PINX:MAST Master Silicon Carbide Industries Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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 000-52988

 

MASTER SILICON CARBIDE INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

 

Nevada   01- 0728141
(State or other jurisdiction of   (IRS Employer
incorporation or organization)   Identification No.)

 

558 Lime Rock Road, Lakeville, Connecticut 06039

 (Address of principal executive offices)

 

(860) 435-7000

(Registrant's telephone number)

 

Indicate by check mark whether the issuer (1) 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 ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer ¨
   

Non-accelerated filer ¨

Do not check if a smaller reporting company

Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨   No x

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

As of May 21, 2012, the registrant had: (i) 4,165,813 shares of common stock, par value $.001 per share,  issued and outstanding; (ii) 996,186 shares of Series A Convertible Preferred Stock, par value $.001 per share, issued and outstanding; and (iii) 920,267 shares of Series B Convertible Preferred Stock, par value $.001 per share, issued and outstanding.

 

 
 

 

TABLE OF CONTENTS

 

    Page
PART I  FINANCIAL INFORMATION   F-1
       
Item 1. Financial Statements.   F-1
       
  Consolidated Balance Sheets As of March 31, 2012 (Unaudited) and December 31, 2011   F-1
       
  Consolidated Statements of Operations and Comprehensive Profit (Loss) for the Three Months Ended March 31, 2012 and 2011 (Unaudited)   F-2
       
  Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011 (Unaudited)   F-3
       
  Notes to the Interim Consolidated Financial Statements (Unaudited)   F-4
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.   2
       
Item 3. Quantitative and Qualitative Disclosures About Market Risk   7
       
Item 4. Controls and Procedures.   7
       
PART II  OTHER INFORMATION   7
       
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds   7
       
Item 4. Mine Safety Disclosure   7
       
Item 6. Exhibits   7
       
Signatures   9
       
Exhibits/Certifications    

 

 
 

 

PART I FINANCIAL INFORMATION

 

Item  1.  FINANCIAL STATEMENTS

 

MASTER SILICON CARBIDE INDUSTRIES, INC.

CONSOLIDATED BALANCE SHEETS

(In US Dollars)

 

   March 31,
2012
   December 31,
2011
 
   (Unaudited)     
ASSETS          
           
Current assets:          
Cash and cash equivalents  $2,344,677   $2,412,325 
Accounts receivable, net   3,163,799    3,165,792 
Inventories   1,331,512    2,457,388 
Prepaid expenses   201,258    158,774 
Total current assets   7,041,246    8,194,279 
           
Deposits-fixed assets   90,135    56,488 
Other receivables   153,314    103,656 
Amount due from related party   -    14,896 
Property, plant and equipment, net   17,027,957    17,320,567 
Construction in progress   1,182,371    848,540 
Intangible assets, net   1,415,166    1,429,424 
Total assets  $26,910,189   $27,967,850 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)          
           
Current liabilities:          
Accounts payable and accrued liabilities  $3,639,331   $4,486,153 
Tax payable   393,669    195,498 
Current portion of loans   1,589,000    1,589,000 
Advance from customers   963,422    386,794 
Other payables   106,153    109,170 
Amount due to related parties   905,351    905,921 
Dividends accrued   150,000    150,000 
Total current liabilities   7,746,926    7,822,536 
           
Technology payable   157,530    144,917 
Long-term loans   3,175,000    3,178,000 
Total liabilities   11,079,456    11,145,453 
           
Redeemable Preferred Stock-A ($0.001 par value, 996,186 shares issued)          
liquidation preference of $10.038 per share   10,000,000    10,000,000 
Redeemable Preferred Stock-B ($0.001 par value, 920,267 shares issued)          
liquidation preference of $10.8664 per share   10,000,000    10,000,000 
           
Stockholders’ equity (deficit):          
Common stock, $0.001 par value, 110,000,000 shares authorized;          
4,016,380 and 3,866,947 shares issued and outstanding, respectively   4,016    3,867 
Additional paid-in capital   6,057,828    5,907,977 
Retained (deficit)   (11,435,493)   (10,304,094)
Accumulated other comprehensive income   1,204,382    1,214,647 
           
Total stockholders’ equity (deficit)   (4,169,267)   (3,177,603)
           
Total liabilities, redeemable preferred stock and stockholders' equity (deficit)  $26,910,189   $27,967,850 

 

See accompanying notes to consolidated financial statements

 

F-1
 

 

MASTER SILICON CARBIDE INDUSTRIES, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE PROFIT (LOSS)

 

(UNAUDITED)

(In US Dollars)

 

   For The Three Months Ended 
   March 31, 2012   March 31, 2011 
         
Revenues:          
Revenues  $1,716,141   $4,320,828 
Cost of revenues   1,886,962    3,517,212 
Gross (loss) profit   (170,821)   803,616 
           
General and administrative expenses   713,468    1,002,232 
Total operating expenses   713,468    1,002,232 
Loss from operations   (884,289)   (198,616)
           
Interest income   3,042    20,995 
Interest expense   (99,090)   - 
Other income   1,598    - 
Other expense   (2,660)   - 
Total other income (expenses)   (97,110)   20,995 
           
Loss before income taxes   (981,399)   (177,621)
           
Income tax provision   -    - 
Net loss  $(981,399)  $(177,621)
Accretion on redeemable preferred stock  $-   $- 
           
Dividends on preferred stock   150,000    150,000 
Net loss attributable to common stockholders  $(1,131,399)  $(327,621)
           
Comprehensive loss:          
           
Net Loss  $(981,399)  $(177,621)
           
Foreign currency translation adjustment   (10,265)   153,837 
Comprehensive loss  $(991,664)  $(23,784)
           
Basic net loss per share  $(0.28)  $(0.10)
Diluted net loss per share  $(0.28)  $(0.10)
           
Weighted average common shares outstanding:          
Basic   4,014,738    3,416,988 
Diluted   4,014,738    3,416,988 

 

See accompanying notes to consolidated financial statements

 

F-2
 

 

MASTER SILICON CARBIDE INDUSTRIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In US Dollars)

 

   For The Three Months Ended 
   March 31, 2012   March 31, 2011 
         
Cash flows from operating activities:          
Net loss  $(981,399)  $(177,621)
Adjustments to reconcile net loss to net cash provided by operating activities:          
Depreciation   283,819    214,707 
Amortization   13,723    11,600 
Allowance for bad debt   14,859    - 
Changes in operating assets and liabilities:          
Notes receivable - trade   -    22,129 
Accounts receivable   -    261,619 
Other receivables   (49,630)   (21,365)
Prepaid expenses   (42,540)   (312,317)
Inventories   1,062,684    (1,492,714)
Accounts payable and accrued liabilities   (839,744)   1,292,144 
Other current liabilities   9,737    (30,697)
Advance from customers   575,782    384,416 
Taxes refundable   -    121,621 
Taxes payable   197,919    (50,451)
Net cash provided by operating activities   245,210    223,071 
           
Cash flows from investing activities:          
Deposits - fixed assets and construction in progress   (305,849)   (39,865)
Purchase of property, plant, and equipment   (5,281)   - 
Purchase of construction in progress   (1,981)   - 
Net cash used in investing activities   (313,111)   (39,865)
           
Cash flows from financing activities:          
Payments to related parties payable   -    (30,377)
Net cash used in financing activities   -    (30,377)
           
Effect of exchange rate changes on cash   253    11,500 
           
Net increase (decrease) in cash and cash equivalents   (67,648)   164,329 
           
Cash and cash equivalents, beginning of year   2,412,325    1,987,041 
           
Cash and cash equivalents, end of period  $2,344,677   $2,151,370 
           
Supplemental disclosures of cash flow information:          
Cash paid for interest  $79,930   $- 
Cash paid for taxes  $-   $- 
           
Noncash investing and financing activities:          
           
Conversion of Series A  preferred stock dividend  $150,000   $150,000 
Construction in progress moved to fixed assets  $-   $- 

 

See accompanying notes to consolidated financial statements

 

F-3
 

 

Master Silicon Carbide Industries, Inc.

March 31, 2012

Notes to the Consolidated Financial Statements

(Unaudited)

 

NOTE 1 - ORGANIZATION AND OPERATIONS

 

Paragon SemiTech USA Incorporated (“Paragon New Jersey”) was incorporated on April 10, 2002 under the laws of the State of New Jersey.

 

Master Silicon Carbide Industries, Inc., formerly Paragon SemiTech USA, Inc. was incorporated on May 21, 2007 under the laws of the State of Delaware.  Prior to September 27, 2007, the date of merger with Paragon New Jersey, the Company was inactive.  On September 2, 2008, Paragon SemiTech USA, Inc., through the acquisition of C3 Capital, Limited, a company incorporated in the Territory of the British Virgin Islands (“BVI”), acquired all of the equity interests in Yili Master Carborundum Production Co., Ltd.  On November 12, 2008, Paragon SemiTech USA, Inc. changed its name to Master Silicon Carbide Industries, Inc. (“Master” or the “Company”). The Company believes that the new name will better identify the Company with the business conducted by its indirectly wholly-owned subsidiary in China, Yili Master Carborundum Production Co., Ltd., namely, the production and distribution of silicon carbide.

 

C3 Capital, Limited (“C3 Capital”), an international business company, was formed on July 26, 2005 in the British Virgin Islands by the Company. C3 Capital was inactive prior to September 2, 2008, the date of acquisition of Yili Master Carborundum Production Co., Ltd.

 

Yili Master Carborundum Production Co., Ltd. (“Yili China”) was incorporated on August 10, 1993 in the People’s Republic of China (“PRC”).

 

Beijing Master Consulting Co., Ltd. (“Master Consulting”) was incorporated on July 14, 2011 in the People’s Republic of China (“PRC”), which was wholly owned by the Company.

 

Master engages in the development, manufacturing and distribution of silicon carbide.

 

Merger of Paragon New Jersey

 

On September 27, 2007, the Company entered into a Reorganization and Stock Purchase Agreement (the “Reorganization Agreement”) with Paragon New Jersey. Pursuant to the Reorganization Agreement, the Company issued 675,000 shares of its common stock at the time representing approximately 81.82% of the issued and outstanding shares of its common stock for the acquisition of all of the outstanding capital stock of Paragon New Jersey. As a result of the ownership interests of the former shareholder of Paragon New Jersey, for financial statement reporting purposes, the merger between the Company and Paragon New Jersey has been treated as a reverse acquisition with Paragon New Jersey deemed the accounting acquirer and the Company deemed the accounting acquiree under the purchase method of accounting in accordance with “Business Combinations” (“FASB ASC 805”).  The reverse merger is deemed a capital transaction and the net assets of Paragon New Jersey (the accounting acquirer) are carried forward to the Company (the legal acquirer and the reporting entity) at their carrying value before the combination. The acquisition process utilizes the capital structure of the Company and the assets and liabilities of Paragon New Jersey which are recorded at historical cost.

  

F-4
 

 

Merger of C3 Capital, Limited

 

On September 2, 2008, pursuant to a Stock Purchase Agreement entered into by the parties and consummated on such date, Yili Carborundum USA, Inc. (“Yili US”), a recently formed Delaware corporation which is wholly-owned by the Company, a Delaware corporation (hereafter referred to as the “Company”, “we” or “us”, as applicable), acquired from Mr. Tie Li, for a cash purchase price of $10,000, all of the outstanding capital stock of C3 Capital, Limited, a company incorporated in the British Virgin Islands (“C3 Capital”).  C3 Capital in turn has an agreement to purchase all of the equity interests of Yili Master Carborundum Production Co., Ltd. (“Yili China”), a wholly-owned foreign enterprise (“WOFE”) in the People’s Republic of China (the “PRC”) (“Yili China”), pursuant to which the Company paid $555,096 in cash for the acquisition of the equity interests of Yili China with the proceeds of the Private Placement (as defined below) closed on September 2, 2008.  In addition, C3 Capital entered into (i) an agreement to purchase 90% of the equity interests in Xinjiang Ehe Mining and Metallurgy Co., Ltd., a corporation incorporated under the laws of the PRC on August 7, 2008 (“Ehe China”) from Mr. Zhigang Gao; and (ii) a Memorandum of Understanding with Mr. Zhigang Gao and Mr. Ping Li, for an option to purchase the assets to be secured by Xinjiang Paragon Master Mining Co., Ltd., a corporation to be formed under the laws of the PRC (“Quartz Mine China”). Ehe China and Quartz Mine China are currently inactive with no assets or operations. Ehe China intends to build a 40,000 ton green silicon carbide project in the Aletai Area of Xinjiang Uygur Autonomous Region of the PRC pending governmental permissions and approvals, and Quartz Mine China intends to obtain the exploration and mining rights for a quartz mine in Wenquan County of Xinjiang Uygur Autonomous Region of the PRC.

 

Dissolution of Paragon New Jersey

 

On March 26, 2009, pursuant to the authorization of Master Silicon Carbide Industries, Inc., the sole shareholder, Paragon New Jersey was dissolved. The corporation has no assets, has ceased doing business and does not intend to recommence doing business, and has not made any distribution of cash or property to the shareholders within the last 24 months and does not intend to have any distribution following its dissolution.

 

Reincorporation

 

On November 2, 2009, Master Silicon Carbide Industries, Inc. (the “Registrant”), formerly a Delaware corporation, completed its reincorporation in Nevada by a merger of the Registrant with and into its wholly-owned subsidiary, Master Silicon Carbide Industries, Inc., a newly formed Nevada corporation (the “Reincorporation”). The Reincorporation effected a change in the Registrant’s legal domicile from Delaware to Nevada. The Registrant’s business, assets, liabilities, and headquarters were unchanged as a result of the Reincorporation and the directors and officers of the Registrant prior to the Reincorporation continued to serve the Registrant after the reincorporation. In addition, the Registrant’s stockholders automatically became stockholders of Master Silicon Carbide Industries, Inc. on a share-for-share basis.

 

F-5
 

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of presentation

 

The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). This basis differs from that used in the statutory accounts of the operating subsidiaries of the Company, which were prepared in accordance with the accounting principles and relevant financial regulations applicable to enterprises in the PRC. All necessary adjustments have been made to present the financial statements in accordance with US GAAP.

 

The consolidated financial statements include (i) the accounts of the Company and (ii) the accounts of its consolidated subsidiaries, C3 Capital, Limited, Yili China and Master Consulting. All inter-company balances and transactions have been eliminated.

 

These consolidated financial statements have been prepared on a going concern basis. The Company has incurred losses since inception resulting in an accumulated deficit of $11,435,493 as of March 31, 2012. The Company’s ability to continue as a going concern is dependent upon the ability of the Company to generate profitable operations in the future and/or to obtain the necessary financing to meet its obligations and repay its liabilities arising from normal business operations when they come due. Management intends to address the going concern issue by funding future operations through the sale of equity capital.

 

Business combination

 

In accordance with FASB ASC 805“Business Combinations”, the Company allocates the purchase price of acquired entities to the tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values.

 

Management makes estimates of fair values based upon assumptions believed to be reasonable. These estimates are based on historical experience and information obtained from the management of the acquired companies. Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash flows from revenues, customer relationships, key management and market positions, assumptions about the period of time the acquired trade names will continue to be used in the Company’s combined product portfolio, and discount rates used to establish fair value. These estimates are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur which may affect the accuracy or validity of such assumptions, estimates or actual results.

 

Use of estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reporting amounts of revenues and expenses during the reported period.  Significant estimates include the allocation of production costs to inventory, allowance for bad debts, reserve for obsolescence, impairment for assets, and estimated useful lives of property and equipment. Actual results could differ from those estimates.

 

F-6
 

 

Cash and cash equivalents

 

For purposes of the statements of cash flows, cash and cash equivalents include cash on hand and demand deposits held by banks. Deposits held in financial institutions in the PRC are not insured by any government entity or agency.

 

As of March 31, 2012, the cash balance in financial institutions in the United States was $908,573. Accounts at these financial institutions are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000. At March 31, 2012, the Company had deposits of $658,573 that were in excess of the FDIC insurance limit.

 

Accounts receivable

 

Trade accounts receivable are recorded at the invoiced amount, net of an allowance for doubtful accounts. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company determines the allowance based on historical write-off experience, customer specific facts and economic conditions. Bad debt expense if any is included in general and administrative expenses.

 

Outstanding account balances are reviewed individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance-sheet credit exposure to its customers.

 

Inventories

 

The Company values inventories, consisting of finished goods, work in process and raw materials, at the lower of cost or market.  Cost is determined on the weighted average cost method. Cost of work in process and finished goods comprises direct labor, direct materials, direct production cost and an allocated portion of production overhead. The Company follows FASB ASC 330-10-30“Inventory-Overall-Initial Measurement” for the allocation of production costs and charges to inventories. The Company allocates fixed production overheads to inventories based on the normal capacity of the production facilities expected to be achieved over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance.  Judgment is required to determine when a production level is abnormally low (that is, outside the range of expected variation in production).  Factors that might be anticipated to cause an abnormally low production level include significantly reduced demand, labor and materials shortages, and unplanned facility or equipment down time. The actual level of production may be used if it approximates normal capacity. In periods of abnormally high production, the amount of fixed overhead allocated to each unit of production is decreased so that inventories are not measured above cost. The amount of fixed overhead allocated to each unit of production is not increased as a consequence of abnormally low production or idle plant and unallocated overheads of underutilized or idle capacity of the production facilities are recognized as period costs in the period in which they are incurred rather than as a portion of the inventory cost.

 

The Company regularly reviews raw materials and finished goods inventories on hand and, when necessary, records a provision for excess or obsolete inventories based primarily on current selling price and sales prices of confirmed backlog orders. As of March 31, 2012, the Company determined and made reserves of $0 for obsolescence of inventories.

 

F-7
 

 

Property, plant and equipment

 

Property, plant and equipment are recorded at cost. Expenditures for major additions and betterments are capitalized. Maintenance and repairs are charged to operations as incurred. Depreciation of property, plant and equipment is computed by the straight-line method (after taking into account their respective estimated residual values) over the assets’ estimated useful lives ranging from five (5) years to twenty (20) years:

 

Furniture and office equipment 5 years
Motor vehicles 5-10 years
Machinery and equipment 10 years
Building 20 years

  

Upon sale or retirement of property, plant and equipment, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in operations. Leasehold improvements, if any, are amortized on a straight-line basis over the lease period or the estimated useful life, whichever is shorter. Upon becoming fully amortized, the related cost and accumulated amortization are removed from the accounts.

 

Land use right

 

Land use right represents the cost to obtain the right to use certain land in the PRC. Land use right is carried at cost and amortized on a straight-line basis over the life of the right of approximately fifty (50) years. Upon becoming fully amortized, the related cost and accumulated amortization are removed from the accounts. Land use right is included in intangible assets on the Balance Sheet.

 

Impairment of long-lived assets

 

The Company follows FASB ASC 360-10-35-15“Impairment or Disposal of Long-Lived Assets” for its long-lived assets. The Company’s long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

 

The Company assesses the recoverability of its long-lived assets by comparing the projected undiscounted net cash flows associated with the related long-lived asset or group of long-lived assets over their remaining estimated useful lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable. If long-lived assets are determined to be recoverable, but the newly determined remaining estimated useful lives are shorter than originally estimated, the net book values of the long-lived assets are depreciated over the newly determined remaining estimated useful lives. The Company determined that there were no impairments of long-lived assets as of March 31, 2012.

 

Redeemable preferred stock

 

On September 2, 2008, the Company completed the sale to China Hand Fund I, LLC and/or its designees or assignees of 996,186 units for total proceeds of $10,000,000, each unit consisting of one share of the Company’s Series A Convertible Preferred Stock and one three year warrant to purchase 2.5 shares of the Company’s common stock (after the 1:10 reverse split). The preferred stock pays annual dividends of 6% regardless of the Company’s profitability, which dividend may be paid in common stock at the option of the Company. Each preferred share is convertible into ten shares of common stock. After December 30, 2010, the Company may be required to redeem for cash the outstanding preferred stock, if not previously converted by the holders, for $1.0038 per share plus accrued but unpaid dividends. The preferred stock is convertible into ten shares of Common Stock but is redeemable for cash if not converted into Common Stock. Because preferred stock contains a redemption feature outside the control of the Company, it is classified outside of stockholders’ equity in accordance with EITF Topic D-98.

 

F-8
 

 

In accordance with FASB ASC 470-20-25, “Debt-Debt with Conversion Options-Recognition”, the Company allocated the proceeds received between the preferred stock and the warrants. The resulting discount from the face amount of the preferred stock is being amortized using the effective interest method over the period to the required redemption date. After allocating a portion of the proceeds to the warrants, the effective conversion price of the preferred stock was lower than the market price at the date of issuance and therefore a beneficial conversion feature was recorded. The dividends on the preferred stock, together with the periodic accretion of the preferred stock to its redemption value, are charged to retained earnings.

 

On September 21, 2009, the Company entered into a Note Purchase Agreement with Vicis Capital Master Fund and/or its successor and assigns, an accredited investor (the “Investor”) where in consideration of $10,000,000, the Investor purchased from the Company a convertible promissory note in a principal amount of $10,000,000, (the “Note”). The Note was due on December 31, 2009, and was automatically convertible into 920,267 shares of the Series B Convertible Preferred Stock of Master Silicon Carbide Industries, Inc., a Nevada corporation (“MSCI Nevada”), within three business days after the Company merged into MSCI Nevada, completing the Company’s reincorporation from Delaware to Nevada on or around November 2, 2009 (the “Reincorporation”). Each preferred share is convertible into ten shares of common stock. After December 31, 2011, the Company may be required to redeem for cash the outstanding preferred stock, if not previously converted by the holders, for $1.087 per share. The preferred stock is convertible into ten shares of Common Stock but is redeemable for cash if not converted into Common Stock. Because the preferred stock contains a redemption feature outside the control of the Company, it is classified outside of stockholders’ equity in accordance with EITF Topic D-98.

 

Fair value of financial instruments

 

The Company follows FASB ASC 825-10-50-10 “Financial Instruments-Overall-Disclosure” for its financial instruments. The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties. The carrying amounts of financial assets and liabilities, such as cash and cash equivalents, accounts receivable, prepayments and other current assets, accounts payable, customer deposits, taxes payable, accrued expenses and other current liabilities, approximate their fair values because of the short maturity of these instruments.

 

Revenue recognition

 

The Company follows the guidance of the United States Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) No. 101 “Revenue Recognition” (“SAB No. 101”), as amended by SAB No. 104 (“SAB No. 104”) for revenue recognition. The Company recognizes revenue when it is realized or realizable and earned less estimated future doubtful accounts. The Company considers revenue realized or realizable and earned when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) the product has been shipped or the services have been rendered to the customer, (iii) the sales price is fixed or determinable, and (iv) collectability is reasonably assured. The Company derives the majority of its revenue from sales contracts with customers with revenues being generated upon the shipment of goods. Persuasive evidence of an arrangement is demonstrated via invoice, product delivery is evidenced by a warehouse shipping log as well as a signed bill of lading from the trucking or rail company and title transfers upon shipment, based on free on board (“FOB”) destination; the sales price to the customer is fixed upon acceptance of the purchase order and there is no separate sales rebate, discount, or volume incentive. When the Company recognizes revenue, no provisions are made for returns because, historically, there have been very few sales returns and adjustments that have impacted the ultimate collection of revenues.

 

F-9
 

 

Shipping and handling costs

 

The Company accounts for shipping and handling fees in accordance with FASB ASC 705 “Cost of Sales and Services”. Shipping and handling costs related to costs of raw materials purchased is included in cost of revenue. While amounts charged to customers for shipping product are included in revenues, the related outbound freight costs are included in expenses as incurred.

 

Research and development

 

Research and development costs are charged to expense as incurred.  Research and development costs consist primarily of remuneration for research and development staff, depreciation and maintenance expenses of research and development equipment and material and testing costs for research and development. There are no research and development costs for the three months ended March 31, 2012 and 2011.

  

Advertising costs

 

Advertising costs are expensed as incurred. Advertising costs for the three months ended March 31, 2012 and 2011 are $0 and $866, respectively.

 

Stock-based compensation

 

The Company adopted the fair value recognition provisions of FASB ASC 718“Compensation-Stock Compensation”.

 

We made the following estimates and assumptions in determining fair value:

 

  Ø Valuation and Amortization Method – We estimate the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. This fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.

 

  Ø Expected Term – The expected term represents the weighted-average period that our stock-based awards are expected to be outstanding. We applied the “Simplified Method” as defined in the Securities and Exchange Commission’s Staff Accounting Bulletins No. 107 and 110.

 

  Ø Expected Volatility – The expected volatility is calculated by considering, among other things, the expected volatilities of public companies engaged in similar industries.

 

F-10
 

 

  Ø Expected Dividend – The Black-Scholes valuation model calls for a single expected dividend yield as an input.

 

  Ø Risk-Free Interest Rate – The Company bases the risk-free interest rate on the implied yield currently available on United States Treasury zero-coupon issues with an equivalent remaining term.

 

Income taxes

 

The Company accounts for income taxes under FASB ASC 740 “Income Taxes”. Deferred income tax assets and liabilities are determined based upon differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. 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. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of operations in the period that includes the enactment date.

 

The Company adopted the provisions of FASB ASC 740. The standard addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FASB ASC 740, we may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FASB ASC 740 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. The Company had no material adjustments to its liabilities for unrecognized income tax benefits according to the provisions of FASB ASC 740.

  

Segment reporting

 

FASB ASC 280, “Segment Reporting” requires use of the management approach model for segment reporting. The management approach model is based on the way a company's management organizes segments within the company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography, legal structure, management structure, or any other manner in which management disaggregates a company.

 

In accordance with FASB ASC 280, the Company has reviewed its business activities and determined that multiple segments do not exist that need to be reported.

 

F-11
 

 

Foreign currency translation

 

Transactions and balances originally denominated in U.S. dollars are presented at their original amounts. Transactions and balances in other currencies are converted into U.S. dollars in accordance with FASB ASC 830 “Foreign Currency Matters” and are included in determining net income or loss.

 

The financial records of the subsidiaries are maintained in their local currency, the Renminbi (“RMB”), which is the functional currency of those subsidiaries. The parent’s functional currency is U.S. dollars. Assets and liabilities are translated from the local currency into the reporting currency, U.S. dollars, at the exchange rate prevailing at the balance sheet date. Revenues and expenses are translated at weighted average exchange rates for the period to approximate translation at the exchange rates prevailing at the dates those elements are recognized in the financial statements. Foreign currency translation gain (loss) resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining accumulated other comprehensive income in the statement of stockholders’ equity.

 

RMB is not a fully convertible currency. All foreign exchange transactions involving RMB must take place either through the People’s Bank of China (the “PBOC”) or other institutions authorized to buy and sell foreign exchange. The exchange rate adopted for the foreign exchange transactions are the rates of exchange quoted by the PBOC. Commencing July 21, 2005, China adopted a managed floating exchange rate regime based on market demand and supply with reference to a basket of currencies. The exchange rate of the US dollar against the RMB was adjusted from approximately RMB 8.28 per US dollar to approximately RMB 8.11 per US dollar on July 21, 2005. Since then, the PBOC administers and regulates the exchange rate of the US dollar against the RMB taking into account demand and supply of RMB, as well as domestic and foreign economic and financial conditions.

 

Unless otherwise noted, the rate presented below per U.S. $1.00 was the noon buying rate for RMB in New York City as reported by the Federal Reserve Bank of New York on the date of its balance sheets contained in these consolidated financial statements. Management believes that the differences between RMB vs. US$ exchange rate quoted by the PBOC and RMB vs. US$ exchange rate reported by the Federal Reserve Bank of New York were immaterial. Translations do not imply that the RMB amounts actually represent, or have been or could be converted into, equivalent amounts in U.S. dollars. Translation of amounts from RMB into United States dollars (“US$”) has been made at the following exchange rates for the respective periods:

  

March 31, 2012     
Balance sheet   RMB 6.2972 to US$1.00 
Statement of operations and comprehensive profit (loss)   RMB 6.3091 to US$1.00 

 

March 31, 2011     
Balance sheet   RMB 6.5564 to US$1.00 
Statement of operations and comprehensive profit (loss)   RMB 6.5839 to US$1.00 

 

December 31, 2011        
Balance sheet     RMB 6.2933 to US$1.00  
Statement of operations and comprehensive profit (loss)     RMB 6.4641 to US$1.00  

 

F-12
 

 

Comprehensive income (loss)

 

The Company has adopted FASB ASC 220 “Comprehensive Income”. This statement establishes rules for the reporting of comprehensive income (loss) and its components. Comprehensive income (loss), for the Company, consists of net income (loss) and foreign currency translation adjustments and is presented in the Statements of Operations and Comprehensive Profit (Loss) and Stockholders’ Equity.

 

Net profit (loss) per common share

 

Net profit (loss) per common share is computed pursuant to FASB ASC 260 “Earnings per Share”. Basic net profit (loss) per common share is computed by dividing net profit (loss) attributable to common shareholders by the weighted average number of shares of common stock outstanding during each period. Diluted net profit (loss) per common share is computed by dividing net profit (loss) attributable to common shareholders by the weighted average number of shares of common stock and potentially outstanding shares of common stock during each period to reflect the potential dilution that could occur from common shares issuable through common stock equivalents.

 

   For the three months ended 
March 31, 2012
   For the three months ended 
March 31, 2011
 
Numerator for basic net loss per share - loss attributable to
common shareholders
  $(1,131,399)  $(327,621)
Numerator for diluted net loss per share - Loss attributable to common shareholders  $(1,131,399)  $(327,621)
Denominator for basic net loss per share - Weighted average shares of common stock outstanding   4,014,738    3,416,988 
Denominator for diluted net loss per share - Weighted average shares of common stock outstanding   4,014,738    3,416,988 
Basic net loss per share  $(0.28)  $(0.10)
Diluted net loss per share  $(0.28)  $(0.10)

 

Potentially dilutive shares were not included in the denominator for diluted net loss per share because their effect would be antidilutive.

 

The following table shows the weighted-average number of potentially dilutive shares for the three months ended March 31, 2012 and 2011:

  

   For the three months ended 
March 31, 2012
   For the three months ended 
March 31, 2011
 
Series A preferred stock   9,961,860    9,961,860 
Series B preferred stock   9,202,670    9,202,670 
Warrants   2,490,465    2,490,465 
Total   21,654,995    21,654,995 

 

Common Stock

 

As of March 31, 2012, the Company had 4,016,380 shares of Common Stock issued and outstanding.

 

F-13
 

 

Dividend

 

During the fiscal year of 2011, the Company issued 597,732 shares of common stock, or $600,000 at a fair market value of common stock as payment for dividends of Series A Convertible Preferred Stock.  During the first quarter of 2012, the Company issued 149,433 shares of common stock, with a fair market value of $150,000 as payment of dividends on the Series A Convertible Preferred Stock accrued at December 31, 2011.  During the first quarter of 2012, the Company also accrued $150,000 in dividends.  The dividends are payable in shares of common stock and the Company issued shares with a fair market value of $150,000, as payment of the dividends on the Series A Preferred Stock in April 2012.

 

Warrants

 

On September 2, 2008, we issued 2,490,465 warrants to the holder or its designees or assignees of Series A Convertible Preferred Stock (after the 1:10 reverse split). The exercise price on a post reverse split basis of this three year warrant is $1.25 per share. On February 9, 2009 and May 12, 2009, Columbia China Capital Group (“CCG”) exercised warrants for 40,000 and 60,000 shares of common stock. According to the resolutions of Board of Directors, the Company extended the expiration date of the original warrants to September 1, 2012 in order to facilitate its future financing activities resulting in a one-time charge of $661,649 to interest expense. The following table summarized the cumulative warrant activity, including the activity for the three months ended March 31, 2012 and 2011:

 

   Number of 
shares
   Weighted average 
exercise price
 
Outstanding, December 31, 2010   2,490,465   $1.25 
Exercised   -    - 
Outstanding, March 31, 2011   2,490,465    1.25 
Exercised   -    - 
Outstanding, December 31, 2011   2,490,465    1.25 
Exercised   -    - 
Outstanding, March 31, 2012   2,490,465   $1.25 

 

The Company issued warrants in connection with financing instruments. The Company analyzed the warrants in accordance with ASC Topic 815 to determine whether the warrants meet the definition of a derivative under ASC Topic 815 and, if so, whether the warrants meet the scope exception of ASC Topic 815, which is that contracts issued or held by the reporting entity that are both (1) indexed to its own stock and (2) classified in stockholders’ equity shall not be considered to be derivative instruments for purposes of ASC Topic 815.

 

The warrants contain standard adjustment provisions upon stock dividend, stock split, stock combination, recapitalization, and a change of control transaction; the warrants do not have “down-round protection”. The warrants meet the conditions for equity classification pursuant to FASB ASC 815 “Derivatives and Hedging” and EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”. Therefore, these warrants were classified as permanent equity.

 

F-14
 

 

Recently issued accounting pronouncements

 

In June 2009, the FASB established the Accounting Standards Codification (“Codification” or “ASC”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with generally accepted accounting principles in the United States (“GAAP”). Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) issued under authority of federal securities laws are also sources of GAAP for SEC registrants. Existing GAAP was not intended to be changed as a result of the Codification, and accordingly the change did not impact our financial statements. The ASC does change the way the guidance is organized and presented.

 

Accounting Standards Update (“ASU”) ASU No. 2009-2 through ASU No. 2011-12 which contain technical corrections to existing guidance or affect guidance to specialized industries or entities were recently issued. These updates have no current applicability to the Company or their effect on the financial statements would not have been significant.

 

Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying financial statements.

 

Going Concern

 

As shown in the accompanying consolidated financial statements, the Company had an accumulated deficit incurred through March 31, 2012, and a working capital deficit and a net loss, which raises substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded assets, or the amounts and classification of liabilities that might be necessary in the event the Company cannot continue in existence.

 

The timing and amount of capital requirements will depend on a number of factors, including demand for products and services and the availability of opportunities for expansion through affiliations and other business relationships. Management intends to seek new capital from new equity securities issuances to provide funds needed to increase liquidity, fund internal growth, and fully implement its business plan.

 

NOTE 3 – ACCOUNTS RECEIVABLE

 

The Company accrued an allowance for bad debts related to its accounts receivable. The accounts receivable and allowance balances at March 31, 2012 and December 31, 2011 were as follows:

 

   March 31, 2012   December 31, 2011 
Accounts receivable  $3,266,164   $3,268,221 
Allowance for bad debts   (102,365)   (102,429)
Accounts receivable, net  $3,163,799   $3,165,792 

 

F-15
 

 

NOTE 4 – INVENTORIES

 

Inventories at March 31, 2012 and December 31, 2011 consisted of the following:

 

   March 31, 2012   December 31, 2011 
Raw materials  $537,147   $425,086 
Finished goods   654,562    2,347,710 
Work in progress   139,803    - 
Provision for impairment   -    (315,408)
Total  $1,331,512   $2,457,388 

 

NOTE 5 – RELATED PARTY

 

We lease our office space at both 558 Lime Rock Road, Lakeville, Connecticut and 420 Lexington Avenue, Suite 860, New York, NY from Kuhns Brothers, Inc. and its affiliates (“Kuhns Brothers”). Our Chairman and CEO, Mr. Kuhns, is a controlling shareholder, President, CEO and Chairman of Kuhns Brothers. The lease commenced on September 1, 2008 for a term of one year with a monthly rent of $7,500, and such lease was extended for two years with the same rate of rent after September 1, 2009. On September 1, 2011, we extended the lease with the same rate of rent for one year.

 

According to the Management Service Agreement, the Company paid Kuhns Brothers an annual management fee of one hundred and fifty thousand dollars ($150,000) starting from January 2010. The management fee was paid on a monthly basis ($12,500 per month) on the first day of each month. The Company totally paid the management fee of $37,500 during the three months ended March 31, 2012.

 

On February 10, 2010, the Company (“Creditor”) signed a loan agreement with China Silicon Corporation, a Delaware corporation (“Debtor” or “CSC”) to extend a loan of One Million U.S. Dollars (US $1,000,000) to Debtor to fund working capital needs. The actual controlling shareholder of Creditor and Debtor is the same one. The interest rate of this loan is six percent (6%) per annum. Debtor promised to pay to Creditor the principal sum of One Million U.S. Dollars on December 31, 2010. CSC has paid off the note on June 15, 2011.

  

As of March 31, 2012 and December 31, 2011, the Company owed Changchun Master Company $905,351 and $905,921 whose stockholder is Zhigang Gao, who is a director of the Company. The loan payable is non-interest bearing, unsecured, and is payable on demand.

 

NOTE 6 – DEPOSITS

 

Deposits to purchase fixed assets amounted to $90,135 and $56,488 at March 31, 2012 and December 31, 2011, respectively. It included the deposits to establish the buildings and equipment.

 

NOTE 7 – INTANGIBLE ASSETS

 

On October 28, 2008, the Company entered into an agreement with the Chinese government, whereby the Company paid RMB 5,403,579 to acquire the land use right and obtained a certificate of the land use right until October 27, 2058. The purchase price is being amortized over the term of the right of approximately fifty (50) years beginning on November 1, 2008 and amortization expense used in production is reported in cost of revenues.

 

F-16
 

 

Intangible assets at March 31, 2012 and December 31, 2011 consisted of the following:

 

   March 31, 2012   December 31, 2011 
Land use right  $858,084   $858,624 
Production license   688,214    688,219 
Software   36,660    36,679 
Less: accumulated amortization   (167,792)   (154,098)
Total  $1,415,166   $1,429,424 

 

NOTE 8 – PROPERTY AND EQUIPMENT

 

Property and equipment at March 31, 2012 and December 31, 2011 consisted of the following:

 

   March 31, 2012   December 31, 2011 
Buildings  $11,144,754   $11,151,772 
Machinery and equipment   7,678,620    7,680,808 
Motor vehicles   346,812    347,030 
Office equipment   131,942    132,025 
Less: accumulated depreciation   (2,274,171)   (1,991,068)
Property and equipment, net  $17,027,957   $17,320,567 

  

Depreciation related to property and equipment used in production is reported in cost of revenues. Depreciation expense for the three months ended March 31, 2012 was $283,819, of which $192,817 was included in G&A expense and $91,002 was included in cost of revenue. Depreciation expense for the three months ended March 31, 2011 was $214,707, of which $20,791 was included in G&A expense and $193,916 was included in cost of revenue.

 

NOTE 9 – CONSTRUCTION IN PROGRESS

 

Construction in progress consists of capitalized costs associated with the construction of production lines that are not yet in service and therefore not yet being depreciated. All facilities purchased for installation, self-made or subcontracted, are accounted for under construction-in-progress. Construction-in-progress is recorded at acquisition cost, including cost of facilities, installation expenses and the interest capitalized during the course of construction for the purpose of financing the project. Upon completion and readiness for use of the project, the cost of construction-in-progress is to be transferred to fixed assets.

 

   March 31, 2012   December 31, 2011 
Construction in progress  $337,707   $- 
Equipment   844,664    848,540 
Total  $1,182,371   $848,540 

 

Total capitalized interest amounted to zero and $24,709 for the three months ended March 31, 2012 and 2011, respectively.

 

F-17
 

 

NOTE 10 – LONG-TERM LOANS

 

On October 23, 2009, Yili China borrowed a three-year long-term loan with principal of $1,573,589 from the Yili branch, Bank of China with an interest rate at 6.48% annually and the maturity date on October 21, 2012. On January 4, 2010, Yili China borrowed a three-year long-term loan with principal of $3,147,178 from the Yili branch, Bank of China with an interest rate at 6.48% annually and the maturity date on January 3, 2013. These loans are secured by the building, machinery and equipment of Yili China. The principal amount will be due at the maturity date. The interest was paid on the quarterly basis.

 

   Interest   Maturity       Interest Expenses 
   Rate   Date   Amount   2011   2012   2013 
Yili branch, Bank of China   6.48%   22-Oct-12   $1,589,000   $102,967   $82,656   $- 
                               
Yili branch, Bank of China   6.48%   3-Jan-13    3,175,000    205,934    205,934    1,692 
                                       
             $4,764,000   $308,901   $288,590   $1,692 

  

NOTE 11 – INCOME TAXES

 

USA

 

The Company and its subsidiaries are subject to income taxes on an entity basis on income arising in, or derived from, the tax jurisdiction in which they operate. As the Company had no income generated in the United States, there was no tax expense or tax liability due to the Internal Revenue Service of the United States as of March 31, 2012. However, the Company has to pay corporate tax due to the rules of certain states.

 

BVI

 

C3 Capital, an international business company, was formed on July 26, 2005 in the British Virgin Islands by the Company. As a BVI company, C3 Capital does not have any income tax.

 

PRC

 

Pursuant to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for Yili China. There is no tax provision for the three months ended March 31, 2012.

 

Master Consulting was incorporated on July 14, 2011 in the People’s Republic of China by the Company. Since there is no revenue, Master Consulting does not have any income tax.

 

F-18
 

 

For the three months ended March 31, 2012 and 2011, the local (United States) and foreign components of income (loss) before income taxes were comprised of the following:

 

   For the three months 
ended March 31, 2012
   For the three months 
ended March 31, 2011
 
loss before income tax          
United States  $(147,722)  $(151,186)
China   (833,677)   (26,435)
Total  $(981,399)  $(177,621)
           
Provision for income taxes          
Current income tax  $-   $- 
Deferred income tax   -    - 
Total  $-   $- 

 

USA

 

MSCI is registered in the State of Nevada and is subject to United States of America tax law. As of March 31, 2012, the operations in the United States of America incurred $8,443,633 of cumulative net operating losses which can be carried forward to offset future taxable income. The Company has provided for a full valuation allowance of $2,110,908 against the deferred tax assets on the expected future tax benefits from the net operating loss carry forwards as the management believes it is more likely than not that these assets will not be realized in the future.

 

PRC

 

Pursuant to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for Yili China. A reconciliation of income (loss) before income taxes to the effective tax rate as follows:

 

   For the three months 
ended March 31, 2012
   For the three months 
ended March 31, 2011
 
Loss before income tax          
Yili China  $(833,677)  $(26,435)
Statutory income tax rate   25%   25%
           
Income tax expense at statutory rate   (208,419)   (6,609)
Tax effect of accumulated loss   -    - 
Net operating loss   208,419    6,609 
Income tax expense at effective rate  $-   $- 

 

During the first quarter of 2012, the United States entity had a net operating loss of $147,722 for which no benefit was realized and a 100% valuation allowance was created. At the same time, the Chinese entity had a net operating loss of $833,677. The tax provision amounted to $0 for the three months ended March 31, 2012 and 2011.

 

F-19
 

 

NOTE 12 - FOREIGN OPERATIONS

 

Substantially all of the Company’s operations are carried out and most of its assets are located in the PRC.  Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC. The Company’s business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency fluctuation and remittances and methods of taxation, among other things.

 

NOTE 13 – CONCENTRATION

 

For the three months ended March 31, 2012, one customer accounted for 10% or more of sales revenues, representing 100% of the total sales. For the three months ended March 31, 2011, three customers accounted for 10% or more of sales revenues, representing 37%, 37% and 13%, respectively of the total sales.

 

NOTE 14 – SUBSEQUENT EVENTS

 

 In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through the reporting date, the date the financial statements were available to be issued.

 

In April 2012, the Company’s board approved issuance of 149,433 shares of Common Stock as dividends of Series A preferred stock.

 

F-20
 

 

 

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

 

The following discussion of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and the notes to those financial statements appearing elsewhere in this Report.

 

Certain statements in this Report constitute forward-looking statements. These forward-looking statements include statements, which involve risks and uncertainties, regarding, among other things, (a) our projected sales, profitability, and cash flows, (b) our growth strategy, (c) anticipated trends in our industry, (d) our future financing plans, and (e) our anticipated needs for, and use of, working capital. They are generally identifiable by use of the words “may,” “will,” “should,” “anticipate,” “estimate,” “plan,” “potential,” “project,” “continuing,” “ongoing,” “expects,” “management believes,” “we believe,” “we intend,” or the negative of these words or other variations on these words or comparable terminology. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements contained in this filing will in fact occur. You should not place undue reliance on these forward-looking statements.

 

The forward-looking statements speak only as of the date on which they are made, and, except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events.

 

The "Company", "we," "us," and "our," refer to (i) Master Silicon Carbide Industries, Inc. (formerly Paragon SemiTech USA, Inc.); (ii) Yili Carborundum USA, Inc. (“Yili US”); (iii) C3 Capital, Limited (“ C3 Capital ”); and (iv) Yili Master Carborundum Production Co., Ltd. (“Yili China”; and (v) Bejing Master Consulting Co., Ltd. (“Master Consulting”).

 

Overview

 

Through our indirectly wholly-owned operating subsidiary Yili China, we produce and sell in China high quality “green” silicon carbide and lower-quality “black” silicon carbide (together, hereinafter referred to as “SiC”). SiC is a non-metallic compound that has special chemical properties and a level of hardness that is similar to diamonds, is produced by smelting (the process of extracting a metal from its ore) quartz sand and refinery coke at temperatures ranging from approximately 1,600 to 2,500 degrees centigrade in a graphite electric resistance furnace.

 

The Company’s present SiC production capacity is 25,500 tons per annum. We have three production lines and the capacity of each line is 8,500 tons per annum.

   

Results of Operations for the Three months ended March 31, 2012 and 2011

 

The following tables and analysis show the operating results of the Company for the three months ended March 31, 2012 and 2011.  

 

   For the Three Months
Ended March 31, 2012
   For the Three Months
Ended March 31, 2011
   Percentage
change
 
Revenues  $1,716,141   $4,320,828    (60)%
Cost of revenues   1,866,962    3,517,212    (46)%
                
Gross (loss) profit   (170,821)   803,616    (121)%
                
General and administrative expenses   713,468    1,002,232    (29)%
                
Total operating expenses   713,468    1,002,232    (29)%
                
Loss from operations   (884,289)   (198,616)   345%
                
Interest income   3,042    20,995    (86)%
Interest expense   (99,090)   -    N/A 
Other income   1,598    -    N/A 
Other expense   (2,660)   -    N/A 
                
Total other income (expenses)   (97,110)   20,995    (563)%
                
Loss before income taxes   (981,399)   (177,621)   453%
                
Income tax provision   -    -    N/A 
                
Net loss  $(981,399)  $(177,621)   453%

 

2
 

 

Revenues 

 

We generated sales revenues of $1,716,141 for the three months ended March 31, 2012, compared to $4,320,828 for the same period in 2011, representing a decrease of $2,604,687, or 60%. A breakdown of total revenues is set forth in the following table:

 

Item  For the Three Months
Ended March 31, 2012
   For the Three Months
Ended March 31, 2011
   Percentage
change
 
Green silicon:               
Selling volume (ton)  $1,735   $3,461    (50)%
Average price in US dollars   989    1,248    (21)%
Subtotal   1,716,141    4,320,828    (60)%
                
Black silicon:               
Selling volume (ton)   -    -    -%
Average price in US dollars   -    -    -%
Subtotal   -    -    -%
                
Total  $1,716,141   $4,320,828    (60)%

 

During the first quarter of 2011, we had all three 8,500-ton production lines in operation. Due to some technical issues, including the breakdown of the raw material feeding system, we conducted an inspection and tests on two of our lines, therefore causing these two lines not to reach their full production capacity. At the same time, our third line operated well. During the second quarter of 2011, in order to replace some corroded parts in our facility and to repair the feeding system, we suspended the operation of Line No. 1 in April and May, and Lines No. 2 and No. 3 in May. Starting from June, all three lines resumed full production capacity and the purity level of our products has greatly improved above current market standards after this repair and inspection that we conducted in April and May.

 

However, during the third and fourth quarter of 2011, due to the European sovereign crisis, the global market demand for solar energy dropped dramatically, which adversely affected the market price of SiC, the essential abrasive material for manufacturing solar panels. The trend continued into 2012 and is estimated to continue for the rest of 2012.

 

For the three months ended March 31, 2012, we produced 445 tons of green SiC and 0 tons of black SiC. The total output of the same period of 2011 was 4,312 tons of green SiC and 101 tons of black SiC.

  

During the three months ended March 31, 2012, the average market prices of green SiC decreased compared to the same period of last year. The Company sold 1,735 tons of green SiC and 0 tons of black SiC during the first quarter of 2012, whereas during the same period of last year, the Company sold 3,461 tons of green SiC and 0 tons of black SiC. The sales volume of green SiC during the first quarter of 2012 decreased by nearly 50% compared to the same period of last year. The Company’s revenue was $1,716,141, or decreased by 60%, compared to the revenue of $4,320,828 during the three months ended March 31, 2011. The decrease of the revenue is mainly due to the decrease of the average unit selling price and the decreased sales quantities, both of which were caused by the less market demand.

 

Cost of Goods Sold

 

Cost of goods sold is primarily comprised of the costs of our raw materials and packaging materials, direct labor, manufacturing overhead expenses, depreciation, amortization, inventory count loss and freight charges. The raw materials include quartz, petrol coke and electricity power. These materials generally account for 8%, 60% and 32% of total raw material costs. Our cost of goods sold for the three months ended March 31, 2012 and 2011 were $1,866,962 and $3,517,212, respectively.

 

Item  For the Three
Months
Ended March
31, 2012
   For the Three
Months
Ended March
31, 2011
   Percentage
change
 
Green silicon:               
Production volume (ton)  $445   $4,312    (90)%
Average cost in US dollars   1,153.04    1,056    9%
Subtotal   513,101    4,552,899    (89)%
                
Black silicon:               
Production volume (ton)   -    101    (100)%
Average cost in US dollars   -    1,036    (100)%
Subtotal   -    104,611    (100)%
                
Total production cost  $513,101   $4,657,510    (89)%

 

3
 

 

During the three months ended March 31, 2012, the Company produced roughly 445 tons of Green SiC, compared to roughly 4,413 tons of Green SiC produced in the same period of last year. During the first quarter of 2012, our production lines consumed approximately 1.59 tons of quartz, 1.41 tons of petrol coke and 7,746 KW of electricity, respectively, for producing one unit of SiC. In the same period of last year, we consumed roughly 1.84 tons of quartz, 1.61 tons of petrol coke and 8,359 KW of electricity. Since our productivity has been enhanced, we saved 9% of costs per ton due to the lower consumption of raw materials. However, the purchasing prices of quartz and electricity increased during the first quarter of 2012 by 9% and 12%, respectively. Therefore, the average production costs during the three months ended March 31, 2012 were nearly 9% higher than the same period of last year.

 

Gross Profit

 

During the three months ended March 31, 2012, we had a gross loss of $170,821 and the gross loss margin was approximately 10.0%. In the same period of last year, we had a gross profit of $803,616 and a gross profit margin of 18.6%. The decrease of our gross profit margin is mainly due to the increase of our average unit production cost, which was more than the increase of our average unit selling price.

 

General and Administrative Expenses

 

Our operating and administrative expenses consist primarily of freight fee, related salaries, professional fee, depreciation and traveling expenses. Operating and administrative expenses were $713,468 for the three months ended March 31, 2012, as compared to $1,002,232 for the same period of 2011, a decrease of $288,764. This decrease was mainly due to the decreased shipping and outbound freight fee in line with decreased sales offset by increased depreciation expenses due to more property and equipment started to depreciate.

 

   For the Three Months
Ended March 31, 2012
   For the Three Months
Ended March 31, 2011
   Percentage
change
 
G&A               
Shipping and outbound freight fee   20,229    425,139    (95)%
Professional fees   88,489    20,208    338%
Travel expenses   13,876    21,132    (34)%
Products tax and related taxes   7,018    7,854    (11)%
Welfare and benefits   261,262    247,910    5%
Social insurance   8,455    5,351    58%
Depreciation expenses   192,817    20,704    831%
Amortization expenses   13,723    16,078    (15)%
Public relations expenses   10,503    11,331    (7)%
Motor car expenses   11,001    11,399    (3)%
Office expenses   69,502    69,220    0%
Interest   -    99,446    (100)%
Others   16,593    46,460    (64)%
Total  $713,468   $1,002,232    (29)%

  

Operating Loss

 

Our operating loss was $884,289 for the three months ended March 31, 2012, as compared to a loss of $198,616 for the comparable period of 2011, an increase of $685,673. Our increase in operating loss for the first quarter of 2012 was mainly due to the decreased gross profit as a result of less sales and less demand which was offset by the decreased general and administrative expenses.

 

Income Taxes

 

Our business operations are solely conducted by our subsidiaries incorporated in the PRC and we were governed by the PRC Enterprise Income Tax Laws. PRC enterprise income tax is calculated based on taxable income determined under PRC GAAP. In accordance with the Income Tax Laws, a PRC domestic company is subject to enterprise income tax at the rate of 25% and value added tax at the rate of 17% for most of the goods sold.

 

Incorporated in Xinjiang province in 2005, Yili China is subject to enterprise income tax at the rate of 25%. Income tax provision for Yili China was zero during the three months ended March 31, 2012 and 2011.

 

4
 

 

Net Loss

 

Net loss for the three months ended March 31, 2012 was $981,399, compared to a loss of $177,621 for the same period of 2011. Such increase of net loss of $803,778 was a result of the decreased revenues generated by the Company for the three months ended March 31, 2012 not exceeding the aggregate decrease of expenses and costs. During the first quarter of 2012, the decreased market demand in the industry lead to fewer orders of our products. As a result, we reduced the production, hence less gross revenue was generated. At the same time, the raw material costs increased.

 

Liquidity and Capital Resources

 

As of March 31, 2012, we had cash and cash equivalents of $2,344,677. Compared to December 31, 2011, cash and cash equivalents decreased by $67,648.

 

The following table sets forth a summary of our cash flows for the periods indicated:

 

   For the Three Months
Ended March 31, 2012
   For the Three Months
Ended March 31, 2011
   Percentage
change
 
Net cash provided by operating activities  $245,210   $223,071    10%
Net cash used in investing activities   (313,111)   (39,865)   685%
Net cash used in financing activities   -    (30,377)   (100)%
Effect of exchange rate changes on cash   253    11,500    (98)%
Net increase (decrease) in cash and cash equivalents   (67,648)   164,329    (141)%
Cash and cash equivalents, beginning of period   2,412,325    1,987,041    21%
Cash and cash equivalents, end of period  $2,344,677   $2,151,370    9%

 

Operating Activities

 

Net cash provided by operating activities was $245,210 for the three months ended March 31, 2012, compared to an amount of $223,071 net cash that was provided by operating activities during the same period of last year. The increase of net cash used in operating activities was mainly due to the facts that the Company had a decrease in inventory, offset by more payments made for accounts payable and accrued liabilities, and increased net loss due to less sales which was caused by less demand and increased production cost caused by increased raw material cost. Therefore, the Company had cash of $245,210 provided by operating activities.

 

Investing Activities

 

Net cash used in investing activities for the three months ended March 31, 2012 was $313,111, compared to an amount of $39,865 net cash that was used in investing activities for the same period of last year. The increase is due to the increased deposit for property, plant and equipment and construction in progress for the three months ended March 31, 2012 compared to the same period of last year. Therefore, the Company had cash of $313,111 used in investing activities.

  

Financing Activities

 

Net cash used in financing activities for the three months ended March 31, 2012 totaled $0, compared to $30,377 used in financing activities during the same period of 2011. The decrease is due to the fact that there was related party transaction during the first quarter of 2011 whereas there are none for the three months ended March 31, 2012. Therefore, the Company had cash of $0 used in financing activities.

 

Inventories

 

Inventories consisted of the following as of March 31, 2012 and December 31, 2011:

 

   March 31, 2012   December 31, 2011 
Raw materials  $537,147   $425,086 
           
Finished goods   654,562    2,347,710 
           
Work in progress   139,803    - 
           
Provision for impairment   -    (315,408)
           
Total  $1,331,512   $2,457,388 

 

Our raw materials mainly include quartz and petrol coke, which account for more than 95% of total raw material. Quartz comes from local mining companies and individual collectors. Quartz in Xinjiang province is 99.99% pure. Petrol coke comes from the Sinopec Group which is the biggest petrol company in China. We have not, in recent years, experienced any significant shortages of manufactured raw materials and normally do not carry inventories of these items in excess of what is reasonably required to meet our production and shipping schedules. Compared with the amount of December 31, 2011, the decrease of inventories is mainly attributable to the decreased finished goods as a result of decreased sales due to less demand.

 

5
 

 

 

Property and Equipment

 

The following is a summary of property and equipment as of March 31, 2012 and December 31, 2011:

 

   March 31, 2012   December 31, 2011 
Buildings  $11,144,754   $11,151,772 
           
Machinery and equipment   7,678,620    7,680,808 
           
Motor vehicles   346,812    347,030 
           
Office equipment   131,942    132,025 
           
Less: accumulated depreciation   (2,274,171)   (1,991,068)
           
Property and equipment, net  $17,027,957   $17,320,567 

 

We lease our office space at both 558 Lime Rock Road, Lakeville, Connecticut and 420 Lexington Avenue, Suite 860, New York, NY from Kuhns Brothers, Inc. and its affiliates (“Kuhns Brothers”). Our Chairman and CEO, Mr. Kuhns, is a controlling shareholder, President, CEO and Chairman of Kuhns Brothers. The lease commenced on September 1, 2008 for a term of one year with a monthly rent of $7,500, and such lease was extended with the same rate of rent until August 31, 2011. On September 1, 2011, we extended the lease with the same rate of rent for another one year.

 

Our operating facilities are located at Zone A, Industry Zone of Yining County of Yili Hasake Autonomous State under Xinjiang Uygur Autonomous Region of the PRC. On October 28, 2008, the Company paid $862,442 to obtain the land use right for fifty years for nearly 107,214 square meters of land where our operating facilities are located. On such property, we have constructed temporary factory buildings covering an area of approximately 2,600 square meters, as well as our office building of 350 square meters and an employee’s dormitory building with a construction area of 350 square meters. The land on which all the buildings are located has an area of approximately 33,333 square meters. The purchase of such land use right is to satisfy the need of our ongoing construction of our new furnaces and to expand our operations.

 

Accounts Payable and Accrued Liabilities

 

Accounts payable and accrued liabilities amounted to $3,639,331 and $4,486,153 as of March 31, 2012 and December 31, 2011, respectively. Accounts payable primarily resulted from our purchases of raw materials and equipment. The decrease of $846,822 is mainly a decrease in accounts payable caused by decreased purchase of raw materials, including quartz, petrol coke and electricity due to less sales caused by decreased demand. Our biggest supplier is Yihe Hydro Center, the payables to which accounted for more than 91% of the total amount of accounts payable as of March 31, 2012 and 50% of the total amount of accounts payable as of December 31, 2011.

 

Critical Accounting Policies and Estimates

 

Management's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The Company's financial statements reflect the selection and application of accounting policies which require management to make significant estimates and judgments. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The Company believes that the following reflect the more critical accounting policies that currently affect the Company's financial condition and results of operations.

 

Revenue Recognition

 

Product sales are recognized when the products are shipped and title has passed.  Sales revenue represents the invoiced value of goods, net of a value added tax (“VAT”). All of the Company's products that are sold in the PRC are subject to a Chinese VAT at a rate of 17% of the gross sales price.  This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing its finished products.

 

Property, Plant and Equipment

 

Property, plant and equipment are recorded at cost less accumulated depreciation and amortization. Depreciation and amortization are recorded utilizing the straight-line method over the estimated original useful lives of the assets.  Amortization of leasehold improvements is calculated on a straight-line basis over the life of the asset or the term of the lease, whichever is shorter.  Major renewals and betterments are capitalized and depreciated; maintenance and repairs that do not extend the life of the respective assets are charged to expense as incurred.  Upon disposal of assets, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in income.  Depreciation related to property and equipment used in production is reported in cost of sales.

 

6
 

 

Long-term assets of the Company are reviewed annually as to whether their carrying value has become impaired.

 

Bad Debts

 

The Company's business operations are conducted in the People's Republic of China. The Company extends unsecured credit only to its relatively large customers with a good credit history.  Management reviews its accounts receivable on a regular basis to determine if the bad debt allowance is adequate at each period-end.  

 

Off-Balance Sheet Arrangements

 

The Company has not engaged in any off-balance sheet transactions since its inception.

 

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Pursuant to Item 305(e) of Regulation S-K (§ 229.305(e)), the Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined by Rule 229.10(f)(1).

 

Item 4.  CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Mr. John Kuhns, our Chief Executive Officer evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Report. Based on that evaluation, our officers concluded that our disclosure controls and procedures were not effective. Please refer to our Annual Report on Form 10-K as filed with the SEC on April 13, 2012, for a complete discussion relating to the foregoing evaluation of Disclosures and Procedures.

 

Changes in Internal Controls

 

There were no changes in the Company’s internal control over financial reporting that occurred during the three months period 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 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

During the three-month period ended March 31, 2012, the Company issued to the holders of the Series A Preferred Stock an aggregate of 149,433 shares of Common Stock on January 3, 2012 which settled the liability for the dividends of the Series A Preferred Stock accrued during the fourth quarter of year 2011.

 

This issuance was effectuated pursuant to the exemption from the registration requirements of the Securities Act of 1933 (the “Act”), as amended, provided by Section 4(2) of the Act and/or Regulation D promulgated thereunder.  

 

Item 6.    EXHIBITS

 

(a) Exhibits

 

31.1 – Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
31.2 – Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
32.1 – Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
101.INS – XBRL Instance Document

 

7
 

 

101.SCH – XBRL Taxonomy Extension Schema Document
   
101.CAL – XBRL Taxonomy Extension Calculation Linkbase Document
   
101.DEF – XBRL Taxonomy Extension Definition Linkbase Document
   
101.LAB – XBRL Taxonomy Extension Label Linkbase Document
   
101.PRE – XBRL Taxonomy Extension Presentation Linkbase Document

 

8
 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned there unto duly authorized.

 

  MASTER SILICON CARBIDE INDUSTRIES, INC.  
       
Date: May 21, 2012 By: /s/  John D. Kuhns  
    John D. Kuhns  
    President and Chief Executive Officer  
    (principal executive officer)  
       
Date: May 21, 2012 By: /s/  Chunli Liu  
    Chunli Liu  
    Chief Accounting Officer  
    (principal financial officer and accounting officer)  

 

9

 

PINX:MAST Master Silicon Carbide Industries Inc Quarterly Report 10-Q Filling

Master Silicon Carbide Industries Inc PINX:MAST Stock - Get Quarterly Report SEC Filing of Master Silicon Carbide Industries Inc PINX:MAST stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

PINX:MAST Master Silicon Carbide Industries Inc Quarterly Report 10-Q Filing - 3/31/2012
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