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CHGS > SEC Filings for CHGS > Form 10-K/A on 8-Nov-2012All Recent SEC Filings

Show all filings for CHINA GENGSHENG MINERALS, INC.

Form 10-K/A for CHINA GENGSHENG MINERALS, INC.


8-Nov-2012

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's Discussion and Analysis of Financial Condition and Results of Operations, which we refer to as the MD&A, is intended to help the reader understand our Company, our operations and our present business environment. The MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K/A. Some of the information contained in this discussion and analysis constitutes forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this annual report on Form 10-K/A particularly under "Special Note Regarding Forward-Looking Statements" and "Risk Factors." Unless otherwise specified, references to Notes to our consolidated financial statements are to the Notes to our audited consolidated financial statements as of December 31, 2011 and 2010.

Overview

We are a Nevada holding company that operates through our direct and indirect subsidiaries. Through our wholly-owned BVI subsidiary, GengSheng International, and its wholly-owned Chinese subsidiary, Refractories, we manufacture monolithic refractory products in China. Through our wholly-owned BVI subsidiary, GengSheng International, and its wholly-owned Chinese subsidiary, Duesail and Duesail's wholly-owned subsidiary Yuxing, we manufacture fracture proppant products. Through Micronized, wholly-owned subsidiary of Refractories, we manufacture fine precision abrasives. Through High-Temperature, 89% owned subsidiary of Refractories, we manufacture industrial ceramic products. We have four primary business segments: refractories, industrial ceramics, fracture proppant and fine precision abrasives. Refractories product is a nonmetallic material that is used in heavy industrial processes present with extremely high temperatures, and the main customers for the segment are steel makers. Our industrial ceramic products, including abrasive balls and tiles, valves, electronic ceramics and structural ceramics, are components for a variety of end-use products such as fuses, vacuum interrupters, electrical components, mud slurry pumps, and high-pressure pumps. Such end use products are used in the electric power, electronic component, industrial pump, and metallurgy industries. Our fracture proppants are very fine ball-like pellets, highly resistant to pressure, and used to reach pockets of oil and natural gas deposits that are trapped in the fractures under the ground. Oil drillers inject the pellets into those fractures, squeezing out the trapped oil or natural gas, which leads to higher yield. The fine precision abrasives are essentially very fine, uniformly round, silicon carbide (SiC) based particles. These ultra-fine high-strength particles are applicable in a broad range of applications, including machine manufacturing, electronics, optical glass, architecture, semiconductors, silicon chips, plastics and lenses. In 2011, the refractories segment contributed approximately $46.6 million or 60.5%, of our total revenue of $76.9 million, industrial ceramics contributed approximately $0.4 million or 0.6% of the total revenue, fracture proppants contributed approximately $22.5 million or 29.3% of our total revenue and fine precision abrasives contributed approximately $7.4 million or 9.6% of the total revenue.

We sell our products to over 170 customers in the iron, steel, oil, glass, cement, aluminum, chemical and solar industries located in China and 11 countries in Asia, North America and Europe. Our refractory customers are companies in the steel, iron, petroleum, chemical, coal, glass and mining industries. Our fracture proppant products are sold to oil and gas companies. Our industrial ceramics are products used by the utilities and petrochemical industries. The Company's fine precision abrasives target solar companies and optical equipment manufacturers. Most of our large customers, measured by percentage of our revenue, mainly operate in the steel industry. Currently, most of our revenues are derived from the sale of our monolithic refractory products and fracture proppants products to customers in China and in the United States. We expect continued revenue growth from fracture proppant products and fine precision abrasives in 2012.

Highlights of Business Operations in 2011

During 2011, our company has maintained a steady growth in sales revenue in spite of significant challenges from both the refractory and fracture proppant markets. From the beginning of 2009, the PRC central government has labeled the steel sector in China an overcapacity-burdened industry and the government is resolved to cut back the industry's excessive capacity. Since then some small and mid-sized steel producers have been shut down, which decreased the demand of refractories. To face the changing market environment, we have since adjusted product offerings in refractories segment, increased full-service contracts and focused on the maintenance of current customers. In the fourth quarter, as the price of raw materials and energy continued to rise, we incurred significant pressure in refractories segment. As many of our contracts are renewed annually, we were unable to quickly pass the increase in costs to our customers and thus resulted in the decrease in gross margin. In fracture proppant segment, our main market remained in the overseas as the international sales brought us higher margin and better payment terms. However, the demand in the U.S. market for fracture proppants products experienced slowdown in the fourth quarter and there is no clear sign of recovery in short term. In fine precision abrasives segment, although we signed a supply contract with one of the main solar producers in China to expand our market share, we still encountered fierce competition from other producers and failed to improve profitability of the segment.


The followings are some financial highlights for the year 2011:

Sales revenue increased by approximately $14.7 million, or 23.7%, to approximately $76.9 million in 2011 from approximately $62.2 million in 2010.

Gross profit decreased by approximately $1.5 million, or 8.4%, to approximately $16.2 million in 2011, from approximately $17.7 million in 2010. Gross margin was 21.1% for 2011, compared with 28.4% for 2010. The decrease in gross margin was largely attributed to the lower gross margin in our refractories segment compared to 2010 resulted from rising costs of raw materials and energy, and the negative gross margin in our fine precision abrasives segment. Net income decreased by approximately $7.8 million, to a net loss of approximately $7.5 million in 2011, from a net income of approximately $264,000 in 2010.

Our consolidated balance sheet as of December 31, 2011 included current assets of approximately $106.0 million and total assets of approximately $148.0 million, with working capital of approximately $11.8 million.

Major Factors that Affect our Financial Condition in 2011

Continued Industry Consolidation of Steel Makers Further Squeezed Our Profit in Refractories Segment

Although the crude steel output in China reached a new record of approximate 696 million metric tons in China, the steel industry still faces overcapacity and weak demand from both domestic and international market. In addition, the PRC government's continued policy to squeeze out small to mid-sized steel makers reduced the overall demand for refractories. Such impacts on our sales continued in 2011, especially in the fourth quarter, as more small and mid-sized steel makers shut down their production.

Considerable Increase of Raw Material Prices and Decrease in Gross Margin

In 2011, China saw its highest inflation rate in over 10 years. While the overall inflation started to ease in the fourth quarter of 2011, the raw materials prices, labor costs and fuel and utilities costs continued to rise. On the other hand, in a fragmented market, hardly could the selling price of our products keep pace with the increase in raw materials prices on a timely basis. As a result, our gross margin for 2011 was significantly impacted.

Increase in Financing Costs Further Limited Our Ability to Expand Business

The unfavorable payment term offered by our customers in refractories segment and fine precision abrasives segment strained our working capital needs, and as a result significantly increased our financing costs, as banks charged higher interest rates when we discounted more bills receivables to meet our working capital needs.


Results of Operations

The following table summarizes the results of our operations during the fiscal years ended December 31, 2011 and 2010, respectively, and provides information regarding the dollar and percentage increase or (decrease) during such years.

(All amounts, other than percentages, in U.S. dollars)

                                                         2011                         2010
                                                                As a                         As a
                                                Dollars      percentage      Dollars      percentage
                                                  in           of net          in           of net
Statement of operations data:                  thousands      revenues      thousands      revenues
Net Sales                                         76,936         100.0%        62,189         100.0%
Cost of goods sold                                60,727          78.9%        44,499          71.6%
Gross profit                                      16,209          21.1%        17,690          28.4%

Operating expenses
     Allowance for doubtful accounts               1,335           1.8%           437           0.7%
     General & administrative expenses             7,011           9.1%         5,741           9.2%
     Impairment on goodwill                          441           0.6%             -           0.0%
     Impairment on intangible assets                 310           0.4%             -           0.0%
    Research and development expenses                699           0.9%           817           1.3%
     Selling expenses                              9,491          12.3%         8,365          13.5%
Total operating expenses                          19,287          25.1%        15,360          24.7%

(Loss) income from operations                     (3,078 )        -4.0%         2,330           3.7%

Government grant income                              380           0.5%           123           0.2%
Guarantee income                                     614           0.8%           239           0.4%
Guarantee expenses                                  (518 )        -0.7%          (622 )        -1.0%
Interest income                                      916           1.2%           364           0.6%
Impairment on deposit for acquisition of a        (1,248 )        -1.6%             -           0.0%
non-consolidated affiliate
Change in fair value of warranty liabilities         970           1.3%             -           0.0%
Other income                                          15           0.0%           129           0.2%
Finance costs                                     (5,279 )        -6.9%        (1,768 )        -2.8%

(Loss) income before income taxes and             (7,228 )        -9.4%           794           1.3%
noncontrolling interest
Income taxes                                        (325 )        -0.5%          (522 )        -0.8%
Noncontrolling interest                               48           0.1%            (8 )        -0.1%

Net (loss) income attributable to Company's       (7,505 )        -9.8%           264           0.4%
common stockholders



                                                                         Dollar ($)     Percentage
                                                                          Increase       Increase
Dollars in thousands                             2011         2010       (Decrease)     (Decrease)
Net Sales                                        76,936       62,189         14,747         23.7 %
Cost of goods sold                               60,727       44,499         16,228          36.5%
Gross profit                                     16,209       17,690         (1,481 )        -8.4%

Operating expenses
     Allowance for doubtful accounts              1,335          437            898         205.5%
     General & administrative expenses            7,011        5,741          1,270          22.1%
     Impairment on goodwill                         441            -            441         100.0%
     Impairment on intangible assets                310            -            310         100.0%
    Research and development expenses               699          817           (118 )       -14.4%
     Selling expenses                             9,491        8,365          1,126          13.5%
Total operating expenses                         19,287       15,360          3,927          25.6%

(Loss) income from operations                    (3,078 )      2,330         (5,408 )      -232.1%

Government grant income                             380          123            257         208.9%
Guarantee income                                    614          239            375         156.9%
Guarantee expenses                                 (518 )       (622 )          104         -16.7%
Interest income                                     916          364            552         151.6%
Impairment on deposit for acquisition of a       (1,248 )          -         (1,248 )       100.0%
non-consolidated affiliate
Change in fair value of warranty liabilities        970            -            970         100.0%
Other income                                         15          129           (114 )       -88.4%


Finance costs                               (5,279 )     (1,768 )     (3,511 )      198.6%

(Loss) income before income taxes and       (7,228 )        794       (8,022 )   -1,010.3%
noncontrolling interest
Income taxes                                  (325 )       (522 )        197         37.7%
Noncontrolling interest                         48           (8 )         56       -700.0%

Net (loss) income attributable to           (7,505 )        264       (7,769 )   -2,942.8%
Company's common stockholders


The average conversion rates between RMB and U.S. dollar used for the consolidated statements of operations and comprehensive loss increased approximately 4.7% during the reporting period of 2011 compared with the reporting period of 2010. As substantially all of our revenues and most expenses are denominated in RMB, the appreciation in the value of RMB relative to the U.S. dollar affected our financial results reported in the U.S. dollar terms without giving effect to any underlying change in our business or results of operations.

Sales revenues. Sales revenues increased approximately $14.7 million, or 23.7%, to approximately $76.9 million in 2011 from approximately $62.2 million in 2010. Excluding foreign currency translation, the revenue increased approximately $11.3 million, or 18.2% compared with 2010. The increase was mainly attributable to increased sales from our fracture proppant segment and fine precision abrasives segment, particularly increased export sales of fracture proppant products compared with 2010.

In our refractory segment, we sold 98,920 metric tons of refractory products in 2011, a 2.7% decrease compared with 101,711 metric tons sold in 2010. The revenue from our refractory products increased to approximately $46.6 million in 2011 from approximately $45.8 million in 2010. Excluding foreign currency translation, the revenue decreased approximately $1.3 million, or 2.8% compared with 2010. The average selling prices reached $473 per metric ton in 2011, representing a 5.1% increase compared with $450 per metric ton in the same period of 2010. Excluding foreign currency translation, the average selling prices stayed flat at $452 per metric ton compared with 2010.

In our fracture proppant segment, we sold 60,388 metric tons of fracture proppant products in 2011, compared with 41,270 metric tons in 2010. The large increase in sales volume was primarily driven by the strong demand from the US customers who use our proppant products in their new natural gas exploration technologies. Revenue from fracture proppant products was approximately $22.5 million for 2011, an increase of 57.3% compared with approximately $14.3 million in 2010. Excluding foreign currency translation, the revenue increased approximately $7.2 million, or 50.3% compared with 2010. Average selling price increased to $381 per metric ton in 2011, compared with $347 per metric ton in 2010, as a result of the change in product mix since U.S. customers purchased more high-density products in 2011. Excluding foreign currency translation, the average selling prices increased $17 per metric ton, or 4.9% compared with 2010.

In our industrial ceramics segment, revenue was approximately $430,000 for 2011. Excluding foreign currency translation, the revenue was approximately $411,000 compared with approximately $1.2 million in 2010. The decrease was primarily attributable to the low demand for our products in 2011.

In our fine precision abrasives segment, we realized sales of approximately $7.4 million. Excluding foreign currency translation, the revenue was approximately $7.1 million compared with approximately $865,000 in 2010. The sales of fine precision abrasives products started in the third quarter of 2010.

Cost of goods sold. Our cost of goods sold increased approximately $16.2 million, or 36.5%, to approximately $60.7 million for 2011 from approximately $44.5 million in 2010. Excluding foreign currency translation, our cost of goods sold increased approximately $13.5 million, or 30.4% compared with 2010. As a percentage of net revenues, the cost of goods sold increased by approximately 7.3% to 78.9% in 2011 from 71.6% in 2010. This increase was primarily due to the higher raw materials costs, energy costs and labor costs compared with 2010.

Gross profit. Our gross profit decreased approximately $1.5 million, or 8.4% to approximately $16.2 million for 2011 from approximately $17.7 million in 2010. Excluding foreign currency translation, our gross profit decreased approximately $2.2 million, or 12.5% compared with 2010. Gross profit as a percentage of net revenues was 21.1% for 2011, as compared with 28.4% for 2010. The percentage decrease was mainly attributable to the decreased gross margin in our fine precision abrasives segment and the increase in the cost of raw materials, energy and labor costs in refractories segment compared with 2010.

Allowance for doubtful accounts. Allowance for doubtful accounts increased 205.5%, to approximately $1.3 million for 2011, from approximately $0.4 million for 2010. The increase was primarily due to the change in our provisioning policy based on the management's analysis of settlement patterns and historical information which increased the allowance for accounts receivables aged over three years and other receivables which have uncertainties in collectability.

General and administrative expenses. Our general and administrative expenses increased 22.1%, to approximately $7.0 million for 2011, from approximately $5.7 million for 2010. Excluding foreign currency translation, the general and administrative expenses increased approximately $958,000, or 16.7% compared with 2010. The increase was primarily due to the higher salary and personnel expenses, depreciation expenses and legal fees. As a percentage of net revenues, general and administrative expenses decreased 0.1% to 9.1% in 2011, compared with 9.2% in 2010.

Impairments on goodwill and intangible assets. Impairment expenses on goodwill and intangible assets were approximately $751,000 for 2011. There was no impairment expense in 2010. The increase was attributable to the write-off of goodwill related to the acquisition of one of our subsidiaries and the write-off of intangible assets related to an unpatented technology acquired in 2007. Based on the results of the impairment review performed by the management at the end of 2011, the probability of recovering the carrying value of the goodwill and intangible assets are considered unlikely and thereafter fully impaired.

Selling expenses. Selling expenses increased by approximately $1.1 million to approximately $9.5 million compared with approximately $8.4 million in 2010. Excluding foreign currency translation, the selling expenses increased approximately $703,000, or 8.4% compared with 2010. As a percentage of net revenues, our selling expenses decreased to 12.3% for 2011, as compared with 13.5% for 2010. The decrease in selling expenses was primarily attributable to the change in product mix as we sold more fracture proppants products and fine abrasive products which normally incurred lower selling expenses than refractory segment. The decrease was partially offset by the increase in the transportation costs, higher post-sales service expenses in our refractory segment.

Research and development expenses. Our research and development expenses decreased to approximately $699,000 for 2011. Excluding foreign currency translation, the research and development expenses were approximately $668,000, compared with approximately $817,000 for 2010 due to fewer R&D activities.


Government grant income. Our government grant income was approximately $380,000 for 2011. Excluding foreign currency translation, the government grant income was approximately $363,000 compared with approximately $123,000 for 2010.

Impairment on deposit for acquisition of a non-consolidated affiliate. Impairment on deposit for acquisition of a non-consolidated affiliate was approximately $1.2 million for 2011. This non-cash impairment charge was related to our investment in Yili YiQiang Silicon Limited ("Yili"). The impairment was attributable to the operating results of Yili and uncertainties surrounding silicon carbide industry. No impairment expenses on deposit were identified in 2010.

Finance costs. Our finance costs increased by approximately $3.5 million, or 198.6% to approximately $5.3 million for 2011, from approximately $1.8 million for 2010. This substantial increase was primarily due to an increase of approximately $2.0 million in bills discounting charges as we discounted more bills receivable instead of holding them to maturity; and an increase of approximately $1.5 million in interest expenses as we increased borrowing activities for 2011. Excluding foreign currency translation, our finance costs increased approximately $3.3 million, or 185.3% compared with 2010.

(Loss) income before income taxes and non-controlling interests. Our loss before income taxes and non-controlling interest was approximately $7.2 million for 2011. Excluding foreign currency translation, our loss before income taxes and non-controlling interest was approximately $6.9 million, compared with an income of approximately $794,000 for 2010. The decrease was primarily attributable to the loss from operations, higher finance costs and non-cash impairment charges during 2011.

Income taxes. Our income taxes were approximately $325,000 for 2011, a decrease of approximately $197,000 or 37.7% from approximately $522,000 for 2010. Excluding foreign currency translation, our income taxes were approximately $311,000.

Net (loss) income. Our net loss for 2011 was approximately $7.5 million, a decrease of approximately $7.8 million from an income of approximately $264,000 in 2010. Excluding foreign currency translation, our net loss was approximately $7.2 million. The decrease was attributable to the factors described above.

Liquidity and Capital Resources

As of December 31, 2011, we had cash and cash equivalents of $3.6 million and restricted cash of approximately $21.1 million. Our current assets were approximately $106.0 million and our current liabilities were approximately $94.2 million as of December 31, 2011 which resulted in a current ratio of approximately 1.12. Total stockholders' equity as of December 31, 2011 was approximately $53.8 million. The following table sets forth a summary of our cash flows for the periods indicated:

Dollars in thousands                                                     2011       2010
Net cash used in operating activities                                  (3,533 )   (7,574 )
Net cash used in investing activities                                 (13,886 )   (6,406 )
Net cash provided by financing activities                              20,048     13,882
Effect of foreign currency translation on cash and cash equivalents        40         30
Net increase (decrease) in cash and cash equivalents                    2,669        (67 )
Cash and cash equivalents, beginning of year                              925        992
Cash and cash equivalents, end of year                                  3,594        925

Operating Activities

Net cash used in operating activities was approximately $3.5 million in 2011, compared with net cash used in operating activities of approximately $7.6 million in 2010. The decrease in net cash used in operating activities was primarily due to the increase in bills payables, trade payables and other payables during 2011, which was partly offset by the increase in trade receivables, bills receivables and lower income compared to 2010.

Investing Activities

Net cash used in investing activities during 2011 was approximately $13.9 million, an increase of approximately $7.5 million from net cash used in investing activities of approximately $6.4 million during 2010. The increase in net cash used in investing activities in 2011 was primarily due to the expansion of our fracture proppants production lines and the construction and renovation of our office buildings.

Financing Activities

Net cash provided by financing activities was approximately $20.0 million during 2011, compared with net cash provided by financing activities of approximately $13.9 million during 2010. The increase in cash flow from financing activities was primarily due to net proceeds from our January 2011 equity financing of $9.3 million, net increase in loans of $5.3 million and the increase of restricted cash of $5.0 million.


Loan Facilities

In 2011, we secured new loans totaling approximately $107.6 million from banks for our working capital needs, and we repaid approximately $104.9 million in bank loans during the year ended December 31, 2011. As a result, the balance of all our bank loans and bank borrowings as of December 31, 2011 was approximately $46.0 million, which includes approximately $29.5 million short-term bank loans and approximately $16.5 million of bank borrowings secured by bank deposits.

As of December 31, 2011, the detail of all our short-term bank loans and bank borrowings are as follows:

All amounts, other than percentages, are in U.S. dollar.

No  Type               Contracting Party            Valid Date    Duration   Amount
 1  Facility Bank Loan Industrial and Commercial  2011-01-18 to    1 year  $2,833,200
                       Bank of China                2012-01-09
 2  Facility Bank Loan Bank of China              2011-03-21 to    1 year    $944,400
. . .
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