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CHINA FORESTRY INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) FORWARD LOOKING STATEMENTS Certain statements in this report, including statements of our expectations, intentions, plans and beliefs, including those contained in or implied by "Management's Discussion and Analysis" and the Notes to Financial Statements, are "forward-looking statements", within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that are subject to certain events, risks and uncertainties that may be outside our control. The words "believe", "expect", "anticipate", "optimistic", "intend", "will", and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update or revise any forward-looking statements. These forward-looking statements include statements of management's plans and objectives for our future operations and statements of future economic performance, information regarding our expansion and possible results from expansion, our expected growth, our capital budget and future capital requirements, the availability of funds and our ability to meet future capital needs, the realization of our deferred tax assets, and the assumptions described in this report underlying such forward-looking statements. Actual results and developments could differ materially from those expressed in or implied by such statements due to a number of factors, including, without limitation, those described in the context of such forward-looking statements. GENERAL DESCRIPTION OF BUSINESS Introduction We were originally incorporated in Nevada on January 13, 1986. Since inception, we have not had active business operations and were considered a development stage company. In 1993, we entered into an agreement with Bradley S. Shepherd in which Mr. Shepherd agreed to become an officer and director and use his best efforts to organize and update our books and records and to seek business opportunities for acquisition or participation. The acquisition of the share capital of Hong Kong Jin Yuan was such an opportunity. As a result of a Share Exchange, Hong Kong Jin Yuan became our wholly-owned subsidiary, Harbin SenRun became our indirect wholly-owned subsidiary, and we succeeded to the business of Harbin SenRun Forestry Development Co., Ltd., a producer of forest products with approximately 1,561 hectares of State forest assets located mainly over the Small Xing An Mountains, Jin Yin County, and the Harbin Wu Chang District of Heilongjiang Province of Northern China. Harbin SenRun was founded in 2004. Historically, it had a workforce of approximately 8 full time employees, mainly in sales, administration and in supporting services. It recruited temporary part-time workers to carry out felling, cutting and forestry plantation and protection. Its principal revenue was log sales. Harbin SenRun lost its wood-cutting quota for log sales from the Bureau of Forestry for the year ended December 31, 2007, and, as a result, did not have any revenues for that period. While Harbin Senrun has applied for a wood cutting quota in subsequent years, it has not been successful in acquiring one. On July 15, 2010, we entered into a Share Exchange with Financial International (Hong Kong) Holdings Co. Limited ("FIHK"). FIHK has no other material operations except a series of contractual arrangements with Hanzhong Hengtai Bio-Tech Limited ("Hengtai"), a company organized and existing under the laws of the People's Reuplic of China that is engaged in the plantation and sale of garden plants used for landscaping, including Chinese Yew, Aesculus, Dove Tree and Dendrobium. Hengtai was incorporated on October 22, 2003 with a registered capital of 15.0 million RMB. The registered address of Hengtai is in Economic Development Zone of Hanzhong City, Shaan'xi Province, China. Hengtai possesses several permits and licenses for its plantation business, including a Seedling Production Permit, a Forestry User Right, and a Seedling Operations Permit. Chinese Yew is the major product of Hengtai and the company plants two types that carry the biological names Taxus chinensis var. mairei and Taxus media. Currently, they take up approximately 28% of the planting area of the company. Hengtai currently has 29 full-time employees, including 3 members of management, 19 agricultural experts, 5 employees in sales and marketing, and 2 administrative employees. RESULTS OF OPERATIONS The following discussion should be read in conjunction with the financial statements included in this report and is qualified in its entirety by the foregoing. 18 --------------------------------------------------------------------------------CRITICAL ACCOUNTING POLICIES The discussion and analysis of our financial condition presented in this section are based upon our audited financial statements, which have been prepared in accordance with the generally accepted accounting principles in the United States. During the preparation of the financial statements, we were required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to investments, fixed assets, income taxes and other contingencies. We base our estimates on historical experience and on various other assumptions that we believes are reasonable under current conditions. Actual results may differ from these estimates under different assumptions or conditions. Financial Instruments The carrying amount reported in the balance sheet for cash, accounts receivable, inventory, other receivables, short-term loans, accounts payable, other payables, accrued expenses, interest payable and long-term loans approximate fair value because of the immediate or short-term maturity of these financial instruments. Fair Value Accounting We adopted the standard "Fair Value Measurements," codified with ASC 820 and effective January 1, 2008. The provisions of ASC 820 are to be applied prospectively. ASC 820 clarifies that fair value is an estimate of the exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (i.e. the exit price at the measurement date). Under ASC 820, fair value measurements are not adjusted for transaction cost. ASC 820 provides for use of a fair value hierarchy that prioritizes inputs to valuation techniques used to measure fair value into three levels: Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities. Level 2: Input other than quoted market prices that are observable, either directly or indirectly, and reasonably available. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent of the Company. Level 3: Unobservable inputs. Unobservable inputs reflect the assumptions that the Company develops based on available information about what market participants would use in valuing the asset or liability. An asset or liability's level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Availability of observable inputs can vary and is affected by a variety of factors. The Company uses judgment in determining fair value of assets and liabilities and Level 3 assets and liabilities involve greater judgment than Level 1 and Level 2 assets or liabilities. Cash and Cash Equivalents Cash and cash equivalents include cash on hand and demand deposits with banks. Cash deposits with banks are held in financial institutions in China, which has no federally insured deposit protection. Accordingly, we have a concentration of credit risk related to these uninsured deposits. Accounts Receivable Accounts receivable are stated at the amount management expects to collect from outstanding balances. Management provides for probable uncollected amounts through a charge to earnings and a credit to an allowance for bad debts based on its assessment of the current status of individual accounts. Balances that are still outstanding after management has used reasonable collection efforts are written off through a charge to the allowance for bad debts and a credit to accounts receivable. Inventories Inventories are stated at the lower of cost, as determined on a standard cost basis, or net present value. Costs of inventories include purchase and related costs incurred in bringing the products to their present location and condition. Management also regularly evaluates the composition of our inventories to identify slow-moving and obsolete inventories to determine if a valuation allowance is required. 19 --------------------------------------------------------------------------------Property, Plant, and Equipment Property, plant and equipment are initially recognized recorded at cost. Gains or losses on disposals are reflected as gain or loss in the period of disposal. The cost of improvements that extend the life of plant and equipment are capitalized. These capitalized costs may include structural improvements, equipment and fixtures. All ordinary repairs and maintenance costs are expensed as incurred. Depreciation for financial reporting purposes is provided using the straight-line method over the estimated useful lives of the assets: Buildings 10 years Machinery and equipment 5 years Transportation equipment 5 years Office equipment 5 years Intangible Assets Intangible assets are stated in the balance sheet at cost less accumulated amortization. The costs of the intangible assets are amortized on a straight-line basis over their estimated useful lives. The respective amortization periods for the intangible assets are as follows: Land use right 30-70 years Impairment of Long-Lived Assets We account for impairment of plant and equipment and amortizable intangible assets in accordance with the standard, "Accounting for Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of," codified with ASC 360, which requires the Group to evaluate a long-lived asset for recoverability when there is event or circumstance that indicate the carrying value of the asset may not be recoverable. An impairment loss is recognized when the carrying amount of a long-lived asset or asset group is not recoverable (when carrying amount exceeds the gross, undiscounted cash flows from use and disposition) and is measured as the excess of the carrying amount over the asset's (or asset group's) fair value. Comprehensive Income The standard, "Reporting Comprehensive Income," codified with ASC 220, requires disclosure of all components of comprehensive income and loss on an annual and interim basis. Comprehensive income and loss is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The comprehensive income arose from the effect of foreign currency translation adjustments. Revenue Recognition We generate revenues from the sales of plants, such as Taxus mairei and etc. Sales are recognized when the following four revenue criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured. Sales are presented net of value added tax (VAT). No return allowance is made as products returns are insignificant based on historical experience. Income Taxes We account for income taxes in accordance with the standard, "Accounting for Income Taxes," codified with ASC 740. ASC 740 requires an asset and liability approach for financial accounting and reporting for income taxes and allows recognition and measurement of deferred tax assets based upon the likelihood of realization of tax benefits in future years. Under the asset and liability approach, deferred taxes are provided for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided for deferred tax assets if it is more likely than not these items will either expire before the Group is able to realize their benefits, or that future deductibility is uncertain. Loss Per Share Basic loss per share is computed by dividing net loss by the weighted average number of shares of common stock outstanding during each period. Diluted earnings per share is computed by dividing net income by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. At June 30, 2011, we had no common stock equivalents that could potentially dilute future earnings per share; however, if present, a separate computation of diluted loss per share would not have been presented, as these common stock equivalents would have been anti-dilutive due to our net loss. 20 --------------------------------------------------------------------------------Segment Information The standard, "Disclosures about Segments of an Enterprise and Related Information," codified with ASC 280, requires certain financial and supplementary information to be disclosed on an annual and interim basis for each reportable segment of an enterprise. We believe that we operates in one business segment (research, development, production, marketing and sales) and in one geographical segment (China), as all of our current operations are carried out in China. Foreign Currency Translation Our functional currency is Chinese Renminbi ("RMB") and our reporting currency is the U.S. dollar. Transactions denominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect on the date of the transactions. Exchange gains or losses on transactions are included in earnings. Our consolidated financial statements are translated into U.S. dollars in accordance with the standard, "Foreign Currency Translation," codified with ASC 830, using year-end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues, costs, and expenses and historical rates for equity. Translation adjustments resulting from the process of translating the local currency consolidated financial statements into U.S. dollars are included in determining comprehensive income. At June 30, 2011 and December 31, 2010, the cumulative translation adjustments of $195,001 and $192,474, respectively, were classified as items of accumulated other comprehensive income (loss) in the stockholders' equity section of the balance sheet. For the six months ended June 30, 2011 and 2010, other comprehensive income (loss) was $2,527 and ($816), respectively. The exchange rates used to translate amounts in RMB into U.S. dollars for the purposes of preparing the consolidated financial statements were as follows: As of June 30, 2011 and December 31, 2010, we used the period-end rates of exchange for assets and liabilities of $1 to RMB6.464 and $1 to RMB6.5897, respectively. For the six months ended June 30, 2011 and 2010, we used the period's average rate of exchange to convert revenues, costs, and expenses of $1 to RMB6.5412 and $1 to RMB6.8252, respectively. We used historical rates for equity. Related Parties A party is considered to be related to us if the party directly or indirectly or through one or more intermediaries, controls, is controlled by, or is under common control with us. Related parties also include our principal owners, our management, members of the immediate families of our principal owners and our management and other parties with which we may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. A party which can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests is also a related party. Commitments and Contingencies Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. RESULTS OF OPERATIONS Three Months Ended June 30, 2011 Compared to the Three Months Ended June 30, 2010 Net Sales We had net sales of $337,590 for the three months ended June 30, 2011 as compared to $101,585 for the three months ended June 30, 2010, an increase of $236,005 or approximately 232%. This result is a function of increased sales to major customers by our subsidiary Hengtai. Cost of Sales and Gross Profit For the three months ended June 30, 2011, cost of sales amounted to $261,964 as compared to cost of sales of $86,093 for the three months ended June 30, 2010. The rise in cost of sales is mainly attributable to the increase in the amount of sales. Gross profit for the three months ended June 30, 2011 was $75,626, as compared to $15,492 for the three months ended June 30, 2010. 21 --------------------------------------------------------------------------------Operating Expenses For the three months ended June 30, 2011, total operating expenses were $65,037 as compared to $27,941 for the three months ended June 30, 2010, an increase of $37,096, or approximately 133%. This result was mainly due to an increase of $23,715 in general and administrative expenses and an increase in selling expenses of $13,381. For the three months ended June 30, 2011, interest expense was $81,250 as compared to $2,803 for the three months ended June 30, 2010. For the three months ended June 30, 2011, total other expenses were $37,110 as compared to total other income of $10,404 for the three months ended June 30, 2010. The increase in total other expenses for the three month period ended June 30, 2011 was attributable to higher interest expense. As a result of these factors, we reported a net loss of $26,521 or $0.00 per share for the three months ended June 30, 2011, as compared to a net loss of $2,045 or $0.00 per share for the same period in 2010. The increase in net loss was attributable to higher operating expenses and interest expense. Six Months Ended June 30, 2011 Compared to the Six Months Ended June 30, 2010 Net Sales We had net sales of $868,579 for the six months ended June 30, 2011 as compared to $146,747 for the six months ended June 30, 2010, an increase of $721,832 or approximately 492%. This result is a function of increased sales to major customers by our subsidiary Hengtai. Cost of Sales and Gross Profit For the six months ended June 30, 2011, cost of sales amounted to $682,098 as compared to cost of sales of $125,792 for the six months ended June 30, 2010. The rise in cost of sales is mainly attributable to the increase in the amount of sales. Gross profit for the six months ended June 30, 2011 was $186,481, as compared to $20,955 for the three months ended June 30, 2010. Operating Expenses For the six months ended June 30, 2011, total operating expenses were $141,168 as compared to $46,237 for the six months ended June 30, 2010, an increase of $94,931, or approximately 205%. This result was mainly due to an increase of $73,181 in general and administrative expenses and an increase in selling expenses of $21,750 for the six months ended June 30, 2011 from the same corresponding period in 2010. For the six months ended June 30, 2011, interest expense was $135,319 as compared to $25,218 for the six months ended June 30, 2010. For the six months ended June 30, 2011, total other income was $22,511 as compared to total other expenses of $2,276 for the six months ended June 30, 2010. The increase in total other income for the six month period ended June 30, 2011 was attributable to greater other income of $157,861 from exemption of VAT. As a result of these factors, we reported net income of $67,824 or $0.00 per share for the six months ended June 30, 2011, as compared to a net loss of $27,558 or $0.00 per share for the same period in 2010. The increase in net income was attributable to higher sales and other income. Liquidity and Capital Resources At June 30, 2011, we had cash and cash equivalents of $58,904. Net cash provided by operating activities for the six months ended June 30, 2011 was $88,179 as compared to net cash provided by operating activities of $3,347 for the six months ended June 30, 2010. For the six months ended June 30, 2011, we had net income of $67,824, our inventories increased by $82,890, accounts payable increased by $20,124, restricted cash decreased by $28,833, accounts receivable decreased by $950, other receivables decreased by $32,333, prepayments increased by $27,534, accrued liabilities and other current liabilities increased by $39,195, offset by non-cash items such as depreciation and amortization of $2,696, provision for bad debts of $6,036 and loss on disposal of property, plant and equipment of $612. For the six months ended June 30, 2010, we used cash to fund our loss of $27,558, our inventories decreased by $42,383, accounts receivable decreased by $1,128, other receivables increased by $20,174, prepayments increased by $7,581, accounts payable decreased by $3,898, accrued expenses and other current liabilities increased by $21,082, offset by non-cash items such as depreciation and amortization of $2,017 and gain on disposal of property, plant and equipment of $3,865. 22 --------------------------------------------------------------------------------Net cash used in investing activities for the six months ended June 30, 2011 was $96,132 as compared to $7,078 net cash provided by investing activities for the six months ended June 30, 2010. For the six months ended June 30, 2011 and 2010, we used cash of $58,949 and $0 for purchase of property and equipment, respectively. For the six months ended June 30, 2011, we received net proceeds of $612 from the disposal of property, plant and equipment compared to $7,078 for the corresponding period in 2010. For the six months ended June 30, 2011, we made loans of $37,795 to related parties. Net cash provided by financing activities for the six months ended June 30, 2011 was $47,316 as compared to net cash used in financing activities for the six months ended June 30, 2010 of $1,907. For the six months ended June 30, 2011, we received proceeds of $37,500 from related parties and repaid $15,856 to related parties. We received proceeds of $67,946 and made repayment of $55,524 for loans. For the six months ended June 30, 2010, we received proceeds of $3,044 from related parties and $5,220 from loans, offset by repayment for loans of $4,348. We have not generated sufficient cash flows from operations. If we do not generate enough revenues from the sales of our products to meet our cash needs, we will need other financing to continue to operate. As we work to increase sales of our products, we expect to increase cash flows from operations. However, we may choose at any time to raise capital through private debt or equity financing to strengthen our financial position and facilitate growth. Off Balance Sheet Arrangements We have no off balance sheet arrangements at June 30, 2011. Recently Issued Accounting Pronouncements In October 2009, the FASB issued ASU No. 2009-13, "Multiple-Deliverable Revenue Arrangements-a consensus of the FASB Emerging Issues Task Force," that provides amendments to the criteria for separating consideration in multiple-deliverable arrangements. As a result of these amendments, multiple-deliverable revenue arrangements will be separated in more circumstances than under existing U.S. GAAP. The ASU does this by establishing a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. A vendor will be required to determine its best estimate of selling price in a manner that is consistent with that used to determine the price to sell the deliverable on a standalone basis. This ASU also eliminates the residual method of allocation and will require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method, which allocates any discount in the overall arrangement proportionally to each deliverable based on its relative selling price. Expanded disclosures of qualitative and quantitative information regarding the application of the multiple-deliverable revenue arrangement guidance are also required under the ASU. The ASU does not apply to arrangements for which industry specific allocation and measurement guidance exists, such as long-term construction contracts and software transactions. For us, ASU No. 2009-13 is effective beginning January 1, 2011. We elected to adopt the provisions of this standard prospectively to new or materially modified arrangements beginning on the effective date. The adoption of this standard did not have a material impact on our consolidated results of operations or financial condition. In October 2009, the FASB issued ASU No. 2009-14, "Certain Revenue Arrangements That Include Software Elements-a consensus of the FASB Emerging Issues Task Force," that reduces the types of transactions that fall within the current scope of software revenue recognition guidance. Existing software revenue recognition guidance requires that its provisions be applied to an entire arrangement when the sale of any products or services containing or utilizing software is considered more than incidental to the product or service. As a result of the amendments included in ASU No. 2009-14, many tangible products and services that rely on software will be accounted for under the multiple-element arrangements revenue recognition guidance rather than under the software revenue recognition guidance. Under the ASU, the following components would be excluded from the scope of software revenue recognition guidance: the tangible element of the product, software products bundled with tangible products where the software components and non-software components function together to deliver the product's essential functionality, and undelivered components that relate to software that is essential to the tangible product's functionality. The ASU also provides guidance on how to allocate transaction consideration when an arrangement contains both deliverables within the scope of software revenue guidance (software deliverables) and deliverables not within the scope of that guidance (non-software deliverables). For us, ASU No. 2009-14 is effective beginning January 1, 2011. We elected to adopt the provisions of this standard prospectively to new or materially modified arrangements beginning on the effective date. The adoption of this standard did not have a material impact on our consolidated results of operations or financial condition. In January 2010, the FASB issued ASU No. 2010-6, "Improving Disclosures About Fair Value Measurements", that amends existing disclosure requirements under ASC 820 by adding required disclosures about items transferring into and out of Levels 1 and 2 in the fair value hierarchy; adding separate disclosures about purchases, sales, issuances, and settlements relative to Level 3 measurements; and clarifying, among other things, the existing fair value disclosures about the level of disaggregation. For us, this ASU is effective for the first quarter of 2010, except for the requirement to provide Level 3 activity of purchases, sales, issuances, and settlements on a gross basis, which is effective beginning the first quarter of 2011. Since this standard impacts disclosure requirements only, its adoption will not have a material impact on our consolidated results of operations or financial condition. 23 --------------------------------------------------------------------------------In April 2010, the FASB issued ASU No. 2010-17, Milestone Method of Revenue Recognition- a consensus of the FASB Emerging Issues Task Force that recognizes the milestone method as an acceptable revenue recognition method for substantive milestones in research or development arrangements. This standard would require its provisions be met in order for an entity to recognize consideration that is contingent upon achievement of a substantive milestone as revenue in its entirety in the period in which the milestone is achieved. In addition, this ASU would require disclosure of certain information with respect to arrangements that contain milestones. For us, this standard would be required prospectively beginning January 1, 2011. The adoption of this standard did not have a material impact on our consolidated results of operations or financial condition. |