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BEFUT INTERNATIONAL CO., LTD. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge)
The following discussion of our financial condition and results of operations
should be read in conjunction with our consolidated financial statements and the
notes to those financial statements appearing elsewhere in this report.
Certain statements in this report constitute "forward-looking statements". Such
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 strategies, (c) anticipated trends
in our industries, (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," "expect," "believe," "intend," or the
negative of these words or other variations on these words or comparable
terminology. Actual events or results may differ materially from those discussed
in forward-looking statements as a result of various factors, including, without
limitation, the risks and matters described in this report generally. 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 statement to reflect events or
circumstances after the date on which the statement is made or to reflect the
occurrence of unanticipated events. Further, the information about our
intentions contained in this report is a statement of our intention as of the
date of this report and is based upon, among other things, the existing
regulatory environment, industry conditions, market conditions and prices, the
economy in general and our assumptions as of such date. We may change our
intentions, at any time and without notice, based upon any changes in such
factors, in our assumptions or otherwise.
Unless the context indicates otherwise, as used in the following discussion, the
words "Company", "we," "us," and "our," each refer to (i) BEFUT International
Co., Ltd. (f/k/a Frezer, Inc.), a corporation incorporated in the State of
Nevada ("Befut Public Co."); (ii) BEFUT Corporation, a corporation incorporated
in the State of Nevada and a wholly owned subsidiary of Befut Public Co. ("Befut
Nevada"); (iii) Hongkong BEFUT Co., Ltd. ("Befut Hongkong"), a wholly-owned
subsidiary of Befut Nevada, incorporated under the laws of Hong Kong; (iv) Befut
Electric (Dalian) Co., Ltd. ("WFOE"), a corporation incorporated under the laws
of the People's Republic of China (the "PRC"), and a wholly-owned subsidiary of
Befut Hongkong; (v) Dalian Befut Wire and Cable Manufacturing Co., Ltd. ("Dalian
Befut"), a corporation incorporated under the laws of the PRC, which is a
captive manufacturer of WFOE pursuant to a series of contractual agreements;
(vi) Dalian Marine Cable Co., Ltd. ("Befut Marine"), a corporation incorporated
under the laws of the PRC, which was 86.6% owned by Dalian Befut as of February
25, 2011; (vii) Dalian Befut Zhong Xing Switch Co., Ltd. ("Befut Zhong Xing"), a
corporation incorporated under the laws of the PRC, and that is 73.5% owned by
Dalian Befut; (viii) Dalian Yuansheng Technology Co., Ltd. ("Dalian Yuansheng"),
a corporation incorporated under the laws of the PRC, and that is 93.3% owned by
Dalian Befut; (ix) Dalian Befut Sales Co., Ltd., a corporation incorporated
under the laws of the PRC, and that is 70% owned by Dalian Befut and 30% owned
by Befut Zhong Xing; (x) Dalian Befut Wire & Cable Engineering and Research Co.,
Ltd., a corporation incorporated under the laws of the PRC, and that is wholly
owned by Dalian Befut; and (xi) Dalian Befut Management Consultants Co., Ltd., a
corporation incorporated under the laws of the PRC, and that is 60% owned by
Dalian Befut .
Unless the context otherwise requires, all references to (i) "PRC" and "China"
are to the People's Republic of China; (ii) "U.S. dollar," "$" and "US$" are to
United States dollars; and (iii) "RMB", "Yuan" and Renminbi are to the currency
of the PRC or China.
Overview
We believe that we are one of the most competitive manufacturers of specialty
cables in northeastern China. For the six months ended December 31, 2011,
approximately 35% of our revenues were generated from traditional cable, about
58% of revenues were generated from specialty cable and about 7% of revenues
were generated from our switch application business. Our cable products consist
of (i) traditional electric power system cable and (ii) an assortment of
specialty cable, including marine cable, mining specialty cable, and
petrochemical cable. Our switch application business consists mainly of high and
low voltage distribution cabinet switches and crane electronic control switches,
which products complement our cable product offerings.
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OEM Agreements
We conduct substantially all of our operations through, and generate
substantially all of our revenues from Dalian Befut, pursuant to an Original
Equipment Manufacturer Agreement, dated February 16, 2009 (the "Manufacturing
Agreement") with Dalian Befut, pursuant to which (i) Dalian Befut is the
exclusive manufacturer of cable and wire products for WFOE, and may not
manufacture products for any other third party without the written consent of
WFOE; (ii) WFOE provides all the raw materials and advance related costs to
Dalian Befut, as well as provides the design requirements of the products to be
manufactured; and (iii) in no event may Dalian Befut use the arrangements under
the Manufacturing Agreement for commercial or noncommercial marketing or
promotional activities in any form. In addition, on February 16, 2009, WFOE and
Dalian Befut entered into (i) an Intellectual Property Rights License Agreement,
pursuant to which WFOE shall be permitted to use the intellectual property
rights such as trademark, patents and knowhow for the marketing and sale of the
products (the "IP Agreement"); and (ii) a Non-competition Agreement, pursuant to
which Dalian Befut shall not compete against WFOE (the "Non compete Agreement",
together with the IP Agreement and Manufacturing Agreement, collectively, the
"OEM Agreements"). We have no direct ownership interest in Dalian Befut nor do
we have voting control of any shares of Dalian Befut. As a result, these OEM
Agreements may not be as effective in providing us with control over Dalian
Befut as direct ownership of Dalian Befut would be. For example, Dalian Befut
may breach the OEM Agreements by deciding not to manufacture products for WFOE,
and consequently the Company. In the event of any such breach, we would have to
rely on legal remedies under PRC law, which may not always be available or
effective to enforce our rights, particularly in light of uncertainties in the
PRC legal system. To mitigate such a risk, WFOE has the exclusive right under
the OEM Agreements, exercisable in its sole discretion, to purchase all or part
of the assets and/or equity of Dalian Befut.
All cash flows generated under the OEM Agreements are maintained in the custody
of Dalian Befut instead of in the custody of the Company. There are no
prohibitions under applicable PRC law on the transfer of cash from Dalian Befut
to WFOE. Accordingly, except for the relevant PRC laws, regulations and
government policies on capital outflow, no risks exist as to the movement of
cash balances from the Company's PRC operating subsidiaries or Dalian Befut up
to the Company. Transfer of cash may be made from Dalian Befut to WFOE and up to
the Company, when necessary to meet the Company's cash requirements, including,
for example, to satisfy any debt obligations or make cash dividends. Such
transfers must be made in compliance with applicable PRC laws regarding, among
other things, currency controls, tax and payment of dividends.
Results of Operations
Three and six months ended December 31, 2011 compared to three and six months
ended December 31, 2010
The following table summarizes the results of our operations during the
three-month and six-month periods ended December 31, 2011 and December 31, 2010,
respectively and provides information regarding the dollar and percentage
increase or decrease from the three-month and six-month period ended December
31, 2011 compared to the three-month and six-month period ended December 31,
2010.
22
Three-months Three-months Six months Six months
ended ended ended ended
December 31, December 31, % December 31, December 31, %
Item 2011 2010 Change 2011 2010 Change
Sales $ 13,382,645 $ 14,871,164 -10 % $ 30,255,721 $ 30,801,975 -2 %
Cost of sales $ 10,056,846 $ 10,954,272 -8 % $ 22,479,087 $ 22,625,032 -1 %
Gross profit $ 3,325,799 $ 3,916,892 -15 % $ 7,776,634 $ 8,176,943 -5 %
Total operating
expenses $ 1,281,884 $ 1,181,902 8 % $ 2,598,980 $ 2,232,129 16 %
Total otherincome/(expenses) $ (521,176 ) $ (206,211 ) 153 % $ (1,103,700 ) $ (425,001 ) 160 %
Net income $ 1,338,345 $ 1,936,565 -31 % $ 3,547,849 $ 4,184,821 -15 %
Gross profit margin 24.85 % 26.34 % -1 % 25.70 % 26.55 % -1 %
Basic earnings per
share $ 0.05 $ 0.07 -29 % $ 0.12 $ 0.14 -14 %
Diluted earnings per
share 0.05 0.07 -29 % 0.12 0.14 -14 %
Basic weighted
average shares
outstanding 29,715,640 29,715,640 0 % 29,715,640 29,715,640 0 %
Diluted weighted
average shares
outstanding 29,715,640 29,786,677 0 % 29,715,640 29,771,813 0 %
Three months ended December 31, 2011 as compared to three months ended December
31, 2010
Sales
Our sales for the three months ended December 31, 2011 were $13,382,645,
representing a decrease of $1,488,519, or 10%, as compared to the three months
ended December 31, 2010. Approximately $0.8 million of the decrease was
attributable to the decrease in sales of our traditional cable products and $0.8
million was attributable to the decrease in sales of our switch appliance
business. Our decrease in total sales was partially offset by increased sales of
our specialty cable products, which were approximately $7.8 million,
representing an increase of approximately $0.1 million, as compared to the three
months ended December 31, 2010.
The decrease in sales was primarily due to the weaker sales of our traditional
cable products and switch appliances. During the three months ended December 31,
2011, the price of copper decreased substantially. Copper, our main raw
material, constitutes approximately 70%-80% of the raw material components in
our cable products. As the purchase price of our products is based on the raw
materials including copper at the time of the order placement while copper price
had been experiencing fluctuation, so certain customers adopted a wait-and-see
attitude and delayed their orders during this period.
The percentage of total sales that was attributable to sales of specialty cable,
traditional cable and switch appliances for the three months ended December 31,
2011 was approximately 59%, 37% and 4%, representing an increase of
approximately 9%, a decrease of approximately 4% and a decrease of approximately
5%, respectively, as compared to the percentage of total sales each of the
respective category represents during three months ended December 31, 2010.
Fluctuations in product percentages are mainly due to the changes in the product
demand from our customers.
23
Cost of Sales
Cost of sales includes the expenses incurred to produce inventory for sale,
including raw materials, direct labor, depreciation of manufacturing facilities
and machinery, overheads, amortization of land use right as well as changes in
reserves for shrinkage and inventory obsolescence. Our cost of sales for the
three months ended December 31, 2011 was $10,056,846, a decrease of $897,426, or
8%, as compared to the three months ended December 31, 2010. This decrease was
mainly due to the decrease in sales.
Gross Profit
Gross profit for the three months ended December 31, 2011 was $3,325,799,
representing a decrease of $591,093, or 15%, as compared to the three months
ended December 31, 2010. Gross profit margin was 24.9% for the three months
ended December 31, 2011, representing a decrease of 1.5%, as compared to the
three months ended December 31, 2010. The decrease in gross profit margin was
primarily attributable to the decreases in margins of our specialty (in
particular, petrochemical) cable and traditional cable products, which were by
4% and 3%, respectively, as compared to the same period in 2010. We lowered our
selling prices of those cable products in an effort to develop new customers for
more market shares. The gross profit margin of each category of our products for
the three months ended December 31, 2011 was approximately 33% for specialty
cable, 15% for traditional cable and 10% for switch appliances, as compared to
gross profit margins of approximately 37% for specialty cable, 18% for
traditional cable and 6% for switch appliances for three months ended December
31, 2010.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses consist primarily of salaries
and bonuses for sales personnel, advertising and promotion expenses, freight
charges, related compensation and professional fees, and amortization expenses.
Selling expenses were $177,529 in the three months ended December 31, 2011, as
compared to $149,643 in the three months ended December 31, 2010, representing
an increase of $27,886, or 19%. The increase in selling expenses was mainly due
to the increase in transportation expenses. This was because the payment
obligation of the transportation expenses for most of our products shifted from
our clients to us during the quarter ended December 31, 2011. General and
administrative expenses were $1,104,355 for the three months ended December 31,
2011, an increase of $72,096, or 7%, as compared to the three months endedDecember 31, 2010.
Income from Operations
Our operating income was $2,043,915 for the three months ended December 31,
2011, a decrease of $691,075, or 25%, as compared to $2,734,990 for the three
months ended December 31, 2010. The decrease was due to the decrease of gross
profit and the increase of selling, general and administrative expenses asset
forth above.
Government Subsidy
For the three months ended December 31, 2011, we received subsidies from various
PRC governmental bureaus in the aggregate amount of $100,138 while we received
subsidies of $180,155 in the three months ended December 31, 2010. The subsidies
received by the Company in the quarter ended December 31, 2011 consisted of a
refund of $21,238 for value added taxes paid by the Company in 2011 and $78,900
received from the Appropriation of Technology Innovation Fund of the Department
of Finance of Liaoning Province.
Interest Expense
Interest expense was $838,898 for the three months ended December 31, 2011, an
increase of $344,046, or 70%, as compared to $494,852 for the three months ended
December 31, 2010. The increase of the interest expense was mainly due to the
significant increase in short-term bank loans that we have obtained for the
three months ended December 31, 2011, as compared to the three months endedDecember 31, 2010.
24
Income Taxes
For the three months ended December 31, 2011, our business operations were
conducted solely by WFOE, Dalian Befut and its subsidiaries, and as such, we
were governed by the PRC Enterprise Income Tax Laws (the "EIT Law"). China
enterprise income tax is calculated based on taxable income determined under
Chinese generally accepted accounting principles. In accordance with the EIT
Law, a Chinese domestic company is subject to taxes, including but not limited
to: (i) an enterprise income tax rate of 25% and (ii) a value added tax of17%
on the goods sold.
Provision for income taxes was $241,586 for the three months ended December 31,
2011, a decrease of $373,309, or 61%, compared to $614,895 for the three months
ended December 31 , 2010. The decrease is a result of the Company being granted,
on May 20, 2011, an income tax holiday at a rate of 12.5%, as opposed to the
regular income tax of 25% for a typical PRC enterprise, which became
retroactively effective on January 1, 2011 and is valid until December 31,2013.
Net Income
Net income for the three months ended December 31, 2011 was $1,338,345, a
decrease of $598,220, or 31 %, as compared to net income of $1,936,565 for the
three months ended December 31, 2010. The decrease was mainly attributable to
the decrease of $691,075 in income from operations and the increase of $344,046
in interest expense, which was partially offset by a decrease in income taxes of
$373,309.
Six months ended December 31, 2011 as compared to six months ended December 31,
2010
Sales
Our sales for the six months ended December 31, 2011 were $30,255,721,
representing a decrease of $546,254, or 2%, as compared to the six months ended
December 31, 2010. Approximately $3.6 million decrease was attributable to the
decrease in sales of our traditional cable products. Our decrease in total sales
was partially offset by increased sales of our specialty cable products and our
switch appliance business, which were approximately $2.8 million and $0.3
million for the period.
The decrease in sales was primarily due to the weaker sales of our traditional
cable products as a result of the copper price fluctuation as explained above
for our sales under the three months comparison..
The percentage of total sales that was attributable to sales of specialty cable,
traditional cable and switch appliances for the six months ended December 31,
2011 was approximately 58%, 36% and 6%, representing an increase of
approximately 10%, a decrease of approximately 11% and an increase of
approximately 1%, respectively, as compared to percentage of total sales each of
the respective category represents during the six months ended December 31,
2010. Fluctuations in our products' sale percentages are mainly due to the
changes in the product demand from our customers.
Cost of Sales
Cost of sales includes the expenses incurred to produce inventory for sale,
including raw materials, direct labor, depreciation of manufacturing facilities
and machinery, overheads, amortization of land use right as well as changes in
reserves for shrinkage and inventory obsolescence. Our cost of sales for the six
months ended December 31, 2011 was $22,479,087, a decrease of $145,945, or 1%,
as compared to the six months ended December 31, 2010.
Gross Profit
Gross profit for the six months ended December 31, 2011 was $7,776,634,
representing a decrease of $400,309, or 5%, as compared to the six months ended
December 31, 2010. Gross profit margin was 25.7% for the six months ended
December 31, 2011, representing a decrease of 0.9%, as compared to the six
months ended December 31, 2010. The decrease in gross profit margin was
primarily due to the slight decreases in margins of our specialty cable and
traditional cable products, which were by 2% and 4% respectively, as compared to
the same period in 2010. The gross profit margins of each category of our
products for the six months ended December 31, 2011 was approximately 34% for
specialty cable, 15% for traditional cable and 9% for switch appliances, as
compared to gross profit margins of approximately 36% for specialty cable, 19%
for traditional cable and 7% for switch appliances for six months ended December
31, 2010.
25
Selling, General and Administrative Expenses
Our selling, general and administrative expenses consist primarily of salaries
and bonuses for sales personnel, advertising and promotion expenses, freight
charges, related compensation and professional fees, and amortization expenses.
Selling expenses were $333,285 in the six months ended December 31, 2011, as
compared to $188,250 in the six months ended December 31, 2010, representing an
increase of $145,035, or 77%. The increase in selling expenses was mainly due to
the increase in transportation expenses as explained under the same heading of
our three months comparison above. General and administrative expenses were
$2,265,695 for the six months ended December 31, 2011, an increase of $221,816,
or 11%, as compared to the six months ended December 31, 2010. The increase of
general and administrative expenses was mainly due to the increased expense from
WFOE. The manufacturing overhead recorded as general and administrative expense
instead of cost of sales since WFOE generated nominal sales for the periodended
September 30, 2011.
Income from Operations
Our operating income was $5,177,654 for the six months ended December 31, 2011,
a decrease of $767,160, or 13%, as compared to $5,944,814 for the six months
ended December 31, 2010. The decrease was due to the decrease of gross profit
and the increase of selling, general and administrative expenses.
Government Subsidy
For the six months ended December 31, 2011, we received subsidies from various
PRC governmental bureaus in the aggregate amount of $285,732 while we received
subsidies of $316,642 in the six months ended December 31, 2010. The subsidies
received by the Company in the six months ended December 31, 2011 consisted of a
refund of $74,079 for value added taxes paid by the Company in 2011 and $211,653
received from the Appropriation of Technology Innovation Fund of the Department
of Finance of Liaoning Province.
Interest Expense
Interest expense was $1,612,194 for the six months ended December 31, 2011, an
increase of $722,440, or 81%, as compared to $889,754 for the six months ended
December 31, 2010. The increase of the interest expense was mainly due to the
significant increase in short-term bank loans that we have obtained for the six
months ended December 31, 2011, as compared to the six months ended December 31,
2010.
Income Taxes
For the six months ended December 31, 2011, our business operations were
conducted solely by WFOE, Dalian Befut and its subsidiaries, and as such, we
were governed by the EIT Law. China enterprise income tax is calculated based on
taxable income determined under Chinese generally accepted accounting
principles. In accordance with the EIT Law, a Chinese domestic company is
subject to taxes, including but not limited to: (i) an enterprise income tax
rate of 25% and (ii) a value added tax of 17% on the goods sold.
Provision for income taxes was $624,880 for the six months ended December 31,
2011, a decrease of $797,150, or 56%, compared to $1,422,030 for the six months
ended December 31, 2010. The decrease is a result of the Company being granted,
on May 20, 2011, an income tax holiday at a rate of 12.5%, as opposed to the
regular income tax of 25% for a typical PRC enterprise, which became
retroactively effective on January 1, 2011 and is valid until December 31,2013.
Net Income
Net income for the six months ended December 31, 2011 was $3,547,849, a decrease
of $636,972, or 15%, as compared to net income of $4,184,821 for the six months
ended December 31, 2010. The decrease was mainly attributable to the decrease of
$767,160 in income from operations and the increase of $722,440 in interest
expense, which was partially offset by a decrease in income taxes of $797,150.
26
Liquidity and Capital Resources
Selected Measures of Liquidity and Capital Resources
The following table sets forth certain relevant measures regarding our liquidity
and capital resources:
December 31, June 30,(dollars in thousands, except ratios) 2011 2011
Cash and cash equivalents and restricted cash $ 13,131 $ 6,290
Working capital $ 11,521 $ 11,502
Ratio of current assets to current liabilities 1.2:1 1.4:1
We have historically financed our operations and capital expenditures through
cash flows from operations and bank loans.
We intend to use our available funds as working capital and to expand and
develop our current business operations. We believe that our available funds
will provide us with sufficient capital for at least the next twelve months;
however, to the extent we expand our operations or make acquisitions, we may
require additional funding, which may include debt and/or equity financing.
There can be no assurance that any additional financing will be available on
terms acceptable to us, if at all. Any equity financing may result in dilution
to existing stockholders and any debt financing may include restrictive
covenants.
Cash Flows
We had a net increase of $3,050,858 in cash and cash equivalents from June 30,
2011 to December 31, 2011. The following table summarizes such changes:
For the six months ended
December 31, 2011 December 31, 2010
Net cash provided (used in) operating activities $ 5,880,647 $ (3,668,743 )
Net cash used in investing activities $ (15,209,378 ) $ (1,216,513 )
Net cash provided by financing activities $ 11,723,497 $ 4,398,291
Net increase (decrease) in cash, cash equivalents $ 2,493,145 $ (557,713 )
Operating Activities
We received net cash of $5,880,647 from our operating activities for the six
months ended December 31, 2011, as compared to net cash of $3,668,743 used in
the six months ended December 31, 2010. Although the net income for the six
months ended December 31, 2011 was $3,449,074, representing a decrease of
$648,709, as compared to net income of $4,097,783 for the six months ended
December 31, 2010, we still received net cash of $5,880,647 from our operating
activities. The positive operating cash flow was primarily due to the increase
of accounts receivable, accounts payable, other current assets, trade notes
payable and advances from customers. However, the decrease of restricted cash
and income taxes payable were partially offset the increase of cash provided by
operating activities.
27
Investing Activities
The net cash used in our investment activities in the six months ended December
31, 2011 was $15,209,378, representing an increase of $13,992,865, as compared
to $1,216,513 in the six months ended December 31, 2010. The increase was mainly
due to, among other things, cash used in connection with the construction of the
Phase II Changxing Facility and loans to unrelated parties.
Financing Activities
The net cash provided by our financing activities in the six months ended
December 31, 2011 was $11,723,497, representing an increase of $7,325,206 as
compared to $4,398,291 in the six months ended December 31, 2010. The increase
was mainly due to approximately $8.7 million in short term bank loans, which was
partially offset by a decrease of $1 million in loans from unrelated parties.
Financial Obligations
As of December 31, 2011, our outstanding loans were as follows:
Creditors Loan Amount Interest Rate Term Maturity Date
China Merchants Bank $ 2,361,000 7.93 %* 6 months 01/18/12
Industrial and Commercial $ 1,416,600 7.32 %& 6 months 01/28/12
Bank of China
Industrial and Commercial $ 1,621,220 7.32 %& 6 months 03/15/12
Bank of China
Industrial and Commercial $ 1,322,160 7.32 %& 6 months 04/30/12
Bank of China
Bank of East Asia $ 1,574,000 7.93 %* 6 months 06/25/11
Bank of East Asia $ 2,361,000 7.93 %* 6 months 06/29/11
Harbin Bank $ 3,148,000 7.872 %& 1 year 09/22/12
Jilin Bank $ 3,148,000 8.528 %* 1 year 09/26/12
Bank of Dalian $ 4,722,000 8.528 %* 1 year 12/06/12
Xinhui Town Bank $ 787,000 9.465 %+ 1 year 11/30/12
PRC National Development $ 14,638,200 7.245 %# 7 years 11/01/16
Bank Joint Equity
Corporation
* Variable interest rate equal to 30% per annum above the floating base rate
issued by the People's Bank of China.
^ Variable interest rate equal to 10% per annum above the floating base rate
issued by the People's Bank of China.
+ Variable interest rate equal to 50% per annum above the floating base rate
issued by the People's Bank of China.
# Variable interest rate equal to 5% per annum above the floating base rate
issued by the People's Bank of China.
& Variable interest rate equal to 20% per annum above the floating base rate
issued by the People's Bank of China.
28
Accounts Receivable
The balance of our accounts receivable was $24,584,186, net of allowance for
doubtful accounts of $121,188, as of December 31, 2011, as compared to
$18,166,580, net of allowance for doubtful accounts of $87,480, as of June 30,
2010. The days' sales in receivables for the six months ended December 31, 2011
were 127 days, as compared to 78 days for the six months ended December 31,2010.
Inventories
Inventories consisted of the following as of December 31, 2011 and June 30,
2010, respectively:
December 31,
(dollars) 2011 June 30, 2011
Category
Raw materials $ 1,823,887 $ 1,963,765
Work-in-process 343,455 241,832
Finished goods 5,592,753 2,401,834
Total inventories $ 7,760,095 $ 4,607,431
We had total inventory of $7,760,095 as of December 31, 2011, representing an
increase of $3,152,664, or 68%, as compared to inventory of $4,607,431 as of
June 30, 2011. Days' purchase in inventory for the six months ended December 31,
2011 were 50 days, compared to 31 days for the six months ended December 31,
2010.
Off-Balance Sheet Arrangements
At December 31, 2011, we did not have any off-balance sheet arrangements.
Foreign Currency Exchange
For the six months ended December 31, 2011, the U.S. Dollar and RMB exchange
rate fluctuated from RMB 6.4716 to 1 U.S. Dollar to RMB6.3009 to 1 U.S. Dollar,
an increase of approximately 2.6% in the value of the RMB. As a result of the
minimum appreciation of the RMB during this period, the Company believes that
currency fluctuations have not had a material impact on the Company's cash
flows, revenues and financial condition.
Critical Accounting Policies and Use of Estimates
Management's discussion and analysis of its financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with United States generally accepted accounting
principles ("US GAAP"). Our financial statements reflect the selection and
application of accounting policies which require management to make significant
estimates and judgments. See Note 2 to our consolidated financial statements,
"Summary of Significant Accounting Policies." We believe that the following
paragraphs reflect the more critical accounting policies that currently affect
our financial condition and results of operations:
Use of Estimates and Assumption
The preparation of consolidated financial statements in accordance with US GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period.
Significant estimates include allowance for doubtful accounts and income taxes.
Actual results could differ from those estimates.
29
Revenue Recognition
The Company derives its revenues primarily from the design, manufacture and sale
of industrial wires and cables in the PRC. In accordance with the provisions of
ASC Topic 605, revenue is recognized when products are shipped, title and risk
of loss is passed to the customers and collection is reasonably
assured. Payments received before the above criteria are satisfied are recorded
as advance from customers.
Cash and Cash Equivalents
In accordance with FASB ASC Topic 230, "Statement of Cash Flows", the Company
considers all highly liquid instruments with original maturities of three months
or less to be cash equivalents.
Accounts Receivable
Accounts receivable are recorded net of allowance for doubtful accounts. The
Company provides an allowance for doubtful accounts equal to the estimated
uncollectible amounts. Periodically, management assesses customer credit
history and relationships as well as performs accounts receivable aging
analysis. Based on the results, management determines whether certain balances
are deemed uncollectible at the end of period. Using its past collection
experience, the Company reserves 0.3% of accounts receivable balances that have
been outstanding for less than one year, 3% of accounts receivable balances that
have been outstanding for more than one year but less than two years, and 10% of
accounts receivable balances that have been outstanding for more than two years.
The Company generally provides customers with credit terms of three to four
months. However, we provide our "large" customers, those with average annual
specialty cable orders of over $7 million, with credit terms of five to six
months. We generally do not conduct further business with customers that have
significant unpaid accounts receivable balances beyond 12 months, unless we
receive advance payments from such customers. As of December 31, 2011, the
amount of our receivables ages less than one year and 1-2 years was $24,589,587
and $115,787, respectively.
As of December 31, 2011 and June 30, 2011, the Company had accounts receivable
of $24,584,186 and $18,166,580, net of allowance for doubtful accounts of
$121,188 and $87,480, respectively.
Consolidation
Pursuant to ASC 810-10-15-14, an entity is deemed to be a variable interest
entity, or VIE, and thus to be consolidated by its primary beneficiary, if, by
intention, any one of the following conditions is present:
A. The total equity investment at risk in the legal entity to be consolidated is
insufficient to permit the entity to finance its activities without additional
subordinated financial support from other parties, including equity holders; or
B. As a group, holders of the equity investment at risk lack any one of the
following characteristics of a controlling financial interest:
1. The power, through voting rights or similar rights to direct the activities
of an entity that most significantly impact that entity's economic performance.
2. The obligation to absorb the expected losses of the legal entity. Such an
obligation does not exist if the shareholders/investors are directly or
indirectly protected from losses or are guaranteed a return on their investment
by the legal entity itself or by other parties involved with the legal entity.
3. The right to receive expected residual returns of the legal entity. Such
right is not considered to be present if the residual returns are capped by the
legal entity's governing documents or by other arrangements with other variable
interest holders or the legal entity itself.
30
Under the OEM Agreements, Dalian Befut can only manufacture products for WFOE
and cannot compete with WFOE in the same or similar lines of business. Dalian
Befut is a captive manufacturer with the sole business purpose of providing
manufacturing services to WFOE and is solely dependent on the business provided
by WFOE, its primary beneficiary. As WFOE controls all of the potential and
future risks and benefits of Dalian Befut, WFOE has the power to significantly
impact the economic performance of Dalian Befut. Furthermore, while Messrs.
Hongbo Cao and Tingmin Li are the two controlling shareholders of Dalian Befut,
collectively owning an aggregate of 98.6% of the equity interests in Dalian
Befut, the Company believes that, due to the OEM Agreements, WFOE, instead of
Messrs. Cao and Li, has the power to direct the activities of Dalian Befut to
significantly impact the economic performance of Dalian Befut. Based on the
aforementioned assessment, Dalian Befut is a VIE of the Company under ASC
810-10-15-14-B.1. described above, and as such, is consolidated into the
Company. Although the Company is only required to meet one criteria under ASC
810-10-15-14 in order to consolidate Dalian Befut, the Company believes that
facts and circumstances exist that would allow it to meet certain other
qualifying criteria set forth in ASC 810-10-15-14.
31
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