|• FORM 10-Q FOR THE PERIOD ENDED 3/31/2012 • EXHIBIT 31.1 • EXHIBIT 31.2 • EXHIBIT 32.1 • EXHIBIT 32.2 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE • XBRL TAXONOMY EXTENSION LABEL LINKBASE|
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to _____
Commission File Number: 000-53131
CHINA XD PLASTICS COMPANY LIMITED
(Exact name of registrant as specified in its charter)
No. 9 Dalian North Road, Haping Road Centralized Industrial Park,
Harbin Development Zone, Heilongjiang Province, PRC 150060
(Address of principal executive offices) (Zip Code)
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No o
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 o Accelerated filer o
Non-accelerated filer o Smaller reporting company x
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of May 8, 2012, the registrant had 47,527,367 shares of common stock, par value US$0.0001 per share, outstanding.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
CHINA XD PLASTICS COMPANY LIMITED AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
See accompanying notes to unaudited condensed consolidated financial statements.
CHINA XD PLASTICS COMPANY LIMITED AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See accompanying notes to unaudited condensed consolidated financial statements.
CHINA XD PLASTICS COMPANY LIMITED AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to unaudited condensed consolidated financial statements.
CHINA XD PLASTICS COMPANY LIMITED AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Basis of presentation, significant concentrations and risks
(a) Basis of presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted as permitted by rules and regulations of the United States Securities and Exchange Commission. The condensed consolidated balance sheet as of December 31, 2011 was derived from the audited consolidated financial statements of China XD Plastics Company Limited (“China XD Plastics”) and subsidiaries (the ‘‘Company’’). The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated balance sheet of the Company as of December 31, 2011, and the related consolidated statements of comprehensive income, changes in equity and cash flows for the year then ended.
In the opinion of the management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the financial position as of March 31, 2012, the results of operations and cash flows for the three-month periods ended March 31, 2012 and 2011, have been made.
The preparation of consolidated financial statements in accordance with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the recoverability of the carrying amounts of property, plant and equipment, the realizability of inventories and deferred income tax assets, the useful lives of property, plant and equipment, the collectibility of accounts receivable, the fair values of financial instruments and stock-based compensation awards, and the accruals for tax uncertainties and other contingencies. The current economic environment has increased the degree of uncertainty inherent in those estimates and assumptions.
(b) Significant concentrations and risks
The Company sells its products, substantially through approved distributors in the PRC. The Company’s sales are highly concentrated. Sales to four and five major distributors, which individually exceeded 10% of the Company’s revenues, accounted for approximately 73% and 83% of the Company’s revenues for the three-month periods ended March 31, 2012 and 2011, respectively. The Company expects revenues from these distributors to continue to represent a substantial portion of its revenue in the future. Any factors adversely affecting the automobile industry in the PRC or the business operations of these customers will have a material effect on the Company’s business, financial position and results of operations.
The principal raw materials used for the Company’s production of modified plastics products are plastic resins, such as polypropylene, ABS and nylon. The Company purchases substantially all of its raw materials through three distributors. Raw material purchases from these three suppliers, which individually exceeded 10% of the Company’s total raw material purchases, accounted for approximately 99% and 95% of the Company’s total raw material purchases for the three-month periods ended March 31, 2012 and 2011, respectively. Management believes that other suppliers could provide similar raw materials on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would adversely affect the Company’s business, financial position and results of operations.
The majority owner of a major raw material supplier that supplied approximately 26% and 23% of the Company’s total raw material purchases for the three-month periods ended March 31, 2012 and 2011, respectively, is also the majority owner of a sales distributor of the Company. Sales to this customer were approximately 15% and 13% of the Company’s total revenues for the three-month periods ended March 31, 2012 and 2011, respectively.
Cash, cash equivalents and restricted cash maintained at banks consist of the following:
The bank deposits with financial institutions in the PRC are uninsured by the government authority. To limit exposure to credit risk relating to bank deposits, the Company primarily places bank deposits with large financial institutions in the PRC with acceptable credit rating.
Cash that is restricted as to withdrawal or usage is reported as restricted cash in the condensed consolidated balance sheets and is not included as cash and cash equivalents in the condensed consolidated statements of cash flows. Restricted cash of US$11,115,522 and US$11,128,106 as of March 31, 2012 and December 31, 2011, respectively, represents short-term bank deposits that are pledged as security for bills payable relating to purchase of raw materials. Upon maturity of the bills payable, which is generally within 6 months, the cash becomes available for use by the Company. The net cash flows from the pledged bank deposits, which relate to purchases of raw materials, are reported within cash flows from operating activities in the condensed consolidated statements of cash flows.
Note–2 - Accounts receivable
Accounts receivable consist of the following:
There was no accrual of additional provision or write-off of accounts receivables during the three-month period ended March 31, 2012.
Note–3 - Inventories
Inventories consist of the following:
Note–4 – Prepaid expenses and other current assets
Prepaid expenses and other current assets consist of the following:
Consistent with the common industry practice in the PRC, the Company is required to pay deposits to the suppliers for the principal raw materials ordered. The Company makes advanced orders of raw materials based upon (1) the demand and supply situation in the raw materials market and (2) the forecasted demand of products. All advances to suppliers as of March 31, 2012 are related to the purchase of raw materials, which were subsequently received by the Company in April 2012.
Note–5 – Property, plant and equipment, net
Property, plant and equipment consist of the following:
Depreciation expense was US$2,472,970 and US$1,197,549 for the three-month periods ended March 31, 2012 and 2011, respectively. For the three-month periods ended March 31, 2012 and 2011, interest expense capitalized as a component of the cost of construction-in-progress was inconsequential.
Note 6 – Short-term bank loans
As of March 31, 2012 and December 31, 2011, the Company’s short-term bank loans bear a weighted average interest rate of 7.1% and 6.1% per annum, respectively. All short-term bank loans mature and expire at various times within one year and contain no renewal terms.
On January 17, 2012, the Company obtained a revolving one-year line of credit in the amount of RMB100 million (approximately US$16 million) from a PRC bank in Harbin, Heilongjiang province. As of March 31, 2012, the line of credit was fully utilized.
Note 7 - Accrued expenses and other current liabilities
Accrued expenses and other current liabilities consist of the following:
Others mainly represent accrual for professional service expenses, accrued payroll, employee benefits, accrued utility charges, non income tax payables and other accrued miscellaneous operating expenses.
Note 8 – Related party transactions
During the periods presented, the Company entered into related party transactions with Xinda High-Tech, an entity controlled by the wife of Mr. Han, the chief executive officer and controlling stockholder of the Company, and Mr. Han’s son. The significant related party transactions are summarized as follows:
The balances due from and to the related parties are summarized as follows:
Note 9 – Income tax
In 2008, Harbin Xinda Macromolecule Material Co., Ltd. (“Harbin Xinda”) was qualified as an Advanced and New Technology Enterprise (“ANTE”). In 2011, Harbin Xinda renewed its ANTE qualification, which entitled it to the preferential income tax rate of 15% from January 1, 2011 to December 31, 2013. In December 2011, Heilongjiang Xinda Enterprise Group Co., Ltd. (“Xinda Group”) was established and is subject to income tax at 25%. In January 2012, as a result of an internal reorganization, Harbin Xinda was merged into Xinda Group which remains subject to income tax at 25% after the merger.
The effective income tax rates for the three-month periods ended March 31, 2012 and 2011 were 24.2% and 19.5%, respectively. The effective income tax rate for the three-month period ended March 31, 2012 differs from the PRC statutory income tax rate of 25% primarily due to the additional 50% deduction against taxable income for certain research and development expenses incurred by two research centers of the Company.
As of March 31, 2012 and December 31, 2011, full valuation allowances of US$1,119,652 and US$1,005,361 were provided against the deferred income tax assets of entities which were in cumulative loss positions.
As of and for the three-month period ended March 31, 2012, the Company did not have any unrecognized tax benefits, and thus no interest and penalties related to unrecognized tax benefits were recorded. In addition, the Company does not expect that the amount of unrecognized tax benefits will change significantly within the next 12 months.
Note 10 - Warrants
The following is a summary of outstanding warrants as of March 31, 2012:
The fair values of the warrants as of March 31, 2012 were calculated using Black-Scholes option pricing model with the following assumptions:
During the three-month period ended March 31, 2012, no warrants were exercised.
Note 11 – Stockholders’ equity
The changes of each caption of stockholders’ equity for the three-month period ended March 31, 2012 are as follows:
Note 12 – Stock based compensation
A summary of stock option activities is as follows:
The Company recognized US$81,923 and US$81,923 of compensation expense in general and administration expenses relating to stock options for the three-month periods ended March 31, 2012 and 2011, respectively. As of March 31, 2012, there was US$449,834 of total unrecognized compensation cost relating to stock options, which is to be recognized over a period of 1.4 years.
A summary of the nonvested shares activity is as follows:
The Company recognized US$70,782 and US$69,891 of compensation expense in general and administration expenses relating to nonvested shares for the three-month periods ended March 31, 2012 and 2011, respectively. As of March 31, 2012, there was US$236,520 of total unrecognized compensation cost relating to nonvested shares, which is to be recognized over a weighted average period of 1.35 years.
Note 13 - Earnings per share
Basic and diluted earnings per share are calculated as follows:
The following table summarizes potentially dilutive securities excluded from the calculation of diluted earnings per share for the three-month periods ended March 31, 2012 and 2011, because their effects are anti-dilutive:
Note 14 - Commitments and contingencies
Future minimum lease payments under non-cancellable operating leases agreements as of March 31, 2012 were as follows. The company’s leases do not contain any contingent rent payments terms.
Rental expenses incurred for operating leases of plant and equipment and office spaces were US$115,704 and US$102,938 for the three-month periods ended March 31, 2012 and 2011, respectively. There are no step rent provisions, escalation clauses, capital improvement funding requirements, other lease concessions or contingent rent in the lease agreements. The Company has no legal or contractual asset retirement obligations at the end of leases.
(2) Plant construction
Pursuant to the agreement with Harbin Shengtong Engineering Plastics Co. Ltd., the Company has a commitment of RMB316,937,900 (equivalent to US$50,327,574) as of March 31, 2012, for the acquisition of land use rights and a production base consisting of five workshops and a building upon completion.
(3) Warehouse construction
Pursuant to the agreement with Oriental International Construction Engineering Company Limited, the Company has a commitment of RMB4,932,698 (equivalent to US$783, 279) as of March 31, 2012, for the construction of a warehouse.
(4) Equipment acquisition
As of March 31, 2012, the Company has a commitment of RMB18,344,000 (equivalent to US$2,912,902) for the acquisition of equipment.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
We make forward-looking statements in this report, in other materials we file with the Securities and Exchange Commission (the “SEC”) or otherwise release to the public, and on our website. In addition, our senior management might make forward-looking statements orally to analysts, investors, the media and others. Statements concerning our future operations, prospects, strategies, financial condition, future economic performance (including growth and earnings) and demand for our products and services, and other statements of our plans, beliefs, or expectations, including the statements contained in this Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” regarding our future plans, strategies and expectations are forward-looking statements. In some cases these statements are identifiable through the use of words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” and similar expressions. We intend such forward-looking statements to be covered by the safe harbor provisions contained in Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and in Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). You are cautioned not to place undue reliance on these forward-looking statements because these forward-looking statements we make are not guarantees of future performance and are subject to various assumptions, risks, and other factors that could cause actual results to differ materially from those suggested by these forward-looking statements. Thus, our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in: economic conditions generally and the automotive modified plastics market specifically, legislative or regulatory changes that affect our business, including changes in regulation, the availability of working capital, the introduction of competing products, and other risk factors described herein. These risks and uncertainties, together with the other risks described from time-to-time in reports and documents that we filed with the SEC should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Indeed, it is likely that some of our assumptions will prove to be incorrect. Our actual results and financial position will vary from those projected or implied in the forward-looking statements and the variances may be material. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.
China XD Plastics Company Limited (“China XD”, “we”, and the “Company”, and “us” or “our” shall be interpreted accordingly) is one of leading specialty chemical companies engaged in the research, development, manufacture and sale of modified plastics primarily for automotive applications in China. Through our wholly-owned operating subsidiaries in China, we develop modified plastics using our proprietary technology, manufacture and sell our products primarily for use in the fabrication of automobile parts and components. We have received 218 certifications from manufacturers in the automobile industry as of March 31, 2012. We are the only company certified as a National Enterprise Technology Center in modified plastics industry in Heilongjiang province. Our Research and Development (the “R&D”) team consists of 93 professionals and 15 consultants, including two consultants who are members of Chinese Academy of Engineering, and one consultant who is the former chief scientist of Specialty Plastics Engineering Institute of Jilin University. As a result of the integration of our academic and technological expertise, we have a portfolio of 26 patents, two of which we have obtained the patent rights and the remaining 24 of which we have applications pending in China as of March 31, 2012.
Our products include seven categories: polypropylene (PP), acrylonitrile butadiene styrene (ABS), modified engineering plastics, polyamides (PA or nylon), environment-friendly plastics, specialty engineering plastics and polyether ether ketone (PEEK). The Company's products are primarily used in the production of exterior and interior trim and functional components of more than 20 automobile brands and 70 automobile models manufactured in China, including Audi, Volkswagen, BMW, GM Mazda, Toyota, Cherry, Geely and Hafei new energy vehicles. Our research center is dedicated to the research and development of modified plastics, and benefits from its cooperation with well-known scientists from prestigious universities in China. We operate three manufacturing bases in Harbin, Heilongjiang in the PRC. As of March 31, 2012, we had approximately 255,000 metric tons of production capacity per annum across 58 automatic production lines utilizing German twin-screw extruding systems, automatic weighing systems and Taiwan conveyer systems. In addition, there are three additional factories which are currently in construction in our third production base and expected to be completed in the second half of 2012 and which could add approximately 135,000 metric tons annual production capacity to support our production capacity expansion beyond 2012.
Highlights for the three months ended March 31, 2012 include:
· Revenue was a record $123.2 million, an increase of 61.8% from $76.1 million in the first quarter of 2011
· Gross profit was $31.2 million, an increase of 68.7% from $18.5 million in the first quarter of 2011
· Gross profit margin was 25.3%, compared to 24.3% in the first quarter of 2011
· Net income was $20.6 million, compared to $11.9 million in the first quarter of 2011
· Total volume shipped was 45,835 metric tons, up 32.6% from 34,558 metric tons in the first quarter of 2011
Results of Operations
The following table sets forth, for the periods indicated, statements of income data in thousands of USD:
Revenues were US$ 123.2 million in the first quarter of 2012, an increase of US$ 47.1 million, or 61.8%, compared to US$ 76.1 million in the same period of last year, due to approximately 32.6% increase in sales volume and 19.3% increase in the average selling price of our products on a constant dollar basis. The increase of sales volume was driven by the strong demand of modified plastics in the PRC market and higher penetration of our business in our existing markets supported by our newly installed twenty production lines in December 2011. Such increase in demand was driven by increasing demand for middle and high-end automobiles by Chinese consumers, continuing substitution of imported modified plastics by domestic suppliers, as well as the increase of plastic content on a per-vehicle basis in China. The increase of average selling price was due to the shift of product mix towards higher-end products as well as higher raw material prices that we have been able to effectively pass through to our customers.
The following table summarizes the breakdown of revenues by product mix in millions of US$:
The following table summarizes the breakdown of metric tons (MT) by product mix:
The Company has shifted product mix from traditional Modified Polypropylene (PP) to higher-end products such as Environmental Friendly Plastics, Engineering Plastics, Modified Polyamide (PA) and Alloy Plastics, primarily due to (i) the increasing demand of advanced modified plastics in luxury automobile models in China, (ii) the stronger demand promoted by Chinese government for clean energy vehicles and (iii) stronger sales of higher-end cars made by automotive manufacturers from China and Germany, US and Japanese joint ventures, which tend to use more and higher-end modified plastics in quantity per vehicle in China.
Gross Profit and Gross Margin
Gross profit was US$ 31.2 million in the quarter ended March 31, 2012 compared to US$ 18.5 million in the same period of 2011, representing an increase of 68.7%. Our gross margin increased to 25.3% during the quarter ended March 31, 2012 from 24.3% during the same quarter of 2011. The increase was mainly attributed to the higher proportion of sales of our high-end products as a percentage of total sales in the first quarter ended March 31, 2012 as a result of our efforts in developing and selling more higher value-added automotive modified plastics.
General and Administrative Expenses
General and administrative (G&A) expenses were US$ 2.3 million in the quarter ended March 31, 2012 compared to US$ 1.4 million in the same period in 2011, representing an increase of 63.0%, or US$0.9 million. This increase is primarily due to increase of payroll resulting from raised average salary and increased headcount and increase of audit fees. On a percentage basis, G&A expenses in the first quarter of 2012 increased to 1.9% of revenues from 1.8% in the first quarter of 2011.
Research and Development Expenses
Research and development (“R&D”) expenses were US$ 2.5 million during the quarter ended March 31, 2012 compared with US$2.3 million during the same period in 2011, an increase of US$ 0.2 million, or 7.5%, reflecting increased research and development activities on new products in order to obtain product certifications for automotive applications from automobile manufacturers as well as other non-automotive applications.
As of March 31, 2012, the number of ongoing research and development projects is 108. We expect to complete and to realize economic benefits on approximately 29% of the projects in the near term. The remaining projects are expected to be carried out for a longer period. The majority of the projects are in the field of modified plastics in automotive applications and the rest are in advanced fields such as ships, airplanes, high-speed rail, medical devices etc.
Total operating income was US$26.3 million in the quarter ended March 31, 2012 compared to US$14.6 million in the same period of 2011, representing an increase of 80.1% or US$11.7 million. This increase is primarily due to higher gross profit, partially offset by higher G&A and R&D expenses.
Other Income (Expense)
Interest Income (Expenses)
Net interest income was US$0.5 million in the quarter ended March 31, 2012, compared to net interest expenses of US$0.3 million in the same period of 2011, primarily due to US$1.0 million interest income generated from time deposits in the first quarter of 2012.
Change in Fair Value of Warrants Liabilities
Change in fair value of warrants liabilities was a gain of US$ 0.3 million in the quarter ended March 31, 2012, compared to a gain of US$0.5 million in the same period of 2011, primarily due to the change of fair value of warrants driven by the fluctuation of our stock price in respective periods. On a percentage basis, change in fair value of warrants liabilities in the first quarter of 2012 decreased to 0.3% of revenues from 0.7% in the first quarter of 2011.
The effective income tax rates for the three-month periods ended March 31, 2012 and 2011 were 24.2% and 19.5%, respectively. The effective income tax rate for the three-month period ended March 31, 2012 differs from the PRC statutory income tax rate of 25% primarily due to the additional 50% deduction against taxable income for certain research and development expenses incurred by our research centers. The significant increase of the effective income tax rate in the three-month period ended March 31, 2012 when compared to the same period in 2011 is primarily due to an internal reorganization in which Harbin Xinda Macromolecule Material Co., Ltd. (“Harbin Xinda”) was merged into Heilongjiang Xinda Enterprise Group Co., Ltd. which was newly established in December 2011 and was subject to income tax at 25% before and after the merger in January 2012. Harbin Xinda was an Advanced and New Technology Enterprise and was entitled to a preferential income tax rate of 15% in 2011.
Our PRC subsidiaries have US$137.5 million of cash and cash equivalents and restricted cash as of March 31, 2012 which is planned to be permanently reinvested in the PRC. The distributions from our PRC subsidiaries are subject to the U.S. federal income tax at 34%, less any applicable foreign tax credits. Due to our policy of indefinitely reinvesting our earnings in our PRC business, we have not provided for deferred income tax liabilities on undistributed earnings of our PRC subsidiaries.
As a result of the above factors, we had a net income of US$20.6 million in the first quarter of 2012 compared to net income of US$11.9 million in the same quarter of 2011.
Selected Balance Sheet Data at March 31, 2012 and December 31, 2011:
Our financial condition continues to improve as measured by an increase of 11.9% in stockholders’ equity as of March 31, 2012 compared to December 31, 2011. Accounts receivable increased by 27.0% as a combined result of both increase in revenues and increase of turnover days of accounts receivable to 42 days for the three months ended March 31, 2012.
LIQUIDITY AND CAPITAL RESOURCES
Historically, our primary uses of cash have been to finance working capital needs and capital expenditures for new production capacity. We have financed these requirements primarily from cash generated from operations, short-term bank borrowings, and the issuance of our convertible preferred stocks and other equity financings. As of March 31, 2012 and December 31, 2011, we had US$ 127.2 million and US$135.5 million, respectively, in cash and cash equivalents, which were primarily deposited with banks in China (including Hong Kong). As of March 31, 2012, we had US$18.7 million outstanding short-term bank loans, including US$15.9 million unsecured loans under the line of credit and $2.8 million loans secured by property, plant and equipment and land use right. These loans bear a weighted average interest rate of 7.1% per annum and have terms of no longer than one year and do not contain any renewal terms. We have historically been able to make repayments when due.
We expect that we will be able to meet our needs to fund operations, capital expenditures and other commitments in the next 12 months primarily with operating cash flows and bank borrowings.
We may, however, require additional cash resources due to changes in business conditions or other future developments. If these sources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities or obtain a credit facility. The sale of additional equity or equity-linked securities could result in additional dilution to stockholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financial covenants that would restrict operations. Financing may not be available in amounts or on terms acceptable to us, or at all.
The following table sets forth a summary of our cash flows for the periods indicated.
Net cash provided by operating activities increased to US$4.5 million in the three months ended March 31, 2012 from US$1.4 million in the three months ended March 31, 2011, primarily due to the increase of approximately US$ 18.8 million in cash collected from our customers in the three months ended March 31, 2012 resulting from increasing sales during the period, which were partially offset by (i) an increase of approximately US$9.7 million in cash operating expenditures, including raw material purchases, rental and personnel costs in the three months ended March 31, 2012 and (ii) an increase of approximately US$ 6.0 million in income taxes payments because we generated more taxable profit.
Net cash used in the investing activities was US$30,587 in the three months ended March 31, 2012 as compared to US$89,784 for the same period of last year, related to purchases of equipment.
Net cash used in the financing activities was US$ 12.7 million in the three months ended March 31, 2012, primarily as a result of US$ 28.5 million repayment of bank borrowings, partially offset by addition of $15.9 million short-term loans from local banks.
Net cash provided by the financing activities was US$ 6.4 million in the three months ended March 31, 2011, primarily as a result of US$ 27.4 million addition of short-term bank loans from local banks, and partially offset by US$ 21.3 million repayment of bank borrowings.
As of March 31, 2012, our cash balance was US$127.2 million, compared to US$ 135.5 million at December 31, 2011.
Days Sales Outstanding (DSO) has increased from 33 days for the three months ended March 31, 2011 to 42 days for the three months ended March 31, 2012. We continued our policy on extending credit terms to certain creditworthy customers that have long-standing business relationships with us in order to capture more market share. The average DSO for the automotive modified plastic industry is generally 90 days based on our industry experience.
Industry Standard Customer and Supplier Payment Terms (days) as below:
Inventory turnover days increased from 43 days for the three months ended March 31, 2011 to 52 days for the three months ended March 31, 2012, due to inventory buildup during the three months ended March 31, 2012 in anticipation of increasing demand from our customers in the following quarters.
The Company is required to pay deposits to the suppliers for the principal raw materials ordered. The Company’s decision to make advanced orders of raw materials is mainly based upon (1) the demand and supply situation in the raw materials market, and (2) the forecasted demand of products. All of the raw materials relating to advances to suppliers as of March 31, 2012 have been subsequently received by the Company in April 2012.
Based on past performance and current expectations, we believe our cash, cash equivalents and cash generated from operating activities and bank borrowings will satisfy our working capital needs, capital expenditures and other liquidity requirements associated with our operations for at least the next 12 months.
The majority of the Company’s revenues and expenses were denominated primarily in Renminbi (“RMB”), the currency of the People’s Republic of China. There is no assurance that exchange rates between the RMB and the U.S. Dollar will remain stable. The Company does not engage in currency hedging. Inflation has not had a material impact on the Company’s business.
COMMITMENTS AND CONTINGENCIES
Set out below are our contractual obligations at March 31, 2012:
Off-Balance Sheet Arrangements
We have not engaged in any off-balance sheet transactions.
Item 3. Quantitative and Qualitative Disclosures about Market Risks
Interest Rate Risk
We are exposed to interest rate risk primarily with respect to our short-term bank loans. Although the interest rates, which are based on the banks' prime rates with respect to our short-term loans are fixed for the terms of the loans, increase in interest rates will increase the cost of new borrowings and our interest expense.
A hypothetical 1.0% increase in the annual interest rates for all of our credit facilities under which we had outstanding borrowings as of March 31, 2012 would decrease income before income taxes by approximately $0.05 million for the three months ended March 31, 2012. Management monitors the banks' prime rates in conjunction with our cash requirements to determine the appropriate level of debt balances relative to other sources of funds. We have not entered into any hedging transactions in an effort to reduce our exposure to interest rate risk.
Foreign Currency Exchange Rates
All of our revenues are collected in and substantially all of our expenses are paid in RMB. We face foreign currency rate translation risks when our results are translated to U.S. dollars.
The RMB was relatively stable against the U.S. dollar at approximately 8.28 RMB to the $1.00 U.S. dollar until July 21, 2005 when the Chinese currency regime was altered resulting in a 2.1% revaluation versus the U.S. dollar. From July 21, 2005 to June 30, 2010, the RMB exchange rate was no longer linked to the U.S. dollar but rather to a basket of currencies with a 0.3% margin of fluctuation resulting in further appreciation of the RMB against the U.S. dollar. Since June 30, 2009, the exchange rate had remained stable at 6.8307 RMB to 1.00 U.S. dollar until June 30, 2010 when the Chinese Central Bank allowed a further appreciation of the RMB by 0.43% to 6.798 RMB to 1.00 U.S. dollar. On March 31, 2012, the RMB traded at 6.2975 RMB to 1.00 U.S. dollar.
There remains international pressure on the Chinese government to adopt an even more flexible currency policy and the exchange rate of RMB is subject to changes in China’s government policies which are, to a large extent, dependent on the economic and political development both internationally and locally and the demand and supply of RMB in the domestic market. There can be no assurance that such exchange rate will continue to remain stable in the future amongst the volatility of currencies, globalization and the unstable economies in recent years. Since (i) our revenues and net income of our PRC operating entities are denominated in RMB, and (ii) the payment of dividends, if any, will be in U.S. dollars, any decrease in the value of RMB against U.S. dollars would adversely affect the value of the shares and dividends payable to shareholders, in U.S. dollars.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The Company’s management has evaluated, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operations of the Company’s disclosure controls and procedures (as defined in Securities Exchange Act Rule 13a-15(e)), as of the end of the period covered by this report. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective because of weaknesses in our internal control over financial reporting as disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
Notwithstanding management’s assessment that our internal control over financial reporting was ineffective as of December 31, 2011 due to a material weakness and a significant deficiency as identified in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, we believe that our unaudited consolidated financial statements included in this Quarterly Report present fairly our financial position, results of operations and cash flows for the fiscal quarter ended March 31, 2012 in all material respects.
(b) Changes in internal controls.
There was no change in our internal control over financial reporting that occurred during the fiscal quarter ended March 31, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
During the three months period ended March 31, 2012, there were no new material pending legal proceedings, other than routine litigation arising in the ordinary course of business, to which we are a party or of which our property is subject, and no material developments in the legal proceedings previously reported.
Item 1A. Risk Factors
As of the date of this filing, there have been no material changes from the risk factors disclosed in the Company’s Annual Report on Form 10-K filed on March 26, 2012, except as set forth below. We operate in a changing environment that involves numerous known and unknown risks and uncertainties that could materially affect our operations. The risks, uncertainties and other factors set forth in our Annual Report on Form 10-K may cause our actual results, performances and achievements to be materially different from those expressed or implied by our forward-looking statements. If any of these risks or events occurs, our business, financial condition or results of operations may be adversely affected.
Our independent registered public accounting firm’s audit documentation related to their audit reports included in our annual report may include audit documentation located in the Peoples’ Republic of China. The Public Company Accounting Oversight Board currently cannot inspect audit documentation located in China and, as such, you may be deprived of the benefits of such inspection.
Our independent registered public accounting firm that issued an audit opinion in the financial statements included in our annual report for the fiscal year ended December 31, 2011 filed with the U.S. Securities and Exchange Commission, or SEC, as auditors of companies that are traded publicly in the United States and a firm registered with the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB. Since significant portion of the audit is conducted in China and the work papers related to such portion are located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, the work papers of our auditors that are located in China are not currently inspected by the PCAOB.
Inspections of certain other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. However, the PCAOB is currently unable to inspect an auditor’s audit work related to a company’s operations in China and where such documentation of the audit work is located in China. As a result, our investors may be deprived of the benefits of PCAOB’s oversight of our auditors through such inspections.
The inability of the PCAOB to conduct inspections of our auditors’ work papers in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may consequently lose confidence in our reported financial information and procedures and the quality of our financial statements.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Exhibits
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.