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APOLLO SOLAR ENERGY, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion contains forward-looking statements that involve risks and uncertainties. Forward-looking statements include, but are not limited to, statements regarding future events, our plans and expectations and financial projections. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed elsewhere in this Form 10-Q and in our Annual Report on Form 10-K filed on May 10, 2013. Unless the context otherwise requires, the terms "we," the "Company," "us," or "Apollo" refers to Apollo Solar Energy, Inc. and our wholly-owned subsidiaries and variable interest entities. Overview We are a China-based vertically integrated refiner of tellurium, or Te, and high-purity tellurium-based metals for specific segments of the electronic materials market. Our main expertise is in the production of Te-based compounds used to produce thin-film solar cells, cell modules and solar electronic products. While no reserves under the SEC's Industry Guide 7 can currently be delineated at our properties, we believe that the tellurium to be used in our products in the future will be primarily sourced from our Dashuigou project located in Sichuan Province, PRC. In addition, we expect to source tellurium from another property in Shimian, Majiagou, PRC, through variable interest entity agreements, or the VIE Agreements, executed in April, 2009, with Sichuan Xinju Mineral Resources Development Corporation and certain of its shareholders holding 51.6619% of its voting stock, which shareholders are our direct or indirect employees. Under the terms of the VIE Agreements, we have been granted the exclusive exploration and mining rights to these two projects in accordance with a license granted by the Chinese government, which extends through January 2014 for exploration and mining activities at our Dashuigou property, and through May 2013 for mining activities at our Majiagou property, subject to potential renewal thereafter. Currently, tellurium is produced as a by-product in the process of processing copper and other metals. As a result, costs are high. We believe that the Dashuigou and Majiagou projects are the only two known deposits in the world in which tellurium, one of the rarest metallic elements on earth, is the primary commodity of economic interest. By the end of 2014, we plan to obtain approximately 50% to 60% of the tellurium necessary for our products from the Dashuigou and Majiagou projects and believe this ability to be a significant competitive advantage because the cost of tellurium sourced from our own properties will be substantially lower than that purchased from an outside third party. We will source the remaining 40% to 50% of our tellurium needs from third-party suppliers with whom we have established good business relationships over the past few years. By vertically integrating our processes, we believe we are able to achieve significant operating efficiencies and produce high-quality products that offer cost and quality benefits to our customers. Our refining operations are currently based in a 330,000 square foot facility in Chengdu, Sichuan Province, PRC. We expect this facility to eventually have the capacity to produce more than 300 tons of high-purity photovoltaic cell materials and 42 other types of electronic materials. Future expansion of this facility in vacant land leased to the Company will have a capacity to produce up to an additional 350 tons of high-purity photovoltaic cell materials. We are currently in the exploration stage of operations in accordance with the requirements of SEC Industry Guide 7. However, we believe we are unique in that we expect to both mine and refine our tellurium-based products, with primary refining capabilities as provided by Sichuan Xinju Mineral Resources Development Corporation pursuant to the VIE Agreements, and secondary refining capabilities directly through our Company. Our primary refining capabilities are such that we can treat metal concentrates (containing, for example, as little as 50% of the metals of interest), and extract and refine the metals of interest so that they can be fed to our secondary refining operations, where we attain a higher level of purity. Because we expect to mine the raw material in the future, and perform both refining functions, both directly and through our VIE Arrangement, we consider ourselves a supplier that will in the future have uniquely integrated capabilities. Our end-products are tellurium, cadmium, zinc and related compounds of 99.999% (five nines, or 5N) purity or above. Our products are critical precursors in a number of electronic applications, including the rapidly-expanding thin-film photovoltaic, or PV, market. 11 -------------------------------------------------------------------------------- Thin film technologies, because of their relatively low usage of raw materials when compared with traditional silicon-based photovoltaic technologies, offer a potential cost advantage in the marketplace. Accordingly, we believe these technologies are beginning to gain an ever increasing foothold in the market. Our Variable Interest Entity Agreements As illustrated in the diagram below, we entered into various exclusive contractual arrangements on April 10, 2009 with Sichuan Xinju Mineral Resources Development Corporation, or the VIE, and certain of its shareholders who are our direct or indirect employees and who collectively own 51.6619% of the VIE. Among other things, these VIE Agreements granted to our wholly-owned subsidiary a first option to purchase the exploration rights related to the Dashuigou area property and the mining rights related to that certain tellurium and bismuth property in Shimian Majiagou, which rights we collectively referred to as the Exploration Business. Additionally, the VIE and certain of its shareholders who collectively own 51.6619% of the VIE granted to our wholly-owned subsidiary an exclusive right to purchase all of the products produced from the Exploration Business for a specified period of time. As a result, we consolidate the financial results of the VIE related to the Exploration Business pursuant to FASB ASC 810-10, "Consolidation." [[Image Removed]] (1) Agreements that provide us with effective control over Sichuan Xinju Mineral Resources Development Co. Ltd., or the VIE, include a purchase option agreement, a business operations agreement and an exclusive technical and consulting agreement. 12 --------------------------------------------------------------------------------The agreements between the VIE and our other affiliated entities or persons are summarized below: · First Option Exclusive Acquiring Agreement among Sichuan Xinlong Tellurium Industry & Technique Co., Ltd., Sichuan Xinju Mineral Resources Development Co., Ltd., Renyi Hou and Ling Yong, which grants to our wholly-owned subsidiary a first option to purchase the Mining Business at such time as the purchase becomes advisable, permissible and in our best interest. · Exclusive Sales Agreement between Sichuan Xinlong Tellurium Industry & Technique Co., Ltd. and Sichuan Xinju Mineral Resources Development Co., Ltd., which grant to our wholly-owned subsidiary the exclusive right to buy all of the output of the Mining Business. · Business Operation Agreement among Sichuan Xinlong Tellurium Industry & Technique Co., Ltd., Sichuan Xinju Mineral Resources Development Co., Ltd., Renyi Hou and Ling Yong, which imposes certain restrictions and obligations on the VIE and certain of its shareholders to support the VIE arrangement, including refraining from competing with our business and modifying the business operations of the VIE without the prior consent of our wholly-owned subsidiary. Exclusive Technical and Consulting Agreement · between Sichuan Xinlong Tellurium Industry & Technique Co., Ltd. and Sichuan Xinju Mineral Resources Development Co., Ltd., which requires the VIE to provide certain technical and consulting services exclusively to our wholly-owned subsidiary in connection with the Mining Business. Our wholly-owned subsidiary agrees to provide up to $6.0 million in investing funding to the VIE in connection with its operation of the Mining Business, on such terms as the parties shall agree from time to time. Results of Operations Sales Sales for the three months ended March 31, 2013 were $1,556,215, compared to the sales of $1,872,034 in the same period in 2012, a decrease of $315,819 or approximately 16.8%. The primary reasons for the reduction in sales were: · Decrease in the selling price of Tellurium to $159 this year from $319 the first quarter of last year; · The sales during three months ended March 31, 2012 including $318,629 sales of Infrared Image; we recorded no sale of Infrared Image in the three months ended March 31, 2013. Gross profit Our cost of sales for the three months ended March 31, 2013 was 1,419,509, compared to the cost of sales of $1,768,154 in the same period in 2012, a decrease of 348,645 or approximately 19.7%. Our gross margin in each of the quarters was less than 9%. The primary reason for the this low level of gross margin was the delay in production from our tellurium mines, caused by new government regulations. Without an internal source of tellurium, we were forced to purchase tellurium on the world market. As a significant amount of our revenue was generated from the sale of compounds incorporating high purity tellurium, our margin was impacted adversely. We expect this situation to improve as we have satisfied the new government regulations and expect internal tellurium production to be initiated in the next year. Selling expense For the three months ended March 31, 2013, selling expenses were $64,548 compared to $56,898 for the three months ended March 31, 2012, representing an increase of 13.5%. This increase occurred because the Company carried out more promotions in the first quarter of 2013 than in the same period of last year. 13 --------------------------------------------------------------------------------General and administrative expenses We incurred general and administrative expenses of $619,048 for the three months ended March 31, 2013, compared to $688,019 in the same period of 2011, representing a decrease of 10%. The principal reason for the improvement was the decrease in stock-based compensation costs from $143,618 in three months ended March 31, 2012 to $70,608 in the three months ended March 31, 2013. Certain members of senior management left the company late in 2012, resulting in expiration of their stock options. Research and development expenses For the three months ended March 31, 2013, we incurred research and development expenses of $295,252, compared to $155,570 for the three months ended March 31, 2012. This represents an increase of 90%. Research and development expenses increased because the Company was able to invest a portion of the proceeds from its sale of convertible debt into the development of new products and production processes. Other income (expense) Other income (expense) consisted of loss in equity in Joint Venture and interest expenses. We hold a 35% interest in COE Apollo, a joint venture. We record our share of the COE Apollo's profits and losses on the equity basis. We recorded a loss of $95,500 and $108,597 on our investment in COE Apollo for the three months ended March 31, 2013 and 2012, respectively. For the three months ended March 31, 2013 and 2012, we incurred interest expenses of $106,529 and $138,896 respectively, representing a decrease of 23.3%. The decrease occurred primarily because we replaced interest-bearing debt with short-term loans from an unrelated party that bear no interest. Net income/loss We recorded a net loss of $1,044,171 and $1,044,100 for the three months ended March 31, 2013 and 2012. Our expectation is that we will continued to incur losses until we are able to source most of our Tellurium from our own mines. Liquidity and Capital Resources We have historically funded our operation primarily through paid-in capital, sales of goods, loan from stockholders and short term loans from financial institutions in China. Based on our current cash level and management's forecast of operating cash flows, management has determined that the Company will require additional funds, either debt or equity, to finance our planned operations for the next twelve months. The Following table summarizes our liquidity and capital resources on the dates presented March 31, December 31, 2013 2012 Cash $ 892,740 $ 940,225 Working capital(deficit) (7,896,851 ) (7,497,221 ) Stockholders' Equity 13,849,204 14,736,634 14-------------------------------------------------------------------------------- The Company had a working capital deficit of $7,896,851 at March 31, 2013. This represented an atrophy of $399,630 since December 31, 2012. The primary reason for the atrophy of working capital was the $1,044,171 loss that we incurred during three months ended March 31, 2013, which we funded by taking short-term loans. The following table describes our contractual commitments and obligations as of March 31, 2013: Payments due by Period (in $) Contractual Less Than 1 Obligations Total Year 1 - 3 Years 3 -5 Years More Than 5 Years Short term loans $ 7,681,199 $ 7,681,199 $ -- $ -- $ -- Convertible loan 400,000 -- -- 400,000 -- Loans from shareholder and related party 453,104 453,104 -- -- -- Total $ 8,534,303 $ 8,134,303 $ -- $ 400,000 $ -- Given that the Company's debt obligations in the next twelve months equal 161% of its current assets at March 31, 2013, management has determined that additional funds will have to be secured in order to finance our operations for the coming year. Cash flows The following table shows the movements of our cash for the periods presented Three Months Ended March 31, 2013 2012 Net cash used in operating activities $ (252,290 ) $ (1,892,724 ) Net cash used in investing activities (1,141 ) (13,499 ) Net cash provided by financing activities 235,707 2,864,464 Effect of exchange rate changes on cash (29,761 ) 2,032 Net increase (decrease) in cash (47,485 ) 960,273 Cash at beginning of period 940,225 363,771 Cash at end of period $ 892,740 $ 1,324,044 Net cash used in operating activities. Our operating activities during the three months ended March 31, 2013 used $252,290 in cash. The cash impact of our net loss of $1,044,171 was partially offset by a reduction in our inventory and a sizeable increase in accounts payable-trade. By comparison, our operations in the first quarter of 2012 used $1,892,724 in cash. The use of cash exceeded our net loss of $1,044,100 primarily because we used $1,297,217 for prepaid expenses and other current assets. In addition, we reduced our accrued expenses and other current liabilities by $315,157. Net cash used in investing activities. Due to our lack of funds, we have made only very modest additions to our capital assets during recent years. Net cash used in investing activities for the three months ended March 31, 2013 and 2012 was $1,141 and $13,499, which resulted from the purchase of property and equipment. 15 --------------------------------------------------------------------------------Net cash /provided by financing activities. Net cash provided by financing activities for the three months ended March 31, 2013 was $235,707. This was primarily attributable to $299,030 in proceeds from the convertible debt we issued as well as $78,663 that stockholders repaid to us. We funded our 2012 operations by taking short-term loans totaling $2,852,495 in the first quarter of 2012. Off-Balance Sheet Transactions We have no material off-balance sheet transactions. |