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CLNT > SEC Filings for CLNT > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for CLEANTECH SOLUTIONS INTERNATIONAL, INC.,

Form 10-Q for CLEANTECH SOLUTIONS INTERNATIONAL, INC.,


13-Nov-2012

Quarterly Report


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 as well as equipment for the solar power industry, 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):

                                                     Nine Months Ended September 30,
                                                    2012                        2011
                                            Dollars          %          Dollars          %
Forged rolled rings and related
components:
   Wind power industry                     $  10,391          26.2 %   $  20,918          50.0 %
   Other industries                           13,229          33.5 %       8,815          21.0 %
     Total forged rolled rings and
related components                            23,620          59.7 %      29,733          71.0 %
Dyeing and finishing equipment                15,966          40.3 %      12,118          29.0 %
Total                                      $  39,586         100.0 %   $  41,851         100.0 %



                                                    Three Months Ended September 30,
                                                    2012                        2011
                                            Dollars          %          Dollars          %
Forged rolled rings and related
components:
   Wind power industry                     $   3,213          18.5 %   $   4,490          38.5 %
   Other industries                            6,613          38.2 %       3,119          26.7 %
     Total forged rolled rings and
related components                             9,826          56.7 %       7,609          65.2 %
Dyeing and finishing equipment                 7,518          43.3 %       4,068          34.8 %
Total                                      $  17,344         100.0 %   $  11,677         100.0 %

As discussed in further detail below in Results of Operations, our consolidated revenues declined by 5.4% for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011. For the three months ended September 30, 2012, our revenue increased 48.5% from the comparable period of 2011. For the nine months ended September 30, 2012 our gross margin decreased from 24.5% to 22.5% from the comparable period of 2011, while, our gross margin increased from 22.5% to 24.9% for the three months ended September 30, 2012 from the three months ended September 30, 2011. Our net income decreased 25.0% from the nine months ended September 30, 2011 to the nine months ended September 30, 2012, but our net income increased 107.5% from the third quarter of 2011 to the third quarter of 2012.

Industry Outlook

Forged Rolled Rings And Other Related Products Division

Through our forged rolled rings and other related products division, we supply the following:

? We produce precision forged rolled rings and other forged components to the wind and other industries. Our forged rolled rings and other related products are sold for use by 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.

? Commencing in 2011, we began to manufacture and delivered test subassemblies for solar cell manufacturing equipment, which marked our entry into the solar products market. For the nine months ended September 30, 2012 and 2011, we generated revenue from the sale of solar industry related products of approximately $409,000 and $126,000, respectively.


The demand for products used in manufacturing in general including wind power 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, 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.

Chinese wind power developers posted worse-than-expected results for the first half of 2012, with grid operators increasingly reluctant to distribute the costly and unpredictable source of power amid a sharp economic downturn. China aims to expand its installed wind power generating capacity to 100 gigawatts (GW) by 2015 and to 200 GW by 2020. The country currently has 62 GW of capacity. Beijing would force grid operators to buy wind power representing 5 to 15 percent of their total offtake, depending on locations, Xie Changjun, president of Longyuan, the world's second-largest wind power developer, said this month. The quota system should underpin long-term demand for renewable energy like wind-generated electricity, but the earnings outlook for wind power developers will remain obscure for the next few years, people in the industry say. Grid construction has so far not kept up with the rise in wind power capacity. In the absence of high-voltage lines, grid firms are unable to absorb all the wind power under their local networks.

In contrast, according to an article published by Greenpeace East Asia on September 19. 2012, in its latest edition, "China Wind Power Outlook 2012", a report that presents a joint assessment and analysis of the wind power sector in China in 2011, including a reading of most recent policy trends made by Greenpeace, the Chinese Renewable Energy Industries Association (CREIA), and the Global Wind Energy Council (GWEC), as well as an outlook for the sector's future development, this annual industry analysis highlights an encouraging trend in the development of the sector. In 2011, apart from the "old market" - namely the Northern, Northeastern and Northwestern areas of China (or the "Sanbei" region) that are rich in wind resources but weak on consumption power, wind power in China saw the emergence of a new market with huge potential. The overwhelming majority of accumulated and added installment is now still focused on these regions. However, due to the long distance between the power stations and major power user markets, they continue to be plagued by grid connectivity and curtailment problems. In the meantime, a new wind power market located closer to power consumers in the central and eastern provinces has steadily become a vigorous, if not prominent, market in 2011.

We believe that this market expansion will continue into 2012. The key issues for the wind power sector in 2012 will be how to break the intrinsic restrictions on the traditional market and how to take the next step in promoting the emerging markets in eastern and central China. In 2011, China added 17.63 GW of newly installed wind power capacity, slightly less than 2010 (18.93 GW). Total installed wind capacity reached 62.36 GW. After years of rapid growth, China's wind power market is now entering a period marked by stable growth, but it is still the global leader in terms of total installed capacity.

In 2011 China's wind energy sector generated 71.5 billion kilowatt hours, or 1.5% of the national total electricity output. Looking at its environmental benefits, wind power has a clear advantage: every 1 kWh generated saves 320 grams of standard coal being burned. That means in 2011 China's wind power sector saved more than 22 million tons of coal from being burned, in total, reducing sulfur dioxide emissions by 360,000 tons, and carbon dioxide emissions by about 70 million tons. Assuming that the average Chinese household uses 1,500 kWh of electricity every year, China's wind power sector met the electricity demands of over 47 million households in 2011.


Among all the renewable energies, 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. We believe that wind power will see its share of China's national energy mix gradually increase.

The decline in our consolidated revenues for the nine months ended September 30, 2012 was attributable to the decrease in revenue for forged rolled rings and related products for the wind power industry, which declined $10.5 million, or 50.3%, during the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011. We believe that the decline in our revenue of forged rolled rings and related products for the wind power industry reflects:

? An apparent decline in the growth rate for the wind industry, following six years of growth.

? Increased competition among Chinese turbine makers and related parts manufacturers.

? The effects of a 2011 decision by the China central bank to tighten the monetary supply, which reduced 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.

? Decisions by turbine manufactures to establish vertically integrated operations, thus eliminating the need to purchase components from outside companies such as us.

? A decrease in the installation of windmills due the China's curbing of construction on land resulting in part from the situation where power-delivery grids for wind power have not matched the significant growth of wind energy in recent years.

Dyeing and Finishing Segment

Revenue from our dyeing segment increased in both the nine and three months ended September 30, 2012 from the comparable periods of 2011. For the nine-month period, the increase was $3.8 million, or 31.8%, and for the three-month period, the increase was $3.4 million, or 84.8%. We believe that the increase reflects our marketing effort for our new airflow dyeing units, which use air instead of water which is used in the traditional dyeing process. We believe that our air-flow technology, which is designed to enable users to meet the stricter environmental standards, results in 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. Our gross margins from our dyeing segment increased from 21.4% for the nine months ended September 30, 2011 to 22.2% for the nine months ended September 30, 2012 and from 22.0% for the third quarter of 2011 to 24.7% for the third quarter of 2012.

The factors that affected our revenue, gross margin and net income during the nine months ended September 30, 2012 may affect our operations during the rest of 2012. 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 and solar 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.

Inventory 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 fix 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. Three major suppliers provided approximately 42% of our purchases of raw materials for the nine months ended September 30, 2012.


During the nine months ended September 30, 2012, our inventory increased by approximately $1.9 million and our advance from customers was approximately $1.8 million at September 30, 2012. This increase in inventory was attributable to an increase in steel inventory to secure steel pricing for anticipated forging orders, an increase in work-in-process for dyeing machinery to meet increased customers' orders, and an increase in inventory related to our solar products. A significant portion of the inventory increase relates to products for our solar customer, for which we received advance payments. At the request of the customer we have kept the products in our warehouse. This sale will be recognized when the last step of the sale, which is passing Chinese customs, is completed. Upon the completion of the sale, the advances from this customer will be recognized as revenues and our inventory will be reduced by the products sold. We expect to recognize this sale in the last quarter of 2012.

Critical accounting policies and estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these 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, income taxes, and the valuation of equity transactions. We base our estimates on historical experience and on various other assumptions that we believed 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 financial statements.

Exchange of Warrants

On May 4, 2012, our board of directors approved a previously negotiated agreement with Barron Partners LP, dated February 7, 2012, pursuant to which the holder of warrants to purchase 55,160 shares of common stock at $12.00 per share and 165,000 shares of common stock at $16.98 per share, agreed to exchange or convert such warrants into (i) 2,201,582 shares of series A preferred stock which were convertible into 73,386 shares of common stock, and (ii) warrants to purchase 73,386 shares of this Corporation's common stock at $2.70 per share, which was the market price of the common stock on February 7, 2012, the date the terms of the exchange were negotiated. The 2,201,582 shares of series A preferred stock were valued at the closing price of the underlying common stock on February 7, 2012 of $2.70 per share, and we recorded it as warrants modification expense of $197,408.

As a result of the transaction, we revalued the fair market value of the original warrants by using the Black-Scholes option-pricing model. The total fair market value of the original warrants was estimated to be $52,896 on February 7, 2012. The fair market value of the newly issued exchanged warrants was estimated to be $90,621 using the Black-Scholes option-pricing model. In connection with the Black-Scholes option pricing calculation, the following weighted-average assumptions were used: stock price of $2.70; expected dividend yield 0%; risk-free interest rate of 0.15%; volatility of 139.58% and an expected term of 0.77 year. We recorded the difference between the fair market value of original warrants of $52,896 and the fair market value of exchanged warrants of $90,621 amounting to $37,725 as warrants modification expense with a corresponding credit of additional paid-in capital.

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 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, whether or not the inventory is retained. 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 cash paid in advance 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
Vehicle                                  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 the year of 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.

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 account for the product sales as a multiple element arrangement. Revenue from multiple element arrangements is allocated among the separate accounting units based on the residual method. Under the residual method, the revenue is allocated to undelivered elements based on fair value of such undelivered elements and the residual amounts of revenue allocated to delivered elements. 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.


Warranty revenue is valued based on estimated service person hours to complete a service and generally is recognized over the contract period. For the nine months ended September 30, 2012 and 2011, amounts allocated to warranty revenues were not material. Based on historical experience, warranty service calls and any related labor costs have been minimal.

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 year 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 . . .

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