|• AMERICAN NANO SILICON TECHNOLOGIES, INC. FORM 10-Q MARCH 31, 2012 • RULE 13A-14(A) CERTIFICATION • RULE 13A-14(B) CERTIFICATION • XBRL INSTANCE • XBRL SCHEMA • XBRL CALCULATION • XBRL DEFINITION • XBRL LABEL • XBRL PRESENTATION|
U. S. Securities and Exchange Commission
Washington, D. C. 20549
For the quarterly period ended March 31, 2012
For the transition period from _____ to _____
Commission File No. 0-52940
Issuer's Telephone Number: 86-817-3634888
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 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 o
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 shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o No x
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. (Check One)
Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company x
APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date:
May 15, 2012
Common Voting Stock: 36,210,558
AMERICAN NANO SILICON TECHNOLOGIES, INC.
QUARTERLY REPORT ON FORM 10Q
FOR THE FISCAL QUARTER ENDED MARCH 31, 2012
TABLE OF CONTENTS
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
Note 1 – ORGANIZATION AND BASIS OF PRESENTATION
American Nano-Silicon Technologies, Inc. (the “Company” or “ANNO”) was originally incorporated in the State of California on September 6, 1996 as CorpHQ, Inc. (“CorpHQ”). The Company has been primarily engaged in the business of manufacturing and distributing refined consumer chemical products through its subsidiaries, Nanchong Chunfei Nano-Silicon Technologies Co., Ltd. (“Nanchong Chunfei”), Sichuan Chunfei Refined Chemicals Co., Ltd. (“Chunfei Chemicals”), and Sichuan Hedi Veterinary Medicines Co., Ltd. (“Hedi Medicines”).
On August 26, 2006, ANNO, through its wholly owned subsidiary American Nano Silicon Technologies, Inc., a Delaware corporation (“ANST”), acquired a 95% interest in Nanchong Chunfei, a company incorporated in the People’s Republic of China (the “PRC” or “China”) in August 2006. Nanchong Chunfei directly owns 90% of Chunfei Chemicals, a Chinese corporation established under the laws of PRC on January 6, 2006. Chunfei Chemicals itself owns 92% of Hedi Medicines, also a Chinese company incorporated under the law of PRC on June 27, 2002.
On September 6, 2011, the Company acquired all minority interests in its subsidiaries by agreeing to issue 1,650,636 shares of common stock to the minority interest holders. Thereafter, Nanchong Chunfei, Chunfei Chemicals, and Hedi Medicines became wholly owned subsidiaries of ANNO. The shares were issued to the minority interest holders on November 28, 2011.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, the information included in these interim financial statements reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for the fair presentation of the consolidated financial position and the consolidated results of operations. Results shown for interim periods are not necessarily indicative of the results to be obtained for a full year.
As reflected in the accompanying unaudited condensed consolidated financial statements, the Company has a working capital deficiency of $3,855,021, an accumulated deficit of $534,563, suspended manufacturing operations in May 2011 as part of an effort to relocate the production facilities, and needs additional cash resources to maintain its operations. These factors raise substantial doubt about our ability to continue as a going concern. Our auditors have expressed substantial doubt about the Company’s ability to continue as a going concern in the audit report on our consolidated financial statements included with the Annual Report on Form 10K for the year ended September 30, 2011. In December 2011, the Company fully completed its relocation to the new manufacturing facility and began limited production on January 2, 2012.The Company will need additional funds to meet its operating and financing obligations until sufficient cash flows are generated from production to sustain operations and to fund future development and financing obligations. The Company’s largest shareholder and President, Mr. Pu Fachun, has the intention to continue providing necessary funding for the Company’s normal operations. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation
The accompanying condensed consolidated financial statements represent the consolidated accounts of the Company and its subsidiaries, Nanchong Chunfei, Chunfei Chemicals and Hedi Medicines. All significant intercompany balances and transactions have been eliminated in the consolidation.
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Prior to the acquisition on September 6, 2011, non-controlling interests result from the consolidation of our 95% directly owned subsidiary, Nanchong Chunfei, 85.5% indirectly owned subsidiary, Chunfei Chemicals, and 78.66% indirectly owned subsidiary, Hedi Medicines.
Use of estimates
In preparing the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, the management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the dates of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Significant estimates required to be made by the management include, but are not limited to, the recoverability of long-lived assets and the valuation of accounts receivable and inventories, valuation of warrant liabilities, and fair value of share based payments. Actual results could differ from these estimates.
Risks and uncertainties
The operations of the Company 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, in addition to the general state of the PRC economy. The Company's results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
Fair value of financial instruments
The Company adopted the provisions of Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures. ASC 820 clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:
Level 1- Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.
Level 2- Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.
Level 3- Inputs are unobservable inputs which reflect the reporting entity’s own assumptions.
The carrying amounts reported in the balance sheets for cash, taxes payable, construction security deposit, due to related parties, prepaid expenses, other receivables, advance to suppliers, short-term loan, accounts payable, advance from customers, other payables and accrued expenses approximate their fair market value based on the short-term nature of these instruments. The carrying value of the long-term debt approximates fair value based on market rates and terms currently available to the Company. The Company uses Level 2 method to measure fair value of its warrant liabilities (see note 12).
Cash includes cash on hand and cash on deposit and all highly liquid debt instruments with an original maturity of three months or less.
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Inventory consists of raw materials, packing supplies, work-in-progress and finished goods. Inventory is valued at the lower of cost or market with cost determined on a weighted average basis. Market value represents the estimated selling price in the ordinary course of business less the estimated costs necessary to complete the sale. No allowance for inventories was considered necessary as of the balance sheet dates.
Advance to suppliers
Advance to suppliers represents the payments made and recorded in advance for goods and services. Advances were also made for the purchase of the materials and equipment of the Company’s construction in progress.
Property, plant & equipment
Property, plant and equipment are stated at cost. The cost of an asset is comprised of its purchase price and any directly attributable costs of bringing the asset to its present working condition and location for its intended use. Depreciation and amortization are calculated using the straight-line method over the following useful lives:
Construction in progress represents direct costs of construction or acquisition and design fees incurred for the Company’s new plant and equipment. Capitalization of these costs ceases and the construction in progress is transferred to plant and equipment when substantially all the activities necessary to prepare the assets for their intended use are completed. No depreciation is provided until it is completed and ready for its intended use. Certain new plant and equipment was available and ready for use in January 2012.
Expenditures for maintenance and repairs are charged to expense as incurred. Additions, renewals and betterments are capitalized.
Impairment of long-lived assets
In accordance with ASC 360, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company periodically reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. The Company recognizes an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value.
The Company recognizes revenue under the FASB Codification Topic 605 (“ASC Topic 605”). Revenue is recognized when all the following have occurred: persuasive evidence of arrangement with customers, products are delivered, fees are fixed and determinable and collection is reasonably assured. Payments received before all of the relevant criteria for revenue recognition are satisfied are recorded as advance from customers. There was no significant revenue for the three and six months ended March 31, 2012 as manufacturing was suspended due to the relocation to our new facility.
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Shipping and handling
Shipping and handling costs incurred for shipping of finished products to customers are included in selling expense. Shipping and handling costs were $632 and $758 for the three months ended March 31, 2012 and 2011, respectively. Shipping and handling costs were $632 and $3,912 for the six months ended March 31, 2012 and 2011
The Company accounts for income tax under the provisions of FASB ASC 740-10-25, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of the events that have been included in the financial statements or tax returns. Deferred income taxes are recognized for all significant temporary differences between tax and financial statements bases of assets and liabilities. Valuation allowances will also be established against net deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized.
Uncertain tax positions
During the course of business, there are certain transactions and calculations for which the ultimate tax determination is uncertain. We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes may be due. These reserves are established when we believe that certain positions might be challenged despite our belief that our tax return positions are fully supportable. We adjust these reserves in light of changing facts and circumstances, such as the outcome of a tax audit or changes in the tax law. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate. As of March 31, 2012, we had no unrecognized tax benefits or provisions.
Value added tax
Value added tax is imposed on goods sold in or imported in the PRC. Value added tax payable in the People’s Republic of China is charged on an aggregated basis at a rate of 13% or 17% (depending on the type of goods involved) on the full price collected for the goods sold or, in the case of taxable services provided, at a rate of 17% on the charges for the taxable services provided, but excluding, in respect of both goods and services, any amount paid in respect of value added tax included in the price or charges, and less any deductible value added tax already paid by the taxpayer on purchases of goods and services in the same financial year. The value added tax recoverable for the Company as of March 31, 2012 and September 30, 2011 was $33,582 and $15,038, respectively.
Earnings (Loss) per share
Earnings per share are calculated in accordance with the ASC 260, “Earnings per share.” Basic net earnings per share are based upon the weighted average number of common shares outstanding, but excluding shares issued as compensation that have not yet vested. Diluted net earnings per share are based on the assumption that all dilutive convertible shares and stock options were converted or exercised, and that all unvested shares have vested. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS.
Note 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Concentration of credit risk
Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of advances to suppliers and other receivables arising from its normal business activities. The Company does not require collateral or other security to support these receivables. The Company routinely assesses the financial strength of its debtors and, based upon factors surrounding the credit risk, establishes an allowance, if required, for uncollectible accounts.
Foreign currency translation
The Company’s principal country of operations is the PRC. The financial position and results of operations of the Company are determined using the local currency, Renminbi (“RMB”), as the functional currency. Foreign currency transactions are translated at the applicable rates of exchange in effect at the transaction dates. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated at the applicable rates of exchange in effect at that date. Revenues and expenses are translated at the average exchange rates in effect during the reporting period. Equity accounts are translated in the historical exchange rate when the transactions took place.
Asset and liability accounts at March 31, 2012 and September 30, 2011 were translated at 6.2960 RMB to $1.00 and at 6.3843 RMB to $1.00, respectively, which were the exchange rates on the balance sheet dates. Equity accounts were stated at their historical rate. The average translation rates applied to the statements of income and cash flows for the six months ended March 31, 2012 and 2011 were 6.3318 RMB and 6.6103 RMB to $1.00, respectively.
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 rates adopted for the foreign exchange transactions are the rates of exchange quoted by the PBOC, which are determined largely by supply and demand.
Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders' equity as "Accumulated Other Comprehensive Income".
Note 3 – INVENTORY
The inventory consists of the following:
Note 4–PROPERTY, PLANT AND EQUIPMENT
The property, plant and equipment consist of the following:
Depreciation expense for the three months ended March 31, 2012 and 2011 was $205,368 and $175,227, respectively. Depreciation expense for the six months ended March 31, 2012 and 2011 was $407,796 and $324,978, respectively.
As of March 31, 2012, the Company still has construction in process of $1,159,472 for certain new manufacturing production lines requiring installation and adjustments before its ready for its intended use. The Company estimates the construction in process would be completed and ready to use by the end of May, 2012.
NOTE 5 - RELATED PARTY TRANSACTIONS
The Company periodically has receivables from its affiliates, owned by Mr. Pu Fachun, the single largest shareholder and president of the Company. The Company expects all outstanding amounts due from its affiliates will be repaid and no allowance is considered necessary. The Company also periodically borrows money from its shareholders to finance the operations.
The details of loans to/from related parties are as follows:
Sichuan Chunfei Daily Chemicals Co. Ltd (“Daily Chemical”) and Sichuan Chunfei Real Estate (“Chunfei Real Estate”) are owned by Mr. Pu Fachun. Zhang Lizi is the wife of Pu Fachun.
Short term loans from Chunfei Real Estate of $842,608 with fixed interest of 1% per month are due on June 1 and October 2, 2012. Short term loan from Mr. Pu of $ 714,743 is due on December 9, 2012 with fixed interest of 1% per month. The loan from Zhang Lizi of $313,481 as of September 30, 2011 was converted into shares of common stock of the Company in November, 2011(see note 13).
Long-term loans from Chunfei Real Estate of $1,485,750 are due on December 31, 2013 with $1,429,486 of these loans bearing interest of 1% per month and $56,265 with no interest. Long term loans from Daily Chemical are due on December 31, 2012 bear no interest. Long term loans from Mr. Pu were $ 1,626,068 which included $1,454,530 due on December 31, 2014 bearing no interest and $171,538 due on January 30, 2014 with interest of 1% per month. Long term loans from other officer and employee were $8,736 due on December 31, 2013 and with no interest
Interest expense, including imputed interest, for the three and six months ended March 31, 2012 was approximately $69,000.
NOTE 6 - LAND USE RIGHT
All land in the People’s Republic of China is government owned and cannot be sold to any individual or company. However, the government grants the user a “land use right” (the Right) to use the land. The Company has the right to use the land for 50 years and amortized the Right on a straight-line basis over the period of 50 years. As of March 31, 2012 and September 30, 2011, intangible assets consist of the following:
The amortization expense for the three months ended March 31, 2012 and 2011 was $6,523 and $6,277, respectively. The amortization expense for the six months ended March 31, 2012 and 2011 was $13,047 and $12,483, respectively.
NOTE 7– TAXES PAYABLE
The taxes payable includes the following:
NOTE 8 – SHORT TERM AND LONG-TERM LOANS
The short term and long-term loans include the following:
The Company recorded interest expense of $163,871, $8,479, $245,974 and $16,863 for the three and six months ended March 31, 2012 and 2011, respectively.
NOTE 9 – CONSTRUCTION SECURITY DEPOSITS
The Company requires security deposits from its plant and building contractors prior to start of the construction. The deposits are to be refunded upon officially certification of the completion of the work within the specified time. The purpose of the security deposits is to protect the Company from unexpected delays and poor construction quality.
The Company offers no interest on the security deposits. As of March 31, 2012 and September 30, 2011, the balance of the construction security deposits was $89,789 and $88,547, respectively.
NOTE 10 – INCOME TAXES
The Company’s subsidiaries are governed by the Income Tax Law of the People’s Republic of China. Chunfei Chemical is a foreign invested entity located in western China, which enjoyed a tax holiday from 2007 to 2011, during which its tax rate was reduced by 10 basis points. Nanchong Chunfei was taxed at 12.5% from 2009 to 2011, which was approved by the local tax authority. Hedi Medicines was taxed at the 25% statutory rate.
The following table reconciles the U.S. statutory rates to the Company's effective tax rate for the six months ended March 31, 2012 and 2011:
Other item represents the net income that could not be offset by loss incurred by other subsidiaries.
The Company incurred a net operating loss for the three and six months ended March 31, 2012. As of March 31, 2012, net operating loss carry forwards, for United States and China income tax purposes amounted to $2,052,269 and $979,351, respectively, which may be available to reduce future years' taxable income. These carry forwards will expire, if not utilized, beginning in 2028 through 2030 for U.S tax purpose and 2017 for China income tax purpose . Management believes that the realization of the benefits arising from these losses appear to be uncertain due to the Company's business operations being primarily conducted in China and foreign income not recognized in the United States for United States income tax purposes. It is also uncertain that the China business operation will have taxable income. Accordingly, the Company has provided a 100% valuation allowance as of March 31, 2012 and 2011, respectively for the temporary difference related to the loss carry-forwards.
NOTE 10 – INCOME TAXES (Continued)
The following table reconciles the changes of deferred tax asset for the six months ended March 31, 2012 and 2011:
The Company’s open tax years for its federal and state income tax returns are for the tax years after 2008. These tax returns are subject to examination by the tax authorities.
NOTE 11 – CONCENTRATION OF RISKS
Two major customers accounted for approximately 72% of the net revenue for the six months ended March 31, 2011, with each customer individually accounting for 44% and 28%, respectively. For the six month ended March 31, 2012, we had generated very limited sales. Therefore we did not rely on any particular customers for the period.
One major vendor provided approximately 99% of the Company’s purchases of raw materials for the six months ended March 31, 2011. For the six months ended March 31, 2012, we had generated very limited sales and made very limited purchase. Therefore we did not rely on any particular vendor for the period.
None of the vendors and customers mentioned above is related party to the Company.
NOTE 12 – WARRANT LIABILITIES
In March and June 2010, the Company issued 4,200,000 shares of common stock and Warrants to purchase 4,000,000 shares of Common Stock (Series B warrants) to three accredited institutional funds and an accredited investor for $2,000,000.
The exercise price of the Series B Warrants is subject to adjustments in certain circumstances for stock splits, combinations, dividends and distributions, reclassification, exchange or substitution, reorganization, merger, consolidation or sales of assets, issuance of additional shares of common stock or equivalents. As a result of its interpretation, the Company concluded that the Series B Warrants and Option to purchase additional common stock and Series B Warrants should be treated as derivative liabilities because the warrants are entitled to a price adjustment provision to allow the exercise price to be reduced in the event the Company issues or sells any additional shares of common stock at a price per share less than the then-applicable exercise price or without consideration, which is typically referred to as a “down-round protection” or “anti-dilution” provision. The Company uses Level 2 inputs to measure fair value of its warrant liability.
NOTE 12 – WARRANT LIABILITIES (Continued)
During the six months ended March 31, 2012, the Company's warrant liabilities account was as follows:
The following table summarizes the shares of the Company's common stock issuable upon exercise of warrants outstanding at March 31 2012:
NOTE 13 – STOCKHOLDERS’ EQUITY
A. Share based payments
In November, 2011, 51,282 shares of restricted common stock were issued at $0.39 per share, the fair value of the shares at the issuance date, to the Company’s independent director as compensation for his services from October 2011 to March 2012, which was valued at $20,000 and expensed as a part of general and administrative expenses.
In November, 2011, 30,000 shares of restricted common stock were issued as part of the July 2011 settlement agreement with investors for not reaching the net income target. No fair value is used because the issuance of stock is treated as reallocation of proceeds on the common stock issued on private placement.
In November, 2011, 1,650,636 shares of restricted common stock were issued to Mr. Pu Fachun for the acquisition of all minority interests in the Company’s subsidiaries.
On September 6, 2011, the Company entered into an agreement with Pu Fachun and four other individuals who had loaned a total of $1,869,906 to the Company at various times between July 2008 and July 2011. Pursuant to the agreement, the Company satisfied the debts in full by issuing shares of its common stock valued at $.60 per share. In November 2011, 3,116,510 shares of restricted common stock were issued to satisfy this debt.
NOTE 13 – STOCKHOLDERS’ EQUITY (Continued)
B: Earnings Per Share
The following is a reconciliation of the basic and diluted earnings (loss) per share computations for the three months ended March 31:
For the three and six months ended March 31 2012, a total of 4,000,000 warrants have not been included in the calculation of diluted earnings per share in order to avoid any anti-dilutive effect.
NOTE 14– COMMITMENTS
As of May 1, 2008, we entered into indefinite employment agreements with Pu Fachun and Zhang Changlong. The agreements provide for an annual salary of $10,000 to Mr. Pu and an annual salary of $7,500 to Mr. Zhang.
The agreements provides that the directors’ compensation will be reviewed by the Board of Directors not less frequently than annually, and may be adjusted upward at any time in the sole discretion of the Board of Directors. The officers will be eligible for bonus compensation to be awarded at such times and in such amounts as determined by the board in its sole discretion. The term of each agreement commenced on the effective date of May 1, 2008 and will continue until an event of termination under the agreement, including the following (i) the disability of the officer, (ii) upon the death of any officer, or (ii) upon thirty days’ written notice from either party.
Remuneration of Directors
The Board of Directors has agreed that it will compensate Mr. Robert Fanella upon commencement of his service and on each anniversary of his commencement date, with $10,000 cash plus $40,000 in the form of restricted shares of the Company’s common stock, calculated on the average closing price per share for the five (5) trading days preceding and including the date stock is issued. The Board will also compensate Mr. He Ping, Mr. Lü Shuming, and Mr. Liu Dechun upon commencement of his service and on each anniversary of his commencement date, with $5,000 in cash.
NOTE 15 – SUBSEQUENT EVENTS
On April 16, 2012, the Company awarded 2,000,000 shares of common stock to Qiwei Zhang, chief engineer and a member of the Board of Directors. The value of these shares was $320,000 based on the stock price on that date. The shares were awarded as compensation for Mr. Zhang’s role in the development of a flame retardant agent, which is expected to make a major contribution to the Company’s revenue in the future.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS
Forward Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking" statements as such term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements contain information relating to the Company that is based on the beliefs of the Company’s management as well as assumptions made by and information currently available to the Company’s management. When used in this report, the words “anticipate,” “believe,” “estimate,” “expect” and “intend” and words or phrases of similar import, as they relate to the Company or Company management, are intended to identify forward-looking statements. Such statements reflect the current risks, uncertainties and assumptions related to certain factors including, without limitations, competitive factors, general economic conditions, customer relations, relationships with vendors, the interest rate environment, governmental regulation and supervision, seasonality, distribution networks, product introductions and acceptance, technological change, changes in industry practices, onetime events and other factors. Factors that might cause such forward-looking statements to prove inaccurate include, but are not limited to, those discussed in Item 1A of our Annual Report on Form 10-K for the year ended September 30, 2011 entitled “Risk Factors.” Based upon changing conditions, should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. The Company assumes no obligation to update these forward-looking statements, except as required by law.
We are a nano-technology chemical manufacturer. We manufacture and market “Micro Nano Silicon™,” our own proprietary product, in China. Micro Nano Silicon is an ultra fine crystal that can be utilized as a non-phosphorous additive in detergents, as an accelerant additive in cement, as a flame retardant additive in rubber and plastics and as a pigment for paint. Micro Nano Silicon can replicate the chemical additives that are utilized in these products, but is less expensive and more environmentally friendly than competitive products. We are in the process of developing additional uses for Micro Nano Silicon for the petrochemical, plastic, rubber, paint and ceramic industries. We have entered into a long-term joint research and development agreement with the China Academy of Science, a technology research institution, Sichuan University of Science and Technology, and Southwest University of Science and Technology’s Department of Material Science and Engineering to assist us in our research and development activities.
Prior to June 2008, the Company was engaged in the business of manufacturing and distributing refined consumer chemical products and veterinary drugs through its subsidiaries. However, our research indicated that the market for non-phosphorus detergent additives offered a significant opportunity. Our research indicated that in China 4A zeolite is the industry standard for non-phosphorus detergent agents and the feedback from our customers indicated that our product could challenge 4A zeolite for the leadership in the industry.
In May 2011, the Company began moving to its new factory site located at Nanchong Shili Industrial Street, Economic and Technology Development Zone, Xiaolong Chunfei Industrial Park, which is approximately 12.4 miles from the Company's previous factory site. The Company temporarily suspended production to facilitate the move, resulting in a decrease in sales in the third quarter of fiscal year 2011 and no sales in the fourth quarter of fiscal 2011 or the first quarter of fiscal year 2012. On December 8, 2011, the Company announced that it had successfully relocated to its new facility in Nanchong, Sichuan, China. In addition to housing existing equipment and machinery from its previous facility,our latest facility also contains new equipment that enables the Company to increase its product diversification capabilities as well as to manufacture its new flame retardant additive product. The Company began limited production of its flame retardant additive product on January 2, 2012.
Results of Operations
We did not generate any significant sales for the three and six months ended March 31, 2012, after having posted $6,265,556 and $12,194,992 in revenue for the three and six ended March 31, 2011. The lack of significant revenue in fiscal year 2012 was due to the fact that when we moved our factory site during the second half of fiscal year 2011 to facilitate product diversification capabilities, production was completely suspended. Although the factory is now functional, we lack the working capital necessary to restore operations. Although we have, to date, relied on loans from our Chairman to meet our working capital requirements, we are currently pursuing a financing strategy that will provide us a basis for long-term growth.
As we discussed above, we didn’t generate any significant revenues for the three and six months ended March 31, 2012, except for limited sales from our trial product. Therefore, we also didn’t generate any significant gross profit for the three and six months ended March 31, 2012. Additionally, the gross profit for the period in this year is not a good indicator of what our gross profits normally are. For example, for the three and six months ended March 31, 2011, we generated $1,516,047 and $2,986,924 in gross profit, respectively.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses, or SG&A, include expenses associated with salaries and other expenses related to marketing and administrative activities. In addition, we have incurred expenses through the use of consultants and other outsourced service providers to take advantage of specialized knowledge and capabilities that we require for short durations of time to avoid unnecessary hiring of full-time staff.
Our SG&A expenses for the three and six months ended March 31, 2012 were $370,426 and $783,718, respectively. In both periods, SG&A expense was significantly higher than in the comparable period of fiscal 2011. The primary reason for the increase was expenses associated with the relocation of our manufacturing facilities. In addition, because the new facility was put into service on January 2, our depreciation expense increased by $83,382 from the first six months of fiscal 2011 to the first six months of fiscal 2012, and a similar increase was experienced in the quarter ended March 31, 2012.
Research and Development Expenses
For the three and six months ended March 31, 2012, we paid $17,508 and $96,162 to Sichuan University of Science and Technology in research and development fees for developing our flame retardant product line. By entering into cooperative research agreements with research institutions and universities, we are able to limit our overhead expenses, but still benefit from the innovations achieved. In comparison, for the same period in fiscal year 2011, we did not incur any expenditure related to research and development, as our staff was totally focused on the impending transfer of our facilities.
Operating income; Other income and expense
For the three and six months ended March 31, 2012, our other expenses totaled $540,866 and $264,909, compared to other expenses of $632,178 and other income of $844,053 for the three and six ended March 31, 2011. In both periods, the primary components of other expenses or incomes were the change in fair value of our outstanding warrant liability that resulted from changes in the price of our common stock.
We incurred a net loss of $926,850 and $1,142,859 for the three and six months ended March 31, 2012 as compared to a net profit of $409,998 and $2,889,448 for the three and six months ended March 31, 2011. Once we fully launch our flame retardant additive product line, we believe that the top line benefits will more than compensate for the increased expenses, and that we will realize increased income from operations in future periods. Whether we also realize net income will depend, in part, on changes in our warrant liability that we may be required to record as other income or other expense.
Liquidity and Capital Resources
As reflected in the condensed consolidated financial statements, the Company has a working capital deficiency of $3,855,021, and an accumulated deficit of $534,563, as it suspended manufacturing operations in May 2011. For those reasons, our auditors expressed substantial doubt about the Company’s ability to continue as a going concern in their audit report on our consolidated financial statements included with the Annual Report on Form 10K for the year ended September 30, 2011.
The Company completed construction of its new plant in January 2012, with the exception of one production line. During the quarter ended March 31, 2012 we were in the process of performing test runs on the new production line, so our production was limited. We are expecting to commence full scale production during the current quarter, ending June 30, 2012. However, because we committed all of our resources to the construction of our new manufacturing facility, at March 31, 2012 we had a working capital deficit of $3,885,021, as our current assets are now insignificant. The deficit is primarily comprised of short term loans totaling $1,770,116 and payable due to related parties totaling $3,399,686. Loans from related parties increased by approximately $1,600,000 from the year end at September 30, 2011, and we expect our principal shareholders to continue to lend the money needed to sustain us through this transition period. Therefore, our expectation is that once our new production lines are tested and running, we will be able to obtain sufficient funds to operate our business, which should generate sufficient cash flow to repay our short term liabilities.
Although we incurred a net loss of $1,142,859 during the six months ended March 31, 2012, our operations used only $655,858 in cash. The principal reason for the discrepancy was the fact that our loss included $420,843 in depreciation expense. In addition, we were able to increase our accrued expenses by $164,979 during that period. By way of comparison, during the first six months of fiscal 2011, when we were engaged in full scale manufacturing operations, our operations provided us $2,928,369 in cash.
For the six months ended March 31 2012, we used $2,012,228 in investing activities, all of which was attributable to additions to property and equipment. To fund that expenditure as well as the cash used in operations, we increased our long term loans from related parties by $1,584,080, increased our short term loan from related parties by $750,887, and obtained additional third party loans in the net amount of $326,400.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of March 31, 2012, we carried out an evaluation, under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, of 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 Securities Exchange Act of 1934. Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures are not effective in enabling us to record, process, summarize and report information required to be included in our periodic SEC filings within the required time period, due to the lack of expertise in U.S. GAAP accounting among the personnel in our accounting department.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
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.