UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 2012
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________to _____________
Commission File No. 001-34812
THT HEAT TRANSFER TECHNOLOGY,
INC.
(Exact name of registrant as specified in its
charter)
Nevada | 20-5463509 |
(State or other jurisdiction of incorporation or | (I.R.S. Employer Identification No.) |
organization) |
THT Industrial Park
No. 5
Nanhuan Road, Tiexi District
Siping, Jilin Province 136000
Peoples
Republic of China
(Address of principal executive offices)
86-434-3265241
(Registrants telephone number,
including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered |
Common Stock, par value $0.001 per share | NASDAQ Capital Market |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [ ] No [ X ]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [ X ]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files)
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
[ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [ ] | Accelerated Filer [ ] |
Non-Accelerated Filer [ ] (Do not check if a smaller reporting company) | Smaller reporting company [ X ] |
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [ ] No [ X ]
As of June 29, 2012 (the last business day of the registrants most recently completed second fiscal quarter), the aggregate market value of the shares of the registrants common stock held by non-affiliates (based upon the closing sale price of such shares as reported on the NASDAQ Global Market) was approximately $29.5 million. Shares of the registrants common stock held by each executive officer and director and each by each person who owns 10% or more of the outstanding common stock have been excluded from the calculation in that such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
There were a total of 20,453,500 shares of the registrants common stock outstanding as of March 31, 2013.
DOCUMENTS INCORPORATED BY REFERENCE
None.
THT HEAT TRANSFER TECHNOLOGY, INC. |
Annual Report on Form 10-K |
Year Ended December 31, 2012 |
TABLE OF CONTENTS |
INTRODUCTORY NOTE
Special Note Regarding Forward Looking Statements
In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We use words such as believe, expect, anticipate, project, target, plan, optimistic, intend, aim, will or similar expressions which are intended to identify forward-looking statements. Such statements include, among others, those concerning market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; as well as all assumptions, expectations, predictions, intentions or beliefs about future events. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those identified in Item 1A Risk Factors herein, as well as assumptions, which, if they were to ever materialize or prove incorrect, could cause the results of the Company to differ materially from those expressed or implied by such forward-looking statements.
Readers are urged to carefully review and consider the various disclosures made by us in this report and our other filings with the SEC. These reports attempt to advise interested parties of the risks and factors that may affect our business, financial condition and results of operations and prospects. The forward-looking statements made in this report speak only as of the date hereof and we disclaim any obligation, except as required by law, to provide updates, revisions or amendments to any forward-looking statements to reflect changes in our expectations or future events.
Use of Terms
Except as otherwise indicated by the context and for the purposes of this report only, references in this report to:
THT, Company, we, us, or our are to the combined business of THT Heat Transfer Technology, Inc., a Nevada corporation, and its consolidated subsidiaries: Megaway, Star Wealth, Siping Juyuan and Beijing Juyuan;
Megaway are to Megaway International Holdings Limited, a BVI company;
Star Wealth are to Star Wealth International Holdings Limited, a Hong Kong company;
Siping Juyuan are to Siping City Juyuan Hanyang Plate Heat Exchanger Co. Ltd., a PRC company;
Beijing Juyuan are to Beijing Juyuan Hanyang Heat Exchange Equipment Co., Ltd., a PRC company;
BVI are to the British Virgin Islands;
Hong Kong are to the Hong Kong Special Administrative Region of the Peoples Republic of China;
PRC and China are to the Peoples Republic of China;
SEC are to the Securities and Exchange Commission;
Exchange Act are to the Securities Exchange Act of 1934, as amended;
Securities Act re to the Securities Act of 1933, as amended;
Renminbi and RMB are to the legal currency of China; and
U.S. dollars, dollars and $ are to the legal currency of the United States.
1
PART I
ITEM 1. BUSINESS.
Overview of Our Business
We are a leading total solution provider in the heat exchange industry. Our major products are plate heat exchangers, heat exchanger units, air-cooled heat exchangers and shell-and-tube heat exchangers. Unlike most other heat exchanger manufacturers in China, we not only provide heat exchange products, but also provide total solutions to our customers. As a total solutions provider, we analyze the working condition of our customers, provide optimized designs based on analysis and simulation, offer high quality heat exchange products, and continuously assist our customers in improving the heat exchange process.
Over the past ten years, we have successfully completed over 3,000 projects in more than 15 industries, including metallurgy, heat and power, petrochemical, food and beverage, pharmaceutical and shipbuilding. We have provided heat exchange solutions to Fortune 500 companies, including Shell, BP, BASF, LG, Sinopec and China Shenhua. We have also provided heat exchange products for important Chinese and international projects such as the Beijing 2008 Olympics Wukesong Sports Center, Guangdong Linao nuclear plant and BASF Chemical plant in Germany.
Our operations are headquartered in Siping, Jilin Province, PRC. Our primary Chinese operating subsidiaries are Siping Juyuan and Beijing Juyuan.
Our Corporate History
Background and History of BTHC VIII, Inc.
We were organized on August 7, 2006 as a Delaware corporation under the name BTHC VIII, Inc. to effect the reincorporation of BTHC VIII, LLC, a Texas limited liability company, mandated by the plan of reorganization discussed below. In accordance with the confirmed plan of reorganization, our business plan was to identify a privately-held operating company desiring to become a publicly held company by merging with us through a reverse merger or other acquisition transaction.
In September 1999, Ballantrae Healthcare LLC and affiliated limited liability companies, including BTHC VIII, LLC, were organized for the purpose of operating nursing homes throughout the United States. On March 28, 2003, they filed a petition for reorganization under Chapter 11 of the United States Bankruptcy Code. On November 29, 2004, the United States Bankruptcy Court in the Northern District of Texas, Dallas Division approved the First Amended Joint Plan of Reorganization. On August 16, 2006, pursuant to the plan of reorganization, BTHC VIII, LLC was merged into our Company.
We were subject to the jurisdiction of the bankruptcy court until we consummated the exchange transaction described below with Sino- America Ventures, Inc., a Delaware corporation, in February 2009. Because we consummated our merger with a qualifying entity in a timely manner, we filed a certificate of compliance with the bankruptcy court asserting that the requirements of the plan of reorganization had been satisfied, which resulted in an order granting the discharge. Thereafter, the post discharge injunction provisions (set forth in the plan of reorganization) and the confirmation order became effective.
Exchange Transaction with Sino- America Ventures, Inc.
On February 12, 2009, we entered into a share exchange agreement with Sino- America Ventures, Inc. and its sole stockholder, Mr. Gerard Pascale, pursuant to which Mr. Pascale transferred 100% of the issued and outstanding shares of the capital stock of Sino- America Ventures, Inc. to us in exchange for 5,404,800 newly issued shares of our common stock that constituted approximately 90% of our issued and outstanding capital stock on a fully-diluted basis as of, and immediately after, the consummation of such exchange. As a result of this transaction, Mr. Pascale became our controlling stockholder and Sino- America Ventures, Inc. became our subsidiary. Sino- America Ventures, Inc. was organized on February 10, 2009 to identify a privately-held operating company desiring to become a publicly held company by combination through a reverse merger or acquisition transaction, and was dissolved on May 22, 2009.
2
Acquisition of Megaway
On June 30, 2009, we completed a reverse acquisition transaction with Megaway, whereby we acquired all of the issued and outstanding capital stock of Megaway in exchange for 14,800,000 shares of our common stock, which, after giving effect to the cancellation of 4,805,387 shares of our common stock by Mr. Gerald Pascale in connection with the reverse acquisition, constituted 92.5% of our issued and outstanding capital stock on a fully-diluted basis as of and immediately after the consummation of the reverse acquisition. Megaway thereby became our wholly owned subsidiary and Wisetop International Holdings Limited, or Wisetop, the sole shareholder of Megaway, became our controlling stockholder. For accounting purposes, the share exchange transaction was treated as a reverse acquisition with Megaway as the acquirer and the Company as the acquired party.
As a result of the reverse acquisition of Megaway, our business became the business of Megaway and its subsidiaries, Star Wealth, Siping Juyuan and Beijing Juyuan.
Megaway was incorporated in the BVI on April 8, 2009. Megaway is a holding company that has no operations or assets other than its ownership of all of the capital stock of Star Wealth. Star Wealth was incorporated in Hong Kong on March 25, 2009. Star Wealth is also a holding company that has no operations or assets other than its ownership of all of the equity interests of Siping Juyuan, which was acquired by Star Wealth on June 8, 2009. Siping City Juyuan Heat Exchange Equipment Co., Ltd., the predecessor of Siping Juyuan, was first incorporated in China in December 1998. In May 2006, it was divided into three individual enterprises, including Siping Juyuan. Siping Juyuan carried on the primary business of Siping City Juyuan Heat Exchange Equipment Co., Ltd., while the other two enterprises gradually ceased operations. Mr. Guohong Zhao, our Chairman, Chief Executive Officer and President, is the founder of Siping City Juyuan Heat Exchange Equipment Co., Ltd.. All of our manufacturing operations are conducted through Siping Juyuan. Siping Juyuan owns 75% of the equity interests of Beijing Juyuan, which is solely engaged in the sales of Siping Juyuans products, and carries no production activities. The other 25% is owned by Hanyang International GmbH, a German company.
Reincorporation
On November 24, 2009, we effected a reincorporation from Delaware to Nevada by merging with THT Heat Transfer Technology, Inc., a corporation that we established in the State of Nevada solely to effect the reincorporation. As a result of the reincorporation, our domicile was changed from Delaware to Nevada and our name was changed from BTHC VIII, Inc. to THT Heat Transfer Technology, Inc.
Our Corporate Structure
The following chart reflects our current corporate organizational structure:
3
Our Control of the PRC Subsidiaries
Siping Juyuan, our PRC subsidiary, is duly organized as a wholly foreign-owned enterprise with limited liability and validly existing under the laws of the PRC. Star Wealth acquired the 100% equity interests of Siping Juyuan on June 8, 2009. All the necessary PRC governmental authorizations were duly obtained in connection with this acquisition, including:
(1) Approval for Equity Merger of Siping Juyuan Han Yang Plate Heat Exchanger Co., Ltd by Star Wealth International Holdings Limited to Establish the Foreign-invested Enterprise (Ref. Ji Jing Ju Shen Ban Zi [2009] 46) issued by the Economic Technology Cooperation Bureau of Jilin Province on May 31 2009; (2) Certificate of Approval for Establishment of Enterprises with Investment of Taiwan, Hong Kong, Macao, and Oversea Chinese in the Peoples Republic of China (Ref. Shang Wai Zi Ji Fu Zi [2009] 0019) issued by Peoples Government of Jilin Province on June 1 2009; (3) Business License (Registration No. 220300000002398) issued by Jilin Province Administration for Industry and Commerce on June 8, 2009.
In accordance with M&A Rule, the approval from MOFCOM is required when a PRC business that is owned by PRC individual(s) is sold to a non-PRC entity that is established or controlled, directly or indirectly, by those same PRC individual(s). But with respect to the Star Wealths acquisition of Siping Juyuans 100% equity interest, Star Wealth, a corporation incorporated in Hong Kong, is not established or controlled, directly or indirectly by Mr. Guohong Zhao and other original shareholders; the Star Wealths actually controller was Ms. Jinghua Zhao by then. Therefore, the approval from MOFCOM is not required for Star Wealths acquisition of the 100% equity interests in Siping Juyuan; and the above-mentioned approvals from the above authorities constituted lawful and valid and necessary PRC governmental authorizations for Star Wealths acquisition of the 100% equity interests in Siping Juyuan.
4
Because there isnt clear definition of Round-trip Investment under M&A Rule, and the relevant regulatory authorities have not issued corresponding explanation of this matter, therefore there are ambiguous understandings regarding the definition of Round-trip Investment. So theoretically speaking, because at the end of the transactions the PRC Individuals became the majority owners of a foreign entity that acquired ownership of Siping Juyuan and Beijing Juyuan, there exists the possibility that the PRC regulatory authorities determine that the whole transactions constitute a Round-trip Investment. Therefore we disclosed the relevant risk on Page 20 and 28, though in reality, MOFCOM has never issued approval concerning Round-trip Investment, neither has any PRC regulatory authority revoked the approval which is issued by itself and further requires the approval from MOFCOM, and the possibility that Star Wealths acquisition of the equity interests in Siping Juyuan will be viewed as a Round-trip Investment and an approval from MOFCOM will be required is very low. However, we cannot assure you that the PRC regulatory authorities will not amend or explain or adjust the M&A Rule further in the future.
To date, Siping Juyuan has not received any letter or notice from the above-mentioned authorities to revoke the above-mentioned approvals, and the above-mentioned approvals still remain lawful and valid.
Beijing Juyuan is duly organized as a Sino-foreign joint venture and validly existing under the laws of the PRC. All the following necessary PRC governmental authorizations were duly obtained in connection with the incorporation of Beijing Juyuan:
(1) Reply Regarding Approval of Joint Venture Contract and Articles of Association of Beijing Juyuan Han Yang Heat Exchange Equipment Co., Ltd (Ref. Chao Shang Fu Zi [2005] No. 1395) issued by Beijing City Chao Yang District Commercial Bureau on August 19 2005 (2) Certificate of Approval for Establishment of Foreign-Invested Enterprises (Ref. Shang Wai Zi Jing Zi [2005] No.05425) issued by Peoples Government of Beijing Municipal City on August 22 2005; (3) Business License (Ref. Qi He Jing Zong Zi No. 027241) issued by Beijing City Administration for Industry and Commerce September 20 2005.
To sum up, both Siping Juyuan and Beijing Juyuan are duly organized as foreign-invested enterprises with limited liability and validly existing under the laws of the PRC. Both Siping Juyuan and Beijing Juyuan have duly obtained all necessary PRC governmental authorizations concerning the incorporation and each alteration, including those from the competent ministry of commerce, administration of industry and commerce, and SAFE. And to date, all the approvals, authorizations and filings have not been revoked or questioned.
But since Mr. Guohong Zhao and the founders have exercised their options and they have become the controlling stockholders, pursuant to the Regulation of the Peoples Republic of China on Foreign Exchange Administration and Measures for the Administration of Individual Foreign Exchange and Circular 75, Mr. Guohong Zhao and the founders are required to filings with competent SAFE for their equity interest in the overseas entities. According to Siping Juyuans statement, it has requested Mr. Guohong Zhao and the founders to register with the relevant branch of SAFE in connection with their equity interests in overseas entities, and Mr. Guohong Zhao and the founders have started communication with the competent branch of SAFE and the preparation of corresponding documents.
Our Industry
A heat exchanger is a device built for efficient heat transfer from one medium to another. It is widely used in various industries including metallurgy, heat and power, petrochemical, food and beverage, pharmaceutical and shipbuilding.
According to Siping Heat Exchanger Association, the world heat exchanger market has grown significantly in the past several years. The global sales value of heat exchangers grew from $38.6 billion in 2008 to $49.7 billion in 2012, representing a growth of 28%, and is expected to grow to $70.4 billion in 2016, representing a growth of 42% in the four-year period from 2009 to 2012. According to the report, China has become the second largest market and one of the fastest growing markets for heat exchangers. The sales value of heat exchangers in China grew from $5.4 billion in 2008 to $8.3 billion in 2012, representing a growth of 54%, and is expected to grow to $ 16.7 billion in 2016, representing a growth of 101% in the four-year period from 2009 to 2012.
We anticipate that growth in the Chinese heat exchanger industry will mainly be driven by the following factors:
5
Rapid Economic Growth in China. According to the National Bureau of Statistics of the PRC, Chinas GDP grew 7.8% in 2012, one of the fastest rates in the world. Because heat exchangers are widely used in various industries, including metallurgy, heat and power, petrochemical, food and beverage, pharmaceutical and shipbuilding, the heat exchanger market benefits from the general growth of the economy.
Expanding Energy Needs. A fast growing economy requires more energy. To keep pace with rising energy demands, additional power plants are being constructed. Heat exchangers are widely used in the closed circulation systems of thermal power plants, nuclear reactor heat exchange systems and regular water cooling systems of nuclear power plants. According to the State Electricity Regulatory Commission, energy investment in China was $84.9 billion in 2009 and is expected to grow at compound annual growth rates of 10% until 2013. The Chinese government plans to spend a total of $66 billion in nuclear power plant construction. By 2020, 23 million kilowatt level nuclear power plants will be constructed. In 2011, construction began on twelve new nuclear power plants in the provinces of Zhejiang, Shandong, Guangdong, Liaoning, Fujian, Hainan and Hainan.
Environmental Protection. New environmental rules and regulations have helped reduce emissions and energy consumption. Both the Chinese and foreign governments encourage investments in order to reduce energy consumption and emissions. In many applications, industry buyers tend to use heat exchangers instead of simple cooling systems after giving consideration to their efficiency and energy savings. In 2012, investment in energy savings and emissions reduction in China was approximately $26.98 billion and is expected to reach $375.56 billion in 2013. According to the World Nuclear Organization, as of March 2011, China had 28 operating nuclear reactors and 57 reactors in the construction or planning phases.
Rapid Urbanization. Heat exchangers are an important part of district heating systems (i.e., systems for distributing heat generated in a centralized location for residential and commercial heating requirements such as space and water heating). Such systems are required in the cities of northern China, an area which is experiencing a rapid pace of urbanization. As well, Heating, Ventilation and Air Conditioning systems, or HVAC, which are essential for buildings, require installation of heat exchangers. In 2009, the HVAC market in China was $6.0 billion and is expected to grow at a compound annual growth rate of 27.42% by 2014.
Rise in Shipbuilding. The sea remains Chinas most important transportation method and we expect that sea transportation will experience growth due to continued globalization. To satisfy the need for more sea transportation, more ships are required to be built. Heat exchangers are installed in the engine cooling and air- conditioning systems of every ship. China has become a strong player in shipbuilding. According to the Chinese Ministry of Industry and Information Technology, in 2012, China delivered 60.21 million deadweight tonnages of new ships and became the worlds leading shipbuilder.
Our Competitive Strengths
We believe that the following strengths enable us to compete effectively in and to capitalize on growth in the heat exchange industry in China:
Leading market position. Our leading sales position will help develop our brand and brand awareness throughout China and assist us in acquiring an even larger market share in the future.
Comprehensive solution provider. Unlike most other heat exchanger manufacturers in China, we not only provide heat exchange products, but also provide comprehensive solutions to our customers. As a total solution provider, we analyze the working condition of our customers, provide optimized design based on analysis and simulation, offer high quality heat exchange products and continuously assist our customers in improving their heat exchange processes.
Broad product range. We provide the broadest range of heat exchanger products in China, surpassed only by Alfa Laval, the global market leader for heat exchanger products. Our products include plate heat exchangers, shell and tube heat exchangers, heat exchange units, air-cooled heat exchangers, welded plate heat exchangers and plate- and-shell heat exchangers. Our broad product variety provides our customers with one-stop purchasing convenience.
6
Solid track record. Over the past ten years, we have successfully completed over 3,000 projects in more than 15 industries, including metallurgy, heat and power, petrochemical, food and beverage, pharmaceutical and shipbuilding. We have provided heat exchange solutions to Fortune 500 companies including Shell, BP, BASF, LG, Sinopec, and China Shenhua as well as for high profile projects in both the PRC and other countries. Noteworthy projects include the Wukesong Sports Center for the 2008 Olympics in Beijing, the Guangdong Linao nuclear plant and the BASF Chemical plant in Germany. Our strong track record and our demonstrated ability to develop and deliver high quality solutions provides our Company with a strong brand and reputation in the industry.
Professional sales team. We have a sales team with 122 experienced sales people, which we believe is among the largest in the Chinese market. Our sales people are organized into four groups by industry: metallurgy, heat and power, petrochemical and shipbuilding. Each group specializes in serving customers in their specific industry. We believe this specialization allows our sales people to be more focused and equipped with superior industry knowledge and experience.
Our Growth Strategies
We are committed to enhancing our sales, profitability and cash flows through the following strategies:
Increasing production and processing capacity. To fulfill future sales growth and enhance our capacity during peak periods, we recently expanded our production facility. Our new workshop has a floor area of 7,356 square meters and our new production line of plate heat exchangers, with a designed capacity of 200,000 square meters annually, was implemented in the new workshop in October 2009.
Expanding sales network. We will further expand our sales network by establishing new sales offices in China. We are also strengthening our international marketing efforts.
Continually developing new products. We will continue to develop new products to broaden our product range so as to meet increased customer demands and seize larger market share. New products under development include semi-welded plate heat exchangers, disassemble plate evaporators, welded plate falling-film evaporators and oversized plate-and-shell heat exchangers. These new products will help us reach a larger number of customers in the chemical, food and beverage, pharmaceutical and refinery industries.
Our Products
Our products and heat exchange solutions are sold to customers in the chemical, metallurgical and shipbuilding industries and our products are also used with HVAC and district heating systems. Our products include plate heat exchangers, heat exchanger units, air-cooled heat exchangers, shell-and-tube heat exchangers, welded plate heat exchangers and plate-and-shell heat exchangers.
Plate Heat Exchangers
A plate heat exchanger is a type of heat exchanger that uses metal plates to transfer heat between two fluids. This type of heat exchanger has a major advantage over a conventional shell and tube heat exchangers since the fluids are exposed to a much larger surface area because the fluids spread out over the plates. This spreading of fluids over the plates facilitates the transfer of heat and greatly increases the speed of the temperature change.
The plate heat exchanger consists of a coiled pipe containing one fluid that passes through a chamber containing another fluid. The walls of the pipe are usually made of metal or another substance with a high thermal conductivity to facilitate the interchange. The outer casing of the larger chamber is made of a plastic or coated with thermal insulation to discourage heat from escaping from the exchanger.
7
Plate heat exchangers are used in a variety of applications including iron, steel and aluminum manufacturing, chemical manufacturing, electric and nuclear power generation, central building air-conditioning, pharmaceutical production, and the food and beverage industry. Plate heat exchanger sales accounted for approximately 39% of our sales revenue in 2012.
Heat Exchanger Units
A heat exchanger unit is a whole set of district heating control equipment. A heat exchanger unit integrates the following components: plate heat exchangers, circulating pump, water supplement pump, thermometer, manometer, sensors, conduits, valves and industrial controls, water supplement system, pressure stabilization system, frequency conversion flux control system, heat measurement and network communication control system. Combining these components on-site at our manufacturing facilities, we utilize our proprietary technologies to customize heat exchanger units to our clients specifications.
Our heat exchanger units are most widely used in thermal power plants and residential heating systems, which require integration of control and monitoring systems for several distinct spaces. Sales of heat exchanger units accounted for approximately 39% of our sales revenue in 2012.
8
Air-cooled Heat Exchanger
An air-cooled heat exchanger is a pressure vessel which cools a circulating fluid within finned tubes by forcing ambient air over the exterior of the tubes. A common example of an air cooler is a cars radiator. Air-cooled heat exchangers are beneficial because they increase plant efficiency and are a green solution as compared to cooling towers and shell and tube heat exchangers since they do not require an auxiliary water supply (therefore, no water is lost due to drift or evaporation, and no water treatment chemicals are required).
Air-cooled heat exchangers are used in various industries where cooling liquids are too costly to obtain or are not readily available. Sales of air-cooled heat exchangers accounted for 3% of our sales revenue in 2012.
Shell-and-tube Heat Exchanger
A shell-and-tube heat exchanger is a type of heat exchanger that consists of a large pressure vessel, or a shell, containing a bundle of tubes. One fluid runs through the tubes, and another fluid flows over the tubes, through the shell, to transfer heat between the two fluids. Heat is transferred from one fluid to the other through the tube walls, either from tube side to shell side or vice versa. The fluids can be either liquids or gases on either the shell or the tube side.
Shell-and-tube heat exchangers are generally used in the same industries as plate heat exchangers, and are most commonly used with extremely high-pressure liquids. Shell-and-tube heat exchanger sales accounted for approximately 9% of our sales revenue in 2012.
Welded Plate Heat Exchanger
A welded plate heat exchanger is used for heat exchange between high-pressure fluids or where a more compact product is required. Instead of a pipe passing through a chamber, there are instead two alternating chambers, usually thin in depth, separated at their largest surface by a corrugated metal plate. The heat transfer plates are connected by welding. Compared with other plate heat exchangers, welded plate heat exchangers can work under situations where the liquid pressure is higher. However, since the heat transfer plates are welded, such units are less convenient to maintain and clean as compared with other types of plate heat exchangers that are connected by gaskets.
9
Welded plate heat exchangers are utilized in many of the same industries as other plate heat exchangers and shell-and-tube heat exchangers. Welded plate heat exchangers accounted for 1% of our sales revenue in 2012.
Plate-and-Shell Heat Exchanger
A plate-and-shell heat exchanger is a hybrid type of heat exchanger that combines aspects of the plate heat exchanger and shell-and-tube heat exchanger. Plate-and-shell heat exchangers consist of a shell with heat transfer plates inside of the shell instead of tubes.
Advantages of a plate-and-shell heat exchanger include its high heat transfer efficiency (more than double that of a shell-and-tube heat exchanger), compact structure and light weight. Shell-and-plate heat exchangers are also resistant to high pressure and high temperatures and are commonly used to meet the requirements of large-scale equipment used in oil refining, the chemical industry, fertilizer production and metallurgy. Sales of plate-and-shell heat exchangers accounted for 1% of our sales revenue in 2012.
Other heat exchange products accounted for 8% of our sales revenue in 2012.
New Products under Development
Our research and development department is constantly working on new products for our customers and enhancements to our existing products. Currently, our research and development team is working on HBLB welded plate heat exchanger, absorption heat recovery unit and nuclear class plate heat exchanger.
10
Absorption Heat Recovery Unit. Absorption heat recovery unit systemmainly combines semi-welded plate heat exchanger, plate flue gas heat exchanger, plate heat exchanger units and absorption heat pump system to achieve better heat recovery. This product will be mainly utilized in the process of waste heat export and heat absorption from industrial waste water, industrial waste gas and industrial waste residue to transfer low grade heat energy to high grade heat energy. It can significantly improve energy utilization efficiency. This technology was the research product of the Company with Xi 'an Jiaotong University. As China has been focusing on environmental protection and energy conservation, the new product will broaden our market. We expect to commercialize our absorption heat recovery unit in December 2013.
The large-scale nuclear plate heat exchanger. This nuclear plate heat exchanger is used by nuclear island and similar to conventional plate heat exchangers. They both have alternate channels for cooling and thermal fluid with completely counter-current flow. The difference between the two products is that the board area of the nuclear heat exchanger is much bigger than that of conventional plate heat exchanger, and the nuclear plate exchanger must go through the National Nuclear Safety Bureaus safety authentication, including thermal test, press drop test, anti- seismic force computation and quality control system examination. The nuclear plate heat exchangers will be mainly used in the nuclear center island cooling system and also used in large-scale petrochemical plants and air conditioning energy system with cold storage. Commercialization is scheduled to take place in June 2013.
Manufacturing
Manufacturing Facilities
Our manufacturing facilities are based in Siping City, Jilin Province, China and Tianjin City. The total floor area of our Siping facility is approximately 17,482 square meters. The production portion of the facility is approximately 11,275 square meters. Our research and development center is approximately 1,164 square meters and our executive office building, garage, and dormitory are approximately 5,043 square meters. We currently have two production lines for plate heat exchangers with an annual capacity of 500,000 square meters and one welding workshop with an annual capacity of 3,000 tons. The plate heat exchanger production line produces all heat transfer plates used in our plate heat exchangers, heat exchange units, air-cooled heat exchangers, welded plate heat exchangers and plate-and-shell heat exchangers. This production line also assembles heat transfer plates into plate heat exchangers. The welding work shop assembles shell and tube heat exchangers, heat exchanger units, air-cooled heat exchangers, welded plate heat exchangers and plate-and-shell heat exchangers, which require intensive welding operations. The facility is located on a 36,530 square meter plot of land for which we own the land use right.
The capacity and utilization of our production lines are set forth below:
Production Line | Current Capacity | 2012 Utilization | 2011 Utilization |
Plate heat exchanger production line (square meters) | 300,000 | 70% | 90% |
Welding workshop (tons) | 3,000 | 90% | 80% |
Plate heat exchanger production line (square meters) | 200,000 | 45% | 25% |
In real operation, the hours our production lines run vary considerably from time to time over the year. This is mainly because our products are customized rather than standard products, and our sales orders are commonly project-based and placed unevenly over the year. In addition, the market demand from the heat industry tends to demonstrate strong seasonality and the period from July to October each year is commonly the peak season, when the residential heating system for northern China is implemented. Under our current utilization rate, our production lines have been running at full capacity during the peak periods.
To fulfill future sales growth and to enhance our capacity during peak periods, we further expanded our production facility. Our new workshop, which began operations in October 2009, has a floor area of 7,356 square meters and a new production line for plate heat exchangers with a designed capacity of 200,000 square meters. With the new workshop, we have been able to further streamline our production lines and have more space available for assembly and welding. In the new plate heat exchanger production line, we installed a 6,000 ton press machine to produce smaller size heat transfer plates while the old plate heat exchanger production line with a 22,000 ton press machine will be used to produce larger sized heat transfer plates. With the new workshop and the new production line, we believe both our production capacity and efficiency will be significantly improved.
11
Manufacturing Processes
The following diagram illustrates the production process for our plate heat exchangers.
Production Process for Plate Heat Exchanger Manufacturing
The manufacturing process for the plate heat exchanger begins with the removal of edges from steel plates that we acquire as a raw material. Once the edges are removed, we cut the steel plate down to the desired size. The next step is the pressing of the steel plate to the desired shape and form. After the pressing is complete, we seal and combine the heat transfer plates together. The final step is to conduct a hydrostatic pressure test, which tests our product for leakage and also tests the strength of the product to ensure conformity to customer specifications.
The following diagram illustrates the production process for our shell-and-tube heat exchangers.
Production Process of Shell-and-Tube Heat Exchanger Manufacturing
The manufacturing process for the shell-and-tube heat exchanger begins with the welding and combination of the shell and heat exchange tube. The next step is to conduct a hydrostatic pressure test, which tests our product for leakage and also tests the strength of the product to ensure conformity to customer specifications.
The production process for our heat exchange units, air-cooled heat exchangers, welded plate heat exchangers and plate and shell heat exchangers is similar to that of our plate heat exchanger production process, except that additional processes are added to arrive at the finished product. With the heat exchange units, additional components are added in the welding workshop, including a circulating pump, water supplement pump, thermometer, manometer, various sensors, conduits and valves. In the case of the air-cooled heat exchanger, additional fans and blowers are added to the plate heat exchanger in the welding workshop. With the welded plate heat exchanger, the heat transfer plates are welded rather than connected by gaskets. Finally, in the case of the plate and shell heat exchanger, the heat transfer plates replace tubes inside the shell vessel.
12
Raw Materials
We purchase raw materials for each project and the procurement is subject to different solutions designed to customer specifications, including the material type, material volume and accessories. Our raw materials are mainly metal plates made of stainless steel, carbon steel, titanium steel, nickel steel and other steel base alloys. Different steel plates are used to produce heat exchangers used in different environments or for use with different fluids. For heat exchangers used in environments containing corrosive air or liquids, such as on a ship or in alumina smelting, or used to exchange heat from highly-corrosive fluids, such as acid and alkali chemicals, corrosion resistant steel plates made from such metals as titanium steel, nickel steel, steel base alloy (such as 254SMO) and Hastelloy alloy are used as raw materials. For heat exchangers used in a regular environment or with regular fluids, stainless steel plates and carbon steel plates are used as raw materials. We also purchase heat transfer tubes from third party vendors to produce shell-and-tube heat exchangers and plate-and-shell heat exchangers.
Suppliers
The raw materials that we use to produce our products are widely available in the market. Since our products are mostly customized rather than standard products, we usually make purchases based on orders received, frequently in small quantities. Accordingly, we purchase from trading companies so that we are able to place orders in small quantities and request quick deliveries. Most of these trading companies are distributors of large global steel or alloy manufacturers such as Nippon Yakin Co., Ltd., TISCO, Haynes International, Inc., BAOTI, and Nippon Steel Corporation.
The following table sets forth our top ten suppliers in 2012:
Supplier |
Raw Materials |
Amount (in thousands of U.S. Dollars) |
Shenyang Oriental Kunlun Stainless Steel Industrial Co., Ltd. | White Steel Plate | 2,528 |
Tianjin Gerui New Metal Co., Ltd. | White Steel Plate | 1,654 |
Shenyang Tong Feng Da Material Co., Ltd. | Carbon Steel Pate | 1,543 |
Qingdao Puxiang Stainless Steel Co., Ltd. | White Steel Plate | 1,388 |
Xian Lianyi Rubber Products Co., Ltd. | Glue Cushion | 1,181 |
Tianjin Taigang Daming Metal Products Co., Ltd. | White Steel Plate | 1,047 |
Jiangmen Xinhao Special Stainless Steel Material Co., Ltd. | White Steel Plate | 1,009 |
Dalian Longde Automation Equipment Co. , Ltd | Electric | 788 |
Siping Tianyan Mechanical and Electrical Manufacturing Co., Ltd | White Steel Plate | 695 |
Qingdao Haituo Zhibo Electrical Engineering Co., Ltd. | Electric Cabinets | 693 |
The following table sets forth our top ten suppliers in 2011:
Supplier |
Raw Materials |
Amount (in thousands of U.S. Dollars) |
Tianjin Gerui New Metal Co., Ltd. | White Steel Plate | 8047 |
Shenyang Oriental Kunlun Stainless Steel Industrial Co., Ltd. | White Steel Plate | 5533 |
Shenyang Tong Feng Da Material Co., Ltd. | Carbon Steel Pate | 2993 |
Xian Lianyi Rubber Products Co., Ltd. | Glue Cushion | 1336 |
Jiangmen Xinhao Special Stainless Steel Material Co., Ltd. | White Steel Plate | 1181 |
Tianjin Taigang Daming Metal Products Co., Ltd. | White Steel Plate | 926 |
Shenyang Kaiweixi valve Co., Ltd. | Valve | 841 |
Shenyang Xinhua Control System Co., Ltd. | Electrical Parts | 727 |
Luoyang Shuangrui Precision Casting Titanium Industry Co., Ltd. | Titanium Tube | 682 |
Beijing Hengsheng Tongda Stainless Steel Co., Ltd. | White Steel Plate | 642 |
We pay the entire purchase price for the raw materials upon delivery. For materials purchased domestically, we pay 100% on receipt. For imported materials, we are usually required to make 30% deposit upon making an order with the balance due upon receipt.
13
Customers
Our customers are widely dispersed throughout various industries, including metallurgy, heat and power, petrochemical, food and beverage, pharmaceutical and shipbuilding. Our products have been well received by Fortune 500 companies in large projects worldwide. The following table identifies some of our customers and the projects in which our products have been used.*
*All marks are trademarks or registered trademarks of their respective owners. The display of trademarks herein does not imply that a license of any kind has been granted.
The following table sets forth our top ten customers in 2012 based on the sales amounts and percentage of sales:
Customer |
Main Products |
Amount (in thousands of U.S. Dollars) (without VAT) |
% of Sales Revenue |
Taiyuan Heating Power Company | Plate Heat Exchanger | 2,613 | 4.16% |
National Electric International Economic and Trade Co., Ltd. | Heat Exchanger Unit | 2,073 | 3.30% |
National Electric Jiuquan Heating Power Company | Heat Exchanger Unit | 2,000 | 3.19% |
Songyuan Heating Company | Heat Exchanger Unit | 1,623 | 2.59% |
Huaneng Daqing Thermoelectric Co., Ltd. | Heat Exchanger Unit | 1,551 | 2.47% |
Daer Kai Sunny (Harbin) Thermal Power Co., Ltd. | Heat Exchanger Unit | 1,524 | 2.43% |
Shanxi Colored Yulin New Material Co., Ltd. | Plate Heat Exchanger Heat Exchanger Unit |
1,084 | 1.73% |
CTIEI | Plate Heat Exchanger | 1,072 | 1.71% |
Qingdao Taineng Gas Group Co., Ltd. | Shell-and-Tube Heat exchanger | 929 | 1.48% |
In Inner Mongolia Meifang Coal Coking Co., Ltd. | Plate Heat Exchanger | 881 | 1.40% |
14
Customer |
Main Products |
Amount (in thousands of U.S. Dollars) (without VAT) |
% of Sales Revenue |
The China Machinery Industry Construction Corporation | Heat Exchanger Unit | 2,111 | 3.66% |
Chiping Xinfa Material Supply Service Co., Ltd. | Plate Heat Exchanger | 1,938 | 3.36% |
Jiangsu Helen Chemical Co., Ltd. | Shell-and-Tube Heat exchanger | 1,625 | 2.81% |
CTIEI |
Air-cooled Heat Exchanger Plate Heat Exchanger |
1,522 |
2.64% |
Liulin, Senze Coal Aluminum Co., Ltd. |
Plate Heat Exchanger Wide Channel Welding Plate Heat Exchanger |
1,433 |
2.48% |
Alumina Branch of Shanxi Zhaofeng Aluminium Co., Ltd. |
Plate Heat Exchanger |
1,007 |
1.74% |
China Hydropower Construction Group International Engineering Co., Ltd. |
Shell-and-Tube Heat exchanger Plate Heat Exchanger |
796 |
1.38% |
Guyuan Municipal Bureau for Urban Administration |
Heat Exchanger Unit |
665 |
1.15% |
Beijing Guodian North China Electric Power Engineering Co., Ltd. |
Plate Heat Exchanger |
662 |
1.15% |
Baynnur Violet Gold Non-ferrous Metal Co., Ltd. | Plate Heat Exchanger | 662 | 1.15% |
Sales and Marketing
As of December 31, 2012, our sales force consisted of 122 experienced sales people organized into four groups based on industry: metallurgy, heat and power, petrochemical and shipbuilding. Each group specializes in serving our customers in their specific industry. We believe this specialization allows our sales people to be more focused and equipped with superior industry knowledge and experience. Of the 122 members of our sales staff, 57 are based in Beijing and Siping, and 65 are based in 13 other sales offices throughout 13 different Chinese provinces.
The following table sets forth the location of our sales offices:
Region | Number of Offices | Location |
Northern China | 4 | Harbin, Shenyang, Baotou, Beijing |
Eastern China | 2 | Qingdao, Shanghai |
Central China | 3 | Wuhan, Zhengzhou, Hangzhou |
Western China | 4 | Xian, Taiyuan, Chengdu, Urumqi |
Each sales office makes direct sales and provides after-sales services to the customers in its area. Our sales offices in Qingdao, Wuhan, Xian, Zhengzhou, Taiyuan, Chengdu, Harbin, Shenyang, Urumqi and Baotou are focused on sales to the heating and power industry while our Shanghai and Hangzhou sales offices are focused on sales to the shipbuilding industry.
Competition
The heat exchanger market in China is very fragmented and competitive. There are over 1,500 heat exchanger manufacturers in China, most of which are relatively small in size. As a leading heat exchanger manufacturer in China, we mainly face competition from the leading domestic players including SmartHeat, Shanghai Accessen and Lanzhou Lanshi, as well as the leading international players including Alfa Laval and Aluminium Plant & Vessel Company Limited, or APV, each of whom has a presence in China. The following is a brief summary and analysis of our major competitors:
15
Alfa Laval is the largest plate heat exchanger manufacturer in the world. Alfa Laval has the broadest range of products covering application in almost all applicable industries. Since it also produces other industrial products like separators, Alfa Laval is also able to provide customers with integrated solutions of heat exchangers and other industrial products. Alfa Laval is especially strong in providing shell-and-tube heat exchanger products to the food and beverage and pharmaceutical industries. Alfa Laval is our key competitor in almost all industries. As compared to Alfa Laval, we are able to provide products of similar quality at a lower price.
APV is one of the most established plate heat exchanger manufacturers in the world. Founded by Dr. Richard Seligman, who made the first plate heat exchanger in 1910, APV was acquired by SPX, a multi-national company listed on the New York Stock Exchange, in 2008. APV is especially strong in providing solutions and products for the power industry. As compared to APV, we have a broader range of products and larger production capacity and sales volume in China.
SmartHeat, Inc. is a Chinese manufacturer of heat exchangers that is listed on NASDAQ Global Market. Its production facility is located in Shenyang, Northeast China. SmartHeat manufactures and sells plate heat exchangers, heat exchanger units and heat meters. It used to be the original equipment manufacturer service provider of Sondex, the Denmark manufacturer of plate heat exchangers, who is an especially strong competitor in the oil and gas industry. SmartHeat is more experienced than us in producing heat exchanger units but does not produce shell-and-tube heat exchangers. As compared to SmartHeat, we believe that we have stronger research and development capabilities, a wider range of products and that we have a more established track record in the industry.
Shanghai Accessen is a Chinese manufacturer of heat exchangers with its production facility in Shanghai. It started to produce and sell plate heat exchangers and heat exchanger units under its own brand in 2002 but does not produce shell-and-tube heat exchangers. As compared to Accessen, we believe that we have stronger research and development capabilities and wider range of products. We also believe that we have a more established track record in the industry and that we are much larger than Accessen in terms of production capacity and sales volume.
Lanzhou Lanshi is a Chinese manufacturer of heat exchangers with its production facility in Lanzhou, Northwest China. It manufactures and sells plate heat exchangers and heat exchanger units. Lanzhou Lanshi caters to the alumina production market. As compared to Lanshi, we believe that we have stronger research and development capabilities and a broader range of products. We are also much larger than Lanshi in terms of production capacity and sales volume.
Intellectual Property
We sell all our products under trademarks of 巨元 and THT. 巨元 has been registered with the State Trademark Bureau of PRC and has a valid term of ten years expiring August 20, 2020. THT has been registered with the State Trademark Bureau of PRC since July 14, 2009 and has a valid term of ten years expiring July 13, 2019.
We own fifteen patents, all of which are for utility models. The term of the patents, as stipulated by the PRC Patent Law, is ten years starting from the authorization date. The following table lists our patents, their registration and certificate numbers and their authorization dates:
Patents |
Registration No. |
Certificate No. |
Authorization Date |
Shell and tube helix baffle plate heat exchanger | ZL201020107719.2 | 1565896 | 2010-10-20 |
High efficiency wide flow channel disassemble plate heat exchanger | ZL200920093790.7 | 1512219 | 2010-08-18 |
Special high efficiency detachable type heat exchanger heat transfer plate | ZL200920094384.2 | 1565896 | 2010-05-12 |
A kind of plate heat exchanger use in air conditioning industry | ZL200920094383.8 | 1411275 | 2010-05-12 |
Variable section flow channel plate heat exchanger | ZL200720093847.4 | 1109105 | 2008-10-08 |
Wide flow channel disassemble plate heat exchanger | ZL200520127760.5 | 876165 | 2007-03-07 |
Wide flow channel welded plate heat exchanger | ZL200520127762.4 | 842256 | 2006-11-29 |
16
Large-scale closed cooling water circulator | ZL200520127763.9 | CN 2842348Y | 2006-11-29 |
Block type heat exchanger | ZL200520127761X | 842022 | 2006-11-29 |
Detachable ceramic multi-tube dust collector | ZL00266939.0 | 465211 | 2001-11-28 |
Powder heat exchanger | ZL20120579425.X | 1817117 | 2010-10-28 |
Semi-welded plate heat exchanger | ZL201120167533.0 | 2055400 | 2011-12-28 |
O-ring composite sealing gasket with U type protective use
in plate heat exchanger |
ZL201120459019.4 |
2298122 |
2012-07-11 |
Plate heat exchangers with double sealed washer | ZL201120444804.2 | 2276392 | 2012-07-04 |
Plate and shell heat exchanger with countercurrent circular plate | ZL201220225259.2 | 2557243 | 2012-12-05 |
Main pump lube oil cooler | ZL201220225258.8 | 2555906 | 2012-05-18 |
Regulation
Because our primary operating subsidiaries are located in China, we are subject to Chinas national and local laws, including those outlined below. We believe that we are in material compliance with all registrations and requirements for the issuance and maintenance of all licenses required by the governing bodies, and that all license fees and filings are current.
We do not face any significant government regulation in connection with the production of our products. We do not require any special government permits to produce our products other than those permits that are required of all corporations in China.
Environmental Matters
Our manufacturing facilities are subject to various pollution control regulations with respect to noise and air pollution and the disposal of waste and hazardous materials. We also are subject to periodic inspections by local environmental protection authorities. Our operating subsidiaries have received certifications from the relevant PRC government agencies indicating that their business operations are in material compliance with the relevant PRC environmental laws and regulations. We are not currently subject to any pending actions alleging any violations of applicable PRC environmental laws.
Occupational Health and Safety
The Standing Committee of the National Peoples Congress promulgated the PRC Safe Production Law on June 29, 2002, which sets out the legal framework to achieve and ensure safety in the production and operation activities of enterprises. Under the Safe Production Law, enterprises are required to establish internal safety systems and regulations, set up internal organization or appoint responsible personnel for safety affairs, to provide necessary safe working conditions and to strictly follow the State or industrial standards in relation to safe production. Enterprises which do not satisfy the facilities and conditions required under the laws and the State or industrial standards are not allowed to start or continue their production or operation activities. Enterprises are also required to set up obvious safety caution signals on those production or operation sites, facilities or equipment where there is a material potential risk for safety and shall further provide protective uniforms and personal care products to the field employees for their personal protection.
The PRC Law on the Prevention and Treatment of Occupational Diseases, which was promulgated on October 27, 2001 and became effective on May 1, 2002, requires that work environment and conditions established or provided by employers meet the occupational health standards and requirements of the State, and that employers shall further adopt and implement measures to assure employees access to occupational health protection. The employers are also required to participate in social insurance for work-related injury in accordance with the law and declare to and be supervised by the relevant health authorities if the employers are engaged in those harmful projects listed in the Occupational Diseases Catalogue.
We have not experienced any incident of injury or death due to violation of health and safety regulations. We have adopted a set of safety and occupational health protection procedures and standards, based on the specifications and guidelines set out under the PRC laws and regulations.
Regulations on Protection of Intellectual Property Rights
China has adopted legislation governing protection of intellectual property rights, including copyrights, trademarks and patents. China is a signatory to the main international conventions governing protection of intellectual property rights and became a member of the Agreement on the Trade Related Aspects of Intellectual Property Rights upon its accession to the World Trade Organization in December 2001.
17
The PRC Patent Law, adopted in 1984 and revised in 1992, 2000 and 2008, respectively, and the Implementing Rules of the PRC Patent Law, promulgated by the State Council in 2001 and revised in 2002 and 2010 respectively, govern and protect the proprietary rights to registered patents. The State Intellectual Property Office, or SIPO, handles patent registration and grants a term of twenty years to inventions and a term of ten years to utility models and designs. The protection to patent rights may be terminated before expiry of the term granted as a result of the failure of the registrant to pay the annual registration fee accordingly. Patent license agreements and transfer agreements must be filed with the SIPO for record.
Land Use Rights
All urban land in China is owned by the State. Pursuant to Interim Regulations of the Peoples Republic of China Concerning the Assignment and Transfer of the Right to the Use of the State-owned Land in the Urban Areas, which became effective on May 19, 1990, individuals and companies are permitted to acquire rights to use urban land or land use rights for specific purposes, including residential, industrial and commercial purposes. The land use rights are granted for a period of 70 years for residential purposes, 50 years for industrial purposes and 40 years for commercial purposes. These periods may be renewed at the expiration of the initial and any subsequent terms. Upon approval by both the land administrative authorities and city planning authorities, industrial parcel uses may be converted to other uses, and the duration and other clauses in the land use right granting agreement will be revised to match the new use. Granted land use rights are transferable and may be used as security for borrowings and other obligations. We have received the necessary land use right certificates for the properties described under Item 2 Properties.
Foreign Currency Exchange
The majority of our sales revenue and expenses are denominated in RMB. Under the PRC foreign currency exchange regulations applicable to us, RMB is convertible for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. Currently, our PRC operating subsidiaries may purchase foreign currencies for settlement of current account transactions, including payments of dividends to us, employee salaries (even if employees are based outside of China), and payment for equipment purchases outside of China, without the approval of the State Administration of Foreign Exchange of the Peoples Republic of China, or SAFE, by complying with certain procedural requirements. Conversion of RMB for capital account items, such as direct investment, loan, security investment and repatriation of investment, however, is still subject to the approval of SAFE. In particular, if our PRC operating subsidiaries borrow foreign currency through loans from us or other foreign lenders, these loans must be registered with SAFE, and if we finance the subsidiaries by means of additional capital contributions, these capital contributions must be approved by certain government authorities, including the Ministry of Commerce, or MOFCOM, or their respective local branches. These limitations could affect our PRC operating subsidiaries ability to obtain foreign exchange through debt or equity financing. In the event of a liquidation of our PRC subsidiaries, SAFE approval is required before the remaining proceeds can be expatriated from China.
Taxation
On March 16, 2007, the National People's Congress of China passed a new Enterprise Income Tax Law, or EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. Before the implementation of the EIT Law, foreign invested enterprises, or FIEs, established in the PRC, unless granted preferential tax treatments by the PRC government, were generally subject to an earned income tax, or EIT, rate of 33.0%, which included a 30.0% state income tax and a 3.0% local income tax. The EIT Law and its implementing rules impose a unified EIT of 25.0% on all domestic-invested enterprises and FIEs, unless they qualify under certain limited exceptions. Despite these changes, the EIT Law gives FIEs established before March 16, 2007, or Old FIEs, a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatments. During this five-year grandfather period, the Old FIEs which enjoyed tax rates lower than 25% under the original EIT law will be subject to gradually increased EIT rates over a 5-year period until their tax rate reaches 25%. In addition, the Old FIEs that are eligible for other preferential tax treatments by the PRC government under the original EIT law are allowed to continue enjoying their preference until these preferential treatment periods expire.
In addition to the changes to the current tax structure, under the EIT Law, an enterprise established outside of China with de facto management bodies within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term de facto management bodies as an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise. If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our organizations global income will be subject to PRC income tax of 25%. For detailed discussion of PRC tax issues related to resident enterprise status, see Item 1A Risk FactorsRisks Related to Doing Business in ChinaUnder the Enterprise Income Tax Law, we may be classified as a resident enterprise of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.
18
In addition, the EIT Law and its implementing rules generally provide that an income tax rate of 10% will normally be applicable to dividends payable to investors that are non-resident enterprises, or non-resident investors, which (i) do not have an establishment or place of business in the PRC or (ii) have an establishment or place of business in the PRC, but the relevant income is not effectively connected with the establishment or place of business to the extent such dividends are derived from sources within the PRC. The State Council of the PRC or a tax treaty between China and the jurisdictions in which the non-PRC investors reside may reduce such income tax. Under the Arrangement between the Mainland and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, effective as of January 1, 2007, such dividend withholding tax rate is reduced to 5% if a Hong Kong resident enterprise owns over 25% of the PRC company distributing the dividends. As Star Wealth is a Hong Kong company and owns 100% of Siping Juyuan, under the aforesaid arrangement, any dividends that Siping Juyuan pays Star Wealth may be subject to a withholding tax at the rate of 5%. However, if Star Wealth is not considered to be the beneficial owner of such dividends under the Notice Regarding Interpretation and Recognition of Beneficial Owners under Tax Treaties, or Notice 601, promulgated by the State Administration of Taxation on October 27, 2009, such dividends would be subject to the withholding tax rate of 10%. The withholding tax rate of 5% or 10% applicable to Star Wealth will have a significant impact on the amount of dividends to be received by the Company and ultimately by stockholders.
Pursuant to the Provisional Regulation of China on Value Added Tax and its implementing rules, all entities and individuals that are engaged in the sale of goods, the provision of repairs and replacement services and the importation of goods in China are generally required to pay value added tax, or VAT, at a rate of 17.0% of the gross sales proceeds received, less any deductible VAT already paid or borne by the taxpayer. Further, when exporting goods, the exporter is entitled to some or all of the refund of VAT that it has already paid or borne.
Dividend Distributions
All of our sales are earned by our PRC subsidiaries. However, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to its offshore parent company. PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in said fund reaches 50% of our registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Given that the Company and the PRC subsidiaries do not intend to pay dividends for the foreseeable future, we consider the impact of restrictions on our liquidity, financial condition and results of operations is not significant.
Circular 75
On November 1, 2005, SAFE issued the Notice on Relevant Issues Concerning Foreign Exchange Administration for Domestic Residents to Engage in Overseas Financing and Round Trip Investment via Overseas Special Purpose Vehicles, or Circular 75, which regulates the foreign exchange matters in relation to the use of a special purpose vehicle, or SPV, by PRC residents to seek offshore equity financing and conduct round trip investment in China. Under Circular 75, a SPV refers to an offshore entity established or controlled, directly or indirectly, by PRC residents or PRC entities for the purpose of seeking offshore equity financing using assets or interests owned by such PRC residents or PRC entities in onshore companies, while round trip investment refers to the direct investment in China by the PRC residents through the SPVs, including, without limitation, establishing FIEs and using such foreign-invested enterprises to purchase or control onshore assets through contractual arrangements. Circular 75 requires that, before establishing or controlling a SPV, PRC residents and PRC entities are required to complete foreign exchange registration with the local offices of SAFE for their overseas investments.
Circular 75 applies retroactively. PRC residents who have established or acquired control of the SPVs which have completed round-trip investment before the implementation of Circular 75 shall register their ownership interests or control in such SPVs with the local offices of SAFE before March 31, 2006. An amendment to the registration is required if there is a material change in the SPV, such as increase or reduction of share capital and transfer of shares. Failure to comply with the registration procedures set forth in Circular 75 may result in restrictions on the foreign exchange activities of the relevant FIEs, including the payment of dividends and other distributions, such as proceeds from any reduction in capital, share transfer or liquidation, to its offshore parent or affiliate and the capital inflow from the offshore parent, and may also subject relevant PRC residents to penalties under PRC foreign exchange administration regulations.
19
As we stated under Item 1A Risk factorsRisks Related to Doing Business in ChinaFailure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into our PRC subsidiaries, limit our PRC subsidiaries ability to distribute profits to us or otherwise materially adversely affect us, we have asked our stockholders, who are PRC residents as defined in Circular 75, to register with the relevant branch of SAFE, as currently required, in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiaries. However, many of the terms and provisions in Circular 75 remain unclear and implementation by central SAFE and local SAFE branches of Circular 75 have been inconsistent since their adoption. Therefore, we cannot predict how Circular 75 will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our PRC resident beneficial holders.
Mergers and Acquisitions
On August 8, 2006, six PRC regulatory agencies promulgated the Regulation on Mergers and Acquisitions of Domestic Companies by Foreign Investors, or the M&A Rule, which became effective on September 8, 2006. According to the M&A Rule, a Round-trip Investment is defined as having taken place when a PRC business that is owned by PRC individual(s) is sold to a non-PRC entity that is established or controlled, directly or indirectly, by those same PRC individual(s). Under the M&A Rule, any Round-trip Investment must be approved by MOFCOM and any indirect arrangement or series of arrangements which achieves the same end result without the approval of MOFCOM is a violation of PRC law.
On June 30, 2009, Mr. Guohong Zhao, our Chairman and CEO and a founder of Siping Juyuan, entered into an option agreement with Ms. Jinghua Zhao, the sole shareholder of Wisetop, pursuant to which Mr. Guohong Zhao was granted an option, exercisable after 180 days, to acquire all of the equity interests of Wisetop owned by Ms. Jinghua Zhao at an exercise price of $3,246,160. This initial expiration date of the option was June 30, 2011, however, on May 16, 2011, the parties extended the expiration date to June 30, 2012. On November 29, 2011, Mr. Zhao exercised his option.
Also on June 30, 2009, Wisetop entered into separate option agreements with the other original founders of Siping Juyuan, pursuant to which such founders were granted options, exercisable after 90 days, to purchase an aggregate of 10,240,786 shares of our common stock owned by Wisetop at a total exercise price of $7,291,440. The founders exercised their options on December 17, 2010. On December 17, 2010, the founders exercised their options and the shares were transferred to the founders. Wisetop owned 4,559,214 after the option exercise.
After Mr. Guohong Zhao and the founders (collectively referred to herein as the PRC Individuals) exercised their options, they became our controlling stockholders. Their acquisition of our equity interest, or the Acquisition, is required to be registered with the competent administration of industry and commerce authorities, or AIC, in Beijing. The PRC Individuals are required to make filings with the Beijing SAFE, to register the Company and its non-PRC subsidiaries to qualify them as SPVs, pursuant to Circular 75 and Circular 106.
As we stated under Item 1A Risk factorsRisks Related to Doing Business in ChinaOur business and financial performance may be materially adversely affected if the PRC regulatory authorities determine that our acquisition of Siping Juyuan constitutes a Round-trip Investment without MOFCOM approval, the PRC regulatory authorities may take the view that the Acquisition and the reverse acquisition of Megaway are part of an overall series of arrangements which constitute a Round-trip Investment because at the end of these transactions the PRC Individuals became the majority owners and effective controlling parties of a foreign entity that acquired ownership of our Chinese subsidiaries. The PRC regulatory authorities may also take the view that the registration of the Acquisition with the relevant AIC in Beijing and the filings with the Beijing SAFE may not be evidence that the Acquisition has been properly approved because the relevant parties did not fully disclose to the AIC, SAFE or MOFCOM the overall restructuring arrangements, the existence of the reverse acquisition of Megaway and its link with the Acquisition. If the PRC regulatory authorities take the view that the Acquisition constitutes a Round-trip Investment without MOFCOM approval, they could invalidate our acquisition and ownership of our Chinese subsidiaries. We believe that if this takes place, we may be able to find a way to re-establish control of our Chinese subsidiaries business operations through a series of contractual arrangements rather than an outright purchase of our Chinese subsidiaries, but we cannot assure you that such contractual arrangements will be protected by PRC law or that we can receive as complete or effective economic benefit and overall control of our Chinese subsidiaries business than if the Company had direct ownership of our Chinese subsidiaries. In addition, we cannot assure you that such contractual arrangements can be successfully effected under PRC law.
20
Employees
As of December 31, 2012, we employed a total of 732 full-time employees. The following table sets forth the number of employees by function:
Function | Number of Employees |
Senior Management | 8 |
Solution design | 18 |
Sales | 122 |
Marketing | 24 |
Procurement | 32 |
Production | 308 |
Quality Control | 22 |
R&D | 38 |
HR & Administration | 147 |
Finance | 11 |
Internal Audit and Control | 2 |
TOTAL | 732 |
As required by applicable PRC law, we have entered into employment contracts with most of our officers, managers and employees. We are working towards entering employment contracts with those employees who do not currently have employment contracts with us. We believe that we maintain a satisfactory working relationship with our employees, and we have not experienced any significant disputes or any difficulty in recruiting staff for our operations.
Our employees in China participate in a state pension scheme organized by PRC municipal and provincial governments. We are currently required to contribute to the scheme at a rate of 30.6% to 31.2% of an employees average monthly salary.
In addition, we are required by PRC law to cover employees in China with various types of social insurance, and we believe that we are in material compliance with the relevant PRC laws.
Insurance
We maintain property insurance for our premises located at Siping, China where our main production facilities are located. The aggregate maximum amount covered by our insurance policy is up to RMB 25.39 million (approximately $3.72 million). We also maintain property insurance for our automobiles. We do not maintain business interruption, product liability insurance or key-man life insurance. We believe our insurance coverage is customary and standard of companies of comparable size in comparable industries in China. However, we cannot ensure that our existing insurance policies are sufficient to insulate us from all loses and liabilities that we may incur.
ITEM 1A. RISK FACTORS.
An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this report, before making an investment decision. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. You should read the section entitled Special Note Regarding Forward Looking Statements above for a discussion of what types of statements are forward-looking statements, as well as the significance of such statements in the context of this report.
RISKS RELATED TO OUR BUSINESS
We face risks related to general domestic and global economic conditions and our revenue will decrease if the industries in which our customers operate experience a protracted slowdown.
The uncertainty arising out of domestic and global economic conditions, including the recent disruption in credit markets, poses a risk to the PRC economy and may impact our ability to manage normal relationships with our customers, suppliers and creditors. If the current situation deteriorates significantly, our business could be materially negatively impacted, as demand for our products and services may decrease from a slow-down in the general economy, or supplier or customer disruptions may result from tighter credit markets.
21
In addition, because our products mainly serve as key components in projects operated by our customers who are mostly in the chemical, metallurgical, shipbuilding, HVAC and district heating industries, we are subject to the general changes in economic conditions affecting those industry segments of the economy. If the industry segments in which our customers operate do not grow or if there is a contraction in those industries, demand for our products will decrease. Demand for our products is typically affected by a number of overarching economic factors, including, but not limited to, interest rates, the availability and magnitude of private and governmental investment in infrastructure projects and the health of the overall global economy. If there is a decline in economic activity in China and the other markets in which we operate or a protracted slowdown in industries on which we rely for our sales, demand for our products and our revenue will likewise decrease.
Our industry is very competitive in China.
The domestic market for heat exchange products is fragmented and highly competitive. We compete with over 1,500 small-sized, local Chinese heat exchanger manufacturers. The number of these companies varies from time to time. While we may have greater resources than our smaller competitors, it is possible that these competitors have better access in certain local markets to customers and prospects and lower production and raw material costs. Some of our products compete on the basis of price and are sold in fragmented markets with low barriers to entry, allowing less expensive domestic producers to gain market share and reduce our margins.
Foreign competition is intense and could have a material adverse effect on our financial condition and results of operations.
In addition to domestic competition, we face intense competition from foreign competitors. The intensity of foreign competition is affected significantly by fluctuations in the value of the U.S. dollar against Chinese currency and by the level of import duties imposed by the Chinese government on certain products. Our major international competitors are Alfa Laval and APV. Many of our competitors have more resources and greater brand recognition than we enjoy. While our resources may not be as great as our larger competitors, we believe our product quality and direct sales offices and distribution network are superior in China. If our competitors are able to gain greater market share or improve their sales efforts, our sales may decrease, we may be forced to lower our prices, or our marketing costs may increase, all of which could negatively impact our financial results.
A significant amount of our sales revenue are derived from our largest customers and any reduction in revenue from any of these customers would reduce our sales revenue and net income.
Approximately 24.46% of our sales revenue in 2012 came from our top ten customers, with our largest customer, Taiyuan Heating Power Company, accounting for approximately 4.16% of our sales revenue in 2012. If we cease to do business at or above current levels with the top customers or with any other large customers who contribute significantly to our sales revenue, and we are unable to generate additional or substitute sales revenue, our net income would decline considerably.
Any decrease in the availability, or increase in the cost, of raw materials could materially affect our earnings.
Our operations depend heavily on the availability of various raw materials. The raw materials for our operations are mainly metal plates made of stainless steel, carbon steel, titanium steel, nickel steel and other steel based alloy. The availability of raw materials may decrease and their prices may fluctuate greatly. We have long-term relationships with several suppliers; however, if our suppliers are unable or unwilling to provide us with raw materials on terms favorable to us, we may be unable to produce certain products. This could result in a decrease in profit and damage to our reputation in our industry. In the event our raw material and energy costs increase, we may not be able to pass these higher costs on to our customers in full or at all. Any increase in the prices for raw materials or energy resources could materially increase our costs and therefore lower our earnings. Additionally, certain of our supply contracts are for fixed prices. Although we currently benefit from favorable pricing in some of these supply contracts, if market prices for these raw materials decline, we may not be able to take advantage of decreasing market prices, and our profit margins may suffer.
22
Our rapid expansion could significantly strain our resources, management and operational infrastructure which could impair our ability to meet increased demand for our products and hurt our business results.
To accommodate our anticipated growth, we will need to expend capital resources and dedicate personnel to implement and upgrade our accounting, operational and internal management systems and enhance our record keeping and contract tracking system. Such measures will require us to dedicate additional financial resources and personnel to optimize our operational infrastructure and to recruit more personnel to train and manage our growing employee base. If we cannot successfully implement these measures efficiently and cost-effectively, we will be unable to satisfy the demand for our products, which will impair our revenue growth and hurt our overall financial performance.
Our business is capital intensive and our growth strategy may require additional capital which may not be available on favorable terms or at all.
We believe that our current cash and cash flow from operations will be sufficient to meet our present and reasonably anticipated capital and capital expenditure needs given the current state of our production line for the marketing of the products. We may, however, require additional cash resources due to changed business conditions, implementation of our strategy to expand our manufacturing capacity or other investments or acquisitions we may decide to pursue. If our own financial resources are insufficient to satisfy our capital requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities. The sale of additional equity securities could result in dilution to our stockholders. The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that would restrict our operations. Financing may not be available in amounts or on terms acceptable to us, if at all. Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.
We depend heavily on key personnel, and turnover of key employees and senior management could harm our business.
Our future business and results of operations depend in significant part upon the continued contributions of our key technical and senior management personnel, including Guohong Zhao, our Chairman and Chief Executive Officer. They also depend in significant part upon our ability to attract and retain additional qualified management, technical, marketing and sales and support personnel for our operations. If we lose a key employee, if a key employee fails to perform in his or her current position, or if we are not able to attract and retain skilled employees as needed, our business could suffer. Significant turnover in our senior management could significantly deplete our institutional knowledge held by our existing senior management team. We depend on the skills and abilities of these key employees in managing the manufacturing, technical, marketing and sales aspects of our business, any part of which could be harmed by turnover in the future.
Unexpected equipment failures may damage our business due to production curtailments or shutdowns.
We conduct periodic inspection and maintenance of all of our equipment to minimize the impact of interruption of production and prevent breakdown because this machinery is highly specialized and cannot be repaired or replaced without significant expense and time delay. On occasion, our equipment may be out of service as a result of unanticipated failures which may result in material plant shutdowns or periods of reduced production. Interruptions in production capabilities will inevitably increase production costs and reduce our sales and earnings. In addition to equipment failures, our facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or adverse weather conditions. Furthermore, any interruption in production capability may require us to make large capital expenditures to remedy the situation, which could have a negative effect on our profitability and cash flows. In addition, longer-term business disruption could result in a loss of customers. If this were to occur, our future sales levels, and therefore our profitability, could be adversely affected.
Our failure to adequately protect our intellectual property rights may undermine our competitive position, and litigation to protect our intellectual property rights may be costly.
We strive to strengthen and differentiate our product portfolio by developing new and efficient manufacturing processes and innovative products and product improvements. We maintain seven utility model patents and three registered trademarks and one trademark application pending registration with State Trademark Bureau of PRC as intellectual property assets. We believe that the protection of our intellectual property will become increasingly important to our business. Implementation and enforcement of intellectual property-related laws in China has historically been lacking due primarily to ambiguities in PRC intellectual property law. Accordingly, protection of intellectual property and proprietary rights in China may not be as effective as in the United States or other countries. We will continue to rely on a combination of patents, trade secrets, trademarks and copyrights to provide protection in this regard, but this protection may be inadequate. For example, our pending or future patent applications may not be approved or, if allowed, they may not be of sufficient strength or scope. As a result, third parties may use the technologies and proprietary processes that we have developed and compete with us, which could negatively affect any competitive advantage we enjoy, dilute our brand and harm our operating results.
23
In addition, policing the unauthorized use of our proprietary technology can be difficult and expensive. Litigation may be necessary to enforce our intellectual property rights and given the relative unpredictability of Chinas legal system and potential difficulties enforcing a court judgment in China, there is no guarantee litigation would result in an outcome favorable to us. Furthermore, any such litigation may be costly and may divert management attention away from our core business. An adverse determination in any lawsuit involving our intellectual property is likely to jeopardize our business prospects and reputation. We have no insurance coverage against litigation costs so we would be forced to bear all litigation costs if we cannot recover them from other parties. All of the foregoing factors could harm our business and financial condition.
If our customers and/or the ultimate consumers of products that use our products successfully assert product liability claims against us due to defects in our products, our operating results may suffer and our reputation may be harmed.
Due to the high pressures and temperatures at which many of our products are used and the fact that some of our products are relied upon by our customers or end users in their facilities or operations, or are manufactured for relatively broad consumer use, we face an inherent risk of exposure to claims in the event that the failure, use or misuse of our products results, or is alleged to result, in bodily injury, property damage or economic loss. We believe that we meet or exceed existing professional specification standards recognized or required in the industries in which we operate. We have been subject to claims in the past, none of which have had a material adverse effect on our financial condition or results of operations, and we may be subject to claims in the future. We currently do not maintain product liability coverage and such insurance may be difficult to obtain on terms acceptable to us and may not cover warranty claims. A successful product liability claim or series of claims against us, including one or more consumer claims purporting to constitute class actions, or a significant warranty claim or series of claims against us could materially decrease our liquidity and impair our financial condition.
Our products may become subject to recall in the event of defects or other performance related issues.
We are at risk for product recall costs which are costs incurred when, either voluntarily or involuntarily, a product is recalled through a formal campaign to solicit the return of specific products due to a known or suspected performance defect. Costs typically include the cost of the product, part or component being replaced, the cost of the recall borne by our customers and labor to remove and replace the defective part or component. Our products have not been the subject of an open recall. If a recall decision is made, we will need to estimate the cost of the recall and record a charge to earnings in that period. In making this estimate, judgment is required as to the quantity or volume to be recalled, the total cost of the recall campaign, the ultimate negotiated sharing of the cost between us and our distributor or customer. As a result, these estimates are subject to change. Excessive recall costs or our failure to adequately estimate these costs may negatively affect our operating results.
We have limited insurance coverage and do not carry any business interruption insurance, third-party liability insurance for our manufacturing facilities or insurance that covers the risk of loss of our products in shipment.
Operation of our manufacturing facilities involves many risks, including equipment failures, natural disasters, industrial accidents, power outages, labor disturbances and other business interruptions. Furthermore, if any of our products are faulty, then we may become subject to product liability claims or we may have to engage in a product recall. We do not carry any business interruption insurance, product recall or third-party liability insurance for our manufacturing facilities or with respect to our products to cover claims pertaining to personal injury or property or environmental damage arising from defaults with our products, product recalls, accidents on our property or damage relating to our operations. Therefore, our existing insurance coverage may not be sufficient to cover all risks associated with our business. As a result, we may be required to pay for financial and other losses, damages and liabilities, including those caused by natural disasters and other events beyond our control, out of our own funds, which could have a material adverse effect on our business, financial condition and results of operations.
24
We have identified material weaknesses in our internal control over financial reporting. If we fail to develop or maintain an effective system of internal controls, we may not be able to accurately report our financial results and prevent fraud. As a result, current and potential stockholders could lose confidence in our financial statements, which would harm the trading price of our common stock.
Companies that file reports with the SEC, including us, are subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404. SOX 404 requires management to establish and maintain a system of internal control over financial reporting and annual reports on Form 10-K filed under the Exchange Act to contain a report from management assessing the effectiveness of a companys internal control over financial reporting. Separately, under SOX 404, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, public companies that are large accelerated filers or accelerated filers must include in their annual reports on Form 10-K an attestation report of their regular auditors attesting to and reporting on managements assessment of internal control over financial reporting. Non-accelerated filers and smaller reporting companies are not required to include an attestation report of their auditors in annual reports.
A report of our management is included under Item 9A Controls and Procedures of this report. We are a smaller reporting company and, consequently, are not required to include an attestation report of our auditor in this annual report. However, if and when we become subject to the auditor attestation requirements under SOX 404, we can provide no assurance that we will receive a positive attestation from our independent auditors.
During its evaluation of the effectiveness of internal control over financial reporting as of December 31, 2012, management identified material weaknesses. We are undertaking remedial measures, which measures will take time to implement and test, to address this material weakness. There can be no assurance that such measures will be sufficient to remedy the material weakness identified or that additional material weaknesses or other control or significant deficiencies will not be identified in the future. If we continue to experience material weaknesses in our internal controls or fail to maintain or implement required new or improved controls, such circumstances could cause us to fail to meet our periodic reporting obligations or result in material misstatements in our financial statements, or adversely affect the results of periodic management evaluations and, if required, annual auditor attestation reports. Each of the foregoing results could cause investors to lose confidence in our reported financial information and lead to a decline in our stock price. See Item 9A Controls and Procedures for more information.
RISKS RELATED TO DOING BUSINESS IN CHINA
If we become directly subject to the recent scrutiny, criticism and negative publicity involving U.S.-listed Chinese companies, we may have to expend significant resources to investigate and resolve the matter which could harm our business operations, stock price and reputation and could result in a loss of your investment in our stock, especially if such matter cannot be addressed and resolved favorably.
Recently, U.S. public companies that have substantially all of their operations in China, particularly companies like us which have completed so-called reverse merger transactions, have been the subject of intense scrutiny, criticism and negative publicity by investors, financial commentators and regulatory agencies, such as the SEC. Much of the scrutiny, criticism and negative publicity has centered around financial and accounting irregularities and mistakes, a lack of effective internal controls over financial accounting, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result of the scrutiny, criticism and negative publicity, the publicly traded stock of many U.S. listed Chinese companies has sharply decreased in value and, in some cases, has become virtually worthless. Many of these companies are now subject to shareholder lawsuits, SEC enforcement actions and are conducting internal and external investigations into the allegations. It is not clear what effect this sector-wide scrutiny, criticism and negative publicity will have on our Company, our business and our stock price. If we become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we will have to expend significant resources to investigate such allegations and/or defend our company. This situation will be costly and time consuming and distract our management from growing our company. If such allegations are not proven to be groundless, our company and business operations will be severely and your investment in our stock could be rendered worthless.
25
Adverse changes in political, economic and other policies of the Chinese government could have a material adverse effect on the overall economic growth of China, which could materially and adversely affect the growth of our business and our competitive position.
Most of our business operations are conducted in China. Accordingly, our business, financial condition, results of operations and prospects are affected significantly by economic, political and legal developments in China. The Chinese economy differs from the economies of most developed countries in many respects, including:
While the Chinese economy has experienced significant growth in the past 30 years, growth has been uneven, both geographically and among various sectors of the economy. The Chinese economy has also experienced certain adverse effects due to the recent global financial crisis. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall Chinese economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.
The Chinese economy has been transitioning from a planned economy to a more market-oriented economy. Although in recent years the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of the productive assets in China is still owned by the Chinese government. The continued control of these assets and other aspects of the national economy by the Chinese government could materially and adversely affect our business. The Chinese government also exercises significant control over Chinese economic growth through the allocation of resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies.
Any adverse change in the economic conditions or government policies in China could have a material adverse effect on overall economic growth, which in turn could lead to a reduction in demand for our products and consequently have a material adverse effect on our businesses.
Future government regulations or other standards could have an adverse effect on our operations.
Our operations are subject to a variety of laws, regulations and licensing requirements of national and local authorities in the PRC. We are required to obtain licenses or permits and to meet certain standards in the conduct of our business. The loss of such licenses, or the imposition of conditions to the granting or retention of such licenses, could have an adverse effect on us. In the event that these laws, regulations and/or licensing requirements change, we may be required to modify our operations or to utilize resources to maintain compliance with such rules and regulations. In addition, new regulations may be enacted that could have an adverse effect on us.
Uncertainties with respect to the PRC legal system could limit the legal protections available to you and us.
We conduct substantially all of our business through our subsidiaries in the PRC. Our subsidiaries are generally subject to laws and regulations applicable to foreign investments in China and, in particular, laws applicable to FIEs. The PRC legal system is based on written statutes, and prior court decisions may be cited for reference but have limited precedential value. Since 1979, a series of new PRC laws and regulations have significantly enhanced the protections afforded to various forms of foreign investments in China. However, since the PRC legal system continues to evolve rapidly, the interpretations of many laws, regulations, and rules are not always uniform, and enforcement of these laws, regulations, and rules involve uncertainties, which may limit legal protections available to you and us. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. In addition, most of our executive officers and directors are residents of China and not of the United States, and substantially all the assets of these persons are located outside the United States. As a result, it could be difficult for investors to affect service of process in the United States or to enforce a judgment obtained in the United States against our Chinese operations and subsidiaries.
26
You may have difficulty enforcing judgments against us.
Most of our assets are located outside of the United States and all of our current operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons is located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce in U.S. courts judgments on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, all of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the PRC would recognize or enforce judgments of U.S. courts. Our counsel as to PRC law has advised us that the recognition and enforcement of foreign judgments are provided for under the PRC Civil Procedures Law. Courts in China may recognize and enforce foreign judgments in accordance with the requirements of the PRC Civil Procedures Law based on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other arrangements that provide for the reciprocal recognition and enforcement of foreign judgments with the United States. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates basic principles of PRC law or national sovereignty, security, or the public interest. So it is uncertain whether a PRC court would enforce a judgment rendered by a court in the United States.
The PRC government exerts substantial influence over the manner in which we must conduct our business activities.
The PRC government has exercised and continues to exercise substantial control over virtually every sector of the Chinese economy through regulation and state ownership. Our ability to operate in China may be harmed by changes in its laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property, and other matters. We believe that our operations in China are in material compliance with all applicable legal and regulatory requirements. However, the central or local governments of the jurisdictions in which we operate may impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures and efforts on our part to ensure our compliance with such regulations or interpretations.
Accordingly, government actions in the future, including any decision not to continue to support recent economic reforms and to return to a more centrally planned economy or regional or local variations in the implementation of economic policies, could have a significant effect on economic conditions in China or particular regions thereof and could require us to divest ourselves of any interest we then hold in Chinese properties or joint ventures.
Future inflation in China may inhibit our ability to conduct business in China.
In recent years, the Chinese economy has experienced periods of rapid expansion and highly fluctuating rates of inflation. During the past ten years, the rate of inflation in China has been as high as 5.9% and as low as -0.8% . These factors have led to the adoption by the Chinese government, from time to time, of various corrective measures designed to restrict the availability of credit or regulate growth and contain inflation. High inflation may in the future cause the Chinese government to impose controls on credit and/or prices, or to take other action, which could inhibit economic activity in China, and thereby harm the market for our products and our company.
Restrictions on currency exchange may limit our ability to receive and use our sales effectively.
The majority of our sales will be settled in RMB, and any future restrictions on currency exchanges may limit our ability to use revenue generated in RMB to fund any future business activities outside China or to make dividend or other payments in U.S. dollars. Although the Chinese government introduced regulations in 1996 to allow greater convertibility of the RMB for current account transactions, significant restrictions still remain, including primarily the restriction that FIEs may only buy, sell or remit foreign currencies after providing valid commercial documents, at those banks in China authorized to conduct foreign exchange business. In addition, conversion of RMB for capital account items, including direct investment and loans, is subject to governmental approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. The Chinese regulatory authorities may impose more stringent restrictions on the convertibility of the RMB.
In addition, the Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-Invested Enterprises, issued by SAFE and effective as of August 29, 2008, or Circular 142, regulates the conversion by FIEs of foreign currency into RMB by restricting how the converted RMB may be used. Circular 142 requires that RMB converted from the foreign currency-dominated capital of a FIE may only be used for purposes within the business scope approved by the relevant government authority and may not be used to make equity investments in PRC, unless specifically provided otherwise. SAFE further strengthened its oversight over the flow and use of RMB funds converted from the foreign currency-dominated capital of a FIE. The use of such RMB may not be changed without approval from SAFE, and may not be used to repay RMB loans if the proceeds of such loans have not yet been used. Any violation of Circular 142 may result in severe penalties, including substantial fines.
27
Fluctuations in exchange rates could adversely affect our business and the value of our securities.
The value of our common stock will be indirectly affected by the foreign exchange rate between the U.S. dollar and RMB and between those currencies and other currencies in which our sales may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars, as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
Since July 2005, the RMB has no longer been pegged to the U.S. dollar. Although the Peoples Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.
Restrictions under PRC law on our PRC subsidiaries ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our business.
Substantially all of our sales are earned by our PRC subsidiaries. Other than that the PRC subsidiaries pay all the service fees to maintain the public company status of the Company, there is no cash flows between our PRC subsidiaries and the Company. There is no restriction for cash flow to move through various subsidiaries up to the Company. However, as discussed more fully under Item 1 Business RegulationDividend Distributions, PRC regulations restrict the ability of our PRC subsidiaries to make dividends and other payments to their offshore parent company. Any limitations on the ability of our PRC subsidiaries to transfer funds to us could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
Failure to comply with PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident stockholders to personal liability, limit our ability to acquire PRC companies or to inject capital into PRC subsidiaries, limit our PRC subsidiaries' ability to distribute profits to us or otherwise materially adversely affect us.
In October 2005, SAFE issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75. Circular 75 requires PRC residents to register with the competent local SAFE branch before establishing or acquiring control over an SPV for the purpose of engaging in an equity financing outside of China. See Item 1 BusinessRegulationCircular 75 for a detailed discussion of Circular 75 and its implementation.
We have asked our stockholders, who are PRC residents as defined in Circular 75, to register with the relevant branch of SAFE as currently required in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiaries. However, we cannot provide any assurances that they can obtain the above SAFE registrations required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiaries ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our PRC resident beneficial holders.
28
In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75. We also have little control over either our present or prospective direct or indirect stockholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiaries ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.
Our business and financial performance may be materially adversely affected if the PRC regulatory authorities determine that our acquisition of Siping Juyuan constitutes a Round-trip Investment without MOFCOM approval.
On August 8, 2006, six PRC regulatory agencies promulgated the M&A Rule, which regulates Round-trip Investments, defined as having taken place when a PRC business that is owned by PRC individual(s) is sold to a non-PRC entity that is established or controlled, directly or indirectly, by those same PRC individual(s). See Item 1 Business RegulationMergers and Acquisitions for a detailed discussion of the M&A Rule.
The PRC regulatory authorities may take the view that PRC Individuals acquisition of our equity interest, or the Acquisition, and the reverse acquisition of Megaway are part of an overall series of arrangements which constitute a Round-trip Investment because at the end of these transactions, the PRC Individuals became the majority owners and effective controlling parties of a foreign entity that acquired ownership of our Chinese subsidiaries. The PRC regulatory authorities may also take the view that the registration of the Acquisition with the relevant AIC in Beijing and the filings with the Beijing SAFE may not be evidence that the Acquisition has been properly approved because the relevant parties did not fully disclose to the AIC, SAFE or MOFCOM the overall restructuring arrangements, the existence of the reverse acquisition and its link with the Acquisition. If the PRC regulatory authorities take the view that the Acquisition constitutes a Round-trip Investment under the M&A Rule, we cannot assure you we may be able to obtain the approval required from MOFCOM.
If the PRC regulatory authorities take the view that the Acquisition constitutes a Round-trip Investment without MOFCOM approval, they could invalidate our acquisition and ownership of our Chinese subsidiaries. We believe that if this takes place, we may be able to find a way to re-establish control of our Chinese subsidiaries business operations through a series of contractual arrangements rather than an outright purchase of our Chinese subsidiaries, but we cannot assure you that such contractual arrangements will be protected by PRC law or that we can receive as complete or effective economic benefit and overall control of our Chinese subsidiaries business than if the Company had direct ownership of our Chinese subsidiaries. In addition, we cannot assure you that such contractual arrangements can be successfully effected under PRC law. If we cannot obtain MOFCOM approval if required by the PRC regulatory authorities to do so, and if we cannot put in place or enforce relevant contractual arrangements as an alternative and equivalent means of control of our Chinese subsidiaries, our business and financial performance will be materially adversely affected.
Under the Enterprise Income Tax Law, we may be classified as a resident enterprise of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.
On March 16, 2007, the National Peoples Congress of China passed the EIT Law, and on November 28, 2007, the State Council of China passed its implementing rules, which took effect on January 1, 2008. Under the EIT Law, an enterprise established outside of China with de facto management bodies within China is considered a resident enterprise, meaning that it can be treated in a manner similar to a Chinese enterprise for enterprise income tax purposes. See Item 1 BusinessRegulationTaxation for a detailed discussion of the EIT Law.
It remains unclear whether the PRC tax authorities would require or permit our overseas registered entities to be treated as PRC resident enterprises. We do not currently consider our company to be a PRC resident enterprise. However, if the PRC tax authorities determine that we are a resident enterprise for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on offering proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiaries may qualify as tax-exempt income, we cannot guarantee that such dividends will not be subject to a 5% or 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new resident enterprise classification could result in a situation in which a 5% or 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our stock.
29
We face uncertainty from Chinas Circular on Strengthening the Administration of Enterprise Income Tax on NonResident Enterprises' Share Transfer that was released in December 2009 with retroactive effect from January 1, 2008.
The Chinese State Administration of Taxation, or SAT, released a circular on December 15, 2009 that addresses the transfer of shares by nonresident companies, generally referred to as Circular 698. Circular 698, which was effective retroactively to January 1, 2008, may have a significant impact on many companies that use offshore holding companies to invest in China. Circular 698, which provides parties with a short period of time to comply with its requirements, indirectly taxes foreign companies on gains derived from the indirect sale of a Chinese company. Where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise by selling the shares in an offshore holding company, and the latter is located in a country or jurisdiction where the effective tax burden is less than 12.5% or where the offshore income of his, her, or its residents is not taxable, the foreign investor is required to provide the tax authority in charge of that Chinese resident enterprise with the relevant information within 30 days of the transfers. Moreover, where a foreign investor indirectly transfers equity interests in a Chinese resident enterprise through an abuse of form of organization and there are no reasonable commercial purposes such that the corporate income tax liability is avoided, the PRC tax authority will have the power to re-assess the nature of the equity transfer in accordance with PRCs substance-over-form principle and deny the existence of the offshore holding company that is used for tax planning purposes. There is uncertainty as to the application of Circular 698. For example, while the term "indirectly transfer" is not defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the relevant authority has not yet promulgated any formal provisions or formally declared or stated how to calculate the effective tax in the country or jurisdiction and to what extent and the process of the disclosure to the tax authority in charge of that Chinese resident enterprise. In addition, there are not any formal declarations with regard to how to decide abuse of form of organization and reasonable commercial purpose, which can be utilized by us to balance if our Company complies with the Circular 698. As a result, we may become at risk of being taxed under Circular 698 and we may be required to expend valuable resources to comply with Circular 698 or to establish that we should not be taxed under Circular 698, which could have a material adverse effect on our financial condition and results of operations.
We may be exposed to liabilities under the Foreign Corrupt Practices Act and Chinese anti-corruption laws, and any determination that we violated these laws could have a material adverse effect on our business.
We are subject to the Foreign Corrupt Practice Act, or FCPA, and other laws that prohibit improper payments or offers of payments to foreign governments and their officials and political parties by U.S. persons and issuers as defined by the statute, for the purpose of obtaining or retaining business. We have operations, agreements with third parties, and make most of our sales in China. The PRC also strictly prohibits bribery of government officials. Our activities in China create the risk of unauthorized payments or offers of payments by the employees, consultants, sales agents, or distributors of our Company, even though they may not always be subject to our control. It is our policy to implement safeguards to discourage these practices by our employees. However, our existing safeguards and any future improvements may prove to be less than effective, and the employees, consultants, sales agents, or distributors of our Company may engage in conduct for which we might be held responsible. Violations of the FCPA or Chinese anti-corruption laws may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, operating results and financial condition. In addition, the U.S. government may seek to hold our Company liable for successor liability FCPA violations committed by companies in which we invest or that we acquire.
The disclosures in our reports and other filings with the SEC and our other public pronouncements are not subject to the scrutiny of any regulatory bodies in the PRC. Accordingly, our public disclosure should be reviewed in light of the fact that no governmental agency that is located in China where substantially all of our operations and business are located have conducted any due diligence on our operations or reviewed or cleared any of our disclosure.
We are regulated by the SEC and our reports and other filings with the SEC are subject to SEC review in accordance with the rules and regulations promulgated by the SEC under the Securities Act and the Exchange Act. Unlike public reporting companies whose operations are located primarily in the United States, however, substantially all of our operations are located in China. Since substantially all of our operations and business takes place in China, it may be more difficult for the Staff of the SEC to overcome the geographic and cultural obstacles that are present when reviewing our disclosure. These same obstacles are not present for similar companies whose operations or business take place entirely or primarily in the United States. Furthermore, our SEC reports and other disclosure and public pronouncements are not subject to the review or scrutiny of any PRC regulatory authority. For example, the disclosure in our SEC reports and other filings are not subject to the review of the China Securities Regulatory Commission, a PRC regulator that is tasked with oversight of the capital markets in China. Accordingly, you should review our SEC reports, filings and our other public pronouncements with the understanding that no local regulator has done any due diligence on our company and with the understanding that none of our SEC reports, other filings or any of our other public pronouncements has been reviewed or otherwise been scrutinized by any local regulator.
30
RISKS RELATED TO THE MARKET FOR OUR STOCK
Although publicly traded, the trading market in our common stock has been substantially less liquid than the average trading market for a stock quoted on the NASDAQ Stock Market and this low trading volume may adversely affect the price of our common stock.
Our common stock is traded on the NASDAQ Capital Market under the symbol THTI. The trading market in our common stock has been substantially less liquid than the average trading market for companies trading on the NASDAQ Stock Market. Reported average daily trading volume in our common stock for the three months immediately prior to March 31, 2013, was approximately 20.45 million shares. Limited trading volume will subject our shares of common stock to greater price volatility and may make it difficult for you to sell your shares of common stock at a price that is attractive to you.
We may be subject to penny stock regulations and restrictions and you may have difficulty selling shares of our common stock.
The SEC has adopted regulations which generally define so-called penny stocks to be an equity security that has a market price less than $5.00 per share or an exercise price of less than $5.00 per share, subject to certain exemptions. Our common stock is a penny stock and is subject to Rule 15g-9 under the Exchange Act, or the Penny Stock Rule. This rule imposes additional sales practice requirements on broker-dealers that sell such securities to persons other than established customers and accredited investors (generally, individuals with a net worth in excess of $1,000,000 or annual incomes exceeding $200,000, or $300,000 together with their spouses). For transactions covered by Rule 15g-9, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser's written consent to the transaction prior to sale. As a result, this rule may affect the ability of broker-dealers to sell our securities and may affect the ability of purchasers to sell any of our securities in the secondary market, thus possibly making it more difficult for us to raise additional capital.
For any transaction involving a penny stock, unless exempt, the rules require delivery, prior to any transaction in penny stock, of a disclosure schedule prepared by the SEC relating to the penny stock market. Disclosure is also required to be made about sales commissions payable to both the broker-dealer and the registered representative and current quotations for the securities. Finally, monthly statements are required to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stock.
There can be no assurance that our common stock will qualify for exemption from the Penny Stock Rule. In any event, even if our common stock were exempt from the Penny Stock Rule, we would remain subject to Section 15(b)(6) of the Exchange Act, which gives the SEC the authority to restrict any person from participating in a distribution of penny stock, if the SEC finds that such a restriction would be in the public interest.
We do not intend to pay dividends for the foreseeable future.
For the foreseeable future, we intend to retain any earnings to finance the development and expansion of our business, and we do not anticipate paying any cash dividends on our common stock. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend on our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board deems relevant.
31
Certain provisions of our Articles of Incorporation may make it more difficult for a third party to effect a change-of-control.
Our Articles of Incorporation authorize our board of directors to issue up to 10,000,000 shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which may be determined at the time of issuance by our board of directors without further action by the stockholders. These terms may include voting rights including the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion rights, redemption rights and sinking fund provisions. The issuance of any preferred stock could diminish the rights of holders of our common stock, and therefore could reduce the value of such common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of our board of directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change-in-control, which in turn could prevent our stockholders from recognizing a gain in the event that a favorable offer is extended and could materially and negatively affect the market price of our common stock.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 2. PROPERTIES.
Land Use Rights
There is no private land ownership in China. Individuals and companies are permitted to acquire land use rights for specific purposes. We were granted land use rights from the PRC government for 36,529.6 square meters of three land slots located at No.5 NanhuanRoad, Tiexi District, Siping City, Jilin Province, China. The land use rights will expire on December 8, 2056, December 30, 2056 and December 30, 2057, respectively. On July 10, 2012, we obtained the certificate from the Chinese government for a total area of 100,247 square meters. We plan to construct a new plant on this land.
Mortgages were created over the land use rights of the three land lots with an area of 17,682.78 square meters, 11,619.6 square meters and 7,227.22 square meters, respectively. Such mortgages are used for securing our indebtedness with China Agriculture Bank, Siping Branch. We believe that all our properties have been adequately maintained, are generally in good condition and are suitable and adequate for our business.
Buildings
Our manufacturing facilities are based in Siping City, Jilin Province, China. The total floor area of our facility is approximately 17,482 square meters. The production portion of the facility is approximately 11,275 square meters. Our research and development center is approximately 1,164 square meters and our executive office building, garage, and dormitory are approximately 5,043 square meters. We currently have two production lines for plate heat exchangers with an annual capacity of 500,000 square meters and one welding workshop with an annual capacity of 3,000 tons. Our welding facility is located on a 36,530 square meter plot of land for which we own the land use right.
We currently own ten buildings covered by ten Property Ownership Certificates issued by Siping City Housing Administration Bureau. All the buildings are located at No.5 Nanhuan Road, Tie Xi District, Siping City. The building with an area of 4,633.93 square meters was mortgaged to secure our indebtedness to China Agriculture Bank, Siping Branch on November 8, 2010.
Our new workshop, which began operations in October 2009, has a floor area of 7,356 square meters and a new production line for plate heat exchangers with a designed capacity of 200,000 square meters.
32
Buildings under Construction
Our third workshop and our research center, located at the south side of NanhuanRoad, Tie Xi District, Siping City, are under construction. We have obtained a License for Construction Land Planning (Ref. Di Zi No. 200802050) issued by Siping City Construction Bureau on July 25, 2008, which shows that the land area approved for our above-mentioned construction is 11,781 square meters.
We also acquired a License for Construction Project Planning (Ref. Jian Zi No. 200803043) issued on September 5, 2008 by Siping City Construction Bureau. The License shows that the area of construction will be 7,716 square meters.
Leased Properties
We currently lease nine real properties as representative offices in Shanghai, Zhengzhou, Taiyuan, Baotou, Shenyang, Harbin, Beijing, Wuhan and Qingdao.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, we may become involved in various lawsuits and legal proceedings, which arise, in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these, or other matters, may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse affect on our business, financial condition, cash flows or operating results.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock is traded on the Nasdaq Capital Market under the symbol THTI.
The following table sets forth, for the periods indicated, the high and low closing prices of our common stock. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions.
Closing Prices(1) | ||||||
High | Low | |||||
Year Ended December 31, 2012 | ||||||
1st Quarter | $ | 1.74 | $ | 0.87 | ||
2nd Quarter | 2.31 | 1.26 | ||||
3rd Quarter | 1.86 | 0.77 | ||||
4th Quarter | 1.30 | 0.92 | ||||
Year Ended December 31, 2011 | ||||||
1st Quarter | $ | 4.20 | $ | 3.30 | ||
2nd Quarter | 3.74 | 3.33 | ||||
3rd Quarter | 3.54 | 1.64 | ||||
4th Quarter | 1.75 | 0.82 |
(1) |
The above table sets forth the range of high and low closing prices per share of our common stock as reported by www.quotemedia.com for the periods indicated. |
33
Approximate Number of Holders of Our Common Stock
As of March 31, 2013, there were approximately 793 holders of record of our common stock. This number excludes the shares of our common stock owned by stockholders holding stock under nominee security position listings.
Dividend Policy
We have never declared dividends or paid cash dividends. Any future decisions regarding dividends will be made by our board of directors. We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Our board of directors has complete discretion on whether to pay dividends, subject to the approval of our stockholders. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant
Securities Authorized for Issuance Under Equity Compensation Plans
We do not have any compensation plans in effect under which our equity securities are authorized for issuance.
Recent Sales of Unregistered Securities
We have not sold any equity securities during the 2012 fiscal year that were not previously disclosed in a quarterly report on Form 10-Q or a current report on Form 8-K that was filed during the 2012 fiscal year.
Purchases of Equity Securities
No repurchases of our common stock were made during the fourth quarter of 2012.
ITEM 6. SELECTED FINANCIAL DATA.
Not applicable.
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following managements discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this report. In addition to historical information, the following discussion contains certain forward-looking information. See Special Note Regarding Forward Looking Statements above for certain information concerning those forward looking statements. Our financial statements are prepared in U.S. dollars and in accordance with United States generally accepted accounting principles.
Overview
We are a leading total solution provider in the heat exchange industry. Our major products are plate heat exchangers, heat exchanger units, air-cooled heat exchangers and shell-and-tube heat exchangers. Unlike most other heat exchanger manufacturers in China, we not only provide heat exchange products, but also provide total solutions to our customers. As a total solutions provider, we analyze the working condition of our customers, provide optimized designs based on analysis and simulation, offer high quality heat exchange products, and continuously assist our customers in improving the heat exchange process.
Over the past ten years, we have successfully completed over 3,000 projects in more than 15 industries, including metallurgy, heat and power, petrochemical, food and beverage, pharmaceutical and shipbuilding. We have provided heat exchange solutions to Fortune 500 companies, including Shell, BP, BASF, LG, Sinopec and China Shenhua. We have also provided heat exchange products for important Chinese and international projects such as the Beijing 2008 Olympics Wukesong Sports Center, Guangdong Linao nuclear plant and BASF Chemical plant in Germany.
Our operations are headquartered in Siping, Jilin Province, PRC. Our primary Chinese operating subsidiaries are Siping Juyuan and Beijing Juyuan.
34
Recent Development
Siping Juyuan entered into a share transfer agreement dated May
10, 2012 (the "Share Transfer Agreement") relating to the acquisition of the
remaining 25% equity ownership interest in Beijing Juyuan from Hanyang
International GmbH (Hanyang). The purchase price for this 25% equity interest
is RMB 2.5 million (approximately $402,325). The purchase price must be paid by
the Company in one lump sum on or before April 30, 2013. Under applicable PRC
law, the acquisition of the 25% equity interest in Beijing Juyuan must be
approved by appropriate foreign investment approval authority, and then
registered with a competent branch of the State Administration of Industry and
Commerce. Failure to obtain these necessary approvals or to pay the purchase
price may result in the unwinding of the acquisition. The Company obtained all
the required PRC regulatory approvals and registrations by March 21, 2013, and
expects the acquisition to be consummated on or before April 30, 2013.
A copy of the Share Purchase Agreement is attached hereto as exhibits 10.10 and
is hereby incorporated by reference.
Financial Performance Highlights
The following are some financial highlights for the year:
Sales revenue: Sales revenue increased by $5.03 million, or 8.71%, to $62.77 million for 2012, from $57.74 million for 2011.
Gross profit: Gross profit decreased by $3.59 million, or 14.22%, to $21.65 million for 2012, from $25.24 million for 2011. As a percentage of sales revenue, gross profit decreased by 9.22% to 34.49% for 2012 from 43.71% for 2011.
Net income attributable to stockholders: Net income attributable to our stockholders decreased by $4.74 million, or 59.98%, to $3.16 million for 2012, from $7.90 million for 2011.
Fully diluted net income per share: Fully diluted net income per share was $0.15 for 2012, as compared $0.39 for 2011.
Principal Factors Affecting our Financial Performance
We believe that the following factors will continue to affect our financial performance:
Growth of Chinas Urbanization and Industrialization. According to China Heat Association, the annual growth rate of the heat exchange industry in China is expected to be 101% from 2012 to 2016. This growth is fueled by rapid industrialization and manufacturing industries developing in China. If this growth continues, we believe that we will be able to sustain our growth and continue to be a leader in the heat exchange industry in China.
PRC Regulations. China has looked favorably on the heat exchange industry and has loosened regulations to promote manufacturing growth in China, which ultimately benefits the Company and similarly situated companies. The Chinese government committed to promote the development of Chinas urbanization, which includes the heat exchange industry, through, among other things, tax incentives, import/export support and capital support. In addition, the stimulus package offered by the Chinese government will provide market opportunities for us. As long as China continues to promote economic growth and allows manufacturing companies to grow and expand their operations, we expect our operations will be positively effected by PRC regulations.
Taxation
The Company is subject to United States tax at a tax rate of 34%. No provision for income taxes in the United States has been made as the Company has no income taxable in the United States.
Megaway was incorporated in the BVI, but is not subject to taxation in that jurisdiction.
Star Wealth was incorporated in Hong Kong and under the current laws of Hong Kong, is subject to a Profits Tax of 16.5% . However, no provision for Hong Kong Profits Tax has been made as Star Wealth has no taxable income.
35
According to the PRCs central government policy, new or high technology companies will enjoy preferential tax treatment of 15%, instead of 25% under the EIT Law. On October 13, 2011, Siping Juyuan was granted the High and New Technology Enterprise status which entitled it to a 15% preferential income tax rate for a period of three years from 2011 to 2014. In addition, Siping Juyuan was entitled to a special tax concession because it employed the required number of handicapped staff according to the relevant PRC tax rules. In particular, this tax concession entitled Siping Juyuan to a refund of VAT paid in the years ended December 31, 2012 and 2011.
Beijing Juyuan, being a sino-foreign joint venture enterprise, was entitled to two years EIT exemption, from the first profit making calendar year of operations after offset of accumulated taxable losses, followed by a 50% tax reduction for the immediate next three calendar years. This tax holiday commenced in the fiscal year of 2008. Beijing Juyuan was therefore subject to EIT at the rate of 12.5% during the years ended December 31, 2012 and 2011.
See Item 1 Business Regulation Taxation for a detailed description of the EIT Law and tax regulations applicable to our PRC subsidiaries.
Results of Operations
The following table sets forth key components of our results of operations for fiscal years ended December 31, 2012 and 2011.
Year Ended December 31, | $ | % | ||||||||||
2012 | 2011 | Change | Change | |||||||||
Sales revenue | $ | 62,77,0692 | $ | 57,741,288 | $ | 5,029,404 | 8.71 | |||||
Cost of sales | (41,118,573 | ) | (32,501,171 | ) | (8,617,402 | ) | 26.51 | |||||
Gross profit | 21,652,119 | 25,240,117 | (3,587,998 | ) | (14.22 | ) | ||||||
Operating expenses: | ||||||||||||
Administrative expenses | 5,910,211 | 5,615,566 | 294,645 | 5.25 | ||||||||
Research and development expenses | 2,230,364 | 1,754,965 | 475,399 | 27.09 | ||||||||
Selling expenses | 8,195,117 | 8,532,879 | (337,762 | ) | (3.96 | ) | ||||||
Total operating expenses | 16,335,692 | 15,903,410 | 432,282 | 2.72 | ||||||||
Income from operations | 5,316,427 | 9,336,707 | (4,020,280 | ) | (43.06 | ) | ||||||
Interest income | 28,245 | 56,080 | (27,835 | ) | (49.63 | ) | ||||||
Other income | 524,463 | 796,893 | (272,430 | ) | (34.19 | ) | ||||||
Finance costs | (1,814,313 | ) | (1,121,133 | ) | (693,180 | ) | 61.83 | |||||
Other expense | (175,538 | ) | - | (175,538 | ) | 100 | ||||||
Income before income taxes | 3,879,284 | 9,068,547 | (5,189,263 | ) | (57.22 | ) | ||||||
Income taxes | (699,950 | ) | (1,619,776 | ) | 91,9826 | (56.79 | ) | |||||
Net income before noncontrolling interests | 3,179,334 | 7,448,771 | (4,269,437 | ) | (57.32 | ) | ||||||
Net income (loss) attributable to noncontrolling interests | (16,309 | ) | 454,305 | (470,614 | ) | (103.59 | ) | |||||
Net income attributable to THT common stockholders | $ | 3,163,025 | $ | 7,903,076 | $ | (4,740,051 | ) | (59.98 | ) |
Sales revenue. Our sales revenue is generated from sales of heat exchange products. Sales revenue increased by $5.03 million, or 8.71%, to $62.77 million in 2012 from $57.74 million in 2011. Our sales volume in 2012 amounted to 3,726 units, a decrease of 407 units, from 4,133 units in 2011. Such decrease was mainly due to the decreased sales revenue from plate heat exchangers and air coolers in 2012 as compared with 2011. Sales revenue from plate heat exchangers decreased by $5.64 million, or 18.87%, to $24.23 million in 2012 from $29.87 million in 2011. Sales revenue from air-coolers decreased by $1.74 million, or 50.09%, to $1.73 million in 2012, from $3.47 million in 2011. The decrease was caused by decreasing demand for our products in some industries as a result of an overall slowdown of Chinas economy in 2012. Although sales revenue from heat exchange units and other products increased, the increase was not enough to offset the decreased sales revenue from plate heat exchangers and air coolers.
The following table shows our sales revenue by product for the years ended December 31, 2012 and 2011:
Year Ended December 31, | ||||||||||||
2012 | 2011 | |||||||||||
$ | % | $ | % | |||||||||
Plate heat exchanger | $ | 24,232,037 | 39 | $ | 29,867,262 | 52 | ||||||
Heat exchange unit | 24,571,248 | 39 | 12,365,970 | 21 | ||||||||
Air-cooled heat exchanger | 1,730,094 | 3 | 3,466,342 | 6 | ||||||||
Shell-and-tube heat exchanger | 5,978,256 | 9 | 6,276,527 | 11 | ||||||||
Others | 6,259,057 | 10 | 5,765,187 | 10 | ||||||||
TOTAL | $ | 62,770,692 | 100 | $ | 57,741,288 | 100 |
36
Gross profit. Our gross profit is equal to the difference between our sales revenue and our cost of sales. Our gross profit decreased by $3.59 million, or 14.22%, to $21.65 million in 2012 from $25.24 million in 2011. The decrease in our gross profit was mainly attributable to decreased sales revenue from plate heat exchangers and air coolers. Although the average sales price per unit increased by 20.00% year over year, our gross profit margin for 2012 dropped to 34.49% from 43.71% for 2011. The decrease in our gross profit margin was mainly attributable to the increase in labor costs in factory and raw material costs in 2012.
Administrative expenses. Our administrative expenses consist of the costs associated with staff and support personnel who manage our business activities. Our administrative expenses increased by $0.29 million, or 5.25%, to $5.91 million in 2012 from $5.62 million in 2011. As a percentage of sales revenue, administrative expenses decreased to 9.42% in 2012, as compared to 9.73% in 2011. The increase in administrative expenses was primarily due to an increase of allowance for doubtful accounts. Bad debt expense increased by $1.47 million to $2.08 million in 2012 compared with $0.61 million in 2011. The increase in the bad debt expense was mainly due to our policies for bad debt reserves. We record an allowance for doubtful accounts at a rate of 25% for receivables aged between 1 to 2 years, 50% for receivables aged between 2 to 3 years and 100% for receivables aged over 3 years. Our account receivables age between 1 to 2 years increased by $4.43 million in 2012 compare to 2011. Our office expenses decreased by $0.60 million to $1.29 million in 2012, compared $0.69 million in 2011. The decrease was mainly due to reduced office purchase in 2012.
We believe our allowance for doubtful accounts is appropriate. We have installment payment arrangement with our customers. The current economic slowdown and Chinas tightened credit policy led to delayed payments and delayed delivery schedules by our customers, which in turn caused us to increase our allowance for doubtful accounts from $0.29 million in the six months ended June 30, 2011 to $0.36 million in the same period in 2012. To control inflation after a massive stimulus plan, the Chinese government tightened its credit policy. As a result, state-owned banks limited their lending to large state-owned corporations and privately held companies continue to have difficulty accessing capital. 54% of our customers have been affected by the tightened credit policy and have limited access to capital. The Company records an allowance for doubtful accounts at a rate of 25% for receivables aged between 1 to 2 years, 50% for receivables aged between 2 to 3 years and 100% for receivables aged over 3 years.
Our allowance of obsolete inventory is also appropriate because we purchase raw materials after we receive purchase orders. Although our customers may delay their payment or delivery schedules which increase our inventories, they do not cancel their orders to cause us classify the delayed inventories as obsolete inventories.
Research and development expenses. Our research and development expenses consist of the costs associated with research and development personnel and expense in research and development projects. Our research and development expenses increased by $0.48 million, or 27.09%, to $2.23 million in 2012 from $1.75 million in 2011. The increase in research and development expenses was mainly attributable to research and development of new products mentioned above.
The detailed information of the last two years on research and development activities expenses are as follows:
2012 | 2011 | change | |
Material | 1,179,592 | 686,625 | 492,967 |
depreciation expense | 210,802 | 236,959 | (26,157) |
cost | 464,103 | 389,366 | 74,737 |
salary | 375,867 | 442,016 | (66,149) |
total | 2,230,364 | 1,754,965 | 475,399 |
37
Selling expenses. Our selling expenses include sales commissions, the cost of advertising and promotional materials, salaries and fringe benefits of sales personnel, after-sale support services and other sales-related costs. Our selling expenses decreased by $0.34 million, or 3.96%, to $8.20 million in 2012, from $8.53 million in 2011. As a percentage of sales revenue, selling expenses decreased to 13.10% in 2012, as compared to 14.78% in 2011. The decrease was mainly attributable to the decreased salaries of our sales personnel. The salaries of sales personnel decreased by $0.99 million, or 42.86%, to $1.32 million in 2012, from $2.31 million in 2011 because both the number of sales personnel and their base salary were reduced.
Income before income taxes. Income before income taxes decreased by $5.19 million, or 57.22%, to $3.88 million in 2012, from $9.07 million in 2011. Such decrease was mainly attributable to decreased gross profit and increased total expenses.
Income taxes. Our income taxes decreased to $0.70 million in 2012 from $1.62 million in 2011, as a result of decreased taxable income.
Net income attributable to common stockholders. As a result of the cumulative effect of the foregoing factors, our net income attributable to common stockholders decreased by $4.74 million, or 59.98%, to $3.16 million for 2012, from $7.90 million for 2011. As a percentage of sales revenue, our net income attributable to common stockholders was 5.04% and 13.77% for 2012 and 2011, respectively.
Liquidity and Capital Resources
As of December 31, 2012, we had cash and cash equivalents of $10.70 million, primarily consisting of cash on hand and demand deposits. We can use our land as collateral to borrow approximately $4.76 million. In addition, we have an approximately $7.95 million credit line from Industrial and Commercial Bank of China. We anticipate that cash on hand and borrowing capacity under our bank loans will be sufficient to satisfy our ongoing obligations.
We believe our allowance for doubtful accounts is appropriate. We have an installment payment arrangement with our customers. The current economic slowdown and Chinas tightened credit policy led to delayed payments and delayed delivery schedules by our customers, which in turn caused us to increase our allowance for doubtful accounts from $2.03 million in 2011 to $4.13 million in 2012. To control inflation after a massive stimulus plan, the Chinese government tightened its credit policy. As a result, state-owned banks limited their lending to large state-owned corporations and privately held companies continue to have difficulty accessing capital. Most of our customers have been affected by the tightened credit policy and have limited access to capital. The Company records an allowance for doubtful accounts at a rate of 25% for receivables aged between 1 to 2 years, 50% for receivables aged between 2 to 3 years and 100% for receivables aged over 3 years.
Our allowance of obsolete inventory is also appropriate because we purchase raw materials after we receive purchase orders. Although our customers may delay their payment or delivery schedules, which increase our inventories, they do not cancel their orders so as to cause us to classify the delayed inventories as obsolete inventories.
We expect that the trend of delayed customer payments and delayed delivery schedules will continue in the future. We have been taking the following measures to mitigate the situation: 1) send the collection letters or call the customers to request payment; 2) appoint specialists to visit our customers to collect payment; and 3) file law suits.
PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiaries are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRCGAAP to a statutory general reserve fund until the amounts in said fund reaches 50% of our registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances, or cash dividends. Given that the Company and the PRC subsidiaries do not intend to pay dividends for the foreseeable future, we consider the impact of restrictions on our liquidity, financial condition and results of operations is not significant.
The following table provides a summary of our net cash flows from operating, investing, and financing activities.
38
Year Ended December 31, | ||||||
2012 | 2011 | |||||
Net cash provided by (used in) operating activities | $ | 4,218,972 | $ | (13,050,147 | ) | |
Net cash used in investing activities | (1,408,769 | ) | (6,239,183 | ) | ||
Net cash provided by financing activities | 475,315 | 7,785,590 | ||||
Effects of exchange rate change in cash and cash equivalents | 77,613 | 405,378 | ||||
Net increase (decrease) in cash | 3,363,131 | (11,098,362 | ) | |||
Cash and cash equivalents at beginning of the year | 7,340,068 | 18,438,430 | ||||
Cash and cash equivalent at end of the year | $ | 10,703,199 | $ | 7,340,068 |
Operating Activities
Net cash provided by operating activities was $4.22 million for 2012, compared with $13.05 million, net cash used in operating activities, for 2011. The increased in net cash provided by operating activities was mainly because the inventories increased $18.03 million in 2011but decreased $0.93 million in 2012. Our cash and cash equivalents increase $3.36 million from $7.34 million on December 31, 2011 to $10.70 million on December 31, 2012. The increase of cash and cash equivalents was mainly attributable to net cash flows provided by operating activities of $4.22 million, which was mainly due to (1) strictly implemented advance payment by the customers, which led to$4.47 million increase in advance from customers, and (2) delay of the payment of the payables.
Investing Activities
Net cash used in investing activities was $1.41 million for 2012, compared with $6.24 million for 2011. The net cash used in investing activities during 2012 was primarily used for the purchase of equipment and pay the balance for land use rights.
Financing Activities
Net cash provided by financing activities was $0.48 million for 2012, compared with $7.79 million for 2011.We had sufficient cash from operation and better advance payments from customers and did not borrow loans as much as we did in 2011.
Short-Term Loans
As of December 31, 2012, the amount outstanding, maturity date and term of each of our short-term bank loans were as follows:
Bank | Amount* | Rate | Maturity Date | Duration | ||||||||
Agricultural Bank of China, Jiuyuan Branch | 3,170,275 | 6.94% | June 26, 2013 | 1 year | ||||||||
Agricultural Bank of China, Jiuyuan Branch | 2,853,248 | 6.6% | July 17, 2013 | 1 year | ||||||||
China Construction Bank | 9,510,827 | 6.6% | June 10, 2013 | 1 year | ||||||||
Bank of Communications | 3,170,275 | 7.2% | August 15, 2013 | 1 year | ||||||||
TOTAL | $ | 18,704,625 |
* Calculated based on the exchange rate of $1 = RMB 6.3086 (December 31, 2012).
The loans from Agricultural Bank of China and China Construction Bank are secured by certain assets of the Company. The unsecured bank loans from Bank of Communications were guaranteed by Mr. Guohong Zhao, our Chairman and Chief Executive Officer, and certain third parties. The third parties received 2% of the loan balance as compensation for acting as guarantors for the Company. The Company put deposits to the guarantors for the unsecured short-term loan in the amounts of $237,771 and $235,676 as of December 31, 2012 and December 31, 2011, respectively. These deposits will be returned to the Company upon the Companys settlement of the loans. As of the filing date, guarantee deposit of $237,771 has been received by the Company.
Long-Term Loan
On July 19, 2011, the Company entered into a loan agreement with China Development Bank for a loan in the maximum principal amount of $4.73 million. The loan bears interest at an annual rate of 15% over the benchmark rate of the Peoples Bank of China and matures on July 18, 2014. The loan is guaranteed by a third party. As a condition to the guarantee for the loan, the Company paid 2.5% of the loan balance to the third party as compensation for acting as guarantor for the Company and put deposits to the guarantor in the amounts of $237,771 and $235,676 as of December 31, 2012 and December 31, 2011, respectively. These deposits will be returned to the Company upon the Companys settlement of the loans. Under the loan agreement, the Companys inventory level cannot be lower than RMB 10 million (approximately $1.58 million) during the loan period.
39
As of December 31, 2012, the amounts outstanding of our long-term bank loans were as follows:
2013 | 1,902,165 | ||
2014 | 951,083 | ||
$ | 2,853,248 |
Capital Expenditures
Our capital expenditures were used primarily for the purchase of equipment to expand our production capacity and deposits for land use rights. On July 10, 2012, we obtained the land use right certificate from the Chinese government for a parcel of land with 100,247 square meters. We plan to construct a new plant on the land. The table below sets forth the breakdown of our capital expenditures for the periods indicated.
Year Ended December 31, | ||||||
2012 | 2011 | |||||
Purchase of equipment | 669.924 | 1,923,633 | ||||
Prepayment for land use right | - | 4,315,550 | ||||
Purchase of land use rights | 738,845 | - | ||||
Total capital expenditures | $ | 1,408,769 | $ | 6,239,183 |
We estimate that our total capital expenditures in fiscal year 2013 will reach approximately $3.15 million: our capital expenditures will be primarily for the purchase of equipment and construct plant.
Obligations Under Material Contracts
Except with respect to the loan obligations disclosed above, we have no material obligations to pay cash or deliver cash to any other party
Seasonality
Our operating results and operating cash flows historically have been subject to seasonal variations. Our revenues usually increase over each quarter of the calendar year with the first quarter usually the slowest quarter because fewer projects are undertaken during and around the Chinese spring festival.
Inflation
Inflation and changing prices have not had a material effect on our business, and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. However, our management will closely monitor price changes in the Chinese economy and our industry and continually maintain effective cost controls in operations.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors.
Critical Accounting Policies, Estimates and Assumptions
The preparation of financial statements in conformity with United States generally accepted accounting principles, or U.S. GAAP, requires our management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements, including the notes thereto, and related disclosures of commitments and contingencies, if any. If actual results were to differ materially from the estimates made, the reported results could be materially affected. We consider our critical accounting policies to be those that require the more significant judgments and estimates in the preparation of financial statements, including the following:
40
Allowance for Doubtful Accounts
We present trade receivables, net of allowances for doubtful accounts, to ensure trade receivables are not overstated due to uncollectible accounts. Allowances, when required, are calculated based on a detailed review of certain individual customer accounts and an estimation of the overall economic conditions affecting our customer base. We review a customers credit history before extending credit. Our allowance for doubtful accounts was $4.13 million at December 31, 2012 compared to $2.03 million at December 31, 2011. The $2.10 million increase was due to the significant increase in our account receivable. If the financial condition of our customers were to deteriorate further based on worsening overall economic conditions, resulting in an impairment of their ability to make payments to us, then additional allowances may be required in future periods, which would adversely affect our financial performance.
Inventory Obsolescence
Our inventories are stated at the lower of cost or net realizable value. We routinely evaluate quantities and value of our inventories in light of current market conditions and market trends, and record a write-down against the cost of inventories for a decline in net realizable value. Expected demand and anticipated sales price are the key factors affecting our inventory valuation analysis. For purposes of our inventory valuation analysis, we develop expected demand and anticipated sales prices primarily based on sales orders as well as industry trends and individual customer analysis. We also consider sales and sales orders after each reporting period-end but before the issuance of our financial statements to assess the accuracy of our inventory valuation estimates. Historically, actual demand and sales price have generally been consistent with or greater than expected demand and anticipated sales price used for purposes of the our inventory valuation analysis. Market conditions are subject to change and actual consumption of inventories could differ from forecasted demand. Furthermore, the price of our primary raw material is subject to fluctuations based on global supply and demand. Our management continually monitors the changes these purchase prices, including advances to suppliers, and the impact of such change on our ability to recover the cost of inventory and our prepayments to suppliers. Our products have a long life cycle and obsolescence has not historically been a significant factor in the valuation of inventories. We have not experienced any material inventory write-downs before.
Income Taxes
Our provision for income taxes is determined using the applicable statutory rate for each jurisdiction. We recognize deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities along with net operating loss and tax credit carryovers. Our deferred tax asset was $0.16 million and $0.25 million at December 31, 2012 and 2011, respectively. We record a valuation allowance against our deferred tax assets to reduce the net carrying value to an amount that we believe is more likely than not to be realized. As a result, Management recorded a valuation allowance against the deferred tax asset of $0.77 million and $0.38 million at December 31, 2012 and 2011, respectively. If we reduce the valuation allowance against our available deferred tax asset, our operating results and financial condition will be positively affected in future periods.
Depreciable Lives of Property, Plant and Equipment
Property, plant and equipment is recorded at cost and depreciated using the straight-line method, which deducts equal amounts of the cost of each asset from earnings every year over its estimated economic useful life. Economic useful life is the duration of time an asset is expected to be productively employed by us, which may be less than its physical life. Assumptions on the following factors, among others, affect the determination of estimated economic useful life: wear and tear, obsolescence, technical standards, contract life, market demand, competitive position, raw material availability, and geographic location.
The estimated economic useful life of an asset is monitored to determine its appropriateness, especially in light of changed business circumstances. For example, changes in technology, changes in the estimated future demand for products, or excessive wear and tear may result in a shorter estimated useful life than originally anticipated. In these cases, we would depreciate the remaining net book value over the new estimated remaining life, thereby increasing depreciation expense per year on a prospective basis.
41
Net property, plant and equipment totaled $7.71 million and depreciation expense totaled $1.10 million as of and for the year ended December 31, 2012, respectively. Net property, plant and equipment totaled $7.70 million and depreciation expense totaled $0.93 million as of and for the year ended December 31, 2011 respectively.
These depreciable lives have been determined based on historical experience combined with judgment on future assumptions such as technological advances, potential obsolescence, competitors actions, etc. Management monitors its assumptions and may potentially need to adjust depreciable life as circumstances change.
Impairment of Long-Lived Assets
Long-lived assets which include property, plant, and equipment and land use rights are grouped for impairment testing at the lowest level for which there is an identifiable cash flow. Impairment testing of the asset group occurs whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Such circumstances would include a significant decrease in the market value of a long-lived asset grouping, a significant adverse change in the manner in which the asset grouping is being used or in its physical condition, a history of operating or cash flow losses associated with the use of the asset grouping, or changes in the expected useful life of the long-lived assets. If such circumstances are determined to exist, an estimate of undiscounted future cash flows produced by that asset group is compared to the carrying value to determine whether impairment exists. If an asset group is determined to be impaired, the loss is measured based on the difference between the asset groups fair value and its carrying value. An estimate of the asset groups fair value is based on the discounted value of its estimated cash flows. Assets to be disposed of by sale are reported at the lower of carrying amount or fair value less cost to sell.
The assumptions underlying cash flow projections represent our best estimates at the time of the impairment review. Factors that we must estimate include industry and market conditions, sales volume and prices, costs to produce, etc. Changes in key assumptions or actual conditions that differ from estimates could result in an impairment charge. Management believes it uses reasonable and supportable assumptions when performing impairment reviews and cannot predict the occurrence of future events and circumstances that could result in impairment charges.
Recent Accounting Pronouncements
See Note 3 to our audited consolidated financial statements included elsewhere in this report.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The full text of our audited consolidated financial statements as of December 31, 2012 and 2011 begins on page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). 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 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 Interim Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
42
As required by Rule 13a-15(e) of the Exchange Act, our management has carried out an evaluation, with the participation and under the supervision of our Chief Executive Officer, Mr. Guohong Zhao, and Interim Chief Financial Officer, Mr. Zhigang Xu, of the effectiveness of the design and operation of our disclosure controls and procedures, as of December 31, 2012. Based upon, and as of the date of this evaluation, Messrs. Zhao and Xu determined that, because of the material weaknesses described below, our disclosure controls and procedures were not effective.
Notwithstanding managements assessment that our internal control over financial reporting was ineffective as of December 31, 2012 due to the material weaknesses described below, we believe that the consolidated financial statements included in this report correctly present our financial condition, results of operations and cash flows for the fiscal years covered thereby in all material respects.
Managements Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Interim Chief Financial Officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP, and includes those policies and procedures that:
(1) |
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; | |
(2) |
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and expenditures are being made only in accordance with the authorization of our management and directors; and | |
(3) |
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements. |
Management evaluated the effectiveness of our internal control over financial reporting as of December 31, 2012. In making this evaluation, management used the framework established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. The COSO framework summarizes each of the components of a companys internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and communication, and (v) monitoring. Based on our evaluation, we determined that, as of December 31, 2012, our internal control over financial reporting was not effective because of the material weaknesses in our internal control over financial reporting described below.
1. Accounting and Finance Personnel Weaknesses Our current accounting staff is relatively new and inexperienced, and needs substantial training to meet the higher demands of being a U.S. public company. The accounting skills and understanding necessary to fulfill the requirements of U.S. GAAP-based reporting, including the skills of subsidiary financial statements consolidation, are inadequate and were inadequately supervised. The lack of sufficient and adequately trained accounting and finance personnel resulted in an ineffective segregation of duties relative to key financial reporting functions.
2. Lack of Internal Audit Function We lack qualified resources to perform the internal audit functions properly. In addition, the scope and effectiveness of the internal audit function are yet to be developed.
3. Lack of Internal Audit System We lack an internal audit department, which renders ineffective our ability to prevent and detect control lapses and errors in the accounting of certain key areas like revenue recognition, purchase approvals, inter-company transactions, cash receipt and cash disbursement authorizations, inventory safeguard and proper accumulation for cost of products, in accordance with our appropriate costing method.
Our management has identified the steps necessary to address the material weaknesses described above and in 2012, we have continued to implement the following remedial procedures.
43
Involve, as needed, both internal accounting and operations personnel and outside contractors with technical accounting expertise early in the evaluation of our complex, non-routine transaction to obtain additional guidance as to the application of generally accepted accounting principles to such a proposed transaction.
Require that our senior accounting personnel and the principal accounting officer review our complex, non-routine transactions to evaluate and approve the accounting treatment for such transactions.
Evaluate our internal audit function in relation to our financial resources and requirements.
The Company has engaged New Century Concepts Consultants Limited, or New Century, as its internal control consultant. New Century started evaluation of the effectiveness of our disclosure controls and procedures on October 27, 2010 and provided a preliminary report to our company on March 31, 2011. It will assist the Company to address issues of timeliness and completeness in financial reporting when we are preparing SEC filings. We will implement an initiative to ensure the importance of internal controls and compliance with established policies and procedures are fully understood throughout our company. We will provide training to our employees to ensure these procedures are properly performed. We will also evaluate hiring additional personnel involved in the preparation of the financial statements and disclosures with the requisite expertise in U.S. GAAP to ensure the proper application thereof. Management believes the actions described above will strengthen our internal control over financial reporting.
Management is committed to improving its internal control over financial reporting and will continue to work to put effective controls in place. The reportable conditions and other areas of our internal control over financial reporting identified by us as needing improvement have not resulted in a material restatement of our financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
Because the Company is a smaller reporting company, this annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Managements report was not subject to attestation by our registered public accounting firm.
Changes in Internal Controls over Financial Reporting
We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. Changes may include such activities as implementing new, more efficient systems, consolidating activities, and migrating processes.
Other than in connection with the implementation of the remedial measures described above, there have been no changes in our internal control over financial reporting during the fourth quarter of fiscal year 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION.
We have no information to disclose that was required to be disclosed in a report on Form 8-K during the fourth quarter of fiscal year 2012, but was not reported.
44
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Directors and Executive Officers
The following sets forth information about our directors and executive officers as of the date of this report:
Name | Age | Position |
Guohong Zhao | 52 | Chairman, Chief Executive Officer and President |
Zhigang Xu | 41 | Interim Chief Financial Officer, Treasurer and Secretary |
Yue Cui | 52 | Vice President of Production |
Fucai Zhan | 42 | Vice President of R&D and Director |
Wenquan Tao | 73 | Director |
Jingxun Chen | 38 | Director |
To Tsang | 37 | Director |
Youjun Lian | 60 | Director |
Ariel Poppel | 60 | Director |
Mr. Guohong Zhao. Mr. Zhao became our Chairman, Chief Executive Officer and President on June 30, 2009, the day that we consummated our reverse acquisition of Megaway, and has served as the Chairman and CEO of Siping Juyuan since founding the company in 1998. Mr. Zhao has over 10 years experience in the heat exchanger industry and over 20 years management experience. From 1996 to 1997, he was the Chairman and CEO of Siping City Traffic Safety Equipment Co., Ltd., a manufacturer of traffic safety equipment. Before 1995, he worked in senior positions in China Agriculture Bank, Siping Branch. Mr. Zhao graduated from Jilin Province Radio and Television University in 1986, holding a college degree in Economics.
Mr. Zhigang Xu. Mr. Xu was appointed as our Interim Chief Financial Officer, Treasurer and Secretary of September 29, 2012. Mr. Xu has worked in different positions in the Companys subsidiaries Siping Juyuan and Beijing Juyuan since 2000. Mr. Xu was Beijing Juyuans accountant and Financial Director. He was also Siping Juyuans Deputy Financial Director and CFO Assistant. From 1993 to 1999, Mr. Xu worked as an account at Siping Jiuyuan Heat Exchange Equipment Co., Ltd. Mr. Xu holds a Bachelors Degree in Accounting from Jilin Industry University.
Mr. Yue Cui. Mr. Cui became our Vice President of Production on June 30, 2009, the day that we consummated our reverse acquisition of Megaway, and has served as Vice President of Production of Siping Juyuan since 2006. From 2000 to 2006, he was the operation manager of Siping Juyuan. With 20 years experience in manufacturing industry, he has significantly improved the production management of the Company. From 1979 to 2000, he was the production manager of Siping Tool Factory, a tool manufacturer.
Mr. Fucai Zhan. Mr. Zhan became our Vice President of Research and Development on June 30, 2009, the day that we consummated our reverse acquisition of Megaway, and became a member of our Board of Directors on September 25, 2009. Mr. Zhan possesses over 15 years comprehensive experience in production, research and development, and sales and is well positioned to lead our research and development function to be highly market oriented. Mr. Zhan joined Siping Junyuan in 1999 as Vice President of Sales and was appointed as Vice President of Research and Development in 2009. Before joining Siping Juyuan, he worked as production manager, Research and Development manager and assistant to GM in Dong Feng Siping Auto Parts Co., Ltd. Mr. Zhan graduated from Jilin University of Technology in 1996.
Mr. Wenquan Tao. Mr. Tao became a member of our Board of Directors on September 25, 2009. Mr. Tao has been working as a professor at School of Energy & Power Engineering of Xian Jiaotong University since 1986. Mr. Tao is currently an academician of the Chinese Academy of Science, a member of the Advisory Board of Numerical Heat Transfer and a member of Editorial Board of Progress in Computational Fluid Dynamics. In addition, he is an associate editor of ASME Journal of Heat Transfer, associate editor of International Journal of Heat & Mass Transfer, and an associate editor of International Communications in Heat & Mass Transfer. In 2003, Mr. Tao was honored by the Ministry of Education of China as National Distinguished Professor. Mr. Tao graduated from Xian Jiaotong University with a M.S. and a B.S. in Power Machinery Engineering.
Mr. Jingxun Chen. Mr. Chen became a member of our Board of Directors on March 15, 2012. Mr. Chen has around 15 years accounting and auditing experience, from which he has gained extensive knowledge of China, US, Hong Kong and International Financial Reporting Standards. After beginning his career as an Auditor with PricewaterhouseCoopers in 1997, he was promoted to Senior Auditor in 1999 and remained with PwC until 2004, when he joined Schwartz Levitsky Feldman LLP as Senior Auditor. In 2006, Mr. Chen joined NASDAQ-listed China BAK Battery, Inc., where he offers strategic counsel on finance and accounting related matters in his role as Financial Consultant. Mr. Chen holds a bachelors degree in Accounting and Auditing from Shenzhen University, China.
45
Mr. To Tsang. Mr. Tsang became a member of our Board of Directors on September 25, 2009. He has extensive knowledge of overseas capital markets and has advised various PRC companies on their pre-IPO restructurings, pre-IPO financing and securities offerings on the overseas capital markets and has advised on numerous reverse acquisitions of overseas public companies by PRC companies. Since May 2008, he has been a partner at King & Wood, practicing mergers and acquisitions, corporate restructurings, securities offerings, and other corporate advisory matters. From April 2006 to April 2008, Mr. Tsang worked as a Hong Kong solicitor with DLA Piper. From July 1997 to March 2006, Mr. Tsang worked as a Hong Kong trainee and paralegal for Michael Cheuk, Wong & Kee. Mr. Tsang holds an LL.M. from the University of London, a PCLL from the City University of Hong Kong, and an LL.B. from Xiamen University. He is admitted as a Solicitor to the High Court of Hong Kong as well as a PRC qualified lawyer.
Mr. Youjun Lian. Mr. Lian became a member of our Board of Directors on July 14, 2011. He is currently a member of China Law Society, the Director of Jilin Province Law Society, the Vice-President of Siping Law Society and is also a guest professor of Jilin Normal University School of Law. He has more than 30 years experience in the legal field. From 2001 to 2010, Mr. Lian worked as the Deputy Chief Judge in Siping Intermediate Peoples Court, the Commissioner of Siping Siping Potical Consultative Conference and Deputy Director of Commission for Legal Affairs of Siping Potical Consultative Conference. From 1995 to 2001, he worked as the Commissioner of Siping National Peoples Congress Standing Committee and Chairman of Committee for Internal and Judicial Affairs. From 1992 to 1995, Mr. Lian worked as the Presiding Judge of Lishu Peoples Court. From 1976 to 1992, he worked as the Judge, Associate Chief Judge And Chief Judge Of Siping Intermediate People's Court. Mr. Lian graduated from Law School of Jilin University and holds a graduate degree.
Mr. Ariel Poppel. Mr. Poppel became a member of our Board of Directors on July 14, 2011. Since 2005, Mr. Poppel has been the Managing Director and CFO of Infinity Group, a leading Chinese-Israeli management group and investment fund. He is also currently the CEO of EIPAT (formally Shellcase). From 2004 to 2005, Mr. Poppel served as the Interim CEO, CFO and VP of Administration of Shellcase, a leading global supplier of innovative wafer level chip size packaging solutions for semiconductor devices for growing digital consumer products and telecom infrastructure markets. Mr. Poppel obtained his Bachelors degree in Economics and International Affairs from Bar Ilan University. He also had MBA training at Israeli Management Center. Mr. Poppel is serving as a director on the boards of Nicast, Teledata, WLCSP, Mango/Mate, China Med, Yaan Securities and United Water which are all private companies.
Directors are elected until their successors are duly elected and qualified.
Except as set forth in our discussion below in Item 13 Certain Relationships and Related Transactions, and Director IndependenceTransactions with Related Persons, none of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.
There are no agreements or understandings for any of our executive officers or directors to resign at the request of another person and no officer or director is acting on behalf of nor will any of them act at the direction of any other person.
Director Qualifications
Directors are responsible for overseeing our business consistent with their fiduciary duty to stockholders. This significant responsibility requires highly-skilled individuals with various qualities, attributes and professional experience. The Board believes that there are general requirements for service on our Board of Directors that are applicable to all directors and that there are other skills and experience that should be represented on the Board as a whole, but not necessarily by each director. The Board considers the qualifications of directors and director candidates individually and in the broader context of the Boards overall composition and our current and future needs.
46
Qualifications for All Directors
In its assessment of each potential candidate, including those recommended by stockholders, the Board considers the nominees judgment, integrity, experience, independence, understanding of our business or other related industries and such other factors the Board determines are pertinent in light of the current needs of the Board. The Board also takes into account the ability of a director to devote the time and effort necessary to fulfill his or her responsibilities to the Company.
The Board requires that each director be a recognized person of high integrity with a proven record of success in his or her field. Each director must demonstrate innovative thinking, familiarity with and respect for corporate governance requirements and practices, an appreciation of multiple cultures and a commitment to sustainability and to dealing responsibly with social issues. In addition to the qualifications required of all directors, the Board assesses intangible qualities including the individuals ability to ask difficult questions and, simultaneously, to work collegially.
The Board does not have a specific diversity policy, but considers diversity of race, ethnicity, gender, age, cultural background and professional experiences in evaluating candidates for Board membership. Diversity is important because a variety of points of view contribute to a more effective decision-making process.
Qualifications, Attributes, Skills and Experience to be Represented on the Board as a Whole
The Board has identified particular qualifications, attributes, skills and experience that are important to be represented on the Board as a whole, in light of our current needs and business priorities. We are a U.S. public company that manufactures and sells heat exchange products. Therefore, the Board believes that a diversity of professional experiences in the heat exchanger industry, specific knowledge of key geographic growth areas, and knowledge of U.S. capital markets and of U.S. accounting and financial reporting standards should be represented on the Board.
Summary of Qualifications of Directors
Set forth below is a narrative disclosure that summarizes some of the specific qualifications, attributes, skills and experiences of our directors. For more detailed information, please refer to the biographical information for each director set forth above.
Mr. Guohong Zhao. Mr. Zhao is a founder of Siping Juyuan and has served as the Chairman and Chief Executive Officer of Siping Juyuan since its inception in 1998. Mr. Zhao has over 10 years experience in the heat exchanger industry and over 20 years management experience. He contributes invaluable long-term knowledge of our business and operations and extensive experience in the heat exchanger industry.
Mr. Fucai Zhan. Mr. Zhan possesses over 15 years of experience in production, research and development, and sales. He joined Siping Junyuan in 1999 as Vice President of Sales and was appointed as Vice President of Research and Development in 2009. He contributes invaluable long-term knowledge of our business and operations to our Board.
Mr. Wenquan Tao. Mr. Tao has been working as a professor at School of Energy & Power Engineering of Xian Jiaotong University since 1986. Mr. Tao is currently an academician of the Chinese Academy of Science, a member of the Advisory Board of Numerical Heat Transfer and a member of Editorial Board of Progress in Computational Fluid Dynamics. His extensive experience and knowledge of the heat exchanger industry makes him a valuable member of our Board.
Mr. Jingxun Chen. Mr. Chen has around 15 years accounting and auditing experience, from which he has gained extensive knowledge of China, US, Hong Kong and International Financial Reporting Standards. His extensive experience in the accounting and auditing fields and deep understanding of Chinese business and culture makes a valuable member of our Board.
Mr. To Tsang. Mr. Tsang has extensive knowledge of overseas capital markets and has advised various PRC companies on their pre-IPO restructurings, pre-IPO financing and securities offerings on the overseas capital markets and has advised on numerous reverse acquisitions of overseas public companies by PRC companies, making him a valuable member of our Board.
Mr. Youjun Lian. Mr. Lian has more than 30 years of experience in the legal field. He bring valuable legal expertise to our Board.
Mr. Ariel Poppel. Mr. Poppel contributes to the Board is extensive experience serving in management positions and on the boards of numerous companies.
47
Family Relationships
There are no family relationships among any of our officers or directors.
Involvement in Certain Legal Proceedings
To the best of our knowledge, none of our directors or executive officers has, during the past ten years:
been convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding traffic violations and other minor offences);
had any bankruptcy petition filed by or against the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time;
been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity;
been found by a court of competent jurisdiction in a civil action or by the SEC or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated;
been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or
been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.
Section 16(A) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our executive officers, directors and beneficial owner of more than 10% of a registered class of our equity securities to file with the SEC statements of ownership and changes in ownership. The same persons are required to furnish us with copies of all Section 16(a) forms they file. Except as set forth below, we believe that all of our executive officers, directors and beneficial owner of more than 10% of a registered class of our equity securities complied with the applicable filing requirements during fiscal year 2012.
During fiscal year 2012, Form 4s were filed late by, Guohong Zhao, our Chairman and Chief Executive Officer, and Jinghua Zhao, a former 10% owner, and a Form 3 was filed late by Jingxun Chen, a director, due to administrative oversight.
In making these statements, we have relied upon examination of the copies of all Section 16(a) forms provided to us and the written representations of our executive officers, directors and beneficial owner of more than 10% of a registered class of our equity securities.
Code of Ethics
On September 25, 2009, our Board adopted a new Code of Ethics that applies to all of our directors, officers and employees, including our principal executive officer, principal financial officer and principal accounting officer. The new Code of Ethics replaces our prior Code of Ethics that applied only to our principal executive officer, principal financial officer, principal accounting officer or controller and any person who performed similar functions. Our Code of Ethics addresses, among other things, honesty and ethical conduct, conflicts of interest, compliance with laws, regulations and policies, including disclosure requirements under the federal securities laws, confidentiality, trading on inside information, and reporting of violations of the code. A copy of the Code of Ethics can be found on our website at www.tht.cn.
48
We are required to disclose any amendment to, or waiver from, a provision of our Code of Ethics applicable to our principal executive officer, principal financial officer, principal accounting officer, controller, or persons performing similar functions. We intend to use our website as a method of disseminating this disclosure, as permitted by applicable SEC rules. Any such disclosure will be posted to our website within four business days following the date of any such amendment to, or waiver from, a provision of our Code of Ethics.
Board Composition and Committees
The Company is governed by a Board of Directors that currently consists of seven members: Messrs. Guohong Zhao, Fucai Zhan, Wenquan Tao, Jingxun Chen, To Tsang, Youjun Lian and Ariel Poppel. Our independent directors, within the meaning of the NASDAQ Marketplace Rules, are Messrs. Wenquan Tao, Jingxun Chen, To Tsang, Youjun Lian and Ariel Poppel. All actions of the Board of Directors require the approval of a majority of the directors in attendance at a meeting at which a quorum is present.
The Board has established three standing committees: the Audit Committee, the Compensation Committee and the Governance and Nominating Committee. Each of the Audit Committee, Compensation Committee and Governance and Nominating Committee are comprised entirely of independent directors. From time to time, the Board may establish other committees. The Board has adopted a written charter for each of the Committees which are available on our website at www.tht.cn.
Audit Committee and Audit Committee Financial Expert
Our Audit Committee is currently composed of four members, Messrs. Wenquan Tao, Jingxun Chen, To Tsang and Youjun Lian. Our Board of Directors determined that each member of the Audit Committee meets the independence criteria prescribed by applicable regulation and the rules of the SEC for audit committee membership and is an independent director within the meaning of the NASDAQ Marketplace Rules. Each Audit Committee member also meets NASDAQs financial literacy requirements. Mr. Chen serves as Chair of the Audit Committee.
Our Audit Committee oversees our accounting and financial reporting processes and the audits of our financial statements. Our Audit Committee is responsible for, among other things:
Our Board of Directors has determined that Mr. Chen is the audit committee financial expert as such term is defined in Item 407(d) of Regulation S-K promulgated by the SEC and also meets NASDAQs financial sophistication requirements.
Compensation Committee
Our Compensation Committee is currently composed of four members, Messrs. Wenquan Tao, Jingxun Chen, To Tsang and Youjun Lian, each of whom is independent within the meaning of the NASDAQ Marketplace Rules. Mr. Tsang serves as Chair of the Compensation Committee.
49
Our Compensation Committee assists the Board in reviewing and approving the compensation structure of our directors and executive officers, including all forms of compensation to be provided to our directors and executive officers. Our Chief Executive Officer may not be present at any committee meeting during which his compensation is deliberated.
The Compensation Committee is responsible for, among other things:
Governance and Nominating Committee
Our Governance and Nominating Committee is currently composed of four members, Messrs. Wenquan Tao, Jingxun Chen, To Tsang and Youjun Lian, each of whom is independent within the meaning of the NASDAQ Marketplace Rules. Mr. Tao serves as Chair of the Governance and Nominating Committee.
The Governance and Nominating Committee assists the Board in identifying individuals qualified to become our directors and in determining the composition of the Board and its committees.
The Governance and Nominating Committee is responsible for, among other things:
Material Changes to Director Nomination Procedures
There have been no material changes to the procedures by which stockholders may recommend nominees to our Board of Directors since such procedures were last disclosed.
ITEM 11. EXECUTIVE COMPENSATION.
Summary Compensation Table Fiscal Years Ended December 31, 2012 and 2011
The following table sets forth information concerning all cash and non-cash compensation awarded to, earned by or paid to the named persons for services rendered in all capacities during the noted periods. No other executive officer received total annual salary and bonus compensation in excess of $100,000.
Name and Principal Position |
Fiscal Year |
Salary ($) |
Bonus ($) |
Stock Awards ($) |
Option Awards ($) |
All Other Compensation ($) |
Total ($) |
Guohong Zhao, | 2012 | 16,819 | - | - | - | - | 16,819 |
Chief Executive Officer | 2011 | 16,819 | - | - | - | - | 16,819 |
Employment Agreements
We do not have an employment agreement with any of our management.
We have not provide retirement benefits (other than a state pension scheme in which all of our employees in China participate) or severance or change of control benefits to our named executive officer
50
Outstanding Equity Awards at Fiscal Year End
For the year ended December 31, 2012, no director or executive officer has received compensation from us pursuant to any compensatory or benefit plan. There is no plan or understanding, express or implied, to pay any compensation to any director or executive officer pursuant to any compensatory or benefit plan.
Compensation of Directors
The following table sets forth the total compensation earned by our directors for their services as directors during fiscal year ended December 31, 2012:
Name |
Fees earned or paid in cash ($) |
All other compensation ($) |
|
Guohong Zhao | - | - | - |
Fucai Zhan | - | - | - |
Wenquan Tao | 24,000 | - | 24,000 |
Jingxun Chen | 36,000 | - | 36,000 |
To Tsang | 24,000 | - | 24,000 |
Youjun Lian | 12,000 | - | 12,000 |
Ariel Poppel | - | - | - |
(1) Mr. Haus resigned on March 9, 2012.
We entered into separate independent director contracts and indemnification agreements with each of Messrs. Wenquan Tao, William P. Haus and To Tsang. Under the terms of the independent directors contracts, we agreed to pay Mr. Tao an annual fee of $24,000, Mr. Tsang an annual fee of $24,000, and Mr. Haus an annual fee of $36,000, as compensation for the services to be provided by them as independent directors. Under the terms of the indemnification agreements, we agreed to indemnify the independent director against expenses, judgments, fines, penalties or other amounts actually and reasonably incurred by the independent director in connection with any proceeding if the independent director acted in good faith and in our best interests.
We agreed to pay Mr. Jingxun Chen an annual fee of $36,000 as compensation for the services to be provided by him as independent director. We have not entered into independent director agreements or indemnification agreements with Mr. Poppel, Mr. Lian and Mr. Chen.
Mr. Guohong Zhao and Mr. Fucai Zhan are paid in their capacity as executive officers of the Company and they do not receive any additional compensation for their service as directors.
It is our practice to reimburse our directors for reasonable travel expenses related to attendance at Board and Committee meetings.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. |
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information regarding beneficial ownership of our common stock as of March 31, 2013 (i) by each person who is known by us to beneficially own more than 5% of our common stock; (ii) by each of our officers and directors; and (iii) by all of our officers and directors as a group. Unless otherwise specified, the address of each of the persons set forth below is in care of the Company, THT Industrial Park, No. 5 Nanhuan Road, Tiexi District, Siping, Jilin Province, 136000, Peoples Republic of China.
51
Name and Address of Beneficial Owner |
Office, If Any |
Title of Class |
Amount and Nature of Beneficial Ownership(1) |
Percent of Class(2) |
Officers and Directors | ||||
Guohong Zhao | Chairman and CEO | Common Stock | 4,559,214 | 22.3% |
Zhigang Xu | Interim Chief Financial Officer | Common Stock | 0 | * |
Yue Cui | VP of Production | Common Stock | 0 | * |
Fucai Zhan | VP of R&D and Director | Common Stock | 0 | * |
Wenquan Tao | Director | Common Stock | 0 | * |
Jingxun Chen | Director | Common Stock | 24,667 | * |
To Tsang | Director | Common Stock | 0 | * |
Youjun Lian | Director | Common Stock | 0 | * |
Ariel Poppel | Director | Common Stock | 0 | * |
All officers and directors as a group (9 persons named above) |
Common Stock |
4,583,881 |
22.4% |
|
5% Security Holders | ||||
Guohong Zhao | Common Stock | 4,217,804 | 20.62% |
* Less than 1%
(1) |
Beneficial Ownership is determined in accordance with the rules of the SEC and generally includes voting or investment power with respect to securities. Each of the beneficial owners listed above has direct ownership of and sole voting power and investment power with respect to the shares of our common stock. |
(2) |
A total of 20,453,500 shares of our common stock are considered to be outstanding pursuant to SEC Rule 13d-3(d)(1) as of March 31, 2013. For each beneficial owner above, any options exercisable within 60 days have been included in the denominator. |
Changes in Control
We are not aware of any arrangements which if consummated may result in a change of control of our Company.
Securities Authorized for Issuance Under Equity Compensation Plans
We do not have any compensation plans in effect under which our equity securities are authorized for issuance.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
Transactions with Related Persons
There have been no transactions since the beginning of the 2012 fiscal year, or any currently proposed transaction, in which we were or are to be a participant and the amount involved exceeded or exceeds the lesser of $120,000 or one percent of the average of our total assets at year end for the last two completed fiscal years, and in which any related person had or will have a direct or indirect material interest (other than compensation described under Item 11 Executive Compensation).
None of our directors, director nominees or executive officers has been involved in any transactions with us or any of our directors, executive officers, affiliates or associates which are required to be disclosed pursuant to the rules and regulations of the SEC.
Director Independence
Each of Messrs. Wenquan Tao, Jingxun Chen, To Tsang, Youjun Lian and Ariel Poppel serves on our board as an independent director as defined by the applicable rules of the SEC and NASDAQ.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Independent Auditors Fees
The following is a summary of the fees billed to the Company for professional services rendered for the fiscal years ended December 31, 2012 and 2011:
52
Year Ended December 31, | ||||||
2012 | 2011 | |||||
Audit Fees | $ | 33,381 | $ | 129,000 | ||
Audit-Related Fees | - | - | ||||
Tax Fees | - | - | ||||
All Other Fees | - | - | ||||
TOTAL | $ | 33,381 | $ | 129,000 |
Audit Fees consisted of fees billed for professional services rendered by the principal accountant for the audit of our annual financial statements and review of the financial statements included in our Form 10-K and 10-Q or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements.
Audit-Related Fees consisted of fees billed for assurance and related services by the principal accountant that were reasonably related to the performance of the audit or review of our financial statements and are not reported under the paragraph captioned Audit Fees above.
Tax Fees consisted of fees billed for professional services rendered by the principal accountant for tax returns preparation.
All Other Fees consisted of fees billed for products and services provided by the principal accountant, other than the services reported above under other captions of this Item 14.
Pre-Approval Policies and Procedures
Under the Sarbanes-Oxley Act of 2002, all audit and non-audit services performed by our auditors must be approved in advance by our board of directors to assure that such services do not impair the auditors independence from us. In accordance with its policies and procedures, our board of directors pre-approved the audit service performed by MaloneBailey LLP for our financial statements as of and for the year ended December 31, 2012.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
Financial Statements and Schedules
The financial statements are set forth under Item 8 of this annual report on Form 10-K. Financial statement schedules have been omitted since they are either not required, not applicable, or the information is otherwise included.
Exhibit List
The list of exhibits in the Exhibit Index to this Report is incorporated herein by reference.
53
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) 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.
Date: April 1, 2013
THT HEAT TRANSFER TECHNOLOGY, INC. | ||
By: | /s/ Guohong Zhao | |
Guohong Zhao | ||
Chief Executive Officer | ||
By: | /s/ Zhigang Xu | |
Zhigang Xu | ||
Interim Chief Financial Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date | |
/s/ Guohong Zhao | Chairman and Chief Executive Officer | April 1, 2013 | |
Guohong Zhao | (Principal Executive Officer) | ||
/s/ Zhigang Xu | Interim Chief Financial Officer | April 1, 2013 | |
Zhigang Xu | (Principal Financial and Accounting Officer) | ||
/s/ Fucai Zhan | Director | April 1, 2013 | |
Fucai Zhan | |||
/s/ Wenquan Tao | Director | April 1, 2013 | |
Wenquan Tao | |||
/s/ Jingxun Chen | Director | April 1, 2013 | |
Jingxun Chen | |||
/s/ To Tsang | Director | April 1, 2013 | |
To Tsang | |||
/s/ Youjun Lian | Director | April 1, 2013 | |
Youjun Lian | |||
/s/ Ariel Poppel | Director | April 1, 2013 | |
Ariel Poppel |
54
THT Heat Transfer Technology, Inc. | ||
Consolidated Financial Statements | ||
For the year ended December 31, 2012 | ||
(Stated in US dollars) |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of:
THT Heat Transfer Technology, Inc.
We have audited the accompanying consolidated balance sheet of THT Heat Transfer Technology, Inc. and its subsidiaries (collectively, the "Company") as of December 31, 2012 and the consolidated statements of income and comprehensive income, changes in shareholders' equity and cash flows for the year then ended. The consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of THT Heat Transfer Technology, Inc. and its subsidiaries as of December 31, 2012, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ MaloneBailey, LLP
www.malonebailey.com
Houston, Texas
April 1, 2013
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of:
THT Heat
Transfer Technology, Inc.
We have audited the accompanying consolidated balance sheet of THT Heat Transfer Technology, Inc. and its subsidiaries (collectively, the Company) as of December 31, 2011 and the related consolidated statements of operations and comprehensive income, change in stockholders equity, and cash flows for the year then ended. These consolidated financial statements and the financial statement footnotes are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audit.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial position of THT
Heat Transfer Technology, Inc. as of December 31, 2011, and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the related financial statement footnotes, when considered in
relation to the consolidated financial statements taken as a whole, present
fairly, in all material respects, the information set forth therein.
/s/ PKF Hong Kong, LLP
Hong Kong
April 1, 2013
THT Heat Transfer Technology, Inc. |
Consolidated Balance Sheets |
(Stated in US dollars) |
As of December 31, | ||||||
2012 | 2011 | |||||
ASSETS | ||||||
Current assets | ||||||
Cash and cash equivalents | $ | 10,703,199 | $ | 7,340,068 | ||
Restricted cash | 1,837,593 | 1,725,546 | ||||
Counter guarantee receivable | 237,771 | 235,676 | ||||
Trade receivables, net | 37,683,275 | 33,573,223 | ||||
Bills receivable | 2,452,478 | 1,415,890 | ||||
Other receivables, prepayments and deposits, net | 11,193,541 | 7,859,563 | ||||
Inventories, net | 31,892,204 | 32,531,053 | ||||
Deferred tax assets | 164,577 | 251,561 | ||||
Total Current Assets | 96,164,638 | 84,932,580 | ||||
Retention receivable | 1,237,473 | 1,184,382 | ||||
Counter guarantee receivable | 237,771 | 235,676 | ||||
Property, plant and equipment, net | 7,707,564 | 7,703,607 | ||||
Deposits for acquisition of property, plant and equipment | - | 345,658 | ||||
Land use rights, net | 6,121,456 | 1,019,045 | ||||
Deposits for land use right | - | 4,389,330 | ||||
TOTAL ASSETS | $ | 111,468,902 | $ | 99,810,278 | ||
LIABILITIES & SHAREHOLDERS EQUITY | ||||||
Current Liabilities | ||||||
Accounts payable | 7,721,067 | 6,619,676 | ||||
Other payables and accrued liabilities | 22,841,489 | 15,853,810 | ||||
Income tax payable | 615,800 | 1,389,140 | ||||
Short-term bank loans | 18,704,625 | 16,183,051 | ||||
Current maturities of long-term loan | 1,902,165 | 1,885,404 | ||||
Total Current Liabilities | 51,785,146 | 41,931,081 | ||||
Non-current liabilities | ||||||
Long-term loan | 951,083 | 2,828,106 | ||||
Total Long-term Liabilities | 951,083 | 2,828,106 | ||||
Total Liabilities | 52,736,229 | 44,759,187 | ||||
SHAREHOLDERS EQUITY | ||||||
Preferred
stock : par value of $0.001 per
share Authorized 10,000,000 shares, none issued and outstanding Common stock : par value $0.001 per share Authorized 190,000,000 shares in 2012 and 2011; issued and outstanding 20,453,500 shares in 2012 and 2011 |
20,454 |
20,454 |
||||
Additional paid-in capital | 27,396,455 | 27,396,455 | ||||
Statutory reserve | 3,295,014 | 2,979,827 | ||||
Retained earnings | 24,345,681 | 21,497,843 | ||||
Accumulated other comprehensive income | 4,253,693 | 3,721,877 | ||||
Total THT Heat Transfer Technology Inc. stockholders equity | 59,311,297 | 55,616,456 | ||||
Noncontrolling interest | (578,624 | ) | (565,365 | ) | ||
TOTAL SHAREHOLDERS EQUITY | 58,732,673 | 55,051,091 | ||||
TOTAL LIABILITIES AND SHAREHOLDERS EQUITY | $ | 111,468,902 | $ | 99,810,278 |
The accompanying notes are an integrated part of these consolidated financial statements
THT Heat Transfer Technology, Inc. |
Consolidated Statements of Income and Comprehensive Income |
(Stated in US dollars) |
For the Years Ended December 31, | ||||||
2012 | 2011 | |||||
Sales revenue | $ | 62,770,692 | $ | 57,741,288 | ||
Cost of revenue | (41,118,573 | ) | (32,501,171 | ) | ||
Gross Profit | 21,652,119 | 25,240,117 | ||||
Operating expenses | ||||||
Administrative expenses | 5,910,211 | 5,615,566 | ||||
Research and development expenses | 2,230,364 | 1,754,965 | ||||
Selling expenses | 8,195,117 | 8,532,879 | ||||
Total Operating Expenses | 16,335,692 | 15,903,410 | ||||
Income from operations | 5,316,427 | 9,336,707 | ||||
Other Income (Expenses) | ||||||
Interest income | 28,245 | 56,080 | ||||
Other income | 524,463 | 796,893 | ||||
Finance costs | (1,814,313 | ) | (1,121,133 | ) | ||
Other expense | (175,538 | ) | - | |||
Total Other Expenses | (1,437,143 | ) | (268,160 | ) | ||
Income before income taxes and noncontrolling interests | 3,879,284 | 9,068,547 | ||||
Income tax expenses | (699,950 | ) | (1,619,776 | ) | ||
Net Income | 3,179,334 | 7,448,771 | ||||
Net (income) loss attributable to noncontrolling interests | (16,309 | ) | 454,305 | |||
Net income attributable to THT Heat Transfer Technology, Inc. common stockholders | $ | 3,163,025 | $ | 7,903,076 | ||
Net Income | 3,179,334 | 7,448,771 | ||||
Other Comprehensive Income | ||||||
Foreign currency translation adjustments | 502,248 | 1,710,758 | ||||
Comprehensive Income | 3,681,582 | 9,159,529 | ||||
Comprehensive (income) loss attributable to noncontrolling interests | (13,259 | ) | 503,474 | |||
Comprehensive income attributable to THT Heat Transfer Technology, Inc. common stockholders | $ | 3,668,323 | $ | 9,663,003 | ||
Earnings per share attributable to THT Heat Transfer Technology, Inc. common stockholders | ||||||
Basic and diluted | $ | 0.15 | $ | 0.39 | ||
Weighted average number of shares outstanding | ||||||
Basic and diluted | 20,453,500 | 20,453,500 |
The accompanying notes are an integrated part of these consolidated financial statements
THT Heat Transfer Technology, Inc. |
Consolidated Statement of Shareholders Equity |
(Stated in US dollars) |
THT Heat Transfer Technology, Inc. | ||||||||||||||||||||||||
Accumulated | ||||||||||||||||||||||||
Common Stock | Other | Total | ||||||||||||||||||||||
Additional Paid-in | Comprehensive | Noncontrolling | Shareholders' | |||||||||||||||||||||
No. of Shares | Amount | Capital | Statutory Reserve | Income | Retained Earnings | Interest | Equity | |||||||||||||||||
Balance, January 1, 2011 | 20,453,500 | $ | 20,454 | $ | 27,396,455 | $ | 1,902,632 | $ | $1,961,950 | $ | 14,671,962 | $ | (61,891 | ) | $ | 45,891,562 | ||||||||
Net income (loss) | 7,903,076 | (454,305 | ) | 7,448,771 | ||||||||||||||||||||
Foreign currency translation adjustments | 1,759,927 | (49,169 | ) | 1,710,758 | ||||||||||||||||||||
Appropriation to reserve | 1,077,195 | (1,077,195 | ) | |||||||||||||||||||||
Balance, December 31, 2011 | 20,453,500 | $ | 20,454 | $ | 27,396,455 | $ | 2,979,827 | $ | 3,721,877 | $ | 21,497,843 | $ | (565,365 | ) | $ | 55,051,091 | ||||||||
Net income | 3,163,025 | 16,309 | 3,179,334 | |||||||||||||||||||||
Foreign currency translation adjustment | 531,816 | (29,568 | ) | 502,248 | ||||||||||||||||||||
Appropriation to reserve | 315,187 | (315,187 | ) | |||||||||||||||||||||
Balance, December 31, 2012 | 20,453,500 | $ | 20,454 | $ | 27,396,455 | $ | 3,295,014 | $ | 4,253,693 | $ | 24,345,681 | $ | (578,624 | ) | $ | 58,732,673 |
The accompanying notes are an integrated part of these consolidated financial statements
THT Heat Transfer Technology, Inc. |
Consolidated Statements of Cash Flows |
(Stated in US dollars) |
For the Years Ended December 31, | ||||||
2012 | 2011 | |||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||
Net income | $ | 3,179,334 $ | 7,448,771 | |||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||
Depreciation and amortization | 1,157,147 | 954,218 | ||||
Deferred tax assets | 89,178 | (81,100 | ) | |||
Allowance for doubtful accounts | 2,081,818 | 614,549 | ||||
Changes in operating assets and liabilities: | ||||||
Restricted cash | (96,661 | ) | 11,786 | |||
Trade receivables | (5,891,584 | ) | (7,501,185 | ) | ||
Bills receivable | (1,023,511 | ) | (914,328 | ) | ||
Other receivables, prepayments and deposits | (3,262,548 | ) | (2,611,237 | ) | ||
Inventories | 927,608 | (18,027,228 | ) | |||
Retention receivable | (42,541 | ) | 270,421 | |||
Trade payables | 1,042,045 | 3,653,116 | ||||
Other payables and accrued expenses | 6,844,002 | 3,172,581 | ||||
Tax payable | (785,315 | ) | (40,511 | ) | ||
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES | 4,218,972 | (13,050,147 | ) | |||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||
Payments to acquire property, plant and equipment | (669,924 | ) | (1,583,786 | ) | ||
Payments to acquire land use rights | (738,845 | ) | - | |||
Deposits paid for acquisition of land use rights | - | (4,315,550 | ) | |||
Deposits paid for acquisition of property, plant and equipment | - | (339,847 | ) | |||
NET CASH FLOWS USED IN INVESTING ACTIVITIES | (1,408,769 | ) | (6,239,183 | ) | ||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||
Proceeds from bank loans | 20,137,483 | 20,545,308 | ||||
Repayment of bank loans | (17,760,911 | ) | (10,813,320 | ) | ||
Repayment of long-term loan | (1,901,257 | ) | (1,699,236 | ) | ||
Payment for counter guarantee receivables | - | (463,428 | ) | |||
Refund of counter guarantee receivables | - | 216,266 | ||||
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES | 475,315 | 7,785,590 | ||||
Effect of foreign currency translation on cash and cash equivalents | 77,613 | 405,378 | ||||
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | 3,363,131 | (11,098,362 | ) | |||
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR | $ | 7,340,068 | $ | 18,438,430 | ||
CASH AND CASH EQUIVALENTS AT END OF YEAR | $ | 10,703,199 | $ | 7,340,068 | ||
Supplementary Disclosures for Cash Flow Information: | ||||||
Interest paid | $ | 1,608,303 | $ | 998,428 | ||
Income taxes paid | $ | 1,479,269 | $ | 1,689,202 |
The accompanying notes are an integrated part of these consolidated financial statements
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
1. | Corporate information |
THT Heat Transfer Technology, Inc. (the Company or THT or the Surviving Corporation) is the surviving corporation pursuant to the Reincorporation Merger as detailed below. The Companys shares are quoted for trading on the Nasdaq Global Market in the United States.
Reincorporation Merger
On November 24, 2009, BTHC VIII, Inc. ("BTHC") entered into an Agreement and Plan of Merger (the "Merger Agreement") with THT, a Nevada corporation and wholly-owned subsidiary of BTHC. Pursuant to the Merger Agreement, BTHC agreed to merge with and into THT, with THT continuing as the surviving entity (the "Reincorporation Merger"). The Reincorporation Merger became effective on November 30, 2009 (the "Effective Time").
As a result of the Reincorporation Merger, the legal domicile of the Surviving Corporation is now Nevada. The Merger Agreement and Reincorporation Merger were duly approved by the written consent of stockholders of BTHC owning at least a majority of the outstanding shares of BTHC's common stock, dated September 16, 2009.
Pursuant to the terms of the Merger Agreement, (i) BTHC merged into THT, with THT being the surviving corporation, and BTHC thereby changed its name to THT Heat Transfer Technology, Inc.; (ii) from and after the Effective Time, THT possesses all of the rights, privileges, powers, and franchises of BTHC, and BTHC's debts and liabilities became the debts and liabilities of THT; (iii) BTHC's existing Board of Directors and officers became the Board of Directors and officers of the Surviving Corporation; and (iv) the Articles of Incorporation and Bylaws of THT now govern the Surviving Corporation.
The Reincorporation Merger did not result in any change in headquarters, business, jobs, management, location of any of offices or facilities, number of employees, assets, liabilities or net worth (other than as a result of the costs incident to the Reincorporation Merger, which are immaterial). Management, including all directors and officers, remain the same in connection with the Reincorporation Merger. There were no substantive changes in the employment agreements for executive officers or in other direct or indirect interests of the current directors or executive officers as a result of the Reincorporation Merger.
As a result of the Reincorporation Merger, each outstanding share of BTHC's common stock, par value $0.001 per share, was automatically converted into one share of THT's common stock, par value $0.001 per share. Each outstanding certificate representing shares of BTHC's common stock is deemed, without any action by BTHC's stockholders, to represent the same number of shares of THT's common stock.
Reorganization
Before the Reincorporation Merger and on June 30, 2009, BTHC entered into a Share Exchange Agreement (the Share Exchange Agreement) with Megaway International Holdings Limited, a British Virgin Islands corporation ("Megaway"), and its sole shareholder, Wisetop International Holdings Limited, a British Virgin Islands corporation ("Wisetop"). Pursuant to the Share Exchange Agreement, Megaway became a wholly-owned subsidiary of the Company and Wisetop was issued 14,800,000 shares of the Company's common stock, which, after giving effect to the Cancellation Agreement disclosed below, constituted 92.5% of the Companys issued and outstanding capital stock on a fully-diluted basis as of and immediately after the consummation of the transactions contemplated by the Share Exchange Agreement, in exchange for 100% of the issued and outstanding shares of Megaway.
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
1. | Corporate information (Contd) |
Megaway was dormant since its incorporation until it acquired 100% of the outstanding capital stock of Star Wealth International Holdings Limited ("Star Wealth"), a Hong Kong company, on May 5, 2009. Star Wealth was also dormant since its incorporation until it acquired 100% of the equity interest of Siping City Juyuan Hanyang Plate Heat Exchanger Co., Ltd. (Siping Juyuan), a PRC corporation, on May 10, 2009.
On May 10, 2009, Star Wealth entered into an equity transfer agreement with all of the shareholders of Siping Juyuan to acquire their entire interests in Siping Juyuan at a total cash consideration of RMB60,000,000 ($8,795,075). The equity transfer agreement was approved by the local government of the Peoples Republic of China (the PRC) on May 31, 2009.
Siping Juyuan has a 75% directly owned subsidiary, Beijing Juyuan Hanyang Heat Exchange Equipment Co. Ltd (Beijing Juyuan).
As a condition precedent to the consummation of the Share Exchange Agreement, on June 30, 2009, the Company entered into a cancellation agreement, or the Cancellation Agreement, with Mr. Gerald Pascale, who was the major stockholder of the Company immediately before the Share Exchange Agreement and served as the Companys sole director and officer from February 12, 2009 until June 30, 2009 when he was replaced by Guohong Zhao (Mr. Zhao), a founder of Siping Juyuan, whereby Mr. Pascale agreed to the cancellation of 4,805,387 shares of the Companys common stock owned by him.
Mr. Zhao was appointed as the Companys director and chief executive officer effective upon the closing of the above reverse acquisition. In addition, the Companys executive officers were replaced by the executive officers of Siping Juyuan upon the closing of the reverse acquisition.
On June 30, 2009, Mr. Zhao entered into an option agreement with Ms. Jinghua Zhao, the sole shareholder of Wisetop, pursuant to which Mr. Zhao was granted an option, exercisable after 180 days, to acquire all of the equity interests of Wisetop owned by Ms. Jinghua Zhao at an exercise price of $3,246,160. This option expired on June 30, 2011. On May 16, 2011, an amendment was signed by both parties extending the exercise period until June 30, 2012.
Also on June 30, 2009, Wisetop entered into separate option agreements with the other original stockholders of Siping Juyuan, pursuant to which such stockholders were granted options, exercisable after 90 days, to purchase an aggregate of 10,240,786 shares of the Companys common stock owned by Wisetop at total exercise price of $7,291,440. The stockholders exercised these options on December 17, 2010.
On November 30, 2010, Juyuan Heat Equipment (Tianjin) Co., Ltd. (Tianjin Juyuan) was established in the PRC, of which Siping Juyuan and Mr. Zhao contributed $1,467,555 and $37,630 respectively to its registered capital, representing 99.5% and 0.5% equity interest in Tianjin Juyuan respectively. On September 22, 2011, Tianjin Juyuan was formally dissolved with the approval of the Tianjin Industrial and Commercial Administrative Bureau Baodi Branch.
The Company is a holding company whose primary business are conducted through its subsidiaries, namely Siping Juyuan which is located in the Jilin Province and Beijing Juyuan which is located in Beijing City of the PRC. The Company is engaged in the manufacturing and trading of plate heat exchangers and various related products.
Siping Juyuan was established in the PRC on May 31, 2006 following the division (the Division) of Siping City Juyuan Heat Exchange Equipment Co., Ltd. (Old Juyuan Company) into three companies, namely Siping Juyuan, Siping City Juyuan Heat Exchange Equipment Co., Ltd. (New Juyuan Company) and Siping City Juyuan Hanyang Pressure Vessels Co., Ltd (Juyuan Hanyang Pressure Vessels).
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
2. | Description of business |
The Company is a holding company whose primary business are conducted through its subsidiaries, namely Siping Juyuan which is located in the Jilin Province and Beijing Juyuan which is located in Beijing City of the PRC. The Company is engaged in the manufacturing and trading of plate heat exchangers and various related products.
Siping Juyuan was established in the PRC on May 31,
2006 following the division (the Division) of Siping City Juyuan Heat Exchange
Equipment Co., Ltd. (Old Juyuan Company) into three companies, namely Siping
Juyuan, Siping City Juyuan Heat Exchange Equipment Co., Ltd. (New Juyuan
Company) and Siping City Juyuan Hanyang Pressure Vessels Co., Ltd (Juyuan
Hanyang Pressure Vessels).
3. | Summary of significant accounting policies |
Basis of presentation and consolidation
After the consummation of the reorganization detailed in note 1 above, Mr. Zhao and the other original stockholders of Siping Juyuan maintain control over Siping Juyuan by virtue of the option agreements. Accordingly, accounting for recapitalization is adopted for the preparation of these consolidated financial statements. These financial statements, issued under the name of the Company, represent the continuation of the financial statements of Siping Juyuan.
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP).
The consolidated financial statements include the financial statements of the Company and its subsidiaries. All significant inter-company balances and transactions have been eliminated on consolidation.
Use of estimates
In preparing financial statements in conformity with US GAAP, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. These accounts and estimates include, but are not limited to, the valuation of trade receivables, other receivables, inventories and deferred income taxes and the estimation on useful lives and residual values of property, plant and equipment and land use right. Actual results could differ from those estimates.
Noncontrolling interest
Noncontrolling interest on the consolidated balance sheets is resulted from the consolidation of Beijing Juyuan, a 75% owned subsidiary, and Tianjin Juyuan, a 99.5% owned subsidiary prior to September 22, 2011.
Noncontrolling interest on the consolidated statements represents the minority stockholders proportionate share of the net income/losses of above subsidiaries.
Concentration of credit risk
Financial instruments that potentially subject the Company to significant concentration of credit risk consist principally of cash and cash equivalents, bills receivable, restricted cash, and trade and other receivables. As of December 31, 2012 and 2011, substantially all of the Companys cash and cash equivalents and restricted cash were held by major financial institutions located in the PRC, which management believes are of high credit quality. With respect to trade receivables, the Company extends credit based on an evaluation of the customers financial condition. The Company generally does not require collateral for trade receivables and maintains an allowance for doubtful accounts of trade and other receivables.
During the years ended December 31, 2012 and 2011, the Company did not have any customers which contributed 10% or more to the Companys sales revenue.
As of December 31, 2012 and 2011, the Company did not have any balance of gross trade receivable due from individual customer that represented 10% or more of the Companys gross trade receivables.
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
3. | Summary of significant accounting policies (Contd) |
Cash and cash equivalents
Cash and cash equivalents consist of cash on hand and highly liquid short-term deposits which are unrestricted as to withdrawal and use, and which have maturities of three months or less when purchased.
Restricted cash
Restricted cash is recorded as an asset when the Company deposits cash in bank to pledge the performance bonds issued by the banks when requested by the Companys customers under their sales contracts, separately from cash and cash equivalents.
Receivables and allowance for doubtful debts
Receivables are stated at cost, net of an allowance for doubtful debts. The Company establishes an allowance for doubtful debts based on managements assessment of the collectability of trade receivables and other receivables. A considerable amount of judgment is required in assessing the amount of the allowance and the Company considers the historical level of credit losses and collection history and applies percentages to aged receivable categories. The Company makes judgments about the creditworthiness of debtors based on ongoing credit evaluations, and monitors current economic trends that might impact the level of credit losses in the future. If the financial condition of the debtors were to deteriorate, resulting in their inability to make payments, a larger allowance may be required.
Bad debts are written off when identified. The Company extends unsecured credit to customers ranging from three to six months in the normal course of business. The Company does not accrue interest on trade receivables.
Historically, losses from uncollectible accounts have not significantly deviated from the general allowance estimated by the management and no significant additional bad debts have been written off directly to the profit and loss. This general provisioning policy has not changed in the past since establishment and the management considers that the aforementioned general provisioning policy is adequate and not too excessive and does not expect to change this established policy in the near future.
Retention receivable
Retention receivable is the amount withheld by a customer until the warranty period is over. Retention receivables which were expected to be collected within one year of $7,903,588 and $6,074,715 were included in the balance of trade receivables as of December 31, 2012 and 2011, respectively. Retention receivables which were expected to be collected after one year of $1,237,473 and $1,184,382 were presented separately as non-current assets.
Inventories
Inventories are stated at the lower of cost or market value. Cost is determined on a weighted average basis and includes all expenditures incurred in bringing the goods to the point of sale and putting them in a saleable condition. In assessing the ultimate realization of inventories, the management makes judgments as to future demand requirements compared to current or committed inventory levels. The Companys reserve requirements generally increase with its projected demand requirements; decrease due to market conditions and product life cycle changes. The Company estimates the demand requirements based on market conditions, forecasts prepared by its customers, sales contracts and orders in hand.
Property, plant and equipment
Property, plant and equipment are stated at cost less accumulated depreciation. Cost represents the purchase price of the asset and other costs incurred to bring the asset into its existing use.
Depreciation is provided on the straight-line basis (after taking into account the respective estimated residual values) over the estimated useful lives of property, plant and equipment. The principal useful lives and residual value are as follows:
Estimated useful lives | Residual value | ||||||
Buildings | 20 years | 5% | |||||
Plant and machinery | 6 years | 5% | |||||
Office equipment | 2 - 5 years | Nil - 5% | |||||
Motor vehicles | 3 - 5 years | 5% |
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
3. | Summary of significant accounting policies (Contd) |
Maintenance or repairs are charged to expense as incurred. Upon sale or disposition, the applicable amounts of asset cost and accumulated depreciation are removed from the accounts and the net amount less proceeds from disposal is charged or credited to income.
Construction in progress mainly represents expenditures in respect of the Companys corporate campus and factories, including offices, factories and research center, under construction. All direct costs relating to the acquisition or construction of the Companys corporate campus and factories are capitalized as construction in progress. No depreciation is provided in respect of construction in progress.
Land use rights
Land use right represents the exclusive right to occupy and use a piece of land in the PRC for a specific contract term. Land use rights are stated at cost less accumulated amortization. Amortization is provided using the straight-line method over the terms of the lease of 50 years obtained from the relevant PRC land authority.
Impairment of long-lived assets
Long-lived assets are tested for impairment in accordance with ASC 360-10-45 Impairment or Disposal of Long-Lived Assets. The Company periodically evaluates potential impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. If circumstances require a long-lived asset or asset group be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. No impairment of long-lived assets was recognized for the years ended December 31, 2012 and 2011.
Government grants
The government grant is recognized in the consolidated statements of income and comprehensive income when the relevant performance criteria are met. Grants applicable to purchase of property, plant and equipment and/or encourage research and development activities are credited to deferred income upon receipt and are amortized over the life of depreciable assets.
Revenue recognition
Revenue from sales of the Companys products is recognized when products are delivered and customer acceptance is made, the sales price is fixed or determinable, no other significant obligations of the Company exist and collection is reasonably assured.
There were no sales returns and allowances for the years ended December 31, 2012 and 2011. The Company does not provide unconditional right of return, pricing protection or any other concessions to its customers. Generally, the Company provides free after-sale service for a period ranging from half year to 1 year. After-sale expense was $87,844 and $82,789 for the years ended December 31, 2012 and 2011, respectively.
Cost of sales
Cost of sales consists primarily of materials costs, freight charges, purchasing and receiving costs, inspection costs, employee compensation, depreciation and related costs, which are directly attributable to production. Write-down of inventories to lower of cost or market is also recorded in cost of sales, if any.
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
3. | Summary of significant accounting policies (Contd) |
Administrative expenses
Administrative expenses consist primarily of rental expenses, office expenses, entertainment, traveling expenses, staff welfare, consumables, labor protection and salaries and wages which are incurred at the administrative level.
Rental expenses under operating leases were $13,966 and $84,424 for the years ended December 31, 2012 and 2011, respectively.
Selling expenses
Selling expenses consist primarily of advertising, salaries and transportation costs incurred during the selling activities.
Advertising, transportation, research and development expenses
Advertising, transportation, research and development expenses are charged to expense as incurred.
Advertising costs amounting to $19,805 and $4,043 for the years ended December 31, 2012 and 2011, respectively, are included in selling expenses.
Transportation expenses amounting to $2,103,297 and $1,103,090 for the years ended December 31, 2012 and 2011, respectively, are included in selling expenses.
Research and development costs are expenses as incurred. Research and development costs for the year ended December 31, 2012 and 2011 were $2,230,364 and $1,754,965, respectively.
Income taxes
The Company uses the asset and liability method of accounting for income taxes pursuant to ASC 740 Income Taxes. Under the asset and liability method of ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statements carrying amounts of existing assets and liabilities and loss carryforwards and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is provided to reduce the amount of deferred tax assets if it is considered more likely than not that some portion or all of the deferred tax assets will not be realized.
Comprehensive income
Pursuant to ASC 220, Comprehensive Income, which establish standards for reporting and display of comprehensive income, its components and accumulated balances. Components of comprehensive income include net income and foreign currency translation adjustments. As of December 31, 2012 and 2011, the only component of accumulated other comprehensive income was foreign currency translation adjustments.
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
3. | Summary of significant accounting policies (Contd) |
Foreign currency translation
The functional currencies of the Company and its subsidiaries include United States dollars USD and Renminbi RMB. The Company and its subsidiaries maintain their financial statements in their respective functional currency. Monetary assets and liabilities denominated in currencies other than the functional currency are translated into the functional currency at rates of exchange prevailing at the balance sheet date. Transactions denominated in currencies other than the functional currency are translated into the functional currency at the exchange rates prevailing at the dates of the transactions. Exchange gains or losses arising from foreign currency transactions are included in the determination of net income or loss for the respective periods.
For financial reporting purposes, the financial statements of the subsidiaries that are prepared using RMB have been translated into USD. Assets and liabilities are translated at the exchange rates at the balance sheet date and revenue and expenses are translated at the average exchange rates and stockholders equity is translated at historical exchange rates. Any translation adjustments resulting are not included in determining net income or loss but are included in foreign currency translation adjustments to accumulated other comprehensive income, a component of stockholders equity. The exchange rates in effect as of December 31, 2012 and 2011 were RMB1 for $0.1585 and $0.1571, respectively. The average exchange rates for the years ended December 31, 2012 and 2011 were RMB1 for $0.1584 and $0.1545, respectively. There was no significant fluctuation in the exchange rates for conversion of RMB to USD after the balance sheet date.
Fair value of financial instruments
ASC 825 requires the disclosure of the estimated fair value of financial instruments including those financial instruments for which fair value option was not elected.
As of December 31, 2012 and 2011, the carrying amounts of the Companys financial assets and liabilities (including the current maturity of long-term loan) approximated their fair values due to short maturities or the applicable interest rates approximate the current market rates.
Stock-based compensation
The Company adopted the provisions of ASC 718 which requires the use of the fair value method of accounting for share-based compensation. Under the fair value based method, compensation cost related to employee stock options or similar equity instruments which are equity-classified awards, is measured at the grant date based on the value of the award and is recognized over the requisite service period, which is usually the vesting period. ASC 718 also requires measurement of cost of a liability-classified award based on its current fair value.
Basic and diluted earnings per share
The Company reports earnings per share in accordance with ASC 260 Earnings Per Share. Basic earnings per share is computed by dividing net income attributable to the Companys common stockholders by the weighted average number of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income attributable to the Companys common stockholders by the sum of the weighted average number of common stock outstanding and dilutive potential common stock during the period.
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
3. | Summary of significant accounting policies (Contd) |
Off-balance sheet arrangements
The Company does not have any off-balance sheet arrangements.
Recently issued accounting pronouncements
In August 2012, the FASB issued Accounting Standards Update (ASU) 2012-03, Technical Amendments and Corrections to SEC Sections: Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (SAB) No. 114, Technical Amendments Pursuant to SEC Release No. 33-9250, and Corrections Related to FASB Accounting Standards Update 2010-22 (SEC Update) in Accounting Standards Update No. 2012-03. This update amends various SEC paragraphs pursuant to the issuance of SAB No. 114. The adoption of ASU 2012-03 is not expected to have a material impact on the Companys consolidated financial statements.
In October 2012, the FASB issued ASU 2012-04, Technical Corrections and Improvements in Accounting Standards Update No. 2012-04 ("ASU 2012-04"). The amendments in this update cover a wide range of topics in the Accounting Standards Codification. These amendments include technical corrections and improvements to the Accounting Standards Codification and conforming amendments related to fair value measurements. The amendments in this update will be effective for fiscal periods beginning after December 15, 2012. The adoption of ASU 2012-04 is not expected to have a material impact on the Companys consolidated financial statements.
In February 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income (ASU 2013-02). Under ASU 2013-02, an entity is required to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures that provide additional details about those amounts. ASU 2013-02 does not change the current requirements for reporting net income or other comprehensive income in the financial statements. The amendments in this update will be effective for fiscal periods beginning after December 15, 2012. The adoption of ASU 2013-02 is not expected to have a material impact on the Companys consolidated financial statements.
4. | Restricted cash |
As of December 31, | |||||||
2012 | 2011 | ||||||
Bank deposits held as collateral for
performance bonds issued by the banks to customers |
$ |
1,837,593 |
$ |
1,725,546 |
When the Companys customers request to receive performance bonds issued by the banks in relation to the Companys performance under the sales contracts, the Company has to place deposits with banks equal to 100% of the bonds amount at the time of issuance.
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
5. | Trade receivables, net |
As of December 31, | |||||||
2012 | 2011 | ||||||
Trade receivables | 41,810,915 | 35,600,032 | |||||
Allowance for doubtful accounts | (4,127,640 | ) | (2,026,809 | ) | |||
37,683,275 | 33,573,223 |
As of December 31, 2012 and 2011, the Companys trade receivables of $9,510,826 and $5,421,295, respectively, were pledged as collateral under certain loan arrangements (see Note 12).
An analysis of the allowance for doubtful accounts for the years ended December 31, 2012 and 2011 is as follows :
Year ended December 31, | |||||||
2012 | 2011 | ||||||
Balance at beginning of year | $ | 2,026,809 | $ | 1,353,375 | |||
Addition of bad debt expense, net | 2,081,818 | 614,549 | |||||
Translation adjustments | 19,013 | 58,885 | |||||
Balance at end of year | $ | 4,127,640 | $ | 2,026,809 |
6. | Other receivables, prepayments and deposits |
As of December 31, | |||||||
2012 | 2011 | ||||||
Advances to employees | $ | 4,076,921 | $ | 2,201,875 | |||
Deposits for public bid | 1,163,751 | 953,444 | |||||
Prepayments to suppliers | 5,465,808 | 3,284,002 | |||||
VAT receivable | - | 1,199,778 | |||||
Other receivables | 560,468 | 293,224 | |||||
11,266,948 | 7,932,323 | ||||||
Allowance for doubtful accounts | (73,407 | ) | (72,760 | ) | |||
$ | 11,193,541 | $ | 7,859,563 |
The advances to employees mainly
represent advances for handling selling and logistic activities for the Company
in the ordinary course of business. The advances to employees also include
advance to Mr. Zhao in the amount of $159,158 as of December 31, 2012 for the
same business purpose.
No further allowance for doubtful accounts was provided during the year ended
December 31, 2012 and 2011.
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
7. | Inventories |
As of December 31, | |||||||
2012 | 2011 | ||||||
Raw materials | $ | 4,434,338 | $ | 6,198,179 | |||
Work-in-progress | 26,912,452 | 25,791,085 | |||||
Finished goods | 564,755 | 560,959 | |||||
31,911,545 | 32,550,223 | ||||||
Allowance for obsolete inventories | (19,341 | ) | (19,170 | ) | |||
$ | 31,892,204 | $ | 32,531,053 |
No further allowance for obsolete inventories was provided during the year ended December 31, 2012 and 2011.
As of December 31, 2012, the inventory of $0 (2011: $3,456,574) was pledged under certain loan agreements (see Note 13).
8. | Income tax |
United States
The Company is subject to the United States Federal and state income tax at a statutory rate of 34%. No provision for the U.S. Federal income taxes has been made as the Company had no taxable income in this jurisdiction for the reporting periods.
No provision for U.S. federal and state incomes taxes has been made in our consolidated financial statements for those non-U.S. subsidiaries whose earnings are considered to be reinvested. The amount of undistributed earnings considered to be reinvested which may be subject to tax upon distribution was approximately $24.8 million and $21.9 million at December 31, 2012 and 2011, respectively. A distribution of these non-U.S. earnings in the form of dividends, or otherwise, would subject the Company to both U.S. federal and state income taxes, as adjusted for non-U.S. tax credits, and withholding taxes payable to the various non-U.S. countries. Determination of the amount of any unrecognized deferred income tax liability on these undistributed earnings is not practicable.
BVI
Megaway was incorporated in the BVI and, under the current laws of the BVI, is not subject to income taxes.
HK
Star Wealth was incorporated in Hong Kong and is subject to Hong Kong profits tax at a tax rate of 16.5% . No provision for Hong Kong profits tax has been made as Star Wealth had no taxable income during the reporting periods.
PRC
Siping Juyuan, Beijing Juyuan and Tianjin Juyuan are subject to PRC enterprise income tax (EIT) at the statutory rate of 25%. As Siping Juyuan was qualified as a High-tech Enterprise, it was entitled to a preferential EIT rate of 15% during the reporting periods. Beijing Juyuan, being a Sino-foreign joint venture enterprise, is entitled to two years EIT exemption from the first profit making calendar year of operations after offset of accumulated taxable losses, followed by a 50% tax reduction for the immediate next three calendar years (Tax Holiday). The Tax Holiday commenced in the fiscal year 2008 and Beijing Juyuan was subject to EIT at the rate of 12.5% during the years ended December 31, 2012 and 2011.
Siping Juyuan was also entitled to a special tax concession (Tax Concession) because it employed the required number of handicapped staff according to the relevant PRC tax rules. In particular, this Tax Concession entitled Siping Juyuan refund of value-added tax paid during the reporting periods (see Note 16).
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
The components of the provision for income taxes are:
Year ended December 31, | |||||||
2012 | 2011 | ||||||
Current taxes | $ | 699,950 | $ | 1,700,876 | |||
Deferred taxes | - | (81,100 | ) | ||||
$ | 699,950 | $ | 1,619,776 |
The effective income tax expense differs from the PRC statutory income tax rate of 25% for the years ended December 31, 2012 and 2011 as follows:
Year ended December 31, | |||||||
2012 | 2011 | ||||||
Provision for income taxes at applicable tax rate | $ | 961,456 | $ | 2,267,137 | |||
Non-taxable items for tax | (57,302 | ) | (80,101 | ) | |||
Non-deductible items for tax | 585,374 | 226,387 | |||||
Additional deduction from tax
bureau on research and development expenses and salary for disabled workers |
(336,466 |
) | (278,565 |
) | |||
Preferential Tax Rate | (461,225 | ) | (741,578 | ) | |||
Valuation allowance | 2,116 | 226,496 | |||||
Income tax expense | $ | 699,950 | $ | 1,619,776 |
The amount of benefit from Preferential Tax Rate was $461,225 and $741,578 for the years ended December 31, 2012 and 2011, respectively, and the effect on earnings per share was $0.02 and $0.04, respectively.
ASC 740 requires recognition and measurement of uncertain income tax positions using a more-likely-than-not approach. The management evaluated the Companys tax positions and considered that no provision for uncertainty in income taxes was necessary as of December 31, 2012 and 2011.
Deferred tax assets as of December 31, 2012 and 2011 are composed of the following :
As of December 31, | |||||||
2012 | 2011 | ||||||
Short-term | |||||||
Allowance for doubtful accounts | $ | 477,751 | $ | 166,193 | |||
Allowance for obsolete inventories | 2,876 | 2,876 | |||||
Deferred income | - | 82,492 | |||||
Valuation allowances | (316,050 | ) | - | ||||
164,577 | 251,561 | ||||||
Long-term | |||||||
Net operating loss carried forward | 455,348 | 384,594 | |||||
Valuation allowances | (455,348 | ) | (384,594 | ) | |||
Total deferred tax assets | $ | 164,577 | $ | 251,561 |
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
8. | Income taxes (Contd) |
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible or are utilized.
9. | Property, plant and equipment, net |
As of December 31, | |||||||
2012 | 2011 | ||||||
Cost : | |||||||
Buildings | $ | 6,188,121 | $ | 6,133,593 | |||
Plant and machinery | 5,133,895 | 4,275,088 | |||||
Office equipment | 798,864 | 715,153 | |||||
Motor vehicles | 484,898 | 388,052 | |||||
12,605,778 | 11,511,886 | ||||||
Accumulated depreciation | (4,925,637 | ) | (3,808,279 | ) | |||
Construction in progress | 27,423 | - | |||||
Net | $ | 7,707,564 | $ | 7,703,607 |
During the reporting periods, depreciation is included in: | |||||||
Year ended December 31, | |||||||
2012 | 2011 | ||||||
Cost of sales and overheads of inventories | $ | 539,505 | $ | 447,223 | |||
Research and development expenses | 210,802 | 295,590 | |||||
Administrative expenses | 332,678 | 189,456 | |||||
$ | 1,082,985 | $ | 932,269 |
During the years ended December 31, 2012 and 2011, depreciation expense amounted to $1,082,985 and $932,269, respectively.
As of December 31, 2012 and 2011, property, plant and equipment with net book values of $5,096,108 and $706,695, respectively, were pledged as collateral under certain loan arrangements (see Note 12 and 13).
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
10. | Intangible assets |
As of December 31, | ||||||
2012 | 2011 | |||||
Land use rights | $ | 6,284,176 | $ | 1,106,788 | ||
Accumulated amortization | (162,720 | ) | (87,743 | ) | ||
$ | 6,121,456 | $ | 1,019,045 |
The Company obtained the right from the relevant PRC land authority for a period of fifty years to use the land on which the Companys office premises, production facilities and warehouse are situated. As of December 31, 2012 and 2011, certain land use rights were pledged as collateral under certain loan arrangements (see Note 12).
During the years ended December 31, 2012 and 2011, amortization expense amounted to $74,162 and $21,949, respectively. The estimated amortization expense for each of the five succeeding years from 2012 is approximately $125,624 each year.
11. | Other payables and accrued expenses |
As of December 31, | |||||||
2012 | 2011 | ||||||
Accrued audit fee | $ | - | $ | 105,000 | |||
Receipt in advance from customers | 15,571,736 | 11,003,379 | |||||
Pension payable | 569,522 | 631,506 | |||||
Salaries payable | 350,976 | 417,726 | |||||
Other payables and accrued expenses | 6,349,255 | 3,696,199 | |||||
$ | 22,841,489 | $ | 15,853,810 |
Pension payable represents accrued staff medical, industry injury claims, labor and unemployment insurances, all of which are third party insurances and the insurance premiums are based on certain percentage of salaries. The obligations of the Company are limited to those premiums contributed by the Company.
Included in other payables as of December 31, 2012 and 2011 was an amount of $3,453,778 and $3,237,831 respectively, representing governmental financial support received for the Companys efficient heat exchange equipment manufacture project and other new project. The project will be subject to the governments inspection and whether the government support is repayable or not is subject to the inspection results.
12. | Short-term bank loans |
As of December 31, | |||||||
2012 | 2011 | ||||||
Secured bank loans | $ | 15,534,350 | $ | 13,826,296 | |||
Unsecured bank loans | 3,170,275 | 2,356,755 | |||||
18,704,625 | $ | 16,183,051 |
All bank loans are repayable within one year and carry annual interest from 100% to 120% of the benchmark interest rate published by the Peoples Bank of China (the PBOC).
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
The secured bank loans were secured by the following assets of the Company:
As of December 31, | |||||||
2012 | 2011 | ||||||
Trade receivables (Note 5) | $ | 9,510,826 | $ | 5,421,295 | |||
Property, plant and equipment (Note 9) | 5,096,108 | - | |||||
Land use rights (Note 10) | 1,452,441 | 1,019,045 | |||||
$ | 16,059,375 | $ | 6,440,340 |
The unsecured bank loans as of December 31, 2012 and 2011 were guaranteed by Mr. Zhao and the non-related parties who received 2% to 2.5% of the loan balance as compensation for acting as guarantors for the Company.
During the reporting periods, there was no covenant requirement under the bank loans granted to the Company.
13. | Long-term loan |
The loan is borrowed from a non-financial institution, bearing interest at an annual rate of 15% over of the benchmark rate of the PBOC for three-year long-term loans and guaranteed by a third party.
The loans were secured by the following assets of the Company:
As of December 31, | |||||||
2012 | 2011 | ||||||
Property, plant and equipment (Note 9) | $ | - | $ | 706,695 | |||
Inventories (Note 7) | - | 3,456,574 | |||||
$ | - | $ | 4,163,269 |
As a condition of guarantee agreements mentioned above, the Company made the counter guarantee deposits to the guarantors of $475,542 and $471,352 as of December 31, 2012 and 2011, respectively. These deposits will be returned to the Company upon the Companys settlement of the loans. As of the filing date, guarantee deposit of $237,771 has been received by the Company.
14. | Common stock |
On November 2, 2010, the Company entered into a securities purchase agreement (the Securities Purchase Agreement) with several accredited investors (the Investors) pursuant to which the Company agreed to issue and sell to the Investors 4,453,500 shares of the Companys common stock, representing approximately 21.8% of the issued and outstanding capital stock of the Company on a fully-diluted basis as of and immediately after consummation of the transactions contemplated by the Securities Purchase Agreement, for an aggregate purchase price of approximately $14,251,200, or $3.20 per share (the Placement Price). Before the deduction of fair value of the escrow arrangement (Note 19), the Company received approximately $13,390,000 in net proceeds after deducting the issuance costs.
In connection with the offering of shares under the private placement, 222,675 warrants were issued to the financial advisor on December 7, 2010, as partial compensation for services, to purchase an aggregate of 222,675 shares of common stock of the Company, representing 5% of the offered shares. The warrants have a term of three years and are exercisable from the first anniversary of the issuance and have an exercise price of $3.84. The fair value of these warrants was $26,743 and they were outstanding as of December 31, 2012.
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
15. | Statutory reserve |
The statutory reserve in the consolidated balance sheets comprises Siping Juyuans statutory reserve. In accordance with the relevant laws and regulations of the PRC, Siping Juyuan and Beijing Juyuan are required to set aside at least 10% of their respective after-tax net profits each year determined in accordance with PRC GAAP and if any, to fund the statutory reserve until the balance of the reserve reaches 50% of their respective registered capital. The statutory reserve is not distributable in the form of cash dividends and can be used to make up cumulative prior year losses.
Beijing Juyuan did not make any appropriation to statutory reserve as it incurred losses for the years.
16. | Other income |
Year ended December 31, | |||||||
2012 | 2011 | ||||||
Refund of value-added tax under Tax Concession | $ | 229,207 | $ | 297,817 | |||
Sales of scrapped materials | 207,560 | 292,669 | |||||
Government grants | 20,597 | 146,598 | |||||
Other income | 67,099 | 59,809 | |||||
$ | 524,463 | $ | 796,893 |
17. | Finance costs |
Year ended December 31, | |||||||
2012 | 2011 | ||||||
Interest expense | $ | 1,608,303 | $ | 998,428 | |||
Bank charges and net exchange loss | 206,010 | 122,705 | |||||
$ | 1,814,313 | $ | 1,121,133 |
18. | Earnings per share |
The basic earnings per share is calculated using the net income attributable to the Companys common stockholders and the weighted average number of shares outstanding during the reporting periods. All share and per share data reflects the recapitalization as if it occurred as of the beginning of the first period presented.
As of December 31, 2012, the warrant shares issued to the financial advisor were outstanding and anti-dilutive. There were no dilutive instruments as of December 31, 2012 and 2011. Accordingly, the basic and diluted earnings per share are the same for both the reporting periods.
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
19. | Make good escrow agreement |
In connection with its entry into the
Securities Purchase Agreement, on November 2, 2010, the Company entered into a
make good escrow agreement (the Make Good Escrow Agreement) with Wisetop (the
Pledgor), the Investors, Infinity I-China Fund (Cayman) L.P. and the escrow
agent, pursuant to which the Pledgor agreed to certain make good provisions in
the event that the Company does not meet certain income thresholds for fiscal
years 2010 and/or 2011. Pursuant to the Make Good Escrow Agreement, the Pledgor
established an escrow account and delivered to the escrow agent certificates
evidencing 2,000,000 shares of the Companys common stock held by the Pledgor
(the Escrow Shares) along with blank stock powers, to be held for the benefit
of the Investors.
If the Company fails to report After Tax Net Income (ATNI) reported in the
Annual Report of at least $8 million (the 2010 Guaranteed ATNI) under U.S.
GAAP for the fiscal year ended December 31, 2010, as filed with the Securities
Exchange Commission (the SEC) on Form 10-K, the escrow agent shall transfer
the 2010 Make Good Shares to the Investors on a pro rata basis for no
consideration other than payment of their respective investment amount paid to
the Company at the closing of the private placement (the Closing) and without
any need for action or notice by or on behalf of any investor. The 2010 Make
Good Shares are calculated based on the following formula, as equitably adjusted
for any stock splits, stock combinations, stock dividends or similar
transactions: ((2010 Guaranteed ATNI - 2010 audited ATNI)/$8 million) multiplied
by 50% of the Escrow Shares.
If the Company fails to report ATNI reported in the Annual Report of at least $12 million (the 2011 Guaranteed ATNI) under U.S. GAAP for the fiscal year ending December 31, 2011, as filed with the SEC on Form 10-K, the escrow agent shall transfer the 2011 Make Good Shares to the Investors on a pro rata basis for no consideration other than payment of their respective investment amount paid to the Company at the Closing and without any need for action or notice by or on behalf of any investor. The 2011 Make Good Shares are calculated based on the following formula, as equitably adjusted for any stock splits, stock combinations, stock dividends or similar transactions: ((2011 Guaranteed ATNI - 2011 audited ATNI)/$12 million) multiplied by 50% of the Escrow Shares.
If prior to the second anniversary of the filing of either of the 2010 Annual Report or 2011 Annual Report (as applicable), the Company or their auditors report or recognize that the financial statements contained in such report are subject to amendment or restatement such that the Company would recognize or report adjusted ATNI of less than either of the 2010 Guaranteed ATNI or the 2011 Guaranteed ATNI (as applicable), then notwithstanding any prior return of 2010 Make Good Shares and 2011 Make Good Shares to the Pledgor, the Pledgor shall , within 10 business days following the earlier of the filing of such amendment or restatement or recognition, deliver the relevant 2010 Make Good Shares and 2011 Make Good Shares to the Investors without any further action on the part of the Investors.
If the 2010 audited ATNI is equal to or greater than the 2010 Guaranteed ATNI, no transfer of the 2010 Make Good Shares shall be required by the Pledgor to the Investors and 50% of the Escrow Shares shall be promptly returned to the Pledgor without the need of any approval or consent thereto by any investor. The remaining 50% of the Escrow Shares shall continue to be held in escrow by the escrow agent. If the 2011 audited ATNI is equal to or greater than the 2011 Guaranteed ATNI, no transfer of the 2011 Make Good Shares shall be required by the Pledgor to the Investors and the remaining 50% of the Escrow Shares shall be promptly returned to the Pledgor without the need of any approval or consent thereto by any investor.
Pursuant to ASC 718-10-S99-2, the SEC staff generally believes that escrow arrangement, which is in substance an inducement made to facilitate the transaction on behalf of the issuer, should be recognized and measured according to its nature and reflected as a reduction of the proceeds allocated to the newly-issued securities. The Company considers the aforementioned escrow arrangement as an inducement to facilitate the private placement on behalf of the Company rather than as compensatory and accordingly, adopted ASC 718-10-S99-2 to recognize this arrangement. The management estimated the probability of the Company not achieving the 2010 Guaranteed ATNI and 2011 Guaranteed ATNI to be 10% (the Probability %) and calculated the fair value of the escrow arrangement with reference to the Probability % and the Placement Price. The calculated fair value of $640,000 was deducted from the placement proceeds with a corresponding credit in additional paid-in capital, resulting in no net change in the Companys equity.
As the target was met for the 2010 Guaranteed ATNI, 50% of the Escrow Shares or 1,000,000 shares were returned to stockholders during the year. As the Company has not met the 2011 Guarantee ATNI, the pledgor is required to transfer the 2011 Make Good Shares to the investors on a pro-rata basis. On March 13, 2013, the pledgor transferred a total of 341,410 shares to the investors pursuant to the Make Good Escrow Agreement, as amended.
For assessing the impact of the 2011 Make Good Shares in 2012, we have used the estimated number of shares to be paid out (341,410 shares) using the actual shortfall net income pro-rated by the number of shares held in escrow.
As at and for the three-month period ended (amounts in USD) | |||||||||||||
3/31/2012 | 6/30/2012 | 9/30/2012 | 12/31/2012 | ||||||||||
Closing share price | 1.42 | 1.86 | 0.91 | 1.18 | |||||||||
Marked to market gain/(loss) | (174,119 | ) | (150,221 | ) | 324,340 | (92,181 | ) |
Our analysis is as follows:
As at and for the three-month period ended | |||||||||||||
3/31/2012 | 6/30/2012 | 9/30/2012 | 12/31/2012 | ||||||||||
Income from operations | 844,381 | 1,829,244 | 846,737 | 1,796,065 | |||||||||
Shareholders equity | 56,005,544 | 57,477,115 | 57,907,060 | 58,732,673 | |||||||||
Total assets | 97,058,938 | 103,917,252 | 114,255,445 | 111,468,902 | |||||||||
Earnings per share | 0.03 | 0.07 | 0.02 | 0.15 | |||||||||
Weighted average shares | 20,453,500 | 20,453,500 | 20,453,500 | 20,453,500 |
Percentage deviation based on calculated market to market gain/(loss) for each of the three month period for the year ended December 31, 2012 is as follows:
As at and for the three-month period ended | |||||||||||||
3/31/2012 | 6/30/2012 | 9/30/2012 | 12/31/2012 | ||||||||||
Based on operating income | 20.62% | 8.21% | 38.30% | 5.13% | |||||||||
Based on equity | 0.31% | 0.26% | 0.56% | 0.16% | |||||||||
Based on total assets | 0.18% | 0.14% | 0.28% | 0.08% | |||||||||
Based on EPS | 28.38% | 10.49% | 79.29% | 3.00% |
We believe that investors and analysts generally use some measure of operating income or net income to evaluate the performance of the Company. Although the impact to net income for several quarters in the periods assessed reflected an impact that exceeded 5%, we looked to the guidance in paragraph 29 of APB Opinion 28 to conclude that such impact was not material. Nonetheless, as there is no quantitative rule of thumb as to when a change is material, we also made a qualitative assessment of the materiality of the error in accordance with SAB 99.
Although we believe that investors and analysts generally use some measure of operating income or net income to evaluate performance of the Company, we do not believe the non-recognition of mark to market gain masks any trends in those measures or that the effect of recognition of the financial liability distorts historical trends in these performance measures. Additionally, the non-recognition of the marked to market gain and financial liability does not improve any negative performance measure in our statement of comprehensive income, such as turning any losses into income or otherwise.
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
Additionally, the non-recognition of the liability and the resulting marked to market gains had no effect on management compensation, (e.g., it had no impact on whether or not earnings targets or performance thresholds were met nor did it affect eligibility for, or the award (or lack of award) of any bonus, equity or other compensation). No member of management received any special compensation in connection with our quarterly and annual results.
We also considered the potential effect of the disclosure of the information on the market. We believe that all the relevant information relating to the Make Good Escrow Arrangement had been disclosed in the previous financial reports. As this was a one-time event related solely to the make good escrow arrangement between Mr. Zhao and the new investors and is unrelated to the fundamentals of our business or any segment or other portion of our business that plays a role in our ongoing operations or profitability, we did not expect that the additional information on the liability and the resulting marked to market gains calculated according to ASC 480-10-25-14 would result in significant positive or negative market reaction.
Based on such analysis, we believe that the difference between recognition and non-recognition of the liability and the resulting marked to market gain for both years are not qualitatively material to the respective financial statements taken as a whole, nor would the recognition or non-recognition of the deviation affect the judgment of a reasonable person relying on our financial information prepared in accordance with US GAAP.
20. | Defined contribution plan |
Pursuant to the relevant PRC regulations, the Company is required to make contributions at a rate of 30.6% to 31.2% of employees salaries and wages to a defined contribution retirement scheme organized by a state-sponsored social insurance plan in respect of the retirement benefits for the Companys employees in the PRC. The only obligation of the Company with respect to the retirement scheme is to make the required contributions under the plan. No forfeited contribution is available to reduce the contribution payable in the future years. The defined contribution plan contributions were charged to the consolidated statements of income and comprehensive income. The Company contributed $241,305 and $186,957 for the years ended December 31, 2012, and 2011, respectively.
21. | Commitments and contingencies |
Capital commitment
As at December 31, 2012 and 2011, the Company had capital commitments $Nil and $317,342, respectively, in respect of the construction of the Companys campus and factory and for purchase of machineries that were contracted for but not provided in the consolidated financial statements.
Contingencies
As of December 31, 2012 and 2011, the Company had contingencies arising from the division of Old Juyuan Company into Siping Juyuan, New Juyuan Company and Juyuan Hanyang Pressure Vessels. According to the division agreement of Old Juyuan Company (Division Agreement), all parties to the Division Agreement undertook joint and several liabilities for the indebtedness of Old Juyuan Company.
In accordance with ASC 450 Contingencies, the Company records a liability in the consolidated financial statements for these contingencies when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. If a loss is possible but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed. In most cases, significant judgment is required to estimate the amount and timing of a loss to be recorded.
The Companys loss in respect of this undertaking is possible but not known or probable. Accordingly, no liability was recognized as of December 31, 2012 and 2011 respectively. The Company believes that a reasonable estimate of the possible loss range from $Nil to approximately $1,757,000 as of December 31, 2012 (2011: from $Nil to approximately $1,741,000).
THT Heat Transfer Technology, Inc. |
Notes to Consolidated Financial Statements |
(Stated in US Dollars) |
The Company's operations are subject to the laws and regulations in the PRC relating to the generation, storage, handling, emission, transportation and discharge of certain materials, substances and waste into the environment, and various other health and safety matters. Governmental authorities have the power to enforce compliance with their regulations, and violators may be subject to fines, injunctions or both. The Company must devote substantial financial resources to ensure compliance and believes that it is in substantial compliance with all the applicable laws and regulations.
The Company is currently not involved in any environmental remediation and has not accrued any amounts for environmental remediation relating to its operations. Under existing legislation, management believes that there are no probable liabilities that will have a material adverse effect on the financial position, operating results or cash flows of the Company.
22. | Segment information |
The Company is solely engaged in the manufacturing and trading of plate heat exchangers and various related products. Since the nature of the products, their production processes, and their distribution methods are substantially similar, they are considered as a single reportable segment under ASC 280 Segment Reporting. The Companys sales revenues by products for the years ended December 31, 2012 and 2011 were as follows :
Year ended December 31, | |||||||||||||
2012 | % | 2011 | % | ||||||||||
Plate heat exchanger | $ | 24,232,037 | 39 | $ | 29,867,262 | 52 | |||||||
Heat exchange unit | 24,571,248 | 39 | 12,365,970 | 21 | |||||||||
Air-cooled heat exchanger | 1,730,094 | 3 | 3,466,342 | 6 | |||||||||
Shell-and-tube heat exchanger | 5,978,256 | 9 | 6,276,527 | 11 | |||||||||
Others | 6,259,057 | 10 | 5,765,187 | 10 | |||||||||
$ | 62,770,692 | 100 | $ | 57,741,288 | 100 |
All of the Companys long-lived assets and revenues classified based on the customers are located in the PRC.
23. | Related party transactions |
Apart from the transactions as disclosed in Note 6 and Note 12 to the consolidated financial statements, the Company had no other material transactions carried out with its related parties during the reporting periods.
24. | Subsequent events |
Siping Juyuan entered into a share transfer agreement dated May 10, 2012 (the "Share Transfer Agreement") relating to the acquisition of the remaining 25% equity ownership interest in Beijing Juyuan from Hanyang International GmbH (Hanyang). The purchase price for this 25% equity interest is RMB 2.5 million (approximately $402,325). The purchase price must be paid by the Company in one lump sum on or before April 30, 2013. Under applicable PRC law, the acquisition of the 25% equity interest in Beijing Juyuan must be approved by appropriate foreign investment approval authority, and then registered with a competent branch of the State Administration of Industry and Commerce. Failure to obtain these necessary approvals or to pay the purchase price may result in the unwinding of the acquisition. The Company obtained all the required PRC regulatory approvals and registrations by March 21, 2013, and expects the acquisition to be consummated on or before April 30, 2013.
EXHIBIT INDEX
Exhibit No. | Description |
2.1 |
Share Exchange Agreement, dated as of June 30, 2009, by and among the Company, Megaway International Holdings Limited and its sole shareholder [incorporated by reference to Exhibit 2.1 of the Companys Current Report on Form 8-K filed on July 7, 2009] |
2.2 |
Share Exchange Agreement, dated as of February 12, 2009, by and among the Company, Sino- America Ventures, Inc. and its shareholders [incorporated by reference to Exhibit 2.1 of the Companys Current Report on Form 8-K filed on February 13, 2009] |
2.3 |
First Amended Joint Plan of Reorganization dated September 29, 2004 [incorporated by reference to Exhibit 2.1 of the Companys Registration Statement on Form 10-SB filed on September 21, 2006] |
2.4 |
Order Confirming First Amended Joint Plan of Reorganization dated November 29, 2004 [incorporated by reference to Exhibit 2.2 of the Companys Registration Statement on Form 10 filed on September 21, 2006] |
2.5 |
Agreement and Plan of Merger, dated as of November 24, 2009, between BTHC VIII, Inc. and THT Heat Transfer Technology, Inc. [incorporated by reference to Exhibit 2.1 of the Companys Current Report on Form 8-K filed on December 4, 2009] |
3.1 |
Articles of Incorporation of the Company, as amended to date [incorporated by reference to Exhibit 3.1 of the Companys Current Report on Form 8-K filed on December 4, 2009] |
3.2 |
Bylaws of the Company, as amended to date [incorporated by reference to Exhibit 3.2 of the Companys Current Report on Form 8-K filed on December 4, 2009] |
4.1 |
Form of Registration Rights Agreement [incorporated by reference to Exhibit 4.1 of the Companys Current Report on Form 8-K filed on November 3, 2010] |
10.1 |
Form of Securities Purchase Agreement [incorporated herein by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed on November 3, 2010] |
10.2 |
Form of Lockup Agreement [incorporated herein by reference to Exhibit 10.2 of the Companys Current Report on Form 8-K filed on November 3, 2010] |
10.3 |
Form of Make Good Escrow Agreement [incorporated herein by reference to Exhibit 10.3 of the Companys Current Report on Form 8-K filed on November 3, 2010] |
10.4 |
Form of Right of Co-Sale Agreement [incorporated herein by reference to Exhibit 10.4 of the Companys Current Report on Form 8-K filed on November 3, 2010] |
10.5 |
Form of Closing Escrow Agreement [incorporated herein by reference to Exhibit 10.5 of the Companys Current Report on Form 8-K filed on November 3, 2010] |
10.6 |
Independent Director Agreement, dated as of September 25, 2009, by and between the Company and Wenquan Tao [incorporated by reference to Exhibit 10.1 of the Companys Current Report on Form 8-K filed on September 28, 2009] |
10.7 |
Independent Director Agreement, dated as of September 25, 2009, by and between the Company and To Tsang [incorporated by reference to Exhibit 10.3 of the Companys Current Report on Form 8-K filed on September 28, 2009] |
10.8 |
Indemnification Agreement, dated as of September 25, 2009, by and between the Company and Wenquan Tao [incorporated by reference to Exhibit 10.4 of the Companys Current Report on Form 8-K filed on September 28, 2009] |
10.9 |
Indemnification Agreement, dated as of September 25, 2009, by and between the Company and To Tsang [incorporated by reference to Exhibit 10.6 of the Companys Current Report on Form 8-K filed on September 28, 2009] |
10.10* | |
14 |
Code of Ethics [incorporated by reference to Exhibit 14.1 of the Companys Current Report on Form 8-K filed on September 28, 2009] |
Exhibit No. | Description |
21 |
Subsidiaries of the Company (incorporated by reference to Exhibit 21 of the Companys Annual Report on Form 10-K filed on March 28, 2011) |
31.1* |
Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2* |
Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1* |
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2* |
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
99.1 |
Audit Committee Charter [incorporated by reference to Exhibit 99.1 of the Companys Current Report on Form 8-K filed on September 28, 2009] |
99.2 |
Compensation Committee Charter [incorporated by reference to Exhibit 99.2 of the Companys Current Report on Form 8-K filed on September 28, 2009] |
99.3 |
Governance and Nominating Committee Charter [incorporated by reference to Exhibit 99.3 of the Companys Current Report on Form 8-K filed on September 28, 2009] |
101* |
Interactive data files pursuant to Rule 405 of Regulation S-T (furnished herewith). |
*Filed herewith.