangements totaled $629,605 and $565,581 as of September 30, 2015 and December 31, 2014, respectively.

Property and equipment

Property and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in the statements of income and comprehensive income in the year of disposition. The Company examines the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.

Included in property and equipment is construction-in-progress which consisted of factory improvements and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation of the assets. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use.

Equipment held for sale

At September 30, 2015 and December 31, 2014, the Company reflected electro-slag re-melted (“ESR”) equipment that was used in 2010 and 2011 to produce forged products for the high performance components market as equipment held for sale on the accompanying consolidated balance sheets. The Company has not found and does not expect to find any potential buyer or lessee in the next twelve months.

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Impairment of long-lived assets

In accordance with ASC Topic 360, the Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable, or at least annually. The Company recognizes an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value. The Company did not record any impairment charge for the three and nine months ended September 30, 2015 and 2014. 

Advances from customers  

Advances from customers at September 30, 2015 and December 31, 2014 amounted to $837,408 and $495,461, respectively, and consist of prepayments from customers for merchandise that had not yet been shipped. The Company will recognize the deposits as revenue as customers take delivery of the goods and title to the assets is transferred to customers in accordance with the Company’s revenue recognition policy.

Revenue recognition

Pursuant to the guidance of ASC Topic 605 and ASC Topic 360, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the purchase price is fixed or determinable and collectability is reasonably assured.

The Company recognizes revenues from the sale of dyeing and finishing equipment, forged rolled rings and other components, petroleum and chemical equipment upon shipment and transfer of title. The other elements may include installation and, generally, a one-year warranty. Equipment installation revenue is valued based on estimated service person hours to complete installation and is recognized when the labor has been completed and the equipment has been accepted by the customer, which is generally within a couple days of the delivery of the equipment. Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the three months ended September 30, 2015 and 2014, amounts allocated to installation and warranty revenues were $18,146 and $32,564, respectively. For the nine months ended September 30, 2015 and 2014, amounts allocated to installation and warranty revenues were $61,032 and $97,884, respectively. Based on historical experience, warranty service calls and any related labor costs have been minimal.

All other product sales with customer specific acceptance provisions, including the forged rolled rings, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.

Income taxes

The Company is governed by the Income Tax Law of the PRC and the U.S. Internal Revenue Code of 1986, as amended. The Company accounts for income taxes using the asset/liability method prescribed by ASC 740, “Accounting for Income Taxes.” Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the period in which the differences are expected to reverse. The Company records a valuation allowance to offset deferred tax assets if based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized as income or loss in the period that includes the enactment date.

The Company applied the provisions of ASC 740-10-50, “Accounting for Uncertainty in Income Taxes,” which provides clarification related to the process associated with accounting for uncertain tax positions recognized in the Company’s financial statements. Audit periods remain open for review until the statute of limitations has passed. The completion of review or the expiration of the statute of limitations for a given audit period could result in an adjustment to the Company’s liability for income taxes. Any such adjustment could be material to the Company’s results of operations for any given quarterly or annual period based, in part, upon the results of operations for the given period. As of September 30, 2015 and December 31, 2014, the Company had no uncertain tax positions, and will continue to evaluate for uncertain positions in the future.

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Stock-based compensation

Stock-based compensation is accounted for based on the requirements of the Share-Based Payment topic of ASC Topic 718 which requires recognition in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments over the period the employee or director is required to perform the services in exchange for the award (presumptively, the vesting period). The Financial Accounting Standards Board (“FASB”) also requires measurement of the cost of employee and director services received in exchange for an award based on the grant-date fair value of the award.

Pursuant to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the “measurement date.” The expense is recognized over the vesting period of the award. Until the measurement date is reached, the total amount of compensation expense remains uncertain. The Company records compensation expense based on the fair value of the award at the reporting date. The awards to consultants and other third-parties are then revalued, or the total compensation is recalculated, based on the then current fair value, at each subsequent reporting date.

Shipping costs

Shipping costs are included in selling expenses and totaled $174,497 and $336,336 for the three months ended September 30, 2015 and 2014, respectively. Shipping costs totaled $804,993 and $951,895 for the nine months ended September 30, 2015 and 2014, respectively.

Employee benefits

The Company’s operations and employees are all located in the PRC. The Company makes mandatory contributions to the PRC government’s health, retirement benefit and unemployment funds in accordance with the relevant Chinese social security laws. The costs of these payments are charged to the same accounts as the related salary costs in the same period as the related salary costs incurred. Employee benefit costs totaled $51,360 and $61,550 for the three months ended September 30, 2015 and 2014, respectively. Employee benefit costs totaled $174,738 and $180,537 for the nine months ended September 30, 2015 and 2014, respectively.

Advertising

Advertising is expensed as incurred and is included in selling, general and administrative expenses on the accompanying unaudited consolidated statements of income and comprehensive income and totaled $10,628 and $17,339 for the three months ended September 30, 2015 and 2014, respectively. Advertising expenses totaled $29,731 and $23,053 for the nine months ended September 30, 2015 and 2014, respectively. 

Research and development

Research and development costs are expensed as incurred. The costs primarily consist of raw materials and salaries incurred for the development and improvement of the Company’s new dyeing machinery. Research and development costs totaled $23,935 and $29,328 for the three months ended September 30, 2015 and 2014, respectively. Research and development costs totaled $81,195 and $87,447 for the nine months ended September 30, 2015 and 2014, respectively. 

Foreign currency translation

The reporting currency of the Company is the U.S. dollar. The functional currency of the parent company is the U.S. dollar and the functional currency of the Company’s operating subsidiaries is the Chinese Renminbi (“RMB”). For the subsidiaries and affiliates, whose functional currencies are the 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. As a result, amounts relating to assets and liabilities reported on the statements of cash flows may not necessarily agree with the changes in the corresponding balances on the balance sheets. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income. The cumulative translation adjustment and effect of exchange rate changes on cash for the nine months ended September 30, 2015 and 2014 was $(615,575) and $(2,582), respectively. Transactions denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing on the transaction dates. Assets and liabilities denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing at the balance sheet date with any 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. 

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Foreign currency translation (continued)

All of the Company’s revenue transactions are transacted in the functional currency of the operating subsidiaries and affiliates. Other than for the purchase of equipment from non-Chinese suppliers, the Company does not enter into any material transaction in foreign currencies. Transaction gains or losses have not had, and are not expected to have, a material effect on the results of operations of the Company.

Asset and liability accounts at September 30, 2015 and December 31, 2014 were translated at 6.3538 RMB to $1.00 and at 6.1385 RMB to $1.00, respectively, which were the exchange rates on the balance sheet dates. Equity accounts were stated at their historical rate. The average translation rates applied to the statements of income for the nine months ended September 30, 2015 and 2014 were 6.1606 RMB and 6.1457 RMB to $1.00, respectively. Cash flows from the Company’s operations are calculated based upon the local currencies using the average translation rate.

Income per share of common stock

ASC Topic 260 “Earnings per Share,” requires presentation of both basic and diluted earnings per share (“EPS”) with a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.

Basic net income per share is computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. The Company did not have any potentially dilutive common stock outstanding during the three and nine months ended September 30, 2015 and 2014.

The following table presents a reconciliation of basic and diluted net income per share:

Related parties

Parties are considered to be related to the Company if the parties, 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 with 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. The Company discloses all related party transactions. All transactions are recorded at fair value of the goods or services exchanged.

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 and nine months ended September 30, 2015 and 2014 included net income and unrealized gains/(losses) from foreign currency translation adjustments. 

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Recent accounting pronouncements

Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its consolidated financial condition, results of operations, cash flows or disclosures.

Reclassification

Certain reclassifications have been made in prior year same period’s consolidated financial statements to conform to the current period’s financial presentation.

NOTE 2 – ACCOUNTS RECEIVABLE

At September 30, 2015 and December 31, 2014, accounts receivable consisted of the following:

The Company reviews the accounts receivable on a periodic basis and makes general and specific allowances when there is doubt as to the collectability of individual balances.

NOTE 3 – INVENTORIES

At September 30, 2015 and December 31, 2014, inventories consisted of the following:

For the three and nine months ended September 30, 2015 and 2014, the Company did not make any change for reserve for obsolete inventories.

NOTE 4 – PROPERTY AND EQUIPMENT

At September 30, 2015 and December 31, 2014, property and equipment consisted of the following:

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 4 – PROPERTY AND EQUIPMENT (continued)

For the three months ended September 30, 2015 and 2014, depreciation expense amounted to $2,022,385 and $2,160,933, respectively, of which $1,861,821 and $1,844,902, respectively, was included in cost of revenues, $0 and $167,660, respectively, which was related to the ESR equipment which was held for operating lease in 2014, was included as a reduction to rental income, and the remainder was included in operating expenses.

For the nine months ended September 30, 2015 and 2014, depreciation expense amounted to $6,166,899 and $6,245,723, respectively, of which $5,494,243 and $5,533,436, respectively, was included in cost of revenues, $0 and $335,647 which was related to the ESR equipment which was held for operating lease in 2014, respectively, was included as a reduction in rental income, and the remainder was included in operating expenses.

Depreciation is not taken during the period of construction or equipment installation. Upon completion of the installation of manufacturing equipment or any construction in progress, construction in progress balances will be classified to their respective property and equipment category.

NOTE 5 – LAND USE RIGHTS

There is no private ownership of land in China. Land is owned by the government and the government grants land use rights for specified terms. The Company’s land use rights have terms of 45 and 50 years and expire on January 1, 2053 and October 30, 2053. The Company amortizes the land use rights over the term of the respective land use right. For the three months ended September 30, 2015 and 2014, amortization of land use rights amounted to $23,614 and $24,000, respectively. For the nine months ended September 30, 2015 and 2014, amortization of land use rights amounted to $71,966 and $72,141, respectively. At September 30, 2015 and December 31, 2014, land use rights consisted of the following:

Amortization of land use rights attributable to future periods is as follows:

NOTE 6 – EQUIPMENT HELD FOR SALE

During the last quarter of 2013, the Company decided to lease the ESR equipment that was used in 2010 and 2011 to produce forged products for the high performance components market to a third party and negotiations took place last quarter of 2013 through March 2014. In March 2014, the Company entered into an operating lease agreement with an eight-year term commencing April 1, 2014, with a third party, whereby the lessee leases the ESR equipment from the Company for quarterly lease payments of 1,450,000 RMB, including value-added tax (approximately $236,000 per quarter). Accordingly, at December 31, 2013, the ESR equipment was reflected as equipment held for operating lease. The lessee stopped using the equipment and stopped paying rent in early 2015. The Company has not found and does not expect to find any potential buyer or other lessees in the next twelve months. Therefore, the Company reclassified the equipment held for operating lease to equipment held for sale on the accompanying consolidated balance sheets at September 30, 2015 and December 31, 2014.

Equipment held for operating lease was depreciated over its estimated useful life starting from the operating lease commencement date of April 1, 2014 through December 31, 2014. Rental payments were recorded as rental income over the lease term as earned. The related depreciation on the equipment held for operating lease was recognized as a reduction of rental income on a straight-line basis.

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 7 – SHORT-TERM BANK LOANS

Short-term bank loans represent amounts due to various banks that are due within one year. These loans can be renewed with these banks upon maturity. At September 30, 2015 and December 31, 2014, short-term bank loans consisted of the following:

For the three months ended September 30, 2015 and 2014, interest expense related to short-term bank loans amounted to $61,131 and $60,487, respectively, which were included in interest expense on the accompanying unaudited consolidated statements of income and comprehensive income.

For the nine months ended September 30, 2015 and 2014, interest expense related to short-term bank loans amounted to $175,102 and $178,313, respectively, which were included in interest expense on the accompanying unaudited consolidated statements of income and comprehensive income.

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 8 – BANK ACCEPTANCE NOTES PAYABLE

Bank acceptance notes payable represent amounts due to banks which are collateralized. All bank acceptance notes payable are secured by the Company’s restricted cash which is on deposit with the lender. At September 30, 2015 and December 31, 2014, the Company’s bank acceptance notes payables consisted of the following:

NOTE 9 – ACCURED EXPENSES

At September 30, 2015 and December 31, 2014, accrued expenses consisted of the following:

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 10 – STOCKHOLDERS’ EQUITY

Common stock issued for services

On January 7, 2015, the Company issued 80,000 shares of common stock pursuant to its 2010 long-term incentive plan, including 20,000 shares to the chief executive officer, 12,000 shares to the chief executive officer’s wife, who the Company employs in its sales department, 18,000 shares to the chief financial officer and 30,000 shares to two other employees. The shares were valued at the fair market value on the grant date, and the Company recorded stock-based compensation of $274,400 on the grant date.

On July 7, 2015, the Company issued 4,000 shares of common stock pursuant to its 2010 long-term incentive plan to a director. The shares were valued at the fair market value on the grant date, and the Company recorded stock-based compensation of $11,160.

NOTE 11– STATUTORY RESERVE

The Company is required to make appropriations to statutory reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (the “PRC GAAP”). Appropriation to the statutory reserve should be at least 10% of the after tax net income determined in accordance with the PRC GAAP until the reserve is equal to 50% of the entities’ registered capital or members’ equity. As of December 31, 2014, the Company appropriated the required maximum 50% of its registered capital to statutory reserve for Heavy Industries; accordingly, no additional statutory reserve is required for the nine months ended September 30, 2015. As of December 31, 2014, the Company had not appropriated the required maximum 50% of its registered capital to statutory reserve for Dyeing and Fulland Wind Energy. For the nine months ended September 30, 2015, statutory reserve activities were as follows: 

NOTE 12 – SEGMENT INFORMATION

For the three and nine months ended September 30, 2015, the Company operated in three reportable business segments - (1) the manufacture of forged rolled rings and related components segment, (2) the manufacture of textile dyeing and finishing equipment segment, and (3) the manufacture of petroleum and chemical equipment segment. For the three and nine months ended September 30, 2014, the Company operated in two reportable business segments - (1) the manufacture of forged rolled rings and related components segment, and (2) the manufacture of textile dyeing and finishing equipment segment. The Company’s reportable segments are strategic business units that offer different products. They are managed separately based on the fundamental differences in their operations. All of the Company’s operations are conducted in the PRC. Information with respect to these reportable business segments for the three and nine months ended September 30, 2015 and 2014 was as follows:

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 12 – SEGMENT INFORMATION (continued)

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES

CONDENSED NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2015

NOTE 13 – CONCENTRATION

Customers

The following table sets forth information as to each customer that accounted for 10% or more of the Company’s sales for the three and nine months ended September 30, 2015 and 2014.

*              Less than 10%.

The largest customer accounted for 4.4% and 0% of the Company’s total outstanding accounts receivable at September 30, 2015 and December 31, 2014, respectively.

Suppliers

The following table sets forth information as to each supplier that accounted for 10% or more of the Company’s purchases for the three and nine months ended September 30, 2015 and 2014.

*              Less than 10%.

The two largest suppliers accounted for 11.4% of the Company’s total outstanding accounts payable at September 30, 2015. The three largest suppliers accounted for 30.4% of the Company’s total outstanding accounts payable at December 31, 2014.

NOTE 14 – RESTRICTED NET ASSETS

Regulations in the PRC permit payments of dividends by the Company’s PRC VIEs only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Subject to certain cumulative limit, a statutory reserve fund requires annual appropriations of at least 10% of after-tax profit, if any, of the relevant PRC VIE’s and subsidiary. Heavy Industries had reached the cumulative limit as of September 30, 2015 and December 31, 2014, respectively. The statutory reserve funds are not distributable as cash dividends. As a result of these PRC laws and regulations, the Company’s PRC VIE’s and its subsidiary are restricted in their abilities to transfer a portion of their net assets to the Company. Foreign exchange and other regulations in PRC may further restrict the Company’s PRC VIEs and its subsidiaries from transferring funds to the Company in the form of loans and/or advances.

As of September 30, 2015 and December 31, 2014, substantially all of the Company’s net assets are attributable to the PRC VIE’s and its subsidiaries located in the PRC. Accordingly, the Company’s restricted net assets at September 30, 2015 and December 31, 2014 were approximately $96,965,000 and $96,519,000, respectively.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are currently engaged in three business segments:

The following table sets forth information as to revenues of our forged rolled rings and related components, dyeing and finishing equipment and petroleum and chemical equipment segments in dollars and as a percent of revenues (dollars in thousands):

In the third quarter of 2015, challenging economic conditions, falling steel prices and limited availability of credit in China presented numerous challenges for our business. Our forged rolled rings and related products segment in particular experienced a significant reduction in sales and operated at a loss during the quarter. In our dyeing equipment segment, we experienced softer demand for our low-emission airflow dyeing machines as many of our customers already upgraded to newer models last year and much of our remaining customer base does not have the ability to make significant capital expenditures at this time. We continue to deliver parts and equipment under our contract with a large state-owned enterprise for a major chemical project in Xinjiang, which helped offset the decreases in revenue from our other two segments.

The factors that affected our revenue, gross margin and net income in our segments during the three and nine months ended September 30, 2015, which are described below, are likely to continue to affect our operations in the rest of 2015. Our ability to expand our operations and increase our revenue is largely affected by the PRC government’s policy on such matters as the availability of credit, which affects all of our operations, and its policies relating to alternative energy such as wind power, which affect our products for these industries. Our business is also affected by general economic conditions. Because of the nature of our products, our customers’ projection of future economic conditions are an integral part of their decisions as to whether to purchase capital equipment at this time or defer such purchases until a future date. We began to market to the petroleum and chemical industries during 2014, but we did not manufacture any products or generate any sales in these industries until the first quarter of 2015. During the three and nine months ended September 30, 2015, sales from the petroleum and chemical equipment segment partially offset the significant decline in revenue for both the forged rolled rings and related components and the dyeing and finishing segments.

Forged Rolled Rings and Related Components Segment

Through our forged rolled rings and other related components division, we produce precision forged rolled rings and other forged components to the wind power and other industries. Our forged rolled rings and other related components are sold to manufacturers of industrial equipment. Forged rolled rings and other forged components for the wind industry are used in wind turbines, which are used to generate wind power.

Revenues from our forged rolled rings and related components segment decreased $7.0 million, or 83.2%, for the three months ended September 30, 2015 as compared to the three months ended September 30, 2014. Revenue from our forged rolled rings and related components segment decreased $12.9 million, or 52.4%, for the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014. The demand for products used in manufacturing in general, including wind power industry and other industries, is uncertain. Although we believe that over the long term, the forged rolled rings and related components segment will expand, and the government of the PRC has announced its desire to increase the use of wind power as an energy source, in the short term, other factors, such as economic factors and the availability of credit, may affect the requirements of our customers and potential customers for our products. To the extent that the demand for our forged rolled rings and related components declines, our revenue and net income will be affected. We believe that there is a degree of market saturation for forged rolled rings and related components for wind power and other industries and this market saturation, combined with the effects of lower oil and gas prices has reduced the demand for construction of wind power facilities, and we expect that our revenues from forged rolled rings and related components will continue to decrease in the near future.

Among all the renewable energies, we believe that wind power is at a mature stage in terms of the technology and represents the best prospect for large-scale commercial development. We believe that it is becoming more competitive against traditional energy sources as the industry continues to grow and production costs continue to fall, although difficulties in transmission of electricity generated by wind power continues to affect this market and, notwithstanding the stated policies of the government of the PRC to encourage renewable energy such as wind power, the recent decline in oil prices is affecting the market for wind power generation facilities and other sources of renewable energy as potential customers are becoming reluctant to make the capital investment necessary to construct the wind power generation plants.

We believe that wind power will see its share of China’s national energy mix gradually increase. While interest in wind power is increasing in many countries, we do not have the infrastructure and personnel to market our products in countries other than China, and we are continuing to limit our sales and marketing efforts to China to wind power and other industries customers.

We previously broke down the information from this segment between wind power and other industries. We no longer believe that this distinction is material. Accordingly, we are providing information as to all forged rolled rings and related components without separating the two types of customers.

Dyeing and Finishing Equipment Segment

Revenue from our dyeing segment decreased $3.4 million, or 29.2%, for the three months ended September 30, 2015 as compared to the three months ended September 30, 2014. Revenue from our dyeing segment decreased $7.4 million, or 23.9%, for the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014. In order to reduce our business risk, we tightened our credit review policies and delayed credit sales to certain customers. In accordance with this policy change, in the nine months ended September 30, 2015, we delayed shipments of low-emission airflow dyeing machines due to a delay in receiving scheduled payments from some of our customers with outstanding accounts receivable. We expect payment from these customers and shipment of these machines in the near future. Additionally, we experienced a slowdown in shipments of our low-emission airflow dyeing machines as customers replaced older dyeing equipment with our low-emission airflow dyeing machine in 2014 and orders for new low-emission airflow dyeing machines have slowed down in the three and nine months ended September 30, 2015. Accordingly, our revenue from dyeing and finishing equipment segment decreased in the three and nine months ended September 30, 2015 as compared to the 2014 periods.

We expect our revenue from dyeing segment will remain at or near the level of the third quarter of 2015 for the near future.

Petroleum and Chemical Equipment Segment

Through our petroleum and chemical equipment division, we produce and sell equipment such as coal chemical equipment, formaldehyde plant and downstream products, reaction kettle, heat exchangers, separators, tanks, towers to petroleum and chemical industries. We started to sell our petroleum and chemical equipment in February 2015. Revenue from our petroleum and chemical equipment segment was $2.2 million and $7.7 million for the three and nine months ended September 30, 2015, respectively. The market for petroleum products is mainly dominated by three major Chinese petroleum companies, and their capital expenditure and purchasing policy will have a significant effect both upon our ability to generate revenue from this segment and the gross margins which we can generate. Furthermore, because we sell our petroleum and chemical equipment products to a very small number of customers, the change in the purchasing policies of one or two customers could have a significant effect on our revenues from this segment. Sales to a large state-owned enterprise for parts and equipment to be used on a major chemical project in Xinjiang, which was generated in the three and nine months ended September 30, 2015, accounted for approximately $2.2 million and $5.4 million, respective, or 100.0% and 70.4% of the petroleum and chemical segment revenue for the three and nine months ended September 30, 2015, respectively.

Inventory and Raw Materials

A major element of our cost of revenues is raw materials, principally steel as well as other metals. These metals are subject to price fluctuations, and recently these fluctuations have been significant. In times of increasing prices, we need to try to establish the price at which we purchase raw materials in order to avoid increases in costs which we cannot recoup through increases in sales prices. Similarly, in times of decreasing prices, we may have purchased metals at prices which are high in terms of the price at which we can sell our products, which also can impair our margins. Two major suppliers provided approximately 41% of our purchases of raw materials for the three months ended September 30, 2015. One of these two suppliers and one other major supplier provided approximately 35% of our purchases of raw materials for the nine months ended September 30, 2015. Three major suppliers of steel provided approximately 51% of our purchases of raw materials for the three months ended September 30, 2014. These three suppliers provided approximately 49% of our purchases of raw materials for the nine months ended September 30, 2014.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our unaudited consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these unaudited consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our estimates, including those related to bad debts, inventories, recovery of long-lived assets, income taxes, and the valuation of equity transactions.

We base our estimates on historical experience and on various other assumptions that we believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Any future changes to these estimates and assumptions could cause a material change to our reported amounts of revenues, expenses, assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the unaudited consolidated financial statements.

Variable Interest Entities

Pursuant to ASC Topic 810 and related subtopics related to the consolidation of variable interest entities, we are required to include in our consolidated financial statements the financial statements of variable interest entities (“VIEs”). The accounting standards require a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss for the VIE or is entitled to receive a majority of the VIE’s residual returns. VIEs are those entities in which we, through contractual arrangements, bear the risk of, and enjoy the rewards normally associated with ownership of the entity, and therefore we are the primary beneficiary of the entity.

The Huayang Companies are considered VIEs, and we are the primary beneficiary. On November 13, 2007, we entered into agreements with the Huayang Companies pursuant to which we shall receive 100% of the Huayang Companies’ net income. In accordance with these agreements, the Huayang Companies shall pay consulting fees equal to 100% of its net income to our wholly-owned subsidiary, Green Power, and Green Power shall supply the technology and administrative services needed to service the Huayang Companies.

The accounts of the Huayang Companies are consolidated in the accompanying financial statements. As VIEs, the Huayang Companies sales are included in our total sales, their income from operations is consolidated with ours, and our net income includes all of the Huayang Companies’ net income, and their assets and liabilities are included in our consolidated balance sheets. The VIEs do not have any non-controlling interest and, accordingly, we did not subtract any net income in calculating the net income attributable to us. Because of the contractual arrangements, we have pecuniary interest in the Huayang Companies that require consolidation of the Huayang Companies financial statements with our financial statements.

Accounts Receivable

We have a policy of reserving for uncollectible accounts based on our best estimate of the amount of probable credit losses in our existing accounts receivable. We periodically review our accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

As a basis for estimating the likelihood of collection has been established, we consider a number of factors when determining reserves for uncollectable accounts. We believe that we use a reasonably reliable methodology to estimate the collectability of our accounts receivable. We review our allowances for doubtful accounts on at least a quarterly basis. We also consider whether the historical economic conditions are comparable to current economic conditions. If the financial condition of our customers or other parties that we have business relations with were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventories

Inventories, consisting of raw materials, work-in-process and finished goods, are stated at the lower of cost or market utilizing the weighted average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, we will record additional reserves for the difference between the cost and the market value. These reserves are recorded based on estimates. We review inventory quantities on hand and on order and record, on a quarterly basis, a provision for excess and obsolete inventory, if necessary. If the results of the review determine that a write-down is necessary, we recognize a loss in the period in which the loss is identified, whether or not the inventory is retained. Our inventory reserves establish a new cost basis for inventory and are not reversed until we sell or dispose of the related inventory. Such provisions are established based on historical usage, adjusted for known changes in demands for such products, or the estimated forecast of product demand and production requirements.

Advances to Suppliers

Advances to suppliers represent the advance payments for the purchase of raw material from suppliers. The advance payments are intended to ensure preferential pricing and delivery.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets are as follows:

The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in the statements of income and comprehensive income in the year of disposition.

Included in property and equipment is construction-in-progress which consists of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use.

We examine the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. We recognize an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value.

Land Use Rights

There is no private ownership of land in the PRC. All land in the PRC is owned by the government and cannot be sold to any individual or company. The government grants a land use right that permits the holder of the land use right to use the land for a specified period. Our land use rights were granted with a term of 45 or 50 years. Any transfer of the land use right requires government approval. We have recorded as an intangible asset the costs paid to acquire a land use right. The land use rights are amortized on the straight-line method over the land use right terms.

Revenue Recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the purchase price is fixed or determinable and collectability is reasonably assured.

We recognize revenues from the sale of dyeing and finishing equipment, forged rolled rings and other components, petroleum and chemical equipment upon shipment and transfer of title. The other elements may include installation and, generally, a one-year warranty. Equipment installation revenue is valued based on estimated service person hours to complete installation and is recognized when the labor has been completed and the equipment has been accepted by the customer, which is generally within a couple days of the delivery of the equipment. Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the three and nine months ended September 30, 2015 and 2014, amounts allocated to installation and warranty revenues were minimal. Based on historical experience, warranty service calls and any related labor costs have been minimal.

All other product sales with customer specific acceptance provisions, including the forged rolled rings, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.

Income Taxes

We are governed by the income tax laws of the PRC and the United States. Income taxes are accounted for pursuant to ASC 740 “Accounting for Income Taxes”, which is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. The charge for taxes is based on the results for the period as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.

Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probably that taxable profit will be available against which deductible temporary differences can be utilized.

Deferred tax is calculated using tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it is related to items credited or charged directly to equity, in which case the deferred tax is changed to equity. Deferred tax assets and liabilities are offset when they related to income taxes levied by the same taxation authority and we intend to settle its current tax assets and liabilities on a net basis.

Stock-based Compensation

Stock based compensation is accounted for based on the requirements of the Share-Based Payment topic of ASC 718 which requires recognition in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments over the period the employee or director is required to perform the services in exchange for the award. The Accounting Standards Codification also requires measurement of the cost of employee and director services received in exchange for an award based on the grant-date fair value of the award.

Pursuant to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the “measurement date.” The expense is recognized over the period of services or the vesting period, whichever is applicable. Until the measurement date is reached, the total amount of compensation expense remains uncertain. We record compensation expense based on the fair value of the award at the reporting date. The awards to consultants and other third-parties are then revalued, or the total compensation is recalculated based on the then current fair value, at each subsequent reporting date.

Currency Exchange Rates

Our functional currency is the U.S. dollar, and the functional currency of our operating subsidiaries and VIEs is the RMB. All of our sales are denominated in 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 of our operations 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 subsidiaries. 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 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.

Our financial statements are expressed in U.S. dollars, which is the functional currency of our parent company. The functional currency of our operating subsidiaries and affiliates is RMB. To the extent we hold assets denominated in U.S. dollars, any appreciation of the RMB against the U.S. dollar could result in a charge in 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.

Recent Accounting Pronouncements 

Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. We do not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to our financial condition, results of operations, cash flow, or disclosures.

RESULTS OF OPERATIONS

Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2015 and 2014

The following table sets forth the results of our operations for the three months ended September 30, 2015 and 2014 indicated as a percentage of revenues (dollars in thousands):

The following table sets forth the results of our operations for the nine months ended September 30, 2015 and 2014 indicated as a percentage of revenues (dollars in thousands):

The following table sets forth information as to the revenues, gross profit and gross margin for our three business segments for the three months ended September 30, 2015 and 2014 (dollars in thousands).

The following table sets forth information as to the revenues, gross profit and gross margin for our three business segments for the nine months ended September 30, 2015 and 2014 (dollars in thousands).

Revenues. For the three months ended September 30, 2015, we had revenues of $12,025,000, as compared to revenues of $20,246,000 for the three months ended September 30, 2014, a decrease of $8,221,000 or 40.6%. The decrease in revenues for the three months ended September 30, 2015 was primarily attributable to decreases in revenue from both our forged rolled rings and related components segment and our dyeing and finishing segment, which were partially offset by revenues generated from petroleum and chemical segment. The change in revenues is summarized as follows (dollars in thousands):

For the nine months ended September 30, 2015, we had revenues of $42,862,000, as compared to revenues of $55,410,000 for the nine months ended September 30, 2014, a decrease of $12,548,000 or 22.6%. The decrease in revenues for the nine months ended September 30, 2015 was primarily attributable to decreases in revenue from both our forged rolled rings and related components segment and our dyeing and finishing segment, partially offset by revenues generated from petroleum and chemical segment. The change in revenues is summarized as follows (dollars in thousands):

Forged rolled rings and related components segment

For the three months ended September 30, 2015, revenues from the sale of forged rolled rings and related components decreased by approximately $7,027,000, or 83.2% as compared to the three months ended September 30, 2014. For the nine months ended September 30, 2015, revenue from the sale of forged rolled rings and related components decreased by approximately $12,861,000, or 52.4% as compared to the nine months ended September 30, 2014. The demand for products used in manufacturing in general, is uncertain. Although we believe that over the long term, the forged rolled rings and related components segment will expand, and the government of the PRC has announced its desire to increase the use of wind power as an energy source, in the short term other factors, such as economic factors and the fluctuations in the price of oil and coal and the availability of credit, may affect the requirements by our customers and potential customers for our products. To the extent that the demand for our forged rolled rings and related components declines, our revenues and net income will be affected. We believe that there is a degree of market saturation, and we expect that our revenues from customers of forged rolled rings and related components will continue to decrease for the near future.

Dyeing and finishing equipment segment

For the three months ended September 30, 2015, revenues from the sale of dyeing and finishing equipment decreased by approximately $3,444,000 or 29.2% as compared to the three months ended September 30, 2014. For the nine months ended September 30, 2015, revenues from the sale of dyeing and finishing equipment decreased by approximately $7,365,000 or 23.9% as compared to the nine months ended September 30, 2014. In order to reduce our business risk, we tightened our credit review policies and delayed credit sales to certain customers. Accordingly, in the nine months ended September 30, 2015, we delayed shipments of low-emission airflow dyeing machines due to a delay in receiving scheduled payments from some of our customers with outstanding accounts receivable. We expect payment from these customers and shipment of these machines in the near future. Additionally, we experienced an anticipated slowdown in shipments of our low-emission airflow dyeing machines as many customers replaced older dyeing equipment with our low-emission airflow dyeing machine in the 2014 periods, and we believe that orders for new low-emission airflow dyeing machines have slowed down in the three and nine months ended September 30, 2015 in part because the remaining potential customer base included more companies that did not have the ability to make the significant capital expenditures necessary to upgrade their equipment. Accordingly, our revenues from dyeing and finishing equipment segment decreased in the three and nine months ended September 30, 2015 as compared to the 2014 periods.

Petroleum and chemical equipment segment

We sought to expand our business to oil and natural gas industries since 2013. We received the certifications needed to serve these markets in mid-2013. However, we did not generate revenues or incur manufacturing costs from the petroleum and chemical segment until the first quarter of 2015. We expect that our revenues from petroleum and chemical equipment customers will have a modest increase in the near future. However, our revenue in this segment is highly dependent upon sales to the three major Chinese petrochemical companies, whose purchasing policies affect both our revenue and gross margin for this segment, one of which accounted for 100.0% and 70.4% of revenue from this segment for the three and nine months ended September 30, 2015, respectively.

Cost of revenues. Cost of revenues includes the cost of raw materials, labor, depreciation and other overhead costs.

For the three months ended September 30, 2015, cost of revenues was $10,023,000 as compared to $15,570,000 for the three months ended September 30, 2014, a decrease of $5,547,000, or 35.6%. Cost of revenues related to the manufacture of forged rolled rings and related components was $1,698,000 for the three months ended September 30, 2015 as compared to $6,464,000 for the three months ended September 30, 2014. Cost of revenues for the dyeing and finishing equipment segment was $6,391,000 for the three months ended September 30, 2015, as compared to $9,106,000 for the three months ended September 30, 2014. Cost of revenues for the petroleum and chemical equipment was $1,934,000 for the three months ended September 30, 2015. Since the manufacture and sale of the petroleum and chemical products commenced in the first quarter of 2015, we had neither revenues nor cost of revenues from this segment in the third quarter of 2014.

For the nine months ended September 30, 2015, cost of revenues was $35,095,000 as compared to $42,376,000 for the nine months ended September 30, 2014, a decrease of $7,281,000, or 17.2%. Cost of revenues related to the manufacture of forged rolled rings and related components was $10,465,000 for the nine months ended September 30, 2015 as compared to $18,695,000 for the nine months ended September 30, 2014. Cost of revenues for the dyeing and finishing equipment segment was $18,091,000 for the nine months ended September 30, 2015, as compared to $23,681,000 for the nine months ended September 30, 2014. Cost of revenues for the petroleum and chemical equipment was $6,539,000 for the nine months ended September 30, 2015. Since the manufacture and sale of the petroleum and chemical products commenced in the first quarter of 2015, we had neither revenues nor cost of revenues from this segment in the nine months ended September 30, 2014.

Gross profit and gross margin. Our gross profit was $2,002,000 for the three months ended September 30, 2015 as compared to $4,676,000 for the three months ended September 30, 2014, representing gross margins of 16.6% and 23.1%, respectively. Our gross profit was $7,767,000 for the nine months ended September 30, 2015 as compared to $13,034,000 for the nine months ended September 30, 2014, representing gross margins of 18.1% and 23.5%, respectively.

We incurred a negative gross profit from forged rolled rings and related components segment of $278,000 for the three months ended September 30, 2015 as compared to gross profit of $1,983,000 for the three months ended September 30, 2014, representing gross margins of approximately (19.6)% and 23.5%, respectively. Gross profit from forged rolled rings and related components segment was $1,228,000 for the nine months ended September 30, 2015 as compared to $5,859,000 for the nine months ended September 30, 2014, representing gross margins of approximately 10.5% and 23.9%, respectively. The significant decrease in our gross margin for the forged rolled rings and related components segment for the three and nine months ended September 30, 2015 was primarily attributed to the reduced scale of operations resulting from lower revenues, which is reflected in the allocation of fixed costs, mainly consisting of depreciation, to cost of revenues, combined with a modest increase in labor costs. We expect that our gross margin from forged rolled rings will continue to be negative in the same range as in the third quarter of 2015, and we can only generate a positive gross margin if we can increase our production, thereby enabling us to operate more efficiently.  Although we are selling our forged rolled rings at prices which are less than our cost, we believe that, in long term, we will be able to operate this segment profitably because we are optimistic about the long-term prospects of the wind power industry and the market for our forged rolled rings and related products.  However, we cannot assure you that we will be able to generate sufficient sales from products in this segment to operate profitably.  We are evaluating the viability of this segment on an ongoing basis and, if we determine that it is not likely that we will be able to operate this segment profitably, we may discontinue operating in this segment.  Such a decision could result in a significant write-off of the value of the assets allocated to this segment.  

Gross profit for the dyeing and finishing equipment segment was $1,964,000 for the three months ended September 30, 2015 as compared to $2,694,000 for the three months ended September 30, 2014, representing gross margins of approximately 23.5% and 22.8%, respectively. The modest increase in our gross margin for the dyeing and finishing equipment for the third quarter of 2015 as compared to the third quarter of 2014 was mainly due to the mix of equipment sales with an increase in sales from products with a higher margin. It has been our experience that, as we introduce new models, our initial margins on the new equipment are lower, and margins have improved as we increase volume, although we cannot assure you that we will be able to improve margins in the future. Gross profit for the dyeing and finishing equipment segment was $5,400,000 for the nine months ended September 30, 2015 as compared to $7,175,000 for the nine months ended September 30, 2014, representing gross margins of approximately 23.0% and 23.3%, respectively. The slight decrease in our gross margin for the dyeing and finishing equipment for the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014 was primarily attributed to the increase in the related miscellaneous sales taxes that are included in cost of revenues. We expect that our gross margin from dyeing and finishing equipment segment will remain in its current quarterly level with minimal increase in the near future.

Gross profit for the petroleum and chemical equipment segment was $316,000 and $1,139,000, respectively, for the three and nine months ended September 30, 2015, representing gross margin of approximately 14.0% and 14.8%, respectively. Many companies bid for the petroleum and chemical equipment orders. Since we are a small company and just entered this market in February 2015 and our customer base is small, we must offer a lower price in order to generate orders. Therefore, our gross margin for petroleum and chemical equipment is low. The low gross margin in this segment was one of factors in overall reduced gross margins, along with the low gross margin for forged rolled rings and related products, particularly the negative gross margin for forged rolled rings and related products in the third quarter of 2015.

Depreciation. Depreciation was $2,023,000 and $2,161,000 for the three months ended September 30, 2015 and 2014, respectively. Depreciation was $6,167,000 and $6,246,000 for the nine months ended September 30, 2015 and 2014, respectively. Depreciation for the three and nine months ended September 30, 2015 and 2014 was included in the following categories (dollars in thousands):

The depreciation expense for cost of revenues for the three and nine months ended September 30, 2015 remained roughly consistent as compared to the three and nine months ended September 30, 2014.

Some manufacturing machinery in forged rolled rings and related components segment and in dyeing and finishing equipment segment were temporary idle during the first quarter of 2015. We recorded the related depreciation in the amount of approximately $177,000 for the first quarter of 2015, for this machinery as operating expenses rather than as cost of revenues.

The increase in depreciation expense for operating expenses for the three months ended September 30, 2015 as compared to the three months ended September 30, 2014 was attributable to an increase in depreciation related to newly purchased office equipment and furniture.

The increase in depreciation expense for operating expenses for the nine months ended September 30, 2015 as compared to the nine months ended September 30, 2014 was attributable to an increase in depreciation related to newly purchased office equipment and furniture and from office and dormitory buildings and other improvements which we started depreciating in the second half of 2014, and the inclusion of depreciation of $177,000 from manufacturing machinery that is temporarily idle during the first quarter of 2015.

The depreciation expense for other expense for the three and nine months ended September 30, 2014 was related to the equipment then held for operating lease during 2014 and was reflected as an offset against rental income.

Selling, general and administrative expenses. Selling, general and administrative expenses totaled $537,000 for the three months ended September 30, 2015, as compared to $825,000 for the three months ended September 30, 2014, a decrease of $288,000 or 34.9%. Selling, general and administrative expenses totaled $2,206,000 for the nine months ended September 30, 2015, as compared to $2,590,000 for the nine months ended September 30, 2014, a decrease of $384,000 or 14.8%. Selling, general and administrative expenses for the three and nine months ended September 30, 2015 and 2014 consisted of the following (dollars in thousands):

Research and development expenses. Research and development expenses were $24,000 for the three months ended September 30, 2015, as compared to $29,000 for the three months ended September 30, 2014, a decrease of $5,000, or 18.4%. Research and development expenses were $81,000 for the nine months ended September 30, 2015, as compared to $87,000 for the nine months ended September 30, 2014, a decrease of $6,000, or 7.1%. Research and development expense related to the development of new dyeing and finishing products.

Income from operations. As a result of the factors described above, for the three months ended September 30, 2015, income from operations amounted to $1,280,000, as compared to $3,673,000 for the three months ended September 30, 2014, a decrease of $2,393,000, or 65.2%. For the nine months ended September 30, 2015, income from operations amounted to $4,807,000, as compared to $9,979,000 for the nine months ended September 30, 2014, a decrease of $5,172,000, or 51.8%.

Other income (expense). Other income (expense) includes interest income, interest expense, grant income, foreign currency transaction gain/(loss) and other income.

For the three months ended September 30, 2015, total other expense, net, amounted to $49,000 as compared to total other expense, net, of $20,000 for the three months ended September 30, 2014, an increase of approximately $29,000 or 149.8%. The increase in other expense, net, was primarily attributable to the decrease in other income of approximately $34,000, offset by the increase in interest income of approximately $7,000.

For the nine months ended September 30, 2015, total other expense, net, amounted to $145,000 as compared to total other expense, net, of $61,000 for the nine months ended September 30, 2014, an increase of approximately $84,000 or 136.6%. The increase in other expense, net, was primarily attributable to the decrease in other income of approximately $68,000, and the decrease in grant income of approximately $35,000, offset by the increase in interest income of approximately $17,000.

The other income for the three and nine months ended September 30, 2014, included rental income, net of related depreciation which was recognized as a reduction of rental income, from our equipment held for operating lease.

Income tax expense. Income tax expense was $326,000 for the three months ended September 30, 2015, as compared to $954,000 for the three months ended September 30, 2014, a decrease of $628,000, or 65.8%. Income tax expense was $1,289,000 for the nine months ended September 30, 2015, as compared to $2,604,000 for the nine months ended September 30, 2014, a decrease of $1,315,000, or 50.5%. The decrease in income tax expense was primarily attributable to the decrease in taxable income generated by our operating entities in the three and nine months ended September 30, 2015 as compared to the three and nine months ended September 30, 2014.

Net income. As a result of the foregoing, our net income was $904,000, or $0.23 per share (basic and diluted), for the three months ended September 30, 2015, as compared with $2,700,000, or $0.70 per share (basic and diluted), for the three months ended September 30, 2014, a decrease of $1,796,000, or 66.5%. Our net income was $3,373,000, or $0.86 per share (basic and diluted), for the nine months ended September 30, 2015, as compared with $7,314,000, or $1.99 per share (basic and diluted), for the nine months ended September 30, 2014, a decrease of $3,941,000, or 53.9%.

Foreign currency translation gain (loss). The functional currency of our subsidiaries and variable interest entities operating in the PRC is the Chinese Yuan or Renminbi (“RMB”). The financial statements of our subsidiaries are translated to U.S. dollars using period end rates of exchange for assets and liabilities, and average rates of exchange (for the period) for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations. As a result of foreign currency translations, which are a non-cash adjustment, we reported a foreign currency translation loss of $4,218,000 for the three months ended September 30, 2015, as compared to a foreign currency translation gain of $29,000 for the three months ended September 30, 2014. We reported a foreign currency translation loss of $3,416,000 for the nine months ended September 30, 2015, as compared to a foreign currency translation loss of $646,000 for the nine months ended September 30, 2014. This non-cash gain/loss had the effect of increasing/decreasing our reported comprehensive income. 

Comprehensive income (loss). As a result of our foreign currency translation gain/loss, we had comprehensive loss for the three months ended September 30, 2015 of $3,314,000, compared to comprehensive income of $2,729,000 for the three months ended September 30, 2014. We had comprehensive loss for the nine months ended September 30, 2015 of $42,000, compared to comprehensive income of $6,668,000 for the nine months ended September 30, 2014.

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 September 30, 2015 and December 31, 2014, we had cash balances of approximately $18,672,000 and $7,836,000, respectively. These funds are located in financial institutions located as follows (dollars in thousands):

The following table sets forth a summary of changes in our working capital from December 31, 2014 to September 30, 2015 (dollars in thousands):

Our working capital increased by $8,778,000 to $32,375,000 at September 30, 2015 from $23,597,000 at December 31, 2014. This increase in working capital is primarily attributable to an increase in cash and cash equivalents of approximately $10,836,000, an increase in restricted cash of approximately $94,000, an increase in notes receivable of approximately $135,000, an increase in advances to suppliers of approximately $64,000, a decrease in accounts payable of approximately $310,000, a decrease in accrued expenses of approximately $503,000, a decrease in VAT and service taxes payable of approximately $331,000, a decrease in income taxes payable of approximately $531,000, offset by a decrease in accounts receivable, net of allowance for doubtful accounts, of approximately $3,157,000 due to the collection efforts made in 2015, a decrease in inventories, net of reserve for obsolete inventories, of approximately $386,000, an increase in short-term bank loans of approximately $53,000, an increase in bank acceptance notes payable of approximately $94,000, and an increase in advances from customers of approximately $342,000.

Because the exchange rate conversion is different for the consolidated balance sheets and the consolidated statements of cash flows, the changes in assets and liabilities reflected on the consolidated statements of cash flows are not necessarily identical with the comparable changes reflected on the consolidated balance sheets.

Net cash flow provided by operating activities was $11,302,000 for the nine months ended September 30, 2015 as compared to $9,794,000 for the nine months ended September 30, 2014, an increase of $1,508,000.

Net cash flow provided by operating activities for the nine months ended September 30, 2015 primarily reflected net income of approximately $3,373,000, and the add-back of non-cash items primarily consisting of depreciation of approximately $6,167,000, amortization of land use rights of approximately $72,000, and stock-based compensation of approximately $286,000, and changes in operating assets and liabilities primarily consisting of a decrease in accounts receivable of approximately $2,546,000 due to the collecting efforts made in 2015, a decrease in inventories of approximately $250,000, and an increase in advances from customers of approximately $370,000, offset by an increase in notes receivable of approximately $143,000, an increase in advances to suppliers of approximately $86,000, a decrease in accounts payable of approximately $168,000, a decrease in accrued expenses of approximately $487,000, a decrease in VAT and service taxes payable of approximately $324,000, and a decrease in income taxes payable of approximately $575,000.

Net cash flow provided by operating activities for the nine months ended September 30, 2014 primarily reflected net income of $7,314,000 and the add-back of non-cash items consisting of depreciation of $6,246,000, amortization of land use rights of $72,000 and stock-based compensation expense of $285,000, and changes in operating assets and liabilities primarily consisting of a decrease in notes receivable of $461,000, a decrease in accounts receivable of $729,000 due to the collection made in 2014, a decrease in prepaid value-added taxes on purchases of $257,000, a decrease in advance to suppliers of $113,000, offset by an increase in inventories of $2,959,000 due to the increase in raw materials and work-in-process in order to satisfy the anticipated increased purchase orders from our customers, a decrease in accounts payable of $314,000, a decrease in accrued expenses of $215,000, a decrease in income taxes payable of $967,000 due to the payments made to China tax authorities in 2014, and a decrease in advances from customers of $1,217,000.

For the nine months ended September 30, 2015 and 2014, net cash flow used in investing activities reflects the purchase of property and equipment of approximately $13,000 and $10,823,000, respectively. The property and equipment purchased in the nine months ended September 30, 2014 related to the expansion of our dyeing and finishing production facilities.

Net cash flow provided by financing activities was approximately $162,000 for the nine months ended September 30, 2015 as compared to net cash flow provided by financing activities of approximately $1,624,000 for the nine months ended September 30, 2014. During the nine months ended September 30, 2015, we received proceeds from bank loans of approximately $4,545,000, and proceeds from the increase in bank acceptance notes payable of approximately $114,000, offset by repayments for bank loans of approximately $4,383,000, and payments for the increase in restricted cash of approximately $114,000. During the nine months ended September 30, 2014, we received proceeds from bank loans of $3,092,000, proceeds from the decrease in restricted cash of $244,000 and net proceeds from sale of common stock of approximately $1,624,000 to our chief executive officer and his wife, offset by the repayments of bank loans of $3,092,000 and the decrease in bank acceptance notes payable of $244,000.

Our capital requirements for the next twelve months relate to purchasing machinery for the manufacture of products in our petroleum and chemical equipment segment. We believe that our cash flow from operations will be sufficient to meet our anticipated cash requirements for the next twelve months.

We generally finance our operations through short term loans from our banks, which we refinance upon expiration. We do not have any long-term financing arrangements. 

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 September 30, 2015 (dollars in thousands), and the effect these obligations are expected to have on our liquidity and cash flows in future periods.

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.

Foreign Currency Exchange Rate Risk

We produce and sell almost all of our products in China. Thus, most of our revenues and operating results may be impacted by exchange rate fluctuations between RMB and US dollars. For the three and nine months ended September 30, 2015, we had unrealized foreign currency translation loss of $4,217,933 and $3,415,632, respectively, because of changes in the exchange rate.

Inflation

The effect of inflation on our revenue and operating results was not significant.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not required for smaller reporting companies.

ITEM 4.  CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

As required by Rule 13a-15 under the Exchange Act, our management, including Jianhua Wu, our chief executive officer, and Adam Wasserman, our chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2015.

Disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating and implementing possible controls and procedures.

Management conducted its evaluation of disclosure controls and procedures under the supervision of our chief executive officer and our chief financial officer. Based on that evaluation, Mr. Wu and Mr. Wasserman concluded that our disclosure controls and procedures were not effective as of September 30, 2015.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act. Our management is also required to assess and report on the effectiveness of our internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”). As reported in our Form 10-K for the year ended December 31, 2014, management assessed the effectiveness of our internal control over financial reporting as of December 31, 2014 and, during our assessment, management identified significant deficiencies related to (i) the U.S. GAAP expertise of our internal accounting staff, (ii) our internal audit functions and (iii) a lack of segregation of duties within accounting functions. Although management believes that these deficiencies do not amount to a material weakness, our internal controls over financial reporting were not effective at December 31, 2014.

We currently have no plans to expand our ERP system during 2015 and have not implemented further ERP modules to manage inventory and to expand existing ERP systems to other areas of our factory. Due to our working capital requirements and the lack of local professionals with the necessary experience in implementing the ERP system, we postponed the hiring of professional staff to implement ERP system. We have found that engaging professionals who are based outside of Wuxi is very costly and we have not been able to find qualified personnel in the Wuxi area.

Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. As a result, we have not been able to take steps to improve our internal controls over financial reporting during the nine months ended September 30, 2015. However, to the extent possible, we will implement procedures to assure that the initiation of transactions, the custody of assets and the recording of transactions will be performed by separate individuals.

A material weakness (within the meaning of PCAOB Auditing Standard No. 5) is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company’s financial reporting.

In light of this significant deficiency, we performed additional analyses and procedures in order to conclude that our consolidated financial statements for the three and nine months ended September 30, 2015 included in this Quarterly Report on Form 10-Q was fairly stated in accordance with the U.S. GAAP. Accordingly, management believes that despite our significant deficiency, our consolidated financial statements for the quarter ended September 30, 2015 are fairly stated, in all material respects, in accordance with the U.S. GAAP.

Changes in Internal Controls over Financial Reporting

There were no changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls over financial reporting that occurred during the period 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

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.