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EX-31.1 - EXHIBIT 31.1 - Cleantech Solutions International, Inc.,ex311.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

COMMISSION FILE NUMBER: 001-34591

CLEANTECH SOLUTIONS INTERNATIONAL, INC.
 (Exact name of Registrant as specified in its charter)

NEVADA
(State or other jurisdiction of 
 incorporation of organization)
90-0648920
(I.R.S. Employer
Identification No.)
 
No. 9 Yanyu Middle Road
Qianzhou Village, Huishan District, Wuxi City
Jiangsu Province, China 214181
 (Address of principal executive offices)

(86) 51083397559
 (Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
(Do not check if smaller reporting company)
o
Smaller reporting company
x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.  3,859,986 shares of common stock are issued and outstanding as of August 14, 2014.
 


 
 
1

 
 
CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
FORM 10-Q
June 30, 2014

 
     
Page No.
 
PART I. - FINANCIAL INFORMATION
 
   
 
 
    Condensed Consolidated Balance Sheets as of June 30, 2014 (Unaudited) and December 31, 2013     3  
    Unaudited Condensed Consolidated Statements of Income and Comprehensive Income for the Three and Six Months Ended June 30, 2014 and 2013      4  
    Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013      5  
    Notes to Unaudited Condensed Consolidated Financial Statements.      6  
    24  
    40  
    40  
PART II - OTHER INFORMATION
 
           
    41  

FORWARD LOOKING STATEMENTS

This report contains forward-looking statements regarding our business, financial condition, results of operations and prospects. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions or variations of such words are intended to identify forward-looking statements, but are not deemed to represent an all-inclusive means of identifying forward-looking statements as denoted in this report. Additionally, statements concerning future matters are forward-looking statements.

Although forward-looking statements in this report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those specifically addressed under the headings “Risks Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our annual report on Form 10-K, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q and information contained in other reports that we file with the SEC. You are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.

We file reports with the SEC. The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report, except as required by law. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this quarterly report, which are designed to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

 

PART 1 - FINANCIAL INFORMATION


CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

   
June 30, 2014
   
December 31, 2013
 
   
(Unaudited)
       
ASSETS
           
             
CURRENT ASSETS:
           
    Cash and cash equivalents
  $ 1,766,655     $ 1,114,873  
    Restricted cash
    357,421       687,353  
    Notes receivable
    100,711       703,718  
    Accounts receivable, net of allowance for doubtful accounts
    13,663,007       15,234,863  
    Inventories, net of reserve for obsolete inventories
    7,915,013       4,733,558  
    Advances to suppliers
    675,372       695,254  
    Prepaid VAT on purchases
    112,231       489,302  
    Deferred tax assets - current portion
    251,331       253,173  
    Prepaid expenses and other
    260,347       74,030  
                 
        Total Current Assets
    25,102,088       23,986,124  
                 
PROPERTY AND EQUIPMENT, net
    72,827,658       70,595,138  
                 
OTHER ASSETS:
               
   Deferred tax assets - net of current portion
    1,213,320       1,222,216  
   Equipment held for operating lease, net
    4,549,061       4,751,206  
   Land use rights, net
    3,710,476       3,786,051  
                 
        Total Assets
  $ 107,402,603     $ 104,340,735  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
CURRENT LIABILITIES:
               
    Short-term bank loans
  $ 3,086,821     $ 3,109,453  
    Bank acceptance notes payable
    357,421       687,353  
    Accounts payable
    5,031,492       4,961,555  
    Accrued expenses
    513,698       899,816  
    Advances from customers
    386,990       1,455,740  
    VAT and service taxes payable
    164,155       126,349  
    Income taxes payable
    460,467       1,623,603  
 
               
        Total Current Liabilities
    10,001,044       12,863,869  
                 
        Total Liabilities
    10,001,044       12,863,869  
                 
STOCKHOLDERS' EQUITY:
               
Preferred stock ($0.001 par value; 10,000,000 shares authorized; 0 share issued and
 
        outstanding at June 30, 2014 and December 31, 2013)
    -       -  
Common stock ($0.001 par value; 50,000,000 shares authorized; 3,859,986 and 3,503,502
 
        shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively)
    3,860       3,503  
    Additional paid-in capital
    33,517,857       31,532,308  
    Retained earnings
    50,454,995       46,322,329  
    Statutory reserve
    3,226,316       2,744,720  
    Accumulated other comprehensive income - foreign currency translation adjustment
    10,198,531       10,874,006  
                 
        Total Stockholders' Equity
    97,401,559       91,476,866  
                 
        Total Liabilities and Stockholders' Equity
  $ 107,402,603     $ 104,340,735  
                 
                 
See notes to unaudited condensed consolidated financial statements
 

CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

   
For the Three Months Ended
   
For the Six Months Ended
 
   
June 30,
   
June 30,
 
   
2014
   
2013
   
2014
   
2013
 
                         
REVENUES
  $ 17,528,018     $ 17,214,134     $ 35,163,289     $ 31,098,833  
                                 
COST OF REVENUES
    13,443,581       13,241,114       26,805,566       23,995,723  
                                 
GROSS PROFIT
    4,084,437       3,973,020       8,357,723       7,103,110  
                                 
OPERATING EXPENSES:
                               
     Depreciation
    118,410       244,673       228,269       351,887  
     Selling, general and administrative
    935,715       620,151       1,823,185       1,358,151  
                                 
        Total Operating Expenses
    1,054,125       864,824       2,051,454       1,710,038  
                                 
INCOME FROM OPERATIONS
    3,030,312       3,108,196       6,306,269       5,393,072  
                                 
OTHER INCOME (EXPENSE):
                               
     Interest income
    3,905       688       9,145       1,169  
     Interest expense
    (60,099 )     (64,526 )     (117,826 )     (169,653 )
     Grant income
    199       -       32,086       -  
     Foreign currency transaction gain (loss)
    1,270       (5,979 )     1,270       (5,979 )
     Other income
    33,866       8,152       33,866       37,082  
                                 
        Total Other Income (Expense), net
    (20,859 )     (61,665 )     (41,459 )     (137,381 )
                                 
INCOME BEFORE INCOME TAXES
    3,009,453       3,046,531       6,264,810       5,255,691  
                                 
INCOME TAXES
    791,549       723,978       1,650,548       1,310,538  
                                 
NET INCOME
  $ 2,217,904     $ 2,322,553     $ 4,614,262     $ 3,945,153  
                                 
COMPREHENSIVE INCOME:
                               
      NET INCOME
  $ 2,217,904     $ 2,322,553     $ 4,614,262     $ 3,945,153  
                                 
OTHER COMPREHENSIVE INCOME (LOSS):
                         
           Unrealized foreign currency translation gain (loss)
    106,313       1,217,027       (675,475 )     1,645,467  
                                 
      COMPREHENSIVE INCOME
  $ 2,324,217     $ 3,539,580     $ 3,938,787     $ 5,590,620  
                                 
NET INCOME PER COMMON SHARE:
                               
    Basic
  $ 0.61     $ 0.79     $ 1.29     $ 1.35  
    Diluted
  $ 0.61     $ 0.79     $ 1.29     $ 1.35  
                                 
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
                         
    Basic
    3,632,222       2,955,786       3,568,219       2,925,355  
    Diluted
    3,632,222       2,955,786       3,568,219       2,925,355  
                                 

See notes to unaudited condensed consolidated financial statements
 


CLEANTECH SOLUTIONS INTERNATIONAL, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



   
For the Six Months Ended
 
   
June 30,
 
   
2014
   
2013
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
Net income
  $ 4,614,262     $ 3,945,153  
  Adjustments to reconcile net income from operations to net cash
 
provided by operating activities:
               
Depreciation
    4,084,790       3,221,159  
Amortization of land use rights
    48,141       47,307  
Decrease in allowance for doubtful accounts
    -       (312,411 )
Stock-based compensation expense
    181,108       132,956  
  Changes in operating assets and liabilities:              
Notes receivable
    599,395       (264,582 )
Accounts receivable
    1,464,659       555,644  
Inventories
    (3,224,025 )     518,191  
Prepaid value-added taxes on purchases
    374,452       (192,840 )
Prepaid and other current assets
    (5,553 )     (60,237 )
Advances to suppliers
    14,859       (473,782 )
Accounts payable
    (283,743 )     (1,740,644 )
Accrued expenses
    (381,669 )     (409,484 )
VAT and service taxes payable
    38,824       (34,233 )
Income taxes payable
    (1,154,225 )     (63,582 )
Advances from customers
    (1,060,826 )     300,212  
                 
NET CASH PROVIDED BY OPERATING ACTIVITIES
    5,310,449       5,168,827  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
Purchase of property and equipment
    (6,280,015 )     (5,824,104 )
                 
NET CASH USED IN INVESTING ACTIVITIES
    (6,280,015 )     (5,824,104 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
Principal payments on capital lease
    -       (130,633 )
Proceeds from bank loans
    2,280,242       3,041,002  
Repayments of bank loans
    (2,280,242 )     (2,240,739 )
Decrease (increase) in restricted cash
    325,749       (1,312,433 )
(Decrease) increase in bank acceptance notes payable
    (325,749 )     1,312,433  
Net proceeds from sale of common stock
    1,623,691       1,767,546  
                 
NET CASH PROVIDED BY FINANCING ACTIVITIES
    1,623,691       2,437,176  
                 
EFFECT OF EXCHANGE RATE ON CASH AND CASH EQUIVALENTS
    (2,343 )     27,354  
                 
NET INCREASE IN CASH AND CASH EQUIVALENTS
    651,782       1,809,253  
                 
CASH AND CASH EQUIVALENTS - beginning of period
    1,114,873       1,445,728  
                 
CASH AND CASH EQUIVALENTS - end of period
  $ 1,766,655     $ 3,254,981  
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
Cash paid for:
               
Interest
  $ 117,826     $ 169,653  
Income taxes
  $ 2,804,773     $ 1,374,120  
                 
NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
Property and equipment acquired on credit as payable
  $ 390,060     $ 840,277  
Common stock issued for future service
  $ 181,107     $ -  
                 
 
See notes to unaudited condensed consolidated financial statements

 

Organization

Cleantech Solutions International, Inc. (the “Company”) was incorporated in Delaware on June 24, 1987 under the name of Malex, Inc. On December 18, 2007, the Company’s corporate name was changed to China Wind Systems, Inc., and on June 13, 2011, the Company’s corporate name was changed to Cleantech Solutions International, Inc. On August 7, 2012, the Company was converted into a Nevada corporation.

Through its affiliated companies and subsidiaries, the Company manufactures and sells forged products and fabricated products to a range of clean technology customers including high precision forged rolled rings and related products for the wind power industry and other industries and manufactures and sells textile dyeing and finishing machines. The Company is the sole owner of Fulland Limited (“Fulland”), a Cayman Island limited liability company, which was organized on May 9, 2007. Fulland owns 100% of the capital stock of Green Power Environment Technology (Shanghai) Co., Ltd. (“Green Power”) and Wuxi Fulland Wind Energy Equipment Co., Ltd. (“Fulland Wind Energy”), which are wholly foreign-owned enterprises (“WFOE”) organized under the laws of the People’s Republic of China (“PRC” or “China”). Green Power is a party to a series of contractual arrangements, as fully described below, dated October 12, 2007 with Wuxi Huayang Electrical Power Equipment Co., Ltd. (“Electrical”) and Wuxi Huayang Dyeing Machinery Co., Ltd. (“Dyeing”), both of which are limited liability companies organized under the laws of, and based in, the PRC. Electrical and Dyeing are sometimes collectively referred to as the “Huayang Companies.”

Fulland was organized by the owners of the Huayang Companies as a special purpose vehicle for purposes of raising capital, in accordance with requirements of the PRC State Administration of Foreign Exchange (“SAFE”). On May 31, 2007, SAFE issued an official notice known as Hui Zong Fa [2007] No. 106 (“Circular 106”), which requires the owners of any Chinese company to obtain SAFE’s approval before establishing any offshore holding company structure for foreign financing as well as subsequent acquisition matters in China. Accordingly, the owners of the Huayang Companies, Mr. Jianhua Wu and Ms. Lihua Tang, submitted their application to SAFE in early September 2007. On October 11, 2007, SAFE approved their application, permitting these Chinese citizens to establish Fulland as a special purpose vehicle for any foreign ownership and capital raising activities by the Huayang Companies.

Electrical was formed on May 21, 2004, and Fulland Wind Energy was formed on August 27, 2008. Beginning in April 2007, Electrical began to produce large-scaled forged rolled rings that are up to three meters in diameter for the wind-power and other industries. In 2009, the Company began to produce and sell forged products through Fulland Wind Energy. Through Fulland Wind Energy, the Company manufactures and machines all forged products, including wind products such as shafts, rolled rings, gear rims, gearboxes, bearings and other components and finished products and assemblies for the wind power industry, and solar products, including large-scale equipment used in the manufacturing process for the solar industry. The Company refers to this segment of its business as the forged rolled rings and related components segment.

Dyeing, which was formed on August 17, 1995, produces and sells a variety of high and low temperature dyeing and finishing machinery for the textile industry. The Company refers to this segment as the dyeing and finishing equipment segment.

 
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Basis of presentation; management’s responsibility for preparation of condensed financial statements

The Company’s unaudited condensed consolidated financial statements include the financial statements of its wholly-owned subsidiaries, Fulland, Green Power and Fulland Wind Energy, as well as the financial statements of Huayang Companies, Dyeing and Electric. All significant intercompany accounts and transactions have been eliminated in consolidation.

In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated  financial statements as of and for the year ended December 31, 2013 and footnotes thereto included in the Company’s Annual Report on Form 10-K filed with the SEC on March 28, 2014.
 
The condensed consolidated balance sheet as of December 31, 2013 contained herein has been derived from the audited consolidated financial statements as of December 31, 2013, but do not include all disclosures required by GAAP.

Pursuant to Accounting Standards Codification (“ASC”) Topic 810, the Huayang Companies are considered variable interest entities (“VIE”), and the Company is the primary beneficiary. The Company’s relationships with the Huayang Companies and their shareholders are governed by a series of contractual arrangements between Green Power, the Company’s wholly foreign-owned enterprise in the PRC, and each of the Huayang Companies, which are the operating companies of the Company in the PRC. Under PRC laws, each of Green Power, Dyeing and Electrical is an independent legal entity and none of them is exposed to liabilities incurred by the other parties. The contractual arrangements constitute valid and binding obligations of the parties of such agreements. Each of the contractual arrangements and the rights and obligations of the parties thereto are enforceable and valid in accordance with the laws of the PRC. On October 12, 2007, the Company entered into the following contractual arrangements with each of Dyeing and Electrical:

Consulting Services Agreement. Pursuant to the exclusive consulting services agreements between Green Power and the Huayang Companies, Green Power has the exclusive right to provide to the Huayang Companies general business operation services, including advice and strategic planning, as well as consulting services related to the technological research and development of dyeing and finishing machines, electrical equipment and related products (the “ Services ”). Under this agreement, Green Power owns the intellectual property rights developed or discovered through research and development, in the course of providing the Services, or derived from the provision of the Services. The Huayang Companies shall pay a quarterly consulting service fees in Renminbi (“RMB”) to Fulland that is equal to all of the Huayang Companies’ profits for such quarter.
 
Operating Agreement. Pursuant to the operating agreement among Green Power, the Huayang Companies and all shareholders of the Huayang Companies, Green Power provides guidance and instructions on the Huayang Companies’ daily operations, financial management and employment issues. The Huayang Companies shareholders must designate the candidates recommended by Green Power as their representatives on the boards of directors of each of the Huayang Companies. Green Power has the right to appoint senior executives of the Huayang Companies. In addition, Green Power agrees to guarantee the Huayang Companies’ performance under any agreements or arrangements relating to the Huayang Companies’ business arrangements with any third party. The Huayang Companies, in return, agree to pledge their accounts receivable and all of their assets to Green Power. Moreover, each of the Huayang Companies agrees that, without the prior consent of Green Power, it will not engage in any transactions that could materially affect its assets, liabilities, rights or operations, including, without limitation, incurrence or assumption of any indebtedness, sale or purchase of any assets or rights, incurrence of any encumbrance on any of their assets or intellectual property rights in favor of a third party or transfer of any agreements relating to their business operation to any third party. The term of this agreement, as amended on November 1, 2008, is 20 years from October 12, 2007 and may be extended only upon Green Power’s written confirmation prior to the expiration of the this agreement, with the extended term to be mutually agreed upon by the parties.
 

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Basis of presentation; management’s responsibility for preparation of condensed financial statements (continued)

Equity Pledge Agreement. Under the equity pledge agreement between the Huayang Companies’ shareholders and Green Power, the Huayang Companies’ shareholders pledged all of their equity interests in the Huayang Companies to Green Power to guarantee the Huayang Companies’ performance of their respective obligations under the consulting services agreement. If the Huayang Companies or the Huayang Companies’ shareholders breach their respective contractual obligations, Green Power, as pledgee, will be entitled to certain rights, including the right to sell the pledged equity interests. The Huayang Companies’ shareholders also agreed that, upon occurrence of any event of default, Green Power shall be granted an exclusive, irrevocable power of attorney to take actions in the place and stead of the Huayang Companies’ shareholders to carry out the security provisions of the equity pledge agreement and take any action and execute any instrument that Green Power may deem necessary or advisable to accomplish the purposes of the equity pledge agreement. The Huayang Companies’ shareholders agreed not to dispose of the pledged equity interests or take any actions that would prejudice Green Power’s interest. The equity pledge agreement will expire two years after the Huayang Companies’ obligations under the consulting services agreements have been fulfilled.

Option AgreementUnder the option agreement between the Huayang Companies’ shareholders and Green Power, the Huayang Companies’ shareholders irrevocably granted Green Power or its designated person an exclusive option to purchase, to the extent permitted under PRC law, all or part of the equity interests in the Huayang Companies for the cost of the initial contributions to the registered capital or the minimum amount of consideration permitted by applicable PRC law. Green Power or its designated person has sole discretion to decide when to exercise the option, whether in part or in full. The term of this agreement, as amended on November 1, 2008, is 20 years from October 12, 2007 and may be extended prior to its expiration by written agreement of the parties.

Pursuant to ASC Topic 810 and related subtopics related to the consolidation of variable interest entities, the accounts of the Huayang Companies are consolidated in the accompanying financial statements. As VIEs, the Huayang Companies’ sales are included in the Company’s total sales, its income from operations is consolidated with the Company’s, and the Company’s net income includes all of the Huayang Companies net income. The Company does not have any non-controlling interest and, accordingly, did not subtract any net income in calculating the net income of the VIEs that is attributable to the Company. Because of the contractual arrangements, the Company has a pecuniary interest in the Huayang Companies that requires consolidation of the Company’s and the Huayang Companies’ financial statements.

Use of estimates

The preparation of the unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Actual results could materially differ from these estimates. Significant estimates in the six months ended June 30, 2014 and 2013 include the allowance for doubtful accounts, the allowance for obsolete inventory, the useful life of property and equipment and intangible assets, assumptions used in assessing impairment of long-term assets and valuation of deferred tax assets and accruals for taxes due.


NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Cash and cash equivalents

For purposes of the unaudited condensed consolidated statements of cash flows, the Company considers all highly liquid instruments purchased with a maturity of three months or less and money market accounts to be cash equivalents. The Company maintains cash and cash equivalents with various financial institutions mainly in the PRC and the U.S. As of June 30, 2014 and December 31, 2013, cash balances in banks in the PRC of $1,607,955 and $704,391, respectively, are uninsured.

Fair value of financial instruments

The Company adopted the guidance of ASC Topic 820 for fair value measurements which clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1-Inputs are unadjusted quoted prices in active markets for identical assets or liabilities available at the measurement date.

Level 2-Inputs are unadjusted quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable, and inputs derived from or corroborated by observable market data.

Level 3-Inputs are unobservable inputs which reflect the reporting entity’s own assumptions on what assumptions the market participants would use in pricing the asset or liability based on the best available information.

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, restricted cash, notes receivable, accounts receivable, inventories, advances to suppliers, prepaid VAT on purchases, deferred tax assets, prepaid expenses and other, short-term bank loans, bank acceptance notes payable, accounts payable, accrued expenses, advances from customers, VAT and service taxes payable and income taxes payable approximate their fair market value based on the short-term maturity of these instruments.

ASC Topic 825-10 “Financial Instruments” allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, unrealized gains and losses for that instrument should be reported in earnings at each subsequent reporting date. The Company did not elect to apply the fair value option to any outstanding instruments.
 
 
NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Concentrations of credit risk

The Company’s operations are carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC’s economy. The Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America. The Company’s results may be adversely affected by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.
 
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. Substantially all of the Company’s cash is maintained with state-owned banks within the PRC, and none of these deposits are covered by insurance. The Company has not experienced any losses in such accounts and believes it is not exposed to any risks on its cash in bank accounts. A significant portion of the Company’s sales are credit sales which are primarily to customers whose ability to pay is dependent upon the industry economics prevailing in these areas; however, concentrations of credit risk with respect to trade accounts receivables is limited due to generally short payment terms. The Company also performs ongoing credit evaluations of its customers to help further reduce credit risk.

At June 30, 2014 and December 31, 2013, the Company’s cash balances by geographic area were as follows:

   
June 30, 2014
   
December 31, 2013
 
Country:
                       
United States
  $ 158,700       9.0 %   $ 410,482       36.8 %
China
    1,607,955       91.0 %     704,391       63.2 %
Total cash and cash equivalents
  $ 1,766,655       100.0 %   $ 1,114,873       100.0 %

Restricted cash

Restricted cash consists of cash deposits held by a bank to secure bank acceptance notes payable.

Notes receivable

Notes receivable represents trade accounts receivable due from customers where the customers’ bank has guaranteed the payment of the receivable. This amount is non-interest bearing and is normally paid within six months. Historically, the Company has experienced no losses on notes receivable. The Company’s notes receivable totaled $100,711 and $703,718 at June 30, 2014 and December 31, 2013, respectively.

Accounts receivable

Accounts receivable are presented net of an allowance for doubtful accounts. The Company maintains allowances for doubtful accounts for estimated losses. The Company reviews the accounts receivable on a periodic basis and makes general and specific allowances when there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, the Company considers many factors, including the age of the balance, a customer’s historical payment history, its current credit-worthiness and current economic trends. Accounts are written off after exhaustive efforts at collection. At June 30, 2014 and December 31, 2013, the Company has established, based on a review of its outstanding balances, an allowance for doubtful accounts in the amounts of $824,168 and $830,211, respectively. 
 

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Inventories

Inventories, consisting of raw materials, work in process and finished goods related to the Company’s products are stated at the lower of cost or market utilizing the weighted average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, the Company will record reserves for the difference between the cost and the market value. These reserves are recorded based on estimates. The Company recorded an inventory reserve of $181,154 and $182,482 at June 30, 2014 and December 31, 2013, respectively.
 
Advances to suppliers
 
Advances to suppliers represent the cash paid in advance for the purchase of raw material from suppliers. The advance payments are intended to ensure preferential pricing and delivery. The amounts advanced under such arrangements totaled $675,372 and $695,254 as of June 30, 2014 and December 31, 2013, respectively.

Property and equipment

Property and equipment are carried at cost and are depreciated on a straight-line basis over the estimated useful lives of the assets. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in the year of disposition. The Company examines the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable.

Included in property and equipment is construction-in-progress which consisted of factory improvements and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation of the assets. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use.

Equipment held for operating lease and related rental revenue

Long-lived assets are classified as held for operating lease when certain criteria are met.  These criteria include: management’s commitment to a plan to lease the assets; the availability of the assets for immediate lease in their present condition; an active program to locate lessees and other actions to lease the assets has been initiated; the lease of the assets is probable and their transfer is expected to qualify for recognition as a completed operating lease within one year; the assets are being marketed at reasonable prices in relation to their fair value; and it is unlikely that significant changes will be made to the plan to lease the assets. We measure long-lived assets to be leased at the lower of carrying amount or fair value, less associated costs to lease.  

At June 30, 2014 and December 31, 2013, the Company reflected electro-slag re-melted (“ESR”) equipment that was used in 2010 and 2011 to produce forged products for the high performance components market as equipment held for operating lease on the accompanying consolidated balance sheets. In March 2014, the Company signed an operating lease agreement related to the lease of such equipment for a period of eight years. Equipment held for operating lease is depreciated over its estimated useful life starting from the operating lease commencement date, April 1, 2014.  Rental payments are recorded as rental income over the lease term as earned. The related depreciation on the equipment held for operating lease is recognized as a reduction of rental income on a straight-line basis. For the three and six months ended June 30, 2014, the rental income was $201,853 and the related depreciation on the equipment held for operating lease was $167,987, all of which was generated in the three months ended June 30, 2014.
 

NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Equipment held for operating lease and related rental revenue (continued)

The Company makes a determination with respect to the lease whether it should be accounted for as operating lease or financing lease. The classification criteria is based on estimates regarding the fair value of the leased ESR equipment, minimum lease payments, the economic life of the equipment, the existence of a bargain purchase option, and certain other terms in the lease agreement. The Company believes the lease should be accounted for as operating lease.

Impairment of long-lived assets

In accordance with ASC Topic 360, the Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable, or at least annually. The Company recognizes an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value.  The Company did not record any impairment charge for the three and six months ended June 30, 2014 and 2013. 

Advances from customers

Advances from customers at June 30, 2014 and December 31, 2013 amounted to $386,990 and $1,455,740, respectively, and consist of prepayments from customers for merchandise that had not yet been shipped. The Company will recognize the deposits as revenue as customers take delivery of the goods and title to the assets is transferred to customers in accordance with the Company’s revenue recognition policy.

Revenue recognition

Pursuant to the guidance of ASC Topic 605 and ASC Topic 360, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectability is reasonably assured. The Company recognizes revenues from the sale of dyeing and finishing equipment, forged rolled rings and other components upon shipment and transfer of title. The other elements may include installation and, generally, a one-year warranty. Equipment installation revenue is valued based on estimated service person hours to complete installation and is recognized when the labor has been completed and the equipment has been accepted by the customer, which is generally within a couple days of the delivery of the equipment. Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the six months ended June 30, 2014 and 2013, amounts allocated to installation and warranty revenues were minimal. Based on historical experience, warranty service calls and any related labor costs have been minimal. Rental income will be recognized on a straight-line basis over the term of the operating lease. All other product sales with customer specific acceptance provisions, including the forged rolled rings, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.

Income taxes

The Company is governed by the Income Tax Law of the PRC and the U.S. Internal Revenue Code of 1986, as amended. The Company accounts for income taxes using the liability method prescribed by ASC Topic 740, “Income Taxes.” Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the period in which the differences are expected to reverse. The Company records a valuation allowance to offset deferred tax assets if based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized as income or loss in the period that includes the enactment date.
 


NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Income taxes (continued)

The Company applied the provisions of ASC 740-10-50, “Accounting for Uncertainty in Income Taxes,” which provides clarification related to the process associated with accounting for uncertain tax positions recognized in our financial statements. Audit periods remain open for review until the statute of limitations has passed. The completion of review or the expiration of the statute of limitations for a given audit period could result in an adjustment to the Company’s liability for income taxes. Any such adjustment could be material to the Company’s results of operations for any given quarterly or annual period based, in part, upon the results of operations for the given period. As of June 30, 2014 and December 31, 2013, the Company had no uncertain tax positions, and will continue to evaluate for uncertain positions in the future.

Stock-based compensation

Stock-based compensation is accounted for based on the requirements of the Share-Based Payment topic of ASC Topic 718 which requires recognition in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments over the period the employee or director is required to perform the services in exchange for the award (presumptively, the vesting period). The Financial Accounting Standards Board (“FASB”) also requires measurement of the cost of employee and director services received in exchange for an award based on the grant-date fair value of the award.

Pursuant to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the “measurement date.” The expense is recognized over the vesting period of the award. Until the measurement date is reached, the total amount of compensation expense remains uncertain. The Company records compensation expense based on the fair value of the award at the reporting date. The awards to consultants and other third-parties are then revalued, or the total compensation is recalculated, based on the then current fair value, at each subsequent reporting date.

Shipping costs

Shipping costs are included in selling expenses and totaled $297,835 and $292,628 for the three months ended June 30, 2014 and 2013, respectively. Shipping costs are included in selling expenses and totaled $615,559 and $555,931 for the six months ended June 30, 2014 and 2013, respectively.

Employee benefits

The Company’s operations and employees are all located in the PRC. The Company makes mandatory contributions to the PRC government’s health, retirement benefit and unemployment funds in accordance with the relevant Chinese social security laws. The costs of these payments are charged to the same accounts as the related salary costs in the same period as the related salary costs incurred. Employee benefit costs totaled $59,146 and $52,362 for the three months ended June 30, 2014 and 2013, respectively. Employee benefit costs totaled $118,987 and $101,097 for the six months ended June 30, 2014 and 2013, respectively.

Advertising

Advertising is expensed as incurred and is included in selling, general and administrative expenses on the accompanying unaudited condensed consolidated statements of income and comprehensive income and totaled $4,850 and $0 for the three months ended June 30, 2014 and 2013, respectively. Advertising expense totaled $5,714 and $0 for the six months ended June 30, 2014 and 2013, respectively. 
 



NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Research and development

Research and development costs are expensed as incurred and are included in selling, general and administrative expenses. The costs primarily consist of raw materials and salaries paid for the development and improvement of the Company’s new dyeing machinery. Research and development costs totaled $31,248 and $37,796 for the three months ended June 30, 2014 and 2013, respectively.  Research and development costs totaled $58,119 and $37,796 for the six months ended June 30, 2014 and 2013, respectively. 

Foreign currency translation

The reporting currency of the Company is the U.S. dollar. The functional currency of the parent company is the U.S. dollar and the functional currency of the Company’s operating subsidiaries is the Chinese Renminbi (“RMB”). For the subsidiaries and affiliates, whose functional currencies are the RMB, results of operations and cash flows are translated at average exchange rates during the period, assets and liabilities are translated at the unified exchange rate at the end of the period, and equity is translated at historical exchange rates. As a result, amounts relating to assets and liabilities reported on the statements of cash flows may not necessarily agree with the changes in the corresponding balances on the balance sheets. Translation adjustments resulting from the process of translating the local currency financial statements into U.S. dollars are included in determining comprehensive income. The cumulative translation adjustment and effect of exchange rate changes on cash for the six months ended June 30, 2014 and 2013 was $(2,343) and $27,354, respectively. Transactions denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing on the transaction dates. Assets and liabilities denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing at the balance sheet date with any transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred.

All of the Company’s revenue transactions are transacted in the functional currency of the operating subsidiaries and affiliates. Other than for the purchase of equipment from non-Chinese suppliers, the Company does not enter into any material transaction in foreign currencies. Transaction gains or losses have not had, and are not expected to have, a material effect on the results of operations of the Company.

Asset and liability accounts at June 30, 2014 and December 31, 2013 were translated at 6.1552 RMB to $1.00 and at 6.1104 RMB to $1.00, respectively, which were the exchange rates on the balance sheet dates. Equity accounts were stated at their historical rate. The average translation rates applied to the statements of income for the six months ended June 30, 2014 and 2013 were 6.1397 RMB and 6.24794 RMB to $1.00, respectively. Cash flows from the Company’s operations are calculated based upon the local currencies using the average translation rate.
 
Income per share of common stock
 
ASC Topic 260 “Earnings per Share,” requires presentation of both basic and diluted earnings per share (“EPS”) with a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity.
 





NOTE 1 – ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Income per share of common stock (continued)

Basic net income per share is computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted net income 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. The Company did not have any potentially dilutive common stock outstanding during the three and six months ended June 30, 2014 and 2013.

The following table presents a reconciliation of basic and diluted net income per share:
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Net income available to common stockholders for basic and diluted net income per share of common stock
  $ 2,217,904     $ 2,322,553     $ 4,614,262     $ 3,945,153  
Weighted average common stock outstanding - basic
    3,632,222       2,955,786       3,568,219       2,925,355  
Weighted average common stock outstanding - diluted
    3,632,222       2,955,786       3,568,219       2,925,355  
Net income per common share - basic
  $ 0.61     $ 0.79     $ 1.29     $ 1.35  
Net income per common share - diluted
  $ 0.61     $ 0.79     $ 1.29     $ 1.35  

The Company did not have any common stock equivalents at June 30, 2014 and December 31, 2013.

Related parties

Parties are considered to be related to the Company if the parties, directly or indirectly, through one or more intermediaries, control, are controlled by, or are under common control with the Company. Related parties also include principal owners of the Company, its management, members of the immediate families of principal owners of the Company and its management and other parties with which the Company may deal with 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. The Company discloses all related party transactions. All transactions are recorded at fair value of the goods or services exchanged.

Comprehensive income

Comprehensive income is comprised of net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. For the Company, comprehensive income for the three and six months ended June 30, 2014 and 2013 included net income and unrealized gains (losses) from foreign currency translation adjustments. 

Recent accounting pronouncement

Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its consolidated financial condition, results of operations, cash flows or disclosures.

Reclassification

Certain reclassifications have been made in prior year same period’s unaudited condensed consolidated financial statements to conform to the current period’s financial presentation.
 
 
NOTE 2 – ACCOUNTS RECEIVABLE

At June 30, 2014 and December 31, 2013, accounts receivable consisted of the following:

   
June 30, 2014
   
December 31, 2013
 
Accounts receivable
  $ 14,487,175     $ 16,065,074  
Less: allowance for doubtful accounts
    (824,168 )     (830,211 )
    $ 13,663,007     $ 15,234,863  

The Company reviews the accounts receivable on a periodic basis and makes general and specific allowances when there is doubt as to the collectability of individual balances. The Company did not change the allowance for doubtful accounts for the three and six months ended June 30, 2014. After evaluating the collectability of individual receivable balances, the Company decreased the allowance for doubtful accounts in the amount of $312,411 for the three and six months ended June 30, 2013.

NOTE 3 - INVENTORIES

At June 30, 2014 and December 31, 2013, inventories consisted of the following:

   
June 30, 2014
   
December 31, 2013
 
Raw materials
  $ 2,893,278     $ 1,627,784  
Work-in-process
    3,631,881       1,778,650  
Finished goods
    1,571,008       1,509,606  
      8,096,167       4,916,040  
Less: reserve for obsolete inventory
    (181,154 )     (182,482 )
    $ 7,915,013     $ 4,733,558  

For the three and six months ended June 30, 2014 and 2013, the Company did not make any change for reserve for obsolete inventory.

NOTE 4 - PROPERTY AND EQUIPMENT

At June 30, 2014 and December 31, 2013, property and equipment consisted of the following:
 
    Useful Life     June 30, 2014    
December 31, 2013
 
Office equipment and furniture
  5 Years     $  161,655     $ 156,810  
Manufacturing equipment
 
5 – 10 Years
      74,509,161       74,187,972  
Vehicles
 
5 Years
      205,156       129,380  
Construction in progress
    -       3,173,902       477,299  
Building and building improvements
 
20 Years
      24,340,232       21,487,286  
              102,390,106       96,438,747  
Less: accumulated depreciation
            (29,562,448 )     (25,843,609 )
            $ 72,827,658     $ 70,595,138  

For the three months ended June 30, 2014 and 2013, depreciation expense amounted to $2,119,516 and $1,651,608, respectively, of which $1,833,119 and $1,406,935, respectively, was included in cost of revenues, $167,987 and $0 which was related to the ESR equipment held for operating lease (see note 6), respectively, was included in other income, and the remainder was included in operating expenses, respectively. For the six months ended June 30, 2014 and 2013, depreciation expense amounted to $4,084,790 and $3,221,159, respectively, of which $3,688,534 and $2,869,272, respectively, was included in cost of revenues, $167,987 and $0 which was related to the ESR equipment held for operating lease (see note 6), respectively, was included in other income, and the remainder was included in operating expenses, respectively.
 

NOTE 4 - PROPERTY AND EQUIPMENT (continued)

Depreciation is not taken during the period of construction or equipment installation. Upon completion of the installation of manufacturing equipment or any construction in progress, construction in progress balances will be classified to their respective property and equipment category.

NOTE 5 – LAND USE RIGHTS

There is no private ownership of land in China. Land is owned by the government and the government grants land use rights for specified terms. The Company’s land use rights have terms of 45 and 50 years and expire on January 1, 2053 and October 30, 2053. The Company amortizes the land use rights over the term of the respective land use right. For the three months ended June 30, 2014 and 2013, amortization of land use rights amounted to $23,976 and $23,796, respectively. For the six months ended June 30, 2014 and 2013, amortization of land use rights amounted to $48,141 and $47,307, respectively. At June 30, 2014 and December 31, 2013, land use rights consisted of the following:

 
Useful Life
 
June 30, 2014
   
December 31, 2013
 
Land use rights
45 - 50 years
  $ 4,386,664     $ 4,418,826  
Less: accumulated amortization
      (676,188 )     (632,775 )
      $ 3,710,476     $ 3,786,051  

Amortization of land use rights attributable to future periods is as follows:

Twelve-month periods ending June 30:
 
Amount
 
2015
  $ 96,039  
2016
    96,039  
2017
    96,039  
2018
    96,039  
2019
    96,039  
Thereafter
    3,230,281  
    $ 3,710,476  

NOTE 6 – EQUIPMENT HELD FOR OPERATING LEASE

The Company measures long-lived assets to be leased at the lower of carrying amount or fair value, less associated costs to lease these assets. During the last quarter of 2013, the Company decided to lease the ESR equipment to a third party and negotiations took place last quarter of 2013 through March 2014.  In March 2014, the Company entered into an operating lease agreement with an eight-year term commencing April 1, 2014, with a third party, whereby the lessee leases the ESR equipment from the Company for quarterly lease payments of 1,450,000 RMB (including value-added tax, approximately $236,000 per quarter).  Accordingly, at June 30, 2014 and December 31, 2013, the ESR equipment has been reflected as equipment held for operating lease on the accompanying condensed consolidated balance sheets. At June 30, 2014 and December 31, 2013, the Company evaluated the ESR equipment for impairment. The Company compared the estimated fair values of the equipment to its carrying value with impairment indicators and recorded an impairment charge for the excess of carrying value over fair value. For the three and six months ended June 30, 2014 and 2013, the Company did not incur any impairment charge on ESR equipment.

Equipment held for operating lease is depreciated over its estimated useful life starting from the operating lease commencement date, April 1, 2014.  Rental payments are recorded as rental income over the lease term as earned. The related depreciation on the equipment held for operating lease is recognized as a reduction of rental income on a straight-line basis. For the three and six months ended June 30, 2014, the Company recorded rental income of $201,853 and recorded related depreciation on the equipment held for operating lease of $167,987, and are included in other income on the accompanying unaudited condensed consolidated statements of income and comprehensive income.
 
 
NOTE 7 – SHORT-TERM BANK LOANS

Short-term bank loan represents an amount due to a bank that is due within one year. This loan can be renewed with the bank upon maturity. At June 30, 2014 and December 31, 2013, short-term bank loans consisted of the following:

   
June 30,
2014
   
December 31, 2013
 
Loan from Agricultural and Commercial Bank, due on May 9, 2014 with annual interest rate of 7.20% at December 31, 2013, secured by certain assets of the Company and repaid on due date.
  $ -     $ 490,966  
                 
Loan from Agricultural and Commercial Bank, due on March 20, 2015 with annual interest rate of 7.20% at June 30, 2014, secured by certain assets of the Company.
    487,393       -  
                 
Loan from Bank of China, due on March 1, 2014 with annual interest rate of 6.27% at December 31, 2013, secured by certain assets of the Company and repaid on due date.
    -       490,966  
                 
Loan from Bank of China, due on March 4, 2014 with annual interest rate of 6.27% at December 31, 2013, secured by certain assets of the Company and repaid on due date.
    -       490,966  
                 
Loan from Jiangsu Huishan Mintai Village Town Bank, due on July 15, 2014 with annual interest rate of 9.30% at June 30, 2014 and December 31, 2013, secured by certain assets of the Company and repaid on due date (see note 15).
    812,321       818,277  
                 
Loan from Bank of Communications, due on April 21, 2014 with annual interest rate of 6.72% at December 31, 2013 and repaid on due date.
    -       327,312  
                 
Loan from Bank of Communications, due on April 23, 2014 with annual interest rate of 6.72% at December 31, 2013 and repaid on due date.
    -       490,966  
                 
Loan from Bank of Communications, due on October 21, 2014 with annual interest rate of 6.72% at June 30, 2014.
    324,928       -  
                 
Loan from Bank of Communications, due on October 23, 2014 with annual interest rate of 6.72% at June 30, 2014.
    487,393       -  
                 
Loan from Bank of China, due on February 16, 2015 with annual interest rate of 6.27% at June 30, 2014, secured by certain assets of the Company.
    487,393       -  
                 
Loan from Bank of China, due on February 18, 2015 with annual interest rate of 6.27% at June 30, 2014, secured by certain assets of the Company.
    487,393       -  
                 
Total short-term bank loans
  $ 3,086,821     $ 3,109,453  

 

NOTE 8 – BANK ACCEPTANCE NOTES PAYABLE

Bank acceptance notes payable represent amounts due to a bank which are collateralized. All bank acceptance notes payable are secured by the Company’s restricted cash which is on deposit with the lender. At June 30, 2014 and December 31, 2013, the Company’s bank acceptance notes payables consisted of the following:

   
June 30, 2014
   
December 31, 2013
 
Bank of China, non-interest bearing, due and paid on January 4, 2014, collateralized by 100% of restricted cash deposited.
  $ -     $ 81,828  
                 
Jiangsu Huishan Mintai Village Town Bank, non-interest bearing, due and paid on February 23, 2014, collateralized by 100% of restricted cash deposited.
    -       327,311  
                 
Jiangsu Huishan Mintai Village Town Bank, non-interest bearing, due and paid on April 15, 2014, collateralized by 100% of restricted cash deposited.
    -       163,655  
                 
Jiangsu Huishan Mintai Village Town Bank, non-interest bearing, due on October 29, 2014, collateralized by 100% of restricted cash deposited.
    81,232       -  
                 
Bank of China, non-interest bearing, due and paid on May 12, 2014, collateralized by 100% of restricted cash deposited.
    -       81,828  
                 
Bank of China, non-interest bearing, due and paid on July 13, 2014, collateralized by 100% of restricted cash deposited.
    64,986       -  
                 
Bank of China, non-interest bearing, due and paid on July 16, 2014, collateralized by 100% of restricted cash deposited.
    97,479       -  
                 
Bank of Communications, non-interest bearing, due and paid on January 3, 2014, collateralized by 100% of restricted cash deposited.
    -       32,731  
                 
Bank of China, non-interest bearing, due on December 4, 2014, collateralized by 100% of restricted cash deposited.
    81,232       -  
                 
Bank of Communications, non-interest bearing, due on December 24, 2014, collateralized by 100% of restricted cash deposited.
    32,492       -  
Total
  $ 357,421     $ 687,353  


NOTE 9 – INCOME TAXES

The Company accounts for income taxes pursuant to the accounting standards that require the recognition of deferred tax assets and liabilities for both the expected impact of differences between the financial statements and the tax basis of assets and liabilities, and for the expected future tax benefit to be derived from tax losses and tax credit carry forwards. Additionally, the accounting standards require the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets. Realization of deferred tax assets, including those related to the U.S. net operating loss carry forwards and to the temporary differences related to the deduction of impairment losses in PRC for income tax purposes as compared to financial statement purposes, are dependent upon future taxable income during the periods in which those temporary differences become deductible or are utilized.

Net deferred tax asset related to the U.S. net operating loss carry forward has been fully offset by a valuation allowance. The Company is governed by the Income Tax Law of the PRC and the U.S. Internal Revenue Code of 1986, as amended. Under the Income Tax Laws of PRC, Chinese companies are generally subject to an income tax at an effective rate of 25% on income reported in the statutory financial statements after appropriate tax adjustments. The Company’s VIEs (Dyeing and Electric) and the Company’s subsidiary, Fulland Wind Energy, are subject to these statutory rates. The Company’s wholly-owned subsidiary, Fulland Limited was incorporated in the Cayman Islands. Under the current laws of the Cayman Islands, this entity is not subject to income taxes.
 
The tax effects of temporary differences under the Income Tax Law of the PRC that give rise to significant portions of deferred tax assets and liabilities as of June 30, 2014 and December 31, 2013 are as follows:

   
June 30, 2014
   
December 31, 2013
 
Deferred tax assets:
           
     Net U.S. operating loss carry forward
  $ 1,958,195     $ 1,844,921  
     Loss on impairment of equipment
    1,213,320       1,222,216  
     Allowance for doubtful accounts and inventories reserve
    251,331       253,173  
Total gross deferred tax assets
    3,422,846       3,320,310  
                 
     Less: valuation allowance
    (1,958,195 )     (1,844,921 )
Net deferred tax assets
  $ 1,464,651     $ 1,475,389  

The valuation allowance at June 30, 2014 and December 31, 2013 were $1,958,195 and $1,844,921, respectively, related to the U.S. net operating loss carry forward. During the three months ended June 30, 2014 and 2013, the valuation allowance was increased by approximately $52,000 and $54,000, respectively. During the six months ended June 30, 2014 and 2013, the valuation allowance was increased by approximately $113,000 and $100,000, respectively.

In assessing the ability to realize the deferred tax asset from the loss on impairment of equipment held for operating lease in PRC and allowance for doubtful accounts and inventory reserve, management considers whether it is more likely than not that some portion or the entire deferred tax asset will be realized. The Company concluded that the temporary difference on the impairment loss of equipment held for operating lease in PRC and allowance for doubtful accounts and inventory reserve will be deductible or utilized on the future PRC taxable income and a deferred tax asset of $1,464,651 and $1,475,389 has been set up at June 30, 2014 and December 31, 2013, respectively.
 

NOTE 10 – STOCKHOLDERS’ EQUITY

Common stock issued for services

In May 12, 2014, the Company issued 65,500 shares of common stock pursuant to its 2010 long-term incentive plan, including 20,000 shares to the chief executive officer, 15,000 shares to the chief financial officer and 3,500 shares to a newly-elected director.  The shares were valued at the fair market value on the grant date, and the Company recorded stock-based compensation of $181,108 during the six months ended June 30, 2014 and prepaid expenses of $181,107 at June 30, 2014 which will be amortized over the rest of the service period.

Common stock sold for cash

On June 2, 2014, the Company sold 290,984 shares of its common stock to its chief executive officer and his wife for $1,623,691. The purchase price per share was the highest closing price per share during the period from the date of Mr. Wu advised the board of his proposal to advance the funds, which was May 2, 2014, until June 2, 2014, when the Company’s independent directors approved the terms of the stock sale.

NOTE 11 STATUTORY RESERVES

The Company is required to make appropriations to reserve funds, comprising the statutory surplus reserve, statutory public welfare fund and discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (the “PRC GAAP”). Appropriation to the statutory surplus reserve should be at least 10% of the after tax net income determined in accordance with the PRC GAAP until the reserve is equal to 50% of the entities’ registered capital or members’ equity. As of December 31, 2013, the Company appropriated the required maximum 50% of its registered capital to statutory reserves for Electric; accordingly, no additional statutory reserve is required for the six months ended June 30, 2014. As of June 30, 2014, the Company had not appropriated the required maximum 50% of its registered capital to statutory reserve for Dyeing and Fulland Wind Energy.

For the six months ended June 30, 2014, statutory reserve activities were as follows:

   
Dyeing
   
Electrical
   
Fulland Wind Energy
   
Total
 
Balance – December 31, 2013
  $ 373,048     $ 1,168,796     $ 1,202,876     $ 2,744,720  
Addition to statutory reserves
    267,360       -       214,236       481,596  
Balance – June 30, 2014
  $ 640,408     $ 1,168,796     $ 1,417,112     $ 3,226,316  

 
NOTE 12 - SEGMENT INFORMATION

For the three and six months ended June 30, 2014 and 2013, the Company operated in two reportable business segments - (1) the manufacture of forged rolled rings and related components for the wind power and other industries segment, which also includes the manufacture of the Company’s solar industry products, and (2) the manufacture of textile dyeing and finishing equipment segment. The Company’s reportable segments are strategic business units that offer different products. They are managed separately based on the fundamental differences in their operations. All of the Company’s operations are conducted in the PRC. Information with respect to these reportable business segments for the three and six months ended June 30, 2014 and 2013 was as follows
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2014
   
2013
   
2014
   
2013
 
Revenue:
                       
Forged rolled rings and related components
  $ 7,849,812     $ 8,197,830     $ 16,106,945     $ 14,724,531  
Dyeing and finishing equipment
    9,678,206       9,016,304       19,056,344       16,374,302  
      17,528,018       17,214,134       35,163,289       31,098,833  
Depreciation:
                               
Forged rolled rings and related components
    1,207,337       1,059,267       2,424,395       2,105,844  
Dyeing and finishing equipment
    744,192       592,341       1,492,408       1,115,315  
Other (a)
    167,987       -       167,987       -  
      2,119,516       1,651,608       4,084,790       3,221,159  
Interest expense:
                               
Forged rolled rings and related components
    22,638       32,761       45,203       79,913  
Dyeing and finishing equipment
    37,461       31,765       72,623       89,740  
      60,099       64,526       117,826       169,653  
Net income (loss)
                               
Forged rolled rings and related components
    1,044,684       1,223,554       2,274,120       2,020,120  
Dyeing and finishing equipment
    1,328,042       1,258,828       2,673,598       2,219,987  
Other (b)
    (154,822 )     (159,829 )     (333,456 )     (294,954 )
    $ 2,217,904     $ 2,322,553     $ 4,614,262     $ 3,945,153  
                                 
Identifiable long-lived tangible assets at June 30, 2014 and December 31, 2013 by segment:
 
June 30,
2014
   
December 31, 2013
                 
Forged rolled rings and related components
  $ 41,250,263     $ 43,987,670                  
Dyeing and finishing equipment
    31,577,395       26,607,468                  
Equipment held for operating lease
    4,549,061       4,751,206                  
    $ 77,376,719     $ 75,346,344                  
                             
 
Identifiable long-lived tangible assets at June 30, 2014 and December 31, 2013 by geographical location:
 
June 30,
2014
   
December 31,
2013
                 
China
  $ 77,376,719     $ 75,346,344                  
United States
    -       -                  
    $ 77,376,719     $ 75,346,344                  
 
(a)  
 The Company does not allocate the depreciation for equipment held for operating lease to any operating segment.
 
(b)  
The Company does not allocate any general and administrative expenses of its U.S. activities to its reportable segments, because these activities are managed at a corporate level.
 
 
NOTE 13CONCENTRATIONS

Customers

The following table sets forth information as to each customer that accounted for 10% or more of the Company’s revenues for the three and six months ended June 30, 2014 and 2013.

     
Three Months Ended June 30,
   
Six Months Ended June 30,
 
Customer
   
2014
   
2013
   
2014
   
2013
 
  A       *       *       *       11 %

*           Less than 10%.

No customer accounted for 10% or more of the Company’s total outstanding accounts receivable at June 30, 2014 or December 31, 2013.

Suppliers

The following table sets forth information as to each supplier that accounted for 10% or more of the Company’s purchases for the three and six months ended June 30, 2014 and 2013.

     
Three Months Ended June 30,
   
Six Months Ended June 30,
 
Supplier
   
2014
   
2013
   
2014
   
2013
 
  A       14 %     27 %     15 %     15 %
  B       15 %     17 %     18 %     17 %
  C       15 %     *       16 %     10 %

*           Less than 10%.

The three largest suppliers accounted for 28.3% of the Company’s total outstanding accounts payable at June 30, 2014. The largest supplier accounted for 10.2% of the Company’s total outstanding accounts payable at December 31, 2013.

NOTE 14RESTRICTED NET ASSETS

Regulations in the PRC permit payments of dividends by the Company’s PRC VIEs only out of their retained earnings, if any, as determined in accordance with PRC accounting standards and regulations. Subject to certain cumulative limit, a statutory reserve fund requires annual appropriations of at least 10% of after-tax profit, if any, of the relevant PRC VIE’s and subsidiary. Electric had reached the cumulative limit as of June 30, 2014 and December 31, 2013, respectively. The statutory reserve funds are not distributable as cash dividends. As a result of these PRC laws and regulations, the Company’s PRC VIE’s and its subsidiary are restricted in their abilities to transfer a portion of their net assets to the Company. Foreign exchange and other regulations in PRC may further restrict the Company’s PRC VIEs and its subsidiary from transferring funds to the Company in the form of loans and/or advances.

As of June 30, 2014 and December 31, 2013, substantially all of the Company’s net assets are attributable to the PRC VIE’s and its subsidiary located in the PRC. Accordingly, the Company’s restricted net assets at June 30, 2014 and December 31, 2013 were approximately $96,184,000 and $90,291,000, respectively.
 
NOTE 15SUBSEQUENT EVENTS

In July 2014, the Company repaid short-term loan from Jiangsu Huishan Mintai Village Town Bank in the principal amount of $812,321, and borrowed the same amount from the same bank. The new loan bears interest rate at 9.36% per annum and is due on July 1, 2015.
 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
 
Overview

We are engaged in two business segments – the forged rolled rings and related components segment, in which we manufacture and sell high precision forged rolled rings, shafts, flanges, and other forged components for the wind power and other industries, and the dyeing and finishing equipment segment, in which we manufacture and sell textile dyeing and finishing machines.

The following table sets forth information as to revenue of our forged rolled rings and related components and dyeing and finishing equipment segments in dollars and as a percent of revenue (dollars in thousands):

   
Three Months Ended June 30,
 
   
2014
   
2013
 
   
Dollars
   
%
   
Dollars
   
%
 
Forged rolled rings and related components:
                       
   Wind power industry
  $ 3,234       18.5 %   $ 3,093       18.0 %
   Other industries
    4,616       26.3 %     5,105       29.6 %
      Total forged rolled rings and related components
    7,850       44.8 %     8,198       47.6 %
Dyeing and finishing equipment
    9,678       55.2 %     9,016       52.4 %
Total
  $ 17,528       100.0 %   $ 17,214       100.0 %

   
Six Months Ended June 30,
 
   
2014
   
2013
 
   
Dollars
   
%
   
Dollars
   
%
 
Forged rolled rings and related components:
                       
   Wind power industry
  $ 6,989       19.9 %   $ 6,789       21.8 %
   Other industries
    9,118       25.9 %     7,936       25.5 %
      Total forged rolled rings and related components
    16,107       45.8 %     14,725       47.3 %
Dyeing and finishing equipment
    19,056       54.2 %     16,374       52.7 %
Total
  $ 35,163       100.0 %   $ 31,099       100.0 %

Forged Rolled Rings and Related Components Segment

Through our forged rolled rings and other related products division, we produce precision forged rolled rings and other forged components to the wind power and other industries. Our forged rolled rings and other related products are sold to manufacturers of industrial equipment. Forged rolled rings and other forged components for the wind industry are used in wind turbines, which are used to generate wind power.

Revenue from our forged rolled rings and related components segment decreased $0.3 million, or 4.2%, for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013.  Revenue from our forged rolled rings and related components segment increased $1.4 million, or 9.4%, for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013. The demand for products used in manufacturing in general, including wind power industry and other industries, is uncertain. Although we believe that over the long term, the forged rolled rings and related components segment will expand, and the government of the PRC has announced its desire to increase the use of wind power as an energy source, in the short term other factors, such as economic factors and the fluctuations in the price of oil and coal and the availability of credit, may affect the requirements by our customers and potential customers for our products. To the extent that the demand for our forged rolled rings and related components declines, our revenue and net income will be affected. We believe that there is a degree of market saturation, particularly for the non-wind users, and we expect that our combined revenues from wind and non-wind customers of forged rolled rings and related components will continue at the current rate for the balance of 2014, with a modest increase in wind sales and a modest decrease in non-wind sales.
 

Among all the renewable energies, we believe that wind power is at a mature stage in terms of the technology and possesses the best prospects for large-scale commercial development. We believe that it is becoming more competitive against traditional energy sources as the industry continues to grow and production costs continue to fall, although difficulties in transmission of electricity generated by wind power continues to affect the market for wind power energy. We believe that wind power will see its share of China’s national energy mix gradually increase.

Dyeing and Finishing Equipment Segment

Revenue from our dyeing segment increased $0.7 million, or 7.3%, for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013.  Revenue from our dyeing segment increased $2.7 million, or 16.4%, for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013.  We believe that the increase reflects both our marketing effort for our new airflow dyeing units, which use air instead of water which is used in the traditional dyeing process, and the response to China’s stricter environmental standards for the dyeing industry. We believe that our air-flow technology, which is designed to enable users to meet China’s stricter environmental standards, provides the customer with reduced input costs, fewer wrinkles, less damage to the textile and reduced emissions. With the growing acceptance of our new dyeing technology and the China government’s mandate to phase out obsolete machinery in China’s textile industry, we expect our revenue from this segment will continue to increase in the near future.

The factors that affected our revenue, gross margin and net income in both of our segments during the six months ended June 30, 2014 are likely to continue to affect our operations in the near future. Our ability to expand our operations and increase our revenue is largely affected by the PRC government’s policy on such matters as the availability of credit, which affects all of our operations, and its policies relating to alternative energy such as wind power, which affect our products for these industries. Our business is also affected by general economic conditions. Because of the nature of our products, our customers’ projection of future economic conditions are an integral part of their decisions as to whether to purchase capital equipment at this time or defer such purchases until a future date.

Inventories and Raw Materials
 
A major element of our cost of revenues is raw materials, principally steel as well as other metals. These metals are subject to price fluctuations, and recently these fluctuations have been significant. In times of increasing prices, we need to try to establish the price at which we purchase raw materials in order to avoid increases in costs which we cannot recoup through increases in sales prices. Similarly, in times of decreasing prices, we may have purchased metals at prices which are high in terms of the price at which we can sell our products, which also can impair our margins. After recent decreases in steel prices, the price of steel has begun to level off in the second quarter of 2014, and we do not expect any significant change in price for the balance of 2014. Three major suppliers provided approximately 44% of our purchases of raw materials for the three months ended June 30, 2014. These three suppliers provided approximately 49% of our purchases of raw materials for the six months ended June 30, 2014. Two of these suppliers provided approximately 44% of our purchases of raw materials for the three months ended June 30, 2013, and these three suppliers provided approximately 42% of our purchases of raw materials for the six months ended June 30, 2013.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We continually evaluate our estimates, including those related to bad debts, inventories, recovery of long-lived assets and income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Any future changes to these estimates and assumptions could cause a material change to our reported amounts of revenues, expenses, assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the unaudited condensed consolidated financial statements.
 

Variable Interest Entities

Pursuant to ASC Topic 810 and related subtopics related to the consolidation of variable interest entities, we are required to include in our consolidated financial statements the financial statements of variable interest entities (“VIEs”). The accounting standards require a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss for the VIE or is entitled to receive a majority of the VIE’s residual returns. VIEs are those entities in which we, through contractual arrangements, bear the risk of, and enjoy the rewards normally associated with ownership of the entity, and therefore we are the primary beneficiary of the entity.
 
The Huayang Companies, which are owned by our chief executive officer and his wife, are considered VIEs, and we are the primary beneficiary. On November 13, 2007, we entered into agreements with the Huayang Companies pursuant to which we shall receive 100% of the Huayang Companies’ net income. In accordance with these agreements, the Huayang Companies shall pay consulting fees equal to 100% of its net income to our wholly-owned subsidiary, Green Power, and Green Power shall supply the technology and administrative services needed to service the Huayang Companies.

The accounts of the Huayang Companies are consolidated in the accompanying financial statements. As VIEs, the Huayang Companies sales are included in our total sales, their income from operations is consolidated with ours, and our net income includes all of the Huayang Companies’ net income, and their assets and liabilities are included in our consolidated balance sheets. The VIEs do not have any non-controlling interest and, accordingly, we did not subtract any net income in calculating the net income attributable to us. Because of the contractual arrangements, we have pecuniary interest in the Huayang Companies that require consolidation of the Huayang Companies financial statements with our financial statements.

Accounts Receivable

We have a policy of reserving for uncollectible accounts based on our best estimate of the amount of probable credit losses in our existing accounts receivable. We periodically review our accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.

As a basis for estimating the likelihood of collection has been established, we consider a number of factors when determining reserves for uncollectable accounts. We believe that we use a reasonably reliable methodology to estimate the collectability of our accounts receivable. We review our allowances for doubtful accounts on at least a quarterly basis. We also consider whether the historical economic conditions are comparable to current economic conditions. If the financial condition of our customers or other parties that we have business relations with were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Inventories

Inventories, consisting of raw materials, work-in-process and finished goods, are stated at the lower of cost or market utilizing the weighted average method. An allowance is established when management determines that certain inventories may not be saleable. If inventory costs exceed expected market value due to obsolescence or quantities in excess of expected demand, we will record additional reserves for the difference between the cost and the market value. These reserves are recorded based on estimates. We review inventory quantities on hand and on order and record, on a quarterly basis, a provision for excess and obsolete inventory, if necessary. If the results of the review determine that a write-down is necessary, we recognize a loss in the period in which the loss is identified. Our inventory reserves establish a new cost basis for inventory and are not reversed until we sell or dispose of the related inventory. Such provisions are established based on historical usage, adjusted for known changes in demands for such products, or the estimated forecast of product demand and production requirements.
 

Advances to Suppliers

Advances to suppliers represent the advance payments for the purchase of raw material from suppliers. The advance payments are intended to ensure preferential pricing and delivery.
 
Property and Equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets are as follows:

   
Useful Life
Building and building improvements
    20  
Years
Manufacturing equipment
    5 – 10  
Years
Office equipment and furniture
    5  
Years
Vehicles
    5  
Years
 
The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in income in disposition.

Included in property and equipment is construction-in-progress which consists of factories and office buildings under construction and machinery pending installation and includes the costs of construction, machinery and equipment, and any interest charges arising from borrowings used to finance these assets during the period of construction or installation. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use.

We examine the possibility of decreases in the value of fixed assets when events or changes in circumstances reflect the fact that their recorded value may not be recoverable. We recognize an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the asset’s estimated fair value and its book value.

Equipment Held for Operating Lease and Rental Revenue

Long-lived assets are classified as held for operating lease when certain criteria are met.  These criteria include: management’s commitment to a plan to lease the assets; the availability of the assets for immediate lease in their present condition; an active program to locate lessees and other actions to lease the assets has been initiated; the lease of the assets is probable and their transfer is expected to qualify for recognition as a completed operating lease within one year; the assets are being marketed at reasonable prices in relation to their fair value; and it is unlikely that significant changes will be made to the plan to lease the assets. We measure long-lived assets to be leased at the lower of carrying amount or fair value, less associated costs to lease.  

At June 30, 2014 and December 31, 2013, we reflected electro-slag re-melted (“ESR”) equipment that was used in 2010 and 2011 to produce forged products for the high performance components market as equipment held for operating lease on the accompanying consolidated balance sheets. In March 2014, we signed an operating lease agreement related to the lease of such equipment for a period of eight years from its April 1, 2014 commencement date. Equipment held for operating lease is depreciated over its estimated useful life of eight years commencing April 1, 2014.  Rental payments are recorded as rental income over the lease term as earned.
 

Land Use Rights

There is no private ownership of land in the PRC. All land in the PRC is owned by the government and cannot be sold to any individual or company. The government grants a land use right that permits the holder of the land use right to use the land for a specified period. Our land use rights were granted with a term of 45 or 50 years. Any transfer of the land use right requires government approval. We have recorded as an intangible asset the costs paid to acquire a land use right. The land use rights are amortized on the straight-line method over the land use right terms.

Revenue Recognition

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the purchase price is fixed or determinable and collectability is reasonably assured. We recognize revenue from the sale of dyeing and finishing equipment upon shipment and transfer of title. The other elements may include installation and generally a one-year warranty.

Equipment installation revenue is valued based on estimated service person hours to complete installation and is recognized when the labor has been completed and the equipment has been accepted by the customer, which is generally close to the date of delivery of the equipment. For the three and six months ended June 30, 2014 and 2013, the amounts allocated to installation revenues were minimal.

Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the three and six months ended June 30, 2014 and 2013, amounts allocated to warranty revenues were minimal. Based on historical experience, warranty service calls and any related labor costs have been minimal.

Rental income is recognized on a straight-line basis over the term of the operating lease.

All other product sales, including the forged rolled rings, with customer specific acceptance provisions, are recognized upon customer acceptance and the delivery of the parts or service. Revenues related to spare part sales are recognized upon shipment or delivery based on the trade terms.

Income Taxes

We are governed by the income tax laws of the PRC and the United States. Income taxes are accounted for pursuant to accounting standards, which is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. The charge for taxes is based on the results for the period as adjusted for items, which are non-assessable or disallowed. It is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date.

Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the financial statements and the corresponding tax basis used in the computation of assessable tax profit. In principle, deferred tax liabilities are recognized for all taxable temporary differences, and deferred tax assets are recognized to the extent that it is probably that taxable profit will be available against which deductible temporary differences can be utilized.

Deferred tax is calculated using tax rates that are expected to apply to the period when the asset is realized or the liability is settled. Deferred tax is charged or credited in the income statement, except when it is related to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity. Deferred tax assets and liabilities are offset when they related to income taxes levied by the same taxation authority and we intend to settle its current tax assets and liabilities on a net basis.
 

Stock-based Compensation

Stock based compensation is accounted for based on the requirements of the Share-Based Payment topic of ASC 718 which requires recognition in the financial statements of the cost of employee and director services received in exchange for an award of equity instruments over the period the employee or director is required to perform the services in exchange for the award. The Accounting Standards Codification also requires measurement of the cost of employee and director services received in exchange for an award based on the grant-date fair value of the award.

Pursuant to ASC Topic 505-50, for share-based payments to consultants and other third-parties, compensation expense is determined at the “measurement date.” The expense is recognized over the period of services or the vesting period, whichever is applicable. Until the measurement date is reached, the total amount of compensation expense remains uncertain. We record compensation expense based on the fair value of the award at the reporting date. The awards to consultants and other third-parties are then revalued, or the total compensation is recalculated based on the then current fair value, at each subsequent reporting date.
 
Currency Exchange Rates

Our functional currency is the U.S. dollar, and the functional currency of our operating subsidiaries and VIEs is the RMB. All of our sales are denominated in RMB. As a result, changes in the relative values of U.S. dollars and RMB affect our reported levels of revenues and profitability as the results of our operations are translated into U.S. dollars for reporting purposes. In particular, fluctuations in currency exchange rates could have a significant impact on our financial stability due to a mismatch among various foreign currency-denominated sales and costs. Fluctuations in exchange rates between the U.S. dollar and RMB affect our gross and net profit margins and could result in foreign exchange and operating losses.

Our exposure to foreign exchange risk primarily relates to currency gains or losses resulting from timing differences between signing of sales contracts and settling of these contracts. Furthermore, we translate monetary assets and liabilities denominated in other currencies into RMB, the functional currency of our operating subsidiaries. Our results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in our statement of shareholders’ equity. We have not used any forward contracts, currency options or borrowings to hedge our exposure to foreign currency exchange risk. We cannot predict the impact of future exchange rate fluctuations on our results of operations and may incur net foreign currency losses in the future.

Our financial statements are expressed in U.S. dollars, which is the functional currency of our parent company. The functional currency of our operating subsidiaries and affiliates is RMB. To the extent we hold assets denominated in U.S. dollars, any appreciation of the RMB against the U.S. dollar could result in a charge in our statement of operations and a reduction in the value of our U.S. dollar denominated assets. On the other hand, a decline in the value of RMB against the U.S. dollar could reduce the U.S. dollar equivalent amounts of our financial results.
 
Recent Accounting Pronouncements 

Accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. We do not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to our financial condition, results of operations, cash flows, or disclosures.
 

RESULTS OF OPERATIONS

Comparison of Results of Operations for the Three and Six Months Ended June 30, 2014 and 2013

The following table sets forth the results of our operations for the three months ended June 30, 2014 and 2013 indicated as a percentage of net revenues (dollars in thousands):

   
Three Months Ended June 30,
 
   
2014
   
2013
 
   
Dollars
   
Percentage
   
Dollars
   
Percentage
 
Revenues
  $ 17,528       100.0 %   $ 17,214       100.0 %
Cost of revenues
    13,444       76.7 %     13,241       76.9 %
Gross profit
    4,084       23.3 %     3,973       23.1 %
Operating expenses
    1,054       6.0 %     865       5.0 %
Income from operations
    3,030       17.3 %     3,108       18.1 %
Other income (expenses)
    (21 )     (0.1 )%     (62 )     (0.4 )%
Income before provision for income taxes
    3,009       17.2 %     3,046       17.7 %
Provision for income taxes
    791       4.5 %     724       4.2 %
Net income
    2,218       12.7 %     2,322       13.5 %
Other comprehensive income:
                               
  Foreign currency translation adjustment
    106       0.6 %     1,217       7.1 %
Comprehensive income
  $ 2,324       13.3 %   $ 3,539       20.6 %

The following table sets forth the results of our operations for the six months ended June 30, 2014 and 2013 indicated as a percentage of net revenues (dollars in thousands):

   
Six Months Ended June 30,
 
   
2014
   
2013
 
   
Dollars
   
Percentage
   
Dollars
   
Percentage
 
Revenues
  $ 35,163       100.0 %   $ 31,099       100.0 %
Cost of revenues
    26,806       76.2 %     23,996       77.2 %
Gross profit
    8,357       23.8 %     7,103       22.8 %
Operating expenses
    2,051       5.8 %     1,710       5.5 %
Income from operations
    6,306       18.0 %     5,393       17.3 %
Other income (expenses)
    (41 )     (0.2 )%     (137 )     (0.4 )%
Income before provision for income taxes
    6,265       17.8 %     5,256       16.9 %
Provision for income taxes
    1,651       4.7 %     1,311       4.2 %
Net income
    4,614       13.1 %     3,945       12.7 %
Other comprehensive (loss) income:
                               
  Foreign currency translation adjustment
    (675 )     (1.9 )%     1,646       5.3 %
Comprehensive income
  $ 3,939       11.2 %   $ 5,591       18.0 %
 

 
The following table sets forth information as to the revenues, gross profit and gross margin for our two business segments for the three months ended June 30, 2014 and 2013 (dollars in thousands).

   
Forged rolled rings and related products
   
Dyeing and finishing equipment
   
Total
 
   
Three Months ended June 30, 2014
 
Revenues
  $ 7,850     $ 9,678     $ 17,528  
Cost of revenues
  $ 6,064     $ 7,380     $ 13,444  
Gross profit
  $ 1,786     $ 2,298     $ 4,084  
Gross margin
    22.8 %     23.7 %     23.3 %

   
Forged rolled rings and related products
   
Dyeing and finishing equipment
   
Total
 
   
Three Months ended June 30, 2013
 
Revenues
  $ 8,198     $ 9,016     $ 17,214  
Cost of revenues
  $ 6,412     $ 6,829     $ 13,241  
Gross profit
  $ 1,786     $ 2,187     $ 3,973  
Gross margin
    21.8 %     24.3 %     23.1 %

The following table sets forth information as to the revenues, gross profit and gross margin for our two business segments for the six months ended June 30, 2014 and 2013 (dollars in thousands).

   
Forged rolled rings and related products
   
Dyeing and finishing equipment
   
Total
 
   
Six Months ended June 30, 2014
 
Revenues
  $ 16,107     $ 19,056     $ 35,163  
Cost of revenues
  $ 12,231     $ 14,575     $ 26,806  
Gross profit
  $ 3,876     $ 4,481     $ 8,357  
Gross margin
    24.1 %     23.5 %     23.8 %

   
Forged rolled rings and related products
   
Dyeing and finishing equipment
   
Total
 
   
Six Months ended June 30, 2013
 
Revenues
  $ 14,725     $ 16,374     $ 31,099  
Cost of revenues
  $ 11,477     $ 12,519     $ 23,996  
Gross profit
  $ 3,248     $ 3,855     $ 7,103  
Gross margin
    22.1 %     23.5 %     22.8 %

Revenues

For the three months ended June 30, 2014, we had revenues of $17,528,000, as compared to revenues of $17,214,000 for the three months ended June 30, 2013, an increase of $314,000 or approximately 1.8%. The increase in revenue for the three months ended June 30, 2014 was primarily attributable to the increase in revenues from our dyeing and finishing equipment segment, an increase in revenues from forged rolled rings and related products for the wind power industry, offset by a decrease in revenues from forged rolled rings and related products to other industries and is summarized as follows (dollars in thousands):

   
For the Three Months Ended June 30, 2014
   
For the Three Months Ended June 30, 2013
   
Increase
(Decrease)
   
Percentage Change
 
Forged rolled rings and related products
                       
   Wind power industry
  $ 3,234     $ 3,093     $ 141       4.5 %
   Other industries
    4,616       5,105       (489 )     (9.6 )%
    Total forged rolled rings and related products
    7,850       8,198       (348 )     (4.2 )%
Dyeing and finishing equipment
    9,678       9,016       662       7.3 %
Total revenues
  $ 17,528     $ 17,214     $ 314       1.8 %
 

 
For the six months ended June 30, 2014, we had revenues of $35,163,000, as compared to revenues of $31,099,000 for the six months ended June 30, 2013, an increase of $4,064,000 or approximately 13.1%. The increase in revenue for the three and six months ended June 30, 2014 was primarily attributable to the increase in revenues from our dyeing and finishing equipment segment, an increase in revenues from forged rolled rings and related products for the wind power industry, and an increase in revenues from forged rolled rings and related products to other industries, and is summarized as follows (dollars in thousands):

   
For the Six Months Ended June 30, 2014
   
For the Six Months Ended June 30, 2013
   
Increase
   
Percentage Change
 
Forged rolled rings and related products
                       
   Wind power industry
  $ 6,989     $ 6,789     $ 200       2.9 %
   Other industries
    9,118       7,936       1,182       14.9 %
    Total forged rolled rings and related products
    16,107       14,725       1,382       9.4 %
Dyeing and finishing equipment
    19,056       16,374       2,682       16.4 %
Total revenues
  $ 35,163     $ 31,099     $ 4,064       13.1 %

Forged rolled rings and related products segment

For the three months ended June 30, 2014, revenue from forged rolled rings and related products for the wind power industry increased by approximately $141,000 or 4.5% as compared to the three months ended June 30, 2013. For the six months ended June 30, 2014, revenue from forged rolled rings and related products for the wind power industry increased by approximately $200,000 or 2.9% as compared to the six months ended June 30, 2013, a slight increase. The increase in revenue from forged rolled rings and related products for the wind power industry was primarily attributable to our sales efforts and the increase in ability and willingness of manufacturing companies and wind power companies to purchase equipment since the availability of bank financing both for owners of wind farms who require bank loans to purchase equipment and for potential purchasers of heavy equipment has improved during 2014. We anticipate sales volumes of forged rolled rings and related products to customers in the wind power industry will remain at its current level for the near future.

For the three months ended June 30, 2014, revenue from the sale of forged rolled rings and related products to other industries decreased by approximately $489,000 or 9.6% as compared to the three months ended June 30, 2013. The decrease in revenue from forging of rolled rings and related products for other industries was mainly attributable to a reduced demand from our customers, who had sufficient inventory from purchases of forging of rolled rings and related products for other industries in prior periods, and the absence of sufficient sales to new customers to offset such reduction. For the six months ended June 30, 2014, revenue from the sale of forged rolled rings and related products to other industries increased by approximately $1,182,000 or 14.9% as compared to the six months ended June 30, 2013. The increase in revenue from forged rolled rings and related products for other industries for the six months ended June 30, 2014 was mainly attributable to our increased sales efforts and repeat orders to use our forged products in various industries. Our sales of forged rolled rings and related products to other industries include sales to a solar customer of approximately $671,000 in the six months ended June 30, 2014 and $774,000 in the comparable period of 2013. We do not anticipate new orders for solar products in the near future. We expect that the sales of forging of rolled rings and related products for other industries will remain at its current level during the remainder of 2014.

The demand for products such as ours which are used for wind power industry is uncertain. We believe that over the long term, our forged rolled rings and related components for wind power industry will expand since the government of the PRC has announced its desire to increase the use of wind power as an energy source. We are currently seeking to expand into other industries, including oil and natural gas. To date, we have not received any orders or generated any revenues from the oil and gas industries, and we can give no assurances that our attempt to sell to the oil and gas industries will be successful.
 

Dyeing and finishing equipment segment

For the three months ended June 30, 2014, revenue from the sale of dyeing and finishing equipment increased by approximately $662,000 or 7.3% as compared to the three months ended June 30, 2013. For the six months ended June 30, 2014, revenue from the sale of dyeing and finishing equipment increased by approximately $2,682,000 or 16.4% as compared to the six months ended June 30, 2013. The increase in revenue from the sale of dyeing and finishing equipment for the three and six months ended June 30, 2014 was primarily attributable to our marketing efforts and the effects of the policies of the PRC local governments to encourage the purchase of low-emission airflow dyeing machine which are intended to reduce pollution from the dyeing process and the increase of a new style of dyeing machinery to meet our customers’ demand. With the growing acceptance of our new dyeing technology and the Chinese government’s mandate to phase out obsolete machinery in China’s textile industry, we expect our revenue from this segment will continue to increase in the near future, although at a lower rate than in previous periods.

Cost of revenues

Cost of revenues includes the cost of raw materials, labor, depreciation and other overhead costs.

For the three months ended June 30, 2014, cost of revenues was $13,444,000 as compared to $13,241,000 for the three months ended June 30, 2013, an increase of $203,000, or 1.5%. Cost of revenues related to the manufacture of forged rolled rings and related products was $6,064,000 for the three months ended June 30, 2014 as compared to $6,412,000 for the three months ended June 30, 2013. Cost of revenues for the dyeing and finishing equipment segment was $7,380,000 for the three months ended June 30, 2014, as compared to $6,829,000 for the three months ended June 30, 2013.
 
For the six months ended June 30, 2014, cost of revenues was $26,806,000 as compared to $23,996,000 for the six months ended June 30, 2013, an increase of $2,810,000, or 11.7%. Cost of revenues related to the manufacture of forged rolled rings and related products was $12,231,000 for the six months ended June 30, 2014 as compared to $11,477,000 for the six months ended June 30, 2013. Cost of revenues for the dyeing and finishing equipment segment was $14,575,000 for the six months ended June 30, 2014, as compared to $12,519,000 for the six months ended June 30, 2013.

Gross profit and gross margin

Our gross profit was $4,084,000 for the three months ended June 30, 2014 as compared to $3,973,000 for the three months ended June 30, 2013, representing gross margins of 23.3% and 23.1%, respectively. Our gross profit was $8,357,000 for the six months ended June 30, 2014 as compared to $7,103,000 for the six months ended June 30, 2013, representing gross margins of 23.8% and 22.8%, respectively.

Gross profit from forged rolled rings and related products segment was $1,786,000 for the three months ended June 30, 2014 and 2013, representing gross margins of approximately 22.8% and 21.8%, respectively. Gross profit from forged rolled rings and related products segment was $3,876,000 for the six months ended June 30, 2014 as compared to $3,248,000 for the six months ended June 30, 2013, representing gross margins of approximately 24.1% and 22.1%, respectively. The increase in our gross margin for the forged rolled rings and related products segment for the three and six months ended June 30, 2014 as compared to the three and six months ended June 30, 2013 was mainly attributed to the increase in operational and cost efficiencies, including the allocation of fixed costs primarily consisting of depreciation, to cost of revenues as we operated at higher production levels and a slight decrease in our raw materials costs.  We expect that we can improve our gross margin from forged rolled rings and related products segment to the extent that we can become more efficient and be able to produce larger quantities for inventory and revenues.