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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 7, 2014. 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 ("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. 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 June 2015 for exploration activities at our Dashuigou property, and through June 2014 for exploration and mining activities at our Majiagou property. The licenses are subject to potential renewal at their termination date. On January 14, 2014 our license to carry on mining activities at the Dashuigou property terminated; our hope is that we will be able to renew it if our exploration activities on that site prove fruitful. 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. We had planned to begin mining at Dashuigou in 2012, but were delayed by new mining regulations adopted by the local government. We have achieved compliance with the new regulations. Our long-term plan, therefore, is to obtain approximately 50% to 60% of the tellurium necessary for our products from the Dashuigou, Majiagou and other 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. For the near-term (at least into 2015), we will source all of our tellurium requirements, and thereafter 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. In November 2009 we entered into a joint venture to produce thin film solar cells. Our principal joint venture partner is Bengbu Design & Research Institute for the Glass Industry, which is an affiliate of China National Building Materials Group, a giant state-owned entity. A local government agency also owns an equity interest in the joint venture. In exchange for our contribution of land and facilities as well as three patents, we received a 35% equity interest in the joint venture, which is named CEO Apollo Solar. At present, COE Apollo Solar is engaged in research regarding glass used in production of thin film solar cells, and is developing a production line for 80MW CdTe thin film solar modules. COE Apollo Solar has obtained the requisite government licenses, and expects to complete construction of the assembly line during 2015. 15 -------------------------------------------------------------------------------- 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 Minteral 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. 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 (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. 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 and six months ended June 30, 2014 were $1,934,173 and 2,921,089 respectively, compared to the sales of $6,365,860 and $7,922,075 in the same period in 2013, a decrease of $4,431,687 or approximately 69.6% for the three months period and a decrease of $5,000,986 or approximately 63.1% for the six months period. The primary reason for the decrease is that the Company engaged in purchase and sale transactions during 2013 that had features of high turnover and low margin, with increased sales as a result. The Company has not been pursuing that kind of transaction during 2014, which has resulted in reduced sales but improved margins. 16 -------------------------------------------------------------------------------- Gross profit/loss Our cost of sales decreased by $4,349,076 and $4,839,938 or 71.4% and 64.4% in the three and six months ended June 30, 2014 compared to the same period of 2013. Our gross margin remained very low: 10% during the three months ended June 30, 2014 and 9% during the six months ended June 30, 2014 compared to 4% and 5% for the same period in 2013. The primary reason for 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 2015. Selling expense For the three months ended June 30, 2014, selling expenses were $41,309 compared to $78,221 for the three months ended June 30, 2013, representing a decrease of 47.2%. For the six months ended June 30, 2014, selling expenses were $70,644 compared to $142,769 for the six months ended June 30, 2013, representing a decrease of 50.5%. Selling expenses were higher during three and six months ended June 30, 2013 because the Company initiated a concerted effort to increase sales by hiring more sales people and increasing efforts to promote the product to the market. Due to lack of resources, we have scaled back our marketing efforts in 2014. General and administrative expenses We incurred general and administrative expenses of $378,910 and $638,411 for the three and six months ended June 30, 2014, compared to $625,128 and $1,244,176 in the same period of 2013, representing a decrease of 39.4% and 48.7% compare to the same period in 2013. The decrease in our general and administrative expenses was primarily due to headcount reduction as a result of internal reform. Research and development expenses For the six months ended June 30, 2014, we incurred research and development expenses of $515,552, less $325,749 of government grant received. For the six months ended June 30, 2013, we incurred research and development expenses of $630,683. For the three months ended June 30, 2014, we incurred research and development expenses of $197,751, compared to $335,431 for the three months ended June 30, 2013. Operating loss Our operating loss for the three months ended June 30, 2014 was $426,456, which was $338,199 or 44.2% less than our operating loss for the three months ended June 30, 2013. Our operating loss for the six months ended June 30, 2014 was $649,075, which was $957,722 or 59.6% less than our operating loss for the six months ended June 30, 2013. Other income (expense) In 2009, we acquired a 35% interest in a joint venture. We accounts for this investment under the equity method of accounting. During the six months ended June 30, 2014 and 2013, the operations of the Joint Venture resulted in net loss of $193,656 and $535,820, respectively. Because we own 35% of the equity in the Joint Venture and account for that investment on the equity method, we recorded Equity in Income of Joint Venture of $100,025 and equity in loss of Joint Venture of $92,039 for the three month periods ended June 30, 2014 and 2013, respectively; we recorded Equity in Loss of Joint Venture of $67,780 and $187,539 for the six month periods ended June 30, 2014 and 2013, respectively 17 -------------------------------------------------------------------------------- In addition, during the three and six month periods ended June 30, 2014, we recorded net interest expense of $146,255 and $296,379, compared to $313,983 and $420,512 in the same period in 2013, respectively. The decrease in interest expenses was related to the decrease in interest rate during year 2014 compared to the same periods in 2013. Net loss We recorded net loss of $472,686 for the three months ended June 30, 2014 and a net loss of $1,013,234 for the six months ended June 30, 2014 . We recorded net loss of $1,170,677 for the three months ended June 30, 2013 and a net loss of $2,214,848 for the six months ended June 30, 2013. Liquidity and Capital Resources We have historically funded our operations 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: June 30, December 31, 2014 2013 Cash $ 1,213,365 $ 2,068,421 Working capital(deficit) $ (8,894,835 ) $ (7,605,859 ) Stockholders' Equity $ 12,276,473 $ 13,403,495 The Company had a working capital deficit of $8,894,835 at June 30, 2014. This represented an atrophy of $1,288,976 since December 31, 2013. The primary reason for the atrophy of working capital was the $1,013,234 loss that we incurred during six months ended June 30, 2014, which we funded from our cash resources. The following table describes our contractual commitments and obligations as of June 30, 2014: Payments due by Period (in $) Contractual Less Than 1 - 3 3 - 5 More Than Obligations Total 1 Year Years Years 5 Years Short term loans $ 9,169,320 $ 9,169,320 $ - $ - $ - Loans from shareholder and related party $ 394,030 $ 394,030 $ - $ - $ - Convertible loans $ 510,000 - - $ 510,000 $ - Total $ 10,073,350 $ 9,563,350 $ - $ 510,000 $ - Given that the Company's debt obligations in the next twelve months equal 210.8% of its current assets at June 30, 2014, management has determined that additional funds will have to be secured in order to finance our operations for the coming year. 18 -------------------------------------------------------------------------------- Cash Flows Six months Ended June 30, 2014 2013 Net cash used in operating activities $ (120,749 ) $ (1,406,067 ) Net cash provided by (used in) investing activities (277,424 ) 31,144 Net cash provided by (used in) financing activities (462,512) 2,014,217 Effect of exchange rate changes on cash 13,979 71,795 Net increase (decrease) in cash (846,706) 711,089 Cash at beginning of period 921,197 940,225 Cash at end of period $ 74,491 $ 1,651,314 Net cash (used in)/provided by operating activities. Our operating activities during the six months ended June 30, 2014 used $120,749 in cash. The use of cash was less than our net loss from operations of $1,013,234, primarily because we reduced our accounts receivable by $238,640 and inventory by $329,118, and increased our accrued expenses by $584,860. Our operating activities during the six months ended June 30, 2013 used $1,406,067 in cash. The cash impact of our net loss of $2,214,848 was partially offset by a reduction in our inventory and a sizeable increase in accounts payable-trade. Net cash (used in)/provided by investing activities. Due to our lack of funds, we have made only very modest additions to our capital assets during recent years. During the six months ended June 30, 2014 and 2013, we invested $277,424 and $13,599 in property and equipment and construction in process. During the six months ended June 30, 2013, we had cash proceeds of $44,743 from disposal of property and equipment. Net cash (used in)/provided by financing activities. During the six months ended June 30, 2014, we repaid $490,000 in partial satisfaction of our outstanding convertible loans and reduced our debts to related parties by $27,488 net. In contrast, during the six months ended June 30, 2013, the Company received $899,030 of proceeds from those same convertible loans and repaid $6,698 to related party and stockholder loans. The Company received $1,121,885 from short-term loans. The Company believes that its cash flows generated internally will not be sufficient to sustain operations and repay short term bank loans for the next twelve months. Therefore, from time to time, the Company will require extra funding through short term borrowing from PRC banks or other financing activities. Off-Balance Sheet Transactions We have no material off-balance sheet transactions. |